Unit II: Economic Environment

Business Environment
BBA LLB
Economic Environment
Economic Factors
 Nature and Structure of Economy, Economic Conditions, Economic Policies

Financial Market
 Money Market, Capital Market-Primary & Secondary
Union Budget
Concept, Main Constituents of Budget, Various Types of Budgetary
Deficits.
Price & Distribution Controls
Objectives, Price Controls; Direct vs. Indirect, Administered Prices, Dual
Pricing, Subsidization, Public Distribution System.
Privatization
Concept, Ways of Privatization, Disinvestment Process in India
Exit Policy
Economic Factors
Economic system
Economic system refers to a set of institutions,
principles and mechanisms created by a society to
facilitate economic units to address their basic
economic problems of allocation of scarce resources
and perform their basic economic activities.
Economic System determines
Pattern of ownership of resources,
Role of public and private sectors,
Role of markets and the price mechanism in the
allocation of resources in an economy.
Economic system
On the basis of ownership of resources
Capitalism
Socialism
Mixed economies
On the basis of allocation mechanism
Market economies
Mixed economies
Planned economies
Economic structure
Economic structure defines the physical framework
under which an economy and business units operate.
It can be ascertained from the long term trends in
various economic variables.
Major determinants of economic structure are:
Population size
Income per capita
Factor endowments
Demographic profile
Technological advancements
Economic Structure constituents
Demand Structure
Production structure
Employment Structure
Fiscal structure
Financial structure
Trade structure
Population structure
Economic Structure
China has
 Achieved an impressive growth of average 10% in the last
three decades
 Became second largest economy, and
 Major exporter and manufacturer in the world.
 Important driving force of global growth.
Economic Structure
Following structural changes have started constraining
its growth rate and raising doubts in its sustainability:
 China’s population is growing older, which will reduce its
workforce size and put pressure on social safety nets.
 Chinese growth is investment led, that leads to excess
capacity. To achieve more balanced growth, it needs to
reduce its investment to GDP ratio and improve its
consumption share.
 China is growingly dependent on exports for its growth,
which makes it susceptible to adverse external shocks.
Production Structure

Source: NSSO
Indian Employment Structure

Source: NSSO
Fiscal Structure
Composition of the government expenditure, tax
revenue and overall size of the government reflects
the fiscal structure.
Fiscal structure can alter the economic environment
through various channels.
Fiscal structure can give an idea about the government
control in economic activities, the resources that are
flowing to the public sector and how much is available
to the private sector. In an economy, with large public
sector, private sector can find resource shortage
Financial structure
Bank based or Market based financial system
Business units usually depend on external sources,
such as financial intermediaries and financial markets
for financing their investment expenditure and
working capital requirements. Availability and cost of
credit are some of the important determinants of
investment by them.
Availability of funds and cost of funds all gets
determined by the structure of financial system and
the level of development of the financial system of a
country.
Financial System
Business (Working Capital, Investment)
External Source of Funds
Availability and Cost of Funds
Funds (Source, Availability, Cost)
Financial Structure (Bank/Market Based)
Development Level of Financial System
(Underdeveloped/Developed)
Trade Structure
Need for Trade
Why do we export and import commodities?
Why do countries participate in international trade?
What are the issues and challenges in International
Trade?
Trade Structure
Trade structure can be gauged from sectoral export
and Import shares.
Trade structure reflects the country’s vulnerability to
external trade shocks as well as its comparative
advantage.
Trade structure gives useful information for policy
making by the country and strategic decisions by
companies involved in international trade.
Population Structure
 Population structure refers to many aspects of population ecology,
such as population size, age class distribution, gender wise
classification and density.
 Population size determines the overall market size, which affects the
overall demand for products,
 Age class distribution called age structure, impacts the product mix.
Age structure affects the labour force size and spending and saving in
the economy, and thus affects the production capacity.
 Countries with higher proportion of aging population like USA,
Germany, Japan, Singapore, Australia, China, and South Korea are
facing severe labour shortage apart from other challenges associated
with such a demographic change. In India, population of children are
increasing and putting the burden on education system. Educational
shortage may turn into skill shortage.
Financial Market
Components of Indian financial system
Functions of Financial System
Provides a payment system for the exchange of goods and
services.
Enables pooling of funds for undertaking large scale
enterprises.
Facilitates transfer of economic resources across time and
space.
Provides a way for managing uncertainty and controlling risk.
Generates information that helps in coordinating
decentralized decision making.
Helps in dealing with the incentive problem when one party
has an informational advantage.
Financial Market
Money Market
Capital Market-Primary & Secondary
Union Budget
Union Budget
Concept,
Main Constituents of Budget,
Various Types of Budgetary Deficits
Budget meaning
The term “budget” comes from the old French
word, bougette, meaning a small bag. “That was the
small purse filled with gold coins that the shipowners
gave to the sea captains before sending them off to
the Far East to buy spices and other goods to be
brought back to Europe,” writes Bjarte Bognes in his
book, Implementing Beyond Budgeting (Wiley, 2017).
Union Budget - Meaning
 According to Article 112 of the Indian Constitution, the Union
Budget of a year, also referred to as the annual financial
statement, is a statement of the estimated receipts and
expenditure of the government for that particular year.
 Government budget is an annual statement, showing item wise
estimates of receipts and expenditure during fiscal year i.e.
financial year. The receipts and expenditure, shown in the
budget, are not the actual figure, but the estimated values for the
coming fiscal year.
Components of Budget
 Components of budget refers to structure of the budget.

