School of Distance Education Economics Module

School of Distance Education
MODULE I
INTRODUCTION TO ECONOMICS
What Economics is about? Importance of the study of economics, relation with other social
sciences (History, Political science, Law, Psychology, Sociology)- Basic problems-Micro versus macro
What economics is about?

Economics is a social science that deals with human wants and their satisfaction. People have
unlimited wants. But the resources to satisfy these wants are limited. They are always engaged in work to
secure the things they need for the satisfaction of their wants. The farmer in the field, the worker in the
factory, the clerk in the office, and the teacher in the school are all at work. The basic question that arises
here is: Why different people undertake these activities? The answer is that they are working to earn
income with which they satisfy their wants.
People have multiple wants to satisfy. They have to satisfy their want for food, cloth, shelter,
education, health, etc. Thus human wants are unlimited. In a sense they are insatiable. When one want is
satisfied another want takes its place and so on in an endless succession. By doing some work or activity
people earn money. This money is used to satisfy their wants. Thus our activities have two common
aspects; first, we are all engaged in earning our living, and secondly, these earnings enable us to satisfy
our want for different goods and services. This action of earning and spending is called economic
activity.
Prof. Seligman says, the starting point of all economic activity is the existence of human wants.
Wants give rise to efforts and efforts secure satisfaction. The things which directly satisfy human wants
are called consumption goods. A few consumption goods like air, sunshine, etc. are abundant . They are
available at free cost. But most of goods are scarce. They are available only by paying a price. And,
therefore, they are called economic goods. They do not exist in sufficient quantity to satisfy all wants.
General Economics
People everywhere are engaged in some kind of economic activity for satisfaction of their wants. Wants,
efforts, satisfaction said Bastitat constitute the circle of economics.
The subject matter of economics is generally divided into four parts. They are Production,
Consumption, Exchange and Distribution. Production means producing things or creation or addition of
utilities to the goods and services to make them capable of satisfying various wants Consumption deals
with human wants and their satisfaction. Exchange refers to transfer of goods and services through the
medium of money and various credit instruments. Finally, distribution refers to the sharing of income
from production by four factors of production namely, land, labour, capital and organization. Here, we
study how wage, rent, interest and profit is determined.
In addition, we also study, Public Finance and Planning. Public finance studies the financial
operations of the governments and other public bodies. Here we study, how the government collects
money, how it spends and how it frames its fiscal policy. Planning is also included in the subject matter
of economics which refers to the systematic, efficient and full utilization of available limited resources for
the maximum public welfare.
How other Social sciences are related to Economics?

Economics is closely related to other social sciences especially History, Political science, Law,
Psychology and Sociology. The whole discussion of value, as we shall see, depends intimately upon
considerations of psychology. Sociology is sometimes defined as the social science, that is, the science of
all social relations. If sociology is considered in this sense, Economics is a branch of sociology. Other
writers hold that sociology deals only with the more general laws which apply to the whole social
structure and that it is coordinate with economics and politics and ethics, and not inclusive of them all.
Politics is the science of the state and because of many important ways in which the state
influences, and is influenced by the manner in which its people make a living, the fields of the two
sciences are closely interwoven and have many problems in common.
Ethics is the science of moral conduct. It asks the question what ought to be. There was a time
when economists held that economics was concerned only with the question, what is, and not with the
question, what ought to be. But now a days most of the economists considered economics as a positive
science as well as a normative science.
Economics is also closely related to the science of law. Government and law form a framework in
which economic forces act. Thus Economics is the repository of information on resource dynamics.
Similar to agriculture and human survival, social sciences must continue to appreciate economics for an
ever growing matrix of phenomena which upon analysis facilitate learning in every discipline.
The Central Economic Problem

Economic problem arises because of scarcity of resources in relation to demand for them. Prof.
Lionel Robbins of London School of Economics has defined economics as a science which studies
human behavior as a relationship between ends and scarce means which have alternative uses.
Accordingly, he has given the following reasons for emergence of economic problems;
1. Human wants(or ends) are unlimited
General Economics
Man is a bundle of wants. There is no end to human wants. As one want is satisfied, many
others crop up and this goes on endlessly. Again one particular want cannot be satisfied for all
times to come e.g. want for food. After fulfilling it at a particular time, it crops up again and again.
Thus wants are not only unlimited but recurring in nature also. In this sense they are insatiable.
Wants differ in urgency or intensity. Some wants are more important while others are less
important. This enables a man to arrange his wants in order of preference and make a choice
among different wants.
2. Resources (means) to satisfy wants are limited (scarce)
Goods and services are produces by an economy with its resources namely-land, labour,
capital and enterprise. Unfortunately, such resources are limited in relation to its demand. Due to
scarcity of resources, we cannot produce all the goods and services that the various sections of the
society need. If more resources are employed for the production of one commodity, less resources
are left for production of other goods. Consequently, some wants will have to go unsatisfied.
Therefore an economy has to decide how to make best possible use of its limited resources.
3. Resources have alternative uses
The resources of an economy are not only scarce but also have alternative uses and
therefore choice has to be made in their use. For example, a plot of land can be used to produce
wheat or for construction of a factory or for a school building. If the plot is used for the cultivation
of wheat, it cannot be used for other purposes. In other words, production of one commodity has
to be sacrificed for production of other. Thus, the economy constantly faced with choosing better
alternative uses to which its resources should be put.
In short, the problem of making a choice among alternative uses of resources is called the
basic or central problem of an economy. Such problems are common to all economies. The central
problems relate to different aspects of resources are cited below;
I. The problem of allocation of resources:
(a) What to produce
(b) How to produce
(c) For whom to produce
II. The problem of utilization of resources:
(a) Problem of efficiency in production and distribution
(b) Problem of full employment of resources
(c) The problem of growth of resources
The problem of allocation of resources
An economy has to allocate its scarce resources in such a way that serves the best needs of the
society. This problem is in fact the problem of what, how and for whom to produce?
(1) What to produce and in what quantities?
Since human wants are unlimited and the resources of the economy to satisfy them are
limited the economy cannot produce all goods and services required by the people. More of one
General Economics
good or service produced means less of other goods. Therefore every society must exactly choose
which goods and services are to be produced and in what quantities. For instance, the economy
has to decide whether the resources are to be allocated for the production of consumer goods or
capital goods, or necessary goods or luxurious goods or civil goods or military goods. After
deciding which goods should be produced society has to decide the quantity of each good has to
be produces.
(2) How to produce?
This problem refers to the choice of technique of production. It means that which
combination of resources or factors to be used for the production of goods and services. There are
two types of techniques of production. ie. the capital intensive technique of production and labour
intensive techniques of production. More labour and less capital or relatively less labour and more
capital can be used for production. Similarly, small scale or large scale production can be used.
The guiding principle here is that only those techniques should be employed which cause the least
possible cost to produce each unit of a commodity or service.
(3) For whom to produce?

This problem refers who will consume the goods and services produces. A few rich and
many poor or vice-versa?. The goods and services produced for the people who can purchase
them. And the purchasing power of the people depends on how the produced goods and services
are distributed among the people who are helped to produce them. i.e., how is the product
distributed among the four factors of production-land, labour, capital and enterprise.
The problem of full utilization of resources is concerned with (i) how to ensure that
limited resources of the economy are used most efficiently and (ii) how to secure full employment
of resources as discussed below.
(4) The problem of efficiency in production and distribution.
Efficiency in production and distribution is another problem which follows automatically
the first three problems mentioned above. Since the resources are limited , it is very important that
they are efficiently used. By efficiency we mean that resources are being put to their best possible
use. Allocation of resources in production is considered efficient when any other alternate
allocation cannot increase production of an article even by one unit. Likewise distribution of
production among agents of production is said to be efficient when alternate distribution does not
make even one person better off without affecting others adversely.
(5) The problem of full employment of resources.
The problem of full employment of resources implies that existing resources, scarce as
they are, should not remain unutilized or under-utilized. Production and supply of goods in every
economy is generally always small than the demand for them. Hence to maximize production, all
the available resources need to be fully utilized. In fact unemployment or under employment of
resources is nothing but wastage of resources. Therefore, an economy has to ensure that its
resources are fully employed.
(6) The problem of growth of resources.
General Economics
Since scarcity of resources is a basic fact of life, its impact can be lessened to some extent
through growth of resources. Again the scarce resources exhaust gradually on being used.
Therefore, to make up their deficiency, growth of resources has become another basic problem of
an economy. Economic growth involves expansion of resources and improvement in technology.
It is through effective growth of resources and improved technology by countries like America,
Canada, Russia, West European countries and Japan that their economies are rich and developed
leading to a higher standard of living. It has, therefore, become most essential for all economies
especially the poor ones to not only make full use of their resources but also ensure to grow them
so as to meet ever increasing demand of their people for goods and services.
(7) The problem of economic growth
Every economy in this world is aiming at its rapid economic growth so as to ensure
continuous rise in the living standard of its citizens. For underdeveloped countries, the problem of
economic growth is highly crucial and significant because they have to grow at a higher rate to
bring the living standard of their people to the level of developed countries. For this, the rate of
economic growth needs to be kept higher than the rate of increase in population. Therefore, an
economy has to explore potentials of its growth and generate new resources so that its capacity to
produce more goods from year to year.
Subject matter: Micro and Macro Economics

The subject matter of economics has been divided into two parts- Micro economics and
Macro economics. Ragner Frisch of Oslo University (Norway) was the first economist to use these
terms in 1933 which now have been adopted by economists all over the world.
Micro Economics
The term micro is derived from the Greek word mikros which means small. Therefore
micro economics studies the economic behavior of individual units of an economy and not an
economy as a whole. It concerns itself with the detailed study of individual decision-makers like a
household, a firm or individual consumers and producers. How a consumer maximizes his
satisfaction with his limited income or how a firm maximizes its profits or how the wage of a
worker is determined are all instances of micro analytical approach.
According to Prof. Boulding Micro economics is the study of particular firms, particular
households, individual prices, particular households, individual prices, wage incomes, individual
industries, particular commodities. Micro economic analysis is also known as microscopic
analysis. Since the subject matter of micro economics deals with the determination of factor
prices and product prices micro economics is called as price theory.
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Macro Economics
The word macro is derived from the Greek word makros which means large.
Therefore macro economics is the study of economy in its totality or as a whole. It is concerned
with the study of national income and not individual income, national saving and not individual
saving, aggregate consumption expenditure and not individual consumption expenditure, total
production and not production of individual firm, price level and not individual price etc. In short
it deals with the economy as a whole. The problem of full employment, aggregate consumption,
aggregate investment, total savings, general level of prices and variations in them are all the
subject matter of macro economics.
The following comparison further clarifies the distinction.

Micro Economics
1. It deals with the study of individual
economic units.
2. It deals with the individual income,
individual prices , individual output,
etc.
3. The central problem is price
determination of commodities and
factors of production.
4. Its main tools are demand and supply of
particular commodity/factor.
5. It deals
analysis
General Economics
with
partial
equilibrium
Macro Economics
1. It deals with the study of economy as a
whole and its aggregates.
2. It deals with national income, price
level, national output, etc.
3. The
central
problem
is
the
determination of level of income and
employment.
4. Its main tools are aggregate demand
and aggregate supply of the economy
as a whole.
5. It deals with the general equilibrium
analysis
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MODULE V
NATIONAL INCOME
Module V :National Income-Concepts and Meaning, Gross Domestic Product, Gross National
Income-Net National Product-Gross Domestic Product at factor cost and market price-GNP at
market price and factor cost-NDP at factor cost and market price-NNP at factor cost and market
pricePersonal income-Disposable Income-Per capita income-Importance of the estimation of
National income-Difficulties in the estimation of national income.
Introduction
Economic growth of a country measured with the help of change in its national income. The rate
of growth of national income of an economy is indicative of the pace at which the economy has been
growing. The rate of growth of national income when compared with the rate of growth of population
indicates whether the economy is declining, stagnant or developing.
Alfred Marshall the labour and capital of a country acting on its natural resources produced
annually a certain net aggregate of commodities, material and immaterial including services of all kinds.
This is the true net annual income or the revenue of the country or the National Dividend.
Simon Kuznets it is the net output of commodities and services flowing during the year from
the countrys productive systems in to the hands of the ultimate consumers or into net addition to the
countrys capital stock.
Concepts:
National Income:
The money value of all final goods and services produced in a country during a financial year.
National Income broadly means the income earned by the residents of a country from work and
property in an accounting or financial or fiscal year. In India, an accounting year is from 1st April of a
calendar year to 31st March of the next calendar year.
National income Accounting:
It is a tool used to summaries the performance of an economy by measuring its total income and
production in a particular year. Or National Income Accounting is a method of presenting National
income Accounts. National income Accounts are statistical statements on National income and other
related macro economic aggregates.
Sources of Income
Following are the different sources of income.
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51
a) Income from work: People earn income mainly from work. The standard of living of the people
depends on quantity and quality of goods and services consumed by them. It in turn depends on
the money income of the people.
b) Income from property: Properties like land, building, factories, machinery etc. can be lent out to
others to earn income. The income so earned is called rental income.
c) Royalties:-Income earned by those who own mineral wealth like iron ore, coals, natural gases etc.
and by those who possess copy rights, patents etc. (intellectual property). The various types of
properties mentioned above are called fixed assets or fixed capital.
d) Dividends:-People can earn dividends by investing the surplus income in stocks and shares.
e) Interest:-The surplus income used for purchasing bonds or debentures or lending to banks or
other agencies may yield interest income .These incomes (d) & (e) are called liquid assets. The
fixed assets and liquid assets together represent capital.
In countries like India economic growth is given more emphasis. The major problem in these
countries is how to remove poverty and unemployment. Raising the standard of living of the people is yet
another problem. These entire problems can be solved only by means of accelerating economic growth.
Economic growth is a process by which the real national income and percapita real income of a country
are increased for a period of time.
In India the Five Year Plans aim at accelerating economic growth. The First Five Year Plan set the
target of doubling the 1950-51 national incomes by 1971-72 and the per capita income by 1977-78.
However, the per capita income was doubled only by 1992-93. This was because of the high rate of
growth of population in the country.
National Income at Current Prices and Constant prices
National Income at current prices means the aggregate money value of all final goods and services
produced in a country during a year, estimated on the basis of market prices in the prevailing year or the
current year.
National income at current prices = (the volume of goods and services in the current year x market
prices of goods and services in the current year)
N.I at current prices =
P (Q) + P(S)
Where, P = price per unit, Q = volume goods produced

S = volume of services
National income at constant prices means the money value of final goods and services in the
current year calculated at their prices in a previous year ( base year).
National income at constant prices = (volume of goods and services in the current year x prices of
goods and services in the base year)
National at current price
N.I at constant prices = ------------------------------------ x 100
Price index in the current year
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52
National at current prices is influenced by the changes in the prices. To know the increase in the
real national income, we have to consider the national income at constant prices. In India, we have
national income and percapita income figures both at current and constant prices since 1950-51 onwards.
Gross Domestic Product (GDP)
The money value of all final goods and services produced in the domestic territory of a country
during a year is called GDP.
Domestic territory of a country includes the following
Political boundary including territorial waters
Ships and aircrafts operated by the residents of a country between two or more
countries.
Fishing vessels, oil and natural gas rigs operated by the residents of a country in the
international waters or where the country has exclusive rights to operate.
Embassies, consulates and military establishments of the country located in other
countries.
Normal residents of a country: All persons who ordinarily live in a country at least for one year
and whose economic interest belongs to that country are called the normal residents of a country. GDP
can be estimated both at market prices and at factor costs.
GDP at market price
GDP at market price is defined as the money value of all final goods and services produced in the
domestic territory of a country during an accounting year estimated at the prices prevailing in the markets.
GDP at market price = (Gross National Product at market price) (Net Factor Income from Abroad)
Net Factor Income from Abroad (NFIA) is defined as income attributable to factor services
rendered by the normal residents of a country to the rest of the world less factor services rendered to them
by rest of the world. That is, NFIA is the difference between the income received from abroad by the
residents of a country for rendering factor services and the income paid for the factor services rendered by
the non residents in the domestic territory of a country.
GDP at factor cost
It is the estimation of GDP in terms of the earnings of factors of production. GDP at factor cost is
the sum total of the earnings received by the factors of production in terms of wages, rent, interest and
profit.
GDP at factor cost = (GDP at market price) (Net Indirect Taxes)
Net Indirect Taxes = Indirect Taxes Subsidies
Gross National Product
GNP is defined as the money value of all goods and services produced by the nationals of a
country within the country and outside the country during a year.
GNP at market price = GDP at market price + NFIA
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Gross National Product at factor cost

GNP at factor cost = GNP at market price NIT
=
or
compensation
of
employees
+ mixed income + depreciation + NFIA
operating
surplus
GDP and GNP comparison

In order to distinguish between GDP and GNP we have to consider two terms; (a) domestic
territory of a country and (b) nationality of citizens.
GDP is a territorial of geographical concept. It includes only those goods and services which are produced
within the domestic territory of a country, during a year. However it does not include income generated
by the home nationals in foreign countries. GNP, on the other hand, is a measure of the value of goods
and services that the nationals or residents of the country produce regardless of where they are located.
That is, GNP includes net factor income from abroad also.
GDP = GNP NFIA
GNP = GDP + NFIA
In short, the difference between GDP and GNP arises from NFIA.
Net Domestic Product (NDP)
Net Domestic Product is Gross Domestic Product minus depreciation or consumption of fixed
capital.
Depreciation or consumption of foxed capital refers to the loss of value of fixed capital due to
wear and tear in the process of production.
NDP at market price and factor cost
NDP at market prices is the market value of all final goods and services produced within the
domestic territory of a country less depreciation during a year.
NDP at market prices includes the contribution of foreigners residing the domestic territory of a
country. However, which excludes the contribution of the citizens of the country residing abroad.
NDP at market price = GDP at market price depreciation.
NDP at factor cost is the total payments made by all the producers to all factors of production
within the domestic territory of a country. In another word NDP at factor cost is the sum total of the
earnings of all factors of production in the form of wages and salaries, rent, interest and profit.
NDP at factor cost = NDP at market price net indirect taxes
Net National Product (NNP) at market prices
It can be defined as the total value of final goods and services produced in an economy after
allowing depreciation
NNP at market price = GNP at market price depreciation
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Net National Product at factor cost or National Income

NNP at factor cost is defined as the volume of goods and services turned out in country during an
accounting year or it is the net value added at factor cost in country during a year. Or it is the sum total of
domestic factor incomes and net factor incomes from abroad. Thus,
NNP at factor cost or National Income = domestic factor incomes + NFIA
Or
NNP at factor cost or National Income = NNP at market price NFIA.
Note
1. The difference between GDP and GNP is the value of NFIA
2. The difference between Gross and Net aggregates is the value of consumption of
fixed capital or depreciation.
3. The difference between market prices and factor costs is the value of net indirect
taxes.
PERSONAL INCOME
Personal income is the income received by the households and non corporate business in a country
during a year.
Personal income = National Income (corporate profits + social security
Contributions + net interest) + (dividends + transfers
Government to individuals + personal interest income)
DISPOSABLE INCOME
Disposable income is the income actually available to the households and to the non corporate
business after they have fulfilled their tax obligation to the government. That is, it is the income actually
available to the individuals for saving and consumption.
Disposable Personal Income = personal income personal tax +non tax Payment.
Per capita Income
It is the average per person national income.
Per capita Income = National income / Population
Importance of the estimation of national income
Importance of the estimation of national income accounts are given below.
1. Indicator of economic performance: it indicates the level of economic growth and welfare in a
country. It tells us the achievement of a country after utilizing its natural, human, capital
resources.
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55
2. Indicator of structural changes: it throws lights on the structural changes of the economy. It
informs us about the direction of changes in the relative shares of primary, secondary and territory
sectors.
3. It helps in policy formulation: the information provided by the national accounts is very helpful
for the formulation of various economic policies by the government.
4. It helps in making comparison: it helps us in comparing the national income and percapita income
of one country with those of other countries.
5. It is helpful to the trade unions: national accounts reflex the nature of distribution of factor
incomes. this helps trade unions in making rational analysis of the remunerations given to them. It
helps them to make necessary actions to ensure considerable payments.
6. It is helpful to the UNO: it is helpful to the UNO for planning welfare programmes for the
developing countries according to their requirements.
Difficulties in estimation of national income
1. Conceptual difficulties: in the first place there have been the differences of opinion regarding
Nation in the concept of national income. It is argued that national income denotes the income of
the nationals and as such income received by the nationals living abroad should be added with the
income produced within the country.
2. Value of services: to calculate the value of services is very difficult. Many services in real life are
rendered out of mercy, friendship and generosity which cannot be equated to money value.
Similarly the services of home makers are excluded from the national income. This will
undervalue the national income.
3. Illegal activities: income earned through illegal source like smuggling, black marketing etc are
excluded from national income on account of social usefulness, though these incomes are
outlawed, their exclusion will underestimate the national income.
4. Activities of foreign firms: the income generated by the foreign firms in a country also creates a
problem in national income accounts. The problem is whether their income is a part of the national
income of a country where they are located or that of the country which own the firms.
5. Choice between methods: another difficulty in estimating national income is connected with the
choice between the methods of estimation. It is argued that any one or all of the methods could be
used simultaneously depending, off course on the availability of data.
6. Stage of economic activities: in accordance with the purpose of national income estimation any
stage of economic activity- production, consumption and distribution could be adopted. For
example, if the purpose is to assess the economic welfare, then the consumption stage and if the
aim to assess the economic potential, then the production stage could be more appropriate.
7. Double counting: the main difficulty in estimating national income is the problem of double
counting. Double counting means the counting the value of a good more than once. The best way
to avoid double counting is to calculate the value of goods and services that enter into final
consumption. Another method of eliminating the double counting is to adopt the the value added
method of estimating national income
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Special Difficulties in under developed countries

1. Existence of non-monetised subsistence sector.
2. Difficulty in classifying economic activities.
3. Valuation of products is also very difficult.
4. Lack of proper accounts.
5. Inadequate and Unreliable statistics.
Measurement of National Income
National Income can be measured in different ways. We look at national income in three ways:
(a)As a flow of goods and services produced
(b)As a flow of income and
(c)As a flow of expenditure
Corresponding to the above three concepts, there are three methods of measuring national income.
They are:
(a)Value added method or product method
(b)Income method and
(c)Expenditure method
Value added method or Product method
National income according to the value added method is the sum of net value added or net final
output produced by all the producing sectors of an economy during a year. The net value added method is
otherwise known as product method or net output method. This method approaches national income from
the output side. According to this method national income is measured by adding up the money value of
all final goods and services produced in an economy during a year.
This method involves three steps in computing national income. They are:
1. Identification and classification of production units into industrial sectors, i.e., primary sector,
secondary sector and tertiary sector.
2. Estimation of net value added factor cost and
3. Estimation of net factor income from abroad.
Estimation of net value added at factor cost
Net value added at factor cost = (net value added at market price net indirect taxes)
Net value added at market price = (gross value added at market price depreciation)
Gross value added at market price = (gross value of output intermediate consumption)
Intermediate consumption means the consumption of secondary inputs or intermediary goods.
Gross value of output = P (Q) + P (S). i.e. the money value of all final goods and services
produced.
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57
Estimation of NFIA
NFIA consists of net compensation of employees, net income from property and entrepreneurship
(net operating surplus) and net retained earnings of resident companies abroad.
Thus, National income = Net value added at factor cost + NFIA
Income method
The income method measures national income from the side of the payments made to the primary
factors of production for their productive services in an accounting year. According to this method
national income is calculated by adding up all the incomes accruing to the basic factors of production
used.
After identifying the production units in to different sectors primary, secondary and tertiary, the
factor incomes received by the factors of production in all production sectors are added up. We get the
factor incomes received by all the three sectors. The sum of this will give us the domestic factor incomes.
When NFIA is added to the domestic factor incomes, we get national income.
The factor incomes are classified in to
1. compensation of employees
2. operating surplus
3. mixed income
National income = Domestic factor incomes + NFIA
Expenditure method
This method measures national income from the expenditure side or by measuring final
expenditure on GDP. The total expenditure is composed of two elements consumption expenditure and
investment expenditure.
There are four components of final expenditure on GDP. They are
1. Private final consumption expenditure.
2. Government final consumption expenditure.
3. Gross domestic fixed capital formation comprising gross fixed capital formation, changes in stock
and net acquisition of valuable assets. and
4. Net exports. (exports impost)
Estimation of National Income in India.
The First estimate of national income in India is prepared by Dadabai Naoroji in 1868. it
was published in his famous work Poverty and Un British rule in India.
The first scientific and reliable estimate of national income was done by V.K.R.V Rao for
the year 1931-32.
The first official estimate of National income was prepared by the ministry of commerce in
1948.
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The national committee was appointed in 1949 under the chairmanship of prof. P.C
Mahalanobis.
The first report of national income committee appeared in 1951 and its final report in
1954.
The CSO (Central Statistical Organization) released the first issue of white paper on
national in the year of 1956. from 1956 onwards, the CSO has been publishing annually
national income statistics under the title National Account Statistics.
We have series in national income estimate;
Conventional series (1948-49 as the base year)
Revised series (1960-61 as the base year)
New series (first with 1970-71 as the base year, later with 1980-81 and 1993-94
as the base year and at present 2004-05 as the base year.)
NOTE: The national Income aggregates estimated at current prices are called nominal and those
at constant prices are called real aggregates. The true indices of economic growth or welfare are real
aggregates like real GDP, real NNP, real PCI etc.
The GDP Deflator

From nominal GDP and real GDP we can compute the GDP deflator. The GDP deflator, also called
the implicit price deflator for GDP, is defined as
GDP Deflator
Nominal GDP
---------------Real GDP
GDP Deflator is defined as the ratio of nominal GDP to real GDP. It measures the price of the
typical unit of output relative to its price in the base year.
Suggested Readings:
1.
Diwedi DN Macroeconomics Theory and Policy Tata McGraw-Hill
2.
Edward Shapiro : Macro economics Oxford University press.
3.
Gregory Mankiw : Macro economics 6th Edn. Tata McGraw Hill.
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SchoolofDistanceEducation
Module I
MONEY
Definition and functions of money, demand for and supply of money, Fischers Quantity Theory of
money, Inflation and deflation
Introduction
The word money is derived from the Latin word Moneta which was the surname of the
Roman Goddess of Juno in whose temple at Rome, money was coined. The origin of money is lost
in antiquity. Even the primitive man had some sort of money. The type of money in every age
depended on the nature of its livelihood. In a hunting society, the skins of wild animals were used
as money. The pastoral society used livestock, whereas the agricultural society used grains and
foodstuffs as money. The Greeks used coins as money.
Stages in the evolution of money
The evolution of money has passed through the following five stages depending upon the
progress of human civilization at different times and places.
1. Commodity money
Various types of commodities have been used as money from the beginning of human
civilization. Stones, spears, skins, bows and arrows, and axes were used as money in the hunting
society. The pastoral society used cattle as money. The agricultural society used grains as money.
The Romans used cattle and salt as money at different times. The Mongolians used squirrel skins
as money. Precious stones, tobacco, tea shells, fishhooks and many other commodities served as
money depending upon time, place and economic standard of the society.
The use of commodities as money had the following defects.
All the commodities were not uniform in quality, such as cattle, grains, etc. Thus lack of
standardization made pricing difficult.
It is difficult to store and prevent loss of value in the case of perishable commodities.
Supplies of such commodities were uncertain.
They lacked in portability and hence were difficult to transfer from one place to another.
There was the problem of indivisibility in the case of such commodities as cattle.
2. Metallic money
With the spread of civilization and trade relations by land and sea, metallic money took the
place of commodity money. Many nations started using silver, gold, copper, tin, etc. as money.
But metal was an inconvenient thing to accept, weigh, divide and assess in quality. Accordingly,
metal was made into coins of predetermined weight. This innovation is attributed to King Midas of
Lydia in the eighth century B C. But gold coins were used in India many centuries earlier than in
Lydia. Thus coins came to be accepted as convenient method of exchange.
As the price of gold began to rise, gold coins were melted in order to earn more by selling
them as metal. This led governments to mix copper or silver in gold coins since their intrinsic
value might be more than their face value. As gold became dearer and scarce, silver coins were
used, first in their pure form and later on mixed with alloy or some other metal.
But metallic money had the following limitations.
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(i)
It was not possible to change its supply according to the requirements of the nation both for
internal and external use.
(ii) Being heavy, it was not possible to carry large sums of money in the form of coins from one
place to another by merchants.
(iii) It was unsafe and inconvenient to carry precious metals for trade purposes over long
distances.
(iv) Metallic money was very expensive because the use of coins led to their debasement and
their minting and exchange at the mint cost a lot to the government.
3. Paper money
The development of paper money started with goldsmiths who kept strong safes to store
their gold. As goldsmiths were thought to be honest merchants, people started keeping their gold
with them for safe custody. In return, the goldsmiths gave the depositors a receipt promising to
return the gold on demand. These receipts of the goldsmiths were given to the sellers of
commodities by the buyers. Thus receipts of the goldsmith were a substitute for money. Such
paper money was backed by gold and was convertible on demand into gold. This ultimately led to
the development of bank notes.
The bank notes are issued by the central bank of the country. As the demand for gold and
silver increased with the rise in their prices, the convertibility of bank notes into gold and silver
was gradually given up during the beginning and after the First World War in all the countries of
the world. Since then the bank money has ceased to be representative money and is simply fiat
money which is inconvertible and is accepted as money because it is backed by law.
4. Credit money
Another stage in the evolution of money in the modern world is the use of the cheque as
money. The cheque is like a bank note in that it performs the same function. It is a means of
transferring money or obligations from one person to another. But a cheque is different from a
bank note. A cheque is made for a specific sum, and it expires with a single transaction. A cheque
is not money. It is simply a written order to transfer money. However, large transactions are made
through cheques these days and bank notes are used only for small transactions.
5. Near money
The final stage in the evolution of money has been the use of bills of exchange, treasury
bills, bonds, debentures, savings certificates, etc. They are known as near money. They are close
substitutes for money and are liquid assets. Thus, in the final stage of its evolution money became
intangible. Its ownership in now transferable simply by book entry.
Definition of Money
It is very difficult to give a precise definition of money. Various authors have given
different definition of money. According to Crowther, Money can be defined as anything that is
generally acceptable as a means of exchange and that at the same time acts as a measure and a store
of value. Professor D H Robertson defines money as anything which is widely accepted in
payment for goods or in discharge of other kinds of business obligations.
From the above two definitions of money two important things about money can be noted.
Firstly, money has been defined in terms of the functions it performs. That is why some
economists defined money as money is what money does. It implies that money is anything
which performs the functions of money. Secondly, an essential requirement of any kind of money
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is that it must be generally acceptable to every member of the society. Money has a value for A
only when he thinks that B will accept it in exchange for the goods. And money is useful for B
only when he is confident that C will accept it in settlement of debts. But the general acceptability
is not the physical quality possessed by the good. General acceptability is a social phenomenon and
is conferred upon a good when the society by law or convention adopts it as a medium of exchange.
Functions of Money
The major functions of money can be classified into three. They are: The primary functions,
secondary functions and contingent functions.
I.
Primary functions of money

The primary functions of money are;
Medium of exchange and
Measure of value
(i)
Medium of exchange
The most important function of money is that it serves as a medium of exchange. In the
barter economy commodities were exchanged for commodities. But it had experienced many
difficulties with regard to the exchange of goods and services. To undertake exchange, barter
economy required double coincidence of wants. Money has removed this problem. Now a
person A can sell his goods to B for money and then he can use that money to buy the goods he
wants from others who have these goods. As long as money is generally acceptable, there will be
no difficulty in the process of exchange. By serving a very convenient medium of exchange
money has made possible the complex division of labour or specialization in the modern economic
organization.
(ii)
Measure of value
Another important function of money is that the money serves as a common measure of value
or a unit of account. Under barter system there was no common measure of value and the value of
different goods were measured and compared with each other. Money has solved this difficulty
and serves as a yardstick for measuring the value of goods and services. As the value of all goods
and services are measured in terms of money, their relative values can be easily compared.
II. Secondary functions
The secondary functions of money are;
(i)
Standard of deferred payments
Another important function of money is that it serves as a standard for deferred payments.
Deferred payments are those payments which are to be made in future. If a loan is taken today, it
would be paid back after a period of time. The amount of loan is measured in terms of money and it
is paid back in money. A large amount of credit transactions involving huge future payments are
made daily. Money performs this function of standard of deferred payments because its value
remains more or less stable. When the price changes the value of money also changes. For
instance, when the prices are falling, value of money will rise. As a result, the creditors will gain in
real terms and the debtors will lose. Conversely, when the prices are rising (or, value of money is
falling) creditors will be the losers. Thus if the money is to serve as a fair and correct standard of
deferred payments, its value must remain stable. Thus when there is severe inflation or deflation,
money ceases to serve as a standard of deferred payments.
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(ii)
Store of value
Money acts as a store of value. Money being the most liquid of all assets is a convenient
form in which to store wealth. Thus money is used to store wealth without causing deterioration
or wastage. In the past gold was popular as a money material. Gold could be kept safely without
deterioration.
Of course, there are other assets like houses, factories, bonds, shares, etc., in which wealth
can be stored. But money performs as a different thing to store the value. Money being the most
liquid of all assets has the advantage that an individual or a firm can buy with it anything at any
time. But this is not the case with other assets. Other assets like buildings, shares, etc., have to be
sold first and converted into money and only then they can be used to buy other things. Money
would perform the store of value function properly if it remains stable in value.
In short, money has removed the difficulties of barter system, namely, lack of double
coincidence of wants, lack of division and lack of measure and store of value and lack of a
standard of deferred payment. It has facilitated trade and has made possible the complex division
of labour and specialization of the modern economic system.
III. Contingent functions
The important contingent functions of money are;
(i) Basis of credit
It is with the development of money market the credit market began to flourish.
(ii) Distribution of national income
Being a common measure of value, money serves as the best medium to distribute the national
income among the four factors of production.
(iii) Transfer of value
Money helps to transfer value from one place to another.
(iv) Medium of compensations
Accidents and carelessness cause damage to the property and life. Compensation can be paid to
such damages in terms of money.
(v) Liquidity
Liquidity means the ready purchasing power or convertibility of money in to any commodity.
Money is the most liquid form of all assets.
(vi) Money guide in production and consumption.
Utility of goods and services can be expressed in terms of money. Similarly, marginal productivity
is measured in terms of prices of goods and factors. Thus money become the base of measurement
and which directs the production and consumption.
(vii) Guarantor of solvency
Solvency refers to the ability to pay off debt. Persons and firms have to be solvent while doing the
business. The deposits of money serves as the best guarantor of solvency.
Forms of money
Money of account
Money of account is the monetary unit in terms of which the accounts of a country are kept
and transactions settled, ie., in which general purchasing power, debts and prices are expressed. The
rupee is, for instance, our money of account. sterling is the money of account if Great Britain and
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mark that of Germany. Money of account need not, however, be actually circulating in the country.
During 1922-24 the mark in Germany depreciated in such an extent that it ceased to be the money
of account.
Limited and unlimited legal tender
Money which has legal sanction is called legal tender money. So its acceptance is
compulsory. It is an offence to refuse to accept payment in legal tender money. Thus a legal tender
currency is one in terms of which debts can be legally paid. A currency is unlimited legal tender
when debts upon any amount can be paid through it. It is limited legal tender when payments only
up to a given limit can be made by means of it. For example, rupee coins and rupee notes are
unlimited legal tender in India. Any amount of transaction can be made by using them. But coins of
lower amounts like 25 or 50 paisa are only limited legal tender (up to Rs.25/-). One can refuse to
receive beyond this amount.
When a coin is worn out and become light beyond a certain limit, then it ceases to be a legal
tender. When one rupee and half-rupee coins are more than 20% below the standard weight they are
no longer legal tender.
Standard money
Standard money is one in which the value of goods as well as all other forms of money are
measured. In India prices of all goods are measured in terms of rupees. Moreover, the other forms
of money such as half-rupee notes, one rupee notes, two rupee notes, five rupee notes etc. are
expressed in terms of rupees. Thus rupee is the standard money of India.
Standard money is always made the unlimited legal tender money. In old days the standard
money was a full-bodied money. That is its face value is equal to its intrinsic value (metal value).
But now-a-days in almost all countries of the world, even the standard money is only a token
money. That is, the real worth of the material contained in it is very much less than the face value
written in it.
Token money
Token money is a form of money in which the metallic value of which is much less than its
real value (or face value). Rupees and all other coins in India are all token money.
Bank money
Demand deposits of banks are usually called bank money. Bank deposits are created when
somebody deposits money with them. Banks also creates deposits when they advance loans to the
businessmen and traders. These demand deposits are the important constituent of the money supply
in the country.
It is important to note that bank deposits are generally divided into two categories: demand
deposits and time deposits. Demand deposits are those deposits which are payable on demand
through cheques and without any serving prior notice to the banks. On the other hand, time deposits
are those deposits which have a fixed term of maturity and are not withdrawable on demand and
also cheques cannot be drawn on them. Clearly, it is only demand deposits which serve as a
medium of exchange, for they can be transferred from one person to another through drawing a
cheque on them as and when desired by them. However, since time or fixed deposits can be
withdrawn by forgoing some interest and can be used for making payments, they are included in the
concept of broad money, generally called M3.
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Demand for money

Why people have demand for money to hold is an important issue in macroeconomics. The
level of demand for money not only determines the rate of interest but also the level of prices and
national income of the economy. The demand for money arises from two important functions of
money. The first is that money acts as a medium of exchange and the second is that it is a store of
value. Thus individuals and businesses wish to hold money partly in cash and partly in the form of
assets.
What determines the changes in demand for money is a major issue. There are two views.
The first is the scale view which is related to the impact of the income or wealth levels upon the
demand for money. The demand for money is directly related to the income level. The higher the
income level, the greater will be the demand for money.
The second is the substitution view which is related to relative attractiveness of assets that
can be substituted for money. According to this view, when alternative assets like bonds become
unattractive due to fall in interest rates, people prefer to keep their assets in cash, and the demand
for money increases, and vice versa. The scale and substitution view combined together have been
used to explain the nature of the demand for money which has been split into the transactions
demand, the precautionary demand and the speculative demand.
Classical economists considered money as simply a means of payment or medium of
exchange. In the classical model, people, therefore, demand money in order to make payments for
their purchases of goods and services. In other words, they want to keep money for transaction
purposes.
On the other hand J M Keynes also laid stress on the store of value function of money.
According to him, money is an asset and people want to hold it so as to take advantage of changes
in the price of this asset, that is, the rate of interest. Therefore Keynes emphasized another motive
for holding money which he called speculative motive. Under speculative motive, people demand
to hold money balances to take advantage from the future changes in the rate of interest or what
means the same thing from the future changes in bond prices.
An essential point to be noted about peoples demand for money is that what people want is
not nominal money holdings, but real money balances. This means that people are interested in
the purchasing power of their money balances, that is, the value of money balances In terms of
goods and services which they could buy. Thus people would not be interested in merely nominal
money holdings irrespective of the price level, that is, the number of rupee notes and the bank
deposits. If with the doubling of price level, nominal money holdings are also doubled, their real
money balances would remain the same. If people are merely concerned with nominal money
holdings irrespective of price level, they are said to suffer from money illusion.
The demand for money has been a subject of lively debate in economics because of the fact
that monetary demand plays an important role in the determination of the price level, interest and
income. Till recently, there were three approaches to demand for money, namely, transaction
approach of Fisher, cash balance approach of Cambridge economics, Marshall and Pigou and
Keynes theory of demand for money. However, in recent years, Baumol, Tobin and Friedman have
put forward new theories of demand for money.
The Supply of Money

The supply of money is a stock at a particular point of time, though it conveys the idea of a
flow over time. The supply of money at any moment is the total amount of money in the economy.
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There are three alternative views regarding the definitions or measures of money supply. The most
common view is associated with the traditional and Keynesian thinking which stresses the medium
of exchange function of money. According to this view, money supply is defined as currency with
the public and demand deposits with the commercial banks. Demand deposits are savings and
current accounts of depositors in a commercial bank. They are the liquid form of money because
depositors can draw cheques for any amount lying in their accounts and the bank has to make
immediate payment on demand. Demand deposits with the commercial bank plus currency with the
public are together denoted as M1 , the money supply. This is regarded as the narrower definition of
the money supply.
The second definition is broader and is associated with the modern quantity theorists headed
by Friedman. Prof. Friedman defines the money supply at any moment of time as literally the
number of dollars people are carrying around in their pockets, the number of dollars they have to
their credit at banks or dollars they have to their credit at banks in the form of demand deposits, and
also commercial bank time deposits. Time deposits are fixed deposits of customers in a
commercial bank. Such deposits earn a fixed rate of interest varying with the time period for which
the amount is deposited. Money can be withdrawn before the expiry of that period by paying a
penal rate of interest to the bank. So time deposits posse liquidity and are included in the money
supply by Friedman. Thus the definition includes M1 plus time deposits of commercial banks in the
supply of money. This wider definition is termed as M2 in America and M3 in Britain and India. It
stresses the store of value function of money.
The third function is the broadest and is associated with Gurley and Shaw. They include in
the money supply, M2 plus deposits of saving banks, building societies, loan associations, and
deposits of other credit and financial institutions.
Measures of Money Supply in India
There are four measures of money supply in India which are denoted by M1, M2, M3, and
M4. This classification was introduced by Reserve Bank of India (RBI) in April, 1977. Prior to this
till March, 1968, the RBI published only one measure of money supply, M or M1 which is defined
as currency and demand deposits with the public. This was in keeping with the traditional and
Keynesian views of the narrow measure of money supply.
From April, 1968 the RBI also started publishing another measure of the money supply
which is called Aggregate Monetary Resources (AMR). This included M1 plus time deposits of
banks held by the public. This was a broad measure of money supply which was in line with
Friedmans view.
Since April, 1977, the RBI has been publishing data on four measures of the money supply
which are cited below;
1) M1 The first measure of money supply M1 consists of:
Currency with the public which includes notes and coins of all denominations in
circulation excluding cash in hand with banks;
Demand deposits with commercial and co-operative banks, excluding inter-bank
deposits; and
Other deposits with RBI which include current deposits of foreign central banks,
financial institutions and quasi-financial institutions such as IDBI, IFCI, etc. RBI
characterizes M1 as narrow money.
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2) M2 The second measure of money supply M2 consists of M1 plus post office savings bank
deposits. Since savings bank deposits commercial and co-operative banks are included in
the money supply, it is essential to include post office saving bank deposits. The majority of
people in rural and urban have preference or post office deposits from the safety viewpoint
than bank deposits.
3) M3 The third measure of money supply in India M3 consists of M1 plus time deposits with
commercial and cooperative banks, excluding interbank time deposits. The RBI calls M3 as
broad money.
4) M4 The fourth measure of money supply M4 consists of M3 plus total post office deposits
comprising time deposits and demand deposits as well. This is the broadest measure of
money supply.
Of the four inter-related money supply for which the RBI publishes data, it is M3 which is
of special significance. It is M3 which is taken into account in formulating macroeconomic
objectives of the economy every year.
FISHERS QUANTITY THEORY OF MONEY: THE CASH TRANSACTIONS APPROACH
The Quantity Theory of Money states that the quantity of money is the main determinant of
the price level or the value of money. Any change in the quantity of money produces an exactly
proportionate change in the price level. According to Fisher, other things remaining the same, as
the quantity of money in circulation increases, the price level also increases in direct proportion and
the value of money decreases and vice versa. If the quantity of money doubled, the price level also
double and the value of money will be one half. On the other hand, if the quantity of money is
reduced by one half, the price level will also be reduced by one half and the value of money will be
twice.
Fisher has explained his theory in terms of his equation of exchange:
MV = PT
Where, M=the quantity of money in circulation
V = transactions velocity of circulation
P = average price level.
T = the total number of transactions.
According to Fisher, the nominal quantity of money M is fixed by the Central Bank of the
country and is therefore treated as an exogenous variable which is assumed to be given quantity in a
particular period of time. Further, the number of transactions in a period is a function of national
income; the greater the national income, the larger the number of transactions required to be made.
Since Fisher assumed full-employment of resources prevailed in the economy, the volume of
transactions T is fixed in the short run.
Fischer extended the equation by including the credit money. That is;
PT = MV + MIVI
Where, MI = total quantity of credit money
VI = the velocity of circulation of credit money
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This equation equates the demand for money (PT) to the supply of money (MV + MIVI).
The total volume transactions multiplied by the price level represents the demand for money.
According to Fischer, PT = PQ. In other words, price level (P) multiplied by quantity bought (Q)
by the community () gives the total demand for money. This equals the total supply of money in
the community consisting of the quantity of total money M and its velocity of circulation V plus the
quantity of credit money MI and its velocity of circulation VI. Thus total value of purchases (PT) in
a year is measured by MV + MIVI. Thus equation of exchange is PT = MV + MIVI. In order to find
out the effect of the quantity of money on the price level, or the value of money,
we write the equation as;
Fisher points out that the price level (P) varies directly with the quantity of money (M+MI),
provided the volume of trade (T) and velocity of circulation (V, VI) remain unchanged. This implies
that if M and MI doubled, while V, VI and T remain constant, P is also doubled, but the value of
money (1/P) is reduced to half.
Criticisms of the theory
Fischers quantity theory of money has been subjected to the following criticisms.
1. Truism. According to Keynes, the quantity theory of money is a truism. Because, it states
that the total quantity of money paid for goods and services (MV + MIVI) must equals their
value (PT). But it cannot be accepted today that a certain percentage change in the quantity of
money leads to the same percentage change in the price level.
2. Other things not equal. The assumption of other things remaining the same is not real. In
real life, V, VI and T are not constant. Moreover, they are not independent of M, MI and P.
3. Constants relate to different time.
Prof. Halm criticizes Fisher for multiplying M and V
because M relates to a point of time and V to a period of time. The former is a static concept ant
the latter is a dynamic concept. Therefore, it is technically inconsistent to multiply these two
non-comparable factors.
4. Fails to measure value of money.
Fishers equation does not measure the purchasing
power of money but only cash transactions, that is, the volume of business transactions of all
kinds or what Fisher calls the volume of trade in the community during a year. But value of
money relates to transactions for the purchase of goods and services for consumption. Thus the
theory fails to measure the value of money.
5. Weak theory.
According to Crowther, the quantity theory is weak in many respects. First, it
cannot explain why there are fluctuations in the price level in the short run. Second, it gives
undue importance to the price level as if changes in prices were the most critical and important
phenomenon of the economic system. Third, it places a misleading emphasis on the quantity of
money as the principal cause of changes in the price level during the trade cycle. Prices may not
rise despite increase in the quantity of money during depression; and they may not decline with
reduction in the quantity of money during boom. Further, low prices during depression are not
caused by shortage of quantity of money, and high prices during prosperity are not caused by
abundance of quantity of money.
6. Neglects interest rate. One of the main weaknesses of Fishers quantity theory on money is
that it neglects the role of the rate of interest as one of the causative factors between money
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and prices. Fishers equation of exchange is related to an equilibrium situation in which rate of
interest is independent of the quantity of money.
INFLATION AND DEFLATION
I. Meaning of Inflation
Inflation is a highly controversial term. By inflation we mean a general rise in prices. More
precisely, inflation is a persistent rise in the general price level rather than a once-for-all rise in it.
It was first defined by neo-classical economists. They meant by it a galloping rise in prices as a
result of the excessive increase in the quantity of money.
To the neo-classical and their followers at the University of Chicago, inflation is
fundamentally a monetary phenomenon. In the words of Friedman, Inflation is always and
everywhere a monetary phenomenon and can be produced only by a morse rapid increase in the
quantity of money than output. Coulborn defines inflation as too much money chasing too few
goods. But many economists do not agree that money supply alone is the cause of inflation. As
pointed out by Hicks, Our present troubles are not of a monetary character. Economists,
therefore, define inflation in terms of a continuous rise in prices. Johnson defines inflation as a
sustained rise in prices. Brooman defines it as a continuing increase in the general price level.
According to Crowther, inflation is a state in which the value of money is falling, ie. the prices
are rising.
Types of Inflation
Inflation is of various types. We can discuss some of its important types.
1. Creeping Inflation.
When the rise in prices is very slow like that of a snail or creeper, it is called creeping
inflation. In terms of speed, a sustained rise in prices of annual increase of less than 3 percent per
annum is characterized as creeping inflation. Such an increase in prices is regarded as safe and
essential for growth.
2. Walking or Trotting Inflation
When prices rise moderately and the annual inflation rate is a single digit such an inflation
is called walking inflation. In other words, the rate of rise in prices is in the intermediate range of 3
to 6 per cent per annum or less than 10 per cent. Inflation at this rate is a warning signal for the
government to control it before it turns into running inflation.
3. Running Inflation
When prices rise rapidly like the running of a horse at a rate or speed of 10 to 20 per cent
per annum, it is called running inflation. Such an inflation affects the poor and middle classes
adversely. Its control requires strong monetary and fiscal measures, otherwise, it leads to hyperinflation.
4. Hyper Inflation
When prices rise very fast at double or triple digit rates from more than 20 to 100 per cent
per annum or more, it is usually called runway or galloping inflation. It is also characterized as
hyperinflation. In reality, hyperinflation is a situation when the rate of inflation becomes
immeasurable and absolutely uncontrollable. Prices rise many times every day. Such a situation
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brings a total collapse of the monetary system because of the continuous fall in the purchasing
power of money.
5. Semi-inflation
According to Keynes, so long as there is unemployed resources the general price level
would not rise as output increases. But a large increase in aggregate expenditure will face shortages
of supplies of some factors which may not be substitutable. This may lead to increase in costs, and
prices starts rising. This is known as semi-inflation or bottleneck inflation because of the
bottlenecks in the supplies of some factors.
6.
True inflation
According to Keynes, when the economy reaches the level of full employment, any increase in
aggregate expenditure will lead to rise in the price level in the same proportion. This is because it
is not possible to increase the supply of factors of production and hence of output after the level of
full employment. This is called true inflation.
7. Open inflation
Inflation is open when markets for goods or factors of production are allowed to function freely,
setting prices of goods and factors without normal interference by the authorities. Thus open
inflation is as a result of uninterrupted operation of the market mechanism. There are no controls
on the distribution of commodities by the government. Unchecked open inflation may leads to
hyper inflation.
8. Suppressed inflation
When the government imposes physical and monetary controls to check inflation, it is known as
suppressed or repressed inflation. The market mechanism is not allowed to function normally by
the use of licensing, price controls and rationing in order to suppress the expensive rise in prices.
So long as such controls exist, the present demand is postponed and there is diversion of demand
from controlled to uncontrolled commodities.
9. Stagflation
Stagflation is a new term which has been added to economic literature in the 1970s. It is a
paradoxical phenomenon where the economy experiences stagnation as well as inflation. The word
stagflation is the combination of stag plus flation taking stag from stagnation and flation
from inflation. Stagflation is a situation when recession is accompanied by a high rate of
inflation. It is, therefore, also called inflationary recession. The principal cause of this
phenomenon has been excessive demand in the commodity markets thereby causing prices to rise,
and at the same time the demand for labour is deficient thereby creating unemployment in the
economy.
Three factors responsible for the existence of stagflation in the advanced countries since, 1970 are;
a. rise in oil prices and other commodity prices along with adverse changes in the terms of
trade;
b. the steady and sustained growth of the labour force; and c) rigidities in the wage structure
due to strong trade unions.
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10. Mark-up inflation

The concept of mark-up inflation is closely related to the price-push problem. Modern labour
organizations possess substantial monopoly power. They, therefore, set prices and wages on the
basis of mark up over costs and relative incomes. Firms possessing monopoly power have control
over the prices charged by them. So they have administered prices which increase their profit
margin. This leads to an inflationary rise in prices.
11. Ratchet inflation
A ratchet is a toothed wheel provided with a catch that prevents the ratchet wheel from moving
backward. The same is the case under ratchet inflation when despite downward pressures in the
economy, prices do not fall. In an economy when aggregate demand falls below full employment
level due to the deficiency of demand in some sectors of the economy the price level do not fall. It
is because the wage, cost and price structure are inflexible downward. Large business firms and
labour organizations possess monopoly power. Consequently, the fall in the demand may not lower
prices significantly. In such a situation prices will have an upward ratchet effect and this is termed
as ratchet inflation.
12. Sectoral inflation
Sectoral inflation arises when there is excess demand in certain sectors. It leads to a rise in prices in
other sectors also.
13. Reflation
It is a situation when prices are raised deliberately in order to encourage economic activity. When
the economy phases depression the monetary authority adopts measures to put more money in
circulation. This leads to rise in prices which is called as reflation
Inflation can also be classified into two broad categories: demand-pull inflation and cost push
inflation.
1. DEMAND PULL INFLATION
Demand pull inflation is a situation where price rises due to the excess
demand in the economy. In this sense, inflation is defined as too much money chasing too few
goods. In other words, an excess of aggregate demand over aggregate supply causes inflationary
rise in prices in the economy. This can be explained easily with the quantity theory of money. The
theory states that prices rise in proportion to the increase in money supply. Given the full
employment level of output, doubling the money supply will double the price level. So inflation
proceeds at the same rate at which the money supply expands. In this analysis the aggregate supply
is assumed to be fixed and there is always full employment in the economy.
Modern quantity theorists led by Friedman hold that inflation is always and everywhere a
monetary phenomenon. The higher the growth rate of the nominal money supply, the higher is the
rate of inflation. When the money supply increases, people spend more in relation to the available
supply of goods and services. This bids prices up. Modern quantity theorists neither assume full
employment as a normal situation nor a stable velocity of money. Still they regard inflation as a
result of increase in the money supply.
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The demand pull inflation is illustrated in the following figure.
Suppose the economy is initially in full employment equilibrium at the

point E. At this point equilibrium price is determined by the intersection of demand and supply
curves D and SS1 respectively. Now with the increase in the quantity of money, the aggregate
demand increases. As a result the demand curve shifts to the right to D1.Since the aggregate
supply is fixed which is shown by the vertical portion of the supply curve SS1, the demand curve
D1 intersects it at the point E1. This raises the price level to OP1.
The Keynesian theory on demand-pull inflation is based on the argument that, so long as there are
unemployed resources in the economy, an increase in investment expenditure will lead to increase
in employment, income and output. Once full employment is reached and bottlenecks appear,
further increase in expenditure will lead to excess demand because output ceases to rise, thereby
leading to inflation.
2.
COST PUSH INFLATION
Cost push inflation is caused by rise in the cost of production that is, rise in wages, price of raw
materials or profits.
a)
Rise in wages
The basic cause of cost-push inflation is the rise in the money wages more rapidly than the
productivity of labour. In advanced countries, the trade unions are very powerful. They press the
employers to raise the wages. This leads to increase in cost of production of commodities.
Employers, in turn, raise the prices of their products. Higher wages enable the workers to buy as
much as before, in spite of higher prices. On the other hand, the increase in prices induces trade
unions to demand still higher wages. In this way, the wage-cost spiral continues, thereby leading
to cost-push or wage-push inflation.
b)
Sectoral rise in prices
A few sectors of the economy may be affected by money wage increases and prices of their
products may be rising. In many cases, these products may be used as inputs by other sectors. As a
result, production costs of other sectors will rise and thereby pushes the prices of their products.
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Thus wage-push inflation in a few sectors of the economy may soon lead to inflationary rise in
prices in the entire economy.
c)
Rise in prices of imported raw materials
An increase in the prices of imported raw materials may lead to cost-push inflation. Since raw
materials are used as inputs by the manufactures of the finished goods, they enter into the cost of
production of the latter. Thus a continuous rise in the prices of raw materials tends to sets off a
cost-push inflation.
d) Profit-push inflation
Monopolist and Oligopolist firms raise the prices of their products to offset the rise in labour and
production costs so as to earn higher profits. Profit-pull inflation is, therefore, also called
administered price theory of inflation or price-push inflation or sellers inflation or market-power
inflation.
Module II
Banking
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Role and functions of Commercial Banks and Central Bank-Monetary policy and its instruments
(cheque, drafts, etc.)
CREDIT AND COMMERCIAL BANKING
With the introduction and use of money credit also came into existence. Credit is created
when one party (a person, a firm or an institution) lends money to another party, the borrower. The
act of lending and borrowing creates both credit and debit. Whereas debt means the obligation to
pay the finance borrowed, credit means the claim to receive this money payment from the other
party.
The act of borrowing and lending and thereby creation of credit is a special type of
exchange transaction which involves future payment of the principal sum borrowed as well as the
rate of interest on it. In the modern times there are a variety of institutions which specialize in
borrowing and lending of money. The bank credit is only one form of credit. Money lenders,
indigenous bankers, credit co-operative societies, commercial and co-operative banks, industrial
financial institutions, LIC, export finance houses, etc. are all credit institutions and do the
borrowing and lending money.
A bank is an institution which accepts deposits from the public and in turn advances loans
by creating credit. It is different from other financial institutions in that they cannot create credit
though they may be accepting deposits and making advances.
A commercial bank is a business organization which deals money; it borrows and lends
money. In this process of borrowing and lending of money it makes profit. The distinction between
money lender and a commercial bank may be noted. Whereas a money lender only lends money to
others and that too from his own sources, a commercial bank does both the lending and borrowing
business. A commercial bank raises its resources through borrowing from the public in the form of
deposits and lends them to the businessmen. Its lending rate of interest is greater than that it pays to
its depositors. It is because of this difference in lending and borrowing rates of interest that it is able
to make profit.
Functions of Commercial Banks
Commercial banks perform a variety of functions. They can be categorized as accepting
deposits, advancing loans, credit creation, agency functions and miscellaneous functions.
1. Accepting deposits
The banks borrow in the form of deposits. This function is important
because banks mainly depend on the funds deposited with them by the public. The deposits
received by the banks can be of three types;
a)Demand or current account deposits: In this type of deposits the depositor can withdraw the
money in part or in full at any time he likes without notice. These accounts are generally kept by
the businessmen whose requirements of making business payments are quite uncertain. Usually, no
interest is paid on them, because the bank cannot utilize these short term deposits and must keep
almost cent percent reserve against them. But in return for these current account deposits, the banks
offer some facilities or concession to the account holders. The most important is the cheque facility
made available to them. Further, on behalf of the current account deposits, bank collects cheques,
drafts, dividend warrants, postal orders, etc.
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b)Fixed deposits or time deposits: These deposits are made for a fixed period of time, which varies
from fifteen days to a few years. These deposits cannot, therefore, be withdrawn before the expiry
of that period. However, a loan can be taken from the bank against the security of this deposit
within that period. A higher rate of interest is paid on the fixed deposits based on the period of the
deposits.
c) Saving bank deposits: In this case the depositor can withdraw money usually once a week.
These deposits are generally made by the people of small means, usually people with fixed salaries,
for holding short-term savings. Like the current account deposits, the saving bank deposits are
payable on demand and also they can be drawn upon through cheques. But in order to discourage
people to use the saving bank deposits very frequently, there are some restrictions on the number of
times withdrawals can be made from these accounts. The saving deposits carry lower rate of
interest than the fixed deposits.
2. Advancing loans
One of the primary functions of the commercial bank is to advance loans to its customers.
A bank lends a certain percentage of the cash lying in deposits on a higher interest rate than it pays
on such deposits. Thus the bank earns profits and carries on its business.
The bank advances loans in the following ways:
a) Cash credit : The bank advances loan to businessmen against certain specified securities. The
amount of loan is credited to the current account of the borrower. In the case of a new customer a
loan account for the sum is opened. The borrower can withdraw money through cheques according
to his requirements but pays interest on the full amount.
b) Call loans : These are very short-term loans advanced to the bill brokers for not more than fifteen
days. They are advanced against first class bill or securities. Such loans can be recalled at a very
short notice. In normal times they can also be renewed.
c) Overdraft: A bank often permits a businessmen to draw cheques for a sum greater than the
balance lying in his current account. This is done by providing the overdraft facility up to a specific
amount to the businessmen. But he is charged interest only on the amount by which his current
account is actually overdrawn and not by the full amount of the overdraft sanctioned to him by the
bank.
d) Discounting bills of exchange: If a creditor holding a bill of exchange wants money
immediately, the bank provides money by discounting the bill of exchange. It deposits the amount
of the bill in the current account of the bill holder after deducting the rate of interest for the period
of the loan which is not more than 90 days. When the bill of exchange matures, the bank gets its
payment from the banker of the debtor who accepted the bill.
3. Credit creation
Credit creation is one of the most important functions of the commercial banks. Like other financial
institutions, they aim at earning profits. For this purpose, they accept deposits and advance loans by
keeping a small amount of cash as reserve for day-to-day transactions. When a bank advances a
loan, it opens an account in the name of customer and does not pay him in cash but allows him to
draw the money by cheque according to his needs. By granting a loan, the bank creates credit or
deposit.
3.Financing Foreign Trade
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A commercial bank finances foreign trade of its customers by accepting foreign bills of
exchange and collecting them from foreign banks. It also transacts other foreign exchange
business and sells foreign currency.
4. Investment
It is obligatory for commercial banks to invest a part of their funds in approved securities.
Other optional avenues of investments are also available. Investments in government securities are
useful in two ways. One is that, the commercial banks can get income from their surplus funds. The
other is that the liquidity, that is, encashability of securities is higher than that of loans.
5.Agency Services
Commercial bands act as an agent of its customers in collecting and paying cheques, bills of
exchange, drafts, dividends, etc. It also buys and sells shares, securities, debentures, etc. for its
customers. Further, it pays subscriptions, insurance premium, rent, electric and water bills, and
other similar charges on behalf of its clients. It also acts as a trustee and executor of the property
and will of its customers. Moreover, the bank acts as an income tax consultant to its clients. For
some of these service, the bank charges a nominal fee while it renders others free of charge.
6.Miscellaneous Services
Besides the above noted services, the commercial bank performs a number of other services.
It acts as a custodian of the valuables of its customers by providing them lockers where they can
keep their jewellery and valuable documents. it issues various forms of credit instruments, such as
cheques, drafts, travellers cheques, etc. which facilitate transactions. The bank also issues letters of
credit and acts as a referee to its clients. It underwrites shares and debentures of companies and
helps in the collection of funds from the public. ATM stands for Automated Teller Machine. It is
also depicted as Any Time Money as it provides the customers to withdraw money 24 hours subject
to certain restrictions.
CENTRAL BANK
In the monetary system of all countries, the central bank occupies an important place. The
central bank is the apex bank in a country. It is called by different names in different countries. It is
the Reserve Bank of India in India (set up in 1935), the Bank of England in England, the Federal
Reserve System in America, the Bank of France in France, etc.
Functions of a Central Bank
The following are the major functions of a central bank.
1. Note Issuing Agency
The central bank of the country has the monopoly of issuing notes or paper currency to the
public. Therefore, the central bank of the country exercises control over the supply of currency in
the country. In India with the exception of one rupee notes which are issued by the Ministry of
Finance of the Government of India, the entire note is done by the Reserve Bank of India.
Central banks have been following different methods of note issue in different countries. The
central bank is required by law to keep a certain amount of gold and foreign securities against the
issue of notes. In some countries, the amount of gold and foreign securities bears a fixed
proportion, between 25 to 40 per cent of the total notes issued. In other countries, a minimum fixed
amount of gold and foreign currencies is required to be kept against note issue by the central bank.
This system is operative in India whereby the Reserve Bank of India is required to keep Rs.115
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crores in gold and Rs. 85 crores in foreign securities. There is no limit to issue of notes after
keeping this minimum amount of Rs 200 crores in gold and foreign securities.
2. Banker to the Government
The central bank acts as a banker, agent and adviser to the government. It keeps the
banking accounts of the government. All the balances of the government are kept with the central
bank. But it pays no interest on these balances. Further, the central bank has to manage the public
debt and also to arrange for the issue of new loans on behalf of the government. The central bank
also provides short-term loans to the government. Thus it manages the public debt and advises the
government on banking and financial matters.
3. Control of credit
The chief objective of the central bank is to maintain price and economic
stability. For controlling inflationary and deflationary pressures in the economy the central bank
adopts quantitative and qualitative measures of credit control. Quantitative methods aim at
controlling the cost and quantity of credit by adopting bank rate policy, open market operations,
and by variations in reserve ratios of commercial banks. Qualitative methods control the use and
direction of credit. These involve selective credit controls and direct action.
4. Bankers bank
The central bank acts as a bankers bank in three capacities:
(a) as the custodian of the cash reserves of the commercial banks;
(b) as the lender of the last resort; and
(c) as bank of central clearance, settlement and transfers.
All other banks in the country are found by law to keep a fixed portion of their total
deposits as reserves with the central bank. These reserves help the central bank to control the issue
of credit by commercial banks. They in return can depend up on the central bank for support at the
time of emergency. This help may be in the form of a loan on the strength of approved securities or
through rediscounting of bills of exchange. Thus the central bank is the lender of last resort for
other banks in difficult times.
In India, scheduled banks have to keep deposits with the Reserve Bank not less than 5% of
their current demand deposits and 2% of their fixed deposits as reserves. In return they enjoy the
privilege of rediscounting their bills with the Reserve Bank as well as securing loans against
approved securities when needed.
Clearing function is also performed by the central bank for the banks. Since banks keep
cash reserves with the central bank, settlement between them may be easily effected by means of
debts and credits in the books of the central bank. If clearing go heavily against some bank, its cash
reserves with the central bank will fall below the prescribed limit and therefore the bank concerned
will have to make up the deficiency.
5. Lender of the last resort
The central bank helps the commercial banks when they face any difficulty. Even a well
managed commercial bank can run into difficulty if there is a great rush of demand for cash by the
depositors. During such occasions it will not be able to meet a sudden and large demand for cash.
The central bank must therefore come to their rescue at such times. Thus the central bank is the last
source of supply of credit.
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6. Custody and Management of Foreign Exchange Reserves

The central bank keeps and manages the foreign exchange reserves of the country. An
important function of a central bank is to maintain the exchange rate of the national currency. For
example, the Reserve Bank of India has the responsibility of maintaining the exchange value of the
rupee. When a country has adopted flexible exchange rate system under which value of a currency
is determined by the demand for and supply of a currency, the value of a currency, that is, its
exchange rate with other currencies is subject to large fluctuations which are harmful for the
economy. Under these circumstances, it is the duty of the central bank to prevent undue
depreciation or appreciation of the national currency. Since 1991 when the rupee has been floated,
the value of Indian rupee, that is, its exchange rate with US dollar and other foreign currencies has
been left to be determined by market forces. RBI has been taking several steps from time to time to
stabilize the exchange rate of rupee, especially, in terms of US dollar.
There are several ways by which RBI can manage or maintain the exchange rate of the rupee.
(i)
If due to speculative activities of foreign exchange operators, the rupee starts depreciating
fastly, RBI can intervene in the market. It can use its reserves of dollars and supply dollars in the
market from its own reserves. With the increase in the supply of dollars, the rupee will be
prevented from depreciation. It may however be noted that the success of this step depends on the
amounts of dollar reserves with RBI.
(ii) Another method by which RBI can manage the exchange rate of rupee is adopting measures
which will reduce the demand for dollars. Some importers, foreign investors, foreign exchange
operators try to avail of cheap credit facilities of banks and borrow rupee funds from the banks and
try to convert them into dollars. This raises the demand for dollars and leads to the depreciation of
the Indian rupee. Such a situation occurred in July-September, 1998. RBI intervened and raised the
Cash Reserve Ratio (CRR) and increased its repurchase rates. This succeeded in mopping up the
excess liquidity with the banks and reduced their lending capacity. This led to the reduction in the
demand for dollars and helped in preventing the rupee from depreciating.
MONETARY POLICY
Monetary policy is an important instrument of economic policy to achieve multiple
objectives. Monetary policy is concerned with the measures taken to regulate the supply of money,
the cost and availability of credit in the economy. It also deals with the distribution of credit
between uses and users and also with both the lending and borrowing rates of interest of the banks.
In developed countries the monetary policy has been used for overcoming depression and inflation
as an anti-cyclical policy. However, in developing countries it has to play a significant role in
promoting economic growth.
It is important to understand the distinction between goals, targets and instruments of
monetary policy. Whereas goals of monetary policy refer to the objectives such as price stability,
full employment or economic growth, targets refer to the variables such as supply of money or bank
credit, interest rates which are sought to be changed through the instruments of monetary policy so
as to attain these objectives. The various instruments of monetary policy are changes in the supply
of currency, variations in bank rates and other interest rates, open market operations, selective
credit controls and variations in reserve requirements.
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Instruments of Monetary Policy

The various instruments of monetary policy are;
1.
2.
3.
4.
1. Bank Rate Policy
Bank rate policy

Open market operations
Variable reserve ratio
Selective credit controls
Bank rate or rediscount rate is the rate fixed by the central bank at which it
rediscounts the first class bills of exchange and government securities held by the commercial
banks. The bank rate is the interest rate charged by the central bank at which it provides rediscount
to banks. The central bank controls credit by making variations in the bank rate. When the economy
needs to expand credit (during the periods of deficient demand), the central bank lowers the bank
rate. Then borrowing from central bank becomes cheap. So the commercial banks will borrow
more. They will, in turn, advance loans to customers at a lower rate. The market rate of interest will
be reduced. This encourages business activity. The opposite happens when credit to be contracted
in the economy. The central bank raises the bank rate when the economy phases excess demand
which makes borrowing costly from it. So the banks borrow less. They, in turn, raise their lending
rates to customers. The market rate of interest also rises because of the tight money market. This
discourages fresh loans. This leads to contraction of credit which depresses the rise in prices. Thus
lowering the bank rate offsets deflationary tendencies and raising the bank rate controls inflation.
2. Open Market Operation
Open market operations are another quantitative method of credit control. This method refers to
the sale and purchase of securities, bills and bonds of government and private financial institutions
by the central bank.
There are two principal of open market operations. One, it influence the reserves of commercial
banks in order to control their power of credit creation. Two, to affect the market rates of interest so
as to control the commercial bank credit. In this method of credit control, when the central bank of
a country wants to control expansion of credit by commercial banks for the purpose of controlling
inflationary pressures within the country, it sells government securities in the money market. The
purchasing power in the economy is reduced to the extent the commercial banks and individuals
purchase government securities.
On the other hand, when the central bank aims at an expansionary policy during a recessionary
period, it purchases government securities from the commercial banks and institutions dealing with
such securities. The central bank pays the sellers of its cheques drawn against itself which are
deposited into their accounts with the commercial banks. The reserves of the latter increase with the
central bank which are just like cash. As a result the supply of bank money increases.
Another impact of the open market policy is that when the supply of money changes as a result
of open market operations, the market rates of interest also change. A decrease in the supply of
bank money through the sale of securities will have the effect of raising the market interest rates.
Similarly, an increase in the supply of bank money through purchase of securities will reduce the
market interest rates. Thus open market operations have a direct influence on the market rates of
interest also.
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3. Variable Reserve Ratio

Variable reserve ratio (or required reserve ratio or legal minimum requirements) as a
method of credit control was first suggested by Keynes in his Treatise on Money(1930) and was
adopted by the Federal Reserve System of the United States in 1935.
Every commercial bank is required by law to maintain a minimum percentage of its deposits
with the central bank. It may be either a percentage of its time and demand deposits separately or of
total deposits. Whenever the amount of money remains with the commercial banks over and above
these minimum reserves is known as the excess reserves. It is on the basis of these excess reserves
that the commercial bank is able to create credit. The larger the size of excess reserves, the greater
is the power of a bank to create credit. and vice versa.
Changes in cash reserve ratio is a powerful method for influencing not only the volume of
excess reserves with the commercial banks but also the credit multiplier of the banking system. A
change in reserve requirements affect the money supply in two ways: (a) it changes the level of
excess reserves; and (b) it changes the credit multiplier
Suppose the commercial bank keep 10% of their central bank. This means Rs.10 of reserves
would be required to support Rs.100 of deposit and the credit multiplier is 10 (ie. 1/10% = 10). To
check inflation, the central bank raises the cash reserve ratio from 10% to 12%. As a result, the
commercial banks will have to maintain a greater cash reserve of Rs.12 instead of Rs.10 for every
deposit of Rs.100 and they will now decrease their lending by 2%. The credit multiplier will fall
from 10 to 8.3 (ie. 1/12% = 8.3). On the other hand, to check deflation, the central bank may reduce
the cash reserve ratio from 10% to 8% and thus make available 2% excess reserve to commercial
banks which they utilize to expand credit. The credit multiplier will then rise from 10 to 12.5 (ie.
1/8% = 12.5).
4. Selective Credit Controls
Selective or qualitative methods of credit control are meant to regulate and control the
supply of credit among its possible users and uses. They are different from quantitative or general
methods which aim at controlling the cost and quantity of credit. The aim of selective credit control
is to channelize the flow of bank credit from speculative and other undesirable purposes to socially
desirable and economically useful uses. They also restrict the demand for money by lying down
certain conditions for borrowers. The main types of selective credit controls generally used by the
central banks in different countries are cited below:
a) Regulation of Margin Requirements
This method is employed to prevent excessive use of credit to purchase or carry securities
by speculators. The central bank fixes minimum margin requirements on loans for purchasing or
carrying securities. Control over margin requirements means control over down payments that must
be made in buying securities on credit. The margin requirement is the difference between the
market value of the security and its maximum loan value. If a security has a market value of Rs.100
and if the marginal requirement is 60% the maximum loan that can be advanced for the purchase of
security Rs.40. Similarly, a marginal requirement of 80% would allow borrowing of only 20% of
the price of the security and a marginal requirement of 100% means that the purchasers of
securities must pay the whole price in cash. Thus an increase in marginal requirements will reduce
the amount that can be borrowed for the purchase of a security.
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b) Regulation of Consumer Credit

Under the consumer credit system, a certain percentage of the price of the durable goods is
paid by the consumer in cash. The balance is financed through the bank credit which is repayable
by the consumer in installments. The central bank can control the consumer credit by (a)changing
the amount that can be borrowed for the purchase of the consumer durables and (b)changing the
maximum period over which the installments can be extended.
c) Rationing of Credit
Rationing of credit may assume two forms: (i) the central bank may fix its rediscounting
facilities for any particular bank; (ii) the central bank may fix the minimum ratio regarding the
capital of a commercial bank to its total assets. In other words, credit rationing aims at (1) limiting
the maximum loans and advances to the commercial banks, and (2) fixing ceiling for specific
categories of loans and advances.
d) Moral Suasion
Moral suasion means advising, requesting and persuading the commercial banks to cooperate
with the central bank in implementing with its monetary policy. Through this method, the central
bank merely uses its moral influence to make the commercial bank to follow its policies. For
instance, the central bank may request the commercial banks not to grant loans for speculative
purposes. Similarly, the central bank may persuade the commercial banks not to approach it for
financial accommodation. This method is a psychological method and its effectiveness depends
upon the immediate and favourable response from the commercial banks.
e) Publicity
The central banks also use publicity as a method of credit control. Through publicity, the
central bank seeks : (i) to influence the credit policies of the commercial banks; (ii) to educate
people regarding the economic and monetary condition of the country; and (iii) to influence the
public opinion in favour of its monetary policy.
f) Direct Action
The method of direct action is most extensively used by the central bank to enforce both
quantitative as well as qualitative credit controls. This method is not use in isolation; it is often used
to supplement other methods of credit controls. Direct action refers to the directions issued by the
central bank to the commercial banks regarding their lending and investment policies. It may take
different forms: (i) the central bank may refuse to discounts the bills of exchange of the commercial
banks whose credit policy is not in line with the general monetary policy of the central bank. (ii) the
central bank may charge a penal rate of interest, over and above the bank rate, on the money
demanded by the bank beyond the pres cribed limit (c) the central bank may refuse to grant more
credit to the banks whose borrowings are found to be in excess of their capital and reserves.
References :
Monetary Economics : -R. R, Paul
Money Banking, International Trade and Public Finance: -M.L. Jhingan
Macroeconomics-Theory and Policy: H.L. Ahuja
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Module 3
PUBLIC FINANCE
Public revenue and its sources- Public expenditure- Public debt- Deficit financing- fiscal
policy-Budget- Finance commission.
Introduction
Public finance deals with the finances of public bodies national, State or Local for the
performance of their functions. The performance of these functions leads to expenditure. The
expenditure is incurred from funds raised through taxes, Fees, Sale of goods and services and loans.
The different sources constitute the revenue of the public authorities. Public finance studies the
manner in which revenue is raised; the expenditure is incurred upon different items etc Thus
public finance deals with the income and expenditure of public authorities and principles, problems
and policies relating to these matters.
Definitions
For all States whether crude or highly developed some provisions of the kind are
necessary and there for supply and application of state resources constitute the subject matter of a
study which is best entitled in English as Public Finance Charles F. Bastable (Public Finance
1892)
One of those subjects which lie on the border line between Economics and Politics. It is
concerned with the income and expenditure of public authorities and with the adjustment of one to
the other Prof. Hugh Dalton (Principles of Public Finance- 1922). The term Public
authorities refers to the Government or State all levels National, State and Local.
A field of enquiry that treats the income and out goes of governments federal, state and
local- Harold Groves. This definition outlines the types of governments whose finances are
studied in Public finance.
Public Finance is the fiscal science, its policies are fiscal policies, its problems are fiscal
problems Taylor. According to him public finance studies the manner in which the state
through its organ, the government, raises and spends the resources required. Public Finance is thus
concerned with the operation and policies of the fisc - The State treasury.
The main content of Public Finance consists of the examination and appraisal of the
methods by which governing bodies provide for the collective satisfaction of wants and secure the
necessary funds to carry out this purpose Mrs. Ursula Hicks. This definition of Public Finance
highlights the satisfaction of collective wants which in turn leads to the need to secure necessary
resources.
The discipline of Public Finance describes and analyses the government services, subsides
and welfare payments and methods by which the expenditure to these ends are covered through
taxation, borrowing, foreign aid and creation of new money CS Shoup. This definition enlarges
the scope of Public Finance for modern governments to include different types of expenditure and
different sources of revenue.
All the definitions started above illustrate the scope of Public Finance. From these
definitions, we can conclude that Public Fianc is and enquiry into the facts, techniques, principles,
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theories, rules and policies which shape, direct, influence and govern the use of scarce resources,
with alternative uses, of the governments.
The subject matters of Public Finance can be broadly classifieds in to five categories
a) Public revenue b) Public expenditure c) Public debt d) Financial administration e)
Economic stabilization and f) Federal Finance.
Public Revenue;
The income of the states is referred to as Public Revenue in this branch, we study the various ways
of raising revenue by the public bodies. We also study the principles and effects of taxation and
how the burden of taxation is shared among the various classes of society.
Public Expenditure
It deals with the principles and problems relating to the allocation of public spending. We study the
fundamental principles governing the flow of public funds in to different channels, classification
and justification of Public Expenditure; expenditure policies of governments and the measures
adopted for welfare state.
Public Debts;
The governments borrow when its revenue falls shot of its expenditure Public debts is a study of
various principles and methods of raising debts and their economic effects. It also deals with the
methods of repayments and managements of public debts.
Financial Administration;
In deals with the methods of Budget preparation, various types of Budgets, war Finance,
Development Finance etc thus, Financial administration refers to the mechanism by which the
financial functions are carried on. In other words, financial administration studies the organizing
and disbursing of the finances of the State.
Economic stabilization and Growth
The use of Public revenue and Public expenditure to secure stability in levels of prices by
controlling inflationary as well as deflationary pressures is studied. Similarly the income and
expenditure policies adopted by the government so as to attain full employment, Optimum use of
resources, equitable distribution of income etc.. are also studied.
Public Finance and Private Finance
The understanding and the study of public finance is facilitated by a comparison of the
public or government finance with private or individual finance. Such a comparison will help us to
know how the aims and objectives and methods of public Finance operation are similar or differed
from the financial operations of the individual.
Similarities
1. Both the State as well as individual aim at the satisfaction of human wants through their
financial operations. The individuals spend their income to satisfy their personal wants
where as the state spends for the satisfaction of communal or social wants.
2. Both the States and Individual at times have to depend on borrowing , When their
expenditures are greater than incomes
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3. Both Public Finance and Private Finance have income and expenditure. The ultimate aim of
both is to balance their income and expenditure.
4. Both kinds of Finances, the guiding principle is rationality. Rationality in the sense that
maximization of personal benefits and social benefits through corresponding expenditure.
5. Both are concerned with the problem of economic choice, that is, they right to satisfy
unlimited ends with scarce resources having alternative uses.
Dissimilarities
1. The private individual has to adjust his expenditure to his income. ie, his expenditure is being
determined by his income. But on the other hand the government first deter minds its expenditure
and the devices ways and means to raise the necessary revenue to meat the expenditure.
2. The government has large sources of revenue than private individuals. Thus at the time of
financial difficulties the state can raise internal loans from its citizens as well as external loans
form foreign countries. In the case of private individual, all borrowings are external in nature.
3. The state, when hard pressed, can resort to printing of currency, as an additional source of
revenue. In fact, during emergencies like war, it meats its increased financial obligations by
printing new currency. But an individual cannot raise income by creating money.
4. The state prep ears its budget or estimate its income and expenditure annually. But there is no
such limitation for an individual. It may be for weekly, monthly, or annually.
5. A surplus budget is always good for a private individual. But surplus budgets may not be good
for the government. It implies two things.
a) The government is levying more taxes on the people than is necessary and The government
is not spending as much as the welfare of the people as it should.
6.
The individual and state also differ in their motives regarding expenditure. The individuals
hanker after profit. Their business operations are guided by private profit motive. But the states
expenditure is guided by the welfare motive.
7.
The private individual spends his income on various items in such a manner as to secure equi
marginal utilities from them. The government on the contrary does not give as much importance
to this law as a private individual does. Modern government some times incur cretin types of
expenditure from which their do not derive any advantage but they do inker this expenditure to
satisfy cretin sections of the community.
8.
Individuals always seek quick returns they save only a small amount for future and spend
more to satisfy their current needs. Individual tent to think more or present as they are dead in the
long run similarly they seldom spend if it does not yield any money income. On the other hand,
State has a long term perspective of its expenditure. It does not care only for immediate benefit.
State spends on projects having long gestation period. The burden of taxation is borne by the
present generation in the interest of long run welfare of the community. Similarly some times
government may have to spend on schemes which may not yield any money income at all ( e.g.
Public Health)
9. An individuals spending policy has very little impact on the society as a whole. But the state
can change the nature of an economy through its fiscal policies.
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10. The pattern of expenditure in the case of private finance is often influence by customs,
habits social status etc The pattern of government expenditures is guided by the general
economic policy followed by the government.
11. Private Finance is always a secret affair. Individual need not reveal their financial
transactions to any one except for filing tax returns. But Public Finance is an open affair.
Government budget is widely discussed in the parliament and out sides. Public accountability is an
important future of public finance.
12. Individuals can plan to postpone their private expenditure. But the state cannot afford to put
off vital expenditure like defense , famine relief etc Findlay Shiraz says that compulsory
character is an important future of public finance.
THE PRINCIPLE OF MAXIMUM SOCIAL ADVANTAGE
One of the important principles of public finance is the so call principle of maximum social
advantage explain by Professor Hugh Dalton. Just like an individual seeks to maximize his
satisfaction or welfare by the use of his resources, the state ought to maximize social advantage or
benefit from the resources at its command.
The principles of maximum social advantage are applied to determine whether the tax or the
expenditure has proved to be of the optimum benefit. Hence, the principle is called the principle of
public finance. According to Dalton, This (Principle) lies at the very root of public finance
He again says The best system of public Finance is that which secures the maximum social
advantage from the operations which it conducts. t may all so called the principle of maximum
social benefit . A.C. Pigou has called it the principle of maximum aggregate welfare.
Public expenditure creates utility for those people on whom the amount is spent. When the
volume of expenditure is small with a slighter increase in it, the additional utility is very high. As
the total public expenditure goes on increasing in course of time, the law of diminishing marginal
utility operates. People derive less of satisfaction from additional unit of public expenditure as the
government spends more and more. I.e. after a stage, every increase in public expenditure creates
less and less benefit for the people. Taxation, on the other hand, imposes burden on the people. So,
when the volume of taxation becomes high , every further increase in taxation increases the burden
of it more and more . People under go greater scarifies for every additional unit of taxation. The best
policy of the government is to balance both sides of fiscal operations by comparing the burden of
tax and the benefits of public expenditure The State should balance the social burden of taxation
and social benefits of Public expenditure there would be maximum social advantage.
Attainment of maximum social advantage requires that;
a) Both public expenditure and taxation should be carried out up to certain limits and
no more.
b) Public expenditure should be utilized among the various uses in an optimum
manner, and
c) The different sources of taxation should be so tapped that the aggregate scarifies
entailed is the minimum
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Diagrammatic Representation
Y
E1
E2
MSS
E
MSS/MSB
F1
F2
MSB
M1
M2
TAX AND EXPENDITURE
The curves MSS and MSB show the marginal social scarifies of taxation and marginal
social benefit of public expenditure respectively. MSS curve slopes up words since taxation
increases marginal social sacrifices. MSB curves slopes down wards showing that public benefit
goes on declining with every increase in public expenditure. The ideal point of financial operations
is where the governments collect OM taxation from the society and uses it for public expenditure.
At this point , MSS is exactly equal to MSB (Point E) at OM 1 , MSS is M1 F1 which is less than
MSB (M1 , E1) the depicting a loss of welfare to the society (E1 F1). Similarly is the government
is collecting OM 2 taxation to finance larger public expenditure, The MSS is higher than MSB by
E2 F2. So the ideal level of taxation and expenditure is at OM. According to Dalton Public
expenditure in every direction, should be carried just so far that the advantage to the community of
a further small increase in any direction is just counter balanced by the disadvantage of a
corresponding increase in taxation or in receipts from any other source of public income. This gives
the ideal public expenditure and income.
PUBLIC REVENUE
The income of government through all sources is known as public revenue or public income.
Prof. Dalton defined public revenue in two senses
a) Narrow sense and be a broader sense. In the narrow sense, it includes income from taxes prices
of goods and services supplied by public sector under takings, revenue from administrative
activities, such as fees fine etc. In the wider sense, it includes all the incomes of the
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governments during a given period of time, including public borrowing from individuals and
banks and income from public enterprise it is known as public receipts.
SOURCES OF PUBLIC REVENUE
The sources of public revenue can be broadly classified in to two Tax source and non tax source.
Taxes: Taxes are imposed by the government on the people and it is compulsory on the part of
the citizens to pay taxes, without expecting a return.
Some definitions:
a) by Prof. Seligman: Tax is compulsory contribution from a person to the government to
defray the expenses incurred in the common interests of all without reference to special
benefits conferred.
b) By Prof. Taylor Taxes are compulsory payments to the governments without expectation
of direct return to or benefit to the tax payer
c) By Prof. BastableTax is compulsory contribution of the wealth of a person for the service
of public power.
d) By Prof. Taussig The essence of a tax , as distinguished from other charges by
government , is the absence of a direct quid pro quo between the tax payer and the public
authority
The revenue from taxes came from three main sources. viz; a) Taxes on income b) Taxes on
wealth and property and c) Taxes on commodities
Characteristics of a Tax
1. It is compulsory payments to the government from the citizen
2. It is imposes a personal obligation. it means that it is duty of tax payer to pay it and he
should in no case think to evade it.
3. Absence of direct benefit or quid pro quo between the State and people.
4. It is payments for meeting the expenses in the common interest of all citizens.
5. Certain taxes are imposed on specific objectives for example, tax on petrol to reduce
consumption and tax on luxuries so as to divert resources for the production of essential
commodities.
6. There is no tax without representation.
Non - Tax Revenue
a) Commercial Revenue. (Income from public property and enterprises)
b) Administrative Revenue ( Fee, Fine, Special assessment )
c) Gifts and grants and
d) Others
Commercial Revenue:
Income earned by public enterprises by selling their goods and services. For example, Payments for
postage, tolls, interest on borrowed funds etc.. They are also known as prices because they come in
the form of prices and goods and services provided by government.
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Administrative Revenue
The receipts of incomes accrued on account of performing administrative functions by the
government are called administrative revenue. The important items of administrative revenue are
listed below.
Fees: Fee is a payments to defray the cost of each recurring service under taken by the government
in the public interest Prof. Seligman. Fees are a payment imposed by the government. For
Example, Court Fee, License Fee, Passport, Fee etc.
Fines and Penalties Fines penalties are imposed on persons as a punishment for infringement of
laws. They are imposed to prevent crime. Fines and penalties are arbitrarily determined.
Special assessments: - according to Prof. Seligman A special assessment is a compulsory
contribution levied in proportion to the special benefit derived to defray the cost of specific
improvement to property under taken in the public interest. For example, when the government
constructs a highway, the prices of plots on either side of it will naturally go up. There for, the land
owners may be required to bear a part of expenses incurred by the government. Such charges are
called as special assessments.
Gifts and grants: - In general gifts and grants are the payments maid by one government to
another for some specific functions for example, central grant to state government. Gifts are
voluntary contribution maid by the people to the government for some special purposes.
Other sources of Revenue: - other sources of revenue are Forfeitures, Escheat, Issues of currency
and Borrowings
Forfeitures: - it is penalty imposed by the court for failure of individual to appear in the court to
complete certain contract as stipulated.
Escheat: - Properties having no legal heirs or without will, that go to government are called
Escheats.
Issue of Currency: - The printing of proper money yields income to the government it is mean to
create extra resources by the printing of paper money. It is normally avoided because if once this
method of financing is started it becomes difficult to stop it. This further leads to inflation.
Borrowings: - This is another source of public revenue. That is through borrowings from the public
in the shape of deposits bonds etc. It also includes
Classification Taxation
Taxes are classified on different bases. Different bases adopted by the economists to classified
taxes are the forms, nature, aims and methods of taxation. The various taxes may be classified
under following major heads.
Classification of Taxes
Direct
Proportional
Progressive
Regressive
Degressive
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Indirect
Specific
Ad Valorem
Single
Multiple
Income and Property

Production and Consumption
Capital goods
Value Added Tax (VAT)
MODVAT
33
Direct Taxes and Indirect Taxes

According to Dalton a direct Tax is really paid by a person on whom it is legally imposed, while
an indirect tax is imposed on one person, but paid partially or wholly by another, owing to
consequential change in the terms of some contract or bargaining between them. According to J S
Mill, A direct tax is one, demanded from the very person who is intended or desired should pay it.
Indirect taxes are those which are demanded from the one person in the expectation and intention
that we shall identify him at the expenses of another.
From the above we can reach in a conclusion that direct taxes are those which are paid by
persons on whom these are imposed and the real burden is also borne by them. Indirect taxes are
imposed on one person but are paid either partly or wholly by another. Examples of direct taxes
are income tax, wealth tax, corporation tax, gift tax etc. Indirect taxes: Sales tax, excise duty, VAT
etc.
Public Expenditure
The expenses incurred by the govt. for its own maintenance, preservation and welfare of the
economy as a whole is referred to as public expenditure. In other words, it referred to the expenses
of public authorities-central, state and local govt. in a federation-for the satisfaction of collective
needs of the citizens or for promotion of economic and social welfare. The development functions
include education, public health, social security, irrigation, canal, drainage, roads, buildings, etc.
The major cause of increase in the public expenditure is nothing but, these developmental
functions. Hence, the study of public expenditure has become very significant in the study of public
finance.
The two major reasons for the same are: a) the economic activities of the state has increased
manifold and b) nature and volume of public expenditure have greatly affected the economic life of
the country in a different manner. ie, it has affected production and distribution and general level of
economic activities.
In the laissez-faire era the state was assigned a very limited role to play. The functions
assigned to the state where based on the principle of least interference or that govt is the best
which spends the least. According to the classicals lead by Adam Smith restricted the functions of
the state to Justice, Police and Arms. They considered govt. expenditure wasteful and that money
could be used much better by private persons than by the govt. Adam Smith in his magnum opus
The Wealth of Nations published in 1776 observed that the sovereign has three main duties to
perform as a) to protect the society from violence and invasion of other independent societies b) to
protect against injustice and c) erecting and maintaining certain public works.
According to David Ricardo, if you want a peaceful govt. you must reduce the budget. JB
Say opined that the very system of all plans of finance is to spend little and the best of all taxes is
that which is least in amount.
In recent time, public expenditure has been increased enormously. The main reason is the
functions of govt. have increased manifold. The modern states are no more police states but welfare
states. Adolph Wagner, a German economist presented his famous Law of Increase of State
Activities he states that comprehensive comparison of different countries and different times
show that among progressive people with which alone we are concerned, an increase regularly
takes place in the activity of both central and local govts. This increase is both intensive and
extensive. The central and local govts. Constantly undertake new functions, while they perform
both, old and new functions more efficiently and completely. In this way the economic needs of the
people, to an increasing extent and in a satisfactory fashion are satisfied by the central and local
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govts. Prof. RA Musgrave, the twentieth century economist, advocated public expenditure since a
govt. is forced to do many activities such as 1) activities to secure a reallocation of resources 2)
redistribution activities, 3) stabilizing activities and 4) commercial activities.
Causes for the Increase in Public Expenditure:
One of the most important features of the present century is the phenomenal growth of
public expenditure. Some of the important reasons for the growth of public expenditure are the
following.
1) Welfare state: Modern states are no more police states. They have to look in to the welfare of
the masses for which the state has to perform a no. of functions. They have to create and
undertake employment opportunities, social security measures and other welfare activities. All
these require enormous expenditure.
2) Defence expenditure: Modern warfare is very expensive. Wars and possibilities of wars have
forced the nation to be always equipped with arms. This causes great amount of public
expenditure.
3) Growth of democracy: the form of democratic govt. is highly expensive. The conduct of
elections, maintenance of democratic institutions like legislatures cause great expenditure.
4) Growth of population: tremendous growth of population necessitates enormous spending on
the part of the modern govts. For meeting the needs of the growing population more
educational institutions, food materials, hospitals, roads and other amenities of life are to be
provided.
5) Rise in price level: Rises in prices have considerably enhanced public expenditure in recent
years. Higher prices mean higher spending on the part of the govt. on items like payment of
salaries, purchase of goods and services and so on.
6) Expansion public sector: Counties aiming at socialistic pattern of society have to give more
importance to public sector. Consequent development of public sector enhances public
expenditure.
7) Development expenditure: for implementing developmental programs like Five Year Plans,
Modern govts are incurring huge expenditure.
8) Public debt: Along with debt rises the problem like payment of interest and repayment of the
principal amount. This results in an increase in public expenditure.
9) Grants and loans to state govts and UTs: It is an important feature of public expenditure of the
central govt of India. The govt provides assistance in the forms of grants-in-aid and loans to
the states and to the UTs ;
10) Poverty alleviation programs: as poverty ratio is high, huge amount of expenditure is required
for implementing allegation programs.
Classification of public expenditure:
Public expenditure has been classified in to a) Revenue expenditure and b) Capital
expenditure. Revenue expenditure is current expenditure. For example, administrative and
maintenance. This expenditure is of a recurring type. Capital expenditure of capital nature and is
incurred once for all. It is non-recurring expenditure. For example, expenditure in building, multi-
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purpose projects or on setting up big factories like steel plants, money spent on land, machinery
and equipment. This can be explained as follows:
Public Expenditure
Revenue expenditure
Developmental
Capital expenditure
Developmental outlay
Non developmental outlay
Loans and advances
Discharge of debts
Non Developmental
Administrative Services
Debt Service
Defence
Social services
Education
Medical and health
Labour welfare
Science and research
Economic services
Grants in aid
Agriculture
Industry
Energy
Minerals
Communication &
Transport and foreign trade
Theories of growth of public expenditure.

