Module 1: Nature and Scope of Business

Meaning of Business:
Business is the organized effort of an enterprise to earn profits. Business may be big or
small, but irrespective of the size they all aim at making profits.

Scope of Business:
The various activities from the organization of raw materials to the manufacture of the
end product. Constitute the scope of the business, The activities involved in this scope of
business are:
1) Production
2) Trading
3) Banking
4) Insurance
5) Marketing
6) Advertising
7) Packing etc.

Business as a system:
There are four sequential stages in the business as a system:
1) Input
2) Conversion
3) Output
4) Feedback

Objectives of business:
1) Profits: Excess of income over expenditure is known as profits. It is reward for
taking risk. Making profits is the primary goal of any organization. It is the main
incentive, motivate, indicator of production basis for growth expansion and
survival. There are many organizations which don’t work for profits, their basic
objective is to provide services to the society.

2) Growth: The overall development of business in all directions is known as

growth, the strategies adopted to achieve growth are:
a) Add new products to the markets
b) Diversify new products
c) Minimize cost, increase the productivity
d) Increase the market share
e) Mergers and Acquisitions

3) Power: Business organizations have huge resources in the form of money,

material human resources and knowledge these resources provide economic and
political powers to the business owners and the managers of the organization.
4) Employee satisfaction and development: Business is men caring for employees
satisfaction and providing for their development is one of the most important
objective of enlightened business organization.

5) Quality product and service: This is the most important objective. Economically
and morally those who give importance to this objective survive in the
competition and stay ahead in the market.

6) Persistent Quality: Persistent quality of products earn brand loyalty and consumer
satisfaction. E.g. the products of Hindustan Lever are used in every house hold of
the country. To maintain the quality of the product there is requirement of R&D
department and high degree of management professionals.

7) Market Leadership: To earn market leadership the main requirement is innovation

the main requirement is innovation and diversification and diversification. E.g.:
Pepsi retains the market leadership by introducing diet Pepsi.

8) Service to Society: Business is part of society and it has several obligations

towards it. Some of them are:
a) Providing safe and quality goods at reasonable prices.
b) Providing Employment.
c) Supporting weaker sections of the society.

9) Good Corporate Citizenship: This implies that business should follow the rules,
pay the taxes regularly to the government, Care for its employees and customers.
If good corporate governance is not maintained, it hampers the growth of the
country.

Forms of Business Organization:

1) Public Sector Enterprises: When government is the owner or the manager of

certain business units it is said to be under public sector. Under this we have:

a) Ministry: In this an undertaking is managed by whole ministry of

government such as railways. Railways are managed by the ministry of
railways and it’s accountable to the parliament.
b) Departmental Undertaking: These undertakings are directly subordinate to
the ministry but they have their own management responsible for
activities. E.g. Post, Telegraph, Production units etc.
c) Statutory Corporations: A corporate created by separate law,
independently financed and vested with the power of independent
management is known as Statutory Corporation. E.g. LIC, RBI, Industrial,
Finance Commission etc.
 d) Central Boards: Central boards are charged with the responsibility of
executing have projects which require huge capital investment, they are
jointly set up by central & State Government. E.g. River Valley Projects.
e) Companies: An enterprise becomes a government company when it has
the following characteristics.
1) Have all the features of private limited company.
2) 51% of share capital is owned by government.
3) Majority of directors are appointed by the government.
4) It is registered under the company’s act 1956.

2) Private Sector Companies: When the organization is controlled and managed by

the private sector it is said to be under private sector enterprise. Private
organizations can be categorized under the following heads:
a) Proprietary: When the enterprise is controlled and managed by a single person it
is known as proprietary.
b) Partnership: When two or more people control the business activities it is known
as partnership. Under this type of system all profits, losses and goodwill is shared
by the partners.
c) Co-Operatives: These are formed by the individuals to help themselves.
Consumer Co-Operative societies are normally formed by the residents of the
locality.
d) Limited Companies: All limited companies are formed when it is registered under
the companies’ act 1956. Share Holders are the owners of the company. Day t day
management of the company is looked after by a group of people known as the
board of directors.

Business and environment interface:

All internal and external forces that influence the business are known as business
environment. Business environment is the present era is Liberalization, Privatization, &
Globalization.
Business environment is a multi layered structure and these layers and these
exhibit different characteristics. If one layer produces any effect, it is transferred to the
other layers may be in a limited manner and over a long period of time.
The various layers of business environment are:
1) International Environment: This layer of business environment concerns
all business firms weather they are part of international trade or not. A
change in the exchange rate can affect the prices of the imported goods
and further the cost of production and the prices of domestic goods. The
various factors that determines the international environment are:
a) The stage of world economy.
b) International economy Co-Operation.
c) Role of multi lateral institutions such as IMF & WTO.
d) International economic Laws and agreements.
e) Political systems of different countries.
f) Cultural factors across the countries.
g) Technology growth and transfer.
 h) Growth of Multinational organizations.
i) National economic policies of different countries.
j) Technology growth and transfer.