1. Revenue Budget

2. Capital Budget
Revenue Budget
 It deals with the revenue aspect of the government budget. It explains
how revenue is generated or collected by the government and how it is
allocated among various expenditure heads. Revenue budget has two
parts:
 Revenue Receipts
 Revenue Expenditures 

 Revenue budget includes the government's revenue receipts and

expenditure. There are two kinds of revenue receipts - tax and non-tax
revenue. Revenue expenditure is the expenditure incurred on day to
day functioning of the government and on various services offered to
citizens. If revenue expenditure exceeds revenue receipts, the
government incurs a revenue deficit.
Capital Budget
 It deals with the capital aspect of the government budget and it
consists of:
 Capital Expenditures

 Capital Receipts

 Capital Budget includes capital receipts and payments of the

government. Loans from public, foreign governments and RBI form a
major part of the government's capital receipts.
 Capital expenditure is the expenditure on development of machinery,
equipment, building, health facilities, education etc.
Budget Receipts
 Budget Receipts refer to the estimated money receipts of
the government from all sources during a given fiscal year.
 Budget receipts may be further classified as:

i. Revenue Receipts
ii. Capital Receipts Other Receipts Recovery Of Loans
Revenue receipts
 Revenue receipts refer to those receipts which neither
create any liability nor cause any reduction in the assets of
the government. They are regular and recurring in nature
and government receives them in its normal course of
activities. A receipts Is revenue receipt, if it satisfies the
following two essential conditions:
 The receipts must not create a liability for the
government.
 The receipts must not cause decrease in the assets.
Capital receipts
 Capital receipts refer to those receipts which either create a
liability or cause a reduction in the assets of the
government. They are non-recurring and non-routine in
nature. A receipt is a capital receipt if it satisfies any one of
the two conditions:
The receipt must create a liability for the government
The receipts must cause a decrease in the assets
Budget expenditure
 Budget expenditure refers to the estimated expenditure of
the government during a given fiscal year. The budget
expenditure can be broadly categorized as:
A. Revenue Expenditure

B. Capital Expenditure
Revenue Expenditure
 Refers to the expenditure which neither creates any asset
nor causes any reduction in any liability of the government.
It is incurred on normal functioning of the government.
Examples: Payment of salaries, pensions, interests, etc.
 An expenditure is a revenue expenditure, if it satisfies the
following two essential condition:
a) The expenditure must not create an asset of the
government.
b) The expenditure must not cause decrease in an liability.
Capital expenditure
 Refers to the expenditure which either creates an asset or causes a
reduction in the liabilities of the government. It adds to capital stock of
the economy and increases its productivity through expenditure on
long period development programs. Examples: Loan to states and
Union Territories, etc.
 An expenditure is a capital expenditure, if it satisfies any one of the
following two conditions:
 The expenditure must create an asset for the government.