As we know in modern times all the countries of the world have witnessed an enormous
increase in public expenditure. The three important theories of the growth public expenditure are
the following:
1) Adolph Wagners hypothesis
2) Wiseman Peacock hypothesis and
3) Colin Clarks Critical limit hypothesis.
Adolph Wagners Hypothesis: Adolph Wagner believed that there was a cause-effect relationship
between economic growth and public expenditure. His hypothesis of Law of Increasing State
Activity lays that as a percapita income and output increase in industrialized counties, the
public expenditure of those counties necessarily grows as a proportion to total economic
activity. He explained that comprehensive comparisons of different countries and different
times shows that among progressive people, with which alone we are concerned, an increase
regularly takes place in the activity of both central and local govts. The increasing both
extensive and intensive, the central and local govts. Constantly undertake new functions, while
they perform both old and new functions more effectively and completely.
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Conclusions:1) As the national income increases in amount, the percentage of outlay for govt. supplied
goods is greater.
2) Increased public expenditure was the natural result of economic growth and continued
pressure for social progress.
Wiseman Peacock hypothesis: According to Wiseman and Peacock Public Expenditure does not
increase in a smooth and continuous manner. The increasing public expenditure over time has
occurred in step-like manner. The general approach to the hypothesis refers to the three related
concepts.
1) Displacement effect 2) Inspection effect and 3) concentration effect.
The movement from older level of expenditure and taxation to a new and higher level is called the
displacement effect.
War and other social disturbances force the people and govts. to find solutions of important
problems, which had been neglected earlier. This is called the inspection effect. That is, new
obligations imposed on state, in the form of increased debt interest and war pensions etc.
The concentration effect refers to the apparent tendency for the central govt. economic activities to
become an increasing proportion of the total public sector economic activity when the society is
experiencing economic growth.
Critical Limit Hypothesis: (Colin Clark): The hypothesis was developed by Colin Clark
immediately after the Second World War. It is concerned with the tolerance level of taxation. By
maximum limit of the tolerance level is 25% of GNP. When the share of govt. expenditure exceeds
25% in the GNP, inflation occurs even in balanced budget.
Public Debt
Among the non-tax sources, the major source of revenue of the government is public debt.
That is, borrowing. It may either be internal or external debts. When the government raises revenue
by borrowing from within the country, it is called internal debt. Similarly, if the government is
borrowing from the rest of the world, it is a case of external debt. According to Philip E. Taylor,
The debt is the form of promises by the treasury to pay to the holders of these promises a principal
sum and in most instances interest on the principal. Borrowing is resorted to provide funds for
financing a current deficit.
Causes for Public Debt
Till the beginning of the 20th century, state performed only limited functions-maintenance
of law and order, protection of the country from external attack etc. Therefore, the state had to
collect only small revenue and little. Recently, in almost all countries of the world there has been a
great increase in the magnitude and variety of governmental activities. The acceptance of the
principle of the welfare state increases the role of state participation in economic activity. This has
necessitated the need to find out additional sources of finance. Hence, modern governments have
come to rely on public borrowings.
Objectives of public debt:
The objectives of public debt are the following.
1)To bridge the budget deficit (Deficit Financing)
2) To fight against depression.
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3) To check inflation.
4) To finance economic development.
5) To meet unforeseen contingencies.
6) An alternate source of income when taxable capacity is reached.
7) To finance wars.
8) To finance public enterprises.
9) To carry out welfare programmes.
10) To create infrastructure.
11) For creation of productive assets.
12) For creation of essential non-income yielding assets( provision of public goods) etc.
Important Sources of Public Debt
Every government has two major sources of borrowinginternal and external. Internally
the government can borrow from individuals, financial institutions, commercial banks and the
central bank. Externally, the governments borrow from individuals and banks, international
institutions and foreign governments. They can be briefly summarized as follows.
1) Borrowing from individuals.
2) Borrowing from Non-Banking Financial Institutions.( Insurance companies, investment
trusts, mutual funds etc,)
3) Borrowing from commercial banks.
4) Borrowing from central banks.
5) Borrowing from External sources( IMF,IBRD,ADB, Foreign Governments| countries)
Classification of Public Debt
1) Voluntary and compulsory (On the basis of legal enhancement): Voluntary debt is the debt
which is paid any legal enforcement. Where as compulsory debt is legally forced in nature.
Here people have no option but repay the debt.
2) Funded and unfunded debt (Provision for repayment): funded debt is long term or definite
period debt. A proper agreement and terms and conditions of repayment with the
percentage of interest payable is declared. They are used for creation of permanent assets.
Un funded debt is for a short term and for indefinite period. It is paid through the income
received from other sources. These are used for meeting current needs.
3) Internal and external debt: When the government raises revenue by borrowing from with in
the country, it is call internal debt. Where as if the government is borrowing from the rest of
the world, it is case of external debt.
4) Productive and unproductive (Purpose of loans) Loans on Projects yielding income
(Construction of plants, railways, power schemes etc.) are called productive debt. Loans on
loan non income yielding projects are called unproductive loans (war, famine relief etc)
5) Redeemable and irredeemable loans (Promise to repay) Redeemable debts refers to the loan
which the government promises to pay off at some future date. (principal plus interest)
Irredeemable debts are those, principal amount of which are never returned by the
government but payees interest regularly.
6) Shot / Medium/ Long term loans (Time duration): Short term loans are usually incurred for
a period varying from three months to one year. Usually governments get such loans from
the central bank by using treasury bills. These loans are calls ways and means advances
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Medium Term loans are those which are obtain for more than one year but less than ten years.
Long term loans are those which are obtain for more than tern years. These are used to finance
developmental activities.
Deficit Financing
Mc. Graw Hill dictionary of modern economics define deficit financing as a practice by
government of spending more than what receives in revenue. Those a government is said to be
practicing deficit Financing when it spends in excess of its current revenue.
According to the Planning Commission of India Deficit Financing is used to denote the
direct addition to Gross National Expenditure through budget deficit whether the deficit are on the
revenue account or capital account. The essence of such a policy lies there for in government
spending in excess of the revenue it receipts in the shape of taxes earning of state enterprises, loan
from public deposits and funds and other miscellaneous sources. The government may cover the
deficit either by running down its accumulated balances or by borrowing from the banking system.
In Indian context deficit financing takes place; when a budgetary deficit financed by using any one
of the following methods.
a) The government may with draw its cash balances from the central bank or
b) Government may borrow fund from the central bank or
c) Government may resort to printing of additional currency
Advantage of deficit financing
1.
2.
3.
4.
Best use of resources.

Helpful to developing countries difficult to create resources through taxation .
Additional purchasing power.
Helpful despite inflationary nature.
Limitations
1.
2.
3.
4.
5.
6.
Raise in prices
Increase in money supply
Speculative activities
Adverse effect on savings.
Less investment.
Unequal distribution of income and wealth.
Fiscal Policy
According to Arthur Smithies Fiscal policies is A policy under which the government uses
its expenditure and revenue programes to produce desirable effect and avoid undesirable effect on
the national income, production and employment.
Fiscal policy is
a) Budgetary policy of the government;
b) It uses public expenditure and taxation as instruments ; and
c) Its objectives is to influence production and employment favorably
The significance of fiscal policy was first emphasized by J.M. Keynes, in mid 1930 s in his
General Theory of Employment, Interest and Money published in 1936.
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Fiscal policy refers to the policy of government with relation to taxation, public expenditure and
management of public debt. In other words fiscal policy refers to the financial activities under
taken to correct either inflation or deflation.
The classical concept of fiscal policy
The classical believed in laissez Faire, Says law of market, full employment, optimum
allocation of resources etc. According to them full employment is a common phenomenon and is
supposed to reach automatically. There is no necessity of any governmental interference. The
concept of fiscal policy held by the classical is known as Principal of sound finance according to
them That government is the best which spends the least and imposes lowest amount of taxes.
Modern concept of fiscal policy
The modern concept of fiscal policy is called Functional Finance. This was first stated by
J.M.Keynes and was developed by Abba P. Lerner. According to the policy of functional Finance
Government has to play a positive roll so as to regulate and control the economy by means of
taxes and expenditure.
Objectives of fiscal policy in developed countries
1. Full employment
2. Price stability
3. High and stable rate of growth
Objectives of fiscal policy in less developed centuries
1.
2.
3.
4.
5.
6.
7.
Full employment
Price stability
Accelerated rate of economic development
Optimum allocation of resources
Equitable distribution income and wealth
Economics stability and
Capital formation and growth
BUDGET
The term budget has been derived from a French word bougette which means a leather bag
or purse. As per Article 112 of Indian Constitution the Govt. has to present in the Parliament an
annual financial statement showing estimates of revenue and expenditure. This is called the Annual
Financial Statement or Budget. Hence, government budget is a schedule of all revenues and
expenditures that the Govt. expects to receive and plan to spend during the following year. A
Budget includes a) financial actions of the previous year b) budget and revised estimates of the
current year and c) the budget estimates for the following year. The budget is presented in the
parliament by the Union Finance Minister. Similarly the State Govts. have also to present the
budget in the State Legislatures as per Article 202 of the Indian Constitution.
Government Accounts
1) Consolidated Fund:- All sums of money. All revenues of the govt,the loans raised by it, receipts
by way of repayment of loans. All expenditures are also incurred out of this fund. No amount can
be withdrawn from this fund without the sanction of the parliament.
2) The Contingency fund:- The fund is placed at disposal of the President to enable the government
to meet the unforeseen emergencies. Prior sanction of the parliament is not required to spend from
the fund.
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3)Public Account:- certain transaction are not included in the contingency fund. The include
transactions relating to provident funds, small savings collections, other deposits etc. The money
thus received is kept in public account. This money does not belong to the government. It has to
paid back to the persons and authorities who have deposited it. Hence, parliamentary approval is
not required for payments.
Features of Budget
1) It is a statement of expected revenue and proposed expenditure.
2)It is sanctioned by some authority.
3) It is periodicity, generally annual and
4) It prescribes the manner in which revenue is collected and expenditure is incurred.
Objectives of a Budget
1)
2)
3)
4)
Re-allocation of resources
Re-distribution of resources
Stabilization of resources
Sources of information to the public of the past, present and future activities, plans and
programmes of the relevant governments.
5) Tool of government policy
6) To estimate income and expenditure
7) An instrument of fiscal policies
8) Basis of public welfare
9) To ensure financial and legal accountability
10) To serve as a tool of management for controlling administrative efficiency.
Components of a Budget
The government budget is divided into Revenue Budget and Capital Budget.
Revenue Budget or Revenue Account is related to current financial transactions of the government
which are of recurring in nature. Revenue Budget consists of the revenue receipts of the
government and the expenditure met from this revenues.
The Capital Account is related to the acquisition and disposal of capital assets.
Revenue Receipts include receipts from taxation, profits of enterprise, other non-tax receipts
like administrative revenue (fees, fines, special assessment etc.), gifts grants etc. Revenue
expenditure includes interest-payments, defence expenditure, major subsidies, pensions etc.
Capital budget is a statement of estimated capital receipts and payments of the government
over fiscal year. It consists of capital receipts and capital expenditure.
Capital Receipts include
a) Borrowings b) Recovery of loans and advances
c) Disinvestments and d) Small savings.
Capital Expenditure includes a) Developmental Outlay b) Non-developmental outlay
b) Loans and advances and d) Discharge of debts.
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Types of Budgets
Based on the balancing of revenue and expenditure, budgets are divided into Balanced Budget
and Unbalanced Budget.
Balanced Budget:- A balanced budget is that over a period of time, revenue does not fall short of
expenditure. i.e., revenue is equal to expenditure. (Revenue= Expenditure).
The Budget imbalance may be due to an excess of expenditure over income or an excess of
income over expenditure. In other words, budget may either be surplus or deficit. A budget is said
to be surplus when public revenue exceeds public outlay. (R>E).
A deficit budget means a budget when expenditure exceeds revenue. (R<E).
Finance Commission
Under the provisions of the constitution, the president is required under Article 280 (1) to
constitute within two years from the commencement of the constitution and there after the
expiration of every fifth year or at such early year time as he may consider necessary. The
commission is charged with the tremendous responsibilities of making requisite recommendation to
the president of India. The Finance Commission consists of a chairman and four members to be
appointed by the president.
Functions of Finance Commission
There are two important functions Suggestive functions and making recommendations to be
performed by the Finance Commission.
Suggestive Functions
1. To suggest the criteria of distribution between union and States of net proceeds which are to be
or may be divided between them.
2. It deter minds the allocation of net proceeds between different states according to their
respective shares of proceeds.
3. Any modification continuance of the term of any agreement entered in to by the union
government with the government of any State in part B of the First schedule under clause (v)
of Article 178 or Article 306
4. The principal which should govern the grants in aid of the revenue of defence state out of
the consolidated fund of India.
5. Any other matter refers to the commission by the President of India.
Making Recommendations
1. The percentage of net proceeds of the Taxes which may be divided between center and State.
2. The allocation of Shares of the proceeds of such taxes in percentages between different States.
3. To deter mind the principal to govern the grants in aid of the revenue out of the
consolidated fund of government of India between States.
4. The modification of continuances of the term of agreement regarding the levy of International
customs and duties with part B States.
5. Grants in aids in tribal areas and
6. Special grants for any particular state.
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Finance Commission in India.

1.
2.
3.
4.
5.
6.
FC
Year
Nov. 1951
June 1956
December 1960
May 64
February 1968
June 1972
7.
8.
9.
10.
11.
12.
13.
June 1977
June 1982
June 1987
June 1992
July 1998
July 2002
October 2009
GeneralEconomicsII
Chairman
K.C. Neogi
K. Santhanam
A.K. Chanda
Dr. P.V. Rajmannar
Mahavir Tyagi
Brahmananda
Reddy
J.M. Shelat
Y.B. Chavan
N.K.P. Salve
K.C. Pant
Prof. A.M. Khusro
C. Rangarajan
Vijay Khelkar
Report Submission
December 1952
September 1957
December 1961
August 1965
July 1969
November 1973
October 1978
November 1983
March 1990
November 1994
June 2000
November 2004
43
Module IV
TRADE
Internal and External Trade; Why international trade?; balance of trade and balance of payment;
foreign exchange rate; devaluation; revaluation; depreciation; appreciation.
Internal and External trade
Internal or domestic trade can be defined as exchange of goods and services amoung the
residents of the same country. It refers to the trade within the geographical territory of a country. It
is the trade between different regions within the same country or the domestic exchanges which
takes place within the country
On the other hand, external or international trade may be defined as exchange of goods and
services between the residents of a given country and those of the rest of the world. Thus,
international trade takes place between the two countries. The main differences between the
internal and international trade are as follows
1) Factor Mobility
The factors of production, notably labour and capital resources, are more mobile within the
country. If the internal mobility were perfect there would not exist interregional differences in
factor prices. The factors would move away from the regions where their prices are relatively lower
towards the regions where their prices are relatively higher, until the factor price differences are
completely wiped off. It is on account of greater mobility of labour and capital within the country
that there is a tendency for the equalisation of wage rates and interest rates.
However, in the international setting, the factor mobility is neither free nor perfect. There
are restrictive immigration laws which prevent free mobility of labour form one country to another.
In respect of capital, there are restrictions on the inflow and outflow of capital and investment
across national frontiers. In addition to these legal barriers, there are several other barriers like
differences in language, climate, social customs and practices, political and educational systems etc
which create additional barriers to factor mobility between countries. Thus, due to comparatively
less mobility of labour and capital, the production costs of the same commodity become different in
two countries. It is on account of the differences in production costs that international trade takes
place.
2) Product Mobility
Within the country, the movement of goods and services from one region to another is free.
The only internal barriers to free movement of goods and services are the distance and cost of
transportation (natural barriers). As against this, there are formidable man-made and natural
barriers on trade between two countries. Besides import and export tariffs, exchange controls and
other non-tariff barriers put obstacles to the free movement of goods and services between one
country and the other. From this point, international trade is quite different from internal trade in
goods and services.
3) Economic Environment
Within the country, the economic environment is more or less same in all regions of the country.
The government policy with regard to interest rates, taxes, wages or prices are the same within the
country. Similarly, market structures and consumer taste patterns and preferences are more or less
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the same throughout the country. But between countries they could all differ very significantly.
This would make the character of international trade significantly different for that of international
trade.
4) Monetary Units
Usually a single currency unit is used throughout the entire country. There is only one currency is
used as a medium of exchange or a measure of value which would make the exchange very smooth
as far as internal trade is concerned. But there are different currencies in different countries. The
differences with the currency systems prevailing in different countries considerably hamper the
smooth flow of goods and services between countries. Thus a number of foreign exchange
difficulties arise in international trade.
5) Natural Advantages
There can be differences in natural resources and the geographical conditions of different countries.
Availability of certain natural resources, geographical and climatic conditions etc give natural
advantages to some countries. These advantages lead to territorial division of labour and
localization of industries. These advantages cannot be transferred from one country to another.
Why international trade?
Since the publication of Wealth of Nations, economists have sought answers to a number of
questions concerning international trade theory such as why do countries trade with one another?
.For more than two hundred years economist have tried to convince the public and policy makers
that countries trade for the same reason individuals trade. Countries like individuals are not equally
capable of producing every good or service they want and need to consume. All countries like
individuals can benefit if each country specialises in producing those goods it can produce best and
satisfy their other wants and needs by trading with other countries. Specialization and trade makes
total world output of goods and services larger than it would be without trade. In international trade
all countries gain and are better-off than the alternative, that is buying and selling goods restricted
to their domestic markets. In the words of Horn and Gomez international trade benefit to all
participating nations and injury to none
Historically, trade has been an important mainspring of growth of countries at different
stages of development. In the 19th century the countries that were industrializing has access to food
and raw materials in the primary producing countries which allowed the more developed countries
to reap the gains from international specialization. In turn, the developing countries were assisted in
their development by the demand for raw materials. But today most trade takes place in industrial
commodities in which many poor countries find it difficult to compete and demand for developing
countrys traditional export is slack relative to demand for industrial goods. Except for a very few
commodity booms, trade does not seem to work to the equal advantage of both sets of countries.
The problem facing developing countries is not so much whether to trade but in what commodities
to trade and to ensure that the terms on which they trade with developed countries are favorable.
During the 19th century, most of the worlds industrial production was concentrated in
England. Large increase in industrial production and population in resource-poor England led to
rapidly rising demand for food and raw material exports of the regions of recent settlements such
as the United States, Canada, Australia, New Zealand etc. The stimulus provided by their rapidly
expanding exports then spread to rest of the economy of these new settled lands. According to R
Nurkse, the export sector was the leading sector that propelled these economies into rapid growth
and development. That is, international trade functioned as an engine of growth for these
countries during the 19th century.
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The regions of recent settlement were able to satisfy Englands growing demand for food
and raw materials because of several circumstances. Firstly, these countries were richly endowed
with natural resources such as fertile land, forests and mineral deposits. Secondly, workers with
various skills moved in large numbers from overpopulated Europe to these mostly empty lands, and
so did huge amounts of capital. The huge inflows of capital and workers made possible the
construction of roads, rails, canals and other facilities that allowed the opening up of new supply
sources of food and raw materials. Finally, great improvement on sea transportation enabled these
new lands to satisfy rising demand for food and raw materials more cheaply than traditional sources
supply in Europe and elsewhere. But there are economists such as Kravis who believe that the rapid
growth of the regions of recent settlements during the 19th century was primarily due to very
favorable internal conditions, with trade playing only an important supportive role.
It is generally agreed that todays developing countries can relay much less on trade for their
growth and development. This is due to less favorable demand and supply conditions. On the
demand side, it is pointed out that the demand for food and raw materials is growing much less
rapidly today than the case for the regions of recent settlement during the 19th century. Main
reasons are
(1) The income elasticity of demand in developed countries for many of the food and raw
materials exports of developing countries is less than one, so that as income rises in developed
countries, their demand for exports of developing countries increases proportionately less than
the increase in income.
(2) The development of synthetic substitutes has reduced the demand for natural raw materials
(3) Technological advances have reduced the raw material content of many products
(4) The output of services (with lower raw material requirement than commodities) has grown
faster in developed countries
(5) Developed countries have imposed trade restrictions on many exports of developing
countries like wheat, vegetables, sugar, oils and other products
On the supply side, it is pointed out that most of todays developing countries are much less
endowed with natural resources than were the regions of recent settlements during the 19th century.
Again, most of the developing countries are overpopulated, so that most of any increase in their
output of food and raw materials is absorbed domestically rather than exported. Furthermore, the
international flow of capital to most developing courtiers today is relatively much less than it was
for the regions of recent settlements during the 19th century and todays developing countries seem
also to face an outflow of skilled labour rather than an inflow. Finally, it is said that until recently,
developing countries have somewhat neglected their agriculture in favour of more rapid
industrialization, thereby hampering their export and development prospects.
Thus, even though international trade, in general, cannot to be an engine of growth today,
there are still ways in which it can contribute to the economic growth of todays developing
countries. Haberler has pointed out the following important beneficial effects that the international
trade can have on economic development:
1. Trade can lead to the full utilization of otherwise unemployed domestic resources. That is
through trade, a developing country can move from an inefficient production point inside its
production frontier to a point on its production frontier with trade. For such a country, trade
would represent a vent for surplus or an outlet for its potential surplus of agricultural
commodities and raw materials.
2. By expanding size of the market, trade make possible division of labour and economies of
scale
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3. International trade is the vehicle for the transmission of new ideas, new technology and new
managerial and other skills.
4. Trade also stimulates and facilitates the international flow of capital from developed to the
developing countries
5. In several large developing countries, the importation of new manufactured products has
stimulated domestic demand until efficient domestic production of these goods become
feasible and
6. International trade is an excellent antimonopoly weapon because it stimulates greater
efficiency by domestic producers to meet foreign competition
Balance of Trade
According to James E Meade balance of trade is the difference between the value of goods
and services sold to foreigners by the residents and firms of the home country and the value of
goods and services purchased by them from foreigners. In other words, the difference between the
value of goods and services exported and imported by a country is the measure of balance of trade.
If the two sums, that is, the value of exports of goods and services and the value of imports
of goods and services are exactly equal to each other, we say that there is balance of trade
equilibrium. If the former exceeds the latter, we say that there is balance of trade surplus and if the
latter exceeds the former we describe the situation as balance of trade deficit. Balance of trade
surplus is regarded as favorable and balance of trade deficit is regarded as unfavorable. In the
familiar macroeconomic equation Y = C+I+G+(X-M), the expression for net exports X-M denotes
balance of trade in Meades sense.
However, some other writers define balance of trade as the difference between the value of
merchandise (or goods) export and the value of merchandise imports, making it the same as goods
balance or balance of merchandise trade. As per this definition, balance of trade takes into account
only visible exports and imports. The visible exports and imports are those which are actually
recorded at the ports.
Balance of Payments
The balance of payment is a statistical record of all the economic transactions of the
residents of a country with the residents of rest of the world during a particular period of time,
usually a year. An international economic transaction refers to the exchange of a good, service or
asset, for which payment is required between the residents of one country with the residents of
other countries. However, gifts and certain other transfers for which no payment is required are also
included in a countrys balance of payments. Thus, it is a flow of goods, services, gifts and assets
between the residents of one country and residents of other countries during a year.
The balance of payments is one of the important statistical statements of a country. It
reveals how many goods and services the country has been exporting and importing and whether
the country has been borrowing from or lending money to the rest of the world. In addition,
whether or not the central bank has added or reduced its foreign exchange reserves is reported in
the balance of payment statistics. The knowledge about balance of payments will inform the
government about the international position of the country and help it its formulation of monetary,
fiscal and trade policies.
An important point about a countrys balance of payments statistics is that, in accounting
sense, they are always balance. This is because they are based upon the principle of double-entry
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book keeping. This means that each international transaction is recorded twice, once as a credit item
and once as a debit item of equal amount. The reason for this is that, in general, every transaction
has two sides. Credit transactions are those that involve the receipts of payments from foreigners
and debit transactions are those that involve the making of payments to foreigners. Thus, each
receipts of currency from residents of rest of the world is recorded as a credit item (a plus in the
accounts) while each payment to the residents of the rest of the world is recorded as a debit item (a
minus in the accounts).
Traditionally, the balance of payment statistics comprises two main sections, namely the
current account and the capital account. The essential difference between the two is that the current
account items refer to the income flows, while the capital account records changes in assets and
liabilities.
Current Account
The current account records exports and imports of goods and services and unilateral
transfers. The current account balance is the sum of visible balance and invisible balance. Trade
balance is referred to as the visible balance because it represents the difference between receipts for
exports of goods and expenditure on import of goods which can be visibly seen crossing national
frontiers. The receipts of exports are recorded as credit in the balance of payments while the
payments for the imports are recorded as debit. The invisible balance shows the difference between
the revenue received for the export and payment made for imports of services such as shipping,
tourism, insurance and banking. In addition, receipts and payments of interests, dividends and
profits are recorded as the invisible items. It should be noted that unilateral transfers are included in
the invisible balance. Unilateral transfers are payments or receipts for which there is no
corresponding quid-pro-quo. Examples of such transactions are migrant workers remittances to
their family back home, payment of pensions to foreign residents, gifts which domestic residents
receive from foreign residents and foreign aid. The net value of the balances of visible and invisible
trade and unilateral transfers defines the balance on current account.
Capital Account
The capital account records all international transactions that involve a resident of the
country concerned changing either his asset or his liabilities to residents of another country. Thus, it
is concerned with the movement of financial capital into and out of the country. Capital comes into
the country by borrowing, sales of overseas asset and investment in the country by foreigners.
These items are referred to as capital inflows and are recorded as credit items in the balance of
payments. In effect, capital inflows are decrease in the countrys holdings of foreign assets or
increase in the liabilities to foreigners. On the other hand, capital leaves the country due to lending,
buying of overseas assets, and purchase of domestic assets owned by foreign residents as these
involves payment to foreigners. These items represent capital outflows and are recorded as debits
in the capital accounts. In effect, capital outflows are an increase are an increase in the countrys
holdings of foreign assets or decrease in the liabilities to foreigners. The summation of the capital
inflows and outflows as recorded in the capital account gives the capital account balance.
Remaining Items in the balance of payments
The balance of payment accounts are completed by the entry of other minor items which do
not fall comfortably into one of the standard categories. These are errors and omissions (statistical
discrepancy) and changes in the official reserves and official liabilities. Errors and omissions or the
balancing item reflect the difficulties involved in recording accurately all the transaction between
domestic and foreign residents. Many of the reports statistics are based on sampling estimates so
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48
that some error is unavoidable. Problem may arise when one or other parts of a transaction take
more than one year. Dishonesty and desire to avoid taxes may also create problem of
underreporting. Finally, there are changes in the reserves of the country whose balance of payments
are considering and changes in that part of the reserves of other countries that are held in the
country concerned. Reserves are held in three forms, namely, in foreign currency, as gold and as
Special Drawing Rights (SDR).
Foreign Exchange Rate
Simply, foreign exchange rate is the price of one currency in terms of other. Since there is an
essential symmetry between the two currencies, the exchange rate may be defined in one of the two
ways
Cost in domestic currency of purchasing one unit of foreign currency. That is, domestic
currency units per unit of foreign currency.
Amount of foreign currency that foreign exchange rate may be bought for one unit of
domestic currency. That is foreign currency units per unit of domestic currency.
Obviously, it can be noted that the second method is the reciprocal of the first method. While it is
not important which method of expressing the exchange rate is employed, it is necessary to be
careful when talking about a rise of fall in the exchange rate because the meaning will be different
depending upon which definition is used. In the economic literature, the practice is to use the first
definition.
In general, the foreign exchange rate is determined by the interaction of the market demand
curve for and market supply curve of the foreign currency. That is, the exchange rate is determined
just like the price of any commodity. On the demand side, one of the principal reasons people
desire foreign currencies is to purchase goods and services from another country or to send a gift or
investment income payment abroad. A second reason is to purchase financial assets in a particular
country. The third reason people demand foreign currency is to avoid losses or make profits that
would arise through changes in the foreign exchange rate. On the other hand, the total supply of the
foreign exchange in a country consists of three sources. Firstly, it results from foreigners
purchasing home exports of goods and services or making unilateral transfers to the home country.
A second source arises from foreign investment in the home country. Finally, foreigners purchase
of home currency to avoid losses or to make profits from changes in the exchange rate is the third
source of supply.
Since the foreign exchange market brings together those people that wish to buy a currency
(which represents the demand) with those that wish to sell the currency (which represents the
supply), then the exchange rate can easily be determined by the intersection of the demand and
supply of the currency.
Devaluation and Revaluation
The terms devaluation and revaluation refers to a legal redefinition of a currencys par value
under a system of fixed exchange rates. Devaluation means the reduction in the external value of
the countrys currency unit, undertaken by government fiat or official proclamation. It means
reduction of the official rate at which one currency is exchanged for another. It is the deliberate
action which reduces the value of a countrys currency in terms of another (exchange rate).
The government of the country may resort to the devaluation of its currency to eliminate or to
reduce the deficits in the balance of payments. Devaluation encourages exports by cheapening them
in foreign countries. On the contrary, devaluation has the effect of discouraging imports by making
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49
them more expensive within the country. For example, if the currency of a country is devalued,
then its purchasing power in foreign countries automatically goes down. In other words, imported
goods become more expensive than before. Hence, devaluation discourages imports into the
country. At the same time, the purchasing power of the devalued currency increases in terms of
foreign currencies as a consequence of devaluation. As a result, the foreigners start importing more
goods from the country. This gives an incentive to the exporters of the country. Hence as a result of
devaluation exports will increase and imports will fall.
Revaluation is the opposite of devaluation. Revaluation means an increase in the external
value of the countrys currency unit, undertaken by government or central monetary authority. It
means deliberate increase of the official rate at which one currency is exchanged for another. It is
an upward revision of the gold parity of the currency. When a currency is undervalued, the prices
and costs in the country are low in relation to world price. The country has a strong competitive
advantage in the world market for its exports, while its own demand for imports is comparatively
low. The purpose of currency revaluation is to cause the home currencys exchange value to
appreciate thus contracting the balance of payment surplus. The balance of payment surplus of the
country grows, which makes the currency more undervalued. Therefore, the country decides to
revalue its currency.
But changes in this direction are rare. A country with favorable balance of payment is under
no pressure to take any corrective action. Examples of revaluation can be found in former West
Germany and Holland in 1961. Their currencies had become undervalued at their existing parities
and monetary authorities revalued them by about five per cent.
Depreciation and Appreciation

A certain change in the exchange rates is always possible and also a matter of everyday
importance as is the case with any commodity market. The price does not remain the same on any
two given days or period due to changes in economic or political conditions or seasonal variations
in demand and supply and demand or the effects of factors such as rate of interest, investment
climate in the country etc. like the price of any commodity exchange rate is also subject to
variation. The terms depreciation and appreciation refers to the actual impact on the market
exchange rate caused by redefinition of a par value or changes in exchange rate stemming from
changes in the supply of or demand for foreign exchange. Thus, Changes in the external value of
currency are known as depreciation or appreciation of currency.
By exchange depreciation is meant a decline in the rate of exchange of the countrys
currency in terms of another. It is a decline in the external value of the currency. Like devaluation,
exchange depreciation of a country will tend to cheapen its domestic goods for the foreigners so
that exports will be boosted up. At the same time, its imports will be costlier so that they tend to
decline. Thus, imports will be checked and exports will be stimulated by depreciation. In other
words, depreciation will ordinarily improve countrys balance of trade and payments by reducing
foreign exchange payments for imports and increasing the foreign exchange receipts from exports.
A currency is stated to have appreciated of become costly when there is a rise in the rate of
exchange. It refers to a rise in the external value of domestic currency when the exchange market is
moving whereby giving a lesser amount of domestic currency against a given amount of foreign
currency. If demand for foreign currencies increases they will appreciate against home currency.
Similarly, a decreased supply of foreign currencies, demand remaining the same will also cause
appreciation of currencies. Appreciation like revaluation refers to the rise in the value of currency
relative to another currency.
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Reference
1. Dominick Salvatore - International Economics., Seventh Edition

2. Charles Sawyer and Richard Sprinkle International Economics.
3. Thirlwall A P Growth and Development: with special reference to
developing countries
4. Mannur H G- International Economics., Second Edition
5. Seth M L Money, Banking, International Trade and Public Finance.
6. Andley K K and Matoo V J - Foreign Exchange Principles and Practice
7. Mithani D M International Economics.
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Module V
INDIA AS A DEVELOPING ECONOMY
Major Issues: Poverty, Unemployment and Inequality-Causes and Remedies
Meaning of a Developing Economy
Developing country is a term generally used to describe a nation with a low level of
material well-being. They are mostly middle income countries and least-developed countries in
Asia (excluding Japan); Central and Eastern Europe; the Middle East and Latin America and
Africa. These economies have standards of living lower than developed economies and economies
in transition. Many have deep and extensive poverty. Developing countries are usually importers,
rather than developers, of innovations in science and technology. They also tend to be more
vulnerable to economic shocks.
There are no official definitions of "developed" or "developing" countries in the UN system.
Developing countries are in general, countries which have not achieved a significant degree of
industrialization relative to their populations, and which have, in most cases a medium to low
standard of living.
The World Banks main criterion for classifying economies is the gross national income
(GNI) per capita. Based on its GNI per capita, every economy is classified as low income, middle
income (subdivided into lower middle and upper middle), or high income. These are set each year
on July 1. Economies were divided according to 2010 GNI per capita using the following ranges of
income:
Low income
Lower middle income Upper middle income High income
-
$1,005 or less.
$1,006 - $3,975.
$3,976 - $12,275.
$12,276 or more
The World Bank classifies all low- and middle-income countries as developing but notes,
"The use of the term is convenient; it is not intended to imply that all economies in the group are
experiencing similar development or that other economies have reached a preferred or final stage of
development. Classification by income does not necessarily reflect development status."
India as a Developing Economy
Since the per capita income is the usual measure of the standard of living, the definition for
developing economy can be stated in terms of per capita income: A developing economy is an
economy where per capita income is rising. On this basis it is sure that after more than 61 years of
planning Indian economy is stood as a developing economy. In almost all fields there are marked
and drastic improvements which can be better understood by the explanation of the following
features:
1. Increase in National income:
National Income is considered as an indicator of a nations growth. In 1950-51 Indias
national Income is Rs.2,04,924 crore at 1999-00 base year price and it rose to Rs. 52,22,027 crore
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at 2004-05 base year price in 2010-11.The growth rate of Indias National Income is 6.9% in 201112 even the economy is in the wave of global financial crisis.
2. Increase in Per capita income
Per capita income is considers as the best index of standard of living of people in a country.
The average annual growth rate of per capita income is only 2% in 1950-51 it was Rs. 5,708 at
1999-00 base year price. But in 2010-11 the growth rate is 6.7% and it is Rs.36, 003 at 2004-2005
base year price. It is true that Indias Per capita growth rate is low, because of excessive growth rate
of population.
3. Improvement in Saving and Investment:
As National Income increases the saving and investment of the economy have also be
stepped up. The rate of Investment as proportion of GDP was only 10% in 1950-51 and it rose to
36.5%in 2009-10.At the same time the rate of saving as a proportion of GDP was 10.2% and 32.2%
in the respective years on current market prices. As a result of these there will be a marked
improvement in capital formation of the country. The rate of capital formation in the last five
decades is very high.
4. Change in Agriculture sector
After independence Indian agriculture sector witnessed a lot of changes. In 1950-51 around
69.7% of the people depend on agriculture. But according to the estimates in 2010-11 still
agriculture is the single largest private sector occupation and 52% of people engaged in agriculture
activities. The share of agriculture to GDP in 1950-51 was 55.4% while it declined to 13.9% in
2011-12.These show that the importance of agriculture sector is coming down. But the country
achieved self sufficiency in food grains production. There should be marked changes in cropping
pattern and Green revolution takes place in the mid of 1960s.
5. Change in Industrial sector
At the time of independence Indias industrial structure was underdeveloped and backward.
As a result basic and capital goods industries are given more priority in the early years of industrial
development of the country. The growth rate in industrial sector is fluctuating. The share of
industrial sector to GDP increased from 13.3% to 27% during 1950-51 and 2011-12respectively.
Since independence industrial production marked a good improvement and a variety of industrial
production structure is formed. The share of people participated in this sector increased from 12%
to 28% during 1950-51to 2010-11.Major industries in India are; Textile, Food Processing, Cement,
Paper and News Print industry, Leather, Steel, Auto mobile, Gems and Jewellery, Oil and Gas
industry, Sugar industry, Civil aviation industry etc.
6. Change in tertiary sector
After the starting of planning, the highest rate of growth happened in tertiary sector. In
1950-51 it contributes only 28.5%, but it increased to 59% in 2011-12.Now the service sector is
considered as Indias work horse. The tertiary sector comprises; Trade, hotels, Transport and
Communication, Financial and Insurance services, Real Estate, IT, Community, Social and
Personal Services etc.
7. Change in foreign trade
Even though Indias share in world trade is around 1%, it is highly diversified. Before
independence foreign trade means only import. But after independence India started export which
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is favorable to Indian economy and adopt import substitution policy. Now Indias trade policy is
export promotion.
8. Social and institutional changes
The spread of education, urbanization, political democracy, transport system, new
technologies etc loosen the underling caste system and other social and institutional stringencies.
This also shows Indias wake up for a bright future.
9. Urbanization
Economic growth is associated with urbanization. The rate of urbanization clearly shows
Indias economic development. In 1951the rate of urbanization is only 17.3% but it increased to
27.8% in 2001 census.
10. Expansion in science and technology
India is Eighth among top 15 countries in the contribution of their scientists. India has over
1300 Research Institutes in different areas like atomic energy, space, defense, forestry, agriculture,
electronics, health etc
11. Improvement in social overheads or infra-structure
Economic development is being assisted by the development in the means of transport and
communication, banking system, education etc. A good deal of improvement has been made by
India in this field. The Indian road net work system is now one of the largest in the world. The
transport system in India has grown both in terms of capacity and modernization. The growth of
commercial banks and other financial institutions are spectacular which helps to solve present
financial crisis.
12. Crisis Management
As far as Indian economy is concerned weather and foreign exchange crisis are the main
problems. But now these issues are managed to a greater extent. Even today most of the developed
nations are failed to solve the recent Global Financial crisis India managed it successfully with less
burden.
Indian economy, through economically backward it remained no longer in such a
situation. More than six decades of development experiences created dynamism in countrys
economy and one can now hopefully say that it would sustain development in the future.
Major Issues: Poverty, Unemployment and Inequality
Even though India is one of the major developing economies in the world, it faces certain
crucial issues in its developmental path. They are Poverty, Unemployment and Inequality. Only by
solving these issues and looking from different angles these are to be removed.
POVERTY
The concept of Poverty
Poverty is a plague as it is prevalent in almost all countries in the world and it has many
faces and dimensions. Therefore it is difficult to define the concept poverty in precise. Poverty is
always defined according to the conventions of society in which it occursi. But in the recent years,
the concept of poverty has been refined and made more comprehensive. The New World requires
better and more scientific ways to assess the concept of poverty in the society. Now its
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multidimensional aspect is recognized and uses a multidisciplinary approach to assess poverty.

Poverty is not simply a social phenomenon but also include economic, political, historical,
geographical and cultural aspects.
Various attempts have been made by societies to define poverty. In human terms poverty
means little to eat and wear, and in economic terms the poverty means the inability to attain a
minimum standard of livingii. It is natural to view poverty as the failure to meet the basic
requirements to maintain a minimum standard of living. This minimum standard of living may vary
from society to society. While biological requirement and nutritional norms provide the most
elementary concept of a minimum standard of living, modern understanding of poverty requires
other factors such as school enrolment, infant mortality, immunization, malnutrition, women
empowerment, overall standard of living, asset holding etc.
Poverty can be defined as a social phenomenon in which a section of the society is unable to
fulfill even its basic necessities of life. In India the generally accepted definition of poverty
emphasizes minimum level of living rather than a reasonable level of living. In economics there are
two important classification of poverty; Absolute Poverty and Relative Poverty.
Absolute Poverty and Relative Poverty
Absolute Poverty is the sheer deprivation or non-fulfillment of bare minimum needs of
existence- of food, shelter, health or education. It is based on the absolute needs of the people and
people are defined as poor when some absolute needs are not sufficiently satisfied. Hence
according to this type poverty is treated as deprivation. Most of the developing countries are
experiencing such type. An absolute poverty line is based on the cost of minimum consumption
basket based on the food necessary for a recommended calorie intake.
Relative Poverty is related with high income countries, where people are poor because
they cannot maintain or equivalent to others in the society. There should be differences in living
standards among the people. It reflects economic distress, despair and dissension that stem from
serious inequalities in income and wealth .The relative poverty line varies with the level of average
income. Relative poverty is based on inequality and differences in standard of living. According to
the relative concept of poverty, people are poor because
From this classification we know that poverty is not inequality. Poverty is only one of the
evil consequences of inequality. Whereas poverty is concerned with the absolute standard of living
of a part of the society i.e.; the poor, inequality refers to relative living standards across the whole
society.
Measurement of Poverty
Once we understand poverty, it is essential to measure it with its various dimensions. The
measurement of poverty is needed to plan policies to check this global phenomenon. Many factors
were listed, some of them are life expectancy, mortality, maternality, safe drinking water, pure air,
women empowerment, energy consumption, literacy, asset holding, sanitation, primary health
facilities, clean surroundings etc. most of these are derived with income. Therefore consumption
data can be used to measure poverty.
Poverty Line
Poverty line is the most widely used measure for assessing poverty. Under this method,
people are counted as poor when their measured standard of living is below a minimum acceptable
level-known as Poverty Line. The poverty line in India is defined as the level of private
consumption expenditure, which ensures a food basket that would supply the required amount of
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calories. Actually in India the Planning Commission estimates the poverty on the basis of Calorie
intake. By considering age, sex, activity etc., Indian Council of Medical Research (ICMR) proposes
2400 calorie intake for the rural person per day and 2100 calorie per person per day in urban. The
calorie requirements in the rural areas is higher because people engaged in heavy work more in
rural areas than in urban areas.
P O V ER TY E S TI M A T I O N
IN THE
I N D EP E N D EN T I N D I A
In independent India, the first official definition of poverty was given in 1962. This pegged
the rural poverty line at a Monthly Family Income of Rs.100 and urban one at Rs.125.
Dandekar and Rath (1971)iii estimated poverty in terms of consumer expenditure needed a
diet adequate at least inform of calories, they adopted 2250 calories per person per day as the norm
for their study. According to them, the consumer expenditure necessary to obtain the minimum
nutritional standard was an amount of Rs. 14.16 per capita per month at 1960-61 prices for rural
India. Based on this norm, 30.92 percent of the rural population lies below the poverty line in 196162, in India.
Bhrdhan (1974)iv adopted the poverty line of Rs 15 at 1960-61 all India rural prices as the
minimum level of living, and also estimate poverty for 1967-68 period, taking Rs. 29.90 as
minimum requirement and find that in 1960-61 about 38% of rural Indians and in 1967 68, 53
percent of rural Indians are below poverty line.
Vaidyanathan (1974)v adopted Rs. 21.44 as rural poverty in India at 1960-61.prices. To his
estimate the rural poverty in India is 15.65percent.
Bhatty (1974) measured the incidence of poverty for the year 1968-69. He selected poverty
lines in terms of Percapita income instead of Percapita consumer expenditure. He made use of the
income distribution data collected by National Council of Applied Economic Research (NCAER)
for 1968-69. In order to overcome arbitrariness in using a single poverty line, Bhatty made use of
five poverty lines namely Rs. 180, Rs 240 Rs. 300, Rs. 360 and Rs. 420. percapita per annum at
1968-69 prices or its percapita monthly equivalent Rs. 15, Rs. 20, Rs. 25, Rs. 30 and Rs. 35. His
results show that the poverty levels vary corresponding to different income levels. The
corresponding rural poverty is 21.95 percent, 39.55 percent, 55.87percent, 69.70 percent, and 78.70
percent corresponding to monthly percapita income.
Ahluwalias (1978)vi estimates shows a fluctuating trend in the incidence of poverty over
time. Rural poverty in India declined from 53.4 percent in 1957-58 to 42 percent in 1960-61. Then
it started rising from 42.3 percent to 57.9 percent during 1961-62 to 1967-68 and then declined to
47.6 percent in 1973-74.
Mahendra Dev (1988)vii estimated the poverty lines for the reference years by making use of
the estimates derived by Bardhan (1974) for the year (1960-61). He adjusted the poverty lines by
the Consumer Price Index of Agricultural Labourers (CPIAL) for the reference years. He found that
the percentage of rural Indian population living below the poverty line was continuously declining
from 46.4 percent in 1964-65 to 44.78 percent in 1972-73 and from 40.45 percent in 1977-78 to
33.20 percent in 1983-84.
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The Planning Commission (1981 and 1985) measured the extent of rural poverty for 4 years
taking Rs 77 (at 1979-80 prices) percapita per month as the poverty line. In 1977-78, about 51.2
percent of rural population was poor as against 54.1 percent in 1972-73. It comes down to 40.4
percent in 1983-84. The Planning Commission calculates the poverty ratio on the basis of
quinquennial Consumer Expenditure Surveys conducted by NSSO. The Planning Commissions
estimates of the poverty ratio for 1987-88 indicated further decline in the incidence of poverty to
33.4 percent in 1987-88.
Criticising the Planning Commissions earlier estimates, Minhas, Jain and Tendulkar (1991)
measured the incidence of poverty by using correct procedure for three years 1970-71, 1983 and
1987-88. They converted the poverty norms to prices prevailing in the year for which NSS
consumer expenditure data are available. They worked out State Specific Cost of Living Indices.
Then, applying these indices, they calculated State Specific Poverty norms for 1970-71, 1983 and
1987-88. The poverty norms for rural India were Rs. 33.01, Rs 93.16 and Rs. 122.63 for the years
considered respectively. Corresponding to these poverty lines, the percentage of population below
poverty lines were 57.3, 49.02 and 44.88 for the corresponding years.
Rohini Nayyar (1991)viii measured the poverty line for 13 years period from 1960-61 to
1983-84 and estimated the incidence of rural poverty. Her calculations are based on actual
consumption data by broad category. She made use of the calorie norm of 2200 to arrive at the
poverty line. To her estimates rural poverty fluctuates over the years.
Kakwani and Subba Rao (1992)ix attempted a study on rural poverty for the period 1973-86.
They used relative price levels in the rural areas to arrive at the poverty lines. Using the price
relatives and consumer price indices for agricultural labourers they worked out the State Specific
Poverty Lines at the current prices for the years 1973-74, 1977-78, 1983 and 1986 87. According
to their estimates the rural poverty continuously declined.
Tendulkar and Jain (1995)x estimated the incidence of poverty for 12 years from 1970-71 to
1992. They estimated the poverty lines for various years taking the Planning Commissions all
India poverty line of monthly percapita total expenditure of Rs. 49.09 at 1973-74 prices. Urban
Poverty profile of the different authors are given in the Appendix,
Even though the earlier estimates of Planning Commission is based on this calorie norms
which is criticised because of methodological defects and it cannot consider the other basic items
like health, education etc. Therefore Planning Commission appointed an Expert Committee, under
Suresh Tendulkar in 2008 and reported its recommendations in November 2009. The committee
suggested a formula based on Consumption Expenditure for identifying BPL families. His
recommendations are more scientific and there is some novelty in the measurement because
Tendulkar committee uses a broad definition of poverty including expenditure for food, education,
health etc., and uses consumer expenditure taking Mixed Recall Period as against Uniform Recall
Period. According the committee the monthly consumption expenditure to measure poverty line is
Rs. 446.68 per person per month in rural areas and Rs. 578.8 per person per month in urban areas.
To their report Indias poverty is 37.2 percent (2004-05) as against the Planning Commissions
estimates of 27.5 percent in 2004-05 calculated on the basis of Dandekar- Rath formula based on
calorie intake.
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Table 4.1 Poverty Rates in Various NSSO Rounds

Year
1973-74
Round
27
Poverty Rate (%)

54.88
1977-78
32
51.32
1983
38
44.48
1987-88
43
38.86
1993-94
50
35.97
1999-00
55
26.10
2004-05
61
27.50
Source: Planning Commission, March, 2011 and NSSO Data
Latest poverty estimates of Planning Commission are seen from the Table 4.1 Planning
Commission estimates Indias poverty both on the basis of Uniform Recall Periodxi and Mixed Recall
Periodxii. It consider Cost of Living as the basis of poverty.
Table 4.2 Poverty in India, New Estimates

Uniform Recall Period
Years
93-94
04-05
Rural
37.3
28.3
Urban
32.4
25.7
All India
36.0
27.5
Mixed Recall Period

99-00
04-05
27.1
21.8
23.6
21.7
26.1
21.8
Source: Economic Surveyxiii

In opposition to Tendulkar committee, Dr. N.C. Saxena committee was appointed by Rural
Development Ministry in August 2008. This committee argued for a New BPL criterion, which
suggests automatic inclusion of socially excluded groups and automatically exclusion of those who
are relatively well-off. The committee recommended a new methodology of Score Based Ranking
and put forwarded that Rs. 700 per month per rural person and Rs. 1000 per month per urban
person to maintain 2400 and 2100 calorie intake for a day. The committee estimates that Indias
poverty is 49.1 percent in 2004-05.
According to Arjun Sengupta committee appointed by National Commission for Enterprises
in the Unorganised Sector (NCEUS) Indias poverty is 77 percent. The Committee uses the same
data of NSSO and takes the norm of Rs. 20 per day per person to measure the poverty line.
Based on World Banks estimates (2005), 41.6 percent of Indians fall below the
International Poverty Line this of $ 1.25 per day (PPP)xiv. In nominal terms Rs. 21.69 per day in
urban area and Rs. 14.3/day in the rural area. They estimate 456 million Indians lived in poverty.
World Banks new International Poverty Line is based on $ 2 per day.
Abbijith Sen found out that if we took calorie norm even then the poverty is much higher
i.e.; in urban 80 percent and in rural 64 percent of the Indians are lived below poverty line. This
estimate is also very higher than official estimate.
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Table 4.3: Poverty line, 1973-74 to 2004-05
Year
1973-74
1977-78
1983
1987-88
1993-94
1999-2000
2004-2005
Rs per capita per month, current prices

Rural
Urban
49.63
56.84
89.5
115.2
205.84
327.56
356.30
56.76
70.33
115.65
162.16
281.35
454.11
538.60
Sources: Planning Commission

Causes of Poverty in India
Poverty is not caused by any single reason. It is the outcome of the interaction of several
factors; economic, non- economic, political, social, cultural, geographical etc.
1. Underdevelopment
The most important cause for poverty is the underdevelopment of the economy. Due to
underdevelopment a large proportion of the people have go without even the basic necessities of
life. With the low national income and percapita income the country cannot increase its aggregate
consumption and investment. Hence the standard of living is also so low among the people. Even
though there is much improvement in the development of the country after independence still we
want to go a lot.
2. Inequality
The second important cause of poverty in India is inequality in income and wealth. Even the
New Economic policies could not reduce the depth of inequality in India. Instead there is increase
in inequality among the people.
3. Inadequate growth rate
In the early years of planning the growth rate of Indian economy is not high enough to check
the problem of poverty. Even though economy railed in a high growth path in the mid of 2000
onwards the benefits are not trickle down to the poor sections of the society. Still the gap between
rich and poor is increasing.
4. Large population
Even though the growth rate of population is coming down still the size of it is very large.
Therefore it is not capable to implement the poverty alleviation programmes successfully.
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5. Unemployment
Another major cause for the growth of poverty is unemployment. The problem of
unemployment is still so acute in the economy. Thus increasing unemployment and
underemployment accentuate poverty.
6. Poor performance of agriculture sector
Still Indian agriculture is carried on largely with primitive techniques. High dependency on
rain, small and scattered holdings, lack of inputs, exploitative land tenure system, competition from
foreign markets, lack of storage and marketing facilities etc. are responsive to the poor performance
of agriculture sector even after the Green Revolution.
7. Poor performance of industrial sector
In spite of much improvement in line with development of modern industries still performance is
not up to the mark. Lack of dynamic entrepreneurs, lack of competitiveness, lack of skilled and
trained workers, inadequate finance, irregular supply of power and raw materials, poor transport
and methods of production etc. leads to slow industrialization of the country.
8. Inflation
Rise in price is an alarming problem to the economy. It is the poor who suffered a lot due to
inflation. When prices are high the purchasing power of money falls and leads to impoverishment
of the poor sections of the country.
9. Social factors
It is agreed that the poverty in India is the outcome of social factors. It includes caste system,
joint family system, law of inheritance, lack of initiative and entrepreneurship etc. India is also poor
in social overheads like education, health, medical facilities, illiteracy etc. The attitudes and
aspirations of the people are not conducive to economic growth and development.
10. Political factors
Even after India escaped from the yoke of British exploitative administration still the political
set up is not that much efficient to solve the problem of poverty. It is true that various programmes
are initiated under five year plans. The Fifth Five Year Plan raised the slogan Garibi Hatao but
still the poverty alleviation is a nightmare to Indian policy makers.
Thus the poverty in India is happened due to various reasons. Regional disparities,
lack of investment, lack of proper implementation of public distributive system, lack of vocational
training and education, migration of rural youth to cities etc. have also contributed to poverty in
India.
Remedial Measures
Poverty is a tragedy not only for the individuals but also for the economy at large. As a
result of this the remedial measures to poverty is emphasized. From the experiences of the economy
we can suggest the following to alleviate poverty.
1. Rapid Economic Growth
Fast economic growth is a necessary condition for poverty alleviation programme for the
following reasons: It changes the low income agricultural set up, helps to strengthen the
redistributive activities of the government, made a radical change in production and distribution
process, create more employment opportunities etc. Even there is the possibility of trickledown
effect to economic growth.
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2. Accelerate agricultural growth

No doubt that when there is agricultural growth it reduces the burden of poverty because
majority of poor are lived with agriculture sector. So steps should be taken to solve the problems of
small and marginal farmers.
3. Accelerate industrial growth
The industrial development will create more income and employment opportunities to the
people. Through this the depth of poverty can be reduced.
4. Development of small- scale and cottage industries
In Indian economy small- scale and cottage industries have played a crucial role. This
sector which being labour intensive, create more employment opportunities and help in the removal
of poverty.
5. Land reforms
Land reforms as poverty alleviation measures aimed to break the old feudal socio-economic
structure of land ownership. It aims to eliminate exploitation by providing security of tenure and
regulation of rent. It also aims to bring direct contact between the state and the tiller and give social
economic status of the landless by distributive measures.
6. Better Public Distributive System
Poverty can be reduced if people are ensured with essential commodities at fair prices.
Therefore the government should establish a wide network of fair price shops to provide the
essential commodities.
7. Control Population
Unless the population is not reduced, the additions to wealth production will be eaten up by
the fresh torrent of babies. Therefore the planners should aim at the family planning measures to
bring down the birth in the country.
8. Provision of Common Services and social Security
The government should spend for the provision of free common services like primary
education, medical aid, potable drinking water, housing and other facilities to the people. This will
increase their real consumption and make them feel better off and hence reduce the poverty.
9. Improve the Status of the Women
Gender equality can help to reduce poverty and encourage growth in variety of ways.
Women are provided with direct access to institutional credit, direct membership in cooperatives,
setting up of women organization etc.
10. Good Administrative Setup
Above all the success of any programme primarily depends on the effective working of the
administrative machinery.
A Brief Review of Poverty Alleviation Programmes
Beginning with the launch of Integrated Rural Development Programme (IRDP, 1978) in
the Sixth Five Year Plan, a number of PAPs have been formulated and implemented; many of them
are have been restructured and formulated fresh from time to time . Among these PAPs the more
important have been:
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(a) Training of Rural Youth for Self-Employment (TRYSEM, 1979)

(b) National Rural Employment Programme (NREP, 1980)
(c) Rural Landless Employment Guarantee Programme (RLEGP, 1983)
(d) Million Wells Scheme (MWS, 1988)
(e) Nehru Rozgar Yojana (NRY, 1989).It is for the urban poor people.
(f) Jawahar Rozgar Yojana (JRY, 1989).NREGP and RLEGP are merged in this in 1989.
(g) Development of Women and Children in Rural Areas (DWCRA, 1992)
(h) Employment Assurance Scheme (EAS, 1993)
(i) Prime Minister Rozgar Yojana (PMRY, 1994)
(j) Prime Ministers Integrated Urban Poverty Eradication Programmes (PMIUPEP,1995)
Most of these programmes have been recently redesigned and restructured to improve their
efficacy or impact on the poor. The important PAPs, presently in operation are;
Self Employment Programme:
Swarnjayanthi Gram Swarozgar Yojana (SGSY, 1999). This replaces IRDP, TRYSEM,
DWCRA, SITRA, GKY and MWS and work for rural poor.
Wage Employment Programme:
National Food for Work Programme (NFWP, 2004). It intensifies the generation of
supplementary wage employment.
Sampoorna Grameen Rozgar Yojana (SGRY, 2001). Rural Employment Generation
Programme (REGP, 1995) was merged in SGRY in 2001.SGRY provide additional
wage employment in the rural areas. Now this programme is entirely subsumed in
NREGS with effect from April, 1, 2008.
National Social Assistance Programme (NSAP, 1995). It provides social assistance
to
the rural poor.
Urban Employment and Anti-poverty Programme:

Prime Minister Rozgar Yojana (PMRY, 1993)
Swarna Jayanti Shahari Rozgar Yojana (Golden Jubilee Urban Employment Scheme,
1997). This scheme integrates three PAPs for urban areas, viz.NRY, PMIUPEP and
Urban Basic Services for the poor.
Unemployment
Another major developmental issue in Indian economy is unemployment. Although this
problem had existed in the past; it has become more acute after the independence. The
backwardness and increasing population are mainly responsible for this problem. The socioeconomic consequences of unemployment are very dangerous. It has economic consequences for
the individual as well as the society.
Unemployment means idleness of man power. It is the state in which labour possesses
necessary ability and health to perform a job, but does not get job opportunities. In other words
unemployment is the situation in which individuals are available for work, but are not able to find a
work.
In order to explain the concept unemployment it is better to distinguish between the concepts
like labour force and work force. The labour force refers to the number of persons who are
employed plus the number who are willing to be employed. In India the labour force excludes
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children below the age 15 and old people above the age 60 and mentally or physically handicapped.
The work force includes those who are actually employed in economic activity. If we deduct work
force from labour force we get the number of unemployment.
The unemployment rate means the number of persons unemployed per 1000 persons in the
labour force.
The labour force participation rate and work force participation rate can be expressed in
percentages and as given below.
Labour Force Participation Rate
Work Force Participation Rate
Labour Force / Size of the population

Work force / Size of the population
Types of unemployment
In every economy there is unemployment but the nature and magnitude differ according to
the economic progress. Following are the important types of unemployment.
1. Voluntary unemployment
This is the main type of unemployment referred by the Classical economists. Voluntary
unemployment is happened when people are not ready to work at the prevailing wage rate even if
work is available. It is a type of unemployment by choice.
2. Involuntary Unemployment
Keynes analysed this type of unemployment. It is a situation when people are ready to work at
the prevailing wage rate but could not find job.
3. Natural rate of Unemployment.
This is postulated by the Post-Keynesians. According to them in every economy there exists a
particular percentage of unemployment.
4. Structural unemployment
This type of unemployment is not a temporary phenomenon. It is chronic and is the result of
backwardness and low rate of economic development. The structural changes of an economy are
the main reason for this type of unemployment.
5. Disguised Unemployment
When more people are engaged in a job than actually required, then it is called disguised
unemployment. If a part of labour is withdrawn and the total production remains unchanged
because their marginal product is zero. This is a part of structural unemployment.
6. Under Employment
This exists when people are not fully employment ie; when people are partially employed.
In other words it is a situation in which a person is does not get the type of work he is capable of
doing.
7. Open Unemployment
Mrs. Joan Robinson calls this type of unemployment as Marxian Unemployment. Open
unemployment is a situation where a large labour force does not get work opportunities that may
yield regular income to them. It is just opposite to disguised unemployment. It exists when people
are ready to work but are not working due to non-availability of work
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8. Seasonal unemployment
Generally this type of unemployment is associated with agriculture because the unemployment
rate is changed according to the season.
9. Cyclical Unemployment
It is generally witnessed in developed nations. This type of unemployment is due to business
fluctuation and is known as cyclical unemployment.
10. Technological Unemployment
When the introduction of a new technology causes displacement of workers it is called
technological unemployment.
11. Frictional Unemployment
It is a temporary unemployment which exists when people moved from one occupation to
another. It will take time lag in transferring one work to another. The market imperfections are the
main reason for this.
Measurement of unemployment in India
The National Sample Survey Organization (NSSO), which provides estimates of the rates of
unemployment in India on the basis of its quinquennial surveys, uses three different concepts.
They are Usual Status Unemployment, Current Weekly Status unemployment and Current Daily
Status unemployment.
I. Usual Status Unemployment (US)
Here the reference period is 365 days. The usual status gives an idea about long- term
employment (or chronic and open employment) during the reference year. A person is considered
unemployed on Usual Status basis, if he/she was not working, but was willing to work for the
major part of the reference year (more than 183 days) but did not get work for even 183 days.
Dividing the usual status unemployment by the size of the labour force, we get unemployment rate
by usual status. This measure is more appropriate to those in search of regular employment
(educated and skilled persons) who may not accept casual work.
II. Current Weekly Status Unemployment (CWS)
Here the reference period is one week .A person is considered unemployed by Current
Weekly Status, if he/she had not worked even for one hour during the week, but was seeking or was available
for work. The estimates are made in terms of the average number of persons unemployed per week.
The Current Weekly Status approach gives an idea about temporary unemployment (or chronic plus
temporary unemployment) during the reference week. Current Weekly Status is used by the
agencies like Inter National Organisations (ILO) to estimate employment and unemployment rates
based on weekly reference period for international comparison. Dividing the weekly status
unemployment by the size of the labour force, we get unemployment rate by weekly status.
III. Current Daily Status Unemployment (CDS)
Here the reference period is each of the 7 days, preceding the date of survey in each of these
days. It records the activity status of a person for each day of the 7 days preceding the survey i.e.
persons who did not find work on a day or some days during the survey week. The
Current daily status approach gives a composite or comprehensive measure of unemployment, i.e.,
it is a measure of chronic and temporary unemployment as well as under employment. Dividing the
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current daily status unemployment by the size of the labour force, we get unemployment rate by
usual status.
The current daily status gives the most faithful picture of unemployment situation.
Magnitude of unemployment in India
A comparison between different estimates of unemployment in 2009-10 indicates that the
CDS estimate of unemployment is the highest (Table 4.8). The higher unemployment rates
according to the CDS approach compared to the weekly status and usual status approaches indicate
a high degree of intermittent unemployment. Interestingly, urban unemployment was higher under
both the usual principal and subsidiary status (UPSS) and current weekly status (CWS) but rural
unemployment was higher under the CDS approach. This possibly indicates higher intermittent or
seasonal unemployment in rural than urban areas, something that employment generation schemes
like the MGNREGA need to pay attention to. However, overall unemployment rates were lower in
2009-10 under each approach vis-a-vis 2004-05.
Table 4.8: All-India NSS 66th Round Rural and Urban Unemployment Rates
Si No Estimates Rural
Urban
Total
Total
(2009-10) (2009-10) (2009-10) (2004-15)
1
UPSS
1.6
3.4
2.0
2.3
2
CWS
3.3
4.2
3.6
4.4
3
CDS
6.8
5.8
6.6
8.2
Source: NSSO
Labour force participation rates (LFPR) under all three approaches declined in 2009-10
compared to 2004-05 (Table 4.2). However, the decline in female LFPRs was larger under each
measure in comparison with male LFPRs which either declined marginally (UPSS), remained
constant (CWS), or increased marginally (CDS).
Table 4.2 All-India Employment and Unemployment Indicators (per 1000)
NSS 66th Round (2009-10)
Indicators
Male Female Total Person Male Female Total persons
UPSS
LFPR
557
233
400
559
294
430
Work Participation Rate 546
228
392
547
287
420
Unemployment Rate
20
23
20
22
26
23
CWS
LFPR
550
207
384
550
257
407
198
370
527
244
389
Unemployment Rate
33
43
36
42
50
44
CDS
LFPR
540
179
365
538
215
381
164
341
496
195
350
Unemployment Rate
61
82
66
78
92
82
Source: Key Indicators of Employment and Unemployment in India, 2009-10, NSSO.
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Causes of unemployment in India

Following are the important causes of unemployment in India
1. Rapid population growth
2. Slow growth of the economy
3. Decay of small scale and cottage industries
4. Low rate of capital formation
5. Defective planning
6. Slow growth of agriculture sector
7. Global financial crisis
8. Illiteracy
9. Lack of training facilities
Remedial Measures for unemployment
In order to solve the problem of unemployment there is both government measures and
other measures. It includes the following measures.
1. Rapid growth and expansion of the economy
2. Establishment of more work and training centers
3. Development of small scale and cottage industries
4. Establishment of poverty eradication programmes
5. Liberal institutional finance and self employment programmes
6. Establishment of more employment exchanges
7. Introduction of population control measures
8. Introduction of more public works programmes
9. Reduce illiteracy
10. Stress on vocational and technical education
The Concept of Inequality

While the concept of poverty is rooted in the lack of access or a low level of access to
food, nutrition, shelter, education and other services. Inequality is related to unequal access or
different degrees of access of different individuals or groups of individuals to opportunities,
services and benefits. Inequality is, thus, a more general concept than poverty. It looks at the
relative levels of access of different groups to development opportunities and benefits. The
different levels of access in the concept of inequality also include the low level of access below
which people are considered poor. In fact, the low level of access or the limit (like for example, the
calorie limit for consumption) that may be set for defining poverty will itself include a number of
lower levels of access.
Inequality in India
India is shining for only a select few. The impressive economic growth of our country has
brought smiles on the faces of the rich and the powerful even as the rest suffer in distress and
drudgery. This was revealed by the Human Development Report, 2011 (HDR) released by Planning
Commission. The report highlights the skewed income and wealth distribution in India and the
widening gap between the rich and the poor. According to HDR 2011, inequality in India for the
period 2000-11 in terms of the income Gini coefficient was 36.8. Indias Gini index was more
favourable than those of comparable countries like South Africa (57.8), Brazil (53.9), Thailand
(53.6), Turkey (39.7), China (41.5), Sri Lanka (40.3), Malaysia (46.2), Vietnam (37.6), and even
the USA (40.8), Hong Kong (43.4), Argentina (45.8), Israel (39.2), and Bulgaria (45.3) which are
otherwise ranked very high in human development.
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There are three important types of inequality exist in India, namely inequality in income and
consumption, inequality in assets and regional inequality. These three forms of inequality are
interrelated and mutually reinforcing. The Government of India has been concerned about rising
inequalities and uneven distribution of the benefits of growth. Accordingly, the thrust of the 11th
Five-Year Plan (2007-12) was on inclusive growth. The forthcoming 12th Five-Year Plan is
expected to deepen and sharpen the focus on inequalities.
Inequality in Income and Consumption
Let us look at levels of inequality in income or consumption. Consumer expenditure of
households is a good proxy for income, at least in the lower classes. A study of inequalities in
levels of consumption will by itself be useful in an economy where agriculture, the unorganised
sector, payment of wages in kind and the non-monetised sector still play an important role. Such an
analysis will be able to pinpoint attention on specific areas of concern in the consumption pyramid.
Let us, therefore, turn to levels of inequality in consumption.
The household consumer expenditure surveys of the NSSO provide the levels of
consumption of expenditure in the population by Monthly Percapita Consumer Expenditure
(MPCE) classes. The Average MPCE of the rural people in India is only Rs.1054 and in Urban it is
Rs.1984xv.
A comparison of the share of the bottom 10 per cent (or 20 per cent or 50 per cent) of the
population in total consumption with that of the top 10 per cent (or 20 per cent or 50 per cent) of
the population brings out dramatically the extent of inequality in consumption. The inequality
situation is worse in urban areas than in rural areas. This is so in all States and Union Territories.
Inequality in consumption is declining, albeit slowly, in rural areas according to all measures of
inequality. On the other hand, urban inequality shows no sign of any decline.
Table: 4.3 Share of Household Expenditure by Percentile Groups of Households (in %)
Percentile groups of Households 1989-90 1994 1997 2004-05
Lowest 20 percent
8.8
9.2
8.1
8.1
Second quintile
12.5
13.0 11.0
11.3
Third quintile
16.2
16.8 15.0
14.9
Fourth quintile
21.3
21.7 19.3
20.4
Highest 20 percent
41.3
39.3 46.1
45.3
Highest 10 percent
27.1
25.0 33.5
31.1
Source: Various NSSO Report
Inequality in Assets
Incomes are derived from two main sources. Namely, assets like land, cattle, shares and
labour etc. In India a few own a large chunk of income-earning assets therefore the distribution of
assets is extremely unequal. The top 5 per cent of the households possess 38 per cent of the total
assets and the bottom 60 per cent of households owning a mere 13 per cent. The disparity is more
glaring in the urban areas where 60 per cent of the households at the bottom own just 10 per cent of
the assets. Predictably, asset accumulation is minimal among the agricultural labour households in
rural areas and casual labour households in urban areas. But the asset distribution is even more
unequal in the urban than in the rural areas. At the one extreme there are highly rich households of
industrial, commercial, financial, and real estate magnates and some ex-princes and political
leaders. They own enormous assets and running for huge profits. On the other extreme there are
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slums, and pavement dwellers, unemployed and casual labourers, independent workers providing
petty services etc. who generally hold negligible assets.
Regional Inequality
Third important type of inequality that India faces is the regional inequality. Some states are
economically and socially advanced while others are backward. Even within each state some
regions are more developed while others are primitive. The co existence of relatively developed and
economically depressed states and even regions within each state is known as regional inequality.
The existence of regional inequality creates social, economic and political issues. The regional
inequality is so prominent in India in the case of HDI Value, growth of the economy, poverty,
unemployment, education, health, monthly percapita expenditure, rural- urban divide etc.
The India Human Development Report, 2011 shows that India has a HDI value of 0.467.
The HDI is the highest for Kerala (0.790)xvi followed by Goa (0.617) and then Punjab (0.605) and
the lowest for Chhattisgarh (0.358), Odisha (0.362) and Bihar (0.367). While the HDI scores across
states show little variation the variation in the sub-indices for education and health show a greater
degree of variation. The income index shows the least degree of variation. The major states are
distributed between the categories of countries with Medium and Low Human Development as
per the HDR 2011 classification. Kerala is in the Medium HDI category. Other major states in
this group are Punjab, Himachal Pradesh, Haryana, Maharashtra, Tamil Nadu, Karnataka, Gujarat,
West Bengal and Uttarakhand. Nine other states, namely Andhra Pradesh, Assam, Uttar Pradesh,
Rajasthan, Jharkhand, Madhya Pradesh, Chhattisgarh, Bihar and Odisha fall in the Low HDI
category India is ranked 134 out of 187 countries in the Global HDI,2011.
The best performer in terms of growth in 2009- 10 was Uttarakhand, followed by Odisha,
Chhattisgarh, and Gujarat and the worst performers were Karnataka, Rajasthan, and Jharkhand.
States with above 10 per cent growth rate for the period 2004-5 to 2009-10 are Uttarakhand,
followed by Maharashtra, Gujarat, and Bihar.
The state-wise estimates of poverty as recomputed by the Tendulkar Committee show that
the highest poverty headcount ratios (PHRs) for 2004-5 exist in Odisha (57.2 per cent), followed by
Bihar (54.4 per cent) and Chhattisgarh (49.4 per cent) against the national average of 37.2 per cent.
The unemployment rate (per 1000) according to usual status(adjusted) as per the NSS 66th
round 2009-10 among the major states is lowest in Rajasthan(4) and highest in Kerala(75) in rural
areas and the lowest in Gujarat(18) and highest again in Kerala(73) and Bihar(73) in urban areas.
In the area of education, Madhya Pradesh has the highest GER (6-13 years) in 2008-9 while
Punjab has the lowest. Pupil-teacher ratios in primary and middle/basic schools are the lowest in
Himachal Pradesh and high in states like Bihar and Uttar Pradesh.
Health-wise, Kerala is the best performer and Madhya Pradesh the worst in terms of life
expectancy at birth (both male and female) during 2002-6. IMR in 2010 is also the lowest in Kerala
and highest in Madhya Pradesh. Kerala has the lowest and Uttar Pradesh the highest birth rate in
2010, followed by Bihar and Madhya Pradesh. Odisha has the highest and interestingly West
Bengal the lowest death rate.
The MPCE indicator shows that there is disparity both in the MPCE and food share across
states. Bihar has the lowest MPCE of Rs 780 with 65 per cent food share in rural areas and Rs 1238
with 53 per cent food share in urban areas whereas Kerala has the highest MPCE of Rs 1835 with
46 per cent food share in rural areas and Rs 2413 with 40 per cent food share in urban areas. States
with low average MPCE tend to have a higher share of food in total consumer expenditure as food
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is the primary need for survival and takes up a larger proportion of overall expenditure in the poorer
sections of population. The top states spending more than the national average on food items both
in rural and urban India are Bihar, Assam, Odisha, and Jharkhand.
Turning to the rural urban gap, we begin with the Monthly per capita expenditure (MPCE)
defined first at household level to assign a value that indicates level of living to each individual or
household. Based on the 66th round (2009-10) of the National Sample Survey (NSS), average
MPCE [Modified Mixed Reference Period (MMRP) based] is Rs. 1054 and Rs.1984 respectively
for rural and urban India at the all India level indicating rural-urban income disparities. Out of the
MPCE, the share of food is Rs. 600(57 per cent) and Rs. 881(44 per cent) for rural and urban India
respectively which shows that food share is more in rural India as compared to urban India.
Causes of Inequality in India
1. Private ownership of means of production
2. Poverty of the people
3. Law of inheritance
4. Concentration of economic power in the hands of a few
5. Highly unequal asset distribution
6. Inadequate employment generation
7. Inadequate development of the economy
8. Differential regional growth
9. Inequalities in professional training
10. Low investment in social sectors
11. Use of capital intensive technique of production
12. Failure of implementation of land reforms
13. Tax evasion and of the richer sections of the community
14. Inflation
15. Privatisation and globalisation
Remedial measures
In order to find out the remedial measures for inequality it is better to solve first the real
causes of it in the country. Any how the following are the some of the measures to solve inequality.
1. Reduction in the concentration of economic power
2. Development of backward areas
3. Better distribution of income and wealth
4. Land reforms
5. Creating more employment opportunities
6. Provide more social security measures
7. Control of black money
8. Progressive income tax
9. Control of monopolies and trade restriction practices
10. High taxes on luxuries
11. Change in inheritance law
12. Use of labour intensive technique of production
13. More investment in social sectors
14. Control of inflation
15. Population control
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End Notes
i.
B.S. Rowntree (1941), Poverty and Progress, Longman, London, p.466.
ii.
D.R. Gadgil (1965), Sholapur City: Socio-Economic Studies, Asia Publishing House, New
Delhi, pp. 223-34 and the World Bank (1990), World Development Report, Poverty,
Oxford University Press for the World Bank, New York, p. 26.
iii.
Dandekar, V.M. and Rath .N. (1971),

