Economics paper-Economics: Paper – 9 (TYBA) Chapter: 4 Budget analysis and its concepts Budget is an accounting statement of the income and expendi

Economics: Paper – 9 (TYBA)

Chapter: 4

Budget analysis and its concepts

Budget is an accounting statement of the income and expenditure of the govt. for a given financial year. The budget is prepared in anticipation of the income and expenditure of the govt. for the ensuing financial year.

Budget indicates the fiscal policy of the govt. In India the central govt. declares the budget on 28^th of February of every year for financial year beginning from April. Each level of govt. in our federal system of governance prepares a separate budget. Budget indicates the fiscal planning of the concerned govt. It is very important that the govt. finances its planned expenditure from the planned incomes.

A budget has a current/capital account, a credit side and a debit side and in the accounting sense ‘A budget always balances.’

The Indian budget gives three sets of figures:

a) The actual figure for the preceding year.

b) The budgeted and revised figure for the current year.

c) Budget estimates for the following year.

For instance the budget estimates for 2008-09 contains:

a) Actual for the year 2006-07.

b) Budgetary and revised estimates for 2007-08.

c) Budget estimates for 2008-09.

The budget of India is divided into two parts

1. Revenue budget or revenue account.
2. Capital budget or capital account.

The current account or Revenue budget

The revenue budget of the central govt. deals with receipts from taxation and non-tax sources and expenditures net out of these sources. This is also called current account balance because their revenues are taken for the current year and are in the form of revenue transaction, similarly expenditure on this account for the current period. The tax revenue comes broadly from three sources:

1. Taxed on income and expenditure.
2. Taxes on commodities and services.
3. Taxes on property and capital or capital transaction.

The non-tax revenues mainly consist of:

1. Currency, coinage, mint.
2. Interest, receipts and dividends.
3. Other non-tax revenue.

The capital budget or capital account

Capital budget of the govt. of India also known as the capital account consists of capital receipts and capital expenditure. The capital receipts of the central govt. are composed of:

1. Net recoveries of loans and advances made previously to the state govts, union territories and public sector undertakings.
2. Net market borrowings (Gross borrowing from the market repayment of public debt.)
3. Net small saving collections (Gross collection/share of states)
4. Other capital receipts such as provident funds, special deposits etc.

The capital expenditure of the union union govt. consists of expenditure on capital items mainly in the form of:

1. Loans to states and union territories for financing plan project.
2. Other capital expenditure on economic development.
3. Capital expenditure on social and community development.
4. Capital expenditure on defense.

Budget of central govt. since 1950-51

Revenue 1950-51 1980-81 2001-02 2008-09

(Actual) (Actual) (Actual) (Budgetary

Figures)

i) Revenue 406 12830 210450 602935

receipts

ii) Revenue 347 14540 301610 658120

Expenditure

iii) Revenue +59 - 1710 - 100160 -55185

surplus/deficit

(+) (-)

Capital account:

i) Capital 120 8770 161000 147950

receipts

ii) capital 182 9630 60840 92765

Disbursement

iii) Capital -62 -860 +100160 +55185

surplus/deficit

Over all -3 -2570 Nil Nil

budgetary deficit/surplus

Trends in Indian budget since 1950-51

1) Huge increase in revenue expenditure: -

Expenditure on revenue expenditure has been rising rapidly which is seen in the table. There was and intensive and extensive expansion of govt. activities during the planning period.

The ration of public expenditure to GDP had steadily risen over the years.

It was:

9.1% in 1950-51

15.3% in 1960-61

17.2% in 1970-71

25.6% in 1980-81

28.5% in 1990-91

27.8% in 2006-07

In the first 30 years from 1950 to 1981 the revenue expenditure increases by more than 40 times and next 28 years from 1981-2009 increased 47 times.

As we see in the data above the public expenditure GDP ratio has declined in the LPG era due to some controls on public expenditure and fiscal discipline.

2) Huge increase in revenue receipts

To meet its current expenditure the central govt. raised certain taxes and receipts. Revenue receipts have increased significantly as shown in the table. During the first three decades from 1951-81 revenue receipts rose by 30 times – during the next 28 years from 1981-2009 revenue receipts increased by 50 times.

(We see that revenue expenditure has increased faster and higher than revenue receipts leading to current account deficit in the budget)

3) Mounting deficit in the revenue account

The above two points clearly indicates mounting deficits in the revenue account. Deficit in revenue account imply that the govt. is spending beyond its means and in forced to borrow even its current expenditure needs. This is a bad budgeting for any kind of budgets.

4) Capital expenditures/disbursements

There are expenditure on capital assets such as financing planned projects acquiring capital items for the defense department and loans to the state govts. As seen in the table the capital disbursements have increased during the plan period.

With the increased development and growth of the economy the plan projects become more and more ambitious, with population increase there is a greater requirement to create asset and to boost economic development greater loans have to be given to state govts. As a result capital expenditure increases.

5) Capital receipts

Capital receipts of the central govt. relate to the recoveries of central govt. loans to states made in the earlier periods, loans raised from the market from banks, financial institutions and general public collations of small savings from the public and provident funds collections.

The table shows the capital receipts have increased considerably during the planed period. However, between 1951-81 capital disbursement exceeded capital receipts and therefore there was a deficit in the entire budget.

The finance ministry gave up this tradition concept of overall budgetary surplus/deficit since the ‘90s and adopted a new concept. According to this new concept:

a) Equate the surplus in the capital account with exactly an amount equal to the deficit in revenue account. Thus there will be no overall budgetary deficit.

b) To achieve as mentioned above the finance ministry manages to create a surplus in the capital account through raising market loans, small savings and borrowings from financial institutions exactly equal to the revenue deficit.

Thus the overall budgetary deficit will be nil.

Performance Budget

Performance budgets use statements of mission, goals and objectives to explain why money is being spent. It is a way to allocates resources to achieve specific objectives based on program goals and measured results.

• The key to understanding performance budget lies in the word result.

It comprises of elements like:-

• The result.
• The strategy (difficult ways to achieve the final outcome).
• Activity /outputs. (What is actually done to achieve the final outcome).

Governments allocate huge amounts of money on various activities, development programs, planned and unplanned. They must be, held accountable for using ‘Tax payers money. Government also incurs deficits that is, they over spend ( above incomes) and borrow money. This creates debt burdens upon the economy present and future generations.

All such expenditures without results are wasteful allocations.

Performance budgets make governments more accountable. It provides and efficiency audit of government expenditures.

Zero Based Budgets:

Generally budgets are viewed to be increasing or decreasing from the previous period.

In traditional budgeting methods only increments over previous budgets are explained. Expenditures already made are assumed to be sanctioned or justified.

In Zero-based budgeting the concerned parties must consider a ‘Zero-based’ for explaining all expenses.

They must justify all expenses for a giver period as if they were new expenses together.

