Indian Economics - 240412 - 162704 - 240418 - 055234

ECONOMICS
Lavkush Pandey
MA: Political Science
dm.lavkush@gmail.com
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and ideas discussed in our lectures and readings. As a diligent student, I have taken detailed notes to capture the most
important information presented in class, as well as my own insights and reflections.
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Lavkush Pandey – dm.lavkush@gmail.com 2

Poverty
According to the World Bank, Poverty is pronounced deprivation in well-being and comprises many
dimensions. It includes low incomes and the inability to acquire the basic goods and services necessary for
survival with dignity. It includes lack of access to basic health and education facilities, lack of access to clean
drinking water and sanitation, lack of social security, lack of voice, and the inability and lack of opportunity
to better one’s own life. To measure poverty, we need objectively measurable criteria so that a standard can
be set, and poverty assessed accordingly. Poverty is a subjective concept as it has different aspects of well-
being on which different people will have different opinions. This makes poverty a normative concept (a
statement of opinion). The objectively measurable dimension of well-being is income and therefore it is
commonly used to measure poverty. In fact, due to its uncertainty and volatility, instead of income the
consumption expenditure is the preferred dimension of poverty measurement. Therefore, deprivation on
Consumption Expenditure is used to measure poverty.
Types of poverty:
1. Absolute Poverty: It is the poverty measured according to the set standards of poverty measurement.
The term “absolute” has no connotations regarding the severity of poverty. standards help in the
comparison of poverty across different times (temporal comparison) and places (spatial comparison).
The standards are usually opinions of an expert body that have been accepted by the authority
responsible for measuring poverty. As such absolute poverty is sometimes referred to as normative
poverty.
2. Relative Poverty: When the poverty status is expressed through comparison between two persons or two
sets of people. Inequality is what helps in understanding relative poverty better. Sometimes it is expressed
as income of /CE of/Wealth of the set of the population in comparison to some fixed reference point such
as the median of population, mean of the population, etc.
Poverty Line(PL): It is the standard for measuring poverty.PL is derived from Poverty Line Basket (PLB).
Poverty Line Basket is the basket of goods and services that is deemed necessary to be consumed to live a
dignified life and hence we consider non-poor. A person/household should be able to consume equivalent to
whatever the PLB suggests, and if not, then the person or the household is deemed to be poor. Usually, an
expert body is constituted to arrive at or construct a PLB. The price of items is ascertained from the market,
and the cost of PLB is calculated. This cost is the poverty line. PLB varies over time and therefore the poverty
line also changes.PL will not change unless PLB is explicitly changed.PL will get updated with the change in
the price of items in PLB. An updation of PL is not a change in PL.
Poverty Ratio: The proportion of the population below the poverty line is called the poverty ratio
or headcount ratio (HCR).
Depth of Poverty is a measure to assess how deep in poverty are households who are below PL. It is a measure
of the gravity of deprivation.
There are two ways to commonly measure the depth:

o Poverty Gap: It measures the depth by calculating the average distance of people below the poverty line
from the poverty line.
o Squared Poverty Gap: It measures the depth by calculating the root mean squared distance of the people
below the poverty line from the poverty line.
Squared Poverty Gap: If we assume that the poverty line is Rs 10,000.

Poverty Gap = Average distance from the poverty line (10,000) = (2000+5000+8000)/3 = 5000
Squared Poverty Gap= Root Mean Squared distance from Poverty Line
=square root of {(2000) ^2 + (5000) ^2+ (8000) ^2)/3} = around 5567.76.
Both PG and SPG measure the depth of poverty from the poverty line. The depth is a measure of the gravity
of deprivation, i.e. the gravity of poverty. It is a mental reference point that is trying to convey how much

would a person who is below the poverty line have to traverse to escape the poverty line. The greater the
distance, the greater the depth. The poverty gap measures the distance by taking a simple average of the
distances from the poverty line.
Squared Poverty Gap tries to convey a greater distance, and hence a deeper extent of poverty by calculating
the depth using the Root-Means-Squared method. By doing this, the reference point i.e. depth is pushed
downwards which is more toward the people who are deeper in poverty. Hence is able to capture the extra
effort that those who are farther away from the poverty line would have to undertake to escape the poverty
line.
We need to identify the poor people Primarily for two purposes:

1. To provide them benefits under anti-poverty programs of the government.
2. To count them from time to time so that we can assess the progress on poverty alleviation.
To identify the beneficiaries, each government scheme has its own criteria. As a result of that, it becomes
overlapping at most times and thus redundant, and it takes effort every time the poor person needs to identify
himself as a beneficiary and thus causing loss of precious time away from work. In 2010, the government
started the process of streamlining the schemes as well as the process of identifying the beneficiaries under
those schemes. For the former, the BK Chaturvedi committee was set up, and for the latter NC
Saxena committees(NCS). NCS Committee's task was to lay down common criteria for identifying BPL
households. Simultaneously, SECC was also conducted to identify households based on certain deprivation
parameters. The results of SECC (which were socially audited) were made available in 2013 and they
classified households into three groups:
1. Automatically included-Those households that were too deprived and therefore were made the
beneficiaries of all government anti-poverty programs. These households included those such as the
PVTGs (Particularly Vulnerable Tribal Groups), those experiencing bonded labour, etc.
2. Automatically excluded: These were the households that was deemed as not generally deserving the
benefits of Anti-poverty programs of the government. For example, those with more than 10 hectares of
land, those possessing a motorized four-wheeler vehicle, etc.
3. Deprived: Most of the households were in this category that is neither were they so poor to be
automatically included nor so well off to be automatically excluded, their deprivation status was assessed
on various dimensions and based on that they were made eligible for anti-poverty programs pertaining
to only those dimensions in which they were deprived.
Evolution of Poverty line: In a pre-independence time, Dadabhai Naoroji was among the first to
scientifically estimate the poverty line. The National Planning Committee (1938) and the authors of
the Bombay plan (1944) also estimated poverty and suggested steps to bring it down. In the post-
independence period, it was the planning commission that was tasked with tracking the progress on poverty.
It constituted expert committees from time to time for this purpose:
1. Dandekar and Rath Committee (1971): It used Calories consumption as the basis to create PLB and
thus find out the poverty line.
2. YK Alagh Committee (1979): It continued with Calorie-based PL, which separated poverty lines
between rural and urban areas.
3. Lakdawala Committee (1993): Based on Calorie consumption but introduced expenditure
on Transportation, housing, and clothing. Also suggested to update PL based on CPI. Also suggested state-
wise segregation of the PLB, to calculate the state-specific poverty line.
Tendulkar and Rangarajan Committee's recommendation: They introduced a behavioural component

in poverty estimation by incorporating the expenses actually incurred by poor Households in their poverty
line baskets. Rangarajan took the information from NCES data by looking at the consumption of a specific
category of Households. Thus, the Poverty line which was till now only normative, included the behavioural
component as well. Expenses such as those on alcohol, tobacco, entertainment, private expense on health and
education, etc which were till now not part of the poverty line were included through the behavioural
component. Tendulkar modified the time period of recall from Uniform to mixed- items of higher frequency
consumption had a lesser recall period whereas items of the low frequency of consumption had a longer recall
period. This drastically improved the accuracy of NCES data and thus the poverty estimates. This change was
introduced at the recommendation of Professor Angus Deaton. Rangarajan further modified the MRP
to MMRP (Modified Mixed Recall Period).
Purchasing Power Parity exchange rate: is the measurement of prices in different countries that uses the
prices of specific goods to compare the absolute purchasing power of the countries' currencies, and, to some
extent, their people's living standards. In many cases, PPP produces an inflation rate equal to the price of
the basket of goods at one location divided by the price of the basket of goods at a different location. The PPP
inflation and exchange rate may differ from the market exchange rate because of tariffs, and
other transaction costs.
International Measures of Poverty:

World Bank’s Poverty line: It provides loans from a developmental perspective. It is involved in the
reduction of poverty. Thus, it tries to estimate poverty. The World Bank has divided the countries into various
groups based on them per-capita income. Each group has a group-specific poverty line, and countries in that
group are assessed accordingly.
1. High-Income Countries:( Per Capita Income > $12000 per annum).
2. Middle-Income Countries:
i. High MIC:(PCI> $ 6000- 12000)
ii. Low MIC:(PCI> $ 2000- 6000)
3. Low-Income Countries:(PCI< $ 2000) (It comes to around $1.9 per person per day).
Extreme Poverty: The poverty line in low-income countries is referred to as the extreme poverty line. It is so
because if somebody is poor in a country to such an extent that such a person would also be poor in a low-
income country, then such poverty is abject or extreme poverty. Sustainable Development Goals
(SDG)1 has the target of eliminating the incidence of extreme poverty by 2030.At present, the extreme
poverty line is 1.9 dollars per person per day. To convert 1.9 dollars into a country-specific currency, PPP
exchange rates (Purchasing Power Parity) are used.
Multidimensional Poverty Index (OPHI & UNDP): Oxford Poverty and Human Development Initiative and
United Nations Development Program. It assesses poverty on three dimensions health, education, and living
standards. There are total of ten indicators that are used to measure the deprivation on three dimensions.
Each indicator has deprivation criteria which are used to assess whether a household is deprived or not. If a
household is found to be deprived on three or more indicators, then it is said to be suffering from
Multidimensional poverty.
Health (1/3 weight) Nutrition (1/6 weight), Child Mortality (1/6 weight)
Education (1/3 weight) Years of Schooling (1/6 weight), School Attendance (1/6 weight)
Standard of Living (1/3 Cooking Fuel (1/18 weight), Sanitation (1/18 weight), Drinking water (1/18 weight),
weight) Electricity (1/18 weight), Housing (1/18 weight), Asset ownership (1/18 weight).
India’s progress on Poverty Alleviation: The pace of reduction of poverty in India has been slow for about
4 decades post-independence. It picked up in the late 1990s and since then it is estimated that we have
reduced poverty at a record pace. In the 1950s, around 56% of the population were poor which reduced to
around 45% in 1993-1994 which is almost a zero reduction in poverty in four decades. In 2004-05, poverty
reduced to around 37%, in 2009-2010 it has come down to around 29%, and by 2011-12 it has reduced to
around 22 %, i.e. the incidence of poverty halved in around 20-year period. Even according to international
measures such as the World Bank, World Poverty Clock, and global MPI, the Indian pace of poverty reduction
has been rapid. World Bank estimated India’s poverty to be around 11-14% in 2014. Further, it is expected
to it to reduce to less than 10 % in the next five years. MPI report in 2016 estimated that there were around
270 million fewer people in multidimensional poverty in 2016 as compared to 2006. In 2020, the poverty
ratio under Multidimensional Poverty Index had come down to around 27% from 38%. The rapid pace of
poverty reduction is attributed to a rapid pace of growth. Faster growth leads to a faster reduction in poverty-
a one percentage point increase in growth rate is associated with a 0.6 percentage point increase in the rate
of poverty reduction. Faster growth is associated with more generation of jobs and greater revenue collection
by the government, and hence greater expenditure. When the government spends more on welfare activities,
it is expected that poverty reduction will take place. There is no certainty, only a higher expectation.
Critical Analysis of India’s Progress in Poverty Reduction: Every measure- Government or International,
points out the fast pace of poverty reduction. However, the poverty reduction seen in the context of income
growth shows a picture that even though fewer people are poor. Those that have been uplifted are vulnerable.
India is now a low-middle-income country(LMIC) with a poverty line of 3.2 dollars Per Person Per Day.
Coincidentally, India’s official poverty line and the World Bank’s extreme poverty line converted to rupees on
a PPP basis, are nearly the same. Using the latest estimates, India’s poverty at 1.9 dollars was around 8 %.
Whereas using the LMIC poverty line of 3.2 dollars, it is estimated to be between 40-45 %. This shows that
even if there is strong progress in poverty reduction. The people who are uplifted are barely so i.e. they are
vulnerable to falling back into extreme poverty all the time. An emergency health expenditure will push them
back into poverty. There is thus a constant churning that takes place around the poverty line. That means
that some people rise above while others fall back. The challenge is to ensure that the vulnerabilities of the
poor are addressed so that they don’t fall back into poverty.
Causes of Poverty in India:

 Population Explosion: India’s population has steadily increased through the years. During the past 45
years, it has risen at a rate of 2.2% per year, which means, on average, about 17 million people are added
to the country’s population each year. This also increases the demand for consumption goods
tremendously.
 Low Agricultural Productivity: A major reason for poverty in the low productivity in the agriculture
sector. The reason for low productivity is manifold. Chiefly, it is because of fragmented and subdivided
land holdings, lack of capital, illiteracy about new technologies in farming, the use of traditional
methods of cultivation, wastage during storage, etc.
 Inefficient Resource utilisation: There is underemployment and disguised unemployment in the
country, particularly in the farming sector. This has resulted in low agricultural output and also led to
a dip in the standard of living.
 Low Rate of Economic Development: Economic development has been low in India especially in the
first 40 years of independence before the LPG reforms in 1991.
 Price Rise: Price rise has been steady in the country and this has added to the burden the poor carry.
Although a few people have benefited from this, the lower income groups have suffered because of it,
and are not even able to satisfy their basic minimum wants.
 Unemployment: Unemployment is another factor causing poverty in India. The ever-increasing
population has led to a higher number of job-seekers. However, there is not enough expansion in
opportunities to match this demand for jobs.
 Lack of Capital and Entrepreneurship: The shortage of capital and entrepreneurship results in low
level of investment and job creation in the economy.
 Social Factors: Apart from economic factors, there are also social factors hindering the eradication of
poverty in India. Some of the hindrances in this regard are the laws of inheritance, caste system, certain
traditions, etc.
 Colonial Exploitation: The British colonisation and rule over India for about two centuries de-
industrialised India by ruining its traditional handicrafts and textile industries. Colonial Policies
transformed India to a mere raw-material producer for European industries.
 Climatic Factors: Most of India’s poor belong to the states of Bihar, UP, MP, Chhattisgarh, Odisha,
Jharkhand, etc. Natural calamities such as frequent floods, disasters, earthquake and cyclone cause
heavy damage to agriculture in these states.

Poverty Alleviation Programs in India:
 Integrated Rural Development Programme (IRDP): It was introduced in 1978-79 and universalized
from 2nd October, 1980, aimed at providing assistance to the rural poor in the form of subsidy and bank
credit for productive employment opportunities through successive plan periods.
 Jawahar Rozgar Yojana/Jawahar Gram Samridhi Yojana: The JRY was meant to generate
meaningful employment opportunities for the unemployed and underemployed in rural areas through
the creation of economic infrastructure and community and social assets.
 Rural Housing – Indira Awaas Yojana: The Indira Awaas Yojana (LAY) programme aims at
providing free housing to Below Poverty Line (BPL) families in rural areas and main targets would be
the households of SC/STs.
 Food for Work Programme: It aims at enhancing food security through wage employment. Food
grains are supplied to states free of cost, however, the supply of food grains from the Food Corporation
of India (FCI) godowns has been slow.
 National Old Age Pension Scheme (NOAPS): This pension is given by the central government. The job
of implementation of this scheme in states and union territories is given to panchayats and
municipalities. The states contribution may vary depending on the state. The amount of old age pension
is ₹200 per month for applicants aged 60–79. For applicants aged above 80 years, the amount has been
revised to ₹500 a month according to the 2011–2012 Budget. It is a successful venture.
 Annapurna Scheme: This scheme was started by the government in 1999–2000 to provide food to
senior citizens who cannot take care of themselves and are not under the National Old Age Pension
Scheme (NOAPS), and who have no one to take care of them in their village. This scheme would provide
10 kg of free food grains a month for the eligible senior citizens. They mostly target groups of ‘poorest
of the poor’ and ‘indigent senior citizens’.
 Sampoorna Gramin Rozgar Yojana (SGRY): The main objective of the scheme continues to be the
generation of wage employment, creation of durable economic infrastructure in rural areas and
provision of food and nutrition security for the poor.
 Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) 2005: The Act provides
100 days assured employment every year to every rural household. One-third of the proposed jobs would
be reserved for women. The central government will also establish National Employment Guarantee
Funds. Similarly, state governments will establish State Employment Guarantee Funds for
implementation of the scheme. Under the programme, if an applicant is not provided employment
within 15 days s/he will be entitled to a daily unemployment allowance.
 National Rural Livelihood Mission: Aajeevika (2011): It evolves out the need to diversify the needs
of the rural poor and provide them jobs with regular income on a monthly basis. Self Help groups are
formed at the village level to help the needy.
 National Urban Livelihood Mission: The NULM focuses on organizing urban poor in Self Help Groups,
creating opportunities for skill development leading to market-based employment and helping them to
set up self-employment ventures by ensuring easy access to credit.
 Pradhan Mantri Kaushal Vikas Yojana: It will focus on fresh entrant to the labour market, especially
labour market and class X and XII dropouts.
 Pradhan Mantri Jan Dhan Yojana: It aimed at direct benefit transfer of subsidy, pension, insurance
etc. and attained the target of opening 1.5 crore bank accounts. The scheme particularly targets the
unbanked poor.
Conclusion- The Global Multidimensional Poverty Index-2018 released by the UN noted that 271 million
people moved out of poverty between 2005-06 and 2015-16 in India. The poverty rate in the country has
nearly halved, falling from 55% to 28% over the ten-year period. Still a big part of the population in India
is living Below the Poverty Line. Rapid economic growth and the use of technology for social sector
programs have helped make a significant dent in extreme poverty in the country. Despite rapid growth and
development, an unacceptably high proportion of our population continues to suffer from severe and
multidimensional deprivation. Thus, a more comprehensive and inclusive approach is required to eradicate
poverty in India.

Inequality
It refers to differences amongst people or places in the context of various aspects of well-being or
development. Like poverty, inequality can also be seen as differences in income, ability to access good
education or health facilities, differences in social status, ability to improve one's present condition,
differences in opportunities available, etc. Objectively inequality is measured on the economic parameter of -
wealth, income and expenditure. Economic inequality is able to capture the differences in various social and
political dimensions to a reasonable extent. Wealth-based inequality is volatile and less accurate as compared
to the consumption expenditure-based inequality and therefore the governments usually prefer to use CE
based inequality.
Reasons for inequality:

1. Conventional reasons:
i) Natural advantages: due to accidents of birth or location. Because of certain natural endowments, some
places or societies or households are better equipped to earn more or progress faster.
Curse of resources - sometimes an inverse relationship between natural endowments and development
indicators is observed, which is wrongly attributed to the existence of natural resources.
Lack of development, however, is not because of resources but because of the inability to utilize them
productively.
This may be because of poor governance, situations like civil war or social unrest or inaccessibility of
resources etc.
ii) Comparative advantages: Despite having the same natural endowments, one place or society or person
may have some comparative advantage over the other and as such will be more favoured in growth,
causing inequality.
iii) Economic reasons - traditionally it has been argued that the growth of profit i.e. the return on capital
has been greater than the return on labour, i.e. the growth rate of profits is more than the growth rate of
the labour.
As such the profits are appropriated by the capitalist and not shared with the labour, which results in
inequality between those that possess capital and those that only have labour.
2. Modern reasons: It has been observed that over a long period the return on capital vs the return on
labour isn't similar. However, the return for a business that survives is far greater than the average return
on the capital. Less than 2% of business survives for more than 20 years, as a result, the market share for
a business, which was earlier divided amongst a large number of firms is divided only amongst a very
small number of firms. The profits of the firm will grow both because of the growth in the market as well
as the demise of its competition, whereas ''the profits for the labour i.e., wages will grow only at the rate
of growth of market '', therefore wages grow at an average pace whereas profit at an exceptional pace.
The firms realized this and therefore have monopolising tendencies. The profit of the firm will grow only
if it survives. As such the firms will follow the legitimate as well as illegitimate means to survive.
Legitimate means include providing better quality goods or services i.e. differentiating their product.
Illegitimate means include influencing the government's policies to favour them over the competition,
unfair trade practices, misuse of their position, etc.
Measurement of Inequality:
 Representation of Inequality:
1. Kuznets curve: It represents the expected relationship
between Income and Inequality over a period of time.
According to Kuznets, it is expected that inequality will
initially worsen, then stabilise and then reduce. It is only a
theoretical expectation rather than being some curve plotted using some historical data. A) Phase of
increasing inequality. B) phase of stabilisation. C) phase of reduction.

2. Lorenz Curve: It is a graphical representation of
inequality in the country. It plots the distribution of
wealth/ income/CE, in the population. Precisely, it
plots the cumulative share of wealth amongst the
cumulative share of people from lowest to highest
possession of wealth.
In the diagram, curve OA is the line of perfect equality
representing the perfectly equal distribution of wealth
in the population. OBA is the line of perfect inequality,
where entire wealth is with just one person and the
remaining population has exactly zero shares in the
wealth.
A country usually neither be perfectly equal nor unequal, rather its Lorenz curve will lie somewhere between
these lines- the more unequal the country the further its Lorenz curve is from the line of equality and closer
it is to the line of inequality.
Gini-Coefficient is the statistical measurement of

inequality with the 2 important properties. The
value of GC varies from 0 to 1, The lesser the value
more equal the society and Vice versa.
Inequality in the World- Inequality and Growth: Inequalities are caused due to multiple factors such as
accidents of birth, locations, Disparities between profits and wages or the monopolistic tendencies of the firms
compounded with poor rule of law. However, these Reasons have been addressed through various steps taken
by the Governments. Inequality continues and is perpetuated because of the model of growth i.e. Persuade
which leads to inequalities increasing as one section benefits more because of Growth than another.
Trickle-down approach: This is a focused approach to growth where the resources, efforts, policies, etc. are
directed towards a certain sector or a region that has a high potential for growth, exports and employment.
For example, Government gives subsidies or frames policies such as the recent PLI scheme (Production linked
incentive) in order to encourage the output of certain sectors. This means that there will be sectors/regions
that will be left out and thus one will benefit while the other won't. This strategy of growth is followed the
world over as everyone would like to develop competence in certain fields. It is theorised that high growth
resulting from this field will be used to speculate the benefits down to those fields that were left out i.e. trickle-
down of the fruits of growth. However, whether the benefits actually trickle down depends on the following
four assumptions:
o Did the chosen sector grow at the desired pace?
o Whether the government was able to collect resources due to this high growth i.e. efficiency of tax
collection (Tax Buoyancy).
o Whether the government decides to reinvest their resources or utilize them elsewhere or use them in
providing benefits to those that were left out. (Expenditure policies)
o The efficiency of government expenditure.
These assumptions may not all be true at once and therefore the people at the bottom receive benefits only
as passive beneficiaries of the growth process. They are dependent on the government discretion along with
coming true of these assumptions to receive the benefits.
Inclusive growth: This is the model of growth in which the people at the bottom, are not merely passive
recipients rather are active contributors to the growth process. The Trickle-down approach is inequality
causing, whereas the inclusive growth approach is a broad-based growth which is expected to be inequality

reducing. The people at the bottom are active contributors, therefore they claim the benefits of growth as a
matter of right rather than governments discretion.
In order to enable them to be active contributors relies on the following:

o Identification of the most vulnerable.
o Addressing their vulnerabilities.
o skill development.
o Industrial Development.
o Job creation relevant to the people at the bottom.
o Addressing regional disparities etc.
Unemployment
It is defined as a state in which a person who is willing to work is unable to get work. This willingness must
be expressed and not vague.
Working-Age Population- Those who are of working age, usually defined as between 16-64 years.
Sometimes age groups 18 to 59 years or 15-65 years are also used.
Dependent Population: Those who are not of working age i.e. less than 16 and greater than 65.
Labour force: Economically active population. The Labour force is that part of the population that
has expressed its willingness to contribute to economic activity.
Labour Force Participation Rate: LFPR refers to the proportion of the population which is in the labour
force. LFPR can be refined to seek the proportion of the population seeking work in any cohort.
LFPR= Number of people in the Labour force in a cohort/Size of the cohort (group).
LFPR of Graduate Women= Graduate women in the Labour force/ Total population of graduate women.
Workers: Those amongst the Labour force who are able to find work.
Worker Population Ratio = Workers/Population. It is commonly expressed as the number of workers per
1000 of the population.
Unemployment Rate = Number of people unemployed/ size of the labour force.
UR is Proportion of people in the Labour force who are yet to find work.
Dependency Ratio= Dependent population/working-age population. DR=Population less than 16 and
greater than 65/ population between 16-64 age groups.
Demographic Dividend: A demographic Dividend is the expected benefit that a country seeks to reap
because of a favourable demographic structure. This favourable demographic structure usually refers to a
skilled and younger working-age population. A country with a younger working-age population will be
expected to be more productive, work with more efficiency, easily acquire new skills and technology and
therefore is expected to grow faster. As a result, the incomes and standard of living are expected to improve
quickly. This expectation is the demographic Dividend. A demographic Dividend is merely an expectation
rather than any guarantee for a faster growth. Whether a country realizes its demographic dividend depends
on the institutions and structures of the country to skill the population and generate productive jobs.
Otherwise, the dividend will turn out to be a disaster. The working-age population of India is not only the
largest but also the youngest and further, it is expected that the working-age population will remain young
for a long period. This means there is a large window of opportunity to reap the demographic Dividend.
Estimation of Unemployment in India: Unemployment is measured by the Periodic Labour Force

Survey(PLFS), conducted quarterly in urban areas and annually at all-India levels since 2017. Up to 2012, it
used to estimate unemployment through EUS (Employment-Unemployment Survey) which was a
quinquennial survey (every five years). PLFS improves the accuracy of estimating unemployment by
increasing the sample size and making it more diverse that is more representative of the economy.
The process of estimation of unemployment is broadly the same: A sample is drawn to collect the
information by NSSO. A set of questions are asked by the respondents and their responses are judged based
on certain principles or approaches. Based on the assessment either of the 3 status is assigned to the people
that is, Employed, Unemployed and Neither working nor looking for work (not in the labour force).
Unemployment rate = Status-2/ (status-1 +status-2).
The Usual Status approach: It is based on the majority of time criteria. Under it first, it is ascertained
whether a person was in the labour force (if he was economically active for a majority of the last year) for
the majority of the time during the last year. If yes, then he is considered to be a part of the labour force for
the entire year.
Principal status: If the person was able to find work for the majority of time for which he was in the labour
force then such a person is said to be principally employed.
Subsidiary status: Some people may find work for more than 30 days during the past year but may be
principally unemployed. For such people, their subsidiary status is considered to be employed while their
principal status remains unemployed. The unemployment rate which is most commonly reported consists of
those people whose both principal and subsidiary status is unemployed and considered as total unemployed
and their proportion out of the total labour force is the unemployment rate.
Current Weekly Status approach: In CWS a person is considered employed if he was able to find work for
at least one hour on any one day during the previous week if he was in the labour force. The unemployment
rate as measured by CWS is usually higher because the recall period is shorter. Hence the response is more
accurate and more importantly, it can capture seasonality in employment. In an economy where a large
number of jobs have seasonal characteristics, CWS can capture this better than the Usual Status.
The Current Daily Status approach: This was an approach to measuring unemployment using the intensity
of work during the EUS that is till 2012. PLFS does not measure unemployment using the CDS approach. CDS
measure unemployment by accounting for employment intensity. It considers the number of hours that a
person has worked relative to the number of hours the person was available for work. It considers work for
more than 4 hours a day with 100% intensity (that is the intensity of 1), work of 1-4 hours as 50% intensity
(that is 0.5) and working less than 1 hour with 0% intensity. The population's total working intensity is
calculated and maximum working capacity is then used to calculate the unemployment based on unutilized
time for work.
Reasons for Unemployment: Unemployment can be seen from three different viewpoints and based on them
we can see various reasons why unemployment may be there.
 From a bird's eye view that is general reasons for why unemployment from a macroeconomic school
thought perspective.
 A point of view closer to the economy i.e. why unemployment in a particular economy at a given time.
 A point of view closer to the individual, that is why is a particular person unemployed.
Unemployment according to the macroeconomic school-classical and Keynesian unemployment:

Classical unemployment (wage rate unemployment):
 Law of demand and law of supply: Demand refers to the
quantity demanded of a particular good at a particular price. The
demand for a good depends on various factors such as the price,
season, culture, tastes and preferences, income, tastes, quality,
availability of substitutes, necessity, quality, population, utility,
etc. The Law of Demand says the quantity demanded of a good
given all factors that determine demand, except price, to be
constant, varies inversely with price. That is quantity demanded
increases with a decrease in price and vice-versa, given other
factors remain constant.

The demand schedule is a downward sloping curve representing the inverse relationship of quantity demand
with the price. It is plotted in a given set of conditions, and if those conditions change we need to plot a new
demand curve, this is called the shift of the curve.
Law of Supply: Supply refers to the quantity produced by all the producers at a given price.
The decision of producers depends on factors such as:
 Price: Price is set by the market. The producer is not a price setter, but rather a price taker.
 Quantity: and availability of the factors of production- Land, labour, capital, entrepreneurship.
 Cost and availability of raw materials.
 Infrastructure in the economy.
 Level of technology.
 Government policies such as labour laws, taxation laws, environmental laws, business regulations, etc.
The law of supply state that the quantity supplied of a good i.e., the quantity which the producers are willing
and able to produce varies directly with price, assuming other factors determining supply to be constant. The
quantity produced will increase due to an increase in price as more producers are able to produce and sell
their goods profitably.
Market Price: A market is a place where producers and consumers transact with each other for goods at a
certain price. This price is arrived at through negotiations between all the producers and consumers, and not
just one producer or consumer. The market price is the price at which the market clears itself. That is there
is no producer whose supply is unsold and no consumer whose demand is unmet.
The price P0 is also called the equilibrium price as at this price there is no
upward or downward pressure on the price. If the price is greater than
P0, Qs > QD, therefore there would be some producers who won’t be able
to sell their produce in the market and hence would be willing to sell at a
lower price, causing downward pressure on price. At P=P0, the price
would be in equilibrium. Bargaining is the property of an inefficient
(perfect) market because, in an inefficient market, the supplier could not
overprice his goods.
Classical unemployment: According to classical economists, unemployment exists because wages in the
labour market are higher than the equilibrium wage. Wages can be higher because of factors such as strong
labour unions that have negotiated for higher wages or the government which has set higher than
equilibrium wages as the minimum wage rate. In the labour market, labour themselves are the supplier of
labour. The demanders of labour are the producers(employers). The demand for labour is inversely
proportional to the price of labour i.e. wages and the supply of labour would be directly proportional. If the
wages are at the equilibrium level or if there is no intervention in the labour market and the wages are
allowed to settle at the equilibrium level, then there would be no unemployment as the demand for labour
and the supply of labour would be equal.
Minimum wage: It is a statutory wage that lays down the minimum wages to be given for an activity at a
particular skill level. Both the Center and states can formulate minimum wages through their respective
minimum wage laws. In which they lay down the least amount of wage to be given for a particular activity
depending on the skill level. The least of minimum wages is called the “Floor wage”. Floor wage may or may
not be explicitly mentioned in the minimum wage law.
Living wage: It is a minimum wage considered necessary to live a dignified life. It is a subjective wage rate
as suggested usually by some expert panel. The government may consider a living wage to arrive at the
statutory minimum wage.

Fair wage: It is the wage that lies somewhere between the living wage and the minimum wage. The
minimum wage may be too low and therefore inhuman. The living wage may be too high and therefore
unaffordable. A fair wage is such that it meets the needs of the employers, the employees as well as those who
are seeking employment.
Keynesian Unemployment:
Cyclical unemployment: An economy grows through cycles of ups and downs, that is there are periods of
high growth, slowdown, recession, and recovery. These phases are cyclical and the unemployment during
these phases also corresponds to the economic cycle- during high growth, unemployment is less and vice
versa. An economy may be stuck in a phase of low growth and may experience higher cyclical experiences for
a prolonged period. Cyclical unemployment is the unemployment over and above the unemployment in the
economy had it grown at an average pace. That is if the economy grows at a lower than average pace
(expected pace) then it will experience higher than usual unemployment. This is cyclical unemployment. For
the policymakers, the objective would be to ensure that the economy gets out of this phase of high
unemployment as quickly as possible.
Keynesian solution: Keynes considers the fall in Aggregate Demand (AD) as a reason for an increase in
unemployment.AD refers to the total demand for all goods and services in the economy. AD is the demand
that all firms together experience in an economy.
It constitutes:
 Demand from households.
 Consumption Expenditure(C).
 Government- Government Expenditure (G).
 Businesses- Investment expenditure (I).
 Foreigners- Net Foreign Expenditure (X-M).
AD= C+G + I +(X-M).
Keynes suggested that during a recession, C would be low as households would face unemployment and earn
very low wages. Since C is low, AD is low and therefore I is also low. Businesses will not invest unless they
expect to sell their goods, i.e. unless AD improves. Merely because labour may be available at a low wage rate,
does not mean that businesses will employ them. It is only when businesses invest is new employment created.
During the time of recession, there is already an unutilized production capacity in the economy, and therefore
businesses will not invest. (X-M) is autonomous and hence outside the model. The only component of AD that
can be increased is G- Government Expenditure. Keynes suggests increasing G to increase AD, to increase I,
and hence, create employment.
Issues with Keynesian solution: Keynes proposes government expenditure to increase aggregate demand.
However, during a recession, revenues are already less and therefore the ability of the government. to spend
is already less and as such, the government needs to borrow.
Borrowing has many risks involved:
It may cause crowding out of the private sector. It causes inter-generational inequity i.e. the future
generation pays for the money borrowed today. Excessive government spending would be inflationary as the
production will lag the expenditure. It will lead to the situation of too much money chasing few goods.
Types of unemployment:
1. Structural unemployment: The word “structure” means the defining characteristic of an economy.
Employment in the economy/sector/industry is adjusted to the present structure. However, the structure
continuously changes and some may fail to fit in the new structure. People unemployed because of this
immobility that is unable to adjust, are said to be structurally unemployed
Types of immobility:
 Occupational immobility: Unable to move between jobs due to lack of skills.
 Geographical immobility: Inability to change the place of work.

