Economy - Shyam Sir PDF

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Introduction
 Economics can be defined in three different ways
o Wealth - is the science of creation and consumption of wealth. Given by Adam
Smith (father of economics). It was criticized as man was given the secondary
importance and wealth primary.
o Welfare - given by Professor Marshal-is a study of man’s income and how
does he utilize it. Although it took into consideration man and wealth, it was
criticized as material welfare could not be measured.
o Scarcity - given by Prof Robbins-is the science which deals with human
behavior in relation to scarce means (with alternative uses) and ends. (three
things to note in the definition are ends are unlimited, means are limited and
means have alternative uses)
 Goods - are tangible i.e. physical attributes are present (eg-weight, width etc)
Services - are intangibles i.e. do not have physical attributes (eg-haircut, car wash
etc)
 Types of goods - based on who produces it (public good and private good), based on
stage of production (Intermediate and final good), based on whether good for
society or not
o Normal goods - as the income increases, the consumption of this good

increases
Inferior goods - as the income increases, the consumption of this good comes
down
o Giffen goods - as the price falls, the demand also falls

Veblen goods - as the price increases, the demand also increases
The above two goods, defy the law of demand
o Public good - available to all equally (non-excludable) and consumption is not

restricted to the existing customers (non-rival). eg-public transport, public
roads etc
Private good - available to those who pay for it (excludable) and are
unavailable for consumption for others (rival). Eg - private education, car etc)
Shyam S Kaggod (Economics faculty, BYJU’S IAS)

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o Intermediate good - remain in economic flow (eg-cement, steel, flour etc)

Final goods - goods are not in the economic flow and are for consumption
purposes (eg-bike, car, bread etc)
o Complementary goods - set of two or more goods, which on combination

satisfy a need. (eg-bread and butter, shoes and socks etc)
Substitute goods - two or more goods which independently satisfy the same
need (hot beverages such as-tea/coffee/milk etc)
o Merit good - the consumption of this good is considered good for the society
(education, health etc)
Non-merit good - the consumption of this good is considered unfavorable for
the society (ex- gold)
 Economics is basically divided into
Micro-economics Macro-economics
Deals with individual as economic units Deals with economic aggregates
Deals with individual income, individual Deals with aggregate income, total
demand, individual output etc output, inflation etc
The main aim is to determine price Main aim is to look at growth in
mechanism, optimal allocation of aggregates with stability.
resources etc
 Since the resources are limited, the allocation has to be done keeping in mind the
tastes/preferences of the people or else the resources will be wasted (either in the
form of overproduction or underproduction).
The scarce resources have competing usages and hence gives rise to the problem of
choice. The problem of choice when resources are used for production of one good
leading to unavailability of these resources for production of another good/s is
referred to the opportunity cost.
Hence the questions arise

o What to be produced and in what quantities?
o How many resources to be used?
o To whom these products to be distributed?
The central problems of the economy are

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o How to allocate the scarce resources?

o How to distribute the final goods and services?
 PPF (Production Possibility Frontier) - The collection of all the possible goods and
services that could be produced from limited resources that are available is referred
to as production possibility set and the curve that is represented by taking all these
possibilities represents the PPF.
 Circular flow in the economy

o Two sector - only households and firms are present. The households provide
factor services for which they receive factor payment. The firms produce and
sell goods for which they receive payments.
o Three sector - in the economy apart from firms and households there is also
the presence of government. The government collects revenues from
households and firms and makes an expenditure in the form of subsidies, tax
exemptions and provision of services
o Four sector - the three domestic economic entities-household, firms and
government not only interact with each other but also interact with the
external world. The government borrows or lends; the firms either import or
export; households import the goods and also provide labour services.
 Types of economies
Features Capitalism Socialism Mixed Economy
Factors of Private Government By both

production are Enterprises
owned by
Role of the Minimal Maximum More of
government providing an
conducive
environment
Price Market forces will Government to Both
determination decide decide (government in
some cases and
market in others)
Competition Very high Almost absent high

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Motive Profits Social welfare both
Exploitation (of Yes No No

factors of
production)
outcomes social strata, Wage gaps absent, Prominence
increasing income prominent role of given to both
gap, thriving PSEs public and
public sector etc private sector
enterprises
Consumer buying behavior- the consumer considers the following parameters

before making the decisions to buy a product
o Price of the product
o Price of the related goods/substitutes
o Preference/taste
o Income
 Law of demand - keeping all the factors constant, if the price of the good
increases, then the demand decreases and with reduction in price the demand
increases. The graphical representation of law of demand is sloping downwards
because
o The increase in the price leads to reduction in the purchasing power
o When the price of the good increases, some users shift to a substitute
o Law of diminishing marginal utility (as we consume more units of the
same product, with consumption of each unit, the satisfaction/utility
keeps on reducing hence the willingness to pay the same amount and
hence the demand) leads to lowering of demand
 Law of supply - the supply depends on

o Price of the commodity
o Price of other goods
o Change in technology
o Change in cost of production
o Taxes and subsidies
o Transportation costs

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Now keeping all the things constant, if price of a good increases, the supply
increases and decreases with decrease in price. This happens from the perspective
of the supplies and since there is an increase in the price this acts as an incentive
for the producer to produce more, hence the supply curve is upward sloping.
 Market equilibrium and dis-equilibrium

When the curve of demand and supply are represented in a single graph, they
intersect at a point, which represents market equilibrium. This represents a
quantity being supplied which is equal to the quantity demanded and at the same
price. Whenever the price goes above the equilibrium price, supply becomes
greater than demand hence the sellers start competing with each other hence
leading to reduction in prices. When the price becomes lower than the equilibrium
price, the demand is higher than supply, hence there will be more buyers
compared to sellers. In this scenario the prices will keep increasing. In both the
scenarios the prices try to reach equilibrium but there are so many factors that
influence the supply and demand, the market equilibrium is only a notion.
 Movement along the curve and shift of curve- whenever there is a variation
in price and quantity, there is a movement along the curve and whenever
there are variations in other factors such as price of other goods, change in
taxes, change in the income, changes in subsidies etc, will lead to either the
curve shifting to left or right.
 Elasticity - it measures the variation in the demand whenever there is a

change in variable such as income, price etc. there are three types of
elasticities
o Price elasticity of demand
%age Change in the demand of product x

PED =
%age change in the price of product x
Elasticity Note
PED<1 Inelastic Usually the essentials
PED=1 Unitary A unit change in price leads to unit
elastic change in demand
PED>1 Elastic luxuries

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o Income elasticity of demand

IED =
%age change in the income
Note Type of good

IED<0 There is fall in the demand with Inferior good
the increase in the income
IED>0 There is rise in the demand with Normal good
the increase in the income
o Cross elasticity of demand

CED =
%age change in the price of good y
Note
CED<0 Complementary goods
CED=0 Unrelated goods
CED>0 Substitutes
 The elasticity is influenced by other determinants

o Availability of substitutes
o Is the good essential or non-essential?
o There may not always be a change in the demand as a reaction to price
take a bit of time (time horizon)
o Effect on the budget/expenditure
 Uses of Elasticities
o Impact of price variations on the revenues of the firm
o The consumption and savings behavior of the economy
o Impact of changing incomes and the impact it has on the consumer
behavior
o Impact of price variation decisions such as government taxes, fuel costs
etc on the consumer behavior etc
 Engel’s law - with the increase in the income there is proportionately lesser
expenditure on food. For the necessities such as food items, the Income
Elasticity of Demand lies between 0 and 1.
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National Income Aggregate

 Tries to measure what has been the growth in the production for comparison with
other countries and with itself over the time (i.e. to comparison over space and time)
 For measuring the production various aggregates are used

o GDP (Gross Domestic Product)
o GNP (Gross National Product)
o NDP (Net Domestic Product)
o NNP (Net National Product)
o National Income
 GDP
o It is a geographic concept. It is the total monetary value of all the goods and
services which have been manufactured in a country in a financial year
o In calculation of GDP
 Intermediary goods will not be considered
 savings is not considered
 goods resold will not be considered (commission generated will be
considered)
 social security transfers (eg-pensions) will not be considered
o Three methods to calculate GDP

 Output/Product Value method=Total output × market price
 Income method=sum of all the factor incomes
 Expenditure method=C+I+G+(X-M)
C= consumption expenditure by households
I= Investment expenditure by firms
G= Government expenditure
X= Exports
M= Imports
 GNP
o It is a nationality concept
o Under this the production done by citizens of a country is considered
o In a country there are inflows and outflows of foreign currency. The inflows
are because some nationals are working outside but are sending back the

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remittances and outflows as foreign nationals are working within but are
sending back the earnings.
o Because there are such inflows and outflows, they need to be accounted
o GNP=GDP+NFIFA (NFIFA=Net Factor Income From Abroad)
o NFIFA=income earned by Indians living abroad-income earned by foreigners
living in India
 NDP
o Depreciation- whenever there is usage of machinery in manufacturing, they
undergo wear and tear; and thereby lose value. This loss of value is considered
as depreciation and has to be deducted from the total value of goods and
services produced to give a better picture.
o NDP=GDP-Depreciation
 NNP
o Under NNP, the production of citizens of a country is adjusted for depreciation
o NNP=GNP-Depreciation
o NNP=GDP+NFIFA-Depreciation
 National Income
o Is considered as the purest form of the income
o It is the NI=NNPFC=NNPMC - Indirect Taxes + Subsidies
o Factor cost=how much money is spent by manufacturer on all the factors of
production
 Why GDP only?

o The inflows and outflows of foreign currency can happen because of various
reasons
o Depreciation rates will vary across countries
o Taxation and subsidization will vary across countries
 Current prices and constant prices

o The current prices will represent the prevailing prices. If GDP is calculated at
these prices, then the inflation will not be discounted
o Hence to discount for the inflation rate the GDP is calculated at constant
prices
o And to account for inflation, GDP deflator is used

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 Limitation of NIA
o Non-availability of data and data collection is a costly affair
o Time lag-it takes time to collect data and arriving at numbers
o Existence of non-monetized consumption (or barter system)
o Parallel economy-the presence of black money in the economy may keep
adding to the demand side
o Lack of occupational specialization-many in India do multiple jobs rather than
sticking to a single job
 Per Capita Income (PCI)-is the average income of every citizen of the country in a
particular year
National Income
PCI =
Population
 Some facts
o 1st estimate - Dadabhai Naoroji (1867-68)
o 1st scientific estimate - Prof V K R V Rao (1931-32)
o 1st official Estimate - Ministry of Commerce (1948-49)
o Calculation done by CSO (MoSPI)
New GDP series

 The rebasing of the new GDP series is for the year 2011-12 rather than for 2009-10
as the data regarding employment is not fully available, there was drought, it wasn’t
a normal year as there was a recession during the year 2009-10
Why the need to rebase

o The structural changes- such as technological changes leading to production
changes, relative changes in the prices of the relative goods leading to
changes in consumption side changes
o This helps in judging the size of the economy
o Which sectors are relatively important can be decided
 Whenever rebasing is done

o accounting procedures change
o price indices are changed
o new estimations are used

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o new databases are used

Till recently whenever the rebasing was done usually cosmetic or peripheral changes
were done but in the new NAS (National Accounts Statistics) the changes have been
comprehensive hence this has attracted a lot of attention and has led to discussion
 The Present rebasing has been done by CSO taking into consideration the
recommendations given the SNA (System of National Accounts) published by UN in
2008. The changes introduced in the rebasing involve
o GVA as a concept comes under SNA (System of National Accounts). SNA was
prepared by UN in 1992-93, and has been ratified by WB, IMF, ADB etc
o Replaced the old base year 2004-05 (decided in 2010) with 2011-12 (in 2015)
o Along with this there have been changes even in the coverage. The old series
covered 8 industries whereas the new covers 11 industries
o GDP at Factor Cost will be replaced with GVA at Basic Prices (The factor cost
do not consider the indirect taxes and subsidies whereas both are considered
under GVA at Basic Prices).
o GDP at Market Costs henceforth will be referred to as GDP
o Gross value added (GVA) is broadly defined as the value of output less the
value of intermediate consumption. It measures the contribution to an
economy of an individual producer, industry, sector or region
o Production taxes and production subsidies are either paid/received and are
independent of volume of any goods produced.
Production taxes - land revenues, stamps and registration fees and professional
tax etc
Production Subsidies - subsidized to Railways transportation, input subsidies to
farmers, subsidies given to small industries, subsidies given to companies etc
Product taxes or subsidies are paid/received on per unit of product.

Product taxes - excise tax, sales tax, service tax and import and export duties etc
Product Subsidies - petroleum and fertilizer subsidies, interest subsidies given to
farmers etc
o The coverage has been increased (Previously RBI used to cover the data through
ASI but has been shifted to MCA21)
o The ASI used the concept of ‘establishment’ (each unit’s GVA was taken into
consideration) whereas the new methodology uses ‘enterprises’ (under this the
parent company’s GVA is taken into consideration which adds to services such as
advertising, accounting, marketing etc) approach. Hence the size of GVA under
the second method will be larger than the first
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o The calculation of labour in the previous methodology was based on Labour Input
method (LI Method) wherein the marginal productivities of labour were not
considered whereas in the new methodology Effective Labour Input (ELI) is used.
 Arguments - In 2015-16, India clocked a GDP growth rate of over 7.5% but the
exports had fallen, investments were at the lowest ebb and IIP growth rate gave a
completely different picture. One of the reasons for this diversion is considered to be
the GDP deflator. In case of India, we use the WPI (along with CPI) as the deflator to
deflate the nominal numbers but the WPI does not consider the services and it is
mainly oriented towards commodity prices
 Producer Price Index

o PPI measures price changes from the perspective of the seller
o Sellers’ and Purchasers’ prices vary as there are taxes and subsidies
o The WPI does not cover services, whereas the PPI covers services
o Many countries have adopted PPI
o The government in 2014 has set up 12-member committee headed by B N
Goldhar to recommend regarding forming a PPI for India (determining its
methodology, data needed for its construction, and selecting a base year
among other things). It’s not the first time as even before two committees
under the Planning commission have been set up to study regarding forming a
PPI for India-one was headed by Abhijit Sen and the other by Saumitra
Chaudhuri
 ASI and MCA21

o ASI
 Annual Survey of Industries (ASI) covers all factories registered under
Sections 2m(i) and 2m(ii) of the Factories Act, 1948 i.e. those factories
employing 10 or more workers using power; and those employing 20 or
more workers without using power
 There were 222120 factories under Annual Survey of Industries (ASI)
 The ASI would capture information from a plant
o MCA21
 Covers more than 5 lakh companies
 Captures the data filed by the companies

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Inflation
 Inflation is a persistent increase in the price levels of a basket of commodities
 Price and price levels are two different things- price refers to the monetary value
that is paid/received for a good sold/bought respectively it is an individual concept;
whereas price level is an aggregate concept which is the monetary value of
basket/group of goods/services
 It is important because inflation is a measure of change in the price levels as the
household buys a mix of goods and services and inflation tries to measure the impact
on the household
 It is a macro-economic aggregate as it takes into consideration a basket of
commodities
 Classification of inflation
o Based on the rate
 Moderate-single digit inflation
 Galloping-double/triple digit
 Hyper-astronomical
o Based on the cause
 Demand pull inflation
 Increasing government expenditure
 Increasing money supply (liberal monetary/fiscal policy)
 Parallel economy/black money
 Increasing forex reserves
Because of the above reasons the demand will go up and in this

situation there could be two outcomes- increase in the production or
increase in the prices. Since in a short run production cannot be
expanded, there will be increase in the prices.
 Cost push inflation

 Increase in wages
 Increase in taxes
 Increase in prices of raw materials
 Supply side shocks
 Structural inflation (is more a feature of a developing country as the
resources availability is limited for them)
 Food shortage
 Scarcity of resources
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 Scarcity of foreign exchange reserves

 Reasons for inflation
o Demand pull factors-higher expenditure by government, expansionary
monetary/fiscal policy
o Cost push factors- increase in wages, increase in taxes etc
o Structural factors-lower investment, lower growth in agriculture, unscientific
storage of food grains etc
o Cartelization-suppliers come together and increase the price irrationally
o Hoarding-the middlemen store part of the goods and create an artificial
scarcity in the market
 Two measures of inflation
o WPI
o CPI
 WPI (Wholesale Price Index)- it measures the level of price changes at a wholesale
market level
It was reformed after the recommendations of Pronab Sen committee
o Base year changed from 1993-94 to 2004-05
o Coverage increased from 435 commodities to 676 commodities
o Published once a month
o Published by Economic Advisor
o Weightages also changed
o All the commodities which were of no daily use were taken off and new
commodities added to make it more representative
In 2017, the government has rebased the WPI and IIP
o The change of BY is from 2004-05 to 2011-12. The working committee that

was set up by the government in this regard was headed by Dr Saumitra
Chaudhuri
o The revision is done to reflect the changes in the industrial sector, to align it
with the base year of other macroeconomic indicators like the Gross Domestic
Product (GDP), Consumer Price Index (CPI-BY 2012)
o Under the new system
 An institutional mechanism (Technical Review Committee) has been
established
 For facilitating dynamic revision of the item list of products and
the panel of factories
 It will be chaired by Secretary (Ministry of Statistics & PI)

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 This Committee will meet at least once a year for identifying

new items that need to be included in the item basket and
removing those that have lost its relevance in the industrial
sector or are no longer being produced
 The revised series will continue to represent the Mining, Manufacturing
and Electricity sectors
 The revised series uses the National Industrial Classification (NIC) 2008
for the purpose of classification of industrial production
 The weightage given to the groups will be (for WPI will be)
 Primary articles – 22.62%
 Manufacturing – 64.233%
 Fuel and Power – 13.15%
 Increase in number of items from 676 to 697. In all 199 new items
have been added and 146 old items have been dropped
 The new series is more representative with increase in number of
quotations from 5482 to 8331, an increase by 2849 quotations
 A new WPI Food Index will also be published (recommendation of
Ministry of Finance). It will be compiled by taking aggregates of WPI for
food “products” under “manufactured goods” and “primary articles”
 The practice of using Wholesale Price Index (WPI) to deflate items for
which data is reported in value terms will continue
 In the new series of WPI, prices used for compilation do not include
indirect taxes in order to remove impact of fiscal policy. This is in
consonance with international practices and will make the new WPI
conceptually closer to ‘Producer Price Index’
o WPI and IIP is calculated by CSO
o The unit coverage of IIP will, as before, cover entities in the organized sector
units registered under the Factories Act, 1948
o The weightage given to the groups will be (for IIP will be)
 Mining – 14.373% (previously it was 14.157%)
 Manufacturing – 77.633% (previously it was 75.527%)
 Electricity – 7.994% (previously it was 10.316%)
 CPI (Consumer Price Index)- it measures the changes in the price levels at retail level.
This inflation has the impact on the common man
o CPI previously was calculated for various groups based on their consumption
patterns

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Industrial Urban Non- Agricultural

Workers manual Laborers
Employees
Base year 2001 1984-85 1986-87
Number of 370 180 60

articles
Services Yes Yes No

included
Published by Ministry of MoSPI Ministry of Labour

Labour
o Recently the CPI has been reformed-the base year has been shifted to 2012.
Rather than having various CPIs, there are three CPIs now which are-CPI
(Urban), CPI (Rural) and CPI (Combined).
Rural Urban Combined

Food and 54.18 36.29 45.86
beverages
Pan, tobacco and 3.26 1.36 2.38
intoxicants
Clothing and 7.36 5.57 6.53
footwear
Housing Not compiled 21.67 10.07
Fuel and light 7.94 5.58 6.84
Miscellaneous 27.26 29.53 28.32

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 Impact of inflation
o Reduces purchasing power
o Reduces real rate of returns
o Has an impact on exports
o Impact on investment scenario
 How to control inflation
o Credit Control-through contractionary monetary/fiscal policy
o Demonetization of Currency-to control the black money
o Reduction in Unnecessary Expenditure
o Increase in Taxes
o Increase in Savings-the government has to incentivize the savings so that
expendable income reduces
o Public Debt-government should not allow the public debt to go beyond the
controllable limit
o To Increase Production-thereby reducing/moderating the prices
o Rational Wage Policy
 Inflation impacts the poor, fixed income class and people in unorganized sector as
their purchasing power keeps on reducing and these groups do not have the savings
to tap into. It has very less impact on the rich class hence it could be concluded that
inflation leads to income redistribution in the favor of rich
 Inflation (manageable terms always works in favor of producers, as this extra price
will act as an incentive for them to produce more
 Inflation Targeting-
o As per the recommendations of Urjit Patel Committee
 CPI must be used as an anchor for monetary policy (adopted by RBI)
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 Inflation must be maintained at 4% (+/-2%) (implemented through

MPFA)
 The monetary policy decisions are to be taken my Monetary Policy
Committee (in process)
o RBI in 2015 has signed Monetary Policy Framework Agreement (MPFA) with
the Government and as per this,
 it will bring down the inflation to lower than 6% by January 2016
(achieved)
And from 2017-18 the target will be 4%(+/-2%)
 will publish a report every 6 months giving-reasons for inflation and
forecasts of inflation
 it would have failed if inflation remains either higher than 6% or lower
than 2% for three consecutive quarters
 in that case it will give a report to the government charting out the
course and specify duration within which the inflation will be brought
down
 Philips Curve- represents the relationship between the inflation and unemployment
o Rate of unemployment and rate of wage inflation are inversely related (when
there is low unemployment, the labour class is in a better position to bargain
for higher wages)
o Rate of inflation and wage inflation are directly related (higher the increase in
wage, higher demand for goods leading to inflation)
o Hence rate of unemployment and inflation are inversely related and the
representation would be a downward sloping curve

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 Some terms
Open Inflation- the prices of goods are allowed to fluctuate freely (or there is least
interference of the government in deciding the prices of goods)
Suppressed inflation- goods are sold at lower prices compared to the market prices
(ex-food grains sold under NFSA)
Stagflation- the period when there is inflation accompanied by increasing unemployment

and lower productivity

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Money and Banking

Money
 Is something that is usually accepted as payment of conducting trade and settling a
debt. The barter system suffers from double co-incidence of wants hence the money
becomes the intermediary stage which allows the trade to take place.
 Features of money
o Medium of exchange
o Valuation of goods/services (across time and region)
o Used for making deferred payments
o Assets usually stored are valued in money terms
 Money supply in India- RBI has recently shifted to a new methodology to calculate
the money supply in India (recommendation of Y V Reddy committee)
o M0=currency in circulation + banker’s deposit & other deposits with RBI

o NM1=currency & coins in circulation + demand deposits with the banks +
other deposits with RBI
o NM2=NM1+short-term term deposits with the banks
o NM3=NM2+long-term term deposits with the banks + borrowings of banks
from financial corporations
RBI
o It was set up on the recommendations of the “Hilton Young Commission” in 1935 and
later it was shifted to Mumbai in 1937.
o Initially it was Privately Owned and was located in Kolkata.
o Since Nationalization in 1949, the Reserve Bank is fully owned by the Government of
India.
 Functions
 Issue of currency- RBI is the sole authority to print and issue the
currency notes (except ₹ 1 note). The printing will be done in order to
infuse/replace old series note, replacing soiled notes etc
 Banker to government- RBI will represent the government at
international financial institutions, raise revenues for the government
and maintain the Public Debt of India

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 Banker to banks/ Regulations of banking system-RBI will lay down

broad guidelines from setting up of the bank to functioning and closing
down.
 Role of RBI in inflation control-
 Government has given the function of controlling inflation to RBI
 MPFA was signed between GoI and RBI
 As per this the RBI has to maintain Inflation at 4% (+/- 2%)
 If inflation goes above 6% or below 2% for three successive
quarters, then the RBI has to give an explanation to the
government listing out-causes and the framework to bring
inflation under control
 Every 6 months it has to bring out a report stating-present level
and future movement of inflation
 Manager of foreign reserve-the forex reserves (gold + SDR + basket of
foreign currencies) are maintained by RBI
 Clearing house functions- In settling inter-bank cheque transactions
RBI plays the role of clearing house
 Formulate monetary policy- the main objective of the policy is to vary
the flow of money in the economy
 Qualitative tools
 Quantitative tools
 Quantitative tools
o Bank Rate (BR)- the rate at which RBI lends long term loans to the banks. The
increase in the rate is called as dear money policy and reduction-cheap money
policy
o Cash Reserve Ratio (CRR)- the ratio of Net Demand and Time Liabilities (NDTL)
that the banks will keep with RBI (the NDTL refer to the time deposits and
demand deposits collected by the bank). It is also referred to as Variable
Reserve Ratio (VRR). If increased will be referred to credit squeeze and if
reduced credit expansion
o Statutory Liquidity Ratio (SLR)- it is the percentage of NDTL that the bank has
to keep with itself either in the form of liquid cash/gold/government securities
o Open Market Operations (OMO)- RBI will issue government securities (or G-
securities or Gilt Edged Securities) to the primary dealers in order to raise the
revenues for the government

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G-securities-are classified into two types based on the maturity-Treasury bills

(maturity period is lesser than a year) and dated securities (maturity period
greater than 1 year)
o Repo and Reverse Repo- Repo is the rate of interest that RBI charges the
banks on the short term loans that it gives. The reverse repo is the rate of
interest that banks will charge RBI on the short term loans.
Repo stands for repurchasing order and Reverse Repo stands for Reverse
Repurchasing Order
 Qualitative tools
o Rationing of credit- RBI tries to regulate portion of the loans to be given to
certain specified sectors. Under Priority Sector Lending (PSL) the loans are
given to agriculture, education, export credit, housing etc (recently the RBI has
added social infrastructure, renewable energy and medium enterprises in the
PSL)
o Restrict Credit and Vary the margin rates- under this RBI can ask the banks to
restrict the flow of credit to a segment or vary the margin (down payment)
values so that the higher demand for this will not add to inflation.
o If banks do not follow the guidelines, then RBI can go for moral suasion and
direct action
 Use of these tools
o If RBI needs to control inflation (it will reduce the liquidity)
 Increase the rates such as repo, CRR, SLR
 Sell more government securities
o If RBI wants to promote growth (it will infuse liquidity)
 Lower repo, CRR, SLR
 Repurchase the g-securities
 Monetary Policy Transmission (MPT)- RBI lowers the policy rate (repo rate) so that
the banks can pass on this benefit to the consumers but with the previous method of
Base rate regime, the banks did not transfer the full reduction to the borrowers.
Hence RBI has done away with BRR and instead introduced MCLR (Marginal Cost of
Funds based Lending Rate).
 Base Rate Regime (BRR)- it replaced the Primary Lending Rate Regime, wherein, the
banks were supposed to consider various factors such as cost of capital, operational
costs, profits etc in order to decide on the lending rate. The banks could not lend
below this rate unless it is either to an employee of a bank or under special scheme
etc
 Marginal Cost of funding based Lending Rate (MCLR)- RBI in order to provide for
efficient monetary transmission has gone ahead with replacing BRR with MCLR.
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Under this the banks are forced to factor in variation in the policy rate or any rate
change announced by RBI under Monetary policy which leads to a change in the
lending rate for the banks. Hence MCLR will be leading to efficient MPT.
How MCLR is better than BRR- in calculation of lending rate under BRR, the banks
used to take only the cost of funds (term deposits, demand deposits etc) but under
MCLR they are forced to take marginal cost of funding i.e. cost of funds (not only
term deposits and demand deposits but also the repo rate) and also consider CRR,
hence whenever there is a change in say Repo rate, banks are forced to vary their
lending rate hence will lead to better Monetary Policy Transmission
Banking Reforms- Narasimhan Committee (1) Recommendations 1991
o No further branch licensing

o No further nationalization
o PSL to be brought down to 10%
o Phased reduction of SLR & CRR
o Computerization of the banks
o Debt Recovery Tribunals to be set up
o Setting up of Asset Reconstruction Companies
o Private sector entry to be allowed
o Banks should be allowed to raise the capital by issue of shares
o Four tier structure of the banks-3 to 4 large banks, 8 to 10National Banks,
Local banks, Rural Banks
Banking Reforms- Narasimhan Committee (2) Recommendations 1998
o Setting up of Credit Information Bureau

o Merger of strong banks to make a mega bank
o Weak banks should be called as narrow banks
o Greater autonomy to bank boards
o Regulator should not be the owner
Nationalization of banks
 1st round-1969-14 banks (which had NDTL over ₹ 50 Cr)

 2nd round-1980-6 banks (which had NDTL over ₹ 200 Cr)
 Reasons
o Concentrated in the hands of the rich-these banks were owned by
industrialists

23
o Concentrated in the urban areas-there banks were majorly concentrated in

urban areas as in rural areas mobilization of deposits is very low
o Loans not reaching the needy- most of the credit was accessed by rich
customers whereas customers such as (farmers, poor) did not get access to
institutionalized credit
o Providing institutional credit- especially in rural areas there was presence of
huge unorganized money lending which led to farmers falling into debt trap
Merger of SBI with its Associates and BMB

Recently, the board of SBI has approved the merger of SBI with associate banks (SB
Travancore, SB Jaipur and Bikaner, SB Mysore, SB Patiala, SB Hyderabad). The merger will
throw up some advantages but also there are some concerns
Some of the features are
 The merger will lead to creation of an asset with value of the asset base of Rs 30
trillion
 The merger of the banks/consolidation of the banking sector is exempt from CCI act
2003
 The formation of big banks was recommended by Narasimhan Committee (but the
recommendation said 4 to 5 big banks)
 The merger will lead to SBI being one of the top 50 banks in the world
Before merger After merger
Value of the assets 21.5 lakh Cr 28.25 lakh Cr
Number of branches 16500 Around 24000
Total employees About 2,70,000
Advantages
 The merged entity will become the biggest bank in terms asset base
 The merged entity will have biggest number of employees in a bank
 The merged entity can utilize the economies of scale i.e. the operating costs will
come down (it is expected that the cost to income ratio will come down by 100 bps)
 The merged entity will have highest coverage in terms of bank branches

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 The merged entity will have huge financial reserves and lowering of margins will
increase the profits
 As per one of the surveys, the savings because of the merger are to the tune of ₹
3500 crore
Concerns
 The merged entity will have more exposure to risks in the market
 The problem with merger is the exposure the merged entity will have in the form of
pension and provident fund outlays
 The working culture will vary which may result into harmonization problems
 The employees are concerned with some employment issues-seniority, transfers,
promotions etc
 The accounting treatment/standards followed are different in SBI and associate
banks which might cause in problem in harmonization of accounts
But the biggest concern with the merger is that SBI is already the biggest in terms of the
asset base and with merger the asset base will only increase (the second largest bank in
terms of asset base is ICICI-Rs 7 lakh crore). This may lead to a worrying trend in case when
there is a crash in the market in the form of higher NPAs, reduction in value or quality of
assets etc.
This has been observed when Lehman Brothers crashed in 2008. To prevent such ripple
effect
 US Federal Reserve has issued a rule wherein the merger of financial entities is
prevented in a case when the merged entity has more than 10% liability of the total
financial system.
 As per Dodd-Frank Wall Street Reform (section 622) and Consumer Protection Act,
prevent acquisition by banks once reach a specified financial limit/value
The merger experience in India
The merger of PSEs in India has not been a smooth affair
 The merger Indian Airlines with Air India led to merged entity suffering losses and the
entity has not acquired larger market share (it so happens that the entities before
the merger were making profits)
 The proposed merger between BSNL and MTNL has not materialized as for over 5
years as the trade unions of both entities have not come any agreement

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Basel
Basel is a place in Switzerland which Houses Bank of International Settlement. It also
houses, BCBS (Basel Committee on Banking Supervision) of which Indian Central Bank is a
member. The BCBS meets and on deliberations issues guidelines and these guidelines are
only regarding financial stability of the banks. So far the BCBS has issued the guidelines -
Basel I, Basel II and Basel III
 Total Capital- the bank has the capital in two forms - Tier I and Tier II. The Tier I is a
form of capital which can absorb the losses without the bank winding up (also
referred to core capital- paid up capital, disclosed reserves, reserves arising as a
result of sale proceeds etc) and Tier II can absorb the losses but the bank has to wind
up (also referred to sub-ordinate capital eg- debt capital instruments, revalued
reserves, long term unsecured loans).
 Risk Weighted Assets=loans are allocated certain risk weights (loans such as
personal loans are given higher risk weights and loans given to government will have
lower risk weight). All the assets/loans that are issued by the bank will be allocated
the risk and the total of these risk weights will give Risk Weighted Assets.
 CAR (Capital Adequacy Ratio) or CRAR (Credit to Risk weighted Assets Ratio)-in
simple terms it represents the ability of the bank in meeting the needs of creditors
and depositors. The CAR also represents the capital (Tier I + Tier II) the bank has to
absorb the losses
 Basel I
o Was introduced in 1998 and were adopted by India in 1999 and the banking
sector in India are BASEL I complaint
o Credit Risk- when the banks issue loans, there is a danger that the loans are
not repaid hence it is referred to as credit risk
o Under Basel I, the CAR has been set at 8% of RWA
 Basel II
o Introduced in 2004
o 3 types of risks have been listed under Basel II

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 Credit Risk- when the banks issue loans, there is a danger that the
loans are not repaid hence it is referred to as credit risk
 Market Risk- banks have to make an investment in gold or government
securities as a part of maintaining SLR and are exposed to the market
risk as the prices of gold will vary
 Operational Risk - attributed to internal systems, processes, people
and external factors.
o 3 pillars have been introduced under Basel II
 CAR- the CAR has been set at 8% of RWA (The Tier I capital is to
maintained at 4% of RWA)
 Supervisory Review- the banks have to develop and use better risk
management techniques in monitoring and managing the three risks
 Market Discipline- the banks have to mandatorily disclose CAR, risk
exposure etc to the central bank
 Basel III
o Introduced in 2010 as a result of 2008 financial crisis
o CAR has been increased to 9% of which the tier I capital has been set at 7% of
RWA
o Tier-1 capital of 7% RWA has two components-4.5% of Tier I capital and 2.5%
of capital conservation buffer
o RBI has said that the banks in India will be Basel III complaint by March 31,
2019
NPA
The banks are the financial institutions whose primary activities are to collect the deposits
and give it to borrowers. Hence the banks play a very important role if there needs to be
movement from capital surplus sectors (eg-households) to capital deficient sectors (eg-
corporates).
Once the loan has been issued the borrower needs to make the payment back to the bank.
This payment usually consists of two components-Principal and interest. If the borrower has
made timely payments then such an account is referred to as Standard Asset, otherwise the
account is classified as an NPA.
 NPA definition- can be classified under two heads-based on duration and type

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Based on type
a. In case of term loan- if the payment/repayment remains overdue for a period
of greater than 90 days from the end of the quarter
b. In case of agriculture loan- if the payment/repayment has remained overdue
for period greater than two or one crop seasons from the due date, in case of
short term and long term loans respectively
Based on duration
a. Sub-standard- if an account remains as NPA for a period lesser than or equal
to 12 months
b. Doubtful- if an account remains as NPA for a period greater than 12 months
c. Loss making- once the account has remained as an NPA for a period of 3 years
or greater will be classified as loss making by the banks either during
internal/external auditing. Otherwise an account will be classified as loss
making if the realizable value of the asset comes below 10% of the total
outstanding debt
 Ways through which banks can recover NPA’s

a. Debt Recovery Tribunal (DRT) - the DRTs were set up under section 3 of the
Recovery of Debt Due to Banks/Financial Institutions Act 1993. Under this
expeditious disposal of suits was provided (around 6 months). So far 33 DRTs
and 5 DRATs have been set up. Over the period of time the number of cases
filed has increased exponentially and as a result of that the cases disposed
have come down (in the last three years DRT has disposed 20% of the cases
filed in each year; at the end of 2015, the outstanding value of the assets stuck
up at DRT is around ₹ 4,50,000 Cr which is more than Gross NPA)
b. SARFAESI act 2002- Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act 2002 was brought in to overcome some
of the deficiencies of DRTs. Under this the creditors having greater than 75%
exposure (cumulatively) will come together and then issue a notice to the
defaulter to make the payments. If the order is not obeyed in 60 days, then
the underlying security will be taken over by the banks. If it is a company, then
the banks can change the management/ sell the security to ARC auction.
c. Asset Reconstruction companies- Purchase NPA’s from the banks at a
discounted price and tries to recover/revive the account. The ARCs usually
give the banks security receipts when they purchase the loan account. In
2014, RBI allowed ARC’s to convert their debt to equity (ceiling of 26%)

28
d. Strategic Debt Restructuring- policy introduced by RBI under which the

lenders (banks) first go for CDR (Corporate Debt Restructuring-the loan
repayment is rescheduled) & If the company fails to abide by the repayment
schedule then take over the management of the company
e. Scheme for Sustainable Structuring of Stressed Assets (S4A) (please find the
detailed discussion on this at the end of the notes)
 Why high NPA’s In India
Basically can be classified under two heads - Internal and External
a. Slowdown in the domestic economy

b. Diversion of funds
c. Volatility in the prices of raw materials
d. Governance issues
e. Willful defaulters
f. Inefficient DRTs
g. Bad lending practices (ex-Poor credit appraisal system)
h. Slowdown in the global demand
i. Lower exports from India (especially commodities such as Iron/steel,
aluminum)
 Impact of high NPA’s

a. Will affect the bottom line (profit) of the banks
b. Will reduce their lending capacity (volume of loans that are given)
c. Will lead to erosion of investors’ confidence (drop in the share prices)
d. The cost of capital will go up (lending rates will be increased for both retail
and corporate)
e. The higher cost of capital is going to deter the investors
f. May lead to inflation
g. Twin Balance Sheet Problem
 Measure taken by the Government and RBI

a. CRILC (Central Repository of Information on Large Credits) - has been created
by RBI to collect, collate, organize, disseminate data on large borrowers (total
borrowing greater than ₹ 5 Cr). It helps in tracking and reviewing exposure of
such borrowers so that remedial measures can be taken timely