Example: ------

Balanced Budget

A balanced budget is when there is neither a budget deficit nor a budget is balance over a cycle and not necessarily over a budget year.

o A balance budget every year may not always be advocated.

o As Keynes maintained that budget deficits provide fiscal stimulus in depression and budget surpluses provide restraint in boom times.

o When and economy is in depression governments must spend maximum to give a push to economic activity even if it creates deficit in the budget.

o When and economy is under boom conditions, the government must spend less and collect maximum taxes from people to reduce their disposable incomes. This way demands can be curtailed in times of inflation.

Deficit Budget

A deficit budget or a budget deficit is traditionally defined as the differences between total governments outlays/ expenditures- including the interest on national debts and, the government’s revenue receipts.

(There however are more complicated definitions also)

o A budget deficit implies that the national debt is increasing. But if the GDP is also rising, the ration of national debt to GDP may or may not be rising.

o This depends upon whether growth rate of national debt is more or less than the growth rate of GDP.

o A continually increasing ration of debt to GDP runs the risk that debt will become unsustainable.( 1991 Asian crisis).

Even if it does not reach crisis levels, a high debt to GDP ratio has serious consequences like—

o High debt servicing.

o Lesser GDP balance for development and employment.

o When government spends less in the economy despite better GDP growth (as significant money goes into debt servicing) the private sector also invests lesser as government support appears lesser, according to some experts.

o Higher debts also mean higher debt payment burdens on future generations.

Chapter: 5

1. Price trends in India since 1991

Price stability is an essential condition for stability in economic growth and economic life. High fluctuations in prices create an atmosphere of uncertainty which is not conducive to development activities. Since the beginning of the mid ‘50s prices have continuously risen in India. The rates of price have however not been same throughout the period.

It is actually difficult to make price comparison for different periods because the govt. of India prepared wholesale price index (WPI) with 1950-51 as the base year but gave up this entire service in middle of 60s and started a new services with 1960-61, as the base year later to 1981082, and finally to 1993-94. With a change in base year every decade it is difficult to make any valid and broad comparison of price movements since economic planning was started in 1950-51.

In the first five year plan the price situation was stable. In the second five year plan there was a gradual and steady rise in prices. In the third five year plan there was a rapid rise in prices and the period around mid 60s, saw acute inflation.

However, this acute inflation was arrested in 1967-68 due to bumper harvest and green revolution. Rise in general price level was rather shown in the beginning of 4^th five year plan but gathered momentum later and there was a galloping inflation until 1974-75, severe measures were taken by the Indira Gandhi Govt. since 1974 and this brought down prices. This creates an environment of stability after the galloping inflation of1974. Between 1977 and 1979 the Janta Party govt. introduced short term demand and supply management policy and the price situation was stable and conducive for the common man.

This price stability would have continued but on callously inflationary budget was introduced by the finance minister in 1979, and the wholesale prices short up. Later in 80s the high price rise continued. Poor agricultural production, industrial production and hike in all prices contributed to the inflation. In spite of anti inflationary measures taken by the govt. the 1^st half continued with a steady rise in price. It was later in the 6^th plan and 7^th five year plan which saw a controlled inflation.

Price Rise during 1990s

The price rise in the beginning of 1990 in India has almost been engineered by the govt. itself through. In 1990-91, the wholesale price index rose by 12.1% and in 1991-92 by 13.7%. at 8.9% in 1992-3 and in 1993-94. The main reasons were:

Ø Deliberate increase in administered prices.

Ø Deliberate increase in direct tax on commodities and services.

Ø Rise in price of food grains on mere political conditions.

Ø Gulf surcharge that raise the price of petroleum products.

Ø Heavy fiscal deficit resulting in expansion of money supply.

Ø Heavy fiscal deficits resulting in expansion of money supply.

Price situation since 1990

Year WPI annual rate of inflation

1990-91 182.7 12.1%

1991-92 207.8 13.7%

1992-93 228.7 10.1%

2000-01 155.7 7.1%

2003-04 175.9 5.5%

The period until 1994-95 is known as the period of double digit inflation. However during 199-96, inflation ratio was brought down to 5%. This was however not the result of prudent economic policies but the Lok Shbha elections were approaching in 1996 and the govt. postponed the revision of administered prices.

Besides there were pressures to reduce fiscal deficit and centre and the state govt. attempted to reduce developmental expenditures to reduce fiscal deficit.

Since these were not economic measures the under current of inflation remained and towards the end of 1997-98 inflation picked up escaladed in 1998-99 particularly due to sharp rise in the prices of primary products. Annual inflation at the end of September 1998 was 8.8% and this was mainly due to rise in prices of primary products. However after peaking at 8.8% inflation started acceleration and reached as low as 4.4% on 16 January 1999.

However as on 27^th January 2000 the rate of inflation on a point to point basis was 8.2%. The 52 week average inflation rate was as high as 7.1% in 2000-01.

Inflation lowered later for the 1^st six months of 2001-02, later rose and again fell in January 02. The fiscal year 2001-02 ended with a lowest inflation rate of 1.6% on a point to point basis and 52 week average basis showed 3.6% inflation in WPI. This was the lowest in decades.

Price Rise in 2000 and after

Severe drought condition prevailed in 17 states in 2002-03, (such drought condition was created after 14 years) from past experience of drought and inflation there was apprehension about severe inflation condition but in did not happen because of abundance surplus stock of food grains which was adequately released.

The annual point to point inflation rate remained below 2% in May 2002 and thereafter stood at 62% on 5^th April 2003.

On a 52 week average basis inflation remained below 4% and annual point to point inflation rate on 3 April 2004 was 4.5 (An annual rate of 4.5% to 6% is an acceptable position for the country)

However, inflation rate rose to a peak of 8.7% on 28^th August 2004 and again declined on 2^nd April 2005to 5% to 7%.

During 2005-06 the average annual rate of inflation was 4.4% and it was 5.5% in 2006-07. However, the pressures started building up towards the last quarter of 2007-08, and inflation rate was 8.02% in March 2008. This was a matter of serious concern and a number of serious steps were announced like:

Raising the CRR by RBI anti inflationary measures by finance minister was announced mainly pertaining to increase the supply of necessary goods exports and imports.

In spite of all these measures inflation continued and on 31 May 2008, it touched 8.75%. To add to this the global prices of crude oil were rising and the govt. of India had to rise or was forced to raise petrol and diesel prices by Rs. 5 and 3 per liter respectively and the prices of cooking gas also increased creating inflation in essential goods.

Therefore the week that ended on 7^th January 2008, inflation rose to a double digit 13 year high of 11.05%.

“Finance Minister deals with supply side, taxes, fiscal policy etc. while RBI only deals with Monetary Policy.”

RBI further increased the CRR and the rapo rate. The major reason for the inflation for ‘90s can be stated as:

a. Policy for the govt. to appease certain section at the time of elections. Unreasonable administered prices for certain sections, unreasonable rates of taxation and so on.

b. On the demand side excessive liquidity has kept constant inflationary pressures. Since 1990-91 NNP has increased at the rate of 6.2% per annum.