2) Domestic Microenvironment: Macro economic environment envelops all

business firms and provides them a frame work with in which they have to
operate and adopt themselves.

Major Economic Systems:

1) Free Market Economy: In this system productive resources are privately owned
individuals and the firms have the freedom to make major decisions about
production and consumption under competitive conditions E.g. US, Australia,
Canada etc follows this system.
2) Command economy: In this system most of the productive resources are owned
and operated by the government. The major decisions regarding the production
and consumption are taken by the government.
3) Mixed Economy: In the mixed economy, neither the government nor the private
sector has the dominant position. In fact both the sectors operate jointly and major
decisions are taken by both the sectors.

Growth and Distribution environment:

Growth refers to the income in the level of real output over a period of time.
There are three basic measures of country’s real output.1) G.D.P 2) N.D.P 3) G.N.P
All these measures give the data on the national income and national income data
describes the prosperity of an economy. Higher the national income more prosperous the
economy is which implies more market potential for the business organizations.

3) Macro Economic Stability: It is manifested in the form of stability of the

price level, exchange rate, investment rate, interest rate, money supply,
balance of payment etc. Variables are inter related and any instability in
one of the variables can output the potential of other variables.

4) Economic policies: The basic objective of economic policies is to

stimulate growth, achieve economic stability and bring economy to full
employment level which depends on the wisdom of the government who
is ruling the country at the point of time. Economic policies can be in the
form of monetary policy, fiscal policy, industrial policy and foreign trade
policy.

5) Competitive Environment: The state of market competition is one of the

major factors affecting the rate of growth, income distribution and welfare
of the consumers. Most governments in capitalistic and mixed economy
attempt to maintain free and fair competition in various sectors of the
economy through suitable laws and regulations. These laws are formed to
control the monopolistic and anti competitive trade practices.
 6) Macro Non Economic Factors: Understanding of non-economic
environment is very essential for the business management. An individual
firm is not in position to bring change in this environment, it has to
operate and adjust according to this environment. Under this the factors
which determine the scope of business activities are: a) Political Structure.
b) Legal Structure. c) Cultural structure.

7) Demographic Environment: Demographic characters of a country have an

important influence on business environment. Apart from the size and
growth of the population demography includes density of the population,
male female ratio, size of working population etc. These factors are
helpful in determining the human resource of the country, demand for the
product and wages or salary structure of the working population.

8) External Environment: This is the enterprise level external macro

environment constituted by the business relations of an organization with
outside parties. Some of the main entities with which the firm has business
relations are Customers, Suppliers, Financial Institutions, Competitors etc.

9) Internal Environment: The determinants of the internal environment are:

a) Mission and vision of the organization.
b) Industrial Relations.
c) Management philosophies and Strategies.
d) Quality controlled system.
e) Team spirit among employees.
f) Quality of Internal Communication system.

Ethics: It refers to a system of moral policies, a sense of right and wrong, goodness and
badness of actions and their consequence.
Business Ethics refers to the applications of ethics in business, it is the extension of
values of personal life to business.

Corporate Governance: Corporate Governance basically refers to a set of systems and sub
systems by which company is controlled and directed, the basic objective of corporate
governance is to maximize long run interests of the stakeholders.

Hallmark of a good Corporate Governance:

1) To maximize the long run corporate values.
2) It is transparent and Effective.
3) It is able to prevent corporate crimes.
4) It promotes competitiveness and overall growth of the organization.
5) It maintains a healthy corporate culture that blends well into the socio economic
and cultural profile of the society.
6) It is ethical and socially responsible.
7) It is flexible and dynamic.
 8) It provides adequate space to the shareholders for effective contribution to the
governance of the company without getting involved in the day to day functioning
of the company.
9) It resolves the conflicts between stakeholders for the long run benefit of the
organization.

Factors influencing the Corporate Governance:

1) Ownership Structure of the organization: The ownership of can be disbursed

among shareholders or can be concentrated in the hands of few shareholders.
2) The structure of Company’s Board: The structure of Company’s Board has a
considerable influence on the way the company’s are managed and controlled.
The board of directors are responsible for establishing company objectives,
policies of the company and selecting the top level executives to carry out these
policies and objectives.
3) Financial structure: The proportion between debt and equity has implications for
the quality of governance. Investors exercise significant influence on the way the
company is managed and controlled.
4) The institutional environment: The legal regulatory and political environment
within which the companies operate determines the quality of corporate
governance.

Mechanism of Corporate Governance:

In our country, there are six mechanisms to ensure corporate governance:

1) Company act 1956.
2) S.E.B.I act 1992
3) Market for Corporate Control.
4) Participation of shareholders in the governance of the companies.
5) Statutory auditing.
6) Code of Conduct.