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b. Willful defaulters-RBI has barred the entry of WD’s in the capital market,
access to the funds (loan accounts) will be cut off, will not be allowed to float
a new company for a period of five years
RBI has also introduced new terminology-NCBs (Non Co-operative Borrowers)
c. Information Technology and Management Information Systems have to be
made robust so that they are able to generate reliable and quality information
on timely basis
d. RBI has issued detailed guidelines regarding revival of MSMEs
e. The government has to decide to set up 6 new DRTs at Bangalore, Chandigarh,
Dehradun, Ernakulum, Hyderabad and Siliguri
f. The Government has advised PSBs to constitute Board level committees for
monitoring and increase the pace of recovery of NPAs
g. The government has proposed Indradhanush - Appointments, Accountability
framework, Banking Board Bureau, Capitalization, Destressing, Empowerment,
Governance framework.
 Measures recommended by Standing committee on finance

a. Set up empowered committees at 3 levels-RBI, Banking, Consumer (since the
banks are not equipped well to undertake the credit appraisals)
b. Naming and shaming of top 30 willful defaulters in order to prohibit the
borrowers from defaulting in the future
c. CDR (Corporate Debt Restructuring) to be finished in 6 months
d. Names of all the companies that have undergone debt restructuring to be
made public
e. RBI should allow the banks to absorb the written off assets gradually in a
staggered manner
f. A vibrant bond market should be developed to provide funds for Infra sector
g. The loan restructuring to be done in order to preserve the economic value of
the asset and taking the temporary inability of the borrower to pay
h. Under SDR the banks should mandatorily change the management of the
company
 Recommendation of Economic Survey 2015-16- has recommended 4R strategy
a. Recognition- the banks must find the true worth of the asset
b. Recapitalization- the banks must be provided funds either by the government
or by RBI
c. Resolution- the NPAs must either be revived or sold off
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d. Reforms- the future incentives to the corporate must depend on their

performance/credit worthiness
The debate as to who should provide for recapitalization has begun. To comply with
Basel III norms and to clear all the NPAs from the balance sheets, the banks would
require funds to the tune of ₹ 1,80,000 and the government has promised ₹ 70000 Cr
(of which ₹ 25000 Cr has been provided under budget 2016-17)
 Willful defaulters
As per RBI guidelines issued in 2014, a borrower will be deemed as willful defaulter if
the borrower has not made the payment/repayment
a. Even when the borrower has the capacity/financial reserves to repay

b. The loan has been utilized for some other purposes
c. The funds have been siphoned off
d. If the borrower has disposed-off or removed the movable / immovable asset
which was given as a collateral/security
Once designated as a willful defaulter
a. Access to funds will be cut off

b. Will not be allowed to enter equity market
c. Will not be allowed to float a new company for 5 years
As per the standing committee on Finance-as of December 2015, the PSBs had 7686
willful defaulters accounting for a total of ₹ 66000 Cr of loans (21% of the total
NPAs). Hence it has recommended naming and shaming top 30 willful defaulters.
 Bankruptcy code or The Insolvency and Bankruptcy bill 2015

a. Provides for a speedy insolvency resolution (IR)-maximum period of 270 days
(180+90 days)
b. It will consolidate all the previous laws such as NCLT, SARFAESI, DRT etc
c. IR for Individuals and Partnerships will be directed to DRTs (Debt recovery
Tribunals).
d. IR for Limited Liability Partnerships (LLPs) and Companies will be directed to
NCLT (National Company Law Tribunal)
e. DRT/NCLT can be approached by lender or the borrower
f. Once approached they will appoint Insolvency Professional (IP, certified, an
expert in the insolvency resolution, once appointed all the assets of the
company will come under his control)
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g. The IP will seek information from Insolvency Agencies about the concerned
borrower and also set up CC (Creditors’ committee) and the CC will have to
deliberate and decide (whether to liquidate or to recapitalize and revive the
company)
h. If the decision is not made, then extension of 90 days could be given (with
approval of majority of creditors by value)
i. Even after the extension, if no decision is made then the IP will recommend
the authority to liquidate the concerned asset
Challenges in implementing IBC

a. The number of cases/workload on NCLT will increase (as of now over 4000
cases are pending under CLB and annually thousands of cases will be filed
under the new law)
b. The case laws are required to be developed for IBC
c. The IPs (Insolvency Professionals) need to be selected based on proficiency,
entry barriers, expertise in the field etc as IPs form the backbone for the new
insolvency process
d. Setting up of Information Utilities (IU) will be a challenge. The IUs will be
providing irrefutable evidence of default of the companies (as of now under
DRT, Bankers Book Evidence Act allows the Banks books’ to be treated as
evidence and winding up petitions under SICA and companies act 1956 take
around two years to be admitted)
e. The borrowers/companies can approach judiciary citing arbitrariness in
selection of stressed assets
S4A (Scheme for Sustainable Structuring of Stressed Assets)

 Launched by RBI, to reduce the impact of NPAs
 Under this the banks will have the option of converting part of the debt into equity
thereby reducing the liability on the borrower and also leading to increase in their
equity holding in the company
 Some of the conditions for restructuring a loan under S4A are
o The cumulative exposure of all the creditors to the borrower must be over ₹
500 Cr
o The project must be up and running (the project should have commenced
operations). This is a way to give a second chance to the company to revive
the company and also to contribute to the economy

32
o In this case the lenders will separate the debt into- sustainable debt (portion
of the loan that can be serviced through the present cash flows) and
unsustainable debt. The sustainable debt value should be at least 50% of the
debt. This unsustainable debt can either be converted into equity/
redeemable optionally convertible preference share or optionally convertible
debentures, with clearly spelt out terms and the banks are not to tinker with
the lending rates in case of sustainable debt.
o First an external consultant will study and approve the Techno-Economic
Viability (TEV) of the Resolution plan. Then S4A/Resolution Plan will be
implemented only when the Overseeing Committee (OC-constituted by IBA in
consultation with RBI) approves it. The OC will basically review the processes
involved in preparation of resolution plan, etc for reasonableness and
adherence to the provisions of the guidelines, and give an opinion on it.
 Limitations
o Change of debt into equity will not always guarantee a turnaround of a
company
 Debt is better as it gets tax breaks and is non-perennial (unlike equity)
 Conversion of debt into equity was tried in case of Kingfisher Airlines
and even then the company could not be saved
o It takes into account secured creditors, what about the unsecured creditors?
They can still go ahead and play spoilsport
o The scheme takes into consideration the current cash flows in deciding
sustainable and unsustainable debt but the cash flows in the future depend
upon the future business environment
o The creditors do not have any power to change the conditions associated with
the loan
o Only those who have started commercial production will be covered under
this but many of the projects are struck up because of lack of regulatory
clearances (in power sector)
Banking Ordinance
 The ordinance will be referred to as Banking Regulation (Amendment) Ordinance
2017
 The ordinance will insert the following provisions in the section 35A of the Banking
Regulations Act 1949

33
o 35AA – the central government may by order authorize RBI to issue directions
to any bank to initiate insolvency resolution process in respect of a default
under the provisions of the Insolvency and Bankruptcy code 2016
o 35AB – without prejudicing the previous provision, RBI from time to time issue
directions to the banks for the resolution of the stressed assets. Also the RBI
may appoint committees/authorities to advise banks on resolution of the
stressed assets
Payment Banks
 These are specialized/differentiated banks which are stripped down versions of the
traditional banks. Under this concept the banks provide the limited services through
the mobile phones
 RBI has issued the preliminary licenses or in-principal-approval (valid for 18 months)
to 11 entities to start the payment banks. This has been done in order to drive the
Financial Inclusion
 The Payment Banks can provide the following services-remittance services, demand
deposits, internet banking and other specified services
 The features of Payment banks are

o Customers can deposit only up to Rs 1,00,000
o Are allowed to issue only debit/ATM cards
o No credit cards can be issued
o No lending activities can be conducted
o Payments and remittance services will be provided
o Insurance and mutual funds will be provided to the customers
o Initial capital of Rs 100 Cr.
 Other conditions applicable are

o Payments banks are targeting migrant labourers, low income households,
small businesses, and other unorganized sector entities.
o Eligibility - Existing pre-paid payment instrument issuers, individuals,
professionals, NBFCs, corporate business correspondents, telecom companies,
super-market chains, real estate sector cooperatives that are owned and
controlled by residents and public sector entities may apply.

34
o Promoter’s contribution initially must be 40% for the first 5 years. For foreign
holding, it is up to 74% of paid-up capital, on a par with private banks.
o The banks must maintain CRR, minimum 75% of demand deposits in
government bonds of up to one year and maximum 25% in current and fixed
deposits with other scheduled commercial banks for operational purposes and
liquidity management.
 Concerns – with passage of time, three players - Cholamandalam, Dilip Sanghvi and
Tech Mahindra have dropped out of the race. Some of the concerns that have been
raised are
o Limited scope of activity (no lending)
o Profitability concerns
o Competitive pressure leading to lower margins
o Increasing technological growth
 List of entities
o Aditya Birla Nuvo
o Airtel M Commerce Services
o Department of Posts
o FINO PayTech
o National Securities Depository
o Reliance Industries
o Vijay Shekhar Sharma, Paytm
o Vodafone M-Pesa
o Dilip Shanghvi
o Cholamandalam withdrawn
o Tech Mahindra
Small Finance Banks

 Small Finance Bank (SFB) are specialized banks
 SFBs are allowed to accept deposits and are allowed to give loans.
 The SFBs will now be able give loans to MSMEs and bring them under the ambit of
financial system
 These will also further the objective of financial inclusion

35
 The features and conditions

o Minimum capital to be Rs 100 Cr
o 75% of the credit must be given in the PSL
o Maximum loan size to a single borrower/person cannot exceed 10% & 15% of
total capital in case of a group
o At least 50% of the loans should constitute loans/advances up to Rs 25 lakh
o Must maintain CRR and SLR
o With the prior approval of RBI, SFBs can undertake financial services
o Must have the word “Small Finance Bank” in the name
o No subsidiaries can be set by these SFBs to take care of non-banking financial
service activities
o 25% of the branches to be set up in unbanked areas
 The 10 entities that received the nod for small banks

o Au Financiers - Jaipur
o Capital Local Area Bank - Jalandhar
o Disha Microfin - Ahmedabad
o Equitas Holdings - Chennai
o ESAF Microfinance and Investments - Chennai
o Janalakshmi Financial Services - Bengaluru
o RGVN (Northeast) Microfinance - Guwahati
o Suryoday Micro Finance - Navi Mumbai
o Ujjivan Financial Services - Bengaluru
o Utkarsh Micro Finance - Varanasi
Some terms
Gross NPA-the amount which has been outstanding in the books
Net NPA- Gross NPA-interest debited to account but not realized
Stressed Asset- NPA+ Restructured loans+ written off assets
 5 sectors contributing to 54% of total stressed assets

o Mining
o Iron and steel
o Infrastructure
o Aviation
o textiles

36
Fiscal Policy - Budget and Finance Commission

There are two policies that are announced in India-Monetary Policy and Fiscal Policy.
The Monetary policy is announced by RBI whereas the fiscal policy is announced by the
government
Fiscal Policy is also referred to as public finance, is the sum total of all the financial decisions
taken by the government regarding expenditure and revenues. Fiscal policy is very
important as the expenditure by a government depends on the revenue that it is
generating. The policy also refers to the quality expenditure i.e. target subsidies, have more
expenditure under the capital head etc.
The objectives of fiscal policy are
o To mobilize financial resources
o To direct the expenditure
o To maintain economic stability
o To promote and accelerate growth
Some of the decisions that are taken under fiscal policy are
o Budget
o Finance Commission
o Taxation system
o Subsidy
o Disinvestment etc
Budget
 Budget is presented under article 112 as Annual Financial Statement
 The government cannot withdraw money from the consolidated fund of India
without the approval of Parliament
 Two types budgets are presented in a financial year-Railway and Union

37
 It is presented on the last working day of February in Lok sabha by the finance
minister but before that the President addresses the parliament (lays down the
cause of the budget)
 Lok Sabha enjoys more powers compared to RS (it can only recommend changes but
it is the prerogative of LS to accept/reject the recommendations)
 No tax shall be levied or collected except by authority of law
 The budget is prepared by Department of Economic affairs (Ministry of Finance)
 Under the budget, 14 documents are presented and the most important documents
are
o Summary document
o Appropriation bill
o Finance bill
o FRBMA documents
 The budget has two accounts-expenditure (appropriation bill) and revenue (finance
bill)
 FRBMA (Fiscal Responsibility and Budget Management Act) 2003- it was passed so as
to provide fiscal consolidation. Under this the government of India proposed to
reduce FD, RD, but the recession in 2008-09, has led to higher expenditure by the
government. The government is on the way to implement FRBMA. In May 2016,
government has set up N K Singh committee to review implementation of FRBMA
 Process of passage
o Government obtains the prior recommendation from the president to present

the budget. The President addressed the parliament and lays the cause for the
budget.
o The Budget is then presented on the floor of Lok Sabha by the Finance
Minister with the "Budget speech".
o It is then presented on the floor of the Rajya Sabha for discussion, but Rajya
Sabha does not have the power to vote on the demands for grants.

38
o The Discussion on Budget in the Lok Sabha is conducted in two stages-General

Discussion (includes broad discussions on the budget, cut motions are not
allowed) and Detailed Discussion (done after the standing committee presents
the reports, during this stage the cut motions are allowed to be introduced,
demand for grants are voted and passed)
o After the voting, an Appropriation Bill is introduced and voted on, which
authorizes the government to withdraw and spend money from the
Consolidated Fund of India.
o After this the finance bill is introduced, passed and sent for president’s assent.
o For the procedure to be over usually it takes till the end of may but till then
the government has to incur certain expenditure, which is allowed to be
withdrawn with passage of Vote-on-Account (which is usually one sixth the
value of total demand for grants)

39
 Cut motions
o Economy Cut= the demand for the grants is reduced by the certain amount
based on the economies
o Token cut= to address a grievance of a member, the amount is reduced by Rs

100
o Policy cut= if the underlying policy (regarding the demand) is faulty then the
demand for grants is reduced to Rs 1
 Budget is divided into two accounts-Capital and Revenue account
o Capital Account-contains items which lead to creation of assets
 Capital Receipts
 Capital Expenditure
o Revenue Account-day today items which do not lead to creation of assets
 Revenue Receipts
 Revenue Expenditure
 Deficits
o Revenue Deficit=difference between revenue expenditure and revenue

receipts
o Budget Deficit= difference between budget expenditure and budget receipts
o Fiscal Deficit=difference between total expenditure and non-debt creating

capital receipts
o Primary Deficit=is the deficit if there was no interest liability (the interest is
paid in the present year on the loans that were taken in the past)
 PD=FD-Interest Payments
o Monetized Deficit= is the scenario wherein the GoI asks RBI to print fresh
currency to bridge the deficit
 FRBMA 2003
o Bring down revenue deficit by 0.5% per year and eliminate it by 2007-08.
40
o Bring down fiscal deficit by 0.3% per year and bring it down to 3% by 2007-08.
o Central government not to provide guarantee (for more than 0.5% GDP) on
the loans of PSU and state governments
o Total liabilities of central government not to increase by more than 9% per

year
o Union Government would place three more documents along with the budget
documents viz. Macroeconomic Framework Statement, Medium Term Fiscal
Policy Statement and the Fiscal Policy Strategy Statement.
o At the end of second quarter, the Finance Minister would make a statement
on the trend of fiscal indicators and corrective measures taken thereof.
o Recently the GoI has set up a committee headed by former revenue secretary
N K Singh (to submit the report by October 31, 2016)
 Review the functioning of the Act in the last 12 years and suggesting
changes
 Review the factors that are taken into consideration in determining

yearly targets
 Whether to have fixed or a range for FD
 Can the government re-align FD with the changes in the credit flow in
the economy
 Fiscal Deficit
o Fiscal deficit is targeted at 3.2% of GDP for FY18 as compared to 3.5% in FY17
and will be 3% by FY19. In case of revenue deficit, it is targeted at 1.9% of GDP
for FY18 as compared to 2.3% in FY17
o Fiscal Deficit
 The targeted fiscal deficit to GDP ratio of 3.5% has been adhered to in
2016-17.
 Further, the FRBM Review Committee chaired by Mr N K Singh had
submitted its report to the Government in January 2017. The
Committee recommends a fiscal deficit to GDP ratio of 3.0% over the
next three years and also introduces the concept of an ‘Escape Clause’
which allows for deviations up to 0.5% of GDP from the stipulated fiscal
deficit target. The Committee recommends a Debt to GDP of 60% for

41
the General Government by 2023 (40% for Central Government & 20%
for State Governments)
 Finance Minister has pegged fiscal deficit to GDP ratio at 3.2% for the
year 2017-18 and at 3.0% for 2018-19. This is a slight deviation from
the target suggested by the Committee and is in light of the need to
undertake higher public expenditure given the backdrop of weak
private investments
o N K Singh Committee report
 The Committee proposed a draft Debt Management and Fiscal
Responsibility Bill, 2017 to replace the Fiscal Responsibility and Budget
Management Act, 2003
 The Committee has recommended using debt as the primary target for
fiscal policy and a debt to GDP ratio of 60% should be targeted (40%
limit for the centre and 20% limit for the states)
 This ratio of expected to be 70% in 2017 and targeted ratio should be
achieved by 2023
 To achieve the targeted ratio, yearly targets have been proposed to
progressively reduce the fiscal and revenue deficits till 2023 (here debt
indicates the total outstanding liabilities of the government, while the
fiscal deficit indicates new borrowings made in the year, and the
revenue deficit indicates what part of these new borrowings have been
used to cover revenue expenses)
 The Committee has recommended creation an autonomous Fiscal
Council
 It will be chaired by a Chairperson and have two members (to be
appointed by the centre)
 The functions of the Council would be
 Preparing multi-year fiscal forecasts
 Recommending changes to the fiscal strategy
 Improving quality of fiscal data
 Advising the government if conditions exist to deviate
from the fiscal target, and
 Advising the government to take corrective action for
non-compliance with the Bill.
 In order to maintain its independence, the committee has
recommended a non-renewable four-year term for the
Chairperson and members. It has also laid a condition that these

42
people should not be employees in the central or state

governments at the time of appointment
 Under FRBMA, the government can deviate from the targets in case of
a national calamity, national security or other exceptional
circumstances notified by it. The Committee has recommended that
the grounds under which the government can deviate from the targets
should be clearly specified, and the government should not be allowed
to notify other circumstances
 The government may be allowed to deviate from the specified targets
upon the advice of the Fiscal Council under the following circumstances
 Considerations of national security, war, national calamities and
collapse of agriculture affecting output and incomes
 Structural reforms in the economy resulting in fiscal implications
 Decline in real output growth of at least 3% below the average
of the previous four quarters. These deviations cannot be more
than 0.5% of GDP in a year
 The Committee has recommended that 15th Finance Commission
should be asked to recommend the debt trajectory for individual
states. This should be based on their track record of fiscal prudence and
health
 The draft Bill restricts the government from borrowing from the
Reserve Bank of India except when
 The centre has to meet a temporary shortfall in receipts
 RBI subscribes to government securities to finance any
deviations from the specified targets
 RBI purchases government securities from the secondary market
 The committee has recommended establishing a committee to review
the functioning of the Bill in 2023-24
 “We do not require a separate Railway budget"- provide the supporting explanation
Answer
o Post-independence railways accounted for more than 75% of public transport
and 90% of freight traffic which has been reduced to 20% and 40%
respectively in recent times
o Size of Railway budget is small compared to Union Budget (during British era it
accounted for more than 80% of the value of the budget but it has come
around 10% compared to the size of union budget)

43
o Since the railways budget was prepared separately from the union budget,
there was duplication of efforts, higher involvement of officials, higher
expenditure etc
o One of the prominent features of Railway budget has been populist measures,
with the merger, this would be somewhat brought under control
o Recommendation of Bibek Debroy Committee-the railway is presented
separately as a convention and there is no constitutional provision which
dictates that. Hence all it takes is the executive decision of the government to
merge it with union budget.
o Presently there is an urgent need to have an integrated transport modal mix
in India which can provide seamless transportation. To achieve this merger is
necessary.
o The 7th Pay Commission Recommendations will increase the burden on its
wage bill. With the implementation of the 7th PC, the salary burden on the
ministry will be increasing by more than 50%- from Rs.53,000 crore
to Rs.77,325 crore in 2016-17 (not accounting for other costs such as
pensions)
o The investment and growth in the railways has been the focus of criticism-the
railway lines are of 66000 kms of which only 17000 kms have been laid down
post-independence
14th Finance Commission

 Was appointed on 2nd January 2013 under the chairmanship of Y V Reddy and the
terms of reference given to it are
o Recommendations regarding the devolution of taxes between the Center and
the States from the divisible pool which includes all central taxes (excluding
surcharges and cess)
o Suggestions regarding the principles which would govern the quantum and
distribution of grants-in-aid
o the measures if needed, to augment State government finances to
supplement the resources of local government and to review the state of the
finances, deficit and debt conditions at different levels of government
 The recommendations are applicable for a period of five years (from 2015-16 to
2020-21)
 the major recommendations are

44
o Vertical Devolution-The 14th FC has recommended a new vertical devolution

(the proportion of distribution of central divisible pool of taxes between the
centre and the states) formula under which the share of states from the
central divisible pool of taxes from 32% to 42%.
Finance Commission Share of states out of central divisible pool

11th 29.0%
12th 30.5%
13th 32.0%
14th 42.0%
o Horizontal Devolution- The 14th FC has recommended a new horizontal

devolution formula under which the variables for the calculation of the
individual states’ share out of the total share allocated for the states
Variable 13th FC 14th FC

Population (1971) 25.0% 17.5%
Population (2011) 00.0% 07.5%
Fiscal Capacity/Income Distance 47.5% 50.0%
Forest Cover 00.0% 07.5%
Area 10.0% 15.0%
Fiscal Discipline 17.5% 00.0%
Total 100% 100%
o Other types of grants proposed-grant to rural and local bodies, performance

grant, disaster relief etc (Rs 5.3 lakh crore)
o It has not given any recommendations regarding sector specific grants (given
under 13th FC-recommended the grants be given under roads, bridges,
education, water sector management etc)
 Features
o The devolution to the state governments has received the highest
jump/increase
o Another feature is that the recommendations are progressive in nature- the
states with lower NSDP will be receiving on average much larger transfers per
capita
o The flow of the grants to the local bodies and urban bodies will be increasing
o Some of the gainers as a result of new methodology are Madhya Pradesh,
Bihar, Uttar Pradesh, Chhattisgarh, Karnataka, Jharkhand etc

45
Taxation
 Tax is a compulsory levy that the state imposes on the citizens. The tax is a binding
force which connects the two important pillars of the democracy i.e.
state/government with citizens. Each citizen enjoys certain entitlements from
government and in return has to contribute to the government in the form of tax
payments. If the citizen doesn’t pay the tax, either he becomes a free rider
(consumes services of the government but doesn’t pay tax) or exits (doesn’t
consume the services of the government). In either case, the accountability factor on
the government reduces. So it could be said that tax is an agreement between the
state and the citizen wherein the government promises to provide certain
entitlements to the citizen and in return the citizen makes the tax payments.
 Types of Taxation Systems
Progressive Regressive
As the income goes up, taxes also go up As the income goes up, taxes go down
Income inequality is reduced Income inequality is increased
Eg-Income Tax
Direct Indirect
Incidence and impact are on the same Incidence on one person and impact
person is someone else
Contribution is greater than 50% Contribution is relatively lesser
Major contributors are corporate and Major contributors are excise (cenvat),
income taxes customs and services
Ex-income tax, wealth tax, corporate tax Ex- Cenvat, sales tax, service tax etc
Advalorem Specific
Imposed on the basis value of the Imposed based on the specific

commodity attributes of the commodities
46
Chelliah committee recommended more

of these taxes
Ex- sales tax, VAT etc Ex - Excise duty etc
o Surcharge- is a charge imposed whenever the income crosses certain level

Cess- a tax imposed to achieve a certain objective
o Countervailing duty- imposed so as to bring the prices of imports on par with

domestic prices
Anti-dumping duty- imposed by the government whenever a country exports
the goods at a lower prices
 Features of Indian Taxation System

o Progressive-most of the taxes imposed by the government are in the form of
progressive taxes eg-Corporate tax, Income tax etc (but the overall taxation
system in India is regressive in nature)
o Complex- even though the various reforms have been implemented over a
period of time in India the taxation structure is considered to be complex with
respect to exemptions, filing etc
o Loopholes- there are various loopholes using which tax evasion is followed
o No tax on income from agriculture
 Some of the taxes

o Service Tax
 Introduced in 1994-95 with 3 services
 Levied by central government
 Gradually the list was expanded and covered more than 100 services
 From 2012 shifted to negative list approach
 2015 it was increased to 14% (inclusive of 3% education cess)
 Present rate is 15%
o Value Added Tax
 VAT is a multi-point tax collection wherein the producer/intermediary
will pay certain tax based on the value addition
 VAT-central VAT (CENVAT) and state VAT (Sales Tax)
 The offsetting is allowed in case of movement of goods either is in the
stage of value addition or in the process of being sold from one
distributor to another distributor
47
 The VAT was introduced in order to reduce the cascading effect
 CESS-
o Imposed as per the article 270
o Recent Cesses-Swachh Bharat Cess, Krishi Kalyan Cess
 Presumptive Taxation
o Refers to imposition of tax on the presumption that a certain
individual/entity/company earns/enjoys profits enough to be able to pay tax,
yet they avoid taxes. The government imposes taxes in such scenario referred
to as Presumptive taxation
o MAT
 MAT is a tax levied on profit-making entities that don’t pay corporate
income tax because of exemptions and incentives
 Tax levied on book profits
 FPIs completely exempted
 Justice A P Shah Committee recommended that FPIs cannot be levied
MAT
o GAAR (General Anti-Avoidance Rules)

 GAAR represents the codification of substance over form. These can be
used against the business decisions which avoid tax but are
camouflaged as a business driven decision (tax avoidance is abusive
form of tax planning complying with the letter but not the spirit of the
law)
 Before GAAR there were SAARs’ which were specifically applicable in
certain events such as transfer pricing, dividend stripping etc
 GAAR has been inserted as Chapter X-A in the Income Tax Act 1961
 These are a set of provisions which try and check tax avoidance. GAAR
would come into implementation from 1st April. Under this the tax
authorities are empowered to take action against tax policies/tools that
are used to avoid the taxes. The tax authorities have the power to re-
characterize, disregard the transactions to determine the actual tax
applicable on a transaction. Presently, the assesse has to prove his
innocence that the motive behind the whole transaction is not tax
avoidance but is one of the outcomes of the transaction. Under GAAR,
part of the transaction can be negated or re-characterized
48
 GAAR is applied to an IAA (Impermissible Avoidance Agreement-it is an

arrangement designed with the objective of avoiding the tax)
 It is not an arm’s length pricing
 It lacks commercial substance
 Results in the abuse of tax law
 The main purpose of the arrangement is obtain tax benefit etc
 The GAAR has a non-obstante clause (the provisions of GAAR can
override other provisions of IT act 1961)
 Three tier mechanism has been provided – Approving Officer, Principal
Commissioner and Approving Panel – to remove the arbitrariness from
the system. Once a case has been taken up, a period of six months has
been given to decide about the applicability of GAAR provisions
 Observations of Parliamentary Standing Committee
 GAAR gives arbitrary powers to tax authorities to challenge
complex deals
 Onus lies on the taxpayer
 Created uncertainty and ambiguity amongst investors
 Parthasarathi Shome Committee

 No retrospective application
 Deferred till 2016-17
 Not applicable on Singapore and Mauritius
 Not on intra-group transactions
 No short-term capital gains tax
 Rate of STT must be increased
 Problems with Indian Taxation System

o The income tax exemption limit has been periodically increased which has led
to more income tax payers being exempted. The last time it was raised from ₹
1,50,000 in 2012-13, as a result of this exemption government had to forego ₹
31500 crore
o Problems with coverage
 Only 5.5% of the income earners pay tax
 The ratio of tax payers to population in voting age comes around to 4%,
which should be more than 23%
o Government provides large tax exemptions to the corporate sector which is a
revenue foregone
49
o Indian Government under-taxes as well as under spends compared to the

developed countries
o As a result of presence of unorganized sector, more than 85% of the economy
is not covered under taxation
 Tax Expenditure
o It does not represent expenditure incurred by the government to collect taxes
o It refers to the opportunity cost of providing subsidies, exemptions,
concessional rates etc. it basically means how much more money in the form
of taxes would have been collected by the government if no exemptions were
provided. These exemptions are provided under the tax laws
o The central government during the presentation of the budget provides
details of the tax expenditure in the form of “statement of Revenue
Foregone”

50
GST (Goods and Services Tax)

The GST will be a revolutionary tax reform which will streamline the indirect tax structure in
India. Before India implements GST, throughout the world more than 140 countries have
shifted to GST (Malaysia implemented it in 2015).
GST bill was introduced (through 115th CAB) during UPA II, as the Lok Sabha was dissolved
the bill lapsed and the new NDA government has re-introduced it as 122nd CAB. The
features of the bill are
 It will be subsuming all the indirect taxes (some exemptions have been provided as of
now)
 It will be streamlining the taxation procedures (only indirect taxes)
 It will be a dual GST-central and state GST
 It will lead to creation of GST council
o Set up by the president
o Union Finance Minister + state Finance ministers
o Functions-model GST laws, taxes/surcharge/cess to be levied by the centre
and state, exemptions to be given etc
o GST council to decide regarding resolution of disputes
 It provides for the input credit across segments
 It further reduces the cascading effect
 The states loosing revenues will be provided compensation
 It will lead to formation of national market
GST vs. Old method
Old taxation method GST

Goods and services were taxed separately No differentiation between Goods and
services
Different states different tax rates Uniform tax rates across the country
National market not possible National market can be established
Tax on production (origin based taxation) Tax on consumption (target based
taxation)
Cascading effect No cascading effect
Many indirect taxes Only one
Setting off in some cases not allowed Setting off is allowed

51
Advantages of GST
 Overall
o It will lead to a unified national market by bringing in uniform indirect tax
rates, and bringing in certainty. GST would make doing business in India tax
neutral, irrespective of the choice of place of doing business
o It will be remove the cascading effect thereby removing the hidden cost of
doing business. This reduction in costs is expected to increase the
competitiveness.
 For companies
o GST will have a robust IT framework which will compliances such as filing of
registrations, returns, payments etc much more easy and transparent
 For Central and State Governments
o The multiplicity of taxes is being replaced by a single robust system with end-
to-end IT framework. This will make it easier and simpler to administer the
taxes
o Will lead to better compliance and increased revenues and also lower the cost
of collection of taxes (will lead to revenue efficiency)
 For the consumer
o Because of removal of cascading effect and efficient method of imposing and
collecting taxes, the tax burden will come down on the common man
Concerns of the states
 The compensation to be paid – the states want a mechanism to be laid down

regarding the payment of compensation (full) to be paid to them for the next 5 years
 The rate of GST
 Dispute Resolution Mechanism – in the original Bill there was a proposal to set up an
Independent Tax Dispute Settlement Authority but was watered down in the bill of
the present BJP government under which the GST council will have the power to set
up Dispute Resolution Mechanism on case-to-case basis. Some of the states agree to
this and some are not comfortable.
Subramanian committee
 The design of the tax must be correct hence it must simplify tax administration,
protect revenues and encourage compliance
 Three Rates-Standard rate (17% to 18%), Lower rate (12%), Sin rate/demerit rate
(40%). over a period, India must impose a single tax that would increase the
simplification and compliance
 The exemption of the goods and services under GST will lead to market distortions
and increased standard rate, hence the exemption list must be very narrow and
52
consist of the goods and services consumed by the poor. Hence alcohol, real estate
etc must be brought under GST
 The tax base of the central government must be the same as that of the state
government (as central government exempts around 300 goods whereas the state
governments exempt only 90 goods)
 1% Interstate GST should not be implemented as it will prohibit formation of national
market
 The shift to new tax regime may not lead to huge losses of the states, hence fair and
timely compensation must be provided by the centre to reinforce trust between
centre and states
 GST implementation must be evaluated every 1 or 2 years
Hurdles in implementing GST in India
 Deciding the tax rate (there is a huge debate going on regarding this and the FM has
said it would be decided by the GST council)
 Inflationary pressures
 Promoting the adoption amongst the small companies
 Training tax collectors (as per one of the estimates there is a need to train 60000 tax
collectors), IT backbone, bringing the companies up to speed
 Deciding the threshold (annual turnover of the company beyond which the GST will
be applicable-Centre and some states are vying for ₹ 25 lakh whereas others want it
to be ₹ 10 lakh)
 GSTN (GST Network)- it’s a SPV formed by the government wherein the central
government and the state governments hold 24.5% stake each and remaining 51% is
held by the private companies HDFC Bank, HDFC Ltd, ICICI Bank, NSE Strategic
Investment Corporation and LIC Housing Finance (some of them have a significant of
foreign holding). The argument is that the tax information is very sensitive and
should completely come under the control of the government. The GSTN provides
the IT framework/backbone for the implementation of the GST.
GSTN will be set up as a section 25 company and its functions will involve
o Common IT infrastructure to central & state governments, tax payers and
other stakeholders
o Back end services to be provided to the state/central tax department
Global Experience of GST implementation
 The rationalization of tax rates has been the biggest hurdle in various countries. The
only country which has successfully implemented dual GST with rationalized rates is
Canada which varied the tax rates many a times even after the implementation.
53
 In some of the cases it has been observed that the implementation of GST has led to
inflationary spikes (in 1994, when GST was introduced in Singapore, it led to
inflation)
 Difficult to make the businesses comply with new tax regime. It was observed in
Malaysia that there was a huge resentment from the business community to adapt a
new tax regime even after giving more than 1.5 years. With very less time remaining
in India (to be implemented from 1st April 2017) it makes the task more challenging
(in Malaysia, sector specific papers regarding practices were published which
provided a smooth passage)
 The infrastructure, training etc. if not implemented well enough could lead to
problems with small, medium enterprises, delay input credits etc.
 Has been regressive in some instances i.e. it has more impact on the poor rather than
rich
The GST tax rates
 Necessity of having multi-tiered structure
o There are too many groups of people using too many goods. Hence based on
the goods used by these groups different tax rates are needed
o The government needs to maintain revenue neutrality
o It may lead to inflation (if all/majority of the commodities used by poor are in
higher slab)
o It may also become regressive in nature
 Disadvantages of having multi-tiered structure
o Administrative difficulties
o Goes against the central idea of GST-One Nation, One Indirect Tax
o May lead to inflation
 Worries about the present tiered structure and commodities allocation
o It looks like a rejig of the present clumsy excise tax structure. Such a complex
structure will result in tax disputes, lobbying and corruption in the future
o A better structure would have provided more benefits to the economy (as per
the HSBC India chief economist Pranjul Bhandari the addition to economic
growth in the medium term will be 0.4 percentage points, rather than 0.8
percentage points from an ideal GST structure)
o Complicated tax structure will increase the compliance costs especially for
small businesses
GST and Anti-Profiteering

 India is not the first country to introduce such provision (Malaysia, Singapore,
Australia etc are some other examples)
54
 The government amended the GST bill (inserted Clause 171), which provides that it is
mandatory to pass on the benefit to the customer which might be accrued as a result
of reduction in rate of tax or from input tax credit in the form of reduced prices
(“commensurate reduction in the price of goods”)
 The provision further provides for an authority (to be appointed by the central
government on recommendations from the GST council) in order to ensure that the
benefits are transferred. As per this the draft rules issued by the government,
National Anti-Profiteering Authority (NAA) has been proposed
o The authority will have 5 members
o It will be headed by a current or retired Secretary level officer, plus four
technical members that are or were Commissioners of State or Central Tax (or
its equivalent)
o It will be supported by a Standing Committee (made up of Centre and State
officers), plus state level Screening Committees in every state (comprised of
one officer of the State concerned and one from the Centre)
o The authority will be in existence for two years (the CEA had recommended a
sunset clause of nine months)
 The problem so far has been that there is no clarity as to what procedures must be
followed by the companies and what they are supposed to do. Some of the examples
of the curious questions which are to be answered are
o How will businesses compute the benefit resulting from increased credits and
reduction in rates?
o Will it be calculated at a company level or product level?
o Will it be a net profit or gross profit?
o Additional expenses incurred because of the implementation of the GST can
be included in arriving at the benefit? Etc
 These confusions exist despite the government releasing the Anti-Profiteering draft
rules 2017 (the only thing that is clear is that the companies will be penalized if found
guilty of not transferring the benefits). The document misses on the definition of the
anti-profiteering
 Other Worries/concerns
o The term “commensurate reduction” is not defined
o The complete lack of information regarding how the rules will be
implemented has added to the uncertainty and confusion
o The prices of the goods are determined taking into consideration various
other factors
o The authority to determine the prices may be forced to look into the balance
sheets of the companies
o Witch hunting by the authorities (usually small companies will be harassed as
cancellation of licenses of bigger companies will lead to ripple effect)
55
Other Initiatives
 TPRU and TPC
The Tax Administration Reforms Council (TARC) which was headed by Parthasarathi
Shome has made the following observations
o In the present scenario there are multiple bodies which give
recommendations-CBDT, CBEC
o The revenue secretary is not a tax expert but takes the call regarding these
taxes
o There is a lack of co-operation between CBDT and CBEC; and the selection of
members is based on seniority not on expertise
o India has one of the highest number of disputes and lowest rate of recovery of
tax arrears
o There’s absence of research based policy and impact assessment studies; and
ICT benefits have not been reaped
Hence the TARC has given the following recommendations
o The Pre-filing of tax returns must be made available to all the individuals
o CBDT and CBEC must be integrated in the next 10 years
o Post of Revenue Secretary must be abolished and the functions must be
allocated to two boards
Governing Council – to oversee the functioning of the two boards
Tax Council – to suggest policy and legislation
o There should be focus on specialization
o Retrospective legislation should be avoided
o Both the boards must start a drive to liquidate the current the current cases
The Ministry of Finance announced the formation of the Tax Policy Research Unit
(TPRU) and the Tax Policy Council (TPC) on February 2, 2016
TPRU – Tax Policy Research Unit

o Functions
 Conduct studies on issues of fiscal and tax policies referred to it by

CBDT and CBEC and will provide independent analysis of such issues
 Will prepare and disseminate policy papers and background papers on
various tax policy issues
 To assist Tax Policy Council chaired by FM in taking appropriate tax
policy decisions
56
 To co-operate with State Commercial Tax Departments.
Tax Policy Council

o The Tax Policy Council will look at all the research findings coming from Tax
Policy Research (TPRU) Unit and suggest broad policy measures for taxation.
o The Council will be advisory in nature, which will help the Government in
identifying key policy decisions for taxation.
o Tax Policy Council under the Union Finance Minister with 9 other members
will be constituted

57
Savings, Investments and Capital formation

 There is economic growth in any economy when the people rearrange the resources
in such a way that leads to more value. With such rearrangement the production of
goods and services get expanded/increases in an economy. This expansion is referred
to as growth. It is also referred to as increase in the national output (or income or
per capita)
 This rate of growth depends on various factors such as Investment, availability of
technology, skilled labour availability etc
 Savings and Investments
o Out of the total earnings made the economy uses part of it for immediate
consumption and rest is used for future consumption. The latter part is
referred to as savings, and this savings will lead to investment and capital
formation
o Investments in an economy are done either by internal sources (government,
households and companies) or through external sources such as FDI. the
classification can also be done in the form of Public Investment (done by the
government and its agencies) and private investments (done by households,
foreign sources, domestic private companies etc)
o Capital refers to machines, tools and equipments etc. any further addition to
this stock over the period of time is referred to as Capital Formation
 Rate of Capital formation = (Investments / GDP) * 100
o Gross Capital Formation has two components
 Gross Fixed Capital Formation - buildings, roads, machines, tools and
equipments etc
 Stock / Inventory - materials and supplies, intermediary goods, finished
goods etc
o Present situation
 Of the total savings in India
 More than 60% comes from the households (again within this
majority of it is the physical savings)
 More than 30% comes from the private sector
 Remaining small proportion comes from the public sector
(government)
o Trends
 The slowdown in savings and investment started in 2010 and 2012
respectively. The current slowdown (both-saving and investment) is a
first in India’s history. The reasons for such slowdown are
 Global factors
 Twin balance sheet problem
 Public policy paralysis
 Inflation rate