M1 and M3 have increased at the rate of 14.8% and 16.0% respectively.

Average annual inflation rate

For all commodities Primary articles

1991-96 11.3

1996-01 5.4

2001-06 3.6

Price situation in 10^th plan

Year Annual rate of inflation primary commodities

of all commodities.

2002-03 3.4 3.3

2003-04 5.4 4.2

2004-05 6.4 3.7

2005-06 6.6 2.9

2006-07 5.3 6.9

The data is based on WPI. (Economic survey of 2006-07 and 2007-08)

2. The causes of price rise in India

Introduction:

The inflationary rise in pries in India has been due to a number of factors. Price have been rising in India from the Second World War due to ever mounting demands and specially after 1951 due to the adoption of faulty planning in management. India which has led to the expansion of money supply and liquidity in the country undue govt. expenditures, corruption, black marketing, money illusion supply shortages etc. In fact the growth process itself has been an important cause of inflation in India.

Besides on the supply side there has been deficiency even through supply of goods and services in rising it has not been proportionately matching to the rise in demand. Reasons being monsoon failure, backward technology, bottlenecks in transport, infrastructure, electricity etc. therefore there has been an imbalance between demand and supply leading to price instability.

In India from time to time all these factors have been contributing to inflationary rise in prices to various extents.

Inflation or Price rise mainly due to

Ø Excess demand in relation to supply i.e. Demand Pull Factors.

Ø Shortage of supply in relation to demand or the Const Push Factors.

Demand Pull Factors and Inflation

1) Mounting govt. expenditure: - Govt. expenditure has been steadily and continuously increased. The total expenditure of state govt., central govt., union territories. Rs. 740 crores in 1951 to 37000 in 1980-81 & to Rs. 902300 crores in 2004-05. Like wise the annual average rate of investments by the govt. under the 5 year plan has also increased when these expenditure and investment inflation rises. In other words the unproductive investments raise inflation; such expenditures create circulation of money in the economy but do not increase the production of essential goods. Hence demand rises supply does not and this triggers inflation.

2) Deficit financing and increase in money supply: - Deficit financing is one method of financing economic development. While the extend of deficit financing was modest in the 1^st 3 plans the magnitude of deficit financing rose rapidly from the 4^th plan. Revenue deficit was rising since 1981-82, but fiscal deficit was rising at a much faster rate. Fiscal deficit is financed through borrowing from the market at high rates of interest deficit financing directly pushes up the money supply which causes demand to rise but it does not ensure to equivalent rise I supply in the short run causing inflation.

Deficit financing in India since 1981-82.

Year revenue deficit as a % of GDP fiscal deficit as % of GDP

1981-82 0.2 5.4

1990-91 3.3 6.6

2000-01 4.0 5.6

2006-07 1.9 3.5

2007-08 1.5 3.3

(revised)

Money supply and monetary resources with the public (Rs. crores)

Year money supply with public (N1) aggregate monetary resources (N3)

1970-71 7340 10460

1980-81 23120 55360

1990-91 92890 265830

2005-06 826375 2729540

2006-07 965195 3336247

The fiscal deficit situation was brought under control during 2007 through rigorous fiscal discipline among the govts.

Some expansion of money takes place in all economic otherwise growth and development cannot take place. But fiscal indiscipline and irresponsibility creates excessive burdens of inflation for which the govts. are solely responsible or to be blamed.

3) Rise in black money/Role of black money:

There is a huge accumulation of unaccounted. Money in the hands of tax evaders, smugglers, corrupt govt. officials and other tax evaders from the business communities.

The extent of black money was estimated to be Rs. 600000 crores in 2006-07. Large proportion of black money goes into buying of some types of goods and services which creates inflation in those sectors and triggers ultimately inflation in the entire economy.

[The unaccounted money creates a demand which is not in proportion to the calculation of national output. This demand is beyond calculations of national output and when there is such a huge demand which is greater than supply inflation occur.]

[Areas where unaccounted money is easily spent in India are identified as real estate, land, gold jewelry, events, entertainment, tourism and other miscellaneous spendings like petrol electricity, garments and so on]

Growth of population

Planning commission realized during the 2^nd plan that the continuous uptrend of wholesale process during the 2^nd plan was undoubtedly rising population and rising incomes. In the early years there was an addition of 18 to 19 million every year in the population. Population growth rates started showing healthy signs only from 2001.

The average growth rate during 2001 to 2005 was 1.56% against 1.9% average population growth rate during 1991-2001. During the early years average population growth rate remained between 2.1% to 2.5% which was very unhealthy for a poor country with lower productivities.

In the later decades the average annual growth rate of population has remained around 1.8% and is showing further signs of declining.

Increasing population – increase in demands – increase in govt. expenditure – but a develop country has low productivities, mismanagement of resources and irregular supplies, black marketing etc. owing to which inflation rates rises.

Cost Push Factors

Introduction:

Inflation in India has also been cause as rising cost of production, marketing and supply.

1. Fluctuation in output and supply: - The production of food grains has fluctuated many times during the planning period. E.g. In 1964-65 the production of food grains was 89 million tones in the immediate next year 1965-66 it reduced sharply to 72 million tons i.e. a fall of 17 million tones indicating 20% decline in food grains in a single year.

In 1978-79 food grain production touched a peak of 132 million tones and in the immediate nest year it decline to 110 million tones decline of 22 million tones in just one year.

In food grain production in the year 2001-02 was in the year when food grain production reached the peak level of 213 million tones but in 2002-03 it sharply decline to 174 million tones in one year.

In 2004-05 food grain production decline to 198 million tones and again reaching a peak of 216 million tones during 2006-07.

A part from fluctuation in agricultural production market arrivals has also been directed. In fact agricultural goods were hoarded, black marketed creating upward pressure on agricultural prices.

In the present time there is a debate regarding the impact of trading in agricultural commodities, some experts believe that they create fair market prices some common people feel that they create inflation in agricultural goods. Along with agricultural commodity production there has been fluctuations in several other goods before 1991 and after 1991 like cement, sugar, steel and so on.

Before 1991 there were licensing constrains, hoarding, black marketing and son on in industrial production. After 1991 international factors have imported industrial production and their process.

[Every year the country adds 18 to 19 million to the population on an average such fluctuations in agricultural and industrial production will therefore have a direct impact on availability, inflation and poverty.]

2. Taxation as a factor in rising cost and prices: - Cost push factors mainly consist of rise in wages profit margin and rise in other cost. In this connection the govt. and public sector is responsible to a large extent for pushing taxes falls on the consumers in the form of higher prices with a lot of evasion and avoidance I taxes. In India the scope of taxation is limited. Within the limit state the govt. has to raise its required incomes and therefore tax rate go on increasing in certain sectors. Rising inflation in these sectors black money in the other sectors and too many exemptions in some other sectors. [Like there are no taxes on agricultural incomes in India.]

[Taxation is a poll of fiscal policy; fiscal policy is a stabilization policy and over tax system instead of creating stabilization in creating inflation.]

