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India’s foreign exchange reserves have increased by more than 50% in the last two years. This has
happened due to following reasons.
i. There has been an inflow of more than 170 billion dollars of FDI in the last two years.
ii. There was very high inflow of FII between January 2020 to July 2021.
iii. The increase in exports from 535 billion dollars in 2019-20 to 675 billion dollars in 2021-
22 has also contributed to foreign exchange reserves.
i. It results in making both financial credit and operational credit cheaper for Indian
borrowers.
ii. High foreign exchange reserve can be used to discourage speculative attack on the
currency.
iii. High foreign exchange reserve can be used for international investment which can be for
both higher returns and international relations.
Therefore, it is advisable that India creates a sovereign wealth fund to assure that some surplus
amount can be used to earn higher return and use it for developmental purpose.
Module –IV -Indian Economy till 1991.
Year Name
i. India inherited backward agriculture such that it contributed more than 53% of GDP and
employed more than 73% of the workforce and still India could not become self-
sufficient in food production. This was due to lack of irrigation facilities, poor technology,
lack of mechanization etc., which kept agriculture backward.
ii. There was industrial backwardness that is industry contributed 17% of GDP and
employed 10% of the workforce. However major concentration was in consumer goods
industry like cotton textile, jute product, sugar etc. The only notable capital good
industry was iron and steel and there was negligible presence or complete absence of
basic industries. (Minerals and metals), heavy industries and key industries (physical
infrastructure-roads) which laid to overall underdevelopment of industrial sector in
India.
iii. Poor social indicators reflected in very low literacy rate of 16%, life expectancy at 32
years, independent estimates have infant mortality in 1951, at above 400 per thousand
children born.
After independence India choose a mixed economy with features of both socialism and capitalism. It
established a planning commission to frame development programs for five years and provide
solutions regarding what to produce, how to produce and for whom to produce. In certain sectors it
was left on market forces to determine the solution to central problems.
a) There was a requirement of balanced regional growth which require the presence of public
sector enterprises because private sector will not have the incentive to invest in
underdeveloped regions.
b) There was fear of concentration of wealth in few hands.
c) India required industrial diversification which needed investment in heavy industries, basic
industries and key industries, all of which had a very long gestation period (time taken
between initiating a business and earning profit)
d) Market structure was absent because Indian economy was based on substances with more
than 90% people in rural areas.
Therefore, India adopted a mixed economy with a long term goal of becoming a socialist state.
The period ended through continuous decline in output, and a recession in the year
1979-80.
Period of Recovery (1980-90)-
i. Business friendly reforms by government. The government relaxed several rules and
regulations to encourage production. Import duty was reduced from an average of 300
% in 1970s to 150% by 1989, Government removed quantitative restrictions on more
than 4000 commodities, licensing was reduced and firms were allowed to produce more
as compared to the earlier rules. The government encouraged exports by giving subsidy,
tax rates were reduced and small reforms in taxation were introduced. All these
measures encouraged the existing businesses to produce more and therefore promoted
industrial development.
ii. The spread of green revolution, yellow revolution and white revolution increased
purchasing capacity in rural areas which increased demand for industrial goods and
promoted growth.
iii. Growth in labor productivity due to better training of workers, better availability of
capital and improvement in technology. Along with workers even capital became
productive which was reflected in a decrease in incremental capital output ratio. This is
the ratio between extra capital used and extra output produced.
Change∈Capital
Incremental capital ratio =
Change∈output
iv. Very high government expenditure- Expenditure on public administration increased by
21% per annum while expenditure on poverty alleviation increased by 15% per annum.
This growth was mainly financed by public borrowing and printing of money.
i. Very high fiscal deficit of both central and state government. High fiscal deficit of the
government resulted in increased borrowings due to which there was an increase in
interest rate leading to crowding out, i.e., decrease in private investment due to
increase cost of borrowing because of high government expenditure, this resulted in
reducing supply capacity of the economy.