 Industrial immobility: Inability to change the job due to lack of skills, lack of jobs due to decline in
industry, the shift of the economy in a new place.
2. Frictional unemployment: It is the unemployment due to the inefficiency of the labour market.
Inefficiency means that there may be a job, as well as a suitable candidate for the job, but because of lack
of information, the job remains vacant and the person remains unemployed for some time. Commonly it
is seen as the time a person when is not working when the person switches from one job to another. With
improvements in technology such as online job portals, information is now rather immediately available
and thus, the inefficiencies have come down.
3. Seasonal unemployment: Certain jobs are seasonal in nature due to the seasonality of the work or
industry. People working in such industries are seasonally unemployed. For example- Tourism,
agriculture, hospitality, the construction market, etc.
4. Voluntary unemployment: It means deliberately not choosing to work despite being offered a job. That
means a job was offered to a person and he chose to remain unemployed.
There can be several reasons such as: Unattractive compensation. Job is perceived to be below the skill
or the dignity. Generous unemployment benefits are being given by the government.
Employment on the basis of the intensity of work:

1. Under-employment: Work is available for less time than what is sought. A person may be employed in
jobs where his skills are underutilized. This is also a case of underemployment; however, it cannot be
objectively measured. Underemployment is commonly seen when a person is available for work full time,
but work is available only part-time.
2. Disguised unemployment: Where the marginal product of labour is zero. That means a person is
working but not contributing. As such the output would have been the same had the person not been
employed.
Marginal means” what about (n+1) given n”. For example –the utility of (n+1) th given the utility of n is the
marginal utility of (n+1) th. The output of (n+1) th given output by n is the marginal product of (n+1) th.
Natural Rate of Unemployment also called Non-Accelerating Inflationary Rate of Unemployment: It

is the unemployment that exists in an economy in the background, i.e. naturally. This means that
unemployment in which the wages are at an equilibrium level (Classical Unemployment is not there) and the
cyclical factors have played out i.e., the economy is not witnessing either a cycle of low growth or high growth.
At this point, the unemployment in the economy will consist only of those who are structurally, seasonally,
frictionally, or voluntarily unemployed. It is the rate of unemployment at which inflation does not accelerate.
i.e. if unemployment is less than this level, it would be expected that prices would rise, and if unemployment
is above this level then prices would be expected to fall.
Philips Curve: The Philips curve is a graph plotted using

the historical relation between prices and unemployment.
It was seen that when unemployment is low, prices are
high and when unemployment is high, prices are low. It
depicts an inverse historical relationship between
unemployment and inflation.
Measuring unemployment in India:

Unemployment statistics: (refer to the latest Periodic Labour Force Survey data, probably June): Since
2017, unemployment is estimated from the PLFS. Under PLFS, the sample size is large and the technique of
collecting information is different from Employment – Unemployment Survey (EUS). In urban areas, a
household is visited once every quarter and therefore the recall period is much shorter than EUS which visited
in a year. The results are expected to be more accurate and cannot be strictly compared with results of EUS.
According to PLFS-3, unemployment rate(UR) has come down to 4.8% and LFPR has increased to 40.1 %. UR
has shown a declining trend from the previous PLFS and Labour Force Participation Rate (LFPR) has shown
an increasing trend. However, the fall in unemployment rate is attributed almost completely to the two
reasons: Increase in agricultural jobs, Increase in self-employment. For a country that seeks to reap the
demographic dividends, moving up the productivity change is essential. Therefore, adding new jobs in already
saturated agriculture or low productivity self-employment would be undesirable. Whether the increase in
these jobs is permanent or just a temporary feature due to covid would be seen from subsequent surveys. The
latest quarterly surveys suggest the number of jobs to be increasing outside agriculture and hence it may
have been a one-off phenomenon.
Jobless growth: The growth of a country can be attributed largely to two reasons:
1. Increase in the quantity of factors of production.
2. Increase in the productivity of factors of production.
Both factors are desirable. However, in an economy where there is a large working-age population, an
increase in jobs when the economy grows is of utmost importance.
Employment Elasticity: measures the sensitivity of employment to a country's economic growth that is it
sees by how much employment grows in a country with economic growth. Employment elasticity
(e)=percentage change in employment/percentage change in output. e=(ΔL/L)/(ΔY/Y). It is a measure of an
economic growth to employment growth versus productivity growth. More the employment elasticity, the
more sensitive is employment to economic growth, and the less sensitive is productivity to economic growth.
In the case of India, Employment elasticity has seen a declining trend wherein it has come down from around
0.5 in the 1970s and 80s to around 0.4 in the 90s and has drastically fallen to less than 0.2 since the 2000s.
During, 2004 to 2009 it came down to 0.01. As such it can be seen that more contribution to economic growth
is attributable to an increase in productivity and less to an increase in employment. This has been
characterized as jobless growth - the economy grew at a record pace of more than 7% since the year 2000
whereas employment has grown only at the rate of around 2% since then.
Counter argument: Even though employment elasticity has been falling, the growth rate of employment has
always been greater than the growth rate of labour force as such the number of new jobs created have been
sufficient to absorb the people entering the labour force. This is reflected in the fact that despite the falling
employment elasticity, the unemployment rate has been range-bound between 5.2 to 5.8 % since 1990
according to ILO estimates as such economic growth should not be characterized as being jobless.
Unemployment in India: Unemployment in India is characterised as a mismatch between aspirations and

eligibility. The workforce aspires for good quality jobs whereas it is mostly ineligible for such jobs. The
number of quality jobs are less as compared to the number of people willing to take up those jobs and hence
unemployment in our country can be seen as due to structural and voluntary reasons.
Structural: mismatch between skill require vs skill available.
Voluntary: mismatch between aspirations and eligibility.
Unemployment is thus because of not enough quality jobs able to satisfy the aspirations of the workforce, and
because of lack of skills in the workforce unable to meet the demand of jobs being created in the economy.
Employment in different sectors: The sectoral share of the three sectors, service, agriculture, and industry
has been changing in employment and as well as in GDP, as such the three sectors have been differing in
employment elasticity. For services, Employment elasticity is less as most of the growth in the services sector
is attributable to an increase in productivity. For agriculture employment elasticity is now negative as the
employment is reducing whereas the growth is positive. For industry, employment elasticity is greater than
the average employment elasticity and the number of jobs created per unit of the sectoral growth is greater
than in other sectors. The ability of services to create more jobs is restricted especially for the productivity-
intensive sub-sectors. The desirability of agriculture to create jobs is less as it is already saturated with
workers. The ability and desirability to create more jobs are in the industry and labour-intensive services
such as tourism. Going forward the focus of the policy of growth should be on such sectors where
employment's response to growth is high.
Types of Employment:
 Formal & Informal: The employer-employee relationship extends to various aspects such as work and
wage, social security, the safety of work, rights of employees for negotiating with the management, etc.
Firms can be usually characterized on the basis of whether they have a structure or if the structure is yet
to be formed. The firms that have a clear hierarchy, clearly defined roles, and responsibilities, methods of
recruitment, and lay-offs are called organized firms. On the other hand, certain firms, mainly start-ups
and small firms do not have a clearly defined organizational hierarchy or roles and responsibilities are
called unorganized firms. The nature of employment in an organized firm is expected to be formal.
Formal refers to the nature of the job, where the employment is formally recognized, and therefore the
rights of the employee and obligations of the employer are easily enforceable.
There are four labour codes that govern the four aspects of the employer-employee relationship:
 Code on wages.
 Code on Social Security.
 Code for safety and security at the workplace.
 Code on Industrial relations.
These four codes are set of multiple laws which put obligations on employers and employees. Over a period
of time, the labour laws expanded in their scope, and compliance became difficult and costly. As a result of
this, the nature of employment became such that employers-maintained deniability with respect to the
employment status of employees so that they could bypass the labour laws. The workers who are formally
recognized such as through payment of wages on a company’s salary slip, through contribution in pension or
provident funds, etc are called formal. On the other hand, those whose employees are working but not
formally recognized are informal workers. In the eyes of law, there is no distinction, an employee is an
employee, not a formal or informal employee. The labour laws are to be enforced for all, and not some.
However, the ability of a formal worker to enforce his rights is much higher compared to the informal worker.
National Commission for Employment in Unorganised Sector: recommended that firms with more than
20 workers, and thus the workers therein be categorized as part of organized sector, and if less than that,
then unorganized sector. This definition was accepted in the laws meant to provide social security benefits in
unorganized sectors.
Contractual employment:
Contract worker: He/she is one who has a job contract with the firm. A job contract is different from an
employment contract as it is a contract for the performance of a task mentioned in the contract. A contract
worker probably does the same work as a directly employed worker but is not considered a direct employee
as the nature of his relationship is different from that of a directly employed worker. A contract worker does
not enjoy the rights of an employee at the workplace as technically he is not an employee.
Contractualisation of the workforce: Over a period, the share of contractual workers increased from
around 15 percent to 27 percent between 2001 and 2011. The pace of growth of directly employed workers
has been slower (around 4%) than the pace of growth of contractual workers (around 8%). Contractual
workers have no job security and have fewer social security benefits as compared to directly employed
workers. Their wages are normally less and grow at a lesser pace than any other worker.
Reasons for Contractualisation: The rigidity of labour laws and high compliance costs. Size of the firm- A
perverse incentive to remain small: The size of the firm (based on the number of workers) is usually a criterion
when it comes to compliance with labour laws. Bigger firms have greater requirements and therefore when
small firms grow big, their costs of compliance will drastically increase. As such it prefers to remain small. To
get the work done they would rather hire workers on a contractual basis than hire them directly and invite
higher costs of compliance. It is a myth that” small firms create jobs. It is the firms that grow big that are job
creators”
Gig Economy: The gig economy refers to a platform economy i.e., the economy in which the platform acts as
a facilitator between the service provider and the consumer. The service provider is not an employee of the
platform and rather is a business in itself. The platform and the service provider do not have a conventional
employer-employee relationship, even though the ability of the service provider to earn is greatly determined
by the platform.
Since the service provider is not an employee, for example, an Ola driver and Ola, a food delivery partner, and
Zomato, therefore there is no responsibility of the platform with respect to any labour law of the service
provider.
However, most of the work on the gig platforms is that of lower end on skill level, and thus the service
providers, even though not employees, rather are firms themselves. They are vulnerable and dependent on
the platform for providing jobs to them. The social security benefits for such gig workers have not yet been
made the responsibility of any single party. It is difficult to provide them with social security benefits through
the platforms as they are not employees of the platform. A mechanism is being deliberated where the three
parties- Gig worker, the platform, and the government will jointly arrange for a social security fund to provide
for social security benefits. Till that time the gig workers can avail social security benefits under government
schemes that target workers in the unorganized sector.
Fixed Term Employment: Employment is generally for eternity, i.e. the time for which the employee will
remain of the working age. It is not interrupted unless in a situation like an employee is willing to leave
voluntarily, or the firm closes due to some reason or decides to fire the employee on some reasonable grounds.
FTE is employment for a predetermined fixed term. A person hired as FTE will enjoy all the rights of a normal
employee, just that they will be for a limited time, as mentioned in The FTE contract. FTE was proposed as a
midway between contractual work and full-time employment. It encourages employers to employ workers
formally and give them all the rights which are ordinarily given to directly hired workers. This gives
employers flexibility and therefore an ability to plan for employment in years to come. Had there been
permanent employment, the employers would find it difficult to fire employees even on reasonable grounds
such as fraud or lack of business. Since FTE is for a limited duration, employers have the ability to plan for a
limited time without the associated burden of full-time employment. For the employees, it gives them rights
as any other formally employed worker would have.
Addressing of unemployment: Improving employability through skill development. Increasing the ability
of firms to create jobs by reducing impediments to their growth such as reducing the costs of compliance with
labour laws, taxation costs, etc. General steps to increase industrialization i.e., encouraging the growth of
high employment elasticity sectors. Such as champion sectors- These are those sectors that have a high
potential for growth, exports, and employment. For example- the food processing industry to absorb the
labour force freed up from agriculture with minimum skilling; also sectors like leather, textile, pharma,
semiconductors, etc have high potential to be “champions”. Other steps such as improvement of
infrastructure, steps to increase productivity, etc.
Economics some basic concepts

Economics as a discipline originates from the basic issue of limited resources and unlimited wants in a
society. This issue leads to questions such as:
 how will the resources be utilised?
 Who will decide how to utilise them
 What is the current distribution in the society
 How will the fruits of production be distributed?
 What price will be paid and by whom, etc.

These questions pertain to the political, social, economic, and ethical dimension. While the answers to these
questions are the subject matter of each individual, social sciences subject, the answers are to some extent
overlapping and hence it becomes difficult to completely separate one aspect from another.
Economic political aspect-types of economies: Economic decisions are broadly categorized on the basis of
who is the decision-maker.
Command & control economy (Authority) Free market economy (Individual)
for example, democratically elected government,

Freedom to enter or exit based on market forces
dictator, king communist party polit bureau
An economy may be based on either an individual deciding various aspects of utilising economic resources or
may be based on an authority doing this. An authority is someone who has the capability to enforce their
decisions. While an individual decision-maker deciding the utilisation of resources may be more efficient, it
may lead to exploitation and an increase in inequalities. On the other hand, when an authority decides on the
economic questions, it may be less efficient but is expected to be more equitable. The authority, therefore
usually appropriates to itself the power of decision making and thus exercises control over the resources in
an economy. Such an economy is called a command and control economy and is described as being socialist
in nature. A Free market economy is based on the idea of liberty and hence is described as a Libertarian
economy. Since, the decision-maker is the person in control of the capital, therefore it is also called
a Capitalist economy. In a Socialist economy, the government may not be able to fulfil the demand of the
economy either because it is incapable, lacks resources, or is unwilling. This may lead to the government
choosing someone from the private sector to fulfil the unmet demand. This is what creates a mixed economy.
In a mixed economy, the private sector is allowed to exist, rather than having a right to provide for what the
market demands. No Country can be completely authoritarian, or a completely free market-based economy.
Governments intervene even in free-market economies in form of regulations. Regulations are those
interventions that are considered necessary for the larger good of the economy and society. For example,
regulations regarding security features in automobiles. Regulations regarding lending activities by banks.
Regulations regarding environmental waste produced by the industries, etc.
Evolution of Economist thought: Adam Smith publishes his book Wealth of the Nation in 1775, through
which he laid the foundation of the organised economic thought as before him the economic thoughts were
not organised. Before Adam Smith, the economist’s opinion was based on what the King wanted. The King’s
objective was to develop a fiscal-military state i.e. Mercantilism.
Tools of Economic decision making:

Production possibility Frontier and Budget constraint: An economist uses the budget constraint which is
the limiting factor of output to project what is the maximum that can be produced in that limiting scenario.
This possibility of production given a certain budget is known as a country's production possibilities
frontier(PPF). PPF represents the optimal utilisation of resources. The level of output beyond a country's PPF
is desirable but not sustainably possible, whereas the level of output below the PPF is possible but not
desirable. The PPF represents those sets of points of production which are possible as well as desirable. PPF
is the opinion of an economist that is different people will have different opinions. It is based on the level of
technology, the quantity, and quality of inputs available in the economy, and the manner of their utilisation.
For a developed country the level of output would be expected to be closer to its PPF as its resources are
expected to be better utilised. For the developing country, the level of production is likely to be farther away
from PPF as its resources may not yet be fully explored, utilisable and its workforce is unskilled. An economist
will compare a country's actual level of output with its PPF and comment on how far from the possible
production a country is. An economist generally does not express preferences unless they are objectively
measurable. The decision-maker is the one who decides on preferences, for example, taste, and externalities
associated with certain production. An economist can at best compare preferences if they are expressed in
monetary value terms.

Opportunity cost: It refers to the benefit forgone when a choice is made in favour of one and against the
other. Given a limited resource, a decision-maker chooses what is desirable, this leads to rejecting something
else that may also have been desirable. The benefit that is foregone when a choice is exercised is called
opportunity cost. For example: hunt 6 deer and gather 400 berries, hunt 4 deers and gather 600 berries.
opportunity cost of choosing option 1 over option 2 is 200 berries.
Marginal cost: Cost incurred in the production of one extra unit, that is given a certain level of
production(output) how much would it take to produce one more unit.
Law of Demand and Law of Supply: The Law of demand holds that the price of the product increases with
an increase in the demand or vice-versa, provided the other factors remain unchanged. The Law of supply
holds that with the rise in the price of the product, the supplier will tend to supply more products in the
market, provided other factors remain constant.
Different types of goods:

On the basis of the slope of the demand curve:
o Necessary goods: These are the goods for which the change in the quantity demanded is very less even
when the change in price is high. These goods have a near-vertical demand curve, reflecting the inelastic
quantity demanded with respect to the price. For example, the demand for life-saving drugs, water,
necessary food items etc.
o Luxury goods: These are the goods in which the quantity demanded changes by a large amount even
when there is a small change in the price. Such goods have a near-horizontal demand curve. For example,
jewellery items, decorative items, luxury cars etc.
On the basis of the relationship between the demand and income:

o Normal goods: It is normally expected that with an increase in income in the society, the demand for
certain goods will increase, such goods are called normal goods. The demand curve of the normal goods
with an increase in the incomes shifts outwards.
o Inferior goods: There are certain goods whose quantity demanded may decrease with an increase in
income. These goods are such that they are not preferred when income rises.
There is no good that can be universally classified as inferior or normal good rather there are
circumstances which make a good normal or inferior. For example, in a society with rising income, people
may demand more eggs to fulfil their protein requirement, making it a normal good. On the other hand,
with rising in income, people may switch over to the non-animal sources of protein and hence consume
fewer eggs, thereby making eggs an inferior good.
On the basis of the relationship with other goods:

o Substitute goods: These are the goods that can substitute each other's consumption i.e. one good can
make up for consumption if another is not available. For example, tea and coffee, matchstick and lighter
etc. When the price of one good increases, it makes the other good relatively more affordable and hence
it is expected that the increase in the price of one will lead to the increase in the quantity demanded of
the other good. It is not always necessary as an increase in the quantity demanded of one good may cause
an increase in the price of that good and hence, its quantity demanded would then come down. However,
it is generally observed that when the price of one increases, the quantity demanded of the substitute
goods increases.
o Complementary goods: These are the goods in which one good complements the consumption of the
other good. Usually, there is one leading good and another good which complements it. The relationship
is such that an increase in the quantity demanded of one good leads to an increase in the quantity
demanded of the other. For example, tea and biscuits, automobiles and fuel etc.
Goods which seem to violate the law of demand:

1. Veblen Goods: These are those goods whose possession is expected to be associated with a higher social
status. These goods generally do not have any practical utility but rather only have a social status that
may be acquired through their possession. When the price of such goods increases, more people would be
willing to possess them and hence their demand would be expected to increase. Whereas if their price
falls, they do not become affordable for those who would want them and become undesirable for those
who can afford them, and hence their demand decreases with a fall in their price. For example, luxury
sports cars, expensive designer jewellery items, rare artefacts, paintings etc.
2. Giffen Goods: These are inferior goods which in very special circumstances show a behaviour which is
violative of the law of demand. For example, assume a household with a certain income consuming two
goods, one inferior and one normal, which can be substituted for each other. With an increase in income,
the household will consume more normal goods and less inferior goods. The consequence of this may be
an increase in the price of the normal good and a marginal fall in the price of the inferior good. If the rise
in the price of the normal good is very high, the total expenditure incurred due to an increase in the
quantity demanded of the normal good would become too high. As such this may make the consumption
of the normal good unaffordable, and hence the household will reduce its consumption and substitute it
with the inferior good. As a result of an increase in quantity demanded of the inferior good, its price will
rise and hence, the total expenditure incurred on the inferior good will also increase.
3. Giffen Stage- With an increase in the expenditure on the inferior good, the disposable income for normal
goods decreases, making it unaffordable. As a result, the households will further cut down on
consumption of the costly normal good and substitute them with the cheaper inferior good. If we observe
only the inferior good, then we see that an increase in its price has led to an increase in its consumption.
This is so because its increased price has made the consumption of normal goods more unaffordable and
hence its consumption is substituted by this inferior good.
Goods on the basis of the role of suppliers:

o Private goods: These are those goods that are provided for by the market on the basis of demand and
supply. This means that there are consumers willing and able to pay for a good that they demand, and
their producers who are willing and able to produce and sell that good at a price expected by the
consumers. Just because the private sector is the producer, does not make a good a private good.
Government can also provide a good based on its market demand and supply.
o Public goods: In certain cases, the market may fail to provide for the goods demanded that is there might
be some reason why suppliers are not able to fulfil what the consumers require. One such reason is seen
in the context of the free-rider problem. The market fails and the desired good or service is not provided
hence there is dissatisfaction in the economy. The market fails because the consumers are even though
willing to consume that good, are not willing to pay for it. This is because they cannot exclude others from
enjoying the benefits associated with the good/service for which they have paid for. Since they cannot
exclude others hence they are unwilling to pay, and since no one is willing to pay therefore no one is able
to produce. Some goods may be such which are necessary or desirable to be provided to the society for its
general well-being. The government thus evaluates which goods and in how much quantity can provide
to the society and such goods are then called as public goods. For example, a clean environment, peace,
and harmony in the society, secure borders, protection of natural and cultural heritage, administrative
and regulatory services, etc. There is no exhaustive list of which good is or is not a public good. The
government, based on its utility and its role in social welfare and most importantly its own capability,
evaluates which good or service can be provided by it as a public good. To provide public goods, the
government collects taxes- these are thought of as a general payment that the society makes to the
government in return for its duty to provide for public goods.
Goods on the basis of effects on the society:

 Merit goods: Goods that have a positive effect on society that is are expected to create positive outcomes
through their production and consumption. For example, life-saving drugs, expansion of forest cover, etc.
 Demerit goods: Goods that have harmful effects on society. For example, tobacco, and alcohol- such
goods may increase expenditure on health, reduce the productivity of the workforce, pollute the
environment and even facilitate crime.
Goods on the basis of their position in the production process:

 Intermediate goods: Intermediate goods are those goods that are used as ingredients in the production
process of a final good.
 final goods: A final good is one that lies at the end of the production process and is used by
the consumer either as it is or after some physical or chemical modification. Economically, intermediate
goods are those which are yet to undergo an economic modification that is they will or have already lost
their economic identity. Final goods on the other hand are those which do not undergo any further
economic modification and their economic identity remains intact. For example, salt for household
consumption is a final good as it will no longer be economically modified, although it may be mixed with
other goods and lose its physical identity there would be no further economic modification. Salt purchased
by the restaurant is an intermediate good as it will not be sold as it is rather a dish that consists of many
other ingredients along with salt will be the item for which the consumer pays. The food item is the final
good and its ingredients like salt are intermediate.
Goods on the basis of their role in the production process:

 Final goods are categorised into:
 Consumer goods
 Capital goods
 Consumer goods are further classified into:
 Consumer durables.
 non-durables.
 Capital goods: Capital goods are those final goods that assist in the production process. These are
not ingredients as they are not used as a constituent in the production of a good rather these are the
machines and tools used to assist in the production process.
 Investment: Firms incur expenditure in the procurement of such machines and tools that is capital
goods. This expenditure is commonly called an investment by the firm. Precisely, this is the amount of
capital formation by the firm.
o Investment in economics consists of three components:
1. Gross fixed capital formation- this is the expenditure incurred in the procurement of capital goods.
Normally expenditure to purchase land by the firm is not considered as part of ross fixed capital
formation This is so as no new capital goods are produced, rather an existing factor of production
has changed hands.
2. Changes in inventory: A firm may accumulate inventory in either a planned or unplanned manner
and these goods may or may not be of the nature of capital goods. However, till the time they are not
sold, they are considered investments by the firm.
3. Residential investment: Households by definition are not producers and therefore they do not buy
capital goods. However, Households purchase residential apartments and use them for some time
before selling them off. In this, they may incur a capital gain or a capital loss, hence acting like a
business. This investment is therefore also conventionally treated as part of investment in the
economy. Investment in financial instruments such as shares and bonds is not considered an
investment from economics' perspective. These are financial investments.
Depreciation: Capital goods assist in the production process and are expected to last for multiple production
cycles. However, their ability to assist deteriorates with time and this leads to a loss in value for these goods.
This loss in value is called depreciation. A firm may or may not incur a maintenance expenditure on
these capital goods to retain their productivity. The total investment incurred by a firm in the procurement
of capital goods is called Gross fixed capital formation, commonly gross investment. However, its existing
stock of capital goods will depreciate by a certain amount every year. The depreciation in value in a year is
subtracted from a firm's gross investment to arrive at net investment.
Net investment=gross investment - depreciation
The investment reflects the change in the stock of capital goods. Gross investment is the addition to the stock
of capital goods, whereas depreciation is the loss of value in the existing stock of capital goods.
National income Accounting: Here we will account for that is measure national incomes. An income is
defined as a payment made whenever a factor of production is provided by someone to a producer(firm).
The word national can be interpreted to mean either the country or the citizens of the country irrespective
of wherever they are. Thus, in NIA we measure the sum total of payments made in return for providing factor
of production either in a country or to the citizens of a country.
Factors of production: In order to commence the production process, a few things are essential, these are
called factor of production:
1. Entrepreneurship: A firm does not exist in nature. It is a creation of a natural person. A person assesses
the demand for a certain good/service and takes a decision to produce it. It requires responsibilities such
as gathering resources, and risks such as the risk of failure. This function is called entrepreneurship and
the person is an entrepreneur. In return for the responsibilities and risks, an entrepreneur expects to earn
a profit is thus an income against this factor of production. Technically, profit belongs to the firm and it
is the firm that decides how much profit will be shared with the entrepreneur. The shared profit is called
a dividend.
2. Capital: Money is required to start and carry on a business. A firm gets capital from different sources
and pays interest in return.
3. Land: A place required for the firm to produce goods and services demanded. For land, the firm pays rent
to the land owners.
4. Labour: People are required to work in a firm, the firm pays them wages.
Thus, incomes in an economy comprise of: rents, wages, interests and profits paid in return of land, labour,
capital and Entrepreneurship respectively.
National incomes=Rent+Wage+Profit+Interest.
Measurement of national incomes: Households

demand goods and the firms produce those goods
by utilising the Factor of productions. As such
Households and firms interact with each other in
the goods market as well as the factors market. In
return for the Factor of production, the firm pays
incomes to the Households. From this income, the
Households incur expenditure to purchase the
goods produced by the firm. The firm receives this
expenditure as revenue which it uses again to pay
incomes for Factor of production. As such, the
money keeps on circulating from firms to
Households in form of income, and from
Households to firms in form of expenditure in
return for goods. The circular flow of income
model leads to a conclusion that:
A=B=Incomes(A), Goods(B) Expenditure(C)
i.e. incomes earned in the economy are equal to
the value of goods and services produced and sold,
which in turn are equal to the value of expenditure
incurred by Households or received by the firms in the economy. For example, if a firm uses land, labour, and
capital worth 400 rupees to produce a good and sells it for 500 rupees to the Households, the value of goods

produced in this economy is 500 rupees(B). The firm earns a profit of 100 rupees and therefore the total value
of incomes earned by Households is 400 +100=500 rupees(A). The Households incur an expenditure = the
value of goods sold to them, which is also 500 rupees(C). Therefore, incomes earned, expenditure incurred,
and value, if goods produced, are equal to each other. Therefore, to measure one, it can either be measured
directly or indirectly by measuring others.
Multi-sectoral model of the economy or dynamic equilibrium model: The circular flow of income model
was based on only two sectors and had multiple assumptions such as:
o There are no savings that is incomes=expenditure.
o Production= sale that is there is no inventory, planned or unplanned
o It has no role for the government, which collects taxes and does expenditures.
o There is no financial sector where Households can save their money or from where the firms can
borrow.
o It assumes a close economy that is no imports and exports, etc.
A real-world economy will have multiple complexities and therefore these assumptions need to be dropped
in order to apply the conclusion of A=B=C, from the circular flow model. These assumptions are dropped and
the economy is understood by using the concepts of injections and leakages.
Injections: Anything that leads to an increase in the magnitude of the values, A, B, and C. Specifically,
injections are those inflows of money that lead to the firm's producing more goods, thus requiring
more factors of production, and hence paying more income. This results in more expenditure incurred by the
Households, and therefore again increases the value of goods produced, Factor of production utilised and
incomes earned. Investments, exports, and government expenditure are common examples of injections.
Leakages: Anything that leads to a reduction in the magnitude of values A, B, and C. Commonly, savings,
taxes, and imports are seen as leakages from the economy. Their effect is opposite to that of injections. An
economy will witness different injections and leakages and based on their magnitude the incomes(A), the
value of goods produced(B) and the expenditures received by the firms(C) will keep on changing. A, B and C
will not be equal to each other at any given moment as they would always change due to one or the other
injection/leakage. However, a change in anyone, A, B, or C will set in motion a set of processes or changes to
adjust the value of others to the changed value. Rather than being statically equal to each other at every
moment, A, B, and C will be dynamically equal to each other over a period of time. Therefore, the values of
incomes earned over a period would be equal to the value of goods produced in that period which will be
equal to the value of expenditures received by the firms over that period. Whether the economy will grow in
size or reduce depends on the magnitude of injections and leakages. Injections and leakages are independent
of each other and their relative value keeps on changing and thus the growth in the size/value of the economy.
Measurement of National Income- approaches: Income approach: In this, we directly measure incomes
earned in the economy. This is the direct method of measuring incomes: National income= R+W+P+Int
Expenditure approach: In this, we measure the total expenditure received by the firm in the economy.
Rather than measuring expenditure incurred, we measure what is received by the firms. This is so because
expenditure incurred also includes expenditure on imports(M). This is not received by the firms and hence is
not available to be paid to the domestic Factor of production. Expenditure received by the firms equals the
aggregate demand in the economy.
The economy can be seen to consist of four entities:
1. HH-->consumption expenditure--C
2. Government---->Government expenditure--->G
3. Firms--->Investment expenditure--->I
4. Foreigners---->import expenditure---->X
The total expenditure incurred, thus is C+G+I+X.
Out of this, some expenditure is incurred by Households, firms, and the government on imports(M). Therefore,
the total expenditure received by the firms, which is available to be paid as an income is C+G+I+X-M.
Aggregate demand(AD)=C+G+I+X-M.
The expenditure method measures the aggregate demand in the economy.
Production approach: In this, we measure the value of goods and services produced by the firms in an
economy. To measure we use the concept of GDP. GDP is equal to the total value of final goods and services
produced in an economy in a given time period, usually a year.
Final goods: We count the value of only final goods produced in the economy as their value already consists
of the value of intermediate goods utilised in their production. Counting the intermediate goods' separately
will result in double counting. The Households work for the firms- both final goods as well as intermediate
good producing firms and hence receive incomes from all kinds of firms. However, when they pay for goods,
they pay only for final goods, and from that, the firm pays other firms from which it buys intermediate goods.
Value: The word value may mean the price of a good or service as accessed by a buyer, and hence it may vary
from person to person. While calculating the GDP market price of a good is treated as its value. This means
that only those goods and services which can have a market value will be included while calculating GDP.
Those items for which market value cannot be determined or has not yet being determined will not be a part
of GDP. For example, care given by the parents cannot be valued, similarly, scientific discoveries may not yet
have been valued and therefore these are not includable in GDP.
Produce: Produced that is what has come into existence in the reference time period. Whether something is
sold or not is immaterial. For example, contracts can be made for items to be produced and sold in the future.
Such items are not part of GDP. Similarly, payments can be made for items that were produced in past. The
value of such items will be included in that year's GDP in which they came into existence.
IN: It refers to the territorial boundary of the economy where production takes place. Economic territory
may be different from geographical territory. For example, embassies of a country in a foreign country are
considered to be part of the home country's economic territory. Therefore, services provided for a fee at the
American embassy in Delhi will be considered part of America's GDP. Similarly, production in international
waters by domestic flagged vehicles is included in a country's economic territory. In a given time period, it
simply means that GDP is a flow variable that is it measures the value of production between two points of
time. In India, we usually measure on a quarterly or yearly basis.
Gross National Product: Value of output produced by the nationals of the country. Unlike, GDP which
measures the output in India, GNP measures output produced by Indians that is irrespective of where they
are. GDP=Value of output produced in India= Output produced by Indians in India(A)+ output produced by
foreigners in India(B). GNP= Value of output produced by Indians=output by Indians in India(A)+ output by
Indians outside India(C).
GNP=A+C
GDP=A+B
Therefore, GNP= GDP-B+C
GNP=GDP+(C-B)
GNP=GDP+ (output by Indians abroad-Output by foreigners in India).
Net Factor Income from abroad: Whether GDP or GNP is greater depends on the magnitude of NFIA. IF
NFIA is positive, then GNP is greater otherwise GDP is greater. GNP would be greater if the output produced
by a country's nationals outside the country is greater than the output produced by foreigners producing in
the country. Gross National Income(GNI) has almost completely replaced the usage of the word GNP. This is
so because it is easier and more accurate to measure the incomes of nationals outside the country as
compared to measuring the value of production.

Value added method: In this method we calculate the value of output in an economy by summing up the
value-added by all the producers in the economy, irrespective of whether they are producing final goods or
intermediate goods. The value of a good can be expressed as a sum value added during all the stages of its
production process. value of a final good = Σ value added in all stages of production = Σ VAi. Therefore, the
value of all the final goods and services, which is equal to GDP can be found out by summing up the value-
added during all stages of production with respect to all the goods and services produced in the economy.
GVAi = ΣVAi.
GVA = GDP = ΣGVAi.
The value of a good is equal to the sum of value added during its production process by all the producers.
While calculating GDP, we need to separate the final goods from intermediate goods to avoid double
counting, however, it is impractical to separate them from a producers' point of view. A producer produces
goods and is not bothered with how the goods are utilized. This is especially true in the case of those goods
which can both be consumed by a consumer or used as an ingredient by another good producer. For example,
salt for HH versus salt in a hotel or bread for HH versus bread at a sandwich shop. The value-added method
calculates the value of output by summing up the value-added by all the producers. Since it sums up only the
value-added, and not the entire value, there is no problem with double counting and hence the need to
separate intermediate from final goods is also obligated.
Measuring value at different prices:

Different prices in time: The value of output can be calculated either at the current year's prevailing prices
or the past year's prices. To calculate the GDP, we use the current year's prices only. However, for comparing
the output with the past or to do a longer-term comparison, we chose the past year's prices. This is
called evaluating GDP at constant prices. Ypy=Value of output produced in the present year.
Nominal GDP= Yyp evaluated at present year's prices= Qpy.Ppy= Quantity of present year X prices of the
present year.
Real GDP= Ypy evaluated at past year's prices= Quantity of present year X prices of the past year
When making a two-year comparison, real GDP is calculated using last year's price. To make a longer-term
comparison, we take the base year's price. The base year is a special year in the past whose prices are used
to evaluate subsequent years' GDPs. This allows a long-term view of the health of the economy.
To choose a base year, two important conditions are required:

1. It should be a stable year that is the prices should not be volatile.
2. It should be a year that is structurally similar in its pattern of production to the present year.
Therefore, it should be preferably as close as possible to the present year. GDP deflator=nominal GDP/Real
GDP = (Quantity of current X price of the current year)/ (quantity of last year X Price of last year).
Prices at different points in the market: The households purchase goods at a price called Market price.
The firms receive a value that may be different from what is paid by the households. The value that the firm
receives is what is available to the firm to pay for factors of production. This is called Factor cost. Factor cost
is different from market price because of the government's intervention in form of taxes and subsidies.
Government levies indirect taxes on goods and services, which makes them expensive. Similarly, it pays
subsidies on certain goods and services, making them cheaper for the consumer as compared to the factor
cost of that good. The effect of taxes is to increase the market price, whereas that of subsidies is to reduce it.
Factor cost is calculated by stripping the market price off taxes and subsidies.
Market price= Factor cost +indirect taxes-subsidies.
GDP can be calculated at either of these prices, the relationship is:
GDPMP=GDPFC+indirect taxes-subsidies
The concept of basic price: Factor cost refers to the cost attributable to the factors of production. To arrive
at factor cost from market price, we remove the effect of the taxes and subsidies given by the government on
that item. To be more precise that is to arrive at true factor cost, we need to remove the effect of not just the
product taxes and subsidies, but also the effect of various production level taxes and subsidies (T and S). The

product T and S are what is given on the product, whereas, production T and S include all T and S given
during the production process.
We arrive at the factor cost in two steps:
 From market price to basic price:
BP=MP- Product taxes+subsidies.
The basic price is defined as the price of the product at the factory gate that is just before it goes out of
the production process and is consumed.
 From Basic price to Factor cost:
Basic price=Factor cost+Production Taxes-Production subsidies. Combining both the equations.
Therefore, Factor cost= Market Price-Product taxes+Product Subsidies-Production taxes+Production
subsidies. Therefore, GDP at market price=GDP = GVA at market price = GVA at basic price+Product
Taxes-Product subsidies. GDP= GVA+ Product Taxes-Product subsidies. GDP is by default conveyed
at market prices.
GDP estimation in India: The process of GDP estimation comprises the following broad steps:
1. Define what will be counted as production in the economy.
2. Construct a sample in such a manner that represents the structure of the economy as closely as possible.
This means the representation of various sectors should be proportional and so should be the type of
firms, the nature of goods that they produce, etc.
3. From the firms in the sample, collect the output information.
4. From this information estimate the output of the economy by extrapolating it to the entire economy.
Before 2015, the primary sample is use was Annual Survey Industry, which had 20000 firms. Output
information was collected and it was extrapolated to calculate the output of the entire economy. The
production method was used. In 2015, changes were introduced and now the MCA21 database became the
primary source of information. Firms register themselves with the Ministry of Corporate Affairs and are
required to file information regarding their costs and revenues regularly. This gives access to "value-added"
by the firms to the government. From this value-added, the government estimates the value added by all the
firms in the economy. The process of estimation requires many assumptions, and therefore even a small
change may lead to over or underestimation of the size of the economy. This also causes a loss of credibility if
the assumption is such that they looked biased in some direction. To overcome this, so that a fair comparison
of the sizes of economies is possible, the UN and IMF have developed the National System of Accounts, 2008.
India's methodology of GDP estimation is fully compliant with it.
Drawback of GDP estimation: GDP is the value of all the goods and services produced in the country and
hence, it is also equal to the value of incomes earned in the country. As such per capita income, which is equal
to GDP/population is a commonly used metric to comment on a country's well-being. It is generally seen that
the countries with higher per capita income have better performance on different aspects of well-being.
However, it is not always so. It can be seen in the context of GDP's limitations:
o GDP valued at market price can be increased by simply increasing taxes or reducing subsidies.
o GDP is an aggregate measure that is it sums up the total production. It is indifferent to the distribution
of factors of production, or incomes, as well as indifferent to the nature of goods produced. An
economy's output can be high even when incomes and Factor of production are concentrated. Similarly,
an economy producing demerit goods, or producing output through environmental destruction may have
a higher GDP.
o Calculation of GDP in economies with a large informal sector, or where there is a large black economy, is
inaccurate. Usually, the size of the economy will be underestimated. Non- Monetary exchanges such
as barter exchanges, and non-valued exchanges cannot be accounted for in GDP and hence it may even
not accurately reflect the incomes or expenditures in the economy. Despite all its limitations, GDP is the
most dependent, the most accurate, and hence the most used measure of economic output and a reflector
of general well-being.