58
 Issues such as land acquisition, clearances from the government

etc
 The private investment accounts for 5 percentage points out of 6.3%
percentage points investment decline between FY08 to FY16
 The fall in the savings in the same period has been around 8 percentage
points which has been mainly driven by an equal decline in the savings
in public and households. The fall in the household savings has been
driven by the decline in the physical savings (although part of it has
been offset by increase in the holdings of financial assets)
o So what should be given higher priority-policies to promote investment or
policies to promote saving? And What is the solution for this?
The standard solution prescribed has been to tackle both the issues
simultaneously. Having said so there is also evidence from a survey which
proves that the successful economic performance is not explained by saving
transition episodes. Rather in such countries there seems to be evidence that
successful economic growth transitions have led to sustained higher rates of
saving to boost growth
Cross-country comparison shows that the relationship is significantly positive

for investment episodes, but insignificant for saving. A one percentage point
fall in investment rate is expected to dent growth by 0.4-0.7 percentage
points. These results are robust to different time periods and specifications (in
certain cases it has also been found that the relationship between fall in
private investment with growth is positive and significant)

59
Poverty
 Poverty is a situation under which part/section of the society is unable to meet the
basic necessities of life such as food and shelter. The state of poverty has two
dimensions-material and non-material (both influence and re-enforce each other). In
case of material deprivation poor do not have access to food, cloth, shelter etc and in
case of non-material they are discriminated against. If such a population is very large
then it is referred to as mass poverty (feature of developing and LDCs). The mere
attempt to define poverty is an indicator that there is an existence of inequality in
the society and another problem with measurement is that most of the times it just
considers minimum level of living rather than reasonable level of living (i.e. whether
normal or effective existence). Having said so a country like India has to be focused
on minimum level of living as the percentage of population that falls in poverty is
considerable and keeping higher levels might be unrealistic, increase the burden on
the state and bring up financial issues.
 Causes behind poverty

o Population- on an average India adds about 17 million to its population. This
addition of population puts a huge pressure on agricultural production. On the
other hand this increase in population also leads to higher pressure on
infrastructure, urban migration etc
o Income gap or Inequality in the incomes is increasing – as per Credit Suisse
Report 2016, the richest 1% of Indians collectively own a total wealth of 58.4%
in India (This was 53% last year)
o Social factors which enforce certain irrational norms/taboos lead to spread of
poverty
o Lower employment generation
o Lower agriculture productivity
 In measurement of poverty two standards are usually used

o Absolute poverty or Subsistence poverty- minimum consumption bundle is
arrived at and then converted into the monetary terms. Population that
spends below this level is considered to be poor
o Relative poverty- since it was difficult to fully accept the concept of absolute
poverty, concept of relative poverty is also developed. Under this poverty is
measures based on the standards of life at a given time and place

60
 Types of Poverty
o Chronic Poor- usually consist of those who always fail to satisfy the needs and
those who are sometimes able to satisfy some of the needs (casual labour)
o Transient Poor- who keep on moving in and out of the poverty (eg-small and
marginal farmers, agriculture labour etc) and those who once a while fall
under the poverty because of some factors such as lower demand in the
market, outdated use of technology etc
 Causes of poverty
o Population – Population explosion has led to very high dep
o Dependence of agriculture – 49% of labour is dependent on agriculture. The
sector is dependent on so many factors and the returns have been volatile
o Inequality – higher income inequality is created because of capitalistic
economy. It means that income distribution is not inclusive which could also
to incidence of poverty. Such inequality will also lead to social inequality
o Vicious Circle theory – the theory argues that poor are trapped in situations
which makes it difficult for them to escape from poverty. For example, poor
do not have sufficient food, which affects their productivity and if they fall ill,
it again has an impact on their income earning capacity
o Geographical factors – the geographical conditions where people live also
have an impact on poverty. For example people living in desert, drought prone
area etc
 Measurement of Poverty
o The first step in estimating the incidence of poverty is to define what the
Poverty Line (PL or threshold expenditure) is. This is usually measured at
individual or household level. It represents the amount necessary to purchase
a basket of goods and services which will satisfy the basic needs at socially
acceptable levels. This basket is referred to as PLB (Poverty Line Basket)
The PL is usually used to achieve three objectives

 Identification of the poor through a comparison of the poverty
 Tracking poverty in a region over time and comparing it across regions
 To estimate the required expenditure on poverty eradication programs
and their allocation across regions.
o Poverty Ratio or Head Count Ratio or Incidence of Poverty measures what

percentage of the population falls below poverty line. It can be used to
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compare the poverty situations in various/different areas but has certain

inherent drawbacks- it cannot measure how many of the poor are living in
abject poverty, differentiation based on levels of consumption cannot be
done. Hence the HCR/PR/IP fails to measure the depth or the severity of
poverty
Population below poverty line

𝐈𝐧𝐜𝐢𝐝𝐞𝐧𝐜𝐞 𝐨𝐟 𝐏𝐨𝐯𝐞𝐫𝐭𝐲 = × 100
Total Population
o PG Index (Poverty Gap Index) is a measure of intensity of poverty. It

measures on average how far the poor fall from the poverty line. calculates
the total shortfall of consumption below the poverty line and then expressed
as a percentage of the poverty line
PL − Per Capita consumption of Poor

𝐏𝐆 𝐈𝐧𝐝𝐞𝐱 = × PR × 100
PL
PL=Poverty Line; PR=Poverty Ratio

o The enumeration is done by the NSSO using consumption bundle list or PLB.
The enumeration till Tendulkar committee was usually through URP (Uniform
Recall Period-expenditure by a household on food and non-food items in the
last 30 days) which has been switched to MRP (Mixed Recall Period-
expenditure on food items in the last 30 days and on non-food items-clothing,
footwear, durable goods, education, institutional medical expenses- in the last
365 days). Recently under Rangarajan committee it has been further changed
to MMRP (Modified Mixed Recall Period-7 days, 30 days and 365 days)
 Committees set up by PC
o Working Group (1962)
o Alagh Committee (1979)
o Lakdawala committee (1993)
o Tendulkar Committee (2005)
o Rangarajan Committee (2012)
 Working Group 1962

o Set up the committee under Dr Gadgil
o The committee took into consideration the recommendations of balanced diet
made by ICMR in 1958 and arrived at a poverty line
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o In case of Urban India consumption was fixed at Rs 25 per person per month
and in case of rural it was fixed at Rs 20 per person per month (at 1960-61
price). It was assumed that the education and health would be provided by
the state hence were not considered as a part of the consumption bundle
o This was widely used in 1960s and 1970s to estimate poverty
 Alagh Committee (1979)

o The Planning Commission in 1977, constituted a Task Force on Projections of
Minimum Needs and Effective Consumption Demand under the Chairmanship
of Dr Y. K. Alagh.
o The Task Force defined the poverty line as per capita consumption
expenditure level, which meets the average per capita daily calorie
requirement of 2400 cal (Rs 49/p/m) in rural areas and 2100 cal (Rs 56/p/m) in
urban areas.
o The consumption levels were decided based on the recommendations given
by the Nutrition Expert Group in 1968.
 Lakdawala Committee (1993)

o This committee did not form a new poverty line rather it used the one defined
by Alagh committee
o The committee disaggregated the rural and urban poverty lines for each of the
states (this was a major departure from the Alagh Committee which used
national poverty line). Hence this captured cost of living in the states more
accurately.
o For adjusting the price levels, the committee used CPI(AL) for the rural
poverty line and CPI(IW) for urban poverty line
o The committee estimated the poverty lines for 18 states
o The PC used the same poverty line to estimate the poverty till 2011
 Tendulkar Committee (2005)

o was set up in 2005 and submitted the report in 2009
o it did not construct a new poverty line basket, rather took the poverty
estimations based on Lakdawala committee and converted this poverty line
from URP based to MRP based
o background for the setting up of this committee
 PC estimated that there was a drop of poverty by 400 bps (fell from
26% to 22% from FY2000 to FY2005)

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 As per the survey conducted by NFHS-45% of children were

undernourished and 60% of women are anemic
 N C Saxena committee on Rural Poverty estimated that about 50% of
rural population is BPL
o Reasons for setting up the committee
 The PLB which was formed in 1973-74 hadn’t been changed, it required
certain changes because the consumption patterns had changed
 There were differences in the prices temporally and spatially hence
these had to be accounted
 Most importantly earlier poverty lines presumed that health and
education were provided by the state which had changed
o The committee made certain important changes
 Nutrition or calorie norm should not be the only consideration
 Inclusion of expenditure on education, health etc
 Common poverty lines for urban and rural
 Collection of data through MRP
 Price differences between Rural and Urban to be accounted by using
Fisher’s Price Index (is an index formula used in price statistics for
measuring the price development of goods and services, on the basis of
the baskets from both the base year and the current year)
o It concluded that in 2004-05, the population BPL was
 Rural-41.8%
 Urban-25.7%
 Overall-37%
At poverty line of Rs 33 and Rs 27 in Urban and Rural area respectively
 Rangarajan Committee (2012)

o Was set up with a background when PC announced a new poverty line of Rs
22 and Rs 28 for Rural and Urban areas respectively
o Important objectives of the committee were
 To provide an alternative method to estimate poverty levels and
examine whether poverty lines should be fixed solely in terms of a
consumption basket or if other criteria are also relevant
 To examine divergence between the consumption estimates based on
the NSSO methodology and those emerging from the National
Accounts aggregates

64
 To review international poverty estimation methods and indicate

whether based on these, a particular method for empirical poverty
estimation can be developed in India
 To recommend how these estimates of poverty can be linked to
eligibility and entitlements under the various schemes of the
Government of India
o Methodology
 The poverty line should be based on certain normative levels of
adequate nourishment, clothing, house rent, conveyance and
education, and a behaviorally determined level of other non-food
expenses.
 Arrived at a consumption expenditure of Rs 7035 and Rs 4860 per
month, for urban and rural areas respectively, for a family of 5.
 This was arrived at by considering consumption of three nutrient norms
 Calorie consumption of 2090 and 2155 for urban and rural (with
an average band of ±10% variation)
 Protein consumption of 50 gms and 48 gms in urban and rural
areas
 Fat consumption of 28 gms and 26 gms urban and rural areas
 MMRP (Modified Mixed Recall Period)
 365-days for clothing, footwear, education, institutional medical
care, and durable goods
 7-days for edible oil, egg, fish and meat, vegetables, fruits,
spices, beverages, refreshments, processed food, pan, tobacco
and intoxicants
 30-days for the remaining food items, fuel and light,
miscellaneous goods and services including non-institutional
medical; rents and taxes
 Criticism against the Planning Commission methodology

o The consumption basket was the same for all the states. This is not true when
the consumption patterns are studied across the length and breadth of the
country.
o The same poverty line is applied pan India. This would be applicable if all the
states were at the same level of economic growth

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o The consumption basket has remained unchanged for most periods. The
consumption expenditure will change along with change in income,
preferences and tastes etc
o The adjustment factors are contested by many experts
 So has growth led to reduction in poverty?

Growth has to be rapid and sustainable if the poverty has to be reduced effectively.
The growth plays two important roles. On one hand it leads to employment
generation leading to increases in the wages/income/salaries. This will increase the
demand for consumer goods and merit goods such as education and health, finally
improving the quality of life.
On the other hand higher growth will increase the revenues of the government,
which it can use to provide support to the people BPL such as MGNREGA, NFSA etc.
Studies have proven that poverty reduction closely tracks the income changes. In
case of India we started out as a country with very low per capita income but during
the period from 2000 to 2013 the PCI has been one and half times the PCI of second
half of last century. Further post reforms the GDP growing steadily at higher rates
especially in the period of FY05-FY12 and post reforms poverty has declined and
more sharply in the period of FY05-FY12.
 Should India have gone directly to redistribution of wealth without waiting for
growth to happen? Or was the trickle down approach of the government post
Independence a wrong strategy to eradicate poverty?
A country can always take care of poverty either by redistributing the wealth or by
promoting growth or doing both simultaneously. The strategy of only redistribution
of wealth helps when the country has been on the higher growth rate or industrial
productivity is high. In this scenario the government need not worry as the growth
will be either stable or even if there is a downturn, it will resume, with some support
of the government.
But the case of India is completely different, in words of an expert “in India there
were too many exploited and too few exploiters”. So even if the decision of only
redistribution could have been politically feasible, eliminating poverty with only that
measure was economically impossible. Hence the government had to push/promote
for growth along with opting for re-distribution (also consider other mitigating
factor-increasing population)
Having said so it cannot be said that government only focused on growth and
ignored poverty. Although the whole strategy of the government since the 2nd FYP

66
has been centered on growth, poverty was always a subsidiary objective and there is
ample evidence to prove it.
o In his book-The Discovery of India-Jawaharlal Nehru has said that during
various deliberations of NPC (1938), the committee did not consider any plan
without attaching a social objective to it (mainly poverty reduction)
o The First FYP stated that the present need for the social and economic change
is because of the fact that there is poverty and inequality. The elimination of
poverty cannot be achieved only through redistribution or through only
increasing production. The two have to be considered together
 How to reduce Poverty

o Short term- majority of population is involved in agriculture, majority of rural
households are dependent on agriculture and allied sectors. Hence in short
term focus on giving more returns to agriculture
o Long term- the long term solution has to be employment generation in
manufacturing and services. The increased GDP growth always reduces the
%age contribution of agriculture and increases that of manufacturing to GDP.
So if the poverty has to be eliminated in the future, the domestic economy has
to generate employment opportunities
o Rural poverty alleviation- majority of population resides in rural India. The
government has to promote stronger connection between primary and
secondary sector so that the poverty can be reduced
o The government has to promote women participation in labour force. It has
been observed that women participation is only one third of its population
and has been on declining trend since 2005
o Usage of technology- the government has to utilize, various ICT tools so as to
improve the efficiency of subsidies (coverage, targeting, reduce leakages etc)
 Poverty and World Bank

o Extreme Poverty is defined by UN as a condition wherein there is deprivation
of basic human needs such as food, safe drinking water, sanitation, health,
shelter
o The World Bank is the global institution which is involved in fighting poverty.
In 2015, it has revised the poverty line from US $1.25 per person per day (on
PPP basis) to US $ 1.90 per person per day (at 2011 prices). As per this
estimation, less than 10% of the total world’s population (i.e. around 800
million) lives in poverty. This is the reduction from over a billion poor in the

67
last decade. Half of the poor live in sub-Saharan Africa and one third live in
south Asia
o As per the report in 2016-Poverty and Shared Prosperity-the poverty has
declined and growth is necessary for eradicating extreme poverty by 2030
(one of the goals under SDG). Three countries-china, India and Indonesia have
led the fight in reducing the extreme poverty. According to the report India
heads the list of countries with highest population living in extreme poverty
(around 224 million followed by Nigeria with 86 million)
In case of inequality, the report states that the inequality across the countries
and in certain cases within the countries have been declining since 1990 and is
especially visible post 2008 crisis
 Poverty estimates – MPI (Multi-dimensional Poverty Index)

o The MPI looks at the multifaceted nature of poverty. It identifies people’s
deprivations across three key dimensions – health, education and living
standards
o In a decade after 2005-06, around 270 mn people in India have moved out of
poverty and the poverty rate has nearly halved (from 55% to 28%)
o This has been provided as per the Multidimensional Poverty Index released by
UNDP and Oxford Poverty and Human Development Initiative (OPHI)
o As per this report around the world 1.3 bn people live in multidimensional
poverty
o The traditional measures of poverty measures how many are unable to meet
the standards i.e. who earn lesser than $1.90 per day whereas MPI provides
information about the ways through which people experience poverty (in the
form of access to health, education, electricity, sanitation etc)

68
Employment
India is said to be having an advantage over rest of the world in terms of demographic
dividend (population in the working age) till the end of 2035-40. Although the population is
available the government faces two issues here-providing skill sets and creating good jobs
(security, well paid and provide scope for acquiring new skills). Let’s understand the
situation of employment in India
 The whole of population can be divided into

o Workers/Labour Force
 Employed-those who are willing to work and get work for which they
are paid. They contribute to the economic activity and growth of the
country
 Unemployed- those who are willing to work and but do not get work.
The society does not utilize the skills that these are offering
o Non-workers
 Those who do not have the willingness or ability to work (eg-senior
citizens, children etc)
 Types of Unemployment
o Frictional/Functional-this kind of unemployment is created when a person is
in the process of switching jobs. Under this the person is unemployed on his
own will
o Structural-the unemployment is created when there is a structural change in
the economy
o Cyclical-because of the economic cycles (expansion, boom, slowdown,
recession)
o Seasonal –because of change in the seasons, there is unemployment
o Disguised unemployment-it is more of a feature of traditional sectors wherein
more workers are involved in doing the work, but there is no incremental
production (eg-agriculture in India)
The unemployment under Frictional and Structural is referred to as Natural Rate

(referred to as natural because whenever there is an economic growth there is
bound to be these two types of unemployment)
 Measurement
o Is done by NSSO
69
o For measurement different activity status can be used

 Usual Principal Status-unemployed if he has not worked for majority of
days in the last one year
 Current Weekly Status-unemployed if he has not worked for at-least
one hour in the last one week
 Current Daily Status-based on the number of working hours the man
working days are calculated
1 to 4 hrs-Half Person Day
4 or more hrs- Full Person day
 Labour Force Participation Rate (LFPR)
 Unemployment Ratio
 Worker Population Ratio (WPR)
 Proportion Unemployed (PU) Ratio
 LFPR=WPR+PU
 WPR
o WPR in India has been low and has been declining (but compared to other
developing countries it is better)
o It means
 People dependent on the working population is increasing
 Low availability of skilled labour
 Low skill availability and increasing population will keep on reinforcing
each other leading to higher poverty

70
o Causes of low WPR

 Youth population is very high (37.25% as per census 2011)
 Working population of women is on the decline
 The adult women working population is low (in developed countries it
is around 40% whereas in India it is around 20%)
 Employment Elasticity (EE)

Growth Rate of Employment
o EE = Growth rate of GDP
o It is the %age change in employment of labour force in response to %age
change in growth
o A higher value of EE is preferred
o If growth is happening with increasing employment then EE must be
increasing
o The simple concept is that whenever growth occurs we assume that the
secondary and tertiary sectors are contributing the highest and both these
sectors are creating employment which will absorb the available workforce
and if growth is happening and employment is not increasing, then it is
referred as jobless growth (the current scenario in India)
o The growth in the last decade has been on an average around 6-7% but the
employment generation has been on a lower side. Hence what we observe is
that EE is on the lower side and to corroborate this, the growth generation in
the 8 key labour intensive sectors has been very low (those 8 sectors are-
textiles, leather, metals, automobiles, transport, handloom, IT/BPO, gems and
jewellary
Year EE
1972-77 0.57
1999-04 0.50
2004-09 0.01
2009-11 0.18

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Year Employment
generation in 8
sectors (in mn)
2009 1.3
2010 0.9
2011 0.92
2012 0.3
2013 0.4
2015 0.1
 Labour Issues in India

o Anarchic Labour laws or Inspector Raj
o Informalization of Labour
o Skewed employment
o Quality of Labour/employment
o Lower women participation
Anarchic Labour laws

o India has more than 200 labour laws and most of these laws are
regressive/time consuming/biased in favor of employees/ vague or lead to
problems for the companies implementing these laws hence one expert has
remarked “you cannot implement 100% of the Indian Labour laws without
violating 20% of them”
Trade Unions Act-firms with 7 or more workers can form trade unions but the
problem is that it allows for the formation of multiple trade unions (for eg-
Neyveli Lignite Corporation has more than 50 trade unions)
Factories Act 1948- limits the maximum number of work hours to 48 per
week, repainting every 5 years, maintaining attendance registry etc
Indian Disputes Act 1947- regulates retrenchment/ termination/ dismissal/
discharge etc. for doing these there is a need to get the permission from
Labour inspectors (which is most of the times rejected).
Informalization of Labour
o It is the movement of labour from formal to informal sector. The movement is
very crucial as in case of formal employment the employee enjoys security,
good pay and perks etc whereas in the latter there is no security, no perks,
low pay etc.
o Of the total workforce only 8% of it is in the formal sector

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o The reasons are

 More and more workers are joining unorganized sector compared to
organized sector (organized refers to industries related to modern
economy and unorganized refers to industries related to traditional
economy)
 Competition scenario-as there is a price war in the market, the
producer would want to lower the costs of production without
reducing the production volume hence easy way out for him is to hire
more and more informal workers
 The rigid/anarchic labour laws in India have become the biggest hurdles
in firms hiring more formal labour
 The Casualisation of workforce is on the rise-the workers are being
hired in the form of contract labour rather than full time labour. Post
1991 reforms the use of contract labour has increased (in 1999,
manufacturing employed 12% contract labour which in 2010 increased
to 25%). The companies prefer contract labour
 It is easy to hire and fire
 The responsibility of these labour falls on the contractor and the
aim is to keep the firm size lower so that it can extract all the
exemptions
 The financial stress on the firm is low
But the drawback of hiring a large number of contract labour is that the
contract labour have no loyalty to the firm and the hiring of contract
labour has been found to be more expensive than the full time labour
(14% more expensive)
Skewed Employment
o The majority of employment in India is concentrated in the agriculture
o Majority of employment in case of manufacturing is in the industries with
lesser than 49 employees (whereas in case of china, the majority of the
employment is concentrated in the companies having more than 200 workers)
o The prominent reasons for this is that the employees do not want come under
the regulation of labour laws and the workers available for hiring are not
having the appropriate skill sets
o Missing Middle Hypothesis-Industries in developing countries are dominated
by large number of micro-enterprise and small number of large enterprises
(and hence there is a disproportionate representation of small and medium

73
enterprises). This is a result of inspector raj (labour regulations) and fiscal

incentives determined by turnover of small scale enterprises.
Quality of Employment
o It is said that only around 10% of the labour in India has got any exposure to
skill sets whereas in the developed countries the skilled labour is abundantly
available
o The problem with this is that either the worker will be underemployed or if he
gets the job he will be underperforming and neither of them is preferred
o To counter this the government of India has introduced Skill India Mission,
amended Apprentices Act etc
o National Apprenticeship Promotion Scheme
 Scheme provided with Rs 10000 cr
 50 lakh apprentices to be trained by 2020
 Under the scheme, the Ministry of Skill Development and
Entrepreneurship will share 25 per cent of the total stipend payable to
an apprentice with employers
Lower participation of women

o Of the total workers in the age range of 18-29 years, 70% are male
o The working population of rural women has come down
o The adult women working population is low (in developed countries it is
around 40% whereas in India it is around 20%)
 Some of the steps that could be taken by the government

o Provide Skill sets to the workers
o Facilitate creation good quality jobs (security, payment and scope for growth
by acquiring new skill sets)
o Revamp the labour laws
o Provide for Bankruptcy
o Provide for ease of doing business
 In June 2016, the government has taken the following decisions

o The capacity of ITIs to be further increased from 1.85 million to 2.5 million in
the next one year
o At least 5,000 new ITIs will be created (India has more than 13,000 ITIs right
now catering mainly to manufacturing sector)

74
o A Central Board for Skills Certification to created and will be the assessment
and certification body for skill trained people.
o 15 million people to be skill trained in 2016-17.
o The government to set up 50 Overseas Employment Skill Training Centers in
those countries where Indians migrate as it helps in a structured export of
human resource to other countries
o Profit-making PSUs will be mandated to scale up apprenticeships, up to 10% of
the total manpower, over the course of this year (even the private
corporations are also expected to follow suit).
o Traditional skills will be recognized, nurtured and promoted through informal
apprenticeships, under various programs.
o Proper skill mapping and identification of the future requirements for skills, so
that schoolchildren and parents are well aware of the emerging trends in the
job market.
o The Central government to run a national competition called ‘India Skills’ “to
recognize the skills of India’s youth”. It will organize 500 formal job fairs and
make skill training aspirational right from the school level.
 New methodology for Labour Survey (September 2016)

o Previously government focused only on 8 industries but now this has been
expanded to 18 sectors and sub-sectors including services
o Basically these sectors would make up the non-agricultural labour market
o Quarterly surveys covering 10000 industries (5 times larger than the coverage
in the previous methodology)
 Skill India Initiative

o Aims to provide skills to 40 cr people by 2022
o Tag line-Kaushal Bharat, Kushal Bharat' (Skilled India, Successful India).
o Includes Pradhan Mantri Kaushal Vikas Yojana (PMKVY) scheme, the Skill Loan
scheme, National Skill Development Mission, and National Policy for Skill
Development and Entrepreneurship 2015
 Pradhan Mantri Kaushal Vikas Yojana (PMKVY)

o Implemented by the Union Ministry of Skill Development and
Entrepreneurship through the National Skill Development Corporation (NSDC).
o To provide skills training to youth and aims to cover about 24 lakh people
(even the class 10 and 12 dropouts will be covered).
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o Of the 24 lakh, 10 lakh will be awarded certification of RPL (recognition of

Prior Learning)
o Schemes to aligned with flagship programmes such as Make in India, Digital
India, Swachh Bharat Abhiyan etc
o The skill training will involve soft skills, good work ethics, personal grooming,
behavioral change for cleanliness etc.
o The skill training to be provided based on demand assessed by NSDC on skill
gaps (for the period 2013-17)
o Fund Allocation is 1,500 crore rupees
 Skill Loan scheme

o Loans ranging from Rs 5000-1.5 lakh will be given to 34 lakh youth seeking to
attend skill development programmes over the next five years.

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Financial Markets
 Financial markets facilitate the movement of funds from surplus sectors to the
sectors which are deficit of finance. The financial markets consist of primary market,
secondary market, debt market, banks, government, household etc
 The structure of financial market

o Money Market - the funds are raised for a period of lesser than one year
 Repo and Reverse Repo - repo is the RoI (Rate of Interest) that RBI
charges on the short term loans that it gives to the banks. Reverse
Repo is the RoI that the banks will charge on the short term loans that
they give to RBI
 Call Money Market - is the market wherein, banks will lend to other
banks for a short period.
 Commercial bills - when the trade is on credit, CBs are drawn by the
seller in the name of buyer (usually for a period of 3 to 6 months). The
CBs can be traded by the seller with the banks (the value of the CB is
discounted at bank rate)
 Commercial Papers - are issued by corporates with a short maturity
period. These are more riskier and hence only the listed companies
satisfying certain guidelines are allowed to issue
 Certificates of Deposit - similar to fixed deposits. The funds are given
for a prefixed period of time and at a prefixed interest rate. These are
tradable
 Treasury Bills -are issued by RBI on behalf of the government. The
maturity period is lesser than 1 year
Role of money market - plays a key role in liquidity management of banks and
in implementation of monetary policy. It also provides liquidity in the market,
maturation or development of money market smoothens the implementation
of monetary policy and is in the best interests of all the stakeholders.
o Capital Market-funds are raised for a period greater than 1 year. Capital
market plays an important role as it promotes savings and investments from
the retail investors, provides access to credit for the corporations in turn
promotes the industrial growth, access to foreign investments etc
 Debt Market- here the company raises funds but comes under a
liability. The instruments that are usually used are bonds and

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debentures. The bonds yield guaranteed returns and are less risky
whereas, the debentures yield higher returns compared to bonds
hence the risk is higher
 Equity Market- companies raise funds by giving away, ownership/stake

in the company. In this market, the company issue shares. The shares
are issued for the first time in the primary market, whereas, the issued
shares are sold and bought in the secondary market. The shares could
be issued through IPO (Initial Public Offering) and FPO (Follow on Public

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Offering). In the IPO, the company would be issuing the shares for the
first time (or the ownership will shift from private to public, even a
common man can holds the shares of such company now) and gets
listed on the stock market. Any subsequent issues of the shares of the
same company are referred to as FPO.
The company can either go for IPO or the Private Placement, wherein
there will be fewer buyers of the stake that is being offered by the
company
 BSE (Bombay Stock Exchange)

o Is the oldest Stock Exchange in Asia with a rich heritage.
o BSE was established in 1875 as “The Native Share & Stock Brokers”.
o First Stock Exchange in the country to obtain permanent recognition in 1956
from GOI.
o More than 5000 Indian companies listed with Stock Exchange.
o The BSE or Bombay stock exchange sensitive Index (Sensex) is a value
weighted index. Composed of 30 stocks with the base April 1979=100.
 NSE (National Stock Exchange)

o In the year 1991 Pherwani Committee recommended to establish National
Stock Exchange (NSE) in India.
o The company operates a nation-wide, electronic market, which offers trading
in derivatives market, capital market and currency derivatives segments
including equities, equities based derivatives, equity based exchange traded
funds (ETF), gold ETF, currency futures and options and retail government
securities.
o The exchange has more than 1,600 listed members.
o The base year for calculation is 1995

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 SEBI(Securities Exchange Board of India)-

o Was set up in 1988 and was given a statutory status in 1992 (SEBI act 1992)
o The main objective of setting up of SEBI has been to protect the interests of
investors’ in securities and to promote the development of, and to regulate
the securities market and for matters connected therewith or incidental
thereto.
o Has been strengthened with each crisis in the capital market
o Functions of SEBI
 Regulate stakeholders in the stock market
 Registering and Regulating Collective investment schemes, mutual
funds, venture capital funds etc.
 Prohibiting fraudulent and unfair trade practices such as insider
trading in securities
 Promoting investors’ education and training of intermediaries of
securities markets.
 Regulates FIIs
 FSLRC (Financial Sector Legislative Reforms Committee)-

o Set up by the finance ministry in 2011 (submitted report in 2013), to
comprehensively review and redraw the Indian Financial System and headed
by Justice B N Srikrishna
o The report observed that current regulatory architecture is fragmented and is
fraught with regulatory gaps, overlaps and inconsistencies
o The committee observed that the framework must address
 Consumer protection- the regulatory body (FRA-Financial Redressal
Agency) must be set up to provide grievance redressal to the
consumer. It also envisages that promotion of competition is also in the
best interest of the customer hence there must be co-ordination
between FRA and CCI
 Regulation of firms- the regulator should regulate the firms under
entry, risk taking, management, loss absorption etc
 In case of failure of a financial institution, the Resolution corporation
must oversee swift closure of the company
 In case of capital controls there is involvement of various/multiple
departments - DIPP, FIPB, RBI, FM, ED etc. It should be the duty of
Finance Ministry to form policies for inbound capital and that of RBI to
take care of regulations of outbound capital
 In case of systemic risks this has to be taken care of FSDC
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 Proposes a single Debt Management Agency

o Recommendations
 Establish FRA (Financial Redressal Agency) to address consumer
complaints against the financial companies across
 Establish five new regulating agencies namely UFA, FSAT, FRA, DMO
and Resolution Corporation
 Set up DMO and FSAT to hear appeals against regulators
 Greater separation of powers
Financial Market Reforms post 1991

 Regulatory reforms- SEBI was given the statutory status in 1992 and since then has
been protecting investors and also developing the market. The government has also
set up IRDA as a statutory body (IRDA act 1999) to regulate insurance sector and
PFRDA-through executive order (2003), to regulate pension sector.
 DIP (Disclosure and Investor Protection) guidelines- Under these guidelines all the
primary market security issuers are expected to disclose information on aspects like
factors used to arrive issue price, profitability, risk factors, board changes etc
 Free Pricing- The issuer along with underwriter is free to decide on the price of
primary issues without SEBIs intervention (rather it regulates)
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 Infrastructure- The SBTS (Screen Based Trading System) has been introduced to
replace the physical trading. This along with online trading has helped the investors
to get the same price in all the markets, increase the participation, get access to
information real time, higher liquidity in the market and a better price discovery
 Settlement Cycle- There are two parties in the trade-buyer and a seller. The buyer
makes the payment and the seller delivers the share/equity. It is the clearing house
which plays the role of the intermediary. Before 1991, the settlement cycle took 2
weeks which was reduced to 7 days and now we follow the T+2 settlement system
under which the trade has to be settled within 2 days from the day of executing the
trade
 Dematerialization- Under this system, the delivery of shares/equity will be done in
demat/electronic format. It has been introduced since 1996 and this helps in quick
settlement, reduction in the cost, no-need of clinging on to physical papers etc
 Integration- The FIIs have been allowed to invest in the stock market which will lead
to integration as well as more investments
 Introduction of new instruments- Post 1991 the regulators have allowed various
types of instruments rather than just promoting vanilla instruments (such as Green
Bonds, AT1 bonds, Masala Bonds, FCNR etc).
Alternate Investment Funds (AIF)

 AIFs refer to an investment vehicle which involves pooling in of the resources/capital
from HNIs and then utilizing it to make an investment. The AIFs are nothing but the
refined version of Venture Capitalists. This area is fairly new and has come in the
usage couple of years ago and the government has introduced various reforms and
guidelines so as to promote development in various sectors through AIFs. Until 2015,
the pooling of such resources was open only for the domestic investors and these
funds were used according to a predetermined policy. Now the government (budget
of FY2016) announced that it will be open for even the foreign investors and the
differentiation of FDI and FPI will not be applicable.
 To set up a AIF the following guidelines have to be satisfied

o The minimum investment from an individual is Rs.1 crore (the individuals must
have a minimum income of at least ₹ 50 lakh)
o The overall corpus of the AIF should be at least ₹ 20 crore
o There should not be more than 1,000 investors at any point in time
o The fund manager or promoter should have contributed at least 2.5% or ₹ 5
crore, whichever is less, to the initial capital
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 AIFs are regulated by the Securities and Exchange Board of India (Alternative
Investment Funds) Regulations, 2012. Types of AIFs (based on the investment
profiles)
o Category I- these are the funds which usually have a positive and direct
impact on the economy, hence may be given certain concessions/support by
the government. These are the funds which usually invest in SME,
infrastructure, social infrastructure, startups etc. These include venture funds,
social venture funds and infrastructure funds
o Category II- these are not given any concessions/support as these are usually
not involved in raising the funds for investing but raise for working capital or
for day-to-day operations (eg-private equity or debt funds)
o Category III- these are the AIFs which use complex trading strategies to make
short term gains. (eg-hedge funds)
 To promote the investments through AIFs, the government has given a Pass Through
Status to category I and Category II investments in 2015. The status in simple terms
means that the income generated would be taxed in the hands of the investor, and
that the fund itself would not have to pay tax on the same.
The government also introduced Safe Harbour Rules under which offshore funds will
not be subject to business income taxation in India even if the investment manager
operates in India.
 Narayanamurthy Panel set up by SEBI submitted the report by end of December

2015. Some of the recommendations are
 Taxation reforms which will benefit the investors
 Revamping norms for establishing AIFs
 Taxation on AIFs should not be higher than that paid by Foreign
Portfolio Investors(FPIs) and Domestic Institutional Investors(DIIs)
 10% tax rate on Long Term Capital Gains (LTCG) to be applicable on
transfers of shares of private limited companies (would help in
attracting foreign hedge funds, pension funds as currently the LTCG is
for a period of 3 years and tax rate of 20%, which should be brought
down to 1 year and 10%)
 Introduce STT (Security Transaction Tax) at an appropriate rate on
private equity (PE) and venture capital (VC) funds invested through the
AIF route (presently there is a withholding tax of 10% which is
counterproductive)
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 Attracting the domestic angel investors
 As of June 2016, SEBI has said that 235 AIFs have got registered
 Importance
o These funds lead to higher investment in certain sectors (infrastructure). By
the end of March 2016, these funds were worth ₹ 22,961 crore (compared to
₹ 9504 Cr by March 2015)
o These will attract certain class of investors (global hedge funds and pension
funds)
o The global experience has shown that these investments will only keep on
increasing
Bond Market
 Corporate bonds are debt instruments which are issued by corporations (either
private or public). These instruments do not provide any ownership interest to the
investors in the issuing company rather the interest on these is paid by issuing
company regularly (annually or semi-annually) irrespective of whether the company
makes a profit or a loss. These instruments are high on security and low on returns.
 Requirement for reforms
o Corporate bond penetration is very low
 In 2014, ratio of bank deposits to GDP was 64% and corporate bond to
GDP was 14%
 At the end of 2015
 Out of all the outstanding bonds, 72% were government
securities (G securities + State Development Loans) and only
28% were corporate bonds
 Corporate Bond penetration was 17% of GDP whereas it was
45% in Malaysia and 75% in South Korea
 As of March 2016, the value of corporate bonds issued was around ₹ 19
trillion. This may look very large in absolute terms but when compared
to GDP its value is just around 14%, whereas for bank assets it is 89% of
GDP and it is 80% of GDP in case of equity markets.
o Majority of the resources raised were in the form of private placement. In
2015-16 of ₹ 4.66 lakh Cr raised, ₹ 4.08 lakh Cr (approx 88%) was in the form
of private placement. The private placement is only useful in case of
companies which are large and with credibility (credit rating of the bonds of
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AAA or AA or A) whereas this will not be a feasible method in case of the small
corporates
o The country needs huge investments in various sectors-especially in
infrastructure
o Investor base is very narrow
o Infrastructure projects are having high gestation periods hence need lenders
for a longer period of time
o In the past the requirement of finances for infrastructure was provided either
by government (through budgetary allocations) or through RBI (which
provided concessional funds to Development Finance Institutions RBI), but
lately the government is finding it difficult to raise huge revenues and divert it
for investment on infrastructure. On the other hand the DFIs have been
formed into commercial banks and the commercial banks are suffering
because of twin balance sheet problem (add to this the BASEL III
requirements). Hence there will have to be accumulation of resources either
in the form of foreign investment or through developing the bond market.
 The GoI announced a set of reforms in budget of FY2017
o New platform for private bond issuances
o A platform for corporate bond repurchase agreement (repo)
o A consolidated reporting platform
o Requires the Life Insurance Corporation of India to set up a credit
enhancement fund for infrastructure projects (however LIC has backed out
from the proposal because of some regulatory issues. Instead a ₹ 500 cr worth
of credit enhancement fund was announced by the FM in October 2016,
which will be anchored by IIFCL and government is trying to rope in SBI and
PNB)
o Extend foreign investment to unlisted debt securities (In September 2016, the
SEBI has allowed the FPIs to purchase unlisted debt securities i.e. the
debentures which are issued by the public company)
Unlisted debt securities are the debt securities which are not traded in the
stock market. These are usually traded OTC (Over-The-Counter) by market
makers (are individuals/companies which provide liquidity in the market by
providing the buy and sell prices for a commodity/financial instrument in the
inventory)
o Reserve Bank of India (RBI) to encourage bond financing by large borrowers