The code of conduct is based on the checks and balances specially at the level of board of
directors to guard against undue concentration of power and to ensure adequate
disclosure of information when it is required. It Comprises of 4 Sections:

1) It is proposed that the number of executive directors should be balanced by adequate

members of non executive directors with one board chairman and chief executive
director.
2) It was emphasized that non executive directors should be appointed only for a specific
time period and there should be formal process for their appointment.
3) There should be full and clear exposure of the emoluments and pay should be set by
the remuneration committee consisting mainly of non executive directors.
4) Financial reporting controls: It was recommended that properly constituted ordered
committee of the board of directors should be appointed and non executive directors
should report regularly on the effectiveness of the system and internal financial control.
 Module 2 - Key Indicators of Macro Economy

Module 2: Key Indicators of Macro Economy

Key indicators of Economic perspectives:

It is one of the most basic and important indicator of the health of the economy. It
provides the measure of aggregate output and its comparison over a period of time help
us to calculate the rate of growth of the economy. Following are the key indicators of
macro economic environment:

1) GDP
2) Sectoral Shares
3) Inflation
4) Agricultural Output
5) Money Supply
6) Foreign Trade
7) Foreign Exchange
8) Electricity Generation
9) Economic Infrastructure
10) Social Indicator

1) G.D.P: G.D.P is calculated both at current prices and constant prices. At current prices
G.D.P growth is partially due to the growth in the prices and partially due to increase in
prices. Thus G.D.P at current price can give misleading picture of growth. E.g. If the
G.D.P at current prices records a growth of 5% then there may be 0 growth in the output
and increase in price making it 5%, thus G.D.P also helps us to calculate the rate of
inflation in the economy. To avoid such type of difficulties, G.D.P is calculated at
constant prices taking one of the past year’s as the base year. Presently C.S.I (Central
Statistical Organization) computes G.D.P for the Indian economy taking 93-94 as the
base year. Thus a G.D.P growth of 5% calculated at constant price indicates 5% increase
in the growth of an Economy.

Difference between nominal and Real G.D.P: Nominal G.D.P is the value of the flow of
output produced in an economy over a period of time calculated at current market prices.
Real G.D.P is the value of physical output produced in the country.

G.D.P Deflator: It is a price index number which can be applied to nominal G.D.P figure
to remove the effect of changing price level. G.D.P Deflator can also give the rate of
inflation of an economy.

2) Sectoral Shares: The sectoral share of G.D.P indicates the type and nature of the
economy. If in the economy the share of agriculture is largest and agriculture provides
employment to major part of the population then such economies are generally
considered as low income and slow developing economies. Economies with good rate of
growth are generally those economies in which share of industry in the national output
are increasing and agriculture is falling over the period of time. Within the industrial
sector the share of industries such as iron & steel, petroleum, electrical engineering
products, Automobiles, Fertilizers etc is indicative of industrial and technological
environment, these industries provides strong base to the growth of agriculture.
Increasing share of service sector in the total G.D.P is the indicative of high rate of
growth as service sector provides finances, transportation, insurance, communication to
the industrial and economic structure.

3) Inflation: Inflation is a process in which the general price level reports a sustained and
appreciable increase over the period of time. There are many kinds of inflation as
follows:
a) Creeping: 0-5%
b) Walking: 5-10%
c) Running: 10-20%
d) Galloping: 20-50%
e) Hyper: Above 50%

Inflation below 5% is generally not a problem rather its considered as good boosters for
the firm’s growth as it provides more profit margins to the producer and profits are
motivator for further growth. Double digit inflation requires anti inflationary policies.
Galloping and hyper inflation can lead to economic crises and requires strong anti
inflationary policies.

Inflation can be of two types: Demand pull inflation and cost push inflation.
Demand pull inflation results when aggregate demand exceeds aggregate supply. The pull
of demand may be due to the fast increase in money supply or bank credit. On the other
hand cost push inflation results because of sustained increase in the prices of inputs
including capital goods, intermediaries and raw materials. Cost push inflation also occurs
when workers negotiate for more wages and salaries or more facilities.

4) Agricultural Output: Agricultural output is also a very important indicator of positive

macro economic environment. Agriculture provides food for the population, raw
materials to the industry and employment to major portion of population. Shortage of
food can create serious scarcity of food and country can become dependant on the import
of food from other countries. It causes a drain of scarce foreign exchange resources.
Given the inequalities of income the shortage of food can also lead to malnutrition,
poverty and hunger. Similarly it can also create dependents of industry on imports as
agriculture provides many types of inputs to the industries.
The imports of these inputs by the industry can increase the cost of production and
reduces the industrial competitiveness in the international markets and also cause
inflationary pressures.