This is so because amongst all the alternates GDP is most accurately measured, has the least subjectivity,
is available in a timely manner, is mostly standardized, and therefore allows for the fairest comparison
across countries.
Refined measures of National Income:

o National Income=NNP at factor cost=NNP at Market price-taxes+subsidies.
o GNP at market price-depreciation-indirect taxes+subsidies
o Per capita income= GDP/population.
o Personal income= income of Households.
o PI= National income - incomes retained or not given by the government and businesses to Households.
PI=NI - (Undistributed profit+net interest payments BY Households+corporate taxes) + (transfer
payments to the Households by the government and businesses).
o Personal Disposable Income=PI-Personal taxes. Personal taxes are taxes paid by the Households on
their income.
Transfer payment: A transfer payment is the transfer of the right to send. It is not an income. For example,
if government transfers money to the Households as an income support measure, it is an example of transfer
payment. Similarly, bonuses paid by the firms
Current transfer- This term is used to signify transfer payments from the rest of the world to a country. For
example, remittances received by Indians from abroad. Transfer payments by themselves are not counted
separately in the GDP or GNP of a country. However, once they are received, they are expected to be eventually
spent, and therefore they will eventually contribute to increases in GDP. They can be looked at as injections-
When government transfers, then government incurs an expenditure, when there are current transfers from
the rest of the world, it increases the money available in the economy to be spent.
Relationship between savings and investment:

Total incomes earned= R+W+P+Int (……1) = total expenditure=C+G+I+X-M (…….2)
Looking at incomes from their usage side, they can either be consumed, saved, or taxed. Therefore, total
incomes= C+S+T (......3). From equation 1, 2 and 3, C+G+I+(X-M) = C+S+T
Assuming a closed economy that is X and M=0, and a balanced budget that is G=T, the above equation reduces
to S=I. It's not important that savings and investments are equal, rather that there is a relationship between
savings, which is the decision of a household, and investments which is a firm's decision. Savings influence
investments. This is seen in two ways:
1. More savings mean more money in the economy and therefore the cost of money that is interest rates is
less. At lesser interest rates, firms are able to borrow at a lower cost, and hence we would expect greater
investments.
2. With more savings, the firms will have a lesser requirement of expansion and thus investment, because
their current capacity of production should be sufficient to meet the demands of the economy.
Therefore, more savings mean lesser willingness of the firms to borrow and invest.
There is a push and pull relationship between S and I. Savings at an adequate level will incentivize
investments but beyond a certain level may be rather discouraging for firms to invest.
Incremental Capital Output Ratio:

ICOR = Capital requires to increasing output by one unit. It is incremental capital/output. Lower ICOR
means a lesser amount of capital or investment is required to increase output by one unit.

Inflation
Inflation is a general rise in the price level. Price level refers to a mental reference point that a specific set of
people may have regarding prices in the economy. For example, the average monthly consumption-
expenditure. If a Household spends 30000 rupees per month and in recent times its expenditure has gone up,
then its reference point regarding prices in the economy would have shifted forward and inflation would have
been said to have occurred. Inflation is not the rise of the price of one good or a few goods. However, if the
price of even one good changes to the extent that the overall consumption-expenditure increases, then
inflation would still have been said to occur.
Price: refers to the value of a good in terms of a measuring unit. The measuring unit can be another good or
some currency used to facilitate exchanges.
The price of the good has two parts: Its own demand and supply and the demand and supply of the
measuring unit. The price of a good can increase if there is a change in demand and supply of the good itself
or of the measuring unit.
Reasons for change in price:

 Demand-pull inflation: Factors that lead to an increase in demand: Increase in income, changing tastes
and preferences, rising population, etc.
 Cost-push inflation: Factors that lead to a reduction in supply: For example, constrain in the availability
of raw materials or factors of production, increase in their cost, government policies such as business,
environment, and labour, poor infrastructure, etc. The reasons which lead to an increase in prices of
goods can also be extended as causes or factors of inflation. Anything that causes an increase
in aggregate demand would be a demand-side factor which is demand-pull inflation. Anything that
causes a reduction in aggregate supply that is the total output of the economy, will be a supply-side factor
or a cost-push cause of inflation.
 Cartelization: A cartel refers to a group of producers coming together and behaving in a monopolistic
manner rather than competing with each other. As a result, this leads to higher prices for goods due to
unrestricted profits which can be made in a monopolistic environment. For example, cement producers
come together to sell it at a higher than fair price due to cartelization.
 International factors: These include factors such as geopolitical relationships between countries,
tensions leading to difficulty in international movements, or broadly factors that result in disruption of
supplies due to sanctions or domestic political considerations. These factors result in non-
availability despite there being a supply and hence lead to inflation. These also include decisions of
monetary policy of one country affecting the value of the currency of another country, making the cost of
imports higher than usual (Refer to the impact of federal reserve’s monetary policy on rupee).
Some important terms:

 Hyperinflation: Very high or intolerable rate of inflation.
 structural inflation: Inflation is due to factors that are slow to be addressed that is factors that have a
persistent character. For example, slower decision-making in the administration, poor infrastructure, etc.
 Skew inflation: When inflation is because of a small set of goods or services. In this, there is a general
rise in prices, but it is largely attributable to only a few goods and services.
 Headline inflation: Inflation number is commonly reported as it is important for policy making.
Presently Consumer Price Index is our headline measure.
 Deflation: It is a fall in prices that is a negative rate of inflation
 Disinflation: It is a fall in the rate of inflation.
 Prices still rise, albeit at a slower pace.
 Recession: Contraction in the output of the economy for two consecutive quarters.
 Depression: A severe or prolonged recession. There are no time criteria.
 Shrinkflation: A reduction in quantity which you get at the same price is shrinkage of packet size.
1. Core inflation: It refers to the change in prices of items in the headline inflation basket of goods whose
prices are non-volatile. Food and fuel items have volatile prices such as due to: geopolitical factors,
Natural calamities, etc. These items are removed and the prices of the remaining baskets are tracked
through core inflation. Automotive fuels such as petrol and diesel are a part of the miscellaneous group
of items in the headline inflation basket. They are not a part of the fuel basket. Hence, the core inflation,
at present does not represent a truly non-volatile basket of goods and services. It has been proposed that
such items be also removed to arrive at a better, more refined measure of core inflation.
2. Stagflation: It is a situation of stagnation of an economy along with high or rising inflation. Merely one
of the two without the other would not be characterized as stagflation. When an economy stagnates, it
creates less number of jobs as compared to the number of people entering the labour force. Therefore,
unemployment rises. When this rise in unemployment is surprisingly accompanied by high inflation, then
it is called stagflation. As was seen in the Phillips curve, inflation and unemployment have an inverse
relationship, especially in the short term. If unemployment decreases, we expect a rise in prices, if
unemployment increases, we expect a fall in prices. However, during stagflation, both inflation and
unemployment are high and therefore at an undesirable level. Therefore, addressing one will further
worsen the other. Therefore, during such times policy-making is highly uncertain and hence this
situation is difficult to address.
Measurement of inflation: Measurement consist of the following steps:

o Choosing the target group for which inflation has to be measured such as CPI- C(Combined)
measures changes in prices for an ordinary consumer, CPI-R(Rural) measures changes in prices for a
rural consumer. WPI tracks changes in prices at the wholesale market level, etc.
o For the identified group, construct a relevant basket of goods and services (if required).
o For the base year, that is each month in the base year, collect the price information for the basket from
the relevant market.
o Indexing: Index the prices for all months in the base year to a common number, usually 100.
For the subsequent years, inflation is measured by collecting the prices of the items in the monthly basket for
the month from the relevant market. Inflation is the percentage change in price. The index value is also
updated for the relevant month and year, and inflation can also be conveyed by simply stating the value of
the index. CPI - C, CPI-U, and CPI-R are released by CSO. WPI is released by the Office of Economic adviser,
DIPP (Department of Industrial Policy and Promotion). PPI has been proposed which will measure inflation
at the producer level. Input PPI for inflation in inputs used, and output PPI for inflation at the output
produced level. In the 2017 revision of WPI, it was adjusted to bring it closer to the prices at the producer
level. This was done by removing taxes from the prices used to calculate WPI.
Effects of the inflation:

o On Consumers and producers: Consumers are worse of due to inflation as the money in the pocket
deteriorates in value- it loses its buying power. Therefore, consumers become poorer in real terms
because of inflation. Producers generally benefit. A higher price gives an incentive as it is more profitable
to produce. Further, it is especially beneficial for those producers who have higher pricing power which
is the ability to transfer the increased prices to the consumers. In the economy, we say that a low and
stable rate of inflation is generally desirable. A low rate is incentivizing to the producer and is tolerable
for the consumer (that is the consumer does not reduce his consumption to a significant extent). A stable
rate is desirable as volatility is a hindrance to planning and leads to poor decisions or indecision for both
consumers and producers.
o Borrowers and lenders: Money loses value with time due to inflation. The present value of money would
be far less than what its value was in past. Because inflation would have increased the prices of goods,
thus making money insufficient to buy the same amount of goods as it could have in the past. In
borrowing-lending transactions, the lender receives the principal amount along with the interest at the
time of maturity, or in instalments during that period. The borrower returns the value that was borrowed,
and not the present value of that amount. Which would have been higher because of inflation. As such, if
inflation is high, the money returned would be lesser in real terms as its present value would be much
higher as compared to what was returned. Hence, the borrower benefits in real terms if inflation is high.
Real Interest Rate = Nominal Interest Rate – Rate of inflation. If inflation is high, real interest received,
or paid would be lower, and hence, the lender will lose out and the borrower will gain. To shield oneself
from the negative effects of inflation, the lender will either charge a high NIR (Nominal Interest Rate) or
anchor the NIR to a fixed RIR (Real Interest Rate). NIR would then be the fixed RIR+ the rate of inflation.
3. Effect on depositors/savers and investors: Depositors are like lenders, and therefore they lose out
because of inflation. The effect is more pronounced for those who are dependent on interest incomes from
their savings. These are usually the senior citizens who survive on interest income, but the incomes
become deficient due to high inflation.
4. Effect on investments:
o Investments and interests rates: Investment decision depends on the cost of borrowing (that is the
interest rates) and the expected return that the investor expects from the investment. The expected return
could be based on rational calculations or merely intuition. IT is difficult to quantify, and hence it is
assumed to be outside the scope of economic modelling. We simply expect that if the cost of borrowing is
high, given constant expectations, less number of borrowers would expect to generate a return more than
the cost of borrowing, as compared to when the cost of borrowing would have been less. Therefore, we
say that given other factors as constant, investment varies inversely with interest rates.
o Inflation and interest rates: When inflation is high, we expect interest rates to be also high. The lenders
charge higher interests to shield themselves from inflation. Therefore, higher inflation leads to higher
interest rates, which discourage investments. In a high inflation economy, investments are usually low
(given other factors as constant).
5. Effect of inflation on government and taxpayer:

o Fiscal Drag: Most of economies have a progressive system of taxation which is the proportion of income
that a person pays as taxes increases with an increase in income. During inflation workers negotiate for
higher wages, which results in the firms passing on the increased cost to the economy. This pushes the
prices up, hence leading to another round of demand for an increase in wages. This is called the Price-
wage spiral. It may happen that workers despite receiving an increment equal to the rate of inflation, are
still poorer in real terms. This is because with an increment they may be pushed into a higher tax bracket,
and therefore pay a greater proportion of their increment in taxes, rather than receiving it themselves.
The government collects more taxes than it what it would normally have collected. The taxpayer ends up
paying more taxes than what would be normally paid. This phenomenon is called fiscal drag. It acts as
an automatic stabilizer. With a rise in prices, workers demand higher wages. With the increase in wages,
they pay more proportion of their income as taxes, and hence they are relatively worse off than before
inflation. As a consequence, they reduce their consumption, leading to a lowering of the total demand in
the economy. This eventually leads to a cooling off of prices. Hence, the automatic stabiliser.
Controlling inflation: The idea is to control prices by identifying the reason which has led to inflation.
Supply-side reasons would need supply-side solutions which are resource-intensive and time-consuming.
Inflation affects the person/economy today that is in present. Supply-side reasons are expected to produce
solutions in the long term only. Hence, most commonly inflation is addressed through demand-side reasons
that is by controlling the demand for goods and services in the economy. Even amongst the demand-side
factors, the most effective and acceptable way is to increase the cost of money to discourage people to spend
it, Increasing the cost means lesser capability and willingness to borrow, and hence lesser expenditure. This
reduces the aggregate demand and helps bring down the prices. The most effective way of increasing the cost
of money is through the conduct of monetary policy.

Money supply and monetary policy
Money is commonly defined as the medium of exchange. This means that it should be such that it can
facilitate economic exchanges between people in general. For something to facilitate such exchanges it should
have the following properties:
o It should always be demanded: Any item to be used as a facilitator of exchanges should be such that the
seller of the good always demands it. In earlier times, it was those goods that had an intrinsic value that
is goods that were thought to possess desirability or utility all the time. For example, gold. In modern
times the value can also be by order of an authority. The authority having the power to enforce such an
order is usually the monetary authority of the country, which is the country's central bank. For example,
RBI. The monetary authority issues currency which is also called fiat money- something which has value
by order. The currency is also called legal tender- It is something that cannot be refused as a means of
repayment of debt.
o To be used as a medium of exchange, the entity should be usable as a store of wealth that is it should be
usable not just today but also in the future if stored today. For this, it must be easily storable and should
not lose value with time.
o It should be an entity whose quality can be assured. For this, it must be such that it is non-
counterfeitable and the authority responsible for creating/issuing must ensure of its quality that is its
value.
o It should be such that it must be able to designate the value of a large number of goods and services. It
must be divisible into smaller units to value low-value goods, or additive to value high-value goods.
Further, it should be usable as a unit of account so that a record of total values bought and sold could be
maintained.
Modern money- currency: Money is not merely the currency notes that are printed by the central bank or
any other authority. Money is introduced into the economy by the authority when it buys something from the
economy and then it forces the seller to accept the entity which it wants to use it as money. Modern money
has evolved from gold (gold coins) to gold standard (gold-backed currency) to a modern multi-asset-backed
currency. For most of history, gold was money. However, as the economy grew in size and a larger number of
goods needed to be exchanged, gold became scares and hence was unable to fulfill its role as money. Instead
of gold, gold-backed promises were introduced to be as currency. Still, the number of promises, even if they
could be issued in lower denominations (such as 1 dollar = I gm of gold), proved to be a limitation as the
transactions could not be carried out due to gold scarcity. As a result, a new asset was required apart from
gold which could be used to create money without compromising the trust of the people in the currency that
is the promises. This new asset was the government bond. It is a promise by the government to return the
money it has borrowed along with the interest in the given time period. This promise is assumed to be
inviolable. The authority to issue currency was separated from the government. Thus, modern central banks
came into existence. The central banks would create money (that is the pieces of paper promising to be
exchanged for a face value written on them), against the assets that it would acquire. For example, the central
bank would acquire gold and print and inject money into the economy against this acquired asset. Further,
the government would print the government bonds which are its promises (inviolable), and the central bank
would purchase these government bonds using the currency that it prints. Modern Currency is thus a promise
against another promise. The currency system is ultimately based on trust- trust in the RBI’s ability to fulfill
its promise written on the currency note which is based on the trust in the government’s promise written on
the government bond.
RBI's balance sheet:

Assets Liabilities
What RBI has or owns What RBI owes
Gold Currency in circulation

Government bonds including foreign government Deposits of banks and government with
bonds RBI
Any other money lent by RBI to governments or to the
Lending by banks or government to RBI
banks
Forex reserves held by RBI
Deposits or cash that RBI holds with the banks
Mo-Total liabilities of RBI (AKA high-powered money or monetary base). RBI creates currency through
the acquisition of assets. A currency note is a promise by RBI and hence signifies RBI's liability. Closely looking
at RBI's balance sheet, we observe that its assets are either appreciating in value or interest-bearing in
nature. Its liabilities, on the other hand, are either zero cost or very low cost. for example, a hundred rupees
note issued in 1980 would still denote a liability of 100 rupees, whereas gold acquired against that currency
note would be much more than worth 100 rupees today. RBI earns profits on its operations because of the
nature of the functions that it performs. Profits are not intentional but accidental. They can be thought of as
the cost that the economy pays to RBI to perform its role as monetary authority effectively. From its profits,
RBI meets all its costs such as salary to its staff, maintenance and operational cost, cost of printing and
storing currency notes, etc. The net profit of RBI is called seigniorage. This profit is usually transferred to the
government, in 2016, the government constituted the Bimal Jalan committee which recommended about the
proportion of these profits to be retained by RBI and transferred to the government. The committee
recommended Economic Capital Framework for RBI to evaluate how much of the profits may be realized and
retained, and how much to be transferred. The RBI adopted ECF, and since then entire money in surplus of
what ECF suggests is transferred by RBI to the government automatically.
Cost of money:
Demand and supply of money.
The demand of money: Money is demanded primarily for two purposes:
o Transaction motive.
o Speculative motive.
o Transaction motive: This is the original purpose for which money was created which is to carry out
transactions. It also includes people's demand for money for precautionary purposes. The transaction
demand (Mtd) is the amount of money needed to carry out transactions in the economy. MDT is directly
proportional to the price level in the economy and the volume of transactions. M td ∝ p.t Further, Mtd is
inversely proportional to the velocity of money in the economy. Velocity(v) refers to the number of
times money changes hands in a given time period. For example, if on
average, a currency notes worth rupees 100 is used five times in a month, Mtd ∝ P.Y
then it can carry out transactions worth rupees 500. Here, 5 is the velocity Also, Mtd ∝ P.Y/v
of money. In an economy, the volume of transactions(T) would be directly Therefore,
proportional to the incomes of the people or the output of the economy that Mtd =(k/v) P.Y
is Y. Therefore, transaction demand will be directly proportional to prices Let k/v= 1/vo
and the level of output that is P and Y. Therefore, vo. Mtd =P. Y
Velocity: Velocity of money is the behavioural parameter that is it depends on the habits of the people
and infrastructure facilitating payment in the economy. If people generally spend money then the velocity
would be higher and hence lesser amount will be required to satisfy the transaction of the demand. The
ease of making payments such as the payments infrastructure also influences velocity. Further, seasons
such as the festive season also influence the rate at which people spend money. Velocity is not something
that can be controlled by the country's monetary authority. It is considered autonomous and hence
assumed to be constant.

Mtd ∝ P.Y/v. P.Y represents the level of nominal GDP of the country. Therefore, transaction demand,
assuming an autonomous velocity is a direct function of nominal GDP. Mtd∝ Nominal GDP
o Speculative demand: A person certain amount of money, M with him, and out of that he may need some
to carry out transactions and the remaining would be the excess amount. The decision with respect to
this excess amount is what gives rise to the speculative demand of money. Keeping this excess as cash
gives the benefit of liquidity. However, the money deteriorates because of inflation if it is not used.
Converting this excess money into an asset with an expectation to generate some return probably shields
the person from inflationary deterioration, but it compromises liquidity. The return earned on the money
converted to an asset would be the opportunity cost of keeping money in liquid form. The decision to
convert this excess amount into an asset thus depends on the expectation regarding the direction of the
value of the asset in the future. If a person expects assets' value to rise, then this excess amount would be
converted into the asset, and hence the liquid component would be less. The liquid component of the
excess amount is called the speculative demand of money. If the person expects asset prices to fall, then
the excess amount would be retained in liquid form and hence the speculative component would be high.
Therefore, we can say that speculative demand depends on the expectations the direction of an asset's
price. If asset prices are expected to increase then speculative demand would be low and vice versa.
Asset prices: Asset prices reflect their relative attractiveness with respect to other avenues of keeping
money. For example, if a government bond(asset) offers a rate of interest of 10 % and a savings bank account
offers a rate of 5% then the government bond has a relative attractiveness. This government bond is available
only in limited quantity, and therefore people would be willing to pay a premium to acquire this asset. At
equilibrium, the price of this asset will rise to a level where the yield (effective return) on this asset is equal
to the yield from the alternate avenue that is the savings bank account in this case. At any given moment any
asset price would reflect its relative attractiveness over any other avenue. People expect to generate returns
from the assets not from the interest earned but from an expected change in their value. The value of the
asset is determined by its relative attractiveness. The asset has a promised fixed interest rate. The interest
rate outside the asset that is a general risk-free interest rate in the market varies. If this interest increases,
the asset will become relatively less attractive, and hence lose its value. If the interest rate decreases, then the
asset will become relatively more attractive and hence gain value. Therefore, people's decision to buy or hold
or not-buy or sell depends upon the expectations they have with respect to interest rates. If they expect
interest rates to fall therefore they will buy assets or hold onto the existing assets. Hence, the speculative
component would be low and vice versa.
Speculative demand and Rate of interest:
The above chart represents the decision-making process of an individual. Based on their view about the
present interest rate, different individuals will have different expectations about asset prices, and therefore
will take different decisions. At the economy-wide level, these differences in expectations, will produce
certain speculative demand for money. When the interest rates(r) are generally high, more people expect
that they will fall, and hence expect asset prices to rise. As such they would convert their money into assets,
reducing the speculative demand for money. at r=rmax (the rate of interest at which everybody expects it to
be the highest, hence it can only fall), everybody would expect interest rates to fall and thus asset prices to

rise. therefore, the speculative demand would be zero. at r=rmin
(the rate of interest at which everybody expects it to be the
minimum, below which it cannot fall), everybody would expect
interest rates to rise and thus asset prices to fall. Therefore, the
Speculative demand will be very high.
Msd ∝(1/r)
Msd ∝(-r)
Total Demand for money: Md= Transaction demand+ Speculative demand. Md= Mtd + Msd.
Supply of money: Money supply refers to the amount of money present in the economy. Money supply is
created primarily by the RBI, and also by the country's banking system. The money created by the banking
system is also largely controlled by RBI, and hence we say that RBI determines money supply to a very large
extent. The decision of RBI regarding money supply is based on the two objectives:
1. To facilitate growth
2. To control prices
More money is expected to facilitate growth
but cause a worsening of prices as such there
is a growth-inflation trade-off. RBI's decisions
are not taken with an intention of earning
profits that is RBI does not create more money
because interest rates because interest rates
are high rather the interest are determined by
RBI's decision with respect to the money
supply. And RBI's decision regarding money
supply depends on its objective of facilitating
growth and controlling prices.
Measures of money supply:
Ms=m.M°
Ms= Money supply
m=Money Multiplier
Money in the economy is created first by RBI(M°) and then the banking system multiplies it through its credit
creation process. To measure money in the economy, we have four standard measures - M1, M2, M3 and M4.

M° High powered money
M1 CC+DD
M2 M1+PO DD
M3 M1+ time deposits with bank
M4 M3+ deposits of PO
CC is Currency in Circulation (Cash and coins) DD- Demand Deposits with the banking system that is money
available on demand. It includes only the net deposits that is does not include the interbank deposits.
Time deposits: This is the money available only at certain points in time such as Fixed deposits and recurring
deposits with the bank. Deposits with the post office in M4 include demand with time deposits and some other
similar deposits. It does not include certain small savings schemes by post offices such as KVP (Kisan Vikas
Patra), and IVP (Indira Vikas Patra)- These are considered illiquid- long-term assets.
Money Creation by the banking system: Ms =m.M0

The banking system takes the high-powered money created by RBI and through its operations of receiving
deposits and lending them, multiplies this initial high-powered money to a higher amount.
The process is as follows:

 RBI buys assets and issues high-powered money in return by printing them. RBI normally deals only with
designated agencies known as primary dealers.
 The person retains some part with himself as cash and deposits the remaining with the bank.
 The bank assesses the requirement that it may face with the respect to the demand for such deposits. It
sets aside certain reserves, and the remaining money is used for lending.
 The money is lent and therefore spent to purchase goods or services. The seller receives this money as his
own money, as it has been used to carry out a transaction. As such the money supply(CC+DD) in the
economy has gone up by this amount. It now consists of currency with the first person, the deposits of the
first person, and the money received by this last person(P3).
 P3 again deposits money, and the bank sets aside reserves and lends(P4) the remaining part. This money
is spent and therefore received as his own money by the seller in this transaction(P5).
 The money supply now consists of the previous money supply (that is in point number 4), and new money
with P5.
 This process of receiving deposits, setting aside reserves, lending, spending, and depositing some
proportion out of the money received continues at Infinitum.
However, the additional amount of money created in each round is less than the previous round.
Eventually the process comes to a halt, and then we can measure the total amount of money present in
the economy.
Ms =m.M0
Money multiplier, m is the factor by which the high-powered money is amplified by to create the actual
amount of money in the economy.
Money multiplier depends on two essential factors:

Reserve deposit ratio(rdr): It is the proportion of deposits that banks have to set aside as reserves.
rdr=(reserves/deposits)
Banks lend deposits and earn interest on them. If they have to set aside reserves, it reduces their lending
capability. On the other hand, lending involves risk- the risk which ultimately the depositor will have to bear
in case the lent money is not received back. As such there might be a situation of a bank run. Bank run is the
situation where people lose trust in the banks' ability to honour their demands. As a result, they run to the
banks to withdraw their deposits. And since the banks no longer have those deposits, it creates chaos and
ultimately collapse of the financial system. In order to prevent this, RBI regulates the banks and directs them
to set aside a certain proportion of their deposits as reserves. This is what is rdr.
The currency deposit ratio(cdr):

cdr=currency/deposits
It is the ratio of money kept with people in currency form vis-a-vis money kept with them in deposits form.
cdr is people's preference for cash as compared to deposits. If a person has 1000 rupees kept as 400 rupees
cash and 600 as deposits, cdr is 400/600. cdr is a behavioural parameter that is its value depends on how
preferentially the society treats cash as compared to deposits. For example, cdr may be influenced by:
 Payments infrastructure in the country- if digital payments are easily facilitated then people may
prefer to keep money in form of deposits rather than cash.
 Season of the year- during the festive season people prefer to keep cash.
 Limits by the government on holding cash freely etc.
Since cdr is the behavioural aspect, we do not consider that the monitoring authority can significantly affect
it. Therefore, it is assumed to be autonomous.
M inversely proportion to 1/rdr
M inversely proportion to 1/cdr
The banks' ability to multiply M0 will be adversely affected if they have to set aside more reserves or if people
do not prefer to deposit money with them.
Tools of monetary policy:

Objective- The conduct of monetary policy is done in pursuit of the objectives of growth and inflation. More
money facilitates growth but causes inflation. Less money controls inflation but causes contraction in growth.
RBI controls the money supply in pursuit of these objectives- facilitation and controlling prices. Monetary
policy is the control of money supply which RBI does to achieve the objectives of growth and inflation.
The tools of monetary policy are classified into:

Quantitative and Qualitative tools: Quantitative are those whose effect on money supply can be
precisely quantified, whereas for Qualitative tools it is difficult to calculate their precise effect.
Qualitative tools- Moral Suasion, Selective credit controls, etc. (Self)
Quantitative tools:
1. tools directly affecting money multiplier(m):
 CRR: The proportion of banks' NDTL which they have to maintain in form of cash with RBI.
It is the proportion of banks' NDTL that is total Demand and Time liabilities less the interbank deposits.
It is maintained with RBI. In form of cash. Does not earn any interest for the bank.
 SLR: Banks have to maintain a certain proportion of their NDTL in form of designated liquid assets. This
is the banks' SLR.
The assets which have been designated are: Gold, Government Bonds, Designated Foreign Government Bonds,
Designated corporate bonds, cash, etc. Keeping money in form of CRR, does not earn any interest for the bank.
On the other hand, a low CRR may not be adequate to shield the financial system in case of loss of trust of the
people or in general when the banks' financial condition is poor. SLR acts as the midway between the banks'
regulatory requirement to protect depositors' money, and its need to earn returns on the deposits. RBI has
thus asked the banks to keep a certain proportion of their NDTL in such assets which can be easily liquidated.
These are designated as such by law.
Tools directly affecting M0:

Open market operations(OMOs): RBI indulges in buying and selling assets in the open market. When RBI
buys assets, it issues currency in return that is money is created. When RBI sells assets, it takes the money
back from the market, and thus extinguishing its liability. therefore, M 0 increases when RBI buys assets and

decreases when RBI sells them. RBI normally buys or sells assets from or to primary dealers. However, during
OMOs it can engage in a general buying or selling from or to anybody in the market. Government Security
acquisition program and retail direct scheme.
Tools that affect both M and Mo-LAF & MSF:
Liquidity Adjustment Facility: RBI performs multiple functions such as it acts as a banker to the banks as
well as to the governments, it acts as a lender of last resort,
it carries out debt management operations for the government, it is responsible for the maintenance
of payments and settlement systems in the country, etc. Under the LAF, RBI lends or borrows, as required to
or from the banks respectively for a very short duration to tie over temporary mismatches of liquidity:
o A bank may face liquidity mismatch- either access of deposits over the demand for credit or vice versa
that is excessive demand for credit as compared to the deposits with it.
o In such a case the bank has multiple options to correct this mismatch. For example, if there is excessive
demand for credit over the available deposits, the bank can solicit more deposits, borrow money from
other banks, issue bonds and borrow money from the market, etc. It can also approach RBI and borrow
money on a temporary basis to correct its liquidity mismatch.
o RBI lends money to the bank on a completely secure basis and charges a rate of interest called the repo
rate.
o Technically in this operation, the banks sell their G-Sec to RBI, which prints money in return and gives it
to the bank. Simultaneously, the bank undertakes to repurchase this security within the maximum period
of 15 days. On this entire operation, RBI charges the Repo rate from the bank.
Repo rate: It is the rate of interest charged by the RBI while lending money to the banks for a short duration.
The money lent is fully secured that is it is created by buying government bonds from the banks. An increase
in repo rate increase the cost of funds for the borrower and hence the demand for money at a higher rate
would be less. Less money is lent, spent, and so on. Therefore, the money multiplier will reduce.
An increase in repo rate, therefore, reduces the money supply. On the other hand, an increase in the reverse
repo rate affects the money supply in the following manner:
(the students are supposed to write themselves)
Marginal standing Facility (MSF): RBI lends to banks under the LAF on a completely secure basis.
Therefore, the banks need G-sec in order to borrow, and they can borrow an amount equivalent to the value
of G-sec only. The banks maintain SLR mostly in form of G-sec as it is a secure easily liquid table and yields a
decent return. Over and above these holdings of G-sec, banks can also have extra holdings. These are banks'
ways of minimizing risk on their lending/investment. The borrowing under LAF is using these G-sec only-
Those G-sec which banks hold in excess of their SLR. If banks exhaust this excess supply of SLR, and still there
is a demand for loans, they would still face a liquidity mismatch. In order to correct this RBI allows banks to
borrow by using some G-sec from their SLR. Usually, the banks are allowed to violate their SLR commitments
by up to a maximum of 1% points. The G-sec freed up in return can then be used to borrow from RBI. Since
the bank would be violating the SLR commitments to avail of this borrowing, RBI imposes a penalty in form
of charging a high rate of interest on this lending. This is usually a 1%age point higher than the repo rate
and is called as MSF rate.
Policy corridor: It is the difference between the repo rate (RR) and the reverse repo (RRR) or the MSF rate.
RRR is usually lesser than RR by this number, and MSF is greater than RR by this number.
Bank rate: It was the rate at which RBI used to lend to the banks for a long term.
Since RBI no longer lends to the banks for the long term, the bank rate is not dormant. It is aligned in its value
to the MSF rate.
Long-term repo (LTRO): During COVID RBI started lending to banks for a relatively longer term in pursuit
of its efforts to maintain liquidity in the system. This lending was done at a long-term (up to 3 years) repo
rate (max. fortnight).

Variable Reverse Repo Rate (VRRR) & Standing deposit facility (SDF): Under RRR, RBI borrows from
banks on a secured basis i.e. using G-sec, this means that RBI's ability to borrow from banks also depends
upon the G-sec the RBI has, during COVID the banks may have had access liquidity, and RBI may have only
limited G-sec.
There were two steps that RBI took-
o Standing deposit facility: under it RBI allows the banks to deposit money with RBI and earn interest on
it. Therefore, the need for repurchasing government securities does not arise as it is a deposit, not a
lending/borrowing.
o Variable Reverse Repo Rate: In order to limit banks to lend money to RBI, RBI conducts variable RRR
auctions. Under this, the bank which quotes the least rate of interest to lend money to RBI is allowed to
lend money to RBI. The banks earned lesser interest rates while lending to RBI. Hence, they would rather
prefer to lend outside.
Conduct of Monetary Policy:

Growth Inflation Monetary Policy Decisions/conduct. Expected consequence
Maintain status quo
High low
(neutral monetary policy).
Expect improvement in growth due to
Increase money supply (Expansionary more availability of money and ease of
monetary policy), also called having a spending it. Also, expect an increase in
Low Low
dovish stance. Example- reduce prices. Expansion. therefore, only up to
RR/CRR/SLR etc. an extent that prices are within the
tolerance range.
Expect prices to cool down, but also
Decrease money supply (MS), i.e.
expect growth to suffer. Therefore,
contractionary monetary policy
High High contraction in MS should only be up to
hawkish stance. Example increase
the extent that unemployment does not
RR/CR/SLR.
rise beyond the tolerance range.
Stagflation is a situation of policy One way or the other there would be
uncertainty, the decision is based on adverse consequences as such they are
Low High
identifying the underline cause, and the minimized through close coordination of
ability of the Central to addressing it. monetary and fiscal policy.
Stagflation: If inflation is attributable to an expansionary monetary policy. Then a contractionary money

policy may be pursued. However, if high inflation is not due to excess money supply, then the choice of policy
is even more difficult. On one hand, cutting done money supply is one of the most effective ways to bring down
the prices. On the other hand, if it is not the cause of high prices, then cutting it down may further jeopardize
growth much more than it already is. As a result, the monetary authority and the government assign
responsibilities to each other to tackle the fallout of the policy of the other. Commonly we see that a neutral
monetary policy with an expansionary base may be pursued.
Inflation targeting framework: Since monetary policy affects growth and inflation in the opposite
direction of desirability, it becomes difficult to choose which objective to pursue. As such RBI may not be able
to take monetary policy decisions independently i.e. Government may influence RBI decisions. In order to
make RBI independent and accountable in matters of monetary policy, the government and RBI signed an
inflation targeting framework in 2015.
Under this:
1. RBI targets to keep inflation at 4%+/- 2 % growth is pursued within this objective.
2. Decisions of monetary policy are taken by a six-member monetary policy committee (3 from RBI
(Governor & 2 deputy governor), 3 nominated by government). Decisions are taken by a majority with
the governor casting the vote.
Transmission of monetary policy: Prime lending rate, the base rate, and MCLR (marginal cost of funds-
based lending rate), Concept of external benchmarking.
Market Sterilization scheme (MSS)- If there is an excessive inflow of foreign currency in the country, this
would create a demand upon RBI to print more rupees as these dollars would be required to be converted to
rupees. MS goes up unintentionally to absorb this MS, RBI in consultation with the government issues MSS
bonds- it sells these bonds and absorbs the excess MS. Merging of railway budget along with Union budget.
Preponement of the budget presentation. Doing away with planned and non-planned expenditures.
External Sector
Balance of Payment:
Significance- How trade happens between two countries when there are no common currencies?
Accounting- Any transaction happening between the resident and non-resident will be recorded.
Settled transaction- no future liability/interest or obligation- these are part of current accounts that
residents incur with non-residents. Money for a current account can come from other current transactions.
Unsettled transaction - creating future interest and obligation can be mentioned in the capital account.
All these Transactions are linked to the change in reserves [either increase or decrease in reserves].
Balance of Payments is a record of a country's residents' transactions with non-residents. It consists of two
parts
 Current Account- Transactions between the residents and non-residents that are settled in nature I.e.
do not create any future interest or obligation
 Capital Account- Transactions that create a future interest or obligation are recorded in the capital
account.
Current account- It Records settled transactions are further subdivided into two sub-parts
 Merchandise trade- (import and exports) Trade in goods i.e. tangibles.
 Invisibles- Consists of three sub-parts.
i. Trade in services.
ii. Earnings and incomes-Earned by providing Factor of production [a factor of payments] on a cross-
border basis most commonly it consists of earnings on investments i.e. Foreign capital. It can also
include interest earned by lending to foreign entities.
iii. Remittances- These are current transfers that a country receives from the rest of the world.
Amazon company example- Amazon established a branch in India named Amazon India and brought $10
billion [This is an unsettled transaction, considered a capital account]. It did some business and earned some
profit; out of this profit it sent the money to its parent company situated in America [This is a settled
transaction and part of the current account].
Capital account- Transactions that create a futuristic interest or obligations.

It consists of -
 Borrowings-There are various ways to classify borrowing. On the basis of the cost of borrowing -
Commercial/market and concessional. Normally it is only the government that is able to incur a
concessional borrowing. Similarly, it can be classified on the basis of sources such as banks or financial
institutions, multilateral institutions, Foreign governments, individuals, funds having individual or
institutional money, etc. Further it can be classified on the basis of the instrument used for borrowing
such as by issuing bonds, further, the type of bonds, Whether the borrowing is secured or unsecured, and
whether the borrowing is in domestic or foreign currency. [India's foreign borrowings are mostly
denominated in US Dollars, but a large part is also denominated in rupees].