3. Administered prices: - The public sector enterprises were continuously raising prices of their products and services which generally constituted raw materials for other industries. There has been a regular upward revision of several administered prices adding further to inflation.

[On the on hand the govt. has to announce several subsidies and provide certain public goods at subsidized rates and on the other hand in order to recover the expenses in raises the administered prices as and when it wishes e.g. The subsidized petrol prices are kept under control during elections and soon after elections they are raised indiscriminately even if inflation rate in the country is already high at that point of time.]

4. Hike in oil prices and global inflation: - serious inflationary pressures were also created because of the sharp hike in price of crude oil. Since 1973 and the consequent upward revision of the prices of oil and oil based goods. In 1980 crude prices were increased by 130% by OPEC. In 1990-91 the Gulf-(War)-Surcharge raised the prices of oil to unprecedented levels. In recent years the price of crude oil in the international market has been rising due to two major factors:

a) Rapid economic development of India, China and other emerging countries necessitating the demand for oil.

b) Inadequate supply because of curtailment of oil production as result of political conflicts and uncertainties in the OPEC countries, African countries and South American countries.

Other Factors:

The other factors include failure of government policies, inappropriate and inconstant govt. policies, corruption and mal-distribution and so on. Though agriculture is the dominant sector of the Indian economy a proper agricultural policy never existed in India. It came up only in 2000.

The govt. created lot of wastage in the buffer stocks public distribution system and inability to control the private traders. The govt. for many years could not control the hoarders and black-market of important agricultural and non-agricultural goods. Most of the support system to farmers remained on paper and had severe implementation and percolation.

Weakness:

“License Raj”, for many many years restricted healthy competition, bread corruption into the system and promoted inefficiencies in production. Severe supply shortages were created on the other hand with increased population demands were increasing. Farmers were made inefficient by subsidies rather than making them independent with the help of technology, proper credit and marketing facilities and reforms.

Many a times govt. exported agricultural commodities without considering the domestic demand and many a times import of agricultural goods were delayed in times of needs.

Effects of Inflation

Inflation in India created an adverse impact on production and on distribution of income. With increased cost in certain sectors production resources were diverted to the non-priority sectors.

The rich became richer and poor became poorer were actually in India during the mid 60s, 70s, and 80s black marketers, hoarders, traders, dealers became very rich where as the middle class, the lower middle class and the poor people struggled against continuous price rise.

Measures to control Inflation

Since inflation arises out of demand pull, cost push and administrative reasons. A systematic anti inflationary programme should consist of demand management, supply management and price policy. India adopted all the three but inconsistence existed in all these measures adopted.

Demand Management

The price policy since 1974-75, had relied permanently on fiscal monetary measures to check the demand.

1. Fiscal measures: - The govt. has always talked about maintaining its own physical discipline and controlling its expenditures. In 1974, the govt. frees the wages and salaries on the one hand and dividends incomes on the other hand. In 1984, the govt. proposed to reduce public expenditures by postponing fresh requirements to govt. jobs. However, there were only populist announcements and govt. both central and state has recklessly spent tax payers money.

Under the impact of Asian crises and globalization for the first time ever in 1991-92, the govt. brought down its fiscal deficit. [From 8.4% of the GDP in 1990-91, to 6.2% of the GDP IN 1991-92]

2. Monetary measures: - The RBI, has tried to restrict bank credit against inflation by using CRR, SLR, Bank rates from time to time. In 80s and 90s, monetary policy was directed essentially to prevent any excessive increase in liquidity and at the same time ensure adequate credit for the genuine requirements of industrial and priority sectors.

Supply Management

These measures are related to the volume of supply and their distribution system.

1) Fixation of maximum crisis: - for elimination the incentive for hoarding and speculative activities in food grains, the state govts. were asked to fix the maximum whole sale and retail process of food grains on the other hand the govt. fixes the minimum procurement prices for major crops based and recommendation of agricultural prices and commission prices and other important goods like cloth, sugar, etc. were also controlled in the past.

2) The system of dual prices: - The govt. has adopted a system of dual prices jin the case of goods like sugar, cement, paper etc. under this system the weaker sections in the community are supplied these goods through fair price shops, at controlled prices and the rest were allowed to purchase their requirements at higher prices from open market.

Dual pricing generally failed to serve the purpose rather it created confusion in the market and led to erratic price movements. There was a lot of corruption in the fair price market. The dual pricing of cement was given up because of corruption and erratic price movements and price of cement is controlled to be determined by market forces of demand and supply.

3) Increase in supplies of food grains: - The govt. used to increase the supply of food grains and other essential goods in times of internal shortage through large imports.

Ø This has become largely unnecessary except in the case of edible oils.

Ø During 1970s and 80s the central govt. took advantage of the success of green revolution and gradually built up large reserves of food grains at one point of time the reserves exceeded 30 million tones.

Ø Release of food grains from buffer stock was many times delayed. A part from this there is a lot of wastage of food grains in the buffer stocks.

4) Supply of oil seeds and edible oil: - from time to time inflation was triggered by hoarding, black marketing or lower product of edible oils.

Ø From 90s to the present time there was a steep rise in the prices of edible oil along with those of pulses, tea, sugar etc which have been responsible for the rise in the general price level. The govt. has prepared medium and long term plans to set up the production of oil seeds in the country.

Ø The govt. has announced higher support prices for groundnut, Soyabeen and sunflower seeds.

Ø In the short period the govt. has been relying on imports of edible oil and reduced or concsessional import duties even though it has found out those imports do not necessarily bring down prices for the domestic consumers.

Ø Soyabeen and sunflower crops offer the maximum scope of augmenting the supply of edible oil in the country.

5) Public distribution system (PDS) and consumer protection: - The govt. tried to strengthen the PDS covering the entire country by setting up a network of fair price shops.

During the planning period govt. set up as many as 40000 lakhs fair price shops which covered a population of over 500 million and these shops mainly distributed wheat, rice, sugar, imported edible oils (palm oil), kerosene, soft cake etc.

Thus public distribution system serves two purposes:

A. It helps to hold down prices.

B. It provides essential commodities to low income groups or middle income groups. In the present time this system works only in low income groups commonly called the BPL, farmers. Wherever PDS is hold pressed due to inadequate supply prices of essential goods tends to rise. PDS have been strengthened and extended to rural areas.

6) Control over private trade in food grains: - To check prices and to eliminate hoarding and speculative activity in food grains were licensed in many states. Limits were fixed beyond which traders and producers could not hold stock without declaration.

At the end of September 1977, pulses and edible oils order was issued under the essential commodities to fix the maximum limit of stocks that would be held by wholesalers and retailers. The food corporation of India has come in a big way to buy surplus areas and sell in deficit areas and this moderate the differences in prices.

7) Other relevant measures: - since 2000-01 the following important measures have been taken by the govt. to control inflation:

a) Adjustment in trade and tariff policies in recent central govt. budgets to ensure that domestic prices of industrial products remain competitive.

b) Substantial reduction in excise duties on a number of items exported to accelerate the pace of individual revival and raise industrial growth.