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 Reforms introduced by RBI (Recommendations of H R Khan Committee)
o RBI to start accepting corporate bonds as collateral to give loan to the banks
under LAF (Liquidity Adjustment Facility)
o Banks will be permitted to issue other forms of bonds such as masala bonds
and AT1 bonds
o To improve participation in the bond market, brokers will be permitted to
trade in bonds
o FPIs and Retail investors will also be allowed to invest directly (without any
middleman)
o PCE (Partial Credit Enhancement) scheme has been expanded
 The aim/objectives of the reforms introduced are to expand the market and also
increase the volume of trading of bond markets. This will be achieved through
o Making it easier to acquire corporate bonds
 The FPI can directly trade in these without any involvement of a broker
 The domestic retail investors can will be allowed to trade in them
directly
o Increased their liquidity
 Allowing them to be used as collateral in RBI operations
 Allowing brokers to participate in the corporate bond repo market
o Expanding the market by allowing the banks to issue bonds such as masala
bonds, AT1 bonds etc
o The aggregate exposure of the whole financial system under PCE scheme will
be increased to 50%
 But the problem with such reforms are that they are driven by the government
rather than being a part of the evolution process. Which cannot be considered to be
all negative, as various earlier reforms have not yielded expected results
(Recommendation of Patil Committee, Percy Mistry Committee and Raghuram Rajan
Committee) but care has to be taken in driving the point that these reforms are
government driven and the effects of it on the other market and other players in the
financial system are made clear.
 Expected outcome – the government by pushing these reforms in the market can
expect
o That the banks and other conservative institutions such as pension and
insurance funds will make more investment in the bond market and become
more bond savvy
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o On the other hand the bond market will become a source of long term
investments for the infrastructure and other sectors in India
o The corporate bond market is not completely detached from the sovereign
bond market hence may get a fillip when the interest comes down
o The growth of corporate bond market will revitalize the growth in the
investment scenario
 Some challenges
o The private sector companies are already overleveraged and they would not
prefer to take such a step when their balance sheets are under stress
o The government has always used the PSBs as avenues for borrowing (through
selling of SLRs) and this has led to lower lending of PSBs at a higher cost,
leading to crowding out of private corporations.
o Insolvency code?
o Some of the capital controls (such as the $50 billion investment limit imposed
on foreign investors in local currency denominated bonds) have to be
withdrawn so as to promote the development of the bond market
 PCE scheme – was introduced by RBI in September 2015, under which a bank will
guarantee a line of credit to the bond issuer if they cannot meet the interest
payments. But the conditions are that this exposure cannot be greater than 20% of
the bond issue size and the bond must have a credit rating of at least BBB-. Under
the new set of reforms the PCE has been extended to 50% (provided a single bank
will have a maximum exposure of 20%) which will increase the credit rating of these
instruments to AAA and make them more attractive for pension funds and insurance
funds to invest in
 Green Bonds
o SEBI- “A green bond is like any other bond where a debt instrument is issued
by an entity for raising funds from investors. However what differentiates a
Green bond from other bonds is that the proceeds of a Green Bond offering
are 'ear-marked' for use towards financing ‘green’ projects.”
The GoI has set an ambitious target of 100 GW and 60 GW of solar and wind
energy. As of March 2016, the targets achieved were around 6 GW of solar
and around 26 GW of wind. As renewable energy is more capital intensive
the GoI has to invest around $160 bn in the coming days ($120 bn in debt
and $40 bn in equity) but the banking system is under a lot of stress as of
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now and hence there will be an impact on financing of these projects

(Currently most of these projects are being financed at a cost of 11-12% per
annum)
o Green bonds are becoming very popular tools in the recent days for the
institutions to raise funds. Guidelines regarding green bonds are issued by
International Capital Market Association (ICMA)
o Currently the government provides support to the green infrastructure
 Accelerated Depreciation- capital expenditure is to be depreciated by
80% in the first year and remaining in the next 5 years
 VGF (Viability Gap Funding)- the government provides a financial
support in the form of capital grant (20% of the expected project cost)
 Feed in Tariffs- are long term contracts wherein the discoms purchase
the electricity at higher prices
 PSL- RBI has allowed loans to be given for green projects under PSL. As
per the notification of RBI, bank loans up to a limit of Rs 15 crore to
borrowers for purposes like solar based power generators, biomass
based power generators, wind mills, micro-hydel plants and for non-
conventional energy based public utilities eg-street lighting systems,
and remote village electrification. For individual households, the loan
limit will be Rs 10 lakh per borrower
o Challenges in promoting green infrastructure

 Fossil fuels have always enjoyed a great subsidy regime
 Lower credit rating of issuers
 Higher cost of issue
 Maturity period is usually short term
o Yes Bank is the first bank in India to issue green bonds and EXIM bank is
the first bank in India to raise dollar denominated green bonds
 Masala Bonds
o These are the debt instruments which can be used by Indian companies to
raise funds in the overseas market
o The name masala represents that it is connected with India. It is not the first
time that such bonds are named after Culinary-Dim sum bonds (china),
Samurai Bonds (Japan) etc

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o Before this the companies in India tapped the foreign market by taking the
route of ECBs but were exposed to fluctuation exchange rates (hence the
exposure is very large and risky if it is a company whose majority earnings are
in rupees)
o The bonds are rupee denominated rather than dollar denominated
o These instruments are likely to be used by the PSEs to tap the global market
and get access to cheaper credit.
o Reforms introduced by RBI in April 2016
 the maturity period has been brought down from 5 years to 3 years
 the Masala bonds can be issued to investors originating from countries
that are listed in FATF (Financial Action Task Force)
o Reforms introduced by RBI in 2017
 All the proposals for raising the masala bonds (External Commercial
Borrowings) will have to go through the approval route (earlier the
entities were allowed to borrow upto ₹ 50 bn through automatic route)
 The maturity period for Masala Bonds (up to $50 million equivalent INR
per financial year) should be three years and above $50 million
equivalent INR should be five years (earlier the period was three years
irrespective of the size of the issue)
o Reforms introduced by RBI in September 2017
 The issue of masala bonds has been taken out of investment limit
imposed on the FPIs (MBs are now part of the ECBs-External
Commercial Borrowings)
 The RoI/Coupon rate offered cannot be over 300 bps on the
government bond yields
o Issues/concerns related to MBs
 The withholding tax of 5% imposed on the interest of the MBs add to
the cost
 The tenure limits imposed by RBI have imposed hurdles for some of the
infra companies
External Commercial Borrowing (ECBs)
 India allows inflow of foreign investment in various forms – FDI, FII, NRI Deposits,
ECBs
 As per RBI, ECB is a “commercial loans in the form of bank loans, buyers’ credit,
suppliers’ credit, securitized instruments (e.g. floating rate notes and fixed rate
bonds, non-convertible, optionally convertible or partially convertible preference
shares) availed of from non-resident lenders with a minimum average maturity of
three years”

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 Advantages of ECBs
o The borrowings are done in terms of foreign currencies using which the
payments can be met by the company
o Borrowings under these are usually are of higher volume (in the last decade,
ECBs formed more than 20% of the foreign capital inflows) provide
opportunity to borrow large volume of funds
o The borrowings are for a long term
o Interest rate arbitrage - Interest rates are comparatively low (compared to
domestic rate of borrowing)
 Worries/concerns
o It leads to increased external debt
o These borrowings will put extra pressure on forex reserves as the companies
will need to pay in terms of foreign currencies on maturity period
o The depreciation in domestic currency will increase the liability
o Higher (or unhindered ECBs) may lead to appreciation of the domestic
currency which may lead to erosion of returns on exports
o These borrowings are more accessible to the large companies and the smaller
companies have to be dependent on the domestic borrowings at higher costs
(which puts them at a dis-advantage)
 Municipal Bonds
o Are used by city corporations to raise funds for the developmental projects
o Have been issued in India since 1997 by many cities such as Nashik,
Ahmedabad, Bangalore etc
o Previously were not tradable but now are allowed to be traded
o The issuer must have the credit rating in the investment grade and must
contribute at-least 20% of the project cost
o The issuer must not have defaulted on any loan repayment in the last one
year
o The revenue collected from the project must be kept in a dedicated account
and the funds must be used to repay the debt

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The Financial Resolution and Deposit Insurance Bill 2017 (FRDI)
 Background
o The bill repeals the Deposit Insurance and Credit Guarantee Corporation Act
(DICGCA) 1962 and 12 other laws
o Features of DICGCA 1962
 The DIC Bill (Deposit Insurance Corporation) was introduced in the
parliament in 1961 and came into force in 1962
 Initially only the commercial banks, SBI and its subsidiaries, and
branches of foreign banks were covered under this but with
amendment in 1968 even the co-operative banks were covered under
this
 The government introduced Credit Guarantee Scheme in 1960 and RBI
was entrusted with the duty of administering this scheme. RBI
operated the scheme up to 1981. Apart from this RBI also promoted a
public limited company – Credit Guarantee Corporation of India Ltd
(CGCI). The main function of CGCI was to provide credit guarantee to
the commercial banks on the loans and advances provided to the
needy borrowers under the priority sector
 DIC and CGCI were merged and the present DICGC came into existence
in July 1978. Consequently, the DIC Act 1961 was changed to DICGCA
1961
 The DICGC insures
 Each depositor is insured a sum of (principal plus interest) of up
to one lakh rupees in each bank, where he holds an account
 It covers savings, current, recurring, fixed deposits
o A resolution Corporation has been recommended to take care of resolution of
the financial institutions by the FSLRC committee
o The finance minister in his budget speech for 2016-17 announced that a bill
dealing with resolution of financial firms would be place on the floor of the
house
o A committee headed by Mr Ajay Tyagi was set up in March 2016 to draft the
bill for the same
o The bill was introduced by the government in the parliament and a JPC (joint
Parliamentary Committee) has been set up, headed by Shri Bhupender Yadav
 The FRDI Bill seeks
o To provide for the resolution of certain categories of financial service
providers in distress
o The deposit insurance to consumers of certain categories of financial services
o Designation of systemically important financial institutions
o Establishment of a Resolution Corporation for protection of consumers of
specified service providers and of public funds for ensuring the stability and

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resilience of the financial system and for matters connected therewith or

incidental thereto
 The proposed legislation together with the Insolvency and Bankruptcy Code, 2016 is
expected to provide a comprehensive resolution mechanism for the economy
 The bill is applicable to a financial institution and any other financial service provider
which is designated as “Systemically important financial institution” by the central
government
 Provisions of the bill
o The central government will set up a Resolution Corporation (RC)
 It will have a chairperson and its members will include representation
from RBI, SEBI, Finance Ministry etc
 Functions
 Providing deposit insurance to banks (to repay deposits to
consumers in case of failure)
 Classifying service providers (such as banks and insurance
companies) based on their risk
 Undertaking resolution of service providers in case of failure
 It may also investigate the activities of service providers, or
undertake search and seizure operations if provisions of the Bill
are not being followed
 The corporation in consultation with the respective regulators (SEBI,
RBI, IRDA, PFRDA etc) can specify criteria to classify the service
providers based on the risk of failure into
 Low - where the probability of failure of a specified service
provider is substantially below the acceptable probability of
failure
 Moderate - where the probability of failure of a specified service
provider is marginally below or equal to acceptable probability
of failure
 Material - where the probability of failure of a specified service
provider is marginally above acceptable probability of failure
 Imminent - where the probability of failure of a specified service
provider is substantially above the acceptable probability of
failure
 Critical - where the probability of failure of a specified service
provider is substantially above the acceptable probability of
failure, and the specified service provider is on the verge of
failing to meet its obligations to its consumers
 Service provider who is classified under “material” or “imminent” will
have to submit a Restoration Plan to the respective regulator and
Resolution Plan to the RC, within 90 days of such classification
 The Restoration Plan will include

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 Distinct identification of the assets and liabilities of the specified

service provider
 Any contingent liabilities of the specified service provider
 Steps which the specified service provider shall take to qualify
for classification in the category of at least moderate risk to
viability and how such steps may result in such classification
 The period within which the entire restoration plan and each
step of the plan will be executed
 Any other relevant information specified by regulations made by
the appropriate regulator
 The Resolution Plan will Include
 Distinct identification of the assets and liabilities of the specified
service provider
 Any contingent liabilities of the specified service provider
 Distinct identification of critical functions of the specified service
provider
 Direct or indirect access to financial market infrastructure
services
 Strategy plans to exit the resolution process which may provide
for the consideration of legal or regulatory requirements as may
be required by the Corporation to sell or transfer the assets and
liabilities of the specified service provider, or change its
ownership
 Other relevant information
 RC will take over the management of the service provider from the
point of it being classified as “critical”
 The Resolution Corporation can undertake the resolution of a service
provider under “critical” category through
 Transferring its assets and liabilities to another person
 Merger or acquisition
 Liquidation etc
The resolution process will be completed within a year from the date
on which the service provider is classified as “critical” (the time limit
can be extended by a year)

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Agriculture
 Features of Indian Agriculture (are also problems of Indian Agriculture)
o Majority of the population is involved in agriculture and 49% of the households
derive their daily income from agriculture but the problem is that agriculture
contributes only 17% to GDP and the productivity is lower comparable to other
countries
o Majority of the land under agriculture is dependent on monsoon (monsoon is
erratic). Only around one third of the land under agriculture is irrigated and this is
one of the problems and lands covered under irrigation, practice traditional
methods of irrigation which are very inefficient methods
o Indian agriculture is suffering because of Lower mechanization disguised
unemployment
o Post the green revolution, agriculture has been oriented towards cereal production
which leads to problems such as over production of cereals, higher storage costs,
lower production of pulses, market distortions etc
o Per capita availability of land is low as a result fragmentation of land is very high
which is leads to higher input costs
o Per capita availability of water is low and with inefficient usage of water has led to
drop in the underground water levels
o Central problem of agriculture is productivity
o The fertilizer usage is very high and this has led to some unwanted outcomes
(dropping levels of water, crop rotation not happening, land loosing fertility,
productivity has not increased etc)
 Subsidy- is the financial transfer or other support provided by the government to an

industry/an individual (the subsidies are transfer payments). The subsidy could be direct
(goods/services are purchased at a market price and the subsidy is transferred to the
consumer) and indirect (goods/services are provided at a subsidized prices). The
government provides subsidies in case many goods-food grains, kerosene, LPG etc
o Is subsidy necessary- especially for a country like India, which has underdeveloped
agriculture, higher disguised unemployment in agriculture, lower availability of
fertilizers etc, subsidies are necessary , having said so, it is also important for the
government to make sure that the subsidies are well targeted and reaches the
intended beneficiaries, thereby achieving the objectives
o Drawbacks of subsidies
 Are regressive in nature-benefits flow more to rich than poor
 LPG-non-poor consume 91%
 Electricity- poor get the subsidy of 49% and rich 49%. The poor
consume only 16% whereas non-poor consume 84%

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 Kerosene-Non poor consume 50%

 lead to diversion and black marketing (fertilizers)
 Market distortions such as price volatility, supply variation etc
 Inefficient usage of resources-overuse of fertilizers, water, electricity etc
 It violates one product one price principle
o Need for subsidy- subsidies are useful for providing inputs for the farmers at a
cheaper cost, reducing the cost of production, controlling the prices, contributing to
growth etc
Fertilizer
 Fertilizer is artificial supply of nutrients. Three types of fertilizers are used N:P:K (Urea :
Diammonium Phosphate : Muriate of Potash)
o In India, Urea attracts the maximum parts of the subsidies provided for fertilizers, of
the three maximum produced, maximum controlled, maximum imported etc
o Urea is produced by 30 manufacturers (these get subsidy based on the cost of
production)
o Urea is imported by 3 agencies (State Trading Corporation of India; Metals and
Minerals Trading corporation of India; India Potash Ltd)
o The other two fertilizers (DAP and MoP) get subsidy based on quantity of raw
materials used (Nutrient Based Subsidy)
o Since the pricing of fertilizers violates “one product, one price” principle, fertilizers
are black marketed, smuggled out of India etc
o Reforms taken in 2015
 Gas pooling policy 2015-gas is one of the raw materials that is needed for
producing the fertilizer and government has introduced the policy wherein
the gas will be provided to the producers at a uniform price
 Nutrient Based Subsidy (NBS)- 75% of urea produced must be neem coated;
Maximum retail price to be Rs 268/50 kg (additional 14 rupees if coated with
neem); Existing subsidy for P&K, DAP,MoP to remain the same; Movement
and sale of fertilizers has been freed; The units at Talcher(odisha),
Gorakhpur(UP), Ramagundam(Telangana), Baruni(Bihar) to be
revived(addition of 52 lakh tonnes)
(Advantages of Neem coated urea-increased yield, acts as insecticide,
reduces leaching etc)
o Steps to be taken
 DBT could be introduced
 Fertilizer could be provided to the households by the size of it
 Imports must be decanalized
 Urea should be brought under NBS
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o Standing Committee report on Fertilizers-Chaired by Hukumdev Yadav (August 2016)

 With the increase in agricultural production, the consumption of fertilizers
has also increased
1960s 2014-15
Agriculture Production 83 mn tn 252 mn tn
Fertilizer consumption 1 mn tn 25.6 mn tn
 To meet the food security targets, there is a need to produce 300 mn tn of

food grains by 2025 for which there would be requirement of 45 mn tn (of
this only 6 to 7 mn tn would be organic). So there is a need to undertake the
studies regarding its impact
 The consumption has increased but the domestic production is not sufficient
hence there is a need for imports
 Huge disparity-56% of the districts account for 85% of the usage
 Recommended usage is 4:2:1 respectively for N:P:K but in case of India it is
skewed 6.7:2.4:1
 The present Fertilizer policy doesn’t include organic fertilizers, bio-fertilizers
etc which are much more effective than the chemical fertilizers. Hence there
is a need to formulate a new subsidy policy for fertilizers
 There is a need of a policy to promote use of bio-fertilizers and organic
farming
 The production of pesticides is monitored by Ministry of Chemicals and
Fertilizers whereas the usage is administered by Ministry of finance, hence
there is a need to set up a body to regulate manufacturing, import and sale of
pesticides
 MSP-it is the price at which the government purchases the food grains from the farmers. It
was introduced during the green revolution so as to support our farmers and prevent the
distress sales by them but over the time, the MSP has been suffering from some drawbacks-
has led to price and production distortions, higher MSP announced in some crops and
ignored for some crops etc. MSP is recommended to the government by CACP (Commission
for Agricultural Costs and Prices) for 23 crops but is decided by the government or CCEA
NITI Aayog Findings

 Over 81% of the farmers have the knowledge of MSP
 67% of the farmers sell the crops through their own means
 Some of the reasons for this are
o The MSP in some states is paid late. Only 20% of the farmers receive the MSP on
the spot (in Karnataka it is paid on the same day and in Maharashtra more than
90% of the farmers get the MSP after a month, which leads to most of the
farmers selling their produce to the middlemen)
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o Long distance between the fields/farms and procurement centers

o FCI procures only rice and wheat in surplus states
o Too much of paper work
 HLC headed by Shanta Kumar has pointed out that only about 6% of the farmers get the
benefits of MSP
 Food Security-aim of the government is to provide food security i.e. provide food to people.
Food security refers to three terms-food availability (enough production of food grains),
food affordability (sold at a lower price) and food accessibility (the place of sales is in the
vicinity)
To achieve food security, the government has introduced NFSA in 2013 as per which
o 50% of urban and 75% of rural population (two-thirds of total population)
o 5 kgs of food grains/person/month
o Poorest of the poor will continue to be covered under AAY
o For issuing ration cards eldest woman of the house will be considered
o Redressal mechanism-DGRO and SGRO
o States have to identify eligible households
o Proposes using AADHAR, ICT for better implementation
 Rural Credit- the farmers require access to credit at lower cost as they are heavily
dependent on such access. The farmers will need the loans for consumption or investment
purposes. The loans in agriculture sector can be explained under two classifications
o Based on the source
 Formal-loans are taken from institutions such as scheduled commercial
banks, rural banks etc (it is also referred to as Institutional credit)
 Informal-loans are given by non-institutional actors such as money lenders,
friends, family, relatives etc.
o Based on the term
 Short term-lesser than 15 months
 Medium term-15 months to 5 years
 Long term-more than 5 years
Problem with agriculture credit is that as per the 70th round of NSSO, 40% of credit is from
informal. This is a cause of worry as informal lending is done at a very high rate of interest
and usually illegal methods of recollections are used and the informal sector is unregulated.
In 2015, RBI has removed the distinction between direct and indirect farm credit (agriculture
credit)
o Direct-the loans given by public sector bank to the farmers directly and the farmer
repaying the loans

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o Indirect-the loans are usually routed through some other institutions such as
fertilizer dealers, FCI warehouses, NBFC (only to those involved in agriculture sector)
etc
Vyas committee was set up to give recommendations regarding the rural credit and the
committee submitted the recommendations in 2004. The recommendations are
o Review of mandatory lending by banks so as to enlarge direct lending programmes
o Direct lending must be increased to 18%
o Reducing the cost of agricultural loans
o Banks to increase their disbursements to small and marginal farmers under Special
Agriculture Credit Plan (SACP)
 Skewed Land Holding Pattern in India

o As per census of 2011
 Marginal(1 hectare or less)-67%
 small(1-2 hectares)-18%
 Medium(2-10 hectares)-14.3%
 Large(above 10 hectares)-0.7
Mechanization
o Mechanization is lesser than 50% in India. In developed countries the mechanization
is high and the percentage population involved is very less but in case of India,
population involved in agriculture is high and mechanization is comparatively less.
o With the labour in agriculture coming down (because urban migration, higher
MNREGA wages) there is a need for higher mechanization
o Higher mechanization will also increase production, increase productivity, lower the
costs
o Case of Higher Mechanization-Madhya Pradesh
The state government has introduced two schemes-Yantradoot scheme and Custom
Hiring Centers (CHCs).
Yantradoot Scheme
The state government will adopt 200 villages per annum are adopted during which
the farmers are given information as to how the mechanization will boost
productivity, save labour costs.
CHCs (Custom Hiring Centers)

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 The CHCs are the centers which will rent out machinery to small and marginal
farmers. They will employ the rural youth for managing these centers.
 The centers will be set up with a capital investment of Rs 25 lakh
 The state government will provide a subsidy of Rs 10 lakh or 40% of the costs,
whichever is lower (it is mandatory to attend a week’s training program to be
eligible for subsidy)
 The applicants will be chosen on lottery system
 The CHCs are mandated to purchase some tools/machinery/equipments
 These will be serving 200 to 300 farmers in a radius of 10 kms
 The models are followed in Punjab and AP
 Warehousing
o Agriculture warehousing accounts for total of 15% warehousing market in India
o Around 40% of the total storage space is handled by state enterprises such as FCI,
CWC and SWC
o 30% of the total storage is held by unorganized and small godown players (lack scale
and quality)
o There is a shortage of storage space-as per the study conducted by Ministry of
Agriculture 7% of food grains, 30% of fruits and 10% of spices are lost due to
improper storage
o Uses
 Price stabilization
 Scientific storage reduces wastage
 Continuous supply
o Types
 Based on ownership-Private and Public
 Based on storage- General and commodity
Some of the warehouses in India are National Co-operative Development
Warehousing Board (1956); Central Warehousing Corporation (1957); Food
Corporation of India (1965)
o Criticism
 Not enough storage
 Economically unviable
 Storage by FCI does not include storage of pulses. oilseeds etc
 Location disadvantages
 Complicated and time consuming procedure of depositing and withdrawing
the produce
 Lack of knowledge amongst the farmers
 Lack of credit accessibility on the produce stored

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In India the total storage potential is 727 lakh million ton which is not sufficient for
even half the rice and wheat produced.
o Buffer Stocks
 Are food grains maintained by GoI for cushion against the fluctuations in
prices
 Uses
 Feed the TPDS
 Ensure food security during the periods of lag phase
 Stabilize food prices
 Issues
 High maintenance cost
 Inadequate storage facility
 After storing for long period they are disposed off
 Procurement of pulses is limited
o Shanta Kumar Committee

 FCI must transfer procurement operations to states which have made
considerable expenditure in infrastructure
 There must be rationality and uniformity in procurement operations
 centre not to accept additional/surplus food grains from states announcing
bonus over MSP
 Stringent quality checks before accepting food grains
 Encourages NWRS (Negotiable Warehouse Receipt System)
 Prioritize pulses and oil seeds and their MSP
 Reduce coverage under NFSA from 67% to 40%
 6 months advance food grains to be issued so that the cost of storage comes
down
 End to end computerization
 Cash transfers in PDS to be operationalised in cities with population over 1
million
 Agriculture Marketing
o Marketing must lead to

 More returns to the producers
 More coverage-small and marginal farmers
 Efficient utilization of resources
 Aim for market surplus

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o The weaknesses of marketing system

 remoteness and connectivity
 Local storage capacity
 Transportation costs
 Mandi infrastructure-information, grading and standardization etc
o The farmers do not get correct prices because

 Too many intermediaries
 The long distance of market from the village forces villagers to sell to
intermediaries
 This is compounded by infrastructural problems
o As agriculture is a state subject, the wholesale of agricultural produce comes under

the APMC acts of state governments
 It empowers government to notify commodities to be sold
 It empowers the sate to regulate the sale by establishing market into APMCs
 Once the area is declared as an market, no person/institution will be allowed
to conduct the trade freely (outside APMC)
Problems with APMC act of states
 Only few of the states have amended their APMC acts on the lines of model
act
 Presence of very large vested interests which prohibit changes in the present
mandi system
 State APMCs have been unable to improve the infrastructure, provide access
to information, modernization of market facilities etc
 The modernization of market infrastructure requires huge investment which

can be obtained with the assistance of private players
Model APMC Act

 Direct sales of farm produce to contract farming sponsors
 Provides for establishment of Farmers’ and consumers’ markets to facilitate
direct sales of agriculture produce
 Setting up of special markets for specified agricultural produce
 Permits private persons, farmers and consumers to establish new markets for
agricultural produce in any areas
 Provides for a single levy of market fees on agriculture produce
 market functionaries have to get registered
 Creation of infrastructure from the revenues raised by APMC

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o State of Bihar has repealed the APMC act and the state of Rajasthan and
Maharashtra have delisted fruits and vegetables to allow the farmers to sell the
produce to private parties without having to go through APMC. Apart from this the
state is also promoting growth of high value crops through PPP
o The central government in order to provide better returns to the farmers has
introduced eNAM (electronic National Agriculture Market)
 This leads to creation of a national market
 This is an electronic platform wherein the farmers can sell their produce
across India
 This will lead to higher participation from both sides (farmers and traders)
leading o better price discovery and will also increase the transparency
 Initially 21 mandis from 8 states will be connected and 25 commodities will
be traded on this platform
 Over the period of time 585 regulated markets will be connected through
eNAM by 2018
 For the implementation the states will have to amend their APMC acts
 Implementation by the Department of Agriculture & Cooperation through
Small Farmers Agribusiness Consortium (SFAC) by creation of a common
electronic platform deployable in selected regulated markets across the
country. A budgetary provision of Rs.200 cr has been made to be spent over
the next three years (2015-16 to 2017-18).
 Hurdles in implementation
 IT backbone
 Information awareness
 The unwillingness of the state government
 Other concerns such as-who guarantees the price, what if there are
no buyers etc
Model Agricultural Produce and Livestock Marketing Act, 2017
 The model act has been released by the Ministry of Agriculture and Farmers
Welfare, the state governments/UTs can adopt this act
 It seeks to facilitate
o Free flow of agricultural produce (including livestock)
o Provide a direct interface of farmers with the buyers and consumers
o Create a barrier free single market in the country
 Key features of the model act are
o Henceforth the state government will declare the whole state as a
Unified market area and in such an area, a single license will be
applicable for the trade of agricultural produce and livestock

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o A Market Committee will be set up which will manage market yards in

these specified areas. These committees will also be responsible for
 Regulating the auction of agricultural produce and livestock
 Providing facilities for marketing of agricultural produce and
livestock
 The committee may also use digital technologies to link
consumers with farmers
 The committee may be involved in managing these market yards
through PPPs
 The committee will be responsible for levying and collecting
single market fee (it cannot be over 2% of value in case of non-
perishables and over 1% of value in case of perishables and
livestock) from buyer on sale of notified agricultural produce and
livestock
o Apart from these market yards, the private market yards could be set
up by private individuals, which will facilitate operations of traders,
agents etc
 Crop Insurance
Agriculture faces various risks (such as deficit monsoon, drought, floods, earthquakes etc).
To protect the farmers the government provides insurance. In 2016, the government has
introduced PMFBY (Pradhan Mantri Fasal Bima Yojana). The features are
o will be rolled out from the kharif season in June this year
o Under the new Crop Insurance Scheme premium-
 2% for kharif food grains and oilseeds crops
 1.5% for rabi food grains and oilseeds crops
 Horticulture and cotton crops the premium has been fixed at up to 5% for
both kharif and rabi seasons
o There is no upper limit on Government subsidy. Even if balance premium is 90%, it
will be borne by the Government (earlier the claim was capped)
o The New Scheme aims to enhance insurance coverage of crops up to 50% of the
total crop areas from the existing level of about 23% over the next 2-3 years and
cover 50 million farmers (although the present coverage is 23% it was not because
the farmers opted for it but it was forced on them and the premium was deducted
from the loans that were given to them)
o The Government's liability on premium subsidy will be shared by the Central and
State Governments on 50-50 basis
o Problem with implementation

 Financial burden on the state is very high (in some the states the financial
burden is more than 60% of the budget allocation for agriculture)

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 The states are using two methods

 The notification is being delayed
 The premium is being reduced thereby reducing the sum insured (eg-
Rajasthan has capped the insurance benefit-farmers owning more
than 7 hectares have to pay the full premium)
 Pulses
o India is the largest producer of pulses and also the largest consumer of pulses-25%
and 28% respectively. India produces on an average of 19 mn tn and consumes
around 21 mn tn of pulses. India produces 67% of the total tur in the world and still
imports about 30% of domestic demand for tur
o India grows pulses on 24 to 25 mn hectares of land with a productivity of 780
kg/hectare
o As per estimations, India will require 39 mn tn of pulses by 2050 and to meet this
demand the production has to grow at a annual growth rate of 2.14%, there has to
be addition of extra land for cultivating pulses by 3 to 5 mn hectares and the
productivity has to be increased to 1200 kg/hectare
o The consumption of pulses has increased but the per capita consumption has been
on declining trend (from 60 grams to 38 grams in a span of two decades-this is lower
than ICMR recommendation of 52 grams per capita)
o The increase in the consumption is because there is change in the dietary patterns
and pulses are the primary sources of proteins
o The other reason for the increased production is that other food items are costlier
(twice in some cases and thrice in some cases)
o The pulses production has come down and consumption has increased as a result of
this, the imports of pulses have increased (in 2000-01 the imports were 0.06 MT and
in 2015-16 it has increased to 5.53 MT) and in the first seven months, the imports
are 33.4%
o The high prices of pulses, has led to higher acreage planted expecting higher returns
but with expectations of higher production, the market prices have started coming
down. If the current trend continues, the mismatch between demand and supply (of
tur and urad) will increase to 1 million tons. Presently the annual growth in the
production was 3% and if India needs to take care of imports then the production
has to increase by over 8%
o To promote the cultivation of pulses the government has increased the MSP of
pulses (but this higher MSP is of little help as-the announcement was done late and
the MSP is lower by 40% to 50% compared to market prices). The MSP for pulses
should be decided based on social costs.
o Considering the current situation to achieve food security, it would be rational in
diverting more land for pulses production (as prices are high and imports will hurt

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India, also the global production is not high), whereas the production of cereals in
India and globally is very high and are cheaper compared to pulses.
o What are the problems
 92% of the area under pulses production is unirrigated
 The pulses because of their richness in nitrogen and phosphorous are
vulnerable to pest attacks
 The pulses are treated as secondary crops whereas the cereals and cash
crops are treated as primary crops
 Unavailability of quality seeds is a major constraint in increasing productivity
 Inefficient policy of MSP in pulses
o Recommendations- Arvind Subramanian committee

1. The farmer has to be protected in two areas-MSP and procurement. The
government has to increase the MSP of tur, urad and moong. The farmers are
taking a risk by increasing the production of pulses and incidentally the prices
are falling hence the government has to protect the farmers by increasing the
MSP.
2. For the procurement activities, the government has to allocate an additional
Rs 10000 crore to the agencies FCI,SFAC, NAFED etc
3. The buffer stock of 2 million tones has to be maintained and should be
monitored in real time by a HLC including Finance Minister, Minister of
consumer affairs, Minister of Agriculture among others
4. The limits on stockholding and exports have to be lifted
5. Although procurement is of utmost importance now, there is also a need for
policies to ensure effective stocking, warehousing, processing and disposal.
Pulses deteriorate more quickly than cereals and hence need more efficient
management
6. New institution could be set up in PPP format which will also be into
procuring; it will not replace present agencies but will lead to competition.
This institution will work independent of the government and to make it
financially viable it could be allowed into procurement, storage, warehousing
of other agricultural commodities
7. As for as the MSP is concerned, it should be increased for the next kharif
season.
8. The diversification of the pulses must be promoted and the government
should transfer the benefits through DBT (Rs 10-15/kg in irrigated areas)
9. GM crops should be promoted, leading to higher productivity
10. Review the implementation of ECA 1955
(Recommendations from 1 to 6, they are to be implemented immediately and

from 7 to 10 to be implemented gradually)

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 E-technology in the aid of the farmers

o Need of e-technology
 Food security
 Sustain the growth in agriculture
 Poverty reduction
 Assist farmers-majority of farmers are into small and marginal farming
 Helps rural and under-developed markets to become efficient and productive
 ICT helps in dissemination of information-technology, market demand, price
information; weather, pest and best practices etc
National Policy for Farmers, 2007

 National Commission on Farmers in 2004 under the chairmanship of Dr. M.S.
Swaminathan.
 The “National Policy for Farmers, 2007” has been formulated and approved
by the Government of India
 It has important provision for use of Technology:
 New technologies which can help enhance productivity per unit of
land and water are needed.
 Biotechnology, information and communication technology (ICT),
renewable energy technology, space applications and nano
technology
 Technology to provide opportunities for launching an “Evergreen
Revolution” capable of improving productivity in perpetuity without
harming the ecology.
Kisan credit card

 It was started by the Government of India, Reserve Bank of India (RBI),
and National Bank for Agriculture and Rural Development (NABARD) in 1998-
99 to help farmers access timely and cheap credit.
 The Kisan Credit Card allows farmers to have cash credit facilities without
going through time-consuming processes in the bank
 The card is valid for three years and subject to annual renewals. Withdrawals
are made using slips, cards, and a passbook
 Repayment can be rescheduled if there is a bad crop season, and extension is
offered up to four years.
Kisan Call Centers

 Launched the scheme in January 2004.
 Main aim of the project is to answer farmers’ queries over the phone in their
own language.

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 The queries are clarified in 22 local languages and the call in facility is
available from 6 am to 10 pm
 These call Centers are working in 14 different locations covering all the States
and UTs.
 A countrywide common eleven digit Toll Free number 1800-180-1551 has
been allotted for Kisan Call Centre.
 KCC agents have access to Kisan Knowledge Management System (KKMS) to
facilitate correct, consistent and quick replies to the queries of farmers and
capture all the details of their calls
Kisan SMS Portal

 Information/advisories/services are provided to the farmers through SMS by
the experts
 Messages are customized based on farmer’s preferences in the language
chosen by them
 Existing databases of the farmers available with central and state
government are being integrated with the portal.
 Those who are not registered, they need to register themselves with the
system. They can register themselves by calling the Kisan call centre on the
toll free number or through web portal or even SMS based registration is also
available.
 The services of the portal include crop production, including horticulture,
animal husbandry, dairying and fisheries. It sends messages relating not only
production aspect but also marketing of produce, weather forecast, soil
testing, etc.
Kisan Choupal
 In collaboration with Krishi Vigyan Kendra
 Is conducted in identified village on need basis (based on the assessment of
the farmers by the scientists)
 Dialogue/discussions are held to solve problems with help of Information
technologies, showing technical videos to farmers, movies, etc.
 It equips the farmers with the knowledge on copping patterns, technology
etc
Village resource centers (VRC)

 Launched by ISRO to provide space based service in association with NGOs/
Trusts and state/ central agencies.
 At present, there are 461 VRCs set up in 22 States/Union Territories
 The VRCs are connected to Knowledge/Expert Centers like Agricultural
Universities, Skill Development Institutes and Hospitals.
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 Programmes conducted by the VRCs are in the areas of,

Agriculture/horticulture, Fisheries, Live stock, Water resources, Tele health
care, Awareness programmes, Women empowerment, Supplementary
education, Computer literacy, Micro credit, Micro finance, Skill development
/ vocational training for livelihood support etc. So far, over five Lakh people
have availed VRC services.
AGMARKNET Portal
 AGriculture MARKeting information system NETwork
 Launched by DMI-Directorate of Marketing in the 9th FYP
 Linked to all important state APMCs, State Agriculture Market boards, DMI
Regional offices
 AGMARKNET provides info on
 Arrivals of agriculture commodities and their prices at various mandis
in 8 Indian languages
 Trend analysis
 Grading, packaging, standards, sanitary and phytosanitary
requirements and marketing charges
o Benefits of E-aid to farmers

 The exposure to technology provides information to the farmers and helps
them to make informed decision making
 The farmers can plan better and try to utilize the resources efficiently
 Some of these lead to higher community involvement
 Precision Agriculture (PA) - is also referred to as Site Specific Agriculture
(SSA), is a modern farming methodology wherein technological tools are used
in real time and the farmers. It involves collecting, analyzing the data in real
time and using it in the farming of large tracts of the land
o Problems
 The reach of the technology is still very poor and large chunk of farmers are
still ignorant about such advancements.
 Usage of regional languages
 Abrupt power supply
 Duplication of the efforts
 Due to low literacy rate among farmers and digital divide
 The rural infrastructure for the use of ICT is also not uniform and lot of
regional disparity persists.