 Investments- investments are made in anticipation of returns, as opposed to borrowings which generate
a fixed, promised interest. Investments can also be classified in various ways such as by amount, by
ownership, by control, by sector, etc [refer to FDI, FPI later].
System of reserves: Transactions on current and capital accounts are independent of each other, however,
they are linked via the system of reserves. A country can have either a deficit or surplus on the current or
capital or both accounts. This deficit or surplus on the overall BoP gets reflected in the country's Forex
reserves. Forex reserves are maintained with a designated entity, normally the country's central bank.
Errors and Omissions: Forex reserves are maintained with RBI and therefore, the change in these reserves
during a time period can be accurately measured. Ideally, if all transactions between the residents and non-
residents [I.e. on current as well as capital accounts] are accurately measured and recorded, then the net
value of BoP should be equal to the net change in forex reserves. For example- if a country has$ a 20 billion
deficit in the current account, and a $10 billion in the capital account then its reserves should also reduce by
$20+$10= $30 billon. However, it may happen that some transactions between residents and non-residents
may not be recorded and thus there may be a discrepancy between the net value of BoP and the change in
Forex reserves. To 'balance' them a term called E&O [errors and omissions] is added as a 'balancing entity'.
Foreign investments- FDI and FII: Earlier [before 2013], the classification of foreign investment in India
was based on certain observed characteristics. FDI was generally that foreign investment where the investor
had the intention for the investment for the long-term. As such the investor would probably be willing to
tolerate some volatility in the short run and would be interested in bringing new technology, competent
management, and a skilled workforce into the avenue of investment. FII on the other hand was characterized
as being short-term in nature and interested in generating quick returns, rather than tolerating some losses
that may occur. However, this characteristic-based classification was not objective and the investment
classified as FDI or FII did not always show the characters normally associated with it. In 2013, the
classification was made objective through the use of the concept of significant control. If a foreigner held
ownership greater than 10% in a publicly listed company [that is listed on a stock exchange], then such an
investment was categorized as FDI, otherwise as FPI [foreign portfolio investment]. The classification reflects
the old characteristics, just that it has been made objective now. [ it is not necessary that FDI will only be in
a listed company], it can be in a privately held company as well. In fact, most of the FDI is in a form of Privately
held companies only, just as the foreigner exercises significant control.
Reforms in FDI/FII- The government used to control foreign investment not just because the control of an
Indian entity would be in the hands of a foreigner, but also because the foreign investment would be
accompanied by a change in the demand and supply of a foreign currency, which would lead to the set
exchange rate being deviated from its set value. The government may have some objectives from the set
exchange rate, and the foreign inflow or outflow may jeopardize those objectives. The government uses FERA
to control this demand and supply with respect to foreign investment. FERA was amended to FEMA, (forex
exchange management act) in which the government control was lessened. The government had set up FIPB
for regulating foreign investment. In 2016 FIPB was abolished and CCEA was given the power to regulate
only very limited aspects of foreign investment. Now, most foreign investment is via automatic route.
Exchange rate- It refers to the value of one currency in equivalent units of another currency. It is simply the
price of one currency in the market where another currency is in use. Like any other item, the price of the
currency is also a function of its demand and supply.
Demand dollars: Sources - Importers buying goods from abroad. Earnings and incomes on Indian
investment of foreigners- transferred abroad. Foreigners withdrawing investment from India. Indians send
money such as education, and health abroad. Interest is to be paid on foreign borrowings. Indian tourists
going abroad etc.
Supply dollars: Sources - Exporters bring dollars by selling their goods abroad. Foreign investment in India.
Indians borrowing from abroad. Remittances, grants, and transfers received by Indians from abroad. Foreign
tourists coming to India etc.

The exchange rate i.e. price of foreign currency is a function of its demand and supply. If the demand increases
because of any of the factors such as those listed above, the foreign currency's price will increase, and vice
versa (similarly for supply).
Exchange rate system: Quoting of exchange rate.

1. Direct Quote: $1 = Rs80- One unit of foreign currency in equivalent units of the domestic currency.
2. Indirect Quote: Rs1 = 1/$80- One unit of domestic currency in equivalent units of foreign currency.
In India exchange rates are normally quoted in a direct manner.
Floating Exchange rate system- In it, exchange rates are completely market-determined i.e. the demand
and supply are market-determined and are not interfered with by the government. As a result, the exchange
rate is dynamic and keeps on fluctuating based on market conditions.
Fixed Exchange rate system- In this XRS the government sets the exchange rate based on certain objectives.
Once set, the demand and supply are managed to keep the exchange rate fixed at that set level. Therefore D
$ & S$ in a fixed XRS are not market-determined but by the government through its policies. More importantly
through its capabilities. For example- If the government keeps XR at a level below the equilibrium price, then
D$ >S$, and the price of the dollar would have a tendency to move upwards. As a result, the government would
either have to augment S$ or curtail the demand or manage both in order to keep the XR fixed at this level.
This greatly depends upon government capability. Their ability to augment supply is limited by their reserves.
Therefore, the commonly preferred manner is to curb demand. The government will exercise its power to
restrict demand, which results in the development of a parallel foreign exchange economy.
Mixed Exchange rate system: Also known as Managed XRS, Dirty float XRS. In this XRS, the XR is largely
market-determined, except if some objective pre-set by the government has to be met and is seen to get
compromised. Authorities can intervene in the forex market based on objectives such as:
1. Keeping the XR within a pre-defined range (band).
2. Volatility of XR i.e. targeting movement in XR over a short period of time.
India, we follow the dirty float system with RBI targeting volatility. Precisely RBI intervenes against
speculative attacks on Indian Rupee.
Pegged Exchange rate system: It is also a type of fixed XRS but used in the condition when a country 'pegs'
or ties its currency to another currency. Pegging is resorted to by those countries where forex markets are
not yet properly developed, hence D&S based exchange rates may not be possible or stable.
Appreciation/Depreciation & Revaluation/Devaluation- When the value of one currency increases, it is

said to appreciate in value i.e. become expensive. Appreciation is a term used in the context of a floating XRS,
whereas revaluation, which is the same directional movement of currency as appreciation, is a term used for
fixed XRS.
Devaluation- Currency is made cheap- Fixed XRS.
Depreciation- Currency becomes cheap- Floating XRS.
Usually, the terms (Appreciation/Depreciation & Revaluation/Devaluation) are in the context of domestic
currency i.e. if the currency loses value, it is depreciation or if the government decides to lower its value it is
devaluation.
Convertibility: It refers to the ease with which one currency can be converted into another. Ease refers to
whether there are any restrictions on purposes for which the currency can be converted. If there are
restrictions, then the currency is said to be only partially convertible, otherwise, if there are no restrictions it
is said to be fully convertible. Post-1991, we have gradually eased restrictions on converting rupees into
foreign currency i.e. convertibility has increased. At present rupee is fully convertible for purposes of the
current account. Since there are restrictions on capital accounts, such as limits on the amount and sectors
for foreign investment, and limits on external commercial borrowings, the rupee is only partially convertible
on capital accounts.
Desirability of full convertibility - Full convertibility of capital accounts has its own challenges in form of
unrestricted inflow or outflow of foreign currency. This causes large movements in exchange rates which may
lead to either import becoming prohibitable expensive or exports becoming uncompetitive.
Tarapore committee 1 & 2 recommended: Full convertibility on the capital account but under certain
conditions--
 A strong resilient and well-capitalized financial system, primarily banks.
 A manageable fiscal deficit i.e. strong financial position of the government.
 Adequate forex reserves for intervention in times of need.
 A manageable current account deficit (refer to the material).
Effective exchange rates & real exchange rates:

Nominal Exchange rate- exchange rate available in the market, a decrease in NER signifies appreciation of
the domestic currency. (1$=Rs 80 to Rs60).
Real Exchange rate- It is the inflation-adjusted ER, it is defined as the nominal ER times the price level in
the foreign market \ price level in the domestic market. RER=NER X P*/P (here P* is the price level in the
foreign market and P is the price level in the domestic market). A decrease in RER is termed an appreciation
of the real exchange rate.
Application- If a country experiences higher inflation as compared to other countries, its RER will reduce in
magnitude i.e. in real terms its currency would appreciate. As a result, its exports would become
uncompetitive (a costly domestic currency makes exports uncompetitive). Therefore, for the country to regain
its competitiveness its NER should depreciate for example- if a country's inflation is 10% i.e. P (price index
rises by 10%, and the partner country's price level i.e. P is constant, then its RER will decrease i.e. appreciate).
If its NER increases i.e. depreciates, also by 10%, then RER would come back to the prior level and hence its
competitiveness i.e. price of its exports would come back to its original level.
Effective Exchange rate (EER): A country trades with several countries, sometimes in some or different
currencies. To assess the fair value of the domestic currency, we do not just view its movement against one
foreign currency, but against a basket of currencies. EER is a gauge to assess this fair value. We calculate
EER by taking into account exchange rate-weighted trade proportions with different countries. An EER can
be thought of as a hypothetical exchange rate that a country would have with the rest of the world if the rest
of the world had some common currency.
EER = weighted avg. of XR
NEER = weighted avg. of NER
REER= weighted avg. of RER
For example:
RBI uses IMF standard formula to
30% trade US rs 100 calculate REER & NEER.
India 40% trade China rs 10
20% EU rs 140
10% Singapore rs 40
More than the value of REER & NEER, their utility in determining
the currency's overvaluation and undervaluation is important.
For this, we index NEER & REER to a hundred in the chosen base
year and then look for its movements. An increase in the
magnitude of NEER or REER is the appreciation of domestic
currency i.e. Rupee. A reduction in magnitude is depreciation.

Current Account Deficit: Current Account Deficit signifies an excess of the outflow of foreign currency as
compared to its inflow on its current account. Broadly it is because a country imports more than its exports.
Reasons for high imports:

 High domestic income due to fast growth.
 A low resource base makes the country dependent upon imports.
 Insufficient production domestically especially of goods needed by households on a regular basis.
 Cheap foreign goods flooding the domestic market.
 Strong exchange rate making imports cheaper etc.
Reasons for low exports:

 Domestic production being less competitive as compared to peers, production of goods at a higher cost,
and inevitability to meet the quality requirements.
 Poor business environment in general such as difficulty to comply with labour laws, environmental laws,
and tax laws.
 Poor infrastructure.
 Barriers to trade.
 Depletion of natural resources.
 Recession abroad.
 Strong currency makes exports uncompetitive
Addressing Current Account Deficit:

Reason Steps taken Consequence
A fall in aggregate demand leads to

Contractionary monetary or
High domestic demand increase unemployment due to slower
fiscal policy.
domestic growth.
Possible violation of WTO commitments,
Increase tariffs on imports and
and hence may be overturned. Retaliation
Cheaper reduce taxes to be paid by the
by trading partners. Imported inflation,
imports/Difficulty in exporters. Similarly, a country
especially affecting the country's exports
exports can impose quotas on imports,
of those goods which are dependent upon
or give subsidies on exports.
imports.
Supply-side reasons- Low Increase investments such as in Investment by itself has little negative
competitiveness due to building infra, improving the effect, rather it has some limitations.
poor infrastructure and productivity of factors of Investment is costly but necessary.
investment production. e.g. labour’s skill
Limitations of investment: All countries are in a race to attach foreign investment and to achieve this they
may invest a lot (incur a high cost) and relax the regulation to an extent that is not in the best interest of
other stakeholders such as labour or environment. Further, only a few countries will be able to attract foreign
investment, and hence the return on the government's efforts would be different for different countries.
Investment will increase competitiveness only in the long run. In the long run, there would be many other
factors that determine its success or failure. Investment today means less expenditure on other aspects such
as welfare expenditure. The magnitude of investment thus should be accessed by evaluating the opportunity
cost.
Exchange rate and Current Account Deficit:

Reasons: Strong exchange rates make imports cheap and exports costly, Cheap imports mean more imports,
Costly exports mean less exports.
Steps to be taken: Generally, countries indulge in the devaluation of their currencies in anticipation that this
will make their exports competitive, and hence increase their quantity, and make their imports costly thereby
reducing their quantity.
Effect on Current Account Deficit & consequences of devaluation:

CAD=value of imports - value of imports
(Pi. Qi) (Pe. Qe) price X quantity = value.
When price changes, quantity changes according to the law of demand. When imports become costly demand
of imports decreases, when exports become cheap demand of exports by foreigners increases. Value= PxQ,
therefore the change in value on the change in price will depend upon the elasticity of quantity with respect
to price. If the quantity is inelastic. When price increases i.e. (delta P > delta Q) Therefore, an increase in price
would be able to more than offset a decline in value due to a decline in quantity. As such the overall value will
increase. When the price decrease i.e. (delta P > delta Q) When the price decreases, the quantity is still
inelastic i.e. (delta P > delta Q) that is the magnitude of the fall in price would be greater than the magnitude
of the increase in quantity due to a fall in price. Therefore, the increase in value because of the increase in the
quantity would be less as compared to the fall in value due to a fall in price and hence the overall value will
decrease. Imports are expected to become costlier due to devaluation, therefore we expect a fall in quantity
(Qi) but a fall in Qi would be less as compared to a rise in Pi. Therefore, the value of imports (Pi. Qi) will
actually increase. Exports are expected to become cheaper due to devaluation. Therefore CAD = value of
imports - value of exports will be affected in the following manner.
 Value of imports will increase if the quantity is inelastic.
 Value of exports will decrease of the quantity is inelastic.
Therefore, CAD actually worsens on devaluation when exports and imports are inelastic. For a country like
India whose exports and imports are inelastic, devaluation worsens CAD.
J-curve effect: As can be seen, devaluation will worsen

the CAD initially, even though exports may rise and
imports fall. As such it may not be the best tool to
correct CAD. On the other hand, devaluation may lead
to competitive devaluation of currencies by other
countries (currency wars). As a result, CAD will
continue to worsen due to this. It will not be beneficial
for any country as the ability to withstand a worsened
CAD is limited by its forex reserves and capital flows.
Only those with large forex reserves will be able to
tolerate a worsened CAD. In a floating XRS, adjustments
of CAD are automatic. A country with high CAD will
have D$>S$, and hence dollar will appreciate, or the
rupee depreciate, this makes exports competitive and
imports costly, leading to eventual improvement in CAD.
Capital account:
External debt: External debt refers to debt owed by residents to non-residents. It includes debt of the
government (external public debt, and debt of ordinary non-government entities such as PSUs, and private
companies) individuals, etc. External debt can be incurred on a commercial or a concessional basis.
Commercial borrowing is called External Commercial Borrowing. It can be incurred by any resident entity,
although with limitations. It can be incurred from foreign banks, foreign financial institutions, or similar
entities. FII debt is rupee-denominated external debt.
Rupee-denominated debt is the second largest component after the dollar of India's external debt.
Masal bonds-offshore rupee denominated bonds-the exchange rate risk is borne by the lender.
Sovereign bonds- proposed but shelved- government bonds supposed to be issued in foreign markets.
Ostensibly to take advantage of low-interest rates abroad.
International Institutions
Background- Every country has its own interests, which for the most part conflict with similar interests of
other countries. As a result, pursuit of these interests leads to less-than-desirable outcomes for most countries.
International institutions have been set up to promote cooperation rather than competition among countries
to promote the orderly development of financial relations. In 1944 when ww-ii was ending a conference was
convened at Bretton woods, New Hampshire, US to deliberate upon the new global economic and financial
order. Till now most countries were following the gold standard, and the trade between them was carried
out in the following manner.
1. The foreign entity selling goods in the domestic market would take the domestic currency to the treasury
and exchange it gold.
2. It will take gold to its home country and exchange it with the home treasury for home currency.
3. Even though it worked conveniently most times, it led to several issues as well.
Issues: If a country was in a trade deficit, more gold would flow out of that country, hence its ability to trade
would decline. Further with the decline in gold, the amount of currency in circulation also goes down, hence
the ability of the economy to carry out transactions also reduces. A country unable to fulfill its obligations to
a trading partner would then have to find other ways to fulfill the promises- either devaluation of currency
i.e. reducing its value in units of gold or verse a compromise on its sovereignty. Devaluation may not be
acceptable to the trading partner, therefore would lead to conflict. A compromise on sovereignty would be
more acceptable to a person/entity with the intentions and ability to govern a foreign territory-Colonization,
through almost bloodless means. Further countries would arbitrarily suspend gold the standard as the gold
standard reduces their ability to create money, especially during times of war. This led to the destabilization
of currencies, hence facilitating further conflicts. Because there was only the gold standard and no official
exchange rates the currencies were converted via gold as such the exchange rates were based on domestic
gold standards and hence fixed. In a floating XRS CAD would have adjusted automatically, hence conflicts due
to BOP could have been avoided. In the Bretton woods conference, therefore the deliberation was on the need
for a global financial system that prevents conflicts.
Precisely three questions were deliberated: To have a stable global financial system: This would require
continuous monitoring of BOP, change rates of different countries, and flagging any potential issues of
unsustainable BOP, or an overvalued/undervalued XR. Further, it helps a country facing a potential or actual
BOP crisis and prevent the crisis from spreading. The answer was IMF. To develop a rules-based trading order
i.e. the terms of trade amongst countries should be fair and non-arbitrary, along with the promotion of free
trade. The answer was ITO (international trade organization), which could not be set up, WTO is its modern
form. A financial institution to give loans for rebuilding economies destroyed in the world war.
World bank: It consists of the following institutions

 IBRD (international bank for reconstruction and development) - Initially set up to give loans to
countries destroyed by war. At present, it gives concessional loans to developing countries.
 IDA (International development agency)- Set up to give loans to the countries left poor due to
colonization. Now gives loans to the poorest/least developed countries. It gives heavily subsidized
concessional loans for a very long term to these countries. India is the largest recipient.
Over a period of time, three more institutions were set up, which together with the above two are called as
world bank group (WBG).
 IFC (international finance corporation)- It is the commercial lending arm of the world bank. Precisely
IFC facilitates entities from developing countries to borrow from the foreign market at a competitive rate
by giving certain guarantees.

 MIGA (multilateral investment guarantee agency)- Developing countries need foreign investment, but it
would not flow simply because the market offers simply higher returns. MIGA protects foreign investment
against arbitrary actions of the government.
 ICSID- (International center for settlement of investment disputes)- India is not a member.
International monetary fund (IMF): It was set up with the following objectives:
 Monitor exchange rates, the country's BOP position, and the adequacy of its forex reserves. In pursuit of
this, it publishes the global financial stability report.
 To flag, any concerns related to financial stability in case the BOP position of a country deteriorates. It
publishes World economic outlook report in this regard.
 To take steps to contain the BOP crisis as quickly as they can be. In pursuit of this, it facilitates countries
to borrow forex from other countries, or in extreme situations lend itself.
Monitoring of exchange rate and BOP: Till 1944, there were no official exchange rates between the
countries, except those that were determined on the basis of the respective gold standards. Post-ww-ii almost
all of the world's gold was with the US and hence no country was in a position to promise to exchange their
currency with gold. Hence even though the only way of carrying out international trade was the gold
standard-based exchange rates, the gold standard itself was not possible as countries did not have gold.
Instead, a new system was designed - The dollar gold standard. The only dollar was the currency that could
be promised to be exchanged against gold, and hence the American government promised to exchange dollars
for fixed units of gold. For trade to be carried out amongst other countries, since gold was no longer the
option, a gold-backed currency became the only option, i. e the dollar. Further to facilitate trade, a few
currencies such as the pound sterling were chosen, and the respective governments fixed the exchange rate
of their currencies with the dollar. For example- The UK pound sterling was no longer convertible to gold as
the British government was not in a position to fulfill its promise. 1-pound sterling = 2 $, and 1 $ 0.02 grams
of gold. The first promise was of the British government and the second was of the American government.
Gold was limited, but dollars could be printed, and hence to carry out world trade dollars would be utilized.
The countries did not exactly want to convert dollars to gold, rather they simply need a trustable medium of
exchange. The American government's promise gives this trust, and hence dollar would now be used to carry
out transactions. Every country would therefore fix the value of their currency in units of gold, or some other
currency pegged to gold (a fixed XRS). IMF tasks were there to monitor these fixed XR. A country facing a
potential BOP crisis would be advised to devalue its currency in order to correct its CAD in the long run.
Structure of IMF: Any fund, including the IMF, has the following structure:
 Owner- who launches the fund to meet some objective- the member countries (190) originally 44 are the
collective owners of IMF.
 Objective- Every fund is launched to meet certain objectives. IMF's objective is as has been discussed
above.
 Fund manager- the entity interested with day to day functions of the fund. It uses the fund in order to
meet the objectives. The executive board of the IMF consists of 25 members including the managing
director is responsible for taking decisions at IMF in pursuit of its objectives.
 The fund itself- The corpus of money- Voluntary contributors in IMF case its owners i.e. the member
countries, contribute money so that the fund can meet its objective.
 Quota: IMF is a quota-based institution. Each member country has a pre-defined quota which is
determined on the basis of factors such as:
1. Relative size of the economy- most important factor
2. Openness to trade.
3. Forex reserves
Once the quota is determined, it determines three important things-

1. Subscription amount- the contribution that each member will make to IMF. 75% of this contribution is
done in domestic currency, and the remaining 25% is made, in commonly acceptable foreign currency

(Dollar, pound, Euro, Yen, Renminbi). This 25% contribution is available to the country at all times to be
used if required, for making foreign currency transactions. Therefore, this is part of the country's official
forex reserves and is known as the reserve tranche position.
2. Voting power- The quota determines the number of variable votes that a country gets. In IMF every
member is assigned an equal number of basic votes in order to maintain equity. Apart from that, each
country is also assigned votes on the basis of its quota. As such the overall voting power is quota
determined. Decisions by the executive votes are taken by the majority of votes. Since there are only 24
members, each member votes as a representative of a larger bloc. For example, India represents the south
Asia bloc. (India, Nepal, Bangladesh, Bhutan, Sri Lanka). Certain decisions need only a simple majority,
while others need an 85% majority.
3. Assistance from IMF- A country is eligible for 1.45 times the quota as normal maximum assistance.
Beyond this, IMF may provide assistance, but that would require a special majority and even that would
be dependent on the country's quota.
Evolution of IMF's role- When IMF was set up, there was a fixed XRS, hence monitoring of XR and BOP was
required. As world trade grew, the demand for dollars from the rest of the world increased. As a result, the
American federal reserve had to maintain a supply, therefore the supply of dollars in the American economy
increased which led to high inflation in the 60s and 70s. Further, the new dollar was created through the
purchase of government bonds and not gold reduced the trust of people in the dollar. Hence the demand for
gold further increased due to the decline in trust in dollar. Increasing demand for gold and generally
increasing price levels led to a disparity between the price of gold in the market and the price of gold under
the gold standard. i.e. promise by the American government. The gold standard was revised, and the
redemptions of dollars against gold limited, but still the trust of people continued to decline. As a result of
the then circumstances- high inflation, falling trust in the currency, increasing market price of gold, and
redemption of gold against dollars. The American government suspended the gold standards in 1971.
Meanwhile, IMF created an international reserve asset in form of special drawing rights (SDR). With the
suspension of the dollar-gold standard, the system of fixed XRS ended and countries eventually moved to float
XRS.
Financial action task force (FATF)- IMF lends money by taking advice from independent entities such as
FATF, which observes the purposes for which the money lent out may possibly be used.
Special Drawing Right: After the withdrawal of the dollar gold standard, the value of the dollar was no
longer guaranteed against gold rather its value was derived based on its utility. The need for dollars to carry
out international trade. The dollar, therefore, started to have an intrinsic value, and not merely fiat value
like that of other currencies. IMF was set up to monitor XR and was no longer required to monitor them as
the value of currencies became market-determined
and hence the adjustments to CAD became
automatic. The role of the IMF was now to assist
countries facing a BOP crisis. In this pursuit, it
created the SDR. SDR - a global reserve asset, was
created to supplement countries' forex reserves. It
could be used by the countries at an IMF-determined
value to exchange freely usable currencies to settle
their transactions. SDR is not a currency, neither is
it a claim on IMF rather it is a potential claim on
freely usable currencies of other members of IMF.
How Special Drawing Right works: Upon joining IMF two equivalent positions are opened against a
country- its holdings and allocation. The country has paid to join fees to IMF (the country's money with IMF)
and IMF has given the country an assurance to help it during the BOP crisis. SDR holdings represent the
country's money with IMF. On this, the country earns an interest. SDR allocations represent what the country
has taken (borrowed) from IMF. On this amount, it pays an interest initially both are equal, and hence net
interest is zero. If a country faces a BOP crisis-
1. It can use its holdings to exchange SDR for dollars or any other currency from a country that has a surplus
BOP position.
2. The surplus country would ordinarily not lend to the deficit country but here IMF guarantees to pay the
interest on its SDR holdings, which now exceed its allocation as it has given dollars in return for SDRs to
the deficit country.
3. IMF is responsible to charge interest from the borrowing country.
4. If its holdings fall to zero, the country can borrow more SDR from IMF and use them as described above.
5. Even after that if the country needs help, IMF facilitates multilateral or bilateral arrangements for that
country.
6. When all else fails, the IMF through the permission of its executive board uses its own funds to lend. This
is accompanied by conditions that might be very strict (aid conditionalities also called the Washington
consensus).
Fiscal policy & Government budgeting

The government budget is a document pertaining to the estimates of expenses and receipts of the government
in the coming financial year. Article 112 requires the President to lay down before the Parliament statement
of accounts pertaining to the estimates of receipts and expenses of the coming financial year (FY). The
government presents four sets of numbers while presenting the budget.
 Budget estimates- Estimates for the coming financial year.
 Advanced estimates- Estimates pertaining to the ongoing or the previous financial year for which
accounting is not yet complete, but there is a fairly accurate idea about actual expenses and receipts.
 Actual- Actual numbers for the latest year for which the accounting exercise is over.
 Revised estimates- If during the year the budget estimates were revised i.e. an authorization from the
Parliament was taken to spend more money than what was originally budgeted, then these revisions are
also presented to the Parliament while presenting next year's budget.
Budget is not merely an accounting exercise rather it is one of the most important ways to uphold and
maximize public trust. The public trust doctrine states that the government must always function in a manner
that upholds the trust of the public in the governance process. The government derives its legitimacy to
govern only if it upholds public trust. The most important way of upholding it is by demonstrating
transparency in financial transactions. The government collects public money in various ways and is required
to spend it in maximising public welfare. The budget, therefore, has three functions corresponding to
the three objectives:
1. Expenditure or allocation function- Maximise public welfare by providing as many public goods to as
many people as efficiently as possible.
2. Taxation function- Maximise tax collection in a manner that is fair and equitable.
3. Stabilization function- To meet the macroeconomic objectives of maximizing growth and minimizing
inflation. Pursuit of any of the two previous objectives independently is neither possible nor desirable.
Example- If the budget tries to maximize tax collection, it may create disincentives to work and
unemployment. The government, therefore, tries to meet several objectives at a time which may seem,
independently, to be contradictory to each other. The balance between these multiple objectives is the
unique aspect of the budget. This is the stabilization function. Example- the government tries to
incentivize certain sectors which have a high potential for growth, employment, and exports by giving
them subsidies or tax breaks.
Budgeting Technique: These are various ways in which the preparation and presentation of the
government's budget have evolved with time.

1. Line item budgeting-This is a detailed record of the item-by-item expected expenses of the government
in the coming FY. It is the simplest, oldest, and still in use technique for preparing a budget.
2. Program budgeting- It involves the better organization of expenses based on the programs that they
are a part of. The expenses are organized in a manner that more meaningful information can be easily
ascertained, and steps taken to make adjustments if required.
3. Performance Budgeting-It is a way of analysing the expenses for their efficiency. It introduces the
element of analysis in the budgeting exercise, expenses should be such that they are efficient i.e. attain
maximum output with minimum resources. example to procure and store max. vaccines at min. cost.
4. Outcome budgeting- it takes the analysis further by analysing the expenses not just for their efficiency,
but also their effectiveness i.e. their ability to meet the intended objectives. The outcome is the ultimate
objective example- whether the IMR actually comes down or not through the procurement and
administration of vaccines. For this mere procurement is not enough, but also requires training of staff,
and carrying out campaigns to encourage people to get their kids vaccinated.
In India outcome budgeting is performed in two ways:

1. Zero-based budgeting- Under it, any expenditure to be incurred in the present year must be justified
every year. Merely because some expenditure under some schemes was incurred in the previous year,
does not mean that fresh allocation would be made this year. It must justify its continuation every
year.
2. Gender-based budgeting- It is not a gender-specific allocation. rather it is gender-specific analysis-

it is the analysis of the differential impact that any expenditure will have on various gender especially
women. For example, how will the modernization of the police force improve women's security or the
general environment for women. Gender-based budgeting is performed by the gender budgeting cell
in the ministry of Women and child development.
Presentation of the Estimates:
Budget components: Article 112 requires that the estimates of expenses be presented on revenue and other
accounts. The practice that has developed is that the other account is understood as a capital account, and
both expenses, as well as receipts, are classified as revenue and capital account.

Revenue account- It consists of those expenses and receipts that the government incurs/earns in pursuit of
its sovereign functions. These are generally but not always recurring in nature.
Capital account- All other expenses and receipts are classified as part of the capital account. These are
generally one-time/not recurring in nature.
Revenue expenses -These are expenses incurred by the government in the performance of its sovereign
duties. These are considered to be necessary to be incurred by the government to maintain and continue its
functions. The government incurs these expenses because these are necessarily those that provide the
government with its identity- i.e. it provides public goods vis with these expenses. These include
administrative functions, maintenance of law and order, defence of the country, payment of subsidies,
repayment of interest on its borrowing, etc.
Revenue receipts-The money that the government collects as a matter of right ie. money collected for the
performance of sovereign functions. This is the money that cannot be claimed from the government- it is the
government's money. These include- money collected as tax and non-tax revenue such as fees and fines,
interest received on its lending, profit, and dividends, etc.
Capital expenditure-Even though we describe revenue first and then the remaining is capital. When it comes
to identifying an expenditure/receipt, determining whether it is sovereign or not becomes subjective.
Therefore, we identify 'capital' first and then the remaining becomes revenue. Any expenditure that leads to
an increase in assets or a reduction of liabilities. For example- government lends money it creates an asset
for the lending government. Money is spent (expenditure) and asset is created, therefore (capital). The
government spends money on purchasing a company/increasing ownership in an existing company/or
creating an entirely new company- this creates a financial asset for the government. The government repays
the money it borrowed- reduces its liabilities.
Defined assets- certain expenses on defined assets are categorized as capital expenses. These include
expenses on building, equipment, roads, ports other infrastructure, and defence assets such as aircraft
carriers, helicopters, etc.
Capital receipt- anything which is on account of either reduction of assets or creation of liabilities. Example-
money received by selling ownership in companies- disinvestment (partial or full) or strategic. Money
received through borrowings from any entity, at a market or concessional rate, etc.
2017 Budgetary reform:

1. Preponement of the date: of presentation from the last working data to the first working day of
February. This was done preponement so that adequate time is available to debate and discuss various
provisions in the budget.
2. Merger of railway and Union budget: these were separated in 1924 on recommendations of Acworth
committee. It was expected that railways would generate additional revenue for the government and
would be run professionally by having complete independence from the general budget. However, a
separate budget led to its politicization, and railways got subjected to political pulls and pressures and
as well remained dependent on the general budget for resources. To overcome this the two budgets were
merged.
3. Abolishing of planned and non-planned classification: Anything that was a part of the ongoing FYP
was categorized as plan expense. The plan expense became synonymous with the developmental expense
and hence the tendency of the government was to inflate plan expenses by categorizing such expenses as
plans which should not have been categorized as such. Example- If the FYP envisaged the building of
schools, the government would categorize not just the building expenditure (infra expense) as planned
but as well the salaries to staff and maintenance expenditure to the schools. This inflates plan expenses
and creates a wrong narrative about the plan being developmental in nature. Several committees, the
last one being Rangarajan in 2012 recommended its abolition. With the end of the 12th FYP, and
abolishing the PC, the classification was dropped in 2017.
Deficits: It is a general situation in which there is deficiency i.e. an excess requirement over what is available.
Types of deficits:
1. Budget deficit: When the government presents a budget such that its total expenses exceed its total
receipt, it is said to represent a budget in deficit.
Total expenses= RE + CE
Total receipt= RR + CR (Debt CR & non-debt CR)
Budget deficit= TE-TR (TR includes estimated borrowing for the year).
2. Monetised deficit- That part of a budget deficit that is monetized by RBI printing money in return for
government bonds.
Critical analysis- Budget deficit is a recognition by the government that it cannot fulfill the promises it has
made in the budget (as TE is greater than TR). As such the budget becomes a political tool for announcing
schemes with an implicit recognition of the inability to fulfill them. Over the years many programs/schemes
were announced and parliamentary approval was taken, but they could not be implemented due to lack of
funds. Further, the government justifies it that it is merely taking parliamentary approval and conveying
intentions to the public as the only way of enforcing accountability was through the periodic elections, there
was no check on what the government could promise. As such, there is a long list of unfulfilled budgetary
promises. The budget became a political tool rather than a tool for enforcing financial propriety in the
government's conduct. Worse than this was the deterioration of the country's monetary system. In order to
spend money more than what it expects to receive, the government would want some source that could
provide it with this money- this was RBI- creates money by buying assets. The decision to buy assets- which
asset and in what quantity is RBI's, is based on its assessment of growth and inflation. This is what gives
independence to RBI. Independence assures that RBI buys only the best quality assets which will enable it to
maintain the trust of people in the pieces of paper they use as money. If it buys poor-quality assets then people
will no longer trust in RBI's promise, and hence the currency loses its value.
As a result of monetization, therefore there are three consequences:
1. Loss of independence of monetary authority.
2. More unintended money supply in the economy causing inflation.
3. The currency loses its value due to poor-quality assets and hence the decline of trust of people in the
monetary system. This is reflected through even higher inflation.
Ways and means advances: Due to the issue described above, the precise of presenting budget deficit would
ultimately be discarded in 1997, after a series of agreements between RBI and the government. Amongst
them is the Ways and means advances agreement. Under Ways and means advances the government
promised that it will no longer force RBI to purchase government bonds. On its part, RBI promised that it
would provide short terms loans to the government to tie over temporary mismatches in liquidity. The
government agreed that from now on it would only borrow from the market, and RBI can participate if it
wants to. Thereby disagreement is a significant landmark towards the independence of RBI. The quantum of
money that government would borrow during the year would be decided in advance in meetings with RBI.
this is the total Ways and means advances (revised from time to time).
There are two components:
 Normal Ways and means advances - Is an unsecured loan.
 Special Ways and means advances - fully secured i.e. the money is lent by keeping government
securities as collateral against the loan.
So, every state has its own limit and it depends on factors such as the minimum balance that any government
has to maintain with RBI, the quality of state finances, etc.
Fiscal responsibility and budget management act, 2003: After Ways and means advances, the natural
consequence of the non-availability of RBI lending was that the government had to be disciplined in its
finances. Since the only source of borrowing was the market government lending would now be on terms and
conditions of the market, and not those dictated by the government as such it needed discipline in its
borrowings. This is because unsustainable debt leads to:
 Inter-generational inequity- The present government borrows and spends at present, but the burden
of repayment is on the future generation which will pay higher taxes for repayment of this debt.
 Intra-generational inequity- The government borrows from those who have money, and since the debt
is unsustainable, it promises a higher rate of interest. The lenders receive higher returns. Further debt
implies excess government spending which causes inflation. The poor suffer far more as compared to the
non-poor.
 Engle law- the proportion of expenditure on necessary goods decreases as income increases. Example
expenditure on food as a proportion of total expenditure. As a corollary, the ability of the poor to reduce
their expenses is very less as almost all of their expenses are incurred on necessary items. Hence inflation
hurts the poor more.
 Effects of debt- debt is inflationary Government borrowing crowds out the private sector (since only a
limited amount of money is available to be borrowed, and if the government borrows more proportion of
it less would be available for the private sector. Therefore, debt must be incurred only on a sustainable
basis. excess debt is bad. (refer to principles of debt management).
 Fiscal deficit (FD)- It is the total borrowing that the government does in a year. FD= Debt capital receipts
(DCR)= total borrowings in a year.
Since TE = TR (BD=0)
Therefore TE= RR + CR
= RR+ debt CR + Non-Debt CR
Debt CR=TE- (RR+ non-debt CR)
FD= Debt CR=TE -) RR+non-debt CR) or FD = TE-total non-debt receipts
Fiscal responsibility and budget management act, limits the amount of FD. In 2003, it laid out that FD
should be restricted to less than 3% of GDP, and it should have been achieved by 2008 (i.e. five years).
Net Fiscal deficit: We visualize government finances by looking at deficits in several ways: Gross FD is what
actually borrows. However, it has many expenditure commitments, and thus, we try to remove them and then
visualize the health of government. finances. In net FD, we reduce the total lending by government from its
expenditure and then see how much amount it would have borrowed if government did not lend itself such
as - To other government states and foreign government, PSUs, etc.
Net FD = {total expenditure - Lending by government} – {RR+ND-CR}

Net FD = Gross FD - Lending by government
Primary deficit- In it, we remove total interest payments from expenditure. Interest is paid on the entire
debt which is outstanding. The deficit pertains only to the present year that is the current year's
borrowing these borrowings accumulate with time when they are not paid the future government is bond to
pay interest on them. Primary deficit is a way to visualize borrowing if government did not pay interest on
past borrowings.
Primary deficit = Fiscal deficit - Interest Payment
Gross Primary deficit = Gross FD - Interest Payment
Net Primary deficit = Net Fiscal deficit - Interest Payment
Revenue deficit- Deficit on the revenue account: Revenue deficit = Revenue Expenditure - Revenue
Receipt The second target under the FRBM act is the elimination of RD BY 2008.
Key points of FRBM act: To bring down FD to within 3% of GDP in the next 5 years. To eliminate RD in the
next 5 years. To keep FD and RD at this level thereafter. To present before parliament every year along with
the budget a set of documents which express the health of government finances and government plans to
improve them. This includes documents such as medium-term fiscal policy statement, Medium-term
expenditure strategy statement. These documents are collectively referred to as a fiscal consolidation road
map- it is a road map specifying how does the government plan to achieve the target over the years.
After the amendment in 2011 now the objective is to eliminate effective RD and not RD. FRBM Act has been
amended several times and targets used forward.
Effective Revenue Deficit: The objective under the FRBM act was on course to be met till 2007. However,
after that, the government's expenditure increased and the fiscal deficit ballooned as a result the targets
could not be met. In 2012 the FRBM act was amended and instead of RD it was decided to target ERD. the
government transfers to states for any purpose except loans are categorized as a revenue expense. However,
some of these expenses may be used for the creation of capital assets. thus, even though they are accounted
as RE, their end use is like CE. These expenses are removed from total revenue RE to arrive at ERD.
RD = RE {Other expenses, Transfer to State (use for creation of capital assets)}- RR

ERD = {RE - Transfer to State for creation of capital assets} - RR
Review of FRBM act- NK Singh committee. The government enacted the FRBM act to instill discipline upon
itself in matters of public finance. however, it is also in a unique position to amend a law even if the law
restricts the government. Thus, it amended the FRBM act several times starting in 2008. Thus, the very
purpose of the act gets defeated. If the government can borrow without restrictions to debt becomes
unsustainable and its negative consequences are faced by the economy. Economic growth takes place when
government spends (AD=C+G+I+(X-M)) and government expenditure also leads to more consumption and
investment expenditure. Thus, there is a multiplier effect. however excess spending leads to high expenses and
borrowing also becomes expensive. as a result, the chances of default on loans (NPAs) rapidly increase. Once
the government is unable to borrow and hence unable to spend, it leads to a rapid collapse in economic
growth and a rise in NPAs. This affects the ability to lend in the future and thus even future growth gets
compromised. In this regard, the government set up the NK Singh committee.
Recommendations:
 Target the combined debt level and not just the fiscal level. The committee recommended that the total
debt of general government (C&S) should not be more than 60% of GDP-Centre- 40%, state 60%, and
each state 20% of its GSDP. The fiscal deficit target of 3% should be achieved within this overall target.
 Counter-cyclical fiscal policy- The current
expenditure policy of government that is when the
economy grows fast it spends more as the government
collects more taxes and can borrow more Whereas
when the economy grows slowly it collects fewer taxes,
is able to borrow less, and thus can spend less.
However, the need to spend is less during the high
growth phase and more during the low growth phase.
NK Singh recommended changing this alignment to a
counter-cyclical fiscal policy-spend less when you can
spend more but need to spend less and spend more
when you can spend less but need to spend more.
Disciplining oneself during the phase of high ability to
spend makes the government capable to borrow more
even when its revenues are less but the spending
requirement is more.
1. High Growth Phase: More revenue, more ability to borrow, less requirement to spend (Less
Unemployment).
2. Low Growth Phase: Less revenue, less ability to borrow, more requirement to spend (High
Unemployment).