Price Policy

Govt. has adopted several measures for demand and supply management but without the proper price policy the factors can not be integrated.

v The component for price policy for growth in the earlier years consisted of price controls, procurement price, administered price, dual price and subsidies

v In the present times a proper price policy for growth must contain the following:

1. Regulation under liberalization

Ø Liberalization helps to set free and fair prices but in there still are serious demand and supply gap in some essential goods.

Ø Investment has to be guided in some particular channel.

Ø Special consideration has to be shown to the needs of vulnerable section of the society.

Therefore policy must aim at regulating these aspects.

2. Policy of administered Prices

The two basic objectives of administered prices in present times are:

i) To fix and maintain prices of essential raw materials so as to avoid cost and price isolation. This has special significance during a period of shortages and rising prices.

ii) To ensure economic prices to non-economic units so that such units can also earn organic profit.

3. The system of dual prices

A system of dual prices by using subsidies can be created for some basic good for a) Certain vulnerable segments of the society and b) encouraging producers for expanding production in certain sectors.

4. Procurement and Support prices

Though the prices of agriculture and other important articles should be left to the market for a fair determination the govt. still however continues to create a proper support prices structures.

This is because: -

Ø Farmers in India are still poor.

Ø Irrigation facilities are insufficient.

Ø Retail marketing is not fully organized.

Ø It is still economically inviolable for individual poor farmers to market their products all by themselves.

Which means there are market imperfections in India because of which for all commodities market price determination will not be always fair and therefore govt. intervention in the price determination process must be necessary.

5. Buffer stock and public distribution system

§ India has experienced droughts and famines many times because of dependence on monsoon.

§ Imports of food grains during such situation and proved very expensive in the past e.g. food grain imports from US under the P.h. 480, during 1964-65,. Therefore price policy should incorporate prices for a proper public distribution system.

§ Besides proper buffer stock should be maintained so that in times of crisis stock can be released at reasonable prices.

3. prices of Industrial products

In an LPG era prices of most industrial products will be determine by flow of goods and demand across nations.

However in India where dual economy structure still exists, magnitude of poverty and unemployment is still high market imperfection exists and equitable opportunity did not exist; govt. must regulate prices o certain goods like electricity, kerosene, coal, fertilizers and so on.

On the other hand certain subsidies should be faced out or done away with completely so as to make these stocks independent and competitive.

7. Monetary policy

Monetary policy is a demand and supply management policy.

Ø Its scope has widened in the present times with increase import of international factors in the monetary market like international gold-flow, impact of international rates of interest and so on.

Ø The demand for money can be distributed by increasing various types of rates and lower circulation of money and lower inflation and vice versa.

Ø When consumers borrow less they demand lesser goods and services and inflation stays under control in the country.

Ø Besides goods can be made and less costing and competitive or more costing by providing subsidies to certain sectors and producers.

Ø The total supply of money can be reduced by forcing fiscal discipline among the govt. or it can be increase fiscal leniency.

Ø When producers borrow less they produce less goods and services and this again helps in arresting inflation.

8. Fiscal Policy

Fiscal policy can control demands by increasing or decreasing people disposable income after tax and compulsory or maintained savings.

Besides it can make goods more or less costing by commodity taxes and increase or decrease their demands.

Conclusion

In the present times when the govt. can not directly restrict the supply of goods because govt. can not stop consumerism and demand for goods a wise use of fiscal policy can help to control demand and supply prices judiciously.

The govt. can also reduce the process of some goods by imposing various taxed on these sales which would make the entire production or supply costly.

Chapter: 6

Banking

The banking sector in India is a constituted of the Indian Financial System. The IFS refers to the system of borrowing and lending of funds or demand for and supply of funds from all individuals, institutions, companies, and govts.

Funds are mainly of the following types;

a) Industrial Funds b) Agricultural Funds

c) Development Funds d) Govt. Finance

The financial system has a banking market (money market) and a capital market that take care of the funds mentioned above. The banking sector generally taking care of the money market has the following structure in India.

RBI (APEX / Supreme Bank)

Scheduled Bank

Scheduled Commercial Bank Scheduled Co-operative Bank

Public Sector Bank Private Foreign Regional

Sector Bank Bank Rural Bank

Nationalized B. State B O I

(19) Its association

Old Private New Pvt.

Sector Bank Sector Bank

(22) (8)

Schedule Scheduled State

Urban Co.B. Co. Bank

(52) (60)

Beyond the scope of RBI there is a huge indigenous/unorganized money market in India.

Q. DESCRIBE THE WORKING SYSTEM OF COMMERCIAL BANK OF INDIA.

In July 1969 14 major banks with a deposit of 15 or more were nationalized, that is the govt. toke over the country. In 1980 again the govt. took control of more co-operative banks. Thus there are 20 co-operative nationalized banks including SBI.

The purpose of nationalization banks was to do away with the limitation of the private banks in those days promote the objectives of planning in India, mobilize saving, enhance the security of mobilized money help the poor, help the priority sector and so on.

Achievements of Banks Nationalization in India;-

1. Bank Expansion;- Nationalization helped branch expansion in the urban as well as in the rural area which was a very requirement of the country.

A lead bank scheme was introduced under which one bank was appointed as a “ LEAD BANK” in a particular area, which was then responsible for the expansion of banking activity in that area.

Branch Expansion for All Commercial Banks;-

As on June Total no. of Banks Rural Branches Rural Branches % Pop. 4 30 Of the total bank office

1969 8260 1,860 22 63,800

1991 60,650 32,750 54 14,150

2006 69,620 30,750 44 15,000

· Branch expansion was not every aggressive after 1991 because the private sector banks and foreign banks were expanding. In the LPG erra the govt. did not prefer to take extra administrative salary and burdens.

2. DEPOSIT MOBILIZATION;- Land economic development, increasing income, increase in the number of branches and increase in awareness of banking habits among people led to an increase in deposit mobilization.

Deposit and credit of all scheduled commercial banks.

Years No.of Reporting Banks Bank deposit in Crore Bank credit in Rs. Crore

1950-51 430 820 580

70-71 73 5,910 4690

90-91 271 1, 92,540 11, 6300

2000-01 279 9, 62,620 511430

06-07 179 26, 08,300 1928910

So much of mobilization occurred because of the following reasons;-

a) Rapid grant expansion

b) Increase in amount of cash with the banking system due to the high magnitude of financing by the govt. of India.

c) The ratio of cash reserves to deposit;- after the recommendation of Narasimhan Comity in 1992 the CRI and SLR gradually decreased by RBI which increase the landing capacity or the mobilizing capacity of bank.

d) Favorable business conditions in the country.

e) High ratio of interest: - increased rates of interest mean increase motivation for bank to expand credit.

3. DEVELOPMENT ORIENTED BANKING

Historically, there was a close association of banks with commerce and some traditional industries for e.g. Cotton – textile in western region. Jute in the eastern region and so on. There were mainly joint sector banks concentrated in commercial area with virtual neglect of non- commercial region.