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Irrigation
 Importance of Irrigation
o The monsoon phenomenon is not uniform in two ways-across geography and time. It
varies from one year to another and across all the states in India and majority of the
land under cultivation is dependent on agriculture. Since there is a huge question
mark over the predictability of monsoons there is a need to promote irrigation
o There is a diversity in India with respect to types of crops cultivated, soils and
terrains on which they are cultivated
 Present status of Irrigation

o More than 90% of the fresh water is consumed by agriculture sector
o Majority of the land under cultivation depends on monsoon
 The Irrigation projects are classified into 3 types based on CCA(Culturable Command Area)
o Minor-less than 2000 ha
o Medium-2000 to 10000 ha
o Major-greater than 10000 ha
 Various Schemes to promote irrigation

o CADP (Command Area Development Programme)
 Started in 1974-75
 Today CADWMP (since 2004)
 Outcomes-improve utilization of irrigation, increase production and
productivity, On Farm Development (construction of field channels, land
leveling etc)
o RIDP (Rural Infrastructure Development Programme)

 Started in 1995-96
 Focus on rural infrastructure (especially irrigation projects)
 Provides funds to the state governments and state owned co-operations
 Resources are from the PSBs who have not met the PSL targets
 40% of the funds have been used for agriculture
o AIBP (Accelerated Irrigation Benefits Programme)

 Loans are given to states for the completion of irrigation projects
 Since 2004-05 grant component has been introduced
 Amalgamation of CADP with AIBP
o NPRRRWB (Repair, Renovation & Restoration)

 Launched in 2005
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 Expenditure of Rs 300 crore (C:S::3:1)

 Focused on development of minor irrigation bodies
 Launched in 26 districts
 Micro-irrigation
o Types
 Sprinkler
 Drip
o Advantages
 Will prevent loss of water due to evaporation, run off, protect the fertility of
soil etc
 Fertigation- water soluble fertilizers are dissolved and directly applied at the
roots
 Reduces the energy consumption
 Increase in the agriculture productivity
 Reduces the costs
o Dis-advantages
 Initial higher cost of setting up
 Regular maintenance will incur certain expenditure and requires expertise
o Penetration
 With more than half the land under cultivation dependent on the monsoon,
irrigation coverage is very low at 5% (approx) i.e. approximately around 8
million hectares of land is under irrigation whereas the potential is around 70
million hectares
 In terms of percentage coverage Israel (absolute coverage is only 0.23 million
hectares) tops the list
o Implementation
 India has an arable land of around 160 mn ha and as per the task force set up
in 2004 on Micro-irrigation, the total area for potential micro-irrigation is
considered to be 69.5 mn ha, of which 27 mn ha is for drip irrigation and 42.5
mn ha is for sprinkler irrigation.
 Over the years, the allocation of funds have kept on decreasing
 Even out of the allocated funds, the utilization also been on a declining trend
 The government has set a target of covering 0.5 mn ha per year under
irrigation. As per one of the survey, if it continues to target at that speed then
it would take the government at least 100 years to attain the potential
coverage, hence the government must increase the target to at least 2 mn ha
per year (with increase by 20% in each year so that it could achieve the
potential by the end of next decade)

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In July 2015, the government has introduced PMKSY (Pradhan Mantri Krishi
Sinchayi Yojana)
o Problem areas
 The focus on policy formulation and implementation has been reduced.
Micro-irrigation was implemented in a mission mode (MMP usually have
defined goals, objectives, targets, allocation of funds and evaluation
parameters) as NMMI (National Mission on Micro Irrigation) but has been
diluted to form a sub-component of various schemes of the government
since 2014-15
 Real time monitoring and usage of IT systems absent or very limited
 Unavailability and in some cases the delay in the disbursal of the funds has
become an impediment
 Financing problems faced by the farmers
o Way out
 Introduce DBT to transfer the subsidy
 States such as Maharashtra, Gujarat, AP and Haryana have dedicated teams
which utilize IT form implementation of micro- irrigation programs hence
these models are to be followed by other states
 Providing credit access, subsidy, interest intervention etc to promote
adoption of micro-irrigation
 Make it mandatory to use micro-irrigation in case of sugar cultivation (sugar
is grown all throughout the year and requires twice as much water as in case
of paddy, wheat etc-states of Maharashtra and Karnataka have already made
it compulsory and have stated that the water consumption on sugarcane
came down by 60%)
 PMKSY- was introduced by the central government in July 2015. It aims at converging
investments on irrigation at the farm level, increasing the area under irrigation and
providing end-to-end solution for irrigation
The central government has allocated Rs 50000 cr for the period from 2015-16 to 2019-20
for the implementation of the project and for 2015-16, Rs 5300 cr has been allocated.
The nodal authority is ministry of Water Resources
The PMKSY has got 4 components
o Accelerated Irrigation Benefits Programme-converging the investments at the farm
level
o Har Khet Ko Paani-increasing the area under irrigation, recharging liquefiers,
rejuvenating wells etc
o Per Drop More Crop-promotion of micro irrigation methods
o Watershed Development- effective management of run-off water and improved soil
conservation (moisture)

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o Pros-merges various schemes under a single head, implementation at the district

level (plans to be implemented by District Magistrates leading to more involvement)
o Cons-fund allocation holds the key and the allocation has been on the downside,
subsidy transfers delays not addressed, DBT model not introduced, DIPs (District
Irrigation Plans) will be stumbling blocks as there are 640 districts in India (as per the
agricultural census 2011),
 Recent Initiatives
o In the budget 2016-17, the central government announced setting up of Irrigation
Fund of Rs 20000 cr under NABARD
o In September 2016, the government has kicked off work to complete 99 major and
medium irrigation projects that have been pending over a long time (the target year
for completion is 2018-19). These projects to be implemented mainly in those areas
which are besieged with farmer suicides such as Budelkhand region in UP and MP;
Marathwada (Maharashtra); Telangana. The estimated cost for the implementation
of the projects is Rs 77595 cr and will be covering 7.6 mn ha
GM crops
 GM stands for genetically modified. The gene of these plants are altered in order to achieve
any one or more of the following features
o Resistance to viral infection
o Resistance to insect damage
o Tolerance towards herbicides
o Tolerance to unfavorable climate conditions-high salinity, high temperatures etc
thereby increasing the production
 The first commercially grown GM food crop was that of tomato (Flavr savr) and it was
developed by an American company Calgene.
 The issues associated with GM crops are

Pros
o Higher resistance to diseases, pests and herbicides
o Improved tolerance to cold/heat/drought/salinity
o Reduced maturation period thereby increasing the shelf life (with medicinal benefits-
edible vaccines)
o The increased production will be advantageous to achieve food security
o Increased nutrients, yields, quality and stress tolerance
o The input costs will come down
Concerns
o The safety of GM crops has been doubted by various stakeholders

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o The GM seeds are patented by MNCs and it will not be available at lower prices to
the farmers
o The MNCs will hold the patents and the concern is that these companies may hold a
sway/control over food security. Hence the developed countries will have a certain
control over developing countries
o Out Cross-the genes will flow into the traditional/natural types of crops because of
cross pollination
o The ethical concerns is raised because of loss of original species
 GM crops and India

o The transgenic crops were introduced in India in the last decade (Bt Cotton in 2002)
o Bt Cotton is the only transgenic crop that has been allowed for commercialization in
India but this result has been positive as well as negative. The cotton production has
increased, the area under cultivation of cotton has increased etc but these have
been shadowed by certain negative outcomes such as loss of traditional cotton
varieties, sway of MNC companies in pricing the GM seeds, government intervention
and IPR issues
o Another GM food crop that gained lot of traction in the last couple of years was Bt
Brinjal. It was developed by Monsanto and received all regulatory clearances in 2009
but because of the opposition the government had to put it on the moratorium and
since then there has been no change in the status
o Present Regulatory Mechanism
The GM crops are regulated under the Environment (Protection) Act, 1986.
Approval process for commercial release of GM crops

 The company developing the GM crop undertakes several biosafety
assessment tests (environmental and food safety assessments)
 Next step is to conduct Bio-safety Research Trials which require prior
approval of the regulators, the GEAC (Genetic Engineering Appraisal
Committee) and the RCGM (Review Committee on Genetic Manipulation)
 After considering the results, GEAC gives the mandatory approvals
 Finally, commercial release is permitted only for those GM crops found to be
safe for humans and the environment.
 Recent updates
o The GEAC has recommended that
 For the tests/trials which are conducted within the premises of the company
there is no need to get the nod/clearances.
 The states must issue the clearances within 90 days
o GM mustard

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 DMH 11 (Dhara Mustard Hybrid 11) developed by centre for Genetic

Manipulation of Crop Plants at Delhi University. Two of the genes that have
been used here are barnase and barstar genes
 Recently the government has placed in the public domain a safety
assessment report prepared by a subcommittee under the Genetic
Engineering Appraisal Committee (GEAC), which has found that the GM
mustard is “safe for food/feed and environment”
 With the agriculture coming under a lot of stress (fragmentation of cultivable land, drop in
the water level, uncertain monsoon, increasing population etc) it becomes imperative to use
technology to increase the productivity in agriculture but the problem with introduction of
GM crops is that the public (stakeholders) do not have the facts such as safety studies
conducted by the government to make an informed decision. Hence government of India
must hold consultations with all the stakeholders, put the safety studies in the public
domain, clear all queries and take the public into confidence before implementing or
allowing any of these food crops for commercial production

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India and International Trade

Exchange Rate
 Foreign Exchange or Forex is the market where the currencies are bought/sold
 It is the minimum number of units of one country’s currency required to purchase
one unit of the other countries currency or vice versa. The need for changing our
currency with other arises as India trades with rest of the world (apart from trade
there is also remittances, investment, tourism etc)
 There are three methods of determining the exchange rate
o Fixed
o Floating
o Managed
 Fixed ER
o It is the system of following a fixed rate for converting currencies.
o In this system, the government (or the central bank acting on its behalf)
intervenes in the currency market in order to keep the exchange rate close to
a fixed target.
o It does not allow major fluctuations from the central rate.
o Example-Currency Board (Singapore and Argentina-The currency board fixes
the exchange rate. Especially useful during the hyperinflation when there is a
lot of money under circulation)
o Advantages
 It ensured stability in forex market
 Countries could formulate long term policies
 During the period of stability and certainty, the trade grows faster
o Drawbacks
 It’s a rigid system, which doesn’t factor in changing economic scenario
 It would bring in stagnancy in the policies of the governments
 The situation in each of the countries keeps changing with time
 Floating
o Under the flexible exchange rate system, the rate of exchange is allowed to
vary to suit the economic policies of the government.
o Flexible exchange rates are exchange rates, which fluctuate according to
market forces.
o The value of the currency is determined solely by the forces of demand and
supply in the exchange market
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o Advantages
 Try to attain efficiency
 Try to eliminate the need to hold foreign reserves
 Try to eliminate barriers on the trade and capital movements
o Drawbacks
 The volatility
 Can have an impact on the exporters/importers
 Managed
o Managed means the exchange rate system has attributes of both systems.
o Managed exchange rate systems permit the government to place some
influence on an exchange rate that would otherwise be freely floating.
Through such official interventions it is possible to manage both fixed and
floating exchange rates.
o India-Managed Market Determined Exchange Rate (The methodology adopted
by RBI has been referred to as a Dirty Float)
o China-Pegged Exchange Rate Mechanism
 Devaluation and Revaluation

o Devaluation and Revaluation are done by the Central bank
o In devaluation more home currencies are offered for every unit of foreign
currency and vice versa happens in revaluation
o Devaluation makes imports costlier and gets higher returns on exports and
Revaluation makes imports cheaper and returns on exports are reduced
 Depreciation and Appreciation

o Are determined by market based on supply and demand of currencies
o No role of the government
o Depreciation makes imports costlier and gets higher returns on exports &
Appreciation makes imports cheaper and returns on exports are reduced
 Currency Crisis- Whenever there is a continuous outflow of dollars, it leads to

appreciation of dollar and depreciation of rupee and if this scenario (where there is a
gradual erosion of faith in the domestic currency leading to domestic currency being
converted to just a piece of paper) is not contained then the domestic currency will
lose all its value, hence to prevent this situation, the central bank intervenes wherein
it dumps the dollars and buys rupee from the market thereby stabilizing the value of

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domestic currency. Post the 2008 crisis, RBI dumped around $900 mn in order to
stabilize the rupee.
 Factors influencing the exchange rates

o Interest rates- various investors are on the lookout for the country that pays
higher interest. Whenever a country pays higher interest foreign currencies
will flow into this country thereby leading to appreciation of the domestic
currency and the domestic investors also will invest within the same country
o Incomes- the rise in the income denotes higher expenditure on consumption
as a result of which the demand for imported goods will increase thereby
leading to depreciation of the domestic currency
o Inflation- the cost of the goods in a country with lower inflation rate will
increase slowly and steadily compared to a country where the inflation rate
will be high. As a general rule it has been seen that the country with lower
inflation has experienced appreciation in its domestic currency as the
purchasing power in this country is higher compared to other countries.
o CAD- CAD represents how much exports and imports have been done in a
short term. If the import value is more it means the country has to pay more
in terms of dollars compared to how many dollars it has earned. In simple
terms when a country suffers from CAD, there is a depreciation of the
domestic currency
o Public Debt- higher government or public debt means, that the government
has to borrow more and this situation leads invariably to inflation thereby
depreciating the domestic currency
o Terms of Trade- is the ratio of export prices to import prices. If the export
prices continuously increase compared to import prices then there is a huge
inflow of dollars leading to appreciation of domestic currency
o Political Stability- it has more to do with the confidence of the investors. If a
country has exhibited good political stability with sound economic principles
then the foreign investors are attracted towards such a country, thereby
leading to appreciation of domestic currency
Balance of Payments
 It represents the trade relationship of a country with rest of the world i.e. balance of
expenditure and revenue that a country must pay/receive from the rest of the world
 The BoP, has two Accounts-Current account and capital account

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o For every component on revenue side there is a component on the

expenditure side
o Revenue represents inflows, whereas expenditure represents outflows
REVENUE EXPENDITURE
CURRENT A/C EXPORTS IMPORTS

INVESTMENT INCOME DEBT SERVICE PAYMETS
INREMITTANCES OUTREMITTANCES
CAPITAL A/C FOREIGN LOANS FOREIGN LOANS
FDI FDI
FII FII
o The current a/c has the exports in visible (goods/merchandise) and invisibles
(services), income and transfers (grants, gifts and remittances)
o The capital a/c capital inflows (debt or equity; maturity) and has FDI, FPI, loans
etc
 Balance of Trade (BoT) - the trade is in the form of merchandise/goods. The BOT
could be surplus/deficit
o BOT Deficit = value of exports<value of imports
o BOT Surplus = value of exports>value of imports
India suffers from BoTD (from April 2015 to January 2016); India exported $ 217.7 bn
and imported $ 324.5 bn, leading to trade deficit of $106.8 bn. The exports declined
by 17.6 and imports by 15.5% during this period. It was because
o Decline in the oil prices

o Decline in the global demand for commodities such as steel and aluminum
 Current Account
Revenue>Expenditure = CAS (Current a/c surplus)
Revenue<Expenditure = CAD (Current a/c deficit)
Although on the face of it, CAD is dangerous, a developing county such as India
(which is scarce in resources) will require high imports, which may lead to deficit but
a higher CAD might cause more harm
The CAD can be bridged by a country by

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◦ Using part of the gold stocks that it has

◦ May use foreign currency reserves
◦ May borrow loans
◦ Attract investments and deposits
Generally, the countries prefer the last mode as it is in their interest
 Which is more dangerous-CAD or FD

Comparatively CAD is more dangerous because
o CAD is in terms of dollars and FD is in domestic currency
o CAD is external and FD is internal
o Fluctuations in exchange rates will have impact on CAD
 BoP-overall the BoP account can be a surplus or a deficit. If it is deficit then the
foreign exchanges are taken from the third account-Forex Account (Balancing
Account) and the deficit is bridged. If the reserves in the forex account are falling
short then this scenario is referred to as BoP crisis. The last time India suffered from
BoP crisis was in 1991 and it had approached IMF for assistance.
How to take care of BoPD
o Increasing exports-the exports lead to accumulation of the foreign currencies
o Decreasing imports will reduce the outflow of foreign currencies
o Doing above two simultaneously
o Encouraging more FDI and FII (more inflow of dollars)
o Reduction of non-essential imports
o Currency Devaluation
o Long term way-out is increasing exports (and it should be noted that the
exports have to made a function of quality)
 Foreign Trade Policy (2015-20)

o Is applicable for a period from 2015-2020
o MEIS and SEIS (Service Exports from India Scheme)-all the previous schemes
for promoting merchandise exports have been merged into MEIS. Served
From India Scheme (SFIS) has been renamed as SEIS. Certain listed goods and
services sent to certain listed countries will get incentives
o Aim is to increase the exports from India to $900 bn by 2020 (since 2011, our
exports are hovering around $ 300 bn and if the target has to be achieved
then the exports have to grow by CAGR of 23% which is very ambitious)
o The duty credit scrips are transferable
o FTP to be aligned with Make In India
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o Challenges
 Port Infrastructure needs huge improvement as they handle almost 95 per
cent of trade volumes or 68% in terms of value
 There has to be ease of documentation
 The banks must provide credit for both import and export, warehousing
facilities etc
 Mid-term Review of Foreign Trade policy

o Objectives
 Exploring new markets and new products as well as increasing India’s
share in the traditional markets and products
 Leveraging the benefits of GST
 Close monitoring export performance and taking immediate corrective
action through state-of-the-art data analytics
 Increasing ease of trading across borders through trade facilitation
 Enhancing participation of Indian Industry in global value chains
 Increasing farmer incomes through a focused policy for agricultural exports
 Promoting exports by MSMEs and labour intensive sectors to increase
employment opportunities for the youth
o Provisions
 MEIS (Merchandise Exports from India Scheme) incentives for two sub-sectors of
Textiles i.e. Ready Made Garments and Made Ups increased from 2% to 4%
involving additional annual incentives of ₹ 2743 Cr
 Across the board increase of 2% in existing MEIS incentive for exports by MSMEs
/ labour intensive industries amounting to ₹ 4576 Cr
 To provide an impetus to the services trade, the SEIS (Service Export from India
Scheme) incentives have been increased by 2% for notified services such as
Business, Legal, Accounting, Architectural, Engineering, Educational, Hospital,
Hotels and Restaurants amounting to ₹ 1140 Cr
 The validity period of the Duty Credit Scrips has been increased from 18 months
to 24 months to enhance their utility in the GST framework. GST rate for
transfer/sale of scrips has been reduced to zero from the earlier rate of 12%
 New trust based Self Ratification Scheme introduced to allow duty free inputs for
export production under duty exemption scheme with a self-declaration. Under
this scheme, instead of getting a ratification of the Norms Committee for inputs
to be used in the manufacture of export products, exporters will self-certify the
requirement of duty free raw materials/ inputs and take an authorization from
DGFT

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 Contact@DGFT service for Complaint Resolution has been activated on the DGFT
website (www.dgft.gov.in) as a single window contact point for exporters and
importers for resolving all foreign trade related issues
 To focus on improving Ease of Trading across Borders for exporters and
importers, a professional team envisaged to handhold, assist and support
exporters with their export related problems, accessing export markets and
meeting regulatory requirements
 New Logistics Division created in the Commerce Department to develop and
coordinate implementation of an Action Plan for the integrated development of
the logistics sector, by way of policy changes, improvement in existing
procedures, identification of bottlenecks and gaps and introduction of
technology in this sector
 For clarity, a negative list of capital goods which are not permitted under the
EPCG (Export Promotion on Capital Goods) scheme has been notified
 The concept of Domestic Tariff Area (DTA) sale from Export Oriented Units (EoUs)
on concessional and full duty has been removed and hence, the limit on
entitlement of DTA sale has also been removed. Consequently, restriction on DTA
sale of motor cars, alcoholic liquors, books and tea has been removed
 Second Hand Goods imported for the purpose of repair/
refurbishing/reconditioning or re-engineering have been made free, thereby
facilitating generation of employment in the repair services sector
 Issue of working capital blockage of the exporters due to upfront payment of GST
on inputs has been addressed. Under advance authorization Export Promotion
for Capital Goods (EPCG) Scheme, 100% EoU’s, exporters have been extended
the benefit of sourcing inputs/capital goods from abroad as well as domestic
suppliers for exports without upfront payment of GST
 e-wallet will be launched from 1st April 2018 to make the above schemes
operational from 1st April, 2018
 The Union Cabinet Committee on 15th December 2017, approved the special
package for employment generation in leather and footwear sector. The package
involves implementation of Central Sector Scheme “Indian Footwear, Leather &
Accessories Development Programme” with an approved expenditure of Rs 2600
Cr over the three years from 2017-18 to 2019-20. The scheme would lead to
development of infrastructure for the leather sector, address environment
concerns specific to the leather sector, facilitate additional investments,
employment generation and increase in production. The Special Package has the
potential to generate 3.24 lakhs new jobs in 3 years and assist in formalization of
2 lakh jobs as cumulative impact in Footwear, Leather & Accessories Sector

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Subsidies
“Subsidies are politicians delight and an economist’s nightmare”
Subsidy is a support (financial or otherwise) extended by the government to an economic

sector (the beneficiaries). The transfer could be in the form of cash/kind (direct/indirect);
universal/targeted; implicit/explicit
 Types of subsidies
o Cash- the government provides the subsidy in the form of cash payment. Such
transfers usually increase the purchasing power of the beneficiary (eg-
MGNREGA wages)
Kind-rather than providing the subsidy in cash, certain goods/services are
provided at a discount rate. The advantage here is that this could reduce the
expenditure diversion but will lead to administrative costs (NFSA)
o Universal- the subsidy can be availed by everyone (Fertilizer subsidy)
Targeted- Beneficiaries satisfying certain criteria will get the benefits (PAHAL)
o Implicit- the government provides benefits/subsidy through certain
exemptions (tax exemptions given to corporates, exemptions on SSS etc)
Explicit- the government provides the benefits in the name of subsidy itself
(Fertilizer subsidy, NFSA etc)
o Conditional-the transfer of benefits are done only when the consumption of it
is guaranteed for the intended purposes only
Unconditional-transfers are done but there is no compulsion on the utilization
of funds
 Need of subsidy
o The subsidization of certain inputs like fertilizer may increase the accessibility
to these inputs, make them cheaper and may promote the usage. This
increased usage will lead to higher production. The higher production also
means the exports could be promoted
o One of the objectives of the government is to reduce the income disparity.
This can be achieved by-taxing rich at a higher rate, taking these revenues and
channeling for redistributive purposes; another way is providing the goods at
a subsidized prices to the people
o The subsidy that is provided leads to moderation and controlling of prices of
these goods (eg-Fertilizers)

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o The subsidy also promoted efficient usage of resources (which are scarce in
nature)
 Criticism against subsidies

o Are regressive in nature-the subsidies inadvertently have benefitted the rich
more than the poor
 LPG-non-poor consume 91%
 Electricity- poor get the subsidy of 49% and non-poor 32%. The
poor consume only 16% whereas non-poor consume 84%
 Kerosene-Non poor consume 50%
o It violates “one product-one price” principle and whenever a good violates
this principle there is a diversion and black marketing of such good
o It leads volatility of prices in the market (eg-MSP) i.e. it distorts the market
o Especially in agriculture sector the subsidy in the form of MSP disturbs the
cropping patterns, variation of supply of pulses and cereals etc
 So are subsidies are necessary?

o The simple answer is yes as there are so many sectors/segments of population
which are stuck up at a certain level because of various reasons. These need
support either directly or indirectly
o It would help if the government starts targeting the subsidy transfers rather
than providing them universally
o It would also help if the government makes the transfers conditional which
may lead to higher efficiency (but high level of corruption will be the biggest
problem for the implementation along with extra costs incurred for
administration)
o In the process of targeting, the government will benefit largely if it uses the
concept of DBT
 The government provides subsidies in

o LPG
o Fertilizers
o NFSA
o MSP
o Electricity etc

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 LPG
o The LPG is available at three different price levels in the market-subsidized
(maximum 12 per annum to each registered household), unsubsidized (once
finished a quota of 12 cylinders the unsubsidized prices have to be paid) and
market prices (apart from absence of any subsidy there are various state and
central taxes levied hence further pushing up the prices)
o The LPG as a good violates the one product one price principle this leads to
diversion and black marketing of the cylinders
o To control it the government has PAHAL (DBT scheme) and very recently has
announced that those household who have a cumulative annual income of
over Rs 10 lakh will not be provided with any subsidy on LPG
o As a result of PAHAL, the government has been able to lower the subsidy
outgo by Rs 12700 cr
o But the problem is that the 12 cylinder allocation is still very high and will lead
to black marketing and diversion
 Fertilizers-are artificial supply of nutrients. Three types of fertilizers are used N:P:K
(Urea : Diammonium Phosphate : Muriate of Potash)
o In India, Urea attracts the maximum parts of the subsidies provided for
fertilizers, of the three maximum produced, maximum controlled, maximum
imported etc
o Urea is produced by 30 manufacturers (these get subsidy based on the cost of
production)
o Urea is imported by 3 agencies (State Trading Corporation of India; Metals and
Minerals Trading corporation of India; India Potash Ltd)
o The other two fertilizers (DAP and MoP) get subsidy based on quantity of raw
materials used (Nutrient Based Subsidy)
o Since the pricing of fertilizers violates “one product, one price” principle,
fertilizers are black marketed, smuggled out of India etc
o Leakages
 Black Market
 Black market prices are more than 61% of the stipulated prices
 41% of urea is smuggled to Nepal, Bangladesh or is diverted to
industries (Urea is used as one of the ingredients in chemical
industry, explosives, automobile systems, laboratories, medical
uses, flavor enhancing additive in cigarettes and others
 51% of the farmers buy urea above MRP

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Usually the Fertilizer Dept estimates the demand and hence imported.
The usual time it takes for the whole process is 60-70 days
 Impact on small farmers-the large farmers using their influence access
subsidized fertilizer whereas it is the small farmers who have to pay
excess price to procure urea from the black market
 Inefficient fertilizer producers-the subsidy paid to a domestic
manufacturer depends on the cost of production. In 2012-13, 24% of
the fertilizer subsidy has gone to such manufacturers.
 The other problems related to usage of urea are- since it is subsidized
the usage of urea is more compare to other two (ideal usage of N:P:K is
4:2:1, whereas present scenario of usage is 6.7:2.4:1)
o Reforms taken in 2015

 Gas pooling policy 2015-gas is one of the raw materials that is needed
for producing the fertilizer and government has introduced the policy
wherein the gas will be provided to the producers at a uniform price
 Nutrient Based Subsidy (NBS)- 75% of urea produced must be neem
coated; Maximum retail price to be Rs 268/50 kg (additional 14 rupees
if coated with neem); Existing subsidy for P&K, DAP,MoP to remain the
same; Movement and sale of fertilizers has been freed; The units at
Talcher(odisha), Gorakhpur(UP), Ramagundam(Telangana),
Baruni(Bihar) to be revived(addition of 52 lakh tonnes)
(Advantages of Neem coated urea-increased yield, acts as insecticide,
reduces leaching etc)
o Steps to be taken
 DBT could be introduced
 Fertilizer could be provided to the households by the size of it
 Imports must be decanalized
 Urea should be brought under NBS
 A case of Implicit subsidies-Small Saving Schemes

o Were initially introduced to promote savings and mobilization amongst small
savers
o The SSS offer higher market rates, they compete with the deposit rates of
banks and hence it is difficult for banks to reduce the deposit rates
o SSS have been classified into 3 types

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 Actually small-range from postal deposits to schemes for the elderly

and women. Most of these are TTT under section 80C of IT
 Not so small-include PPF. (EEE under section 80C)
 Not small at all-include tax free bonds which are TET
o Under section 80C of IT, it allows deductions from gross income for various
saving schemes
o EEE/EET/TET/TTT principle-contribution, accumulation, withdrawal
o Hence the SSS attract implicit subsidies and fetch better returns to the
investors
o Another important area of implicit subsidies are corporate tax exemptions.
The companies are levied on an average a tax rate of around 33% but by using
various tax exemptions and end up paying on average taxes at 23%. This leads
to under collection of taxes/revenues for the ex-chequer. The central
government recently has said that these tax exemptions will be phased out
and in parallel reduce the corporate tax rate.
 The regressive nature of subsidies has led to rich using up large chunk of subsidies
un
o Gold-top 20% of the population consumes 80% of the gold which is taxed at 1-
1.6% whereas other commodities are taxed at 26% (including state and
central taxes). 98% of the implicit subsidy is consumed by the non-poor
o LPG-subsidized at 36% and the better off consume 91% of the LPG
o Electricity-better off are subsidized at a rate of 32% and poor at 49% but
better off consume 84% of the demand
o Kerosene-subsidized at a rate of 38% for both. 50% of the kerosene given at
PDS is consumed by well off
o Overall such subsidies which are consumed by the non-poor are to the tune of
Rs 1,03,249 cr
 DBT (Direct Benefit Transfer) - under this the subsidies are transferred directly into
the bank accounts of the beneficiaries. The government has proposed JAM (Jan
Dhan-Aadhaar-Mobility) to implement DBT in various goods.
 JAM- it is dependent on 3 pillars ITC (Identification, Transfer and Coverage)

o Government  Beneficiary Identification
 AADHAAR has been implemented to identify the right beneficiaries
 The coverage has reached 975 million (75% of the population and 95%
of the adult population)
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 In 2015 alone there have been creation of 210 million numbers

 Chattisgarh-90.6%
o Government  Bank-challenge of transfer
 Jan Dhan Yojana launched
 The coverage has reached 46%
 Two states Chhattisgarh and MP have a coverage greater than 75%
 It could be said that the unbanked are more likely to constrain the
growth of JAM, compared to unidentified
o Bank Beneficiary-Last mile coverage challenge
 Only 27% of the villages have a bank within 5 Kms (to improve
accessibility RBI issued 23 banking licences-2 universal+11 payment+10
small finance)
 The BC coverage is less
 Mobile penetration is very high hence must be used for faster, efficient
service delivery
There are 3 stages to pursue JAM
o First Mile-issues deal with beneficiary identification and eligibility (wealth and
health of beneficiary, universal/targeted etc)
o Middle Mile-issues deal with administrative challenge of coordinating
government actors (how many departments, incentive for the players etc)
o Last Mile-issues deal with risks of excluding genuine beneficiaries (how many
have the bank a/c, accessibility etc)
Hence the GoI should introduce JAM in areas where central government has
significant control and also where the leakages are high
Considering the limited developments in Banking coverage and certain drawbacks in

the DBT, the government could consider another methodology BAPU (Biometrically
Authenticated Physical Uptake) till all the issues related to DBT are addressed.
 WTO and Subsidies

o WTO uses the term AMS (Aggregate Measure of Support) to measure the total
subsidies (provided on inputs and products) provided by the government to
the agriculture sector.
o WTO concluded AoA (Agreements on Agriculture) in 1994 and is aimed at
promoting integration of global markets by removing the trade barriers and
promoting market access. This tool has been criticized as a measure used by

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developed countries to beat down developing and LDCs. It has 3 pillars-

Market Access, Domestic Support and Export Subsidies
o Under the domestic support, it represents the subsidies under 3 categories
 Green box- are the subsidies (or expenses) by the government which
do not cause or cause very minimal impact and cause least distortions
(does not involve any price support). Basically this considers the
indirect price supports that could be provided by the government eg-
storage for food security purposes, expenditure on pest management
etc
 Amber Box- subsidies that distort the production and trade (eg-MSP,
Fertilizer subsidy, electricity subsidy etc) fall under the category. The
provisions limit such subsidies to 10% in case of developing countries-
India
 Blue Box- basically is an extension of Amber boxes, the subsidies which
are usually directed towards a single product for ex- the subsidies that
are given to livestock
o The contention of the WTO is that the distortions (the subsidies that are given
by the government to agriculture sector either in the form of fertilizer subsidy,
electricity subsidy, irrigation subsidy, MSP etc will lower the cost of cultivation
thereby giving an undue advantage to the cultivator). So the WTO under the
“de minimis” (under Amber Box) limits the agriculture subsidy to 5% and 10%
for developed and developing countries respectively (at 1986 price levels).
o If this is implemented then India will be forced to cut down the subsidies to
agriculture sector by more than 90% of the present value. Which is simply
unthinkable as the problems of agriculture sector are increasing and it
requires help from the state and not to forget the NFSA which is being
implemented and the subsidy outflow under this is more than a lakh crore
rupees per annum
o To protect the interest of the developing countries, a Peace Clause was signed
under the Bali Agreement (9th Ministerial Conference of WTO) which
protected developing countries from any claims against their agriculture
subsidies till 2017.
o Then the question arises-how come the developed countries are able to
control these subsidies and is becoming difficult for developing countries?
The developed countries for one do not suffer from having to maintain very
high population unlike India and China.
Second the agriculture is very highly mechanized and the same cannot be said
to be the case with India
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Another trick that was used by the developing countries was they have
gradually taken the subsidies from the Amber box and shifted them to green
box and have achieved two things-increased the support, the Green box
subsidies cannot be challenged whereas the amber box subsidies can be

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Industries
“A government which would engage itself in trade would come to grief”-Sardar
Vallabhbhai Patel
“The current danger is that India will stretch into centuries what took other countries
decades”-Milton Friedman (1963)
Industrial Policies
 Post-independence “Cult of nationalism was replaced by church of socialism”. The
socialists looked at every crisis/bump in the economy as a chance to nationalize or to
increase the hold of the government on the economy. Hence to increase the control
the government introduced license-permit-quota-raj which stifled growth, stifled
exports (exports contribute to build of the forex reserves and India did not
concentrate on that), stifled competition by not allowing more private sector
participation, and promoted inefficiency (all these are perfect ingredients for
disaster)
 The question of what would be appropriate economic development model for India
post-independence was being debated in 1930s and 1940s as there were three
distinct groups whose viewpoints in this matter differed.
o One was led by Gandhiji, who said that there must be self-sufficient villages
having cottage co-operatives (to create employment, self-sufficiency, increase
the rural income etc) which would be protected from the large industries
o Another group was led by Sardar Vallabhbhai Patel and Rajendra Prasad who
envisaged a mixed economy
o Third, the most dominant group was led by Pandit Jawaharlal Nehru which
emphasized the need for socialism or nationalization of resources so as to
provide for the redistribution of wealth
Hence the point was discussed at congress working committee meet in Wardha in
1937 and a National Planning Committee was set up under the leadership of Nehru
at the next meeting in Haripura (1938)
 Just to emphasize why this idea of state control (socialism) became widely accepted
here
o India had suffered under the British rule who had come into India in the garb
of doing business and it was also a widespread feeling that the business class
in India were lenders to British and partners in the exercise of British

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Colonization. Hence the government was unwilling to give away the precious
natural resources which could benefit the industrial class
o The viewpoint was that the natural resources were very scarce and very
precious and that only the government was mature enough to utilize them
o The implementation of reforms in Soviet Union and regime change in china
added to the demand for national control
o India contributed around 22.6% of the global income in 1700s and by 1950s it
had come down to mere 3.8% (British rule had changed India from the
brightest jewel in the British crown to one of the poorest countries)
Sensing this business class/industrialists started to prepare a model/plan for

development for India post-independence which would protect their interests. This
was called as Bombay Plan. The plan envisaged that the government has to play an
important role as it could promote investment, control inflation and protect the
environment. In simple terms the plan accepted that the government would start
controlling the economy but put in the case of business class, that has to be kept in
mind while formulating the policies. So the business class went short on freedom
and long on survival
In essence this was fight between two groups-one the government that would be
formed post-independence (there were enough indications that it would go for more
control) and the business class which wanted to stay relevant and important after
the independence.
But the most important insurance the industrialists took under this plan was that
they did not propose the route of foreign investment to promote the economic
growth in India. Rather there was no mention of foreign investment in the plan
thereby it restricted the participation in the economy only to the domestic business
class (and this sort of agreed by the government when it introduced the Import
substitution and self-reliance. The word “sort of” is used as the government felt that
it should be the PSEs which would provide most of the goods/services and in case of
Bombay plan it was the industrialists themselves)
 Need of Industrial Policies (IP)

o At the time of independence India did not have thriving industries, hence it
was felt that there was a need of a policy to protect and develop small and
medium enterprises. It was also felt that the Indian enterprises were in the
infant stage and require protection from the global competitors

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o There was scarcity of resources, skewed distribution of income, inequality

was persistent hence there was a need to maintain a sustained growth in
productivity and have a balanced growth
o The policy would be promoting creation of gainful employment
o To achieve optimal utilization of human resources
o To transform India into a major partner and player in the global arena
 Arguments against IP
o Interests of the pressure groups- whenever a state tries to exert control over
industries it forms policies and it has been found that these policies are
usually influenced by an interest group or a pressure group. In case of the
IPRs post-independence, it was the political class (specifically those who
believed in socialist ideas) that formulated and enforced the policies
o Government knows best - basically all the IPRs till 1991 were enforced by the
government in spite of opposition of the private sector. This imposition was
done with a reason that the government knew what it was doing and only it
can promote the growth along with the welfare
o Devoid of any economic rationality- the IPRs announced by the government
did not consider the economic realities such as promotion of exports,
recalling infant industry policy, natural advantages that India had in sectors
such as steel and textiles etc
o Ignoring the views of stakeholders- government should have formulated the
IPRs taking into consideration the viewpoints of the private sector, rather it
treated the private sector in a hostile manner
 Under this scenario GoI proposed various Industrial policies

o Industrial Policy Resolution (IPR) 1948
o Industries Development and Regulation Act (IDRA) 1951
o IPR 1956
o IPR 1973
o IPR 1977
o IPR 1980
o NIP/IPR/NEP 1991 (New Industrial Policy/New Economic Policy)
 IPR 1948
o Was presented by Shri Shyama Prasad Mookerjee
o It gave a model of a mixed economy wherein there was importance given to
public as well as private sector. The role of Public sector was limited to arms
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and ammunitions; atomic energy; and railways. The policy also stated that
whether more areas would be nationalized would be decided after ten years
and any further investment in expanding capacities in the sectors such as
coal, telegraphs and wireless, coal, ship building etc would be undertaken by
the government only
o It basically divided the industries into 4 categories
 1st - Solely under or exclusive monopoly of GoI
 2nd- Mixed Sector-New units would be established by GoI
 3rd-GoI regulated 18 industries-those basic sectors that government
wants to regulate (ex-sugar, cement, cotton etc)
 4th-all those not included in above three were thrown open for the
private sector
 IDRA 1951
o This act has to be understood with the background that India adopted the
constitution and also that the Planning Commission was set up in 1950 and
the First Five Year Plan period is from 1951-56
o The act was passed by the parliament. The act increased the stranglehold of
the government over the enterprises. The provisions of the acts were
 Compulsory licensing for setting up of units and expansion (in pre-
existing), if the investment was more than Rs 1 lakh.
 70 industries listed under the act
 GoI could review the functioning of the units and if found to be not
functioning well then the management could be overtaken by the
government or the license was cancelled
 Government had the control over the price, distribution and supply of
the goods manufactured by these units
o Although the government continued policy of co-existence of private and
public sector the provisions did not let anyone keep guessing that in the
future the growth and development and also the redistribution would be led
by the government. As it was stated by Nehru during the discussions in the
parliament that state controlling the economy would be an inevitable
development (1948)
 IPR 1956
o The government proposed the second FYP for the period of 1956-1961. This
plan just switched the growth model to top to down model or trickledown
theory. The architect of this plan was P C Mahalanobis. As per his model the
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investment in India has to done by the government in the heavy industries

which will eventually lead to higher consumption. This line of thinking was as
a result of Harrod-Domar Model which emphasized the importance/need of
the capital and stressed that the investments would drive growth. This was
more applicable during that period as the world had suffered through 2 nd
world war, demand was very less, there was surplus labour available etc.
Hence the government felt that the private sector would simply keep running
behind the demand which would delay the growth hence felt that the growth
would be driven by the PSEs (add to this the fear of private sector corporates
India had experienced during the British Raj).
o The result of this thought was the IPR 1956. The provisions of which are
 The industries were divided into three schedules
 Schedule A- contained 17 industries wherein only the
government was allowed to participate or were the monopolies
of the state (ex-arms and ammunitions, railways, atomic energy,
iron, coal, mineral oils etc)
 Schedule B- contained 12 industries which would be
progressively owned by the state and the state would set up
new units. But nevertheless private participation will be allowed
only to supplement the efforts of the public sector
 Schedule C- all the other industries and their future
developments would be left to the private sector.
 Other features of the policy were (the line of difference was not
watertight)
 the government reserved the rights to enter into schedule C
industries if there was a need
 in certain other areas, the private sector could be allowed to
enter Schedule A industries
 The resolution underscored the importance of the foreign
investment. But also opined that gradually the Indian personnel
and managers have to be trained to replace the foreign experts
 The resolution promoted the SSIs and stressed that they will be
protected from large industries either through differential
taxation or through direct subsidies (the policy of reserving the
products was introduced in 1967 and was expanded till 1996)

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 The resolution stressed on removing regional disparities so that

the industrial development may benefit the whole nation rather
than few pockets
o But the colossal change that this resolution brought could only be understood
when we can relate this with the Essential Commodities Act 1955, Companies
Act 1956.
The ECA empowered the central government to regulate or to prohibit the
production and control of supply and distribution and absolute control over
anything could be declared by the government as “essential” and the
companies act is considered to be one of the most detailed and stringent
codes which virtually provided all the powers to the government to regulate
the private sector.
Under this the government could decide-where the business should be set up,
what should be produced, how much should be produced, to whom the
product should be sold and at what price!
o There is no doubt that what India needed during this period was more of
open economy rather than a controlled economy. Hence the IPR 1956 and the
Second FYP were criticized for the approach it was taking. Notable among
them are
 Rajaji called it as “license-permit-quota-raj” system
 G D Birla characterized the plan as “theoretical shibboleth which if
enforced will in one sweep endanger India’s future industrialization”
The counterpoint of some of these economists was that rather than focusing
on government led growth, the focus should be on empowering sectors in
which India had inherent competitive strengths like steel and textiles and rely
on the market forces to achieve industrial development. This would lead to
investment, employment, growth, consumption etc
One such example is the recommendation of Sir Arthur Lewis who said that
India possesses huge availability of raw material resources and surplus labour,
should increase the production of steel from 1 mt to 10 mt thereby
promoting domestic consumption and also exports (which would bring in
precious foreign currencies). The idea was opposed by the government and
later Japan captured the market
o The concept of controlled economy that GoI had introduced was further
under criticism by mid sixties. One of the economists Milton Friedman
observed that India has huge potential for growth and will have to compress
into decades what took other countries centuries, but the rate of growth,

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which the officials are estimating it would take India centuries to reach the
current level of growth achieved in USA.
o The critique doesn’t mean that policies weren’t working, in fact experts opine
that the policies were too many and chaotic at best. For example let’s look at
what were the objectives of the government-to prevent the concentration of
economic power, equitable distribution of income, balance investment and
growth across India; promote industrial and economic growth; increasing
employment; and protection of balance of payments.
To achieve these objectives the GoI introduced various policies which further
made the process more chaotic.
To appreciate the nature of these policies let’s consider an example. An
entrepreneur who wants to open a company will have to first go to Ministry
of Industry to get In-Principle-Approval (or Letter of Intent). Once he got it if
he wanted to import the machinery he would have to approach Ministry of
commerce, in case of raw material imports he would again have to go to
ministry of Industry to get non-availability clearance. If he wanted foreign
collaborators he would have to approach ministry of finance. Once all these
required licenses were issued now he had to go to ministry of Industry to get
the formal license. This multi-ministry process of license issue only made it
difficult for the business class, introduced delays and the bureaucratic
involvement gave rise to corruption.
o Although the policy introduced some protection to SSIs the licensing regime
and controls that the GoI imposed on this sector did not help it at all
The result of all these controls was initially experienced in 1957 when there
was a foreign exchange crisis and was again experienced in mid 1960s. The
scenario was that India had gone through two wars, two successive years of
drought, agricultural production was at all time low, the domestic private
companies were under regulation, imports continued to flow, US had stopped
sending us food grains protesting various protection measures that the
government had introduced (such as import substitution, state control etc).
When India approached the Bretton Woods twins for assistance, it demanded
that India bring down various non-tariff measures, scale down the role of
government and devalue the currency. Although these were observed to
certain extent, the aid did not materialize. Rather a friendship treaty was
offered by Soviet Union in 1969 and was signed in 1971.