[Note- If government expenditure is done on capital goods or capacity creation like creating
physical infrastructure, social infrastructure, training facilities etc. then it reduces cost of doing
business in the economy and encourages more private investment. This is called crowding in.]
ii. Very high level of inflation- Inflation reached above 10% in 1990 mainly due to high
government borrowing, high food price and high price of fuel.
iii. Very high current account deficit- Current account deficit was above 4% of GDP in 1990
due to rising imports and lack of export competitiveness because of high price and low
quality of Indian product.
iv. Very high amount of short-term loans taken from abroad- In 1990 total short-term loans
were 1.45 billion dollars while total foreign exchange reserves was 1 billion dollars.
v. Gulf war resulted in increasing price of crude oil which increased India’s import bill and
remittances from gulf stopped and both resulted in very high shortage of foreign
exchange reserves in India.
In March 1991, India did not have enough foreign exchange reserve to pay for even
four weeks of import.
Economic reforms-
Economic reforms imply taking decisions to remove all those reasons which result in poor economic
performance. It is done in two ways - microeconomic structural reform and macroeconomic
stabilization.
Macroeconomic stability implies less fiscal deficit, less current account deficit, less inflation and
stable GDP growth. It means the country should be able to meet its expenditure through its own
resources.
To achieve both India implemented policies of liberalization, privatization, and globalization. The
reforms were called LPG reforms.
Lecture-12
Liberalization-
Liberalization is the policy of simplifying rules and regulations so that it is easier for people to
participate in the economy such that there is larger investment and growth possibilities.
i. Industrial liberalization-
a. Removal of licensing- The government removed licensing requirements in all the
industries except 18 industries. It was reduced further to 5 industries, they are
alcohol, cigarettes, hazardous chemical and pharmaceuticals, electronic aerospace
and industrial explosives or defense ordnance. This implied that government had
less discretionary power and entry was now based on “condition based permission”,
i.e., any form which fulfilled the set of conditions fixed by the government could
enter the market.
b. Removing exclusive right to produce for public sector- Government reduced the
number of industries reserved for public sectors from 17 to 8 in 1991. It was further
reduced to three by 2001 and under Atmanirbhar Bharat announcements in June
2020 the government announced that it will exit all the sectors except those which
are declared core and strategic. In August 2021 government notified 4 sectors as
core and strategic which are
i. Atomic minerals, defense and space research,
ii. Telecom and transportation,
iii. Energy, power, coal, oil and other minerals
iv. Banking, insurance and financial sectors
c. Government removed restrictions on price and quantity so that there can be more freedom to
participate in the economy which also increased investment in India.
d. Government removed monopolistic and restrictive trade practices act in 1991 to liberalize
investment and promote competition.
MRTP act was passed in 1969 with the objective of controlling concentration of wealth among few
industrialists. Under MRTP act the firms were classified into national monopoly (if investment is
more than rupees 20 crore) and product monopoly (if investment is above Rs. 3 crores and 25% of
market is controlled by the firm. If a firm qualified in any of the two categories, then it had to take
further permissions from MRTP commission for any more investment.
The government removed MRTP act in 1991 and replaced it by competition act in 2002, under which
competition commission of India was established in 2009.
External Liberalization-
Lecture-13
Full capital account convertibility implies no restriction on capital account in movement of funds
into and outside from the country.
i. It will result in higher inflow of investment which will provide not only more resources
but it will also help in reducing saving investment gap.
ii. It will help in larger inflow of technology due to higher freedom to invest in the
economy.
iii. It can promote higher economic growth as country will be receiving more investment
and there will be higher connectivity to global economy.
i. It can result in large fluctuations in currency which can destabilize the economy.
ii. It increases the risk of speculative attack by freedom to invest in any currency in India.
iii. It will make India more vulnerable to negative external shocks.