This kind of banking hindered the development of the economy, they required push promotion of entrepreneurship and self-employment, development of the poor people, development of rural areas, bringing about balance regional development, pursue the socialistic objectives and so on.

The nationalization of bank in 1969 promoted development oriented banking in the country. A lead bank in every district was identified and this bank was held responsible for: -

a) Opening bank offices in all the important localities.

b) Providing maximum facility for development in the district.

c) Mobilizing savings of people in that district.

d) Promoting awareness and banking habits among the poor and the illiterate and other people.

PRIORITY SECTOR LENDING BY BANKS

Neglect of PSL was one of the causes for nationalization of banks in 1969. The PSL programme was chaired by Dr. K.S. Krishna swami. According to him PSL means lending to those groups segments and sectors for activity in a manner that increases the national income of India.

In 1980 RBI issued the following character for Priority Lending by the nationalized banks.

a) Priority Sector advances should constitute 40% of the aggregate bank credit.

b) Out of the Priority Sector advances at least 40% should be provide to agriculture sector.

c) Direct advances to the weaker section in agriculture activity in the rural areas should form at least 50% to the total direct lending to agriculture.

d) Bank credit to rural artisans, village craftsman and cotton industries should at least be 12. % of the total advances to small scale industries.

e) About 12% should go to exporter

100 crore

40% priority sector=40 crore Village artisans cottage industry 10% export (1200)

40% to agriculture 12.5% of the total advances to

(40% of 40 crore=1600) small scale sector(x) is the advance

To the S.S.I 12.5% if x=cottage it.

50% of this to weaker section (craftsman, farmers) village

In agriculture

50% of 16 or= 800

5. SOCIAL BANK ;- Under the objective of social banking the govt. of India uses public sector banks to finance many of its programmes of poverty alleviation, employment generation etc. E.g. In times of droughts govt. may direct the bank to foreign the loans of poor farmers. The govt. may ask the bank to finance some of its programme for generating self-employment in rural areas. The govt. may ask the bank to support some community or group of people by way of micro finance.

The profitability of nationalized bank is low because of priority sector lending and social bank. P.S.L. and social Banking is many a time undertaken by …

a) Using policy of “DIFFERNTIAL INTEREST OF RATES” : - The govt. of India introduced D.I.R. scheme in April 1972 covering 162 districts and later it was extended to our country. Under this scheme the public sector bank gave loans at concession rate of 4% to the weaker section of the community who have no tangible security to offer but who can improve their economic condition to financial assistance from public sector banks.

b) Banks contributed to the IRDP programme of govt. of India by assisting the rural poor by giving soft loans, subsidies etc. Other schemes supported by banks under social banking are…

c) Prime Minister Rozgar Yojna for educated unemployed youth (PMRY)

d) Scheme For Urban Micro Enterprises ( SUME )

e) Bank Credit To Minority Community ( BCMC )

6. DIVERCIFICATION IN BANKING: - Since their nationalization govt. of India encouraged nationalized bank to diversify their function under section 6 of the Banking Regulation Act, 1949. Accordingly banks have diversified in the following ways;-

a) Commercial banks have now set-up merchant banking division and are under writing new issue, especially preference shares, and they have been instrumental in the conclusion of differed payment agreements between industrial houses of India and foreign terms.

b) Some banks were promoted to follow subsidy as mutual funds ( so far 7 banks have done this) ( at one time mutual fund operations were a monopoly of the Unit Trust Of India )

c) Retail Bank: - Retail banking refers to transaction loans for purchase of durable goods like car, TV …etc. Credit cards, educational loans… These loans can average Rs. 2000 and 1 crore and generally for a duration of 5-15 years

Besides, banks have also…

d) Set up ATMs

e) Introduced Anywhere Banking

f) Introduced Internet Banking in India

g) Introduced launched Venture Capital Funds

h) Introduced Factoring………..

Banking

Reserve Bank of India (RBI) and its Functions:

Introduction:

The RBI was inaugurated in April 1935, whit a capital of 5 crores divided into fully paid up shares of 100 each. The RBI Act of 1934 provided for the appointment of a governor and 2 deputy governors by the central govt. The RBI was nationalized in 1949.

The RBI is the apex bank of the country. It controls the entire banking system of the country. It is a banker and adviser of the country and it stabilizes the monetary functions of the country.

1. Q. The Functions of RBI: (from Xerox)

2. Q. The Monetary Policy of RBI

The monetary policy of RBI since 1952 …………the two aim of the economic policy of the govt.

a) Speed up economic development of the country, to raise up national income and standard of the country.

b) To control and reduce the inflationary pressures.

Accordingly the monetary policy of RBI can be;

1. Credit restriction policy, but, in actual practice this does not happening in India practically because India is a developing country and credit expansion is a necessary.
2. Policy o credit expansion:

This policy is required on a off in India but this policy has to be administered with a lot of regulation owing to the nature of developing country.

3. Anti-inflationary policy

The anti-inflationary has been used from time to time. Since Indian economy was gripped by high inflation time and again because of under development on the one hand and development policy on the other hand.

4. The RBI also has to control from time to time the value of Indian currency in the international market. Therefore it has to intervene sometimes in the international market by buying and selling foreign exchange, by devolution policy, by adopting rich foreign exchange policy and so on.
5. Foreign exchange regulation is maintained not just for stability of Indian currency but also to steer imports and exports to maintain a BoP stability.
6. RBI also has to look into issues of monetization of the economy, creating banking habits and awareness among people, help the poor and the priority sector and modernization of banking sectors for which it adopts a policy of persuasion, moral suasion directing the other banks and so on.

The Tools of Monetary Policy of RBI are: -

1. Measures of Credit control/Regulation:

[Quantitative and Qualitative]

1. General measures of credit control

a) Bank Rate (Quantitative)

b) CRR (Quantitative)

c) SLR (Quantitative)

[Qualitative persuasion and direction]

2. Open market operation.
1. Selective measures of credit control.
2. Credit Authorization Scheme (CAS).
3. Credit monitoring arrangement (CMA).

1. Measures of credit control/regulation

1. General measures of credit control

These are measures that impact all the banks, all the sectors and all the segments equal. The measures can be quantitative and qualitative. The quantitative measures are used to control volume of credit and qualitative are those of moral suasion, persuasion, direction and so on.

a) Bank rate: - Bank rate is a rate of discount at which the RBI discounts the 1^st class bills of exchange or gives credit to the other banks.

This rate ordinarily becomes the lending rate of all other banks.

When the lending rate is low people/businesses get loans at a lower rate and therefore they borrow more money and vice-versa, if lending rates are high.

When rate are low, → credit creation is high, → i.e. more loans are given/taken by people and organizations, people and businesses, → thus many supply or money circulation increases.

This called a policy of credit expansion or cheap credit (vice-versa).

The lower bank rate fixed for India was 3% and the higher up to 12%.