 Objectively specifying the times at which FRBM targets can be breached that is the government should
not exceed deficits/debt on the pretext of some reason. The reasons must be genuine. he specified certain
conditions such as- times of war, Natural disasters, Calamities, Pandemics. Contraction of economic
output for two consecutive quarters. Continuous fall in economic growth rate, Contraction in Agriculture
output.
Principles of debt management: Debt to be incurred at least cost. Preferably it should be of a long-term
maturity profile that is not more than 25% of total debt and should be maturing in less than 5 years.
Preferably it should be financed from domestic sources. Foreign debt should preferably be denominated in
domestic currency. The cost of debt should be less than the expected growth rate of the economy. The
economy's growth rate signifies the rate of revenue growth of government that is taxes. Thus, the cost of debt
should be less than the growth rate of government’s revenue.
Government's Debt management: RBI is the government's debt manager, it has been entrusted with the
responsibility along with other functions such as the conduct of monetary policy and regulation of banks. As
the government's debt manager, it is expected to adhere to the principles of debt management listed above.
However, there is an inherent conflict between its function as a debt manager, and its responsibility as a
conductor of monetary policy. If inflation is high, RBI should increase the interest rate by either reducing MS
or increasing the repo rate. When it does this, the cost of borrowing for everyone increases, including the
government. As a result, the government will now borrow at a higher cost. This leads to a violation of the first
principle i.e. incurring debt at least cost. Recognizing this conflict, the government proposed to hand over this
function to a professional agency PDMA. Till the time a full-fledged PDMA was not set up, an interim
arrangement in form of first a middle office(MO), then a PDMC (PDM cell) was proposed. RBI was supposed
to train professionals for the government's debt management and eventually hand over the responsibility to
PDMA. As of now, in December 2022 RBI continues to be the government's debt manager.
Central government Expenditure: The revenue expense of the centre consists of two major parts:
1. Centre expenditure.
2. Transfers.
It comprises establishment expenditures such as maintenance of its offices, departments, etc. Further, they
include expenses on central sector schemes. These are the central government's schemes formulated on
subjects in the centre/concurrent list. These are usually fully financed by the centre but may be implemented
with help/assistance from states. Another major component is interest payments. Amongst transfers to states
the two major components are:
1. Finance commission grants: Example- revenue filling grants for states facing persistent revenue deficit.
2. Centrally sponsored schemes (CSS): These are schemes formulated by the centre but proposed to
states to be accepted as their own. Now it becomes a state scheme, which the centre partly sponsors. After
abolishing the planning commission (which used to formulate these schemes, and decide the funding
pattern), setting up recommendations of the Chief ministers committee for rationalizing Centrally
sponsored schemes and accepting the recommendations of the 14th FC to increase states' share
significantly from 32% to 42% in net proceeds of taxes, the total expenditure on CSS has been
rationalized. Now there is six core of core CSS, and 24 core CSS, each having its own pattern of sharing
between centre and states.
Taxation:
 Direct tax - Direct tax is Where the burden of payment is on the individual and the burden is not shared
by anyone.
 Indirect tax -It is collected by an entity where in the burden lies on another person.
Manner of levying: Specific and ad valorem: Taxes are the general payment that society makes to the
government for providing public goods and services. These are rightful of the government i.e. they cannot be
claimed from the government. They are classified broadly on three bases:
1. On the basis of Redistributive features-
 Progressive taxes- the rate of tax increases with the increase in incomes i.e. a person with higher income
pays more proportion of income as taxes.
 Regressive taxes -Even though the tax amount paid is higher, a less proportion of income is paid as
taxes by a person earning more.
 Proportional taxes - Same rate for everyone.
2. Once the basis of the bearer of burden: Direct Tax and indirect Tax - The responsibility to pay a tax
is always of the person on whom the tax was levied, except if there are some statutory exceptions. In
certain cases, the person responsible to pay the tax can charge this tax from somebody else i.e. shift the
burden. This is an indirect tax, when he can be it direct.
3. On the basis of levying- Ad valorem and specific- Taxes levied according to the value of the good or
service being transacted are ad valorem. Taxes are levied on the basis of some other features apart from
a value such as weight, length, fuel, environmental impact are specific taxes. Both can be levied together.
Types of taxes:
Value-added tax (VAT): VAT simply refers to sales tax levied in a value-added manner.
Income Tax: Direct tax, levied by the center.
Event of taxation- earning of income by the individual.
Income Tax Act 1961: The IT Act also provides for various exemptions which can be availed to reduce tax
liability by reducing taxable income. These exemptions generally pertain to desirable expenses/investments
by individuals and usually have limitations. Under the act, agricultural income is not taxed as the center does
not have the power. States have the power to tax it. Income is 'widely' defined, i.e. the scope of what is
considered as income is quite wide. 6 sources of Income are defined: wages/salary, agricultural income,
business income, professional income, rental income, and capital gains. Some of these incomes can be clubbed
together and are taxed accordingly, while others are taxed separately.
Corporate tax: Tax paid by companies on their profits, also taxed under the IT Act 1961. Like individuals,
companies can also avail of various exemptions, in their profits for the purposes of calculating the tax burden.
For example, investments by the companies, certain benefits provided to employees, etc. Some exemptions
have limitations, while others may not.
Minimum Alternate Tax (MAT): The companies may reduce their tax burden by availing excessive
exemptions. In order to limit this, the government-imposed MAT under the IT Act 1961.According to this, the
companies will have to pay at least 15% of their book profit (verify the latest update).
Professional Tax: One of the rare direct taxes with states, levied on a professional, and not on the
professional income. Few states levy it and that too only on a few professions. The IT Act 1961 defines 6
professions (Dr, C.A, Lawyer, IT professional, Models, and Interior designers). The states can notify, any other
activity as a profession as well. It is capped at 2500 rupees per person per year.
Capital Gains Tax: Part of IT Act 1961, levied on actual capital gains, i.e. on the gains realized by selling an
asset at an appreciated value. For example, selling lands, shares, bonds, gold, pieces of art, etc at a higher
value. Different assets are taxed differently, with each asset having a distinct long-term/short-term defined
period of holding, according to which the tax on gains also varies.
Wealth tax: Levied on the value of wealth possessed. Presently withdrawn.

Levied in the interest of equity, however, is deemed unjust (double taxation) and has negative effects on the
economy (wealth moves underground, i.e. remains undeclared).
Indirect taxes: Event - production of goods:

 Excise duty: The event is the production of goods (not services), levied by the center, levied on the
producer, who charges it from the buyer. Therefore, the buyer bears the burden. Is now levied, not on the
entire value produced, but only the value added by a producer. This is now called CENVAT/MODVAT.
Event- Change of Boundary:

 Custom Duties: Change of international boundary, levied by the center on the entity in possession of
goods at the time of change of boundary. This entity charges it from the entity, responsible for causing
this change of boundary.
 Octroi/ Entry tax: Change of domestic boundary- State, District, Municipal body. levied by the
administration in whose jurisdiction, the goods enter.
Event- sales:
 Sales tax: Sale of goods within a state- Sales tax levied by the state. Imposed on the seller on the value of
the transaction (the value of a sale), the seller charges it from the buyer and deposits it with the state
government.
 Central sales tax(CST): Sale of goods from one state to another- interstate sale- Central sales tax. Under
Articles, 301 to 307, the inter-state sale of goods is prohibited to be taxed by any state (seller or receiver),
so that the national market does not become fragmented. Central government. gets a right to tax such
inter-state sales and the tax amount collected is given entirely to the state in which the sale originated.
 Service Tax: Sale of Services, levied by the center on the sale of service.
VAT: the sales tax of the state was effectively modified only on the value added and not on the entire
value. Levying a tax on the entire value resulted in overburdening of the final consumer, due to
o Double taxation: taxing the value, which has been already taxed again and again.
o Tax on tax: not just the same value taxed repeatedly but taxation in subsequent stages are also
levied taxes in previous stages as well as on taxes on taxes.
Tax is always levied on the value of the transaction but the purpose is that it should be levied only on the
value added. This is implemented through the ITC system (Input Tax Credit). A seller of goodwill collects a
sales tax on the total value, for example, 10 % Sales tax on 1 crore of rupees of sale, i.e. 10 lakh rupees. This
is his tax liability. To sell these goods he should have procured some inputs, say, worth 50 lakh rupees, and
would have paid a sales tax himself, say, at the rate of 10%, i.e., 5 lakh rupees. The tax paid by him (5 lakhs
rupees), can be used to offset his tax liability of 10 lakh rupees, hence he is now required to pay 10-5, i.e., 5
lakh rupees of tax. this is effectively a 10 % tax on value added by him. (1 crore-50 lakh=50 lakh rupees). ITC
is the system that makes VATting possible. Sales tax was modified, to be levied in this manner in 2005, and
finally was adopted by all states by 2010.
Still, the effect of cascading remained as:

o VATting could be done (ITC could be claimed) only for the same event of taxation, against the same prior
event, i.e. sales against sales, and not sales against excise.
o VATting could be done, only in case of the same authority i.e. ITC could be claimed, only if tax was paid to
the same authority at a prior stage.
For example, sales tax to the UP government could not be offset against sales tax to the MH government.
Hence, to remove the effect of cascading completely, two things were required:
o A single event of taxation.
o A common authority for collecting tax on that event. This was GST.
Compliance Under GST: under the pre-GST system, the cascading of taxes led to an increased burden upon
the final consumer. Thus, the consumer would not be willing to comply. For the seller (collector of VAT), in
order to comply, there were several submissions(returns), to be filed with various administrative authorities.
For example, businesses operating in three states would have to file returns with the centre, and the three
states and also pay taxes to the local bodies- all this was time and effort-consuming, needing around 300
returns to be filed per month. Thus, the seller would also be unwilling to comply with the taxation system.
Further, the cost of non-compliance is not practically the penalty. Rather, it is based on the probability of
getting caught, and then the probability of establishing evasion of taxes. As such, any person supposed to pay
taxes may be willing to pay their chances of non-compliance. The effective rate of all indirect taxes, pre-GST,
was around 33% (10% excise, 14% VAT, 6 % local taxes cascading). Thus, ideally if someone was paying taxes
they would have paid Rs. 33, on a value of Rs 100. That is, the government (Centre as well as States) Indirect
tax to GDP ratio should have been around 33%. The total tax to GDP ratio (Centre and States) (Direct and
Indirect) is around 15-17%, with the centre's share of 11 %, and 5.5% of states. Further Centre's taxes are
equally divided between direct and indirect. Since State taxes are almost totally indirect, the total indirect
tax to GDP ratio is around 11 %- whereas, ideally it should have been around 33%. This implies, that
effectively we were able to tax only one-third of our GDP (Indirect taxes). With GST, we expected increased
coverage due to the lesser cost of compliance and greater cost of non-compliance.
Revenue Neutral rate: It is the rate of tax at which the government collects the same revenue as before,
after the change in the taxation system. For example: If under the GST regime, the government expects to tax
50 % of GDP, as compared to 33 % earlier, which was taxed at 33 % then RNR would be around 22 %.
Laffer Curve: It expresses an idea that government

maximises its tax revenue at some optimum rate
between 0 and 100%. This optimum rate or Laffer
curve is not known in advance. It simply expresses the
idea that tax revenues will not increase only by
increasing tax rates
Tax Buoyancy and Tax elasticity: These concepts are used to ascertain the responsiveness of taxes to factors
that affect them.
Tax Elasticity= (Change in Tax revenue/changes in factors that affect tax Revenue)
Factors affecting tax revenue include changes in taxation structure, changes in the tax system, changes in the
tax rate, changes in compliance etc.
Tax Buoyancy= (Percentage Change in tax revenue/ Percentage change in GDP) = (Growth rate of Taxes/
Growth rate of GDP).
It reflects the sensitivity of the taxes to GDP. A government would want the taxes to be buoyant i.e. having a
buoyancy of more than 1.
Composition Scheme: The composition levy is an alternative method of levy of tax designed for small
taxpayers. The composition scheme aims to bring simplicity and reduce compliance costs for small taxpayers.
Anti-profiteering under GST: It was included so that seller passes on the profit to the customers, and not
just increases his profit.
Tax Evasion: Three terms are used.

 Tax planning: legally allowed ways to reduce the tax burden.
 Tax avoidance: Illegitimate interpretation of tax laws, not yet illegal. For example, in tax avoidance,
business income is shown as agricultural income, which is non-taxable, rental income is claimed as
business income etc.
 Tax Evasion: Avoidance which has been deemed illegal. That is, it is undoubtedly a violation of tax laws.
Companies use various ways to reduce their tax burden. For example, BEPS (Base Erosion and Profit
Shifting), i.e. eroding the income profit base on which taxes has to be paid. They don't declare their profits
or use illegitimate means to shift their profits to a lower tax jurisdiction. One of the ways is RPT (Related
party transaction).

Companies buy goods, at inflated prices from their related companies located abroad to increase their
expenses i.e. reduce their profits. Further, they set up shell companies abroad. These companies merely exist
on paper, but the business is managed from the domestic territories. This is done, to avoid paying higher taxes
in the home country. To reduce BEPS, the government came up with several measures- the most important is
GAAR (General Anti Avoidance Rules), on the recommendation of the P. Shome Committee in 2013, finally
implemented on 1st April 2019.
Some features of GAAR are:

 Advance Pricing Agreement: Companies sign agreements with the government declaring their pricing
strategy in advance to the government. As a result, the government doesn't bother the company with
repeated tax demands. These APAs can be based on certain settled principles of fair pricing, for example,
ALP (Arm's Length principle). Under ALP, the transactions between the two parties, even if related are
such that they are unbiased, i.e. dealing by keeping everyone at an arm's length distance.
 Place of Effective Management (POEM): Taxation requires the determination of the residential status
of the firm. Under POEM rules, the residential status is determined based on the place where management
is effectively carried out, and not where the headquarter may be. Apart from GAAR, efforts to reduce
BEPS, have been made by OECD/G20 countries. These include MLF-ALI (Multilateral framework for
automatic exchange of information), between countries regarding tax filing by MNCs.
 Global Minimum Corporate Tax(GMCT): To ensure that some minimum tax on profits, is paid by every
company across the world, GMCT is proposed. Double Taxation Avoidance Agreements between two
countries are meant to facilitate companies to do business in both countries and pay tax on profits only
in one jurisdiction of their choice. This avoids payment of taxes on the same income at two places (Double
taxation). Companies exploit DTAAs with countries which have very low tax rates. These are called Tax
Havens. These countries have a 0-3 per cent tax rate, and hence, companies declare their profits here, and
devoid the income-generating countries from legitimately taxing this company's profits. With GMCT, the
home country can levy the difference between GMCT and tax paid by the company in Tax Haven, as the
rate at which the company pays the tax in the home country. DTAA would not stop, the country from
levying such tax.
 Equalization levy: This is the tax that the government levies on foreign entities that make revenue from
online advertisements in India.
Vodafone Case: Hutch wanted to exit the Indian market, and Vodafone wanted to enter the Indian telecom
market. Hutch made the capital gains on this transaction.
Hutch established a firm CGP, in the Cayman Islands to avoid the tax. This firm was established only to avoid
the tax, there was no other reason. Effectively Indian assets were transferred, and thus Hutch should have
paid tax by Section 9 of the income tax act. Vodafone won the case in the Supreme Court. The government
moved a retrospective amendment, to be able to tax Vodafone and Hutch for their transaction.
Investment Models
 What is the investment
 Savings and investment
 Investment led growth
 Investment-led growth model
 Types of investment Model
 Factors
What is the investment: Investment is something that will lead to the capital formation or accumulation
of capital goods, It is that part of the final output that comprises physical capital goods. (Gross investment).
Investment in a country is not measured as money put into the business or any economic activity but it is
basically that proportion of final output which consist of capital goods. If the total output or production is
1000 rupees (800 rupees for consumption goods, 200 rupees for capital goods). Gross investment in the

economy=200/1000. Now when the factory runs for a year then wear and tear happens in the factory which
is also called depreciation. Depreciation is also defined as the consumption of physical capital. In the above
example suppose there is wear and tear of rupees 100, this implies that to produce rupees 800 of consumption
goods and rupees 200 of capital goods, there is a loss of rupees 100 of capital goods in the economy that is
a net production of capital goods (investment in the economy is 200-100=100). The term investment is
different for economics and the rest of the world. Purchase of assets like stock, mutual funds, and insurance
products are not investments for economists as they do not add to the net wealth of the nation. Rather they
reflect a credit relationship between two parties. The financial asset of one party in the economy could be
offset by the financial liability of another party. Thus, when we aggregate the wealth of all members of the
economy, these assets and liabilities cancel and there is no creation of new assets. On the expenditure side,
the computation of national income, GDP is represented by GDP=C+I+G+(X-M). Investment is everything
that remains after consumption, government spending, and net exports.
Net investment=gross investment-depreciation
What is investment-led growth: Investment led growth relies on investment to create new capacity
(capacity creation). This creates more employment and hence higher demand while
simultaneously increasing production capacity. In investment-led growth, supply rises in tandem with higher
demand. This leads to increased growth.
Chinese experience of investment-led growth: Chinese introduction of capitalist market principles led to
mass privatisation and opening up of their markets to foreign investment. Due to the availability of cheap
labour, overseas firms started building factories in China to take advantage of cheap labour. Chinese
development strategy increased their focus on larger cities like Shanghai and Beijing. Investment-led growth
model increased production but did not increase the consumption base proportionately which is a lack of
inclusiveness. China was successful in increasing GDP growth but failed to increase household income
growth. The consumption to GDP ratio of China is lower than in India and the household savings rate is also
not as high as in India. India's growth model was different from the investment export-oriented strategy of
China:
 China has derived the predominant part of its growth from external sources both in terms of foreign
investment and export markets. India's growth is from internal sources. India's net export to GDP
ratio has been significantly lower than that of China.
 India has a large trade deficit yet it has managed to grow at reasonably high rates.
 Domestic savings to investment gap in India has been kept at low levels and India has managed to finance
a predominant part of its capital formation from domestic savings.
Factors that will determine the type of growth Model to be followed:

 Demographics of the country.
 Strength of the manufacturing sector.
 Openness of economy.
 Trade balance and economic strength of the country.
 Consumer behaviour.
Reasons for China's shift to consumption-led growth:

 Protectionist policies and move towards deglobalization.
 Ageing population and change in demands.
 Sub-Prime crisis and impact on the external trade of the country.
 Lack of new markets for Chinese goods.
 Changes in consumer attitude and technology.
Reasons for India's shift to investment-led growth:

 Huge Demographic Dividend.
 Aim of emerging as an industrialized country to handle industrialization 4.0.

 To attract more foreign investment in the form of FDI (Foreign Direct Investment), and FII (Foreign
Institutional Investment).
 Need for fiscal and social infrastructure development.
Foreign Direct Investment: Foreign investment which is mainly focussing on setting up subsidiary firms,
investing in greenfield projects, acquiring existing companies, etc. FDI brings in technology and also leads to
the creation of jobs.
Foreign Institutional Investment: It is the investment that generally moves into the Indian stock market.
FIIs are volatile and they are regulated by an institution called SEBI.FII investments above 10% in a
particular company are treated as FDI.
Feasibility of investment-led growth Model:

 Higher rates of inflation will reduce the propensity to save thereby affecting investment.
 Challenges of twin Balance Sheet syndrome. Corporate's balance sheet affects Bank's balance sheet and
vice-versa.
 Infrastructure is a prerequisite for an investment-led growth model. Currently, the government has to
focus simultaneously on infrastructure development along with ensuring welfare.
 High Capital output ratios make investments inefficient. Thereby affecting the economic growth of the
nation.
 Savings-investment gap will increase during the pandemic making it even more difficult for the private
player to channel investment.
 Increase in protectionism, and currency wars will demotivate India's exports.
 Increase in the debt burden of the government will crowd out private investment.
Depreciation of currency =Fall in value of a currency due to market fundamentals. Rupee depreciation is
with respect to a strong currency called Dollar. Depreciation of currency will make exports cheaper and
imports costly.
Currency War: Competitive devaluation of the currency to make exports cheaper.
Harrod- Domar Model: It is the model of economic growth in development economics developed by Harrod
in 1939 and Domar in 1946. The model focused on understanding economic instability by analyzing the
dynamic nature of capital and investment. Major economic determinants like: Natural resources, Population,
Technological Growth, etc. constantly influence two important factors:
1. Rate of investment
2. Capital output ratio
Economic growth=savings*(1/ Capital Output ratio)
Capital Output ratio: It is the ratio of Capital to output. It measures how much capital is required per unit
of output. So, if more capital is required per unit of output then the capital is less efficient. Hence COR
measures the average efficiency of capital.
Capital Output ratio: = Capital/output.
Higher COR is bad for the economy. If COR is (4/1), it means rupees one unit of output is produced from rupees
four units of capital. COR is lower for developed countries in comparison to developing nations.
Relevance of Harrod-Domar: The model was devised for the developed countries to protect themselves from
chronic unemployment. The model focussed on accurate COR and high propensity to save which is generally
absent in developing economies. More the investment in capita, more employment will be generated and
thereby higher economic growth. The Model believed in the virtuous cycle of increased savings transforming
into increased investments which results in higher capital stock causing higher economic growth.

Limitations of the Model: It is difficult to increase the savings ratio in low-income countries. A sound
financial system is lacking in many emerging countries is increased family savings will not be channelized
through the banking systems. Due to human capital deficiencies, assuming a constant capital-output ratio is
difficult. R&D required to enhance COR is frequently underfunded. Borrowing from abroad to make up for a
shortfall in funds leads to an increase in external debt. A rise in capital spending is not always a pre-condition
for economic growth and development.
Lewis Model: In 1954, sir Arthur Lewis published a paper entitled "economic development with unlimited
supplies of labour". This model mainly postulates two sectors:
 Subsistence
 Modern
This can also be termed agriculture and industry. Although Lewis meant a broader class of subsistence which
included agricultural labour, urban poor, domestic servants, etc. Generally, the rural subsistence sector is
characterised by zero marginal labour productivity which is surplus labour that can be withdrawn from the
agricultural sector without any loss of output hence this surplus when shifted to the industrial sector will
improve productivity. There is continuous labour migration from the traditional to the modern sector. Wages
remain constant and low for longer periods of time and economic growth occurs as a rising share of profits
gets re-invested. In the Lewis model eventually, the reservoir of cheap labour gets exhausted. Capital
accumulation slows down and wages get determined by marginal productivity.
Relevance of Lewis Model for India: Nehru's approach was based on Lewis Model. The basic idea was that
India had agricultural labour with very low levels of productivity and this surplus labour when shifted to the
industrial sector. It increases marginal productivity. If the industrial sector is promoted, it will generate profit
and this profit when re-invested back into machines and tools, the capital per worker will increase and this,
in turn, will boost profits leading to capital formation at a faster rate. Thus, the basic understanding has been
that industry is going to be the prime moving force which will put the Indian economy on a growth trajectory.
Criticisms: Capitalists' profits may not be reinvested. Capitalists may focus on capital-intensive
technology which may replace labour. Constant wage rate in manufacturing is questionable.
Mahalanobis Model: During the second five-year Plan (1956-61), Mahalanobis focussed on industrialisation
with a primary focus on heavy industries:
1. Capital goods
2. Basic industries
PC Mahalanobis is an investment allocation model. Mahalanobis two sector theory focuses on consumer
goods and capital goods. ICOR (Incremental Capital Output Ratio) is better for consumer goods.
ICOR: It is defined as how much additional capital will be required to produce one additional unit of output.
ICOR=Change in capital to GDP/change in output to GDP
ICOR represents how efficiently the new additional capital is being used in a country to produce output. If
ICOR of India=6 that means India requires rupees 6 value of extra capital goods to produce rupees 1 of
additional output. Exponential growth is possible in capital goods.
Mahalanobis four sector model focuses on: Agriculture and small-scale industries, Consumer goods,
Capital goods and Services.
Why is the industry as Prime moving force: More job creation, Faster growth, Services cannot be
developed without industry.
Economic Planning: It refers to the allocation of resources in a comprehensive way to achieve the pre-
determined objectives with optimal utilisation of resources. In India, economic planning was adopted in 1951,
in an economic system characterised by the co-existence of the public and private sectors. For four decades,
the Public sector was considered the engine of growth. However, with the beginning of the liberalisation
process, the government started withdrawing from direct involvement in productive activities and hence the
private sector has now become the dominant sector and the public sector is nearly an adjunct to the former.
Rationale for economic planning: The common perception at the time country got independence was that
economic planning, if adopted in India’s democratic framework could put this country’s economy on a high
growth trajectory.
1. Failure of market mechanism:
 When India got independence in 1947, it was economically backward. Keen to develop rapidly in a short
period, it was realised that relying entirely on market mechanisms will not bring inclusiveness. Therefore,
India decided to rely on market mechanisms along with proper economic planning.
 To ensure social justice: In a free enterprise economy, the benefits of economic growth rarely trickle
down, hence in an underdeveloped country like India, state intervention is required for poverty
alleviation along with ensuring social justice.
2. Reasons for failure of trickle-down:

 Excessive focus on PSU-led growth model.
 Our growth process was capital intensive rather than labour intensive.
 Excessive dependence on economic growth without having a direct focus on poverty alleviation till the
fifth five-year plan.
 Inefficiencies with respect to the implementation of government schemes.
 Failure of centralised planning model in terms of achieving inclusiveness.
 Stagnation of manufacturing sector leading to problems like disguised and seasonal unemployment.
 Lack of financial inclusion and financial inclusion is a prerequisite for ensuring inclusive growth.
 Ineffective mobilisation of resources.
3. Need to strike a changed equation with developed countries: India wanted to focus on self-
reliance and it was decided that planned intervention by the state-regulated both trade and movement
of capital and thereby provided a developing country with an equation with the industrialised world
which is less exploitative.
4. Mobilisation and allocation of resources: As India lacks resources, it has to be careful about
the optimum utilisation of resources. Resources should be pushed into socially low-priority areas to make
the growth egalitarian.
Challenges related to long-term goals of planning:

Self-Reliance:
Why Self-reliance: India was dependent on other countries with respect to food security(PL480), and foreign
aid, importing capital goods and technology. Therefore, self-reliance was one of the most important
objectives of India's five-year Plan. Currently, self-reliance is a partial success as India still depends on other
countries with respect to oil, manufacturing technology, etc. India was successful in achieving self-reliance,
especially with respect to food security, Less dependence on foreign aid and development of indigenous
technology
Elimination of poverty: Failure of trickle-down theory, Economic growth was not inclusive, Poverty is
a multi-dimensional concept handling issues like social exclusion, gender equality, political rights, access to
education and health care, and also ensuring social security, No specific strategy till the fifth five-year Plan
(Garibi hatao).
Challenges in the removal of unemployment: Stagnation of the manufacturing sector, Stringent labour
laws, Excessive concessions to MSMEs turning them into dwarfs (10 years of existence but less than 100
permanent jobs), The government did not have a specific strategy in the five-year plans to handle

unemployment, Capital-intensive rather than labour-intensive growth, Inefficient tax policies, Cascading
effect that is the tax on tax increases the cost of the product.
Reduction in income inequalities:

 Improper implementation of the government schemes.
 Excessive marketisation of basic services like primary health care and education.
 India was not ready enough to implement LPG in its true format.
 Over emphasis on the industry over agriculture.
 Failure of trickle down.
Types of economic Planning:

1. Imperative Planning: It is also called authoritative Planning by direction or command. There is one
central authority that decides all aspects of planning. Generally practiced in socialist economies.
2. Indicative Planning: It is also called inducement planning (flexible in nature). Government acts as a
facilitator to encourage the private sector's role in the economy (8th Five Year Plan) 1992-1997.
However, the government regulates the private sector to achieve specific targets. Practised in the mixed
economy which is more inclined towards the private sector.
3. Rolling Plan: Under the Rolling plan every year, three new plans are prepared and acted upon: Plan for
the current year which includes the annual budget. A plan for a fixed number of years (3 to 5 years) is
revised every year as per the requirement. A Perspective plan for 10 to 15 to 20 years. It was introduced
by Janata Government in 1978.
First Five-Year Plan (1951-56): It was based on Harrod-Domar Model. Community Development
Programme was launched in 1952. Renowned economist K.N. Raj was one of the main architects of this plan.
Focus was on- Agriculture, in view of large-scale import of food grains and to achieve food security,
Irrigation (River Valley Projects like Bhakra Nangal, Damodar Valley, Hirakud, etc. were undertaken), Rural
Development, Price Stability, Power Stability
During this plan- National Programme for Family Planning was launched in 1952, State Financial
Corporation Act was passed in 1951, Estate duty was introduced in 1953.
Second Five-Year Plan (1956-61): It was based on the Nehru-Mahalanobis Strategy. Articulated by J.L.
Nehru’s vision and P.C. Mahalanobis was its chief architect. Focus was on rapid industrialisation, self-reliance
and investment in heavy capital goods industries. Advocated huge imports through foreign loans. Based on
the premise that it would attract all-round investment, ancillarisation, build townships and result in higher
rate of growth-the trickle-down effect. Emphasised on import substitution and public sector to provide basic
infrastructure like power, transport etc. However, it shifted basic emphasis from agriculture to industry far
too soon. During this plan, prices increased by 30%, as compared to a decline of 13% during the first FYP.
During this plan- Industrial Policy Resolution of 1956 (IPR 1956) was adopted. Durgapur, Bhilai and
Rourkela steel plants were established in collaboration with Britain, Russia and Germany respectively
Third Five Year Plan (1961-66): At its conception, it was felt that the Indian economy had entered a take-
off stage. Its aim was to make India a Self-reliant and Self-generating economy. Focus was on both Heavy
Industrialisation and Food grains production. Based on the experience of the first two plans, agriculture was
given top priority to support the exports and industry. However, there was a complete failure in reaching the
plan targets due to unforeseen events such as Chinese aggression (1962), Indo-Pak war (1965) and severe
drought (1965-66). India resorted to borrowing from the IMF due to severe foreign exchange crisis. The rupee
was devalued for the first time in June 1966, though technically it was not during the 3rd FYP. India also faced
acute food shortage and United States exported food grains to India in exchange of Indian rupee. The food
aid was popularly called PL480 as it was provided under section 480 of Public Law of US.
During this plan- Food Corporation of India was established in 1965. Industrial Development Bank of
India(IDBI) was set up under the Industrial Development Bank of India Act, 1964. Unit Trust of India (UTI)
was established in 1963. Agriculture Prices Commission was set up in 1965, later it was renamed as
Commission for Agricultural Costs and Prices (CAPC) This also delayed the finalisation of the 4th FYP.
Three Annual Plans (1966-69): Though draft of the 4th FYP was ready, the Annual Plan was planned and
formulated for the next three years due to worsened financial conditions. This three-year period was termed
as Plan Holiday by the critics. During these three Annual Plans, a whole new agricultural strategy was
implemented, involving: Widespread distribution of High Yielding Variety (HYV) seeds under the larger
umbrella of the Green Revolution, Extensive use of fertilisers, Exploitation of irrigation potential, Focus on
soil conservation. During these three Annual Plans, the economy absorbed the shocks generated during the
Third FYP.
Fourth Five Year Plan (1969-74): Based on the Gadgil strategy with main focus on growth in agriculture
in order to enable other sectors to move forward and progress towards self-reliance. First two years of the
plan saw record production. The last three years, however, did not meet the target due to poor monsoon. For
the first time, importance was given to social justice. Bank Nationalisation, privy purse abolition to princes,
results of green revolution, Indo-Pak war were significant developments in this plan period. Family planning
was another important prospect of this plan. Influx of Bangladeshi refugees before and after the 1971 Indo-
Pak war was a major challenge.
During this plan- The Monopolistic and Restrictive Trade Practices Act, 1969 was introduced. The
Command Area Development Programme (CADP) was launched in 1974-1975.
Fifth Five Year Plan (1974-79): It was prepared by D.D. Dhar. It proposed to achieve two main objectives:
Poverty eradication (Garibi Hatao) and Attainment of self-reliance. The following programmes were
launched:
 Minimum Needs Programme to provide certain basic minimum needs and thereby improve the living
standards of the people.
 Directed anti-poverty programme: Twenty-point Programme was adopted in 1975 with the objective of
improving the quality of life of people, especially BPL families.
The key instruments were: Promotion of high rate of growth, Better distribution of income, Significant
growth in the domestic rate of savings.
As emergency was declared in 1975, the plan was terminated and Rolling Plan (1978-83) was introduced by
the new Janata Government in 1978. However, the Rolling Plan too got abandoned due to again a change in
Government in 1980. The Congress Government treated 1978-79 as part of the original 4th FYP and 1979-80
as a separate annual plan. During this plan, Desert Development Programme was launched as a centrally
sponsored scheme in 1977-78.
Sixth Five Year Plan (1980-85): Focus was laid on: Increasing national income, Modernisation of
technology, Ensuring continuous decrease in poverty and unemployment. The plan was adopted with the
slogan Garibi Hatao to alleviate poverty with more targeted approach. A shift was seen from industrialisation
towards infrastructure. Some programmes focused to generate employment were: National Rural
Employment Programme, Integrated Rural Development Programme, Village and Small Industries
Development Programme. The highest financial allocation during this plan went to the Energy Sector.
During this plan- NABARD was established in 1982. Export-Import Bank of India was established in 182,
under the Export-Import Bank of India Act, 1981.