The government has established committees under S. Tarapore in 1997 and under C. Rangrajan in
2008 to find the viability of introducing full capital account convertibility in India. Both the
committees advised against full CAC immediately. They suggested that India can introduce it if it has
inflation stability, control over fiscal deficit and controlled current account deficit to assure that
there is no sudden panic among investors.
i. Provision of autonomy-
Once MoU is signed there will be no role for ministry in daily affairs of CPSE.
Miniratna Category-II
All those firms which have a positive net worth and which earned profit for 3
consecutive years can qualify in this category. All these firms have the freedom to invest
up to Rs. 300 crores or their net worth whichever is lesser. There are 16 firms in this
category.
Miniratna Category-I
All those firms which have a minimum net worth of Rs 300 crore and which earn profit
for 3 consecutive years or which have earned profit of at least Rs 30 crore in one of the
last 3 years can qualify. All these firms have the freedom to invest up to Rs 500 crore or
their net worth whichever is lesser. There are 58 firms in this category.
Navratna-
All those CPSE which have been miniratnas for at least 3 years and which fulfill the
criteria of getting at least sixty points out of 100 given by the government on six criteria
can qualify. All these firms have the freedom to invest up to Rs. 1000 crore to make
appointments up to general manager level and to take all operational decisions. There
are 15 firms in this category.
Maharatna-
All those firms which have been a Navratna for 3 consecutive years and which earn
minimum turnover of Rs. 25000 crores, minimum net worth of Rs. 15,000 crores and
minimum profit of 5,000 crores can qualify. They have the freedom to make investments
up to Rs. 5000 crores, make appointments for all levels except board of directors, enter
in to foreign collaboration and to take all operational decisions. There are 10 firms in this
category. Last two- power Finance Corporation, Rural Electrification Corporation
Advantages-
i. It promotes competition, by not reserving any industry for public sector.
ii. It promotes investment by encouraging public sector to grow by increasing in its
turnover and net worth and getting more autonomy.
ii. Disinvestment/Divestment
It is sale of govt. share in any P.S unit to any other enterprise or household. There can be 3 types
of disinvestment.
i. Minority sale-
If government shareholding after disinvestment is greater than 74% it is called minority
sale.
ii. Strategic minority sale-
The government shareholding is less than 74% but more than 50%.
iii. Privatization-
Government shareholding becoming less than 50% and management control is with
private sector.
Challenges-
i. It may result in under valuation of public sector. This results in losses for common
people of India.
Solution-
The government should appoint an investment banking firm to value the public sector
and fix its base price.
ii. Social security of the workers can be compromised due to threat to their jobs.
Solution-
The government should use a combination of VRS, Rehabilitation and negotiating a
peace clause that is workers can not be removed up to a stipulated time period.
iii. The funds of disinvestment can be used for meeting populist expenditure and not for
asset creation.
Solution-
The government should make a rule that all proceeds from disinvestment will directly go
to national investment fund where it can be used only for developmental activity.
Lecture 14
Corporatization implies that there will be a hierarchy of board of directors who will appoint the CEO
and the CEO will hold managers responsible who will be holding the workers in discipline. This was
suggested for defense ordnance factories by all the three committees i.e., TKS Nayar committee in
2001, Vijay Kelkar Committee in 2005 and admiral Poorie committee in 2015. The government
announced corporatization in 2019 and it was finally completed in Jan 2021. Seven new defense
PSUs were established in Jan 2020 and all 41 factories will be divided among these PSU.
The training centers of defense ordnance board and the research and development centers will not
be transferred to the PSU, they will remain under ministry of defense. Benefits expected from
corporatization are
i. Manufacturing growth is labour intensive and therefore it can create more employment
compared to service led growth.
ii. Manufacturing growth reduces import requirements and improves export potential
which will help in improving on problem of current account deficit.
iii. High manufacturing growth becomes the source of promoting shift of the workforce
away from agriculture towards more productive employment.
iv. High manufacturing growth becomes the source of promoting research and
development such that there is high value product creation in the economy.