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Indira Gandhi was the PM at this point and she went for introduction of more
reform at this point. The three important policies that were introduced during
this period were
 Nationalization of Banks (1969) - GoI went ahead and
nationalized 14 banks which had a total NDTL of over Rs 50 Cr on
the pretext that these banks were not serving the purpose of
agricultural lending
 MRTP Act (1969)

o Was introduced to prevent companies from gaining
monopoly in the market
o As the companies grow in size, there is a tendency that
they tend to monopolize the market
o The principal objectives were
 Prevention of concentration of economic power
 Controlling monopolies
 Prohibition of monopolistic trade practices
 Prohibition of restrictive trade practices
 MRTP was not applicable for PSEs
 FERA (1973)
o Was implemented after independence itself but was
comprehensively amended in 1973, when the forex
reserves position of India was not stable
o was applicable to whole of India
o the main idea was to regulate the foreign exchanges and
anything that was related to it such as foreign currency
payment/receivables, conservation, foreign investments
in India etc
o RBI was given the right to determine the exchange rate,
allow a company/person to deal with foreign currencies,
permit exchangers/authorized dealer to exchange the
currencies at that rate etc (everybody else was prohibited
from dealing with foreign currencies)
o No payments or recieval of any kind in foreign currency
will be allowed without the prior sanction from RBI
o Only RBI was allowed to send dollars out of India

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o Violators of any of the provisions were treated as criminal

offenders rather than civil offenders and ED (Enforcement
Directorate) was given huge powers of search and seizure
o It had very stringent provisions regarding the foreign
exchanges. Hence was called as a draconian law by
experts. Under FERA “everything was prohibited unless
specifically permitted”
o Under this act, the foreign investors were obliged to bring
down their stake in Indian operations from 51% to 40%
FERA was replaced by FEMA (Foreign Exchange Management

Act) in 1999. This is considered to be more facilitative in nature
and was unlike FERA. Under FEMA “everything was permitted
unless specifically prohibited”. The provisions of FEMA are
o Was applicable for residents (as opposed to citizens in

case of FERA. Anybody is considered as a resident if he
has stayed for 182 or more days in India in the last year)
o Only authorized dealers (have received licenses from RBI)
can deal with the foreign exchanges
o In cases of violations, RBI will be levying financial penalty
o The exporters of goods/services shall furnish the correct
details of foreign exchange they are to receive to RBI
 IPR 1973
o The concept of core industries or infrastructure industries was included and
was covering 6 industries-cement, coal, crude oil, oil refining, iron & steel;
and electricity-if a private player wanted to invest/apply for licenses in any of
these, then they must be having assets worth Rs 20 Cr
o The concept of PPP was proposed which was also referred to as Joint Sector
o The Secretary of Industrial Approval (SIA) was set up to provide single window
clearance
 IPR 1977
o Was proposed by Janata government and had a strong bias at the heavy
industries and favored small scale and cottage industries. These were
classified into three categories
 Cottage and Household industries-provide self-employment

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 Tiny sector-allowed to set up in towns with population of less than

50000 with machinery investment up to Rs 1 lakh
 Small Scale Industries- industrial units with investment of Rs10 lakh.
Protection policies have been introduced by various governments for
this industry (reservation list had more than 800 items). To support this
government revamped KVIC and set up DICs (District Industrial
Centers). DICs were set up to function as nodal point for marketing,
raw material distribution and credit facility provision for the small scale
and cottage industries
o The large industries were classified as core, capital, high technology and other
industries
o Foreign investments will be allowed only in some sectors and would be
decided by the government based on the national interest
 IPR 1980
o Was announced by the congress government after coming to power and tried
to undo some of the provisions of 1977 IPR
o It was outward oriented and allowed for promotions of exports
o Some items reserved for SSIs were de-reserved
o Foreign investment was allowed
o Problem of industrial sickness was sought to be resolved
 IPR/ NIP/NEP 1991

o Following features led to the crisis in 1991
 Increase in Fiscal Deficit
 Increase in adverse balance of Payment
 Gulf Crisis
 Fall in foreign Exchange Reserve
 Rise in Prices
 Poor Performance of Public Sector
o In this scenario financial help was provided by IMF but with certain riders
 IMF provided the financial assistance albeit certain conditions
Conditions
 Excise duty must be increased by 20%
 Rupee to be devalued by 22%
 Reduction of import tariffs
 Government to cut its expenditure by 10% each year

139
Logic/Rationale behind the conditions
 Government’s role is to provide a conducive environment for the

growth of the economy.
 The assets and revenues made by the private sector companies belong
to the shareholders.
 Production activities are profit driven.
 Decision making process is much faster in private companies compared
to in the Public sector
o In this scenario the government introduced LPG reforms

 L- Liberalization
 P- Privatization
 G- Globalization
o Liberalization- It means to free the economy from direct or physical controls

imposed by the government
 Industrial sector
 Industrial licensing was abolished
 Only three areas were reserved for PSEs (presently 2)
 Licensing was abolished for all except 6 (presently it is 5-
electronic,aerospace and defence equipments; industrial
explosives; hazardous chemicals; tobacco; alcoholic drinks)
 The markets were allowed to determine the prices
 Some goods which were reserved for SSI were de-reserved
 Financial sector
 Banks were allowed to raise the funds from the market by issue
of shares
 Setting up of private and foreign banks
 Entry of FIIs was allowed
 Tax reforms
 Lowering of corporate and income tax
 Procedures for tax compliance simplified so as to increase
compliance
 Foreign Exchange reforms
 Rupee was devalued
 Exchange was determined by market forces

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 Trade policy reforms

 Import licensing was abolished
 Removal of export duties
o Privatization
 Privatization refers to sale of stake/ownership of PSEs
 51% - majority stake
 26% - strategic stake
 100% - sole ownership/PSEs
 Rationale for disinvestment
 The large amount of resources (which are scarce in overall
availability) can be redeployed
 The government can raise revenues and also control the debt
 The private sector will get access to the resources
 It will promote competition
 The disinvestment will bring in the private resources which can
be utilized for better productivity
 To make rapid industrial development
 To earn more foreign currencies (by promoting exports)
 Rangarajan Committee
 IPO method would be the best method of once a normal trading
atmosphere is established
 Disinvestment should be planned in phased manner rather than
year to year basis
 A disinvestment committee should be set up
 The level of disinvestment should be up to 49% in the PSEs
reserved under NIP (strategic sectors) and up to 74% in other
sectors
 Over the period the government has not only strategically disinvested
various PSEs, it has also gone ahead and divested (selling off 100% of
the stake/ownership) various PSEs which have been booking losses
(eg-VSNL, BALCO, ITDC hotels, Maruti Udyog Limited etc)
 BRPSE
 Board for Reconstruction of Public Sector Enterprises
 Established in 2004
 Has been wound up in November 2015
 Would work under Department of Public Enterprises
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 Is an advisory body, to advise GoI on forming strategies to

strengthen, revive, restructure, modernize CPSEs
o Globalization
It is defined as a process associated with increasing openness, growing
economic independence and Deeping economic integration in the world
economy.
 Reduction of trade barriers
 Free flow of technology
 Free flow of financial capital
 Free flow of human capital
 Free movement of goods
 Free movement of services
o Evaluation
 Positive outcomes
 Rate of growth - During pre-reforms period there was an
average growth rate of 2%, post the reforms, there was an
average growth rate of over 5% and PCI growth rate of over 3%
 Composition of national product- the percentage contribution
of agriculture to GDP has gradually come down and that of
secondary and tertiary has increased
 The savings and investments have increased.
 The industrial growth rate has fluctuated before 2000 but post
which it has been more or less stable, but the most important
outcome is that the growth is happening across all the sectors
 External Sector
o Exports have increased rapidly (exports contributed only
17% of GDP in 1990-91, presently they contribute around
40%)
o India’s share of exports was 0.5% in 1990-91 and today is
around 2%
o Large inflow of foreign capital (FDI and FPI)
o forex reserves are valued over $360 bn
 Infrastructure
o Transportation-railways, roadways, air and shipping-have
expanded and are contributing to the growth

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o Communications has expanded rapidly

o Social infrastructure- investment in health and education
infrastructure has increased
 Financial sector
o Taxation reforms has led to higher collection of taxes and
increase in tax base
o Reforms were introduced in secondary market, banking
sector which led to increase in the investment
 Areas where India has fallen short

 Although there has been higher growth it has been-uneven and
exclusive
 Higher growth is usually associated with employment growth,
has not been so in India
 Has led to increasing income disparities and regional imbalances
 The hurdles such as licenses, regulations still exist
 The nexus between bureaucracy and politicians is still strong
leading to leakages and corruption
 Growth and supply of infrastructure is still weak
 Environmental degradation
 Poverty numbers are still high
o Recommendations
 Bring bolder reforms-insolvency, exit policy, labour reforms etc
 Provide more space for private sector
 Increase co-ordination between the centre and the state
 Loss making PSEs must be privatized
 More FDI reforms
 Reforms in financial sector-Banking sector reforms, tax reforms etc

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Public Sector Enterprises (PSEs)

 Need
o Heavy industries- they require heavy investment, long gestation period and
usage of scarce resources
o Socialistic pattern of society- providing employment opportunities, providing
public goods, prohibit concentration of wealth
o Growth- was important to develop infrastructure, growth (including balanced
regional growth)
o To promote exports and import substitution
 Drawbacks
o The PSEs in the absence of competition from the private sector became
complacent and started making losses
o PSEs could not use the resources allocated to them efficiently
o Intervention from the political class
o Delays in completion-cost and time overruns
o Since there was no competition, technology up gradation, economies of scale,
superior quality goods, competitive pricing of goods were not the features
 Special status given to CPSEs - Special status is given to various CPSEs by Dept of
Public Enterprises (Mo Heavy Industries and Public Enterprises)
o Miniratna status - introduced in 1997
 Category1
 profits in the last three years or earned a net profit of more
than Rs 30 cr in any of the last three years
 Can incur capital expenditure of Rs 500 cr or equal to their net
worth (whichever is lower), in a year without the government
approval
 56 CPSEs
 Category 2
 profits in the last three years continuously
 have positive net worth
 Can incur capital expenditure of Rs 300 cr or equal 50% of their
net worth(whichever is lower), in a year without the
government approval

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 17 CPSEs
o Navaratna-introduced in 1997
The Miniratna Category – I CPSEs which have obtained ‘excellent’ or ‘very
good’ rating under the Memorandum of Understanding system in three of the
last five years, and have composite score of 60 or above in the six selected
performance parameters, namely,
 net profit to net worth,
 manpower cost to total cost of production/services,
 profit before depreciation, interest and taxes to capital employed,
 profit before interest and taxes to turnover,
 earnings per share and
 Inter-sectoral performance.
Navaratnas are given following powers

 Company can invest up to Rs 1000 cr in a project without the approval
from the GoI
 Enter into technological JVs/strategic alliances
 To affect organizational restructuring
 There are 17 companies listed under this status
o Maharatna status-introduced in 2010
The CPSEs fulfilling the following criteria are eligible to be considered for grant
of Maharatna status. There are 7 CPSEs under this status
 Having Navratna status.

 Listed on Indian stock exchange with minimum prescribed public
shareholding under SEBI regulations.
 Average annual turnover of more than Rs. 25,000 crore, during the last
3 years.
 Average annual net worth of more than Rs. 15,000 crore, during the
last 3 years.
 Average annual net profit after tax of more than Rs. 5,000 crore, during
the last 3 years.
 Should have significant global presence/international operations.

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Powers
 Company can invest upto Rs 5000 cr in one project without the Govt’s
approval
 The boards of these companies will have enhanced powers in areas
such as JVs, organizational restructuring etc compared to a Navaratna
company
 Industrial Sickness
o SICA-Sick Industrial Companies Act was passed in 1985 (T Tiwari committee-
1981)
o Under this the objective was to determine how sick a company was and if it
could be revived, if found unviable it would be closed down.
o The SICA is applicable to public and private sector enterprises which own
industrial undertakings. It will cover
 Industries specified in the first schedule of IDRA 1951
 Not the small scale industrial undertakings under section 3(j) of IDRA
 The criteria to determine sickness are
 Company must have a license
 Accumulated losses must be greater than the total net worth of
the company
 Company must have employed at least 50 men on any day of
the preceding 12 months
o In FY16, CPSEs made a profit of ₹ 1.4 trillion whereas there were 78 PSEs
which had incurred losses of ₹ 287.5 bn. The DPE (Department of Public
Enterprises) has issued guidelines to have “Time bound closure of Sick/Loss
making Central Public Sector Enterprises and Disposal of Movable Assets” (a
CPSE is considered sick if accumulated losses in any financial year is equal to
50% of more of its average net worth during 4 years immediately preceding
such financial year and/or a CPSE which is a sick company within the meaning
of Sick Industrial Companies Act 1985 as per which a CPSE is declared sick if its
accumulated losses are more than its networth)
 The concerned administrative departments/ministries are responsible
for formulation and implementation of closure plans and NITI Aayog
will carry out monitoring the implementation of the decision of the
closure
 The sick units will be closed down within a year from the date (Zero
Date) of issue of minutes of cabinet approval (presently the process
drags on for years)

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 The statutory dues (towards revenue and tax department) and

payment to secured creditors will be done in two months
 The employees (those not opting VRS) will be retrenched within 4
months
 The disposal of movable assets will be completed within three months
 In case of immovable asset (land), the sale is to be finished in six
months. The central government will get the first priority, followed by
departments of the central government and state government bodies
and departments. In case no offer is received in 6 months, the disposal
of immovable asset will be done through auctioning process. Even
after this, if the land remains unsold, the property will be used for
public purposes (affordable housing or central government flagship
scheme)
o BIFR (Board for Industrial and Financial Reconstruction) was established in

1987 under SICA in order to ensure early detection of sickness in a unit and
formulating a package to revive the unit. SICA was amended in 1991 to
include the public sector. SICA has been repealed by SICA (Repeal) Act 2003 as
it was ineffective in reviving the sick industries and in its place NCLT is
expected to perform the same function more effectively
 Exit Policy / Chakravyuha Challenge

o Post 1991 GoI has taken number of reforms but majority of them are in the
field of removing entry barriers
o Hence there are enough exit barriers which have piled up over the time and
these not only affect public sector companies, but also affect the private
sector companies
o When the sick firms do not exit, they are subsidized by the Government.
These funds are nothing but the public funds
o This affects poor the most as they too pay taxes (indirect) but are forced to
purchase the goods at higher prices because of inefficient firms
o Whenever exit of companies does not happen
 It will have held up valuable resources
 Imposes financial, economic, political costs
o Cost of impeded exit
 Fiscal-GoI supports either explicitly (bailout package) or implicitly
(reduction of tariffs, loans etc). The effect is on the economy as it is
forced to make better use of remaining tax revenues, higher FD,
reduced revenues etc

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 Economic-prohibits the factors of production (scarce resources) to be

used by other efficient companies
 Political-the benefits of the support flow to the rich businessmen
hence giving the impression that the Government favours large
corporates
o Why there is an Exit Problem?
 Vested Interests-trade liberalization benefits (collectively large and
individually small) a large number of customers and few producers
(influential) are losers. Hence the losers use the clout/influence in the
policy matters (eg-JAM in MNREGA)
 Weak and Strong Institutions-India has got a set of very powerful and
weak institutions. This exerts an asymmetric incentives on the
bureaucrats
 Ideas/Ideology-it is difficult to phase out entitlements
In India more than 50% of the schemes are schemes are more than 25
years old and of the 104 schemes 92 have been going on for over 15
years leading to bureaucratic inertia
o Recommendations
 Allow private participation along with PSEs
 Weak institutions must be strengthened and over strong institutions
must be addressed by empowering bureaucrats (bankruptcy code and
amendment to PCA are examples)
 Technology must be used as it reduces human discretion and reduces
layers of intermediaries
 Transparency must be increased
 Exit in private sector must be made as an opportunity (the resources
garnered must be earmarked for the employees)
 Bankruptcy code
o Provides for a speedy insolvency resolution (IR)-maximum period of 270 days
(180+90 days)
o It will consolidate all the previous laws such as NCLT, SARFAESI, DRT etc
o IR for Individuals and Partnerships will be directed to DRTs (Debt recovery
Tribunals).
o IR for Limited Liability Partnerships (LLPs) and Companies will be directed to
NCLT (National Company Law Tribunal)
o DRT/NCLT can be approached by lender or the borrower

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o Once approached they will appoint a Insolvency Professional (IP, certified, an

expert in the insolvency resolution, once appointed all the assets of the
company will come under his control)
o The IP will seek information from Insolvency Agencies about the concerned
borrower and also set up CC (Creditors’ committee) and time will be given for
them to deliberate and decide (whether to liquidate or to recapitalize and
revive the company). If no decision is made then the IP will recommend the
authority to liquidate the concerned asset
 National Manufacturing Policy (2011)

o Increase manufacturing growth to 12-14%
o GDP contribution to be 25% by 2022
o Create 100 million jobs by 2022
o Create appropriate skill sets among urban poor and rural migrants so that
they are employed
o Enhance global competitiveness of Indian manufacturing
o Simplify and rationalize business regulations
o Setting up of NIMZs
o Incentives for SMEs
o Simple and expeditious exit mechanism for manufacturing units

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Small Scale Industries to MSME

 1955- Karve committee recommended using SSIs to promote rural development
 Policies regarding Small Scale Industries (SSI) were formulated during the Janata
Government in IPR 1977. For these to grow and contribute to growth, they were protected
by reserving various items
 In 2006, the government merged the three types of industries and passed the MSME act
2006 and MoMSME was set up in 2007
 The reserved items list of SSIs crossed 800 items and the GoI has de-reserved all these by
2015 and instead has introduced Public Procurement Policy (PPP-every Central Government
Ministries, Departments and Public Sector Undertakings shall procure minimum of 25 per
cent of their total annual value of goods or services from Micro and Small Enterprise)
 The importance of MSME
o Provides large scale employment (labour intensive)
o Diverse manufacturing base (more than 8000 products)
o Rural development
o Prevent migration
o Contribute to growth
o Act as ancillary unit to large companies
 26.1 million MSMEs accounts for 45% of manufactured output, 8% of GDP, and provide
employment to 59.7 million people (Economic Survey 2014-15)
 One of the issues that are associated with MSME sector is the credit availability. As per RBI,
against a total demand of a loan of ₹ 26 lakh crore of loans for MSMEs, credit availability is
only ₹ 11.10 lakh crore with majority of such enterprises depending upon informal sources
of financing (total finance requirement of around 32 lakh Cr of which ₹ 26 is in debt and 6 in
equity). To provide relief to MSMEs RBI has taken/will take following measures
o Will appoint Accreditation of Credit Counselors who will assist the MSMEs to
prepare better project reports and help the banks in making better credit informed
decisions
o To issue final guidelines in P2P (Peer to Peer) lending. There has been an emergence
of new players have entered MSME lending landscape in form of P2P companies,
and these entities use an online platform to match lenders with borrowers to
provide unsecured loans
o A movable assets registry would be set up
 Loans given to Food and Agro Processing Industries are under Direct Agricultural Lending
and lending to Medium enterprises is under PSL

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Investment Models (Part-1)

 Conventionally the growth of the economy has been revolving around savings and
investments (the ability of the investments depends on the savings) hence the
growth can be said to be a function of investments and savings. There have been two
models of growth in the past
o Savings driven – the savings (household + government + private) will lead to
higher investment which will lead to economic growth (eg-India)
o Consumption driven – more the consumption more the production leading to
higher growth (eg – USA)
o Investment Driven – this model was brought out by China
 In India the investments have been predominantly in the form of PSEs. The aim was
to increase capacity and achieve self-reliance and also leading to growth. Such an
investment is referred to as Core or Basic Investment or Top down Investment. India
had a low savings rate, which led to lower growth (Hindu Rate of Growth). This kind
of model had some limitations
o The investment was limited hence limited growth
o the government did not have all the required financial resources (as the
government had the dual duty of promoting growth and also social welfare)
o The government spending is not efficient. The projects are usually associated
with time and cost overruns
o The capacity that was developed under this was not technology intensive
o This led to capital deepening rather than capital efficiency
 But post reforms the investment models have come into prominence especially in
the last decade as there has been a slowdown in the financial savings of the
households and primary importance has shifted to the investment driven models
 The other model of investment is bottom up investment wherein the investments
are made in small and village industries which is then scaled up leading to growth
 The investment models which are under discussion as of now are
o Induced Investment (FDI)
o Leveraged Investment (PPP)
o Sector Specific Investment Models
 SEZ
 NIMZ

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FDI (Foreign Direct Investment)

 FDI is an investment done by a foreign company in India either in manufacturing or
infrastructure or services or technological knowhow or more than one of these areas
As per Arvind Mayaram committee

o In a listed company investment in a stake by a foreign company of more than
10% will be considered as FDI (if it’s lesser than 10% even then it will be
considered as FDI provided the investor guarantees that the FDI investment
will cross 10% in the next one year, otherwise it will be considered as FII)
o The foreign investments in an unlisted company irrespective of the limit will
be considered as FDI
o A foreign company may either be allowed to hold a FII or FDI stake in one
domestic company
 FDI usually adds to the productive capacity of the country. The FDI usually comes into
a country with the aim of staying for a longer period of time and also contribute to
economic activity which leads to the growth. It is the most stable form of foreign
investment
 Routes
o Direct Route – the GoI publishes the list of sectors wherein the direct route of
FDI is allowed. Under the direct route, the companies which wish to bring in
investment will inform RBI one month in advance. These companies need not
require any other prior permission
o Approval Route – Until recently the approval of FDI above ₹ 5000 Cr was done
by FIPB. It has been abolished and the government has announced that
henceforth the approval would be provided by individual ministries.
Previously the following mechanism was provided for
 If the investment proposal is up to ₹ 5000 Cr then individual
departments will clear these proposals (earlier these were approved by
Foreign Investment Promotion Board
 Through CCEA (Cabinet Committee on Economic Affairs) – if the
investment proposal is over Rs 5000 Cr then the approvals are sought
directly from CCEA

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 Caps/Ceilings – the government of India allows investment proposals based on the

ceiling (maximum limit). Usually the caps are fixed at a higher level in those sectors
which are not strategic or are in need of huge funding requirement. The caps are
usually fixed at 26%, 49%, 51%, and 100% (100% FDI means the entire stake in the
company is owned by the foreign company).
 Merits –
o The foreign investors bring in huge resources into the country in the form of
financial resources, expertise etc
o Brings new technology
o Will promote competition
o Improves balance of trade - as there would be higher production leading
reduced imports and it may lead to higher exports
o Generates employment
o Generates backward and forward linkages
o Expands the markets and integrates the domestic market with that of the
world
 Demerits
o Threatens political and economic instability – the foreign investments usually
form interest groups or pressure groups which would influence the decision
making power
o May bring obsolete technology
o May promote unhealthy competition
o Escalation in land and property prices
o Transfer pricing practices (The trade conducted between two related
companies is referred to as Intra trading. A subsidiary company in India may
buy goods from its parent company at higher prices leading lower profits of
the subsidiary and resulting in lower tax payment to GoI. This practice is
referred to as Transfer Pricing Practice. The transaction value or the pricing of
goods could be contested by the tax authorities of the sourcing country.
Hence to prevent this government has introduced the concept of Advanced
Pricing Agreements under which the tax authorities have pre-fixed the prices
of the goods and this is in the form of agreement between both the parties.
This is referred to as Advanced Pricing Agreement. As a result of this there is
clarity in taxation methodology, reduces tax disputes and litigations and
enhances tax revenues. Between 2014-16 a total of 104 APAs have been
signed. As a result of this it has been estimated that Rs 2.23 lakh Cr has been
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added to the profit base of these companies on which the taxes have been
collected)
 What are the factors that would determine the investment decisions of foreign
investors?
o Return on Investment (hence we can see that booming sectors such as DTH,
Airlines, Pharmaceuticals have been included)
o Frequent Market and Pricing Interventions (the non-clarity in pharmaceutical
sector may work against India whereas exemption of technological transfer,
sourcing norms will work in India’s favor)
o In case of long term investments, the companies want to have control of the
company (introduced in defence sector)
Foreign Portfolio Investment

 Are the foreign investors mainly the foreign institutional investors (such as
Investment funds, Pension Funds, Insurance Funds, Hedge Funds etc) which are
allowed to make investments in the stock market. The FPIs by definition are short
term funds which flow into a country with the expectations of huge returns within a
short time. If not they simply keep on moving from one country to another in the
search of higher returns. This in essence may lead to certain instability/liquidity in
the market. Hence FPI is popularly known as “Hot Money” or “Fly by night money”
 FPIs are in the form of

o FII (Foreign Institutional Investors) – are usually the foreign financial
institutions such as hedge funds, pension funds, insurance funds etc which
after getting registered with SEBI are allowed to invest in the stock market. As
per Arvind Mayaram Committee recommendations if the stake of the foreign
investor is lesser than 10% of the total, then it will be classified as FPI. Post
2012, RBI has also allowed QFI (Qualified Financial Investors-individuals,
groups or associations of those countries which are the signatories of FATF-
Financial Action Task Force) also to make investments under FII, provided they
satisfy the KYC norms of SEBI and RBI
o ADR (American Depository Receipts)/ GDR (Global Depository Receipts) –
The companies under this issue their shares in a foreign market. If they issue
in American stock market, they are referred to ADR and if issued in European
stock market-GDR. These issues are done by taking approval from SEBI, and
through foreign brokerage firms which are then with a trustee (Foreign
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Depository) who issues receipts denominated in foreign currency (but

underlying value of these shares is in Rupees)
o NRI investments
o P-notes
 are offshore derivative instruments
 Introduced in 1995
 issued by registered foreign institutional investors (FIIs such as
brokerage firms) to overseas investors, who wish to invest in the Indian
stock market without coming under KYC norms
 2007-as per SEBI guidelines P-notes must not be more than 40% of
their (FPI) investments in India
 2014-P notes could be issued to those investors who come from
countries having anti-terror funding and anti-money laundering norms
 Recent Guidelines
 The transfers of P-notes can be done only after the approval of
the issuer
 And only to those who are on a pre-approved list
 The issuer must submit information regarding who controls the
management of the P note subscriber
 Round Tripping or Treaty Shopping

o The investments of a particular country are routed through the tax heavens so
as to obtain huge tax exemptions. This not only leads to foregoing of
revenues, also promotes flow of genuine investments in this form and also
promotes flow of black money
 DTAA (Double Taxation Avoidance Agreements)

o A foreign institutional investor comes across two countries-a source country
and a resident country. Source country is the one wherein it has made
investments and is making profits. A resident country in which it has got itself
registered.
o In the process of making profits it may end up paying taxes in both the
countries - Double Taxation. To prevent this situation various countries, sign
up the treaties which provides relief to such investors. DTAAs provide relief
from dual taxation and make countries investment attractive. Such relief is
provided by exempting income earned abroad from tax in the resident

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country or providing credit to the extent taxes have already been paid abroad.
DTAAs also provide for concessional rates of tax in some cases. If the company
doesn’t pay any taxes (because as per the DTAA, the residence country might
have the right to tax and it chooses to fix it at 0%) then it is referred to as
double tax avoidance (the present scenario between India and Mauritius).
o To prevent the misuse of DTAA, countries may have limitation of benefits
clause (ex- investments from Singapore must be in stock market and the
company must have invested at least $ 200,000 on operations in Singapore
two years ago)
o India has signed DTAAs with more than 80 countries (with countries such as
Australia, Canada, Germany, Mauritius, Singapore, UAE, the UK and US) and
has recently amended the DTAA with Mauritius
o The countries such as India are on the route of development and need
investments and part of the investment come through the foreign route.
Hence there is a need for stable, clarity on cross border transactions,
progressive taxation regime which would be provided through DTAAs
o The problem with DTAAs are
 Will lead to round tripping or treaty shopping
 DTAAs become a favored route even to the legitimate investors who
route the investments through low tax regimes
o Mauritius
 Mauritius accounted for $93.65 billion or one-third of the total FDI
flows into India between April 2000 and December 2015
 It has been one of the favorite routes for FII (Foreign Institutional
Investor)
 The DTAA between both the countries was signed in 1983
 As per the latest amendments henceforth taxes on capital gains (based
on share sales) will be source based rather than residence based. With
this, Mauritius will lose its edge as a popular jurisdiction for routing
investments into India. Mauritius currently has ‘nil’ tax rate on capital
gains.
 This would help India to prevent treaty shopping or round tripping
 The protocol also provides for a ‘limitation of benefit’ clause for the
transition period (April 1, 2017 to March 31, 2019), during which the
capital gains tax rate will be 50 per cent of the normal rate.

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 The treaty is said to be reinforcing India's commitment to OECD-BEPS

(Base Erosion of Profit Sharing) initiative to stop ‘double non-taxation’
enjoyed by companies
SEZ (Special Economic Zones)

 The model of SEZ has become very popular amongst various countries to promote
investment, infrastructure development and ultimately leading to industrialization.
The number of SEZs have grown from 79 (in 29 countries in 1975) to more than 3500
(in more than 130 countries by 2006) as per ILO
 SEZ is a specifically demarcated area within the territory of a country provided with
special privileges such as exemptions in taxation, labour laws, investments, exports
promotion etc. the GoI announced SEZ policy in 2000 (under EXIM Policy), later in
2005 passed the SEZ Act which came into implementation from 2006. The objectives
of the SEZ act are
o Generation of additional economic activity

o Promotion of exports of goods and services
o Promotion of investment from domestic and foreign sources
o Creation of employment opportunities
o Development of infrastructure facilities
SEZs will also play a very important role in achieving targets under FTP 2015-2020
Features
o For all tax policy purposes an SEZ to be treated as a foreign entity
o The output in and SEZ is predominantly for export
o Tax exemption for initial 5 yrs and 50% exemption for the next 5 yrs
o No import duty on any imported goods
o Labour laws will be relaxed
o All the facilities are to be taken care of by the developer
o The act provides for single window clearance which will better the ease of
doing business in India
The idea of SEZs is not new for India as there was concept of EPZ (Export Processing
Zones) before. GoI followed the EPZ scheme to promote exports by giving incentives.
The first such EPZ was set up in Kandla in 1965. There were two main objectives of
setting up of EPZs-Export Promotion and Earning foreign exchanges. Although the

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policies did not explicitly point out the objectives the CAG report in 1989 listed the
following objectives for EPZs
o Earning foreign exchange
o Develop export oriented industries
o Stimulate investment
o Generate employment opportunities
o Creating an internationally competitive environment for export production at
low cost
There were no committed policies announced by the GoI, rather there were some
unwanted control measures, complex clearance processes, infrastructural lack led to
underperformance of the EPZs. There were such 6 more EPZs in India which have all
been converted into SEZs post the passage of SEZ act 2005 (Santa Cruz Electronics
Export Processing Zone, Falta Export Processing Zone, Cochin Export Processing Zone,
Noida Export Processing Zone, Madras Export Processing Zone, Visakhapatnam Export
Processing Zone). On the other hand the EPZ models have been very successful in
countries such as Singapore, China etc
 SEZ can be set up by- Private entity, Public entity, both, state and central entities
How to set up
o The prospective developer submits the proposal to the BoA (Board of

Approval) - a single window clearance system (Board of Approval- it’s an
inter-ministerial body headed by the Secretary of Ministry of Commerce)
which issues in-principle-approval
o When the developer can provide possession rights to the government then
the government issues notification-Notified SEZs. The SEZ has been
accorded with Formal Approval
o Once the developer is issued with approvals, it allows him to start the
operation – Operational SEZs
Types
Types Remarks Area

Multi-sector Produce more than 1000 hectares
one products/goods
from more than one
sectors
Sector specific Produce one or more 100 hectares
than one product in a
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sector
Free trade warehousing zone Focused on 40 hectares
warehousing and
trading. Used as an
international trading
hub
IT/ITES/Jewellery/BT 10 hectares
 Incentives given to SEZs
o Duty free import/domestic procurement of goods for development,

operation and maintenance of SEZ units
o 100% Income Tax exemption on export income for SEZ units under Section
10AA of the Income Tax Act for first 5 years, 50% for next 5 years
thereafter and 50% of the ploughed back export profit for next 5 years.
o Exemption from minimum alternate tax under section 115JB of the Income
Tax Act.
o External commercial borrowing by SEZ units up to US $ 500 million in a
year without any maturity restriction through recognized banking
channels.
o Exemption from Central Sales Tax.
o Exemption from Service Tax.
o Single window clearance for Central and State level approvals.
o Exemption from State sales tax and other levies as extended by the
respective State Governments.
 Concerns with SEZ

o Financial exemptions are a burden on the government. SEZs would be
given tax exemptions which would become a loss to the exchequer
o SEZs would be developed within the territories which would lead to
creation of islands of development surrounded by oceans of gloom.
o The development of SEZs would lead to unfair land acquisition (forced
acquisitions as the government has relaxed certain provisions and also the
concern is regarding acquiring irrigated land)
Although these are valid, there has been no valid proof to validate these
concerns. On the other hand the once all the SEZs are developed it would be
involving an investment to the tune of 1, 00, 000 cr and would be providing a
total of 2 million jobs. So overall the returns are more compared to the financial
exemptions that are given by the government

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 Performance of SEZs
o The SEZs have not able to perform as per the high expectations that were
formed based the performance of SEZs in china. To study regarding this
the Ministry of Commerce had set up a study done by ICRIER (INDIAN
COUNCIL FOR RESEARCH ON INTERNATIONAL ECONOMIC RELATIONS)
which has listed following two reasons for unsatisfactory performance
 Some of the incentives that were provided under the FTP 2009 to
the exporters outside the SEZ acted as dis-incentive to invest in
SEZs. Hence the investments in SEZ were inferior. The government
gave certain incentives such as-duty drawback scheme (given to
manufacturers on the imports of raw materials), focus market and
focus product schemes incentivize exports to specific geographical
regions and specific products. This was further made more severe
because of global slowdown and the SEZs goods/services were not
allowed to be sold in India.
 The SEZs have failed in becoming the centers of goods exports
rather they have only become the centers for setting up of
technology companies attracting incentives
 The SEZs enjoy duty free imports compared to other domestic
importers but with India signing FTAs with various countries, this
comparative advantage of the SEZs have been wiped out
 Reasons for Failure
o The GoI was forced to withdraw the exemption that was given in the form
of DDT (Dividend Distribution Tax) and MAT (Minimum Alternate Tax) in
2011-12
There was an opinion that the developers were misusing these exemptions
for real estate arbitrage and the service companies (especially the
software companies) were seen to be shifting to the SEZs when their
exemption period under section 10A/10B was about to be over
As per WTO regulations MAT rules were punishable, hence the GoI
implemented 20% tax rate for both DDT and MAT
o Another major reason for failure of the SEZs is the absence of
infrastructure support. The SEZs must be connected with ports and
airports with world-class roads and rail; ports and airports. This is not the
case at present.
o Signing of FTAs has led to loss of competitive advantage which was
enjoyed by SEZs

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o The incentives that were provided to the exporters and importers outside
SEZ became a disincentive to invest in SEZs (the incentives provided were
Duty Drawback Scheme, Focus Market, Focus Product etc)
o Majority of the units in SEZs are related to IT/ITeS
o Problem with land acquisition-As per the report of CAG
 No more than 62% of land (much of it acquired from farmers) for
special economic zones (SEZs) has been used for its intended
purpose- to boost manufacturing, exports and jobs.
 Most SEZs are populated with information technology (IT) and IT-
related companies, while manufacturing accounts for only 9 percent
of all SEZ projects.
 Challenges
o Land acquisition is one of the significant hurdles in implementation
o The SEZs so far have been focused on the service/technology industries
o The single window system is not working efficiently
o How to integrate the SEZ with Make in India, Foreign Trade Poly 2015-2020
NIMZ (National Investment Manufacturing Zones)

 The global experience has shown that the clustering of manufacturing units will lead
to economies of scale in
o Industrial infrastructure
o Supply chain responsiveness
o Access to market and human resources
o Lower logistics cost etc
Hence the GoI introduced SEZ and now has implemented broader concept of NIMZ
which includes even the MSMEs to achieve broad base production or manufacturing
and will catalyze growth
 The NIMZs are envisaged under NMP (national Manufacturing Policy), which aims to
increase share of manufacturing in GDP to 25% and also generate 100 million jobs
 The NIMZs are large areas of developed land, with eco-system for promoting world
class manufacturing activity. (They would be different from SEZs in terms of size,
level of infrastructure planning, and governance structures related to regulatory
procedures and exit policies)

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 The NIMZs are to be developed as integrated industrial townships (which are

autonomous and self-governing) and will be declared so by state governments under
art 243 Q(c)
 Features
o NIMZs to have state-of-the art infrastructure and land use on the basis of
zoning
o NIMZs to focus usage of clean and energy efficient technology
o Necessary social infrastructure would be developed
o Skill development facilities (to facilitate movement of labour from the primary
sector to the secondary and tertiary sectors).
 These NIMZs would be managed by SPVs (Special Purpose Vehicles) which would
provide for master planning of the Zone; getting all the clearances for setting up the
industrial units (to be located within the zone) and perform other functions as
specified in the various sections of this policy.
 Procedure for setting up of NIMZ

o The first and foremost step is to identify the land (could be government or
privately owned. In case of privately owned the acquisition to be done by the
state government) in which the NIMZs are to be built (in case of NIMZs the
minimum land that will be required is 5000 hectares). This land ownership
model is left to the state government itself. It could follow
 Sole ownership
 Transfer the ownership to the state government undertaking
 Joint ownership with the private sector
 Any other model developed by the state
Some of the other things that are to be considered while acquiring the land
are that it should not fall in the ecologically sensitive zone, minimum
cultivable land, Rehabilitation and Resettlement (the state government to
bear the financial costs if any or an provision recover the costs from SPV could
be put in place) to be focused etc
o Once the land is identified, the state government must get the EIA
(Environmental Impact Assessment) study done (regarding this DIPP in
consultation with MoEF&RE will identify some of the institutions)
o At least 30% of the total land to be utilized for setting up of the manufacturing
units. The state government if it wishes can use part of the land to promote
establishment of MSMEs
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 Administration
o SPV
o Developer
o State government
o Central government
 SPV (Special Purpose Vehicle)

o A company/institution to be set up/established by the central government
through the official gazette which will perform the functions as per this policy
o Every SPV to be a legal entity to be set up as section 25 company
o The administrative structure will be decided based on providing appropriate
participation to all the stakeholders in the BoD. The SPV will be headed by
CEO, who will be a senior Central/State government official
o Functions - SPV will undertake such tasks/measures as it thinks fit for the
development, growth, operation and management of the NIMZ. Such as
 Master planning of the Zone
 Preparation of a strategy for development of the Zone
 Selection of Developer/Co-developers for the development and
maintenance of infrastructure internal to the NIMZ
 Formulation of rules and procedures for development, operation,
regulation and management of the NIMZ
 Enforcement of the above rules and Master Plan
 Obtaining prior environmental clearance under the provisions of EIA
Notification 2006, if the area is more than 500 ha and the clearances
under the Air and Water Act as applicable to an individual unit, which
clearances would be expedited/facilitated by SPV
 Working out an arrangement with the State Government regarding
revenue streams including levy of user or service charges or fees or
rent for the use of infrastructure/properties in the NIMZ and creation
of specific mechanisms for specialized services.
 Promotion of investment, both foreign and domestic, into the NIMZ
 Implementation of Resettlement & Rehabilitation package
 Any other function as may be decided mutually between state
government and other stakeholders.