Seventh Five Year Plan (1985-90): The focus was laid on: Rapid growth in food grain production, Increased
employment opportunities and Productivity within the framework of planning, Long term fiscal policy
started. A 3 years’ the export-import policy was announced for the first time. The plan was also termed the
Infrastructure Plan. The import Substitution strategy was given due importance and the economy began its
journey towards gradual liberalisation.
During this plan- Jawahar Rozgar Yojana was launched in 1989, Operation Blackboard was launched in
1987.
Annual Plans (1990-92): The Eighth Plan could not take off in 1990 due to the fast-changing political
situation at the centre and the years 1990-91 and 1991-92 were treated as Annual Plans. The Eighth Plan
was finally formulated for the period 1992-1997.
Eight Five Year Plan (1992-97): Policy of Liberalisation, Privatisation, and Globalisation (LPG) was
undertaken. Structural reforms were adopted and the country’s economic growth model was reoriented. Plan
based on the Rao-Manmohan Singh model of liberalisation. Recasting of the planning model from imperative
and directive (hard) to indicative (soft) planning.
Some of the major outcomes of the plan were:

 Rapid overall economic growth.
 High rate of growth in agriculture, manufacturing, and allied sectors.
 Growth in imports and exports.
 Improvement in trade and current account deficit.
 However, social spending was neglected in this plan.
During this plan- The Employment Assurance Scheme was launched in 1993, Swarna Jayanti Shahari
Rozgar Yojana was launched in 1997, Rastriya Mahila Kosh (RMK) was established in 1993 and Midday Meal
Scheme was launched in 1995.
Balance of Payment: BoP of a country can be defined as a systematic statement of all economic transactions
of the country with the rest of the world during a specific period usually one year.
Components of BoP: Economic transactions with the rest of the world are grouped under two different
accounts:
1. Current account: It shows the export and import of visible (also called merchandise or goods trade
balance) and Invisibles (also called non-merchandise). Invisibles include services, transfers, and income.
If the current Account deficit increases, it may also lead to an increase in inflation, and also government
may land up borrowing more money (increase in fiscal deficit).
Perspective plan: Planning for a long-term period (15-20 years) but not one plan for the whole period.
It is implemented through five-year plans and annual plans. NITI Aayog has adopted this type of planning.
Core plan: The planning authority requests the states to submit their projected revenue estimates. This
helps to prevent states from diversion of funds from the priority sector.
2. Capital Account: It gives a summary of the net flow of both public and private investment into an
economy. Capital Account has two components:
 Investments: FDI, FPI (FII also), NRI deposits.
 Borrowings: ECB (long-term loans taken by corporates) External assistance (soft loans).
Ninth Five-year Plan (1997-2002): It was developed in the context of four important dimensions: Quality
of life, Generation of productive employment, Regional balance, Self-reliance. Priority was also given to
agriculture and rural development. Swarna Jayanti Gram Swarojgar Yojana (SGSY) launched in 1999 and
Pradhan Mantri Gram Sadak Yojana (PMGSY) started in 2000. Privatisation of public sector units was started
in this plan while dis-investment began in the previous plan.
During this plan- Antyodaya Anna Yojana was launched in 2000 and Sarva Shiksha Abhiyan (SSA) was
launched in 2001.
Tenth Five-year Plan (2002-2007): The main objectives were:

Reduction of:
 Poverty ratio by 5% points by the end of the plan period.
 Gender gaps in literacy and wages by at least 50%.
 Decadal rate of population growth between 2001 and 2011 to 16.2%.
 Infant mortality rate to 45per 1000 births by 2007 and 28 per 1000 births by 2012.
 Overall capital outflow.
Increase in:
 8% GDP growth per year.
 Literacy rates to 72% by 2007 and 80% by 2012.
 Forest and tree cover to 25% by 2007 and 33% in 2012.
 Domestic savings, foreign investment, and foreign exchange.
 Universal access to primary education.
Eleventh Five-year Plan (2007-2012): Plan launched amidst emerging Global Financial Crisis (2008).
The major highlights of the plan were:
To increase
 Overall GDP growth from 8% to 10%.
 Agriculture sector growth to 4%.
 The real wage rate of unskilled workers by 20%.
 Literacy rate for persons of age 7 years or above to 85%.
 The sex ratio for age group 0-6 to 935 by 2011-12 and to 950 by 2016-17.
 Forest coverage by 5% points.
 Energy efficiency by 20% points within 2016-17.
To reduce
 Dropout rates of children from elementary school from 52.2% in 2003-04 to 20% by 2011-12.
 The total fertility rate of 2.1%.
 Infant mortality rate to 28.
 Malnutrition among children aged 0 to 3 years to half of its present level.
 Anaemia among girls and women by 50.
Achievements of the five-year plan:

 Increase in economic growth, savings, and investment per capita income.
 Progress in industry and industrial growth.
 Self-sufficiency in the basic and capital goods industry.
 Development in the field of science and technology.
 Diversification of industrial structure.
 Development of economic infrastructure particularly in the field of transport, irrigation, and
telecommunication.
 Improvement in social indicators like IMR, literacy rate, etc.
Criticism of the five-year plan:

 Failure to eliminate poverty.
 Failure to check the growth of black money.
 Planning did not focus on handling unemployment specifically till the seventh five-year plan (lop-sided
employment strategy).
 The concentration of economic power.

 Regional imbalances.
 Centralised nature of planning that is plans were program-driven rather than demand-driven.
 Politicisation of planning process.
 Excessive emphasis on PSUs.
 Agriculture over shadowed by industry.
NITI Aayog: The Planning Commission was replaced by NITI Aayog by the union government after the key
announcement PM Narendra Modi made on Independence Day which came into action on 1st Jan 2015. The
Planning Commission was established on 15th march, 1950 which was set up with an intention of being an
advisory institution with the main motive of Five-year plans.
NITI Aayog was set up on 1st Jan 2015 to provide directions in which the development process can take place.
It was also deemed to be an advisory institution that can advise both central and state governments on
important policy matters. The Chairperson of the committee is the Prime Minister, Governing Council consists
of CMs of states and lieutenant Governors of UTs. Regional Councils are set up to address specific issues, it
comprises of CMs of states and lieutenant Governors of UTs of the concerned region. The whole staff of NITI
Aayog is divided into two hubs:
1. knowledge and innovation hub: It has 12 to 14 verticals that deal with different sectors and builds
NITI's think tank capabilities.
2. Team India hub: It works as an interface between the central government and state government.
NITI Aayog Planning Commission

NITI Aayog cannot allocate funds. These powers IT enjoyed the power to allocate funds to
still remain with the finance ministry ministries and state governments
It has no power to impose policy.
It used to impose policy on states
It is essentially an advisory body
State Governments play a proactive role when it Decisions were more centralised under Planning
comes to NITI Aayog Commission.
It has provision for part-time members No provision for part-time members
The bottom-up approach is followed Top Down Approach is followed
It has Governing Council with Chief ministers of It reports to the NDC comprising of CMs and
states and lieutenant Governors of UTs as members lieutenant Governors
Structural reforms:
1. Foreign Exchange reform: The first important reform in the external sector was made in the foreign
exchange market to resolve the BoP crisis. It included the devaluation of the rupee which also led to an
inflow of foreign exchange.
Deregulation of the industry: The regulatory mechanism in India was introduced in various ways. It
refers to industrial licensing under which every entrepreneur had to get permission from the government
to start a firm or close a firm or decide the number of goods that could be produced. The private sector
was not allowed in many industries and some goods were specifically reserved for small-scale industries.
Industrial reforms removed many of these barriers. Industrial licensing was abolished for almost all
product categories except a few (alcohol, hazardous chemicals, industrial explosives, electronics,
aerospace, drugs, etc). Many goods produced by small-scale industries have now been de reserved and
the market is allowed to determine the prices.
2. Tax reforms: These are concerned with reforms in Government taxation and public expenditure policies
which are collectively known as fiscal policy. Fiscal policy deals with revenues and expenditure of the
government. Steps have been taken to minimise the cascading effect. Since 1991 there has been a

continuous reduction in the taxes on individual incomes as it was felt that high rates of income tax were
an important reason for tax evasion.
Tax Evasion: Escaping from paying tax (illegal).
Tax Avoidance: Companies use loopholes in the taxing system to avoid paying taxes. Tax avoidance is
not illegal.
3. Financial Sector Reforms: It includes financial institutions such as commercial banks, investment
banks, and stock exchange operations. The major aim of financial sector reforms is to reduce the role of
the RBI from being a regulator to a facilitator. Foreign institutional investors such as merchant bankers,
mutual funds, and pension funds are now allowed to invest in the Indian financial market. A bond is
the debt instrument (bond holders=creditors). Share markets are regulated by SEBI. India was following
a regime of Quantitative restrictions on imports through tight control over imports and by keeping the
tariffs very high. These policies reduce the efficiency and competitiveness of the manufacturing sector.
Export duties have been removed to increase the competitive position of Indian goods in the international
market.
World Trade Organisation

 Prebisch Singer Hypothesis.
 History of WTO.
 Principles of WTO.
 Major agreements under WTO.
 Ministerial Conferences
 Dispute Settlement Body.
Prebisch Singer Hypothesis: The traditional theory of free trade proposed by Adam Smith stated that free
trade should result in higher profits for all the nations engaged that is it is virtually impossible for any nation
to produce all their consumption requirements themselves at the least possible cost. A particular country will
find it profitable in producing commodities with a comparative advantage. It should export such commodities
and import other commodities on the basis of economic principles. The developed countries often argue to
promote free trade through organisations like WTO but the conclusions of the above theory can change when
we look at empirical evidence with respect to LDCs. For most LDCs, their comparative advantage lies in the
production of agriculture and other primary products such as cotton, coffee, sugar, etc. It has been
empirically proved that income elasticity of demand is lower for these products in contrast income elasticity
for manufacturing goods is higher. The result of these two effects leads to a decline in the relative price of
primary products and this decline does not lead to a significant rise in demand. These two phenomena
together make export earnings of LDCs highly unstable thus making free trade harmful for them. The above
finding is popularly known as Prebisch Singer Hypothesis. This finding is the issue of conflict between
developed and developing countries on aspects related to international trade. Apart from this, developed
countries are protecting their agricultural market by giving huge subsidies which are adversely affecting
developing countries markets.
Evolution of WTO: The formation of the WTO can be traced back to the economic situation immediately
after the second world war. International economic cooperation was a necessity and to achieve this goal, a
number of international organisations were formed under Bretton Woods conference, 1944. Apart from the
formation of World Bank and IMF, an organisation called ITO (International Trade Organisation) was also
proposed to tackle trade barriers and other issues related to trade. Although ITO was never formed due to a
lack of consensus, another agreement called GATT (General Agreement of Trade and Tariffs) was signed by
23 countries in Geneva. GATT came into existence on 1st Jan 1948 till the formation of WTO in 1995. GATT
was the only multilateral agreement governing international trade. Totally, 8 multilateral trade
negotiations(MTNs) were held under GATT. They tried MTNs to tackle some of the basic issues related to
international trade like tariff and non-tariff barriers but within 40 years of operation of GATT, its members
felt that the system was inefficient to handle the problems of globalising world economy. These issues came
to the forefront during the 8th MTNs of GATT in Uruguay. During the Uruguay round (1986-1994), the talks
took place on many new areas of the trading system like trade-in services, IPRs, etc. Apart from the emergence
of these new issues, differences also arose among member countries on issues like agricultural subsidies, etc.
To tackle this deadlock, Sir Arthur Dunkle proposed the Dunkle draft on the basis of this draft an act was
signed by 123 nations including India on April 15th, 1994 at Marrakech. As a result of the Marrakech
agreement, WTO came into existence on 1st Jan 1995 with its headquarters in Geneva. Currently, WTO
comprises 164 members and the current head of WTO is Ngozi-Okonjo-Iweala.
IPRs (Intellectual Property Rights): It pertains to the protection of IPR and was negotiated during the
Uruguay round. TRIPS came into existence as a result of intense lobbying from the US supported by other
developed nations. Under TRIPS, the IPR owners are granted exclusive rights to a variety of intangible assets
such as works of art, innovation etc. The Justification given for such rights is the monopoly profit that acts as
an incentive for R&D. Prior to the TRIPS agreement, IPR-related trade was governed by Paris Convention.
Paris convention was fairly liberal in giving the national government the right to decide on the subject matter
of the patents, trademarks etc.
The two important agreements under TRIPS are:
1. The agreement to shift from the necessity of the process patents to product patents in the field of food,
medicine, and chemicals i.e. in the new regime the same product cannot be produced using a different
process. If a product is patented, it is valid for a period of 20 years while in the case of copyrights, the
protection is generally for 50 years and at times, even after the lifetime of the author.
2. The scope of IPR is extended to cover patents, Geographical Indicators, Industrial designs, layout designs
of Integrated Circuits and also protection of undisclosed information. The obligation is applicable equally
to all member nations. However, the developing counties were allotted extra time to implement these
changes to their national laws. The transition period for the developing countries expired on 01st Jan
2005 and hence the regime of product patents has now been introduced into these countries. For LDCs, it
is 2016 and is currently extended to 2023 with respect to certain aspects.
Patents Amendment Act, 2005: India passed this Act with a focus on product patents for food, chemicals
and drugs. India was required to introduce a product patent regime by the year 2005 (TRIPS) Prior to 1970,
80% of our pharma market was occupied by MNCs. 1970s Patent Act granted process patents i.e. India had
permission to manufacture generic drugs beneficial not only for India but also for other third world countries.
Highlights of Patents Amendment Act, 2005:

Introduction of the provision for enabling the right of compulsory licensing and parallel imports to meet the
public health crisis. The Discovery of a new form of a known substance does not qualify a product for a patent.
Nor a mere discovery of a new use will qualify the product for a patent. Product patent protection for pharma,
food and chemicals.
Safeguards:
 Compulsory Licensing: The government may issue compulsory licensing to a company for producing
generic drugs when faced with a public health crisis. Some amount of royalty or compensation is given to
the patent holder. Examples include Nexavar.
 Parallel Imports: These are drugs imported from other countries where they are sold at lower prices to
meet a public health crisis. These imports are allowed if there are no manufacturers in the country facing
the public health crisis and the pharma company that holds patents is reluctant to lower the prices of
those drugs.
Way Forward: It is discussion and not confrontation because India needs foreign technology and investment.
Favouring India Stance: In India, patents are issued after due process and not arbitrarily. There are very
few instances of using flexibilities. This clearly indicates that India uses these safeguards seriously. In the
recent past, despite strong recommendations from the health ministry. The government refused to give
compulsory licenses for the production of the copy of Bristol Myer Squibb, a cancer drug known as Desatinium
in India. This clearly indicates that India didn't misutilise the safeguards for its vested interest.
Principles of WTO:
1. Trade Without Discrimination:
o Principle of Most Favoured Nation: In international economic relations and international politics, MFN
is the status or level of treatment accorded by one state to another in international trade. The term means
the country which is the recipient of this treatment must nominally receive equal trade advantages as
the most favoured nation by the country granting such treatment. In a nutshell, MFN is a non-
discriminatory trade policy as it ensures equal trading among all WTO members. Exceptions: Regional
Trade Blocs, Bilateral FTAs.
o Principle of National Treatment: It means treating foreign and local goods equally. This principle is
also found in all 3 main WTO agreements (Article 3 of GATT, Article 17 of GATS, Article 3 of TRIPS).
National treatment only applies once a product, service or item of intellectual property has entered the
domestic market. Therefore, charging customs duty on imports is not a violation of the national
treatment, even if locally produced products are not charged an equivalent tax.
2. Principle of Predictability of Trade Rules: The multilateral trading system is an attempt by the
governments to make the business environment stable and predictable. In WTO, when countries agreed
to open their markets for foreign goods or services, they bind their commitments.
3. Principle of Fair Competition: Though WTO is described as a free trade institution, the system allows
tariffs in limited circumstances. It also allows other forms of protection in spite of rules like non-
discrimination. Fair competition aims to reduce dumping, predatory pricing, excessive non-tariff barriers
and also issues related to rules of origin etc.
4. Free trade/Improved market access: Lowering trade barriers is one of the most obvious means of
encouraging trade. The barriers concerned include customs duties/ tariffs and measures such as import
bans or quotas (quantitative restriction) that restricts the quantity selectively. Free trade focuses on
converting non-tariff barriers into tariff barriers and reducing tariff barriers progressively.
GATS (General Agreement on Trade in Services): It is the first and only multilateral agreement that
governs international services trade. It was negotiated as a part of the Uruguay round in response to the
growing importance of services in global trade and the rise of the services sector.
Purpose: To establish a credible and reliable system of international trade rules. It is also based on the
principle of non-discrimination. To stimulate economic activity through guaranteed policy bindings and
promote trade and development through progressive liberalisation.
Modes of Services: It divides services into 4 categories: Cross-Border trade, international consumption,
commercial presence and natural person's presence.
Mode 1: It includes the cross-border supply of services. It is where the commercial presence of a service
provider is not required. Examples include distance learning, BPO services etc.
Mode 2: It includes the consumption abroad or services consumed abroad. Examples include tourism,
education, medical treatment etc.
Mode 3: It includes the commercial presence of the service provider. Examples include hotels, banking etc.
Mode 4: It includes the movement of natural persons. Examples include a foreign national who works as a
consultant or employee in another country delivering services such as a doctor, nurse, IT engineer etc.
Note- The developed countries are more inclined towards liberalising norms with respect to mode 2 and 3
services but restricting services related to mode 4 & mode 1.

TRIMS Agreement: During Uruguay Round, the US proposed an agreement not only focusing on investment
but also on national treatment. The proposals were rejected by many developing countries, and the scope of
TRIMS was thus restricted to four specific trade-related investment measures.
 No Restriction on Local Content Requirements: That is, to use local inputs by the foreign investor.
 Trade balancing requirement: The foreign investor should not be forced w.r.t. Balancing trade, i.e.
forcing the foreign investor to produce for exports as a precondition to obtain imported goods as inputs.
 Export Restrictions: Not to export more than a specific proportion of local production.
 Forex Restrictions: The foreign player should have easy access to foreign exchange. Member states were
given a transition period during which these notified TRIMS have to be implemented. For developed
countries, this period was 2 years, and for developing countries and LDCs, it was 5 years and 7 years
respectively. TRIMS cover aspects related to goods only.
Agreement on Agriculture: Signed by the end of the Uruguay Round, and it provides for a framework w.r.t.
Long term reforms related to agricultural trade and agricultural policy, so that market orientation for
agriculture can increase gradually. The Agreement on Agriculture has 3 components under it: Reduction in
domestic subsidy, Reduction in export subsidy and Improved market access.
Reduction in Domestic Subsidy: The agreement mainly divides subsides into: Trade distorting and non-
trade distorting subsidies, which were categorized under 3 different boxes:
1. Amber Box: All trade-distorting subsidies are part of Amber Box. The total reduction commitment in
Amber Box is expressed in terms of the total Aggregate Measure of Support (AMS), which includes all
support given for a specific product. This agreement stipulates the reduction of total AMS by 20% for
developed countries over a period of 6 years. While the developing countries were required to reduce the
total AMS by 13% over a period of 10 years. If a member nation wants to avoid reduction commitments
under AMS, the total subsidy given under AMS must be less than 5% of the total value of production for
developed countries and 10% for developing countries. Such as level of subsidy is known as the De
Minimis level of subsidy.
2. Green Box: The subsidy under Green Box is considered completely under non-trade distorting subsides,
and hence it is excluded from reduction commitment, this box mainly contains fixed payments to
producers for environmental programs, rural infrastructure, protection of plants and animals, etc. as
long as these programs do not affect the current production level.
3. Blue Box: It is an exception from the general rule that all subsidies linked to production should be kept
at the De Minimis level. It is related to production limiting agreements whose origin can be traced back
to Uruguay Round negotiations between the EU and US.
Reduction in Export Subsidies: Apart from domestic subsidies, developed countries also give export
subsidies to enable their farmers to export their agricultural products at lower prices, which makes the
competition tougher for LDC farmers. The AOA required developed countries to reduce their export subsidies
by at least 36% by value or by 21% by volume over a period of 6 years. For developing countries, the reduction
commitment is 24% by value or 14% by volume over a period of 10 years.
Free Trade/Improved Market Access: Market access refers to the abolition of existing non-tariff barriers
in agriculture and converting them into tariff barriers. Subsequently, it also requires progressive reduction
of tariff barriers also. Developed Countries are required to reduce their tariff line by 36 percent in 6 years.
And the corresponding reduction for developing countries is 24% for 10 years.
Structure of WTO:
 Ministerial Conference: The highest decision-making body in WTO is the Ministerial Conference. It
usually meets every 2 years. The Ministerial Conference can take decisions on all matters under any of

the multilateral trade agreements. The first ministerial conference took place in 1996: Singapore
Ministerial Conference.
 General Council: It has representatives, usually, the ambassadors from all member governments, and
has the authority to act on the behalf of the Ministerial Conference. The General Council also meets under
different rules:
 As a dispute settlement unit.
 Trade Policy Review Body.
 General Council.
Dispute Settlement Body: The General Council convenes as the Dispute Settlement Body to deal with
disputes between WTO members. Such disputes may arise with respect to any agreement contained in the
final act of the Uruguay Round.
The Dispute Settlement Body focuses on:
 Establishing Dispute Settlement Panels.
 Refer matters to arbitration.
 Adopt Panel/Appellate Body/Arbitration Reports.
 Maintain surveillance over the implementation of recommendations and rulings contained in such
reports. And authorize the suspension of concessions in the event of non-compliance with those
recommendations and rulings.
Appellate Body: It was established in 1995 under Article 17 of the Understanding of Rules and Procedures
governing the settlement of disputes. The Dispute Settlement Body should appoint persons to serve on the
Appellate Body for a 4 years term. It is a standing body of 7 persons, that hears appeals from reports issued
by the panels with respect to disputes brought by the WTO members. The Appellate Body can uphold, modify
or reverse the legal findings and conclusions of a panel. The Appellate Body report once adopted by the DSB
must be accepted by the parties to the dispute. DSB is losing relevance as the multilateral nature of WTO is
being diluted because of countries like the USA. The US is also blocking the reappointment and also the new
appointment of the judges in the dispute settlement system.
Trade Policy Review Body: The General Council meets as the Trade Policy Review Body to undertake trade
policy reviews of members under the TPRB. And to consider the Director General’s regular reports on Trade
Policy Development. The TPRB is open to all WTO members.
Singapore Ministerial Conference 1996: Singapore Conference revolved around 4 issues, popularly known
as Singapore issues.
 Investment.
 Competition policy.
 Procurement.
 Trade facilitation.
The main reason given by developed countries for the introduction of the first 3 issues was the WTO principle
of national treatment. They argued on the basis of this principle that foreign goods and investors should be
given equal rights as locals, and the government should be prevented from giving special preferences to local
investors and firms. The first issue of investment was also discussed under the TRIMS
agreement during Uruguay Round, it says that foreign investors should be allowed to enter and establish
businesses in member countries with minimum restrictions. The second issue of competition aims to give
greater market access to developed countries. According to the third issue, i.e. government procurement, the
government should not give special preferences to local companies for the supply of goods and services, and
also w.r.t. Granting concessions for implementing projects. The fourth issue states that the rules and
procedures related to trade facilitation in developing countries should be the same as that in developed
nations, it ignores the differences between developed and developing countries. Although the first 3 issues are
derived from the WTO principle of national treatment, they have been criticized both in principle and
practice. Investment is generally not a trade issue and bringing it within the ambit of WTO can distort the

trading system. Further, developing countries argue that, if the proposed agreements are implemented under
WTO, they would find it increasingly difficult to devise their own developmental policies and would no longer
be allowed to support their domestic industries. In addition to the above, there was a green room mechanism,
that was visible under Singapore Round.
Doha Conference Round or Doha development agenda: Doha development agenda is the most important
trade negotiation under WTO. The main agreements under DDA included
1. Agriculture: It has become the most important and controversial issue. Doha declaration called for
strict implementation of the agreement on agriculture. The US was opposed by developing counties to
significantly reducing their domestic support for agriculture. The US was insisting upon a reduction in
tariffs and limiting the number of import-sensitive and special products that would be exempted from
tariffs cut
 Special product: These agro-products are of particular importance for farming for reasons of food
security, rural development, etc.
 Non- agricultural market access [NAMA]- These are products that are not covered under AoA and
GATS, in practice, the NAMA products include manufacturing goods, fuel, and fisheries. NAMA products
are important as they account for almost 85% of the world's merchandise exports. DDA called for a
reduction of tariffs and non-tariff barriers on these products by May 2003, but the deadline was not
followed.
2. Implementation issues: They are related to the effective implementation of all aspects discussed during
the Uruguay round. Developing countries claim that they had problems implementing agreements
because of limited capacity. They also claim that they have not realized certain benefits which were
expected from the round
3. TRIPS & Public Health: The issue involves a balance of interest between pharma companies of developed
countries and public health issues in developing nations. To tackle this problem a draft was prepared by
The TRIPS council chairman which allowed the government to issue compulsory licensing.
4. Special and differentiated treatment [S&D]: There remains a conflict between developed and
developing nations on how S& D provisions will be put into practice. While developing countries want to
negotiate the developed countries wanted to steady them further.
India & Doha round: India backed SSM [special safeguard mechanisms] to protect its farmers from an influx
of imports.
SSM [special safeguard mechanism]- SSMs will allow Developing countries to temporarily decrease import
duties on farm products so as to counter a sudden increase in imports and price falls. This mechanism will
empower developing countries to impose additional duties on farm products. When their imports breached
specified ceilings and prices. India wanted developed countries to cut their trade-distorting farm subsidies,
especially with respect to agriculture. India needs a long-term solution with respect to public stockholding.
India also stated that GI IPR [Geographical indication intellectual property rights] protection should not be
confined to Wine and spirits but should be expanded to other products like Basmati rice. India advocated for
limits on the use and misuse of biological and genetic resources as well as traditional knowledge. India
advocated duty-free and quota-free market access for LDC [least developing countries] exports.
Bali ministerial conference: Took place in 2013. It was the 9th ministerial conference.
 India expecting a permanent solution to public stockholding [Background - NFSA- 67% of the
population was covered so we were ready to cross the de-Minimis level of the subsidy]. We got a
temporary relief in the name of the Peace clause till 2017 [specifically with respect to amber box
subsidies]
 Trade facilitation agreement [TFA]- Easy custom clearances, single window clearance, everything has
to be made online, reduce Red Tapism, hierarchy was to be handled.
 Promoting LDC exports- India was also supporting duty-free and quota-free market access for LDC.
Nairobi Ministerial conference 2015: It was the 10th Ministerial conference.

Outcomes:
 Special safeguard mechanism:
 The emergence of new issues: Some developing countries were attempting to categorize nations such
as India and China as emerging economies instead of developing countries. Rich countries wanted to
revitalize WTO by introducing new issues often called emerging trade issues.
1. Labour and environmental standards.
2. e-commerce.
3. Competition and investment provisions.
4. Transparency in government procurement.
5. Environmental and sustainable goods are produced using clean and green energy.
6. Transparency in state-owned enterprises and designated monopolies.
7. Supply chain management.
India's stand on new issues: India has made it clear that it will not sign any binding agreements. The issues
of labour and environment should be discussed under concerned international bodies such as ILO, and
UNFCCC. India wanted developed countries to include human capital movement under the category of new
issues. India also wanted rich countries to drastically reduce their trade-distorting farm subsidy. India wants
on priority a permanent solution to the issue of public stockholding. India was also looking for Effective
implementation of the package for LDCs including duty-free and quota-free market access.
Note- Developed countries accepted to remove export subsidies with respect to agriculture with immediate
effect and developing countries will do it by the year 2019 except for marketing and logistics subsidies which
will be removed by 2023.
Buenos Aires ministerial conference: It was held in 2017. It ended up without any declaration because of
a lack of consensus. Trump wanted to discuss the development issues Emergence of pressure groups.
[discussion on the particular issue which was not related to trade] Fisheries-related subsidies- Preventing
harmful fishery subsidy [signed in Geneva 2022]. Women-related aspects. Work on discussing the new issues
raised in the Nairobi ministerial conference. India's stand- India said that the WTO platform should be used
to discuss trade-related issues and not the other issues which can be discussed on the multilateral platform.
Geneva Ministerial conference 2022: It was the 12th Ministerial conference. Members committed to a well-
functioning dispute settlement system accessible to all members by 2024.
1. Agreement on global food security- Members agreed to a binding decision to exempt food purchases
by the UN's World Food Program for humanitarian purposes from any expert restriction due to COVID
and War.
2. Agreement on COVID-19 vaccine production- WTO members agreed to temporarily waive intellectual
property patents on COVID-19 vaccines without the consent of the patent holder for 5 years. The current
agreement is a milder version of the original proposal made by India and south-Africa in 2020, where
they wanted a broader intellectual property waiver on vaccines, treatments, and diagnostic tests.
3. e-commerce transactions- India asked WTO to review the extension of the moratorium on customs
duties on e-commerce transactions which included digitally traded goods and services. All the member
countries agreed to continue the moratorium until the subsequent ministerial conference or March 31st,
2024 depending upon whichever comes first.
4. Curb harmful subsidies: Curb harmful subsidies on illegal, unreported, and unregulated fishing for the
next 4 years, India and other developing countries were able to win some concessions in this agreement
i.e. small-scale artisanal and traditional farmer would not face any restrictions under this agreement.
Issues raised by India- Permanent solution with respect to Public stock holding. Reserving Special and
differentiated treatment [S& D]. Another critical issue for India is that it is not allowed to export food grains
from publicly held stocks.
Agreement beneficial for LDC countries:
 Agreement on Textiles- a case study of Bangladesh- It has revoked the earlier agreement of multi-fiber
agreement- [in multi-fiber agreement, developed countries were allowed to block the export of textiles
by imposing the non-tariff barriers [Quantitative restriction].
Agreement on sanitary and phytosanitary measures:

 The agreement on SPS provides guidelines for member countries to adopt measures related to food
safety and plant & animal health from various biosafety risks arising from trade. These risks are usually
related to pests and diseases and may come from risks arising from toxins and contaminants in food and
feed. While importing items members can adopt restrictive measures under the SPS agreement, Thus SPS
provides bio-security measures that are applied to protect human, animal, plant life, or health. WTO
gives detailed guidelines for the enforcement of sanitary [human/animal life or health] and
phytosanitary [Plant life/health] measures that may affect trade. SPS allows countries to set their own
standards but SPS regulations must be based on science. They should be applied only to the extent
necessary to protect Human, animal, or plant life/health. Measures under SPS should not be arbitrary to
protect one's trade. During COVID several countries imposed SPS on the import of agricultural goods and
other items fearing disease spread. To enhance transparency members should notify the measures under
WTO. AS per WTO data, out of 175 notifications related to COVID, 40% were submitted under the WTO's
agreement on technical barriers to trade, and 25% were notified under the SPS agreement.
Food security in India:

Concept of PDS: PDS can be distinguished from private distribution in terms of control exercised by public
authorities and the motive is predominantly welfare rather than private gain. Broadly the system includes
all the agencies that are involved from the procurement stage to the final delivery of goods to the consumer.
The agency involved in the process of procurement, transportation, storage, and distribution is the FCI [food
corporation of India]. At the state level, it is the state civil supplies department and fair price shops that are
agencies involved in the provision of PDS. Fair price shops [FPS] are the links in this process which are mostly
owned by private individuals. Procurement of cereals is undertaken by FCI on behalf of the central
government. Some state government agencies also procure grains for the central pool as well as their own
account. Allocation to different states is made by the government and fair-price shops are not allowed to sell
other than government-supplied essential commodities. Specific quantities are allocated to each FPS
depending upon the number of ration cards attached to the FPS. The prices of these commodities are fixed
by the government and the FPS dealer has to procure a license to run them.
Evolution of PDS: Food security is not only about security but also deals with Availability, affordability,
stability, and nutrition. The growth of PDS in India can be grouped into three-time periods.
 Stage I- 1945-65: In the first period up to the mid-1960s, PDS was seen as a mere rationing system for
the distribution of scarce commodities, and later it was seen as a fair price system in comparison with
private trade. Rice and wheat occupied a very high share in food grain distribution. The need for
extending PDS to rural areas was realized but not implemented. The operation of PDS was irregular and
dependent on the import of PL-480 with little internal procurement. In effect, imports constituted a
major proportion of the supply of PDS during this period. The procurement prices offered were not
remunerative.
 Stage II- 1965-75: By the mid-60s it was decided to look much beyond, the management of scarce
supplies in a critical situation. Stoppage of PL-480 imports forced the government to procure grains
internally in effect India took a quantum league in the direction of providing a more sustainable
institutional framework for food security. The setting up of FCI and the bureau of agricultural cost and
prices in 1965 marked the beginning of the second phase. The food security system during this period
evolved as an integral part of the development strategy to bring about a striking technological change
in selected food crops, especially rice and wheat.

 Stage III- 1975-Today: In the third phase, there was an increase in food grain production. The buffer
stock accumulation also increased in the FCI and hence the initial emphasis on buffer stock maintenance
shifted to an increase in PDS supply. During the 5th and 6th, five-year plan the government focussed on
plans like Garibi Hatao (poverty alleviation) along with reducing overstocking of food grains. The
imports gradually decline and India became a net exporter by 1975. Till the late 70s, PDS was largely
confined to the urban population and did not guarantee adequate food to rural poor in times of crisis.
During the early 80s, some state governments extended the coverage of PDS to rural areas and also
introduced a targeted grouping approach (Tamil Nadu, Andhra Pradesh, Gujarat, etc). The PDS which
started to meet crisis situations was transformed into an instrument for efficient management of
essential consumer goods necessary for maintaining stable price consideration. PDS has been designed
and implemented by both the central and state governments. The central government mainly deals with
buffer stock operations and controls the external and internal trade of food grains. The state government
focuses on distribution and identification.
Challenges in implementation of PDS:

o Leakage and corruption.
o Inclusion & Exclusion errors.
o Government burden (Fiscal burden).
o No appropriate grievance redressal system.
o Lack of quality issues.
o Challenges with respect to inefficiency in FCI.
o Issues in procurement (open-ended for rice & wheat).
Terms with respect to PDS:

1. Food Corporation of India (FCI)- It was set up under the food corporation act 1964 in order to fulfill
the following objective:
 Distribution of food grains throughout the country for PDS.
 Maintaining a satisfactory level of operational and buffer stock to ensure national food security.
 Effective price support operation for safeguarding the interest of farmers.
2. Central issue price- Prices at which FCI and central government sell food grains for PDS to states.
Generally, it will be set at half the economic cost incurred by FCI for BPL and at full economic cost for APL
households. Economic cost comprises procurement cost and cost of distribution.
3. Fair price shops (FRP)- Essential commodities like rice, wheat, sugar, iodized salt, and kerosene are
being distributed to the targeted cardholders as per eligibility and rates fixed by the government.
Minimum support price (MSP): MSP is recommended by Commission for agricultural cost and prices
(CACP). It takes into account several factors like:
 The cost of production.
 Changes in input cost.
 Input/output price parity.
 Demand and supply.
 Other micro and macro level data to determine MSP for the season.
Benefits of MSP:
 Ensure stable income for farmers.
 The stability of prices ensures the stability of supply for the next season as well.
 It also protects farmers from money lenders.
 It acts as insurance against price volatility.
 It allows farmers to be able to use the higher returns to invest in mechanization.
Issues of MPS:
Calculation issues- currently MSP is calculated using actual cost.