Therefore, government introduced new manufacturing policy in 2011 with the objectives of
increasing share of manufacturing to 25% by 2022 and creating 100 million new jobs in
manufacturing by 2022.
In 2014 government introduced make in India programme under which 25 industries were selected
to support through policy, by fiscal incentives providing research and development supports and
marketing support to promote manufacturing in India.
Lecture 15
Remaining
Lack of efficiency in environmental protection laws, tax laws and corporate law results in
discouraging manufacturing investment.
i. Input market reforms like labour market reforms, land acquisition reforms and credit
reforms are required.
ii. Logistical cost needs to be reduced from 14% of GDP to 6% of GDP by developing
infrastructure, promoting storage capacity, improving grading and measurement
facilities etc.
iii. Doing tax reform to improve manufacturing potential by reducing tax burden.
iv. Improving ease of doing business through simplification of entry laws, introducing single
window clearance, and improving exit law.
v. Improving intellectual property rights and promoting research and development to
promote high value production in India.
vi. Improving government procurement policies, environmental laws and simplifying rules
in companies act in order to encourage higher investment.
vii. Improving law and order, administration, and systemic protection to business to
encourage honest people to do business in India.
After 1991, India shifted to indicative planning i.e., where public sector is not the commanding
height and role of planning commission changed from central controlling authority to a regulatory
authority which indicated the targets that it wanted the economy to achieve. Both public sector and
private sector were incentivized through resource distribution.
In 2015, government replaced planning commission by NITI (National Institution for Transforming
India) Aayog developed as a think tank to suggest long term development through resource
mobilization in India. NITI Aayog has 3 main differences with planning commission.
i. NITI Aayog has a decentralized structure with state governments also playing an active
role in it. Planning commission was highly centralized.
ii. NITI Aayog does not determine allocation of central schemes (now it is determined by
MoF).
iii. NITI Aayog does not develop five year plans which are binding on government, it
develops short term plans (up to 3 years), medium term plans (up to 8 years) and long
term vision (over 15 years) which can be used as a suggestion by the government in
policy making.
Lecture-18
200 crore worth of gold and foreign exchange reserves out of which 115 crores should be
gold. – This much amount of money should be reserved to print any amount of money.
i. Money created a unit of account – Money provided the facility to express all
commodities in terms of one unit that is money, therefore the inconvenience due to
multiple pricing was removed.
ii. Money acted as a medium of exchange which could distinguish producers from
consumers and this removed the problem of double coincidence of wants.
iii. Money could be used as store of value which was not very convenient in case of
commodities.
iv. Money made it possible to give credit, it was not possible to give credit in terms of
commodities therefore invention of money in its modern term could make it possible to
introduce banking, insurance etc. as business.
Money supply-
i. It is the stock of money held in an economy at any given point of time. In case of high
inflation bond yield increases.
ii. If bond yield rises then bond price is low due to which people demand more bond and
less money. Therefore, demand for commodity falls as interest rate is high and this can
reduce inflation.
Narrow money1 (NM1) = Currency with public + Demand deposits + Other deposits with RBI
Broad money (NM3) = NM2 + All term/time/fixed deposits with maturity of more than 1 year +
All call/term borrowings by banks from non-depository financial institutions
Central bank is the top most institutions of any financial system which is responsible for regulation
and implementation of monetary policy. It fulfills following functions
a. It is the only authority to issue currency and increase its circulation in the economy. Central
bank has the authority to increase base money, high powered money which is recorded in
India as NM0. It is the sum of currency in circulation and reserve of commercial banks with
the central bank. It represents total liability of the central bank. Total money supply in the
economy is the product of money multiplier and high-powered money. Money multiplier is
the constant which shows the amount by which money supply increases due to an increase
in high powered money.
i. A high required reserve ratio will result in lesser value of money multiplier because it will
increase bank’s requirement to keep reserves and reduce its ability to create more
loans.
ii. If people have less banking habit in a country, then money multiplier is small because it
restricts deposits in the bank and therefore restricts bank’s ability to create loans.
iii. If currency deposit ratio is high then money multiplier is low because ability to create
more deposits and therefore more loans gets restricted.