5) Money Supply: It is an important indicator of macro economic environment; it is

determined by the central bank of our country along with the wide network of
commercial banks and other financial institutions.
R.B.I has adopted 4 measures of money supply i.e. M1, M2, M3 & M4.
M1 & M3 are the most popular components from the operational point of view. M1 is
known as narrow money and M3 is known as broad money.
M1 Consists of:
a) Currency with the public in the form of coins and notes.
b) Demand deposits with the bank and other deposits with R.B.I
M3 consists of M1 plus time deposits with post offices and other commercial banks
Ideally money supply should be equal to the growth of the output, this is important to
maintain price stability in the economy under competitive conditions.
If money supply is less then the growth of the output, it means sufficient money is not
available in the economy to conduct transactions. It creates shortage of liquidity and leads
to increase in the market rate of interest. Increase in the rate of interest increases the cost
of capital and lowers the competitiveness of the firm. Thus a low money supply is the
indicator of negative macro economic environment.
Excess of money supply may lead to inflationary pressures from the economy.
6) Foreign Trade: Foreign trade of a country not only affects the national income of a
country but is also an indicator of country’s openness and competitiveness in the
international market. It is also indicative of economic liberalization and positive attitude
of government towards globalization. A country with low level of imports and exports
indicates poor economic relations.
The commodity composition of foreign trade reflects the nature of an economy. A slow
growing and low income economy exports primary and low value added product and
import high value industrial products.
Foreign trade balance is the key indicator of foreign exchange, a positive trade balance
which is known as surplus increases the foreign expenses and is an indicator of positive
macro economic environment.

7) Foreign Exchange Reserves: It consists of foreign currencies, gold holding of central

bank and Special Drawing Rights of World Bank. Foreign exchange reserve of a country
indicates its ability to pay, import, clear off debt liabilities etc.
The international credibility of a country is seriously jeopardized if it does not
maintain adequate foreign reserves. To protect good image of the economy, most of the
governments, particularly in developing economies would maintain comfortable level of
reserves even through borrowings from the other countries. A low level of foreign
exchange reserves of a country indicates a substantial devaluation of the currency,
foreign exchange crisis and heavy restrictions on imports.
Foreign trade involves the use of the currencies of different countries, the price of one
unit of a currency in terms of the number of units of other currency is known as foreign
exchange rate. E.g. If 40 Rupees are exchanged for 1 U.S.D, its called rupee exchange
rate, if this rate increases to rupees 45 a dollar, then rupee depreciates and dollar
appreciates. On the other hand if the rate falls to 35, then rupee appreciates and dollar
depreciates.
A currency which has a long term tendency to depreciate is known as the weak
currency and foreign investors generally don’t prefer weak currency. Thus, foreign
exchange stability is the key indicator of positive macro economic environment.
8) Electricity Generation: Electric power is the device of modern technology; it is the
major component of the company’s infrastructure and the cost of production. Because of
massive investment and manpower requirements, it is managed by government
companies in most of the developing countries. Availability of sufficient power is a key
indicator of positive macro economic environment. Insufficient power supply upsets
production schedules and creates excess capacities in production units. This increases
cost per unit and reduces the competitiveness of the organization. Power inadequacy
discourages both domestic and foreign investment in the corporate sector, it equally
affects agricultural sector too. Keeping in mind the macro economic importance of
power, the government of India has already initiated a program of power sector reforms.

9) Economic Infrastructure: It is the foundation on which various economic activities

takes place. The growth of economic factors including power, telecommunication,
roadways etc is essential to sustain growth and development. Insufficiency or poor
quality of infrastructure constrains business operations and increases operational costs
E.g. Poor quality of roads and congested ports increases the delivery time of cargo and
also increases the working capital requirements etc.
A number of private sector projects in infrastructure have been held up for reasons such
as power shortage, lack of resources etc.
Availability of good quality infrastructure expands the scope of economic activities,
Activities of almost all the industrial countries of the world have developed
infrastructure.

10) Social Indicator: Economic growth does not have much meaning in the economy if it
does not bring quality of life of the people. Social development is directly related to
human resource development, hence it takes place through education, nutrition etc.
Specific programs targeted at women, children,, old population and economically
backward classes are the important components of social service.
Other social indicators are: Poverty rate, Labor force participation rate, Health Indicator
etc.

Module 3 - Industrial Policy and Performance

Industrial policy refers to the government policy towards industries. It is related to their
establishment, functioning, growth and management. It also focuses in the respective
areas of small scale, medium scale and large scale industries. It also indicates the
government policies towards foreign capital, taxes, subsidies and other related areas.

Present industrial policy 1991:

Objectives:
1) To de regulate the economy in substantial manner.
2) To remove the weaknesses or distortions of the earlier policies.
3) To maintain sustained level of growth and productivity.
4) To promote the growth of entrepreneurship.
 5) TO upgrade technology to match the standards of international competitiveness.

The steps taken to achieve these objectives are as follows:

1) Abolition of industrial licensing: The important landmark of new industrial

licensing for all the industries except the few industries because of social and
security reasons. Some of these reasons are sugar, coal, hazardous chemicals
producing industries, medicinal industries, petroleum etc. The exemption from
licensing will make the economy more competitive, efficient and modern and will
take its right place in the world of industrial growth.