 The expenditure must cause a decrease in the liabilities.

Budgetary deficit
 When the government spends more than it collects, then it
incurs a budgetary deficit.
 In India budgetary deficit can be of 3 types:
 Revenue Deficit

 Fiscal Deficit

 Primary Deficit
PRICE AND DISTRIBUTION
CONTROLS
Price & Distribution Controls
Objectives, Price Controls;
Direct vs Indirect, Administered Prices, Dual Pricing,
Subsidization,
Public Distribution System.
 Objectives of Price and Distribution Controls
1. Equity or Distributive Justice
2. Maintain Quality of Goods and Services
3. Prevention of Monopolistic, Restrictive and Unfair
Trade Practices
4. Augmentation of Supply
5. Enlargement and Smoothening of the Supply System
6. Supply of Inputs to Priority Sectors
7. Resource Allocation
8. Prevention of Hoarding and Blackmarketing
9. Control of Inflation and Deflation
Why price and distribution controls
Scarcity, market imperfections and social concerns
made price and distribution controls as one of the
important means of achieving the socio-economic
goals in many planned, especially developing,
economies
The important factors that call for price and
distribution controls in countries like India are short
supply of goods and services; an unreasonable level of
prices in the free market and the very low levels of
income of a large number of people
Price and Distribution controls
 Government has significant role in regulating price and distribution to maintain
smooth economy in nation. It has been established that if there is good
production, but it has no value when the goods produced are not delivered to the
end-users at the right time in the right quantity and at the reasonable price.
 Price Control is a regulatory mechanism used by the government to achieve
socio- economic objective
Price Controls
Indirect Controls
Indirect controls are exercised mainly through the
monetary policy, fiscal policy and commercial (foreign
trade) policy.

Direct Controls
Direct controls work through legislative and
administrative measures.
Price and Distribution Control: Methods
Price and Distribution Control: Methods
Administered Prices
The term administered price often refers to the
government determined price.
Administered prices were generally fixed on the
recommendations of an expert body.
The principal aim of the administered price system
is the protection of the interests of both the
producers and consumers.
Dual Pricing
The system of dual pricing has been designed to allow the
weaker sections of the people or the privileged buyers like
the government to get the commodity at a lower price.
Under dual pricing, a part of the output of an industry may
be acquired by the government at a price fixed by it, which
is usually lower than the market price, and the remaining
part of the output may be sold by the industry at the
market price.
Some commodities like sugar, cotton textiles, paper and
aluminium were subject to dual pricing in India in the
past.
Subsidisation
Prices of certain commodities are directly affected
by the policy of subsidisation.
The principal objective of subsidies is the
protection of weaker sections and priority sectors.
The Essential Commodities Act

The main purpose of the Essential Commodities Act,

1955, was to provide, in the interest of the general
public, for the control of the production, supply and
distribution of, and trade and commerce in, certain
commodities.
This Act empowers the Central Government to regulate
or prohibit the production, supply and distribution of,
and trade and commerce in, any essential commodity.
The Public Distribution System