Lecture-19
Government borrowings-
i. Short term- It is done through treasury bills which are bonds issued by govt. for a period
of 91 days, 182 days, and 364 days. They are issued on behalf of government by RBI.
They are zero coupon bonds i.e.; they give the same maturity value as their initial value.
To give return to their buyers they are issued at a discount.
ii. Long term – dated securities – Government issues this bond or securities for more than
one year time period. These are also issued by RBI on behalf of the government and RBI
can not buy them from primary market. It can buy them from secondary market.
c. Banker to the banks-
RBI as banker to the bank helps in taking deposits of a bank, giving loans to the bank,
managing the bank with respect to their lending and borrowing behavior, settling
transactions among different banks, and acting as lender of last resorts to the banks.
Apart from these RBI is also a regulator in banking system i.e., it assures that banks don’t
lend indiscreetly, they don’t overborrow from the market and they do not take too many
risks which can put depositors’ money in danger. RBI also instructs the banks to maintain
enough capital so that in case of sudden adversity they are not found unprepared.
d. RBI as custodian of foreign exchange reserves.
Management of govt loans means that RBI assures that government bonds are issued on time,
the loans don’t become very high, and assuring that the loans are paid back on time.
e. RBI implements monetary policy by managing money supply through liquidity management
in an economy. RBI uses quantitative tools and qualitative tools to manage liquidity.
Quantitative tools are those which affect amount of money in an economy. These are
i. Bank rate- The rate at which RBI gives loans to commercial banks with or without a
collateral. An increase in bank rate implies contractionary monetary policy i.e.,
liquidity in the economy is reduced as it becomes costlier to borrow. Similarly, any
reduction in bank rate is considered an expansionary monetary policy because
liquidity becomes more.
ii. Reserve requirements fixed for the banks.
i. Cash Reserve ratio- It is the proportion of total Net Demand and Time
Liabilities (NDTL) that commercial banks must keep with the central bank in
terms of cash.
NDTL = Demand & time liability of a bank – demand and time deposits of
that bank with another bank
Any increase in CRR is considered as a contractionary monetary policy
because it implies that commercial banks will have lesser number of
deposits that they can freely lend to the market.
ii. Statutory liquidity ratio-
It shows the proportion of total deposits that banks must invest in particular
assets like gold, central govt. bonds, state govt bonds, public sector
enterprise bonds, certain highly rated private sector bonds and other assets
like cash. It restricts bank’s ability to provide loans freely. Therefore, an
increase in SLR is considered as contractionary monetary policy and a
decrease in SLR is expansionary monetary policy.
iii. Open market operations-
OMO implies buying and selling of govt. securities by RBI to control liquidity
in the economy. Purchase of govt. securities by RBI will result in increasing
currency in circulation and it is called expansionary monetary policy.
Similarly sell of govt security by RBI reduces currency in circulation and
therefore represents contractionary monetary policy. (Lec-20) It is done in
India through bond market transactions by RBI. In 1997 RBI introduced
Liquidity adjustment facility. (Marginal standing facility, Repo window,
Reverse Repo window)
Under Repo window RBI discounts government securities that banks sell to
it with a repurchase obligation after 1 day. The rate of discounting is repo
rate. Here the banks are allowed to transact up to 2% of their NDTL in repo
window. If repo transaction takes place for a period of 1 day, then it is called
overnight rate. If it is for more than 1 day like for 14 days or 21 days then it
is called term repo rate. Therefore, repo market treats government security
as a collateral for the time period of transaction.