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 Developer
o The SPV can take up the function of infrastructure development in NIMZs on
its own or can contract it out to an independent contractor/developer
 Financing
o Viability Gap Funding (VGF):
 Provided by Ministry of Finance - Scheme for Support to PPP in
infrastructure in the form of capital grants in the construction stage
 All the projects may not attract private investment
 The investment might be high and the recovery of investment might be
slow
 The government pitches in by providing part of the investment (usually
up to 20%)
 Even the state government/implementing authority can pitch in with
extra assistance
 Usually awarded in the bid projects and the bid that proposes lowest
VGF is chosen
o Long term soft loans from multilateral financial institution
 Soft loans from multilateral institutions would be taken for funding
infrastructure development in NIMZ.
 Assistance would be provided for negotiating non-sovereign
multilateral loans by providing support, if needed
o External Commercial Borrowings:
 The developers of NIMZs will be allowed to raise ECBs for developing
the internal infrastructure of the NIMZs
 Eight NIMZs are along the Delhi Mumbai Industrial Corridor (DMIC) (these 8 NIMZs
on completion are expected to generate cumulative employment opportunities of
around 60 lakh)
o Ahmedabad-Dholera Investment Region, Gujarat
o Shendra-Bidkin Industrial Part city near Aurangabad, Maharashtra
o Manesar-Bawal Investment Region, Haryana
o Khushkhera-Bhiwadi-Neemrana Investment Region, Rajasthan
o Pithampur-Dhar-Mhow Investment Regioin, Madhya Pradesh
o Dadri-Noida-Ghaziabad investment Region, Uttar Pradesh
o Dighi Port Industrial Area, Maharashtra
o Jodhpur-Pali-Marwar Region in Rajasthan

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Apart from these eight the GoI has identified 14 more NIMZs
o Nagpur in Maharashtra
o Prakasam in Andhra Pradesh
o Chittoor in Andhra Pradesh
o Medak in Telangana
o Hyderabad Pharma NIMZ at Rangareddy and Mahabubnagar Districts in
Telangana
o Tumkur in Karnataka
o Kolar in Karnataka
o Bidar in Karnataka
o Gulbarga in Karnataka
o Kalinganagar, Jajpur District in Odisha
o Ramanathapuram District of Tamil Nadu
o Ponneri Taluk, Thiruvallur District, Tamil Nadu
o Auraiya District in Uttar Pradesh
o Jhansi District in Uttar Pradesh
 Section 25 company
o Is an entity registered under section 25 of The Companies Act 1956
o US 25 allows the formation of a company involved in charity without having to
set up a Trust or a Society, which will exist as a legal entity but the catch is any
company set up under this section must utilize/re-invest all income towards
achieving the same objective i.e. unlike a regular company no money will go
out of the company either in the form of profits or dividends
o Advantage
 Very easy to set up
 Minimum capital requirements are not applicable
 Much easier to run – easy to join the board of directors, minimum
quorum to conduct the board of directors meeting etc
 Tax benefits are provided
Place of Effective Management

 The company which is set up in more than one countries need to pay taxes and the
taxes that are paid by this company in a country is usually decided by the residency
of the company (Residency is a taxation concept-as per IT act 1961, a company is said

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to be resident of India if the control and management of its affairs is situated wholly
in India).
 The provision deciding the resident status was

o It is an Indian company during a particular financial year
o The control and management of its affairs is situated wholly in India
Since the word “wholly” was used, the companies used various methods to
circumvent these provisions and gained exemptions from paying any taxes in India.
 Now this was used by various companies in claiming that they were offshore
companies (by establishment of shell companies in tax heavens) leading to tax
disputes and litigation and in many cases this has led to tax exemption being
accorded to these companies
 As the global standards vary from the Indian practice the GoI has amended these
provisions in Finance Act 2015 and has defined a company as a resident company in
India if
o It is an Indian Company or
o its Place Of Effective Management (POEM) is in India (for that particular
assessment year)
For the purpose of clarity POEM refers to “place where key management and
commercial decisions that are necessary for the conduct of the business of
an entity as a whole are made”
The POEM is a subjective test in determining the residence status for taxation
purposes, because what constitutes key management decisions and whether
the residential address of BoDs will be considered or the place where the
meetings have taken place will be considered. Nevertheless the same concept
of POEM is promoted by OECD, which is used as a tie breaker to determine
the resident status of various types of companies (eg-shipping, air transport
etc). So in essence India is aligning its taxation practices with the global
standards.
 The tax department in December 2015 has issued guidelines regarding this issue. As
per the guidelines, the POEM of a company is considered to be outside India if
o Majority of board of directors meetings of the company are held outside India
or

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o Majority of its assets, employees, income, and employee expenses are from
outside India.
o A company will be considered as resident company if directors are not
involved in decision making and such decision making powers are exercised by
a holding company or a person resident of India
o To determine whether a company is active (or passive) outside India, the
average of past 3 years data are taken into consideration. A company will be
deemed to be engaged in active business outside India if the passive income
(royalty, capital gains, dividend, interest, rental income) is not more than 50
per cent of its total income, less than 50 per cent of its total assets are
situated in India, less than 50 per cent of the employees are situated in India
and the pay roll expenses on such employees is less than 50 per cent of the
total
o If a company’s board delegates its powers to a committee, then the location
where the members of the committee formulating the key decisions is
considered as the POEM
o In case technology (eg- telephone or video conferencing) is used by the board
members to hold meetings, the location of head-office is considered as place
of effective management. The person taking decisions need not be physically
present at a particular location.
 Expected outcome
o More and more companies to come under the coverage of taxation system
o Tax avoidance to be minimized
o Tax litigations to come down
o Tax revenue collections to improve
o Establishment of shell companies will be stymied
o Indian taxation system on the path to adopting global practices
o Investment climate to be simplified
o As of now Indian companies pay tax on the revenues but the objective of
POEM is to even tax the passive revenues (royalties, interests etc)
 Criticism
o Retrospective implementation – looking into past 3 years data is retrospective
in nature
o The rules are subjective and are open for usage of discretion (such as usage of
technology, meaning of key management etc)
o The new norms may lead to double taxation
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o The cost of compliance is set to increase
BEPS (Base Erosion and Profit Shifting)

 A firm comes across two jurisdictions-source country and resident country. It
transfers the profits from one country to another country and uses all the loopholes
that are present and end up paying very negligible tax or no tax at all (double non-
taxation or double tax avoidance). As per the conservative estimates of OECD
(Organization for Economic Co-operation and Development) there is an annual loss
of around $ 100 bn – 240 bn per annum of corporate taxes.
 This will have a large impact on especially the developing countries who are heavily
dependent on corporate taxes (for 2016-17, GoI is aiming to collect 19% of the
revenues from the corporate taxes)
 So OECD in collaboration of G20 is pushing for various reforms that have to be
implemented so as to reduce such losses and one of the prominent area is tax
challenges
In October 2015, OECD has come out with a vision report which outlines 15 actions
o Action 1 - Addressing the tax challenges of the digital economy
o Action 2 - Neutralizing the Effects of Hybrid Mismatch Arrangements
o Action 3 – Designing Effective Controlled Foreign Company Rules
o Action 4 - Limiting Base Erosion Involving Interest Deductions and Other
Financial Payments
o Action 5 – Countering Harmful Tax Practices More Effectively, Taking into
Account Transparency and Substance
o Action 6 – Preventing the Granting of Treaty Benefits in Inappropriate
Circumstances
o Action 7 – Preventing the Artificial Avoidance of Permanent
Establishment Status
o Action 8 to 10 – Aligning Transfer Pricing Outcomes with Value Creation
o Action 11 – Measuring and Monitoring BEPS
o Action 12 – Mandatory Disclosure Rules
o Action 13 – Guidance on Transfer Pricing Documentation and Country-by-
Country Reporting
o Action 14 – Making Dispute Resolution Mechanisms More Effective
o Action 15 – Developing a Multilateral Instrument to Modify Bilateral Tax
Treaties
 GoI has conveyed to UN that following practices of BEPS happen in India

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o Shifting of profits by aggressive transfer pricing by way of payments to foreign

affiliated companies (Action 8 to 10 & 13)
o Non Taxation of digital economy in country of source (Action 1)
o Treaty Shopping (Action 6)
o Artificial avoidance of PE status (Action 7)
 Very recently the GoI in budget 2016-17 announced “equalization levy” of 6% on all
the online ad services (provided by non-resident entities-Facebook, Google etc) on
which the payment exceeds Rs 1 lakh. India is the first country to impose such a levy
(after the announcement of 15 actions report)
A tax panel has recommended expanding the ambit of this levy to cover a wide
gamut of transactions including online marketing, cloud computing, website
designing, hosting and maintenance, platforms for sale of goods and services, and
online use of or download of software and applications.

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Land Reforms
 The concept of Land Reforms was floated by UN in 1951 as per which it is an
integrated program with main objective to remove the barriers for economic and
social development that emerged from deficiencies in the land tenure. The important
features of this programme were
o Elimination of the traditional economic-political exploitative power structure
in rural society at large
o Redistribution of surplus agricultural land which would lead to more extensive
utilization of factors of production specially land and labour
o More rapid adoption of innovative technology and thereby increasing
production and productivity
o Strengthening of motivation of the peasants for work and readiness to invest
in agriculture
 The scenario at the dawn of Independence
o Taxation rate was very high- the colonial state made a very high demand from
the agriculture. Be it through Zamindari or through Ryotwari, the collection of
taxes was very high. On an average, the land revenues collected were to the
tune of 75% of total agricultural produce of the farmers and till the turn of the
century, the majority of the revenues that the government collected were in
the form of the land revenue
o The British raj led to lot of powerful intermediaries- the collection and transfer
was done by various intermediaries and amongst them the most important
were the zamindars who grew to be very powerful force in India and remained
so even after the independence. On the eve of independence, around 60% of
the cultivable land in India was controlled by zamindars
o The regime created conditions favorable for tenancy and rack renting- the
destruction of traditional handicrafts and artisanal industry and absence of
modern industries led to the farmers taking up rack renting and tenant
farming
o Illegal extractions- Apart from the revenue the zamindars also extracted lot of
illegal extractions in the form of cash, begar (unpaid labour) etc which further
burdened the farmers. Apart from the land revenue the zamindars collected
various innovative cesses from the tenants such as motorana (to pay for the
new car of zamindar) and hathiana (to pay for the elephants of zamindar)
o No investments in Agriculture- the landlords rented out the lands and the
British raj was not interested in agriculture except for collecting revenues,

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hence the only one left to make investments in the agriculture was the farmer
and he did not have access to cheap credit, most of his produce went in the
form of taxes hence could not make any investments. This was accentuated by
the problem of small/marginal holdings. (Nearly 97% of the ploughs used in
1951 were wooden ploughs)
o Agriculture remained traditional rather than capitalistic- the
landlords/zamindars under the scenario wherein they benefited by renting
out the land rather than cultivating on all the land by themselves led to the
ruining or underperformance of agriculture. Hence even after independence
the agriculture kept on underperforming though it has attracted a lot of
human labour
 Almost from the day congress was established, they claimed that British government
was exploiting the peasantry in India and promised that once they came to power
the following will be on the top of their agenda
o Abolition of land revenue
o Expanding irrigation
o Reforms in the land tenure systems
 Land Revenue Systems (Pre-Independence)

o Zamindari
 Introduced by Lord Cornwallis in Bengal & Bihar in 1793.
 The revenue to be collected was fixed
 The zaminadar would own the lands
 Zamindari rights were inheritable
o Ryotwari
 Recommended by Reed and Munro
 Implemented in Madras & Bombay
 Rent would be collected directly from the cultivator
o Mahalwari
 Another form of Zamindari
 Was implemented in Agra, Punjab etc
 The ownership of the lands went collectively to a village or an estate
(mahal) and they paid the revenue
 Post-independence the government aimed to promote the agricultural production as

it was the mainstay, but the problem was with the land-less was available for
agriculture, it was owned by few, it was fragmented, tenant farming was the norm,
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lack of credit etc were some of the issues. To resolve this the government took some
measures
o Government cleared off half a million hectares of forest area (colonization) in
northern terai, central Indian hills and western ghats (this was possible as the
insecticidal value of DDT was discovered by Paul Herman Muller and was
being used for controlling malaria)
o A non-violent land donation initiative of Bhoodan Movement was launched by
Vinoba Bhave
o The government decided to take the legislative route to introduce land
reforms
 The need for land reforms

o Precursor for Infrastructure – There is a huge need for developing economic
as well as social infrastructure (such as industrial corridors, industrial clusters,
hospitals, schools, affordable housing etc) and one of the important
requirement for that is the availability of land.
o Litigation
 As per the World Bank, the land litigations account for around two
thirds of the total pending cases in India
 As per NITI Aayog Report, the land disputes take about 20 yrs to be
resolved
 This not only ties up the land in litigation, also increases the burden on
the judicial system. Once the land is under dispute, the projects will
also get stuck up
o Agriculture
 Land is used as a collateral by the farers to get access to institutional
credit. If the land records are not clear, then it may force the farmer to
borrow from informal sources
 On other hand the allocation of agriculture credit has increased, this
will lead to financial exclusion of the small and marginal farmers
o Urbanization
 There has been a spurt in the demand of real estate with increased
urbanization. The inner cities are getting crowded and the housing
projects are moving outwards. This has led to demand for land with
clean titles
o Black Money / Benami Transactions
 As per the White Paper on Black Money (2012), the black money
generated is invested in Benami properties. Clear titles and updated
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land records will enable transfer of such properties in a transparent

manner
o Economical- Indian Agriculture was in distress, the productivity of the farmers
was low, and majority of the population was involved in agriculture and also
the reforms were needed to augment the contribution of agriculture to GDP
o Social- The farmers who put in the labour did not benefit from the feudal
methodology, the farmers remained poor whereas the landlords/zamindars
pocketed the maximum benefits became rich. The biggest atrocity was that
the zamindars did not invest for modernization of the agriculture. There was
also need for upliftment of the poor and this could be done by increasing the
revenues of the farmers
o National- reduce the agricultural imports, reduce the disparities between rich
and poor, reduce the disparities between the regions
 The land reforms can be studied in two phases

o Institutional reforms ( reforms implemented by GoI before 1990)
 Abolition of Zamindari
 Tenancy Reforms
 Land Ceiling
 Consolidation of land holdings
 Co-operative farming
o Market reforms
 Modernization of Land records
 Land Acquisition (LARR Bill of 2013)
 Abolition of Zamindari (or Abolition of Intermediaries)

o It was noted in the 1st FYP that the land policy had to be formed in India
keeping in mind that the interests of the intermediaries are inversely related
to the agricultural production and second FYP stated that the abolition of
intermediaries and protection given to the tenants are intended
 to give the tiller the rightful place in the system
 to provide him an incentive to increase the agricultural production
 to directly connect the state with the tenant
 to break the landlord-tenant nexus
o the main objective of the programme was to identify ownership with
management and operation i.e. the owner should operate the farm business
o The states had to pass and implement the laws separately regarding abolition
of Zamindari
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o The Zamindars tried to stymie the passage and the implementation of the law-
politically (where they forced the bill to be sent to various standing
committees), judicially (they appealed against the laws twice in the supreme
court and lost) and executive (denied handing over the land ownership
documents to the government which was forced to prepare new documents
and were hand in glove with revenue officials)
o Their contentions were on two issues -the compensation and infringement of
fundamental rights. The compensation paid was low and nil in some states (in
J&K, Punjab no compensation was paid; in UP the compensation was inversely
related to the revenues that they paid)
o Outcome- as per one estimate the tenant farmers were reduced from 42%
(1950s) to around 20% (1960s), but nevertheless some criticism is that the
reduction of tenant farmers was not completely because of abolition of
Zamindari but the zamindars in many cases resorted to large scale evictions.
As per some other estimates this benefitted around 25-30 million tenants
o Problems- the Self Cultivation clause was not defined hence it led to large
scale evictions, the revenue officials were hand in glove with the zamindars,
absence of updated land records (faulty in some cases), it led to increased
absentee landlordism, the compensation became a burden in the state (as
mentioned the zamindars took their cause to the supreme court which ruled
that acquiring of the land was within the purview of the legislature but the
compensation is a justiciable cause, hence the government had to rework the
compensation paid to the zamindars was around Rs 670 cr which became a
burden on the state) faulty land records etc
 Tenancy Reforms- the tenant was the virtual owner of the land. The tenants could be
occupancy or permanent tenant (are the ones who enjoyed heritable rights over the
land, security of tenure and could claim compensation from the landlords for any
improvement that they had to the land and these features are not applicable to the
next two types of tenants), tenant-at-will/temporary tenant and sub-tenants. The
problem with tenancy is that the temporary and sub-tenants was exploited in the
form of higher rents, begar, evictions on flimsy grounds etc. as per the 8th round of
NSSO (1953-54)-one fifth or twenty percent of the area under agriculture was leased
out either under sub-tenant or temporary tenant. To compound this problem the
issue of oral tenancy or informal tenancy is a common feature in the Indian system
o Security of tenure
 Security of tenure to be provided
 Right of resumption given to the owners

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 The ownership of the land could be resumed only when the owner
wants it for self-cultivation and the procedure is to be followed
 Ejectment of the tenant could be done only when-he has made a
permanent damage to the land, sublet, no-payment of the rent etc and
for that the owner must get the permission from the revenue court
 In case of resumption by the tenant, he is to be guaranteed certain
minimum tenanted land under his possession
o Regulation of rent
 Initially the rent collected was more than half the produce
 1st FYP recommended it should be around one-fourth to one-fifth
 Various states have various standards ( Gujarat-one sixth, Assam-one
fourth)
o Transfer of ownership
 The tenants were allowed to purchase the lands from the owners
wherein-the land will be sold at a discounted price (lesser than the
market price) and the tenant farmer was allowed to make the
payments in annual payments spread though certain period
 The installments were usually paid for a period of over 8 to 10 years
 The law prescribed that such acquiring of land should not leave the
owner landless and there was a ceiling limit imposed on how much land
can be owned by these landowners
o Evaluation of tenancy reforms- some of the states fixed very high rents, loose
definition of self-cultivation was misused by landlords who undertook share
cropping on the guise of self-cultivation, the law did not cover the share-
croppers who formed majority of the tenant cultivators
 Ceiling Laws- this measure was introduced to provide for rationing of cultivable land
i.e. take the land from one who holds above prescribed limits and distribute it to the
one who needs. Since the implementation was done at the state level there were
huge differences amongst the states-what should be considered for
measurement?(an individual or a family); what should be the ceiling level etc. these
varied from a state to state and hence were standardized in 1972 during the CMs
conference which laid down following guidelines
o Basic unit is a family of 5 members

o Ceiling of 10-18 acres (which have irrigation and can grow two crops a year)
o In case of a single crop 27 acres and 54 acres for inferior dry lands

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o Relaxation to be allowed but after the relaxation total value will not be more
than twice the initial value
o For the distribution of surplus land priority to be given to landless agricultural
workers particularly from SC and ST
o Compensation payable for surplus land was fixed at a price well below market
price
Regarding the evaluation, it had an impact only on 2% of the total lands and as it was
a measure against an influential class some of the states delayed the implementation
for a long period. However on a positive note this reform led to redistribution of
surplus land amongst 4.5 million people
 Bhoodan Movement- was launched in 1950s by Vinoba Bhave. For this he organized
an all-India Federation of constructive workers-the Sarvodaya Samaj. They decided
follow the principles of Gandhiji, do padayatra from village to village persuading the
large landowners to give up one sixth of their land which could be distributed
amongst those who did not have lands. The target they had set was 50 million acres
and by 1956, they were able pool in 4.5 million acres, but the problem was with the
quality of land as it was seen that even after collecting more than 4 mn acres they
were able to distribute only about 8.72 lakh acres. Over the period of time the
appeal for Bhoodan has fizzled out, nevertheless it becomes very important for
couple of reasons
o It was a movement and not a reform proposed and implemented by the
government
o The idea was commendable as it was based on trusteeship
o It incorporated the principles of Gandhian teachings
 Co-operative farming- initiative launched by the government and was voluntary in

nature. Under this the farmers were asked to pool in their resources and utilize the
economies of scale. This would be more beneficial for small and marginal farmers as
it was economical and there would not be any change in the ownership. Was not
very successful as only 0.2-0.3% of the land was covered
o Kumarappa committee in 1949 recommended
 States should be empowered to push the idea of cooperatives
 The family farmers should be using the multipurpose cooperatives for
marketing, credit and other matters and the smaller farmers will have
to pool in their resources with other farmers
o Coopeartive farming will

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 Pooling of resources will promote economies of scale

 Will address the issue related to land fragmentation
 Access to resources such as water, mechanization can be availed
 Evaluation of Institutional land reforms

o Pros-it led to some of the tenants becoming owners, provided security of
tenure and rent, laid down procedure for eviction of the tenant farmers,
reduced the skewed distribution of the land, promoted private investment in
the agriculture
o Cons- the reforms were not uniformly implemented across the states, absence
of the land records caused huge delays, did not check sub-letting, no clear
definitions were given (for eg-self cultivation, right of resumption), some of
the states were unwilling to implement the reforms etc
 Market Reforms
o Modernization of Land Records (2008)
o Land Acquisition Act (2013)
o Rajasthan Land Titling Act (2016)
o Land Leasing Act (2016)
 Modernization of Land Records

o Started in 2008
o Merger of two-Computerization of Land Records (CLR) and Strengthening of
Revenue Administration and Updating of Land Records (SRA &ULR)
o Target is to finish by end of 12th FYP
o Aim is to update and digitize land records
o There will be a shift from Presumptive title to conclusive title
o It will also lead in reducing the cost of transactions and make government an
intermediary during the transfer of ownership
 Land Acquisition Act

o LARR (The Right to Fair Compensation & Transparency in Land Acquisition,
Rehabilitation and Resettlement Act)
o Land can be acquired for the purpose of private use and PPP
o Consent clause-80% (private), 70% (PPP)
o Compulsory SIA by a third party
o In case of failure by the authorities, the Head of the department will be held
accountable
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o Compensation-twice (urban), two to four times (rural) (the total

compensation consists of 100% solatium)
o Land if remains unutilized for a period of 5 years would be returned to the
previous owners or the land bank
o Maximum 5% of irrigated land (multi-cropped) per district could be acquired
o As part of rehabilitation, those affected can choose from three options
 Employment for at least one member of every affected family in the
project concerned
 A one-time payment of ₹ 5 lakh per family
 An inflation adjusted monthly payout of not less than ₹ 2,000 for 20
years
o The government in 2014 issued an ordinance wherein they introduced some
changes but later the ordinance lapsed and was not re-issued.
 The government gave exemptions (no SIA and no requirement of
consent) wherein exemption was given to 5 categories of projects-
Defence, Rural Infrastructure, Affordable housing projects, Industrial
corridors, Infrastructure projects including PPP projects
 Under these five categories ceiling for acquisition of multi-cropped area
was not provided
 The period for returning the unutilized land was five years or as per the
period provided in the approved project
 To prosecute a government official for offence committed, prior
sanction is required
 Rajasthan Land Titling Act (2016) - Till now the only proof of ownership of land in
India is either documents which provide proof of transfer between buyer and
property tax receipts but the problem is that these only provide presumptive title
(and not conclusive title) as a result of this there are huge number of cases pending
in Indian courts regarding land titles, which in turn will affect the ease of doing
business.
Rajasthan state has become the first state to pass a land titling act under which
conclusive titles are given
 Land Leasing Act 2016

o The act has been passed as a recommendation of Dr T Haque committee
which was set up by NITI Aayog

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o This aims to promote agricultural efficiency, equity and poverty reduction. The
states will have to implement these individually and it also provides for
dispute Redressal
o Post-independence the government was focused abolishing Zamindari and on
taking excess land away and distributing it amongst the landless. Hence the
government, viewed tenancy as a part of feudalism and provided protection
and transfer of ownership to discourage sub-leasing of the land (having said so
it should not be forgotten that the powerful landowners used various ways to
subvert the reforms. As per A S Appu in his book “Land Reforms In India”, till
1992 only 4% ownership of operated lands had been transferred and 97% of
this came from states-Karnataka, Kerala, WB, Assam, Gujarat, Himachal
Pradesh, Maharashtra)
o Hence to promote the land transfer, various states (UP, Bihar, Telangana,
Karnataka etc) abolished the tenancy and some states (Punjab, Haryana,
Gujarat, and Maharashtra) regulated the rent (and allowed the tenants to
purchase the land after some years of tenancy). This although led to small
change of ownership but also led to withdrawal of any protection that was
provided to the farmers
o Today the scenario has changed and the restrictive tenancy laws are not
required, as today more and more of the landowners and their children are
moving out in search of employment and we require tenancy farming which is
more liberal and gives protection to both the parties. The importance is more
as there is a subsidy regime (intended is DBT), Crop insurance scheme etc
where in the difficulty is to make sure the tiller gets the access to the benefits
o The biggest hurdle in the implementation of leasing law is that the landowners
are afraid that future populist governments may suddenly may change the
policy and consider the agreement as the basis for transfer of ownership.
Hence the state government has to clarify on this and give conclusive title of
the lands to the owners.
o As per the Act, the land owner can now legally enter into a lease (‘Lease’ is
defined as a contract between the land owner and cultivator) contract with
the tenant for use of his/her Agricultural Land for agriculture and allied
activities for a specified period for a consideration based on an agreement
with terms and conditions mutually agreed by the owner and the cultivator
o The contract will have details on
 the location and area of leased out land
 the duration of lease
 the lease amount and the due date by which it has to be paid
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 Terms and conditions for the renewal or extension of lease.

o The Tehasildar or Revenue officer will have the right to enforce the agreement
o Termination
 failure of cultivator to pay the lease amount after a grace period of
three months
 use of land for purposes other than those specified in the agreement
sub-leasing of land or damage caused to it by the cultivator

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Food Processing
 Food Processing involves
o Manufacturing-raw product belonging to agriculture and allied sectors (such
as animal rearing, fishery etc) is transformed by a process, the output of which
has a commercial value
o Value addition process-the value addition process leads to increase in the
shelf life of the product
 Why focus on FPI

o Food and groceries account for a major portion of total expenditure of
households (both in rural and urban) as the disposable income is on the rise.
As per an estimate the expenditure on food is 21% of GDP
o Increasing number of working women in urban India increases the expendable
income and majority of this is in the consumption of food
o Changing demographic profile (the younger population is very high and this is
usually associated with higher consumption of processed foods)
o Growth of organized retailing in India-in the last decade number of retailers
have increased (More, Reliance, Big Bazaar etc) so is the case with their sales
o The consumption pattern has undergone huge changes-as per NSSO
 proportion of non-vegetarians has increased from 58.2% in FY05 to
62.3% in FY12
 The rise in the meat-eating population has come mainly from poultry-
meat eaters, whose numbers increased by about 68%
 monthly per capita consumption of chicken has grown by a staggering
224% compared to just 10.7% in milk, 28.3% in fish and 93% in eggs
between FY05 and FY12
o Agriculture wastages in India
India till 1960s was suffering because the agricultural production and supply
was lesser than the demand thereby leading shortage in the supply. Post
1960s we promoted Green revolution as a result of which the production
increased and we shifted from facing the problem of shortage to plenty.
Some reasons for higher wastages in India are
 Insufficient storage capacity (both for food grains and horticulture
products)
 Unscientific methodologies of storage (Plinth and coverage storage)
 Irrational MSP policies

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 Inefficient transportation-the number of refrigerated vehicles shortage

is more than 50000
As per the report by ICAR
 Cereals – post harvest losses of 3.9 to 6.0%

 Pulses – post harvest losses of 4.3 to 6.1%
 Oilseeds- post harvest losses of 2.8 to 10.1%
 Fruits and vegetables- post harvest losses of 5.8 to 18%
 Value wise the post-harvest losses amount to Rs 44000 cr per year
It is a great tragedy as India on one side is wasting huge volumes of food

grains and on the other we have the largest number of hungry people in the
world and fare very badly in the GHI (Global Hunger Index-India performs
worse compared to some of its neighbors and some countries in Africa)
o Some facts
 Fruits and vegetables-India is one of the largest producer and aims to
process 25% of the total production by 2025
 Meat and poultry-One of the largest producer of meat, chicken and
egg
 Consumer food- Among fastest growing-aerated soft drinks, packaged
food, alcoholic drinks etc
 Milk- One of the largest producers
 Marine products- Aim is to increase the production
 Grain processing- Higher production With each year
 Importance of FPI in India

o Contribution to GDP (more than 6%)
o Employment Generation (Annual Survey of Industries 2012-13 showed 1.6
million employees in organized sector and is expected to create 9 million jobs
by 2024)
o The FPI is highly labour intensive
o Even the input output ratio is favorable (input output ratio represents
productivity)
o The capital output ratio is on the lower side compared to the other industries
(capital that must be invested to get one unit of output)
o Create linkages between Agriculture and Industry (contract farming, sourcing
from farmers directly)

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o Promotes exports (During FY11–15, India's exports of processed food and

related increased at a CAGR of 23.3 per cent to $ 21.5 billion)
o Reduces wastage (wastages estimated around $ 13 bn)
o Increases investments in agricultural and also productivity
o Enhances rural income
o Increase revenues for the government
 Initiatives by the GoI

o Under the 12th FYP an outlay of Rs 15000 cr has been provided for FPI.
o GoI has also launched National Mission on FPI 2012
 An outlay of 6500 cr
 To raise the processing of perishable food items from 6% to 20% by
2015
 To raise %age value addition from 20% to 35%
 India’s share of global trade to 3% (from 1.6%)
 To provide skills to 1.5 million
 To make quality consciousness in FPI a significant parameter
GoI aimed at achieving the above targets by spreading the message of

significance of food processing, assist state governments in forming
strategies, providing skills and assisting MSMEs in setting up of FPU
o Mega Food Park Scheme

 Launched in September 2008 to provide state of the art infrastructure
in food sorting, grading, processing, packaging etc
 Initially aimed at establishing 30 such parks but brought it down to10
 Financial assistance in the form of grant-in-aid of 50% of the project
cost or 50 cr (75% in difficult areas)
 Presently 42 approved of which 8 are functional
 Each to have around 30-35 food processing units with a collective
investment of around Rs 250 cr, having a turnover of Rs 450-500 cr and
creating around 30000 jobs
 Mega Food Park Scheme-to function on Hub and Spoke model
 As per the notification issued by GoI
 100% tax deduction for the first 5 yrs and 25% for the next 5 yrs
 Credit can be obtained under PSL (have been classified under
agricultural activities)

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 100% FDI allowed in case of food processing park
o Food Processing Fund

 Set up with NABARD with a corpus of Rs 2000 cr in 2014-15
 The objective is to provide affordable credit
 Provide loans at a concessional rate of 8-9%
o Modernization of Abattoirs
 Grant-in-aid given to local bodies/PSEs to modernize/establish
abattoirs (from 1/4/2014)
 50% of the project cost or up to Rs 15 cr
 40 approved of which 4 are functional
o Cold Chain Scheme

 Grant-in-aid @ 50% of cost of the project or up to Rs 10 cr
 So far 134 cold chain projects have been approved (2009-15) of which
88 have been completed
 Will increase the storage capacity
(Cold Storage-post independence the duty of developing cold chain was on

the government but the legislation was changed in 1997 to allow for private
sector participation. It is estimated that the country has around 6891 cold
storage units with a capacity of 31.82 mn tn)
As per the report by NCCD (National Centre for Cold-chain Development)

 To fulfill current consumption of urban clusters, India needs about
70,000 pack-houses (currently around 250) each equipped with a pre-
cooler and dispatch room for onwards transport links.
 The gap in cold store capacity is projected at only about 3.2 million tons
in space. (there is certain disagreement here as the required capacity
as per this report has been pegged at around 35 mn tn but there are
two more reports-one by NSEL and other by Emerson Climate
Technologies, both of which peg the requirement to a high of 60 mn tn)
 The country is said to have less than 10,000 refrigerated vehicles,
whereas the requirement is estimated at 62,000 vehicles
 The existing food distribution suffers food losses due to lack of
integrated cold-chains.

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 Lack of transportation and packing results in a losses and extra costs in

the cold-chain.
o Agri Export Zones

 To increase exports of agri products, a concept of Agri Export Zones
was introduced in 2001.
 APEDA (Agricultural and Processed Food Products Export Development
Authority) is the Nodal Agency
 Entire effort is centered on the
 Cluster approach of identifying the potential products,
 The geographical region in which these products are grown
 Integrating the entire process right from the stage of production
till it reaches the market(farm to market)
 There would also be a need to identify/enlist difficulties/
problems encountered at each stage
 Identification of such potential crops is responsibility of state
governments. Projects in such areas for identified crops will be
eligible for financial assistance and certain fiscal incentives
o Ease of Doing Business

 a food map which identifies surplus and deficit areas has been
prepared and will allow the investors in identifying the availability of
raw materials in various regions
 At various ports the infrastructure to provide digital No Objection
Certificate (NOC) has been provided. Which reduces the dwell time as
well as provides single window clearance for customs
 single window facilitation cell has been set up by MoFPI to address
queries, facilitating and hand holding foreign investors
 the government has also set up a food sector skill council - FISCI (Food
Industry Capacity and Skill Initiatives) which has 46 affiliated Trading
Partners and 192 Training Centers
o Other initiatives
 100% income tax exemption on food processing units in the first five
years and thereafter 25% for the next 5 years
 Reduction of Excise Duty in case of
 Refrigerated containers from 12.5% to 6%

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 Machinery for food processing and packaging has been reduced

from 10% to 6%
 Machines used in dairy sector for Pasteurizing, drying,
evaporating etc are exempted from Excise Duty
 The Basic Customs Duty (BCD) on machines imported for cold storage,
cold chambers, cold units etc has been reduced from10% to 5%
 Service tax exempted on pre-conditioning, pre-cooling, ripening,
waxing and retail packing, labelling of fruits and vegetables
 Service tax exemption also given for transportation of food grains
including rice and pulses, flours, milk and salt by rail, vessels or road
 Challenges and constraints

o Lack of suitable infrastructure in terms of cold storage, warehousing, etc
o Lack of adequate quality control and testing infrastructure
o Unorganized sector (40% of the food processing happens in unorganized
sector)
o Inefficient supply chain and involvement of middlemen
o High packaging cost
o Affordability and cultural preference of fresh food
 Features which are in favor of India

o Availability of land for agriculture (195.25 mn ht of Gross Cropped Area and
65.26 mn ht of Net Irrigated Area.)
o Amongst the leaders in production of (food grains, milk, meat, fishery etc)
o Strategically placed-in the middle of Asia with access to other parts of Asia and
long coastline allowing to access to Americas, Africa and Europe
o Different agro-climatic zones will allow us to produce varieties of agriculture
crops-cereals, pulses, horticulture produce, cash crops, citrus fruits etc
o Large availability of human capita
 Recent Initiatives
o 100% FDI in Marketing of domestically produced goods
 Previously allowed 100% FDI through automatic route in processing
sector
 Has the ability to attract big players like Wal-Mart, Tesco, Amazon,
Alibaba, etc apart from also promoting domestic players such as big
basket, future retail etc
 The reforms will lead to-procurement, storage and distribution

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 Grocery delivery start-up Grofers India Pvt. Ltd has sought the
government’s approval for foreign direct investment (FDI) to carry out
trading in food products
 The problem is-APMC act and ECA 1955
o FPI and Make in India

The government has launched Make in India programme covering 25 sectors
and the food processing is one of them. This has been aimed at attracting the
investment from domestic and foreign investors. The government has also
declared the Mega food park will be part of Harmonized List of Infrastructure
of Sub-sectors wherein the access to capital will become easier. The
government is also promoting information through investor portals
o The food processing ministry has proposed to organize the World Food
Summit in 2017- it will be a platform bringing together investors, technology
solution providers, processors, manufacturers and all other relevant national
and international stakeholders.