2) Liberalization of foreign investment and technology inflow: Foreign investment

brings advantages of technology transfers, marketing expertise, introduction to
modern management techniques, and new possibilities for the promotion of
exports.
The emphasis of industrial policy of 1991 has been to invite foreign investment
in high priority areas requiring large investment and sophisticated technology.
Initially policy provided F.D.I up to 51% but in the subsequent years the limit has
been raised substantially
The policy explicitly recognizes the need for foreign investment for export
development. The policy also provides automatic approval for technical
collaborations within specified parameters. The policy provides freedom to Indian
companies to negotiate terms of technology transfer with foreign companies
according to their own commercial wisdom subject to the condition that no
foreign exchange is drained out. The basic intention behind the provision is to
motivate Indian firms to develop the capacity to absorb foreign technology in
their production processes and invest more in research and development. No prior
government clearance is required for having foreign techniques and testing
foreign technologies.

3) Public sector refocusing: The new industrial policies impart a new focus to the
problems of public sector.
The problems of the public sector identified by the policy are:
a) Insufficient growth of productivity.
b) Poor management.
c) Poor manpower planning and overstaffing.
d) Lack of continuous technical up gradation.
e) Inadequate attention to R & D and H.R.D
f) Very low return on capital.

New Industrial policy lays emphasis on the restructuring of public sector and lays
down following priority areas for its growth:

a) Essential infrastructure for the production of goods and services

b) Exploration and exploitation of mineral oil resources.
c) Technological development.
 d) Building of manufacturing capabilities in those areas which are required for
the long run development of an economy.
e) Manufacturing of products which are of strategic importance such as defense
equipment.

4) Removal of size limit on large companies: The new industrial policy provides
more freedom to large scale companies to enable them to attain greater
competitiveness particularly in foreign markets. According to the M.R.T.P act the
industries having assets more then 100 crores were required to obtain a separate
license for additional investment and capacity expansion. This provision was kept
to prevent or control monopolistic or dominant influence on the market however
under the new industrial policy; such firms need not require obtain approval of the
government for investment.

5) Removal of mandatory convertibility clause: The new industrial policy has

removed the convertibility clause under which the financial institutions financing
the industrial projects had the option of covering their loans into equity if they
wanted to do so. This clause was compulsory although this option was not often
exercised and it was considered to be a hanging threat of take over by the
financial institutions. This clause is no longer compulsory in the new industrial
policy.

6) De-Reservation of the industries of public sector: The new industrial policy

opened up a number of industries to the private sector which were earlier reserved
for the public sector. Under the industrial policy of 1956, 17 industries were
reserved for public sector and in 1991 industrial policy the number of reserved
industries were brought down to 8. The new industrial policy provides that the
focus of the public sector would be on strategic and high technology industries.
The industries De-Reserved include Iron & Steel, Electricity, Airlines, Ship
Building and heavy machinery industries.

7) Privatization of government share in public sector units: The government has

resolved to offer 49% of the government share holding in 31 public sector
undertakings to mutual funds, financial institutions, general public and workers.

Evaluation: The new industrial policy makes the end of old policies and the beginning
of new era in the government approach towards the management and control of the
industrial sector. The departure from the old industrial policy is of a drastic nature
and some of the changes are:

1) Earlier industrial policies made the public sector the main instrument of industrial
growth however in the new policy private sector has been made the main
instrument for the future industrial growth.
2) The earlier industrial policies allowed foreign investment on selected basis with
40% of share however the new industrial policy invites foreign investment to 34
industries to 51% share.
 The new industrial policy is expected to make Indian industry more efficient and
internationally competitive. It is expected to encourage new private investment in
areas open for private sector. The industrial growth rate is around 7% since new
industrial policy came in force. The short term performance is certainly better but
long run still has to come, we still have to wait for the results of new industrial policy
in the country.

The board of industrial & Financial Reconstruction:

- It was formed on 12Jan87
- Total Cases 5147
- Restructures 434
- Under Revival 259
- Wound Up 1377

Benefits given for small scale industries:

a) Industrial Estate program.
b) Integrated infrastructural development scheme.
c) Growth centre scheme.
d) Identification of growth centers.

Regulatory role of the government:

Regulatory measures ensure orderly development of industry with least wastage
of resources. These regulatory resources can be in the form of direct controls or indirect
controls, these measures include:
a) Industry Development & Regulation Act (I.R.D.A)
b) Competition Act
c) Company Act
d) Foreign rate exchange management act 2000
e) Labor Laws
f) Indirect control in the form of monetary and fiscal policy.
1) Industrial Development & Regulation Act: It is one of the most powerful and efficient
weapon in the hands of the government to regulate the development and control the
activities of industrial sector.
The Objectives of the act are:
a) To take necessary steps for the development of the industry.
b) To regulate the pattern and direction of industrial development.
c) To control the activities, performance and results of industrial undertakings in public
interest.
d) Main provisions for the regulations are:
- Regulation of conduct and management of business.
- Regulation of growth of the business.
- Regulation of production, supply, price and distribution.
- And also the decorum of management.
2) Competition Act: This act was introduced by the government to restrict the unfair trade
practices which restricts the competition, affects the flow of goods & services in the
market or manipulation of prices. Through this act, if there is any misuse of market
power, the case can be referred to the competition commission of India for enquiry and
report.