[up to 1953 - 3%,

In 1953 - 3.5%,

1981 - 10%,

1981-91 – 10% (unchanged),

July 1991 – 11%,

Oct. 1991 – 12%]

b) Cash Reserve Requirement (Ratio) [CRR]: - This tool is known as the valuable Cash Reserve Requirement. Under the RBI Act of 1934, every commercial bank has to keep certain minimum cash reserved with the RBI. This cash requires a statutory.

Initially it was fixed at,

· 5% of demand deposits.

· 2% of time deposits.

Since 1962, RBI was empowered to vary the CRR between 3% to 15% of the total deposits (demand + time).

If CRR is low, → banks have to keep lesser reserves as cash, → therefore they have more money to lend or for credit creation, → more lending means more money in the economy.

This is credit expansion or cheap money policy, and vice-versa.

[During 1973 – 5%

September – 1973 – 7%]

Ø Was raised up to 15% (for 4 years.)

Ø Later on reduced to 8% in 1991.

Ø Further reduced to 5% in 2002.

Ø 4.5% in June 2003.

Ø 8.75% in July 2008.

c) Statutory Liquidity Ratio (SLR): - According to the banking regulation 1939, apart from CRR (RBI Act of 1934), all commercial banks have to maintain liquidity assets in the form of cash, gold and unencumbered approved securities, equal to or not les than 25% of their total demand and time deposits liability.

This measure again means that banks cannot lend all the money that they have.

If SLR is raise above 25% the lending capacity of banks is reduced further and credit contraction or contraction of money supply takes place in the economy.

The SLR has been raised further to 38.5%. But after the recommendation of Narasighum Committee in 1991, the RBI reduced it successfully back to 25% in October 1997.

SLR helps: -

Ø To control credit expansion.

Ø Diverts banks funds from loans to in investments in gold, in govt. and in other approved securities.

Ø Ensures enough liquidity with the banking system in times of crises.

[There is a demand to abolish altogether.]

2. Open Market Operation of the RBI

Central banks indulge into buying and selling eligible securities from/in the open market. This influences the volume of cash reserves with the banks which in turn influences the volume of loans and advances given by the banks. RBI did not use this instrument for many years.

[When RBI buys security from the market it creates its less cash reserves to give to other thus, people find less option for buying other goods and securities.]

Since 1991 the enormous inflow of foreign funds in India created the problem of excess liquidity in the banking sector and it undertook large scale open market operation.

2. Selective and direct measures of credit control

Under the banking regulation act of 1949 the RBI is empowered to issue directives to the banking companies regarding their advances. These directives may pertain to the purpose of loans/advances, the margins to be maintained in the secured advances. The maximum amount should be given to a single borrower; the amount up to grantees may be given by banks on behalf of any form. The rate of interest and other term for granting advances and so on.

RBI has used this very regularly and frequently. In 1956-57 RBI used this to check speculation and rises prices. In 1964-65 RBI fixed minimum margin to be maintained by commercial banks stall food grains, oil seeds, including vanaspati etc.

The purpose of this was to restrict the volume of bank loans extended against these goods which were in short supply. Since January 1970, the nationalized banks have to get prior approval of RBI for the purchase of shares and the ventures of a joint stock company for any amount of more the Rs. 1 lakh. The RBI has introduced differential interest rate for agriculture, industries, personal loans and so on i.e. with changing purpose loans the rate of interest changes and the RBI can steer development of each sector as required.

3. Credit Authorization Scheme:

This was one form of selective Credit Control Scheme introduced by the RBI in 1965. According to this commercial banks have to obtain RBI’s authorization before sanctioning any fresh credit of Rs. 1 crore or more to any single party. This was later raised gradually to Rs. 6 crores in April 1986.

The cut off point for all manufacturing units and exporters was raised to Rs. 7 crores. The CAS was liberalized in 1978 to allow for greater access to credit for genuine production needs. However in 1988 the RBI abolished CAS.

4. Credit Monitoring Arrangement (CMA)

This is an alternative arrangement introduced by RBI. Under this the RBI would monitor and scrutinize all sanctions of banks loans exceeding;

1. Rs. 5 crores to any single party for working capital requirements.
2. Rs. 2 crores in case of term loans.

Q. Evaluation of Monetary Policy of RBI: (from xerox) [short note.]

The monitory policy of central control expansion: - The monitory policy of RBI since the 1^st planned period was termed broadly as one of controlled expansion. Controlled expansion means, “Expansion of adequate financing of economic growth and at the same time ensuring reasonable price stability.”

Anti-inflationary Policy since 1972:

Since 1972 Indian economy has been working with considerable inflationary potential. These have been rapid increase in money supply with the public and the banking system. There was significant expansion of bank credit to finance trade and industry. There were frequent fluctuations in agricultural production;

v Faulty govt. policy.

v Oil price hike.

v Gulf war and oil price hike.

There were many other reasons for inflation. Therefore RBI had to adopt an Anti-inflationary Policy.

Q. Evaluation of Monetary Policy of RBI: [short note.]

Introduction:

Though monitory policy has mattered in times of serious inflationary or recessionary situations, its over all performance has not been consistent, has not been fully fulfilling to the requirement of Indian economy.

1. From 1952-74, the monitory policy of RBI was characterized as one of “controlled expansion”. However, during the same tome the RBI was taking step such as the Bill Market Scheme to expand bank credit to industries and trade and thus help economic growth. On the other hand it was raising both general and selective measures of credit control to regulate credit expansion of banks.

Though these 2 contradictory policies actually meant to “Control Credit Expansion”, because of some inherit constraints of the monitory policy itself and of the Indian economy; this policy was not very effective in fulfilling the objective.

2. The Indian economy is not fully monetized. In other words many transactions are not impacted even by the general measures of credit control. For example – the RBI may raise interest rate to control expansion of credit which should equally impact all sections of the economy since the rate of interest is increased in equitable proportion by the entire banking system – but in India there is a very large unorganized money market which does not fall under the domain of monitory policy of RBI – a lot of credit mobilization takes places in unorganized market irrespective of the policy measures and this way the monitory policy is rendered ineffective.

3. Many a times it becomes difficult for the govt. and RBI to control situation that require contradictory policy. For example – in times of shortages of food and essential commodities and simultaneous inflation, the Chakrawarti Committee recommended a two – pronged strategy.

a. The govt. should aim at raising output limit.

b. The RBI should control the expansion of reserve money by banks and money supply.

In order to increase the supply of essential commodities, govt. has to promote more credit activity and – traders would require easy credit to do so. But on the other hand easy credit is restricted by RBI to control inflation. So, both the measures become ineffective if traders approach the unorganized money market for finances or else they would indulge into black marketing of essential goods.

To avoid such a situation [the Chakrawarti Committee recommended that for particular year and three target should be aimed in advance – this target should be in terms of a range based on anticipated growth in output and – also based on the price situation. This will help the RBI to exercise the general measures more effectively. But, a large non-monetization/unorganized sector may render ineffective even this kind of management ineffective.]