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Inclusive growth
“IG is the process and the outcome where all groups of people have participated in the
organization of growth and have benefited equitably from it”- UNDP
“Inclusive Growth refers both to the pace and pattern of growth, which are interlinked and
must be addressed together.”-World Bank
Rapid and sustained poverty reduction requires inclusive growth that allows workers from
every section (rich, middle and poor class) to contribute to the growth and also to benefit
from the growth. Here “rapid” means higher growth and “sustained” growth refers to the
growth rate remains the same in long term, is broad based-across all sectors. Thus IG
implies participation in the process of growth and sharing of benefits from it (it represents
the combination of process and the outcome). IG on one hand ensures that everybody
participates in the growth process in terms of decision making and also in terms of
implementation of the decisions and on the other hand ensures that everybody shares the
benefits equitably. If there is participation without benefit sharing it will lead to unjust
growth and on the other hand will lead to welfare outcome if there is sharing without
participation.
It is not that the GoI has never considered the concept of IG before the 11th FYP. The
premises based on which the GoI implemented the FYP was basically on two areas-growth
and redistribution both put together essentially gives us the concept of IG. (Growth usually
represents the value of production whereas development usually represents the flow of
these benefits to the bottom of pyramid. Growth is quantitative, where as development is
qualitative). GoI tried to have a higher growth path and expected that the development
would take place through trickledown effect. What was fundamentally wrong with such an
approach was that the government treated both the objectives separately rather than
treating them the same as a result of which the government ended up spending precious
resources resulting in dilution of efforts and resulting in unsatisfactory outcomes. But after
evaluating the impact of 1991 reforms GoI realized that although on one side the
government was able to achieve higher GDP growth rate, concurrently the benefits of this
growth was not reaching to all the stakeholders. Hence to overcome this situation, the GoI
introduced the concept of IG in the 11th FYP and also in 12th FYP.
 How can we say that India has not achieved inclusive growth
o As per the latest report from WB, India is the country with the largest population
living in extreme poverty (224 million)
o As per the World Hunger Report of FAO (UNDP), India houses the highest number
of the hungry people (194 million)
o As per WHO and UNICEF Joint Monitoring Programme 61% of rural Indians
defecate in the open

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o Only around 10% of the labour force has any kind of skill sets
o Literacy level is around 74%
o The banking coverage is only 46% and only 27% of the villages have a bank in the
vicinity of 5 kms
o More than 300 million people and 75 million households (about a third of the
total) do not have access to electricity (as per census 2011, about 67% of the
households have been electrified)
o Total expenditure on Social Services including Education, Health, Social Security,
Nutrition, Welfare of SC/ST/OBC etc was around 7% of GDP (for FY 2015) whereas
it’s 15% in case of Brazil.
 Need of Inclusive growth in India

o India is the 7th largest country by area and 2 nd by population. It is one of the
largest economies at market exchange rate as well as at PPP.
o India is suffering from low development in social indicators like malnutrition,
poverty, lower literacy rates, sanitation problems, corruption etc
o India is suffering from unsatisfactory growth in economic indicators like GDP,
Industrial Production, Development of infrastructure etc
o Although there is higher GDP growth being achieved, the fruits of that are not
reaching all the people.
 IG is dependent on 4 pillars
o Growth & Economic Opportunity
 Growth rate of GDP per capita at PPP
 Employment rate
 Per capita consumption of electricity
 Percentage of paved roads etc
o Social Inclusion
 School life expectancy
 Pupil-teacher ratio
 Government expenditure on education as percentage of total
government expenditure
 Gender parity in labor force participation
 Percentage of population with access to electricity etc
o Social Safety Nets

 Social security expenditure
 Government expenditure on social security and welfare as percentage
of total government expenditure
 Social protection etc

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o Good Governance and Institutions

 Accountability
 Government effectiveness
 IG in 11th FYP- The central theme was “Rapid and inclusive growth” with main
emphasis on the Social sector and delivery of services therein. Education, in
particular, was accorded utmost priority during the 11th Five Year Plan period. Some
of the achievements are
o GDP growth in the Eleventh Plan was 8 per cent compared with 7.6 per cent in
the Tenth Plan
o Agricultural GDP growth accelerated in the Eleventh Plan, to an average rate
of 3.6 per cent, compared with 2.4 per cent in the Tenth Plan
o The rate of unemployment declined from 8.2 per cent in 2004–05 to 6.6 per
cent in 2009–10
o Rural real wages increased 6.8 per cent per year in the Eleventh Plan (2007–08
to 2011–12) compared to an average 1.1 per cent per year in the previous
decade,
o Complete immunization rate increased by 2.1 ppt per year between 2002–04
and 2007–08, compared to a 1.7 ppt fall per year between 1998–99 and
2002–04
o Institutional deliveries increased by 1.6 ppt per year between 2002–04 and
2007–08 higher than the 1.3 ppt increase per year between 1998–99 and
2002–04
o Net enrolment rate at the primary level rose to a near universal 98.3 per cent
in 2009–10.
 IG in 12th FYP – the theme is “Faster, More Inclusive and Sustainable Growth”
o The Plan aims to achieve average growth rate of more than 8 per cent during
the 12th Five Year Plan
o It aims to raise the farm sector growth rate to 4%
o Achieve a growth rate of 10 per cent in the manufacturing sector
o The target is to generate 50 million new jobs
o The Plan aims at increasing investment in infrastructure to 9-10 per cent of
the GDP
o The 12th Plan also seeks to reduce poverty by 10 percentage points

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 Issues related to IG
o Growth vs. Development debate
o Defining Poor is tricky
o Fiscal Deficit, CAD, High/increasing debt etc
o LPG has favored only the private companies and the rich
o Social Infrastructure development has been neglected
o Need to boost Technology and Innovation
o Social disparity is not reducing at a faster pace
 World Economic Forum - Inclusive Growth and Development Report 2015

o For the first time such a report has been published by WEF
o The report observes that the debates around IG has been very narrow and
hence the aim of the report is to push this growth to be more broad based
and deeper
o Seeks to identify the various ways policymakers can drive economic growth
and equity at the same time and assesses them on their relative success in
implementing these measures.
o It has ranked 144 countries based on 7 parameters and 15 sub-pillars
o India ranks at a low 71 for 2014-15
o Some important observations are
 There is no hostility between economic growth and social justice hence
it is possible for the policy makers to be pro-growth and also pro-equity
 Social inclusion can be broadened by various ways apart from taxation
and social protection and the social inclusion policies can be found in
many countries (apart from high income countries)
 There is a scope of improvement as no country has scored above the
average in all the 15 sub-sectors
 There are larger regional and cultural similarities
 Current debate on inequality is unduly narrow
o Position of India
 Under utility of fiscal transfers (Tax) & Income Tax is regressive
 Presence of large unorganized/informal economy
 The growth in India needs to be broad based (in terms contribution
from all sectors and benefits reaching all)
 Low Educational Enrollments across all levels
 Quality of education is not uniform
 Large Vulnerable employment situation

191
 Low social spending – limiting accessibility of health care and other

basic services
 Problem of sanitation
 HDI (Human Development Index)

o Is the most popular index
o The report was first launched in 1990 by Mahbub ul Haq and Amartya Sen
o Published annually in HDR by UNDP
o It measures human development of a particular country in terms of three
dimensions-Longevity, Knowledge and Standard of Living
o Longevity is measured by Life Expectancy at Birth
o Knowledge- pre 2010 it was measured as ratio of number of individuals
enrolled in a given level of schooling to the number of individuals that actually
attended the schooling. Post 2010, this has been changed to
 Average or mean years of schooling in the adult population
 Expected years of schooling for school children
o Standard of Living is measured by GNI per capita on PPP basis (previously GDP
per capita on PPP basis)
o As per the 2015 report India’s rank is 130th and India needs to work on the
following areas to improve its ranking:
 The social expenditure of the country on health and education is very
low. There is a need for increasing it and the private investment must
be promoted
 India performs poorly in reducing income inequality, gender parity,
regional imbalances etc
 Emphasis on building social capital to unleash untapped potential and
optimize human capital.
 There is an urgent need for India to focus on human development if it
wants to be a developed country
 The government has introduced various schemes to promote IG. They are in the
following sectors
o Growth- Make In India, Mudra Yojana, Start Up India, Stand Up India etc
o Education- Right to Education, Sarva Shiksha Abhiyaan, Mid day Meal scheme
etc
o Food- NFSA, PDS etc
o Health- ASHA, MAA project, ICDS etc
o Sanitation- Swacchh Bharat Abhiyaan
o Financial Inclusion- Jan Dhan Yojana, PMJJBY, PMSBY, National Pension
Yojana, MGNREGA, AADHAAR etc
o Agriculture- PMFBY, subsidy regime on Micro Irrigation and Fertilizers etc
192
o Employment- Skill India, Nayi Manzil, Digital India etc

o Bridging regional imbalances- Backward Region Grant Fund, Special Category
States etc
o Urban/Rural Development- Smart Cities, AMRUT, Pradhan Mantri Awas
Yojana, Sansad Aadarsh Grameen Yojana etc
 Backward Region Grant Fund

o Launched in 2007
o Covers 272 districts
o Financing-75:25
o Objective is to strengthen municipality & panchayat level governance; provide
funds for infrastructure; to provide professional assistance
 Special Category States

o Previously was granted by NDC
o Introduced in 5th FYP
o Given to those regions having hilly & difficulty terrain; low population
density/sizeable tribal population; economic backwardness; non-viable nature
of state finances etc
o States get-higher share in government’s resource allocation; get significant
excise duty concessions; financial assistance to be in the form of 90% of grants
 Swachh Bharat Abhiyaan

o The GoI has launched Swacchh Bharat Abhiyaan under which
o Target year is 2nd October 2019
o 100% open defecation free
o Build household toilets, community toilets and public toilets
o Efficient solid waste management in all 4041 statutory towns
 Saansad Adarsh Gram Yojana

o Yojana launched in October 2014
o Under this scheme the MPs will be developing model villages- 8 by 2024
o The first village to be developed by 2016, two more by 2019 and five by 2024
o Identification- MPs can select any gram panchayat with a population of 3000-
5000 but it should neither be in their constituency nor in the constituency of
their spouse
o Resources of funding- no new funds will be allocated, the resources may be
raised through MPLAD, PMGSY, IGAY, BRGF, Gram Panchayat revenue, central
and state finance commission grants etc

193
o Regarding implementation the GPs will have to formulate a plan and the list of
activities that would be allowed have been provided under the guidelines ex-
providing access to healthcare, promoting diversified livelihood through skill
development, housing of all etc
 Evaluation of MGNREGA
o Background- it provides 100 days of labour to one adult per household in rural
India. It was initially launched on pilot basis in 200 rural districts in February
2006 but covered all the rural districts by April 2008. The wages have kept on
increasing and the objective of reducing urban migration has paid off to some
extent
o Has reduced poverty by up to 32% and prevented 14 million people from
falling into poverty
o 53% of the workers employed were women (2004-05 to 2011-12). In 2004-05
women in rural India earned for a rupee earned by mail but the scheme gives
equal pay for both hence has empowered women.
Only 24.4 per cent of rural households participate in the scheme nationwide and nearly 70
per cent of interested households cannot participate due to lack of work. Most importantly,
about 70 per cent of households below the poverty line do not participate.

194
Infrastructure
 Infrastructure is the foundation on which the factors of production interact to give an
output. Development/prosperity of a country depends upon the development of
agriculture and industry and all the facilities and services which help in the industrial
and agricultural development are collectively referred to as Infrastructure. There is a
close relation between infrastructure development of a country with its growth and
poverty reduction. Hence in developing countries especially such as India there is a
need to have sector specific polices which can provide a sustained growth
 The infrastructure has been classified into two types-physical and social. In physical
infrastructure is concerned with the direct needs of industries and agriculture (eg-
power, irrigation, transport etc) and under this majority of the capital investment
happens on facilities
The social infrastructure is concerned with supply of services which help to meet the
basic needs of the society (eg-health, education etc) and in these sectors lesser
capital investment is done on facilities.
 There is a close relationship between infrastructure, GDP and growth. There is no
denying to the fact that India has the largest working population and in couple of
decades will have the largest elderly population. So there is urgent need to make
sure that the working population gets productive jobs, earn well, accumulate wealth
and also save for their old age or else “India will become old before becoming rich”. If
it comes to that then there will be far reaching consequences.
 The features of infrastructure are
o These are generally natural monopolies (an industry could attract such a high
investment that, involvement of more than one producer/provider may result
into wastage of resources and duplication of efforts hence such industries
have natural monopolies. Usually the public utilities such as water, power,
transportation etc exhibit natural monopolies). In case of infrastructure the
facilities could be provided by either the government or the private firm. In
case of a private firm usually we see that there is intervention by the
government.
o Infrastructure projects have large upfront costs (or sunk costs) and long
payback periods or the gestation period is very high. This also makes it difficult
to invest/finance and manage. Since the investments to be done is huge it is
characterized by lumpiness/indivisibility
o The sector is sensitive to the policy changes that are implemented by the
changing governments
o The services produced are not tradable. Once produced in case of excess
cannot be stored and in case of shortage cannot be imported

195
o Infrastructure are marked by presence of externalities i.e. the benefits are

accumulated by other parties who are not part of the transaction
o The infrastructure exhibits the nature of a public good (non-rival and non-
exclusiveness)
o Infrastructure services have low elasticity of demand (variation in the prices
do not affect the demand of these facilities/services)
o Usually infrastructure is associated with employment (three types of
employments are generated-direct, indirect and induced), growth.
 There is a need to make investment in the infrastructure to achieve higher economic

growth. In case of India, the investment in Infrastructure has been lower compared
to other developed countries. As per the McKinsey Report during the period of 1999-
2010, the investment in Infrastructure in India has been around 4.7 of GDP,
compared to 7.3% of GDP across countries like China, Indonesia and Vietnam. So the
requirement as per the plan documents are
Spending on infra Private Spending on infra in

as %age of GDP Investment absolute terms
10th FYP 5% 22% Rs 8,37,159 Cr
11th FYP 7% (target-9%) 37% (target-30%) Rs.23,74,307 Cr
12th FYP Target is 10% Target-48% Rs.55.75 lakh Cr
The experience so far in the 12th FYP has shown that the private sector investment is
much below the expected level (public investment-20% and private investment-
43%), the number of stalled projects has gone upwards so is the case of the value of
stalled projects. The number of infrastructure projects which have been stalled
amount to 8% of GDP. These stalled projects have not only reduced the investment
capability of the companies but also have affected the balance sheet of the banks
thereby limiting the credit outflow in the infrastructure investment. Hence it would
be irrational to expect the private sector to step up the investment rather the
government must change the scenario so as to crowd in the investment and
revitalize the PPP model
 Problems with Infrastructure development in India
o The investment- historically, the investment in infrastructure has been on
lower side, but the important point is if high and sustainable growth is to be
attained we need infrastructure. As per the expectations of Planning
Commission, to achieve a growth rate of 7%, there is a need to invest around
8-9% in infrastructure and the 12th FYP has put up a target of investing around

196
10% in infrastructure (which is very ambitious as we targeted around 9%

investment in 11th FYP and were able to achieve only 7%)
o Private sector Participation- private sector investment is usually associated
with augmenting infrastructure, better management of resources (although
cost is an inferior objective compared to quality), better quality, genuine
developers can be chosen etc hence the private sector participation is an
imperative (even the investment in infrastructure is very high under 12th FYP).
Having said so even the private sector participation has got some drawbacks
such as the power delegation is very high (as there is bundling of various
services-DBOF&M), cost of capital is very high
o Inter-modular mix- any rational study regarding transportation mix in
railways, roads and waterways would result in recommending more and more
of the traffic in waterways and railways, but in case of India the share under
these two has been declining and that of roadways increasing post-
independence. This will lead to inefficient usages of fuel (when majority of our
fuel requirements are imported), time and cost overruns, environmental
impact etc
One of the reasons for such a situation is absence of co-ordination between
the different ministries/departments leading (in this case merger of railway
budget under the union budget may bring in some common objectives)
Hence there is a need to shift the traffic and provide an efficient inter-
modular transportation mix so that all these concerns are taken care of
o Pricing the infrastructure – to get the optimum traffic mix, there is a need to
first estimate the traffic in all the modes, estimate the cost effectiveness and
then provide incentives for the users to shift from one mode to another. The
present scenario is far away from it. The features associated with the railways
(which could provide a better transportation mode compared to roads) use
cross subsidization methods for pricing the tickets, ministers over the periods
have focused on populist measures rather than bringing in efficiency, delays
are a norm etc. Hence the roads have historically provided more freight traffic
compared to railways.
o Infrastructure project delivery – the usual feature associated with infra
projects is time and cost overruns. As per MoSPI in terms of road projects
completion, on an average the traditional methods take 126 months for
completion whereas the PPP take 50 months. This is not just limited to roads
but also with railways also. Some of the reasons that have been given are

197
 Procedural delays – for implementing these projects there is a

requirement of large number of clearances and more than often there
is a delay which will add to the delays in implementation.
 Improper planning – the process of calling for tenders and allocating
them is time consuming and upon this, different activities are allocated
to different contractors (both are applicable especially to railways). This
leads to lower cooperation amongst the contractors as well as with the
department leading to time delays
 Unbundling of services – the services such as development,
maintenance, operation etc have to be bundled so as to give the
contractor an incentive to finish the project as soon as possible and
also to deliver quality projects

198
PPP (Public Private Partnership)

 PPP is an arrangement between two parties- government/statutory
entity/government owned entity with a private sector entity to provide public
asset/service through investment/management for a particular pre-fixed period of
time wherein the risk has been allocated and the private participant will receive a
pre-fixed/performance based payment
Essential features of PPP are

o Involvement of a private sector entity
o Public services are those services, which have to be provided by the state eg-
electricity, water, transportation, healthcare etc. to provide these services the
government sets up Public assets which are the vehicles through which the
public services are provided (eg-roads, hospitals etc). Eg-to provide the
transportation the government first needs to develop roads, to provide
healthcare, there is a need to construct hospitals, clinics etc
o Investment based/management based- the PPPs in India could involve, private
sector entity making the investments or the role of private sector entity is
limited to management/operations only
o The arrangement is only for a pre-fixed period of time, risks associated with
implementation have been allocated (so as to differentiate between
outsourcing an activity/function and PPP) and the financial payments are
performance based (timely completion, quality and quantity, services
provided etc)
 PPP is an arrangement/partnership between the government/entity owned by the

government on one side and a private entity on the other. The agreement involves
certain things
o What is the role/duty/obligations of both the parties
o The provisions regarding public asset/services that is under consideration
o The financial incentives that will be paid
o What will be the time period for which the agreement will be in existence
 Advantages of PPP
o Using new technology will lead to creativity and innovation
o The infrastructure deficit can be bridged without putting any financial
constraints on the government

199
o On time and on budget delivery

o Shifting of construction and operation risks to the private sector
o Strong customer service orientation
o Enable the public sector to focus on outcome and core business
o Not to forget the employment opportunities that could be created
 Evolution of PPPs in India

o Although PPP model has been in implementation since mid-1990s, the
impetus for these projects was given under 10th FYP and 11th FYP. The
government since then has been implementing various reforms to promote
PPP
o 2004- The GoI set up CoI (Committee on Infrastructure) headed by the PM.
The main objective of this was to promote the development of time bound
world class infrastructure
o 2006- PPPAC (Public Private Partnership Appraisal Committee) was set up at a
secretariat level for approval of PPP projects. Viability Gap Funding was also
introduced (under this the central government will provide 20% of the project
value in the form of financial support to the PPP project being implemented
by the state/local/private body. If the sponsoring ministry desires then it can
further provide additional 20%). During this year the government also set up
IIFCL (India Infrastructure Finance Company Ltd) was set up to provide long
term debt to the PPP projects (up to 20% of the project costs)
o 2009- The CoI was replaced with CCI (Cabinet Committee on Infrastructure). It
reviewed policies, approved projects, considered and decided on financial,
institutional and legal measures necessary to promote infrastructure
investment/development. The CCI has been merged with CCEA in 2013.
o 2013- The GoI constituted CCI (Cabinet Committee on Investment) whose
function was to identify projects involving investment (in
infrastructure/manufacturing) of at-least Rs 1000 Cr and prescribing the time
limits for implementation of these projects, monitoring and reviewing the
implementation.
 Types of PPPs
1. Service Contracts
2. Management Contracts
3. Affermage or Lease Contracts
4. Concessions
5. Build-Operate-Transfer (BOT)
200
6. Joint Ventures
1. Service Contracts
o The government usually tenders/contracts out part of the services/specified
tasks of services to a private company. Usually there are certain specifications
required in terms of performance standard, costs and the selection is usually
through competitive bidding.
o Under this, the government remains the primary service infrastructure
provider and part of it is outsourced (usually for a period of 1-3 years)
o The government pays a predetermined costs and hence it is in the interest of
the private company in reducing the cost of operations without affecting the
operational specifications/standards
o Strengths
 Most suitable where service can be clearly defined in the contract
 Performance can be monitored easily
 Provide a tool wherein a quick transfer of technology, managerial
efficiency etc can observed form a private sector to public sector
 Since the contract term is low it can provide for competition (as there is
bidding there is participation from many players)
o Weaknesses
 Unsuitable in projects/sectors where government wishes to attract the
private capital investment
 The effectiveness may be limited (as only part of the operations are
being given to the private company)
2. Management Contracts
o The services to be contracted out include some or all of the management and
operation of the public service (i.e., utility, hospital, port authority, etc.)
o The private contractor is paid a pre-determined rate for the services provided.
The arrangement may also provide for incentives and profit sharing
o The obligation for service provision remains in the public sector
o The day to day management control and authority is assigned to the private
partner or contractor
o In such arrangements, the investment is provided by the government
whereas; the private partner provides working capital
o A management contract typically, will upgrade the financial and management
and decisions related to services and these decisions will be commercial

201
o Strengths
 Without transferring the asset ownership operational gains can be
achieved
 The contracts are usually associated with low costs
 Such an arrangement can be used as an interim arrangement during
which the government can focus on the structural development
 If the progress is as per the expected level, it may lead to extensive
engagement
o Weaknesses
 The diversion between management and obligation of service delivery
is tricky to manage
 If the agreement provides for incentives and share of profits, then
there is a need for having a auditing system which will prevent the
contactor from downgrading expenditure on service delivery and
inflating the achievements
 Since the ownership/control lies with the government, it may be
difficult for the private sector to implement all the measures that they
would want to implement
3. Lease Contracts/Affermage
o The private party is responsible for providing the services in its entirety
(involves obligations on service quality and standards). The initial
establishment of the system is financed by the public authority and contracted
to a private company for operation and maintenance
o The duration of such an arrangement is typically 10 years
o The financial risks associated with this are borne by the private sector
operator
o The lease does not involve any sale of assets
o There is a slight difference between the Affermage and lease contract. In the
lease contract, the private operator is allowed to retain the revenues that are
collected but under Affermage the operator has to pay a fee to the
government and retain the remaining part of the revenue. The affermage fee
is typically an agreed rate per every unit sold.
o Strengths
 Since the profits of the private operator depends on the sale of utility
and its costs, it may be forced to go for efficiency and higher
productivity
 The asset ownership is not transferred
202
o Weaknesses
 The tariff revisions are very sensitive
 The capital investment has to be done by the government itself
4. Concessions
o Under this, the private sector operator (concessionaire) responsible for the
full delivery of services in a specified area (operation, maintenance, collection,
management)
o Importantly, the operator is now responsible for all capital investment
o Although the concessionaire is responsible for providing the assets, such
assets are publicly owned even during the concession period
o The public sector is responsible for establishing performance standards and
making sure that the concessionaire meets them. In simple terms here the
public sector’s role is shifting from being the service provider to regulator (of
the price and quality of service)
o The tariff is usually established under the contract
o A concession contract is typically valid for 25–30 years so that the operator
has sufficient time to recover the capital invested and earn an appropriate
return over the life of the concession
o The government may also provide part of the investment (in the part of the
Viability Gap Funding)
o Strengths
 Is an effective way to attract private investment
 It provides incentives for the concessionaire to achieve efficiency
 Since the operations and finances have been delegated to the
concessionaire, it will have better planning and prioritize accordingly
o Weaknesses
 The government has to upgrade its regulatory mechanism in terms
performance monitoring (as the revenue for the government is based
on the revenue collected by the concessionaire)
 The long term or period of the project throws up certain doubts on the
scenarios/events down the line
 Concessions, it is argued, provides competition only to a limited players
5. BOT
o Are a kind of specialized concession in which a private firm finances and
develops a new infrastructure project or a major component according to
performance standards set by the government
203
o There are various forms/types of BOT

 Here the private partner provides the capital required to build the new
facility and owns the asset for a particular period as provided in the
contract
 During this period the developer can recover the cost and make some
profits
 At the end of the contract, the public sector assumes ownership
 The distinction between a BOT and Concession is that a concession
generally involves extensions to and operation of existing systems,
whereas a BOT generally involves large "Greenfield" investments
requiring substantial outside finance
 There are many variations on the basic BOT structure

 Build–Transfer–Operate (BTO), where the transfer to the public
owner takes place at the conclusion of construction rather than
the end of the contract (Turnkey Projects)
 Build–Own–Operate (BOO), where the developer constructs and
operates the facility without transferring ownership to the
public sector
 Design–Build–Operate (DBO), contract is let out for design,
construction, and operation of the infrastructure project
 Design–Build–Finance–Operate (DBFO), the responsibilities for
designing, building, financing, and operating are bundled
together and transferred to private sector partners.
o Strengths
 BOTs have been widely used to attract private financing to the
construction or renovation of infrastructure
 BOT agreements tend to reduce commercial risk for the private partner
because there is often only one customer, the government
 An advantage to DBFO projects is that they are financed partly or
completely by debt
 Direct user fees (like tolls) are the most common revenue source
o Weaknesses
 BOTs have a project-specific application (so are potentially a good
vehicle for a specific investment)
 It is difficult to link the increases in production brought about by a BOT
with commensurate improvements on the demand side
 While initial capital construction costs may be reduced through the
private sector’s experience, private debt may be an expensive
substitute for public financing
 The benefit of competition is limited to the initial bidding process and
these contracts are often renegotiated during their life of the project

204
6. Joint Ventures (JVs)

o are alternatives to full privatization-infrastructure is co-owned and operated
by the public sector and private sector operator
o Under JV, the public and private sector partners can either form a new
company or assume joint ownership of an existing company through a sale of
shares to one or several private investors
o It is important for this structure to have good corporate governance, in
particular the ability of the company to maintain independence from the
government
o The joint venture structure is often accompanied by additional contracts
(concessions or performance agreements) that specify the expectations of the
company
o Strengths
 both the parties have invested and hence have stake in its success
 there are incentives for efficiency
o Weaknesses
 The dual role of the government role may lead to conflict of interest
(regulator and stakeholder)
 There are concerns of corruption associated as the JV involves direct
negotiations and follow less formal procurement norms
 PPPs so far in India – as per NITI Aayog’s report

o PPPAC (PPP Appraisal Committee)
 has approved 281 projects worth over Rs 3 lakh Cr
 Of which 182 projects worth Rs 1.85 lakh Cr have been awarded
 Of which24 projects worth Rs 0.13 lakh Cr have been completed
o EI (Empowered Institution)
 Has approved 183 project proposals involving investment of Rs 95127
Cr, seeking VGF from the central government
 Of which 55 projects with an investment of Rs 30917 Cr have been
awarded
 Of this 44 projects are in the road sector amounting to investments of
Rs 18198 Cr
o Experience of PPP implementation in the last decade
 Skewed across sectors and across states. PPP has taken off in roads,
ports etc but is yet to take off in railways, civil aviation etc. some states
such as Maharashtra, Madhya Pradesh have gone ahead compared to
other states
205
 In case of approvals of PPP projects the road sector is leading. It has

been observed that the average completion time under PPP for these
projects is around 50 months compared to 126 months under Item
Rate (IR) Contracts.
 Having said so there are delays in implementation of PPP projects and
this delay is said to be around 20 months. Whereas in case of Non-PPP
projects the delay is considered to be around 72 months. The delays in
implementation is because of delay in land acquisition, environmental
and forest clearances, change of scope, statutory clearances, delays in
tie-up for project financing, etc
o Challenges – there has been a delay in the private investments from 2012-13
and there has been a slowdown (in terms of awarding and implementing the
projects). Some of the reasons for such delays are
 MCAs (Model Concessionaire Agreements) – is basically the
agreement between the private entity and the government. Some of
the problems associated with the MCAs are
 The MCAs focus more on fiscal benefits rather than efficient
service provisions
 There is no provisions/structures for renegotiations
 It neglects the principles of risk allocation to the party that is
best suited to manage it
 Contracts are over dependent on the market wisdom
 Enforcement and monitoring – it has been observed in various
instances either the government authority or the private entity
involved do not comply or discharge their contractual obligations.
Hence there is a need of enforcement and monitoring mechanism. It is
suggested every ministry involved in PPP should create a dedicated
division/cell to monitor PPPs
 Dispute Resolution – the absence of a dispute resolution framework
has led to huge number of projects getting struck in arbitration (it
usually takes around 3 to 10 years for this in India). The PPP projects
under dispute have increased to 116 amounting to Rs 11580 Cr in 2015
(whereas it was 56 cases amounting to Rs 803 Cr in 2013) in road
projects. Overall projects in this sector under dispute is 870, worth Rs
21000 Cr
 Financing – the infrastructure financing has been under a lot of stress
in the last couple of years because of

206
 A large number of projects are stuck up resulting in higher NPAs

of the banks and inability of the banks to provide further credit
 The equity inflows to these projects are drying up as a result of
which the investors are unable to make further investments
 The present practice of financing these projects based on the
spread of revenue streams for a period of 20 to 30 years but
with a debt period of 10 to 15 years is unsustainable.
 Kelkar Committee Recommendations

o MCA – the MCAs have been standardized which have a one size fits all
approach in allocating the risks. Most of these risks have been passed on to
the private entity which may not be able to manage all the risks. Hence there
is a need to reallocate the risks according to the parties that are best suited to
manage the risks. A generic risk monitoring and evaluation framework should
be developed covering all aspects of a project’s lifecycle.
o Obsolescing Bargains – the PPPs usually span a period of 20-30 years and
hence it becomes very difficult to estimate the amount/volume of cash flows.
When the private developer has invested in the project he may lose the
bargaining power in matters of tariff, because of changes in the economic or
policy environment which are beyond his control. Hence the MCAs must have
an inbuilt mechanism to protect the developers in such scenario. Some critical
assumptions could be made and if the reality is significantly divergent than the
assumptions then there should be the option for bilateral renegotiations (it
will not only protect the developers but also cut down the scope of misuse)
o Renegotiation of Contracts – since the PPPs are implemented for a longer
period all the externalities cannot be predicted and in such a scenario there is
a need to provide for renegotiations of the contracts provided there is a
framework to determine that the demand for renegotiations is not because of
some ulterior motive. The renegotiations will not be allowed under
 Any event that could affect the developer in the normal course of
business just like any other company
 Any impact/drawback arising from the assumptions made by the
developer himself
 Any impact arising out of the direct or indirect or inaction of the
concessionaire
 Any failure of by any of the related parties of the concessionaire in
terms of performance or in terms of providing finance

207
 Any event of distress that was foreseeable at the time of financial

closure
Having said so the renegotiations will be allowed if
 Project distress is real and if continued may lead to default by the

concessionaire in the future
 Is not caused by a private party and will not cause adverse outcomes to
the government
 There is evidence that shows the cost of doing nothing would be
greater than the cost of renegotiations for the government
 Not materially different in allocating risks to the government
Hence the financial decision for renegotiations should be based on
 Full disclosure of renegotiated costs, risks and benefits

 Comparison with the financial position of the government at the time
of signing the agreement
 Comparison with the existing financial position of the government just
before renegotiation.
o For there could be some valid reasons or hidden agendas for the private
authority.
EPC PPP
Stands for Engineering –Procurement- Public Private Partnership
Construction
Type DB Framework DBFOT Framework
Cost Objective is to keep the cost Usually higher
lower
Risk Risks borne by developer are Borne by the developer
limited (construction costs by
developer and; maintenance
& commercial risks by the
government)
Finance By government (through Private investors (debt
budget) +equity)
Services Unbundled Bundled
Focus on quality Not really Definitely (as the services are
bundled)
Delays Very high Comparatively less

208
 Reforms undertaken
o A Public Utility (Resolution of Disputes) Bill to be introduced in 2016-17 to
streamline institutional arrangements for the resolution of disputes in
infrastructure related contracts.
o The guidelines for renegotiations related to MCA will be issued
o A new credit rating system for infrastructure projects has been developed by
CRISIL. As per the estimates, infrastructure sector will require investments to
the tune of Rs 43 lakh Cr by FY2020 and the bond sector has to pitch in with at
least Rs 11 lakh Cr worth of investment as the banking sector is under stress.
In case of infrastructure investment in India, the private sector investors
(especially long term investors) have shied away from investing for two
reasons-perceived higher risk and lower credit ratings. This has happened
despite the analysis showing that once the projects stabilize, their credit
positions have improved significantly. Hence CRISIL in consultation with
Finance Ministry has developed a new credit rating system for infrastructure.
This new measure will be based on the EL Methodology (Expected Loss),
under which, two factors associated with risk are considered to arrive at
ratings-Probability of Default (PD) and Prospects of Recovery (PR). Traditional
credit rating methodologies have considered only the PD. The new
methodology is more comprehensive and provides important information to
the investors about the infrastructure projects which have features such as
shorter debt tenure compared to economic life of the project, volatile cash
flows etc. The credit ratings will have the grades starting from CRISIL INFRA
EL1 to CRISIL INFRA EL7 (wherein EL1 will have lowest EL and EL7 the highest)
o Swiss Challenge Model

 Is a way to award a project based on unsolicited proposal
 The government enters into negotiations with a player who submits a
proposal if the negotiations fail, then the government may call bids
from interested parties
 In another variant the government may call for proposals and will give
the right of refusal to the ideator of the proposal
 Have been implemented in various countries (South Africa, Chile,
Korea, Indonesia, the Philippines and Taiwan) as well as in Indian states
 Advantages
 It cuts red tapes and shortens timelines

209
 The private sector brings innovation, technology to a project,

and an element of competition can be introduced by modifying
the Challenge
 Disadvantages/worries
 Lack of transparency and competition while dealing with
unsolicited proposals
 It can potentially foster crony capitalism, and allow companies
space to employ dubious means to bag projects
o Hybrid Annuity Model

 Basically a fixed payment is done for a period of time and then a
variable amount is paid for the remaining period
 The Indian model of HAM is a mix of EPC and BOT
 The government will contribute to 40% of the project cost in the first
five years through annual payments
 The remaining payment will be done on the basis of the assets created
and the performance of the developer. The developer has to make the
60% of the payment by raising loans/equity
 Since the government makes the annuity payments of 40%, the
developer has no right to collect tolls (this right is given to NHAI)
 Under HAM, the developer has financial liquidity and the risk is shared
with the government
The government has stated that the HAM will be used in those sectors where the projects
have got stalled. The government in January 2016 has allocated Rs 25000 Cr of HAM in case
of road projects

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1

o Normal goods - as the income increases, the consumption of this good

o Giffen goods - as the price falls, the demand also falls

o Public good - available to all equally (non-excludable) and consumption is not

Shyam S Kaggod (Economics faculty, BYJU’S IAS)

o Intermediate good - remain in economic flow (eg-cement, steel, flour etc)

o Complementary goods - set of two or more goods, which on combination

 Economics is basically divided into

Hence the questions arise

The central problems of the economy are

Shyam S Kaggod (Economics faculty, BYJU’S IAS)

o How to allocate the scarce resources?

 Circular flow in the economy

Features Capitalism Socialism Mixed Economy

Factors of Private Government By both

Shyam S Kaggod (Economics faculty, BYJU’S IAS)

Motive Profits Social welfare both

Exploitation (of Yes No No

Consumer buying behavior- the consumer considers the following parameters

 Law of supply - the supply depends on

Shyam S Kaggod (Economics faculty, BYJU’S IAS)

 Market equilibrium and dis-equilibrium

 Elasticity - it measures the variation in the demand whenever there is a

o Price elasticity of demand

%age Change in the demand of product x

Shyam S Kaggod (Economics faculty, BYJU’S IAS)

o Income elasticity of demand

%age Change in the demand of product x

Note Type of good

o Cross elasticity of demand

%age Change in the demand of product x

 The elasticity is influenced by other determinants

National Income Aggregate

 For measuring the production various aggregates are used

o Three methods to calculate GDP

Shyam S Kaggod (Economics faculty, BYJU’S IAS)

 Why GDP only?

 Current prices and constant prices

Shyam S Kaggod (Economics faculty, BYJU’S IAS)

New GDP series

Why the need to rebase

 Whenever rebasing is done

Shyam S Kaggod (Economics faculty, BYJU’S IAS)

o new databases are used

Product taxes or subsidies are paid/received on per unit of product.

 Producer Price Index

 ASI and MCA21

Shyam S Kaggod (Economics faculty, BYJU’S IAS)

Because of the above reasons the demand will go up and in this

 Cost push inflation

 Scarcity of foreign exchange reserves

In 2017, the government has rebased the WPI and IIP

o The change of BY is from 2004-05 to 2011-12. The working committee that

Shyam S Kaggod (Economics faculty, BYJU’S IAS)

 This Committee will meet at least once a year for identifying

Shyam S Kaggod (Economics faculty, BYJU’S IAS)

Industrial Urban Non- Agricultural