Reverse repo rate- In case of reverse repo window RBI sells government
securities to commercial banks with a repurchase obligation after 1 day, the
commercial banks purchase these securities after discounting their value by
reverse repo rate. In 1997 the difference between repo rate and reverse
repo rate was kept at one percent that is reverse repo rate was 1% lesser
than repo rate.
By 2017 the difference between repo and reverse repo rate had come down
to 0.25% (also known as 25 basis points). In May 2020, RBI reduced reverse
repo rate and made the difference 0.65% (65 basis points) in order to
encourage the banks to lend more to the market rather than keeping their
deposits with RBI.
A decrease in repo rate is expansionary and an increase in repo rate is
contractionary.
In 2011, RBI introduced another window called marginal standing facility
(MSF). Under MSF banks can sell government securities worth another 1%
of NDTL which will be discounted by RBI in repurchase obligation at 25 basis
points or 0.25% above repo rate. This is done to discourage banks from
unnecessarily borrowing from the RBI. MSF rate is also called penalty rate
because it is 0.25% higher than repo rate.
Standard deposit facility was introduced by RBI in April 2022 in order to
control liquidity, under SDF RBI offers to the banks that they can lend to RBI,
without a collateral at 0.25% below the repo rate which translates into a
gain of 0.4% above reverse repo rate. Unless a bank does not need
government security for its SLR requirements, it will prefer SDF over reverse
repo. Therefore, RBI has declared SDF rate as the new floor rate. The policy
range or difference between highest rate in liquidity adjustment facility
(LAF) and lowest rate in LAF is now represented by MSF – SDF.
i. Margin requirement- Under margin requirement the banks specify a fixed proportion of
loan that must be raised by the borrowers from the market to show their credibility. If
margin requirement is increased then the demand for loan will decrease and if it is
reduced then more loan will be demanded.
ii. Priority sector lending- This was introduced in India from 1971 after nationalization of
banks. Under PSL government identifies priority sectors like agriculture and within
agriculture a fixed amount for small and marginal farmers, MSME and within MSME
specific amount for micro and small enterprises, renewable energy producers, suppliers
of components for renewable energy generation, businessman in under developed
districts of India etc. are covered under PSL. The government instructs the bank to give
40% of total loans extended to these sectors which affects the directions of flow of
credit.
iii. Credit Rationing- Under credit rationing the banks restrict the loan offered in the market
even if borrower is willing to pay the interest that is demanded by the bank. In this case
lending becomes discretionary.
iv. Moral suasion- Under moral suasion RBI gives informal and verbal instructions to
commercial banks to fulfill the need of liquidity management. It is generally related to
decisions on flow of liquidity to different sectors, it is also related to choice of projects
that banks should prefer while choosing to give loans in the market.
Therefore, qualitative tools do not affect amount of money in the economy rather they have an
impact on flow of money and its direction.
Inflation Targeting-
RBI controls monetary policy with the objective of promoting GDP growth, promoting employment
generation, and reducing or controlling inflation.
RBI introduced inflation targeting from August 2016 on the recommendations of Urijit Patel
committee. The monetary policy committee meets every two months to restrict or support liquidity
based on business cycle situation. The benefits of inflation targeting are-
i. It will help RBI to focus on only inflation and therefore attain better results for economy.
ii. It will allow RBI to use both interest rate and money supply to target inflation which will
bring better coordination with fiscal policy.
iii. It will discourage speculators in both bond market and currency market by sending a
signal that inflation will not breach the given range.
i. RBI will have limited ability to control inflation from supply side.
ii. It is possible that inflation targeting can affect exchange rate management by RBI. This
can result in overvaluation of currency on real exchange rate which can have a negative
impact on net exports.
iii. It can restrict RBI from practicing sterilization (sterilization is buying and selling of
government bonds in domestic market to cancel the impact of outflow or inflow of
foreign exchange in domestic territory.
Therefore, it is important that in developing countries like India inflation targeting is supported
by structural reforms to assure that RBI does not have to take more than proportionate burden.