Public Distribution System (PDS), under which the

government makes available essential mass
consumption goods at reasonable prices, especially to
the poor.
In June 1997 the Government launched the Targeted
Public Distribution System (TPDS) by streamlining
the PDS by issuing special cards to the families below
the poverty-line (BPL) and selling essential articles
under PDS to them at specially subsidised prices.
Regulations
Industries (Development and Regulation) Act, 1951
Essential Commodities Act, 1955
Competition Act 2002 (Previously MRTP Act, 1969)
Foreign Trade Development and Regulation Act
[earlier the Imports and Exports (Control) Act
 Prevention of Blackmarketing and Maintenance of
Supplies of Essential Commodities Act, 1980
Conservation of Foreign Exchange and Prevention of
Smuggling Act, 1947
PRIVATISATION AND
DISINVESTMENT
Privatisation and Disinvestment
Privatisation
Concept, Ways of Privatization,
Disinvestment Process in India
Privatisation
Privatisation means transfer of ownership and/or
management of an enterprise from the public
sector to the private sector.
It also means the withdrawal of the State from an
industry or sector, partially or fully.
Another dimension of privatisation is opening up
of an industry that has been reserved for the public
sector to the private sector.
Ways of Privatisation
1. Divestiture
2. Denationalisation
3. Contracting
4. Franchising
5. Government withdrawing
6. Privatisation of management
7. Liquidation
Ways of Privatisation
Divestiture or privatisation of ownership through
the sale of equity.
Contracting.
Another option for the government is to withdraw
from the provision of certain goods and services
leaving them wholly or partly to the private sector.
Privatisation may also take the form of
privatisation of management, using leases and
management contracts.
Benefits of Privatisation
 Privatisation benefits the society in several ways.
Some of them are
1. reduces the fiscal burden
2. enables the government to mop up funds
3. result in better management of the enterprises
4. encourage entrepreneurship
Privatization
Privatization is the process of transferring ownership of a
business, enterprise, agency, public service or property from
the public sector (government) to the private sector or to
private non-profit organizations. The term is also used in a
quite different sense, to mean government out-sourcing of
services to private firms.
Main aspects of privatization in India
 Autonomy to Public sector :

Greater autonomy was granted to nine PSUs referred to as ‘navaratnas’

( ONGC, HPCL, BPCL, VSNL, BHEL) to take their own decisions.
 De-reservation of Public Sector :
The number of industries reserved for the public sector were reduced in a
phased manner from 17 to 8 and then to only 3 including Railways,
Atomic energy, Specified minerals. This has opened more areas of
investment for the private sector and increased competition for the
public sector forcing greater accountability and efficiency.
Main aspects of privatization in India
 Disinvestment Policies :

Till 1999-2000 disinvestment was done basically through sale of minority

shares but since then the government has undertaken strategic sale of it’s
equity to the private sector handing over complete management control
such as in the case of VSNL , BALCO .etc
 Potential benefits of privatization
 Improved efficiency

The main argument for privatisation is that private companies have a

profit incentive to cut costs and be more efficient. If you work for a
government run industry, managers do not usually share in any profits.
However, a private firm is interested in making a profit, and so it is more
likely to cut costs and be efficient. Since privatisation, companies such as
BT, and British Airways have shown degrees of improved efficiency and
higher profitability.
Main aspects of privatization in India
 Lack of political interference

It is argued governments make poor economic managers. They are

motivated by political pressures rather than sound economic and
business sense. For example, a state enterprise may employ surplus
workers which is inefficient. The government may be reluctant to get rid
of the workers because of the negative publicity involved in job losses.
Therefore, state-owned enterprises often employ too many workers
increasing inefficiency.
Main aspects of privatization in India
 Short term view

A government many think only in terms of the next election. Therefore,

they may be unwilling to invest in infrastructure improvements which
will benefit the firm in the long term because they are more concerned
about projects that give a benefit before the election.
 Shareholders
It is argued that a private firm has pressure from shareholders to perform
efficiently. If the firm is inefficient then the firm could be subject to a
takeover. A state-owned firm doesn’t have this pressure and so it is easier
for them to be inefficient.
Main aspects of privatization in India
 Increased competition
Often privatisation of state-owned monopolies occurs alongside
deregulation – i.e. policies to allow more firms to enter the industry and
increase the competitiveness of the market. It is this increase in
competition that can be the greatest spur to improvements in efficiency. For
example, there is now more competition in telecoms and distribution of gas
and electricity.
 Government will raise revenue from the sale
Selling state-owned assets to the private sector raised significant sums for
the UK government in the 1980s. However, this is a one-off benefit. It also
means we lose out on future dividends from the profits of public companies.
Disadvantages of privatisation
 Natural monopoly