MSP=1.5XA2+FL.
A2= Actual cost.
FL= Imputed cost of the family about.
M.S Swaminathan and farmers want MSP to be calculated based on comprehensive cost (C2).
C2 included imputed rent on land and interest in the capital which makes the cost of production much higher
than the level at which CACP bases its recommendations. Only 6% of the farmers are benefitting from MSP
(NSSO report). Exploitation by the middle man and agent defeats the purpose of MSP. It leads to
overproduction (cereal-centric production). MSP distorts the market because the government procurement
agencies procure 70%-80% of rice and wheat forcing out private players.
Challenges of PDS:
The TPDS currently suffers from a number of issues that makes it difficult to achieve the objective of food
security: A Large number of families living below the poverty line have not been enrolled, Errors in the
categorization of families that lead to BPL families getting APL cards and vice-versa (inclusion & exclusion
errors), Significant portion of benefits provided to the APL category under TPDS is not availed by the intended
beneficiaries and instead diverted out of the system, Problems of Ghost beneficiaries increasing the Fiscal
burden of the government, Scale and quality issues of food grain, Problems of grievance redressal, Inefficiency
of FCI.
Reforms to improve the PDS system:

 One nation one ration card or integrated management of PDS- Launched in all states and UTs to
ensure nation-wise portability of ration card holders under the National food security Act. Through this
migratory ration card holders can receive their entitled food grains from any FPS in India.
 Automation of FPS- Through the installation of electronic point-of-sale devices ensuring end-to-end
computerization.
 Use of GPS technology- To track the movement of trucks carrying food grains from state depots to FPS.
 Direct cash Transfer (DBT)- Where the subsidies are directly transferred to the bank account of the
beneficiary.
 PDS and UID synergy- To enable distribution of food grains to beneficiaries after biometric
authentication.
FCI reforms (Shanta Kumar Committee recommendation):

Procurement:
 No open-ended procurement.
 Appropriate quality check.
 Decentralised the procurement system.
 Popularising warehouse receipts.
Storage:
 Optimization of storage mechanism.
 Use of silos instead of gunny bags.
 Forex as reserve to import food grain.
 Privatization with respect to building warehouses, cold storage facilities, etc.
Transportation:
 Using containers instead of Gunny bags
 Mechanization
 VRS to permanent staff
Distribution:
 NFSA should cover 40% of the population.

 A direct cash transfer to the lady of the house.
 Six months ration at once.
Criticisms of Committee: It was criticized that the committee recommendations are just to value the
commitments under WTO and not to support the citizen. Bringing private players into the ecosystem will
increase the cost for the final consumer. The opposition of trade unions. Using critical resources of forex for
food security may not be appropriate. Committee recommendations are based on NSSO data which can be
faulty.
Land reforms:
Abolition of Zamindars/intermediaries:
Tenancy reforms:
 Regulation of rent
 Security of tenure
 Ownership rights
Reorganization of agriculture:
 Land ceiling
 Consolidation of land holding
 Cooperative farming
At the time there were three types of land tenure systems prevalent in the country Zamindari, Mahalwari,
and Ryotiwari. In all three systems, the usual practice adopted was to get the land cultivated by tenants.
There are three types of tenants:

1. Occupancy- They enjoyed permanent and heritable rights on land, they had the security of tenure, and
could claim compensation from the landlord for any improvement effected on land.
2. Tenant at will- They did not have security and could be evicted from the land anytime.
3. Sub Tenant: The position of the sub-tenant was similar to tenants at will with the only difference being
that the sub-tenants were appointed by the occupancy tenant.
Objectives of land reforms: Assure equality of status and opportunities to all sections of the rural
population to eliminate all forms of exploitation and social justice within the agrarian system and to provide
security to the tiller of the soil. Reducing rural poverty and abolishing intermediaries.
Measure taken by the government to achieve the objectives:

1. Abolition of intermediaries: Even before Independence, it was widely recognized that the main cause
of stagnation in the economy was stagnation in the agriculture sector. This could be largely attributed
to explorative agrarian relations and the chief instrument of exploitation was the Zamindar promoted
and patronized by the alien government. Approximately 57% of the area of the country was under the
Zamindari system on the eve of Independence. In some states, legislation was passed for the abolition of
Zamindars before 1951 but in more states, it was implemented during the period of the first five-year
plan. The process of initiation and passage of the bill for Zamindari abolition has taken a very long-time
example UP zamindari abolition act took four and half years to become law. Once the stage of legislation
is completed new difficulties were realized during implementation. Zamindars were not willing to lay
down their lands and turned to courts and the legal battle between zamindars and the state government
took an unduly long time. In spite of losing the battle, zamindars refuse to hand over land records and
other documents. The biggest loophole in the legal system was the one pertaining to the permission to
obtain land for personal cultivation (zamindars could evict tenants for this purpose). Personal cultivation
was loosely defined to include personal supervision by the zamindar or members of his family. The policy
laid down in the first five-year plan was that the zamindar could assume land for personal cultivation up
to a ceiling limit and the tenant could acquire permanent and heritable rights only over and above the
ceiling limit. Subsequent changes were brought in during the second five-year plan to refine the definition
of personal cultivation by adding aspects like: Risk of cultivation, Labour & Personal supervision. Though
the official documents claim that the zamindari system has been completely abolished yet the fact is that
it originated in a different format. They are now designated as big land owners and along with the rich
peasantry, a new dominant class of rural capitalists has emerged. Despite the above observations, the
government was largely successful in reducing the exploitation and oppression of tenants and reforming
the feudal rural structure of the country.
2. Tenancy reforms: They focussed on the following aspects:

 Regulations of rent: In the pre-independence period, the rent charged by the zamindars was exorbitant.
The British government was only interested in the share and therefore it has given unlimited powers of
suppression to the zamindars. It has been estimated that in Punjab as much as 80% of the product was
extracted from the tenant in the form of rent. In Bombay, it was around 40-50%. The first five-year plan
stated that the maximum rent should be fixed at 1/4 or 1/5 of the total produce. Excepted states like
Punjab, Haryana, Andhara Pradesh this limit was adhered to by most of the states, however, legislation
fixing the maximum limit of rent has often been violated because of the strong socio-economic and
political hold of land owners in the rural areas. This is partly due to the fact that in some of the areas
sharecroppers are not aware of the legal provisions but more importantly because of the fact they are
economically and socially weaker they could not assert their rights. Even when the law provides for the
security of tenure the tenants are not in the position to assert their rights as most of the leases are oral
and informal.
 Security of tenure: Legislations related to the security of tenure focussed on the following:
o Ejectment of tenants should take place only in accordance with provisions of law.
o Land may be resumed by the owners only for personal cultivation.
o In the event of reassumption of land the tenant is assured of the minimum prescribed area
The implementation of the law depends on the following: Definition of the word tenant, Status of land
records, Definition of the term personal cultivation.
The circumstances in which the land owners are allowed to resume tenanted land for cultivation. In all the
tenancy laws of the country persons who cultivate the land of others on payment of rent either in cash or kind
or both are treated as tenants, however, in some states like UP and West Bengal sharecroppers (who pay rent
by division of produce) are not regarded as tenants. Thus, all laws aiming at protecting tenants do not help
them. The rights of resumption combined with the flaws with the definition of personal cultivation have made
tenants insecure. It was an account of this fact that the 4th five years plan recommended that all tenancy
should be declared non-resumable and permanent except in cases of land owners in Defence, suffering from
a disability. Another serious problem is related to voluntary surrenders. Many landlords compel the tenants
to give up the tenancy on their own accord and no law can help the tenants if they give up their rights
voluntarily. laws related to the security of tenure can be implemented effectively only if current and up-to-
date land records are available. A person can claim himself to be a tenant only if his name appears as such in
the land records. However, it has been observed that in many states either no records of tenancy exist or they
are incomplete or outdated.
Ownership rights to the tenant: It has been repeatedly emphasized that ownership rights should be
conferred on the tenant (five-year plan). Some states have passed legislation to confer rights of ownership,
however, on a whole, the process has been very unsatisfactory and it was envisaged in the 6th five-year plan
to confer ownership rights to all tenants by the year 1982. For a long time, many tenants did not exercise
their rights due to reasons like: Many tenants could not afford to pay the purchase price, many for unwilling
to purchase the land reflecting the dominant controlling power of the land owners.
Evaluation of land reforms:

1. Snags in legislation:
 Definition of personal cultivation- It was highly unsatisfactory; nowhere did it mean what it should
have actually meant i.e. cultivation by one personal labour. In most states personal supervision was taken

to be part of personal cultivation i.e. It would suffice if supervision is done by any member of the landlord's
family.
 Transfer of land to family members- To escape the laws related to the land ceiling zamindars indulged
in large-scale transfers of land to their family members for quite some time there was no law in some
states to prevent such transfers and in states in which such laws existed the benevolent definition of
personal cultivation provided sufficient scope for zamindars to break the law.
2. Definition of the words tenant was inadequate:

 Lack of political will: Radical laws like land reforms aimed at restructuring the entire property relations
require a substantial amount of courage and determination for implementation. In the context of socio-
economic conditions prevailing in the rural areas of the country, no tangible progress can be expected in
the absence of a requisite political will. The lack of political will is clearly visible due to large gaps
between policy and legislation and between law and its implementation.
 Apathy of Bureaucracy:
 Improper updation of land records:
 Inadequacy in land ceiling laws: The levels of ceilings among different states and within the different
areas of the state differed considerably, this created a lot of confusion and frequent dispute. Accordingly,
a conference of state ministers was held in July 1972 to bring uniformity in ceiling laws, however
considerable damage has already been done and various types of transfers and other underhand dealing
had left only small areas as surplus.
Land ceiling: The ceiling on agricultural holdings means the statutory absolute limit on the amount of land
which an individual may hold.
The imposition of a ceiling has two aspects:

 Ceiling on a future acquisition.
 Ceiling on existing holding.
The first five-year plan favoured the former to avoid conflicts related to administration. The second Five-year
plan recommended a ceiling on existing holdings. The plan proposed that the ceiling shall apply to all future
acquisitions and all existing agricultural holdings held under personal cultivation. The second plan also
suggested the option of family holding as a criterion for the land ceiling.
The second plan proposed exemptions for the following classes of firms:
 Tea, coffee, and rubber plantations.
 Sugarcane farms operated by sugar factories.
 Specialised farms engaged in cattle breeding, wool raising, dairying, etc.
 Farms where heavy investment was already made.
The second FYP also suggested measures related to preventing illegal transfers of land, compensation to be
paid, and redistribution of the acquired land. These guidelines laid down by the second plan were endorsed
by subsequent plans as well. But these have not been implemented uniformly across all the states. To bring
uniformity in different policies regarding the imposition of ceilings a conference of state ministers was held
in July 1972 based on which a new policy on the land ceiling was evolved.
The main features of the policy are:

 Fewer exemptions from ceilings.
 Retrospective application of land ceiling rules for declaring Benami transactions null & void.
 The changeover to family rather than an individual as a unit for determining landholding. Most of these
laws were included in the 9th schedule of the constitution which insulated them beyond any challenge in
the court of law on grounds of infringement of Fundamental Rights.

 Lowering of the ceiling to 18-22 acres of wetland and 54 acres of unirrigated land. According to the 12th
FYP document only around 3 million hectares have been declared surplus which is hardly 2% of the net
sown area of India. About 30% of this land has not been distributed due to litigation. Moreover, as
correctly pointed out by the 12th plan the balance of power in rural India is so heavily weighed against
the landless and the poor that implementing land ceiling laws became difficult. In certain states like
Karnataka, the industry and large farmers are being exempted from ceiling laws without seeking
permission from GOI clearly indicating the problems in implementation.
Benefits of land ceiling:

1. Social Justice - It is socially unjust to allow a small number of people to hold a large part of the land and
thereby subjugate the interests of the millions of laborers to the interest of this handful of minorities.
2. Improving the position of the poor - According to FAO the redistribution of 5% of the land in India
coupled with increased access to water could reduce rural poverty by almost 30%. According to World
Development Report for every 1% growth in agriculture it is 2-3 times more effective in reducing poverty
in comparison to non-agricultural sectors.
3. Employment creation - According to some economist’s small farms are less capital-intensive and
therefore can be considered efficient in a situation of widespread unemployment and underemployment
in a country.
4. Inculcating the spirit of cooperation - It has been argued that once the surplus land is distributed the
beneficiaries can form cooperatives to increase agricultural productivity. It will enable the poor peasants
to learn the techniques of joint cultivation on one hand and also enable them to realize the benefits of
large-scale farming.
Negatives of land ceiling:

 The economic efficiency of the farm is adversely affected.
 Modern technology can’t be used due to fragmented land holdings.
 The growth of output and employment may also slowdown in the long run due to the reduction of savings
and investments as small farmers consume a large proportion of their income in comparison to large
farmers.
Causes of fragmentation of land holdings:

 Population pressure.
 Laws of inheritance.
 Psychological attachment to land acts as a deterrence to consolidation.
 Breakdown of the joint family system.
 Farmer's indebtedness.
Disadvantages of fragmentation:
 Wastage of land.
 Difficulties in modernisation.
 Disputes over boundaries.
 Disguised unemployment.
 Low productivity.
Way forward:
1. Consolidation of land holdings -The process of consolidation is seen as a solution to reduce the
fragmentation of land holdings. Consolidation is termed as a process of planned rearrangement and
readjustment of land parcels to form larger holdings for the benefit of the agrarian economy. Through
legislation by states a standard area was fixed as the basis of consolidation. However, as per available
data, only about 46% of the total cultivated land has been consolidated. This step of consolidation was
successful in states like Haryana, Punjab, UP, etc. Currently 86% of the land holdings are less than 2
hectares making it difficult to increase productivity.

2. Cooperative Farming - To reap the benefits of economies of scale Cooperative Framing provides an
alternative to land consolidation. But, farmers could not be motivated in spite of various incentives and
subsidies given to cooperative farms by the government. A report from Gadgil Committee on Cooperative
Farming stated that only 1/3rd of these societies were successful.
Reasons for failure of cooperative farming: Societies were mainly formed by large farmers to receive
certain benefits from the government, Societies lack professional and management skills and Corrupt
practices.
3. Land Ceiling Act - Kindly refer to the handout for this.
4. Model Agricultural Land Leasing Act 2016 - This act seeks to permit and facilitate the leasing of
agricultural land to improve access to land by marginal and landless farmers. It also provides for
recognition of farmers cultivating on leased land to enable them to access loans through institutional
credit. Through this act the landlord can legally lease the land with mutual consent. In order to resolve
the dispute between the landlord and leaseholder the provision of the special land tribunal has been
made in the civil court.
Challenges of the Land Leasing Act:

 Absentee Landlordism - The Model Land Leasing Act will prevent the redistribution of land through
ownership transfers as people living outside the area will prefer leasing instead of selling.
 Diversion of land from crop cultivation to commercial use.
 Lack of uniformity - Since agriculture is a state subject it is difficult to implement due to the existence of
multiple rules and regulations.
 The exploitation of small and marginal farmers - The act doesn't specify the rent on leased land and the
period of the lease and is rightly left to the concerned parties which could lead to the exploitation of small
and marginal farmers.
 Food Security - Leasing out land to activities other than agriculture might endanger the food security of
the country in the long run.
Way forward for land leasing act:

 Proper awareness and education among the farmers about the benefits that land leasing can bring to
their household income and life.
 Since most of the small and marginal farmers are dependent on cattle the grazing lands must not be
leased out in the name of fallow lands.
 Farmer activists have strongly advocated that agricultural land must not be used for industrial purposes.
Food processing
What is processed food?
It pertains to the following two processes:
 Manufactured processes - If any product of agriculture, animal husbandry, or fisheries is transformed
through a process involving machines, employees, power, etc. in such a way that its original physical
properties undergo a change and if the transformed product is edible and has commercial value then it
is termed as processed food.
 Other value-added processes - If there is significant value addition in terms of increased shelf life or
ready for consumption, such produce also comes under processed foods even if it doesn't undergo
manufacturing processes. India is the second largest horticultural producer but loses approximately
13,000 crores every year on processed foods (Horticultural Waste). The primary reason is the lack of cold
storage facilities. The size of the food processing industry in India is estimated to reach over half a trillion
dollars by 2025.

The industry can be broadly divided into 6 segments-
1. Fruits & Vegetables.
2. Milk and its products.
3. Meat & Poultry.
4. Marine products.
5. Grain processing.
6. Consumer food including packaged food, aerated drinks, alcoholic beverages, etc.
The GVA of the food processing sector was Rs. 2.24 lakh crores in 2019-20 contributing to 1.69% of the total
GVA in the country. The GVA of the food processing sector is around 9.87% of GVA in manufacturing and
11.38% of GVA in agriculture, forestry, and fishery, respectively.
Drivers of the food processing sector:

1. Shift in consumption pattern – To Health and value-seeking urban consumers looking for a nutritious
and convenient solution in packaged food. For Example, skimmed milk, whole-wheat biscuits, low-
cholesterol oil, etc.
2. Packaging has increased the shelf life of the packaged food.
3. Increase in per capita incomes.
4. Consumers are able to compare the value offerings and choose the best option before buying.
5. Increase in nuclear families.
6. Huge potential for the agricultural sector due to diverse climatic conditions.
Potential for food processing: India is the world's second-largest producer of fruits and vegetables but
hardly 2% of the produce is processed. Despite a large production base, the level of processing is low (<10%).
India's livestock population is the largest in the world where 50% of the world's buffaloes, and 20% of the
cattle, but only about 1% of the total meat production is converted to value-added products. Rapid growth
in organized retail acts as a catalyst for the food processing industry. Deregulation and liberalization of the
Indian economy driven by the central and state government.
Evolution of Food processing in India: The food crisis in India during the 1960s forced the government to
adopt the Green revolution which increased self-sufficiency in food Policies before 1960 were more focused
on the industrial sector especially capital goods though 50% of India's GDP was contributed by agriculture.
By the early 1960s GDP growth was only 3% against the expected 5% but population growth was 2.3%
against the expected 1.4% thus creating issues of food security in India. As India imported cereals with 28%
of its export earnings.
Boosters between 1960 to 1990: Focus on agriculture - Introduction of Green revolution and
institutionalization of periods. Land ceiling act 1972 to provide land to landless farmers. Restrictions on
agricultural exports.
Focus on food processing industries increased after 1991:

 100% FDI in food processing industries.
 Export promotion incentives and other schemes to attract investment.
 The government has identified the food and agro-processing industry as one of the sunrise sectors that
have a high potential for domestic demand and export market.
 No industrial license is required to start the industry except for alcohol, beer, etc.
 Mega food parks and export zones were promoted which provide duty-free imports, and exemption to
corporate taxes.
Functions of Food processing:

 To make food sage micro-biologically and chemically (toxin removal).
 Functional benefits- Fortified food, and food supply to people suffering from critical illnesses.

Challenges in food processing - More than 75% of the processing industry is operating in an unorganized
sector. An unorganized sector cannot compete with MNCs due to issues like economies of scale, branding,
advertising, etc. Indian companies are less price competitive in comparison to MNCs. A long supply chain
leads to high wastage and high cost especially due to the seasonality and perishability of products. Improper
backward and forward integration. Lack of export quality. Despite being an agrarian economy and one of
the largest producers of fruits and vegetables it is unfortunate that the productivity of crops is quite low
related to international standards. The Indian public is price sensitive i.e. higher income elasticity in relation
to expenditure. Preference for fresh food. Agriculture-related issues- Fragmented land holdings, APMC issues,
Low yield, etc. Challenges of infrastructure. The private sector is unwilling to invest in logistics. Credit-related
issues. Problems related to manpower i.e. lack of skilled manpower and entrepreneurship talent. Low-value
addition in processing. Limited control over quality and safety. Low consumer awareness. Challenges of
small-scale processing units- more into primary processing rather than complex
Significance of food processing:

 Doubling farmer's income: With the rise in demand for agricultural products, there will be an increase
in the price paid to the farmers thereby increasing farmers' income.
 Reduce food wastage: UN estimated that 40% of production is wasted similarly NITI Aayog estimated
an annual post-harvest loss of close to 90000 crores. With proper focus on sorting and grading and
diverting extra produce to FDI, this wastage can be reduced leading to better price realization for
farmers.
 Reduce malnutrition: Processed food when fortified with minerals and vitamins can reduce the
nutritional gap in the population.
 Curbing food inflation: Processing increases the shelf life of the food thus keeping supplies in line with
the demand thereby controlling inflation.
Supply chain - A supply chain is a network between suppliers (farmers) of raw materials, companies (food
processors), and a distribution network to market the finished products. The supply chain represents the steps
it takes to get the product or service to the end consumer.
Inputs:
1. They are farm input example national seed corporation limited
2. Production- farmers and cooperatives like AMUL.
3. Procurement and storage- warehouse, cold storage facilities, entities like FCI, etc.
4. Processing like grading, sorting, packaging, and other value addition.
5. Sales and retailing- malls, cash and carry shops, etc.
Backward & Forward linkages:

o Backward linkage - It means connectivity of FPIs with sources of raw material supplies example- The
supply of raw materials like potatoes to a chips manufacturer.
o Forward linkage - It means connectivity of FPIs with the markets through the distribution networks
comprising of physical infrastructure like road and rail networks etc.
o Significance of linkage: It ensures the timely delivery of food products to the consumer markets. Enables
farmers to grow products of appropriate quality. Ensure appropriate and remunerative returns to
marginal and small farmers. Reduces food wastage, especially of perishable products like fruits,
vegetables, dairy products, etc. The level playing field for all stakeholders enhances their competitive
capacity. Helps in improving hygiene and food safety standards leading to greater acceptability of
processed food domestically and internationally.
Challenges:
 High seasonality of raw material production.
 Poor infrastructure facilities.
 Sub-standards levels of the processing industry.
 A highly fragmented industry that is dominated by the unorganized sector.
 Inadequacy of information with farmers and small processors.
 Small and disperse marketable surplus due to fragmented holdings.
 Anomalies in domestic food laws in comparison to international food safety standards.
 Underdeveloped food testing network.
 The multiplicity of legislation leads to conflicts and administrative delays.
Policies and schemes: Policy initiatives and measures are taken by the government to support the
food processing sector - Food procession industries were included in the priority sector for bank lending in
1999. Automatic approval of foreign equity up to 100% except for alcoholic drinks. 0% duty on import of
capital goods and raw materials for 100% export-oriented units. Union budget 2017-18 the government has
set up dairy processing infrastructure fund worth 8000 crores. Union budget 2016-17 proposed 100% FDI in
the marketing of food products produced and manufactured in India. The food safety standards authority of
India plans to invest around 482 crores to strengthen food testing infrastructure by upgrading 59 existing
food testing labs and setting up 62 new mobile testing labs across the country. Setting up mega food parks in
the state of Bihar, Maharashtra, Himachal, and Chhatisgarh. Government plans to set up 42 new mega food
parks in the next four years.
Mega Food parks: The scheme of the mega food park aims at providing a mechanism to link agricultural
produce to the market by bringing together farmers, processors, and retailers to ensure maximizing value
addition, minimizing wastage, increasing farmers' income, and creating employment opportunities,
particularly in the sector. The scheme is aimed at providing model infrastructure facilities along the value
chain from the farm gate to the market through backward and forward linkages. The scheme is based on the
hub-spoke model. It includes the creation of infrastructure for primary processing and storage near the farm
in the form of primary processing centers and collection centers.
Collection center: They work as a point of aggregation of produce from individual farmers, farmer groups,
and SHGs. CC supplies raw materials to PPC. The CC is managed by local entrepreneurs and serves as farm
level aggregation point for adjoining areas within a radius of 10 km.
Primary processing center (PPC): Act as a link between the producers and processors for the supply of raw
material to the central processing center. they also work as primary work handling centers and some PPC
have inhouse facilities for pulping, grading, swapping.
Central processing center (CPC): It is an industrial park in an area of around 50 acres and houses several
processing units owned by different business houses. The park provides common facilities like electricity,
water, cold storage facilities, warehousing, logistics, and backward integration through CC and PPC. The
scheme is demand-driven and would facilitate food processing units to meet environmental safety and social
standards.
Implementation and financial assistance: MFP projects are implemented by a special purpose vehicle
which is a body of corporate registered under the companies act. The financial assistance for MFP is provided
in the form of grants and aid at 50% of the eligible project cost (general areas), and 75% of the eligible cost
in north-eastern areas subject to a maximum of 50 crores per project.
Benefits:
 Reduction enforces harvest losses.
 Additional income to farmers.
 Maintenance of the supply chain in a sustainable manner.
 Shifting the farmers to more market-driven and profitable farming activities.
 As per experts, it will directly employ around 10K people.
 Wastage across the food value chain will also be reduced and quality and hygiene will be improved.

Challenges:
 Problems of land acquisition especially in small and hilly areas.
 Cooperatives are not integrated into food parks.
 CPC is not able to attract PPC and CC.
Other Initiatives - A special food processing fund of Rs 2000 crore was set up with NABARD to provide
affordable credit for investing in setting up MFP. As well as processing units in MFP. PM Kisan Sampada
Yojana has been launched for agro-marine processing and development of agro-marine clusters with 6000
crores allocated for the period 2016-20. It is under the ministry of food processing. It is a comprehensive
package that aims to create a model infrastructure with efficient supply chain management from the farm
gate to the retail outlet.
Schemes to be implemented under this program:

1. MFP scheme.
2. Integrated cold chain and value addition infrastructure especially for horticulture.
3. Infrastructure for agro-processing clusters.
4. Food safety and quality assurance infrastructure.
5. Human resources and institutions.
6. Creation of backward and forward linkages.
Under the budget 2018-19 PM Kisan Sampada allocation has been increased from 700 crores to 1400 crores.
Setting up of fisheries and aqua-culture funds for the fisheries sector and animal husbandry infrastructure
funds for financing infrastructure requirements of the animal husbandry sector. The total corpus of both
combined is Rs 10K crores. Launching of a centrally sponsored scheme PM formalization of micro food
processing enterprises scheme, for providing financial, technical, and business support for setting up of two
lakh micro food processing enterprises across the country for five years. from 2021-2024-25. Based on one
district one product approach with an outlay of 10K crores.
Capital Market
Financial market:
Money market: It caters to short-term borrowing requirements such as working capital. The money market
deals with a financial instrument whose maturity is up to 1 year. Common money market instruments are
treasury bills, cash management bills, call money, certificate of deposit, commercial paper, commercial bill,
etc.
Treasury bills: These are discounted securities (non-coupon/zero coupon bonds). These bills are issued by
RBI on behalf of the central government. Generally, the state government does not issue T-bills. Buyers include
RBI, commercial banks, NBFCs, LIC, UTI, and General insurance companies.
There are three types of T-bills 91days, 182 days, and 364 days.
Cash management bills: Introduced in 2010, it is a discounted security similar to T-bills with a tenure
period of fewer than 91 days.
Commercial bills- These are negotiable instruments drawn by the seller or buyer of goods on the value of
goods delivered. Trade bills become commercial bills when they are accepted by commercial banks. The
maximum allowed period is 90 days. These bills are first discounted by commercial banks and rediscounted
by RBI.
Commercial paper: Introduced in 1990. It is a short-term money market instrument issued as an unsecured
promissory note and is privately placed. Companies, primary dealers, and financial institutions can issue CPs
to meet their short-term fund requirements. They are issued in multiples of five lakh.
Other instruments:
Certificate of Deposit (CD): issued by scheduled commercial banks and selected financial institutions that
are permitted by RBI. The maturity period is more than 7 days and less than 1 year. Banks cannot provide
loads against CDs. The minimum number of CDs should be 1 lakh and multiples of 1 lakh. (updated to 5 lakhs
recently).
Recent Amendments- All individual residents in India can invest in CDs. RBI has increased the minimum
denomination for CD to 5 lakh and multiples of 5 lakh. Currently, all Indian financial institutions, commercial
banks, RRBs and SFBs are allowed to issue CDs. RBI does not allow the issuing bank to grant a loan against
CDs. CDs can be issued in dematerialized form only.
Share market:
Types of shares
 Trading- insider trading
 QIPs- Qualified Institutional Placement
 Anchor investors- Invest in IPOs.
 FIIs- Foreign institutional investors registered with SEBI.
 P-notes- Issued by FIIs for investment in the Indian market.
 Derivatives.
Other concepts:
Insider trading
Convertible and non-convertible debentures
Chit funds- Legal, work on networking
Ponzi schemes- Provide unrealistic profits, not legal
Financial instruments in capital markets:

Share: The capital of a company is divided into shares and each share forms a unit of ownership of a company
and is offered for sale to raise capital for the company. Can be divided into two broad categories:
1. Equity shareholders- Give their holders the power to share the profit as well as voting rights in the
annual general meetings of the company. The holders have a share in the profit and also bear losses
incurred by the company.
2. Preference share: They receive a fixed amount of dividend and they do not have voting rights. Preference
shareholders are given a preference over the equity shareholders during the settlement of the company.
Debentures: These are debt instruments with a fixed rate of interest and the debentures issued by the
company are generally unsecured. Debenture holders do not have voting rights, unlike equity shareholders.
There are different types of debentures:
 Convertible debenture
 Non-convertible debentures
Derivatives- It is a financial instrument whose value is derived from one or more underlying assets or
securities. The underlying assets could be shares, bonds, currencies, or commodities like gold, silver, and
sugar. A derivative itself is a contract between two or more parties and helps in protecting parties from price
fluctuations and uncertainties. SEBI is the regulator of the Derivative market. Can either be traded over the
counter(OTC) or at an exchange. Examples- forwards, futures, option, etc.
Forwards: It is an agreement or contract between the two parties to buy & sell a particular asset at a certain
price and date. They are unregulated and are traded Over-The-Counter. They can be customized as per
the needs of the parties involved.
Futures: It is similar to "Forwards" but these are regulated & traded on the stock exchanges and the parties
are under an obligation to perform the contract.
Options: It is a contract where the buyer has a right to buy/sell the underlying asset at a certain price (called
a strike price) during a certain period of time. There is no obligation on the buyer to perform the contract.
Options are also traded on the stock exchange. Types of options include: Call option, Put Option, Swaps.
Bonds: A bond is a debt security/instrument. The government uses bonds as a means to raise funds to meet
its expenditure requirements which are generally capital in nature. For
example, NHAI issues bonds frequently to fund infrastructure. Borrowers issue bonds to raise money from
investors willing to lend them money for a certain amount of time.
Bond Yield: The yield of a bond is an effective return that it earns. Bond prices are inversely related to
the bond yield. Factors that affect bond prices & bond yields are interest rates, inflation, open market
operations (OMOs) of RBI, the fiscal policy of a government, and the yield from competitive instruments like
bonds in the US.
Negative Bond Yield: A negative bond yield is when an inventory receives less money at the maturity of the
bond than the original purchase price of a bond. They are generally issued by the central banks during times
of stress & uncertainty as investors look to protect their capital from significant erosion.
Zero coupon bond: A coupon bond pays interest to the bondholder over the life of the bond and repays the
principal at the time of maturity but a zero-coupon bond does not pay interest and face value of the bond
received by the bond holders after it reaches maturity.
Masala Bonds: Are rupee denominated bonds issued in other countries outside India by Indian entities.
Before the introduction of masala bonds, companies & financial institutions borrowed through
issuing bonds in the oversees market like the USA, the UK, Singapore, etc. This exposed the Indian borrowers
to foreign currency exchange risk. Depreciation of rupees has led to increased cost of capital. Masala Bonds
help in reducing this currency risk. The first Masala bond was issued by International Finance Corporation
(IFC) in 2014 to fund infrastructure projects in India.
Inflation-Indexed Bonds (IIBs): It provides a constant return irrespective of the level of inflation and
protects the investors against macroeconomic risks. Initially, IIBs were issued in the name of capital-index
bonds in 1997. The capital index bond provided inflation protection only to the principal and not to the
interest payment. However, IIBs provide inflation protection to both principal & interest payments.
External Commercial Borrowings (ECBs): Loans in India. Made by non-resident lenders. In foreign
currency. To Indian borrowers. In other words, External Commercial Borrowings (ECB) refer to commercial
loans (in the form of bank loans, buyers’ credit, suppliers’ credit, and securitised instruments like floating rate
notes and fixed rate bonds) availed from non-resident
lenders.
Demate Account:
Buy-back shares: A buy-back occurs when a company repurchases its own shares in the market,
this results in the reduction of the total number of shares of the company that are traded
publicly increasing the earnings per share and the value of the share.
FPI and FDI: Foreign Investment means any investment made by a person resident outside India on
a repatriable basis in capital instruments of an Indian company or to the capital of a LLP.
FPI: Foreign Portfolio Investment refers to an investment that is less than 10% of equity and the investor is
only interested in the financial assets than the functioning of the company. Foreign Portfolio Investment is
any investment made by a person resident outside India in capital instruments where such investment is: less

than 10% of the post-issue paid-up equity capital on a fully diluted basis of a listed Indian company or less
than 10% of the paid-up value of each series of capital instruments of a listed Indian company.
FDI: FDI is the investment through capital instruments by a person resident outside India in 10 per cent or
more of the post-issue paid-up equity capital on a fully diluted basis of a listed Indian company.
Industry
Industry accounts for around 28% of GVA at current prices in 2021-22 this is lower than the average share
of 35% for most developing countries. Indian industry experienced slow and poor productivity performance
during the period 1950 to 1980. The policy regime had a strong preference for the public sector, extensive
control over private investment, highly protective trade policy and inflexible labour laws, and promotion of
the small-scale sector and ensuring regional balance were additional objectives of the industrial policy
regime. The period after the mid-1960s witnessed an aggressive import substitution regime and the
strengthening of domestic regulatory structures. In 1991 in response to a major BOP crisis, India made a
radical shift away from its long-standing policy of inward orientation and subsequent reforms have policy
regime significantly towards market orientation, deregulation, and liberalization.
Industrial policy resolution 1948: It made clear that India is going to follow a mixed economy model. It
classified industries into four broad categories:
1. Strategic industries (public sector)- It included three industries in which the central government had
a monopoly. These included arms and ammunition, atomic energy, and rail transport.
2. Basic industries (public and +private sector)- Six industries i.e. coal, iron and steel, aircraft
manufacturing, shipbuilding, manufacture of telephone and wireless apparatus, and mineral oil were
designated as the basic industries. These industries were to be set up by the central government however
existing private-sector enterprises were allowed to continue.
3. Important industry (controlled private sector)- It included 18 industries including chemicals, sugar,
cotton, cement, paper, salt, machine tools, tractors, etc. These industries continue to remain under the
private sector however the central government in consultation with the state government had general
control over them.
4. Other industries (private and cooperative sector)- All other industries which were not included in the
above-mentioned three categories were left open to the private sector.
Industrial policy resolution 1956: Parliament has accepted the socialist pattern of society as the basic aim
of economic policy. A second industrial policy resolution was adopted in 1956 and replaced in 1948. IPR
divided industries into the following three categories:
 Schedule A- The industries that were the monopoly of the state or government. It included 17 industries,
the private sector was allowed to operate in these industries if national interest so required.
 Schedule B- In this category of industry the state was allowed to establish new units but the private
sector was not denied setting up or expanding existing units, for example, chemical industries, fertilizer,
rubber, aluminium, etc.
 Schedule C- The industries not mentioned in the above category formed part of schedule C. Supportive
measures were suggested for the mutual existence of the public and private sector industry. There was
also an adequate focus on small-scale and cottage industries. There was also a special emphasis on the
reduction of regional disparities. Fiscal concessions were granted to open industries in backward
regions. Public sector enterprises were given a greater role to develop these areas.
Monopolies commission 1964: The commission looked at the concentration of economic power in the area
of industry. On the basis of the recommendations of the commission MRTP act, of 1969 was enacted. The
commission sought to control the establishment and expansion of all industrial units that asset size over a
particular limit.