4) Foreign Exchange Management Act (F.E.M.A): This act came into effect from 1st Jan
2000 and applies to all branches, offices and agencies outside India, owned or controlled
by residents of India
Objectives of F.E.M.A:
a) Facilitates external trade and payments.
b) To promote the orderly development and maintenance of foreign exchange market.
c) According to this law, deals in foreign exchange should be through authorized persons
permitted by the reserve bank of India only.

5) Labor laws: Labor is the important component and factor of production, it is the
responsibility of each organization to maintain and motivate this human resource as it
occupies a significant place in the process of production. There are several laws related to
labor, some of them are:
a) Laws related to industrial labor organizations which aim on improving the working
conditions of labor.
b) Laws related to wage payment.
c) Laws related to union and management.
d) Indirect control.

Module 4: Monetary and fiscal Policies

Monetary Policies:

Introduction: Monetary policy is an important tool of macro economic policy. It is

designed, formulated and implemented by central bank to a wide network of commercial
banks and other financial institutions. The policy is announced one or twice a year and is
kept tuned to take care of changes in business environment and economic conditions of
the country. Monetary policy is generally designed to include all measures, direct or
indirect that affects the supply of money, availability of credit, interest rate and overall
development of financial sector. All these measures have significant effect on the
decisions of business organization.
Changes in the monetary policy affect the aggregate demand and the level of prices in
the economy, availability of credit can alter the investment decisions of the business
organizations as changes in interest rates can influence the profitability of the investment
and the capital structure of business firms at the household level, change in interest rates
also influences the savings and credit based consumptions and asset management. At the
macro level, change in interest rates influences the exchange rates and flow of foreign
investment in an economy. Finance managers watch the monetary policy developments
very sharply and make adjustments in their financial strategies to adjust with the macro
economic environment.

Goals of monetary policy:

Various objectives of monetary policies are:
1) Achieve high growth rate.
2) Full Employment level.
3) More equitable distribution of income and wealth.
4) Price Stability.
5) Stability of exchange rate.
6) Stability in balance payment.
7) Controlling business cycles.

Targets of Monetary Policies:

1) Expansion of monetary supplies.
2) Expansion and contraction of money supply.
3) Interest Ratio.
4) Reserved ratios of commercial banks.
5) Reserved ratios of central bank.
6) Money and credit ratio in the economy.

Quantitative Instruments in Monetary Supply:

The mechanism of bank trade in monetary policy is as follows:

1) Increase in Bank rate: Raise in bank rate signifies a restrictive monetary policy
designed basically to control inflation, in this process some slow down in the rate
of growth takes place which is taken as the cost of restrictive monetary policy.
The reverse action takes place when high rate of growth has to be achieved in the
economy and that type of monetary policy is known as expansionary monetary
policy.

2) Open market operations: These operations are mainly conducted by the central
bank of the country and involve pre audit sale and purchase of government
securities. As the central bank sells securities money gets transferred from the
commercial bank to the central bank, The opposite happens when there is
purchase of securities.
The mechanism of open market operations are as follows: Sale of Bonds will
lead to decrease in deposits which lead to decrease in credit which lead to
decrease in investment which lead to Decrease in aggregate demand which lead to
Decrease in prices.
Sale of bonds causes bank deposits to fall further causing fall in credit supply,
as credit is the main component of money supply this decreases money supply.
The decrease in money supply affects the aggregate demand and decreases the
prices in the economy.
 3) Cash Reserve Ratio: Commercial banks are generally required to hold a minimum
amount of non interest bearing reserves with central bank, these reserves are
statutorily required and it is a certain percentage of their demand and time
liability. In India these reserves requirements are called as cash reserve ratio
under R.B.I and it can be varied by R.B.I in the range of 3% to 15%. The central
bank uses this money in buying foreign exchange and giving loans to commercial
banks. Changes in the reserve ratio are used as the important tool of monetary
policy.
Under restrictive monetary policy, the reserve requirements would be raised and
this would transfer a substantial portion of money from active deposits of banks to
passive deposits of R.B.I, this leads to decrease in the credit creation in the
economy. These factors are expected to slow down the aggregate demand and fall
in the general price level. The mechanism works in the opposite direction when
the cash reserve ratios are reduced.

4) S.L.R (Statutory Liquidity Requirements): Every bank is legally required to

maintain a certain percentage of deposits in cash to meet the withdrawal
requirements of the depositors. Such reserves are held by the bank not only in the
form of cash but also in the form of near money assets. A raise in S.L.R directly
reduces the credit creating capacity of banks and hence it immediately affects the
supply of money and credit in the economy.

Qualitative Measures in Monetary Supply:

These measures are selective rather then generally applied. They affect the
distribution and flow of credit rather then quantity of credit. The central bank with the
help of these instruments may increase the flow of credit to certain sectors which acts as
the growth drivers or which are socially important and it reduces the flow of credit to
sectors which are non essential or inefficient. Some of the qualitative measures are as
follows:
1) Changes in margin requirements: Margin requirements may be varied according
to the type of securities and assets to be financed. A higher margin requirement
reduces the quantum of finance for specific industry.

2) Differential Interest Rate: Central bank may prescribe different rate of interest to
different sectors or for different activities E.g. Lower interest rate could be
required for priority sector such as small scale industries, exports, agriculture and
higher rates may be permitted to those sectors where central bank wants to reduce
the credit.

3) Moral Suasion: It is the method of persuading or Convincing the commercial

banks to advance credit in accordance to the policy decisions taken by the
economic interest of the country. Under this method the central banks writes
letters, publishes articles and hold direct discussions and meetings with the banks.
Certain times central banks may use direct methods in the form of cancellation of
license if any commercial bank is not following the instructions of the central
bank however these methods are very rare.
Fiscal Policies:

Fiscal policy is the important tool of the macro economic policy and has the
power to influence the key variables of the economy. It has both macro economic and
micro economic effects which determine the business environment. A business
manager has to monitor fiscal policy developments closely in order to make strategic
adjustments. Fiscal policies have the power to affect aggregate demand, general price
level, past conditions, international trade and distribution of wealth and overall
growth of an economy.
It is a policy under which the government of the country uses taxation, public
expenditure and public debt to achieve pre determined economic and social goals to
solve specific problems of an economy. Fiscal policy is the overall budgetary
management through which the government manages the public revenue most
effectively and efficiently, It is reflected in the annual presentation of the budget.

Objectives of Fiscal Policies:

1) Attainment of full employment.

2) Achieving high rates of growth.
3) Optimum allocation of resources.
4) Equitable distribution of income and wealth.
5) Price Stability.
6) Control of Business cycle.
7) Balanced growth and export development.

Instruments of fiscal policies:

1) Taxation: Taxation is the most important tool of fiscal policy and it is also a major
source of source mobilization. Tax is a compulsory levy imposed by the
government on most of the economic units. Taxes can be classified as direct and
indirect taxation: Direct tax is generally defined as the one in which the incidence
of the tax rests upon the person who bears the impact also. E.g. Income Tax,
Property Tax, Wealth Tax etc. If the incidence is passed on to other person, it is
known as indirect tax.
Taxation as a instrument of fiscal policy has a wide effect on aggregate demand,
production, cost, supply of investment and overall resource allocation in the
economy.

2) Public Expenditure: It is another tool of fiscal policy which is very powerful, a

raise or fall in public expenditure brings changes in public expenditure brings
changes in the level of national income. Public expenditure is mainly financed
through taxes, market borrowings and deficit financing. Public expenditure
weather in the form of consumption or investment increases the aggregate
demand and hence G.D.P of the country.
3) Public Debt: Changes in Public Debt transfers money from the public and
business organizations to the government. As the public expenditure increases
through public borrowings in the household sector, consumption falls and in the
business sector the investment falls. Investment is further discouraged because of
increased rate of interest. The combined effect is that the aggregate demand falls
which slows down the output and prices. Fiscal operations of the government
have significant effect on the business sectors of an economy as different rates of
taxes makes investment in certain sectors more attractive then others. Thus fiscal
policy is an important economic policy through which government tries to control
various important economic variables.

4) Budget: Budget means the estimation of revenue and expenditure of the

government. Budget approval is very important exercise because without its
approval no taxes can be levied or no expenditure can be incurred as the
government can spend only on approved items.
As per the constitution of our country the government has been preparing annual
budget and placing them before the parliament, getting its approval and spending
and raising the revenue.
The work of preparing the annual budget begins in the month of august every
year and after its finalization, it is presented in the parliament on the last day of
February by the finance minister in the name of the president of India, the budget
speech of finance minister is of great importance and is eagerly awaited by the
finance and business circles as it contains fresh information about fresh taxes and
proposals relating to expenditure.
Occasionally in times of financial crisis an interim budget may be introduced by
the government to increase taxes or expenditure. The receipt and expenditure of
the government are audited by controller and auditor general in order to ensure
that the executives have spent the money in accordance with the wishes of the
legislature.
The budget is divided into two parts – Revenue budget and capital budget: the
revenue budget deals with the revenue receipts which includes receipts from
taxes, interest, dividends, profit and revenue expenditure is mainly on the
administration. Capital budget is the statement of all capital expenditure and
capital receipts which include market loans, external loans, deposits etc.

State Budget: Every state government needs to prepare a budget of its own, over
the years following problems have emerged from the way the states have been
managing their respective finances.
1) The states combined fiscal deficit: The states combined fiscal deficit has
gone up which is a disturbing feature.
2) The states have failed to deliver on the social indicators that would benefit
the poor people.
3) Expenditure on establishment is growing year by year
4) Loss making public sector undertakings are continued to be financed
which drains stray finances.
 Technological Perspectives

Environmental cost audit:

It is to asses the impact of industrial trade on the environment. Environmental auditing
has been regarded as a significant technique which includes:

a) Life Cycle Assessment: Under this the manufacturer should account the impact of their
entire product cycle on the environment. This means from the extraction of resources,
manufacturing and till disposal, the entire impact has to be accounted for.
Life cycle assessment provides information for labeling program that can help the
consumer in selecting products according to their environmental attributes such as
quality, price, warning against harmful usage etc.

b) Training: If environmental policies have to be launched successfully, then training is

very important. Companies should identify different methods of training required for
managers & supervisors. Training must ensure that employees can effectively apply and
use technical and engineering control methods to conserve energy, prevent pollution and
implement emergency measures.

c) Consumer Education: Consumer education is very important of consumer has to play

an important role in environment improvement. The aim is “Buy Better, Not More”,
business must play a supporting role by providing eco labeling of product giving proper
information on inputs, energy use, disposal etc.

d) Toxins release inventory: Industries should develop policies and strategies to reduce
the source of environmentally hazardous chemicals such as several European countries
are developing active pesticide policies to reduce the risk of human health and
environment. In short it can be said that the business and industry should adopt true cost
accounting procedures which include environmental cost auditing. Such a situation will
ultimately create more efficient use of economic resources and enhance long term global
economic performance.

Technology Transfer:
Technology is an essential mode for socio economic development of a country, as it
is a known fact that today the modern know how and technology is the monopoly of the
multinational corporations, the loss developed economies are totally dependent on
M.N.C’s for borrowing the sophisticated and costly technology.

Methods of transfer of technology:

1) According to the nature of technology, it can be transferred in the following ways:

a) Simple direct sale of technology: It consists of sale of embodied technology or

disembodied technology by unrelated firms for prices which are more or less competitive.
b) Process package sale of technology: It is a method where technology is accompanied
by other requirements for the commercial operation of a product. It is a system where a
complete industrial process or plant is supplied by manufacturing engineering firm.

c) According to the nature of the instruments used: In this method, technology is sold in
the form of equipment, designing of plant, management, licenses, direct investment etc.
Technology transfer can take place by the following ways:
- By Flow of books and other published information.
- By the movement of people between countries including study visits.
- By the import of machinery and equipment.
- By technical operation programs.
- By Licensing.
- By Patent.
- By Know how agreement.

Technology transfer by flow of books and published material is more important for the
transfer of fundamental scientific knowledge; all the other methods are directly related
relevant for the transfer of industrial technology.

Incentives for technological research and development:

1) The department of scientific and industrial research operates a scheme for having
recognized in house R&D units. The various incentives and support provided by the
government to recognized R & D units in the industry includes:
a) Income tax deduction for sponsor research program.
b) Income tax relief on R & D expenditure.
c) Exemption from the payment of customs duty on goods imported for use in
government funded R & D projects.
d) Excise duty waiver for 3 years on goods produced using technology patented in U.S.A,
Japan, or in any country of European Union.
e) Direct financial support to R & D centers.
f) Technology promotion for self reliance.

2) The department holds annual national conference on in house R & D in industry and
certain awards are given for the development of technology. These departments provides
partial financial support R & D designs and engineering projects for the development of
new processes and products for Indian and foreign parties. It also provides partial
financial assistance for development of technologies which promotes self reliance.
Under its scheme of transfer and trading in technologies it promotes and supports
activities relating to exports of technologies, projects and related services.

3) Consultancy Support: A part of technology development program consists of those

measures which promote consultancy capabilities of the country. These measures are
taken through consultancy development centre which is a non profit making society.
Some of the measures to assist and promote consultancy are:
a) Conducting human resource development and training program for consultancy.
b) Sponsoring consultancy development programs for other organizations.
c) Providing computerized database for consultants.

Information System for technology development:

For the promotion of suitable technology, national information system for science and
technology provides support to the inter working of informational systems on science and
technology. The system seeks to promote the services provided by the existing network
for technological development. It is also operative in the direction of improvement in
existing information technique.
The system supports 12 major information networks in the country and many of these
have access to international databases.

Entrepreneurship: Entrepreneurship is the process of innovation and

organization of resources with a motive of earning profits under conditions of
risk and uncertainty.

Privatization: In narrow sense, privatization implies the induction of private

ownership in publicly owned enterprises, but in broader sense besides private
ownership there is the induction of private management and control in the
public sector enterprise.
Thus privatization is the general process of involving the private sector in the
ownership or operation of a state owned enterprise. Thus the term refers to
the private purchase of all or part of a company