A natural monopoly occurs when the most efficient number of firms in an

industry is one. For example, tap water has very significant fixed costs.
Therefore there is no scope for having competition amongst several firms.
Therefore, in this case, privatisation would just create a private monopoly
which might seek to set higher prices which exploit consumers. Therefore it is
better to have a public monopoly rather than a private monopoly which can
exploit the consumer.
Disadvantages of privatisation
 Public interest

There are many industries which perform an important public service,

e.g., health care, education and public transport. In these industries, the
profit motive shouldn’t be the primary objective of firms and the
industry. For example, in the case of health care, it is feared privatising
health care would mean a greater priority is given to profit rather than
patient care. Also, in an industry like health care, arguably we don’t need
a profit motive to improve standards. When doctors treat patients, they
are unlikely to try harder if they get a bonus.
Disadvantages of Privatisation
 Government loses out on potential dividends.

Many of the privatized companies in the UK are quite profitable. This

means the government misses out on their dividends, instead going to
wealthy shareholders.
 Problem of regulating private monopolies.

Privatisation creates private monopolies, such as the water companies

and rail companies. These need regulating to prevent abuse of monopoly
power. Therefore, there is still need for government regulation, similar to
under state ownership.
Method of Privatisation
 Liquidation / Dis-investment:

Government to sale of a state-owned firm to the private sector

 Subsidization:

Government makes provision of grants to non-profit orgs for public

service
 Outsourcing :

Retention of responsibility but hiring a private contractor

Sins and Pitfalls of Privatisation
1. Lack of Proper Strategy
2. Ambiguity of Objectives
3. Connivance
4. Wrong Timing
5. Lack of Political Consensus
6. Wrong Labour Strategies
7. Lack of Political Will
8. Poor Financial Strategies
9. Wrong Environment
10. Prevalence of Monopoly Elements
11. Problem of Cultural Change
EXIT POLICY
Exit Policy
Exit policy refers to the policy regarding the
retrenchment of the surplus manpower resulting from
restructuring of industrial units or the workers
becoming unemployed by the closure of sick units.
The exit policy in its wider context covers the policy for
the compensation for the employees who leave the
organisation and the measures for their rehabilitation
also.
Need for the Exit Policy
 Surplus manpower is a major problem of many
industrial units in India.
1. Surplus manpower increases costs which becomes a
major drawback in to days correct competitive
market.
2. Many unviable risk units both in public and private
sector to be closed. Otherwise, they society has to
been the cost of the same.
3. Technology is converting industry from labour
intensive to capital intensive.
Extent of Overmanning
The overmanning has two dimensions, viz., the surplus
even with the existing technology employed by the
enterprises and the surplus that will emerge if the
existing technology is replaced by modem technology.
A study by Mrityunjaya Athreya, conducted in 1987,
revealed that the Steel Authority of India (SAIL) had a
surplus of 80,000 workers.
At least 50 per cent of the workers of the State road
transport undertakings were estimated to be surplus. The
same may be true of state electricity boards.
The figures given above give some indication of the extent
of the alarming overmanning of the Indian economy.
VRS and Golden Handshake
A popular method to trim the manpower is the voluntary
retirement scheme (VRS). Under the VRS, employees who
have attained forty years of age or ten years of service
would seek voluntary retirement. The minimum benefits
under this scheme would be forty five days emoluments for
each completed year of service before normal date of
retirement or the monthly emoluments at the time of
retirement multiplied by the remaining months of service
before the normal date of service, whichever is less. The
benefits would be in addition to the amount that has
accrued to the Provident Fund as per the rules or to the
Gratuity fund whichever is applicable.
National Renewal Fund
 The objectives of the NRF are the following.
1. To provide assistance to firms to cover the cost of
retraining and redeployment of employees
2. To provide funds for compensation to employees
affected by restructuring or closure of industrial
units
3. To provide funds for employment generation
schemes in the organised and unorganised sectors in
order to provide social safety net for labour.