Economy, Pune.
iv.
Pranab. K. Bardhan (1974), On the Incidence of Poverty in Rural India in the Sixties,
Sankhya, vol. 36. Series c. pp. 264-80.
Bhatty, I.Z. (1974), Inequality and Poverty in Rural India Sankhya vol. 36, series c, pp
291, 336.
Ahluwalia.M.S (1978), Rural Poverty and Agricultural Performance in India, Journal of
Dent: Studies, vol.l 14(3), April.
Mahendra Dev.S (1988), Regional Disparities in Agricultural Labour Productivity,
Indian Economic Review, Vol. 23, No. 2, July- December, pp. 167-205.
Rohini Nayyar (1991), Rural Poverty in India: An Analysis of Interstate Differences,
Oxford University press, Bombay, pp. 27-61.
v.
vi.
vii.
viii.
Poverty in India, Indian School of Political
ix.
Kakwani N & Subba Rao K (1992), Rural poverty in India 1973-86, in Kadokodi, G.K and
Murthy, GV.S.N. (ed), Poverty in India: Data Base issues, Vikas publishing house, New
Delhi, pp 273-345.
x.
Suresh D. Tendulkar & L.R. Jain (1995), Economic Reforms and Poverty, EPW vol. 30, No.
23, June 10, pp. 1373-77.
xi.
URP=Uniform Recall Period took consumption in which the consumer expenditure data for
all items are collected from 30- day recall period.
xii.
MRP = Mixed Recall Period took consumption in which the consumer expenditure data for
five non-food items, namely, clothing, footwear, durable goods, education and institutional
medical expenses are collected from 365-day recall period and the consumption data for
the remaining items are collected from30-day recall period.
xiii.
xiv.
xv.
xvi.
Economic Survey, 2009 10 Government of India, New Delhi, p.273

PPP- Purchasing Power Parity.
66 th Round of NSSO Report
HDI value estimated in 2007-08.
References
1. Alkire, Sabina and Foster, James (2010): Designing the Inequality-Adjusted Human
Development Index (HDI)" OPHI Working Paper No 37, Oxford Poverty & Human
Development Initiative, Oxford.
2. Government of India (2006a): Level and Pattern of Consumer Expenditure, 2004-05, NSS
61st Round (July 2004 - June 2005), Report No. 508(61/1.0/1), National Sample Survey
Organization, Ministry of Statistics and Programme Implementation, New Delhi.
3. UNDP (2010): Human Development Report 2010 The Real Wealth of Nations: Pathways to
Human Development, New York.
4. India Human Development Report 2011: Towards social inclusion, Oxford University
Press, New Delhi.
5. Economic Survey2011-12, Government of India.
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Module VI
MAJOR SECTORS OF INDIAN ECONOMY
Importance; contribution and problems of agricultural sector; green revolution; land reforms;
Industry: importance; contribution and problems; Services: contribution to the national
economy- Impact of economic reforms on major sectors.
6.1 Importance of agriculture sector in Indian economy
Agriculture sector plays a strategic role in the process of economic development of the
Indian economy. Agriculture is the foundation upon which the entire superstructure of the country
is built. Indian Agriculture may be considered the backbone of the Indian economy. Most of the
people of India lived with the agriculture sector. To Indian people agriculture is not mere an
occupation rather than it is their life style. As a result of these agriculture has crucial importance in
our economy. The importance or role of agriculture in Indian Economy can be better explained in
the following points.
1. Contribution to national economy or GDP
Agriculture is the single most sector which contributes much to the national income at the
time of independence. It contributes 56.5 % in 1950-51. Agriculture including allied activities
accounted for 13.9 per cent of GDP at 2004-05 prices in 2011-12 as compared to 14.5 per cent in
2010- 11. In terms of composition, out of a total share of 14.5 per cent in GDP in 2010-11,
agriculture alone accounted for 12.3 per cent, followed by forestry and logging at 1.4 per cent, and
fishing at 0.7 per cent. Even though the contribution from agriculture sector declined still it has a
dominant role in Indias economy. The average annual growth in agriculture and allied sectors
realized during the Eleventh Plan Period was 3.3 per cent against the targeted growth rate of 4 per
cent. The share of agriculture in national income is often taken as an indicator of economic
development. Normally, developed economies are less dependent on agriculture as compared to
underdeveloped countries. For example in the developed countries like USA and UK the
contribution of agriculture ranges between 2 to 3 percentages.
2. Agriculture provides raw materials
Agriculture development is necessary for improving the supply of raw materials for agrobased industries. The shortages of agriculture sugar, goods have its own impact upon the industrial
production and consequent increase in the general price level. It will impede the growth of the
economy. Indian agriculture provides raw materials to many industries such as cotton, jute, sugar,
flour mills, tea, coffee, etc.
3. Agriculture provide employment
Agriculture sector can carry more employment opportunities than any other sectors. India is
basically an agricultural country and most of the people lived with agriculture sector. Agriculture is
the single largest private sector occupation. At the time of independence about 80 % of the people
lived with agricultural sector while according to the 2010-11 estimates 52.1 % of the people lived
with agricultural sector. The employment potentiality of the sector is very high. As a result of all
these the burden of unemployment gets reduced in India.
4. Importance in international trade
Indian agriculture is very vibrant in terms her international competitiveness. At the time of
independence about 70 % of the export earning comes from agriculture sector. According to the
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estimates of 2009-10, 10.59 % of the export earning is from agriculture sector. The important
exportable items of agriculture include tea, sugar, oilseeds, tobacco, spices etc. Large percentage of
foreign exchange can be earned through the export of agricultural products.
5. Creation of infrastructure
The development of agriculture requires roads, market yards, storage facilities,
transportation, railways, irrigation facilities, and many other facilities. They are the infrastructure
facilities helped to the development of the country.
6. Importance in industrial development
Agriculture development is also essential to the development of industries in the country.
Both are complementary to each other in the development process. Various important industries in
India find their raw material from agriculture sector; cotton, jute and plantation industries (viz., tea,
coffee, and rubber), textile industries, sugar, vanaspati, etc are directly dependent on agriculture.
Handloom, spinning, oil milling, rice thrashing etc., are various small scale and cottage industries
which are dependent on agricultural sector for their raw material. Agriculture is also one of the
biggest markets for industry.
7. Necessary for the food stuffs
In order to feed the large population of our country the development of agriculture is
essential. The growth in population demands more and more food stuffs. It can provide only by
development of agriculture.
8. For growth with stability
Economic development without agriculture development will create some bottle necks and
inflationary pressures. Low rate of agricultural development resulted in shortage of food and
essential raw materials leading to inflation.
Growth in agriculture and allied sectors remains an important objective and a necessary
condition for inclusive growth. However, it is a matter of concern that agricultural growth is still,
to a certain extent, characterized by fluctuations due to the vagaries of nature, though there has not
been actual decline in terms of output since 2002-03.
Table 6.1 Sectoral Composition of GDP
Year
Agriculture Industry
Service
1950-51
1960-61
1970-71
1980-81
1990-91
2000-01
2010-11QE
2011-12AE
53.1
48.7
42.3
36.1
29.6
22.3
14.5
13.9
30.3
30.8
33.8
38.0
42.7
50.4
57.7
59.1
16.6
20.5
24.0
25.9
27.7
27.3
27.8
27.0
Source: Economic Survey 2011-12
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Table 6.2 Agriculture Sector: Key Indicators (per cent)

2009-10@ 2010-11*
SI Items
no
1 GDP-Share and growth(at 2004-05 prices)
a) Growth in GDP in agriculture & allied sectors
b) Share in GDP - Agriculture and allied sectors
c) Agriculture
d) Forestry and logging
e) Fishing
2 Share in total Gross Capital Formation in the
Country (per cent at 2004-05 prices) ) Share
of agriculture & allied sectors in total
Gross Capital Formation
a) Agriculture
b) Forestry and logging
c) Fishing
3 Employment in the agriculture sector as share
of total workers as per census2001
1.0
14.7
12.4
1.5
0.8
7.0
14.5
12.3
1.4
0.7
7.1
7.2
6.6
0.1
0.5
6.6
0.1
0.5
2011-12**
2.5
13.9
58.2
Source: Central Statistics Office (CSO) and Department of Agriculture and Cooperation.
Notes: @ Provisional Estimates *Quick Estimates **Advance Estimates
6.2 Problems of Indian Agriculture
1. Lack of proper land reform measures.
2. Lack of credit facilities.
3. Lack of proper storage facilities.
4. Lack of chemical fertilizers.
5. Lack of proper agriculture research.
6. Lack of proper vision from the part the government.
7. Small and uneconomic holdings.
8. Prevalence of natural calamities.
9. Inadequate irrigation facilities.
10. Defective marketing facilities.
11. Out model technologies.
12. Absence of double cropping and crop rotation.
13. High pressure on land.
14. Soil erosion.
15. Pests and plant diseases.
16. Challenges from the international market.
17. Slow growth of agriculture sector.
18. Fall in total area of food grains production.
19. Fall in per capita availability of food grains production.
20. Very high dependency on monsoons.
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6.3 Green Revolution (1966)

Green revolution is the term connecting the agriculture sector. Green revolution means the
tremendous hike in the agricultural production and productivity during the mid of 1960s. The
Green Revolution is happened due to the simultaneous use of package of inputs which is otherwise
referred as New Agriculture Strategy comprises IADP, IAAP and HYVP. The Green Revolution
happened in India for the first time in the Kharif season of 1966. This crucially depended on regular
and adequate irrigation, fertilizers, and high yielding varieties of seeds, pesticides and insecticides.
Some critics call this as the wheat revolution because due to Green revolution wheat production
increased tremendously compared to all other crops. The born place of Indian Green revolution is
Punjab and Dr: M.S. Swaminathan was considered as the father of Indian Green revolution.
6.4 New Agriculture Strategy (NAS)
New Agriculture Strategy (NAS) is a programme based on the concept of application of
science and technology to farming for increasing yield per hector. It is the New Agriculture
Strategy which contributes to the Green Revolution in the Indian agriculture. The NAS worked
through IADP, IAAP and HYVP
a) Intensive Agricultural District Programme (IADP)
Intensive Agricultural District Programme was introduced as a pilot project in 1960-61.
This programme meant to use various agricultural resources simultaneously in selected regions.
The objective of this programme was to increase the production of food grains and to prepare the
basis for the rapid economic development of the country. Under this programme farmers were
given inputs like irrigation facilities, seeds, fertilisers, implements etc. There were 7 selected
districts under this programme. As a result of implementing this there should be a rapid rise in the
agricultural production. After the initial success this programme expanded to 13 more districts also.
b) Intensive Agricultural Area Programme (IAAP)
Intensive Agricultural Area Programme was a modified version of the IADP introduced in
1964-65. This programme was for the intensive development of major crops such as wheat, paddy,
millets, cotton, sugar cane, potato, pulses etc and staff employed was on a reduced scale.
c) High Yielding Varieties Programme (HYVP)
High Yielding Varieties Programme was launched in 1966. Both the programmes IADP
and IAAP gave importance to the intensive agricultural development. These programmes worked
for only some selected crops. The farmers were not satisfied with the success of these programmes
and seek a new programme. During this time Indian council of agricultural Research and
Agricultural Universities like Patnagar, Koyambathoor are developed high yielding seeds. A
number of high yielding varieties of rice and wheat, both exotic and local, and hybrids of maize,
Jowar and bajra, responsive to fertilisers were introduced. Since then a number of new high
yielding varieties of these cereals and millets have been evolved and improved in the programme.
6.5 Components of Green Revolution
There are various factors which contribute to the happening of Green revolution in Indian
agriculture in the Fourth Five Year Plan. It includes the following components.
1. Package of inputs
The green revolution is happened due to the application of the package or the combination
of improved practices. The new agriculture strategy aims at making them adopt simultaneously all
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the elements needed for increasing production. It includes high yielding varieties of seeds, chemical
fertilisers, plant protection measures, mechanisation, irrigation facilities, etc.
a) HYV seeds: The most important feature of the new agriculture strategy which contribute to
the green revolution was the use of HYV seeds in areas where good rainfall and irrigation facilities.
HYV seeds of wheat, paddy, bajra, maize etc. were introduced since 1965-66.For wheat new
Mexican dwarf varieties like Lerma Roja, 64 A, Sonara, Kalyan, and PV-18 and for bajra HB-10,
For maize Vijay etc were introduced. In the case of paddy adopt TN-1, IR 8, Tinen-3 etc.
b) Use of chemical fertilisers: The use of chemical fertilisers is one of the key elements of the
strategy for accelerating the growth of agricultural output. The use of nitrogenous, phosphoric and
potassic fertilisers have been increased by importing fertilisers.
c) Plant protection: another important measure used under the new agriculture strategy is plant
protection by using many pesticides and insecticides.
d) Farm mechanisation: A significant aspect of green revolution is the use of modern machinery
like tractors, harvesters, pump sets, tube wells etc. They are used on a large scale.
e) Extension of irrigation: Water is the basic input in agriculture. New seeds and fertilisers can
produce desired results only if adequate water is made available. HYV programmes were started in
those areas where sufficient water supply. Many minor irrigation facilities have started under this
programme.
2. Multiple cropping
The NAS is concerned with not only higher yields, but with great intensity of cropping,
which aimed at intensive cultivation of land by raising three or more crops in the same plots of land
in a year. New crop rotations have made possible by the development of new short duration
varieties of paddy, Jowar, maize and bajra suited to different agro-climatic conditions. Among
other crops included in the rotation are barley, ragi, oil seeds, potato and vegetables. As a result of
this there was not only tremendous increase in production but the fertility of the land was also
maintained.
3. Improved credit-facilities
Credit has played an important role in popularising the use of HYV programme among the
farmers. Short term and medium term loans were given to farmers through Primary Co-operative
Societies, Land Development Banks, Commercial Banks, Regional Rural Banks, and Farmers
Service Co-operative etc. They have helped the farmers in buying the seeds, fertilizers, implements,
machines and other inputs.
4. Processing , storage and marketing facilities
These facilities are also speedily extended and improved so that the increased agriculture
production is put into profitable use.
5. Dry land development
To promote agricultural development in dry land areas, cultivation of drought resistant and
short duration varieties of seeds based on latest dry farming technology was encouraged.
6. Price incentives
Another contributing factor to the green revolution has been the policy of support price of
food grains. In 1965 Agricultural Price Commission and Food Corporation of India were set up for
the purpose ensuring price stability and fare price. All these boosted agriculture.
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7. Farmers training and education

A pilot scheme for Farmers training and education was started in 1966-67 in 5 selected
districts. In subsequent years it was extended to other districts. This programme emphasis the
literacy of the farmers and they were given agricultural information through audio-visual media and
formation of the formation of farmers discussion group.
8. Agricultural research and technology
NAS give emphasis agricultural technology as a major input of agricultural production and
to development of agricultural research. The Indian Council of Agricultural Research (ICAR) and
agricultural universities in different states has been undertaking the task of research in agricultural
products.
9. Setting up of new institutions
In view of the importance assumed in inputs and services in the NAS new institutions were
set up provided with funds to support agricultural production. Among them more prominent are,
National Seeds Corporation, Agro-Industries Corporation, Agriculture Refinance and Development
Corporation etc.
In brief it can be observed that the New Agricultural Strategy (NAS) or the package
programme improves the agricultural pattern in the country and brings tremendous hike in
agricultural production and productivity. All the above points are the contributing factors and bring
much needed Green Revolution in the country.
6.5 Impacts of Green Revolution
No doubt that New Agricultural Strategy brings lot of changes in Indian agriculture. It has
far reaching impact upon the agriculture and the economy as well. After 1966 there is substantial
increase in food grains production especially wheat, but it is clear that the New Agricultural
Strategy led to an increase in inter regional and interpersonal inequalities. Thus The Green
Revolution had both positive and negative impacts.
(A) Positive Impacts of Green Revolution
1. Hike in agricultural production and productivity
2. Increase in food production
3. Boost the production of cereals
4. Fall in poverty
5. More employment is created
6. Use of modern technology
7. Use of chemical fertilisers
8. More irrigation facilities developed
9. More research work is taking place
10. More saving and investment are created
11. More infrastructures is created
12. More land is added to agriculture
13. Better distribution of land
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(B) Negative Impacts of Green Revolution

1.
2.
3.
4.
5.
6.
7.
8.
9.
Increase in both inter-regional and intra regional inequalities

Environmental degradation took place
Reduction in employment elasticity
Increase in personal inequality
Traditional knowledge was lost
Neglects the production of coarse cereals and pulses
Ground water level down
Health problems due to excess of mosquitoes in waterlogged area around lands
Irrigation of fields without proper drainage led to stalenization and alkalization of soils
Rainbow Revolution
The Rain bow revolution means the Food Chain Revolution to put a check on destroying
food grains, vegetables and fruits. The Rain bow revolution includes the following:
Revolution
Area
1. Green Revolution..................Agriculture (Food grains production)
2. White Revolution...................Milk
3. Blue Revolution.....................Fish
4. Yellow Revolution.................Oilseeds
5. Golden Revolution................Fruits/Apple
6. Black Revolution...................Petroleum/non-conventional energy
7. Silver Revolution...................Eggs
8. Round Revolution..................Potato
9. Red Revolution......................Meats/Tomato
10. Grey Revolution....................Fertilizers
11. Pink Revolution.....................Shrimp
12. Brown Revolution.................Leather
6.6 Land reforms

In abroad sense land reforms refer to all kinds of policy induced changes relating to the
ownership, tenancy and management of land. It includes the whole agrarian structure within which
a peasant operates. In a sense the changes brought about in the agrarian structure through direct
intervention are characterised as land reforms. In other words land reform means abolishing the
existing defective structure of land holding by introducing a rationalised structure in order to
increase the agriculture productivity.
6.7 Land Tenure System in India
Land Tenure refers to the system of land ownership and management. The various features
that distinguish a land tenure system from the others relate to the following: (a) Who owns the land;
(b) Who cultivate the land; (c) Who is responsible for paying the land revenue to the government.
On the basis there are three different types of land tenure existed in India before independence.
They are Zamindari system, Mahalwari system and Ryotwari system.
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1. Zamindari system or the Land lord-Tenant System

This system was created by the British East India Company, when in 1793; Lord Cornwallis
introduced Permanent Settlement Act. Under this system the land lords or the Zamindars were
declared as the owner of the land and they are responsible to pay the land revenue to the
government which is fixed. The share of the government in total rent collected is fixed at 10/11 th,
the balance going to the Zamindars as remuneration. The actual tiller does not come into contact
with the state and thus the Zamindars act as an intermediary between the state and the tiller. The
land lords lease land to the tenants and collect rent from them. The land lord gets pre-determined
share of the produce. The cultivators do not have any owner ship rights on the land and they are
only tenants under the Zamindari system. Under this system nobody is interested for the
development of the agriculture. This system is more prominent in West Bengal, Andhra Pradesh,
Madhya Pradesh, Utter Pradesh, Bihar and Orissa. In pre independence India, about 25% of area
was covered by this system.
2. Mahalwari System or Communal System of Farming
This system was introduced by William Bentinck in Agra and Oudh. It was later extended
to Madhya Pradesh and Punjab. Under this system the ownership of the land is maintained by the
collective body usually the villagers which serves as a unit of management. They distribute land
among the peasants and collect revenue from them and pay it to the state. But this system also leads
to absentee landlordism. About 39 % the land area is covered under this system before
independence in India.
3. Ryotwari system or the Owner Cultivator System
This system was initially introduced in Tamil Nadu and later extended to Maharashtra,
Gujarat, Assam, Coorg, East Punjab and Madhya Pradesh. Under this system the owner ship rights
of use and control of land are held by the tiller itself. There is the direct relationship between owner
cultivator i.e. state and the tiller in revenue collection. Therefore this system is considered as the
least oppressive system among the land tenure systems that existed in India before independence.
About 36 % the land area is covered under this system before independence in India.
6.8 Objectives of Land reforms in India
1.
2.
3.
4.
5.
6.
Restructuring of agrarian relation to achieve egalitarian social structure

Elimination of exploitation in land reforms
Actualisation of the goal of land to the tiller
Improvement of the socio-economic conditions of the rural poor by widening their land base
Increasing agricultural production and productivity
Facilitating land base development of rural poor
7. Infusion of a greater measure of equality in local institutions

6.9 Measures and Progress of land Reforms in India
For the fulfilment of the above objectives, the major steps adopted under the land reforms
programme are ; Abolition of Zamindari System, Tenancy Reforms, Ceiling on holdings,
Consolidation of Holdings and Co-operative Farming. No doubt that there are certain
improvements in land reforms due to the efforts undertaken by the various State Governments in
India since it is come under State List.
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a. Abolition of Zamindari System

After independence a strong voice was raised against the Zamindari system. As a result a
high priority was given to the abolition of Zamindari system. Accordingly, every state enacted its
own legislation for the abolition of this system. Among the Indian states Utter Pradesh enacted
Zamindari Abolition and Land Reforms Act in 1950. By 1952, necessary legislations had been
enacted in all the states.
b. Tenancy Reforms
Various tenancy reform measures were under taken by the government of India and state
governments. It includes Regulation of rent, Security of tenure and Conferment of Ownership Right
on Tenants. It would not be in correct to say that barring some backward regions and tribal areas
where the poor are too poor to resist, tenancy relations today are less exploitative than they were in
the pre-independence period.
c. Ceiling on holdings
By a ceiling on land holdings we mean the fixing of the maximum size of holdings that an
individual cultivator or a household can possess. Beyond this maximum size all the land belonging
to the land lords is taken by the government and distributed to the land less. Ceiling on land holding
is considered as the most important methods to accomplish land reforms. Different laws were
enacted by the states in India regarding the ceiling on land holdings. Even though various legal
hurdles existed, the ceiling on land holding is successfully implemented in certain states like,
Kerala, Bengal etc. The ceiling law generated a hope in the minds of rural masses initially, but
progress made in acquiring surplus land suffered a setback due to judicial proceedings.
d. Consolidation of Holdings
The major cause for the low productivity in agriculture is the sub divisions and
fragmentations of agricultural land. Therefore the consolidation of holdings is essential to avoid the
evils of fragmentation of agricultural land. Under consolidation several scattered pieces of land
should taken together and implemented different types of cultivating system. All states except
Kerala, Tamil Nadu, Andhra Pradesh (Partially) and North-Eastern states have passed the law for
consolidation of holdings. The consolidation can be either on voluntary or compulsory. However
the progress of consolidation of holdings has been very slow.
e. Co-operative Farming
Co-operative farming means adopting the idea of co-operation in farming. Under this
method, several farmers, while retaining their ownership of land and managing it individually
adopted the principle of co-operation for non-farm operations like marketing the products,
processing the products, obtaining inputs of agriculture like seeds, fertilisers, tools etc. In spite of
the efforts made so far, the actual progress of co-operative farming is very meagre.
6.10 Economic Reforms and Indian Agriculture
Globalization has caused misery and despair among millions of Indian farmers, driving
large numbers of them to suicide. Since agriculture continues to be a tradable sector, this economic
liberalization and reform policy has far reaching effects on (I) agricultural exports and imports, (ii)
investment in new technologies and on rural infrastructure (iii) patterns of agricultural growth, (iv)
agriculture income and employment, (v) agricultural prices and (vi) food security. The GATT
Agreement signed in 1995 will fundamentally change the global trade picture in agricultural sector.
Any how the impacts of economic reforms on agriculture can be pointed out as follows.
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1. The deceleration in the growth of crop yields

The first and foremost important impact of economic reforms on agriculture is the
deceleration in the growth of crop yields as well as total agriculture output. The deceleration is due
to fall in investment in irrigation and other rural infrastructure and also non availability of yield
raising cost reducing new technology.
2. Deceleration in net sown area in the country.
There is deceleration in net sown area especially in major food crops except in central
region of India and in some states like Punjab, Haryana, and Gujarat etc.
3. Diversification of cropping pattern.
Another important change due to reforms is the cropping pattern from food crops to non
food crops. The cultivation of non food crops like oilseeds, fibre crops, sugar cane, fruits and
vegetables increased. There is also a decline in the production of coarse cereals.
4. Problems related with the input seeds.
The biggest input for farmers is seeds. Before liberalisation, farmers across the country had
access to seeds from state government institutions. With liberalization, Indias seed market was
opened up to global agribusinesses like Monsanto, Cargill and Syn Genta. The seed market was
well regulated, and this ensured quality in privately sold seeds too. These hit farmers doubly hard:
in an unregulated market, seed prices shot up, and fake seeds made an appearance in a big way.
Genetically modified pest resistant seeds like Monsantos BT Cotton are introduced but it again
raises many issues in the agriculture sector. The abundant availability of spurious seeds is another
problem which leads to crop failures.
5. Export drive.
One measure of the liberalisation policy which had an immediate adverse effect on farmers
was the devaluation of the Indian Rupee in 1991 by 25% (an explicit condition of the IMF loan).
Indian crops became very cheap and attractive in the global market, and led to an export drive.
Farmers were encouraged to shift from growing a mixture of traditional crops to export oriented
cash crops like chilli, cotton and tobacco. These need far more inputs of pesticide, fertilizer and
water than traditional crops.
6. Reduction in export subsidy and tariff.
Liberalisation policies reduced subsidy to agriculture a greater extent. (another explicit
condition of the IMF agreement).As a result of this prices of pesticides, fertilizer have increased .
Electricity tariffs have also been increased. With a view to open Indias markets, the liberalization
reforms also withdrew tariffs and duties on imports, which protect and encourage domestic
industry. By 2001, India completely removed restrictions on imports of almost 1,500 items
including food. As a result, cheap imports flooded the market, pushing prices of crops like cotton
and pepper down.
7. Development of corporate style farming.
The reform policies encouraged corporate style of farming. Even though this will encourage
the regular agricultural production and productivity it will harm to the land ownership and crop
diversity to a greater extent.
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8. Reduction in smooth credit facilities.

Earlier the farmers are given cheap credits from various financial institutions. In lieu of
reforms process and recommendations of Khusrao Committee and Narasingham Committee, there
is a reduction in Commercial Bank credit to agriculture. It might lead to a fall in farm investment
and impaired agricultural growth.
9. Marginalization of Small farmers.
The most neglected section from the benefits of reform is the marginal farmers. The size of
them increased they even forced to subdue their ownership rights. Both Information Technology,
Genetic Engineering and Bio-Technology, which are the "drivers" of globalization with their
complementarities of liberalisation, privatisation and tighter Intellectual Properties Rights, are
bound to create new risks of marginalisation and vulnerability.
10. Debt of the farmers
The biggest problem Indian agriculture faces today and the number one cause of farmer
suicides is debt. Forcing farmers into a debt trap are soaring input costs, the plummeting price of
produce and a lack of proper credit facilities, which makes farmers turn to private moneylenders
who charge exorbitant rates of interest. In order to repay these debts, farmers borrow again and get
caught in a debt trap.
6.11 Industry
Indian manufactures had a worldwide market before the rise of modern industrial system.
Indian muslin and calicoes were in great demand. It is true that British industrial and economic
policies had brought a mixture of impact upon the industrial front of India. Industrial development
is essential for the rapid development of any nation. Therefore immediately after independence the
government of India take necessary steps to accelerate the growth of industry. The first industrial
Policy Resolution was passed on 6 th April 1948. This policy established the base for Mixed and
Controlled Economy in India and clearly divided the industrial sectors into private and public
sectors. Any how the second five year plan laid foundation to the development of basic and key
industries and referred as the Industrial Plan.
6.12 Industrial Performance
The index of industrial production (IIP), released each month, is the key indicator of
industrial performance. The new IIP series with 2004-05 as base was released in June 2011
replacing the earlier IIP series with base 1993-94 .Since the IIP is a fixed weight and fixed base
series, a dated base often has limitations in reflecting the industrial scenario. The new series not
only has a more recent base, it has a larger and more representative product basket and weights that
appropriately reflect the relative importance of the sectors, products, and product groups. Recent
industrial growth, measured in terms of IIP, shows fluctuating trends. Growth had reached 15.5 per
cent in 2007-8 and then started decelerating. Initial deceleration in industrial growth was largely on
account of the global economic meltdown. There was, however, a recovery in industrial growth
from 2.5 per cent in 2008-09 to 5.3 per cent in 2009-10 and 8.2 per cent in 2010-11. Fragile
economic recovery in the US and European countries and subdued business sentiments at home
affected the growth of the industrial sector in the current year growth of IIP in terms of its major
components is indicated in Table 6.3
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Table 6.3 Growth in the IIP and its major components (per cent)
Weight 2008-09 2009- 10 2010-11
Overall IIP
100.0
2.5
5.3
8.2
In terms of structured national industrial classification
Mining
14.16
2.6
7.9
5.2
Manufacturing
75.53
2.5
4.8
9.0
Electricity
10.32
2.7
6.1
5.5
In terms of use-based classification
Basic goods
45.68
1.7
4.7
6.0
Capital goods
8.83
11.3
1.0
14.8
Intermediates
15.69
0.0
6.0
7.4
Consumer Goods 29.81
0.9
7.7
8.6
Durables
8.46
11.1
17.0
14.2
Non-durables
21.35
-5.0
1.4
4.3
Source: MOSPI.
6.13 Importance of industrial sector in Indian economy
The industrial sector had poured much vitality into the growth dynamics of Indian economy.
1. Increase in the share of GDP
The share of the industrial sector in Gross Domestic Product has slowly but consistently
increased over the planning period. For example, the share of industry in 1950-51is 16.6 % and it
rose to 27 % in 2011-12. This is a good sign.
2. Growth of infrastructure industries.
The development of infrastructure is essential for the development of a nation. In India,
electricity, coal, steel, crude petroleum and cement industries act as the basic infrastructure
industries and they provide ample scope for the further development and industrialisation of the
nation.
3. Building up of heavy and capital goods industries
The second five year plan gave importance to the development of heavy and capital goods
industries. As a result of these a wide range of engineering goods, iron and steel, metals and metal
based products are now produced within the country itself and the dependence on other countries
has considerably declined.
4. Diversification of industrial structure
At the time of independence only four industries namely, food products, textiles, wood and
furniture, and basic metals were contributed more than two-thirds of production. But now there is
much diversity in the industrial structure. The share of electrical and non-electrical machinery,
chemicals, transport equipment, etc had risen considerably. Thus, now the country has a well
diversified industrial structure.
5. Growth in consumer durables
Due to the liberalisation policies of the government, the output of consumer durables had
expanded at a faster rate. The intermediate goods sector also grows considerably.
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6.14 Problems of Industrial sector

The major problems that happened in Indian industries are the following.
1. Gaps between targets and achievements
Except the periods 1980s the achievements were below the targets. In many years the
targets are much higher than the achievable level.
2. Underutilisation of installed capacity
A large number of industries in India are suffering from underutilisation of capacity. It may
be due to many reasons like, raw material shortage, power failure, government policies, labour
problems, demand problems etc.
3. Poor performance of the public sector
During the early years of planning the public sector has an advantage in industrial
development. But large losses of public sector units is a serious matter and calls for immediate
corrective measures.
4. Infrastructural constrains
It is said that one of the important constraints in the industrial development is the poor
quality and quantity of infrastructure and high cost particularly power and transport. As a result the
competitiveness of Indian industries lost.
5. Growth of regional imbalances
The industrial development in India is mainly concentrated in few states like Maharashtra,
Gujarat and Tamil Nadu and others are lagged behind. Thus regional imbalances increased.
6. Industrial sickness
In India numbers of industries are plagued by sickness due to bad and inefficient
management. Adequate attention was not given to the improvements in technology and quality of
products.
7. High cost industrial economy
Another major issue related with the industrial sector is the hike in the cost of industrial
products. Compared to the products of other countries Indian industrial products priced high.
8. Increasing capital-out put ratio
The industrial sector in India shows an increasing capital out-put ratio which definitely act
as an obstacle in the development of industrial sector.
9. Creation of environmental problems
Liberalisation give way for the establishment of many new industrial concerns. Some of
them creates environmental problems.
10. New challenges
The Indian industrial sector faces new challenges from the globe. The recent global
financial shock raises many problems to Indian industries. Many trading partners of India dump
heir products in the Indian market. The large scale industrial production create environmental and
demand problems. Many big corporates handled the production process of certain profit making
industrial ventures.
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6.15 The impact of economic reforms on the industry in India

The economic reforms of 1991 changed the Indian business context from one of statecentered, control orientation, to a free, open market orientation, especially for hi-tech companies. It
allowed Indian companies to start competing effectively on a global scale. As evident, the
economic reforms benefited corporations in numerous ways. The reform process in India has
benefited the nation tremendously and is now irreversible. In fact, successive governments have
continued the reform process. These governments irrespective of their political affiliations have
introduced measures to improve the speed and flexibility of decision-making of corporations. These
include measures such as allowing listing on foreign exchanges, and formulating acquisition norms
as well as regulations for Employee Stock Option Plans (ESOPs).
1. Increase competitiveness.
Decentralization of power to regional and state offices led to speedier decision-making and
reduction in friction to business. Entry of multinational companies enhanced the competitive
environment for Indian companies, thus, forcing them to benchmark themselves against global
standards. Moreover, Indian companies should benchmark themselves globally in terms of quality,
cost, time, customer responsiveness, investor friendliness and corporate governance practices.
Further, our government has to enhance its efficiency in every interface it has with businesses.
Finally, we, Indians, can succeed only if our political leadership, bureaucracy, corporate leadership
and academia work collaboratively.
2. Increase exports
Indian export industries show an upward trend during the reform period. It helps to get more
foreign exchange earning to the country.
3. Increase imports
During the reform period the imports are also in hike. Many sophisticated technological
products imported to India.
4. Growth in industrial sector
The industrial sector helps to the robust growth of the economy. Now industry is the second
largest growing productive sectors in India.
5. Creation of more employment opportunities
Even though closure of less competitive firms and therefore job losses and income reduction
in the initial phase following trade liberalization, however, that by 1999 it was possible to expect
the impact of increased productivity, competitiveness and accelerated growth.
6. Reduction in poverty
In the industrial sector more employment opportunities are created thereby there is the
reduction in poverty of the masses. More income is also passed into the hands of the people.
7. Increase in investment
However, the more substantial benefits were reduction in the interference of the
bureaucracy, enhancement of the confidence of Indians in exploring global markets, and India
emerging as an attractive destination for Foreign Institutional Investors (FIIs).More investments are
flow to India.
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8. Entry of multinational companies

Economic reform measures liberalise the licensing system and there by encouraged the
entry of multinational companies. This itself is creating certain negative impacts upon the economy
also.
9. Flow of foreign capital
Market determined pricing of Initial Public Offerings (IPOs) made equity a viable financing
option. The balance of payment position of India improved drastically.
10. Better consumer products and services
Indian consumers deserve better products and services. This can be provided through liberal
economic policies. They are met with world class products due to liberalisation.
11. Increase foreign relations
Current account convertibility removed restrictions on availing foreign currency, led to
easier foreign travel, and facilitated hiring of foreign consultants and international branding efforts.
6.16 INDIAS SERVICES SECTOR
The services sector has been a major and vital force steadily driving growth in the Indian
economy for more than a decade. The services sector covers a wide range of activities from the
most sophisticated information technology (IT) to simple services provided by the unorganized
sector, such as the services of the barber and plumber. National Accounts classification of the
services sector incorporates trade, hotels, and restaurants; transport, storage, and communication;
financing, insurance, real estate, and business services; and community, social, and personal
services. In World Trade Organization (WTO) and Reserve Bank of India (RBI) classifications,
construction is also included in the service sector. Different indicators like share in national and
states GDP, FDI, employment, and exports indicate the importance of the services sector for the
Indian economy. The share of services in Indias GDP at factor cost (at current prices) increased
from 33.5 percent in 1950-51 to 55.1 per cent in 2010-11 and 56.3 per cent in 2011-12 as per
Advance Estimates. Trade, hotels, and restaurants as a group, with 16.9 per cent share, is the largest
contributor to GDP among the various services sub-sectors, followed by financing, insurance, real
estate, and business services with 16.4 per cent share. Community, social, and personal services
with a share of 14.3 per cent is in third place. Construction, a borderline service inclusion, is at
fourth place with an 8.2 per cent share. If construction is also included, the service sectors share
increases to 63.3 per cent in 2010-11 and 64.4 per cent in 2011-12 (Table 6.4).
The service sector growth rate at constant prices has always been above the overall GDP
growth rate since 1996-97 except for 2003-04. The compound annual growth rate (CAGR) of the
services sector at 10.2 per cent for the period 2004-5 to 2010-11 has been higher than the 8.6 per
cent GDP growth rate during the same period. In the years 2009-10 and 2010-11, the services
sector registered a growth rate of 10.5 per cent and 9.3 per cent respectively. In 2011-12, as per the
Advance Estimates, the growth rate of services has been placed at 9.4 per cent.
6.17 Composition of Service Sector in India
In India, the national income classification given by Central Statistical Organization is
followed. In the National Income Accounting in India, service sector includes the following:
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1. Trade, hotels and restaurants (THR)

1.1 Trade
1.2 Hotels and restaurants
2. Transport, storage and communication
2.1 Railways
2.2 Transport by other means
2.3 Storage
2.4 Communication
3. Financing, Insurance, Real Estate and Business Services
3.1 Banking and Insurance
3.2 Real Estate, Ownership of Dwellings and Business Services
4. Community, Social and Personal services
4.1 Public Administration and defence (PA & D)
4.2 Other services
Table 6.4 : Share of different services categories in GDP at factor cost (current prices)
Category of services 2008-09 2009-10 2010-11 2011-12
Trade, Hotels, & Restaurants
16.9
16.6
16.9
25.2
7.8
7.8
7.7
NA
15.8
16.4
16.9
14.3
14.2
8.2
8.1
Transport, Storage,
& Communication
Financing, Insurance, Real
Estate, &Business Services
15.9
Community, Social,
14.5
& Personal Services
13.3
Construction
8.5
Total Services
(Excluding Construction)
8.2
54.7
53.9
55.1
56.3
63.3
64.4
Total Services
(Including Construction)
62.4
63.0
While agriculture continues to be the primary employment-providing sector, the services

sector is the principal source of employment in urban areas. As per the National Sample Survey
Organizations (NSSO) report on the Employment and Unemployment Situation in India, 200910, for every 1,000 people employed, 679 and 75 people are employed in agriculture sector in rural
and urban areas respectively (measured in terms of usually working persons in the principal status
and subsidiary status). On the other hand, the services sector accounted for 147 and 582 of every
1,000 persons employed in rural and urban areas respectively.
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6.18 Problems/Challenges Ahead

The sustainability of impressive growth of Indian economy has been questioned in the wake
of some challenges in the form of lack of social infrastructure, physical infrastructure; IT
infrastructure (Joshi, 2008b, 2006a), agricultural and industrial sector reforms, rupee appreciation
and U.S sub-prime crisis, etc. Besides, challenges in the field of IT and ITES like rising labour
costs, rapid growth in demand for talented manpower/quality staff, high attrition rate, outsourcing
backlash etc are some other limiting factors (Joshi, 2008a, 2006). The growth of IT and ITES is
having social, economic, health, ethical and environmental implications also Further, delay in the
promotion of conducive business environment and good governance will un able us to catch up
with the global giants in terms of world wide presence and scale. It is also important to point out
here that the measurement of output , productivity , non-availability of data or availability of data
after a time lag are other problems confronted with in case of services. The problem gets further
compounded because of the entry of new species of services (like IT, ITES etc ) and lack of
development of concepts on the one hand and non-inclusion of unpaid households on the other.
Further, quality of each unit of the same service varies from the other.Further, quality
improvements stemming from the application of new technologies are extremely hard to measure.
6.19 Prospects for Growth in the Services Sector
One of the major drivers of service sector growth in the post globalization era in India is the
IT and ITES sector. That is why NASSCOM (2005) says that, The IT and BPO industries can
become major growth engines for India, as oil is for Saudi Arabia and electronics and engineering
are for Taiwan. Indias IT and BPO industries could account for 10-12% of Indias GDP by 2015.
According to NASSCOM (2005), Indias offshore IT and BPO industries hold the potential to
create over 9 million jobs by 2010, 2.3 million direct jobs and 6.5 million indirect induced jobs.
The revenue generation from total software and services segment is likely to touch $ 60-billion
mark by 2010 as per NASSCOM estimates. In addition, there is a huge potential for growth in the
services sector because of increase in disposable income, increasing urbanization, growing middle
class, a population bulge in the working age groups providing demographic window of
opportunity, and emergence of a wide array of unconventional new services like IT, ITES, new
financial services (ATMs, credit cards) and tourism services (eco-tourism, health tourism) etc.
6.20 The Impact of Reform on Service Sector
Service sector is the main sector which is affected by economic reforms in the past two
decades of economic liberalisation. Now service sector is the leading sector in the contribution to
the GDP.
1. Growth of service sector
At the same time, the services sector grew by an average of 11 percent per year, with the
more liberalized sectors generally growing at relatively faster rates. The share of services in overall
value added rose from 39 percent in 1993 to 59 percent in 2011-12. Growth has been particularly
strong in the services sectors. Communication services displayed average annual growth rates of
13.6 percent in the 1990s, while banking grew by 12.7 percent on average, transport grew at an
average rate of 6.9 percent and insurance grew at a rate of 6.7 percent. Output per worker in the
services sectors in India has increased by over 7.5 percent per year during the 1990s, clearly
outpacing the agricultural or industrial sectors. Other evidence suggests that strong total factor
productivity growth was at the root of this remarkable performance, not capital deepening or higher
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mark ups. Indeed, services prices decreased relative to manufacturing prices, as indicated by a
slower pace of growth in the services deflator than the overall GDP deflator. The overall growth
rate of service sector in 2011-12 is 9.4%
2. Increase the competitive spirit
The reforms produced striking improvements in sectoral performance. In 1990, the average
turn-around time for a container at major ports in India was 8 days, and at major Mumbai ports the
average was 11. This meant that manufacturing companies exporting their products or importing
inputs had to factor in more than a week of transit time for their goods, which increased the cash
outlays necessary for exporting and importing. By 2005, the average turn-around time at major
ports in India had decreased to 3.5 days, with 4.5 days as the average time at Mumbai ports .This
reduction in transit time is likely to have improved the ability of Indian firms to compete in highly
variable markets such as textiles and electronics in which the ability to respond quickly to changes
in demand is crucial.
3. Change in financial sector
Prior to liberalization even at the most efficient public sector banks, bank loan approvals in
64 percent of cases were mechanically made for the same loan amount as prior loans. The rationing
of credit by the public sector reduced the ability of companies to respond to new business
opportunities and finance improvements in products or production processes. Because liberalization
allowed banks to set interest rates at their risk adjusted cost of capital and choose diversified loan
portfolios, by 2005 the level of investment by banks increased to 4.75 times the size of investment
in 1994. The share of investment by foreign and private banks also increased during the period
from 11 percent in 1994 to 24 percent in 2005. Despite the slow pace of reforms, credit provision
and investment have increased across the sector, led by foreign and locally-owned private banks.
4. Inflow of FDI
The elimination of barriers to entry in services provoked a dramatic response from foreign
and domestic providers. FDI inflows into services following liberalization by far exceeded those
into other sectors. Ten percent of FDI inflows during 1990-2005 went into the transport sector, 9.6
percent of the inflows were into the telecommunications sector, and 9.6 percent of the inflows were
into the financial and other services sector.
5. Change in telecommunication
Before the beginning of the reforms in telecommunications, the sector was controlled by
MTNL, a publicly owned company which provided local telephone service, and VSNL, a publicly
owned company which provided long distance service. Both companies were plagued by faults,
which averaged 19 faults per 100 stations per month in 1991. In addition, service was poorly
distributed and access to new lines was difficult.10 Businesses were severely handicapped in their
ability to communicate with their customers and suppliers and to coordinate activity across plants.
Liberalization has interacted powerfully with technological change to transform the
telecommunications market. By 2005, the number of faults had declined to 7.5 percent and the
waiting lists for telephone services had virtually disappeared in urban areas. Even rural customers,
projected by critics of the liberalization reforms to lose from the privatization, saw increases in
access to phone lines. Access to internet services, provided initially only by MTNL, increased
quickly as private providers were allowed to enter the market.
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6. Change in transport services

In the 1980s, air transport providers and several of the largest shipping companies were
publicly-owned companies. After liberalization, increasing competition from foreign companies put
pressure on Indian carriers to improve their performance. They responded positively, and operating
efficiency increased. In fact, operating revenue per employee in Indian Airlines increased over 5
times over the period 1990-2004 from 0.5 million per employee to 2.5 million per employee. The
increased efficiency has led to continued growth of India carriers in the period 1990-2005, of nearly
15 percent yearly in passenger traffic and 11 percent yearly in cargo traffic .
7. Change in insurance sector
Until 2002, private sector competition in the insurance market was proscribed, severely
limiting the range of insurance services on offer. Market penetration of insurance quickly increased
following the entry of private and foreign insurers. After decades of public monopoly, premiums
were equal to only 1.9 percent of GDP in 1999-2000, but they jumped to 2.86 percent of GDP by
2002-2003. Government projections at the time of liberalization suggested that market participation
by foreign firms in 2005 would reach only five percent of the market, but by November 2005,
private firms with foreign shareholding had acquired a 34 percent market share. This corresponded
to limited contraction by Indian public sector incumbents.
In sum, liberalization led to a metamorphosis of services in India from narrow range of
products of sub-standard quality and poor distribution, to the current environment in which service
providers are highly competitive and offer their consumers, including manufacturing firms, a wide
range of new and high quality services products.
References
1. Agricultural Statistics at a Glance, Indian Farmers Fertilizer Co-operative Limited, New
Delhi, August 2004.
2. Ahluwalia, M.S., (2002), Economic Reforms in India Since 1991: Has Gradualism
Worked?, Journal of Economic Perspectives, vol. 16, no. 3, Summer.
3. Bajpai, N., (2002), A Decade of Economic Reforms in India: the Unfinished Agenda,
CID Working Paper No. 89, Center for International Development at Harvard University.
4. Basu, K. (ed.), (2004), Indias Emerging Economy, Oxford University Press, Delhi.
5. Bhagwati, Jagdish (1993), India in Transition: Freeing the Economy. Clarendon Press,
Oxford.
6. Bhalla, G S (2004): Globalisation and Indian Agriculture, State of the Indian Farmer: A
Millennium Study, Volume 19, Academic Publishers.
7. Chand, Ramesh (2002): Trade Liberalisation, WTO and Indian Agriculture: Experience and
Prospects (New Delhi: Mittal Publications).
8. Chaudhuri, S. (2002), Economic Reforms and Industrial Structure in India, Economic and
Political Weekly, January, p.155-162.
9. Chossudovsky, M 1997, The globalization of poverty: Impacts of IMF and World Bank
Reforms, Zed Books Ltd., New Jersey & Third World Network, Penang.
10. Ghosh, J & Chandrasekhar, CP 2005, The burden of farmers debt Macroscan, September
14, 2005
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11. Ghosh, J 2000, Poverty amidst plenty?, Frontline, Volume 17 Issue 05, March 04 17,
2000
12. Government of India (2010-11), Economic Survey.
13. Hardikar J, 2006 The rising import of suicides, India together, viewed June 10, 2006
14. Issac, R 2005, The globalization gap, Pearson Education Inc., New Jersey.
15. Jalan, Bimal (1992), Balance of Payments: 1956 to 1991, in The Indian Economy:
Problems and Prospects, Penguin Books India(P) Ltd., New Delhi.
16. Joshi, Seema (2004), Tertiary Sector- Driven Growth in India ----- Impact on Employment
and Poverty,
17. Joshi, Vijay and I.M.D. Little (1996), Indias Economic Reforms 1991-2001, Oxford
University Press, Delhi.
18. Land and Livestock Holdings Survey, NSS Forty-Eighth Round, 1991, Government of
India.
19. Mitra, Arup (2008), Tertiary Sector Growth: Issues and Facts, Artha Beekshan, Vol.16,
No.4, March.
20. Mohankumar, S & Sharma, RK 2006, Analysis of farmer suicides in Kerala, Economic
and Political Weekly, April 22, 2006.
21. Nambiar, R.G., B.L. Mungekar, G.A. Tadas, (1999), Is Import Liberalisation Hurting
Domestic Industry and Employment?, Economic and Political Weekly, February, p. 417424.
22. Parikh, Kirit. (2002), Overview: Ten Years of Reforms, What Next? in Kirit Parikh and R
Radhakrishna (eds.), India Development Report 2002. Oxford University Press, New Delhi
23. Pursell, G., (1988), Trade Policies and Protection in India, The World Bank, Washington,
DC.
24. Sainath, P 2005, No lessons from past mistakes, The Hindustan Times, viewed 4 June,
2006.
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Module VII
PLANNING
Economic Planning and its objectives; Five Year Planning in India Achievements and
Failures
Introduction
Economic Planning has become part and parcel of economic development since the dawn of
the 20th Century. All countries of the world have adopted some kind of planning to achieve their
development objectives. Several factors have been responsible for the institutionalization of
planning across countries. Hence, an understanding of the evolution, meaning and definition of
planning in general and the various dimensions of planning in India is interesting as well as
meaningful. This module is an attempt to familiarize you with the technical as well as functional
aspects of economic planning. After studying this module you will be able to define planning,
elucidate the planning attempt before independence and also the performance of eleven five year
plans of our country.
The 20th century was an era of planning. Almost every country had some sort of planning.
In socialist countries, planning is almost a religion. Even in countries like the U.S.A. and the U.K,
with a capitalistic system, they have partial planning. The 19th century State was a Laissez faire
state. It followed a policy of non intervention in economic affairs. As you know, the apostle of
Laissez faire, Adam Smith set apart only three main activities of an economy to the Government.
They were: maintenance of law order, construction of social and economic overheads and
protecting the country from internal and external aggregation. But the modern State is a welfare
State. The two World Wars, the Great Depression of 1930s and the success of planning in the
erstwhile Soviet Union have underlined the need for planning. Planning is really a gift of former
Soviet Russia to the world, for; it was the first country to practice economic planning on a national
scale.
Justification for Planning
Many economists today agree that planning is an organized, conscious and continuous
attempt to select the basic available alternatives to achieve specific goals. Planning involves the
economizing of scarce resources. Most of the underdeveloped countries of the world became
independent only fifty or sixty years back and most of them were poor at that time. So it became
the main business of the Governments of the newly emergent nations to provide food, clothing and
shelter to their people. For that, first of all, they had to increase their national income. Since most
of them were agricultural countries, they had to evolve some programmes for agricultural
development. Not only that, they had to industrialize their economies, they had to provide more
jobs to their people. That means, they had to do something for expanding employment
opportunities. Further, as most of them were wedded to some kind of socialism, they had to reduce
inequalities of income and wealth. To realize these goals at early time, the poor countries embrace
the way of economic planning.
Another main reason for the emergence of planning in underdeveloped countries is the
failure of the market mechanism. Market failures refer to the set of conditions under which a
market economy fails to allocate resources efficiently. The self promoting actions of the
participants in an economy do not lead to an efficient outcome. The capitalist economy is
basically a market economy and price mechanism works through the market system. The price
system is a basic institution of capitalism. The allocation of resources and distribution of rewards
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are done through the price system. All decisions of the businessmen, farmers, industrialists and so
on are guided by the profit motive. If the market is perfect, price system is good. But if there is
monopoly and other types of imperfect competition, the market system fails and necessitates
government intervention by way of planning.
Due to recent developments in the socialist countries, rationale of planning and state
intervention came under increasing question. The focus of discussion shifted from market failure to
Government failure or distortions caused by state intervention. The causal factor for the failure is
not state intervention per se but the incentive system entrenched in a planned economy. Despite
this recent dilemma in the question of state versus market, many a countries still believe in the
efficacy of economic planning.
Define Economic Planning?
Planning involves ex ante co-ordination and conscious direction of economic activity with a
view to achieve certain social objectives. The attainment of certain social objectives provides an
extensive justification for planning. Mixed economy framework was adopted in the Indian case to
achieve these objectives. In this context it is interesting to go through some of the attempts to
define the term planning.
One can see several definitions of economic planning. Here we recapitulate some of those
definitions for the utility of the learners. According to Lionel Robbins, strictly speaking, all
economic life involves planning. To plan is to act with a purpose, to choose and choice is the
essence of economic activity. In the words of Barbara Wooten, Planning may be defined as the
conscious and deliberate choice of economic priorities by some public authorities.
Planning in India
The necessity of economic planning in India was realized not only in the post-independence
era but a number of efforts were made in this direction even during the pre-independence period.
The first effort at introducing economic planning in India was made in 1934 by Dr. M.
Visvesvarayya who at that time published his book Planned Economy for India. He formulated a
10 year development plan. However, it remained merely of academic interest and did not directly
influence any social action. An effort to evolve a national plan was made in February 1938 when
Subhas Chandra Bose in his Presidential Address to the Indian National Congress at Haripura
emphasized that, the very first thing which our future national government will have to do would
be to set up a Commission for drawing up a comprehensive plan for reconstruction. The plan will
have two parts-an immediate programme and a long period programme. But nothing has done
effectively. In the next few years, the eight leading industrialists of Bombay took the initiative of
preparing A plan of Economic Development for India. It was published in January 1944 and
came to be known as the Bombay Plan. Though the Bombay plan was also not implemented as
suggested by the industrialists, it may be emphasized here that the publication of the Bombay Plan
acted as a signal for many other similar exercises viz., the Peoples Plan under the leadership of
M.N. Roy and a Gandhian Plan under the leadership of S.N. Agarwal.
Another important step in the sphere of planning was the setting up of a planning Advisory
Board by the Interim Government in October 1946 for a review of the projects prepared by the
various Government departments and to report on them. The Board submitted its Report in
December 1946.
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Soon after Independence, the All-India Congress Committee appointed the Economic
Programme Committee under the Chairmanship of Pt. Jawaharlal Nehru in November 1947. The
Committee submitted its Report in January 1948 and recommended the institution of a permanent
Planning Commission which was set up by the Government of India in March 1950 with a view to
prepare a blueprint of development taking into consideration the needs and resources of the
country. The draft of the first five-year plan was published in July 1951 and it was approved in
December 1951. The period of various Five Year Plans in India is given in the table.
Table 7.1: Five Year Plans in India (Period-wise)
Five Year Plan
Period
I plan
1951-56
II Plan
1956-61
III Plan
1961-66
Annual Plans
1966-69
IV Plan
1969-74
V Plan
1974-79
Rolling plan (Annual Plan)
1979-80
VI Plan
1980-85
VII Plan
1985-90
Annual Plans
1990-92
VIII Plan
1992-97
IX Plan
1997-2002
X Plan
2002-07
XI Plan
2007-12
XII Plan
2012-17
Broad Objectives of Five Year Plans in India
The Indian economy has now the experience of more than six decades of economic
planning. Broadly, the objectives of the five year plans can be summarized as increasing the
national and per capital income, raising the investment-income ratio, reducing inequalities in the
distribution of wealth and income, and providing additional employment opportunities, maintaining
price stability, removal of poverty and attainment of self-reliance. However, each of the Plans also
laid special emphasis on particular objectives.
The principal aim of the First Plan was to rehabilitate the Indian economy devastated by the
effects of he Second World War and the partition of the country. The Second Plan laid stress on
rapid industrialization with particular emphasis on the development of basic and heavy industries.
The Third Plan gave top priority to agriculture with a view to achieve self-sufficiency in food
grains and increase agricultural production to meet the requirements of industry and exports. The
fourth Plan laid stress on growth with stability. In between the Third and the Fourth Plan, there
was a Plan holiday and between 1966 and 1969 three Annual Plans were formulated because the
situation created by the Indo-Pakistan conflict, two successive years of drought, devaluation of the
currency, general rise in prices and erosion of resources available for plan purposes had delayed the
finalization of the Fourth Plan. The two strategic objectives of the Fifth and Sixth Plan were
removal of Poverty and attainment of economic self reliance. In the 7th plan, modernisation was
stressed. The government which assumed in 1991 virtually abandoned these long term objectives
of economic planning. Its entire concern was to implement a programme of Macro economics and
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stablisation through Fiscal correction. Moreover, trade, industrial and public sector policies aimed
at undermining the very system of economic planning. For the first eight Plans the emphasis was
on a growing public sector with massive investments in basic and heavy industries, but since the
launch of the Ninth Plan in 1997, the emphasis on the public sector has become less pronounced
and the current thinking on planning in the country, in general, is that it should increasingly be of
an indicative nature. The 9th plan focused on accelerated growth, recognizing a special role for
agriculture, for its stronger poverty reducing and employment generating facts which will be
carried out over a period of 15 years. The eleventh plan has given top priority to inclusive growth.
Role of Planning Commission and NDC in the Planning Process
Two important agencies in the process of planning in India is the Planning Commission and the
National Development Council. It is meaningful to understand the constitution and functions of these two bodies.
a) Planning Commission
Rudimentary economic planning, deriving the sovereign authority of the state, first began in
India in 1930s under the British Raj, and the colonial government of India formally established a
planning board that functioned from 1944 to 1946. Private industrialists and economist formulated
at least three development plans in 1944.
After India gained independence, a formal model of planning was adopted, and the planning
commission, reporting directly to the Prime Minister of India was established. Accordingly, the
Planning Commission was set up on 15 March 1950, with Prime Minister Jawaharlal Nehru as the
chairman. Planning Commission though is a non statutory as well extra constitutional body, i.e. has
been brought by an executive order.
Jawahar Lal Nehru was the chairman of the first Planning
Commission of India.
The composition of the Commission has undergone a lot of change since its inception. With
the Prime Minister as the ex-officio Chairman, the committee has a nominated Deputy Chairman,
who is given the rank of a full Cabinet Minister. Mr. Montek Singh Ahluwalia is presently the
Deputy Chairman of the Commission. Cabinet Ministers with certain important portfolios act as
part-time members of the Commission, while the full-time members are experts of various fields
like Economics, Industry, Science and General Administration. The majority of experts in the
Commission are Economists, making the Commission the biggest employer of the Indian
Economic Services.
Functions
The Planning Commission's functions as outlined by the Government's 1950 resolution are
following:
1. To make an assessment of the material, capital and human resources of the country,
including technical personnel, and investigate the possibilities of augmenting those
resources which are found to be deficient in relation to the nation's requirement.
2. To formulate a plan for the most effective and balanced utilisation of country's resources.
3. To define the stages, on the basis of priority, in which the plan should be carried out and
propose the allocation of resources for the due completion of each stage.
4. To indicate the factors that tend to retard economic development.
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5. To determine the conditions which need to be established for the successful execution of the
plan within the incumbent socio-political situation of the country.
6. To determine the nature of the machinery required for securing the successful
implementation of each stage of the plan in all its aspects.
7. To appraise from time to time the progress achieved in the execution of each stage of the
plan and also recommend the adjustments of policy and measures which are deemed
important vis-a-vis a successful implementation of the plan.
8. To make necessary recommendations from time to time regarding those things which are
deemed necessary for facilitating the execution of these functions. Such recommendations
can be related to the prevailing economic conditions, current policies, measures or
development programmes. They can even be given out in response to some specific
problems referred to the commission by the central or the state governments.
From a highly centralised planning system, the Indian economy is gradually moving
towards indicative planning where the Planning Commission concerns itself with the building of a
long-term strategic vision of the future and decide on priorities of nation. It works out sectoral
targets and provides promotional stimulus to the economy to grow in the desired direction. It also
plays an integrative role in the development of a holistic approach to the policy formulation in
critical areas of human and economic development. In the social sector, schemes that require
coordination and synthesis like rural health, drinking water, rural energy needs, literacy and
environment protection have yet to be subjected to coordinated policy formulation. It has led to
multiplicity of agencies. The commission has now been trying to formulate and integrated approach
to deal with this issue.
b) The National Development Council
The Government of India set up a National Development Council on 6th August, 1952. The
N.D.C. consists of the Prime Minister, all Union Cabinet Ministers, Chief Ministers of all States
and Union Territories and the Members of the Planning Commission. The Lt. Governor and the
Chief Executive Councilor of the remaining Union Territories and the respective Chief Ministers
represent the Delhi Administration. It is also provided that other Union and States Ministers may be
invited to participate in the deliberations of the N.D.C. The
Secretary of the Planning
Commission is Secretary of the Council also.
Its functions are:
(1) To review the working of the National Plan from time to time,
(2) To consider important questions of social and economic policy affecting national development.
(3) To recommend measures for the achievement of the aims and the targets set out in the National
Plan, including measures to secure the active participation and co-operation of the people, improve
the efficiency of the administrative services, ensure the fullest development of the less advanced
regions and sections of the community and, through sacrifice borne equally by all citizens, build up
the resources for national development.
Thus, it is now the N.D.C., which prescribes the guidelines for the formulation of the
National Plan. In this new set-up the function of the Planning Commission is to prepare the Plan
according to these guidelines. In this way, the National Development Council has emerged as the
top- most policy-laying agency in the Government. Thus success of this new planning organization
could depend mainly upon the tact and sagacity of the Prime Minister and Chief Minister.
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An overview of India's Five Year Plans:

Having gone through the various aspects of Five year plans, let us review the features of
various Plan implemented so far.
First Five Year Plan (1951-56)

The 1st five year plan was presented by Jawaharlal Nehru, who was the then Prime
Minister. The primary aim of the 1st five year plan was to improve living standards of the people
of India. This could be done by making judicious use of India's natural resources. The total outlay
of the plan was Rs.2,069 crore. This amount was assigned to different sectors viz., Industrial
sector, Energy, Irrigation, Transport, Communications, Land rehabilitation, Social services,
Development of agriculture and community, Miscellaneous issues The target set for the growth in
the gross domestic product was 2.1 per cent every year. In reality, the actual achieved with regard
to gross domestic product was 3.6 percent per annum. This is a clear indication of the success of the
1st five year plan. The First Plan was basically an Agricultural Plan as this sector had got the
largest outlay. The following Irrigation projects were started during that period: Mettur Dam,
Hirakud Dam and Bhakra Dam.
2nd Five year plan(1956-61)

Industries got more importance in the 2nd five year plan. The focus was mainly on heavy
industries. The Indian government boosted manufacturing of industrial goods in the country. This
was done primarily to develop the public sector. The 2nd year five year plan, functioned on the
basis of Mahalanobis model. The Mahalanobis model was propounded by the famous Prasanta
Chandra Mahalanobis in the year 1953. His model addresses different issues pertaining to
economic development. As many as five steel plants including the ones in Durgapur, Jamshedpur
as well as Bhilai were set up during the plan. During the term of the 2nd five year plan, Atomic
Energy Commission came into being. The Commission was established in the year 1957. During
the same period, Tata Institute of Fundamental Research was born. The institute conducted several
programs to search for talented individuals. These individuals would eventually be absorbed into
programs related to nuclear power.
3rd five year plan (1961-66)

The 3rd five year plan laid considerable stress on the agricultural sector.
In addition to the above the Planning Commission aimed at I ncreasing the national income by 5
percent per annum, m aking India self sufficient by increasing agricultural production, minimizing
rate of unemployment and ensuring that people enjoy equal rights in the country. However, with
the short lived Sino Indian War of 1962 India diverted its attention to the safety of the country.
Due to the Sino Indian War, India witnessed increase in price of products. The resulting inflation
was cost push in nature. As a result of these developments, most of the targets set for the project
could not be realized.
Three Annual Plans (1966 69)
The fourth Plan could not be started immediately on completion of the Third Plan due to the
War and other problems. So there were only annual plans for three years from 1966 to `1969. It
was considered as plan holiday. The prevailing crisis in agriculture and serious food shortage
necessitated the emphasis on agriculture during the Annual Plans. During these plans a whole new
agricultural strategy involving wide spread distribution of High Yielding Varieties (HYVs) of
seeds, the extensive use of fertilizers, exploitation of irrigation potential and soil conservation was
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put into action to tide over the crisis in agricultural production. During the Annual Plans, the
economy basically absorbed the shocks given during the Third Plan, making way for a planned
growth.
4th five year plan (1969-74)

The 4th five year plan of India also served as a stepping stone for the economic growth.
India had to reform and restructure its expenditure agenda, following the attack on India in the year
1962 and for the second time in the year 1965. India had hardly recuperated when it was struck by
drought. India also had a stint of recession. Due to recession, famine and drought, India did not pay
much heed to long term goals. Instead, it responded to the need of the hour. It started taking
measures to overcome the crisis. Food grains production increased to bring about self sufficiency
in production. With this attempt, gradually a gap was created between the people of the rural areas
and those of the urban areas. The need for foreign reserves was felt. This facilitated growth in
exports. Import substitution drew considerable attention. All these activities widened the industrial
platform.

The objective of the 5th Five Year Plan was to increase the level of employment, reduce
poverty and to attain self sufficiency in agriculture. The plan was in the backdrop of a deteriorating
international scenario. The world economy was in a troublesome state when the fifth five year plan
was chalked out. This had a negative impact on the Indian economy. Prices in the energy and food
sector skyrocketed and as a consequence inflation became inevitable. Therefore, the priority in the
fifth five year plan was given to the food and energy sectors. Other important cardinal objectives
of the Plan were: Reducing the discrepancy between the economic development at the regional,
national, international level; improving the agricultural condition by implementing land reform
measures; improving the scope of self-employment through a well integrated program; reducing the
rate of unemployment both in the urban and the rural sectors; encouraging growth of the small scale
industries; enhancing the import substitution in the spheres including chemicals, paper, mineral and
equipment industries; stressed on the importance of a labour intensive production technology in
India.

The sixth plan also marked the beginning of economic liberalization. Price controls were
eliminated and ration shops were closed. This led to an increase in food prices and an increase in
the cost of living. This was the end of Nehruvian Plan and Rajiv Gandhi was prime minister during
this period. Family planning was also expanded in order to prevent overpopulation. In contrast to
China's strict and binding one-child policy, Indian policy did not rely on the threat of force. More
prosperous areas of India adopted family planning more rapidly than less prosperous areas, which
continued to have a high birth rate. The major objectives of the plan were Increase in National
Income, Modernization of Technology, Ensuring continuous decrease in Poverty and
Unemployment, Population Control through Family Planning, etc. The target growth rate of the
plan was 5.2 per cent and the actural growth was 5.4 per cent. In that sense the sixth plan was a
great success.
The Seventh Plan emphasized policies and programs which aimed at rapid growth in food
grains production, increased employment opportunities and productivity within the framework of
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basic tenants of planning.

The plan laid stress on improving the productivity level of industries
by upgrading of technology.
As an outcome of the sixth five year plan, there had been steady
growth in agriculture, control on rate of Inflation, and favourable balance of payments which had
provided a strong base for the seventh five Year plan to build on the need for further economic
growth. The 7th Plan had strived towards socialism and energy production at large. The thrust areas
of the 7th Five year plan have been:
Social Justice
Removal of oppression of the weak
Using modern technology
Agricultural development
Anti-poverty programs
Full supply of food, clothing, and shelter
Increasing productivity of small and large scale farmers
Making India an Independent Economy
Based on a 15-year period of striving towards steady growth, the 7th Plan was focused on
achieving the pre-requisites of self-sustaining growth by the year 2000. The Plan expected a growth
in labour force of 39 million people and employment was expected to grow at the rate of 4 per cent
per year. Under the Seventh Five Year Plan, India strove to bring about a self-sustained economy
in the country with valuable contributions from voluntary agencies and the general populace. It
was a great success, the economy recorded 6% growth rate against the targeted 5%.

The period 198991 was a period of economic instability in India and hence no five year
plan was implemented. Between 1990 and 1992, there were only Annual Plans. In 1991, India
faced a crisis in Foreign Exchange (Forex) reserves, left with reserves of only about US$1 billion.
Thus, under pressure, the country took the risk of reforming the socialist economy. P.V. Narasimha
Rao was the twelfth Prime Minister of the Republic of India and head of Congress Party, and led
one of the most important administrations in India's modern history overseeing a major economic
transformation and several incidents affecting national security. At that time Dr. Manmohan Singh
(currently, Prime Minister of India) launched India's free market reforms that brought the nearly
bankrupt nation back from the edge. It was the beginning of privatisation and liberalisation in India.
Modernization of industries was a major highlight of the Eighth Plan. Under this plan, the
gradual opening of the Indian economy was undertaken to correct the burgeoning deficit and
foreign debt. Meanwhile India became a member of the World Trade Organization on 1 January
1995. This plan can be termed as Rao and Manmohan model of Economic development. The major
objectives included, controlling population growth, poverty reduction, employment generation,
strengthening the infrastructure, Institution building, tourism management, Human Resource
development, Involvement of Panchayat raj, Nagar Palikas, N.G.O'S and Decentralization and
people's participation. Energy was given priority with 26.6% of the outlay. An average annual
growth rate of 6.78% against the target 5.6% was achieved.

The Ninth Five Year Plan India runs through the period from 1997 to 2002 with the main
aim of attaining objectives like speedy industrialization, human development, full-scale
employment, poverty reduction, and self-reliance on domestic resources. Ninth Five Year Plan
was formulated amidst the backdrop of India's Golden jubilee of Independence.
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The main objectives of the Ninth Five Year Plan of India are:
to prioritize agricultural sector and emphasize on the rural development
to generate adequate employment opportunities and promote poverty reduction
to stabilize the prices in order to accelerate the growth rate of the economy
to ensure food and nutritional security.
to provide for the basic infrastructural facilities like education for all, safe drinking water,
primary health care, transport, energy
to check the growing population increase
to encourage social issues like women empowerment, conservation of certain benefits for
the Special Groups of the society
to create a liberal market for increase in private investments
During the Ninth Plan period, the growth rate was 5.35 per cent, a percentage point lower than the
target GDP growth of 6.5 per cent.

The 10th Five Year Plan (2002-2007) targets at a GDP growth rate of 8% per annum.
Taking note of the inabilities of the earlier Five Years Plans, especially that of the 9th Five Year
Plan, the Tenth Five Year Plan decides to take up a resolution for immediate implementation of all
the policies formulated in the past. This amounts to making appeals to the higher government
authorities, for successful completion of their campaigns associated with the rapid implementation
of all past policies.
The primary aim of the 10th Five Year Plan is to renovate the nation extensively, making it
competent enough with some of the fastest growing economies across the globe. It also intends to
initiate an economic growth of 10% on an annual basis.
Chief Objectives of the 10th Five Year Plan:
The Tenth Five Year Plan proposes schooling to be compulsory for children, by the year
2003.
The mortality rate of children must be reduced to 45 per 1000 livings births and 28 per
1000 livings births by 2007 and 2012 respectively
All main rivers should be cleaned up between 2007 and 2012
Reducing the poverty ratio by at least five percentage points, by 2007
Making provision for useful and lucrative employments to the population, which are of the
best qualities
According to the Plan, it is mandatory that all infants complete at least five years in
schools by 2007.
By 2007, there should be a decrease in gender discriminations in the spheres of wage rate
and literacy, by a minimum of 50%
Taking up of extensive afforestation measures, by planting more trees and enhance the
forest and tree areas to 25% by 2007 and 33% by 2012
Ensuring persistent availability of pure drinking water in the rural areas of India, even in
the remote parts
The alarming rate at which the Indian population is growing must be checked and fixed to
16.2%, between a time frame of 2001 and 2011
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The rate of literacy must be increased by at least 75%, within the tenure of the Tenth Five
Year Plan
There should be a decrease in the Maternal Mortality Ratio (MMR) to 2 per 1000 live
births by 2007. The Plan also intended to bring down the Maternal Mortality Ratio to 1 per
1000 live birth by the year 2012.
The achievement of the 10th plan was 7.7 per cent compared with the target growth of 8.0 per cent.

The Eleventh Five Year Plan had aimed at achieving faster and more inclusive growth.
Rapid GDP growth, targeted at 9.0 per cent per annum, was regarded necessary for two reasons:
first, to generate the income and employment opportunities that were needed for improving living
standards for the bulk of the population; and second, to generate the resources needed for financing
social sector programmes, aimed at reducing poverty and enabling inclusiveness.
The economy has performed well on the growth front, averaging 8.2 per cent in the first
four years. Growth in 2011-12, the final year of the Eleventh Plan was originally projected at
around 9.0 per cent continuing the strong rebound from the crisis, which saw an 8.5 per cent growth
in 2010-11. Instead, the economy actually slowed down somewhat in 2011-12 compared to the
previous year a phenomenon common to all major economies reflecting the fact that 2010 was a
rebound from depressed levels in 2009. Growth in 2011-12 is likely to be around 8.0 per cent. The
economy is therefore, likely to achieve an average GDP growth of around 8.2 per cent over the
Eleventh Plan period, which is lower than the 9.0 per cent targeted originally, but higher than the
7.8 per cent achieved in the Tenth Plan. This implies a nearly 35 per cent increase in per-capita
GDP during this period. It has also led to a substantial increase in government revenues, both at the
Centre and the States, resulting in a significant step-up of resources for the programmes aimed at
inclusiveness. A healthy increase in aggregate savings and investment rates, particularly in the
private sector, testifies to the strength of our economy as it enters the Twelfth Plan period.
12th Five Year Plan (2012-17)
As Indias government prepares to submit its approach paper for its 12th five-year plan (a
plan which covers years 2012 to 2017), the Planning Commissions focus on instilling inclusive
growth is making headway. The plan is expected to be one that encourages the development of
Indias agriculture, education, health and social welfare through government spending. It is also
expected to create employment through developing Indias manufacturing sector and move the
nation higher up the value chain. Prime Minister Manmohan Singh, however, warned that
maintaining fiscal discipline is important as well. The commission will likely strive to enact
policies that will achieve somewhere around a 10 percent growth rate in factories and a 4 percent
growth rate in farm produce, though Prime Minister Singh has asked the plan to set the nations
growth rate firmly at 9 percent to 9.5 percent.
As indicated from the planning commissions presentation to the prime minister on April
21, the quantitative metrics known thus far in the early stage of the five-year plan are:
A target of GDP growth in the 9 percent to 9.5 percent range
An increase in literacy rates to 100 percent between the plans period from 2012 to 2017
An increased expenditure on health from 1.3 per cent to 2.0 per cent of GDP
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In a boon for industry, the planning commission indicated that it aims to have industry and
manufacturing-related activities grow by 11 percent over the next five years, contrasted to 8 percent
over the previous 11th five-year plan. It also aims to undertake somewhat vaguely defined, but
certainly well-intentioned, structural and regulatory reforms to facilitate investment. The plan has
also emphasized the importance of the energy sector development considering the point that
commercial energy demand is expected to increase by 7 percent per year over the next five years.
To address that increase in demand, the planning commission recommended that all methods of
current energy production and distribution be developed, from coal to nuclear energy to solar and
wind, and proposed that existing taxes on electricity should not be raised.
All told, in its early stages, the 12th five-year plan promises a lot for rural development and
growth. In that sense, it is similar to Chinas latest reiteration of its five-year plan, which seeks to
improve the lot of rural Chinese peoples by increasing urbanization and industrial efforts in central
and western China. But, by contrast, while the Chinese government seems to be continuing with
nation-wide industrialization efforts, the Indian government may be attempting to promote a policy
of reverse migration by making rural living more attractive with some access to modern amenities,
but hopefully without the accompanying chaos that goes with it.
Achievement of Economic Planning
In India the Five Year Plans have helped strengthen the foundations of economic and social
life and stimulated Industrial and Economic Growth as well as promoted Scientific and
Technological advancement. Each Five Year Plan is both and assessment of the past and a call for
the future. The Five Year Plans seek to translate into practical action the aspirations and ideas of
the millions in the country and also generate opportunity of service in the common cause of
elimination of poverty and raising standards of living. Let us examine the major achievements of
our planning efforts.
Increase in National Income
During planning period national income has increased manifold. The average annual increase in
national income was registered to be 1.2 percent from 1901 to 1947. This increase was recorded to
be 3 percent in two decades i.e. 1950-70. Moreover, average annual growth rate of national income
was 4 per cent in 1970-80 which, further, increased to 5 percent in 1980-90. From 1980-81 to 200001, it increased to 5.8 per cent. During the eleventh five year plan, the growth of the economy was
around 8 per cent. Thus, a rise in national income has been key indicator for economic development
of India.
Increase in Per capita Income
Before independence, increase in per capita income was almost zero. But after the adoption of
economic planning in India, per capita income has continuously been increased.
Development of agriculture
Agricultural productivity has also marked an upward trend during the plan period. The production
of food grains which has 510 lakh tones in 1950-51 increased to 1804 lakh tones in 1990-91 and
further to 212.0 million tones in 2000-01. During 2010-11, food grains production stood at 225
million tones. Thus, agriculture production during planning period has increased. During the entire
planning period, growth rate of agricultural production remained 2.8 per cent per annum. However,
use of chemical fertilizer, better seeds, irrigation and improved methods of cultivation has increased
productivity per hectare and per worker many times. This development has laid the foundation of
green revolution and other institutional changes in agriculture sector.
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Increase in industrial production

The industrial production has increased manifold during the plan. A number of steel plants were
built during the period of economic planning.
Self Reliance:
During the last six decades, considerable progress seems to have been made towards the
achievement of self reliance. We are no longer dependent on other countries for the supply of food
grains and a number of agricultural crops. In the same fashion, we have made substantial
investment in basic and heavy industries. We are in a position to produce all varieties of basic
consumer goods. The foreign exchange reserves of the country have also gone up.
Employment:
During the planning period, many steps have been taken to increase the employment opportunities
in the country. In the first five year plan employment opportunities to 70 lakh people were
provided. In the fourth and fifth plans about 370 lakh persons got employment. Subsequent plans
have given due importance in generating more employment through the implementation of a
number of rural and urban employment generation programmes.
Development of Science and Technology:
In the era of planning, India has made much progress in the field of science and technology. In
reality, the development is so fast that India stands third in the world in the sphere of science and
technology. Indian engineers and scientists are in a position that they can independently establish
any industrial venture.
Failures of planning in India
Despite the fact that India had made rapid progress in the sphere of agricultural as well as industrial
sectors but it is most disheartening to observe that it has miserably failed on many fronts. Its gains
turn into insignificance when we highlight how it has failed to achieve declared objectives. Let us
now discuss the major failures of our plans.
Poverty:
Though eradication of poverty has been one of the avowed objectives of Indias five year plans,
one third of our population still lives below the poverty line. These five year plans have miserably
failed to make a dent on poverty as 40 per cent of population is still in tight grip of poverty. Poverty
is greatly responsible for poor diets, low health and poor standard of living.
Unemployment:
The unemployment is a constant threat to the social atmosphere of the country as they resort to
various unlawful activities. The NSSO estimates of unemployment give us the gravity of the
problem. The pitiable position is found in rural areas where disguised unemployment and white
collar unemployment (educated unemployment) in urban areas are in a deplorable position. The
rising unemployment may be attributed to galloping population, capital intensive techniques,
defective j education system and unstable agriculture.
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Unequal Distribution of Income and Wealth:

Another failure of the planning is that the distribution of income and other assets in rural and urban
areas continues to be skewed. The bulk of increased income has been pocketed only by the rich
few while weaker section of the society lives from hand to mouth and lead a very miserable life.
This inequality is mostly seen in the possession of land, building and the like.
Inflationary Pressure:
Inflation has started with the onset of heavy doses of investment programmes during different five
year plan periods. Now, it turned to the gravity of the problem as it has created serious imbalances
in the socio-political and economic relations. During the beginning of the XIth Five year plan, rate
of inflation has crossed double digit. The people with fixed income group find it extremely
difficult to maintain the standard of living. Abnormal rise in prices has generated other problems of
corruption, black marketing, dishonesty and immorality etc.
Other issues
Along with the failures noted above, our planning has failed in other fronts too. The
planning has not succeeded in controlling galloping population growth. Balance of payment
problem is frequently disturbing our economy badly. High imports especially the POL items have
given way to balance of payment difficulties. Corruptions are on the high end. Our Ministers and
top officials are often found to be the culprits in scams and corruptive cases. Deficient capital
formation cripples our economic growth. Heavy dependence on foreign capital is increasing.
Conclusion
Indian experience with economic planning is not an unmixed blessing. We have succeeded in
several fronts while limitations are there in many areas. Unless concerted efforts are made
systematically our efforts to become a developed country in the near future will only be a dream.
Let us hope our planners and policy makers will rise up to the occasion and lead our country to a
developed one through an efficient planning process.
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Module I:
Why study Economics
A Methodological framework of studying Economics Its relevance and importance
1.1 What is Economics?
Economics studies the allocation of scarce resources among people examining what goods and
services wind up in the hands of which people. Why scarce resources? Absent scarcity, there is no significant
allocation issue. All practical, and many impractical, means of allocating scarce resources are studied by
economists. Markets are an important means of allocating resources, so economists study markets. Markets
include stock markets like the New York Stock Exchange, commodities markets like the Chicago Mercantile,
but also farmers markets, auction markets like Christies or Sothebys (made famous in movies by people
scratching their noses and inadvertently purchasing a Ming vase) or eBay, or more ephemeral markets, such as
the market for music CDs in your neighborhood. In addition, goods and services (which are scarce resources)
are allocated by governments, using taxation as a means of acquiring the items. Governments may be
controlled by a political process, and the study of allocation by the politics, which is known as political
economy, is a significant branch of economics. Goods are allocated by certain means, like theft, deemed
illegal by the government, and such allocation methods nevertheless fall within the domain of economic
analysis; the market for marijuana remains vibrant despite interdiction by the governments of most nations.
Other allocation methods include gifts and charity, lotteries and gambling, and cooperative societies and clubs,
all of which are studied by economists.
Some markets involve a physical marketplace. Traders on the Bombay Stock Exchange get
together in a trading pit. Traders on eBay come together in an electronic marketplace. Other markets,
which are more familiar to most of us, involve physical stores that may or may not be next door to each
other, and customers who search among the stores, purchasing when the customer finds an appropriate
item at an acceptable price. When we buy bananas, we dont typically go to a banana market and
purchase from one of a dozen or more banana sellers, but instead go to a grocery store. Nevertheless, in
buying bananas, the grocery stores compete in a market for our banana patronage, attempting to attract
customers to their stores and inducing them to purchase bananas. Price exchange of goods and services
for money is an important allocation means, but price is hardly the only factor even in market
exchanges. Other terms, such as convenience, credit terms, reliability, and trustworthiness are also
valuable to the participants in a transaction.
We may also define Economics as the study of how people choose to use resources. Resources
include the time and talent people have available, the land, buildings, equipment, and other tools on hand,
and the knowledge of how to combine them to create useful products and services. Important choices
involve how much time to devote to work, to school, and to leisure, how many dollars to spend and how
many to save, how to combine resources to produce goods and services, and how to vote and shape the
level of taxes and the role of government.
Often, people appear to use their resources to improve their well-being. Well-being includes the
satisfaction people gain from the products and services they choose to consume, from their time spent in
leisure and with family and community as well as in jobs, and the security and services provided by
effective governments. Sometimes, however, people appear to use their resources in ways that don't
improve their well-being.
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In short, economics includes the study of labor, land, and investments, of money, income, and
production, and of taxes and government expenditures. Economists seek to measure well-being, to learn
how well-being may increase over time, and to evaluate the well-being of the rich and the poor. The most
famous book in economics is the Inquiry into the Nature and Causes of The Wealth of Nations written
by Adam Smith, and published in 1776 in Scotland.
Let us go through some of the formal definitions of Economics.
Economics is the study of people in the ordinary business of life.-- Alfred Marshall(Principles
of Economics).
Economics is the science which studies human behavior as a relationship between given ends and
scarce means which have alternative uses. -- Lionel Robbins(An Essay on the Nature and Significance of
Economic Science)
Economics is the study of how societies use scarce resources to produce valuable commodities
and distribute them among different people. -- Paul A. Samuelson(Economics)
1.2 Subject matter of Economics
There
is a
difference of
opinion
among economists regarding
the
subject-matter
of economics. Adam Smith, the father of modern economic theory, defined economics as a subject, which
is mainly concerned with the study of nature and causes of generation of wealth of nation.
Marshall introduced the concept of welfare in the study of economics. According to
Marshall; economics is a study of mankind in the ordinary business of life. It examines that part of
individual and social actions which is closely connected with the material requisites of well being. In this
definition, Marshall has shifted the emphasis from wealth to man. He gives primary importance to man
and secondary importance to wealth.
The Robbinsians concept of the subject-matter of economics is that: economics is
a science which studies human behavior as a relationship between ends and scarce means which have
alternative uses. According to Robbins (a) human wants are unlimited (b) means at his disposal to satisfy
these wants are not only limited, (c) but have alternative uses. Man is always busy in adjusting his limited
resources for the satisfaction of unlimited ends. The problems that centre round such activities constitute
the subject-matters of economics.
Paul. A. Samuelson, however, includes the dynamic aspects of economics in the subject matter.
According to them, economics is the study of how man and society choose with or without money, to
employ productive uses to produce various commodities over time and distribute them for consumption
now and in future among various people and groups of society.
The subject matter of economics has been divided into two parts: microeconomics and
macroeconomics. In Microeconomics we study the economic behaviour of an individual, firm or industry
in the national economy. It is thus a study of a particular unit rather than all the units combined. We
mainly study the following in microeconomics:
1) Product pricing 2) Consumer behaviour 3) Factor pricing 4) Economic conditions of a section
of the people 5) Study of a firm and 6) Location of a industry.
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In macro economics, we study the economic behaviour of the large aggregates such as the overall
conditions of the economy such as total production, total consumption, total saving and total investment
in it. It includes: 1) National income and output 2) General price level 3) Balance of trade and payments,
4) External value of money 5) Saving and investment and 6) Employment and economic growth.
The problem of scarcity and choice making can be depicted using the tool of production
possibilities curve. The basic economic problems of what, how and for whom to produce can be solved in
many ways by an economy. If it gives the whole charge of the economy, to private ownership we get
capitalist economy, to public ownership we get socialist economy and jointly to private and public
ownership we get mixed economy.
1.3 Nature of Economics: Is economics a science or an art?
Economics is both a science and an art. Economics is considered as a science because it is a
systematic knowledge derived from observation, study and experimentation. However, the degree of
perfection of economics laws is less compared with the laws of pure sciences.
An art is the practical application of knowledge for achieving definite ends. A science teaches us
to know a phenomenon and an art teaches us to do a thing. For example, there is inflation in Pakistan.
This information is derived from positive science. The government takes certain fiscal and monetary
measures to bring down the general level of prices in the country. The study of these fiscal and monetary
measures to bring down inflation makes the subject of economics as an art.
1.4 Philosophy of economics
The philosophy of economics concerns itself with conceptual, methodological, and ethical issues
that arise within the scientific discipline of economics.
Philosophical reflection on economics is ancient, but the conception of the economy as a distinct
object of study dates back only to the 18th century. Aristotle addresses some problems that most would
recognize as pertaining to economics mainly as problems concerning how to manage a household.
Scholastic philosophers addressed ethical questions concerning economic behaviour, and they condemned
usury - that is, the taking of interest on money. With the increasing importance of trade and of nationstates in the early modern period, mercantilist philosophers and pamphleteers addressed questions
concerning the balance of trade and the regulation of the currency. There was an increasing recognition of
the complexities of the financial management of the state and of the possibility that the way that the state
taxed and acted influenced the production of wealth.
In the early modern period, those who reflected on the sources of a country's wealth recognized
that the annual harvest, the quantities of goods manufactured, and the products of mines and fisheries
depend on facts about nature, individual labour and enterprise, and state and social regulations. Trade also
seemed advantageous, at least if the terms were good enough. It took no conceptual leap to recognize that
manufacturing and farming could be improved and that some taxes and tariffs might be less harmful to
productive activities than others. But to formulate the idea that there is such a thing as the economy
with regularities that can be investigated requires a bold further step. In order for there to be an object of
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inquiry, there must be regularities in production and exchange; and for the inquiry to be non-trivial, these
regularities must go beyond what is obvious to the producers, consumers, and exchangers themselves.
Only in the eighteenth century, most clearly illustrated by the work of Cantillon (1755), the physiocrats,
David Hume, and especially Adam Smith, does one find the idea that there are laws to be discovered that
govern the complex set of interactions that produce and distribute consumption goods and the resources
and tools that produce them.
Crucial to the possibility of a social object of scientific inquiry is the idea of tracing out the
unintended consequences of the actions of individuals. Thus, for example, Hume traces the rise in prices
and the temporary increase in economic activity that follow an increase in currency to the perceptions and
actions of individuals who first spend the additional currency (1752). In spending their additional gold
imported from abroad, traders do not intend to increase the price level. But that is what they do
nevertheless. Adam Smith expands and perfects this insight and offers a systematic Inquiry into the
Nature and Causes of the Wealth of Nations. From his account of the demise of feudalism to his famous
discussion of the invisible hand, Smith emphasizes unintended consequences.
One can distinguish the domain of economics from the domain of other social scientific inquiries
either by specifying some set of causal factors or by specifying some range of phenomena. But since so
many different causal factors are relevant to the study of production or consumption, from the laws of
thermodynamics and metallurgy to the laws governing digestion, economics cannot be distinguished from
other inquiries only by the phenomena it studies. Some reference to a set of central causal factors is
needed. Thus, for example, John Stuart Mill maintained that, Political economy is concerned with such
of the phenomena of the social state as take place in consequence of the pursuit of wealth. It makes entire
abstraction of every other human passion or motive, except those which may be regarded as perpetually
antagonising principles to the desire of wealth, namely aversion to labour, and desire of the present
enjoyment of costly indulgences. Economics is mainly concerned with the consequences of individual
pursuit of wealth, though it takes some account of less significant motives such as aversion to labour.
Mill takes it for granted that individuals act rationally in their pursuit of wealth and luxury and
avoidance of labour, rather than in a disjointed or erratic way, but since he does not have a theory of
consumption, he develops no explicit theory of rational economic choice. Such theories were developed
only in the wake of the so-called neoclassical revolution, which linked choice (and price) of some object
of consumption not to its total utility but to its marginal utility. For example, nothing could be more
useful than water. But in much of the world water is plentiful enough that another glass more or less
matters little to an agent. So water is cheap. Early neoclassical economists such as Jevons held that
agents make consumption choices so as to maximize their own happiness (1871). This implies that they
distribute their expenditures so that a dollar's worth of water or porridge or upholstery makes the same
contribution to their happiness. The marginal utility of a dollar's worth of each good is the same.
In the Twentieth Century, economists stripped this general theory of rationality of its hedonistic
clothing. Rather than supposing that all consumption choices can be ranked in terms of the extent to
which they promote an agent's happiness, economists focused on the ranking itself. All that they suppose
concerning evaluations is that agents are able consistently to rank the alternatives they face. This is
equivalent to supposing first that rankings are complete that is, for any two alternatives x and y, either
the agent ranks x above y (prefers x to y), or the agent prefers y to x, or the agent is indifferent. Second,
economists suppose that agent's rankings of alternatives (preferences) are transitive. Though there are
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further technical conditions to extend the theory to infinite sets of alternatives and to capture further
plausible rationality conditions concerning gambles, economists generally subscribe to a view of a
rational agent as possessing complete and transitive preferences and as choosing among the feasible
alternatives whatever he or she most prefers. Attempts have also been made in the theory of revealed
preference to eliminate all reference to subjective preference or to define preference in terms of choices .
In clarifying the view of rationality that characterizes economic agents, economists have for the
most part continued to distinguish economics from other social inquiries by the content of the motives or
preferences with which it is concerned. So even though an agent may for example seek happiness through
asceticism or may rationally prefer to sacrifice all his or her worldly goods to a political cause,
economists have supposed that such preferences are rare and unimportant to economics. What economists
are concerned with are the phenomena deriving not just from rationality, but from rationality coupled
with a desire for wealth and larger consumption bundles.
Economists have flirted with a less substantive characterization of individual motivation and with
a more expansive view of the domain of economics. In his influential monograph, An Essay on the Nature
and Significance of Economic Science, Lionel Robbins defined economics as the science which studies
human behaviour as a relationship between ends and scarce means which have alternative uses.
According to Robbins, economics is not concerned with production, exchange, distribution, or
consumption as such. It is instead concerned with an aspect of all human action. Although Robbins'
definition helps one to understand efforts to apply economic concepts, models, and techniques to other
subject matters such as the analysis of voting behaviour and legislation, it seems evident that economics
maintains its connection to a traditional domain.
Economics has been of philosophical interest in three main regards. First, it raises moral questions
concerning freedom, social welfare and justice. Although economists often deny that their theories have
ethical content, they are ready with advice about how to make life better. Markets, which are the central
institutions with which economics traditionally has been concerned, involve voluntary interactions, yet
they are simultaneously mechanisms that regulate individual activities and allocate goods to people. They
thus raise intricate moral questions concerning coercion, voluntary action, and social justice.
Second, contemporary theoretical economics is largely a theory of rational choice. This may seem
surprising, since economics is supposed to be an explanatory and predictive science of the actual
interactions among people rather than a normative discipline studying how people ought rationally to
choose, but it is indeed a fact. This fact joins the interests of economists to the interests of those
philosophers concerned with rational choice.
Third, economics raises important questions in philosophy of science. In part this is because all
significant cognitive enterprises raise questions for epistemology or philosophy of science. But orthodox
theory is of particular methodological interest for seven reasons.
1. Positive and normative: The extent to which economics appears to be permeated with normative
concerns raises methodological questions about the relationships between a positive science (of what is)
and a normative science (of what ought to be). The standard view is that the positive science of
Macro Economics-I
economics, like engineering, helps policy makers to choose means to accomplish their ends, but that it has
no bearing on the choice of ends itself. This view is questionable, because economists have to interpret
and articulate the incomplete specifications of goals and constraints provided by policy makers.
2. Reasons and causes: It is of philosophical interest that orthodox theoretical economics is as
much a theory of rational choices as it a theory that explains and predicts economic outcomes. Although
economists are more interested in the aggregate results of individual choices than in the choices
themselves, their theories offer both causal explanations for why individuals choose as they do and
accounts of the reasons for their choices. Embedded within orthodox economics is a specific variant of
folk psychology, and orthodox economics provides a specific context in which to question whether
folk-psychological explanations in terms of reasons can also be causal explanations.
3. Naturalism: Of all the social sciences, economics most closely resembles the natural sciences.
Economic theories have been axiomatized, and essays and books of economics are full of theorems. Of all
the social sciences, only economics boasts a Nobel Prize. Economics is thus a test case for those
concerned with the extent of the similarities and differences between the natural and social sciences.
4. Abstraction and idealization: Economics raises questions concerning the legitimacy of severe
abstraction and idealization. For example, economic models often stipulate that everyone is perfectly
rational and has perfect information or that commodities are infinitely divisible. Such claims are
exaggerations, and they are clearly false. Can good science make such false claims?
5. Ceteris paribus clauses: Because economists attempt to study economic phenomena as
constituting a separate domain, influenced only by a small number of causal factors, the claims of
economics are true only ceteris paribus -- that is, they are true only if there are no interferences or
disturbing causes. What are ceteris paribus clauses, and when if ever are they legitimate in science?
6. Causation: Many important generalizations in economics make causal claims. For example, the
law of demand asserts that a price increase will (ceteris paribus) diminish the quantity demanded. Yet
economists are wary of causal language because of its suggestion that outcomes have single causes and
because of difficulties integrating talk of causation and talk of equilibrium mutual determination.
Econometricians have also been deeply concerned with the possibilities for determining causal relations
from statistical evidence and with the relevance of causal relations to the possibility of consistent
estimation of parameter values.
7. Structure and strategy: During the past generation philosophers of science have been concerned
to comprehend the larger theoretical structures that unify and guide research within particular research
traditions or research programmes. Since orthodox economics is very systematically unified, though not
in quite the way that Kuhn (1970) or Lakatos (1970) discuss, it poses interesting puzzles about what
guides research. Since the success of orthodox economics is controversial, this research tradition also
poses questions about how unified and constrained research ought to be.
These are the seven most significant philosophical issues concerning neoclassical economic
theory, and many of these issues arise concerning all schools of economics.
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10
1.3 Fields of Economics

Economists organize their discipline in fields from agricultural economics to urban economics.
The fields are in two sets: Those that develop core skills and those that emphasize application of the skills
in specific settings. The core itself involves two modes of analysis. The Skills page gives simple
examples. First, mathematical description of economic phenomena allows derivation of relationships.
This mode of thought is called economic theory. Mathematics allows arguing by deductive reasoning
from stated premises to a conclusion. It offers the internal consistency of mathematical proofs but
requires no evidence of applicability.
The second core method looks for evidence based on observing economic phenomena. It draws
inference from persistent patterns. A consistent pattern that is distinct from the complexity and
randomness in nature is likely to have meaning. This mode of thought is called inductive reasoning. It is
the mode of analysis of economic historians, statisticians, and experimenters. The study of formal
methods for drawing inferences from statistical evidence in economics is called econometrics.
The fields of economics, then, are more signposts than fences. They include the core areas of
mathematical and statistical methods as well as the many arenas in which the core methods are applied.
Most undergraduate Programs include study in the core fields and in a selection of applied fields. The
standard classification of economic fields given below appears in the Journal of Economic Literature.
These field labels provide enduring markers on the terrain of economic thought.
A). General Economics and Teaching -- The principles course in the economics curriculum
develops core ideas. The course also provides the big picture of how individual economic events fit
together to shape aggregate outcomes. Mastering basic ideas and getting a sense of how the parts fit into
the whole is an essential entry point to the study of other fields and more advanced ideas in economics.
The A category also includes discussion of the teaching of economics.
B). Schools of Economic Thought and Methodology -- Economists who study the history of
economic thought investigate how the core ideas in economics have developed.
C). Mathematical and Quantitative Methods -- Econometricians develop methods to measure
economic phenomena. They apply the scientific method by formulating hypotheses, gathering evidence,
and judging whether the evidence is consistent with the hypotheses. Mathematical economists develop
tools for finding optimal solutions to economic problems and advance ideas in game theory. Game theory
is the method for analyzing how one player chooses strategies in light of knowledge of the possible
strategies a rival might choose. Game theory is used to analyze many economic phenomena including the
interaction between firms. In recent decades, experimental economists have tested economic theories in
laboratories and in the field.
D). Microeconomics -- Studying how markets function and the role of prices is of central concern
in understanding economics. Investigation of the behavior of individual households, firms, and prices and
quantities of specific products like automobiles is called microeconomics. Behavioral economists study
the cognitive and emotional dimensions of economic decisions.
E). Macroeconomics and Monetary Economics -- The actions of individuals sum to the total
activity in a whole economy. In the aggregate, the total amount of products consumed by households and
firms must equal the total amount produced. The total amount firms pay to workers and investors must
equal the amount households receive in income. Study of the aggregate relationships in an economy is
called macroeconomics. Economic growth, the role of money and interest rates, and changes in the
overall level of prices and the aggregate level of unemployment are central concerns of macroeconomics.
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F). International Economics -- International economists study trade among nations and the flow of
finance across international borders. Globalization and the deficit in the U.S. balance of payments with
other countries are current concerns.
G). Financial Economics -- Financial economists study the process of saving and investing with a
specific concern for how individuals and firms deal with risk.
H). Public Economics -- Public finance economists consider the role of government in the
economy. Some focus on evaluating government programs and others focus on the design of tax systems.
Public finance economists are also interested in how the political process makes decisions. Issues of
national security and defense appear here as well the study of state and local governments.
I). Health, Education, and Welfare -- Some economists focus on the markets and government
policies that directly shape access to health care. Others focus on schools and educational policies. Still
others consider the economic circumstances of the poor and evaluate alternative government programs to
improve the well-being of the poor.
J). Labor and Demographic Economics -- Labor economists study employers decisions to hire
workers and employees decisions to work. They study how wages are set, the nature of incentives
workers face, and the role of minimum wage laws, unions, pensions plans, and training programs. They
are also interested in the formation of families, determinants of birth rates, migration, population change,
and aging.
K). Law and Economics -- Some economists use the tools of economics to study the incentives for
human behavior that are defined by the legal system. Property rights, for example, are essential for
markets to work well but they can be defined in a variety of ways that have different effects on the wellbeing of people.
L). Industrial Organization -- IO is the study of individual markets, the nature of competition, and
the role of prices. Some economists study issues in anti-trust policy. Others study the role of advertising,
pricing policies, and how costs vary with the scale of operations. Some IO economists investigate
particular industries such as appliances, software, and electricity. In the last decade a number of
economists have studied economic issues in sports, recreation, and tourism.
M). Business Administration and Business Economics, Marketing, Accounting --Business
economists study decisions made by firms. How do firms maximize profit? What prices should they set
and how much should they produce? What is the role of incentives within the firm, of entrepreneurship,
and leadership?
N). Economic History -- Economic historians explore changes in economic well-being and how
economic institutions have developed. The emergence of markets, the forces shaping the industrial
revolution, the sources of improvements in agricultural productivity, the influence of railroads and other
new technologies provide perspective on current economic issues.
O). Economic Development, Technical Change, and Growth -- Economists who are interested in
the development of economies often focus on third world countries. Why have some countries developed
while others have not? How might the industrialized countries improve the prospects for development
around the world? Who gains and who loses with industrialization?
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P). Economic Systems -- Analysts compare the capital market system to the various forms of
socialism and the transition from centrally planned to more market-based economic systems. Economists
sometimes address issues in specific countries like China, Cuba, and Poland.
Q). Agricultural and Natural Resource Economics, Environmental and Ecological Economics -Economists study farming, fishery, and forests with a focus on prices, markets, and changing
technologies. Natural resource economists study markets forenergy (oil, coal, and electricity) and mineral
resources. Economists have played an important role in the evolution of policies to promote clean air,
water, and land.
R). Urban, Rural, and Regional Economics -- Economists analyze the location decisions of
households and firms and the associated issues in housing, transportation, and local government.
S). Miscellaneous Categories -- Data, dissertations, and book reviews are classified here.
T). Other Special Topics -- Other special topics include the economics of the arts, religion, and
culture.
1.4: Economics and ethics
Most economists would insist that one distinguish between positive and normative economics, and
most would argue that economics is mainly relevant to policy because of the information it provides
concerning the consequences of policy. Yet the same economists who so sharply distinguish positive and
normative economics will often turn around and offer their advice concerning how to fix the economy. In
addition, there is a whole field of normative economics.
Economic outcomes, institutions, and processes may be better or worse in several different ways.
Some outcomes may make people better off. Other outcomes may be less unequal. Others may restrict
individual freedom more severely. Economists typically evaluate outcomes exclusively in terms of
welfare. This does not imply that they believe that only welfare is of moral importance. They focus on
welfare, because they believe that economics provides a particularly apt set of tools to address questions
of welfare and because they believe or hope that questions about welfare can be separated from questions
about equality, freedom, or justice. As sketched below, economists have had some things to say about
other dimensions of moral appraisal, but welfare takes centre stage. Indeed normative economics is called
welfare economics.
1.4.1. Welfare
One central question of moral philosophy has been to determine what things are intrinsically good
for human beings. This is a central question, because all plausible moral views assign an important place
to individual welfare or well-being. This is obviously true of utilitarianism (which hold that what is right
maximizes total or average welfare), but even non-utilitarian views must be concerned with welfare, if
they recognize the virtue of benevolence, or if they are concerned with the interests of individuals or with
avoiding harm to individuals.
There are many theories of well-being, and the prevailing view among economists themselves has shifted
from hedonism (which takes the good to be a mental state such as pleasure or happiness) to the view that
welfare is the satisfaction of preferences. Unlike hedonism, taking welfare to be the satisfaction of
preference specifies how to find out what is good for a person rather than committing itself to any
substantive view of a person's good. Note that equating welfare with the satisfaction of preferences is not
equating welfare with any feeling of satisfaction. If welfare is the satisfaction of preferences, then a
person is better off if what he or she prefers comes to pass, regardless of whether that occurrence makes
the agent feel satisfied.
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1.4.2. Efficiency
Economists have instead explored the possibility of making welfare evaluations of economic
processes, institutions, outcomes, and policies without making interpersonal comparisons. Consider two
economic outcomes S and R, and suppose that some people prefer S to R and that nobody prefers R to S.
In that case S is Pareto superior to R, or S is a Pareto improvement over R. Without making any
interpersonal comparisons, one can conclude that people's preferences are better satisfied in S than in R.
If there is no state of affairs that is Pareto superior to S, then economists say that S is Pareto optimal or
Pareto efficient. Efficiency here is efficiency with respect to satisfying preferences rather than
minimizing the number of inputs needed to produce a unit of output or some other technical notion.
1.4.3. Other directions in normative economics
Although welfare economics and concerns about efficiency dominate normative economics, they
do not exhaust the subject, and in collaboration with philosophers, economists have made a wide variety
of important contributions to contemporary work in ethics and normative social and political philosophy.
In addition economists and philosophers have been working on the problem of providing a formal
characterization of freedom so as to bring tools of economic analysis to bear. Others have developed
formal characterizations of equality of resources, opportunity, and outcomes and have analyzed the
conditions under which it is possible to separate individual and social responsibility for inequalities. John
Roemer has put contemporary economic modelling to work to offer precise characterizations of
exploitation. Amartya Sen and Martha Nussbaum have not only developed novel interpretations of wellbeing in terms of capabilities, but Sen has linked them to characterizations of egalitarianism and to
operational measures of deprivation.
1.5 Relevance of Economics
About the importance of economics Malthus says, Political economy is perhaps the only science
of which it may be said that the ignorance of it is not merely a derivation of good but produce great
positive evil.
Following are the main advantages of the study of economics.
1) For the producer: Economics is very useful for the producer. It guides him that how he should combine
the four factors of production and minimize the cost of production.
2). For the consumer: The consumer can adjust his expenditure of various goods in better way if he knows
the principles of economics. He will spend his income according the law of Equi-Marginal utility in order
to get maximum satisfaction.
3). Solving economic problems: It helps in removing the poverty from the country. Devloping countries
are facing many problems like unemployment , over population low per capita income and low
production. Economics is very useful in solving these problems.
4). Leaders of nations: Its study is helpful for the leaders to understand the economic problems if they
have a knowledge of Economics.
5). Finance minister: Finance minister prepares the yearly budget of the country. Economics guides him
that how he should frame the tax policy and monetary policy.
6). For the distribution of the national income : From the study of economics one can easily judge that
how the income should be distributed among the four factors of production. For this purpose Marginal
productivity theory is suggested by economics.
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7). Cultural value: A person's education can not be considered complete unless he has some knowledge of
economics. The events which happen daily around us have an important economic bearing. So there is
also the cultural value of the study of economics.
8). Common man: The study of economics is very useful for every citizen. It enables him to understand
and criticize the economic policies of the government. He can also guide the government.
9). Economic planning: In the modern age the importance of economic planning can not be ignored.
Through planning we can utilize our natural resources in better way and can improve our economic
condition.
10). Importance of labour : It guides the workers that how they can get maximum wages from the employer. It
enables them to get the right of trade union , collective bargaining and fixation of working hours.
11). Solution for economic crisis: It guides the nations that how they can save themselves from the
economic crises. The advanced countries desire is that there should be economic stability and full
employment without inflation to achieve these objectives, economics is very useful for them.
12). Inspiration for development :The study of advanced countries economy inspires the less development
countries that they can also improve their economics conditions.
13). Intellectual value: Economics has great intellectual value, because it broadens our out-look, sharpens
our intellect and inculcate in us the habit of balanced thinking.
14). Optimum use of resources: In the many countries there is a lot of wastage of resources. The study of
economic development will enable them to make the optimum use of their resources.
15). Creates the sense of responsibility: Economics develop the sense of responsibility among the citizens
by explaining the various problems and their solutions.
16). Useful for international trade : Its study is very useful for international trade. It helps the importers
and exporters to earn maximum profit. A businessman can easily understand the trade policies of various
countries.
1.6 Economic Analysis
Economic analysis is a process whereby the strengths and weaknesses of an economy are
analyzed. Economic analysis is important in order to understand the exact condition of an economy.
Macroeconomics and Economic Analysis: Macroeconomic issues are important aspects of the economic
analysis process. However, economic analysis can also be done at a microeconomic level.
Macroeconomic analysis gives insight into the fundamentals of an economy - and the strengths and
weaknesses of economies. Macroeconomic analysis takes into account growth achieved by aar economy,
or rather a sector of that economy. It tries to reveal reasons behind a particular economic phenomenon
like growth or reversal of the economy.
Inflation and Economic Analysis: Many countries in the world are plagued by rising inflation. Economic
analysis tells us why inflation has taken place. It also suggests ways in which the rate of inflation could be
reduced, so that economic development could continue.
Economic Analysis and Government Policies: Government policies and plans that affect the economy
have always been an important part of economic analysis. Since policies and plans adopted by a particular
government are responsible for shaping an economy, they are always closely scrutinized by various
processes of economic analysis.
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Economic Ratings and Economic Analysis: Economic ratings are another important aspect of economic
analysis, as it provides an accurate picture of how an economy is faring compared to others.
Economic Analysis and Comparison of Economic Policies: It is a good way to analyze an economy by
comparing its policies with those of other economies. This is all more applicable in the case of economies
that are of similar types, for example developing economies.
1.7 Economic methodology and social studies of science
Throughout its history, economics has been the subject of sociological as well as methodological
scrutiny. Many sociological discussions of economics, like Marx's critique of classical political economy,
have been concerned to identify ideological distortions and thereby to criticize particular aspects of
economic theory and economic policy. Since every political program finds economists who testify to its
economic virtues, there is a never-ending source of material for such critiques.
The influence of contemporary sociology of science and social studies of science, coupled with
the difficulties methodologists have had making sense of and rationalizing the conduct of economics,
have led to a sociological turn within methodological reflection itself. Rather than showing that there is
good evidence supporting developments in economic theory or that those developments have other
broadly epistemic virtues. Many methodologists and historians have argued that these changes reflect a
wide variety of non-rational factors, from changes in funding for theoretical economics, political
commitments, personal rivalries, attachments to metaphors, or mathematical interests.
Furthermore, many of the same methodologists and historians have argued that economics is not
only an object of social inquiry, but also as a tool of social inquiry. By studying the incentive structure of
scientific disciplines and the implicit or explicit market forces impinging on research (including of course
research in economics), it should be possible to write the economics of science and the economics of
economics itself.
1.8. Methodenstreit
Methodenstreit is a German term referring to an intellectual controversy or debate over
epistemology, research methodology, or the way in which academic inquiry is framed or pursued. More
specifically, it also refers to a particular controversy over the method and epistemological character of
economics carried on in the late 1880s and early 1890s between the supporters of the Austrian School of
Economics, led by Carl Menger, and the proponents of the (German) Historical School, led by Gustav
von Schmoller. On an intellectual level the Methodenstreit was a question of whether there could be a
science, apart from history, which could explain the dynamics of human action. The Historical School
contended that economists could develop new and better social laws from the collection and study of
statistics and historical materials, and distrusted theories not derived from historical experience. Thus, the
German Historical School focused on specific dynamic institutions as the largest variable in changes in
political economy. The Historical School were themselves reacting against materialist determinism, the
idea that human action could, and would (once science advanced enough), be explained as physical and
chemical reactions. The Austrian School by contrast believed that economics was the work of
philosophical logic and could only ever be about developing rules from first principles - seeing human
motives and social interaction as far too complex to be amenable to statistical analysis - and purporting
their theories of human action to be universally valid.
1.9 Nature of Economic Laws:
Economics, like all other sciences, has drawn its own set of generalizations or laws. Economic laws are
nothing more than careful conclusions and inferences drawn with the help of reasoning or by the aid of observation
of human and physical-nature. In everyday life, we see man is always busy in satisfying his unlimited wants with
limited means. In doing so, it acts upon certain principles. These principles or generalizations which an average
man usually follows when he is engaged in economic activity are named Economic Laws.
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Economic laws the statements of general tendencies. In the words of Marshall: Economic laws
are those social laws which relate to branches of conduct, which the strength of motive chiefly concerned
can be measured by money prices.
(1) Laws of economics are less exact. The nature of economic laws is that they are less exact as
compared to the laws of natural sciences like Physics, Chemistry, Astronomy, etc. An economist cannot
predict with surety as to what will happen in future in the economic domain. He can only say as to what is
likely to happen in the near future.
(2) Economic laws are essentially hypothetical. Economic laws, writes Seligman, are essentially
hypothetical. They are true under certain given conditions. If these conditions are fulfilled, the
conclusions drawn from them will be true and exact as those of the laws of physical sciences. From this
statement that laws of economics are hypothetical, we should not conclude that, they are useless or unreal.
In the words of Samuelson writes Despite the approximate character of economics laws, it is blessed
with many valid principles.
(3) Economic laws qualitative or quantitative. Laws of economics are qualitative in nature. They are
not exactly stated in quantitative terms. They tell the direction of change which is expected rather than the
amount of change. For example, according to the law of demand, the quantity demanded varies inversely
with price. We do not say that 10% rise in price will lead to 30% fall m the quantity demanded.
4) Applies on the average in normal conditions. Economic laws do not deal with any particular
individual, firm, commodity etc. It takes an average economic unit and lays down its economic behavior.
(5) Laws of economics are more exact than the laws of other social sciences. We do admit that the
laws of economics are not 100% exact. They are, however, more exact than the laws of any other social
science.
1.10 Methods of Economic Analysis:
An economic theory derives laws or generalizations through two methods: (1) Deductive Method
and (2) Inductive Method.These two ways of deriving economic generalizations are now explained in
brief:
(1) Deductive Method of Economic Analysis:
The deductive method is also named as analytical, abstract or prior method. The deductive method
consists in deriving conclusions from general truths, takes few general principles and applies them draw
conclusions. For instance, if we accept the general proposition that man is entirely motivated by selfinterest. In applying the deductive method of economic analysis, we proceed from general to particular.
The classical and neo-classical school of economists notably, Ricardo, Senior, Cairnes, J.S. Mill, Malthus,
Marshall, Pigou, applied the deductive method in their economic investigations.
Merits of Deductive Method:
The main merits of deductive method are as under:
(i) This method is near to reality. It is less time consuming and less expensive. (ii) The use of
mathematical techniques in deducing theories of economics brings exactness and clarity in economic
analysis. (iii) There being limited scope of experimentation, the method helps in deriving economic
theories. (iv) The method is simple because it is analytical.
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Demerits of Deductive Method:

It is true that deductive method is simple and precise, underlying assumptions are valid. (i) The
deductive method is simple and precise only if the underlying assumptions are valid. More often the
assumptions turn out to be based on half truths or have no relation to reality. The conclusions drawn from
such assumptions will, therefore, be misleading. (ii) Professor Learner describes the deductive method as
armchair analysis. According to him, the premises from which inferences are drawn may not hold good
at all times, and places. As such deductive reasoning is not applicable universally. (iii) The deductive
method is highly abstract. It require; a great deal of care to avoid bad logic or faulty economic reasoning.
As the deductive method employed by the classical and neo-classical economists led to many facile
conclusions due to reliance on imperfect and incorrect assumptions, therefore, under the German
Historical School of economists, a sharp reaction began against this method. They advocated a more
realistic method for economic analysis known as inductive method.
(2) Inductive Method of Economic Analysis:
Inductive method which also called empirical method was adopted by the Historical School of
Economists". It involves the process of reasoning from particular facts to general principle. This method
derives economic generalizations on the basis of (i) Experimentations (ii) Observations and (iii) Statistical
methods.
In this method, data is collected about a certain economic phenomenon. These are systematically
arranged and the general conclusions are drawn from them.
For example, we observe 200 persons in the market. We find that nearly 195 persons buy from the
cheapest shops, Out of the 5 which remains, 4 persons buy local products even at higher rate just to
patronize their own products, while the fifth is a fool. From this observation, we can easily draw
conclusions that people like to buy from a cheaper shop unless they are guided by patriotism or they are
devoid of commonsense.
Merits of Inductive Method:
(i) It is based on facts as such the method is realistic. (ii) In order to test the economic principles,
method makes statistical techniques. The inductive method is, therefore, more reliable. (iii) Inductive
method is dynamic. The changing economic phenomenon are analyzed and on the basis of collected data,
conclusions and solutions are drawn from them.
(iv) Induction method also helps in future
investigations.
Demerits of Inductive Method:
The main weaknesses of this method are as under:
(i) If conclusions drawn from insufficient data, the generalizations obtained may be faulty. (ii) The
collection of data itself is not an easy task. The sources and methods employed in the collection of data
differ from investigator to investigator. The results, therefore, may differ even with the same problem.
(iii) The inductive method is time-consuming and expensive.
The above analysis reveals that both the methods have weaknesses. We cannot rely exclusively on
any one of them. Modern economists are of the view that both these methods are complimentary. They
partners and not rivals. Alfred Marshall has rightly remarked: Inductive and Deductive methods are
both needed for scientific thought, as the right and left foot are both needed for walking. We can apply
any of them or both as the situation demands.
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Module II
Micro Economics and Macro Economics
Micro Economics and Macro Economics - National Income concepts Potential GNP - Actual GNP GDP Gap Green GNP Macro - Economic Models Exogenous, Endogenous, ex-ante, ex-post,
Nominal, real, dependent and independent variables Identities and Equations.
Economics is the branch of knowledge that studies about the behaviour of individuals and their
activities. In doing so, the discipline focuses upon the economic factors that influence the behaviour and
activities. Specifically, economics studies about the behaviour of economic units (like households, firms).
Such a study can be conducted by focussing upon the individual activity or by considering the
aggregate aspects of activities of all individuals together.
Broadly speaking, the first one is called as the micro economic study and the second one is called
as the macroeconomic study. Specifically, micro economics studies and explains the behaviour of
individual economic units where as macro economics studies and predicts the behaviour of economic
variables in aggregate form like aggregate consumption, employment etc. The study of individual
decision maker (household, firm) and the economic choices that he faces are the starting blocks of micro
economic enquiry. On the other hand, macroeconomics visualises relationships among aggregate
variables and explores the consequences as the aggregate variables interacts each other.
Aggregate activity is the result of activities of individual economic units. Then why should we
need a separate macroeconomic study as microeconomics attempts to study about the behaviour and
activities of individual economic units? The reason is that many a times even the best decisions, from the
viewpoint of individual economic units, may not result in best results for the society as a whole.
Another view regarding the distinction between micro and macro economics is provided by the
Swedish economist Axel Leijonhufvud (pronounced as leonwood). He argued that the fundamental
difference between micro economics and macroeconomics is that the former primarily studies about the
situations of full utilisation of resources whereas the latter primarily studies about the situations of
underemployment and excess capacity.
Introduction of the Concepts
It is widely accepted that the Norwegian economist Ragnar Frisch in 1933 coined the terms
microeconomics and macro economics. But the Austrian economist Fritz Machlup argued that the
writings of Frisch only have terms like micro dynamic and macro dynamic even though he used them
with a meaning almost near to the current meaning and usage. It is after the publication of General
Theory by John Maynard Keynes in 1936, the term macroeconomics became popular and the
distinction between micro and macro got attention. Even though Keynes did not use these terms explicitly
but, in fact, refereed to macroeconomics as the the theory of output and employment as a whole in
General Theory.
Disconnect between Micro and Macro Economics
The disconnect between micro and macro economics many a times resulted in intense debate
among economists. In fact, both attempt to study about the aspects of economic activity but from different
viewpoints. Once Kenneth J Arrow remarked it as a major scandal that the neo classical price theory
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which is micro economic in nature cannot explain macroeconomic phenomena like unemployment
(especially the crisis of 1930s). At the same time economists like Robert Lucas and Thomas Sargent
argued that Keynesian economics is fundamentally flawed as many of the Keynesian macroeconomic
ideas do not have micro foundations (explanations). As a matter of fact, lack of micro foundations does
not by it mean that the Keynesian macroeconomic ideas could not be explained from micro economic
level.
Review Questions
1) Distinguish clearly the terms micro and macro economics with examples.
2) Why do we need microeconomic and macroeconomic studies separately?
3) Discuss about the absence of connection between micro and macro economics.
4) Write a note on the origin of the concepts micro and macroeconomics.
National Income Accounting
Put simply, national income accounting (also called as social accounting) is the measurement of
value of all economic activities of a nation. According to Paul Studenski who wrote the history of
development of national accounts, the pre history of national accounting is located in the mercantilist
period of sixteenth century. Mercantilists considered wealth of a nation consist of stock of precious
metals (like gold, silver). However, it was William Petty, a British mercantilist economist and French
economist Pierre Boisguillebert (pronounced as Bos gil bert) pioneered the first real estimates of national
income.
Petty defined the income of the people as annual value of labour and annual proceed of the
stock or wealth of the nation. Boisguillebert considered what a nation produces and exchanges as the
wealth of a nation rather than the stock of precious metals or so. Later, the French Physiocrats of
eighteenth century argued that agriculture was the only productive activity and hence national income is
simply equal to the net product of agriculture.
By the end of the eighteenth century Adam Smith
pointed out that apart from the agricultural production there are many other productive activities like the
production of material goods etc. and they also need to be counted. But Smith considered the activities of
government employees (including the judicial men, police personnel etc) as unproductive and hence
argued for their exclusion.
Karl Marx critiqued Smiths view and argued that whether labour was productive or not was
determined by the social relations of production. For instance, Marx pointed out that hotel chefs and
waiters all are productive labourers as their labour is converted into capital for their employer. Hence all
that labour is productive if it produces capital. However Marxian theory became problematic during
1890s when the Austrian economist Bohm Bawerk launched his famous attack (transformation problem)
on Marxs labour theory of value.
In the broader history of national accounting the distinction between productive and unproductive
activities etc were considered as closed with the advent of marginalist revolution brought about by the
writings of Italian economist Leon Walras, the British economist Stanley Jevons and the German
economist Carl Menger. The British economist Alfred Marshall (also belongs to the marginal school)
gave the final blow and pointed out that, "Everything that is produced in the course of a year, every
service rendered, every fresh utility brought about is a part of the national wealth."
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The Great Depression, Keynes General Theory and National Accounts

The neo classical economists could not explain the reasons for the crisis and it was Keynes who
first made a comprehensive explanation with the concept of aggregate demand. He argued that during a
period of downturn the aggregate demand would be very low and the solution is to increase it by
increasing the government expenditure.
The suggestions of Keynes required changes in economic policy (especially in the expenditure
policy of the government) and this necessitated the analysis of components of aggregate demand. It
eventually resulted in the conversion of time series data on national income into national income
accounts. The components of national income accounts like consumption, investment, saving, exports,
wages, profits etc are considered as necessary elements to understand and analyse the behaviour and
structure of the economy.
However, the Russian economist Simon Kuznets estimation of U.S.
national income for 1929-1932 (published in 1934) came well ahead of the publication of General Theory
of Keynes and was the first major attempt in the estimation of national income.
Measurement of Economic Activities
All economic activity generates income in one way or other. So its measurement can be made by
simply estimating the income generated in the economy. But the competing definitions regarding what
constitutes productive activity make it difficult to measure economic activity through income
measurement. So national product becomes the widely used concept in the measurement of economic
activity. There is one more reason for the shift from national income to national product.
Keynes was concerned with the effect of financing the British war effort (Second World War)
upon the economy. National product involves all final capital goods produced in the economy but in the
course of time some part of that capital goods get used up in the process. This consumption of capital
goods is called as depreciation and need not happen in the same year in which the measurement takes
place. Hence the estimation of the productive capacity of a nation requires the consideration of these
aspects. When depreciation is deducted from the gross national product (GNP) we get net national
product (NNP) which is equal to national income.
NNP = GNP minus Depreciation
The gross national product (GNP) is defined as the market value of all final goods and services produced
by residents of a nation in a given period of time, usually a year.
If a person resides in a nation for more than 180 days in a calendar year he is considered as the
resident of a nation. Such a resident need not be a citizen of the nation. Hence, GNP refers to the total
income earned by the residents of a nation. But what about the total income produced but available within
the nation? It is called as the gross domestic product/income(GDP).
The gross domestic product (GDP) is defined as the market value of all final goods and
services produced within an economy in a given period of time, usually a year.
GDP = GNP minus net factor payments.
Factor payments can flow out of the nation or to the nation. Hence,
Net factor payments = Factor payments from abroad minus Factor payments
to abroad.
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For instance, consider the ownership of an agricultural estate in India by an American citizen. The
profit received by the American citizen is due to the economic activity conducted with in India but since
he is an American citizen he wants to send it to America. That means the profit so earned will be no
longer available with in India for domestic use. This withdrawal of profit from India is called as factor
payment to abroad. Hence, the profit generated in the estate will be included in GNP but excluded from
the GDP. (Why?) Since the profit will be send to America. Similarly if Indian citizens working in other
countries send income to India it will be considered as factor payments from abroad
GDP as both Income and Expenditure
GDP can be considered as the total income available for domestic use or as the total expenditure
on goods and services produced in the economy. GDP as a measure of income and expenditure is not
difficult to understand. For every transaction there will be a seller and buyer. What the seller receives is
income whereas what the buyer spends is expenditure and both must be equal. The idea can be better
explained with the help of a diagram called as circular flow of income.
Circular Flow of Income
The concept was first introduced by the French economist Francois Quesnay. Quesnay was a
trained surgeon and his knowledge in medical science helped him to take the example of blood circulation
proved by the British physician William Harvey to explain the inter connectivity between different
economic activities. The figure given below explains the circular flow for an economy with single input
labour and single output cloth.
The inner loop shows the flow of labour units from the households to the firms and from firms
households receive cloth. This inner loop represents the flow of goods. The outer loop represents the
flow of income/expenditure. Firms give wages to the labour which becomes the income of the
households. The households in turn spend this income for buying the cloth produced by the firm and
hence it becomes the expenditure of the households. It is now clear that the GDP is equal to the income
received by the households from the labour and the expenditure on the purchase of cloth.
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Stocks and Flows

On the basis of nature of economic variables, they are measured at a point of time or by per unit of
time. The value of some economic variables is constant over a period of time while that of the others are
changing as time elapses. The former are called as stock variables and the latter are called as flow
variables. For instance, GDP is a flow variable as its value changes as time elapses. If you compute the
value of GDP every hour it changes as time elapse even though we do not compute like that due to the
complexities involved in it. On the other hand, wealth is a stock variable. Its value will not change by
every hour as what happens in the case of GDP. The value of wealth changes very slowly. Hence its value
is measured at a point of time whereas the value of a flow variable is measured per unit of time. That is
why GDP is often measured per year. The list of some common stock and flow variables are given below:
Stock
Flow
1) Wealth
Income, Expenditure
2) Debt
Fiscal deficit, Revenue deficit
3) Capital
Investment
4) Unemployment
Number of persons losing jobs
Measuring GDP: Points to Remember
Market Value
The definition of GDP is:
The gross domestic product (GDP) is defined as the market value of all final goods and
services produced within an economy in a given period of time, usually a year.
Suppose the nation produces 10 kg of rice and 20 kg of wheat. A simple addition of these
quantities would become a wrong calculation. That is, it is wrong to say that 30 kg of cereals represent the
GDP. Rice and wheat are valued differently by the people and the calculation of GDP must reflect that.
Because of that in the definition we take the market values. If the price of rice/kg and wheat/kg is Rs 12
and Rs 15 respectively the GDP will be:
= (10 kg of rice X Rs 12/kg) + (20 kg of wheat X Rs 15/kg)
= Rs. 120 + Rs. 300 = Rs 420.
Used Goods
The sale/purchase of used goods will not be considered for GDP calculation as GDP considers only the
value of goods and services produced in a given year. Used goods are produced some year back and had
been included in that years GDP. Thus sale/purchase of used goods represents only transfer of assets not
fresh production of income.
Inventories
Inventories mean addition to the stock of a firm. Suppose a firm produced more cloth than it could
sell. Also assume that the unsold cloth has been destroyed. The workers received wages for this increased
production of cloth but expenditure remains same. In such a situation the profit of the firm must fall equal
to the additional wages given for the increased production. Thus income also remains same and hence
there is no change in the GDP.
Consider another scenario where the additional cloth has been considered as stock for sale in
future. Such addition is called as inventories. When inventories are made it is considered as purchase by
the firm itself. Then expenditure increases. There will not be a fall in the profit of the firm and hence
income also increases. As such both income and expenditure increases by the same amount and GDP also
increases by the same value.
Macro Economics-I
23
The sale of inventories by the firm in a later period is considered just as a sale of used good and so
GDP will not increase. Thus, treatment of inventories ensure that the GDP will always reflect the
production of goods and services in the current year or in a given year.
Intermediate Goods
Intermediate goods are goods used in the different stages of production. They can be considered as
the inputs for each stage of production till the final product is released. The wheat flour produced by a
mill is an input for the production of bread by a bakery and again becomes an input for a restaurant for
making the sandwich. Similarly, a mining company that produces iron ore sells it to a steel factory which
produces cold rolled (CR) steel. Iron ore becomes an input for this stage of production. Again the CR
steel is purchased by an automobile factory to produce cars. If the car is purchased by a consumer for his
personal use the car becomes a final good. But if the car is purchased by a business firm that produces
PVC pipes the car becomes an input for the production of pipes and becomes an intermediate good. In
short, wheat flour, bread, iron ore, CR steel, car purchased by the PVC pipe manufacturer are
intermediate goods required for the production of other goods. But the car purchased for personal use is
not an intermediate good, it is a final good.
Since the GDP includes the value of all final goods and services, the value of intermediate goods
are excluded from the calculation of GDP. If we consider the value of these intermediate goods at all
stages of production, it would amount to the counting the same value several times (sometimes called as
double counting) and result it in an inflated value for the GDP.
The problem of intermediate goods can be better solved by considering the value added at each
stage of production. Since GDP is the total value of all final goods and services, the value added at each stage
of production alone need to be counted. Value added at each stage of production is found out by
deducting the value of input from the value of output.
The final goods can be easily identified if they are:
(1) purchased by the consumers (households including individuals)
(2) purchased by the government
(3) purchased by the business firms as investment and not as an input for further production
Imputations
Remember GDP includes the market value of all final goods and services. Then what happens if
there if there no market for a particular good or if it is not sold in the market? Such goods cannot be
ignored in computing GDP. The problem is solved by estimating the market value of such goods and is
called as the imputed value.
Imputed value is often computed for the rent of owner occupied houses. If a family or a business
firm takes an apartment/shop space for rent that rent immediately enters into the calculation of GDP.
Hence owner occupied apartment/shop space also need to be treated similarly. The rent that would have
received becomes the imputed value of rent for owner occupied properties.
Imputation is applied in valuing the services of government like the services of police, judiciary,
civil services etc. Since these services do not enter into a market yet takes place in public place,
imputation is necessary to compute their value. The imputed value is calculated by considering the cost
incurred (wages and other allowances) to provide such services.
If the same logic is extended to the self owned cars, that it gives car rental service to the owner, an
imputed value for the services of the car can also be computed. But such imputations are not attempted to
avoid complexities.
Macro Economics-I
24
The output produced in the family kitchen are indeed output of the nation but are excluded from
the GDP calculation simply because of the reason that such output do not enter into the market. The
services of house wives are thus excluded although they engage in an important productive activity. It is
for these reasons Gregory Mankiw in Macro Economics remarks that GDP is an imperfect measure of
economic activity.
Again, as more and more female persons enters into the labour market the production of food in
the home kitchen declines as it is difficult to find enough time for cooking. Consequently food purchased
from the hotels and restaurants and dining out increases and GDP also increases correspondingly.
Actually there is no noticeable increase in food production between these two situations but GDP
increases in the second situation. Bradford DeLong in Macro Economics, points out that from the
viewpoint there is no increase in the societys wealth or its output.
Other Measures of Economic Activity

Recall that we have already defined:
The gross national product (GNP) is defined as the market value of all final goods and services produced by residents of
a nation in a given period of time, usually a year. _______________________________ (1)
NNP = GNP minus Depreciation ________________________________
(2)
GDP = GNP minus net factor payments from abroad. __________________

(3)
Net factor payments = Factor payments from abroad minus Factor payments to abroad. ___________ (4)
To summarise;
GNP is National Product
GDP is Domestic Product
In this context, computation of National Income considers GNP and NNP. NNP represents the
market value of all final goods and services minus depreciation. Market value involves indirect business
tax (or sales tax/VAT) and is received by the government. This tax amount is not realised by the firms
and hence cannot be distributed as income. Recall the figure of circular flow of income. As such, national
income is calculated;
National Income = NNP minus Indirect Business Taxes ___________ (5)
It is from the national income that we find out the total personal income of the nation. Personal
income is the total income received by the individuals (households and non-corporate businesses) of the
nation. The following adjustments in the national income will give the personal income:
Personal Income =
National Income
minus
plus
Macro Economics-I
Corporate profits
Social Insurance Contributions
Net interest earned by the businesses
Dividend distributed
Government transfers to individuals
Personal interest income____________________ (6)
25
The above given three items are subtracted from the national income but out of the corporate
profits the companies distribute a portion of it as dividend to the share holders and is available to
households. Therefore the dividend income is added. Similarly the social insurance contributions made to
the government is not available for the households but the government transfers or redistributes some
income to the households. Similarly, net interest earned by the businesses (involves interest payment
made to the households, interest earned by the firms etc) needs to be subtracted but interest income
earned by the households is to be added.
The total income available to the individuals for their own personal use is called as disposable
income and is found out from the personal income. In fact from the personal income, the personal income
tax and other non tax payments (toll, fees etc) are made and when that is subtracted from the personal
income the disposable income is computed.
Disposable Income = Personal Income
minus
personal income tax and

non tax payments (toll, fees etc)______________ (7)
Methods of Measurement
Three are three methods of measurement; income method, product or value added method and the
expenditure method. In the initial phase, production of goods and services take place. During the course
of production payment is made to all factors of production like wages to labour etc. Once the production
completes the output is distributed for different uses like consumption etc. The different methods of
measurement are better understood by observing the circular flow of income for a simple economy. The
income, product and the expenditure loops of the figure given below represent these methods
respectively.
Macro Economics-I
26
GDP computed with these methods are summarised as:

1) Expenditure Method:
Y
Consumption + Investment + Government Purchases + (Exports Imports)

=
C + I + G + (X-M)
2) Income Method:
Wages + Profits + Interest + Rent
3) Product/Value Added Method:
Sum of Gross Value added by all firms
Nominal and Real Values: The Case of GDP

Recall that, the GDP is computed by considering the market value of each and every commodity
produced in the nation. For instance, if the price of rice and wheat per kg is Rs 12 and Rs 15 respectively
in the first year, the GDP will be:
= (10 kg of rice X Rs 12/kg) + (20 kg of wheat X Rs 15/kg)
= Rs. 120 + Rs. 300
= Rs 420.
Suppose in the second year, the price of rice increased to Rs. 15/kg but the production remains
same at 10 kg. The GDP will increase to Rs. 450 since it takes into account the market value. But
remember there is no increase in production. In fact GDP must give a measure of the level of domestic
production however that is not get reflected in the computation of GDP in the above manner. The
problem is that the current prices are used to compute the GDP and is called as the nominal GDP. Instead
of the nominal GDP, the real GDP must be computed to get a realistic measure of the level of domestic
production. Real GDP measures the domestic production without considering the rise or fall in prices. It
measures production on the basis of constant prices rather than current prices. Constant price means price
for a particular year is chosen and is taken as fixed to compute GDP for other years.
Suppose production of rice and its price also increased to 15 kg in the second year. The nominal
and real GDP will be computed as:
Nominal GDP= (15 kg of rice X Rs 15/kg) + (20 kg of wheat X Rs 15/kg)
= Rs. 225 + Rs. 300
= Rs 525.
(on the basis of second year price)
Real GDP = (15 kg of rice X Rs 12/kg) + (20 kg of wheat X Rs 15/kg)
= Rs. 180 + Rs. 300
= Rs 480.
(on the basis of first year price)
The relationship between Nominal GDP and Real GDP will give a measure of nominal GDP per
one unit of real GDP.
Macro Economics-I
27
Although it is called as GDP deflator, actually it gives a measure of increase (inflation) in nominal
GDP with respect to real GDP. In practice, GDP is computed in nominal terms because the current
market prices can be immediately used for the computation. But as pointed out above, a realistic
estimation of level of domestic production by ignoring the influence of increase in prices needs
computation of real GDP. The easy method to find the real GDP is to deflate the nominal GDP by using
the so called GDP deflator. It is for its deflating purpose, the ratio of nominal to real GDP is called as
GDP deflator!
=> GDP Deflator
Real GDP = Nominal GDP, that is
Similarly, nominal and real values of any variable can be computed. The real expenditure, real
investment etc all can be computed from their respective nominal values by using the appropriate
deflators. To sum up, nominal values are computed on the basis of current prices where as the real values
are computed on the basis of constant prices (means price for a chosen year and consider it as fixed).
Real values are important to get a realistic picture of change in the value of a variable and so have to
remove the influence of price increase.
Potential GNP, Actual GNP and GNP Gap

The concept of potential GNP got popularity after the research of US economist Arthur Okun. He
was a member of Council of Economic Advisors of US President John F Kennedy. When the council
was asked to explain the benefits of reduction of unemployment from 7 % to 4 %, it was Okun who
conducted the research and explained about the negative relationship between unemployment and real
GNP (potential GNP). It later became the famous Okuns Law. Okun found that for every 1% reduction
in unemployment the real GNP (potential GNP) increased by 3%. As unemployment decreases, more and
more people are employed and it results in a more than proportionate increase in the productive capacity
of the nation.
Real GNP or potential GNP simply means the full employment (at natural rate of
unemployment) level of real output an economy can produce. Actual GNP means the current level of GNP
produced by the nation.
The widely used actual GNP estimates and its growth rates, normally get high attention but the
real standing of the economy against its potential level can be found out only by comparing the actual
GNP with its Potential GNP. GNP growth rates by itself convey only little information regarding the
production effort of the nation.
The difference between the potential GNP and the actual GNP is called as the GNP gap and
signifies the shortfall of production effort. Hence the GNP gap can be considered as a useful measure for
macroeconomic policy decisions.
Macro Economics-I
28
Green GDP
The green GDP concept emerged out of the limitations and inadequacies of conventional GDP
accounting. Since GDP is viewed as a measure of economic activity of a nation naturally it also
considered as a measure for the welfare of the nation. But on both these counts criticisms are pouring
upon the conventional GDP measures. When an environmental damage happens due to a chemical
leakage or so (like pollution to Ganga river, Bhopal gas tragedy etc) the cleanup activities undertaken to
solve the damage eventually increases the GDP. The tragedy is that the economic and environmental
damage never gets accounted anywhere. In such a situation welfare of the nation will not increase but
certainly fall although the GDP increases due to the cleanup activities. This is a clear limitation of the
conventional GDP figures. It is in this context alternative measures of GDP are defined to take into
account the environmental damage inflicted upon the economy by various economic activities. The
concept of green GDP got popularity during the 1990s and later international organizations took up the
matter and released many documents regarding its measurement. Simply speaking,
Green GDP = Traditional GDP minus environmental/ecological damage or cost.
The first green GDP calculation was made by China for the year 2004 and found that the green
GDP was lower by 3% than the conventional GDP. But later China abandoned the release of green GDP
figures as for many provinces the gap between these two is very high which will adversely affect the
reputation.
The environment minister Sri. Jairam Ramesh has announced that in November, 2009 that India
would release the green GDP figures from 2015 onwards.
Future of Green GDP
In the Handbook of National Accounting published in 2003 by the United Nations in association
with European Commission, International Monetary Fund, Organisation for Economic Co-operation and
Development and World Bank and titled as Integrated Environmental and Economic Accounting it is
pointed out that adjustments in the traditional GDP accounting methods as mentioned above will not
solve the problem. What is more important is the adjustment of the economic behaviour that damages the
environment itself. It is pointed out that what is required is not a greener GDP measure by adjusting
the national income accounting methods but a GDP measure for a different economy which is greener by
using the same national income accounting methods. The GDP so calculated is called as the greened
economy GDP (geGDP)
Macroeconomic Models
Economic model is a theoretical construct that captures the essential features, characteristics and
the relationships between different set of variables of the underlying phenomena. Construction of an
appropriate model will help to understand the underlying phenomena in an easy manner. It also helps
theory building. But remember model is not a theory in itself.
When a model is constructed to represent a macroeconomic phenomenon it is called as a
macroeconomic model. The circular flow diagram is a simplified graphical macroeconomic model of an
economy. Models can also be constructed with verbal explanations and mathematical equations. The
explanation of the circular flow diagram is a verbal model of the economy. But frequently, mathematical
models are used to represent economic phenomena as it is easy to make further manipulations and
computations. Moreover mathematical models have better precision and accuracy in representation. A simple
mathematical model is a mathematical equation constructed to represent an economic phenomenon.
Macro Economics-I
29
Consider the simple model that represents the domestic economy given by the following equation.
Y = C + I + G + (X-M)
The model explains that the domestic expenditure of the economy is comprised of consumption,
investment, government purchases and net foreign trade. There can be different models to explain the
same theoretical relationship between variables. For instance consider the simple econometric models that
theorise the relationship between income and consumption.
C = + .Y
(Deterministic Model)
_____________
(1)
C = + .Y + U
(Stochastic Model)
_____________
(2)
Where C = Consumption expenditure
= Intercept term (autonomous consumption)
= Slope coefficient
Y = Monthly family income
U = Error term (represents the influence of variables other than income)
The first model explains that income as the only factor that influences consumption where as the
second model explains that the consumption is influenced by not only income but by other factors also. It
is obvious that the second model captures the reality in a better manner.
Exogenous and Endogenous Variables

Endogenous variables are variables whose value is determined within the model and exogenous
variables are variables whose value is determined outside the model. Alternatively, endogenous variable
is the variable whose value is explained by the model but for an exogenous variable the model cannot
explain its value. Consider the following model:
C = + .Y + U
The variable C that stands for consumption expenditure is the endogenous variable as its values
is determined by the model. But the value of the variable Y that stands for monthly family income is
supplied from outside the model. The data on monthly family income is collected through a survey.
Hence it is considered as exogenous variable.
Independent and Dependent Variables

Independent variable is the variable whose value changes initially where as the dependent variable
is the variable whose value changes in response to the changes in independent variable. Alternatively, the
variable upon which the researcher introduces manipulation is called as the independent variable and the
variable which is observed for the impact of this initial manipulation is called as the dependent variable.
With respect to the above mentioned model, Y is the independent variable and C is the dependent
variable. The factors that cause changes in the independent variable are not considered at all. In
econometrics, the terms exogenous and endogenous variables are used interchangeably for independent
and dependent variables respectively.
Ex ante and Ex post

These are Latin terms and the meaning of ex ante is before the event and ex post is after the
event. The terms are introduced into economics by the Stockholm school during the 1920s and 1930s. It
was Erick Lindahl in 1924 who first introduced the term ex post. A more comprehensive treatment of
both these terms is given by the Nobel laureate Gunnar Myrdal in his thesis on expectations and price
changes published in 1927. It is because of this reason Myrdals name is associated with the introduction
Macro Economics-I
30
of these terms into economics. But these terms are popularised by another Nobel laureate Bertil Ohlin
with the publication of Stockholm theory of savings and investment.
The purpose of these terms is to emphasis the time factor in economic analysis. Myrdal used these
terms to emphasise the fundamental difference between foreseen and unforeseen changes. Myrdal
argued that expectations under uncertainty are to be analysed by including the time element in the
calculation of the value of economic variables before the event and after the event. The importance of
these terms in macroeconomics is that the divergence in the value of a variable both ex ante and
ex post due to uncertainty are often encountered and considered as one of the relevant factors for
determining the level of employment.
Identities and Equations

Identities
Identities are mathematical statements or equations that are true in definitional form. Whatever be
the value of the unknown quantities or variables, an identity is considered as true so long as definitional
meaning is true. Identities are represented with triple bar while equations are represented with equality
sign. Consider the simple macroeconomic model explained earlier.
Y = C + I + G + (X-M)
This model becomes a true representation of the economy because of its definitional correctness.
As such it is also called as the national income identity and is represented as:
Y
C + I + G + (X-M)
The true numerical values of the variables in the right hand side of the identity may or may not be
equal to the left hand side of the equation in a numerical sense and there can be small discrepancies. But
definitionally the right hand side is equal to the left hand side and hence called as identity.
Another well known macroeconomic identity is the quantity equation of money. It is the definition
of the four variables in the equation that make it true.
M.V P.T where M = Money
V = Velocity
P = Price
T = Transactions
Equations
On the other hand equations are mathematical statements that emphasises the equality between
two mathematical expressions. An equation is true only for particular values of the variables in the
equation. Unlike identities, variables cannot take any values to keep the equation true. The values of these
variables are found out by solving the equation. The unknown quantities or variables are represented by
the last letters of the alphabet like w, x, y and z. Consider the following equation.
28 = 2
+10
Note that the equation is true only for a particular value of
Suggested Readings:
1. Diwedi DN Macroeconomics Theory and Policy Tata McGraw-Hill
2. Edward Shapiro : Macro economics Oxford University press.
3. Gregory Mankiw : Macro economics 6th Edn. Tata McGraw Hill.
Macro Economics-I
31
Module III
Classical Macro Economic Model
Says Law of Markets Wage Price Flexibility Classical Model of Output and Employment
Quantity Theory of Money Fishers Equation of Exchange Cash Balance Approach Neutrality of
Money Money illusion Pigou effect Real Balance effect Classical dichotomy Concept of full
employment voluntary unemployment.
Classical Economics
The term "classical economics" was coined by Karl Marx to refer to the economics of David
Ricardo and James Mill and their predecessors. However, the usage was subsequently extended to include
the followers of Ricardo. The term Classical economics refers to work done by a group of economists in
the eighteenth and nineteenth centuries. They developed theories about the way markets and market
economies work. The study was primarily concerned with the dynamics of economic growth. It stressed
economic freedom and promoted ideas such as laissez-faire and free competition. Famous economists of
this school of thought included Adam Smith, David Ricardo, Thomas Malthus and John Stuart Mill and
J.B.Say.
The Classical Theory
The fundamental principle of the classical theory is that the economy is self-regulating. Classical
economists maintain that the economy is always capable of achieving the natural level of real GDP or
output, which is the level of real GDP that is obtained when the economy's resources are fully employed.
While circumstances arise from time to time that cause the economy to fall below or to exceed the natural
level of real GDP, self-adjustment mechanisms exist within the market system that work to bring the
economy back to the natural level of real GDP. The classical doctrinethat the economy is always at or
near the natural level of real GDPis based on two firmly held beliefs: Say's Law and the belief that
prices, wages, and interest rates are flexible. The classical approach to macro economics is that
individuals and firms act in their own best interest. The wages and prices adjust quickly to achieve
equilibrium in the free market economy. Classical macroeconomics is the theory and the classical model
of the economists Adam Smith, David Ricardo, John Mills and Jean Baptiste Say.
Assumptions of the classical macroeconomics
The Classical theories made a number of assumptions about the markets and their
competitiveness.
1. There is freedom of entry and exit. No monopoly elements are present in the market to prevent
newcomers from entering the market or stopping the present ones from quitting the market.
2. Prices and wages are flexible in both upward and downward directions according to the
demand
and supply forces.
3. No single seller or buyer of a product has sufficient market power to influence the industry price, nor
does any supplier or purchaser of labor services have sufficient market power to influence themarket
wage rate.
4. Thus all economic agents are price-takers and not price-setters.
5. The markets are competitive and so disequilibrium can only exist for a short period of time.
Macro Economics-I
32
SYLLABUS
COURSE TITLE: BANKING AND FINANCE
Module I : Commercial Banking
Meaning of Banks Origin and growth Functions of Commercial banks Role of
Commercial Banks in Economic Development Credit Creation Meaning and basic concepts
Module II : Reserve Bank of India (RBI)
Management and Structure of RBI - Functions of RBI - Monetary policy - Objectives of
monetary policy Instruments of Monetary Policy
Module III : Money Market
Meaning of Mone market Constituents of Money market Call money market
Collateral Loan market, Acceptance market, Bill market Institutions of Money market
Commercial Banks, Central Bank, Acceptance houses, Non-banking financial intermediaries
Features of Indian Money market.
Module IV : Capital Market
Meaning and function Components of Capital market Important Financial Instruments
Equity shares, Preference shares, Debentures or Bonds The Primary market Methods of Public
Issue IPO Physical shares and Demat shares Stock Exchanges Meaning and functions
BSE and NSE Stock Indices in India SENSEX and Nifty DIIs and FIIs Securities and
Exchange Board of India (SEBI) Role and Functions.
References:
1. S.N Maheswari and R.R Paul, Kalyani Publishers, Ludhiana (Recent Edition)
2. K.C Shekhar and Lekshmi Shekhar, Banking Theory and Practice, Vikas Publishing House Pvt. Ltd,
New Delhi ( Recent Edition)
3. S.Gurusamy, Capital Markets, Vijay Nicole Imprints Pvt. Ltd, Chennai (Recent Edition)
4. Sahshi.K.Gupta, Nisha Agarwal and Neeti Gupta, Financial Markets and Institutions, Kalyani
Publishers, New Delhi (Recent Edition)
Online Resources:
1.
2.
3.
4.
5.
6.
7.
8.
9.
www.rbi.org.in
rbidocs.rbi.org.in/rdocs/Content/PDFs/FUNCWWE 080910.pdf
rbidocs.rbi.org.in/rdocs/Publications/PDFs/RBI140520012.pdf
en.wikipedia.org/wiki/money/_market
en.wikipedia.org/wiki/money/_market_in_india
study-material4u.blogspot.in/2012/07/chapter5-indian-money-market.html.
www.sebi.gov.com
www.bseindia.com
www.nseindia.com
Banking & Finance
MODULE I
COMMERCIAL BANKING
Evolution of Banking (Origin and development of Banking)

The evolution of banking can be traced back to the early times of human history. The history of
banking begins with the first prototype banks of merchants of the ancient world, which made grain
loans to farmers and traders who carried goods between cities. This began around 2000 BC in
Assyria and Babylonia. In olden times people deposited their money and valuables at temples, as
they are the safest place available at that time. The practice of storing precious metals at safe
places and loaning money was prevalent in ancient Rome.
However modern Banking is of recent origin. The development of banking from the traditional
lines to the modern structure passes through Merchant bankers, Goldsmiths, Money lenders and
Private banks. Merchant Bankers were originally traders in goods. Gradually they started to
finance trade and then become bankers. Goldsmiths are considered as the men of honesty, integrity
and reliability. They provided strong iron safe for keeping valuables and money. They issued
deposit receipts (Promissory notes) to people when they deposit money and valuables with them.
The goldsmith paid interest on these deposits. Apart from accepting deposits, Goldsmiths began to
lend a part of money deposited with them. Then they became bankers who perform both the basic
banking functions such as accepting deposit and lending money. Money lenders were gradually
replaced by private banks. Private banks were established in a more organised manner. The growth
of Joint stock commercial banking was started only after the enactment of Banking Act 1833 in
England.
Evolution and Growth of banking in India
India has a long history of financial intermediation. The first bank in India to be set up on
modern lines was in 1770 by a British Agency House. The earliest but short-lived attempt to
establish a central bank was in 1773. India was also a forerunner in terms of development of
financial markets. In the beginning of 18th century, British East India Company launched a few
commercial banks. Bank of Hindustan(1770) was the first Indian bank established in India. Later
on, the East India Company started three presidency banks, Bank of Bengal(1806), Bank of
Bombay(1840) and Bank of Madras(1843) These bank were given the right to issue notes in their
respective regions. Allahabad bank was established in 1865 and Alliance Bank in 1875. The first
bank of limited liability managed by Indians was Oudh Commercial Bank founded in 1881.
Subsequently, the Punjab National Bank was established in 1894. In the Beginning of the 20 th
century, Swadeshi movement encouraged Indian entrepreneurs to start many new banks in India.
Another landmark in the history of Indian banking was the formation of Imperial bank of India in
1921 by amalgamating 3 presidency banks It is the Imperial Bank which performed some central
banking functions in India. A number of banks failed during the first half of the 20th Century. It
affected the peoples belief and faith in Banks.
Banking & Finance
By independence, India had a fairly well developed commercial banking system in

existence. In 1951, there were 566 private commercial banks in India with 4,151 branches, the
overwhelming majority of which were confined to larger towns and cities. Savings in the form of
bank deposits accounted for less that 1 per cent of national income, forming around 12 per cent of
the estimated saving of the household sector. The Reserve Bank of India (RBI) was originally
established in 1935 by an Act promulgated by the Government of India, but as a shareholder
institution like the Bank of England. After India's independence, in the context of the need for close
integration between its policies and those of the Government, the Reserve Bank became a state owned institution from January 1, 1949. It was during this year that the Banking Regulation Act
was enacted to provide a framework for regulation and supervision of commercial banking activity.
By independence, India had a fairly well developed commercial banking system in
existence. Reserve bank of India was nationalized in the year 1949. The enactment of the Banking
Companies Act 1949 (Later it was renamed as Banking Regulation Act) was a bold step in the
history of banking in India. In 1955, Imperial Bank of India was nationalized and renamed as State
bank of India(SBI). The SBI started number of branches in urban and rural areas of the country.
In 1967, Govt introduced the concept of social control on banking sector. Nationalization
of 14 commercial banks in 1969 was a revolution in the history of banking in India. Six more
commercial banks were nationalized in 1980. Other landmarks in the history of Indian banking
were the establishment of National Bank for Agricultural and Rural Development (1988), merger of
New Bank of India with Punjab National Bank (1993), merger of State Bank of Sourashtra with
SBI (2008) and the merger of State Bank of Indore with SBI (2010).
At present, there are 26 Public sector banks, 21 private sector banks, 32 Foreign banks and
82 Regional Rural Banks in India.
Origin of the word bank
The term Bank is derived from the Italian word banca, Latin word bancus and French
word banque which means bench. In fact, Medieval European bankers transacted banking
activities displaying coins on a bench.
Another view is that bank might be originated from German word banc which means joint stock
fund.
Definitions
Definition of bank varies from countries to countries. Under English common law, a banker
is defined as a person who carries on the business of banking, which is specified as conducting
current accounts for his customers, paying cheques drawn on him/her, and collecting cheques for
his/her customers.
According to H. L. Hart, a banker is one who in the ordinary course of his business
honours cheques drawn upon him by person from and for whom he receives money on current
accounts.
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Banking Regulation Act of 1949 defines banking as accepting for the purpose of lending
or investment, of deposits of money from the public, repayable on demand or otherwise, and
withdrawable by cheque, draft, order or otherwise.
Characteristics of Banker/Banking
1. Banker deals with others money
2. Banks repay deposits either on demand or after the expiry of specified period
3. They utilise deposits for lending/investment
4. They perform subsidiary services and innovative functions
5. Banking should be dominant part of business of bank
6. A bank should hold itself out as a bank
Importance of banks
Bankers play very important role in the economic development of the nation. The health of
the economy is closely related to the growth and soundness of its banking system. Although banks
create no new wealth but their fund collection, lending and related activities facilitate the process of
production, distribution, exchange and consumption of wealth. In this way, they become very
effective partners in the process of economic development.
1. Banks mobilise small, scattered and idle savings of the people, and make them available for
productive purposes
2. By offering attractive interests, Banks promote the habit of thrift and savings
3. By accepting savings, Banks provide safety and security to the surplus money
4. Banks provide convenient and economical means of payments
5. Banks provide convenient and economical means of transfer of funds
6. Banks facilitate the movement of funds from unused regions to useful regions
7. Banking help trade, commerce, industry and agriculture by meeting their financial requirements
8. Banking connect saving people and investing people.
9. Through their control over the supply of money, Banks influence the economic activities,
employment, income level and price level in the economy.
Types of banks
Functional classification
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1. Commercial banks/Deposit banks

Banks accept deposits from public and lend them mainly for commercial purposes for
comparatively shorter periods are called Commercial Banks. They provide services to the general
public, organisations and to the corporate community. They are oldest banking institution in the
organised sector. Commercial banks make their profits by taking small, short-term, relatively
liquid deposits and transforming these into larger, longer maturity loans. This process of asset
transformation generates net income for the commercial bank. Many commercial banks do
investment banking business although the latter is not considered the main business area. The
commercial banking system consists of scheduled banks (registered in the second schedule of RBI)
and non scheduled banks. Features of Commercial banks are;
They accepts deposits on various accounts.
Lend funds to organisations, trade, commerce, industry, small business, agriculture etc by
way of loans, overdrafts and cash credits.
They are the manufacturers of money.
The perform many subsidiary services to the customer.
They perform many innovative services to the customers.
2. Industrial banks/Investment banks

Industrial banks are those banks which provide fixed capital to industries. They are also
called investment banks, as they invest their funds in subscribing to the shares and debentures of
industrial concerns. They are seen in countries like US, Canada, Japan, Finland, and Germany. In
India industrial banks are not found. Instead, special industrial finance corporations like IFC and
SFC have been set up to cater to the needs of industries. Features of Industrial Banks are:
Participate in management.
Advise industries in making right investment
Advise govt. on matters relating to industries
3. Agricultural banks
Agricultural banks are banks which provide finance to agriculture and allied sectors. It is
found in almost all the countries. They are organised generally on co-operative basis. In India, Cooperative banks are registered under the Co-operative Societies Act, 1912. They generally give
credit facilities to small farmers, salaried employees, small-scale industries, etc. Co-operative
Banks are available in rural as well as in urban areas. Agricultural banks are of two types;
Agricultural co-operative banks: They provide short term finance to farmers for purchasing
fertilizers, pesticides and seeds and for the payment of wages.
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Land Development Banks: They provide long term finance for making permanent improvement on
land. They assist to purchase machinery, equipments, installation of pump sets, construction of
irrigation works etc.
4. Exchange banks
Exchange banks finances foreign exchange business (export, import business) of a country.
Special exchange banks are found only in some countries. The main functions of exchange banks
are remitting money from one country to another country, discounting of foreign bills, buying and
selling gold and silver, helping import and export trade etc.
5. Savings bank
Savings banks are those banks which specialise in the mobilisation of small savings of the
middle and low income group. In India, saving bank activities are done by commercial banks and
post offices. Features of savings banks are;
Mobilise small and scattered savings
Promote habit of thrift & savings
Keep only small portion in hand and invest major part in govt. securities
They do not lend to general public.
6. Central / National banks
It is the highest banking & monetary institution in a country. It is the leader of all other
banks. Since it is occupying a central position, its known as Central Bank. It is operating under
states control and is not a profit motive organisation. Reserve Bank of India (India), Bank of
Canada (Canada), Federal Reserve System(USA) etc are the examples of Central Banks. The
main functions of a Central Bank are;
Monopoly of currency issue
Acts as banker to the govt.
Serves as bankers bank
Act as controller of credit
Custodian of nations gold and foreign exchange reserve.
Functions of commercial banks

Functions of a Commercial Bank can be classified into three.
1. Principal/ Primary/ Fundamental functions
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2. Subsidiary/ Secondary/ Supplementary functions

3. Innovative functions.
Principal functions
Commercial banks perform many functions. They satisfy the financial needs of the sectors
such as agriculture, industry, trade, communication, so they play very significant role in a process
of economic social needs. The functions performed by banks, since recently, are becoming
customer-centred and are widening their functions. Generally, the functions of commercial banks
are divided into two categories; primary functions and the secondary functions. Two acid test
functions of commercial banks are Accepting deposits and Lending loans. These functions along
with credit creation, promotion of cheque system and investment in Government securities form
basic functions of commercial banks. The secondary functions of commercial banks include agency
services, general utility services and innovative services.
1. Receiving deposits
Most important function of a commercial bank is to accept deposit from those who can save
but cannot profitably utilise this savings themselves. By making deposits in bank, savers can earn
something in the form of interest and avoid the danger of theft. To attract savings from all sorts of
customers, banks maintain different types of accounts such as current account, Savings bank
account, Fixed Deposit account, Recurring deposit account and Derivative Deposit account.
Features of Current Accounts
o It is generally opened by trading & industrial concerns.
o It is opened not for profit or savings but for convenience in payments
o Introduction is necessary to open the account.
o Any number of transactions permitted in the account.
o Withdrawals are generally allowed by cheque
o Deposit is repayable on demand
o No interest is allowed but incidental charges claimed.
o Minimum balance requirement varies from bank to bank.
Features of Saving Bank (SB) accounts
o It is generally opened by middle/low income group who save a part of their income for future
needs
o Introduction is necessary to open the account if cheque facility is allowed.
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o There are some restrictions on number of withdrawals.

o Fair interest (less than FD) is offered on the deposits of this account.
Features of Fixed Deposit accounts
o
It is generally Opened by small investors who do not want to invest money in risky industrial
securities like shares.
No introduction is necessary to open the account.
No maximum limit for investing.
Minimum period of investment is 15 days
Withdrawal is allowed only after the expiry of a fixed period.
Withdrawal is generally allowed by surrendering FD Receipt
Higher rate of interest is offered on the deposits of this account,
Features of Recurring Deposit accounts / Cumulative Deposit account.

o
This account is meant for fixed income group, who can deposit a fixed sum regularly.
The amount is paid back along with interest after a specified period.
High rate of interest is offered on recurring deposits.
Passbook is the means through which deposits and withdrawals are made
2. Lending of funds
The second important function of commercial banks is to advance loans to its customers.
Banks charge interest from the borrowers and this is the main source of their income. Modern
banks give mostly secured loans for productive purposes. In other words, at the time of advancing
loans, they demand proper security or collateral. Generally, the value of security or collateral is
equal to the amount of loan. This is done mainly with a view to recover the loan money by selling
the security in the event of non-refund of the loan.
Commercial banks lend money to the needy people in the form of Cash credits, Term loans,
Overdrafts (OD), Discounting of bills, Money at call or short notice etc.
(i) Cash Credit: In this type of credit scheme, banks advance loans to its customers on the basis of
bonds, inventories and other approved securities. Under this scheme, banks enter into an agreement
with its customers to which money can be withdrawn many times during a year. Under this set up
banks open accounts of their customers and deposit the loan money. With this type of loan, credit is
created.
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11
(ii) Term loans: A term loan is a monetary loan that is repaid in regular payments over a set period
of time. In other words, a loan from a bank for a specific amount that has a specified repayment
schedule and a floating interest rate is called Term loan. Term loans usually last between one and
ten years, but may last as long as 30 years in some cases. It may be classified as short term, medium
term and long term loans.
(iii) Over-Drafts: It is the extension of credit from a bank when the account balance reaches zero
level. Banks advance loans to its customers up to a certain amount through over-drafts, if there are
no deposits in the current account. For this, banks demand a security from the customers and charge
very high rate of interest. Overdraft facility will be allowed only for current account holders.
(iv) Discounting of Bills of Exchange: This is the most prevalent and important method of
advancing loans to the traders for short-term purposes. Under this system, banks advance loans to
the traders and business firms by discounting their bills. While discounting a bill, the Bank buys the
bill (i.e. Bill of Exchange or Promissory Note) before it is due and credits the value of the bill after
a discount charge to the customer's account. The transaction is practically an advance against the
security of the bill and the discount represents the interest on the advance from the date of purchase
of the bill until it is due for payment. In this way, businessmen get loans on the basis of their bills
of exchange before the time of their maturity.
(v) Money at Call and Short notice: Money at call and short notice is a very short-term loan that
does not have a set repayment schedule, but is payable immediately and in full upon demand.
Money-at-call loans give banks a way to earn interest while retaining liquidity. These are generally
lent to other institutions such as discount houses, money brokers, the stock exchange, bullion
brokers, corporate customers, and increasingly to other banks. At call means the money is
repayable on demand whereas At short notice implies the money is to be repayable on a short
notice up to 14 days.
3. Investment of funds in securities
Banks invest a considerable amount of their funds in government and industrial securities.
In India, commercial banks are required by statute to invest a good portion of their funds in
government and other approved securities. The banks invest their funds in three types of
securitiesGovernment securities, other approved securities and other securities. Government
securities include both, central and state governments, such as treasury bills, national savings
certificate etc. Other securities include securities of state associated bodies like electricity boards,
housing boards, debentures of Land Development Banks, units of UTI, shares of Regional Rural
banks etc.
4. Credit Creation
When a bank advances a loan, it does not lend cash but opens an account in the borrowers
name and credits the amount of loan to this account. Thus a loan creates an equal amount of
deposit. Creation of such deposit is called credit creation. Banks have the ability to create credit
many times more than their actual deposit. (The process of credit creation is explained in the last
part of the module in detail)
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5. Promoting cheque system

Banks also render a very useful medium of exchange in the form of cheques. Through a
cheque, the depositor directs the banker to make payment to the payee. In the modern business
transactions by cheques have become much more convenient method of settling debts than the use
of cash. Through promoting cheque system, the banks ensure the exchange of accounted cash. At
present, CTS (Cheque Truncation System) cheques are used by Indian Banks to ensure speedy
settlement of transactions in between banks. In contrast to the declining importance of cheques, the
use of electronic payment instruments at the retail level has been growing rapidly.
Subsidiary functions
1. Agency services : Banks act as an agent on behalf of the individual or organisations. Banks, as
an agent can work for people, businesses, and other banks, providing a variety of services
depending on the nature of the agreement they make with their clients. Following are the important
agency services provided by commercial banks in India.
Commercial Banks collect cheques, drafts, Bill of Exchange, interest and dividend on
securities, rents etc. on behalf of customers and credit the proceeds to the customers account.
Pay LIC premium, rent, newspaper bills, telephone bills etc
Buying and selling of securities
Advise on right type of investment
Act as trustees (undertake management of money and property), executors (carry out the wishes
of deceased customers according to will) & attorneys (collect interest & dividend and issue
valid receipt) of their customers.
Serve as correspondents and representatives of their customers. In this capacity, banks prepare
I-Tax returns of their customers, correspond with IT authorities and pay IT of their customers.
2. General Utility Services : In addition to agency services, modern banks performs many general
utility services for the community. Following are the important general utility services offered by
Commercial Banks
Locker facility: Bank provide locker facility to their customers. The customers can keep their
valuables such as gold, silver, important documents, securities etc. in these lockers for safe
custody.
Issue travellers cheques: Banks issue travellers cheques to help their customers to travel
without the fear of theft or loss of money. It enable tourists to get fund in all places they visit
without carrying actual cash with them.
Issue Letter of Credits: Banks issue letter of credit for importers certifying their credit
worthiness. It is a letter issued by importers banker in favour of exporter informing him that
issuing banker undertakes to accept the bills drawn in respect of exports made to the importer
specified therein.
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13
Act as referee: Banks act as referees and supply information about the financial standing of
their customers on enquiries made by other businessmen.
Collect information: Banks collect information about other businessmen through the fellow
bankers and supply information to their customers.
Collection of statistics: Banks collect statistics for giving important information about industry,
trade and commerce, money and banking. They also publish journals and bulletins containing
research articles on economic and financial matters.
Underwriting securities: Banks underwrite securities issued by government, public or private

bodies.
Merchant banking: Some bank provide merchant banking services such as capital to companies,
advice on corporate matters, underwriting etc.
Innovative Functions
The adoption of Information and Communication technology enable banks to provide many
innovative services to the customers such as;
1.
ATM services
Automated Teller Machine (ATM) is an electronic telecommunications device that enables the
clients of banks to perform financial transactions by using a plastic card. Automated Teller Machines are
established by banks to enable its customers to have anytime money. It is used to withdraw money, check
balance, transfer funds, get mini statement, make payments etc. It is available at 24 hours a day and 7 days a
week.
2.
Debit card and credit card facility
Debit card is an electronic card issued by a bank which allows bank clients access to their account to
withdraw cash or pay for goods and services. It can be used in ATMs, Point of Sale terminals, e-commerce
sites etc. Debit card removes the need for cheques as it immediately transfers money from the client's
account to the business account. Credit card is a card issued by a financial institution giving the holder an
option to borrow funds, usually at point of sale. Credit cards charge interest and are primarily used for shortterm financing.
3.
Tele-banking :
Telephone banking is a service provided by a bank or other financial institution, that enables
customers to perform financial transactions over the telephone, without the need to visit a bank branch or
automated teller machine
4.
Internet Banking:
Online banking (or Internet banking or E-banking) is a facility that allows customers of a financial
institution to conduct financial transactions on a secured website operated by the institution. To access a
financial institution's online banking facility, a customer must register with the institution for the service,
and set up some password for customer verification. Online banking can be used to check balances, transfer
money, shop onlline, pay bills etc.
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14
5.
Bancassurance:
It means the delivery of insurance products through banking channels. It can be done by making an
arrangement in which a bank and an insurance company form a partnership so that the insurance company
can sell its products to the bank's client base. Banks can earn additional revenue by selling the insurance
products, while insurance companies are able to expand their customer base without having to expand their
sales forces
6.
Mobile Banking:
Mobile banking is a system that allows customers of a financial institution to conduct a number of
financial transactions through a mobile device such as a mobile phone or personal digital assistant. It allows
the customers to bank anytime anywhere through their mobile phone. Customers can access their banking
information and make transactions on Savings Accounts, Demat Accounts, Loan Accounts and Credit Cards
at absolutely no cost.
7.
Electronic Clearing Services :
It is a mode of electronic funds transfer from one bank account to another bank account using the
services of a Clearing House. This is normally for bulk transfers from one account to many accounts or viceversa. This can be used both for making payments like distribution of dividend, interest, salary, pension, etc.
by institutions or for collection of amounts for purposes such as payments to utility companies like
telephone, electricity, or charges such as house tax, water tax etc
8.
Electronic Fund Transfer/National Electronic Fund Transfer(NEFT):
National Electronic Funds Transfer (NEFT) is a nation-wide payment system facilitating one-to-one
funds transfer. Under this Scheme, individuals, firms and corporate can electronically transfer funds from
any bank branch to any individual, firm or corporate having an account with any other bank branch in the
country participating in the Scheme. In NEFT, the funds are transferred based on a deferred net settlement
in which there are 11 settlements in week days and 5 settlements in Saturdays.
9.
Real Time Gross Settlement System(RTGS):
It can be defined as the continuous (real-time) settlement of funds transfers individually on an order
by order basis . 'Real Time' means the processing of instructions at the time they are received rather than at
some later time. It is the fastest possible money transfer system in the country.
NEFT
RTGS
Based on Deferred Net Settlement(DNS)
Based on Gross Settlement
Fastest method of money transfer
Slower than RTGS transfer
Complete transactions in batches
Complete transactions individually
There is no minimum limit of transactions.
Minimum amount to be remitted is 2 lakhs
Settlement on hour basis. (11 settlements from

9am to 7pm)
Settlement in real time (at the time the

transfer order is processed)
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15
Role of commercial banks in a developing economy

A well developed banking system is necessary pre-condition for economic development of
any economy. Apart from providing resources for growth of industrialisation, banks also influence
direction in which these resources are utilised.
In underdeveloped and developing nations banking facilities are limited to few developed
cities and their activities are focussed on trade & commerce paying little attention to industry &
agriculture.
Commercial banks contribute to a countrys economic development in the following ways.
1.Capital formation
Most important determinant of economic development is capital formation. It has 3
distinctive stages
Generation of savings
Mobilisation of savings
Canalisation of saving
Banks promote capital formation in all these stages. They promote habit of savings by
offering attractive rate of return for savers. Banks are maintaining different types of accounts to
mobilise savings aiming different types of customers. They make widespread arrangements to
collect savings by opening branches even in remote villages. Moreover, banks offer their resources
for productive activities only.
2. Encouragement to entrepreneurial innovations
Entrepreneurs in developing economies, generally hesitate to invest & undertake
innovations due to lack of fund. Bank loan facilities enable them to introduce innovative ideas and
increase productive capacity of the economy.
3. Monetisation of economy
Monetisation means allow money to play an active role in the economy. Banks, which are
creators and distributors of money, help the monetisation in two ways;
They monetise debt i.e., buy debts (securities) which are not as acceptable as money and
convert them to demand deposits which are acceptable as money.
By spreading branches in rural areas they convert non-monetised sectors of the economy to
monetised sectors.
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4. Influencing economic activity

They can directly influence the economic activity & pace of economic development through
its influence on
(a) The rate of interest (reduction in rates make investment more profitable and stimulates
economic activity)
(b) Availability of credit. (Through Credit creation banks helps in increasing supply of
purchasing power)
5. Implementation of monetary policy
Well developed banking system is necessary for effective implementation of monetary
policy. Control and regulation of credit is not possible without active co-operation of banks.
6. Promotion of trade and industry
Economic progress of industrialised countries in last 2 centuries is mainly due to expansion
in trade & industrialisation which could not have been made possible without development of a
good banking system. Use of cheques, drafts and BoE as a medium of exchange has
revolutionalised the internal and international trade which in turn accelerated the pace of
industrialisation.
7. Encouraging right type of industries
In a planned economy it is necessary that banks should formulate their loan policies in
accordance with the broad objectives and strategy of industrialisation as adopted in the plan.
8. Regional development
Banks can play role in achieving balanced development in different regions of the economy.
They can transfer surplus funds from developed region to less developed regions, where there is
shortage of funds.
9. Development of agricultural & other neglected sectors
Under developed economies primarily agricultural economies and majority of the
population live in rural areas. So far banks were paying more attention to trade and commerce and
have almost neglected agriculture and industry. Banks must diversify their activities not only to
extend credit to trade, but also to provide medium and long term loans to industry and agriculture.
Credit Creation
(Loans create deposits and deposits create loans)
Banks, unlike other financial institutions, have a peculiar ability to create credit i.e., to
expand their demand deposits as a multiple of their cash reserves. This is because of the fact that
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17
demand deposits of the banks serve as the principal medium of exchange, and in this way, the
banks manage the payment system of the country. In short multiple expansion of deposits is called
credit creation.
When a bank extends loans it is not directly paid to the borrower, but is only credited to his
account and a cheque book is given. Thus every bank loan creates an equivalent amount of
derivative deposit. By using this deposit, banker can again extend loan to some other parties after
keeping a specified amount as reserve. Thus with a little cash in hand the banks can create
additional purchasing power to a considerable degree.
Credit can be created by a single bank or by more than one banker. When it is created by
more than one banker, it is called multiple credit creation.
Imagine that the CRR maintained by the bank is 20%. Now, Mr. A deposits Rs.10,000 with
Federal Bank. The bank need not keep the entire cash in reserve to meet its day to day demand for
cash. After keeping a 20% (Rs.2,000) in hand, bank extends a credit of Rs.8,000 (initial excess) to
Mr. B by opening a credit account in his name. This creates another derivative deposit of Rs.8,000
in the bank. By keeping 20% (Rs.1,600) of this in hand bank again advances Rs.6,400 to Mr.C and
he deposits the same in his bank, SBT. This creates a primary deposit to SBT, and it extend a credit
of Rs.5120 to Mr.D after keeping 1,280 (20%) in the bank. This process continues until the initial
primary deposit of Rs.10,000 with Federal Bank lead to the creation of total deposits (both primary
and derivative) of Rs.50,000 or initial excess reserve of Rs. 8,000 creates a total derivative deposit
of Rs.40,000 (8,000+6,400+5120+4096+. = 40,000)
From the above illustration, it is clear that the initial primary deposit of Rs.10,000 in
Federal Bank leads to the expansion of total deposit of Rs. 50,000. Initial excess reserve of
Rs.8,000 creates multiple derivative deposits of Rs. 40,000. Credit creation is 5 times (Rs.40,000)
of the initial excess reserve (Rs.8,000)
Credit multiplier (5) is =
Total derivative deposits
Initial excess reserve
4000
800
Or 1/ CRR
i.e., 1/20%
Destruction of credit:
Banks create credit by advancing loans. Similarly banks can destroy credit by reducing
loans. Extend of destruction depends on CRR. Higher the CRR greater will be the destruction of
credit.
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Various ways of creating money

by advancing loans
by allowing Overdrafts
by providing Cash Credits
by discounting bill of exchange
by purchasing securities
Limitations of credit creation
Bank cannot expand deposits to an unlimited extent by granting loans and advances even
though this process of granting loans and advances is profitable to them. Their power to create
credit is subject to the following limitations:
Amount of Cash available with the Bank: Credit creation depends on the amount of cash
available with bank. Larger the amount of cash with the banking system, greater will be the
credit creation and vice versa.
Cash Reserve Ratio: CRR is the minimum cash required to be maintained by a bank with RBI.
CRR sets the limit for the creation of credit. Higher the CRR smaller will be the credit creation
and vice versa.
Leakages: The credit creation by the banks is subject to certain conditions. If there is any leakage in this
process the credit creation by the banks will be limited. In credit creation, it is expected that the banks
lend the entire amount of excess deposits over the minimum statutory reserve. If there is any down fall
in such lending, it will affect the creation of credit to that extent. Leakage may occur either because of
unwillingness of banks to utilise their surplus funds for granting loans or unwillingness of borrower to
keep whole amount of loan in the bank. Both will lead to lesser credit creation.
Security for loans: The securities acceptable to bank places a limit on credit creation by the
banks. While lending, the banks insist upon the securities from the customers. All type of assets
are not acceptable to banks as securities. If borrower is not able to provide sufficient security,
credit creation is not possible.
Credit policy of banks: If banks want to create excess reserves, the credit creation will be
limited to that extent.
Monetary Policy of the Central Bank: The capacity of credit creation by banks is largely
depends upon the policies followed by the Central Bank from time to time. The total supply of
cash depends upon the policy of the Central Bank.
Banking habit of the people: The banking habit of the people also sets the limit for the capacity
of banks to create credit. The volume of employed population, monetary habits, etc., determines
the amount of cash that the public wishes to hold. If people prefer to make transactions by
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using cash instead of using cheques, the banks will be left with smaller amount of cash and
there will be lesser credit creation.
Effect of Trade Cycle: The effects of trade cycles also place the limitation on the credit
creation, i.e., the conditions of inflation and deflation set a limit on the creation. During the
period of economic prosperity there will be greater demand for bank loans and therefore, they
can create greater volume of credit. But in times of recession, there is no prosperity and the
business people will hesitate to borrow.
Leaf-cannon criticism
Walter Leaf and Edwin Cannon raised serious objection against theory of credit creation.
They are of the view that it is the depositor who creates credit and not the banker, because, credit
creation is possible only if depositors do not take home their deposits. The banks cannot loan more
than what is deposited by customers. But this criticism was rejected by Crowther both on
theoretical and on practical grounds citing the empirical evidences of the UK.
References:
1. K.C Shekhar & Lekshmy Shekhar (2005), Banking Theory and Practice, Vikas Publishing House,
New Delhi.
2. S.N Maheshwari & S.K Maheswari (2007), Banking Law and Practice, Kalyani Publishers,
Ludhiana.
3. O.P Agarwal (2008), Modern Banking of India, Himalaya Publishing House, Mumbai
4. Dr.P.K Srivastava (2008), Banking Theory and Practice, Himalaya Publishing House, Mumbai.
5. P.N Varshney (2008), Banking Law & Practice, Sulthan Chand & Sons, New Delhi.
6. www.rbi.org.in
7. www.wikipedia.org
8. www.investopedia.com
9. www.idrbt.ac.in
10.www.google.com
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MODULE II
RESERVE BANK OF INDIA
Introduction
As per the recommendation of the Central Banking Enquiry (Hilton Young) Commission,
an Act was passed in the parliament called RBI Act in 1934 and accordingly RBI started its
operation in April 1935 with a share capital of Rs. 5 crores. The share capital was divided into
shares of Rs. 100 each fully paid which was entirely owned by private shareholders in the
beginning. On establishment it took over the function of management of currency from Govt. of
India and power of credit control from the then Imperial Bank of India.
The Central Office of the Reserve Bank was initially established in Calcutta but was
permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and where
policies are formulated. RBI was taken over by GOI in 1948 by passing the RBI (transfer of public
ownership) Act 1948. It started functioning as a state owned and state controlled central bank from
1st January 1948 onwards.
The Reserve Bank of India (RBI) is now the apex financial institution of the country
which is entrusted with the task of controlling, supervising, promoting, developing and planning the
financial system. RBI is the queen bee of the Indian financial system which influences the
commercial banks management in more than one way. The RBI influences the management of
commercial banks through its various policies, directions and regulations. Its role in banking is
quite unique. In fact, the RBI performs the four basic functions of management, viz., planning,
organizing, directing and controlling in laying a strong foundation for the functioning of
commercial banks.
RBI possesses special status in our country. It is the authority to regulate and control
monetary system of our country. It controls money market and the entire banking system of our
country.
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Preamble
The Preamble of the Reserve Bank of India describes the basic functions of the Reserve
Bank as:
" ..to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary
stability in India and generally to operate the currency and credit system of the country to its
advantage."
Management
The Reserve Bank's affairs are governed by a central board of directors. The board is
appointed by the Government of India in keeping with the Reserve Bank of India Act.
The organization structure of RBI consists of a Central Board and Local Board.
Central Board: The general supervision and control of the banks affairs is vested in the Central
Board of Directors which consists of 20 member team including a Governor, 4 Deputy Governors
and 15 Directors (of which 4 are from local boards, and one is a finance secretary of Central
Government). All these persons are appointed or nominated by Central Govt. The chairman of the
Board and its Chief Executive authority is the Governor. Governors and Deputy Governors hold
office for such a period as fixed by Central Government not exceeding 5 years and are eligible for
reappointment. Directors hold office for 4 years and their retirement is by rotation.
As a matter of practical convenience, the Board has delegated some of its functions to a committee
called the Committee of the Central Board. It meets once in a week, generally Wednesdays. There
are sub committees to assist committees such as building committee and staff sub-committee.
Local Board: For each regional areas of the country viz., Western, Eastern, Northern and Southern,
there is a Local Board with head quarters at Bombay, Calcutta, New Delhi and Madras. Local
boards consist of 5 members each appointed by the Central Government. The functions of the local
boards are to advise the central board on local matters and to represent territorial and economic
interests of local cooperative and indigenous banks; advice on such matters that may generally be
referred to them and perform such duties as the Central Board may delegate to them.
The Central office of the RBI, located at Mumbai is divided into several specialized
departments. The main departments are:
1. Issue Department: - It arranges for the issue and distribution of currency notes among the different
centers of the country.
2. Banking Department: - It deals with Government transactions and maintains the cash reserves of the
commercial banks.
3. Department of Banking development:- It is concerned with the development of banking facilities in the
unbanked and rural areas in the country.
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4. Department of Banking operations: - This department supervises and controls the working of the
banking institutions in the country.
5. Non-Banking Companies Department: - It regulates the activities of non-banking financial companies
existing in the country.
6. Agricultural credit Department: - This department studies the problems connected with the agricultural
credit in the country.
7. Industrial finance Department: - It is concerned with the provision of finance to the industrial units in the
country.
8. Exchange control Department: - The entire business of sale and purchase of foreign exchange is
conducted by this department.
9. Legal Department: - The main function of this department is to give legal advices to the other
departments of RBI.
10. Department of Research and Statistics: - This department is concerned with conducting research on
problems relating to money, credit, finance, production etc.
Objectives of RBI
Prior to the establishment of the Reserve Bank, the Indian financial system was totally
inadequate on account of the inherent weakness of the dual control of currency by the Central
Government and of credit by the Imperial Bank of India.
The Preamble to the Reserve Bank of India Act, 1934 spells out the objectives of the
Reserve Bank as: to regulate the issue of Bank notes and the keeping of reserves with a view to
securing monetary stability in India and generally to operate the currency and credit system of the
country to its advantage.
The important objectives are:
1. To act as Monetary Authority: Formulates implements and monitors the monetary policy to
maintain price stability and ensuring adequate flow of credit to productive sectors.
2. To Regulate and supervise the financial system of the country: It prescribes broad parameters
of banking operations within which the country's banking and financial system functions. It helps to
maintain public confidence in the system, protect depositors' interest and provide cost-effective
banking services to the public.
3. To Manage the Exchange Control: Manages the Foreign Exchange Management Act, 1999 to
facilitate external trade and payment and promote orderly development and maintenance of foreign
exchange market in India.
4. To issue currency: Issues and exchanges or destroys currency and coins not fit for circulation
to give the public adequate quantity of supplies of currency notes and coins and in good quality.
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5. To undertake developmental role: RBI performs a wide range of promotional functions to

support national objectives.
6. To undertake related Functions by acting as:
Banker to the Government: performs merchant banking function for the central and the state
governments; also acts as their banker.
Banker to banks: maintains banking accounts of all scheduled banks.
Owner and operator of the depository (SGL-Subsidiary General Ledger account) and exchange
(NDS)
Negotiated Dealing System is an electronic platform for facilitating dealing in
Government Securities and Money Market Instruments that will facilitate electronic submission
of bids/application for government bonds.
To sum up the objectives include:
1.
To manage the monetary and credit system of the country.
2.
To stabilizes internal and external value of rupee.
3.
For balanced and systematic development of banking in the country.
4.
For the development of organized money market in the country.
5.
For facilitating proper arrangement of agriculture finance and be in successful for maintaining
financial stability and credit in agricultural sector.
6.
For proper arrangement of industrial finance.
7.
For proper management of public debts.
8. To establish monetary relations with other countries of the world and international financial
institutions.
9.
For centralization of cash reserves of commercial banks.
10. To maintain balance between the demand and supply of currency.

11. To regulate the financial policy and develop banking facilities throughout the country.
12. T o remain free from political influence while making financial decisions
13. To assist the planned process of development of the Indian economy. Besides the traditional
central banking functions, with the launching of the five-year plans in the country, the
Reserve Bank of India has been moving ahead in performing a host of developmental and
promotional functions, which are normally beyond the purview of a traditional Central Bank.
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Functions of RBI
RBI performs various traditional banking function as well as promotional and
developmental measures to meet the dynamic requirements of the country. Main functions of RBI
can be broadly classified into three. These are
I.
Monetary functions or Central banking functions
II.
Supervisory functions
III.
Promotional and Developmental functions.
I.
Monetary functions include
A. Issue of currency notes

B. Acting as banker to the Government
C. Serving as banker of other banks
D. Controlling credit
E. Controlling foreign exchange operations
A. Issue of currency notes: Under Section22 of the Reserve Bank of India Act of 1934, the Reserve Bank of India is given the
monopoly of note issue. Now RBI is the sole authority for the issue of currency notes of all denominations
except one rupee notes and coins in the country. One rupee notes and coins are issued by Ministry of
Finance of GOI. The RBI has a separate department called the Issue Department for the issue of currency
notes
Since 1956 system of Note Issue changed from Proportional Reserve System to minimum reserve
system. Under Proportional reserve system of note issue, not less than 40% of the total volume of notes
issue by the RBI was to be covered by gold coins, bullion and foreign securities. But under the Minimum
reserve system of note issue, RBI is required to maintain a minimum reserve of gold or foreign securities or
both against the notes issued. No maximum limit is fixed on the volume of notes. RBI maintains gold and
foreign exchange reserves of Rs.200 crores of which 115 crores is in gold & balance in foreign securities,
Govt. of India securities, eligible commercial bills, Pro-notes of NABARD for any loans etc.
This change from Proportional Reserve system to Minimum Reserve system is made because of two
major reasons. Firstly, the planned economic development of the country called for an increased supply of
money, which could not be had under the proportional reserve system. Secondly, the foreign exchange held
as reserve by the Reserve bank had to be released for financing the five year plans. In short, this was to
enable the expanding currency requirements of the economy.
B. Acting as Banker to government: The Reserve bank act as a banker to the Central and State Governments. As a banker to the
Government RBI acts in three capacities, viz., (a) as a banker,(b) as a financial agent, and (c) as a
financial advisor
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(a) As a banker: - RBI renders the following services

1. Accepts deposits from the Central and State Government.
2. Collects money on behalf of Government.
3.
Makes payments on behalf of the Government, in accordance with their instructions.
4. Arranges for the transfer of funds from one place to another on behalf of the Governments
5. Makes arrangements for the supply of foreign exchange to the Central and State Governments.
6. It maintains currency chests with treasuries and other agencies in places prescribed by the Government
of India. These chests are supplied with sufficient currency notes to meet the requirements for the
transactions of the Government.
7. Short term advances are granted to Central and State Governments for a period not exceeding three
months. These advances are granted up to a certain limit without any collateral securities.
8. In times of emergencies like war, extraordinary loans are also granted to the Governments by the RBI.
(b) As a financial agent: - The services given are
1. Acts as an agent of the Central and State Governments in the matter of floatation of loans. On account
of Reserve Banks intimate knowledge of the financial markets, it is able to obtain the best possible
terms for the Government in this matter. Further by coordinating the borrowing programmers of the
various Governments, it is able to minimize the adverse effects of Government borrowings on the
money and securities market.
2. On behalf of Central Government RBI sells treasury bills of 90 days maturity at weekly auctions and
secures short-term finance for the Central Government. Apart from that RBI also sells adhoc treasury
bills of 90 days maturity to the State Governments, Semi-Government Departments and foreign
central banks on behalf of the Central Government.
3. RBI manages and keeps the accounts of the public debts of the Central and State Governments. It
arranges for the payment of interest and principal amount on the public debt on the due dates.
4. As an agent RBI also represents Government of India in the International institutions like the IMF, the
IBRD etc.
The Reserve Bank is agent of Central Government and of all State Governments in India except for
that of Jammu and Kashmir and Sikkim.
(c) As a Financial Adviser: - renders following services
1. It advices the Central and State Government on all financial and economic matters such as the floating
of loans, agricultural and industrial finance etc.
2. Advice on matters of International finance is also given to Central Government.
3. It collects the recent information on current economic and financial developments in India and abroad,
with the help of its Research and Statistics Department and keeps Government informed periodically.
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C.
Bankers bank: -
RBI acts as banker to Scheduled banks. Scheduled Banks include commercial banks, foreign
exchange banks, public sector banks, state co-operative banks and the regional rural banks. As a bankers
bank it renders the following services:
1. It holds a part of the cash balances of the commercial banks:- Every commercial bank in India is
required to keep with the Reserve Bank a cash balance of not less than 6% of its demand and time
liabilities. This rate can be increased up to 20%. The two main purposes of maintaining cash reserve by
commercial banks are as follows. Firstly to protect the interest of the depositors, secondly to enable the
Reserve Bank to accommodate the commercial banks on times of difficulties and thirdly the Reserve
Bank can control the credit created by the commercial banks by varying the statutory cash reserve
requirements.
2.
It acts as the clearing house: - By acting as clearing house the Reserve bank helps the member banks
in the settlement of the mutual indebtedness without physical transfer of cash.
3. It provides cheap remittance facilities to the commercial banks

4. It provides financial accommodation to the commercial banks: - At times of financial crisis the RBI is
the lender of last resort for the commercial banks. Financial assistance is given by The Reserve bank
either by rediscounting eligible bills or by granting loans against approved securities.
D. Control of Credit: RBI undertakes the responsibility of controlling credit in order to ensure internal price stability and
promote sufficient credit for the economic growth of the country. Price stability is essential for economic
development. To control credit, RBI makes use of both quantitative and qualitative weapons by virtue of the
powers given to it by Reserve Bank of India Act of 1934 and the Indian Banking Regulation Act of 1949.
These weapons are listed below.
(a)Quantitative weapons
1. Bank rate policy:
Bank rate is the lending rate of central bank. It is the official minimum rate at which central
bank of a country rediscounts the eligible bills of exchange of the commercial banks and other
financial institutions or grants short term loans to them. By increasing bank rate, RBI can make
bank credit costlier.
2. Open Market Operations:
RBI Act authorizes the RBI to engage in the purchase of securities of central and State
Government and such other securities as specified by Central Govt. But by and large, its open
market operations are confined to Central Government Securities and to a very limited extend to
State Government Securities.
RBI uses this weapon to offset the seasonal fluctuations in money market. When there is
an excessive supply of money, RBI sells the securities in the open market. In that way RBI is able
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to withdraw the excess money from circulation. But when there is shortage of money supply in the
market, it purchases securities from the open market and as a result, more money is arrived at for
circulation
3. Variable Cash reserve ratio:
Under the RBI Act of 1934, every scheduled and non- scheduled bank is required to
maintain a fixed percentage of total time and demand liabilities as cash reserve with RBI. It is
called statutory Cash Reserve Ratio (CRR). An increase in CRR reduces lending capacity of the
bank and a decrease in CRR increases the lending capacity. RBI can prescribe a CRR ranging up to
15% which is at present 4% (as on Jan 2014).
4. Variable Statutory Liquidity Ratio
According to sec 24 of BRA 1949, every commercial bank is required to maintain a certain
percentage of its total deposits in liquid assets such as cash in hand, excess reserve with RBI,
balances with other banks, gold and approved Government and other securities. This proportion of
liquid assets to total deposits is called SLR. BRA empowers RBI to fix the SLR up to 40%. The
variation of the SLR is intended to reduce the lendable funds in the hands of the commercial banks
and to check the expansion of bank credit. An increase in SLR will decrease the lendable funds in
the hands of commercial banks and vice versa. Present rate of SLR is 23%. (As on Jan 2014).
5. Repo Rate and Reverse Repo Rate
Repo rate is the rate at which RBI lends to commercial banks generally against government
securities. Reduction in Repo rate helps the commercial banks to get money at a cheaper rate and
increase in Repo rate discourages the commercial banks to get money as the rate increases and
becomes expensive. Reverse Repo rate is the rate at which RBI borrows money from the
commercial banks. The increase in the Repo rate will increase the cost of borrowing and lending of
the banks which will discourage the public to borrow money and will encourage them to deposit.
As the rates are high the availability of credit and demand decreases resulting to decrease in
inflation. This increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the policy.
As of October 2013, the repo rate is 7.75 % and reverse repo rate is 6.75%. On January 28, 2014,
RBI raised repo rate by 25 basis points to 8.00 %.
b. Selective credit controls (Qualitative weapons)
1. Credit Ceiling
In this operation RBI issues prior information or direction that loans to the commercial
banks will be given up to a certain limit. In this case commercial bank will be tight in advancing
loans to the public. They will allocate loans to limited sectors. Few example of ceiling are
agriculture sector advances, priority sector lending.
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2. Credit Authorization Scheme

Credit Authorization Scheme was introduced in November, 1965 when P C Bhattacharya
was the chairman of RBI. Under this instrument of credit the commercial banks are required to
obtain the RBIs prior authorization for sanctioning any fresh credit beyond the authorized limits.
3. Moral Suasion
Moral Suasion is just as a request by the RBI to the commercial banks to follow a particular
line of action. RBI may request commercial banks not to give loans for unproductive purpose
which does not add to economic growth but increases inflation.
4. Regulation of margin requirements:
Margin refers to the difference between loan amount and the market value of collateral
placed to raise the loan. RBI fixes a lower margin to borrowers whose need is urgent. For e.g. if
RBI believes that farmers should be financed urgently, RBI would direct to lower the margin
requirement on agricultural commodities. RBI has used this weapon for a number of times.
5. Issuing of directives:
BRA empowers RBI to issue directives to banks and banks are bound to comply with such
directives. RBI directives may relate to:
Purpose for which advance may or may not be made
Margins requirement
Maximum amount of loan that can be sanctioned to any company, firm or individual
Rate of interest and other terms and conditions on which loans may be given
E. Control of foreign Exchange operations
One of the central banking functions of the RBI is the control of foreign exchange
operations. For the control of foreign exchange business, the RBI has set up a separate department
called the Exchange Control Department in September, 1939. This Department has been granted
wide powers to regulate the foreign exchange business of the country. As the central bank of India,
it is the responsibility of the RBI to maintain the external value of the Indian rupee stable. India
being member of the IMF, the RBI is required to maintain stable exchange rates between the Indian
rupee and the currencies of all other member countries of the I.M.F.
Besides maintaining stable exchange rates, RBI also acts as the custodian of the foreign
exchange reserves of the country. The foreign exchange reserves of the country held by RBI
includes Euro, U.S. dollars, Japanese yen etc
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RBI also acts as the administrator of exchange control. It ensures that the foreign exchange
reserves of the country are utilized only for approved purposes and the limited foreign exchange
reserves of the country are conserved for the future.
II.
Supervisory functions
RBI has been given several supervisory powers over the different banking institutions in the
country. The supervisory functions relate to licensing and establishment, branch expansion,
liquidity of assets, amalgamation, reconstruction and liquiditation of commercial banks and cooperative banks
III.
Promotional and developmental functions
RBI is also performing promotional and developmental functions. These functions includes
the following
a) Provision of Agricultural Credit: - For the promotion of agricultural credit RBI has set up a
separate department called the Agricultural Credit Department. It. has also set up two funds namely
1. The National Agricultural Credit (Long term operations) and 2. The National Agricultural
credit (stabilization) fund for facilitating Long term, Medium term and Short term finance for
agricultural purposes.
b) Provision for Industrial finance: - RBI has played a very significant role in the field of industrial
finance by helping the setting up of a number of public sector industrial finance corporations that
provide short term, medium term, and long term finance for industrial purpose. These industrial
finance corporations include 1. Industrial finance Corporation of India (IFCI), 2. State Finance
Corporations (SFC), Industrial Development Bank of India (IDBI), 3.Industrial Reconstruction
Corporation of India (IRCI), 4. Refinance Corporation of India, and 5. Unit Trust of India (UTI).
Besides the above RBI also renders the Credit Guarantee Scheme which intends to give
protection to banks against possible losses in respect of their advances to small scale industrial
units.
c.) Development of Bill Market: - A bill market is a place where short term bill of 3 month duration
are generally discounted or rediscounted. RBI plays a very important role in the promotion of Bill
Market as a well-developed bill market is essential for the smooth functioning of the credit system.
d.) Collection and publication of statistics on financial and economic matters: - These functions of
RBI are extremely useful to the Government in knowing and solving the various economic
problems. They are also of immense help to financial institutions, business and industry and for
general public.
e.) Miscellaneous functions:- RBI has established training centers for staff for its own staff and
other banks. Bankers training college Mumbai, National Institute of Bank Management Mumbai,
Staff Training College Madras, and College of Agricultural Banking at Pune are the institutions
run by RBI.
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Monetary policy
Meaning
Monetary policy is the process by which monetary authority of a country, generally a
central bank controls the supply of money in the economy by exercising its control over interest
rates in order to maintain price stability and achieve high economic growth. In India, the central
monetary authority is the Reserve Bank of India (RBI). It is so designed as to maintain the price
stability in the economy
Monetary policy can be either expansionary or contractionary. Under an expansionary
policy the total supply of money are increased in the economy more rapidly than usual, and under
contractionary policy the money supply expands more slowly than usual or even shrinks.
Expansionary policy is traditionally used to reduce unemployment in a recession by lowering
interest rates in the hope that easy credit will encourage the entrepreneurs to begin new enterprise
or expand their existing businesses. Contractionary policy is intended to slow inflation in order to
avoid the resulting distortions and deterioration of asset values.
Definition
According to Prof. Harry Johnson,
"A policy employing the central banks control of the supply of money as an instrument for
achieving the objectives of general economic policy is a monetary policy."
According to A.G. Hart,
"A policy which influences the public stock of money substitute of public demand for such assets
of both that is policy which influences public liquidity position is known as a monetary policy."
From both these definitions, it is clear that a monetary policy is related to the availability
and cost of money supply in the economy in order to attain certain broad objectives. The Central
Bank of a nation keeps control on the supply of money to attain the objectives of its monetary
policy.
Objectives of the monetary policy
The objectives of a monetary policy in India are similar to the objectives of its five year
plans. In a nutshell planning in India aims at growth, stability and social justice. The objectives of
the monetary policy of India, as stated by RBI, is:
1. Price Stability :
It implies promoting economic development with considerable emphasis on price stability.
The centre of focus is to facilitate the environment which is favorable to the architecture that
enables the developmental projects to run swiftly while also maintaining reasonable price stability.
All the economics suffer from inflation and deflation. It can also be called as Price Instability. Both
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are harmful to the economy. Thus, the monetary policy having an objective of price stability tries to
keep the value of money stable. It helps in reducing the income and wealth inequalities. When the
economy suffers from recession the monetary policy should be an 'easy money policy' but when
there is inflationary situation there should be a 'dear money policy'.
2.
Rapid Economic Growth :

It is the most important objective of a monetary policy. The monetary policy can influence
economic growth by controlling real interest rate and its resultant impact on the investment. If the
RBI opts for a cheap or easy credit policy by reducing interest rates, the investment level in the
economy can be encouraged. This increased investment can speed up economic growth. Faster
economic growth is possible if the monetary policy succeeds in maintaining income and price
stability.
3.
Controlled Expansion of Bank Credit

One of the important functions of RBI is the controlled expansion of bank credit and money supply
with special attention to seasonal requirement for credit without affecting the output.
4.
Exchange Rate Stability :

Exchange rate is the price of a home currency expressed in terms of any foreign currency. If
this exchange rate is very volatile leading to frequent ups and downs in the exchange rate, the
international community might lose confidence in our economy. The monetary policy aims at
maintaining the relative stability in the exchange rate. The RBI by altering the foreign exchange
reserves tries to influence the demand for foreign exchange and tries to maintain the exchange rate
stability
5.
Balance of Payments (BOP) Equilibrium :

Many developing countries like India suffer from the Disequilibrium in the BOP. The
Reserve Bank of India through its monetary policy tries to maintain equilibrium in the balance of
payments. The BOP has two aspects i.e. the 'BOP Surplus' and the 'BOP Deficit'. The former
reflects an excess money supply in the domestic economy, while the later stands for stringency of
money. If the monetary policy succeeds in maintaining monetary equilibrium, then the BOP
equilibrium can be achieved.
6.
Equal Income Distribution :

Many economists used to justify the role of the fiscal policy in maintaining economic
equality. However in recent years economists have given the opinion that the monetary policy can
help and play a supplementary role in attaining an economic equality. Monetary policy can make
special provisions for the neglect supply such as agriculture, small-scale industries, village
industries, etc. and provide them with cheaper credit for longer term. This can prove fruitful for
these sectors to come up. Thus in recent period, monetary policy can help in reducing economic
inequalities among different sections of society.
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7.
Neutrality of Money :
Economist such as Wicksteed, Robertson has always considered money as a passive
factor. According to them, money should play only a role of medium of exchange and not more
than that. Therefore, the monetary policy should regulate the supply of money. The change in
money supply creates monetary disequilibrium. Thus monetary policy has to regulate the supply of
money and neutralize the effect of money expansion. However this objective of a monetary policy
is always criticized on the ground that if money supply is kept constant then it would be difficult to
attain price stability.
8.
Full Employment :
The concept of full employment was much discussed after Keynes's publication of the
"General Theory" in 1936. It refers to absence of involuntary unemployment. In simple words 'Full
Employment' stands for a situation in which everybody who wants jobs get jobs. However it does
not mean that there is Zero unemployment. In that senses the full employment is never full.
Monetary policy can be used for achieving full employment. If the monetary policy is expansionary
then credit supply can be encouraged. It could help in creating more jobs in different sector of the
economy.
9.
Promotion of Fixed Investment:

The aim here is to increase the productivity of investment by restraining non essential fixed
investment.
10.
Promotion of Exports and Food Procurement Operations
Monetary policy pays special attention in order to boost exports and facilitate the trade. It is
an independent objective of monetary policy.
11.
Desired Distribution of Credit
Monetary authority has control over the decisions regarding the allocation of credit to
priority sector and small borrowers. This policy decides over the specified percentage of credit that
is to be allocated to priority sector and small borrowers.
12.
Equitable Distribution of Credit
The policy of Reserve Bank aims equitable distribution to all sectors of the economy and all social
and economic class of people
13.
To Promote Efficiency
It is another essential aspect where the central banks pay a lot of attention. It tries to
increase the efficiency in the financial system and tries to incorporate structural changes such as
deregulating interest rates, ease operational constraints in the credit delivery system, to introduce
new money market instruments etc.
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14.
Reducing the Rigidity
RBI tries to bring about the flexibilities in the operations which provide a considerable
autonomy. It encourages more competitive environment and diversification. It maintains its control
over financial system whenever and wherever necessary to maintain the discipline and prudence in
operations of the financial system.
Instruments of Monetary policy:

Instruments of Monetary operations involve monetary techniques which operate on
monetary magnitudes such as money supply, interest rates and availability of credit aimed to
maintain Price Stability, Stable exchange rate, Healthy Balance of Payment, Financial stability,
Economic growth etc. RBI, the apex institute of India which monitors and regulates the monetary
policy of the country stabilizes the price by controlling Inflation.RBI takes into account the
following monetary policies:
The instruments of monetary policy and control can be classified into two:I. Quantitative weapons (Indirect Instruments): Quantitative methods or weapons are those
which control total volume or size of credit in the country without any reference to the purpose for
which it is used. They affect indiscriminately all sections of the economy. Important quantitative
weapons are:
a. Bank rate policy
b. Open market operations
c. Variable Cash Reserve Ratio (CRR)
d. Variable Statutory Liquidity Ratio (SLR)
e. Liquidity Adjustment Facility (LAF) includes Repo rate and Reverse Repo rate
f. Marginal Standing Facility (MSF)
II. Qualitative weapons (Direct Instruments): Qualitative weapons are those which regulate the
quality of credit i.e., uses to which credit is put. They are concerned with the encouragement of
credit to productive uses, and discouragement of credit to non essential activities. The main
qualitative credit control weapons are:
a. Regulation of margin requirements
b. Regulation of consumer credit
c. Issuing of Directives
d. Rationing of credit
e. Credit authorisation scheme
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f. Moral suasion
g. Direct action
The details review of the quantitative methods of monetary policy are discussed here under.
a.
Bank rate policy: - Section 49 of RBI Act, 1934 defines the bank rate as the standard rate at which
the Reserve Bank is prepared to buy or rediscount bills of exchange or other commercial papers eligible
for purchase under the Act. Thus bank rate is the minimum rate at which the RBI is ready to rediscount
eligible bills of exchange or other commercial papers presented to it by the commercial banks or grant
loans to the commercial banks against approved securities. By manipulating the bank rate the RBI can
control the bank credit and the general price level of the country.
By raising the bank rate, it can make the bank credit costlier and thereby cause contraction of bank
credit. By lowering the bank rate, on the other hand, it can make the bank credit cheaper and thereby
cause contraction of bank credit.
Though the bank rate policy of RBI has had some effects on some occasions, on a whole, it
has not been very effective. The ineffectiveness of bank rate in controlling credit is due to the
following factors.
A major portion of credit requirements is met by indigenous bankers, who are not under the
control of RBI.
Lack of co-ordination between various sectors of money market: There is a wide disparity of
interest rates in Indian money market.
Market rate of interest does not change in same proportion of bank rate.
There is scarcity of eligible bills in Indian money market and rediscounting is not so popular in
India.
Banks are left with large deposits even after meeting the minimum statutory reserves. So they did
not feel the necessity of seeking financial assistance from RBI.
b. Open Market Operations(OMO): - An open market operation is an instrument of monetary policy

which involves buying or selling of government securities from or to the public and banks. This
mechanism influences the reserve position of the banks, yield on government securities and cost of bank
credit. The RBI sells government securities to contract the flow of credit and buys government securities
to increase credit flow. Open market operation makes bank rate policy effective and maintains stability
in government securities market.
Apart from outright purchase and sales of securities, RBI also involves in the Switch
operations i.e., purchase of one type of securities against the sales of another type of securities. The
main objectives of open market operations are:
Objectives of OMO
To facilitate borrowing of funds by the govt. from the public.
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To maintain the prices of Government Securities stable. When there is a fall, RBI purchases
them to raise their prices.
To offset the seasonal changes in the supply of money in money market.
To support the bank rate policy.
To control credit.
c. Variable Cash Reserve Ratio (CRR): - Cash Reserve Ratio is a certain percentage of bank deposits
which banks are required to keep with RBI in the form of reserves or balances .Higher the CRR with the
RBI lower will be the liquidity in the system and vice-versa.RBI is empowered to vary CRR between 15
percent and 3 percent. But as per the suggestion by the Narshimham committee Report the CRR was
reduced from 15% in the 1990 to 5 percent in 2002. As of October 2013, the CRR is 4.00 percent.
Though the RBI was empowered to make use of the weapon of variable cash reserve ratio as early as
1951, the RBI made use of this weapon only since March,1960.
d. Variable Statutory Liquidity ratio (SLR): - The current SLR is 23%. According to sec 24 of BRA 1949,
every commercial bank is required to maintain a certain percentage of its total deposits in liquid assets
such as cash in hand, excess reserve with RBI, balances with other banks, gold and approved
Government and other securities. This proportion of liquid assets to total deposits is called SLR. BRA
empowers RBI to fix the SLR up to 40%. The variation of the SLR is intended to reduce the lendable
funds in the hands of the commercial banks and to check the expansion of bank credit. An increase in
SLR will decrease the lendable funds in the hands of commercial banks and vice versa. Present rate of
SLR is 23%. (as on jan2014)
e. Liquidity Adjustment Facility (LAF) includes Repo rare and Reverse Repo: -LAF consists of daily
infusion or absorption of liquidity on a repurchase basis ,through repo (liquidity injection) and reverse
repo (liquidity absorption) auction operations through government securities as collateral securities.
Repo rate is the rate at which RBI lends to commercial banks generally against government
securities. Reduction in Repo rate helps the commercial banks to get money at a cheaper
rate and increase in Repo rate discourages the commercial banks to get money as the rate
increases and becomes expensive.
Reverse Repo rate is the rate at which RBI borrows money from the commercial banks. The
increase in the Repo rate will increase the cost of borrowing and lending of the banks which
will discourage the public to borrow money and will encourage them to deposit. As the rates
are high the availability of credit and demand decreases resulting to decrease in inflation
This increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the policy.
As of October 2013, the repo rate is 7.75 % and reverse repo rate is 6.75%. On January 28,
2014, RBI raised repo rate by 25 basis points to 8.00 %.
f.
Marginal Standing Facility: - This was instituted under which the scheduled commercial banks can
borrow over night at their discretion upto one percent of their respective NDTL at 100 basis points
above the repo rate to provide a safety valve against unanticipated liquidity shocks
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36
The detailed explanations of the major qualitative methods are given here under.
a. Regulation of margin requirement: - Margin refers to the difference between loan amount and the
market value of collateral placed to raise the loan. RBI fixes a lower margin to borrowers whose
need is urgent. For e.g. if RBI believes that farmers should be financed urgently, RBI would direct to
lower the margin requirement on agricultural commodities. RBI has used this weapon for a number
of times.
b. Issuing of Directives : - Under section 21,of the BRA of 1949, RBI is empowered to issue
directives to any particular bank or to the entire banking system and the banks are bound to comply
with the directives issued to them. RBI directives can be in regard to:
Purpose for which advance may or may not be made
Margins requirement
Maximum amount of loan that can be sanctioned to any company, firm or person.
Rate of interest and other terms and conditions on which loans may be given
c.
Credit Ceiling: In this operation RBI issues prior information or direction that loans to the
commercial banks will be given up to a certain limit. In this case commercial bank will be tight in
advancing loans to the public. They will allocate loans to limited sectors. Few example of ceiling are
agriculture sector advances, priority sector lending.
d.
Credit Authorization Scheme: - Credit Authorization Scheme was introduced in November, 1965
when P C Bhattacharya was the chairman of RBI. Under this instrument of credit the commercial
banks are required to obtain the RBIs prior authorization for sanctioning any fresh credit beyond the
authorized limits.
e. Moral Suasion: - Moral Suasion is just as a request by the RBI to the commercial banks to follow a
particular line of action. RBI may request commercial banks not to give loans for unproductive
purpose which does not add to economic growth but increases inflation.
f.
Direct Action : - This method is rarely used by RBI. But it is adopted when all other measures fail. It
implies refusal of RBI to extend rediscounting facilities to banks which follows unsound banking
practices and such other measures.
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Key Indicators and their rates as on January 2014

Indicator
Current rate
Inflation
7.52%
Bank rate
9%
CRR
4.00%
SLR
23%
Repo rate
8.00%
Reverse repo rate
7.00%
Marginal
facility rate
9.00%
Standing
References:
1. Banking Theory Law and Practice, Gordon & Natarajan, Himalaya Publishing House.
2. Banking Theory Law and Practice, B. S. Raman, United Publishers
3. Banking Theory and Practice, Dr. P. K. Srivastava, Himalaya Publishing House.
4. www.rbi.org.in
5. rbidocs.rbi.org.in/docs/content/pdfs/FUNCWWE080910
6. www.Wikipedia.in
7. www.Investopedia monetary policy
8. www.rbi.org.in/scripts/aboutusdisplay.aspx
9. www.finance.indianmart.com/investment
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38
MODULE III
MONEY MARKET
MEANING OF MONEY MARKET
Market is a place where goods are bought and sold. It is aggregate of buyers and sellers of a
certain good or service and the transactions between them. Financial market is a type of market that
deals in financial assets and credit instruments such as currency, cheques, bank deposits, shares,
debentures, govt. securities, treasury bills, bill of exchange etc.
On the basis of maturity of assets that is dealt with, financial market is divided into two
categories viz., money market & capital market. Money market deals in highly liquid short term
financial assets (maturity ranging between several days to one year) whereas capital market deals
in long term financial instruments (say, with a maturity of more than one year) like equity shares.
But money market does not refer to a particular place where money is borrowed and lent by
the parties concerned. Mostly, transactions between takes place over phone or mail or through
agents. No personal contact or presence of the two parties is essential.
Thus money market refers to the institutional arrangements facilitating borrowing and
lending of short term funds. According to Crowther Money Market is the collective name given to
the various firms and institutions that deal in various grades of near money.
RBI defined money market as a market for short term financial assets that are close
substitute for money, facilitate the exchange of money, in primary and secondary markets
Constituents of Indian money market

Main constituents of money market are the lenders who supply funds and borrowers who
demand short term credit. Suppliers of funds may belong to either
1. Unorganised sector whose activities are not controlled or coordinated by RBI (comprising of
indigenous bankers and village money lenders) or
2. Organised sector (comprising of RBI, commercial banks, Development Financial Institutions,
co-operative banks and other financial institutions such as LIC)
The main borrowers of short term funds are central government, state governments, local
authorities (such as municipal corporations), traders and industrialists, farmers, exporters, importers
and general public.
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Sub- markets of organised money market

1. Call/Notice/Term money market
Call/Notice money is an amount borrowed or lent on demand for a very short period say, a
few hours to 14 days. If the period is less than 24 hours it is Call money'. They can be recalled on
demand and that is why it is known as call money. If the period of loan is more than one day and up
to 14 days it is called 'Notice money'. Term money refers to borrowing/lending of funds for a
period exceeding 14 days. No collateral security is required to cover these transactions. Banks are
the major borrower and lender of call money. Banks with temporary deficit of funds, to meet their
CRR requirements, form the demand side and banks with temporary excess of funds from the
supply side of call money market. In India major suppliers of call money are Non-Banking
Financial Institutions like LIC, GIC etc. It is a completely inter-bank market hence non-bank
entities are not allowed access to this market. Interest rates in the call and notice money market are
market determined. In view of the short tenure of such transactions, both the borrowers and the
lenders are required to have current accounts with the RBI.
2. Commercial bill market:
A bill of exchange is a written, unconditional order by one party (the seller of goods/the
drawer) to another (the buyer/the drawee) to pay a certain sum, either immediately (a sight bill) or on
a fixed date (a term bill), for payment of goods and/or services received. These bills are called trade
bills. These trade bills are called commercial bills when they are accepted by commercial banks.
Maturity of the bill is generally three months.
If the bill is payable at a future date and the seller needs money during the currency of the
bill then he may approach his bank for discounting the bill. The maturity proceeds (face value of
discounted bill), from the drawee, will be received by the bank.
If the bank needs fund during the currency of the bill then it can rediscount the bill already
discounted by it in the commercial bill rediscount market at the market related discount rate.
The bill discounting market is not so popular in India. It barely constitute 10% of total bank
credit. The establishment of Discount and Finance House of India (DFHI) in 1988 has been an
important step towards the development of an active discount market in India. In India, the major
reason cited for the non-development of bill financing is the hesitation of the industry and trade to
subject themselves to the rigours of bill discipline.
3. Bankers acceptance
Bankers' acceptances date back to the 12th century when they emerged as a means to
finance uncertain trade, as banks bought bills of exchange at a discount. A short-term debt
instrument issued by a firm that is guaranteed by a commercial bank. Banker's acceptances are
issued by firms as part of a commercial transaction. It is a promised future payment which is
accepted and guaranteed by a bank and drawn on a deposit at the bank. The banker's acceptance
specifies the amount of money, the date, and the person to which the payment is due. After
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40
acceptance, the draft becomes an unconditional liability of the bank. The party that holds the
banker's acceptance may keep the acceptance until it matures, and thereby allow the bank to make
the promised payment, or it may sell the acceptance at a discount today to any party willing to wait
for the face value payment of the deposit on the maturity date.
Banker's acceptances make a transaction between two parties who do not know each other safer
because they allow the parties to substitute the bank's credit worthiness for that who owes the
payment.
4. Treasury bill (T bill) market
Treasury Bill Market refers to the market where treasury bills are bought and sold. T Bill
is a promissory note issued by RBI on behalf of central/state government. It is issued to meet short
term requirements of the govt. TBs are highly secured and liquid as repayment is guaranteed by
RBI. Treasury bills are available for a minimum amount of Rs.25000 and in multiples of Rs. 25000.
Treasury bills are issued at a discount and are redeemed at par.
Types of T-bills
In India, there are 2 types of treasury bills viz
1. Ordinary or regular
2. 'Ad-hoc' known as 'ad hocs'.
Ordinary are issued to the public and other financial institutions for meeting the short-term
financial requirements of the Central Government. These are freely marketable and they can be
bought and sold at any time and they have a secondary market also.
On the other hand, 'ad-hocs' are always issued in favour of the RBI only. They are not sold
through tender or auction. They are purchased by the RBI and the RBI is authorised to issue
currency notes against them. They aren't marketable in India. Holders of these bills can always sell
them back to the RBI.
On the basis of periodicity, Treasury bills may be classified into three
1. 91-day (3 months) T bill- maturity is in 91 days. Its auction is on every Wednesdays of every
week.
2. 182-day (6 months)T bill- maturity is in 182 days. Its auction is on every alternate Wednesdays
preceding non-reporting Fridays. (Banks are required to furnish various data to RBI on every alternate
Friday, called reporting Fridays).
3. 364-Day (1 year) T bill- maturity is in 364 days. Its auction is on every alternate Wednesdays
preceding reporting Fridays.
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A considerable part of the government's borrowings happen through TBills of various

maturities. Based on the bids received at the auctions, RBI decides the cut off yield and accepts all
bids below this yield.
All entities registered in India like banks, financial institutions, Primary Dealers, firms,
companies, corporate bodies, partnership firms, institutions, mutual funds, Foreign Institutional
Investors, State Governments, Provident Funds, trusts, research organisations, Nepal Rashtra bank
and even individuals are eligible to bid and purchase Treasury bills
These T bills which are issued at a discount can be traded in the market. The treasury bills
are issued in the form of promissory note in physical form or by credit to Subsidiary General
Ledger (SGL) account or Gilt account in dematerialised form.
Advantages of investment in TB
1. No tax deducted at source
2. Zero default risk being sovereign paper
3. Highly liquid money market instrument
4. Better returns especially in the short term
5. Transparency
6. Simplified settlement
7. High degree of tradability and active secondary market facilitates meeting unplanned fund
requirements.
4. Certificates of Deposits
Certificate of Deposit (CD) is a negotiable money market instrument issued against funds
deposited at a bank or other eligible financial institution for a specified time period. After treasury
bills, this is the next lowest risk category investment option.
Allowed in 1989, CD is a negotiable promissory note, secure and short term in nature. The
maturity period of CDs issued by banks should not be less than 7 days and not more than one year,
from the date of issue. The maturity most quoted in the market is for 90 days. The FIs can issue
CDs for a period not less than 1 year and not exceeding 3 years from the date of issue. A CD is
issued at a discount to the face value, the discount rate being negotiated between the issuer and the
investor.
CDs in physical form are freely transferable by endorsement and delivery. CDs in demat
form can be transferred as per the procedure applicable to other demat securities. There is no lockin period for the CDs. It can be issued to individuals, corporations, companies, trusts, funds,
associations, etc. Non-Resident Indians (NRIs) may also subscribe to CDs.
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The minimum issue of CD to single investor is Rs.1 lakh and additional amount in multiples
of Rs.1 lakh each.
CDs are issued by banks and FIs mainly to augment funds by attracting deposits from
corporates, high net worth individuals, trusts, etc. Those foreign and private banks which do not
have large branch networks and hence lower deposit base, use this instrument to raise funds.
5. Commercial Paper Market
Introduced in 1990, CPs are negotiable, short-term, unsecured promissory notes with fixed
maturities, issued by well rated companies. Subsequently, primary dealers and all-India financial
institutions were also permitted to issue CP to enable them to meet their short-term funding
requirements for their operations. Companies having a net worth of Rs.4 crores and whose shares
are listed in a stock exchange can issue CPs either directly to the investors or through merchant
banks. All eligible participants shall obtain the credit rating for issuance of Commercial Paper from
a credit rating agency as notified by RBI such as CRISIL. These are basically instruments
evidencing the liability of the issuer to pay the holder in due course a fixed amount (face value of
the instrument) on the specified due date. These are issued for a fixed period of time at a discount
to the face value and mature at par.
CP can be issued for maturities between a minimum of 7 days and a maximum of up to one
year from the date of issue. These instruments are normally issued in the multiples of five lakhs for
30/ 45/ 60/ 90/ 120/ 180/ 270/ 364 days. CP can be issued either in the form of a promissory note or
in a dematerialised form through any of the depositories approved by and registered with SEBI.
Banks, FIs and PDs can hold CP only in dematerialised form.
Funds raised through CPs do not represent fresh borrowings for the corporate issuer but
merely substitute a part of the banking limits available to it. Hence a company issues CPs mostly to
save on interest costs i.e. it will issue CPs only when the CP rate is lower than the banks lending
rate.
Individuals, banking companies, other corporate bodies (registered or incorporated in India)
and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs)
etc. can invest in CPs. However, investment by FIIs would be within the limits set for them by
Securities and Exchange Board of India (SEBI) from time-to-time.
The maximum amount a company can raise through CP is up to 75 % of its total working
capital limit. Fixed Income Money Market and Derivatives Association of India (FIMMDA), may
prescribe, in consultation with the RBI, any standardised procedure and documentation for
operational flexibility and smooth functioning of CP market.
On October 15 1997, total outstanding amount on Commercial paper transaction in Indian
money market was Rs. 3377 crore. This outstanding amount increased substantially to Rs. 1,28,347
crore on July 15, 2011. This growth of Commercial paper market may be attributed to the rapid
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expansion of corporate manufacturing and financial companies in liberalized and Globalized Indian
economy.
6. REPO Market
A repurchase agreement, also known as a repo, is the sale of securities together with an
agreement for the seller to buy back the securities at a later date. Predominantly, repos are
undertaken on overnight basis, i.e., for one day period. The repurchase price should be greater than
the original sale price, the difference representing interest, sometimes called the repo rate. The
party that originally buys the securities effectively acts as a lender and the original seller is acting
as a borrower.
Different instruments can be considered as collateral security for undertaking the ready
forward deals and they include Government dated securities, Treasury Bills, corporate bonds,
money market securities and equity. Legal title to the collateral security which is used in repo
transaction, passes to the buyer during the repo period. As a result in case the seller defaults the
buyer does not require to establish right on the collateral security.
The Repo/Reverse Repo transaction can only be done at Mumbai between parties approved
by RBI and in securities as approved by RBI.The repo rate is the rate at which the banks borrow
from RBI, while the reverse repo rate is the rate offered by RBI for funds borrowed from banks.
A reverse repo is the mirror image of a repo. For, in a reverse repo, securities are acquired
with a simultaneous commitment to resell. Hence whether a transaction is a repo or a reverse repo
is determined only in terms of who initiated the first leg of the transaction.
As part of the measures to develop the corporate debt market, RBI has permitted select
entities (scheduled commercial banks excluding RRBs and LABs, Primary Dealers, all-India FIs,
NBFCs, mutual funds, housing finance companies, insurance companies) to undertake repo in
corporate debt securities. This is similar to repo in Government securities except that corporate debt
securities are used as collateral for borrowing funds. Only listed corporate debt securities that are
rated AA or above by the rating agencies are eligible to be used for repo. Commercial paper,
certificate of deposit, non-convertible debentures of original maturity less than one year are not
eligible for the purpose.
7. Collateralised Borrowing and Lending Obligation
CBLO is another money market instrument operated by the Clearing Corporation of India
Ltd. (CCIL), for the benefit of the entities who have either no access to the interbank call money
market or have restricted access in terms of ceiling on call borrowing and lending transactions.
CBLO is a discounted instrument available in electronic book entry form for the maturity period
ranging from one day to ninety days (up to one year as per RBI guidelines). In order to enable the
market participants to borrow and lend funds, CCIL provides the Dealing System through Indian
Financial Network (INFINET), a closed user group to the Members of the Negotiated Dealing
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44
System (NDS) who maintain Current account with RBI and through Internet for other entities who
do not maintain Current account with RBI.i
Membership to the CBLO segment is extended to entities who are RBI- NDS members,
viz., Nationalized Banks, Private Banks, Foreign Banks, Co-operative Banks, Financial
Institutions, Insurance Companies, Mutual Funds, Primary Dealers, etc. Associate Membership to
CBLO segment is extended to entities who are not members of RBI- NDS, viz., Co-operative
Banks, Mutual Funds, Insurance companies, NBFCs, Corporates, Provident/ Pension Funds, etc.
By participating in the CBLO market, CCIL members can borrow or lend funds against the
collateral of eligible securities. Eligible securities are Central Government securities including
Treasury Bills, and such other securities as specified by CCIL from time to time. Borrowers in
CBLO have to deposit the required amount of eligible securities with the CCIL based on which
CCIL fixes the borrowing limits.
Difference-Capital Market & Money Market
Money Market
Capital Market
Concerned with short term funds, for a Concerned with long term funds for a period
period not exceeding one year
exceeding one year.
Meets short term requirements of govt. Meet long term requirements of govt and fixed
&working capital requirement of business capital requirement of business concerns
concerns
Instruments are TBs, BoEs, CPs, CDs & Instruments are shares, debentures govt. Bonds
govt. Bonds etc.
etc.
Major players are
commercial banks
central
bank
and Major players are development

insurance cos, MFs etc.
banks,
Central bank and other banks are working as Capital market is functioning through money
part of money market
market and it has no direct contact with central
bank.
Transactions are of larger amount
Transactions are of smaller amount.
Instruments do not have an active secondary Instruments have active secondary market.
market
Transactions normally takes place over Transactions take place at formal place.
phone and there is no formal place
Transactions have to be conducted without Transactions are conducted with the help of
the help of brokers
brokers.
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45
Defects /Features of Indian money market

A well-developed money market is a necessary pre-condition for the effective
implementation of monetary policy. RBI controls and regulates the money supply in the country
through the money market. However, unfortunately, the Indian money market is inadequately
developed, loosely organised and suffers from many weaknesses. Major defects are discussed
below
1. Existence of unorganized money market: unorganised money market comprises of indigenous
bankers and money lenders. Substantially higher rate of interest prevails in unorganised sector.
They follow their own rules of banking and finance. RBIs attempt to bring them under control
has failed many times.
2. Absence of integration: Different sections of money market are loosely connected with one
another. Organised and unorganised sector of money market do not have any contact between
them. With the setting up of RBI and passing of BRA 1949, the conditions have improved.
3. Multiplicity in rates of interest: The immobility of funds from one section to another creates
diversity in interest rates. Immobility arises due to difficulty of making cheap and quick
remittance of funds from one centre to another. At present wide divergence does not exist.
4. Seasonal stringency of funds: The demand for money in Indian money market is seasonal in
nature. During busy season from October to April money is needed for financing and marketing
of agricultural products and seasonal industries such as sugar. RBI attempt to lessen the
fluctuations in money rates by increasing money supply during busy season and withdrawing
the same in lean season.
5. Absence of bill market: a well organised bill market is essential for smooth functioning of a
credit system. An important shortcoming of Indian Money Market is the absence of a welldeveloped bill market. Though both inland and foreign bills are traded in Indian Money Market
yet its scope is very limited. In spite of the efforts of Reserve Bank in 1952 and in 1970, only a
limited bill market exists in India. Thus, an organised bill market in the real sense of the term
has not yet been fully developed in India. The establishment of DFHI has improved the
situation now. The main obstacles in the development of bill market appear to be the following:
The lack of uniformity in drawing bills in different parts of the country,
The large use of cash credit as the main form of borrowing from commercial banks,
Presence of Inter-call money market and
The pressure of cash transactions. Thus, Bill Market is relatively underdeveloped.
6. Absence of Acceptance and Discount Houses
There is almost complete absence of acceptance and discount houses in the Indian money
market. This is due to the underdeveloped bill market in India.
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7. No contact with foreign money market: Indian money market is an insular one with little
contact with money market in other countries. Indian money market does not attract any foreign
fund as western money markets do.
8. Limited instruments: Supply of money market instruments like bills, TBs etc. is very limited
and inadequate in nature considering the varied requirements of short term funds.
9. Limited secondary market: Secondary market is very limited in the case of money market
instruments. Practically it is restricted to rediscounting of commercial and treasury bills. In
India banks have the tendency to hold these bills till maturity, thus preventing an active trade in
these bills.
10. Limited participants: participants in Indian money market are also limited. Entry into the
market is strictly regulated. In fact there are a large number of borrowers but a few lenders.
Hence, the market is not very active.
11. Absence of specialized financial institutions: Specialised institutions are lacking to carry out
specialised jobs in certain fields like bank for tourism, bank for financing SSIs. etc.
12. Underdeveloped Banking Habits: In spite of rapid branches expansion of banks and spread of
banking to unbanked and rural centres, the banking habits in India are still underdeveloped.
There are several reasons for it.
Whereas in U.S.A. for every 1400 persons there is a branch of a commercial bank, in
India there is a branch for every 13,000 people,
The use of cheques is restricted,
The majority of transactions are settled in cash,
The hoarding habit is widespread.
IMPORTANCE OF MONEY MARKET
If the money market is well developed and broad based in a country, it greatly helps in the
economic development. The central bank can use its monetary policy effectively and can bring
desired changes in the economy for the industrial and commercial progress of the country. The
importance of money market is given, in brief, below:
Financing Industry: A well-developed money market helps the industries to secure short term
loans for meeting their working capital requirements. It thus saves a number of industrial units from
becoming sick.
Financing trade: An outward and a well-knit money market system play an important role in
financing the domestic as well as international trade. The traders can get short term finance from
banks by discounting bills of exchange. The acceptance houses and discount market help in
financing foreign trade.
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Profitable investment: The money market helps the commercial banks to earn profit by investing
their surplus funds in the purchase of Treasury bills and bills of exchange, these short term credit
instruments are not only safe but also highly liquid. The banks can easily convert them into cash at
a short notice.
Self sufficiency of banks: The money market is useful for the commercial banks themselves. If the
commercial banks are at any time in need of funds, they can meet their requirements by recalling
their old short term loans from the money market.
Encourages economic growth: If the money market is well organized, it safeguards the liquidity
and safety of financial asset. This encourages the twin functions of economic growth, savings and
investments.
Effective implementation of monetary policy: The well-developed money market helps the
central bank in shaping and controlling the flow of money in the country. The central bank mops up
excess short term liquidity through the sale of treasury bills and injects liquidity by purchase of
treasury bills.
Proper allocation of resources: In the money market, the demand for and supply of loan able
funds are brought at equilibrium. The savings of the community are converted into investment
which leads to pro allocation of resources in the country.
Help to government: The organized money market helps the government of a country to borrow
funds through the sale of Treasury bills at low rate of interest The government thus would not go
for deficit financing through the printing of notes and issuing of more money which generally leads
to rise in an increase in general prices.
COMPONENTS OF THE MONEY MARKET
The money market operates through various institutions
1. Central bank/RBI
2. Commercial Banks
3. Non-Banking Financial Intermediaries
4. Discount Houses
5. Acceptance Houses
CENTRAL BANK (RESERVE BANK OF INDIA)
The Central Bank is the leader and supreme authority of Money market. It is the main
source of supply of funds to the money market. It also controls and channelise the credit facilities
through methods such as open market operations, rediscounting of securities etc. it is the lender of
last resort. It does not enter into direct transactions with public. It regulates money supply by
changing bank rates.
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Detailed discussion on RBI, its functions etc. are given as a separate chapter elsewhere in
this book
COMMERCIAL BANKS
Commercial banks are the oldest banking institutions in the organised sector. They
constitute the predominant segment of the banking system in India. They cater to the needs of trade,
commerce, industries, agriculture, small business etc. through its wide network of branches. The
commercial banks form the most important part of the money market. They make advances, grant
overdraft and discount bills of exchange to the business community. They also borrow from central
bank directly or indirectly.
The commercial banking system consists of scheduled banks and non-scheduled banks.
Scheduled Banks are those banks which have been included in the Second Schedule of Reserve
Bank of India (RBI) Act, 1934. RBI in turn includes only those banks in this schedule which satisfy
the criteria laid down vide section 42 (6) (a) of the Act.
Scheduled Commercial Banks are grouped under following categories:
1. State Bank of India and its 5 Associates (public sector banks)
2. Nationalised Banks (20 including IDBI Bank) (public sector banks)
3. Foreign Banks (43 Numbers)
4. Regional Rural Banks (61 Numbers)
5. Other Scheduled Commercial Banks (21 numbers) (Private Sector Banks)
Functions of commercial banks

1. Principal/primary/fundamental
2. Subsidiary/secondary/supplementary
Principal functions
Two acid test functions of commercial banks are
1. Accepting deposits and
2. Lending or advancing loans
These functions along with credit creation, promotion of cheque system and investment in govt.
securities form basic functions of commercial banks.
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49
1. Receiving deposits
Most important function of a bank is to accept deposit from those who can save but cannot
profitably utilise this savings themselves. By making deposits in bank, savers can earn something in
the form of interest and avoid the danger of theft. To attract savings from all sorts of customers,
banks maintain different types of accounts.
Current accounts
Savings Bank accounts
Fixed Deposit accounts
Recurring Deposit Accounts or Cumulative Deposit Account.
2. Lending of funds by means of

Term Loans
Overdrafts (OD)
Cash credit
Discounting of bills
Money at call or short notice
3. Investment of funds in securities
Banks invest a considerable amount of their funds in govt. and industrial securities. In India,
commercial banks are required by statute to invest a good portion of their funds in government and
other approved securities.
4. Credit Creation
When a bank advances a loan, it does not lend cash but opens an account in the borrowers
name and credits the amount of loan to this account. Thus a loan creates an equal amount of
deposit. Creation of such deposit is called credit creation. Banks have the ability to create credit
many times more than their actual deposit.
5. Promoting cheque system
Banks also render a very useful medium of exchange in the form of cheques. Through a
cheque the depositor directs the banker to make payment to the payee. In the modern business
transactions cheques have become much more convenient method of settling debts than the use of
cash.
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Subsidiary functions
1. Agency services
Collect cheques, drafts, BoE, interest and dividend on securities, rents etc. on behalf of
customers and credit the proceeds to the customers a/c.
Pay LIC premium, rent, newspaper bills, telephone bills etc.
Buying and selling of securities
Advise on right type of investment
Act as trustees (undertake management of money and property), executors (carry out the wishes
of deceased customers according to will) & attorneys (collect interest & dividend and issue
valid receipt) of their customers.
Serve as correspondents and representatives of their customers. In this capacity, banks prepare
I-Tax returns of their customers, correspond with IT authorities and pay IT of their customers.
2. General utility services
Locker facility to keep valuables.
Issue travellers cheques which enable tourists to get fund in all places they visit without
carrying actual cash with them.
Issue Letter of Credits for importers. It is a letter issued by importers banker in favour of
exporter informing him that issuing banker undertakes to accept the bills drawn in respect of
exports made to the importer specified therein.
Act as referees and supply information about the financial standing of their customers on
enquiries made by other businessmen.
Collect information about other businessmen through the fellow bankers and supply
information to their customers.
Collection of statistics, giving important information about industry, trade and commerce,
money and banking. They also publish journals and bulletins containing research articles on
economic and financial matters.
Underwriting securities issued by government, public or private bodies.
Deals in foreign currencies.
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Role of commercial banks in a developing economy

A well-developed banking system is necessary pre-condition for economic development of
any economy. Apart from providing resources for growth of industrialisation, banks also influence
direction in which these resources are utilised.
In underdeveloped and developing nations banking facilities are limited to few developed cities and
their activities are focussed on trade & commerce paying little attention to industry & agriculture.
Commercial banks contribute to a countrys economic development in the following ways.
1.Capital formation
Most important determinant of economic development is capital formation. It has 3
distinctive stages
Generation of savings
Mobilisation of savings
Canalisation of saving
Banks promote capital formation in all these stages. They promote habit of savings by
offering attractive rate of return for savers. Banks are maintaining different types of accounts to
mobilise savings aiming different types of customers. They make widespread arrangements to
collect savings by opening branches even in remote villages. Moreover, banks offer their resources
for productive activities only.
2. Encouragement to entrepreneurial innovations
Entrepreneurs in developing economies, generally hesitate to invest & undertake
innovations due to lack of fund. Bank loan facilities enable them to introduce innovative ideas and
increase productive capacity of the economy.
3. Monetisation of economy
Monetisation means allow money to play an active role in the economy. Banks, which are
creators and distributors of money, help the monetisation in two ways;
They monetise debt i.e., buy debts (securities) which are not as acceptable as money and
convert them to demand deposits which are acceptable as money.
By spreading branches in rural areas they convert non-monetised sectors of the economy to
monetised sectors.
4. Influencing economic activity
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They can directly influence the economic activity & pace of economic development through its
influence on
(a) The rate of interest (reduction in rates make investment more profitable and stimulates
economic activity)
(b) Availability of credit. (Through Credit creation banks helps in increasing supply of
purchasing power)
5. Implementation of monetary policy
Well-developed banking system is necessary for effective implementation of monetary
policy. Control and regulation of credit is not possible without active co-operation of banks.
6. Promotion of trade and industry
Economic progress of industrialised countries in last 2 centuries is mainly due to expansion
in trade & industrialisation which could not have been made possible without development of a
good banking system. Use of cheques, drafts and BoE as a medium of exchange has
revolutionalised the internal and international trade which in turn accelerated the pace of
industrialisation.
7. Encouraging right type of industries
In a planned economy it is necessary that banks should formulate their loan policies in
accordance with the broad objectives and strategy of industrialisation as adopted in the plan.
8. Regional development
Banks can play role in achieving balanced development in different regions of the economy.
They can transfer surplus funds from developed region to less developed regions, where there is
shortage of funds.
9. Development of agricultural & other neglected sectors
Under developed economies primarily agricultural economies and majority of the
population live in rural areas. So far banks were paying more attention to trade and commerce and
have almost neglected agriculture and industry. Banks must diversify their activities not only to
extend credit to trade, but also to provide medium and long term loans to industry and agriculture.
NON-BANKING FINANCIAL INSTITUTIONS (NBFIs)
The function of transferring funds from savers to investors is performed by financial
intermediaries. Financial intermediaries are generally classified into two groups viz. banking
institutions and NBFIs. NBFIs includes institutions such as life insurance companies, mutual funds,
pension funds, chit funds etc.
A banking institution is different from non-banking institution in the following respects
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A cheque can be issued by a banking company where as no such facility is available for
NBFIs
Commercial banks can manufacture credit (credit creation) while NBFIs cannot
Commercial banks are able to enjoy certain facilities like rediscounting facilities, deposit
insurance coverage, refinancing facilities etc. these facilities are not available for NBFIs
Commercial banks offer/charges lesser rate of interest than that of NBFIs
Commercial banks are subject to strict control of RBI than that of NBFIs
Functions of NBFIs
1.Mobilisation of savings by offering schemes to suit the needs of different classes of people.
2.Offers easy and timely credit to those are in need of it
3.Acting as financial super market by offering variety of services
4.Channelizing funds for productive purposes
5.Providing housing finance
6.These institutions, particularly, investment companies, render expert advice in investment of
funds.
DISCOUNT HOUSES
Discount houses are meant for discounting bill of exchange on behalf of others. A discount
house is a firm that operates in buying, selling, discounting and/or negotiating bills of exchange or
promissory notes. This is usually performed on a large scale, and some of its transactions include
dealing with government bonds and treasury bills.
In India, Discount and Finance House of India (DFHI) was established for this purpose.
DFHI was set up in March 1988 by Reserve Bank of India jointly with public sector banks
and all India Financial Institutions to develop the money market and to provide liquidity to money
market instruments as a sequel to Vaghul Working Group recommendations. With the introduction
of new money market instruments such as Certificates of Deposits and Commercial Paper, DFHI
began dealing in these instruments as well. With effect from 1992-93, DFHI was authorised to deal
in dated Government Securities. After DFHI was accredited as a Primary Dealer in February 1996,
its operations significantly increased particularly in Treasury Bills and dated Government
Securities. During these years, DFHI opened its branches at Ahmedabad, Bangalore, Calcutta,
Chennai, New Delhi and at Hyderabad with a view to catering to the requirements of the small and
medium sized institutions operating at these centres and at the same time integrating the markets at
these regional centres with main money market at Mumbai.
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Objectives of DHFI
i.
To even out the liquidity imbalances in the banking system i.e. to balance the demand with
the supply for short term finance in the money market.
ii.
To promote secondary market in short term money market instruments i.e. to be an active
trader in money market instruments rather than a mere repository, and thereby, impart
improved liquidity to short term money market instruments.
iii.
To integrate markets at regional centres with the main market at Mumbai, through its
network.
iv.
Provide safe and risk-free short-term investment avenues to institutions; DFHI being an
institution promoted by the public sector banks/financial institutions and RBI, enjoys
excellent credit rating in the market.
v.
Provide greater liquidity to money market instruments.
vi.
Facilitate money market transactions for small and medium sized institutions who are not
regular participants in the market.
vii.
DFHI provides the 'Constituent SGL' Account facility which enables even those entities
which otherwise do not have an SGL Account facility with the RBI to reap the full benefits
of investing in government securities.
DFHI deals in the following instruments/products:

i.
Treasury Bills
ii.
Dated Government Securities
iii.
Certificates of Deposit
iv.
Commercial Papers
v.
Call (overnight) Money
vi.
Notice Money
vii.
Term Money
viii.
Derivative Usance Promissory Notes of Commercial Banks
ix.
Interest Rate Swaps/Forward Rate Agreements

ACCEPTANCE HOUSES
Acceptance houses are another constituent of money market. They work in bill market.
They function as an intermediary between lenders and borrowers, exporters and importers in the
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short term. They accept the bills of buyers whose position is unknown to sellers and thus facilitates
transaction between them, for a reward of commission.
In India commercial banks are also acting as Acceptance Houses.
References
1. http:banks-india.com/banks/repo.market/
2. Baking theory Law and Practice, Gordon Natarajan, Himalaya Publishing House 2006
3. Financial Market Operations, Alok Goyal, Mriduula Goyal, VK (India) Enterprises 206
4. http://www/informationbible.com
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MODULE IV
CAPITAL MARKET
Financial System
Financial system is a system that allows the transfer of money between savers and
borrowers. It is a set of institutions, instruments and markets which encourage savings and
channelise them for productive purposes. It consist of specialised and non specialised financial
institutions, organised and unorganised financial markets, financial services and instruments which
facilitate transfer of financial surplus of the economy.
Constituents of a Financial System
Components of a formal financial system include financial institutions, financial markets,
financial instruments, financial services and regulators.
Financial assets/Instruments A financial asset is an intangible asset that derives value

because of a contractual claim. It consist of Cash, Marketable securities, bank deposits, mutual
fund units, insurance policies etc
Financial Institutions - Financial Institution is an institution (public or private) that collects

funds (from the public or other institutions) and invests them in financial assets. It include
Banking and Non-banking institutions, Term finance institutions, Specialised finance
institutions, investment institutions etc
Financial services Financial services are the economic services provided by the financial
institutions. These may be either Fund based services such as underwriting, leasing, hire
purchase, insurance etc. or Fee based services such as merchant banking, issue management,
credit rating, stock broking etc.
Financial Markets A financial market is a market in which people and entities can trade
financial assets such as securities, bonds, derivatives, currencies etc. The main financial
markets are Money market, Capital market , Derivative market etc.
Regulators - These are bodies which regulate and controls various constituents of financial
system. Examples are Securities and Exchange Board of India (SEBI), Insurance Regulatory
and Development Authority (IRDA), Reserve Bank of India (RBI), Forward Market
Commission (FMC) etc.
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Capital Market
Meaning
Capital market refers to the institutional arrangements for facilitating borrowing and lending
of long term funds. It is the organised mechanism for effective and efficient transfer of money
capital from individuals and institutional savers to entrepreneurs engaged in industry of commerce
in both private sector and public sector. Modern capital markets are almost invariably hosted on
computer-based electronic trading systems.
For a long time, the Indian capital market was considered too small to warrant much
attention. However, this view has changed rapidly as vast amounts of international investment have
poured into our markets over the last decade. The Indian market is no longer viewed as a static
universe but as a constantly evolving market providing attractive opportunities to the global
investing community.
Role / Functions of Capital Market:
Capital market plays an important role in mobilising resources, and diverting them in
productive channels. In this way, it facilitates and promotes the process of economic growth in the
country. It ensures better coordination between the flow of savings and the flow of investment that
leads to capital formation and directs the flow of savings into most profitable channels.
In addition to resource allocation, capital markets also provide a medium for risk
management by allowing the diversification of risk in the economy. A well-functioning capital
market tends to improve information quality as it plays a major role in encouraging the adoption of
stronger corporate governance principles, thus supporting a trading environment, which is founded
on integrity.
Following are the main role or functions of capital market.
1. Link between Savers and Investors:
The capital market acts as a link between savers and investors. It plays an important role in
mobilising the idle savings of people and diverting them in productive and profitable investment. In
this way, capital market plays a vital role in transferring the financial resources from surplus and
wasteful areas to deficit and productive areas, thus increasing the productivity and prosperity of the
country.
2. Encouragement to Saving:
With the development of capital market, the banking and non-banking institutions provide
facilities to invest money in stock market, which encourage people to save more. In the lessdeveloped countries, in the absence of a capital market, there are very little savings and those who
save often invest their savings in unproductive and wasteful areas such as rela estate, gold etc.
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3. Capital Formation:
The capital market facilitates lending to the businessmen and the government and thus
encourages investment. It helps to mobilise the huge capital required for business. It is an
important and efficient means to channel and mobilize funds to enterprises, and provide an
effective source of investment in the economy.
4. Promotes Economic Growth:
The capital market not only reflects the general condition of the economy, but also
smoothens and accelerates the process of economic growth. The proper allocation of resources
results in the expansion of trade and industry in both public and private sectors, thus promoting
balanced economic growth in the country. It plays a critical role in mobilizing savings for
investment in productive assets, with a view to enhancing a country's long-term growth prospects,
and thus acts as a major catalyst in transforming the economy into a more efficient, innovative and
competitive marketplace within the global arena
5. Stability in Security Prices:
The capital market tends to stabilise the values of stocks and securities and reduce the
fluctuations in the prices to the minimum. The process of stabilisation is facilitated by providing
capital to the borrowers at a lower interest rate and reducing the speculative and unproductive
activities.
6. Assists to Government :
Capital market assists the Government to close resource gap, and complement its effort in
financing essential socio-economic development, through raising long-term project based capital.
7. Benefits to Investors:
Capital market is beneficial to the investors in many ways:
a) Liquidity of Investment: Shares and bonds are easily transferable at low transaction cost as compared to
other assets such as real estate. Therefore an investor can buy and sell at considerable convenience.
b) Hedge against inflation: Securities prices over the long term tend to outperform inflation, therefore
investment in securities can be a reliable hedge against inflation in the long term.
c) Higher Return: Capital market provides comparatively higher return in the long run than other invest
avenues such as real estate, gold, and bank deposits.
d) Collateral: Securities represent stocks of wealth, and can be used as ollateral to secure financing such as
loans from lending institutions.
e) Flexibility: Shares and bonds are traded in units and lots that are affordable by investors of different
income levels. As such, investment in securities can be customized to the specific incomes of investors.
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f) Tax advantage: The government offers many tax advantages to the long term investment in equity
market.
Components of Capital Market:

Capital market can be classified into two;
1. Primary market
2. Secondary market.
Primary market is the market where the securities are issued for the first time. It is the
primary market in which the companies issue their securities. Secondary market is the market for
already issued (second hand) securities. Secondary market enables the further buying and selling of
issued securities.
Important Financial Instruments in Capital Market:
1. Shares:
According to the Companies Act 1956, a share is the share in the share capital of a
company. It is a portion of capital which is divided among number of people. It is a unit of
ownership interest in a corporation and offered for sale. Shares are of two types, Preference shares
and Equity shares.
(i) Preference shares:
Preference shares are those shares which have a preferential right for the payment dividend
during the life time of the company and for the return of capital at the time of winding up.
Preference shares carry fixed rate of dividend that are paid to shareholders before equity stock
dividends are paid out.
Following are the major types of preference shares.
Cumulative Preference Shares: When unpaid dividends on preference shares are treated as arrears
and are carried forward to subsequent years, then such preference shares are known as cumulative
preference
shares.
Non-cumulative Preference Shares: Non-cumulative preference shares are those type of
preference shares, which have right to get fixed rate of dividend out of the profits of current year
only.
They
do
not
carry
the
right
to
receive
arrears
of
dividend.
Redeemable Preference Shares: Those preference shares, which can be redeemed or repaid after
the expiry of a fixed period are known as redeemable preference shares.
Non-redeemable Preference Shares: Those preference shares, which cannot be redeemed during
the life time of the company, are known as non-redeemable preference shares. The amount of such
shares
is
paid
at
the
time
of
liquidation
of
the
company.
Participating Preference Shares: Those preference shares, which have right to participate in any
surplus profit of the company after paying the equity shareholders, in addition to the fixed rate of
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their
dividend,
are
called
participating
preference
shares.
Non-participating Preference Shares: Preference shares, which have no right to participate on
the surplus profit of the company are called non-participating preference shares.
Convertible Preference Shares: Those preference shares, which can be converted into equity
shares at the option of the holders after a fixed period according to the terms and conditions of their
issue,
are
known
as
convertible
preference
shares.
Non-convertible Preference Shares: Preference shares, which are not convertible into equity
shares, are called non-convertible preference shares.
(ii) Equity shares (Ordinary shares or Common shares):
Equity shares are the ordinary shares of a company which have no preferential rights. They
are the shares representing the ownership interest. Equity shares give their holders the power to
share the earnings in the company as well as a vote in the Annual General Meetings of the
company. Such a shareholder has to share the profits and also bear the losses incurred by the
company. Equity share holders are the real owners of the company.
2. Debenture / Bond :
A debenture is an acknowledgement of the debt of the Company. It is a long term debt
instrument yielding a fixed rate of interest issued by a company. A debenture is like a certificate of
loan or debt evidencing the fact that the company is liable to pay a specified amount with interest.
Debenture is not secured by the physical asset of the company. Debenture holders are the creditors
of the company and hence they have no voting right in the company.
Bonds are the debt instruments secured by the physical asset of the company. In some
countries, the term denture is used interchangeably with bond.
Primary Market
It is also called New Issue Market. It is the market where securities are issued for the first
time. These securities are never traded before elsewhere. Both new companies and existing
companies approach primary market for raising capital. The main function of primary market is to
facilitate transfer of funds from willing investors to the entrepreneurs setting up new business or
diversification, expansion or modernisation of existing business.
A new issue market is of paramount importance for economic growth and industrial
development as it supplies necessary long term capital. Though the functions of primary market are
so different from that of secondary market, the sentiments in the secondary market do affect the
primary market activities.
Primary market Intermediaries
A number of intermediaries play a critical role in the process of issue of new securities.
They are
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1. Merchant bankers/lead managers: it is an institution that extends a number of services in

connection with issue of capital. Their services include management of security issues, portfolio
management services, underwriting of capital issues, credit syndication, financial advice and
project counselling etc. It has now made mandatory that all public issues should be made by
merchant bankers acting as lead managers.
2. Underwriters: underwriter guarantee that the securities offered for the public will be
subscribed if it is not subscribed by the public. It is an insurance to the issuing company against
the failure of issue. In case, the public fails to subscribe, the underwriter will have to take them
up and pay for them. They charge a commission called underwriting commission for their
service. It should not exceed 5 percent in case of shares and 2.5 percent for debentures.
3. Bankers to an issue: Banker to an issue accepts applications and application money, refund
application money after allotment and participate in the payment of dividend by companies. No
banker can act as a banker to an issue unless it possesses a registration with SEBI. SEBI grants
registration only when it is satisfied that the bank has enough infrastructure, communication
and data processing facilities and requisite man power to discharge such duties. The banker is
required to maintain documents and records relating to the issue for a period of 3 years. It is
also required to furnish information to the SEBI regarding the number of applications received,
number of issues for which it has acted as a banker to an issue, date on which applications from
investors were forwarded to registrar of issue, date and amount of refund to investors etc
4. Registrar to an issue: It is an intermediary who performs the function of collecting application from
investors (through bankers), keeping record of applications, keeping record of money received from
investors, assisting companies in allotment and helping despatch of allotment letters, refund orders etc.
5. Share transfer agents: They maintain the record of holders of securities on behalf of companies and
deals with all activities connected with transfer or redemption of securities.
6. Debenture trustees: A debenture is an instrument of debt issued by the company

acknowledging its obligation to repay the sum along with an interest. In the case of public issue
of debentures, there would be a large number of debenture holders on the register of the
company. As such it shall not be feasible to create charge in favour of each of the debenture
holder. A common methodology generally adopted is to create Trust Deed conveying the
property of the company. A Trust deed is an arrangement enabling the property to be held by a
person or persons for the benefit of some other person known as beneficiary. It has been made
mandatory for any company making a public/rights issue of debentures to appoint one or more
debenture trustees before issuing the prospectus or letter of offer and to obtain their consent
which shall be mentioned in the offer document.
7. Brokers to an issue: Brokers are the persons who procure subscriptions to issue from
prospective investors spread over a larger area. A company can appoint as much number of
brokers as it wants.
8. Portfolio managers: Portfolio construction, formulation of investment strategy, evaluation and regular
monitoring of portfolio is an art that requires skill and high degree of expertise. Any person who
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pursuant to a contract or arrangement with a client, advises or directs or undertakes on behalf of the
client [whether as a discretionary portfolio manager or otherwise(adviser)] the management or
administration of a portfolio of securities or the funds of the client, as the case may be is a portfolio
manager.
Different Kinds of Issue

Every Company needs funds for its business. Funds requirement can be for short term or for
long term. To meet short term requirements, they may approach banks, lenders & may even accept
fixed deposits from public/shareholders. To meet its long term requirements, funds can be raised
either through loans from lenders, Banks, institutions or through issue of capital. Capital can be
raised through private placement of shares, public issue, right issue etc.
1. Public Issue :
Public issue means raising funds from public. The main purpose of the public issue,
amongst others, is to raise money through public and get its shares listed at any of the recognized
stock exchanges in India.
Methods of Public Issue:
Public issue may be an Initial Public Offering (IPO) or Further/Follow on Public Offering
(FPO). During the IPO or FPO, the company offers its shares to the public either at fixed price or
offers a price range, so that the investors can decide on the right price. The method of offering
shares at a fixed price is called Fixed Price Public Issue and the method of offering shares by
providing a price range is called as book building method.
Initial Public Offering : It is the first time issue of securities to the public. The promoters of the
companies after complying the with the guidelines of SEBI and the Companies Act ask the public
at large to subscribe to their shares so that they can generate capital. It may be done through
prospectus or Offer for Sale(Securities issued to a issue house and they sell securities to the public
by issuing advertisement called OFS) Public issue through offer for sale is not popular in India.
Further (Follow on) Public Offering : If an already listed company makes the issue of
securities after IPO, it is called Follow on Public Offering. If an existing company again intends
to raise capital from the general public after IPO, it can again make a public issue called FPO.
It is a supplementary issue made by a company once it is listed and established on the stock
exchange.
Book Building
Book building refers to the process of generating and recording investor demand for shares
during an Initial Public Offering (IPO), or FPO during their issuance process, in order to support efficient
price discovery. A price range (Price Band) is specified in the offer document with a floor price (Minimum
price). Based on the demand and supply of the shares, the final price is fixed. The lowest price in the price
range is known as the floor price and the highest price in the price range is known as cap price. The price at
which the shares are allotted is known as cut off price. Usually, the issuer appoints a major investment bank
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to act as a major securities underwriter or book-runner. Book-runner/Lead manager/Syndicate manager is

the underwriter/investment bank who manage the book building process.
2. Right Issue:
It is an issue of rights to a company's existing shareholders that entitles them to buy
additional shares directly from the company in proportion to their existing holdings, within a fixed
time period. In a rights issue, the shares are generally offered at a discount to the current market
price. Rights are often transferable, allowing the holder to sell them on the open market.
3. Bonus Issue (Gift shares):
It is an issue of additional shares to shareholders of a company instead of paying dividend.
These are company's accumulated earnings which are not given out in the form of dividends, but
are converted into free shares. Fully paid new shares are issued to shareholders in proportion to
their holdings. For example, the company may give one bonus share for every five shares held.
4. Private Placement:
Issue of securities (by a listed company) to a selected group of investors not exceeding 49 is
called Private Placement. Investors involved in private placements are usually large banks, mutual
funds, insurance companies and pension funds. Private placement is the opposite of a public issue,
in which securities are made available for sale on the open market. Following categories of issue
can also be included in Private placement.
Preferential Allotment: It is a type of Private placement by unlisted companies. Preferential

Allotment is the process by which allotment of securities is done on a preferential basis to a select group
of investors such as directors, existing shareholders etc.
Qualified Institutions Placement (QIP) : It is also part of private placement (by Listed companies).
It is the issue of securities to Qualified institutional Buyers (QIB) in terms of the provisions of the Issue
of Capital & Disclosure Requirements (ICDR) of SEBI.
Employees Stock Option Scheme (ESOS) - A stock option scheme granted to specified
employees of a company is called Employee Stock Option Scheme. ESOS carry the right, but
not the obligation, to buy a certain amount of shares in the company at a predetermined price.
Physical Shares and Demat shares:

Shares with share certificates printing on a paper is called Physical shares where as the
shares in electronic format is called Demat (Dematerialised) shares. The process of converting the
physical form of shares to dematerialised form is called Dematerialisation. The Depositories
Act was passed by the parliament in 1995 and this paved the way for conversion of physical
securities into electronic format. Depository and Depository participants are the organisations
through which the physical shares can be converted into electronic form. If one wishes to get back
his securities in physical form after dematerialisation, he can request his Depository participants for
rematerialisation.
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Depository:
A depository is an organisation which holds securities (like shares, debentures, bonds,
government securities, mutual fund units etc.) of investors in electronic form at the request of the
investors through a registered Depository Participant. It also provides services related to
transactions in securities. At present two Depositories viz. National Securities Depository Limited
(NSDL) and Central Depository Services (India) Limited (CDSL) are registered with SEBI.
Depository Participants
A Depository Participant (DP) is an agent of the depository through which it interfaces with
the investor and provides depository services. Public financial institutions, scheduled commercial
banks, foreign banks operating in India with the approval of the Reserve Bank of India, state
financial corporations, custodians, stock-brokers, clearing corporations /clearing houses, NBFCs
and Registrar to an Issue or Share Transfer Agent complying with the requirements prescribed by
SEBI can be registered as DP. As on December 21, 2012, a total of 866 DPs (289 NSDL, 577
CDSL) are registered with SEBI.
Following services are provided by a depository to the beneficial owners through a
depository participant:
Opening a demat account;
Dematerialization, i.e. converting physical securities into electronic form
Rematerialization, i.e. converting electronic securities into physical form
Maintaining record of securities held by the beneficial owners in the electronic
form
Settlement of trades by delivery or receipt of securities
Settlement of off-market transactions
Receiving electronic credit in respect of securities allotted by issuers under IPO or otherwise on
behalf of demat account holders;
Secondary market/Stock market

Secondary Market refers to a market where securities are traded after being initially offered
to the public in the primary market and/or listed on the Stock Exchange. Majority of the trading is
done in the secondary market. Secondary market comprises of equity markets and the debt markets.
It is the organized mechanism for purchase and sale of existing securities. Investors in new issue
market who do not want to hold the securities up to maturity can approach stock market to sell their
securities. Similarly those who want to become an investor in an existing company which do not
offer new issue of securities at present, approach stock market for purchasing securities.
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Definition
Securities Contract & Regulation Act 1956 defines secondary market as any body of
individuals whether incorporated or not, constituted for the purpose of assisting, regulating or
controlling the business of buying, selling of securities.
Difference between Primary Market and Secondary Market
Primary Market
Secondary Market
1. It is the market where securities are 1. It is the market for already issued
issued for the first time
(Second hand) securities
2. It deals with issuing of securities
2. It deals with buying and selling of

securities.
3. Primary market for a security opens for a

limited period
3. Secondary market for a security is always
open
4. Company is directly involved in
transaction
4. Company is not directly involved.
Transactions occur between investors
through Stock exchanges
5. Primary market is a source of fund to the 5. It is not a direct source of fund to the
company
company
Stock Exchange
Stock exchange is an organized market for buying and selling corporate and other securities.
In Stock exchange, securities are purchased and sold out as per certain well-defined rules and
regulations. It provides a convenient and secured mechanism or platform for transactions in
different securities. Stock exchanges are indispensable for the smooth and orderly functioning of
corporate sector in a free market economy. A stock exchange need not be treated as a place for
speculation or a gambling. It acts as a place for safe and profitable investment.
Characteristics of a Stock Exchange
1. It is the place where securities are purchased or sold
2. It is an Association of Person whether incorporated or not
3. Trading is regulated by rules & regulations prescribed by SEBI and itself.
4. Both genuine investors and speculators buy and sell shares
Banking & Finance
66
5. Securities or corporations, trusts, governments, semi govt. bodies etc. are allowed to be dealt at
stock exchanges.
Investors and Speculators:

Stock market participants consist of Investors and Speculators. Investor is a person or
institution who makes investment in securities with the intention of getting a fair return from the
investment. But the Speculator make investment in risky securities in an attempt to profit from
short and medium term fluctuations in the market value of shares.
Types of Speculators in Stock market:

Bull (Tejiwala): Bull is a speculator who is hopeful of price rise in the near future. He makes
purchases of securities with the intention of selling them at a higher price in future.
Bear (Mundiwala): Bear is a speculator who expect fall in prices. He sell securities with the
intention of buying them at a lower price in future.
Lame Duck: When the bear fails to meet his obligations, he is called Lame Luck. Generally a bear
agrees to dispose off certain shares on specific date. But sometimes he fails to deliver due to non
availability of shares in the market.
Stag: Stag is a speculator who purchases shares to sell them above par value to earn premium. He
rapidly buy and sell stocks in quick succession.
Jobber: Jobber is a professional speculator who has a complete information regarding the particular
shares he deals. He conducts the securities in his own name. He is the member of the stock
exchange and he deals only with the members.
Role of stock exchange in economic development

The liquidity that an exchange provides affords investors the ability to quickly and easily
sell securities. This is an attractive feature of investing in stocks, compared to other less liquid
investments such as real estate.
History has shown that the price of shares and other assets is an important part of the
dynamics of economic activity, and can influence or be an indicator of social mood. Rising share
prices, for instance, tend to be associated with increased business investment and vice versa. Share
prices also affect the wealth of households and their consumption. Therefore, central banks tend to
keep an eye on the control and behavior of the stock market and, in general, on the smooth
operation of financial system functions.
Exchanges also act as the clearinghouse for each transaction, meaning that they collect and
deliver the shares, and guarantee payment to the seller of a security. This eliminates the risk to an
individual buyer or seller that the counterparty could default on the transaction.
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67
The smooth functioning of all these activities facilitates economic growth in that lower costs
and enterprise risks promote the production of goods and services as well as employment. In this
way the financial system contributes to increased prosperity.
Functions / services of stock exchange
1. Liquidity & marketability of securities: ensures ready and continuous market where buyers and
sellers are continuously available. Securities can be easily converted to cash without time delay
in two days.
2. Safety of fund: Exchanges are working under strict rules & regulations which are meant to
ensure safety of funds.
3. Supply of long term funds: Securities traded in stock market are negotiable or transferable in
character. One investor is substituted for another. Company is assured of long term availability
of funds.
4. Flow of capital to profitable ventures: Profitability and popularity of companies are reflected in
stock prices.
5. Motivation for improved performance: prices are visible to the public. This public exposure
makes a company conscious of its status in the market.
6. Promotion of investment through capital formation
7. Reflection of business cycles. Central bank can make suitable monetary policies based on the
behaviour of stock market.
8. Marketing of new issues: If new issues are listed in exchange, they are readily acceptable to the
public.
Stock Exchanges in India

There are twenty two stock exchanges in India (2013) out of which seven are permanent.
Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) are the main stock
exchanges in India.
Bombay Stock Exchange (BSE):
It was established in 1875 as "The Native Share & Stock Brokers' Association". BSE Ltd
(formerly known as Bombay Stock Exchange Ltd.) is Asias first Stock Exchange and one of
Indias leading exchange groups located in Dalal Street, Mumbai.. BSE is a corporatized and
demutualised entity, with a broad shareholder-base which includes two leading global exchanges,
Deutsche Bourse and Singapore Exchange as strategic partners. BSE provides an efficient and
transparent market for trading in equity, debt instruments, derivatives, mutual funds. More than
5000 companies are listed on BSE. The companies listed on BSE Ltd command a total market
Banking & Finance
68
capitalization of USD 1.32 Trillion as of January 2013. BSEs popular equity index - the S&P BSE
SENSEX is India's widely tracked stock market benchmark index.
National Stock Exchange (NSE)
The National Stock Exchange of India Ltd. (NSE) is one of the countrys leading stock
exchange located in Mumbai. National Stock Exchange (NSE) was established in the mid 1990s as
a demutualised electronic exchange. NSE has a market capitalisation of more than US$989 billion
and 1,635 companies listed as on July 2013. NSE's flagship index, the S&P CNX Nifty, is used
extensively by investors in India and around the world to take exposure to the Indian equities
market.
Stock Index
An Index is basically an indicator of stock prices. It gives us a general idea about whether
the prices of stocks have gone up or gone down. The Dow Jones Industrial Average (DJIA),
Standard & Poor's 500 (S&P 500), Wilshire 5000, Nasdaq Composite Index etc are the
examples of worlds top stock market indices. BSE-Senex and NSE-Nifty are the main stock
Indices in India.
BSE-SENSEX
The S&P BSE SENSEX is a stock market index of 30 well established and financially
sound companies listed in Bombay Stock exchange. These 30 component companies which are
some of the largest and most actively traded stocks, are representative of various industrial sectors
of the Indian economy. Published since 1 January 1986, the BSE SENSEX is regarded as the pulse
of the domestic stock markets in India. The base value of the BSE SENSEX is taken as 100 on 1
April 1979, and its base year as 197879. Other popular indices of BSE are S&P BSE 100, S&P
BSE 200, S&P BSE MIDCAP, S&P BSE SMALLCAP etc.
NSE-NIFTY
The CNX NIFTY, also called the NIFTY 50 or simply the NIFTY, is National Stock
Exchange of India's benchmark index for Indian equity market. It is a stock market Index of 50
companies of 22 sectors of the Indian economy. NIFTY, is used extensively by investors in India
and around the world to take exposure to the Indian equities market. The base period for the CNX
NIFTY is November 3, 1995 and base value of the index has been set at 1000. Besides CNX
NIFTY there are many other stock market Indices for NSE such as CNX NIFTY JUNIOR, LIX
15, CNX MIDCAP, INDIA VIX, CNX SMALLCAP etc.
Listing of securities
Listing of securities means the enrolment of a name of company in an official list of the
Stock exchange. Listing means admitting for trading on a recognized stock exchange. It facilitates
buying and selling of securities in the exchange. Listing provides an exclusive privilege to
securities in the stock exchange. Only listed shares are quoted on the stock exchange. Stock
Banking & Finance
69
exchange facilitates transparency in transactions of listed securities in perfect equality and

competitive conditions. Listing is beneficial to the company, to the investor, and to the public at
large.
A company, desirous of listing its securities on the Exchange, shall be required to file an
application, in the prescribed form, with the Exchange before issue of Prospectus by the company,
where the securities are issued by way of a prospectus or before issue of 'Offer for Sale', where the
securities are issued by way of an offer for sale. The company shall be responsible to follow all the
requirements specified in the Companies Act, the listing norms issued by SEBI from time to time
and such other conditions, requirements and norms that may be in force from time to time.
Advantages / Importance of Listing
Fund Raising: Listing provides an opportunity to the corporates / entrepreneurs to raise

capital to fund new projects/undertake expansions/diversifications and for acquisitions.
Liquidity and Ready Marketability of Security: Listing brings in liquidity and ready
marketability of securities on a continuous basis adding prestige and importance to listed
companies.
Ability to raise further capital : An initial listing increases a company's ability to raise
further capital through various routes like preferential issue, rights issue, Qualified Institutional
Placements and ADRs/GDRs.
Supervision and Control of Trading in Securities: The transactions in listed securities are
required to be carried uniformly as per the rules and bye-laws of the exchange. All transactions
in securities are monitored by the regulatory mechanisms of the stock exchange, preventing
unfair trade practices. It improves the confidence of small investors and protects them.
Fair Price for the Securities: The prices are publicly arrived at on the basis of demand and
supply; the stock exchange quotations are generally reflective of the real value of the security.
Thus listing helps generate an independent valuation of the company by the market.
Tax advantage: The listed companies are treated as widely held companies under the
income tax act and all the tax advantages available to a widely held company is available for
listed companies.
Protect the Interest of Investors: The listing agreement signed with the exchange provides
for timely disclosure of information relating to their assets, dividend, bonus and right issues,
facilities for transfer, other company related information etc by the company. Thus providing
more transparency and building investor confidence.
Collateral Value of Securities: Listed securities are acceptable to lenders as collateral for
credit facilities. A listed company can also borrow from financial institutions easily as it is
Banking & Finance
70
rated favorably by lenders of capital. The company can also raise additional funds from the
public through the new issue market with a greater degree of assurance.
Better Corporate Practice: Since the violation of the listing agreement entails the delisting/suspension of securities from the rings of the exchange, the listed companies are
expected to follow fair practices to the advantage of investors and public.
Benefits to the Public: The data daily culled out by the stock exchange in the form of price
quotations provide valuable information to the public which can be used for project and
research studies. The stock exchange prices can be an index of the state of the economy.
Financial institutions, NRl, individual investors etc. can take wise decisions before making
investments.
Procedure for dealing in stock exchange

1. Selection of a broker: Individual investors are not permitted to transact securities through an
exchange without a broker. The buying and selling of securities can only be done through SEBI
registered brokers who are members of the Stock Exchange. So the first thing to be done is to select
a broker.
2. Opening Demat account with Depository Participant: Demat (Dematerialized) account refer
to an account which an Indian citizen must open with the Depository participant (DP) to trade in
listed securities in electronic form. Hence, the second step in trading procedure is to open a Demat
account.
3. Placing an order: Next step is to place an order for purchase or sale of securities. Broker helps
in selection of securities and proper time for it. Invester must place the order very clearly specifying
the range of price at which the securities can be bought and sold.
4. Executing the Order: As per the Instructions of the investor, the broker executes the order i.e.
he buys or sells the securities. Broker prepares a contract note for the order executed. The contract
note contains the name and the price of securities, name of parties and brokerage (commission)
charged by him. Contract note is signed by the broker.
5. Settlement: This means actual transfer of securities. This is the last stage in the trading of
securities done by the broker on behalf of their clients. The selling broker hands over the transfer
form and share certificates to the buying broker after receiving the price. Complete settlement is
made in 2-7 days of the transaction. Settlement of securities is done by the clearing corporation of
the exchange.
Domestic Institutional Investors (DII) and Foreign Institutional Investors (FII)

Institutional investors are organizations which pool large sums of money and invest those
sums in securities, real property and other investment assets. They can also include operating
companies which decide to invest their profits to some degree in these types of assets. Typical
Banking & Finance
71
investors include banks, insurance companies, retirement or pension funds, hedge funds, investment
advisors and mutual funds.
Domestic institutional investors (DII) are those institutional investors established or
incorporated in India which undertake investment in the financial markets of India. These are
institutions or organizations such as banks, insurance companies, mutual funds etc. An institutional
investor that has met certain qualifications to invest in securities outside its home country is called
Qualified Domestic Institutional Investor (QDII).
An investor or investment fund that is established or registered in a foreign country and
investing in the financial markets of India is called Foreign Institutional Investor (FII).
International institutional investors must register with the Securities and Exchange Board of India
to participate in the market. FIIs are investing huge amounts in the Indian stock exchanges and it
reflects their high confidence and a healthy investor sentiment for our markets. However, the
ceiling for overall investment for FIIs is 24 per cent of the paid up capital of the Indian company
and 10 per cent for NRIs/PIOs. The limit is 20 per cent of the paid up capital in the case of public
sector banks.
The ceiling of 24 per cent for FII investment can be raised up to sectoral
cap/statutory ceiling, subject to the approval of the board and the general body of the company
passing a special resolution to that effect. In December 2013, there are more than 1700 Foreign
Institutional Investors registered with SEBI.
Securities and Exchange Board of India (SEBI)

The Securities and Exchange Board of India (SEBI) is the regulatory authority for the
securities market in India. It was established in the year 1988 under a resolution of the Government
of India and given statutory powers on 12 April 1992 through the SEBI Act, 1992. Its headquarters
is located at Mumbai. It has four regional offices in New Delhi, Kolkata, Chennai and
Ahamedabad. Controller of Capital Issues derived from the Capital Issues (Control) Act, 1947 was
the regulatory authority in capital market before SEBI came into existence.
The SEBI is managed by a chairman and eight members. The chairman is nominated by
Union Government of India. Two members are selected from the officers of the Union Finance
Ministry and one member from The Reserve Bank of India. The remaining 5 members are
nominated by Union Government of India, out of them at least 3 shall be whole-time members.
Functions of SEBI
The Preamble of the Securities and Exchange Board of India describes the basic functions of the
Securities and Exchange Board of India as "...to protect the interests of investors in securities and to
promote the development of, and to regulate the securities market and for matters connected
therewith or incidental thereto". SEBI adopts the following measures to protect the interest of
investors and to regulate and promote the securities market in India.
(a) Regulating the business in stock exchanges and any other securities markets
Banking & Finance
72
(b) Registering and regulating the working of stock brokers, sub-brokers, share transfer agents,
bankers to an issue, trustees of trust deeds, registrars to an issue, merchant bankers, underwriters,
portfolio managers, investment advisers and such other intermediaries who may be associated with
securities markets in any manner
(c) Registering and regulating the working of the depositories, Depository Participants (DP)
custodians of securities, foreign institutional investors, credit rating agencies and such other
intermediaries.
(d) Registering and regulating the working of venture capital funds and collective investment
schemes including mutual funds.
(e) Promoting and regulating self-regulatory organisations.
(f) Prohibiting fraudulent and unfair trade practices relating to securities markets.
(g) Promoting investors' education and training of intermediaries of securities markets.
(h) Prohibiting insider trading in securities.
(i) Regulating substantial acquisition of shares and take-over of companies.
(j) Calling for information from, undertaking inspection, conducting inquiries and audits of the
stock exchanges, mutual funds, other intermediaries and self regulatory organisations associated
with the securities market.
(k) performing such functions and exercising such powers under the provisions of the Securities
Contracts (Regulation) Act, 1956 as may be delegated to it by the Central Government;
(l) Levying fees or other charges for carrying out the purposes of the Act.
(m) Conducting research for the above purposes
(n) performing such other functions as may be prescribed.
Powers of SEBI
For the discharge of its functions efficiently, SEBI has been vested with the following
powers:
1. Power to regulate the matters relating to the issue of capital, transfer of securities etc
2. Power to issue directions to the parties and intermediaries associated with securities market.
3. Approve bylaws of stock exchanges.
4. Inspect the books of accounts and call for periodical returns from recognized stock
exchanges.
Banking & Finance
73
5. Power to investigate the affairs of intermediaries or persons associated with securities

market.
6. Inspect the books of accounts of financial intermediaries.
7. Compel certain companies to list their shares in one or more stock exchanges.
8. Registration of intermediaries
.
References:
1. M.Y Khan (2013), Indian Financial System, Mc Graw-Hill Education (India) Pvt. Ltd, NewDelhi
2. Frank.J.Fabozzi & Franco Modigliani (2009), Capital Markets-Institutions and Instruments, PHI
Learnig Pvt.Ltd, NewDelhi.
3. C.L Bansal (2006), Business and Corporate Laws, Excel Books, New Delhi
4. Vasanth Desai (2012), The Indian Financial System and Development, Himalaya Publishing House,
Mumbai.
5. V.A Avadhani (2013), Security Analysis and Portfolio Management, Himalaya Publishing House,
Mumbai.
6. www.sebi.gov.in
7. www.bseindia.com
8. www.nseindia.com
9. www.rbi.org.in
10. www.investopedia.com
11. www.wikipedia.org
12. www.economictimes.indiatimes.com
13. www.google.com
Banking & Finance
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Contents
Page No.
MODULE I
RESOURCE BASE AND STRUCTURE OF

INDIAN ECONOMY
MODULE II
AGRICULTURE
42
MODULE III
INDUSTRY
69
MODULE IV
EXTERNAL SECTOR
100
Indian Economy
Page 3
Indian Economy
Page 4
MODULE 1
RESOURCE BASE AND STRUCTURE OF INDIAN ECONOMY
Economic Geography of India Basic features - Human Resource: Demographic
Features, extent of unemployment, poverty, and inequality: Recent trends and conceptual
issues. HDI of India.- Trend in National Income and Per capita income. Sectoral composition
(output and employment), Primary, Secondary and Tertiary Sectors.
Economic Geography
Contemporary economic geographers tend to specialize in areas such as location
theory and spatial analysis (with the help of Geographical Information System), market
research, geography of transportation, real estate price evaluation, regional and global
development, planning, Internet geography, innovation, social networks. Economic
Geography is the analysis of spatial organizations of economic activities which are directly or
indirectly related to the physical or human resources of a country and its levels of
development. As economic geography is a very broad discipline, with economic geographers
using many different methodologies in the study of economic phenomena in the world some
distinct approaches to study have evolved over time:
Theoretical economic geography focuses on building theories about spatial

arrangement and distribution of economic activities.
Regional economic geography examines the economic conditions of particular regions
or countries of the world. It deals with economic regionalization as well as local
Economic Development.
Historical economic geography examines the history and development of spatial

economic structure. Using historical data, it examines how centers of population and
economic activity shift, what patterns of regional specialization and localization evolve
over time and what factors explain these changes.
Critical economic geography is an approach taken from the point of view of
contemporary Critical geography and its philosophy.
Behavioral economic geography examines the cognitive processes underlying spatial

reasoning, locational decision making, and behavior of firms and individuals.
Economic geography is sometimes approached as a branch of anthropogeography that

focuses on regional systems of human economic activity. An alternative description of
different approaches to the study of human economic activity can be organized around
spatiotemporal analysis, analysis of production/consumption of economic items, and analysis
Indian Economy
Page 5
of economic flow. Spatiotemporal systems of analysis include economic activities of region,

mixed social spaces, and development.
Alternatively, analysis may focus on production, exchange, distribution and consumption

of items of economic activity. Allowing parameters of space-time and item to vary, a
geographer may also examine material flow, commodity flow, population flow and
information flow from different parts of the economic activity system. Through analysis of
flow and production, industrial areas, rural and urban residential areas, transportation site,
commercial service facilities and finance and other economic centers are linked together in an
economic activity system.
Economic geography can be divided into these sub disciplines:
1.
Geography of agriculture
3.
Geography of international trade
2.
4.
5.
Geography of industry
Geography of resources
Geography of Transport and communication
Economists and Economic Geographers
Economists and economic geographers differ in their methods in approaching similar

economic problems in several ways. An economic geographer will often take a more holistic
approach in the analysis of economic phenomena, which is to conceptualize a problem in
terms of space, place and scale as well as the overt economic problem that is being examined.
The economist approach, according to some economic geographers, has the main drawback of
homogenizing the economic world in ways economic geographers try to avoid.
New Economic Geography
With the rise of the New Economy, economic inequalities are increasing spatially. The
New Economy, generally characterized by globalization, increasing use of information and
communications technology, growth of knowledge goods, and feminization, has enabled
economic geographers to study social and spatial divisions caused by the arising New
Economy, including the emerging digital divide. The new economic geographies consist of
primarily service-based sectors of the economy that use innovative technology, such as
industries where people rely on computers and the internet. Within these is a switch from
manufacturing-based economies to the digital economy. In these sectors, competition makes
technological changes robust. These high tech sectors rely heavily on interpersonal
relationships and trust, as developing things like software is very different from other kinds
of industrial manufacturingit requires intense levels of cooperation between many
different people, as well as the use of tacit knowledge. As a result of cooperation becoming a
necessity, there is a clustering in the high-tech new economy of many firms.
Indian Economy
Page 6
Economic Geography of India-Basic features

Despite the fact that India started with economic planning as early as 1951 and now
has compelled to 15 years planning instead of 5 years, little attention has been paid to spatial
aspects of social and economic development. However, many good basic surveys both
regional and topical have been published now.
Human Resource
The present day economies considered as the greatest wealth of an economy is the
human resource of a nation. Human being is not only the instruments of production but also
ends in themselves. The qualities of them are crucial in the developmental process of a nation.
That is why most of the nations put much on Human capital development. A country should
concentrate more on the developmental aspect of its people and put all its efforts upon it. In
this respect it is necessary to know the size and growth of the population and also its
compositions.
Demographic Features of India
India, with 1,21,01,93,422 people is the second most populous country in the world,
while China is on the top with over 1,350,044,605 people. India possesses about 2.4% of the
total land area of the world but support 17.5% of the world population, which means one out
of six people on this planet live in India. Although, the crown of the world's most populous
country is on China's head for decades, India is all set to take the Chinas position by 2030.
With the population growth rate at 1.58%, India is predicted to have more than 1.53 billion
people by the end of 2030.
Even though the first census in India is under taken in 1871 it was not considered as
scientific. Therefore the first scientific complete general census in India was conducted in the
Year 1881. Indias census is decadal census. In 1891 the population of India is just 23.6
crores; while it rose to 121 crores in 2011 census.2011 census is the 15 th and 7 th after
independence. The growth of Indias population can be analysed into four phases:
I.
II.
III.
IV.
1891-1921: Stagnant Population
1921-1951: Steady Growth of population

1951-1981: Rapid growth of population
1981-2011: High growth with definite signs of slowing down.
During the first phase the population of India is stagnant and she is in the first stage of
Theory of Demographic Transition. The year 1921 is called the Year of Great Divide because
in this year India entered in the second stage of Theory of Demographic Transition. During
this period the population growth rate is steady.
Indian Economy
Page 7
It is in the third phase India faces a population explosion, where there is a rapid
growth of population.
The fourth stage shows the definite signs of slowing down of population and it is
believed that India will enter soon in the third stage of Theory of Demographic Transition.
India going through the second stage of Theory of Demographic Transition witnesses
lot of change introduced by Frank Notenstien. In different aspects of demography of India
there are changes.
Table 1.1
Population of India-2011
Rank State or Union Territory
1
Uttar Pradesh
Bihar
2
4
5
6
7
8
9
10
11
12
Maharashtra
West Bengal
Andhra Pradesh
Madhya Pradesh
Tamil Nadu
Rajasthan
Karnataka
Gujarat
Odisha
Kerala
Population
199,581,477
Density
(per km2)
828
908
112,372,972
103,804,637
1102
946
91,347,736
84,665,533
1029
72,597,565
308
947
236
72,138,958
68,621,012
61,130,704
60383,628
365
Sex
Ratio
555
201
319
308
916
992
930
995
926
968
918
41,947,358
33,387,677
269
978
859
1,084
13
Jharkhand
32,966,238
414
947
15
Punjab
27,704,236
550
893
14
16
17
18
19
Indian Economy
Assam
Haryana
Chhattisgarh
Jammu Kashmir
Uttarakhand
31,169,272
25,353,081
25,540,196
12,548,926
10,116,752
397
573
189
56
189
954
877
991
883
963
Page 8
20
Himachal Pradesh
6,856,509
123
974
22
Meghalaya
2,964,007
132
986
21
23
24
25
26
27
28
UT1
UT2
UT3
UT4
UT5
UT6
UT7
Tripura
Manipur
Nagaland
Goa
Arunachal Pradesh
Mizoram
Sikkim
Delhi
Puducherry
Chandigarh
Andaman &Nicobar Islands

Dadra & Nagar Haveli
Damman & Diu
Lakshadweep
Total India
3,671,032
2,721,756
1,980,602
1,457,723
1,382,611
1,091,014
607,688
350
122
119
394
17
52
86
16,753,235
9,340
1,054,686
9,252
1,244,464
379,944
342,853
242,911
64,429
1,210,193,422
961
987
931
968
920
975
889
866
2,598
1,038
46
878
698
2,169
2,013
382
818
775
618
946
940
Source: Census of India, 2011.
1. Size and Growth of Population

Out of the total population, male population in India is 623724248 (51.53%) and
female population is 586489174 (48.47%). The state Uttar Pradesh stands top in total
population with199,581,477 and Sikkim is in the bottom with a population 607,688.This is
shown in the Table 1.1and the size and Growth of Indias population from 1891 to 2011 is in
the Table 1.2.
Indian Economy
Page 9
Table 1.2
Size and Growth of Indias Population
Census Year Population In Crores
% increase or decrease
1891
23.6
1901
23.84
1921
25.13
1911
1931
1941
1951
1961
1971
1981
1991
2001
2011
--
0.0
25.20
+5.75
27.89
+11.0
36.10
+13.3
31.86
-0.3
+14.2
43.92
+21.64
68.33
+24.66
54.81
84.64
102.87
121.02
Source: Census Report 2011
+24.80
+23.87
+21.54
+17.64
2. Birth Rate and Death Rate

Actually the growth rate of population is the function of birth rate and death rate.
Consequently the variations in these affect the population growth rate. The average annual
birth rate and death rates are given in the Table 1.3
Table 1.3
Average Annual Birth Rate and Death Rates
Decade
Birth Rate
Death Rate
per 1000
per 1000
1891-1901
45.8
44.4
1901-1911
48.1
42.6
1911-1921
49.2
48.6
1921-1931
46.4
36.3
1931-1941
45.2
31.2
1941-1951
39.9
27.4
1951-1961
40.0
18.0
1961-1971
41.2
19.2
1971-1981
37.2
15.0
1985-1986
32.6
11.1
2011
21.8
7.1
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Page 10
3. Sex Ratio in India

Sex ratio means the number of females for 1000 males. In India the sex ratio is infavour
to the male from 1901 onwards. Kerala is the only exemption where the sex ratio is in favour
to females and it is 1084 per 1000 males. Whereas the lowest sex ratio is shown in the state
Haryana (877). The Sex ratio declines continuously except for the years1981, 2001 and 2011.
In 1901 the sex ratio is 972 and it falls to 940 in 2011. It is shown in the Table 1.4.
Table 1.4
Sex Ratio in India
Year
1901
1911
1921
1931
1941
1951
1961
1971
1981
1991
2001
2011
4. Density of Population
Females per 1000

males
972
964
955
950
945
946
941
930
934
927
933
940
Density of population implies the average number of population lived in a Sq. K.m. From
a small number 77 in 1901 it rose to 382 in 2011. Bihar is the most densely state in India with
1102 person per sq. k.m., followed by West Bengal (1029) and then Kerala (859). Arunachal
Pradesh is in the bottom position with 17 per sq.k.m. It was given in the Table 1.5.
Table 1.5
Density of Population
Year
1901
1911
1921
1931
Indian Economy
1941
Density Per sq.k.m

77
82
81
90
103
Page 11
1951
117
1971
178
1961
142
1981
230
1991
273
2001
324
2011
5.Rural-Urban Population
382
Urbanization is considered as the true representation of development of a country. In

India the process of urbanization is very slow. According to 1901census, 89% of Indian
people are lived in rural areas and only 11 % are in the urban areas. The percentage of urban
population increased to 31.16 % in 2011 census. The percentage share of Rural- Urban
population is given in the Table 1.6.
Table 1.6
Percentage Share of Rural- Urban Population
Year
Rural
Urban
1901
89.2
10.8
1921
88.8
11.2
1911
1931
1941
1951
1961
1971
1981
1991
2001
89.7
88.0
86.1
82.7
82.0
80.1
76.7
74.3
72.2
2011
68.84
Indian Economy
10.3
12.0
13.9
17.3
18.0
19.9
23.3
25.7
27.8
31.16
Page 12
6. Literacy Rate in India

The literacy rate is one of the important indicators of quality of population. From
independence onwards the literacy rate is on hike. The male literacy rate is more than female
in India, which is given in the Table 5.7. Kerala ranks first in literacy with 93.91% and Bihar is
in the bottom with 63.82% in 2011.Literacy rate for up to 1971 is estimated
Table 1.7
Crude Literacy in India from 1901 to 2011
Year
Male
Female
Total
1901
9.83
0.60
5.35
12.21
1.81
7.16
1911
10.56
1931
15.59
1921
1941
24.9
1951
16.67
1971
39.45
1961
1981
1991
2001
2011
1.05
2.93
7.3
18.69
29.45
46.89
24.82
82.14
16.1
16.67
12.95
75.26
9.5
9.45
34.44
52.74
5.92
32.17
53.67
65.46
24.02
36.23
42.84
64.83
74.04
on the population aged 5 and above after that the age is raised to 7 years and above. Census of
India, 2011 indicates that only 65.46 % women are literate as compared to 82.14% men.
Female literacy is highest in Kerala (91.98%) and lowest in Rajasthan (52.66%). The literacy
rate taking the entire population into account is termed as crude literacy rate and taking the
population from age 7 and above into account is termed as effective literacy rate. Effective
literacy rate is increased to a total of 74.04% with 82.14% of the males and 65.46% of
females being literate. The Table 1.7 lists the crude literacy in India from 1901 to 2011
7. Life Expectancy
In Life expectancy at birth the females surpasses the male population of the country.
The average life expectancy at birth in 1951 is only 41.2 years. It is due to the very high infant
mortality rate. The Life expectancy Rate of both men and female are given in the Table 1.8
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Page 13
Table 1.8
Life Expectancy at Birth in India (in years)
Year
Male
Female
Total
1931
26.6
26.6
26.6
1921
1941
1951
1961
1971
1981
1991
2001
2010-11
8. Child Sex Ratio
19.4
32.1
32.4
41.9
47.1
54.1
50.9
63.9
62.6
20.9
31.4
31.7
40.6
45.6
54.7
50.0
66.9
64.2
20.1
31.7
32.1
41.2
46.4
54.0
50.4
65.3
63.5
The Child sex ratio indicates the number of girls per 1000 boys in the 0-6 age group.
Now the fall in this ratio is an alarming problem. According to the2001 estimates it is 927
while it falls to 914 in the 2011 census .In the case of Kerala, the only state where the sex ratio
is in fovour to the female population ranked first with 959 girls for 1000 boys. Haryana is in
the bottom position with 830 girls for 1000 boys.The child sex ratio from 1961to 2011 is
given in the Table 1.9.
Table 1.9
Child Sex Ratio
Year
Number of girls
1961
976
1981
962
1971
1991
2001
2011
Indian Economy
964
945
927
913
Page 14
9.Infant Mortality Rate (IMR)

Infant Mortality Rate Means the number of deaths of infants under one year old in a
given year per 1,000 live births in the same year; included is the total death rate, and deaths
by sex, male and female. This rate is often used as an indicator of the level of health in a
country. The infant mortality is high in rural areas (61) than the urban areas (37).The IMR is
lowest in the state, Goa and it is only 10.It is high in Meghalaya where it is 55.IMR for different
years are given in the Table 1.10
Table 1.10
Infant Mortality Rate

Year
IMR
1980
114
1971
1985
1990
2000
2007
2011
192
97
80
68
53
47.57
10. The Maternal Mortality Rate (MMR)
The maternal mortality rate (MMR) is the annual number of female deaths per 100,000
live births from any cause related to or aggravated by pregnancy or its management
(excluding accidental or incidental causes). The MMR includes deaths during pregnancy, child
birth, or within 42 days of termination of pregnancy, irrespective of the duration and site of
the pregnancy, for a specified year. The MMR for India in 2008-09 is 212 per 100,000live
births.
11. Age Structure of Indias Population
The age composition or the age structure will change over the years. The working age is
considered as 15-60. The proportion of child population is decreasing slightly now while slow
improvement in the age group 60 and above. The age composition is given in Table 1.11.
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Page 15
Table 1.11
The Age Composition ( In %)
Year
1911
1921
1931
1961
1971
1981
1991
2001
2011
Age Group
0-14
15-60
60 and above
39.2
59.6
1.2
38.8
38.3
41.0
41.4
39.7
36.5
35.6
60.2
60.2
53.3
53.4
54.1
57.1
58.2
Below 15 15-64
29.1
65.4
1.0
1.5
5.7
5.2
6.2
6.4
6.3
65 and above
5.5
Major Issues: Poverty, Unemployment and Inequality
Even though India is one of the major developing economies in the world, it faces
certain crucial issues in its developmental path. They are Poverty, Unemployment and
Inequality. Only by solving these issues and looking from different angles these are to be
removed.
The Concept of Poverty
Poverty is a plague as it is prevalent in almost all countries in the world and it has many
faces and dimensions. Therefore it is difficult to define the concept poverty in precise.
Poverty is always defined according to the conventions of society in which it occurs. But in
the recent years, the concept of poverty has been refined and made more comprehensive. The
New World requires better and more scientific ways to assess the concept of poverty in the
society. Now its multidimensional aspect is recognized and uses a multidisciplinary approach
to assess poverty. Poverty is not simply a social phenomenon but also include economic,
political, historical, geographical and cultural aspects.
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Page 16
Various attempts have been made by societies to define poverty. In human terms
poverty means little to eat and wear, and in economic terms the poverty means the inability
to attain a minimum standard of living. It is natural to view poverty as the failure to meet the
basic requirements to maintain a minimum standard of living. This minimum standard of
living may vary from society to society. While biological requirement and nutritional norms
provide the most elementary concept of a minimum standard of living, modern
understanding of poverty requires other factors such as school enrolment, infant mortality,
immunization, malnutrition, women empowerment, overall standard of living, asset holding
etc.
Poverty can be defined as a social phenomenon in which a section of the society is

unable to fulfill even its basic necessities of life. In India the generally accepted definition of
poverty emphasizes minimum level of living rather than a reasonable level of living. In
economics there are two important classification of poverty; Absolute Poverty and Relative
Poverty.
Absolute Poverty and Relative Poverty
Absolute Poverty is the sheer deprivation or non-fulfillment of bare minimum needs

of existence- of food, shelter, health or education. It is based on the absolute needs of the
people and people are defined as poor when some absolute needs are not sufficiently
satisfied. Hence according to this type poverty is treated as deprivation. Most of the
developing countries are experiencing such type. An absolute poverty line is based on the
cost of minimum consumption basket based on the food necessary for a recommended calorie
intake.
Relative Poverty is related with high income countries, where people are poor
because they cannot maintain or equivalent to others in the society. There should be
differences in living standards among the people. It reflects economic distress, despair and
dissension that stem from serious inequalities in income and wealth .The relative poverty line
varies with the level of average income. Relative poverty is based on inequality and
differences in standard of living. According to the relative concept of poverty, people are poor
because
From this classification we know that poverty is not inequality. Poverty is only one of
the evil consequences of inequality. Whereas poverty is concerned with the absolute standard
of living of a part of the society i.e.; the poor, inequality refers to relative living standards
across the whole society.
Measurement of Poverty
Once we understand poverty, it is essential to measure it with its various dimensions.

The measurement of poverty is needed to plan policies to check this global phenomenon.
Many factors were listed, some of them are life expectancy, mortality, maternality, safe
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Page 17
drinking water, pure air, women empowerment, energy consumption, literacy, asset holding,
sanitation, primary health facilities, clean surroundings etc. most of these are derived with
income. Therefore consumption data can be used to measure poverty.
Poverty Line
Poverty line is the most widely used measure for assessing poverty. Under this
method, people are counted as poor when their measured standard of living is below a
minimum acceptable level-known as Poverty Line. The poverty line in India is defined as the
level of private consumption expenditure, which ensures a food basket that would supply the
required amount of calories. Actually in India the Planning Commission estimates the
poverty on the basis of Calorie intake. By considering age, sex, activity etc., Indian Council of
Medical Research (ICMR) proposes 2400 calorie intake for the rural person per day and 2100
calorie per person per day in urban. The calorie requirements in the rural areas is higher
because people engaged in heavy work more in rural areas than in urban areas.
Poverty Estimation in the Independent India
In independent India, the first official definition of poverty was given in 1962. This
pegged the rural poverty line at a Monthly Family Income of Rs.100 and urban one at Rs.125.
Dandekar and Rath (1971) estimated poverty in terms of consumer expenditure

needed a diet adequate at least inform of calories, they adopted 2250 calories per person per
day as the norm for their study. According to them, the consumer expenditure necessary to
obtain the minimum nutritional standard was an amount of Rs. 14.16 per capita per month at
1960-61 prices for rural India. Based on this norm, 30.92 percent of the rural population lies
below the poverty line in 1961-62, in India.
Bhrdhan (1974) adopted the poverty line of Rs 15 at 1960-61 all India rural prices as
the minimum level of living, and also estimate poverty for 1967-68 period, taking Rs. 29.90 as
minimum requirement and find that in 1960-61 about 38% of rural Indians and in 1967 68,
53 percent of rural Indians are below poverty line.
Vaidyanathan (1974) adopted Rs. 21.44 as rural poverty in India at 1960-61.prices. To
his estimate the rural poverty in India is 15.65percent.
Bhatty (1974) measured the incidence of poverty for the year 1968-69. He selected
poverty lines in terms of Percapita income instead of Percapita consumer expenditure. He
made use of the income distribution data collected by National Council of Applied Economic
Research (NCAER) for 1968-69. In order to overcome arbitrariness in using a single poverty
line, Bhatty made use of five poverty lines namely Rs. 180, Rs 240 Rs. 300, Rs. 360 and Rs.
420. percapita per annum at 1968-69 prices or its percapita monthly equivalent Rs. 15, Rs.
20, Rs. 25, Rs. 30 and Rs. 35. His results show that the poverty levels vary corresponding to
different income levels. The corresponding rural poverty is 21.95 percent, 39.55 percent,
55.87percent, 69.70 percent, and 78.70 percent corresponding to monthly percapita income.
Indian Economy
Page 18
Ahluwalias (1978) estimates shows a fluctuating trend in the incidence of poverty

over time. Rural poverty in India declined from 53.4 percent in 1957-58 to 42 percent in
1960-61. Then it started rising from 42.3 percent to 57.9 percent during 1961-62 to 1967-68
and then declined to 47.6 percent in 1973-74.
Mahendra Dev (1988) estimated the poverty lines for the reference years by making
use of the estimates derived by Bardhan (1974) for the year (1960-61). He adjusted the
poverty lines by the Consumer Price Index of Agricultural Labourers (CPIAL) for the
reference years. He found that the percentage of rural Indian population living below the
poverty line was continuously declining from 46.4 percent in 1964-65 to 44.78 percent in
1972-73 and from 40.45 percent in 1977-78 to 33.20 percent in 1983-84.
The Planning Commission (1981 and 1985) measured the extent of rural poverty for 4
years taking Rs 77 (at 1979-80 prices) percapita per month as the poverty line. In 1977-78,
about 51.2 percent of rural population was poor as against 54.1 percent in 1972-73. It comes
down to 40.4 percent in 1983-84. The Planning Commission calculates the poverty ratio on
the basis of quinquennial Consumer Expenditure Surveys conducted by NSSO. The Planning
Commissions estimates of the poverty ratio for 1987-88 indicated further decline in the
incidence of poverty to 33.4 percent in 1987-88.
Criticising the Planning Commissions earlier estimates, Minhas, Jain and Tendulkar
(1991) measured the incidence of poverty by using correct procedure for three years 197071, 1983 and 1987-88. They converted the poverty norms to prices prevailing in the year for
which NSS consumer expenditure data are available. They worked out State Specific Cost of
Living Indices. Then, applying these indices, they calculated State Specific Poverty norms for
1970-71, 1983 and 1987-88. The poverty norms for rural India were Rs. 33.01, Rs 93.16 and
Rs. 122.63 for the years considered respectively. Corresponding to these poverty lines, the
percentage of population below poverty lines were 57.3, 49.02 and 44.88 for the
corresponding years.
Rohini Nayyar (1991) measured the poverty line for 13 years period from 1960-61 to
1983-84 and estimated the incidence of rural poverty. Her calculations are based on actual
consumption data by broad category. She made use of the calorie norm of 2200 to arrive at
the poverty line. To her estimates rural poverty fluctuates over the years.
Kakwani and Subba Rao (1992) attempted a study on rural poverty for the period
1973-86. They used relative price levels in the rural areas to arrive at the poverty lines. Using
the price relatives and consumer price indices for agricultural labourers they worked out the
State Specific Poverty Lines at the current prices for the years 1973-74, 1977-78, 1983 and
1986 87. According to their estimates the rural poverty continuously declined.
Tendulkar and Jain (1995) estimated the incidence of poverty for 12 years from 197071 to 1992. They estimated the poverty lines for various years taking the Planning
Commissions all India poverty line of monthly percapita total expenditure of Rs. 49.09 at
1973-74 prices. Urban Poverty profile of the different authors are given in the Appendix,
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Page 19
Even though the earlier estimates of Planning Commission is based on this calorie
norms which is criticised because of methodological defects and it cannot consider the other
basic items like health, education etc. Therefore Planning Commission appointed an Expert
Committee, under Suresh Tendulkar in 2008 and reported its recommendations in November
2009. The committee suggested a formula based on Consumption Expenditure for identifying
BPL families. His recommendations are more scientific and there is some novelty in the
measurement because Tendulkar committee uses a broad definition of poverty including
expenditure for food, education, health etc., and uses consumer expenditure taking Mixed
Recall Period as against Uniform Recall Period. According the committee the monthly
consumption expenditure to measure poverty line is Rs. 446.68 per person per month in rural
areas and Rs. 578.8 per person per month in urban areas. To their report Indias poverty is
37.2 percent (2004-05) as against the Planning Commissions estimates of 27.5 percent in
2004-05 calculated on the basis of Dandekar- Rath formula based on calorie intake. Latest
poverty estimates of Planning Commission are seen from the Table 1.12.
Table 1.12
Poverty Rates in Various NSSO Rounds

Year
Round
Poverty Rate (%)
1973-74
27
54.88
1983
38
44.48
1977-78
1987-88
1993-94
1999-00
2004-05
2009-10
32
43
50
55
61
66
51.32
38.86
35.97
26.10
27.50
29.80
Source: Planning Commission, March, 2011 and NSSO Data
Planning Commission estimates Indias poverty both on the basis of Uniform Recall
Period(Uniform Recall Period took consumption in which the consumer expenditure data for
allitems are collected from 30- day recall period.) and Mixed Recall Period (Mixed Recall
Period took consumption in which the consumer expenditure data for five non-food items,
namely, clothing, footwear, durable goods, education and institutional medical expenses are
collected from 365-day recall period and the consumption data for the remaining items are
collected from30-day recall period.). It consider Cost of Living as the basis of poverty.
Indian Economy
Page 20
Table 1.13
Poverty in India, New Estimates
Uniform Recall Period
Mixed Recall Period
Years
93-94
04-05
2009-10
99-00
04-05
2009-10
Urban
32.4
25.7
23.6
21.7
20.9
Rural
37.3
All India 36.0
28.3
27.5
.
.
27.1
26.1
Source: Economic Survey
21.8
21.8
33.8
29.8
In opposition to Tendulkar committee, Dr. N.C. Saxena committee was appointed by

Rural Development Ministry in August 2008. This committee argued for a New BPL criterion,
which suggests automatic inclusion of socially excluded groups and automatically exclusion of
those who are relatively well-off. The committee recommended a new methodology of Score
Based Ranking and put forwarded that Rs. 700 per month per rural person and Rs. 1000 per
month per urban person to maintain 2400 and 2100 calorie intake for a day. The committee
estimates that Indias poverty is 49.1 percent in 2004-05.
According to Arjun Sengupta committee appointed by National Commission for
Enterprises in the Unorganised Sector (NCEUS) Indias poverty is 77 percent. The Committee
uses the same data of NSSO and takes the norm of Rs. 20 per day per person to measure the
poverty line.
Based on World Banks estimates (2005), 41.6 percent of Indians fall below the
International Poverty Line this of $ 1.25 per day (PPP). In nominal terms Rs. 21.69 per day in
urban area and Rs. 14.3/day in the rural area. They estimate 456 million Indians lived in
poverty. World Banks new International Poverty Line is based on $ 2 per day.
Abbijith Sen found out that if we took calorie norm even then the poverty is much
higher i.e.; in urban 80 percent and in rural 64 percent of the Indians are lived below poverty
line. This estimate is also very higher than official estimate.
Table.14
Poverty line, 1973-74 to 2009-10
Year
1973-74
1977-78
Indian Economy
1983
Rs per capita per month, current prices

Rural
Urban
56.84
70.33
49.63
89.50
56.76
115.65
Page 21
1987-88
1993-94
115.2
205.84
1999-2000 327.56
2004-2005 356.30
2009-2010 672.80
162.16
281.35
454.11
538.60
859.60
Sources: Planning Commission
The Planning commission has updated the poverty lines and poverty ratios for the
year 2009-10 as per the recommendations of the Tendulkar Committee using NSS 66
thround(2009-10) data from the Household Consumer Expenditure Survey. It has estimated
that the poverty lines at all India level as an MPCE of Rs. 672.80 for rural and Rs. 859.60 for
urban in 2009-10. Based on these cut-offs, the percentage of people living below thw poverty
line in the country has declined from 37.2 % in 2004-05 to 29.8 % in 2009-10.
Causes of Poverty in India
Poverty is not caused by any single reason. It is the outcome of the interaction of several
factors; economic, non- economic, political, social, cultural, geographical etc.
1. Underdevelopment
The most important cause for poverty is the underdevelopment of the economy. Due to
underdevelopment a large proportion of the people have go without even the basic
necessities of life. With the low national income and percapita income the country cannot
increase its aggregate consumption and investment. Hence the standard of living is also so
low among the people. Even though there is much improvement in the development of the
country after independence still we want to go a lot.
2. Inequality
The second important cause of poverty in India is inequality in income and wealth. Even
the New Economic policies could not reduce the depth of inequality in India. Instead there is
increase in inequality among the people.
3. Inadequate growth rate
In the early years of planning the growth rate of Indian economy is not high enough to
check the problem of poverty. Even though economy railed in a high growth path in the mid
of 2000 onwards the benefits are not trickle down to the poor sections of the society. Still the
gap between rich and poor is increasing.
4. Large population
Even though the growth rate of population is coming down still the size of it is very large.
Therefore it is not capable to implement the poverty alleviation programmes successfully.
Indian Economy
Page 22
5. Unemployment
Another major cause for the growth of poverty is unemployment. The problem of
unemployment is still so acute in the economy. Thus increasing unemployment and
underemployment accentuate poverty.
6. Poor performance of agriculture sector
Still Indian agriculture is carried on largely with primitive techniques. High

dependency on rain, small and scattered holdings, lack of inputs, exploitative land tenure
system, competition from foreign markets, lack of storage and marketing facilities etc. are
responsive to the poor performance of agriculture sector even after the Green Revolution.
7. Poor performance of industrial sector
In spite of much improvement in line with development of modern industries still

performance is not up to the mark. Lack of dynamic entrepreneurs, lack of competitiveness,
lack of skilled and trained workers, inadequate finance, irregular supply of power and raw
materials, poor transport and methods of production etc. leads to slow industrialization of the
country.
8. Inflation
Rise in price is an alarming problem to the economy. It is the poor who suffered a lot due to
inflation. When prices are high the purchasing power of money falls and leads to
impoverishment of the poor sections of the country.
9. Social factors
It is agreed that the poverty in India is the outcome of social factors. It includes caste
system, joint family system, law of inheritance, lack of initiative and entrepreneurship etc.
India is also poor in social overheads like education, health, medical facilities, illiteracy etc.
The attitudes and aspirations of the people are not conducive to economic growth and
development.
10. Political factors
Even after India escaped from the yoke of British exploitative administration still the
political set up is not that much efficient to solve the problem of poverty. It is true that
various programmes are initiated under five year plans. The Fifth Five Year Plan raised the
slogan Garibi Hatao but still the poverty alleviation is a nightmare to Indian policy makers.
Thus the poverty in India is happened due to various reasons. Regional disparities,
lack of investment, lack of proper implementation of public distributive system, lack of
vocational training and education, migration of rural youth to cities etc. have also contributed
to poverty in India.
Remedial Measures
Poverty is a tragedy not only for the individuals but also for the economy at large. As a
result of this the remedial measures to poverty is emphasized. From the experiences of the
economy we can suggest the following to alleviate poverty.
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Page 23
1. Rapid Economic Growth

Fast economic growth is a necessary condition for poverty alleviation programme for
the following reasons: It changes the low income agricultural set up, helps to strengthen the
redistributive activities of the government, made a radical change in production and
distribution process, create more employment opportunities etc. Even there is the possibility
of trickledown effect to economic growth.
2. Accelerate agricultural growth
No doubt that when there is agricultural growth it reduces the burden of poverty
because majority of poor are lived with agriculture sector. So steps should be taken to solve
the problems of small and marginal farmers.
3. Accelerate industrial growth
The industrial development will create more income and employment opportunities to
the people. Through this the depth of poverty can be reduced.
4. Development of small- scale and cottage industries
In Indian economy small- scale and cottage industries have played a crucial role. This
sector which being labour intensive, create more employment opportunities and help in the
removal of poverty.
5. Land reforms
Land reforms as poverty alleviation measures aimed to break the old feudal socioeconomic structure of land ownership. It aims to eliminate exploitation by providing security
of tenure and regulation of rent. It also aims to bring direct contact between the state and the
tiller and give social economic status of the landless by distributive measures.
6.Better Public Distributive System
Poverty can be reduced if people are ensured with essential commodities at fair
prices. Therefore the government should establish a wide network of fair price shops to
provide the essential commodities.
7. Control Population
Unless the population is not reduced, the additions to wealth production will be eaten
up by the fresh torrent of babies. Therefore the planners should aim at the family planning
measures to bring down the birth in the country.
8. Provision of Common Services and social Security
The government should spend for the provision of free common services like primary
education, medical aid, potable drinking water, housing and other facilities to the people. This
will increase their real consumption and make them feel better off and hence reduce the
poverty.
Indian Economy
Page 24
9. Improve the Status of the Women

Gender equality can help to reduce poverty and encourage growth in variety of ways.
Women are provided with direct access to institutional credit, direct membership in
cooperatives, setting up of women organization etc.
10. Good Administrative Setup
Above all the success of any programme primarily depends on the effective working of
the administrative machinery.
A Brief Review of Poverty Alleviation Programmes
Beginning with the launch of Integrated Rural Development Programme (IRDP, 1978)
in the Sixth Five Year Plan, a number of PAPs have been formulated and implemented; many
of them are have been restructured and formulated fresh from time to time . Among these
PAPs the more important have been:
(a) Training of Rural Youth for Self-Employment (TRYSEM, 1979)
(b) National Rural Employment Programme (NREP, 1980)
(c) Rural Landless Employment Guarantee Programme (RLEGP, 1983)

(d) Million Wells Scheme (MWS, 1988)
(e) Nehru Rozgar Yojana (NRY, 1989).It is for the urban poor people.
(f) Jawahar Rozgar Yojana (JRY, 1989).NREGP and RLEGP are merged in this in 1989.
(g) Development of Women and Children in Rural Areas (DWCRA, 1992)
(h) Employment Assurance Scheme (EAS, 1993)
(i) Prime Minister Rozgar Yojana (PMRY, 1994)
(j) Prime Ministers Integrated Urban Poverty Eradication Programmes (PMIUPEP,1995)
Most of these programmes have been recently redesigned and restructured to improve
their efficacy or impact on the poor. The important PAPs, presently in operation are;
Self Employment Programme:

Swarnjayanthi Gram Swarozgar Yojana (SGSY, 1999). This replaces IRDP,
TRYSEM, DWCRA, SITRA, GKY and MWS and work for rural poor.
Wage Employment Programme:
National Food for Work Programme (NFWP, 2004). It intensifies the generation
of supplementary wage employment.
Sampoorna Grameen Rozgar Yojana (SGRY, 2001). Rural Employment
Generation Programme (REGP, 1995) was merged in SGRY in 2001.SGRY
provide additional wage employment in the rural areas. Now this programme is
entirely subsumed in NREGS with effect from April, 1, 2008.
National Social Assistance Programme (NSAP, 1995). It provides social assistance

to the rural poor.
Indian Economy
Page 25
Urban Employment and Anti-poverty Programme:

Prime Minister Rozgar Yojana (PMRY, 1993)
Swarna Jayanti Shahari Rozgar Yojana (Golden Jubilee Urban Employment
Scheme, 1997). This scheme integrates three PAPs for urban areas, viz.NRY,
PMIUPEP and Urban Basic Services for the poor.
Unemployment
Another major developmental issue in Indian economy is unemployment. Although

this problem had existed in the past; it has become more acute after the independence. The
backwardness and increasing population are mainly responsible for this problem. The socioeconomic consequences of unemployment are very dangerous. It has economic consequences
for the individual as well as the society.
Unemployment means idleness of man power. It is the state in which labour possesses
necessary ability and health to perform a job, but does not get job opportunities. In other
words unemployment is the situation in which individuals are available for work, but are not
able to find a work.
In order to explain the concept unemployment it is better to distinguish between the

concepts like labour force and work force. The labour force refers to the number of persons
who are employed plus the number who are willing to be employed. In India the labour force
excludes children below the age 15 and old people above the age 60 and mentally or
physically handicapped. The work force includes those who are actually employed in
economic activity. If we deduct work force from labour force we get the number of
unemployment.
The unemployment rate means the number of persons unemployed per 1000 persons
in the labour force.
The labour force participation rate and work force participation rate can be expressed
in percentages and as given below.
Labour Force Participation Rate
Work Force Participation Rate
Types of unemployment
Labour Force / Size of the population
Work force /Size of the population
In every economy there is unemployment but the nature and magnitude differ
according to the economic progress. Following are the important types of unemployment.
1. Voluntary unemployment
This is the main type of unemployment referred by the Classical economists. Voluntary
unemployment is happened when people are not ready to work at the prevailing wage rate
even if work is available. It is a type of unemployment by choice.
2. Involuntary Unemployment
Keynes analysed this type of unemployment. It is a situation when people are ready to
work at the prevailing wage rate but could not find job.
Indian Economy
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3. Natural rate of Unemployment

This is postulated by the Post-Keynesians. According to them in every economy there
exists a particular percentage of unemployment.
4. Structural unemployment
This type of unemployment is not a temporary phenomenon. It is chronic and is the

result of backwardness and low rate of economic development. The structural changes of an
economy are the main reason for this type of unemployment.
5. Disguised Unemployment
When more people are engaged in a job than actually required, then it is called
disguised unemployment. If a part of labour is withdrawn and the total production remains
unchanged because their marginal product is zero. This is a part of structural unemployment.
6. Under Employment
This exists when people are not fully employment ie; when people are partially
employed. In other words it is a situation in which a person does not get the type of work he
is capable of doing.
7. Open Unemployment
Mrs. Joan Robinson calls this type of unemployment as Marxian Unemployment. Open
unemployment is a situation where a large labour force does not get work opportunities that
may yield regular income to them. It is just opposite to disguised unemployment. It exists
when people are ready to work but are not working due to non-availability of work
8. Seasonal unemployment
Generally this type of unemployment is associated with agriculture because the

unemployment rate is changed according to the season.
9. Cyclical Unemployment
It is generally witnessed in developed nations. This type of unemployment is due to

business fluctuation and is known as cyclical unemployment.
10. Technological Unemployment
When the introduction of a new technology causes displacement of workers it is called

technological unemployment.
11. Frictional Unemployment
It is a temporary unemployment which exists when people moved from one occupation
to another. It will take time lag in transferring one work to another. The market imperfections
are the main reason for this.
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Measurement of Unemployment in India

The National Sample Survey Organization (NSSO), which provides estimates of the
rates of unemployment in India on the basis of its quinquennial surveys, uses three different
concepts. They are Usual Status Unemployment, Current Weekly Status unemployment and
Current Daily Status unemployment.
I. Usual Status Unemployment (US)
Here the reference period is 365 days. The usual status gives an idea about long- term
employment (or chronic and open employment) during the reference year. A person is
considered unemployed on Usual Status basis, if he/she was not working, but was willing to
work for the major part of the reference year (more than 183 days) but did not get work for
even 183 days. Dividing the usual status unemployment by the size of the labour force, we get
unemployment rate by usual status. This measure is more appropriate to those in search of
regular employment (educated and skilled persons) who may not accept casual work.
II. Current Weekly Status Unemployment (CWS)
Here the reference period is one week .A person is considered unemployed by Current
Weekly Status, if he/she had not worked even for one hour during the week, but was seeking or was
available for work. The estimates are made in terms of the average number of persons
unemployed per week. The Current Weekly Status approach gives an idea about temporary
unemployment (or chronic plus temporary unemployment) during the reference week.
Current Weekly Status is used by the agencies like Inter National Organisations (ILO) to
estimate employment and unemployment rates based on weekly reference period for
international comparison. Dividing the weekly status unemployment by the size of the labour
force, we get unemployment rate by weekly status.
III. Current Daily Status Unemployment (CDS)
Here the reference period is each of the 7 days, preceding the date of survey in each of
these days. It records the activity status of a person for each day of the 7 days preceding the
survey i.e. persons who did not find work on a day or some days during the survey week. The
Current daily status approach gives a composite or comprehensive measure of
unemployment, i.e., it is a measure of chronic and temporary unemployment as well as under
employment. Dividing the current daily status unemployment by the size of the labour force,
we get unemployment rate by usual status.
The current daily status gives the most faithful picture of unemployment situation.
Magnitude of Unemployment in India
A comparison between different estimates of unemployment in 2009-10 indicates that

the CDS estimate of unemployment is the highest (Table 1.15). The higher unemployment
rates according to the CDS approach compared to the weekly status and usual status
approaches indicate a high degree of intermittent unemployment. Interestingly, urban
unemployment was higher under both the usual principal and subsidiary status (UPSS) and
current weekly status (CWS) but rural unemployment was higher under the CDS approach.
This possibly indicates higher intermittent or seasonal unemployment in rural than urban
Indian Economy
Page 28
areas, something that employment generation schemes like the MGNREGA need to pay
attention to. However, overall unemployment rates were lower in 2009-10 under each
approach vis-a-vis 2004-05.
Table 1.15
All-India NSS 66th Round Rural and Urban Unemployment Rates

Si No Estimates Rural
Urban
Total
Total
UPSS
1.6
3.4
2.0
2.3
CDS
6.8
5.8
6.6
8.2
(2009-10) (2009-10) (2009-10) (2004-05)
CWS
3.3
4.2
Source: NSSO
3.6
4.4
Labour force participation rates (LFPR) under all three approaches declined in
2009-10 compared to 2004-05 (Table 1.16). However, the decline in female LFPRs was larger
under each measure in comparison with male LFPRs which either declined marginally
(UPSS), remained constant (CWS), or increased marginally (CDS).
Table 1.16
All-India Employment and Unemployment Indicators (per 1000)

LFPR
557
233
400
559
294
430
Unemployment Rate
20
23
20
22
26
23
LFPR
550
207
384
550
257
407
Unemployment Rate
33
43
36
42
50
44
LFPR
540
179
365
538
215
381
Unemployment Rate
61
82
66
78
92
82
Indicators
UPSS
Male Female Total Person Male Female Total persons

CWS

CDS
228
198
164
392
370
341
547
527
496
287
244
195
420
389
350
Source: Key Indicators of Employment and Unemployment in India, 2009-10, NSSO.

Indian Economy
Page 29
Causes of unemployment in India

Following are the important causes of unemployment in India
1. Rapid population growth
2. Slow growth of the economy
3. Decay of small scale and cottage industries

4. Low rate of capital formation
5. Defective planning
6. Slow growth of agriculture sector

7. Global financial crisis
8. Illiteracy
9. Lack of training facilities
Remedial Measures for unemployment

In order to solve the problem of unemployment there is both government measures
and other measures. It includes the following measures.
1. Rapid growth and expansion of the economy
2. Establishment of more work and training centers
3. Development of small scale and cottage industries
4. Establishment of poverty eradication programmes
5. Liberal institutional finance and self employment programmes

6. Establishment of more employment exchanges
7. Introduction of population control measures
8. Introduction of more public works programmes

9. Reduce illiteracy
10. Stress on vocational and technical education
The Concept of Inequality
While the concept of poverty is rooted in the lack of access or a low level of access
to food, nutrition, shelter, education and other services. Inequality is related to unequal
access or different degrees of access of different individuals or groups of individuals to
opportunities, services and benefits. Inequality is, thus, a more general concept than poverty.
It looks at the relative levels of access of different groups to development opportunities and
benefits. The different levels of access in the concept of inequality also include the low level
of access below which people are considered poor. In fact, the low level of access or the limit
(like for example, the calorie limit for consumption) that may be set for defining poverty will
itself include a number of lower levels of access.
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Page 30
Inequality in India
India is shining for only a select few. The impressive economic growth of our country
has brought smiles on the faces of the rich and the powerful even as the rest suffer in distress
and drudgery. This was revealed by the Human Development Report, 2011 (HDR) released by
Planning Commission. The report highlights the skewed income and wealth distribution in
India and the widening gap between the rich and the poor. According to HDR 2011, inequality
in India for the period 2010-11 in terms of the income Gini coefficient was 36.8. Indias Gini
index was more favourable than those of comparable countries like South Africa (57.8), Brazil
(53.9), Thailand (53.6), Turkey (39.7), China (41.5), Sri Lanka (40.3), Malaysia (46.2),
Vietnam (37.6), and even the USA (40.8), Hong Kong (43.4), Argentina (45.8), Israel (39.2),
and Bulgaria (45.3) which are otherwise ranked very high in human development.
There are three important types of inequality exist in India, namely inequality in
income and consumption, inequality in assets and regional inequality. These three forms of
inequality are interrelated and mutually reinforcing. The Government of India has been
concerned about rising inequalities and uneven distribution of the benefits of growth.
Accordingly, the thrust of the 11th Five-Year Plan (2007-12) was on inclusive growth. The
forthcoming 12th Five-Year Plan is expected to deepen and sharpen the focus on inequalities.
Inequality in Income and Consumption
Let us look at levels of inequality in income or consumption. Consumer expenditure of

households is a good proxy for income, at least in the lower classes. A study of inequalities in
levels of consumption will by itself be useful in an economy where agriculture, the
unorganised sector, payment of wages in kind and the non-monetised sector still play an
important role. Such an analysis will be able to pinpoint attention on specific areas of concern
in the consumption pyramid. Let us, therefore, turn to levels of inequality in consumption.
The household consumer expenditure surveys of the NSSO provide the levels of
consumption of expenditure in the population by Monthly Percapita Consumer Expenditure
(MPCE) classes. The Average MPCE of the rural people in India is only Rs.1054 and in Urban it
is Rs.1984.
Table: 1.17
Share of Household Expenditure by Percentile Groups of Households (in %)

Percentile groups of Households 1989-90 1994 1997 2004-05
Lowest 20 percent
8.8
9.2
8.1
8.1
Third quintile
16.2
16.8
15.0
14.9
Second quintile
Fourth quintile
Highest 20 percent
Highest 10 percent
Indian Economy
12.5
21.3
41.3
27.1
13.0
21.7
39.3
25.0
Source: Various NSSO Report
11.0
19.3
46.1
33.5
11.3
20.4
45.3
31.1
Page 31
A comparison of the share of the bottom 10 per cent (or 20 per cent or 50 per cent) of
the population in total consumption with that of the top 10 per cent (or 20 per cent or 50 per
cent) of the population brings out dramatically the extent of inequality in consumption. The
inequality situation is worse in urban areas than in rural areas. This is so in all States and
Union Territories. Inequality in consumption is declining, albeit slowly, in rural areas
according to all measures of inequality. On the other hand, urban inequality shows no sign of
any decline.
Inequality in Assets
Incomes are derived from two main sources. Namely, assets like land, cattle, shares
and labour etc. In India a few own a large chunk of income-earning assets therefore the
distribution of assets is extremely unequal. The top 5 per cent of the households possess 38
per cent of the total assets and the bottom 60 per cent of households owning a mere 13 per
cent. The disparity is more glaring in the urban areas where 60 per cent of the households at
the bottom own just 10 per cent of the assets. Predictably, asset accumulation is minimal
among the agricultural labour households in rural areas and casual labour households in
urban areas. But the asset distribution is even more unequal in the urban than in the rural
areas. At the one extreme there are highly rich households of industrial, commercial, financial,
and real estate magnates and some ex-princes and political leaders. They own enormous
assets and running for huge profits. On the other extreme there are slums, and pavement
dwellers, unemployed and casual labourers, independent workers providing petty services
etc. who generally hold negligible assets.
Regional Inequality
Third important type of inequality that India faces is the regional inequality. Some
states are economically and socially advanced while others are backward. Even within each
state some regions are more developed while others are primitive. The co existence of
relatively developed and economically depressed states and even regions within each state is
known as regional inequality. The existence of regional inequality creates social, economic
and political issues. The regional inequality is so prominent in India in the case of HDI Value,
growth of the economy, poverty, unemployment, education, health, monthly percapita
expenditure, rural- urban divide etc.
The India Human Development Report, 2013 shows that India has a HDI value of
0.547. The HDI is the highest for Kerala (0.790) followed by Goa (0.617) and then Punjab
(0.605) and the lowest for Chhattisgarh (0.358), Odisha (0.362) and Bihar (0.367). While the
HDI scores across states show little variation the variation in the sub-indices for education
and health show a greater degree of variation. The income index shows the least degree of
variation. The major states are distributed between the categories of countries with Medium
and Low Human Development as per the HDR 2011 classification. Kerala is in the Medium
HDI category. Other major states in this group are Punjab, Himachal Pradesh, Haryana,
Maharashtra, Tamil Nadu, Karnataka, Gujarat, West Bengal and Uttarakhand. Nine other
states, namely Andhra Pradesh, Assam, Uttar Pradesh, Rajasthan, Jharkhand, Madhya
Pradesh, Chhattisgarh, Bihar and Odisha fall in the Low HDI category India is ranked 134 out
of 187 countries in the Global HDI,2011.
Indian Economy
Page 32
The best performer in terms of growth in 2009- 10 was Uttarakhand, followed by

Odisha, Chhattisgarh, and Gujarat and the worst performers were Karnataka, Rajasthan, and
Jharkhand. States with above 10 per cent growth rate for the period 2004-5 to 2009-10 are
Uttarakhand, followed by Maharashtra, Gujarat, and Bihar.
The state-wise estimates of poverty as recomputed by the Tendulkar Committee show
that the highest poverty headcount ratios (PHRs) for 2009-10exist in Odisha (57.2 per cent),
followed by Bihar (54.4 per cent) and Chhattisgarh (49.4 per cent) against the national
average of 37.2 per cent.
The unemployment rate (per 1000) according to usual status(adjusted) as per the NSS
66th round 2009-10 among the major states is lowest in Rajasthan(4) and highest in
Kerala(75) in rural areas and the lowest in Gujarat(18) and highest again in Kerala(73) and
Bihar(73) in urban areas.
In the area of education, Madhya Pradesh has the highest GER (6-13 years) in 2008-9
while Punjab has the lowest. Pupil-teacher ratios in primary and middle/basic schools are the
lowest in Himachal Pradesh and high in states like Bihar and Uttar Pradesh.
Health-wise, Kerala is the best performer and Madhya Pradesh the worst in terms of
life expectancy at birth (both male and female) during 2002-6. IMR in 2010 is also the lowest
in Kerala and highest in Madhya Pradesh. Kerala has the lowest and Uttar Pradesh the highest
birth rate in 2010, followed by Bihar and Madhya Pradesh. Odisha has the highest and
interestingly West Bengal the lowest death rate.
The MPCE indicator shows that there is disparity both in the MPCE and food share
across states.According to the 66 th round NSSo round estimates India s average monthly per
capita expenditure is Rs .1053.64 ror rural and Rs. 1984.46 in urban areas. Bihar has the
lowest MPCE of Rs 780 with 65 per cent food share in rural areas and Rs 1238 with 53 per
cent food share in urban areas whereas Kerala has the highest MPCE of Rs 1835 with 46 per
cent food share in rural areas and Rs 2413 with 40 per cent food share in urban areas. States
with low average MPCE tend to have a higher share of food in total consumer expenditure as
food is the primary need for survival and takes up a larger proportion of overall expenditure
in the poorer sections of population. The top states spending more than the national average
on food items both in rural and urban India are Bihar, Assam, Odisha, and Jharkhand.
Turning to the rural urban gap, we begin with the Monthly per capita expenditure
(MPCE) defined first at household level to assign a value that indicates level of living to each
individual or household. Based on the 68th round (2011-12) of the National Sample Survey
(NSS), average MPCE [Uniform Reference Period (URP) based] is Rs. 1281.45 and Rs.2401.68
respectively for rural and urban India at the all India level indicating rural-urban income
disparities. Out of the MPCE, the share of food is 53.6 per cent and Rs. 40.7 per cent for rural
and urban India respectively which shows that food share is more in rural India as compared
to urban India.
Indian Economy
Page 33
Causes of Inequality in India

1.
Private ownership of means of production
4.
Concentration of economic power in the hands of a few
2.
3.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
Poverty of the people

Law of inheritance
Highly unequal asset distribution
Inadequate employment generation
Inadequate development of the economy

Differential regional growth
Inequalities in professional training

Low investment in social sectors
Use of capital intensive technique of production

Failure of implementation of land reforms
Tax evasion and of the richer sections of the community

Inflation
Privatisation and globalisation
Remedial measures
In order to find out the remedial measures for inequality it is better to solve first the
real causes of it in the country. Any how the following are the some of the measures to solve
inequality.
1.
Reduction in the concentration of economic power
2.
Development of backward areas
3.
Better distribution of income and wealth
4.
Land reforms
5.
Creating more employment opportunities
6.
Provide more social security measures
7.
Control of black money
8.
Progressive income tax
9.
Control of monopolies and trade restriction practices
10.
High taxes on luxuries
11.
Change in inheritance law
12.
Use of labour intensive technique of production
13.
More investment in social sectors
14.
Control of inflation
15.
Population control
Indian Economy
Page 34
HDI of India
Human Development Index was introduced by UNDP in 1990.The committee for the
introduction of this index is headed by the Pakistani Economist Mahbub-Ul-Haq and helped
by Amartya Sen. The Human Development Report2013,The Rise of the South: Human Progress
in a Diverse World,notes that over the last decades, all countries accelerated their
achievements ineducation, health, and income dimensions as measured in the Human
Development Index. In 2010 Human Development Report the UNDP began using a new
method of calculating the HDI. The HDI combines following three dimensions:
A long and healthy life: Life expectancy at birth
Educational Index: Mean years of schooling and Expected years of schooling

A decent standard of living: GNI per capita (PPP US$)
1. Life Expectancy Index (LEI) =

2. Educational Index (EI) =
2.1 Mean Years of Schooling Index (MYSI) =
2.2 Expected Years of Schooling Index (EYSI) =
3. Income Index (II) =

HDI =
Finally, the HDI is the Geometric Mean of the previous three normalized indices:
LE: Life Expectancy at Birth.
MYS: Mean Years of Schooling (Years that a 25-year-old person or older has spent in schools).
EYS: Expected Years of Schooling (Years that a 5-year-old child will spend with his education
in his whole life).
GNI pc: Gross National Income at Purchasing Power Parity Percapita.
Indias progress in each of the HDI indicators is given in Table 1.18 . Between 1980
and 2012, Indias life expectancy at birth increased by 10.5 years, mean years of schooling
increased by 2.5 years and expected years of schooling increased by 4.4 years. Indias GNI per
capita increased by about 273 % between 1980 and 2012.
Indian Economy
Page 35
Table:1.18
Year
1980
Indias HDI Trend Values Components and Indicators

Life expectancy Expected Years Mean Years GNI Percapita
at Birth
of Schooling
of Schooling (2005 PPP $) HDI Value
55.3
6.3
1.9
0,880
0.345
1990
58.3
7.4
3.0
1,191
0.410
2000
61.6
1985
1995
2005
2010
2011
2012
57
7.1
59.8
8.2
8.3
63.3
9.9
65.1
10.7
65.8
10.7
65.4
10.7
2.4
3.3
3.6
4.0
4.4
4.4
4.4
1,007
1,389
1,702
2,190
3,009
3,175
3,285
Source: Various Reports of UNDP.
0.379
0.438
0.463
0.507
0.547
0.551
0.554
The human development index is estimated in terms of three basic capabilities: to live
a long and healthy life, to be educated and knowledgeable, and to enjoy a decent economic
standard of living. Between 1980 and 2012, Indias HDI value increased from 0.345 to 0.554,
an increase of 61 percent or average annual increase of about 1.5 percent. In the 2011 HDR,
India was ranked 134 out of 187 countries. The HDI value of India at different years is given
in Table.1.19. However, it is misleading to compare values and rankings with those of
previously published reports, because the underlying data and methods have changed.
Among the Indian states Kerala ranks First with HDI value 0.790 in 2011 while Chattisgarh in
the bottom with HDI value 0.304 in the same year.
The HDI for India was 0.554 in 2013 with an overall global ranking of 136 out of186
countries placing the country in medium human development category.Novey stands First
with HDI value 0.955.
Table: 1.19
India and HDI Value for Different Years

Years
HDI Value
1980
0.345
1975
1985
Indian Economy
1990
0.419
0.380
0.410
Page 36
1995
0.437
2005
0.507
2000
2006
2007
2008
2009
2010
2011
2012
2013
0.463
0.515
0.525
0.533
0.540
0.547
0.551
0.554
0.554
Source: Various Reports of UNDP

Trends in National Income and Percapita Income
In the Pre- independence Period the first estimation of National Income is done by the
father of Indian economy DadaBhai Naoroji in 1868.In his book Poverty and Un-British Rule in
India, estimated Indias Percapita Income as Rs.20.
While the first systematic effort to
estimate National Income is undertaken by V.K.R.V. Rao in his Book, National Income in British
India 1931-32. In 1949, the Govt. of India appointed a National Income Committee under the
Chairmanship of P.C. Mahalanobis and V.K.R.V. Rao and D.R. Gadgil as the Members. Its first
Report came in 1951 and second in 1954. According to the report the National Income of the
country is Rs. 8650 crore and Percapita Income is Rs.246.90. Now, in India the National
Income is estimated by CSO which is founded in 1951 and located in Delhi. The National
Income is estimated both in current and constant year prices.
National Income is defined as the money value of all final goods and services produced in
a country during a particular time period.
In India it is one year period known as financial year. The financial year starts from
April
ends in March 31st..The national income figures are deflated at constant prices to
eliminate the effect of any change of price level during the period. The national income figures
at constant prices, therefore, become comparable, but they conceal the population effect and
show nothing about the standard of living. Therefore the percapita national product or
percapita income is calculated. PCI at constant price is an indicator of change in the standard
of living of the people. The current base year for the estimation of National Income in India is
2004-05. Since NNP at factor cost represents the national income, table 1.20 shows both NI
and PCI in the base year 2004-05. Its growth rate is also shown in table 1.21.
1stand
Indian Economy
Page 37
From the data given in the table revealed that for the 30 years periods ie., 1950-50 to
1980-81 the average annual growth rate is 3.5%. This was referred as the Hindu Rate of
Growth by Prof. Raj Krishna because the growth rate of the economy is very similar to the
growth rate of Hindu families in India during the same period of time. During this period the
growth rate of percapita income is very low and it is just 1.4 % annually.
There was very perceptible improvement in the growth rate during the eighties.
During 1980-81 and 1990-91 the national income showed a growth rate of 5.2 % per annum
and the Percapita NNP at 3 % per annum. This is very healthy development as far as the
economy is concerned.
During 1990-91 to 2000-01 the annual average growth rate of NNP at factor cost (NI)
was 5.5 % per annum and that of NNP Percapita was 3.4 % per annum. During 2000-01 and
2004-05, NNP growth rate accelerated to 6.4 % and Percapita NNP grew at the rate of 4.7 %
per annum. During 2004-05 to 2010-11 we find further acceleration in the NNP to 8.4 % and
that of Percapita income to 6.9 %.
In State wise GSDP at constant price Maharashtra stood top with Rs. 8,05,031 crores in
2011-12 and Mizoram in the lowest position with GSDP Rs. 5,017. In the case of Percapita Net
State Domestic Product Goa stood top with Rs.1,12,602 and Bihar in the bottom with
Rs.13,178 in 2011-12 estimates at constant price.
Table: 1.20
NNP at Factor Cost and Per Capita NNP at constant Price (2004-05)
NNP at Factor
Per Capita NNP
Period
Cost(In crore)
at factor Cost(In Rs.)
1950-51
255,405
7,114
1955-56
314,238
7,996
1970-71
541,867
10,016
913,143
12,095
1960-61
1965-66
1975-76
1980-81
1985-86
385,761
436,650
626,779
727,359
1990-91
1,202,305
2005-06
2,877,284
1995-96
2000-01
2010-11
2011-12
2012-13(AE)
1,547,480
2,074,858
4,268,715
4,549,652
4,764,819
8,889
9,003
10,326
10,712
14,330
16,675
20,362
26,015
35,993
37,851
39,143
Source: A Hand Book on Indian Economy Published by RBI
Indian Economy
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Table: 1.21
Rate of growth of NNP at Factor Cost and Per Capita NNP
NNP at Factor Per Capita NNP
Period
Cost
at factor Cost
1950-51 to1960-61
4.2
2.3
1970-71 to 1980-81
2.9
0.6
1960-61 to 1970-71
1980-81 to 1990-91
1990-91 to 2000-01
2000-01 to 2004-05
2004-05 to 2010-11
2011-2012
2012-2013
3.5
5.2
5.5
6.4
8.4
6.2
4.9
1.2
3.0
3.4
4.6
6.9
4.7
2.9
Source: A Hand Book on Indian Economy Published by RBI
Sectoral Composition
After independence there should be change in the sectoral composition of GDP also
along with the growth of NI and PCI. We can broadly classify the sectors into three as Primary,
Secondary and Tertiary sectors.
The share of primary sector which includes agriculture, forestry gone down from 55.4
% in 1950-51 to 14.3 % in 2010-11 and further to 13.68 % in 2012-13. Its position changed
from the highest contributor to lowest contributor to the Indian economy. The main cause for
the decline is the rapid decline in agriculture alone.
The share of industry which includes mining, manufacturing, electricity, gas & water
supply and construction has shown a steady increase from 15% in 1950-51 to 27.03 % in
2012-13.
The share of service sector shows a sharp improvement from 29.6% in 1950-51 to
59.29 % in 2012-13. Now the service sector is considered as the power horse of Indian
economy. There was significant increase in the share of trade, transport and communication.
Indian Economy
Page 39
Table 1.22
Share of GDP by Industry origin at 1999-00 series
Primary
1950-51 1960-61 1970-71 1980-81 1990-91 2001-02
2010-11 2012-13
55.4
54.8
46.3
38.0
32.2
24.0
14.3
13.68
29.6
28.6
32.1
38.0
40.6
49.3
57.8
59.29
Secondary 15
Tertiary
16.6
21.6
24.0
27.2
26.7
27.9
Source: CSO and Various Economic Surveys
27.03
Sector wise Employment

There should be changes in share of employment also. At the time of independence the
major source of employment is Primary sector which provides 72.1 % employment in 1951
and it falls to 53.2 % in 2009-10. The industrial sector provides employment to just 10.6 %
people in 1951 and it increased to 21.5% in 2009-10. The tertiary sector provides
employment to 17.3% of the people in India in 1951 and it rose to 25.2% in 2009-10. As a
result it is clear that even though the share of primary sector falls to GDP still it dominates in
employment sector and employment creation in the service sector is less compared to its
income generation.This is clear from the Table:1.23.
Table1.23
Share of Employment in different sectors

1951 1961 1971 1981 1990-91 2001-02 2004-05 2009-10
Primary
72.1
71.8
72.1
68.8
62.7
59.3
57.0
53.2
17.3
16.0
16.7
17.7
22.4
22.5
24.8
25.3
Secondary 10.6
Tertiary
12.2
11.2
13.5
14.9
18.2
Source: CSO and Various Economic Surveys
18.2
21.5
As per the National Sample Survey Offices (NSSO) report on Employment and
Unemployment Situation in India 2009-10, on the basis of usually working persons in the
principal and subsidiary statuses, for every 1000 people employed in rural India, 679 people
are employed in the agriculture sector, 241 in the services sector (including construction),
and 80 in the industrialsector. In urban India, 75 people are employed in the agriculture
sector, 683 in the services sector(including construction) and 242 in the industrialsector.
Construction; trade, hotels, andrestaurants;and public administration, education, and
communityservices are the three major employment-providingservices sectors.Studies show
that the tertiary employmentshare has strong upward trends in all the incomequintiles both
in rural and urban areas.
Indian Economy
Page 40
References
1. Ahluwalia, M.S., (2002), Economic Reforms in India Since 1991: Has Gradualism
Worked?, Journal of Economic Perspectives, vol. 16, no. 3, Summer.
2. Basu, K. (ed.), (2004), Indias Emerging Economy, Oxford University Press, Delhi.
3. Dandekar V. M (1996), Indian Economy 1947-92, Population, Poverty and

Employment: Sage Publication, Volume II, New Delhi.
4. Dandekar.V.M and Rath Nilakanth (1971), Poverty in India- 1: Dimensions and Trends.
EPW, Special Article. New Delhi.
5. Demographic and Health Survey(2010).http://www.measuredhs.com/start.cfm,Data
sets accessed from January 2010.
6. Economic Survey, (2011-12) Government of India, New Delhi.
7. Government of India (2006a): Level and Pattern of Consumer Expenditure, 2004-05,

NSS 61st Round (July 2004 - June 2005), Report No. 508(61/1.0/1), National Sample
Survey Organization, Ministry of Statistics and Programme Implementation, New
Delhi.
8. Government of India (2010-11), Economic Survey.
9. Himanshu, Recent Trends in Poverty, EPW, Special Article, February 10, 2007.
10. http://www.censusindia.net
11. India Human Development Report 2011: Towards social inclusion, Oxford University
Press, New Delhi.
12. Jalan, Bimal (1992), Balance of Payments: 1956 to 1991, in The Indian Economy:
Problems and Prospects, Penguin Books India(P) Ltd., New Delhi.
13. Joshi, Seema (2004), Tertiary Sector- Driven Growth in India ----- Impact on
Employment and Poverty,
14. Kakwani N & Subba Rao K (1992), Rural poverty in India 1973-86, in Kadokodi, G.K
and Murthy, GV.S.N. (ed), Poverty in India: Data Base issues, Vikas publishing house,
New Delhi.
15. NSSOs 66th Round of Poverty estimation
16. UNDP (2010): Human Development Report 2010 The Real Wealth of Nations:
Pathways to Human Development, New York.
Indian Economy
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MODULE II
AGRICULTURE
Trends and Composition of Output of major crops - Trends in Investment, Credit and
Agricultural Subsidy. - New Agricultural strategy of 1960s (Green Revolution) Food security
and PDS in India - Evaluating Land Reforms in India - New Agricultural Policy (In the context
of liberalization.)
Introduction
On the eve of independence, the agricultural sector was the pre dominant sector of the
Indian economy both in terms of its contribution to the gross domestic product ( GDP) and
in providing employment to the countrys labour force . Therefore , the fortunes of large
majority of people in India were basically linked with agricultural performance .
Accelerated growth of agriculture was instrumental not only in raising the income levels
of agricultural workers but also in transforming India from a chronic food- deficit country
into a food self-sufficient country .
The differential growth of various sectors in India in the post independence period has
resulted in major changes in the composition of gross domestic product of India . One
important consequence is that in the share of agriculture in the total gross domestic
product ( GDP) has sharply declined from about 57.7 percent during 1950 .51 to only 20.8
percent in 2004.05 but the share of agriculture in total employment has declined only
marginally from 73.9% in 1973-74 to 56.5% by 2004.05.
In addition to its contribution to GDP and employment the agricultural sector in

India also plays a major role in the economy by producing a large proportion of food grains,
fodder, edible oils and fruits and vegetables , and milk ,meat and food products etc. The
agricultural sector also provides bulk of raw materials to most traditional agro-based
industries. In addition, agricultural sector also makes a notable contribution to export and
accounts for nearly one eighth of total exports of the country.
Finally, since a very large number of workers are engaged in agriculture , they provide a
huge market for manufacturing industries and services .
Trends and composition of output

A .During British Period
The growth rate of agricultural output was quite low throughout the first half of the
20th century . According to Blyns estimates prepared on the basis of 18 major crops
during 1901-4 to 1940-44 , agricultural output recorded a growth rate of 0.262% per
annum at 1925-9 prices . According to Siva _Subramonians extended
study of the
princely states of India covering 25 using 1938-9 prices , the growth rate of total
agricultural out put was 0.41% pa during 1900-1 to 1946-7. While foodgrains grew at
0.15% pa ,the growth rate of non foodgrains was 0.77% pa.
Indian Economy
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But despite this the structure of the economy did not undergo any significant change
and the share of agriculture in the labour force remained more or less constant at75% from
1900-1 to 1946-7 .
B. During post -Independence period
The independence of India in 1947 marked a turning point in the history of its
economic development . In agriculture , the public sector played a promotional role through
mobilizing financial and physical resources for investment . The main elements of plan
strategy for agricultural growth consisted of land reforms and large investment in
irrigation and other rural infrastructure , investment in science and technology , promotion
of new technology in agriculture through input subsidies , and guaranteed minimum
support prices .
These policies resulted in bringing about a creditable acceleration in the growth rate
in Indian agriculture. Taking the entire period 1950-51 to 2003-04, agricultural GDP recorded
a growth rate of 2.54 % pa as compared with a growth rate of agricultural product of 0.46%
pa during 1900-01 to 1946-41
For analysis, the post independence period 1950-51 to 2003-04 is divided into 4 sub
periods. The agricultural sector as a whole recorded a reasonable high growth during
the first period 1950-51 to 1964-65. There was a notable deceleration in growth rates of
agriculture during the second period 1967-68 to 1979-80 despite the introduction of seedfertilizer technology during the mid sixties . With the maturing of green revolution ,the
agricultural sector recorded the highest growth during 1980-81 to 1990-91.The growth
rate of the economy accelerated during the post- reform period 1990-91 to 2003-04. But the
growth rate of agriculture recorded a significant deceleration during this period .The trend
of growth rates of agriculture both in terms of GDP and value of output during 1950-51 to
2003-04 and in different sub periods are described in the following section .
Growth of Agricultural GDP:
During 1950-51 to 1965-65, the overall GDP

recorded a growth rate of about
3.94% pa and percapita incomes grew at a rate of 1.86 percent per annum . The growth rate
of income from the agricultural sector was 2.54% per annum. The period 1967-68 to 197980 is characterized by a perceptible deceleration of growth of overall and sectoral GDP .
This happened primarily because of after effects of severe drought during 1956-66 and
1966-67 and also as a consequence of the after effects of wars , two oil crises and a drastic
reduction in foreign aid .The period 1980-81 to 1990-91 showed a marked revival in the
agricultural sector because of the rapid spread of Borlaug new seed -fertilizer technology to
new crops and new areas. The changes in macro economic policy and trade policy with the
initiation of economic reforms in 1991, had a deep effect on the agricultural sector.During the
post reform period 1991-91 to 2003-04, the growth rate of agriculture decelerated to 2.38%
per annum compared with a growth rate of 3.08% per annum during 1980-81 to 1990-91.
Growth of Production of Major Crops.
Food grains output increased more than four fold from 50.82 million tonnes in 195051 to 213.5million tonnes in 2003-04. In the meantime wheat output increased 12 times from
6.46 million tonnes to 88.30 million tonnes. Some of the commercial crops like oilseeds,
cotton and sugar cane also registered large increases in output.
Indian Economy
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The growth rate of output is studied under two heads:
(a) Growth of crop output in different periods ,and

(b) Production of major crops ( crop- wise analysis )
a. Growth of crop output Different periods

The whole period is conveniently divided into four sub periods.
(i) Pre -Green revolution period (1950.51 to 1964.65)

During the first period (1950-51 to 1964-65) total crop output in India
recorded a trend growth rate of 3.15% per annum . This growth rate was fairly
high and was achieved mainly as a result of increases in irrigation and net sown
area .The growth rate of food grains output was 2.82 percent per annum
during this period .
(ii)The Beginning of Green Revolution (1967 -68 to 1979 80)

The growth rate of total crop output during ( 1967-68 to 1979-80) decelerated to
2.19% per annum compared with a growth rate of 3.15% per annum during the
earlier period .The growth rate of food grains output also decelerated to 2.15%
per annum during this period compared with 2.82% per annum earlier. Wheat
output had more than doubled to 23.8 million tones by 1970-71 . It constituted
nearly 22% of total food grains output in that year . Even by 1970 -71 rice
accounted for nearly 40 % and coarse cereals 28.2% of total food grains
output .It shows that the impact of HYV on growth of the food grains is only limited
(iii)
(iv)
The Maturing of Green Revolution ( 1980-81 to 1990-91 )

The growth rate of crop output recorded a spectacular growth rate of 3.19%
during the period 1980-81 to 1990-91. A notable feature of this period was that
the rapid growth of agriculture was not confined only to wheat ; it also spread
in a big way to rice and also some coarse cereals as well as some commercial
crops like cotton , sugar cane and oil seeds .Another notable feature was that the
green revolution which was hither to confined to the north western region ,
spread almost evenly to all the regions of India .
EconomicLiberalization ( 1990-91 to 2003- 04)

` A new policy framework of economic liberalisation consisting of comprehensive
macro economic and trade policy reforms was initiated in India in 1991 . In the
agricultural sector, the key areas of reform consisted of liberalising the working
of commodity markets , reforming commodity price policy and gradual
withdrawal of input subsidies.One of the main objectives of policy was to end
discrimination against agriculture and improve the terms of trade of agriculture
vis a vis other sectors of the economy.
How ever , contrary to expectation instead of showing any buoyany , the growth
rates of agricultural sector recorded a significant deceleration after the introduction of
economic reforms in 1991. The growth rate of agricultural GDP decelerated from 3.08 %
per annum during 1980 -81 to 1990-91 to 2.38 % per annum during 1992- 93 to 2003-04 .
Indian Economy
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The growth rate of crop out put decelerated from 3.19% per annum during the 1980s
to only 1.18% per annum during the latter period . Similarly , the growth rate of food
grains out put decelerated to an all period low of 1.16 %. There took place a decline in the
per capita availability of food grains during the post reform period .
B. Production of Major Crops. (Crop- Wise Analysis)
A comparative analysis of the performance of the food grain crops and the non-food
grain crops in India from 1980-81 onwards, vividly shows that in terms of production, the
performance of non-food grain crops had been relatively better compared to the post reforms
period, the annual growth rates in production of both the food grain and non food grain crops
are found to be higher during the 1980s . During the period from 1980-81 to 1990-91, the
index number of the production of food grain crops registered an annual compound growth
rate of 3.20 per cent, but during the period from 1990-91to 2006-07 it declined to 1.27 per
cent. In the case of non food grain crops the respective growth rate were 4.84 and 2.75 per
cent. Similarly, the annual growth rate in the yield of food crops during the period from 199091 to 2006-07 is found to be 3.43 per cent while the corresponding figure for the non food
grain crops was only 1.76 percent.
1.Rice:
Rice is the predominant food grain crop in India. In the production of rice India ranks
second, next to China. During the period from 1980-81 to 2006-07, rice production in India
increased from 53.63 million tones to 93.35 million tones registering an overall increase of
74.06 per cent and an annual compound growth rate of 2.15 per cent.
2.Wheat:
India holds second position among the wheat producing countries of the world, next
only to China. In 2007 the country accounted for 12.51 per cent of the worlds wheat
production. Within a period of 26 years from 1980-81 to 2006-07, wheat production in India
increased from 36.31 million tonnes to 75.8 million tonnes, showing more than twofold
increase.
3.Coarse Cereals:
In sub group of coarse cereals consists of six cereals, viz. jowar, bajra, maize, ragi,
barley and millets. In the production of coarse cereals, India holds the sixth position in the
world. During the year 1980-81 the country produced 29.02 million tonnes of the coarse
cereals, and it increased to 32.70 million tonnes by the year 1990-91. Since the early years of
the 1990s production of the coarse cereals in India stagnated around 30 million tonnes. The
average annual growth rate in the production during the period from 1980-81 to 1989-90
had been 2.03 per cent and during the period from 1990-91 to 2006-07 it declined to 0.23 per
cent.
4.Pulses
In the production of pulses, India ranks first in the world. During the period from
1980-81 to 2006-07, the total production of pulses in the country increased from 10.63
million tonnes to 14.20 million tonnes showing an aggregate increase of 33.58 per cent.
Indian Economy
Page 45
5.Nine Oilseeds
The sub-group of nine oilseeds consist of ground nut, castor seed, linseed, niger seed,
safflower, sesamum, soyabean, sunflower, rape seed and mustard. Nearly 25 percent of the
global production of ground nut comes from India. India is the second largest producer of the
crop. Similarly, the country holds the second position in the production of rapeseed and
mustard also. During the period from 1980-81 to 2006-07, the total annual production of the
crop increased from 9.37 to 24.29 million tonnes registering on overall increase of 169.90 per
cent and an annual growth rate 3.59 percent.
6.Cotton
Cotton is one of the important commercial crops cultivated in India. Next to China and
the U.S, India commands the third position among the cotton producing countries of the
world. The domestic production of cotton which was 7.01 million bales in 1980-81, increased
to 22.63 million bales by the year 2006-07 registering a more than three fold increase.
7.Jute and Mesta
India holds first position in the world in the production of jute and jute like fibres. The
production of jute and mesta increased from 8.16 to 10.84 million bales during the period
from 1980-81 to 2006-07.
8.Sugar Cane
Among the sugar cane growing countries in the world, India holds the second position
next to Brazil in the production of the crop. In the year 2006, 20.19 percent of the global
production of sugar cane came from the country. Within the period from 1980-81 to 2006-07,
the production of sugar cane increased from 154.25 to 355.52 million tonnes, showing an
aggregate increase of 130.48 percent, and an impressive annual growth rate of 3.26 per cent.
9.Plantation Crops
Tea ,coffee and natural rubber are the three important plantation crops cultivated in
India. India is the second largest producer of tea in the world. During the period from 198283 to 2007-08, the production of tea in India increased from 561 to 987 million kilograms and
the annual compound growth rate in production during the period is estimated as 2.29 per
cent.
In the production of coffee India holds the sixth position in the world. Total production
of the crop during the year 2007-2008 had been 262 million kilograms.
India is the third largest producer of natural rubber in the world, next to Thailand and
Indonesia. In the country, Kerala has near monopoly in the production of natural rubber.
During the period from 1990-91 to 2007-08, the production of natural rubber in the country
increased from 3.3 to 8.2 lakh tonnes, showing an overall increase of 148.8 percent and an
annual compound growth rate of 5.5 per cent .
In addition to the major crops, mentioned above, a wide variety of condiments and
spices like pepper, ginger, garlic, chilly, turmeric, areca nut, coriander, cardamom, etc. and
fruits and vegetables like potato, onion, banana, cashew nut, tapioca, sweat potato, etc. are
also cultivated in India.
Indian Economy
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Trends in Investment
There has been a secular decline in public investment in agricultures. Any decline in
investment in agriculture has to be viewed with concern. This is particularly so because the
growth of infra structural facilities determines the growth of a particular sector. Less
investment in agriculture would mean less growth of infra structural facilities and this would,
in turn, affect agricultural growth adversely.
Gross Capital Formation and Public Investment
The gross capital formation in agriculture stood at Rs.1034 crores in 1950-51,

constituting 22.14 per cent of the gross domestic capital formation. During the first decade,
the gross capital formation in agriculture increased at the rate of 5.19 per cent per annum. By
1970-71, the gross capital formation reached Rs.7379 crores, the percent share in the gross
capital formation being 15.63, During the same period, the public and private sectors
respectively, contributed 28.51 and 71.49 per cent. In the next dead , there were substantial
improvements in the gross capital formation in agriculture. Between 1980-81 and 1985-86,
the gross addition of capital formation in the agriculture sector was Rs.2404 crores, the per
cent contribution from public and private sector being 37.54 and 62.46 respectively. In 1985
gross capital formation in agriculture contributed just 8.43 per cent to the gross domestic
capital formation. The gross capital formation in agriculture and allied sectors as a proportion
of total GDP stood at 2.66 per cent in 2004-05 and improved to 3.34 per cent in 2008-09.
Another notable change during the period was the significant cut in the public sector
contribution and improvement in the private sector share.
From the above discussion, the following observations emerge.
i.
The share of the gross capital formation in agriculture to gross domestic capital
formation came down drastically since 1990.
ii. The decline in the share of the agricultural sectors capital formation in GDP from 2.2
per cent in the 1990s to 1.7 per cent in 2004-05 is a matter of concern.
iii. The decline in the share of agricultural sectors capital formation in GDP is mainly due
to the fall in the public investment in irrigation, particularly since 1990.
iv. The public sector investment on agriculture, which accounts for about one third of the
total investment, has been drastically declining in the recent years and it is the
private sector which is playing a major role.
Subsidies and Public Investment
There seems to be some trade off between input subsidies and public investment. The
problem of mounting subsidies and its effects in terms of crowding out public investment in
agriculture has been highlighted in the Tenth plan document. Input subsidies (on power,
fertilizer and irrigation) have been rising while public investment has been declining. Some
estimates show that these input subsidies along with food subsidy amount to roughly five to
six times the public investment in agriculture. (Gulati and Narayana 2003) For example, food
subsidy increased from Rs.7500 crore in 1997-98 to Rs.43,668 crore in 2008-09. As far as
input subsidies are concerned, they were as high as Rs.30,473 crore in 1999-2000 and rose
further to Rs.74,037 crore in 2007-08 (at current prices). During the same period, public
investment declined from Rs.4221 crore (at 1993-94 price) to a lower level.
Indian Economy
Page 47
Methods for Raising Agricultural Investment

Reducing the subsidies itself is a source of finance for public investment in agriculture.
However, there is a view that subsidy reduction should not be linked to resource
mobilization. State governments have to increase investments for creating productive assets
by reducing funds for populist and unproductive activities. Tax/GDP ratio of both central and
state governments should be increased in order to provide for more funds for investment in
agriculture. One of the factors determining private investment is public investment because
of the complementarity between the two. The institutional credit seems to be another crucial
variable in determining private investment.
One important step taken for improving public sector investment was the creation of
Rural Infrastructure Development Fund (RIDF). It was started in 1995-96 with corpus of
Rs.2000 crore. Its main objective was to provide funds to state governments and state owned
corporations to enable them to complete various types of rural infrastructure projects. The
total corpus of RIDF amounted to Rs.86,000 crore. The resources for the fund are contributed
by the scheduled commercial banks to the extent of the short fall in meeting their priority
sector lending targets. Loan under RIDF are given for various purposes like irrigation
projects, watershed management, construction of rural roads and bridges, etc.
Trends in Subsidies
The question of subsidies in agriculture has emerged as an important issue in recent

policy debates. Undoubtedly, subsidies are effective in pushing agricultural growth to a
certain extent but it is important to make sure that they do not become a permanent feature
of the Indian economy. In developing countries, subsidies are provided simply to ensure self
reliance and self sufficiency.
In India, agricultural inputs like fertilizers and water, implements and rural electricity
are subsidized. If inputs are not subsidized, the poor farmers will not be able to use them.
Similarly, food subsidy is essential to maintain and sustain the food security system and
ensure a safety net for the poor. On the other hand, the opponents have argued that
agricultural subsidies are fiscally unsustainable and encourage misuse of resources, leading
to environmentally malignant development. It is also argued that continuation of agriculture
subsidies is against the spirit of Agreement of Agriculture as adopted by the WTo
Therefore, the issue of agricultural subsidies is not to be examined only from the point
of view of fiscal unsustainability but from a much wide perspective of ensuring food security
and safety net for the poor and protecting the interest of the country in the new emerging
international economic order that is taking shape under the aegis of the WTO.
Subsidization of agricultural inputs has become an important instrument of
agricultural policy in India since the introduction of the high yielding varieties programme
(HYVP) in the 1960s . Subsidy on fertilizers is provided by the central government while
subsidy on water is provided by the state governments. Water subsidy is of two kinds:-power
subsidy and irrigation subsidy. Power subsidy is granted on power that is used to draw on
ground water. Irrigation subsidy means subsidy on canal water (i.e. surface water)
usage.Information on agricultural inputs clearly indicates that substantial amounts of subsidy
are provided on agricultural inputs. Total subsidy on agricultural inputs was Rs.33,591 crore
in 1999-2000 which rose to Rs.77,935 crore in 2007-08
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Power and Irrigation Subsidies

Power and irrigation subsidies are provided by the government as water and
electricity fall within their domain. Subsidy on electricity was Rs.6033 crore in 1999-2000
which increased to Rs.20,547 crore in 2007-08. Subsidy on irrigation increased from
Rs.11,196 crore to Rs.21,000 crore during the same period. The main reason for the high level
of power subsidies is the pricing policy of the State Electricity Boards (SEBs). Gulati and
Narayanan have estimated that the average revenue tariff from power supply to agricultural
consumers in 2000-01 was only 28.42 paise per kwh whereas the estimated average cost of
supply of power to all sectors combined was as high as 303.86paise per kwh. This implies a
subsidy of 275.44paise on every kwh supplied to agriculture. Gulati and Narayanan estimated
that in 2000-01, SEBs were recovering from agriculture only 9.35 percent of the average unit
cost of power supply.
Irrigation Subsidies arise because of the neglect of rational pricing for canal water.
Gulati and Narayanan have estimated that the pricing of canal water did not cover more than
20per cent of the operation and maintenance expenses in the mid 1990s. In 1999-2000
subsidy on irrigation was Rs.11,196 crore which rose to Rs.21,000 crore in 2007-08.
Fertilizer Subsidy
Fertilizer subsidy is borne by the centre. The need of fertilizer subsidy arises from the
nature of the fertilizer pricing policy of the government of India. This policy has been
governed by the following two objectives.
i.
Making fertilizers available to the farmers at low and affordable prices to encourage
intensive high yielding cultivation, and
ii. Ensuring fair returns on investment to attract more capital to the fertilizer industry.
To fulfil the former objective, the Govt.has been statutorily keeping the selling prices of
fertilizers at a largely static, uniformly low level throughout the country. In order to attain the
second objective, the Govt. under the Retention Price Scheme (1977) fixes a fair ex-factory
retention price for various products of different manufacturers. The fertilizer industry is
largely insulated against cost escalation by the system of retention prices. Under this pricing
policy of fertilizer subsidy, farmers get fertilizers at a low rate which is pre-determined, called
the maximum selling price. The manufacturer is paid the retention price. The difference
between the retention price and the selling price is the subsidy paid by the Govt.
For
imports, subsidy is equal to the difference between the cost of imported material and the
selling price. Because of increasing differential between the retention price and the selling
price, the burden of subsidy on the government has increased enormously. For instance,
fertilizer subsidy was Rs.505 crore in 1980. It rose from Rs.4,562 crore in 1993-94 to
Rs.13,800crore in 200-01 and further to Rs.32,490 crore in 2007-08.
Many economists have argued that RDs has outlived its utility and must be abandoned.
In fact, as feared by the Fertilizer Prices Committee, the RDs has created a vested interest in
proving costs rather than in reducing them, in claiming escalation rather than in finding ways
and means of containing costs.On account of the above reason, the Expenditure Reforms
Commission (2000) recommended the dismantling of the control system in a phased manner.
The government has introduced a Nutrient Based Subsidy Policy for the fertilizer sector from
April1, 2010.
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Food Subsidy
The Government incurs food subsidies so as to fulfil the obligation towards
distributive justice. Food subsidy went up from Rs.2850 crore in 1991-92 to Rs.7500 crore in
1997-98. It then increased to Rs.2100 crore in 2000-01 and further to RS.27748 crore in
2004-05. It is a strange that food subsidy has gone up substantially during the period of
liberalization. Food subsidy showed an annual increase of above 30 per cent during each of
the three years namely 2000-01, 2001-02 and 2002-03 but it is relatively stable since
2003-04.
Arguments in favour of Subsidisation

1.
If agricultural inputs are not subsidized , the poor farmers will not be able to use
them and this will lead to a decline in productivity levels and in their income .
3.
The subsidization of input and credit will influence the adoption of the new
technology.
2.
4.
5.
Subsidies must be considered more as an instrument for promoting risk-bearing

function of the farmers.
Input subsidization reduces prices of raw-materials and food items. This will have
favourable effect on the growing industrial sector or large mass of poor living in the
developing countries.
Value-added by subsidized inputs far exceeds the cost of subsidy.
Arguments against the Continuation of Subsidies

1.
2.
3.
4.
5.
6.
7.
8.
9.
Agricultural subsidies are fiscally unsustainable and encourage misuse of resources.
Subsidies result in crowding out public investment resources and adversely affect the
overall agricultural growth in India.
Fertilizer and irrigation subsidies have widened regional disparities to some extent.
The marginal cost of power to the farmer is almost zero. This power pricing
framework provides perverse incentives to the farmers, leading to excessive and
inefficient use of power
Low price canal water has led to the highly wasteful use of canal water, ecological
degradation from water logging and salinity.
Another worrisome factor is the reckless exploitation of ground water, resulting in the
shortage of drinking water in several parts of the country.
The prevailing heavy subsidy on nitrogenous fertilizers perpetuates inefficiencies in

the domestic fertilizer industry .
Most of the fertilizer subsidy goes to the farmers under irrigated area.
The maximum benefit of subsidisation of inputs is reaped by large and medium

farmers.
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WTO and Subsidies

Under the WTo Agreement, an index known as Aggregate Measurement of Support
(AMS) has been introduced. It seeks to provide the overall permitted measure of subsidies
allowed as a percentage of gross agricultural production. Under the Agreement , product
specific and non-product specific domestic support, as measured by the AMS, would have to
be reduced if they exceed 5 per cent of the value of production. For developing countries the
percentage is 10 percent. However, the following are exempted.
i.
ii.
Govt. measures which encourage agricultural and rural development, like subsidies for
low income producers in developing countries.
Govt. service programmes like research , pest and disease control, training, extention
and advisory services, inspection, marketing and promotion and infrastructural
services.
In India , the aggregate value of agricultural subsidies was not only far below the 10%
limit but also negative. In fact, in many cases India actually taxes her farmers by not
allowing them to export their products freely at international prices which are higher
than the domestic prices. India, whose prices will them become competitive, will stand
to gain. India would further gain out of the provision that the countries with balance
of payments problems are not required to provide minimum market access.
Agricultural Credit.
Agricultural production depends on factors like the availability of land, quality of

seeds, irrigation facilities, the application of fertilizers and timely availability of credit, and a
host of other factors. Credit is a critical input for revitalizing agriculture. Over the years, India
adopted a multi agency approach for providing agricultural credit. The major agencies which
provided agricultural credit are the co-operatives, the RRBs and the commercial banks. These
agencies provide short term, medium term or long term credit .
Types of Agricultural Credit
Short term credit is normally given for a period of 15 months, exclusively for
purchasing seeds, manures, fertilizers, labour charges and similar quick needs of the farmers.
Short term credit is repaid immediately after the harvest .Medium term loans are provided
for purposes like sinking of wells, purchase of bullocks, pumping plants and to make
improvements in implements. The period of medium term loan is from 15 months to 5 years.
Loans repayable over a long period of time, normally above 5 years are included in the long
term credit.
Sources of Agriculture Credit
The sources of credit can be divided into institutional and non institutional . The main
non institutional sources are the money lenders , relatives ,friends, land lord ,etc.
Institutional sources include . co operative banks , regional rural banks , farmers service
societies, NABARD etc. Intuitional loans are generally for productive purposes and carry
much lower interest rate.
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Trends in agriculture credit
A. Non .Institutional sources of credit

Money lenders are the oldest source of agricultural credit. Over the years, the influence of
money lenders has declined sharply in the farm credit scenario of India, still they play a
significant role. They are popular even today because they have only limited formalities ;
they give loans at any time of the year for any agricultural purpose and are easily
approachable .The total contribution of non institutional sources towards agricultural
credit has gradually declined from 92.7 percent in 1950 -51 to 25.0 percent in 1996. The
share of money lenders was 7.0 percent in 1996
B. Institutional sources of credit
Institutional sources of credit to agriculture has expanded at a very rapid rate after
independence .It increased from Rs 880 crore
in 1971-72 to Rs 1,25,309 crore in 2004 05. The share of institutional sources in agricultural credit increased from 7.3 percent in
1951 to 75.0 percent in 1996 Institutional credit to agriculture rose from Rs 1,25,309 crore
in 2004 05 to Rs 2,92,437 crore in 2008 -09 .
(i) Co -operative credit societies :
There are two separate wings of the co operative credit structure in India; one
provides short term and medium term loans; whereas the second provide long term
loan. The former has three tier structure with 31 state co operative banks at the
apex 371 central co-operative banks at the district level and 94,942 primary
agricultural credit societies at the village level .Long term credit is provided by 20
state co operative Agricultural and Rural Development Banks and 697 primary co
operative Agricultural and Rural Development Banks .
It is seen that the co operative credit stood Rs 4403 crores in 1991-92, which
improved to Rs 10,047 crores in 1993-94. In the later years, the co-operative credit
gradually improved and reached Rs.48,258 crores in 2007-08. It is also noted that the
share of the co-operative stood at 39.03 per cent in 1991-92 but only 20 per cent in
2008-09. Short term co-operative credit constituted 62.18 per cent of the total short
term credit in 1991-92, and 46percent in 2003-04. In the case of the medium and longterm credit, it is also seen that the shares of the co-operativeis were zero in 1991-92
and 12.90 per cent in 2006-07.Agriculture and Rural Development Bank gives only
meager amount for the long term agricultural development. It shows that the role of
co-operative credit in augmenting investment in agriculture is very limited.
(ii)Commercial Banks:
The second institution providing credit to agriculture is the commercial banks.
One of the objectives of bank nationalization was to provide the maximum credit to the
farming operations throughout the country. The commercial bank credit constituted
20.89 per cent in 1990-91 and reached about 68 per cent in 2008-09. Compared to the
long term credit, the short term credit constituted a major part of commercial bank
credit for agriculture.
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(iii) Regional Rural Banks (RRBs)
(iv)
(v)
The Regional Rural Banks were set up in 1975. The main objective of the RRBs was to
take banking to the door steps of the rural masses, particularly in areas without
banking facilities. In 1991-92, RRBs disbursed just Rs.336 crores to agriculture, that
too as short term credit. This subsequently increased and reached Rs. 26,724 crores in
2008-09. In 2008-09 the share of the short term credit remained at 60 per cent.
National Bank for Agricultural and Rural Development.(NABARD)
The NABARD was set up on July 12,1982. It has taken over the functions of the
agricultural credit department of RBI and the Agricultural Refinance and Development
Corporation (ARDC). NABARD is now the apex bank for rural credit.
The amount of loan sanctioned by NABARD increased from RS.16,867 crore in 200405to Rs.35,243 crore in 2006-07.
Other Programme
(a)Kisan Credit Card Scheme: This scheme aims at providing adequate and timely
credit support from the banking system to farmers for their cultivation needs in a
flexible, hassle free and cost effective manner has been operationalised. The farmers
may use the cards for the purchase of agricultural inputs such as seeds, fertilizers,
pesticides etc. and also draw cash for their production needs. Credit limits are fixed on
the basis of size of operational land holding, cropping pattern, scale of finance, etc.
In the year 2008-09, 85.93 lakh cards were issued and the credit disbursed
amounted to RS.53,085 crore.
(b)Self Help Groups-Bank Linkage:
This programme was initiated in 1992 with a view to improving the flow of
credit to the resource poor section of the society. The main objective of the SHG-Bank
linkage programme is to provide thrift-linked credit support to the members of SHGs.
This enables the rural poor to have access to the formal banking system and get loan in
a reasonally short time and at a low cost. By December 2005-06, 18.29 lakh SHGs have
been financed by banks with credit of over Rs.8,319 crores. Over 90per cent of the
SHGs are exclusive women groups. This programme has emerged as the largest and
fastest growing micro finance programme in the country.
New Agricultural Strategy
During the sixties, Indian agriculture experienced a spectacular increase in production,

especially in that of wheat and rice crops. It was mainly through an increase in productivity
per hectare of these crops. The jump in the rate of increase in productivity of these crops was
so sudden and conspicuous that some economists termed the new change as green
revolution .By green revolution we mean two things:
(a)Well marked improvement in agricultural production in a short period: and
(b) The sustenance of the higher level of agricultural production over a fairly long period of
time.
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It has been claimed that the contributory cause for the spectacular increase in
agricultural production is the adoption of the new strategy in agriculture. This new strategy
was adopted in India during the Third plan, i.e. during 1960s. The first stage of new strategy
pertained to the Intensive Agricultural District Programme (IADP). It was started in 1960-61
in three districts and was subsequently extended by stages to another thirteen. The district
selected under IADP was required to posses qualities such as assured water supply, minimum
hazards, (like floods, drought etc.) well developed institutions and maximum potentialities for
increasing agricultural production within a short span of time. Farmers of selected districts
were provided with all types of facilities such as improved seeds, implements, fertilizers, easy
credit, soil testing facility, etc .Thus IADP is also called package programme due to the use of
a package of improved practices. Later on, this programme was extended to remaining states
and one district from each state was selected for intensive development. Accordingly, in 1965,
144 districts (out of 325) were selected for intensive development and the programme was
renamed as Intensive Agricultural Areas Programme (IAAP). The main concern of the
programme was with specific crops.
In the kharif season of 1966, India adopted High Yielding Varieties Programme (HYVP)
for the first time. This programme was adopted as a package programme as the very success
of the programme depends upon adequate irrigation facilities, fertilizers, high yielding
varieties of seeds, pesticides , insecticides, etc.
Components of the New Strategy:
Green revolution is the combined result of various measures taken by the Govt. Some of
these are:(i) Supply of New Inputs
(a) High yielding varieties of seeds

The use of high yielding varieties of seeds since 1966 has resulted in substantial
increase in food grains production. Wheat production has been more than trebled.Rice
and Bajra production also registered same increase. The break through in the production
of wheat and rice has been attributed to magic seeds adopted by the farmers. Some
important quality seeds of wheat used in the initial stages were Lerma Rojo, S 308,
WG.357, WL 212 and those of rice were IR8 and jaya. The area under high yielding
varieties of wheat increased from 0.54 million hectares in 1966-67 to 24.0 million
hectares in 1998-99.
(b) Supply of Fertilizers:
Besides high yielding varieties of seeds chemical fertilizer is the other input which is
responsible for ushering forth the green revolution in India. In fact the lastest agricultural
technology is called the seed cum fertilizer technology. Crops of high yielding variety
cannot grow properly if regular doses of fertilizers are not applied to them. The total
amount of fertilizers used in 1960-61 was 292 thousand tonnes . It increased to 13960
thousand tonnes in 1995-96. In 2008-09, consumption of fertilizer stood at 249 lakh
tonnes.
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( c)Expansion of Irrigation Facilities:

The new high yielding variety of seeds require more fertilizers and the use of fertilizers
necessitates a regular supply of water. Since dependence on monsoon is unreliable,
irrigation facilities will have to be expanded. In India, irrigation potential has increased
from 22.6 million hectares in 1950-51 to 102.8 million hectares in 2006-07.
(d)Plant Protection and Pest Control:
The seeds sown through use of new seeds are more prone to disease. The use of
fertilizers for their production, also increases the susceptibility of these crops to
diseases.So, use of plant protection measures becomes necessary in order to get the
maximum yield from the new seeds. In 1995-96 the quantity of chemical pesticides used
was 61260 tonnes
(e) Development of Infrastructure:
Infrastructure comprises those activities and facilities which aid in increasing

production. Important elements of infrastructure include transport and communication
regulated markets, storage and warehousing ,agricultural education and training etc.
(f) Use of Machinery:
New technology has necessitated the use of machinery. Bumper harvest of wheat
necessitated the use of threshers and the combined harvesters. For timely sowing,
tractors became important. There was a sudden jump in the use of machinery in Indian
agriculture since 1965.
(ii)Multiple Cropping Programme
(iii)
The multiple cropping programme aims at increasing the cropping intensity of

land through better utilization of the existing irrigation facilities as well as
development of new irrigation potential throughout the country. In 1960-61, the
area sown more than once was about 1.9 crore hectares which increased to 4.43
crore hectares in 1993-94.
(iv)
The provision of cheap agricultural credit facilities has encouraged the

adoption of new agricultural technology. Farmers need credit for the purchase of
new seeds, better implements, chemical fertilizers, insecticides etc. Accordingly,
co-operative credit society, commercial banks, Regional Rural Banks, NABARD and
certain specialized institutions have been established by the Govt. throughout the
country. The short term and long term loans advanced by the commercial banks
and the RRBs to the agricultural sector increased from Rs.212 crore in 1976 to
Rs.12083 crore in 1995-96.
Privision of Agricultural Credit:
Incentive Prices:
In order to enable the farmers to reap more profits through the adoption of
modern technology, it is essential to assure them of certain minimum prices for
their products. The Agricultural Price Commission was set up in 1965. This
commission advises the Govt. on price policy for agricultural commodities.
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(v) Public Institutions:

A number of new public institutions were promoted and provided with funds to
lend support to production programmes. It includes:
(a)The National Seeds Corporation (1963)
(b)The State Farms Corporation of India (1969)

(c )Agro Industries Corporation (1965)
(d)The National Co-operative Development Corporation (1963)

(e)The Agricultural Refinance Corporation (1963)
(f)The Food Corporation of India (1965)
Effects of Green Revolution
The effects of the green revolution can be studied in two parts, viz. i)its economic effects
and (ii)its sociological impact.
Economic Effects:
Two important economic effects of green revolution are: (a)an increase in agricultural
production, and
(b)an increase in productivity.
(a) Increase in Agricultural Production:

Due to the adoption of new agricultural strategy , the volume of agricultural production
has recorded manifold increase. The production of wheat, rice, maize and potatoes have
increased substantially . Total production of food grains in India has increased from 81.0
million tonnes in the Third plan to 202.0million tonnes in the Tenth plan. In 2008-09, it stood
at 233.9 million tonnes.
However, this improvement in production has not been shared equally by all the crops,
especially in the initial stages. (1966-72). The gains of the green revolution were largely
cornered by wheat crop, and only to a very little extent by the rice crop. In the second phase,
however, the revolution has spread to other crops also.
(b)Increase in Productivity:
The new technology has brought about a sharp increase in agriculture productivity. The
gain in yield was very large in the initial years. Thereafter, the phenomenon continued,
although at a somewhat slow pace. The yield per hectare of all food grains has increased by
more than three times from 552 kgs per hectare in 1950-51 to 1898kgs per hectare in 200809. More significant has been the rise in the growth rate of wheat productivity from 1.3 per
cent per annum in the pre-revolution period to 2.5 per cent per annum in the green
revolution period.
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Sociological Impact
Important sociological implications of the green revolution can be summed up as follows.
(a)Personal Inequalities:
The green revolution has promoted inequalities and has widened the already existing
gulf between the rich and the poor in the rural sector. There seems to be a general consensus
that in the early period of green revolution, large farmers benefitted much more from new
technology as compared with the small and marginal farmers.
(b)Regional Inequalities:
Another harmful consequence of green revolution has been that it has promoted regional
inequalities. The region of Punjab, Haryana and Western Uttar Pradesh derived the benefits of
new agricultural strategy. Thus the introduction of new agricultural strategy into some
restricted areas and crops has widened the regional disparity in respect of agricultural
production and productivity of the country.
Undesirable Social Consequences:
Green revolution has also raised certain unwanted social consequences. Green revolution
paves the way for transforming a large number of tenants and share croppers into
agricultural labourers due to large scale eviction of tenants.
Moreover, increased mechanization of farm has resulted huge number of accidents.

Again, the increasing application of poisonous pesticides, has added to serious health
problem.
Land Reform
Changes brought about in the agrarian structure through direct intervention by the state
are characterized as land reforms. It refers to all kinds of policy induced changes relating to
the ownership of land, tenancy, and management of land.
The significance of land reforms arises from the defects of the prevalent agrarian
structure. In this context, it will be proper to have a look at the agrarian structure that
obtained on the eve of independence.
Agrarian structure on the Eve of Independence
At the time of independence India inherited a semi feudal agrarian structure with
onerous tenure arrangements over substantial areas . There were three types of land tenure
systems prevailing in the economy viz. the Zamindari system, the Mahalwari system and the
Ryotwari system.
Under the Zamindari system, the landlord is simply the provider of land and the tenant
provides all the management and labour. The landlord gets the pre-determined share of the
produce. The landlord is responsible for the payment of land revenue to the state. The actual
tiller does not come into contact with the state. The landlord acts as an intermediary.
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Under the Mahalwari system land is maintained by a collective body; usually the village
serves as a unit of management. Revenue is collected from them, the responsibility of paying
revenue to the state rests with the village.
Under the Ryotwari system, every individual registered, and holder is recognized as the
proprietor of land and is responsible for the payment of land revenue to the Government. The
Ryot possess the right to sub let his land or to transfer the land by gift, sale or mortgage. A
ryot cannot be ejected by the Government till he pays his land revenue.
Objectives
It was basically to stop exploitation of the actual tiller of the soil and pass on the
ownership of land to them that land reforms were introduced in the post independence
period in India. The major objectives of land reforms in India are as follows.
1.
2.
3.
4.
Restructuring of agrarian relations to achieve egalitarian social structure.

Elimination of exploitation in land relations.
Actualisation of the goal of land to the tiller
Improving the socio, economic conditions of the rural poor by widening their land
base.
5. Increasing agricultural production and productivity.
6. Infusion of a greater measure of equality in local institutions.
For the fulfillment of these objectives, the major steps adopted under the land reforms
programme are as follows:
1.Abolition of intermediaries
2.Tenancy reforms:- (a) regulation of rent (b) security of tenure and (c )conferment of
ownership rights for tenants
3.Reorganisation of agriculture:- (a) redistribution of land (b) consolidation of holdings and
(c ) Co-operative farming
Progress of Land Reforms
1.Abolition of the Zamindari System

The Zamindari system manifested absentee landlordism at its worst and was largely
responsible for the continuously deteriorating condition of tenant farmers. This system led to
the exploitation and moral degradation of the tiller. Immediately after independence, a strong
voice was raised against these vested interests in land. As a result, a high priority was given to
the abolition of the Zamindari system. Accordingly, by 1952, necessary legislation had been
enacted in all the states. As a result of the abolition of intermediaries more than 2 crore
cultivators have been brought under direct relationship with the state. A considerable area of
culturable wastelands and private forests belonging to the intermediaries have been vested in
the state. This has facilitated the distribution of 57.7 lakh hectares to landless agriculturists .
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2.Tenancy Reforms
Tenants can be classified into (a) occupancy tenants, (b) tenants at will, and (c) subtenants. The rights of the tenancy of the occupancy tenants are permanent and heritable.
Hence, the occupancy tenants do not face the fear of eviction so long as they pay rent on time.
But the position of tenants-at-will and sub-tenant is very precarious ; since such tenants
depend on the mercy of land lords. Hence,special laws had to be enacted and implemented to
protect these tenants. These laws relate to (i) regulation of rent (ii) security of tenure and
(iii) conferment of ownership rights on tenants.
(i) Regulation of rent : During the pre-independence period, rents were fixed either by
custom or were the result of market forces of demand and supply. The rate of rent
prevalent were one-half of the produce which were considered excessive by any
standard of social justice. Consequently, the first and second plans recommended
that rents should not exceed one-fourth or one-fifth of the gross produce.
Accordingly, various states have passed necessary legislation in this regard, but
there were variations in the rates of rent fixed in different states.
(ii)Security of tenure: Legislations have been passed in most of the states to protect
tenants from ejectment and grant them permanent rights in the land. The purpose
of these legislations is to ensure that (a) ejectment are lawful (b) land resumed by
an owner is only for personal cultivation, and (c) the tenant is assured of a
prescribed minimum area in case of resumption.
Due to the enactment of tenancy legislation, Indian tenants have acquired
security in only 9 percent of total cultivated area of the country.
(iii)
Conferment of ownership rights: Legislative provisions have been made in many

states for conferment of ownership rights on tenants or allowing cultivating
tenants to acquire ownership rights on payment of compensation. It has been
estimated that as a result of laws conferring ownership rights on tenants in various
states, approximately 12.42 million tenants have acquired ownership rights over
6.32 million hectares of land.
3. Reorganisation of Agriculture:
It includes (i) ceiling on agricultural holdings (ii) consolidation of holdings and , (iii)
Co-operative farming
(i)
Ceiling on Agricultural Holdings:

By ceiling on land holdings, we mean the fixing of the maximum size of holdings that
an individual cultivator or an household may possess. The basic aim of ceiling is to
accomplish the elimination of excess ownership of land. In this system, the land
over and above the permissible limit for personal cultivation would be taken over
by the state. The surplus land is distributed among the landless labourers and small
and marginal farmers.
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To bring uniformity in land ceiling policies a conference of Chief Ministers was held in
1972. The main features of the new policy were as follows.
1. Lowering of ceilings to 18 acres of irrigated land and 54 acres of unirrigated land.
2. Making family and not the individual as the unit for determining land holding.
3. Lowering ceiling for a family of 5.
4. Declaring binami transaction null and void.
5. Including the land reform laws in the Ninth Schedule of the constitution.
In the light of new policy, land ceiling legislations were enacted by all the states ,
except Goa and the North East Region. However ,the success has been limited due to poor
enforcement. The committee on state Agrarian Relations and the Unfinished Task in Land
Reform points out that the potential of ceiling surplus land was approximately 210 lakhs
hectares. As against it, the declared surplus has been put at only 27 lakh hectares. Out of
this states have taken possession of 23 lakhs hectares and distributed only 19 lakh
hectares among 55 lakh households.
(ii) Consolidation of Holdings:
Consolidation of fragmented agricultural land has been an integral part of the land
reform policy. By consolidation of holdings, we mean bringing together into one
compact block scattered fragments of land of a cultivator. Initially the programme of
consolidation was started on a voluntary basis but was later made compulsory.
Recognizing the importance of consolidation, legislations have been passed in most

of the states to prevent sub division and fragmentation of land. However ,progress
under the programme has been very slow. As on March 31,2002 consolidation of
holdings had taken place only in an area of 66.10 million hectares against a total
cultivable area of 142 million hectares. In fact ,only 15 states have passed laws of
consolidation.
(iii) Co-operative Farming :
Co-operative farming has been one of the major objectives of the land reforms
programme in India. By developing Co-operative farming the small holdings will be
pooled and cultivated jointly to increase the size of the operational unit. Four kinds of
Co-operative farming were identified by the Co-operative Planning Committee. These
are (i) Co-operative collective farming, in which members have to give up their land
forever but are paid wages and gain a share in the surplus produces. (ii) Co-operative
tenant farming ,in which land owned by a society is divided into holdings and then
distributed among them. Each farmer has to pay a rent for his portion of land. However,
the produce of his holdings is entirely his own. (iii) Co-operative better farming where
farmer get together to perform agricultural activities with improved methods but on
their own separate lands; and (iv) Co-operative joint farming where in small farmers
pool their lands together for better cultivation without giving up the ownership of their
lands.
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Co-operative farming in India has not been a success.
4.Land Records :
Correct and up-to-date land records are an essential condition for effective
implementation of land reforms programme. It is also necessary to ensure smooth flow of
credit and agricultural inputs to land holders. Land records are now being computerized
throughout the country, although the progress is slow.
Impact of Land Reforms
Indias achievement in the field of land reforms have been praiseworthy which may be
described as follows:
The abolition of exploitative agrarian relation- marked by intermediary tenures-was

the first and foremost task of the country after independence. This task has been
accomplished in an appreciable manner. Zamindari and all intermediaries were completely
abolished by the end of the First plan. It has been estimated in all about 173 million acres of
land were acquired from the intermediaries. As a result, about two crore tenants were
brought into direct relationship with the government.
As regards tenancy reforms , nearly 124.22 lakh tenants got their rights protected
over an area of 156.30 lakhs acres by September 2000. The total quantum of land declared
surplus in the entire country in 73.49 lakh acres in September 2000, out of which about 64.84
lakh acres were taken possession of and 52.99 lakh acres distributed to 55.10 lakh
beneficiaries. About 147.47 lakh acres of public waste land have been distributed among the
poor so far. Further ,a total of 39.19 lakh acres of land was acquired under Bhoodan land.
As far as a consolidation of fragmented agricultural land holdings in concerned, an
area of 1633.47 lakh acres has been consolidated all over the country so far. As regards
updating and maintenance of land records, the computerization of land records scheme is
being implemented in 554 districts of the country. Co-operative farming has failed to serve
the end.
Evaluation :
An evaluation of the implementation of land reforms brings out that land reforms in
India achieved only a partial success. Whereas legislation succeeded in the matter of abolition
of intermediaries, other objective of land reforms namely tenancy reforms and ceilings on
landholdings were only partially realized. The partial success of land reforms is attributable
to the fact that the reform measures were generally promulgated by ruling elites composed of
the upper echelons of agrarian society.
The distribution of land has remained much skewed despite the enactment of
legislation for land reforms. The Indian rural scene is characterized by extreme inequality in
land and asset distribution. The latest data brings out that the concentration ratios of both the
ownership and the operational holdings continue to be very high.
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Some other adverse socio political consequences have also followed because of partial
implementation of land reforms. According to Joshi, ..it served primarily the
richer peasants rather than the rural poor. One such consequence is the emergence of a well
to do peasantry as a powerful and political force in the rural areas.
Reasons for poor performance:
The reasons for the poor performance of land reforms programmes in India can be
studied under three broad heads:- legislative snags , lack of political will, and bureaucratic
apathy.
(a) Legislative snags : These include the following

(i)
(ii)
(iii)
(iv)
Definition of personal cultivation: personal cultivation should have meant

cultivation by ones personal labour. Personal supervision was generally
considered a part of personal cultivation. Such an interpretation of personal
cultivation led to a large scale transfer of land by the land lords to their family
members to escape the laws relating to land ceiling. This reduced the effectiveness
of ceiling laws.
Inadequate definition of tenant :in some states, sharecroppers and oral
informal tenancies are not accorded the status of tenants. Therefore, laws relating
to tenancy reform are not effective in protecting their rights.
The problem of voluntary surrender: The laws related to tenancy reforms
cannot help tenants if they surrender their land voluntarily. This provision
provided the landlords an opportunity to use their muscle and money power
against the poor tenants, thereby forcing the latter to evict their lands voluntarily.
Inadequate ceiling laws: The levels of ceiling were different in different states.
This created a lot of confusion and disputes. The list of exemption from ceiling was
also unduly large.
(b) Lack of political will power:
Bringing reform in the age-old agrarian relation requires a substantial amount of

courage and determination on the part of the authorities, which is unfortunately lacking in
India. Our political leadership has adopted a two faceted policy as far as land reforms are
concerned, viz., expressing sympathy with the poor while still aligning with the rich.
(c) Bureaucratic apathy:
Bureaucratic apathy is also a great obstacle in the progress of land reforms. It has been
observed that a number of persons in the higher echelons of the administration are
substantial land owners themselves who often prefer to protect the interests of the land
owning section of the society. The bureaucracy is responsible for non-implementation of land
reforms measures. Hence, a politician- bureaucrat-landlord nexus has developed in the
country much to the detriment of land reforms.
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Other reasons:
(a)
(b)
(c)
Legal hurdles : Land reform laws were defective in many ways. Legislation relating to
the land reform were so full of loop holes.
Absence of updated land records : Land reforms cannot succeed unless the
beneficiaries can produce evidence of their rights. The position regarding records of
tenancies is not satisfactory anywhere in the country and no records exist in some areas.
This has been creating difficulties in the implementation of land reforms.
Agrarian reforms discouraged by foreign aid institution :Key players in the

international community gave low priority to agrarian reforms as part of a strategy for
addressing poverty issues and pursuing rural economic development. There were more
interested in the achievement of aggregate production increases in agriculture by
applying new technology in that sector.
Suggestions for improvement :
In order to implement the land reform measures successfully, the following

suggestions are worth mentioning.
(a)
Effective implementation
(d)
Update land records
(b)
(c)
(e)
(f)
Efficient administrative machinery

Simplifying legal procedures
Generation of awareness among potential beneficiaries, and

Lessening political interference
Agricultural policy
Agricultural policy is designed by the Govt. for raising agricultural production and
productivity and also for raising the levels of income and standard of living of farmers within
a definite time frame. This policy is formulated for all round and comprehensive
development of the agricultural sector.
Main objectives : The following are some of the important objectives of Indias agricultural
policy.
1.
Raising the productivity of inputs
4.
Modernizing agricultural sector
2.
3.
5.
6.
7.
Raising value-added per hectares
Protecting the interest of poor farmers

Checking environmental degradation
Agricultural research and training
Removing bureaucratic obstacles
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New National Agricultural Policy-2000.

In view of the problems associated with the agricultural sector during the 1990s , the
National Agricultural Policy was announced on July ,2000. The policy document aims to attain
the following objectives.
1. An annual growth rate of over 4 percent in the agricultural sector.
2. Growth that is based on efficient use of resources and conserves our soil, water and
bio diversity
3. Growth with equity, i.e growth is widespread across regions and farmers
4. Growth that is demand driven and caters to domestic market and maximizes benefits
from exports of agricultural products.
5. Growth that is sustainable technologically, environmentally and economically.
In order to attain these objectives ,National Agricultural Policy envisages measures in

the following areas.- Sustainable agriculture, food and nutritional security ,generation and
transfer of technology, incentives for agriculture, investment in agriculture, institutional
structures ,and risk management.
The main features of the new agricultural policy are as follows:
This policy seeks to harness the vast untapped potential of Indian agriculture and also to
strengthen rural infrastructure that is necessary for faster agricultural development.
Therefore, this policy seeks to promote technically sound, economically viable,
environmentally non degrading, and socially acceptable use of countrys natural resources to
promote sustainable development, to raise and to serve as a vehicle for building a resurgent
national economy.
The new policy promises a lot. It hopes to achieve green revolution, white revolution,
and blue revolution. In other words , it promises Rainbow Revolution.
The policy aims at removing controls and restrictions and subsidies to inputs. The
policy also lays emphasis on private sector through contract farming by land leasing
arrangements.
Private sector investment in agriculture will be encouraged. The domestic agricultural

market will be liberalized. Restrictions on the movement of agricultural commodities will be
progressively dismantled. The policy aims at encouraging lease markets for raising the size of
holdings. It also seeks to encourage consolidation of holdings and speeding up tenancy
reforms to recognize the rights of the tenants and sharecroppers. The policy encourages
future trading in all important products. The policy has recommended formulation of
commodity wise strategies and arrangements to protect farmers from adverse impact of
undue price fluctuations in the world market and promote exports.
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Food Security
From the chronic shortage of foodgrain and virtually ship to-mouth existence in the
mid 196o s ,India has made considerable strides towards achievings food security . Thanks
to green revolution the country has not only achieved self sufficiency in food grains but has
become a net exporter .There has been a significant decline in the incidence of poverty since
the mid 1960 s .Even then , according to latest official estimates in 2004- 05 27.5 per cent
of the population was still below the poverty line . This implies that despite the availability
of food grains for meeting the requirements of the entire population , we are still far from
generating the necessary purchasing power or effective demand from the poor to satisfy
their needs .Since effective food security implies achievement of both physical and
economic access to food , a large section of our population can still be considered to be
suffering from food insecurity .
Food security implies access by all people at all times to sufficient quantities of food
to lead an active and healthy life . (P.V. Srinivasan). Food security exists when all people
at all times have physical and economic access to sufficient , safe and nutritive food to
meet the dietary needs and food preference for active and healthy life (FAO .1996) Food
security is broadly defined as a synchronization of three important elements . it envisages
the availability of quality food at affordable prices to the citizens of a country .It any time
and place . it has three main elements to fulfil the food availability , the quality of food
available and the accessibility of the people to such food. At the household levels, food
security implies having Physical and economic access to food that is adequate in terms of the
quantity , quality and safety .
Food Security in India
If the objective of ensuring a healthy and productive life to all households is to be

fulfilled , a time bound programme to meet four critical requirements for food security
have to be met . They are : (a) adequate availability , (b) reasonable stability in terms of
quantity and price ,(c) purchasing power to access food and desired nutritional intake .Let
us summarise some important action in these areas .
Pre-reform period: The first condition for ensuring food security is availability of food
grains to meet the requirement of the countrys population . With concerted efforts we have
transformed a heavily import depended agricultural economy into one of food self
sufficiency, in fact , one with exportable surpluses . it has been largely due to several policy
and programmatic interventions . The most important among them being (a) Technological
improvement , (b) Institutional and infra structural reforms ,and (c) Support prices Another
requisite for ensuring food availability is making sure that the domestic market functions
efficiently
Per capita food availability recorded a notable increase during the period 1950-51
to 1990-91, since the growth rate of foodgrain during this period was significantly
higher than the growth rate of population . The per capita availability of food grains
increased from an average of 391 grams per day during 1951 to an average of 494 grams
per day during 1991, but declined to 449 grams per day by 2003.
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The Indian economy and all its sectors registered a high growth during the 1980s
resulting in increasing per capita incoms and increased access to food in general . The
economic access to food increased both because of rising income in agriculture and also,
the real price of food declined during the 1980s and the proportion of per capita income
required to buy food had also increased as a result of operation of numerous anti
poverty and employment generating programmes . Food management and the policy of
buffer stocking were also instrumental in imparting stability to prices of major cereals .
According to the Planning Commission , the most significant contribution of food

management in India was to encourage food production , increase per capita availability ,
keep real price of food grains low and contain food price variability .
Post liberalisation period :
Available data suggest that the state of food security deteriorated during the post
reform period 1990-91 to 2003-04 .
Availability of foodgrain is the first component of food security.
The availability of food grain declined since the growth rate of foodgrains
production which was 2.85% per annum during
1980-81 to 1990-91 decelerated
significantly to only 1.16% per annum during the post liberalisation period 1990-91 to
2003-04. This growth rate was lower than the population growth rate of 1.95% per
annum during this period , there by resulting in a reduction of per capita availability of
food grains from 492 kg per capita during 1992 to 449 kg per capita during 2004. The
available data indicate that a decline in per capita availability of foodgrains has adversely
affected their nutritional status .
Stability of supplies is the second feature of food security .Indian food production is
characterized by large year to- year fluctuations . For instance , foodgrains out put which
had increased to a peak level of 212.9 million tonnes in 2001-02 fell down to 174.2 million
tonnes during 2002-03 and rose again to 212 million tonnes in 2003-04 . However ,the policy
of buffer stocking has enabled India to maintain a satisfactory level of stability of food
supplies and effectively Insulated domestic prices from high volatility in international
prices of wheat and rice .
Economic access to food is the third component of food security. There is mixed
evidence as to whether or not access to food increased during the post reform period. Both
the GDP and per capita income recorded a significant acceleration during the post reform
period 1992-93 to 2003-04. According to official data , the incidence of poverty declined
from 36 percent during 1993-94 to 28 percent by 2004 -05. This implies that the access to
food access to food of the poor has increased at a slow rate.
But the declaration in the growth rate of agriculture during the post reform period
has resulted in slower growth in income of agricultural workers . Hence, their access to
food is likely to have declined . The access of rural people to food has also declined
because of collapse of employment in agriculture .Rapid rise in wheat and rice prices also
resulted in reducing the access of the poor to food
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The introduction of TDPS are well as various other schemes have all had a positive
impact on access of food to the poor
Public Distribution System( PDS)
The most important component of the food security system is public distribution of
foodgrains through a network of fair price shops. The basic objectives of the public
distribution system is to protect the interest of the vulnerable sections of population
against high prices . It operates through a network of fair price shops . With a network of
more than 4.47 lakh fair price shops, distributing consumption items worth more than Rs
30000 crore annually , to about 16 crore families , the PDS in India is the largest
distribution net work of its kind in the world . Its broad features are as follows :
1. Selected essential commodities are distributed through the fair price shops and cooperatives
2. The Govt. maintains a buffer stock and replenishes the same through the system of
procurement .
3. Prices charged are lower than the market prices .
4. Free market mechanism co- exists with the public distribution system .
5. It has been basically an urban oriented system.
Objectives
The important objectives of the system are:-
1. To improve the distribution of basic goods e.g. rice , wheat , edible oil , sugar ,
kerosene, etc.
2. To control prices of essential commodities ,
3. To meet consumption needs of masses
4. To maintain good quality at low cost ;
5. To bring stability in prices ,
6. To weave production and marketing system into a unified whole.
Public distribution system is being seen more as an anti-poverty programme with the
onset of the Structural Adjustment Programme.In January 1992 the Govt. introduced a
scheme of revamped PDS in 1700 blocks located in most difficult areas of the country .
Food grains are allocated to these blocks at Rs 50 per quintal lower than normal issue
price .The other programmes under which food grains are distributed are National Food
for Work Programme , Antyodya Anna Yojana , Midday Meals Scheme, etc.
Public distribution system has been widely criticized for its failure to serve the
population below the poverty lines , its urban bias , limited coverage in the states with
high concentration of the rural poor and lack of transparent and accountable
arrangements for delivery. In order to meet some of these objections , in June 1997,the
Govt. of India launched the Targeted Public Distribution System . (TPDS) with focus on the
poor.
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Targeted Public Distribution System (TDPS)

Under the Targeted Public Distribution System (TDPS) , foodgrains are distributed
to the BPL Families at highly subsidized rate . States are required to formulate and
implement foolproof arrangements for identification of the poor for delivery of food grains
and for its distribution in a transparent and accountable manner at the fair price shop
level .
The population below the poverty line is worked out by adopting the methodology
suggested by the expert groups set by the planning commission. Under the TPDS , the
prices for the below poverty line families were 50 percent of the economic cost of the
FCl but the amount was only 10 kg per family per month . APL families are also eligible for
10 kg per family per month but at a higher price , Later the Govt. of India increased
allocation to BPL families from 10kg to 20 kg of foodgrains per family per month at 50
percent of the economic cost with effect from April . 1. 2004
The introduction of the TPDS combined with large scale anti. Poverty programmes
has, no doubt, tended to benefit the poor in India but it has also resulted in large increases
in food subsidy from Rs 7500 crore in 1997-98 to Rs 25,800 crore by 2004-05 .TPDS suffers
from several other deficiencies such as urban bias in coverage . diversion of grains to the
open market etc.
References:
Uma Kapila, (2008) Indian economy: Performance and Policies, Academic Foundation, New
Delhi.
Prakash, B.A. (2009) Indian Economy since 1991: Economic Reforms and Performance, Sage,
New Delhi.
EPW Various Issues
Yojana various issues
Special issue of Agriculture by the Hindu News paper.
Indian Economy
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MODULE III
INDUSTRY
Industrial structure in India: Traditional, SSI, Village, Cottage and Modern industries. Industrial Policy Resolution in India till 1991 - New Industrial Policy and its impacts
Introduction
Industry includes manufacturing (registered and un registered), mining ,construction
and electricity , gas and water supply . But manufacturing occupies a central role in the
industrial sector of a country . Industrial development in necessary to bring about structural
changes in the economy . Economic development of a country in associated with
industrialization .Western capitalist countries amply demonstrates this thesis .Their rate of
growth are attributed to industrialization .The high rate of growth of income of industrially
advanced countries is due to the fact that these countries are industrially advanced .
Industrialization brings about favourable change in the countrys occupational structure.
Industrialisation offers the only way to the creation of employment .Further , agricultural
development is largely conditioned by industrial development . For security consideration ,
no one can deny the role of industrialization in an economy .Thus , it is quite clear that
industrial development is of urgent necessity in a country like India .
Industrial scene at Independence .
The main features of the industrial scene in India on the eve planning were as under :
1. There was preponderance of consumer goods industries vis .a .vis producer goods
industries resulting in lop-sided industrial development
2. The industrial sector was extremely under developed with a very weak infrastructure.
3. The lack of government intervention in favour of the industrial sector
4. Export orientation has been against the countrys interest
5. The structure of ownership was highly concentrated .
6. Technical and managerial skills were in short supply .
With independence, India turned its back on an open economy in pursuit of its
objective of an industrial self -sufficiency . Organized thinking concerning the direction of
industrial development may be traced to the statement of industrial policy. Since the
initiation of planned development , the economy has attained considerable diversification
.The broad aims of the plan have been to turn India into an industrial power .The strategy
adopted involved the establishment of a heavy industrial base and consumer goods
industry to self sufficiency. As a result, the industrial structure has been widely diversified
covering broadly the entire range of consumer, intermediate and capital goods industries.
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Industrial structure in India

The changes in the structure of industrial growth in India during the last five decades
can be analyzed under two broad heads . viz: (a) Industrial growth ,and (b) pattern of
industrialization.
A. Industrial Growth
One can identify four distinct phases of industrial growth in India since the planning
era. The first phase of rapid growth ends from 1956-1965. The second phase of slow growth
or deceleration extends from 1965-66 to 1979-89 .The third phase is a phase of recovery
and revival of growth since 1980s and the fourth phase starts with 1991 economic policy
reform since 1991.
First phase (1951-65)
Phase I laid the basis for industrial development in the future . There occurred a
noticeable acceleration in the compound ( annual) growth rate of industrial production over
the first three plan periods up to 1965 from 5.7 percent in the First plan to 8.0 percent in the
Third plan .This period of growth has been named the period of industrial growth with
regulation
This high rate of a industrial growth were due to (a) Emphasis on industrialization
(b) Heavy industry oriented strategy of industrialization ,and (c) Substantial investment
made in the industrial sector .
Second phase (1966-80)
The period 1966-80 was marked by a sharp deceleration in industrial growth. The
growth rate declined to 5.7 percent in the period 1966-67 to 1979-80 .This period was
characterized by structural retrogression.
Major reasons for deceleration and
retrogression are as follows.
(a) Slow down in public investment.
(b) Poor management of infrastructure.
(c) Slow growth of agricultural income ,and

(d) Restrictive industrial and trade policies
Third phase (1981-1991)
The period of 1980s can be broadly termed as the period of industrial recovery or
revival. The rate of industrial growth was 6.5 percent per annum during 1981-85 ; 8.5
percent during the seventh plan (1985-90) ;and 8.3 percent in 1990-91. This performance is
an improvement upon the growth rate achieved during the First and Second plan
periods
The major factors that contributed to this turn around are explained below .
(1)Liberalization of industrial policy. (2) Increase in public investment (3) Notable

improvement is private sector investment. (4) Improvement in the agricultural production.
(5) Growth of service sector, (6) Better performance of infrastructure industries , (7) A
decline in inter sectoral terms of trade in favour of non.- agricultural sector. (8) positive
role of state in stimulating recovery , and (9) Liberal fiscal regime .
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Fourth phase (1991-92 on wards )

The 1990s have certainly been on eventful period for the industrial economy of India
. Crisis, adjustment ,recovery , rapid growth and then a downward slide this decade has
seen it all .The period after reform can be divided into two sub periods .(1) The period of
1990s (upto 2001-02) and (2) the period since 2002-03.
(i)
The period of 1990s

The post reform period up to 2001-02 was marked by considerable fluctuation and
showed total lack of consistency in industrial growth performance. The set back in industrial
production occurred during 1991-93 extended right into 1993-94 also. The rate of
industrial growth began to accelerate in the second half of 1993-94 .The three years from
1993-94 to 1995-96 saw an average growth of 13 percent per annum . The average annual
growth rate of industrial production was 5 percent during the period 1990-91 to 19992000.The rate of growth of industrial production was just 2.7 percent in2001-02
The industrial deceleration was due to (a) demand constraints , (b)
constraints , and (c) structural and cyclical reasons.
ii The period since 2002-03 ( Revival and strong growth )
supply
The period of the Tenth plan (2002-03-2006-07) has witnessed revival of industrial
growth . The industrial recovery in 2002-03(5.7 percent ) , which consolidated during
2003-04 (7.0 percent ) ,has gathered momentum since then reaching 8..4 percent in 200405 , 8.2 percent in 2005-06 and 11 percent in 2006-07 . For the plan as a whole , the average
rate of growth of industrial production comes out to be 8.2 percent per annum . In fact , the
rate of growth in industrial production at 11 percent in the last year of the plan ( 2006-07)
is the highest growth achieved since 1995-96 .
The surge in industrial growth could be attributed to certain structural changes in the
economy. These included rise in savings rate from 23.5 percent in 2000-01 to 37.7 percent
in 2007-08; increase in exports /GDP ratio (33.2% in 2007-08) and financial deepening
Though the growth of industrial sector started to slow down in the first half of
2007-08 , the overall growth during the year remained as high as 8.5 percent . The year
2008-09 witnessed slow down due to the global financial recession . The pace of slow
down accelerated in the second half of 2008-09 . The year 2008-09 thus closed with the
industrial growth at only 2.4 percent .There was, however , a recovery in industrial
growth from 2.4 percent in 2008-09 to 5.3 percent in 2009 and 8.2 percent in 2010-11.
B. Pattern of Industrialization .
Another dimension of the structure of the Indian

industry is pattern of
industrialization . The pattern of industrialization can be studied under two heads:
(i)
(ii)
Functional pattern of Industries (use based classification )and

Ownership pattern of industries
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(i)Functional pattern of Industries

With use based or functional classification as the criterion , various industries can be
divided into four group s ; viz (a) Basic goods industries (b) capital goods industries ,(c)
Intermediate goods industries ; and (d) consumer goods industries .In this context , five
distinct phase relating to the compound rates of growth in different industries can be
observed .
(i)
The first phase( till 1965) of industrial development has been characterized by high
growth .The pattern of industrialization that evolved during this period had shown two
features (i )The rate of growth of capital goods industries has been rapid . The rate of
growth increased from 9.8 percent per annum in the First plan to 19.6 percent per annum
in Third plan.
(ii) The rate of growth of basic goods industries also registered a significant increase
from 4.7 percent per annum in the First plan to 10.4 per cent per annum in the Third plan.
(iii)
A slow growth of consumer goods industries

The second phase(1965-75) has been characterized by structural retrogression .
During this period, capital goods industries group registered an annual rate of only 2.6
percent .
During the third Phase (1975-90) , industrial growth was fairly diversified and
growth rates in all the different segment picked up .Basic goods industries maintained a
fairly high rate of growth ( 8.4 % per annum ) as did the capital goods (5.7% per annum )
and inter mediate goods ( 4.3% per annum ) industries .
During the fourth phase (1990 onwards), the relative share of basic and capital
goods sector declined whereas the contribution of intermediate and consumer goods
industries increased. The relatively low contribution of the basic and capital goods sector
reflect the impact of trade liberalization and of financial liberalization.
The fifth phase (2008-09 on wards) is characterized by slow down in the growth rate
of consumer durables. But growth in production of capital goods continued at a robust pace.
By the last quarter of 2008-09, all sectors of the industrial economy had entered the revival
mode .Consumer durable goods sector grew by an average 25.8 percent during 2009-10
.Basic goods and intermediates also recorded higher and more consistent growth during
2009-10
ii. Ownership Pattern of Industries :
The present economic structure of Indian economy is known as mixed economy ,

where there is a co- existence of both the public sector and the private sector . All the
different types of industries are divided between there two sectors The scope of each
sector was defined in the industrial policy resolutions announced from time to time by
the Govt. An attempt is made in this section to examine the structure of Indias industrial
sector on the basis of ownership pattern . After independence especially after ther
introduction of economic planning the importance of public sector was realized .
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The public sector accounted for 6.1 percent of total number of factories , 28 percent
of employees , 55 percent of net fixed capital and 32.1 percent of net value added by the
industrial sector in 1992-93 .The private sector accounted for 92.3 percent of total
number of factories , 67.2 percent of employees , 39.4 percent of net fixed capital and
61.5 percent of a net value added in 1992-93 . Joint sector accounted for 1.5 per cent of
total factories , 4.7 percent of employees , 5.6 percent of net fixed capital and 6.4 percent of
net value added in 1992-93 .
Around the mid 1990,s public sector accounted for 4.7 percent of the total number of
factories , 27.4 percent of employees , 55.0 percent of net fixed capital , 30.1 percent of
value added , 25.5 percent of value of output and 34.3 percent of emoluments . It would
be observed that while Govt. occupies the commanding heights of investment , its share in
output , value added and employment is substantially smaller .
Industrial policy
The pace, pattern and structure of industrialization in a country is highly influenced

by its industrial policy .The industrial policy of a country consists of (i) the philosophy of a
given society to bring about industrial expansion and (ii) the principles , procedures ,
rules and regulations which can give concrete shape to the philosophy .
At independence , India inherited a state of economy with a very weak industrial

base . So there was a need for a strong and effective industrial policy . The first industrial
policy resolution was issued by the Government of India on April 6, 1948. This was
followed by industrial policy resolution of 1956,1977,1980 and 1991 . The main industrial
policies are briefly discussed below .
I . Industrial policy Resolution - 1948
Industrial policy resolution of 1948 recogised the principle of mixed economy. This
policy divided the various industries into four broad categories .
i. State Monopolies :The first category included three industries ,viz: arms and
ammunition, atomic energy and rail transport . This category would belong to the
exclusive monopoly of the central Government .
ii. Basic industries : The second category included six industries , viz :coal, iron and
steel , aircraft manufacture , ship building , manufacture of telephone , telegraph
and wireless apparatus and mineral oils .New undertakings in this category would
be taken only by the Government but the existing private under takings were
allowed to continue for 10 years .
iii. Regulated industries : The third category included 18 industries of national
importance such as automobiles ,heavy chemicals , heavy machinery , machine
tools , etc .The Government of India would regulate these industries because of
the importance of these industries .
iv. Private industries: The last category included all the other industries except the
above . These industries were open to private sector .
This industrialpolicy resolution also stressed importance of cottage and small
scale industries .
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II. Industrial Policy Resolution-1956

The formulation of the second five year plan and the acceptance of a Socialistic
pattern of society as the objective of social economic policy necessitated a new Industrial
Policy Resolution on April ,1956. The objectives of the new industrial policy were :
i.To accelerate the rate of economic growth and to speed up industrialization ,
ii. To develop heavy industries and machine making industries ,
iii.To expand the public sector ,
iv. To reduce disparities in income and wealth ,
v. To prevent monopolies and the concentration of economic power ,and
vi. To build up a large and growing co-operative sector . The 1956 Resolution divided the
industries into three schedules .
i. Schedule A:This schedule includes 17 industries , the future development of which was
to be the exclusive responsibility of the state . Of the 17 industries 4 industries -arms
and ammunition , atomic energy , railway and air transport were to be government
monopolies . In the remaining 13 industries , new units were to be established by the
state but the existing private units were allowed to subsist and expand .
ii. Schedule B: Schedule B contained 12 industries. Such industries would be

progressively state owned . The state was to establish new under takings but the
private enterprise can also supplement the efforts of the state in these fields .Some of
the important industries in this schedule are machine tools , the chemical industry ,
fertilizer etc.
iii. Schedule C: Schedule C includes all the remaining industries, mostly in the consumer
goods sector. The future developmentthese industries had been left to the initiative and
enterprise of the private sector .
The 1956 Resolution recognized the importance ofsmall-scale and cottage industries
and the interdependence between public and private sector .It also called for the
reduction in regional imbalances and inequalities .This policy has been described as the
economic constitution of India .
III. Industrial Policy of 1977
In December,1977, the Janatha Government announced its New Industrial Policy in the
parliament . Following are the main elements of the new policy .
(1)Development of small scale sector : The main thrust of new policy was the
emphasis on the development of small scale industries .The Janatha Government
classified small scale industries in to:(i) Cottage and house hold sector ,(ii) Tiny industry sector , (iii) small scale industries
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(2)Areas of large scale Industry sector :The 1977 Industrial Policy prescribed the following areas for large scale industries
sector :- (a)Basic industries (b)Capital goods industries (c) High technology
industries , and (d) Other industries out side the list reserved items for the small
scale sector
(3)Approach to Large Industrial Houses :
The new policy restricts the scope of large business houses so that no unit of the same
business group acquired a dominant and monopolistic position in the market .
(4)Expanding Role of the Public Sector :
The new policy expanded the role of the public sector .It was stated that the public
sector industries would produce not only basic and strategic goods but also
essential consumer goods. This sector would be encouraged to develop ancillary
industries .
(5)Promotion of Technological Self reliance :
Govt.recognized the necessity of allowing the inflow of foreign technology in high

priority industries where domestic technology has not yet adequately developed .
(6)Approach towards Foreign collaboration :
It was maintained that In areas where foreign technological know how is not
needed, existing collaboration will not be renewed
(7)Measures in case of Sick Industrial units ;
The new policy aimed at adopting a selective approach in the case of sick industrial
units. While the govt. cannot ignore the necessity of protecting existing
employment, the cost of maintaining such employment has also to be taken into
account. .
(8)Labour Management Relations
The new policy put emphasis on reducing the occurrence of labour unrest .The
Govt. encouraged the workers participation in management of industrial units from
shop floor level to this board level
IV. Industrial policy of 1980
The congress Government announced its industrial policy on 23 rd July 1980 .This
policy was based on the Industrial Policy Resolution of 1956 .The IP of 1980 believed
that industrialization was essential for the rapid economic development of the country .It
believed in Governments commitment to rapid industrialization in the country with a
view to benefit the common man
The Industrial policy statement of 1980 had the following socio economic objectives .
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(i)
Optimum utilization of installed capacity ,
(ii) Maximization of industrial production and achieve higher productivity .

(iii) Generation of employment opportunities ;
(iv) Correction of regional imbalance by setting up industrial units in backward areas ,

(v) High priority and preferential treatment to agro-based industries
(vi) Faster promotion of export oriented and import substitution industries
(vii) Promoting economic federalisam by properly spreading investment in small scale

industries ,
(viii) Reviving the economy by removing infra structural gaps
Policy Measures :-
(1)Revitalization of the public sector industries :

The Govt. proposed to revitalize the public sector industrial units by strengthening
their management , developing management cadres , making unit by unit study ,
converting loss making units into viable units , etc .
(2)Small scale and village industries
Taking into consideration the rise in prices , investment limits were raised from Rs
10 lakh to Rs 20 lakh in the case of small scale units; from Rs 15 lakh to Rs 25 lakh
in the case of ancillaries and from Rs 1 lakh to Rs 2 lakh in the case of tiny units :
(3)Economic Federalism
The Industrial policy statement of 1980 proposed to promote economic federalism

by setting up nucleus plants in each district identified as industrially backward ;
with a view to generate ancillary and small scale industries around the nucleus
industry .
(4)Automatic Expansion :
The facility of automatic expansion was extended to 15 other basic industries .
(5)Industrial sickness
The IP statement of 1980 proposed to devise an early warning system to identify

incipient sickness . It was proposed to give income tax and other concessions in the
case of voluntary merger of sick units with a healthy unit . Govt. was to takeover
sick units only when public welfare demanded such a take over .
(6)Export oriented industries
The IPR of 1980 proposed to offer special facilities for export oriented industrial
units .
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(7)Advanced Technology
This policy favour advanced technology . The idea behind permitting advanced
technology was both to increase international competiveness and also to bring
about improvement in quality of goods and reduction in their costs and prices
(8)Modernization
The IPR of 1980 proposed to evolve Modernization Package that would suit the
requirements of each industry .
(9)Ecological Balance
The Industrial policy of 1980 proposed to continue the policy of not allowing
setting up of new industrial projects in metropolitan areas which are already
congested . It encourages dispersal of industries to relatively less industrially
developed areas .
(V) New Industrial Policy of 1991
The government announced a new industrial policy on July -24 , 1991 in line with the
liberalization measures taken during the eightees . It marks a sharp departure from earlier
policy resolutions. The basic philosophy of the new policy has been summed up as
continuity with change
(i)
(ii)
(iii)
(iv)
(v)
Objectives : the prime objectives of the new industrial policy are :

To unshackle the economy from the cobwebs of unnecessary bureaucratic
controls ,
To consolidate the strength built up during the last four decades of economic
planning and to build on the gains already made ,
To correct the distortion or weakness that may have crept in the industrial
structure .
To maintain a sustained growth in the productivity and gainful employment ,
and
To attain international competitiveness.
To fulfil these objectives, the government introduced a series of initiatives in

the new industrial policy in the following areas.
A. Industrial Licensing Policy
(i) Industrial licensing has been abolished for all projects except for a short list of
industries related to security and strategic concerns, social reasons hazardous
chemicals and overriding environmental reason , and items of elitist consumption .
Now licensing is compulsory for only 5 Industries ,( ie. alcohol , cigarettes , hazardous
chemical , electronic aero scope , defence equipment and industrial explosive ).
(ii) Only three industries groups where security and strategic concerns predominate ,
will be reserved exclusively for the public sector .(ie atomic energy , substance
notified by the Dept. of Atomic Energy , railway transport ).
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(iii) . In projects where imported capital goods are required , automatic clearance will
be given in the following cases :
(a) Where foreign exchange availability is ensured through foreign equality .
(b) If the CIF value of imported capital goods required is less than 25 per cent
of the total value of plant and equipment , up to a maximum value of Rs .2
crore
B. Foreign Investment
(i)
Automatic approval will be given for direct foreign investment up to 51 per

cent equity in high priority industries . The limit was subsequently raised
from 51 percent to 74 percent and then to 100 percent for many of these
industries .[ FDI is only prohibited in retail trading , atomic energy lottery
business, and gambling and betting]
(ii)
(iii)
To provide access to international markets , majority foreign equity holding

up to 51 percent equity will be allowed for trading companies primarily
engaged in export activities .
The Foreign Investment Promotion Board has been constituted to negotiate
with a number of large international firms and approve direct foreign
investment in the selected areas
C. Foreign Technology Agreement

(i)
(ii)
Automatic permission will be given for foreign technology agreements in high

priority industries up to a lump sum payment of $ 2 million , 5 per cent
royalty for domestic sales and 8 percent sales over a 10 year period from the
date of agreement or 7 days from commencement of production .
In respect of industries other than those included above , automatic
permission will be given subject to the same guidelines as if no foreign
exchange is required for any payments.
D. Public Sector Policy

(i)
The 1991 industrial policy reduced the number of industries reserved for the
public sector to 8. Now only three industries (atomic energy , minerals and rail
transport) are reserved for public sector.
(ii) Potfolio of public sector investments will be reviewed with a view to limit these to
strategic , high-tech and essential infra structure .Where as some reservation for
the public sector is being retained , there would be no bar on opening up areas
reserved exclusively for the public sector to the private sector selectively .
Similarly , the public sector will also be allowed entry in areas not reserved for it
(iii) Public enterprises which are chronically sick and which are unlikely to be turned
to normal health , will be referred to the Board for Industrial and Financial
Reconstruction (BIFR) for advice about rehabilitation and reconstruction .
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(iv)
(v)
In order to raise resources and encourage wider public participation , a part

of the governments share holding in the public sector would be offered to
mutual funds, financial institutions , general public and workers
Board of public sector companies would be made more professional and given
greater powers
E. MRTP Act
(i)
(ii)
MRTP (Monopolies and Restrictive Trade Practices ) Act has been amended to
remove the threshold limits of assets in respect of MRTP companies and
dominant undertakings .
(iii)
Emphasis will be placed on controlling and regulating monopolistic , restrictive

and unfair trade practices .
Provisions relating to concentration of economic power , pre entry restrictions

with regard to prior approval of the central government for establishing new
undertakings, expanding the existing undertaking , amalgamation , merger etc.
have been deleted
F.
Abolition of Phased Manufacturing Programmes and removal of mandatory
convertibility clause and liberalization of location policy; etc . are some other provisions of
this policy
Appraisal of New Industrial policy (impact )
The new industrial policy (1991) paves way for liberalization which will again result
in faster industrial growth as the industrial sector is being relieved of unnecessary control
and regulation. J.C. Sandesara argued that the new policy will accelerate industrial
production as it reduces project time and project cost of production , attracts capital ,
technology and managerial expertise from abroad and improves the level of efficiency of
production , enhances the allocative efficiency of the public sector and curbs anticompetitive behaviour of firms in the monopolistic and oligopolist markets.
However, some economist have criticized this new policy on various ground :
(i) The new policy package makes a complete departure from the Nehruvian model .
(ii) Indian businessmen are facing unequal competition from MNCs . The various
measures to promote foreign investment and various concessions to such
investment have provided opportunities
to MNCs to penetrate the Indian
economy and gobble up Indian enterprises
(iii)
(iv)
India has moved from the much protection to too little protection , which may
eventually result in policy induced de industrialization .
It cause distortions in production structure .
(v) Excessive freedom given to foreign . capital may affect our economic sovereignty and
will push the country towards debt trap
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Thus considering all these apprehensions sufficient care should be taken in near future
to keep the industrial economy in right track
Large Scale Industries Traditional
We distinguish the industries in terms of capital investment as large, small and tiny
sectors. Industrial units with investment higher than specified for small scale industries are
large-scale industries. Large-scale industries can further be classified as traditional and
modern. Industries may be described as Traditional in the sense that they have a fairly long
history and were well established when the First Five Year plan was launched. They include
most prominently the cotton and jute textiles, sugar, iron and steel, paper and cement
industries. Let us now discuss the present status of some of these major large scale industries
in India.
Cotton Textile Industry
The cotton industry is one of the oldest industries in India. It has become one of the
major large scale industries in India.
The first cotton mill was established in 1818 at Fort Gloster near Calcutta. The real
growth of the industry started with the setting up of the Bombay Spinning and Weaving Mills
in 1854 with Parsi capital. The Swadeshi movement and the First World War helped in the
expansion of the industry. In the early period of this century the industry faced stiff
competition from Japan. After 1930, however, the situation improved as a result of bilateral
trade agreements with Japan. With the grant of protection in 1927 the industry began to
make rapid progress. During the Second World War competition from Japan ceased and the
industry increased its production to cater to war demands. In 1947 protection to the industry
was withdrawn.
The partition of the country was a serious blow to the industry. India retained most of
the factories whereas 40% of the area under cotton cultivation went to Pakistan. This
adversely affected the supply of raw cotton.
Till 1920 the development of cotton textile industry was concentrated in and around
Mumbai. With the establishment of cotton textile mills in north India ,Tamil Nadu, Karnataka,
and Madhya Pradesh ,there took place decentralization of this industry. Even now sixty
percent of the spindles and looms are concentrated in Mumbai and Ahamedabad.
The industry has three mutually exclusive and disparate sectors, namely, the mills,the
handlooms and the power looms. The mills manufacturing cloth come under the organized
sector while the other two are generally included in the decentralized sector.
Till 1960 ,a major proportion of cloth output in India was produced in the mill sector
(72.5% in 1960). Since the mid 1960s the major share (95%) of cloth output comes from the
decentralized sector. Of the two sub sectors -handlooms and power looms in the
decentralized sector, it is the power looms sub sector that has grown at a faster pace. For
instance in 1998-99, the share of power looms in total fabric production was as large as 74.7
percent while handlooms contributed 18.8 percent.
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Cotton textile industry provide employment to about 35 million workers and accounts
for 14 percent of total industrial production in the country. This industry accounts for 16.33
percent of the total value of exports and 4percent to the GDP in this country. Textiles and
cloths worth US Dollar 26.82 billion were exported during 2010-11.
With the aim of developing the three sectors of the industry, viz,mills, power looms
and hand looms in an integrated manner, the government announced a new textile policy in
1985. The main objective of this policy was to enable the industry to increase production of
cloth of good quality at reasonable prices for the vast population of the country as well as for
exports. A textile modernization fund of Rs. 750 crore was created in 1986 to meet the
modernization requirements of the textile industry. A textile workers rehabilitation fund has
been set up to provide interim relief to workers rendered unemployed as a consequence of
permanent closure of the textile mills.
The Govt.of India has agreed to phase out Multi Fibre Agreement within 10 years. The
MFA is now to be dismantled in four stages. Thus immense opportunities await the Indian
textile exports in years to come.
The Cotton Technology Mission has been launched to improve cotton yield in the
country. The mission is a major initiative of the Govt. to help the industry face global
competition once the MFA under the August of the WTO ends.
Problems :
1.Modernisation and rationalization : There are four aspects of the problem.
a) Modernization requires funds. Textile mills lack internal surpluses to meet their
modernization needs. But banks are unwilling to provide necessary funds. The attitude
of various financial institutions has been lukewarm.
b) Lack of modernization raises the cost of production. The cost of production is further
increased by hike in wages in the organized sector and the cost of raw materials.
Higher costs lead to higher prices. This adversely affects their competitive position and
hence their share in the export market.
c) Non- availability of modern sophisticated machinery within the country. Moreover,
textile industry has not attracted enough foreign investments.
d) The decreasing share of the organized sector and increasing share of the decentralized
sector on account of a deliberate policy adopted by the Govt, the modernization of one
sector alone will not do either.
2.Lack of raw-materials:
Among the raw materials, cotton is the most important. Given the fact that the
productivity of crop Is very low in India, its cost of production, and hence price is relatively
higher. Moreover, the quality of Indian cotton is deplorably low. The prices of other raw
materials like dyes, chemicals and starch have also been increasing sharply. All these have
raised the prices of yarn and cloth. Thus, rising prices of raw materials, particularly cotton,
are bound to have great impact on the economics of textile production. In addition to raw
cotton, non-availability of power and coal and railway wagons make things more complicated.
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3.Low demand for cotton cloth :

a) Cotton cloth is pitted against synthetic cloth. Synthetic cloth has been attracting more
demand both from the urban and the rural consumer. Further massive power loom
sector has been flooding the market with its cheap products. All this adversely affected
cotton cloth industry.
b) Low demand for cotton cloth has also been a consequence of low availability of the
purchasing power with the weaker sections of the society. Lack of demand is also due
to changing pattern of consumption. There is a trend of an increase in consumption of
mixed fabrics.
c) The capacity utilization of cotton textile industry is very low.
4.Sickness :
Because of two problems i.e out dated plant and machinery and labour disputes, a
number of cotton mills are facing recession and are turning sick, which often leads to
widespread unemployment Govt. of India established the National Textile Corporation in
1968 with the objective of reviving the sick textile mills.
Suggestions :we may make the following suggestions.
Proper attention should be paid to quality. Steps should be taken to ensure full
utilization of spindles and looms. Timely financial assistance on easy terms should be
provided to such of the sick mills as are capable of generating repayment capacity out of such
assistance. If is essential that measures are taken to ensure a steady consumption of
indigenous cotton and create buffer stock operations for cotton. A reasonable floor price of
cotton should be assured to the grower, so that he is encouraged to grow more cotton. The
uneconomic subsidy system has to be discontinued.
New textile policy :
A new textile policy was announced on Nov.2,2000. The aims of the new policy are:
1. To increase apparel and textile exports to $ 50 billion from the present level of $ 11
billion.
2. To encourage the private sector in setting up specialized financial arrangements to
fund the diverse need of the industry.
3. To encourage the private sector to set up integrated complex and units.
The principal provisions of the new policy are as follows:

i.
ii.
iii.
iv.
v.
Free flow of capital allowed in the sector.

Duty structure would be reviewed.
A venture capital fund should be set up to encourage entrepreneurship among
technocrats.
There should not be any mandatory export obligation on FDI.
The highly export oriented garment sector has been taken off SSI reserve list.
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Iron and Steel Industry

The iron and steel industry is the basic industry of the country. Indeed, steel is the
backbone of all development, industrial as well as agricultural. The development of machinebuilding, consumer goods industries, transport and communications, irrigation and scientific
agriculture is dependent on the availability of adequate quantity of cheap and good quality
steel in the country.
The real beginning of modern iron and steel production started with the establishment
of Tata Iron and Steel works in 1907 (TISCO). In 1919 the Indian Iron and Steel company and
in 1923 Mysore State Iron Works were started. The first unit in the public sector, now known
as the Visvesvaraya Iron and Steel Works Ltd. started functioning at Bhadravati in 1923.
Progress after independence:
The iron and steel industry has been accorded the highest priority under the five year
plans. During the Second plan three steel plants were set up in the public sector at Bhilai
(M.P), Durgapur (West Bengal) and Rourkela (Orissa). The Third plan placed emphasis on
expansion of these three plants and the setting up of new steel plant at Bokaro. The Fourth
plan aimed at setting up new steel plants at Salem in Tamil Nadu, Vijaya Nagar in Karnataka
and Vishakapatanam in A.P. The Bokaro steel plant was commissioned in 1978.
There are at present six integrated steel plants in the country five in the public sector
and one TISCO in the private sector. The public sector steel plants are owned by the Steel
Authority of India Ltd.(SAIL) which was set up in 1974. At present there are 177 mini steel
plants in the country. As a result of the investment in new plants and expansion of the old
ones, the production of finished steel has increased from 55.15 million tonnes in 2006-07 to
59.33 million tonnes in 2009-10. India ranked as the fourth largest producer of crude steel in
the world during January- November 2011.
Production and Consumption
The steel industry is regarded as the barometer of the overall industrial growth. The
production of finished steel in India rose from 1.04 million tonnes in 1950-51 to 59.33 million
tonnes in 2009-10. India has now emerged as the third largest producer of steel in the world.
The consumption of finished steel in 2008-09 was 52.4M.T. Indias per capita
consumption of steel was at about 38k.g. Total export of finished steel in 2008-09 was
4.44M.T.
Steel Policy
The iron and steel sector is now almost entirely open with no sectoral reservations,
with no licensing, pricing, distribution and import controls.
Problems of the Industry
(1) Lack of technical and trained personal: In India, we do not have adequate technical
staff and trained workers. Therefore, we have to take the services of foreign
technicians on high remuneration.
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(2) Shortage of Metallurgical coal: For melting iron, good quality coal is required. India
does not possess sufficient good quality coal. This adversely affects the production of
finished steel.
(3) Shortage of Finance:One of the important problems facing the industry is shortage of
finance. This industry requires heavy capital investment which is difficult to secure.
(4) Under-utilisation of Capacity: The iron and steel industry has been working below full
capacity. It was 70% in the public sector concerns whereas it was 97 percent in private
concerns.
(5) Sickness of Mini Steel Plants: The main problem faced by the mini steel plants is their
sickness. The problems faced by these units include short supply of inputs like scrap,
inadequate power supply, constraint of working capital and poor management.
(6) Labour unrest : There were periods of strained labour relations at many plants.
Production suffered as a result.
(7) Rapidly increasing demand: Demand for steel is increasing very fast under the impact
of Five Year Plans. This requires that the output of the industry should be increased
rapidly to cope with the ever increasing demand.
(8) Product-mix and waste-materials: There is need to reorient the product-mix of the
industry and to use the waste materials namely slag.
(9) Distortions of Planning: Excessive control and lakh of proper co-ordination also
resulted in the poor performance of the iron and steel industry.
Sugar Industry
Sugar industry is one of the major industries of India. It ranks second among the agrobased industries. It provides employment in mills and in the production of sugar cane. Its
contribution to the revenues of both the Central and the State Governments in the form of
various taxes is quite high. It provides direct employment to about 3.25 lakh workers. The
industry contributes an estimated Rs.1600 crore annually to the Central and State
exchequers.
History:
Sugar industry had its origin in India in 1903. But the industry developed on modern
lines only after 1920. Since 1920, the development of the industry was phenomenal when the
industry was given tariff protection against foreign competition. The industry has been
described as the Child of Protection. Within five years of the grant of protection, the number
of factories increased from 31 in 1931-32 to 137 in 1936-37. In fact by 1939-40 India attained
self sufficiency in sugar production. After the Second World War, the prices of sugar started
rising and the Govt. had to adopt the system of price control and rationing. In 1952,
production reached its peak level and controls were given up.
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Progress under the Plans:

Production of sugar increased by leaps and bounds during the planning period. The
number of sugar mills rose from 138 in 1950-51 to 582 in 2006-07, out of which 189 are in
the private sector,306 in the co-operative sector and 62 in the public sector. The production
of sugar increased from 11.34 lakh tonnes in 1950-51 to 282 lakh tonnes in 2006-07. At
present there are 245 sugar factories in the private sector, 62 in the public sector and
remaining 317 factories in co-operative sector working in the Country, India is the second
largest producer of sugar with a share of over 15 per cent of world sugar production.
Problems of the Industry:
Sugar industry has been suffering from the following problems.
(1)
Shortage in the Supply of Sugar Cane:
The sugar industry suffers from an inadequate and irregular supply of sugar
cane. Cane output fluctuates with general weather conditions and the diversion of the
land under cane to other crops.
(2)
Problem of Uneconomic Units:
Most of the sugar mills of the country were of uneconomic size, and they cannot
be expected to produce sugar on a very large scale. As a result of this, production cost
of these mills was quite high.
(3)
Low Yield of Cane per acre:
The yield of sugar cane per hectare in India is very low. It is much less than that
of Cuba. Java,and Hawai Islands. Further, quality of sugar cane produced in India is not
quite satisfactory.
(4)
Centralization :
Most of the sugar mills were situated in U.P. and Bihar, whereas the area in the
south was more suitable for the setting up of sugar mills only.
(5)
(6)
Use of by Products:
The by products of the industry such as baggasse, molasses, etc. are not put to
economic use. The economic utilization of by-products can help in reducing cost of
production.
Problem of Modernisation:
Most of the sugar mills of our country possess out-dated machines. The
machines are to be replaced by a new one to increase the productivity and to reduce
the cost of production.
(7)
Burden of Excessive Taxation:
The industry has to face the burden of excessive taxation.

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(8)
(9)
Short duration of the Crushing season:

Another problem is short duration of the crushing season in India. The average
duration of the crushing season is about 4 to 5 months in India as against 8 to 10
months in Cuba and Jawa.
The Sugar economy is highly controlled:
This industry requires compulsory licensing under the existing policy. There is
a statutory minimum price (SMP) for sugar cane fixed by the centre and state advised
price over and above the SMP. Though there is no price control on free sale sugar, its
market supplies are regulated by fixing quarterly release quotas to maintain stability.
(10) Governments Changing policy :
The frequently changing government policy with short term objectives in view ,
injected an element of serious uncertainty in the development of the industry .
Jute Industry
This is another important traditional industry which helps India to earn substantial of
foreign exchange. The jute manufacturing industry which came to be established in India in
1855 went on recording progress as India had almost attained a monopolistic position in
respect of jute products in the world.
Till partition of the country in 1947, the India jute industry held a dominant position ,
not only in Indian economy, but also in the entire world economy. The Indian jute industry
received a rude jolt with the partition of the country. While practically all the manufacturing
jute mills happened to be in and around Calcutta, which formed part of India, more than 70
percent of raw-jute growing areas became part of East Pakistan. This created a serious
shortage of raw-material for jute factories in India.
In 1951 while the total production of raw-jute in India was around 3.3 million bales,
requirement of industry was around 7.2 million bales. Later, production of raw-jute increased
to 4.1 million bales in 1960-61 and further to 7.8 million bales in 1990-91.
Present position:-
At present , there are 77 jute mills in India with nearly 44,990 looms, out of which only
70 units are in operation and 60 are in West Bengal. This industry accounts for about 32
percent of the world production and about 46 percent of world export of jute goods. The total
capital employed in the industry is of the order of Rs.500 crore. This industry provides
employment to about 2.3lakh workers. Moreover, the cultivation of jute provides living to
nearly 40lakh families. The production of jute and mesta textiles increased from 8.37
thousand tonnes in 1950-51 to 16.0lakh tonnes 2008-09. The estimated value of the output of
the industry is of the order of Rs.1000 crore, out of which goods worth about Rs.700 crore are
exported.
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Problems of the Industry:

The Indian jute industry has been facing a number of problems of which the following are the
important ones.
(a) Problem of Raw materials:
The partition of the country in 1947 gave rise to the problem of raw-materials.
Inspite of vigorous efforts to produce raw-jute by extensive and intensive cultivation
even at present the supplies of raw-jute are inadequate and irregular.
(b) Problems of Modernisation:
Machinery of the Indian jute industry is to a large extent old and obsolete. As a
result production is uneconomic and cannot be sustained for long without
modernization . Unless we modernize our plants and equipments, it will be extremely
difficult for us to compete with low priced jute goods produced by new mills set up in
Bangladesh and other countries .
(c) Problem of Substitution:
A more important and disturbing problem is the emergence of a new range of

packing material. Paper and plastic bags and covering and specially designed cloth
wrappings have proved to be extremely competitive substitutes for jute bags and
wrappings. All these developments adversely affected the demand for jute products
and its competitive strength in the world market.
(d) Decling Demand for Jute Goods.
Demand, especially from foreign markets, has been declining an account of the
following reasons. Synthetic producers are able to undercut jute in both the primary
and secondary backing markets. Cost of production of Indian jute industry is relatively
high. This has also adversely affected demand.
(e) Irregular Power Supply, Low yield per hectare, fall in export etc., are some other
problems facing this industry.
Government Measures
In order to enable the Indian jute industry to over come some of these difficulties and
barriers, the Govt. of India have been taking some short-term measures such as the
reintroduction of cash compensatory support to almost all types of jute goods to be exported,
insisting on Indian cement, fertilizer and some other industries to use only new jute bags, and
providing additional funds to Indian jute mills to purchase more raw-jute from jute
producers.
In addition, Govt. has announced a package of financial assistance from the Industrial
Reconstruction Corporation to sick jute mills. Govt. has also set up a separate fund to explore
the possibilities of increasing jute goods exports.
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Suggestions:
1. The government should announce a long-term policy on jute so as to protect the
interest of both jute growers and consumers.
2. There should be a monopoly procurement of raw jute by Jute Corporation of India.
3. The prices of raw-jute should be determined by an independent body like the

Commission on Agricultural Costs and Prices.
4. Attempts should be made to make the industry cost competitive.
5. There is an urgent need to intensify research and development activity in the jute
industry.
6. Diversify the jute products.
7. The import of machinery and spares should be liberalized.
8. To boost domestic demand for jute goods, mandatory use of jute goods is to be
envisaged.
Cement Industry
Cement is one of the key industries in India. It is a capital intensive industry. The first
cement manufacturing unit was started in 1904 in India. But the systematic manufacturing of
cement was started in 1914 by the India Cement Company Ltd. (Gujarat). At the beginning of
economic planning, there were 21 factories in India with an annual capacity of 3.28 million
tonnes.
The government had complete control over the production, distribution and price of
cement and this had dampened the growth of the cement industry. Later a policy of partial
decontrol was announced in 1982 and this policy was continued till 1989. The cement
industry was delicensed in 1991. The industry responded favourably to the government
initiatives and the production capacity also increased. Total production increased from a
mere 2.7 million tonnes in 1950-51 to 51.7 million tonnes in 1991-92 and finally to 190
million tonnes in 2009-10. At present (2011) there are 166 large cement plants in the country
with an installed capacity of 282.09 million tonnes per annum. Besides, there are about 350
mini -steel plants with an estimated installed capacity of 11.10 million tones per annum. Now,
India is the second largest producer of cement in the world after China. This industry
provides employment to about 2 lakh people. The production during 2010-11 rose to
223.6MT. During 2007-08, cement export was 3.65 million tones and it increased to 4.62 MT
in 2010-11.
The major Indian cement companies are Associated Cement Company (ACC), Grasim
Industries, Ambuja Cements, J.K. Cements and Madras cement.
The Indian government has ranked different states in India in terms of current
production. Rajasthan ranks first, (16.18%) followed by Andhra Pradesh (15.5%), Madhya
Pradesh (11.02%) Tamil Nadu (10.47%) and Gujarat (8.38%)
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Problems
The cement industry in India has been suffering from the following problems: a)
under-utilisation production capacity, b) cost escalation and rigid pricing, c) excessive burden
of excise duty, d) unrealistic distribution policy, e) partial control and dual pricing, f) Low
profitability and g) obsolete technology, etc.
Small-scale and Cottage Industries
Development in any system hinges on the growth of smalls first and bigs next. There is
a growing recognition worldwide that micro, small and medium enterprises (MSMEs) have an
important role to play in terms of resource use efficiency, capacity for generation of
employment, technological innovation, promoting inter-sectoral linkages, raising exports and
developing entrepreneurial skills. This is particularly true in the case of India.
Definition: There is no single, uniformly acceptable definition of a small or medium
enterprise. Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 provided
a comprehensive definition of Micro, Small, and Medium enterprises. Under the Act,
enterprises have been categorized broadly as : i) Manufacturing Enterprises and ii) Service
Enterprises. Both categories have been further classified into three groups as micro, small
and medium enterprises based on their investment in plant or in equipment as under.
A. Manufacturing Enterprises
i. Micro enterprises investment upto 25 lakh,
ii. Small enterprises investment above Rs.25 lakh and upto Rs.5 crore.
iii. Medium Enterprises investment above Rs.5 crore and upto Rs.10 crore
B. Service Enterprises
i. Micro enterprises - investmentuptoRs.10 lakh,
ii. Small enterprises investment above Rs.10 lakh and upto Rs.2 crore.
iii. Medium Enterprises investment above Rs.2 crore and upto Rs.5 crore
According to the Fourth All India Census Report of MSMEs, there were 2.61 crore
MSMEs in 2006-07. They represent 92 per cent of Indias registered companies. They account
for about 40 per cent of GDP and contribute about 50 per cent of exports. This sector accounts
for about 39 per cent of the manufacturing out put and 33 per cent of the total export of the
country. Of the total, 72 per cent of these enterprises are engaged in service sector and only
28 per cent of MEMEs constitute the manufacturing sector. These service sector units are
largely in Apparel (14.03%) and Maintenance of Personal and Household goods (9.25%). The
MSMEs sector accounts for employment of 5.95 crore persons, of which 0.95 crore are in
registered units.
New Small Enterprise Policy
Classified small enterprises under two headings : a) Small and tiny enterprises and b) Village
industries
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a) Small and Tiny Enterprises

According to this classification all units within the investment limit of Rs.5 lakh
and located in bigger towns (population of 50,000 plus) will now become a part of the
tiny group. All industry related services and business enterprises, irrespective of their
location are now recognized as small enterprises but their investment limit corresponds
to those of tiny enterprises.
b) Village Industries
A major objective for the group of village industries seems to be to promote rural
industrialization. The other major objective is to promote employment, which is more
welfare-oriented than efficiency oriented. A number of measures are proposed to achieve
these objectives, such as supply of raw materials, sale of products, upgradation of
production methods, etc.
Small scale and cottage industries
Small scale industries have emerged as a vibrant and dynamic sector of the Indian
economy. This sector plays a pivotal role in the Indian economy in terms of its contribution to
the countrys industrial production, exports, employment and the creation of an
entrepreneurial base.
Role of Small scale Industries (Rationale)
Small scale and cottage industries have an important role in Indias industrial and
economic development. The rationale of SSis (Small Scale Industries) can be explained in
terms of the following arguments.
i.
ii.
iii.
iv.
Employment Generation: The cottage and small-scale industries are believed to be

labour intensive, i.e. they use more labour with given amount of capital in comparison
to large-scale industrial units. It has been estimated that Rs.1 lakh of investment in
fixed capital in the SSI generates employment for 4 persons. Employment in the smallscale sector grew at the rate of 5.45 per cent per annum. It has been estimated that
labour intensity in micro and small enterprises sector is almost 4 times higher than the
large enterprises. In 2007-08 the SSI sector employed 322.28 lakh people.
Equitable Distribution of Income: Development of cottage and small-scale industries
helps to reduce income inequalities and secure more equitable pattern of income
distribution. This is accomplished because of two reasons. I) ownership of small-scale
industries is more widespread, and ii) labour intensive nature of production.
Use of Latent Resources: Development of village and small-scale industries in the
rural areas would lead to utilisation of latent resources such as hoarded wealth,
surplus rural man-power, local entrepreneurship and native skills.
Industrial Decentralisation: Development of cottage and small-scale industries

prevents concentration of industries at only a few places as it disperses them all over
the country. Small industry helps in fostering enterprises from amongst the members
of the castes, classes and professions which have hitherto not contributed to the
entrepreneurial class in India. All these will lead to a balanced regional growth.
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v.
vi.
Efficiency: Economists differ over the issue of efficiency in the small-scale industries
vis--vis large scale industries. Economists like Dhar, Lydall and Sandesara inferred
that modern small scale industry is less efficient relative to large scale sector industry.
However, some studies reached the conclusion that small scale is more efficient in
terms of labour productivity, total factor productivity and employment potentiality.
For instance, a rupee worth of fixed assets produced almost seven times an output in
small as compared to large industries and that the value added by a rupee worth of
fixed investment in small factories was at least three times as large as that for a large
factory. Similarly, it is found that organized sector requires an investment of Rs.5 lakh
to generate employment to one person whereas the SSI sector generates employment
for 7 persons with the same investment.
Less Industrial Disputes: Supporters of small-scale industries argue that small-scale
industries are free from industrial disputes and there is consequently less loss of
output. In the case of cottage industries, the question of disputes does not arise at all
since the main form of labour in these industries is family labour.
Other Arguments:
A.Economic Factors
i. The small-scale sector has certain inherent advantages in terms of flexibility of decisionmaking. This makes small firms more innovative and open to new ideas.
ii. This sector is better placed to cater to specific and changing customer needs.
iii. Small sector plays an important part in the innovation process.
iv. Small sector has build up brands that are small, reliable, trusted and local. These tiny
brands have remained small in their volume turn over but are truly big in their equity in the
markets they operate in.
B. Sociological Factors.
i. There exists in man a desire to gamble, so that he takes risks irrespective of consequence
and small industry provides an outlet for this desire.
ii. Man often enjoys the independence or status of an entrepreneur for its own sake, and this
is possible for men in small industry than in large industry.
Major Problems:
The small-scale and cottage industries face a number of problems. Let us now consider
the main problems that the small scale units have to face.
i.
Problem of Finance: The most important problem faced by those industries is that of
finance. The capital base of the small industrial units is usually very weak. These units
are forced to sell their products on credit basis to their clients. In many cases credit is
obtained on a very high rate of interest and is thus exploitative in character. Banks are
reluctant to lend to SSI units. They insist on collarteral. Further, with the
implementation of the Base II norms, banks would be discouraged to lend to SSI that is
not rated because a loan to an unrated entity will attract 100% risk weight.
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ii.
iii.
Problem of Raw-materials: Another problem affecting the SSIs is scarcity of raw

materials. Scarcity of raw-material means a waste of productive capacity for the
economy and a loss for the unit. The problem has assumed the shape (i) an absolute
scarcity, (ii) poor quality of materials and (iii) a high cost. Scarcity intensified
competition and the small units competing with the large scale producers have suffered
severely.
According to Sebastian Morris, tariffs on certain materials remain high in comparison
to tariffs on manufactured goods (other than consumer goods). This has created a
problem of a significant inversion in tariff structure which specifically hurts small
firms.
iv.
Problem of Technical know-how: One of the major handicaps of the small-scale

sector has been the absence of the latest technology. This sector is still saddled with
obsolete technology, resulting in poor productivity, inferior quality, excessive cost and
inadequate returns. Moreover, the small-scale units often do not care about the
changing tastes and fashions of the people. There is an urgent need for upgradation of
technology, otherwise technological polarization between the large and small-scale
sectors will be intensified.
v.
Ancillary industries have their own problems, like(i)delayed payment by parent

units,(ii) frequent changes in fiscal levies, (iii) absence of well defined pricing system
and regulatory system,(iv) inadequacy of technological support extended by parent
units. etc.
vi.
Problem of Marketing: Most of the SSI units do not have staying capacity and are
forced to sell their products to the local market at unremunerative prices. The inability
to procure clientele from distant markets compels them to restrict their scale of
operation and forgo economies of scale. Further on, in the post WTO scenario with the
removal of quantitative and non-quantitative restrictions across countries, SSIs would
have to face increasing competition from imports.
Problem of sickness: There are two main issues in respect of sick SSIs(i) existence of a
large number of sick units which are non-viable, and (ii) rehabilitation of potentially
viable units. At the end of March 2008 as many as 8,5187 units were sick and an
amount of Rs.13,849 crore was blocked in them. Rehabilitation is a costly proposition.
Exogenous Forces: There are some exogenous forces which influence the performance
of SSI. Such forces are exposing SSIs to a world of intensive competition, risk and
uncertainties. Some of these exogenous forces include advancement in generic
technology of computers and telecommunications, rise in E-commerce, globalization
and liberalization policies, multilateral trading rules under the WTO, mergers and
acquisitions, etc. For instance, opening up the industrial sector to both internal and
external competition, lowering of tariff, removal of quantitative restrictions, etc have
had an adverse effect on the small scale sector. The most serious threat is being posed
by cheap Chinese imports as the so called China Price is forcing many small scale
units to close down.
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vii. Infrastructural Constraints: Studies have shown that many productive activities of
SSIs are being constrained by inadequate physical infrastructure. The most severe
constraint is power. Power supply is not always everywhere available to the small
industry on the mere asking. Moreover, ulike large industries, the SSIs cannot afford to
go in for alternatives like installing own thermal units. Transport and communication
infrastructures are also universal constraints. In many SSI units (i.e. beverages, tobacco,
paints, varnish etc.) water supply is fast emerging as an important infrastructural
constraint.
viii. Other Problems: In additional to above mentioned problems, the small-scale

industries face a number of other problems like inefficient management, delayed
payments, location bars, lack of accommodation, deteriorating industrial relations, high
rate of mortality among units, faulty planning and inadequate appraisal of projects,
problem of recoveries, etc. All these constraints have resulted in a skewed cost
structure placing this sector at a disadvantage vis--vis the large industries, both in the
domestic and export markets.
Measures to promote SSIs (Government Policy)
It has been argued by some economists that small-scale industries are hampered in
their growth by imperfections in factor markets. Therefore, special support policies are
needed for small-scale enterprises. The policy of the Government of India towards the smallscale sector has been guided by this consideration. Amongst developing countries India was
the first to display special concern for small-scale enterprises, before it became fashionable to
do so. (Rakesh Mohan). In the post-reforms period, there has been a shift in focus from
protection to promotion.
Organisational Structure: In order to give more impetus to SSI, a number of Central and
State level organization have been set up to look after different aspects of the development
programmes. At the central level the following institutions have been set up.
a. Small Industries Development Organisation (SIDO) was set up in 1954. It functions

as an apex body in the formulation of policies and co-ordination of institutional
activities for sustained and organised growth of small-scale industries. SIDO has now
been renamed as the Micro, Small and Medium Enterprises Development Organisation.
b. Regional Small Industries Service Institutes (4) with a number of branches (30),
extension centres (38), field testing centres (18) were set up to provide technical
assistance to the small scale industries.
c. National Small Industries Corporation Ltd. (NSIC) was set up in 1955 to provide
machinery to small-scale units on hire purchase basis and to assist these units in
procuring orders from government departments and offices.
d. Small Industries Development Bank of India (SIDBI)
It is an apex all India financial institution set up in 1989. SIDBI is to function as

the principal financial institution for the promotion, financing and development of
industry in the small-scale sector. At the same time, it has to co-ordinate the functions
of institutions engaged in promoting the small-scale units.
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SIDBIs immediate thrust is on : (1) initiating steps for technological upgradation and
modernization of existing units.
ii. expanding the channels for marketing the products of SSIs in domestic and overseas
markets, and
iii. promotion of employment-oriented industries, especially in semi-urban areas to create
more employment opportunities .
SIDBI provides refinance to primary lending institutions like the commercial banks,
State Industrial Development Corporation, State Financial Corporations for meeting the Nidhi
Scheme, National Equity Fund Scheme, Seed Capital Scheme, etc. The SIDBI has also set up the
SIDBI Growth Fund and the National Fund for Software and IT industry.
i.
The major activities of the SIDBI are:

Refinance of loans and advances,
ii. Discounting and re-discounting of bills of exchange,
iii. Subscribing to or purchasing stocks, shares, bonds or debentures,

iv. Extension of seed capital or soft loans,
v. Granting direct assistance and refinancing of loans,
vi. Leasing any asset to any industrial concern in the small-scale sector.
e. National Institute of Entrepreneurship and Small Business Development

(NIESBUD)
It was established in 1983 to assist the small-scale industries. It co-ordinates
Entrepreneurship Development Programme (EDP) organized by various EDP institutions in
the country.
For cottage and traditional industries also, a number of institutions have been set up
both at the all India and state levels. These include All India Handloom Board (1955), All India
Handicrafts Board (1962), All India Khadi and Village Industries Board (1953) The Small
Scale Industries Board (1954), The Coir Board (1954) and the Central Silk Board (1949).
Financial Assistance: Several schemes were introduced to provide financial assistance to

small-scale industries. These include the following:
i. The Small Industries Development Fund (SIDF).
SIDF provides re-finance assistance for development, expansion, diversification

and rehabilitation of small-scale, cottage and village industries.
ii. National Equity Fund (NEF).
NEF provides equity type support to small entrepreneurs for setting up new
projects in tiny/small-scale sector and also assistance for rehabilitation of viable
sick units in the small-scale sector.
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iii. The Single Window Scheme (SWS).
iv.
SWS provides working capital loans along with term loans for fixed capital to new
tiny and small-scale units.
v.
vi.
vii.
viii.
Small enterprises are treated as a priority sector for extending credit by financial
institutions. As such 10 per cent of the total credit to be advanced by commercial
banks should go to SSI units.
The State Governments provides seed capital and margin money assistance to
small-scale entrepreneurs in order to enable them to secure loan from commercial
banks and the SFCs.
A credit Guarantee Fund Trust for small industries has been constituted.
The Industrial Development Bank of India (IDBI) provides funds to the commercial
banks and the State Financial Corporation (SFCs) through the scheme of
refinancing.
Public sector banks have decided to introduce a scheme called Laghu Udyami
Credit Card Scheme for providing simplified and borrower friendly credit facilities
to small entrepreneurs.
Technical Assistance
Technical assistance to SSI takes the form of identification of new lines of production,
assistance in installing plant and machinery and in solving various production problems from
time to time. Technical advice is also an important part of assistance.
Small Industries Service Institutes and State Government agencies have set up
common facility workshops and prototype and production centres.
A Quality Certificate Scheme was launched in 1994 to improve the quality standards of
SSI products.
A scheme introduced in 1993 aims to promote the adoption of clean technology by

small industries. The scheme covers three main areas. I) reduction of waste and pollution
from the manufacturing processes, ii) recycling, collection, storage and processing of
industrial and household wastes for re-use, and iii) effluent treatment and disposal.
A Small Enterprise Information and Resources Centre Network (SENET)
been set up by installing net link computers in various institutes.
has
There has also special training programmes in khadi and village industries conducted
by the KVIC for technicians, supervisors, managers and artisans.
The Council for Development of Rural Technology (CART) now renamed as CAPART
(Council for Peoples Action and Development of Rural Technology) acts as a nodal point for
the co-ordination of all efforts for the dissemination of technology relevant for rural areas.
The Technology Bureau for the Small Enterprises (TBSE) has been set up as an
endeavour to bridge the technology gap.
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Physical Facilities
The programme of Industrial Estates was initiated in 1955. The programme aims at
providing factory accommodation with infrastructural facilities such as water, power
transport, etc to small entrepreneurs at one place. One of the stated objectives of the
programme is to facilitate industrialisation of the economically backward and rural areas.
NABARD launched District Industries Project. Under this project efforts are being
made for creating an environment and infrastructure conducive to increased production and
income earning opportunities to the setting up of commercially viable unit in rural areas.
A merge plan to set up about 1000 rural technology parks was taken. This will provide
all the infrastructural needs in the village.
In 1994, the Infrastructural Development Scheme was started. It aims at providing

sites, power distribution network, water, raw material depots, storage and marketing outlets,
etc.
District Industries Centres (DICS) was introduced in 1978. The DICs were charged
with the responsibility of providing all the services and support required at pre-investment
and post investment stages to small scale entrepreneurs and institutions. The DICs provide
and arrange a package of assistance and facilities for credit guidance, raw-materials, training,
marketing etc, including the necessary help to unemployed educated young entrepreneurs in
general and custom services.
Marketing Assistance
Marketing assistance programmes mainly include:
a. Exclusive assistance of specific products of the SSIs for the Government.

b. Price preference to small-scale enterprise in public sector procedure.
c. Provision of quality control and testing facilities.
d. Opening sales emporia
e. Setting up of sub-contract Exchange for SSIs.
f. Launching of Market Development Assistance Scheme.

g. Plan to set up a consortium.
Fiscal Incentives:This includes tax holiday for new industrial undertakings, investment
allowances, capital subsidy to industries in backward areas, excise duty exemption, price
preference, etc.
Other Schemes: It includes the following : Rural Industrial Projects (RIP), Rural Artisan
Programme (RAP), etc
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Recent Policy Measures (1991 onwards)

The industrial policy measures announced in 1991 laid special thrust on promotion
and strengthening of small, tiny and village industries. Besides raising investment limits to Rs.
5 lakh, equity participation upto 24 per cent by other undertakings, a new scheme of
integrated infrastructure development for SSIs with the participation of state government
and financial institution was initiated.
A comprehensive policy package for the small-scale sector was announced on August
30, 2000. The main elements of this package were mentioned below.
1. Investment limit of the SSI has been increased to Rs. 5 crore.
2. The Government has enacted the Micro, Small and Medium Enterprises Development
(MSMED) Act 2006 to facilitate the promotion and development of micro, small and
medium enterprises.
3. The turn over eligibility limit under the general SSI Excise Exemption Scheme has been
raised from Rs.3 crore to Rs.4 crore.
4. The government launched the Credit Guarantee Fund Scheme for Micro , and Small
enterprises in 2000 with the objective of making available credit to SSI units .
5. To encourage technology up gradation , a credit linked capital subsidy scheme has
been launched .
6. A new Promotional Package for Small and Medium Enterprises is being formulated
.This would include measures to provide infrastructure and marketing facilities ;
fiscal support ,cluster based development , etc.
7. In recent times the Govt. has been following the policy of dereservation. At present ,
only 14 items are reserved for the small-scale sector
Modern industries (Sun Rise Industries )
1. Engineering industry
Engineering industry is one of the recently developed industries of the
country .The engineering industry was gradually being developed in the country
since the second plan .At present engineering industrial sector is contributing nearly
31.2 percent of industrial out put . The employment in the engineering industry is
nearly 28 percent of the total industrial employment in the country .Total investment
in the industry accounts nearly 31.5 percent of the total industrial investment of the
country . The share of engineering goods export to total export earning increased
from a mere 1.3 percent in 1960-61 to 11.9 percent in 1990-91
2. Electronic Industry
The development of the electronics has opened unimagined vistas in human

life. Electronic have become vital for modern industry , communication data
processing and strategic sector such as development and application atomic energy,
defence and space .
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Electronics industry is labour intensive and can employ a large trained man power.
It is not location specific and lends itself to regional dispersal and small- scale
production .
The Indian electronics industry has made rapid progress during the last four decades .
This industry covers a wide range of products and technology starting from
entertainment electronics to telecommunication equipment ,
industrial and
professional equipment like computers , defence and space electronics . it provides
direct employment to 2.60 lakh persons and indirect employment to more than 5
lakh people .
The Indian electronics industry is estimated to have had production wroth Rs.
3,68,220 crore during 2008-09 as compared to that of Rs 2,95,820 crore during 200708 , registering a growth rate of 24.4 percent. Production of electronics item is likely
to register a growth rate of 30 percent per annum during the Eleventh plan period .
Bangalore has emerged as the electronic capital of India .Other major
electronics goods producing centres are Hyderabad ,Delhi ,Mumbai , Chennai
,Kolkata, Kanpur ,Pune ,Lucknow and Coimbatore .
3. The Automotive industry
The automotive industry has growth at a spectacular rate of 17 percent over the last
five years . The industry provides direct employment to about 5 lakh people . At
present there are 15 manufactures of passenger car and multi utility vehicle , 9
manufactures commercial vehicles, 5 manufactures of engine . The turn over of the
automotive industry exceeded Rs 92,500 crore in 2003-04 .The automotiveindustry
recorded a growth 13.6 percent in 2006-07. In 2008-09 the industry has witnessed a
modest growth of 30 percent
4. Fertilizer industry
The first fertilizer plant was set up in India at Ranipet in Tamil Nadu in 1906. The
real growth of the industry began with the establishment of a plant at Sindri by the
Fertilizer Corporation of India in 1951. The increased demand for fertilizer as a result
of Green Revolution led to the spread of the industry in several parts of India .
Gujarat ,Tamil Nadu , Uttar Pradesh ,Punjab and Kerala produce more than half of the
total fertilizer production in India .
India is the fourth largest producer of fertilizer after China, the U.S and Russia .There
are , at present , more than 57 fertilizer ,units manufacturing a wide range of nitro
genous and complex fertilizers including 29 units producing urea and nine units
producing ammonium sulphate as by- product .
The production capacity of nitrogen has increased from modest 85000 tonnes in
1950-51 to 120.31 lakh tones in 2005 . Against the nominal production of 16,000
tonnes of nitrogen in 1950-51 the country produced 113.39 lakh tones of nitrogen
in 2003-04 The domestic production of urea in the year 2010-11 was 218.8 lakh
MT.
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5. Petro chemical Industry

The petro chemical industry is a post war phenomenon .Production of petro chemical
s increased from 7.M.T.in 2003-04 to 7.35 M.T in 2004-05. However , during the first
half of 2005-06 production of petro chemicals remained almost the same as in the
corresponding period of the previous year .
6. Chemical industry
The chemical industry occupies an important position in Indian economy. The

industry is growing fast . Rapid growth has been recorded in both inorganic and
organic chemical industries .Heavy organic chemicals provide basic building blocks
for many product like dyes, pharmaceutical , pesticides , paints , etc . Inorganic
chemicals included sulphuric acid, nitric acid ,alkalies ,soda ash and caustic soda .
It contributes 20 percent of the excise revenue to the government .Its
turnover is estimated at around us $ 35 billion in 2011.
7. Information Technology
The marriage of computer and communication has given birth to what is now called
information technology (IT) . This industry is popularly known as InfoTech industry .
Recognizing the huge potential of IT and IT enabled services , top priority has
been given for its promotion and development . The total number of professional
employed in this sector increased to 2.2 million in 2008-09 .The volume of software
and IT enabled services (ITES ) exports from India grew from Rs 28,350 crore in
2000-01 to Rs 103,200 Crore in 2005-06 .Total revenue earned from software and
services industry increased from $ 39.3 billion in 2006-07 to $ 52.0 billion 2007 -08 .
8. Software industry
The one industry which has profited most from the bourgeoning of IT revolution and
economic liberalization is the software industry .AS a result soft ware industry has
emerged as one of the stand out sectors of the economy , recording a growth
of24.0 percent in production and an increase in export by 31.5 percent in 2008-09
During 2009-10 software exports amounted to a total of $ 80 billion and the
domestic soft ware market a total of 10 billion. This shows that software is basically
an export based industry .
Towards end of 2008 , the IT sector began to suffer from adverse effects of
global slowdown . But it is being projected that important structural changes taking
place on the back of global economic meltdown will propel a new market order in
the domestic Indian IT/ITES industry.
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MODULE IV
EXTERNAL SECTOR
Trends and composition of Indias Imports - Trends and direction of Indias Exports - EXIM
Policy of India in relation to trade liberalization and its impacts-FDI, FII and MNCs in India External Borrowing and BOP problem in India International Institutions (IMF, WB, ADB,
WTO) and the Indian Economy.
The countrys external sector comprises its trade, investments, borrowings, the
relations with the international bodies etc. An understanding of such variables helps us in
understanding the strength and weakness of our economy. Trade policy reforms constitute
the core of economic reforms in India. This chapter analyzes Indias external sector while
highlighting the positive impact of Indias trade policy reforms. The trends in Indias foreign
trade, changes in the composition and direction of Indias exports and imports have been
examined in detail in the chapter. There has been a consistent increase in Indias exports and
imports and degree of openness to trade since 1991. Further, diversification of the export and
import basket and markets has reduced the vulnerability of the economy to external shocks.
Indias commitments to the WTO have also helped India to compete in world markets and
strengthen its external sector.
TRENDS AND COMPOSITION OF INDIAS IMPORTS
After independence, composition of Indias import trade has undergone many changes.
By 1975, imports of food grains, cotton, jute etc. increased very much. Imports of petroleum,
chemicals fertilizers, steel, iron, non-ferrous metals, industrial raw materials machinery,
capital goods, edible oils, un-cut precious stone etc. have increased.
Pattern of Imports
On the basis of the volume of imports, it has been divided into bulk imports and nonbulk imports. The bulk imports comprises Petroleum, crude and its products, bulk
consumption goods like cereals and pulses, edible oils and sugar and other bulk items like
fertilizers, non-ferrous metals, metallic ores, iron and steel, paper, rubber, pulp etc. The nonbulk imports comprises capital goods, export related items like pearls, precious metals,
chemicals textile, coal , artificial resins, plastic materials, non metallic mineral etc.
Changes in composition of Imports
After independence, composition of Indias import trade has undergone many changes.
By 1975, imports of foodgrains, cotton, jute etc. increased very much. Imports of pertroleum,
chemical fertilizer, steel, iron, non-ferrous metals, industrial raw materials, machinery, capital
goods, edible oils, un-cut precious stones etc., have increased. The important changes in the
composition of imports can be listed as follows.
1. The imports of agricultural products fell considerably. Agricultural products
include foodgrains, edible oils, raw cotton, jute etc. In 1970-71, the share of
agricultural products in the total imports was 14.6 % which came down to 2.1% in
2008-09.
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2. However, there has been a substantial rise in import expenditure on petroleum

products from Rs. 163 crore in 1970-71 to Rs.419946 crore in 2008-09. The
reasons for this increasing trend were firstly the increase in the prices of crude oil
and secondly increase in the demand of petroleum products for the expanding
industrial and transport sectors.
3. Increase in imports of capital goods consequent upon the programme of

industrialization initiated during the planning period import of machines, metals,
electrical equipments, transport equipments etc. increased considerably. The
expenditure on imports of capital goods were increased to 216511cr. in 2008-09
from 404cr.in 1970-71. However, in percentage terms, the share of capital goods
in total imports declined. In 1970-71, its share was 25% which declined to 15.75%
in 2008-09.
4. There has been substantial increase in the expenditure on imports of raw materials
and intermediate goods. In 1970-71, the percentage of expenditure on imports of
raw materials and intermediate goods was 54% of the total expenditure on
imports. It increase to about 82.15% in 2008-09.
5. The imports of chemical fertilizers have also increased during the same period
from 86 crore to 59569 crore.
TRENDS AND DIRECTION OF INDIAS EXPORTS
Since independence it is the percentage share of exports of agricultural products in

total exports has been declining e.g., in 1970-71 the agricultural products contributed 31% of
total export earnings. It declined to 9.2% in 2008-09. The main reason of this decline is the
increase in domestic demand of agricultural products due to increase in population. Hence
the availability of agricultural products for export has considerably declined.
The major changes in the sectoral composition of Indias export basket seen in the last
decade have accelerated in the beginning of this decade. While the share of petroleum crude
and product increased by 11.8 % during the 10 year period from 2000-01 to 2009-10. The
share of other two sectors, i.e., manufactures and primary products fell almost
proportionately over the same period. The biggest gainer is the engineering goods sector with
its share increasing from 15.7% in 2000-01 to 22.2% in the first half of 2011-12.
Export growth was high in 2010-11 and the first half of 2011-12 in case of agriculture
and allied products due to export growth in cereals, meat, oil meals and coffee. Among
manufactured exports, engineering goods, gems and jewellery, and chemicals and related
products registered high growth, while textiles export growth was moderate. Ores and
minerals is the only item with negative growth in the first half of 2011-12 due to a ban on
export of iron ore by the state governments of Karnataka and Odisha.
Since 2007-08, electronic goods have displaced leather and manufactures from fifth
place with the share of the former increasing and the later decreasing. There has been a
gradual shift in Indias manufactures exports from labor intensive like textiles, leather and
manufactures handicraft to capital and skill intensive sectors. Engineering goods exports has
seen an almost steady rise in shares from 1999-2000 to the first half of 2011-2012.
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Changes in the composition

The important changes in the composition of exports can be listed as follows.
1. A decline in percentage share from 41 in 1970-71 to 13.3 in 2008-09 of conventional

items like jute, tea food grains etc. in total exports.
2. Increase in percentage share of Manufactured goods in total exports. In 1970-71, the
share of manufactured goods in export earnings was 56%, by 2008-09 it increased to
66.4%.
3. Export of Gems, Engineering goods and Ready-made garments has emerged as an
important foreign exchange earner in recent years.
4. The composition of the export of agricultural products has undergone considerable

changes. In 1970-71, the export of rice was negligible. But in 2008-09 rice worth Rs.
11164 crore was exported.
5. Due to enhance refining capacity, India has also been exporting petroleum products. In
1970-71, petroleum products worth Rs.13crore were exported. In 2008-09 these have
increased to Rs. 127324 crore.
6. The continuous programmes of industrialization initiated during planning period,
export of engineering good rose substantially.
7. India is exporting software, consultancy services and other information technology

related services. Export of services are rising over 25% per annum during the last 10
years.
EXPORT-IMPORT (EXIM) POLICY IN INDIA
Foreign trade has played a crucial role in Indias economic growth. The composition
and direction of Indias foreign trade has undergone substantial changes, particularly, after
the liberalization process which began in the early 1990s. Our major exports now includes
manufacturing goods such as Engineering goods, Petroleum products Chemicals and related
products, Gems and Jewellery Textiles etc. which constitute over 80 per cent of our export
basket. On the other side, major import items constitute capital goods and intermediates
which not only support the manufacturing sector but also supply raw materials for the export
oriented units.
Trade Policy in India during the post independenceperiod
During the first five years after independence, the country had to led wartime controls.
Since our Balance of payment with the dollar area was heavily adverse and an effort was
made to screen imports from hard currency areas and boost up exports to this area so as to
bridge the gap. This also necessitated India to devalue her currency in 1949. Consequently,
the import policy continued to be restrictive during this period. Since then, liberalization of
foreign trade was adopted as the goal of the trade policy. Import license were granted
liberally. The export policy were also encouraged by relaxing export controls, reducing
export duties, abolishing export quotas and providing incentives to exports. This liberalized
policy led to a huge increase in our imports but export did not rise appreciably which might
have led to fast deterioration in Indias foreign exchange reserve then.
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After assuming the need for reversal of trade policy a re-orientation was made to
meet the requirements of planned economic development. A very restrictive import policy
was adopted and a vigorous export promotion drive was launched. The trade policy assumed
that a lasting solution to the balance of payments problem lies in the promotion and
diversification of our export trade. Similarly, import substitution industries should also be
encouraged so that dependence on foreign countries be lessened. It was this period that
Indias trade policy was thoroughly reviewed by the Mudaliar Committee in 1962. The
committee felt that developmental and maintenance imports were both essential for a
growing economy like India. Therefore the recommention of the committee led to an import
policy of restriction of non-essential goods on the one side and liberalization of imports of
essential good on the other was successful to a large extent. So that the imports were
controlled and exports were pushed up. This policy helped to reverse the persistent trade
deficit.
Trade policy in India since 1991was mainly aimed to cut down administrative controls
and barriers which acted as obstacles to the free flow of export and imports. Therefore, the
Government of India decided that while all essential imports like POL, fertilizer and edible oil
should be protected; all other imports should be linked to exports by enlarging and
liberalizing the replenishment license system. With a view to increase Indias share in the
international trade, Government of India has been making consistent efforts through various
policy initiates an reform measures. Accordingly, foreign trade policy underwent a
comprehensive change since 1991. Tariff restrictions have been considerably moderated and
presently it is the competition that prevails and not the quotas and tariffs. Efficiency is the
benchmark of growth, not merely expansion. Trade policy after 1991 is to facilitate
integration of the Indian markets with the rest of the world with a view to enhancing
economic growth through global competition and non-competitive controls and protection.
New Foreign Trade Policy(2009-14)
The Union Commerce Ministry, Government of India announces the integrated Foreign
Trade Policy (FTP) every year five years. This is also called EXIM policy. This policy is
updated every year with some modifications and new schemes. New schemes come into effect
on the first day of financial year ie. April 1,every year. The foreign Trade Policy which was
announced on August 28, 2009 is integrated policy for the period 2009-14. The policy aims at
developing export potential, improving export performance, boosting foreign trade and
earning valuable foreign exchange. FTP assumes great significance this year as Indias exports
have been battered by the global recession.
The major objectives of Foreign Trade Policy 2009-14 are the following
1. To arrest and reverse declining trend of exports is the main aim of the policy.
This aim will be reviewed after two years.
2. To double Indias export of goods and services by 2014.
3. To double Indias share in global merchandise trade by 2020 as a long term aim
of this policy. Indias share in Global merchandise exports was 1.45% in 2008.
4. Simplification of the application procedure for availing various benefits.
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5. To set in motion the strategies and policy measures which catalyse the growth
of exports.
6. To encourage exports through a mix of measures including fiscal incentives,

institutional changes, procedural rationalization and efforts for enhance market
access across the world and diversification of export markets.
Special Economic Zones (SEZ)
Another major policy issue in the trade sector which created a lot of heat was that of
Special Economic Zones. SEZ are growth engines that can boost manufacturing, augment
export and generate employment. The Act of SEZ-2005 supported by SEZ rules, came into
effect on February 2006. The main objectives of the SEZ Act are generation of additional
economic activity, promotion of exports of goods and services, promotion of investment from
domestic and foreign sources, creation of employment opportunities and development of
infrastructure facilities.
The SEZ require special fiscal and regulatory regime in order to impart a hassle free
operational regime encompassing the state of the art infrastructure and support services. The
policy is to provide an internationally competitive and hassle free environment for exports
and are expected to give a further boost to the countrys export.
The SEZ rules also provide for simplified procedures for development, operation and
maintenance of the SEZ and setting up units in SEZs, single window clearance both relating to
Central as well as State governments for setting up of an SEZ and units in a SEZ.
Various incentives and facilities are offered to both-units in SEZs for attracting
investments into SEZ and for SEZ developer. These incentive and facilities are expected to
trigger a large flow of foreign and domestic investment in SEZs, particularly in infrastructure
and productive capacity, leading to generation of additional economic activity and creation of
employment opportunities.
FOREIGN DIRECT INVESTMENT
Foreign Direct Investment (FDI) in India has played an important role in the
development of the Indian economy. FDI in India has in a lot of ways enabled India to achieve
a certain degree of financial stability, growth and development.
Definition: - FDI is an investment that a parent company makes in a foreign country.

FDI not only brings in capital but also helps in good governance practices and better
management skills and even technology transfer. The FDI flows into the primary market and
only targets a specific enterprise. It also aims to increase the enterprises capacity or
productivity or change its management control
Impact on India
Liberalizing FDI was another important part of Indias reform, driven by the belief that
this would increase the total volume of investment in the economy, improve production
technology, and increase access to world market. These reforms have created a very different
competitive environment for Indias industry than existed in 1991. Indian companies have
upgraded their technology and expanded to more efficient scales of production. They have
also restructured through mergers and acquisition and refocused their activities to
concentrate on areas of competence.
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India has continually sought to attract FDI from the worlds major investors. In 1998
and 1999, Government of India announced a number of reforms designed to encourage and
promote a favorable business environment for investors. FDIs are permitted through
financial collaborations, through private equity, by way of capital markets through euro
issues, and in joint ventures. FDI is not permitted in the arms, nuclear railway, coal and
mining industries.
A number of projects have been implemented in areas such as electricity generation,

distribution and transmission, as well as the development of roads and highways, with
opportunities for foreign investors. The Government of India also granted permission for
FDIs to provide up to 100% of the financing required for the construction of bridges and
tunnels. Presently, FDI is allowed in financial services, including the growing credit card
business. These also include the non-banking financial service sector. Foreign investors can
buy up to 40% of the equity in private banks, also there is condition that these banks must be
multilateral financial organization. In 2007, India received $34 billion in FDI, a huge growth
compared to the previous years, but significantly less than the $134 billion that flowed into
China.
FOREIGN INSTITUTIONAL INVESTORS
The introduction of foreign investment in Indian equity has not added significantly to
market liquidity or volatility of stock prices. However, the presence of FIIs in Indian markets
has contributed to the expansion of wholesale capital market and the evolution of the
institutions and financial structure in the country. This has given an extra momentum to
improve market efficiency and transparency.
Definition: - Foreign Institutional Investment is an investment made by an investor in
the markets of a foreign nation. In FII the companies only need to get registered in the stock
exchange to make investment. The FII is also known as hot money as the investors have the
liberty to sell it and take it back. These investment flows only into the secondary market. It
helps in increasing capital availability in general rather than enhancing the capital of a
specific enterprise.
Impact on India
Portfolio investors may become the ultimate arbiters of national macro economic
policy to the determinant of economically vulnerable groups. Under floating exchange rate, a
withdrawal of portfolio investment may trigger a nominal and real depreciation of the
domestic currency.
Securities and Exchange Board of India (SEBI) is the nodal agency for dealing with FIIs.
FIIs include asset management companies, pension funds, mutual funds, investment trusts as
nominee companies, institutional portfolio managers, university funds, endowment
foundations, charitable trust and charitable societies. FII investment is frequently referred to
as hot money for the reason that it can leave the country at the same speed at which it comes
in. In India statutory agencies like SEBI have prescribed norms to register FIIs and also to
regulate such investments flowing in through FIIs. FEMA norms include maintenance of
highly rated bonds with security exchange.
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MULTINATIONAL CORPORATIONS
An MNC (Multinational Corporation )is one which undertakes FDI. It means the MNC
owns or controls income generation assets in more than one country. It also does the
production of goods or service outside its country of origin. The MNCs are multi-process,
multi-national composite enterprises. The assets and sales of MNCs run into billions of dollars
and they also make supernormal profits.
Till 1991, India was more or less a closed Economy. The rate of growth of the economy
was limited. The contribution of the local industries to the countrys GDP was limited that
were the main cause of shortage of funds for various development projects initiated by the
government. In an effort to revive the industries and to bring the country back on the right
track, the government began to open various sectors such as Infrastructure, Automobile,
Tourism, Information Technology, Food and Beverages, etc to the Multinational Corporations.
The MNCs slowly but reluctantly began to pour capital investment, technology and other
valuable resources in the country causing a surge in GDP and upliftment of the economy as a
whole. This was the post 1991 era where the government began to invite and welcome giant
MNCs into the country.
The opportunities for developing economies are significant as well. Through the
application of capital, technology, and a range of skills, multinational companies' overseas
investments have created positive economic value in host countries, across different
industries and within different policy regimes. The single biggest effect evidenced was the
improvement in the standards of living of the country's population, as consumers have
directly benefited from lower prices, higher quality goods, and broader selection. Improved
productivity and output in the sector and its suppliers indirectly contributed to increasing
national income. And despite often-cited worries, the impact on employment was either
neutral or positive in two-thirds of the cases.
Investments by multinational companies (MNC) allow developing economies to share
in the considerable benefits of the global economy. Official incentives, trade barriers, and
other regulatory policies, though, can result in inefficiency and waste.
Case studies reveal that in virtually all cases, MNC investment had a positive to very positive
impact on the host country. Rather than leading to the exploitation of lower-wage workers, as
some critics have charged, the investments fostered innovation, productivity, and an
improved living standard. Therefore, government seeking those advantages would be advised
to favor policies of openness, rather than regulation, when it comes to foreign direct
investment.
In 2007, exports stood at US$145 billion and imports were around US$217 billion.
Textiles, jewellery, engineering goods and software are major export commodities while
crude oil, machineries, fertilizers, and chemicals are major imports. India's most important
trading partners are the United States, the European Union, and China. India is the world's
most-populous democracy and has one of the fastest economic growth rates in the world (8.9
percent GDP increase in 2007, the second-fastest major economy in the world after China).
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Multinational companies are like double-edged sword. The sword can harm if not
handled properly. Similarly the Multinational companies have their own pros and cons.
The extent of technology and management of know-how transfer by the MNCs depend to a
large extent on their corporate strategy; for example, firms desiring to have a longer-term
relationship with the suppliers (rather than those simply using the host country as a
marketing/export base) will be more inclined to effect transfer technology.
As pointed out in the World Investment Report, 2000, MNCs may restrict the access of
particular affiliates to technology in order to minimize inter-affiliate competition. It is noted
that MNCs are more likely to license older technologies from which they have already derived
significant rents than newer technologies on which there are still relying for market
leadership. Further, they may hold back the upgrading of the affiliate technology or invest
insufficiently in host-country training and R&D in accordance with their global corporate
strategies. Therefore, arguing that FDI inflows and economic liberalization automatically
facilitates technology transfer is being extremely nave.
INTERNATIONAL MONETARY FUND (IMF)
International Monetary Fund is the inter-governmental organization that oversees the

global financial systems by following the macroeconomic policies of its member nations, in
particular, those countries with an impact on exchange rate and the balance of payments. The
IMF was conceived in July, 1944 during the United Nations Monetary and Financial
Conference. Later, it was formally organized on December 27, 1945, when the first 29
countries signed its Articles of Agreement at the Conference of Bretton Woods. Its head
quarters are in Washington DC, United States of America. The IMF is accountable to the
governments of its member countries. The IMFs resources are provided by its member
countries, primarily through payment of quotas, which broadly reflect each countrys
economic size.
Activities of IMF
The IMF is generally, responsible for promoting the stability of the international
monetary and financial system-the system of international payments and exchange
rates among national currencies that enables trade and financial transactions to take
place between countries.
The IMF works to promote global growth and economic stability-and thereby prevent
economic crisis-by encouraging countries to adopt sound economic policy.
Usually once a year, the IMF conducts in-depth appraisals of each member countrys
economic situations and policies, and advises on desirable policy adjustments.
In the event that member countries do experience crises, the IMF resources may be
trapped to help finance balance of payments needs.
In low-income countries, the IMF provides financial support through its concessional
lending facilities-the Poverty Reduction and Growth Facility (PRGF) and the
Exogenous Shock Facility (ESF)- and through debt relief under the Heavily Indebted
Poor Countries(HIPC).
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Special Drawing Rights (SDR)

Special Drawing Right was created by the IMF in 1969 to support the Bretton Woods
fixed exchange rate system. The SDR is neither a currency, nor a claim on the IMF. Rather, it is
a potential claim on the freely usable currencies of IMF members. Today, the SDR has only
limited use as a reserve asset, and its main function is to serve as the unit of account of the
IMF and some other international organizations.
A country participating in this system needed official reserves-government or central

bank holdings of gold and widely accepted foreign currencies- that could be used to purchase
the domestic currency in world foreign exchange markets, as required maintaining its
exchange rate. But the international supply of two key reserve assets- gold and the US dollar
proved inadequate for supporting the expansion of world trade and financial development
that was taking place. Therefore, the international community decided to create a new
international reserve asset under the leadership of the IMF. However, only a few years later,
the Bretton Woods system collapsed and the major currencies shifted to a floating exchange
rate regime.
India and IMF
India joined the IMF on December27,1945. As a founder-member of the IMF, India was
initially assigned a quatas of 400 million dollar or 5.2 percent of the total. Being the fifth
largest quota holder, India was also given a seat on the IMFs Executive Board with successive
reviews, however Indias quota share has dwindled.
The finance minister is the ex-officio founder member of IMF Board of Governors. Till
1970, India was among the first five nations having the highest quota with IMF and due to this
status India was allotted a permanent place in Executive Board of Directors. After the recent
review of IMFs General Quota share has been raised from 2.44% to 2.75% placing India at
eighth position in General Quota. In July 2004, Joint India-IMF Training Programme at the
National Institute of Bank Management, Pune was established. The training programme will
provide policy oriented training in economics and related operational fields to Indian official
and officials of countries in South Asia and East Asia.
As a member of the IMF, India has derived following benefits:
a) Foreign exchange for meeting balance of payments deficits.

b) Oil facility from the IMF.
c) Assistance under the extended credit facility.

d) Financial assistance.
India has been one of the major beneficiaries of the Fund assistance. India borrowed
eight times between 1957 to 1975. Besides receiving loans to meet deficits in its balance of
payments India has benefited in certain other respects from the memberships of the Fund.
The role and responsibility of the IMF has been increasing with passage of time since its
inception. Thus, it has been helping members especially developing countries in many ways
for the promotion of economic development and stabilization of balance of payment.
Indian Economy
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WORLD BANK
World Bank is one of the Bretton Woods twins and came into existence in December
27, 1945. The World Bank group is a family of five international organizations that provide
leveraged loans, generally to poor countries. Its five agencies are the following.
1. International Bank for Reconstruction and Development (IBRD)
2. International Development Association (IDA)
3. International Finance Corporation (IFC)
4. Multilateral Investment Guarantee Agency (MIGA)
5. International Centre for Settlement of Investment Dispute (ICSID)
The chief functions of WB are to help in reconstruction and development of its

member countries by facilitating investment and productive deployment of capital, to arrange
for loans for taking up infrastructural and social development projects.
India and World Bank
India has been borrowing from the WB through IBRD and IDA for various
development projects in the areas of poverty alleviation, infrastructure, rural development
etc. IDA funds are one of the most concessional external loans for Government of India and
are used largely in social sector projects that contribute to the achievement of Millennium
Development Goals. IBRD funds are relatively costlier but cheaper than external borrowings.
In India the Government utilizes IBRD loans primarily for infrastructure projects. The
Government of India and the WB signed a Credit Agreement of $1billion for the National
Rural Livelihoods Project (NRLP). This project will strengthen the implementation of the
newly launched National Rural Livelihood Mission (NRLM).
WORLD TRADE ORGANIZATION(WTO)
The World Trade Organization is an international organization designed by its

founders to super view and liberalizes international trade. The organization officially
commenced on January 1, 1995 under the Marrakesh Agreement, replacing the General
Agreement on Tariffs and Trade (GATT), which commenced in 1947. The WTO deals with
regulation of trade between participating countries. It provides a framework for negotiating
and formalizing trade agreements and dispute resolution process aimed at enforcing
participants adherence to WTO agreements. Its head quarter is in Geneva, Switzerland.
The WTO has 154 members, which represents more than 95% of total world trade.
The WTO is governed by a Ministerial Conference, which meets every two years; a General
Council, which implements the conferences policy decisions and is responsible for day-to-day
administration; and a director general, who is appointed by the Ministerial Conference. The
inaugural ministerial conference was held in Singapore in 1996. Disagreement between
largely developed and developing economics emerged during this conference over four issues
initiated by this conference, which is also known as Singapore issues.
Indian Economy
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Issues in WTO
Agriculture has become the linchpin of the agenda for both developing and developed
countries. Three other issues have been important. The first, now resolved, related to
compulsory licensing of medicines and patent protection. Second deals with a review of
provisions giving special and differential treatment to developing countries. Third addresses
problems that developing countries are having in implementing current trade obligations.
The Singapore issues refers to four working group set up during the WTO Ministerial
conference of 1996 in Singapore. These groups are tasked with the issues like: transparency
in government procurement, trade facilitation (customs issues), trade and investment, and
trade and competition. These issues were pushed at successive ministerial by the European
Union. Japan and Korea, and opposed by most developing countries. The United States was
lukewarm about the inclusion of these issues, indicating that it could accept some or all of
them at various times, but preferring to focus on market access.
Agreements
The WTO oversees about 60 different agreements which have the status of international
legal texts. Member countries must sign and ratify all WTO agreements on accession. Some of
the most important agreements follow.
a) General Agreement on Trade in Services (GATS): This was created to extend the
multilateral trading system to service sector. The Agreement entered into force in
January 1995.
b) Trade-Related Aspects of Intellectual Property Rights Agreement (TRIPS) : This

agreement sets down minimum standards for many forms of Intellectual Property
regulation. It was negotiated at the end of the Uruguay round of the GATT in 1994.
c) Sanitary and Phyto-Sanitary Agreement (SPS): Under this agreement, the WTO sets
constraints on members policies relating to food safety as well as animal and plant
health (imported pests and diseases).
d) Agreement of Technical Barriers to Trade (TBT): The object of the TBT Agreement is to
ensure that technical negotiation and standards, as well as testing and certification
procedures, do not create unnecessary obstacles to trade.
India and WTO
The organization is currently endeavoring to persist with trade negotiation called Doha
Development Agenda (Doha Round), which was launched in 2001 to enhance equitable
participation of poorer countries. The Doha Round of trade negotiations is important for the
developing
countries
like
India.
The
main
negotiating
issues
in
the
WTO from Indias perspective are
1. In the case of agriculture, there has been reduction in overall trade-distorting support
by developed countries.
Indian Economy
Page 110
2. The Special and Differential (S&D) treatment for developing countries must be
substantial. And the Non-Tariff Barriers such as horizontal mechanism must be taken
up.
3. Clarifying and improving, anti dumping Agreement and the Agreement on Subsidies
and Countervailing Measures.
4. Establishing a clear linkage between the TRIPS Agreement and the Convention on
Biodiversity.
ASIAN DEVELOPMENT BANK
The Asian Development Bank is a regional development bank established in 1966 to

promote economic and social development in Asian and Pacific countries through loans and
technical assistance.
It is a multinational regional development bank established for the purpose of lending
funds, promoting investment and providing technical assistance to the developing member
countries and generally for fostering the economic growth and co operation in the asian
region. Its head quarters are located at Manila in Philippines.
ADB is managed by a Board of Governor, a Board of directors, a president, four vicepresidents and the heads of departments and officers. Each member country nominates one
governor and alternate governor to vote in its behalf. Its mission is to help its developing
member countries reduce poverty and improve the quality of life of their citizen. The bank
was conceived with the vision of creating a financial institution that would be Asian in
character to foster growth and cooperation in one of the worlds poorest region.
Objectives and functions of the ADB
The basic objective of the ADB is to promote economic development of and mutual
cooperation among the countries of Asia. The ADBs objective is to help accelerate the process
of economic development of developing countries in the Asian region. To realize the objective
the ADB performs the following functions.
1. To promote investment of public and private capital for economic development of

Asian countries.
2. To channelize the funds of the ADB for the implementation of those projects which
are important for the development of major sectors of the countrys economies.
3. To render assistance to member countries in co-ordinating their programmes and

policies of economic development and at the same time to promote interregional
trade and cooperation among countries of the Asian region.
4. To promote technical assistance for the execution of projects.
5. To mobile fund for economic development of member countries by extending

cooperation to the World Bank and other UN bodies and public as also private
institutions located among member-countries.
Indian Economy
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India and ADB

It may be noted that India has started borrowing from the ADB since 1986. Indias
borrowing from the ADB amounted to 250 million US Dollars in 1986. India had received 65
loans amounting to 5.8 billion US dollars at the end of 2000 for infrastructure, energy and
financial sectors.
There are many criticisms that are generally made in regard to the role and
functioning of the ADB. Most importantly, it is alleged that the role and working of ADB is
greatly influenced by United States. And it is also alleged that ADB provides tied loans and
complex borrowing, countries to use those loans only for the specified projects.
Although recent economic growth in many member countries have led to a change in
emphasis to some degree, throughout most of its history the Asian Development bank has
operated on a project basis, specifically in the areas of infrastructure investment, agricultural
development and loans to basic industries in member countries. Although by definition the
ADB is a lender to governments and government entities, it also provides direct assistance to
private enterprises and has also participated as a liquidity enhancer in the private sectors of
regional member countries.
EXTERNAL BORROWING AND BALANCE OF PAYMENT PROBLEM IN INDIA
Indias external debt has increased over time and India is one of the highly indebted
countries of the world in terms of total debt outstanding. External debt increased from US
$83.8 billion in 1990-91 to US $326.6 billion at end September 2011. The increase in the
external debt was primarily on account of higher commercial borrowing and short term debt
which together contributed over 80% of the increase in the countrys external borrowing.
The maturity profile of the Indias external debt indicates the dominance of long term
borrowings. The long term external debt at US $ 255.1 billion at end of September 2011,
accounted from 78.1% of total external debt, while the remaining 21.9% was short term debt.
However, Indias external debt has remained within manageable limits as indicated by the
external debt to GDP ratio of 17.8% and debt to service ratio of 4.2% in 2010-11.
Trends in Balance of Payment
India had faced pressure on balance of payment since planning period due to either
internal or external factors. The whole period of planning is more than six decades, can be
divided into four sub-periods depending on the nature of BoP problems, overall economic
environment and external aid situation.
Period I (1956-57 to 1975-76)
This period comprising the second, third and fourth plans and first two years of fifthe
plan saw heavy deficit in balance of payments and extremely tight payment position. This
period witnessed three wars, several droughts and the first oil shock in 1973, though the
government resorted to serve import controls and foreign exchange regulation etc.
Indian Economy
Page 112
Period II (1976-77 to 1979-80)
This was relatively short period and was a golden period as far as BoP is concerned. In
this period, India had a small current account surplus of 0.6% of the GDP, and also possessed
foreign exchange reserves equivalent to about seven months imports. The country had got
relatively comfortable position on the BoP front due to the rapid increase in private
remittance from oil exporting countries and there was a strong growth in export too. The
elimination of large price gap between domestic and foreign markets of gold was also helped
to strengthen the BoP in India. Aid receipts were reasonably buoyant and India drew on
various IMF facilities during this period.
Period III (1980-81 to 1990-91)
This period broadly corresponds to the period of sixth and seventh plans and was
marked by severe BoP difficulties. Widening trade deficit, gradual decline in net receipts from
invisibles, the reductions in flows of concessional assistance from World Bank and the third
oil shock during 1990-91 were the chief reasons for the problems in BoP in India during third
period.
Period IV (1991-92 onwards)
In 1991, India found itself in its worst balance of payments crisis since independence.
The inflow of foreign borrowing had increased at a rapid rate during the late eighties. This
was due to the excess domestic expenditure over income-the fiscal deficit of Centre and the
States soared to over 11 per cent in 1991. During this period total public debt as the
proportion of GNP doubled reaching the level of 60 per cent and foreign currency reserves
were depleted rapidly.
The reforms of 1990s have facilitated India to move away from closed economy
framework towards a more open and liberal economy. Due to the liberalized foreign trade
deregulated industrialization and the thrust on globalization had made the countrys balance
of payment become stronger. The foreign exchange reserves were built to very comfortable
positions and the problem of BoP has come under control.
Reasons for Deficits in Indias Balance of Payments
The important reasons for deficit in Indias BoP position can be listed as follows.
1. Rise in imports :- The reasons for rapid rise in imports are building industrial base,
increase in export related imports ( gems, jewellery, capital goods) increase in imports
of industrial raw materials, rise in the price and imports of POL
( petroleum, oil
and lubricants )products etc.
2. Devaluation and depreciation of the rupee: - The devaluation and depreciation of the
rupee have led to an increase in the price of imports. Exports have become cheaper,
the low price and income elasticity of demand for exports have resulted in slow
increase in exports.
3. Slow rise in export earnings: - Export earnings rose, however, they were not sufficient
to meet the rising imports. Thus, rise in exports has neither been substantial nor
continuous. Therefore, the growth in export has not been enough to finance the rising
imports.
Indian Economy
Page 113
4. Debt-Service: - The balance of payment problem has also aggravated due to the rising
obligation of amortization payments in 2008-09, debt-service ratio was 4.4% with the
ever increasing imports and slow pace of exports, the most effective solution for
Indias balance of payments problem is cost reduction and competitiveness in global
market.
References:
Uma Kapila, (2008) Indian economy: Performance and Policies, Academic Foundation, New
Delhi.
Prakash, B.A. (2009) Indian Economy since 1991: Economic Reforms and Performance, Sage,
New Delhi.
EPW Various Issues
Yojana Various issues.
**********
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