Industrial policy state 1973: It categorizes a list of the industry to be started by large business houses so
that the competitive efforts of small industries were not affected. The entry of competitive small
entrepreneurship was encouraged in all industries. Large industries were permitted to start operations in
ruler and backward areas with a view of developing those areas and also enabling the growth of all
industries.
Industrial policy statement 1977: Development of small-scale sectors which encourage self-employment.
Restrictive approach towards large business houses. Expanding the role of the public sector.
Industrial policy 1980: It focussed on the liberalization of industrial licensing. Effective management of the
public sector. The policy statement provided liberalized measures with respect to licensing in terms of
automatic approvals to increase the capacity of existing units which are regulated under MRTP and FERA.
Redefining small-scale industries (SSI) i. e the investment limit to define SSI was increased to boost the
development of this sector. In the case of the tiny sector, the investment limit was raised to 1 lakh. For small-
scale units, the investment limit was raised from Rs 10 lakh to 20 lakhs and for ancillaries Rs 15 lakh to 25
lakhs.
Assessment of Pre-1991 policy: Rapid industrial growth in the company. A Diverse industrial structure with
self-reliance on a large number of items. At the time of independence, the consumer goods industry accounted
for half of the industrial production in contrast capital goods production was less than 4%. By 1991 capital
goods production has increased to almost 24%. However, it is argued that the industrial licensing system
promoted inefficiency and resulted in a high-cost economy. Due to discretionary powers, the system promoted
corruption and restricted the entry of new enterprises which adversely affected the competition.
New industrial policy 1991: This policy was radical compared to other industrial policies. It emphasizes the
need to promote further industrial development based on consolidating the gains already made and
correcting the distortions or weaknesses to achieve international competitiveness. The liberalized industrial
policy aimed at rapid economic growth along with integration with the global economy.
Objectives:
 International competitiveness- NIP emphasizes the need to develop indigenous capabilities and
technologies which will help India manufacture products according to global standards. None of the
earlier industrial policies either explicitly or implicitly had made reference to international technology
and manufacturing capabilities in the context of domestic industrial development.
 Redefining the concept of self-reliance - Earlier India followed an ISI strategy of (import substitution
industrialization) to achieve self-reliance. Economic self-reliance meant indigenous development of
production capabilities and production indigenously all industrial goods. It helped to build a vast base of
capital goods, intermediate goods, and basic goods industries over a period of time. NIP redefined
economic self-reliance i.e the ability to pay for imports through foreign exchange earnings through
exports and not necessarily depending upon the domestic industry.
The important elements of NIP are as follows:

 De-licensing- The removal of licensing requirements for industries, domestic as well as foreign,
commonly known as delicensing of industries. Till the 1990s licensing was compulsory for almost every
industry which was not reserved for the public sector. With progressive liberalization and deregulation
of the economy, industrial licenses which are regulated under the 1956 policy are required in very few
cases. The objective of industrial delicensing is to enable business licenses to respond to changing external
conditions. Entrepreneurs are free to make an investment decision based on their own commercial
judgment which facilitates technological dynamism and international competitiveness.
 De-reservation & Privatization through disinvestment- Reduction in the number of industries

reserved for the public sector. Currently, only two industries Atomic energy & railway operations are
reserved for the public sector. The policy emphasizes bringing down government equity in all non-
strategic PSUs to 26% or lower. Restructure or revive potential PSUs and close down PSUs that cannot
be revived and fully protect the interests of workers.
 Rationalization of manpower- A VRS scheme has been introduced in a number of PSUs to reduce the
surplus manpower. Private equity participation- PSUs have been allowed to raise equity finance from the
capital market. This has put additional pressure on PSUs to improve their performance. Disinvestment
and privatization of existing PSUs mainly focus on corporate efficiency, financial performance, and
competition among PSUs.
 Amendment of MRTP act 1969- Since 1961 MRTP act has been restructured and pre-entry restrictions
have been removed with respect to expansion, mergers, acquisitions, and appointment of a board of
directors. The MRTP act has been replaced by the competition act, the law aims at upholding competition
in the Indian market. Currently, CCI controls competition in India.
 Liberalize foreign policy- It reformed foreign investment policy to attract foreign investment. FERA was
repealed and replaced by FEMA. Investment and returns can be freely repatriated except where the
approval is subject to specific conditions as specified in the sector-specific policies. Focus on dilution of
restriction on FDI, FII, etc.
 Dilution of protection to small-scale industries and emphasis on competitiveness: SSIs enjoyed a

unique status due to their diversified status across the country and thereby utilizing resources and skills.
Due to their potential to generate large-scale employment and alleviate poverty SSIs were a special
preference in the Indian economy. Since 1991 the protection of SSIs has been diluted due to: Promoting
competitiveness by addressing the basic concerns of the sector namely technology, finance, and
marketing. The number of items reserved exclusively for small-scale industries manufacturing was
gradually removed.
Assessment of NIP: The policy has removed various barriers with respect to licensing, entry barriers for
foreign investment, replacing FERA with FEMA, and replacing MRTP with CCI to regulate anti-competitive
behaviours. The policy also focussed on opening up of markets that were earlier reserved for SSI. However,
the microeconomic reforms and judicial reforms were slow. Thereby reducing the efficiency of the policy.
Trade policy reforms made a radical break with the past by discontinuing the complex system of import
licensing and making an open commitment to lower the tariff rates on imports. In 2001 India also removed
quantitative restrictions on consumer goods and agricultural goods thereby increasing competition within
the domestic market. In the 1990s the FDI rules with liberalized with an intention of improving access to
foreign technology and world markets. Many industries were deregulated and open to FDI, and boards like
FIPB (which does not exist) have been set up to expedite applications for foreign investment.
Ministry of micro, Small & Medium enterprises:

Data related to MSME-
 Women ownership- 20% of all MSME businesses are owned by women. Share in exports around 45%.
Employment- Around 100 million workers are employed in MSMEs. Rural base- 60% of MSMEs belong to
ruler India. Share in GDP- 6.1 %.
Significance of MSME:
 Employment transition - Key driver for the transition from agrarian to industrialized economy.
 Inclusive growth - Women's ownership, traditional craftsmen, and 60% of MSMEs belong to rural India
ensuring inclusive growth.
 Building brand India- participation in the global market.
 Indigenous growth- This can help develop India's domestic strength and substitute foreign products.

 Strengthen the domestic supply chain- MSMEs create an environment where they act as ancillaries to
larger industries and integrate with the global supply chain.
 Value-added services- There is a clear opportunity in terms of global demand for value-added services
and products.
Social significance:
 Social justice- It can give marginalized groups to participate in the economic growth of the nation e.g.
tribal handicrafts generate a flow of revenue to underdeveloped tribal areas.
 Balance regional development- with almost even distribution of MSMEs across the length and breadth of
India.
 Women empowerment.
 MSME reduces work base migration.
 Reduces income inequality.
 Rural development and tribal development.
Challenges: Poor insolvency process- Takes around 7.9 years according to the world bank. Unorganised
market- More than 90% of MSMEs operate in an unorganized sector. Inadequate branding, and lack of
economies of scale, Anti-red-Tapism, Regulatory hurdles, MSMEs require government permission and
approval making it difficult for smaller entrepreneurs, Delay payments, Low production capacity, Lack of
access to credit, Increasing international competition, Non-availability of skilled labour, Lack of adequate
infrastructure, Poor digital presence, MSMEs turning out to become doabs (10 years in existence but less than
100 permanent jobs), Automation and artificial intelligence.
Government initiatives: The government doubled the budgetary allocation. Udyog Aadhar memorandum-
it replaces the filing of manual entrepreneur memorandum with the online facility for filing entrepreneur
memorandum. Labour reforms- Introduction of Shram Suvidha portal to comply with labour laws. Credit-
linked capital subsidy scheme. Focus on skill development.
Way forward: Implement UK Sinha committee recommendations- restructuring stressed loans through
government-sponsored funds (10K crores), Collateral free loans, focus on cluster manufacturing, and
development of infrastructure. MSME and e-commerce can collaborate on various roles and supply links
resulting in better supply chains. Promoting a culture of innovation and leveraging industrialization.
Banking
Bank vs. NBFC:
Non-performing Asset (NPA's)- The biggest threat the Indian banking system was facing between 2011-16
was the NPA. NPAs are loans lent by banks and financial institutions whose principal and interest are delayed
beyond 90 days. In simple terms, any asset that seizes to provide returns to its investors for an extended period
is referred to as NPA.
Classification of NPA-
1. Sub-standard asset- NPAs less than equal to 12 months.
2. Doubtful asset- NPAs greater than 12 months.
3. Loss-making asset- when the banks have identified the loss but it has not been written off.
Impact of NPAs-
 Negative impact on economic growth.
 NPAs can increase inflation.
 Credit lending to small-scale sectors will be affected.
 Indirect impact on inclusiveness.

Slippage ratio- It indicates how standard assets are turning out to become NPAs. Steps were taken by the
government to curb NPA's: S/25 scheme 2014, Strategic debt restructuring, Asset quality review 2015,
Scheme for sustainable structuring of stressed assets SARFAESI Act, 2002, Asset reconstruction companies,
Bad banks.
Basel norms: The Basel committee on banking supervision (BCBS) issues Basel norms for maintaining
international standards with respect to banking stability. Basel is a city in Switzerland and it is the
headquarters of the Bureau of international settlements (BIS), which promotes the corporation among the
central banks with a common goal of financial stability and banking regulatory standards. The Basel accord
refers to a set of agreements by the NCBS that primarily address risks related to banks and the financial
system. The agreement's goal is to ensure that financial institutions should have sufficient capital to meet
obligations and absorb expected losses. The Basel accord has been accepted by India, in fact, RBI has imposed
more stringent standards on a few parameters than the BCBS.
Basel -I norms: BCBS introduced a capital measurement system called the Basel capital accord in 1988. It
was also known as Basel-1 and was entirely concerned with credit risk. It established the capital and the risk-
weighted structure for the banks in the form of a capital adequacy ratio. CAR is equal to total capital divided
by risk-weighted assets. The required minimum capital was set at 8% of the risk-weighted asset.
Risk-weighted assets- RWA refers to assets with varying risk-weighted profiles e.g. an asset backed by
collateral would be less risky than a personal loan with no collateral security. Capital is divided into two
categories tier-1 and tier-2 capital.
Tier-1 is a bank score capital because it is a primary measure of a bank's financial strength. The majority of
tier-1 capital is made of disclosed reserves (retained earnings) and common equity.
Tier-2 capital is used as supplemental funding since it is less reliable, it consists of undisclosed reserves,
preference shares, and subordinate debt.
In 1991 India adopted Basel -I guideline.
Basel-II norms: BCBS published Basel -II guidelines in June 2004 which were considered to be refined and
reformed versions of the Basel-1 accord. The guidelines were founded on three pillars.
1. Capital Adequacy requirements- Banks should keep adequate capital requirements of 8% of the risk-
weighted asset.
2. Supervisory review- Banks were required to develop and implement better risk management
techniques for monitoring and managing all three types of risks (credit, operational, and market risks).
3. Market discipline- It requires strict disclosure requirements, i.e. banks must report their CAR, risk
exposure, and other information to the central bank on regular basis.
Basel -III Norms: In the wake of the Lehman collapse in 2008 and the financial crisis, BCBS decided to update
and strengthen the accord. The guidelines were intended to promote a more resilient banking system focusing
on four critical banning promotions i.e. capital, leverage, funding & liquidity. Base-III was focussing on better
capital quality i.e. higher loss-absorbing capacity. It also suggested additional capital conservation buffers
and counter-cycle buffers.
Capital conservation buffer (CCB): Banks are required to hold a CCB of 2.5%. The focus of this buffer is to
ensure that banks maintain a cushion of capital that can be used to absorb losses.
Counter cyclical buffer: This buffer has been introduced with the objective of increasing capital
requirements during good times and decreasing the same during the crisis. The buffer will slow the banking
activities when the economy overheats and will encourage lending during a crisis. The buffer will range from
0--2.5% consisting of common equity or other loss-absorbing capital.
Leverage Ratio-The ratio of banks' core capital to the total consolidated assets.

Funding & liquidity- Basel-III established two liquidity ratios- LCR & NSFR.
Liquidity coverage ratio- It requires banks to maintain a buffer sufficient to deal with cash outflows
encountered in short-term scenarios. The goal is to ensure that banks have enough liquidity to handle a 30-
day stress scenario if it occurs.
Net stable funding ratio- It requires banks to fund their operations with stable sources of funding for a
minimum period of 1 year & above i.e. LCR assesses short-term resilience & NSFR we'll assess medium to long-
term resilience.
Marginal cost of fund landing rate (MCLR): It is the lowest rate of fund lending. No bank is permitted to
lend below this. It is determined by banks internally depending upon the loan repayment time. The rate varies
from one bank to another. MCLR was introduced due to a lack of monetary transmission under the base rate
system. Under MCLR as soon as the repo rate changes banks must adjust their interest rates. Banks will take
into consideration several aspects like FD rates, current accounts, savings accounts, etc. In determining the
cost of funds.
Factors that impact MCLR- The marginal cost of funds, CRR cost, Operating cost and Tenure premium. As
the ensure increases i.e. with a longer duration of loan its risk increases to cover this risk the bank charges
an amount from the borrowers. This amount is called the tenure premium. Banks generally publish their
MCLR, concerning different maturities every month on a specific date, however, they may also consider
reviewing their MCLR quarterly for the first year after which they can go back to monthly reviews.
Difference between MCLR and base rate: MCLR is an advanced version of the base rate. The base rate uses
the average cost of funds whereas MCLR uses marginal cost or incremental cost. While calculating base rate
a minimum rate of return or profit margin is used whereas for MCLR banks is required to include tenure
premium into the calculation i.e. banks charge a higher rate of interest for long-term loans. Shadow banking,
differentiated banking, and Payment banks (need to be read from handouts).
Insolvency and Bankruptcy Code (IBC): IBC is a one-stop solution for resolving insolvencies which were
formerly a time-consuming process. IBC tries to protect small investors' interests while also making the
business process easier. IBC is India's Bankruptcy law which aims to unify the existing framework by
establishing a single structure. Insolvency is a condition in which a debtor is not able to pay his debt and
bankruptcy is a legal process that involves an involved person or company that is unable to pay its debts. IBC
establishes a faster insolvency procedure to assist creditors such as banks in recovering debts and avoiding
bad loans which are a major drag on the economy. The code establishes a legal structure focussing on a time-
bound resolution and faster liquidation mechanism. The framework consists of the following elements:
 Adjudicating authority - They will start the resolution process, appoint an insolvency professional and
also sign on the creditor's ultimate judgment. NCLT is the deciding authority for corporations and the
debt recovery tribunal handles individuals and partnership firms.
 Insolvency professionals- They will be in charge of the resolution procedure. They also handle debtors'
assets and provide information to creditors. To help them make appropriate decisions. Insolvency
professional agency- Insolvency practitioners will be registered with a professional agency. A code of
behaviour will be enforced by these agencies.
 Information Utility center- They will maintain track of debts owed to creditors as well as repayment
and debt defaults.
 Insolvency and bankruptcy boards- These will oversee insolvency experts and professional agencies. It
is a regulatory authority for insolvency and bankruptcy proceedings. The goal of IBC is to address
insolvencies within a prescribed time limit. The company is subject to 180 days moratorium which can be
extended up to 270 days. The resolution time frame for start-ups and small businesses is 90 days which
can be extended by another 45 days.
Benefits of IBC: Faster resolution, prevents job losses, Reduces NPA, Greater debtor autonomy.
Challenges of IBC: Lack of resources and judicial intervention. Greater emphasis on liquidation rather than
revival. Poor approval rate- According to the Insolvency and bankruptcy board of India NCLT approved just
15% of corporate insolvency cases from 2016 to 2019.
Infrastructure
Infrastructure is the set of basic physical systems of a business, region, or nation. Infrastructure is
fundamental in the sustainable functionality of the very entity itself. These are basic facilities necessary for
the proper functioning of an economy and society.
Types Infrastructure:
 Social- It includes housing, health, education, etc.
 Economic- This refers to a set of fundamental structures which support the process of production and
distribution in an economy e.g. transportation, power, etc.
 Soft - It refers to infrastructure that comprises institutions that help in maintaining the economy. They
include the delivery of certain essential services to the population. Human capital usually forms the main
component of this infrastructure e.g. Healthcare systems, financial systems, education systems, etc.
 Hard- It refers to the physical system that is necessary for running a nation e.g. roads, highways, bridges,
etc.
The current state of India's infrastructure: the Indian infrastructure has been showing a growing trend.
India has the plan to spend $1.4 Tn in infrastructure between 2019-2023. Road transport holds a dominant
share of traffic in the transportation sector. It is estimated that the national highway Authority of India will
generate about Rs 1 Lakh crores in revenue from tolls. The telecommunication sector is also booming in India
as per the economic survey 2019-20, total mobile phone connections grew by 18.08% from 2014-15 to 2018-
19. It is estimated that India will become the world's 3rd largest construction market. With COVID -19
pandemic suddenly things came to a halt and therefore government wants to refocus on ensuring a
sustainable growth rate with respect to the Indian infrastructure sector.
Infrastructure financing: It is a challenge in India, according to the 11th five-year plan 45% of the total
infrastructure funding is coming from the government budget, and 55% is managed through debt and equity
sources. Banks play an instrumental role in Infrastructure financing.
Challenges: The fiscal burden of the government is high. Increase in funding gaps, especially after the 2008
subprime crisis (ECBs were affected). Asset liability mismatch of banks. The bond market is still not developed
in India. (corporate bond market, municipal bond market). Investment obligations on insurance and pension
fund companies. Legal and procedural issues.
The measure took by the government toward Infrastructure financing: PPP projects in infrastructure-
government faces tight budgetary constraints in the rule-based fiscal policy framework. It was important to
encourage the private sector to invest in infrastructure.
Viability gap funding (VGF)- Introduced in 2006, where the central government provides 20% of the total
capital cost concerning PPP projects (total 40%, 20% government & 20% sponsoring agency).
FDI in infrastructure development- To facilitate infrastructure financing 100% FDI is allowed under
automatic route into sectors like mining, power, SEZ, etc. Setting up of infrastructure debt fund- RBI & SEBI
notify guidelines for setting up of IDFs in the form of NBFC and mutual fund companies. The government has
reduced withholding tax on interest payments from 20% to 5%. IDFs are expected to channel funds from
insurance companies, pension fund companies, and other long-term sources into the infrastructure sector.

Liberalization and rationalization of ECBs. Introduction of credit default swaps to strengthen the banking
sector.
Public-private partnership (PPP): Government typically has several objectives to perform like
infrastructure development, welfare mechanism, timely delivery of services, meeting public needs, and so on.
PPPs have shown their potential as an important tool to meet these objectives and address infrastructure
shortages, these projects provide new sources of capital for public infrastructure development by shifting the
responsibility for arranging the finances to the private sector. PPPs refer to a contractual agreement between
a government agency and a private sector entity that allows for greater private participation in the delivery
of public infrastructure projects.
PPP models for existing projects:

 Management or service contract- It's a contractual agreement for the management of part or whole
public enterprise for example a specialized port terminal for container handling by the private sector. A
management contract allows private sector skills to be brought into service, design, and delivery however
the public sector retains the ownership of the facility. A private contractor is paid a fee to manage and
operate and the payment is generally performances based. Usually, the contract period is short-term (3-
5 years).
Advantages: Less risk due to shorter duration, Least number of conflicts.

Disadvantages Almost all risk is taken up by the public sector, less incentive for a private player to invest.
Turn Key management project: It is a traditional public-sector procurement model for infrastructure
facilities. Generally, a private player is selected through a bidding process. A private player builds and designs
the facility for a fixed fee which is one of the criteria for selecting the winning bid. The scale of investment by
the private player is generally low and for a short-term period.
Affermage/Lease- In this category of arrangement, the leaseholder is responsible for operating and
maintaining the infrastructure facility that already exists. Generally, the operator is not required to make
any large investment except when this model is implemented with another model. The difference between
affermage and lease is technical. Under the lease, the operator retains the revenue collected from the
customer and makes specified lease payments to the contracting authority. Under the affermage, the
operator and the contracting authority share the revenue.
Concession- In this form of PPP government grants specific rights to a private player to build and operate
the facility for a fixed period. In concession, payments can take place both ways i.e. the private player pays
the government for concession rights and the government pays the private payer for providing certain
services. Usually, such payments by the government are necessary to make the projects commercially viable.
e.g. area concession, water. The public sector's role shifts from being a service provider to regulating the price
and quality of service.
Hybrid Annuity model: 40% cost provided by government. Proposed in 2015. It is a mix of BOT and EPC
Generally, there are three models in India for awarding National Highway Projects: BOT- Annuity, BOT- Toll
& EPC. In BOT- Annuity, the developer constructs and maintains the road and gets a fixed payment from the
government. This model needs frequent government. payments that are guaranteed though differ sometimes.
Since the annuity contracts are long-term (15-20 Years), this model may not be attractive in all places. In the
case of BOT- Toll, the traffic or commercial risk is on the concessionaire and the investment is sustained by
the toll revenues. The toll is not feasible in every place (Rural and semi-urban areas). Further, since the
collection of tolls depends upon traffic, the developer faces traffic risk in this model. In the case of EPC, the
developer faces construction risk. Under the new model (HAM), the government. provide upfront 40% of the
project cost to start the work and the remaining 60% would be financed by the private player. NHAI will
collect tolls and refund the private player in instalments. This implies that the toll collection risk will be
handled by NHAI.
Benefits: Compared to BOT-Annuity, it would ease the cash flow pressure on the government. Compared to
the BOT-Toll Model, the traffic risk is not associated with the concessionaire. Operations and maintenance
are handled by the private player increasing the efficiency of the project.
Negatives: Escalation of cost can lead to an increase in conflicts.
Swiss Challenge Method: In this method, without an invitation from the government., a private player can
submit a proposal to the government. for the development of an infrastructure project with an exclusive
intellectual property right.
The government has two options:

1. Government. can buy IP rights from the original proponents and call for competitive bidding to award
the project.
2. The government. may also allow other players with similar capabilities to submit their proposals.
If any proposal is better than the original proposal, the original proponents are asked to modify the proposal.
If he fails, the project will be awarded to the best bidder. Many states in India are using this method for
awarding road and housing projects. Several states included it in their infrastructure development acts. The
draft PPP ruler 2011 allows the use of Swiss Challenge only in exceptional circumstances i.e. for projects in
rural areas or for the BPL population.
Advantages: Encourages Private players to bring innovation, technology, and uniqueness to the
development of the project. It will enhance cost efficiency, reduce red tape, and shortens the project timeline.
Problems: The CVC has observed that there is a lack of transparency and lack of fair and equal treatment of
potential bidders in the Swiss Challenge method. The Planning commission has advised the state governments
to adopt the swiss challenge method as an exception rather than a rule. In the recent past, Vijay Kelkar’s
committee on revisiting and revitalizing the PPP infrastructure model has discouraged the government. from
following the swiss challenge method. Without a strong regulatory framework, the method fosters crony
capitalism and is also conducive to discretionary favours.
Positives of PPP: Access to private sector finance, potentially increase transparency, Efficiency advantages
from using private sector skills and transferring risks to the private sector, Enlargement of focus from only
creating an asset to delivery of service including maintenance of infrastructure assets during its operating
lifetime, Access to advanced technology and availability of additional resources.
Limitations of PPP: Not all projects are feasible due to political reasons along with commercial viability.
The success of PPP depends on regulatory efficiency. The private sector may not be interested due to perceived
high risk, lack of an easy exit mechanism, etc.
Regional Rural Banks (RRBs): RRB Act, 1976, Operate at the regional level in various states of India. Owned
by 3 entities: Central government., State government. and sponsor bank in the ratio of 50:15:35 respectively.
Note: Dictation and details have been mentioned in the PPT of the banking System.
Reforms in 2020: Cooperative banks under the regulation of RBI.
Agriculture
Agriculture: Accountable for 18.8% of the GVA of the country. Growth of 3.6% in 2020-21 & 3.9% in 2021-
22. The livestock sector has grown at a CAGR of 8.15%. Government. placed focus on the food processing
sector. Food processing sector - Significant employer of the surplus workforce.
Trends in Agriculture: The sector which is the largest employer of the workforce accounted for a sizeable
18.8% (2021-22). In GVA of the country registering a growth of 3.6% in 2020-21 and 3.9% in 2021-22. Growth
in allied sectors including livestock, dairying, and fisheries have been the major drivers of overall growth in
the sector. The livestock sector has grown at a CAGR of 8.15% over the last 5 years ending 2019-20.
Improvement in the contribution of allied sectors is in line with the recommendations of the committee on
doubling farmers' income which has suggested a greater focus on allied sectors to improve farmers' income.
The government. has increased its focus on the food processing sector which is not only a major market for
agricultural products but also a significant employer of the surplus workforce engaged in agriculture. The
growth in agriculture and allied sector includes 4 constituents of agriculture and allied sectors namely crops,
livestock, forestry, and fishing and aquaculture. IN 2018-19, the growth in agriculture was mainly because of
the performance of livestock and fisheries even though the growth of the GVA of crops was -1.6%. The share
of agriculture and allied sector in total GVA however improved to 20.2 % in the year 2020-21 and around
18.8 % in 2021-22.
Role of agriculture in the Indian economy: Indian agriculture has reached the stage of development and
maturity much before the now advanced countries of the world. There was a proper balance between
agriculture and industry and both flourished hand in hand till the mid-eighteenth century. The interference
of the British and its deliberate policy which has devasted cottage industries and handicrafts has disturbed
this balance affecting the Indian economy. Britishers focussed on intermediaries like zamindars who directly
exploited poor farmers. A substantial part of the produce was taken away by this parasitic class and the
actual cultivator was left with mere subsistence therefore Indian agriculture in the pre-independence period
can be described as a subsistence occupation. It was only after the advent of planning and more precisely
after the first green revolution that some farmers started adopting agriculture on a commercial basis.
Share of agriculture: At the time of WW-I agriculture contributed to around 2/3rd of National income, this
was on account of the practical non-existence of industrial development and infrastructure. However, after
the initiation of planning the share of agriculture has persistently declined. Along with the development of
industry and the tertiary sector. From 53.4% in 1951, it has almost reduced to 15.4% in 2015-16 (GVA at
basic price) the share of agriculture in national income is often considered an indicator of economic
development. Normally developed economies are less dependent on agriculture compared to underdeveloped
economies i.e. as the country progresses dependence on agriculture reduces.
Largest employment-providing sector: In the 1970s around 65% to 75% of the working population was
engaged in agriculture this reduce to almost 60% in the 1990s and subsequently to 48.9% in 2011-12. With
the rapid increase in population, the absolute number of people engaged in agriculture has become
exceedingly large. The development of other sectors of the economy has not been sufficient to provide
employment further increasing the pressure on land. This has increased the problem of underemployment
and disguised unemployment. The scenario is the same for most underdeveloped economies.
Provision of food surplus to exploding population: The existing levels of food consumption in these
countries are very low and with little increase in per capita income, the demand for food rises exponentially
i.e. income elasticity of demand for food is higher in developing countries. Therefore, unless agriculture
increases its marketed surplus of food grains a crisis is likely to emerge. Providing raw materials to industry.
Role of agriculture with respect to poverty reduction: According to a World development report over the
last 25 years in developing countries for every 1% growth in agriculture is at least 2 to 3 times more effective
in reducing poverty than the same growth coming from the non-agricultural sector.
The market for industrial products: Since more than 2/3rd of developing countries' population live in rural
areas increased rural purchasing power is a valuable stimulus for industrial development. In India with the
spread of the first green revolution income of large farmers increased whereas their tax liabilities are
negligible. The corporate sector has identified the potential market in rural areas of India, especially after
1991.
Importance in International trade: For several years agro-based exports like cotton textiles, jute, and tea
accounted for more than 50% of our export earnings. The development of agriculture in India is a pre-
condition of sectoral diversification and economic development. A growing surplus of agricultural produce is
needed to increase the supply of food and agricultural raw materials at non-inflationary prices. Agriculture
plays an important role in widening the domestic market for industrial goods, by increasing the purchasing
power of the rural sector, and facilitating inter-sectoral transfers of capital needed for infrastructure
development. Also increasing forex earnings through agriculture-exports therefore agriculture has to be kept
at the center of every reform agenda or planning process to make a significant dent in poverty and
malnutrition and to ensure long-term food security for the poor.
Nature of Indian agriculture:

1. Rain-fed agriculture
2. Feudal relations are affecting the agrarian economy.
3. Issues of capital and rural indebtedness- Indebtedness is the common legacy of poor farmers during
the pre-independence period. Money lenders were the only credit entities available for the farmers. After
independence government developed cooperative credit institutions along with increasing participation
of banks in proving rural credit. However small and marginal farmers are still dependent on
moneylenders due to several reasons. The phrase 'once in debt always in debt' expresses the condition of
these farmers.
4. Labour market dualism-Due to excessive pressure on land wages in the agricultural sector tend to be
considerably lower in comparison to the modern industrial sector. This leads to labour market dualism
i.e. large number of workers remain with traditional agriculture despite low wages.
5. Outdated farming techniques- with the advent of the first green revolution modern techniques of
production was initiated in certain selected regions of the country like Punjab, Haryana, western UP, etc.
However, many other areas of the country continue with outdated techniques leading to technological
dualism.
6. Fluctuation and instability in crop output- Even today approximately 52% of the gross cropped area
continues to depend on rainfall and therefore monsoon plays a critical role in determining the level of
agriculture production.
7. Diversities in the agricultural sector and the problem of generalization- India is a large country
having substantial agricultural diversities.
8. Different regions exhibit different characteristics and therefore no one plan can be conceived for all
agricultural regions of the country.
9. Fragmented land holding (land reforms).
10. Competition from developed countries especially 1991.
11. Subsidies and investment into research and development.
12. Infrastructure, middlemen, and issues of agricultural marketing.
13. Issues of agricultural credit.
Agricultural market: Advanced agricultural marketing resulted in surplus production which changed the
subsistence phase of Indian agriculture. Approximately 33% of the output of food grain, pulses, and cash
crops like cotton, oil seeds, etc are marketed as they remain surplus after meeting the consumption needs of
the farmer. Increasing the efficiency of the marketing mechanism would result in the distribution of the
products at lower prices to consumers having a direct bearing on national income. An improved marketing
system will stimulate the growth in the number of agro-based industries mainly in the field of processes.
History of Agricultural marketing in India: For a long time, a traditional market system was existing in
India. It was characterized by village sales of agricultural commodities, post-harvest immediate sales by
farmers, etc. In 1928, the royal commission pointed out the problems of traditional marketing as high
marketing costs, unauthorized deductions, and the prevalence of various malpractices. This led to the
demand of having regulated markets in India.
Regulated markets- The regulated market aims at the elimination of unhealthy and unscrupulous practices,
reducing market costs and providing benefits to both producers as well sellers in the market. Post-
independence most of the states enacted the agricultural produce market regulation act. It authorizes states
to set up and regulate marketing practices in wholesale markets. The objective was to ensure that the farmers
get a fair price for their produce. However regulated markets had the following drawbacks:
1. Under this regulation no exporter or processor could buy directly from the farmers so it discourages the
processing and exporting of agricultural products.
2. Under the act state could only set up the market thus preventing private payers from setting up markets
and investing in marketing infrastructure.
3. Formation of a cartel with links to caste and politics makes the system inefficient.
4. An increased number of middlemen formed a virtual barrier between the farmer and the consumer
5. The licensing of commission agents in the state-regulated markets has led to the monopoly of license
traders acting as a major entry barrier for new entrepreneurs.
6. The fragmentation of markets within the state hinders the free flow of agro commodities from one market
area to another and multiple handling of agri-produce and multiple levels of mandi charges end up
escalating the prices for the consumers without adequate benefits to the farmers.
Solutions:
Amendments in APMC Act - consequently the inter-ministerial task force on agricultural marketing reforms
2002 recommended the APMC, Act is amended to allow for direct marketing and establishment of the
agricultural market by the private and cooperative sectors to provide more efficient marketing and create
an environment conducive to private investment. In response, the Ministry of Agriculture proposed the model
act on agricultural marketing in consultation with the state governments for adoption by states. It is within
the powers of the state government to decide whether to make amendments or not.
Model APMC Act-2003 - As per the act, the state is divided into several market areas each of which is
administered by a separate agricultural produce marketing committee that imposed its marketing
regulation including fees. Producers and local authorities are permitted to apply for the establishment of new
markets for agricultural produce in any area. Provision for contract farming, Allowing direct sales of farm
produce. Single point levy of market fees on the sale of notified agricultural commodities in any market area.
Separate provision is made for notification of special markets in any market area for specified agricultural
commodities. It provides for the creation of marketing infrastructure from the revenue earned by the APMC.
Provision made for resolving disputes in the private market.
National agricultural market (e-NAM)- It is an online trading platform for agricultural produce aiming to
help farmers, traders, and buyers with online trading and get a better price to smooth marketing mechanism.
Need for e-NAM- Administration of agricultural marketing is carried out by the respective state. Each state
has its own APMC act with varied provisions and every state is further divided into several market areas
which are separately administered by respective APMCs. This fragmentation of markets even at the state level
hinders the free flow of Agri commodities between different markets. Multiple handling of Agri produce and
multiple levels of mandi charges led to higher prices for the consumers without equivalent benefits for the
farmers. These challenges are addressed by e-NAM by creating a unified market through online trading
platforms both at the state and the national level. e-NAM mandates three changes in the agricultural
marketing laws of the state:
1. Providing for electronic trading.
2. Providing a single trading license i.e. valid in all mandis in a state.
3. Provide a single window levy of transaction fees.
Salient features of e-NAM- The e-NAM portal will enable farmers to showcase their products through their
nearby markets and facilitate traders from anywhere to quote the price. e-NAM provides a single window
service for all APMC-related aspects including commodity arrivals, quality, and prices, buy and sell offers, and
e-payment settlements directly into the farmer's account. Using the e-NAM service licenses for the traders,
buyers, and commission agents can be obtained from the state-level authorities without any pre-conditions
of physical presence or premises in the market yard.
Benefits of e-NAM
 Transparent online trading.
 Real-time price discovery.
 Better price realization for product.
 Reduce transaction costs for buyers.
 Stable price and availability to consumers.
 Payment and delivery guarantee.
 Error-free reporting of transactions.
New features of e-NAM:

The two new features:
1. warehouse-based trading module in e-NAM software will enable trade from warehouses according to
electronic negotiable receipt.
2. Farmers producer's organization trading module in e-NAM enables FPOs to trade their produce from
their collection centers without bringing the produce to APMC.
These new features make it more convenient for farmers to sell their produce at the warehouse and
collection center established by the FPO.
Economic of Animal rearing: Animal husbandry deals with the breeding of livestock like buffalo, pigs,
horses, and sheep that are useful to humans. It includes poultry farming and fisheries, it includes dairy farm
management, poultry farm management, bee-keeping, and fisheries.
Benefits of animal husbandry:

1. Contribution to GVA- it has an important place in the Indian economy, livestock contributes to around
5.2% of total agricultural GVA.
2. Income security- Additional income from animal husbandry can help augment rural income, it also
provides employment to about 8.8% of the population in India.
3. Employment to millions in rural India- For many, it is the only source of livelihood, about 20 million
people depend on livestock for their livelihood.
4. Ensuring food security- The livestock provides food items such as milk, meat, and eggs for human
consumption. Around 95 Billion eggs, and 177 million tonnes of milk.
5. Transport - Pack animals like camel, horses, and donkeys and are extensively used to transport goods in
different parts of the country.
6. Nutrition- They serve as a vital portion of protein by improving human health and welfare.
7. Cultural benefits and social security- Families especially landless to own animals are better placed.
Benefits of allied activities-

1. Creation of multiple revenue sources.
2. Helping the farmers during crop failure.
3. Nutritional security for farmers - Reducing their day-to-day household expenses, would ensure more
disposable income that can be reinvested into farming activities.
4. Special focus on dry land areas- Small and medium farmers with fragmented land can benefit from
poultry and other allied activities.
5. Promote downstream industry and employment related to food processing.


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ECONOMICS

Lavkush Pandey – dm.lavkush@gmail.com 2

There are two ways to commonly measure the depth:

Squared Poverty Gap: If we assume that the poverty line is Rs 10,000.

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We need to identify the poor people Primarily for two purposes:

Tendulkar and Rangarajan Committee's recommendation: They introduced a behavioural component

International Measures of Poverty:

Causes of Poverty in India:

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Reasons for inequality:

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Gini-Coefficient is the statistical measurement of

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In order to enable them to be active contributors relies on the following:

Estimation of Unemployment in India: Unemployment is measured by the Periodic Labour Force

Unemployment according to the macroeconomic school-classical and Keynesian unemployment:

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Employment on the basis of the intensity of work:

Natural Rate of Unemployment also called Non-Accelerating Inflationary Rate of Unemployment: It

Philips Curve: The Philips curve is a graph plotted using

Measuring unemployment in India:

Unemployment in India: Unemployment in India is characterised as a mismatch between aspirations and

Economics some basic concepts

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for example, democratically elected government,

Tools of Economic decision making:

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Different types of goods:

On the basis of the relationship between the demand and income:

On the basis of the relationship with other goods:

Goods which seem to violate the law of demand:

Goods on the basis of the role of suppliers:

Goods on the basis of effects on the society:

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Goods on the basis of their position in the production process:

Goods on the basis of their role in the production process:

Measurement of national incomes: Households

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Measuring value at different prices:

To choose a base year, two important conditions are required:

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Refined measures of National Income:

Relationship between savings and investment:

Incremental Capital Output Ratio:

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Reasons for change in price:

Some important terms:

Measurement of inflation: Measurement consist of the following steps:

Effects of the inflation:

5. Effect of inflation on government and taxpayer:

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RBI's balance sheet: