Class XI - India's Economic Development

Chapter 1

Before British India had a independent economy - agricultural + manufacturing involved

handicrafts industry
[Francois Bernier - French traveler - visited India (Surat) - he was physician of Darah Sikoh
and later Aurangzeb]
British didnt allowed any industry to come up in India
To make India a net exporter of raw materials
To provide market to British companies for finished products
India had a net export surplus but this was used by British to pay the offices set up and for
war expenses and others
1881 - first census held in India
Railways was developed to ease them in transporting raw material and finished products

Chapter 2

Modernization refers not only to use of new technology of production but also change in
social outlook - for eg women should have equal rights as that of men
Self reliance - it was feared that dependence of food imports, outside technology can make
India sovereignty influenced by foreign countries
Class XII - Microeconomics

 Chapter 1

1. 'scarcity of resources leading to problems of choice'
2. Central problems of economics
a. What to produce and in what quantities?
b. How to produce?
c. For whom these are produced?
1. 'allocation of scarce resources and distribution of final goods is the central problem of
economics'
1. Production Possibility Frontier/Curve [PPF/PPC]
2. Centrally planned economy vs the Market economy
a. All decisions taken by government vs leaving production decisions to market
mechanisms [Adam Smith's invisible hand]
b. Though, in practice all present day economies are mixed economies with varied level of
govt. control [more in China and less in US, etc.]
3. Positive Economics vs Normative Economics
a. Studying different mechanisms vs finding whether these mechanisms are suitable or
not
b. Though this distinction is not that sharp

Chapter 2

1. Indifference Curve
a. Slopes downwards
1. Optimal point for consumer is where budget line is tangential to the indifference curve
 1. Law of Demand
2. Normal vs Inferior goods
a. Inferior goods - demand falls as income increases - [ nano lene wale b alto lenge salary
bdhne pe]
b. Two effects - income effect & substitution effect -> works counter to each other
i. Substitution Effect - change in demand of X associated with a change in price of X
with level of utility held constant
ii. Income Effect - change in demand of X associated with a change in income with
price of X held constant
c. When income effect > substitution effect -> Giffen goods [the price of a good increases
people buy more of it]
*Giffen goods are basically inferior goods but with no close substitutes
a. Income effect < substitution effect -> normal goods
1. Substitutes vs Complementary Goods
a. Subs - tea & coffee - ek k daam kam ho to dusre k maje lo
b. Comp - tea & sugar - price of sugar increases => demand of tea falls
1. Elasticity of demand = % change in demand / % change in price
a. It depends on nature of good + availability of close substitutes
b. Food is inelastic whereas iPhone is elastic
c. In Food also - one type of pulse can be elastic -> people can shift to other if price of
one increases
1. Engel Curves - relate quantity of good consumed to income

* Engel curves are upward sloping for normal goods and downward sloping for inferior goods. In
 the example above we have a hamburger which is a normal good for income level of below 20 but
inferior good for income level of above 20.
1. Consumer Surplus - what a consumer is willing to pay for a good - what he actually pays
2. Externalities - purchase of a good by Tom influencing choice of Dick and Harry
a. Positive - Tom's purchase increases Dick and Harry's demand
i. The Bandwagon Effect - if BHAI wears orange jeans demand of orange jeans will
increase among Bhai followers - desire to be in fashion - swag
b. Negative - decreases
i. The Snob Effect - desire of being exclusive - if Anil has Ferrari and Mukesh also
buys a ferrari - Anil has to buy Lamborghini

Chapter 3

1. Production function - relation between inputs used and output produced by a firm
a. For various quantities of input used, it gives the maximum output obtained
b. It considers only efficient use of inputs - optimal output
2. Isoquant - a graphical way to represent production function - set of all possible values of two
factors that give the same maximum output

1. Short run vs Long run -> in short run firm cannot vary all factors of production whereas in
long run it can.
a. Fixed factor and variable factors - in short run
1. Total Product - if we keep all the factors of production constant except 1 and we vary this
factor to obtain different outputs -> total product
 a. Relationship between the variable factor and the product obtained at any particular
value of the variable factor
2. Average Product - total product / variable factor
1. Marginal Product - change in output / change in variable factor

a. In the above table we can see that cumulative sum of Marginal Product gives us the total product

1. Law of diminishing marginal product -> on increasing the variable factor, we will reach a point where
marginal product will start to decrease
2. Law of variable proportions -> marginal product of a variable factor initially rises but after a point, it
starts falling
*These two are somewhat related concepts
1. Returns to scale [RTS] - if we increase all input simultaneously then
a. Constant RTS - output and input changes in same proportion
b. Increasing RTS - output increases more than input
c. Decreasing RTS - output increases less than input
1. Cost function - output - cost relationship of a firm [ a particular output can be obtained by various
combinations of inputs - which should firm use? - depends on cost ]
a. Total Cost = Total Variable Cost + Total Fixed Cost
b. Short Run Average Cost = Total Cost / Total production
c. Average Variable Cost = Total Variable Cost / Total Production
d. Short Run Marginal Cost = change in Total Cost / Change in Production






Chapter 4

1. Total Revenue = Price of one unit * # unit
2. Average Revenue and Marginal Revenue [ increase in revenue for one more unit of production]
3. Marginal revenue = market price -> perfect competition
4. Perfect Competition
a. Conditions
i. Many players offering the same product
ii. No barriers to entry
iii. No advantage to existing firms
iv. Good price information for both buyer and seller
v. Firm is price taker - means market sets the price which firm adopts

a. Though no market is perfectly competitive

b. Eg. Airline industry
c. If economic profit is positive more and more firms will enter the sector till the economic profits
becomes neutral
d. If economic profit is negative then firms will exit the sector till price rises and again the economic
profit becomes neutral
e. In short run - firms can make supernormal profits


 a. Due to this new firms are attracted to the sector which increases supply in the market. As the supply
increases - price falls and all firms start making normal profits [just enough to cover their opportunity
costs]

1. Monopoly
a. Conditions
i. One player
ii. Huge barriers to entry
iii. Ultimate advantage for existing players
iv. Price info - not imp - as there is only one player
b. They can set the price anywhere they wish because they are the price setters
*though perfect monopoly is difficult to be seen in today's market structure, for the purpose of regulation monopoly
exists if a company has 25% or more market share.
1. Monopolies can maintain supernormal profits in long-run
a. MC = MR

a. Leads to higher prices for customers -

The traditional view of monopoly stresses the costs to society associated with higher prices. Because of
the lack of competition, the monopolist can charge a higher price (P1) than in a more competitive market
(at P).
The area of economic welfare under perfect competition is E, F, B. The loss of consumer surplus if the
market is taken over by a monopoly is P P1 A B. The new area of producer surplus, at the higher price P1,
is E, P1, A, C. Thus, the overall (net) loss of economic welfare is area A B C.
The area of deadweight loss for a monopolist can also be shown in a more simple form, comparing perfect
competition with monopoly.

a. Though there are some advantages also but they are overshadowed by disadvantages
 i. High profits can lead to higher R&D
ii. Can lead to innovation as the company in dominant position has nothing to fear
1. Monopolistic Competition - [Chowmien-Momo]
a. Conditions
i. Large number of independent firms selling differentiated products
ii. Firms are price maker - they set their own price depending on their product and costs of
production
iii. No major barrier to entry or exit
iv. They have to engage in fierce advertisements to advertise their product
b. In short run - supernormal profits are possible
c. In long run - normal profits as new firms will enter, existing products will become more elastic
and demand curve shifts to left, and reduce the price
d. Firms benefit most by staying in short run and they will try to do that by keep on innovating.
2. Oligopoly
a. Only few firms dominate the market and share among them
b. Herfindahl - Hirschman Index - measures concentration in a market - whether oligopoly or not
c. Interdependence - IOCL & HPCL have their petrol pumps
i. IOCL wants to increase market share by decreasing price
ii. If it decides to do so - it has to consider that what if HPCL also retaliates with a price cut
d. Barriers to entry - natural + artificial
i. Natural - high costs + economies of scale to existing firms + control of resources by
existing firms
ii. Artificial - Predatory pricing - existing firms decrease prices to force out rivals
1. Limit Pricing - incumbent firm sets low price and high output so that entrants can't
make profit at that price
2. Loyalty Schemes
 3. Predatory Acquisition - acquire rival firms - it may be regulated by govt.
4. Exclusive patents/contracts
5. Vertical integration - managing whole supply chain - Heinken - beer brew -> sold in
their own pubs
e. Price competition - leads to price wars and declining revenues
f. Best strategy is to be in Non- price competition
i. Try to improve quality
ii. After sales service
iii. Promotional offers, etc.
g. There is a strong tendency to form cartels as cooperation is the most beneficial strategy for
firms [Prisoner's Dilemma]
Class XII - Macroeconomics

Chapter 2

1. Final Good - an item meant for final use and doesnt have to go through any further stages of
production
2. Estimation of National Income
a. Product Method/ Gross Value Added Method
i. Aggregate value of goods and services produced in an economy in an year
ii. We consider the value added by a firm = value of a firm's produce - value of intermediate
goods used in production = Gross Value Added [GVA]
iii. Net Value Added [NVA] = GVA - depreciation
iv. Depreciation comes because in making a final produce the machines used may undergo
wear and tear
v. If we add the GVA's of all firms in an economy we will get the GDP of that economy.
 vi. If there is a change in firm's inventories in an year then GVA = value of final produce +
change in inventories - value of intermediate goods used
vii. Change in inventories can be either positive or negative depending on whether company
sells more or less than produce [ Production - sales ]
b. Expenditure Method
i. Here we calculate the expenditure received by each of the firm in an economy
ii. It has 4 components
iii. Household Consumption [C] = the consumption done on the part of households - buying
final goods and services of a firm [ if a firm makes an expenditure on the part of their
employees eg. Holiday packages, it counts as household consumption]
iv. Investment [I] = Investment carried out by firm's for the accumulation of capital goods
v. Government Spending [G] = It can have both components Investment + Household
Consumption
vi. Net Exports [NX] = Exports - Imports
vii. Expenditure Y = C + I + G + NX
viii. NX = X - M [ X is inflow; M is outflow]
ix. On adding this expenditure for all the firms we get GDP of an economy
c. Income Method
i. Income received by all the factors of production in an economy
ii. GDP = W + I + P + R
iii. W - Wages [Workers]; I - Interest Payments [Capital]; P - Gross Profit [entrepreneur]; R -
Rent[Land]
d. How households may use their income?
i. Consumption
ii. Savings
iii. Taxes
 iv. Assuming no donations or sending money abroad
v. GDP = C + S + T
e. C + S + T = C + I + G + X - M
f. S + T = I + G + X - M
g. ( I - S) + (G - T) = ( M - X )
i. G - T = Budget Deficit - how much more government is spending than its revenue
ii. M - X = Trade deficit
3. Gross National Product = GDP + Net Factor Income From Abroad [NFIA]
4. National Income = Net National Product at Factor Cost = GDP at FC + NFIA - depreciation
5. GDP at MP = GDP at FC + indirect taxes - subsidies
6. Personal Income [PI] = National Income - Undistributed Profits - Net Interest Payments made by
household - Corporate Taxes + Transfer Payments to Households
a. Undistributed Profits - part of profit of firm that is not paid to factor of production
b. Corporate Taxes - taxes paid by firms
c. Net interest payments by households
i. Households receive interest on their loans to firms and govt. - investment in company,
shares, forwards, G-secs
ii. Households pay interest on loans received by them - banks, etc.
d. Transfer Payments to households
i. Govt. subsidies, scholarships
7. Personal Disposable Income - households have complete say over this - how to spend - save or
consume
a. PDI = PI - Tax Deductions - Non-Tax Deductions
i. Tax = Personal Income Tax
ii. Non- Tax = Fines, Challan
8. National Disposable Income = NNP at MP + other transfers from world [ Gifts, aids, etc.]
 a. Gives an idea about how much goods and services an economy can consume
9. Nominal GDP = GDP at current market prices
10. Real GDP = GDP at market prices of base year [which is chosen from time to time]
11. GDP deflator = Nominal GDP / Real GDP
12. GDP deflator is different from CPI/WPI
a. CPI/WPI doesnt takes into account all the goods produced in an economy
b. CPI/WPI include prices of imported goods also
c. Weights are constant in CPI/WPI but in GDP deflator they change depending on the production
level

Chapter 3

1. Liquidity Trap
a. Interests rate are at minimum (or too low) that everyone expects them to rise
b. When interest rates rise price of bonds decreases so no one wants to hold on to bonds
c. Injecting money into economy leads to people holding more of cash and not buying bonds
d. Demand of money is infinite (theoretically)
e. Monetary policy fails
2. Currency notes issued by RBI except Re. 1 note and coins - issued by GoI MoF
3. Currency is a legal tender - no one can refuse to accept payments in currency issued by RBI.
However cheque is not a legal tender and people may refuse it
4. Money Supply - regulated by RBI
a. M0 = currency in circulation + bank's deposit with RBI + Other deposits* with RBI -> monetary
base
b. M1 = Currency + Demand Deposits(excluding interbank deposits)
c. M2 = M1 + Post Office Savings [demand deposits only]
 d. M3 = M1 + Net time deposits of commercial banks
e. M4 = M3 + Total savings in Post Office (including demand and time deposits except National
Savings Certificate)
f. M1, M2 -> narrow money; M3, M4 -> broad money
g. M3 is also called aggregate monetary resources
5. Currency Deposit Ratio = Currency with people / Demand Deposits
6. Reserve Deposit Ratio = Money kept in reserve / Total Deposits of a Bank
7. High Powered Money / Monetary Base - total liabilities of RBI -> currency + demand deposits with
SCB and GoI
8. Money Multiplier = stock of money / stock of high powered money [M3/M0]
9. Reserve Money
a. RBI's net credit to govt.
b. RBI's net credit to banks
c. RBI's net credit to commercial banks
d. Net Forex reserves
e. Govt. currency liability to public
f. Non-monetary liabilities of RBI
*other deposits include deposits of quasi-govt. body + primary dealers + other central banks and govt. account with
RBI + a/c of international agencies such as IMF

Chapter 4 - Not Important

Chapter 5
1. Revenue Receipts - which are not redeemable by government for eg. Taxes
2. Capital Receipts - which results in increasing liability or decreasing assets of govt. -> borrowing or
sale of PSUs
 3. FRBM Act - Medium Term Fiscal Policy Statement + Fiscal Policy Strategy Statement +
Macroeconomic Framework Statement
4. FRBM Act - FD to 3% + RD to 0% + no loan from RBI except ways of advances to meet temporary
mismatches + RBI not to subscribe to primary sales of G-secs
5. Revenue Deficit = Revenue Receipts - Revenue Expenditure
6. Effective Revenue Deficit = Revenue Deficit - [ Revenue Expenditure involved in creation of assets1 ]
7. Fiscal Deficit = Net Borrowings of govt [ desi + videsi + RBI ]
8. Primary Deficit = FD - Net interest liabilities
1GoI gives various grants to states which are treated as part of revenue expenditure but many such grants are used
for asset creation which are owned not by GoI but by the government of the state concerned. So these grants were
removed from RD to get ERD [ grants under Centrally Sponsored Schemes like PM Gram Sadak Yojana, etc. ]


Chapter 6

1. Balance of Payments = Current A/c + Capital A/c

2. Current A/c
a. Imports & Exports
i. Trade Balance = Exports - Imports
ii. Trade Deficit if Import > Export
iii. Trade Surplus if Export > Import
b. Invisibles [Trade in services]
i. Net Factor Income = Net compensation to employee, Net interest on investment
ii. Non-Factor Income = shipping, banking, insurance, etc.
iii. Transfer Payments = Pvt. Remittances, gifts, etc.
c. Current A/c Balance = sum of these two
 d. Current A/c Deficit = if outflow more than inflow
3. Capital A/c
a. All international purchases and sale of assets
4. BoP = Capital A/c + Current A/c
a. If BoP > 0 => increase in forex reserve
b. If BoP < 0 => decrease in forex reserve or finance it via borrowing
5. Real Exchange Rate = Nominal Exchange Rate * PPP
6. Nominal Effective Exchange Rate = Price of a representative basket of foreign currencies weighted
according to their importance to the country's trade [ trade volume used as an indicator]
7. REER = Real Effective Exchange Rate = weighted average of Real Exchange Rates of a basket of
foreign currencies
1. Exchange Rate Determination - Fixed/Floating/Managed Floating[ 'Dirty Floating' ]

Chapter 12

Indian Banking Sector


Banking Institutions
Non-Bank Financial Companies
Similarity
Accept different form of deposits and lends them to prospective borrower
Same
Differences
Can take demand deposits [CASA]
Part of payment and settlement system - can issue cheques
Public deposits are insured
No CASA - no demand deposits
Not a part of settlement and payment system - cannot issue cheques
Not insured

NBFCs have to be registered with RBI, however some are exempted to obviate dual-regulations
Venture capital funds, Merchant Banking, Stock Broking -> SEBI
Insurance Company -> IRDA
Chit Funds -> Chit Funds Act
Nidhis -> Companies Act - regulated by Mo Corporate Affairs
Housing Finance Companies -> NHB of RBI

Reserve Bank of India

Set up as a private bank in 1935 with 2 extra functions - regulating banks + bank to govt.
Nationalized in 1949
Functions
 Issues currency (except Re. 1 note -> issued by govt. with sign of Revenue Secy. + coins issued by
govt.)
Circulates currency including coins
Banker to govt.
Banker to banks
Monetary policy
Inflation targeting
Forex reserve
Stabilizes exchange rate
Agent of GoI in IMF

Monetary Policy
CRR & SLR - no floor or ceiling now - RBI is free to decide
Repo Rate is the key policy rate with others aligned to it
Reverse Repo = Repo - 1 [w.e.f April 2016 Reverse Repo = Repo - 0.5%]
MSF = Repo + 1 [w.e.f April 2016 MSF = Repo + 0.5% ]
Bank Rate = MSF
Bank Rate also acts as penal rate when banks fail to meet their SLR and CRR requirements [Bank
Rate +3% or 5% ]

Banking Sector Reforms

Narsimhan - I [Committee on Financial System]

"the resources of the banks come from general public and are held by the banks in trust that they are to be
deployed for maximum benefit of depositors"
This implies that
 Even govt. has no right to endanger the solvency and health of PSBs on the pretext of social and
economic planning
Govt. should not secure low interest rate loans from PSBs to cover their RD and FD -> akin to fraud
Recommendations
Operational flexibility
Internal autonomy
Professionalism
5 fold reco
a. On Direct Investment
i. Cut down CRR & SLR
ii. RBI focus more on OMOs not CRR & SLR
iii. Govt. should move to market based borrowing
iv. To increase funds available for lending and lower interest rates
b. On Directed Credit Program
i. Phase out gradually
ii. No concessional loans
iii. PSL should be temporary to meet extraordinary situations and not permanent
iv. PSL only to weaker sections and only 10% of bank lending
v. Review PSL composition every 3 years
c. On structure of interest rates
i. RBI to be the sole authority for interest rates
ii. Interest rates to be based on market forces only
iii. Govt. should not skew interest rates with its policies
iv. No control on interest rates of deposit and lending
d. On structural reorganization of banks
i. RBI to be sole regulator [earlier Banking Division of MoF also regulated]
 ii. Reduce no. of PSBs by mergers to increase capital base and efficiency
iii. Make PSBs free and autonomous
iv. Appointment of CMD on capability not contacts
v. Change work culture to promote efficiency
e. Open up ARC to fight the menace of NPAs
Narsimhan - II
Merge AIFIs and PSBs
3 Tier banking sector
Tier 1 - 2/3 banks of international orientation
Tier 2 - 9/10 banks of national orientation
Tier 3 - large number of local banks
Cut NPAs
Legal support for loan recovery [SARFAESI Act passed later]
Depoliticize banks
Rationalize bank branches and staff
Higher CRAR ratio
Budgetary recapitalization not viable and should be abandoned

Differential Rate of Interest Lending = 1% of total lending of previous year to be lend to 'poorest of poor' at 4%
interest rate
PSL - 40% for Indian banks and 32% for foreign banks - PSL criteria changes from time to time
[ allow issuing of PSL certificates - if one bank has exceeded PSL norms and one has deficit -> deficit bank can
buy PSL certificate from excesses one to meet its own PSL requirements ]

NPAs and tackling them from current affairs

Cushions to banks
CRR
SLR
CAR

CAR - Capital Adequacy Ratio - it was devised at the meeting of Bank of International Settlements [BIS] at
Basel, Switzerland
Also known as Basel Accord
CAR is the ratio of total capital to the total risk-weighted assets
[if CAR is 8% it means that if bank has investments and loans of Rs. 100 than it has to maintain free
capital of Rs. 8]
Also known as CRAR - Capital to Risk Weighted Assets Ratio
Why CAR?
Capital helps to absorb losses
Amount of capital affects returns to owner of banks
It prevents bank from being insolvent
Basel III
Aim to promote a more resilient banking system
3 types of capital
Tier I -> can absorb losses without bank ceasing its operations -> most reliable and liquid form
of capital -> stockholders equity and disclosed reserves of bank
Tier II -> can absorb losses in the event of winding up of bank's operations -> measure of
bank's financial strength from a regulator point of view
Tier III -> tertiary capital used to support market and commodities risk and foreign currency risk
-> variety of debt other than Tier I and Tier II
*disclosed reserves are total liquid cash and SLR of a bank
 *undisclosed reserves are hidden reserves not appearing on balance sheet documents but
cannot be use at the will of the bank
Common equity capital 4.5% - amount that all common shareholders have invested in the company
Tier I capital 6%
CAR at 8%
Additional 2.5% capital conservation buffer to meet emergencies
Central Banks may require banks to maintain 0-2.5% of counter cyclical buffer depending on
economic conditions of the time

CIBIL - Credit Information Bureau of India Limited - database of all borrowers from various banks - provides
information to banks about the credit worthiness of a prospective borrower

FCNR(B), NRE & NRO a/c's hold by foreigners in India are also part of India's external debt as this amount can
be repatriated.
FCNR(B) - term deposits
NRE - can be savings, term or recurring deposits
NRO - Ordinary Rupee account for collecting funds from their local transactions in India


3 types of ATMs
1. Bank's own ATMs - owned, operated and managed fully by banks
2. Brown label ATMs - owned and operated by 3rd party - concerned bank does cash handling and providing
backend server connectivity
 3. White Label ATMs - doesn't belong to any bank - provides services to all banks and connected to the entire
network - banks provide them with a/c information and back-end money transfers - Tata Communication
Payment Solution - Indicash - first white label ATM - have to deploy 67% in rural areas

These brown & white label ATMs help banks reduce the cost of providing ATM services as managing own ATM
proves most costly to bank.


Payment & Small Banks - Nachiket More Committee - Read

Chapter 13
Insurance in India

Anything used to cut down risk -> insurance

LIC and GIC were formed by government by nationalizing various private sector insurance companies in
India
Entry of private players was banned in insurance sector
After Economic Reforms of 1991 - insurance reforms committee was set up and insurance sector was
opened up in 1999
Insurance Regulatory and Development Authority [IRDA] - regulatory body for all insurance companies in
India
1 chairman & 5 members (2 full + 3 part-time) appointed by govt.
AICIL - Agricultural Insurance Company of India Limited -> responsible for agricultural insurances in India
LIC + AICIL + 4 former GIC companies = 6 PSU in insurance sector
Reinsurance -> Insurance coverage of insurance policies of company
 A precondition for the growth of insurance industry
GIC is the sole re-insurer in India [Govt. is the best insurer or re-insurer unless it's Iraqi Govt.]
Deposit Insurance and Credit Guarantee Corporation [DICGC] -> focus on insuring deposits, financial
stability, averting panics, boosting depositor confidence
Export Credit Guarantee Corporation [ECGC]
Under Mo Commerce & Industry
For providing credit cover to Indian companies exporting outside [insurance for failure in payment,
etc.]
Sometimes such exports are necessary also for maintaining India's economic and political relations
with a country
National Export Insurance Account [NEIA]
Under same Mo Commerce & Industry
For providing insurance cover to projects where ECGC can't do due to purely commercial reasons
But the project should be commercially viable and strategically important for India
Challenges
Low insurance penetration
Health insurance can help India in increasing human development and also mobilize people's
savings
Micro-insurance should be promoted [requires radical changes in insurance laws]
NGOs and individuals register themselves as MFI and then they sell insurance policy to people
- now since they risk themselves they can buy reinsurance with a bigger insurance company
Private companies are demanding governmental insurance company to be privatized - b/c pvt.
Companies offer lucrative offers still they fail to attract clients -> losses to them
Insurance Penetration = premium underwritten in an year / GDP
Insurance Density = premium underwritten in an year / Population

Read - Insurance Laws Amendment Act, 2015

Chapter 14
Security Market in India

What is Security Market?

Market for raising long term capital via shares, securities, bonds, debentures, etc.

World's first stock exchange was opened in Antwerp, Belgium (then in Netherlands)
India's first - Bombay Stock Exchange - 1870

Largest stock exchanges

NYSE > NASDAQ > Tokyo Stock Exchange > London Stock Exchange > BSE

OTCEI - India's first fully computerized exchange -> Over The Counter Exchange of India

SEBI - Security and Exchange Board of India

By SEBI Act, 1992
1 chairman + 9 members
4 full time
1 each from RBI, MoF and Mo Law
2 appointed by GoI
Functions
Registering stock exchanges, merchant banks, brokers, etc.
Promoting financial awareness
 Inspection and audit of exchanges, etc.
Levy of various fees on transactions
National Securities Clearing Corporation
A PSU
Takes counterparty risk of all the transactions done at NSE

Sahara Case
It was an unlisted firm of Sahara Group
OFCD issue has to be completed within 10 days - Sahara continued for 2 years
It can be subscribed only by 50 individual/institution - Sahara sold it to 23 million!
OFCDs are for financial experts only but Sahara tricked novice public into buying this
SEBI can't regulate unlisted firms [which are regulated by MoC Corporate Affairs] - though SEBI said it can
since the firm issued OFCDs - regulatory confusion
Aftermath!
Companies Act, 2012 contains clause which gives SEBI undisputed jurisdiction to regulate any
investment scheme with 50+ investors
Sahara asked to return capital raised with 15% pa interest

Indian Depository Receipts

A foreign company issues shares to Indian Depository which in turn issues shares at Indian stock
exchanges
Allows Indians to invest in foreign companies in Indian rupees
Saves exchange rate risk
Avoids hassle of investing on foreign stock exchanges
StanChart only company to issue IDRs

Participatory Notes [P-notes]

Offshore derivative instruments [ODI]
Issued by FII in their own jurisdiction [ basically FII buys an Indian security and based on that issues p-
notes in their country]
Provides exposure to foreign individuals exposure to Indian security markets w/o going through all the
hassles of investing directly as entry to Indian security market is restrictive, though it is opening up slowly
Also allows FII to hedge their risk if they intend to hold long term positions
They may be used to invest illegal black money back into Indian security market to earn huge profits
Pro & Cons for foreign individuals
No need of going through regulatory procedure of direct entry
Saves infrastructure and time
But they won't get title and voting rights by owning p-notes
Regulations
P-notes are foreign instruments so Indian regulators can't regulate them
But SEBI has issued certain guidelines for p-notes issue
PN can only be issued to entities which are regulated by relevant authority in their own
jurisdiction
No PN to NRIs
SEBI asked FIIs to submit info regarding PN on monthly basis - who holds PN and how much -
though still it is outside real time surveillance of SEBI
Moreover SEBI can ask for any info on ODI's from FIIs which have Indian securities as base
SEBI took action against two FIIs for non-compliance of rules in 2009-10 including Barclays

ECB - External Commercial Borrowings - Rules & Regulations from RBI website



Chapter 15
External Sector

Forex Reserve includes

All foreign currencies
Gold holdings of Central Bank
SDRs
Reserve Tranche Position at IMF
Each member of IMF is assigned a quota which is payable part in SDRs and part in the
member's own currency - difference between a member's quota and it's IMF holdings is RTP ->
it can be used by the member country anytime
Optimum Forex Reserves?
A debatable topic - no quantifiable answer
CEA in Eco Survey said India should target forex of $1 trillion [Citing China's example which has
assumed role of IMF & WB as lender of last resort to troubled govt.'s owing to their high forex reserve
- but should India target China type policy is again an open question]
RBI officially doesnt targets a particular exchange rate or forex level
It intervenes in markets to stabilize exchange rate and reduce volatility
Some people argue that forex reserves should be adequate to cover country's external debt + 3
months of imports [or some say 6 months]
Why forex reserves?
Act as insurance when exchange rate is volatile
Can be used in times of crisis
Costs of keeping forex?
 When RBI buys dollars, it infuses rupee into market which creates inflationary pressure
To stop this, RBI converts spot purchase to forward purchase which causes a premium cost
[premium has to be paid on forward]
RBI invests these dollars into US treasuries which offer low yield [ though RBI is not their to earn
profit, it's work is to maintain stability and these costs are associated with maintaining stability - some
even argue that return from Rupee assets would be even less ]
By keeping forex - you finance another country

India's external debt profile
80% long term debt -> which is good compared to short term debt
80% private sector debt
60% is dollar denominated
In govt. debt SDR denominated debt accounts for 1/3rd -> due to soft loans from IDA of WB
Within Manageable limit - depicted by external debt to GDP ratio and debt service ratio
Comparing with other countries India's external debt was 6th lowest and forex cover to debt was 6th
highest

Exchange Rate in India

During British time it was pegged to Pound Sterling
With IMF, India switched to fixed regime
And after the financial reforms of 91 the currency was left to float freely in market
Initially India followed 'dual currency regime' - there are two rates - market rate and the official rate -
the official rate is determined by the market rate of the currency
This was a transitionary step as ultimately the two rates converged and Rupee was left to float free
[ If directly let to float it could have created lot of volatility ]
RBI intervenes from time to time to stabilize the currency or for other purposes

Current A/c
Maintained by RBI on behalf of Govt.
Lists all foreign currency transactions of India
Can be surplus or deficit [ 2000-03 - only 3 years when it was +ve]
Capital A/c
Similar account with all the capital transactions in foreign currency
Balance of Payment - sum total of these two a/c over a year is termed as BoP
It can either be +ve or -ve
If it's negative it doesnt implies it is BoP crisis
BoP crisis occurs when the country doesnt has forex reserves to fill this BoP gap - then go to IMF to
give loan
If it's positive -> forex will increase

Convertibility - allowing domestic currency to convert into foreign currency

May be full or partial [only a part can be converted fixed by govt.]
India follows full current a/c convertibility [ was required to do so by IMF during BoP crisis 1991 - IMF
preconditions]
Means for current transactions one is allowed to convert Rupee into any foreign currency
Capital A/c Convertibility - Presently India allows 40:60 - though India is gradually moving towards
full Capital A/c Convertibility with many waivers to Indian companies and individuals [ corporates are
allowed full convertibility upto $500 million investment abroad ]
Tarapore Committee in 1997 recommended full convertibility but the SE Asian crisis led govt to
ignore the recommendations [ as that crisis was partly b/c of the countries allowing full converibility]
 Though unlimited amount of gold was allowed to be imported [ it is akin to full capital account
convertibility via current route - but not everyone can do this] - now not allowed - govt. can regulate
by imposing various duties
Convertibility only deals with foreign currency outflows

Extended Fund Facility - an IMF facility which allows members to draw any amount of money from IMF to
meet it's BoP crisis but on the condition of structural reforms that IMF body puts on it.
IMF precondition on India during BoP crisis
Custom duty cut to 30% from 130%
Increase excise duty by 20% to compensate from loss of revenue due to customs
Devalue Rupee by 22%
Govt. spending to be cut by 10% per annum
These conditions were opposed vehemently by opposition, corporate and majority of Indians but after a
period of time it helped India to grow economically -> hard decisions led to good outcomes -> but taken out
of compulsion not as an initiative by government

Special Economic Zones [SPZ] - set up by govt in 2000 to promote exports in India and provide
employment to people
Industrial clusters marked by different set of rules to promote exports
Better infrastructure and less red tape
Treated as foreign territory for the purpose of trade
Duty free export
If selling in India -> have to pay full customs duty like foreing goods
No routine examination of export/import cargo
Have to become net earner of forex within 3 years

 General Anti-Avoidance Rules [GAAR ]

For minimizing tax evasion by companies in India
Rules formulated but not put in force
As they were very broad based and can be used by tax officials in wide scope as it can be applied to
most of the tax saving arrangements
Will create obstacles to ease of doing business in India
Onus of proving that a transaction is not for the purpose of evading tax lies with the corporate -
against the basic fundamentals of law - as it should be responsibility of tax officials to come with
proper data and findings to prove that a transaction is impermissible
[ also read BEPS report by OECD + G20 ]

Chapter 16
International Organizations & India

International Monetary System or International Monetary Regime

Set of rules and facilities that facilitate international payments
Two objectives
Maximizes foreign trade and investment
Equitable benefit from trade to member nations
Evaluated on 3 criteria
Adjustment - cost and time for adjusting to BoP crisis
Liquidity - amount of reserves for settling BoP crisis
Confidence - among nations towards IMS

Bretton Wood's Conference

US plan adopted - setting up of WB & IMF
 UK plan led by JM Keynes [ On most of the points on which he was opposed by US - he proved to be true
later on ]
Set up an Int'l Clearing Union [ICU] - a central bank of all central banks - and a new currency Bancor
to solve BoP crisis of member nations
Individuals can't trade in bancor - to be used only for foreign trade - gold can be exchanged for
bancor but not reverse
Penalize countries having trade surpluses with a global tax - [IMF did opposite - penalize countries
with trade deficits and putting the onus of managing BoP crisis on them]
Use the funds raised by these taxes to set up a buffer stock of food products - to be used for
shortages in member nations
For reconstruction of Europe a fund to be set up for rehabilitation - [US sponsored Marshall plan was
adopted so that Europe remains close to US]
set up an Int'l Trade Organization [ITO] which will set up buffer stock of agricultural products and use
that to stabilize the prices in international market - [charter was drawn but never set up due to US
opposition]
IMF
At IMF every country has a Governor and an Alternate Governor
For India Governor is FM and Alt. Gov. is RBI Gov.
India includes 3 other constituency country -> Bhutan, Bangladesh and Sri Lanka
Contribution paid partly in cash [ counted as India's reserves ] and part in securities [ issued by RBI
to IMF - non-interest bearing - but can be encashed by IMF at any time to meet it's lending
requirements ]
With the financial crisis of 2008, there are debates about revival of Keynes idea of bancor
Problems with setting Dollar as the int'l reserve currency or any other currency of country
Triffin Dilemma
 Conflict of economic interests due to short term domestic and long term international objectives for
countries whose currency serves as reserves
These countries has to supply an additional amount of their currencies to meet global demand
This leads to fundamental imbalances in the BoP - as some goals require outflow and other inflow
People's Bank of China Chairman suggested to use SDR as a reserve currency to overcome this -
SDR not that widely used so a problem

India is at 8th position at both IMF and WB by their quota's

Asian Development Bank - HQ -> Manila

FM - Governor; Secy Economic Affairs - Alt. Gov.
India's constituency includes Bangladesh, Bhutan , Lao PDR, Tajikistan
Loans mainly in energy, transportation, infrastructure and finance

Fortazela Declaration - BRICS

Led to founding of NDB -> New Development Bank
1 member 1 vote - key feature
Funds for development projects
Also has a Contingency Reserve Arrangement(CRA) to provide liquidity to members during BoP crisis - an
arrangement of currency swaps

China also set up it's AIIB [Asian Infrastructure Investment Bank]

Why
Growing disenchantment with slow pace of developments at IMF & WB
US dominated IMF, WB and ADB
Increasing capital requirements for infrastructure development in the Asian region
 Despite of development, many people in China, India and Korea are mired in poverty
China's huge forex reserves can be put to good use here which earn next to nothing by being put in
US treasury
Also supports China's strategic Silk Road and OBOR initiatives - they will use the capital from bank
to finance these projects in the country
Will also help China diversify it's foreign assets portfolio
Will emerge as a global power challenging US's dominance in a rules-based order

US stands opposed to it, doubting the transparency and governance of the institution though many of it's
close allies have joined it.

Chapter 17
Tax Structure in India

Tax -> fund raising by govt. to meet it's obligations and also for income redistribution

Characteristics of Good Tax System

1. Fairness -> horizontal and vertical equity -> people with same income should pay same -> people with
more income should pay more
2. Efficiency -> raises maximum revenue with least cost to taxpayers
3. Administrative Simplicity -> easy to file tax returns and pay income tax
4. Flexibility -> easy to make modifications in tax structure
5. Transparency -> people should know how much they are getting in form of public services against what
they are paying

Why VAT in India?

 Value Added Tax - imposed at each level of value addition to a product
Doesn't have a cascading effect which non-VAT type taxes have
Earlier tax system had a cascading effect which led to high prices -> poor masses suffer
No uniformity in state taxes was there which was an obstacle in making India a single market economy
High rate of tax evasion was there earlier - with VAT large scale tax evasion isn't possible
Reduced the complexity of taxes for taxpayers as many taxes were merged into VAT
Increases total tax revenue [world experience shows this]

VAT actually increased the revenue collection by 13.8% of states

GST is a tax to be based on VAT method only. - read more after it is passed by Parliament

Commodity Transaction Tax [CTT] ->0.01% on transactions on commodity exchange

Securities Transaction Tax [STT] -> 0.01% on transactions in securities
Though few securities exempted like G-sec, bonds, debenture, gold ETF
Collected by stock exchanges for GoI

CTT/STT tends to reduce speculation in markets and also widen govt.'s tax base
CTT/STT are direct tax

Capital Gains Tax

If on selling an asset, any profit is made than it is subjected to CGT
Short Term CGT - if asset is sold before 3years of buying -> subjected to income tax [1 year for share,
mutual funds and units of UTI -> 15% tax]
Long Term CGT - if asset is sold after 3 years of buying -> 20% tax [ for share, MF -> 0 tax provided it was
subjected to STT]

Chapter 18
Public Finance

Article 112 of Indian Constitution - Annual Financial Statement

Planning Commission eclipsed the role of MoF in budget formulation as the plan expenditure part of the budget
was made based on discussion of ministries with the PC - the artificial distinction b/w Plan & Non-Plan
expenditure created problems as whenever government opted for fiscal consolidation the Non-Plan part got the
cut -> running and maintenance of hospitals and schools for eg. Also, the control of PC in Plan allocation for
states was over-arching. Also, the PC tended to be bit optimistic about the expected revenue generation as
fiscal consolidation was the responsibility of MoF and not PC so they tended to move towards higher Fiscal
Deficits - The central govt. had to fix the borrowings of state by considering the fiscal position and it's own needs

Monetized Deficit - The part of the FD of the govt. that is provided by RBI - it's called monetized b/c this deficit
involves creation of new high powered money that is injected into the economy b/c RBI purchases govt. debt
using the money it created.

It's good to have a revenue surplus budget -> revenue receipts > Revenue expenditure as the excess part of
government's income can be used in creation of capital assets. But it is also important to know how that surplus
have been managed. During 2nd Plan India had a revenue surplus but experts were against it as there were
high tax rates which led to tax evasion, corruption and black money.

Deficit Financing - idea promoted by JM Keynes - though govt. Have run deficits before Keynes too
US in 1930s tried it's hand at deficit financing and later it was adopted by all European and American
countries
 India also tried deficit financing in 1960s and then it was routine
India's illogical deficit financing and it's composition led to unsustainable levels ultimately leading to a crisis
Sources of Deficit Financing
External Aids - soft loans
External Grants - muft ka paisa - but often comes with terms & conditions - India didnt take
Internal Borrowings - leads to crowding out effect - can send economy in recession
External Borrowings - strain on Forex reserves
Best option is a sustainable mix of both of these
Printing Currency - last and worst option - can lead to hyperinflations if done excessively like in
Zimbabwe

Deficit Financing in India

Phase I [1947-70]
Trying to borrow externally as well as internally - but didnt met targets
Increased taxes to increase revenue -> led to high tax evasion and corruption and black money
Heavy borrowing from RBI
Nationalization of banks - making them political bodies and using public money for govt. expenditure
Expansion of PSUs -> all making loss + more than required workforce -> further RD
Still investment target not met
Phase II [1971-91]
Pesa aise kharch kia ki baap ka hoga!
Further nationalization + expansion of loss making PSUs using public money + failed to control
population + no employment generation + illogical subsidies
Planned development remained highly centralized -> local aspirations not considered -> this led to
rise of extremism adding further strain on already strained police and judicial system
Non-economic use of public money led to Non-Plan use of Plan Money
 Phase III [1991 onwards]
Due to Maa-Bete ki sarkar in Phase II -> financial crisis -> IMF loans
IMF restructuring program started which made significant changes to economy
Meanwhile the finances of States were not also good -> but due to statutory overdraft regulations of that time
states were not allowed to borrow independently from RBI or market. So they had to control their deficits ->
mostly they did by cutting social sector expenditure -> as a result further sufferings to people

If so many problems than why deficit financing?

Political Factors -> subsidies for votes - govt. expenditure increases if election nearby
Institutional factors -> more focus on supervising, monitoring and reporting than delivery of goods and
services -> as a result to deliver 1Re to people Rs. 3 spend
Ethical factors -> govt.'s schemes for employment, poverty alleviation, food subsidies have to go on

Later in 2003, India enacted FRBM Act to impose a legal limitation on government's power of money creation
[ Before that India was like UK - where govt. has overriding power over it's Central Bank in creation of money ] -
though a provision exists in India's constitution Article 292 to limit government's expenditure -> but it has been
never invoked.

New Zealand is exact opposite of UK -> Central Bank has been legally empowered to override government's
money creation powers so that it doesnt increases the inflation target

Composition of FD
Level of FD is important for an economy but what is more important is the composition of FD
3 cases
FD used for capital expenditure and not for Revenue [ zero RD or -ve RD ] - best use
 Major part of FD used for capital and a small part for Revenue - 2nd best - have to eliminate RD soon
Major part for revenue and less for capital - worst case
Running FD consistently along with RD is not good for an economy

Fiscal Policy -> "policy with regards to level of govt. purchases + govt. transfers + tax structure"
Changes in govt. expenditure and taxes to achieve desired macro growth.

Zero Based Budgeting
Allocation of resources to agencies based on continuous revaluation of the programs they are running
Based on this revaluation funding is continued or terminated or reduced
3 essential questions
Should we spend?
If yes. How Much?
Where should we spend?
Advantages
Helps in getting a macro view of the expenditure of a department
Helps in prioritizing the expenditure and based on that funds are allocated
Requires a detailed cost-benefit analysis of all the expenditures
Optimizing performance with a given amount of resources
Criticisms
Leads to MoF becoming all powerful dictating all other ministries
Certain activities cannot be subjected to cost-benefit analysis like defense, foreign relations, etc.
Can lead to more focus of departments on short term benefits to obtain funding, leading to neglect of
long term goals
Subject to bias

Performance Monitoring and Evaluation System - each ministry/dept. reqd to bring out a RFD [Result-
Framework Document] in the beginning of year which will contain the expected objectives to be achieved during
the year and the resources required for that with other details. At the end of the year all RFDs have to be
reviewed considering the objectives achieved and put on website.

Outcome Budget - by all Ministries and Departments detailing their outcomes of the year
Performance Budget - by MoF on behalf of government.

Cut Motions
Token Cut - Cut amount by Rs. 100 -> to bring attention to an grievance
Economy Cut - reduce the amount of money to a particular scheme
Policy Cut - reduce the allocation to Re. 1 -> disapproval of policy
Guillotine -> all outstanding demands put to vote without discussion

Earth Trilemma
Increased Economic Development -> we need more Energy -> rise in Environmental issues

Impossible Trinity
Country cannot maintain 3 things simultaneously
Fixed exchange rate + Free capital flows + independent monetary policy

Comparative Rating Index of Sovereigns [CRIS] - an index to rate sovereign debt by MoF GoI -> it's a
comparative scale [like percentile] where other's are given in absolute terms [Moody's, Fitch, etc. ] -> helps
investor to see how a country stands among others.

Chapter 19

Low Carbon Strategies
Power -> on supply side use efficient technologies for production of energy - supercritical technologies in
coal plants, gas in heat plants, invest in renewables. On demand side use of more efficient appliances by
market and regulatory measures, reduce transmission and distribution loss.
Transport -> increases share of rail freight, improve fuel efficiency, dedicated freight corridors
Industry -> new plants to adopt most efficient technologies and existing to upgrade themselves
Forestry -> increase forest cover and also the forest density
Buildings -> develop standard building codes with focus on energy efficiency