4. In the present times of globalization and liberalization the monitory policy is expected to contribute to sustainable economic growth by low and stable inflation. However, the RBI can not fully control the external shocks environment and factors. On the other hand it also has to provide an environment to the Indian economy to bear the external shocks. For example – RBI tries to manage credit expansion to keep prices under control. On the other hand it also has to allow foreign investment for modernization and globalization in Indian economy. In the process if excessive money comes into the economy, the RBI’s price control measures become ineffective.

Questions for exams.

Economics Paper: - IX

Chapter: 1

Q. 1. State the objectives of planning in India?

Q. 2. Discuss the experiences/achievements and limitations of planning in India?

Q. Write a note on five year plan? (It’s for the University exam.)

Q. 3. The purpose & objectives of planning in India?

Chapter: 2

Q. 1. Give an over view of the reform process in India, the objectives of reforms in India?

Q. 2. Explain the agricultural reforms undertaken after 1991, also state their purpose and objectives?

Q. 3. State the important industries reforms post 1991, state their purpose objectives?

The following are for short notes:

Q. 4. What is meant by sectoral reforms?

Q. 5. Write a note on new industrial policy up to 1991?

Q. 6. Agricultural policy after 1991?

Q. 7. State the important service sector reforms post 1991?

Q. 8. State the important financial sector reform post 1991?

Chapter: 3

Q. 1. Explain the process of Liberalization of the Indian economy?

Q. 2. Explain the process of Privatization of the Indian economy?

Q. 3. Explain the process of Globalization of the Indian economy?

[Answer must include Process, meaning, steps undertaken; (Advantages fear and threats? could be asked as a separate short question in the University exam.)

Chapter: 4

Q. 1. Explain the following concepts:

a) Budget

b) Current account/revenue receipts and expenditure

c) Capital account/ capital receipts and expenditure

d) Performance budget

e) Balance budget

f) Deficit in the budget

g) Ziro based budget

h) Revenue deficit

i) Capital deficit

j) Budgetary deficit

k) Primary deficit

l) Fiscal deficit

Short notes:

Q. 2. Different types of deficit in a budget drawing data from the recent budget?

Q. 3. Discuss the latest union budget of India?

Chapter: 5

Q. 1. Discuss price trends in India since independence specifically since 1991?

Q. 2. State & explain the causes of price rise in India?

Q. 3. Discuss measures taken by the Govt. to control price rise in India also suggest your own measures to control price rise in India?

Chapter: 6

Q. 1. Write a note on Indian system of banking?

The following are for long question:

Q. 2. Evaluate the performance of nationalized and commercial banks in India/that means the achievements and limitations of commercial banks in India?

Q. 3. Write a note on the functions of RBI?

Q. 4. Critically evaluate the Monitory Policy of RBI?

Q. 5. Discuss the important instruments used by RBI?

Q. 6. A note on evaluation of the Monitory Policy? [In introduction to this answer write down the monitory policy between 1952-72 and the monitory policy after 1972 as well as a list of the instruments of monitory policy of RBI only the list, then write the evaluation in detail.]

Chapter: 7

Foreign Trade

Q. Give the trends/ directions and composition of India’s Foreign Trade since 1991?

Foreign trade is an important indicator of the technical, technological and commercial growth and progress of an economy. India’s foreign trade has changed significantly in terms of volume – value, composition and direction since independence.

Value of India’s Foreign Trade (1948-49 to 1960-61)

On the eve of planning there was an excess of imports and exports owing to post world war demands, shortage of food and basic raw materials due to partition of India and rise in the imports of machinery and equipments.

During a second plan the programme of heavy industrialization was initiated. This called for imports of very high value and volume in the areas of spare parts, technology, capita, maintenance, industrial raw materials etc.

Annual average value of imports/exports (in crores)

Year Exports F.O.B Imports C.I.F. B.O.T.

1951-52 to 1955-56 622 730 - 108

1955-56 to 1960-61 613 1080 - 467

• During the early 60s imports of industrial raw materials, machinery know how.
• “The import situation was aggravated into wars China and Pakistan”.
• “To make a situation even worse there was a crop failure and large amounts of food grains had to be imported.”
• As a result imports increased considerably and devaluation of Indian rupee was done in 1966 by 46.5%.

	For the first time 1972-73 BOT surplus of Rs. 104 crore emerged. Devaluation produced some healthy effect in stimulating exports, there was better crop in the later years owing to success of green revolution and consequently the balance of trade deficit was reduced to some extent. After green revolution therefore food imports declined.

Annual average value of imports/exports (crores)

Year Exports F.O.B. Imports C.I.F. B.O.T.

1961-62 to 1965-66 742 1224 - 477

Average of Fourth plan:

Year Exports F.O.B. Imports C.I.F. B.O.T.

1236 1925 - 689

1969-70 TO 1973-74 1810 1972 - 162

5^TH Plan period (1974-79)

Ø Oil price hike by OPEC in 1973.

Ø Triggered other imports price rise also like fertilizers and food grains.

Ø But a significant increase in India’s exports of fish and fish production, coffee, tea, ground-nuts, cotton, fabrics, readymade garments and handicrafts.

Ø In 1976-77 a second time BOT surplus emerge at Rs. 69 crores.

Ø But the next 2 years Janta Party govt. followed a haphazard import liberalization policy and trade deficit, BOT deficit worsened.

1980 onwards (6^th & 7^th plan)

Ø Petrol hike by OPEC in 1997-80, increased by import bill.

Ø Exports earning were rising but could not cope up with import bills.

Ø BOT deficit were very large and govt. approached IMF in 1981for a huge loan.

Ø After 1983-84 Petroleum and Oil Imports (POL) but non POL bill increased sharply.

Ø In the 7^th plan indiscriminate liberalization was adopted and the huge trade deficit compelled the govt. to borrow an unprecedented loan over dollar 6.7 billion from World Bank/IMF.

Ø Finally the govt. had to control licenses for imports.

Average annual Exports/Imports (in crores)

Plan Exports F.O.B. Imports C.I.F. B.O.T.

5^th plan 4728 5538 - 810

6^th plan 8967 14683 - 5716

7^th plan 17382 25112 - 7730

8^th Plan Onwards (LPG era)

Ø Exports effort picked up.

Ø Liberalization, Privatization, Globalization policies shaped up.

Ø Exports jumped but simultaneously polices of liberalization accompanied with reduction in custom duties resulted in import increase.

Ø Trade deficit was very weak.

Ø In the beginning of the 9^th plan world output decline by 2% consequently world trade declined and India’s foreign trade slowed down.

Ø World output decline because of continued impact of South East Asian crisis, continued recession in Japan, sever economic crises in Russia.

Ø During 1998-99 exports decline between 1999 and 2000 exports picked up but imports rose more sharply.

Ø During 2001-02 exports decline but imports continued their foreword march.

10^th Plan

Ø Policies of facilitating imports under WTO pressure resulted in increase in imports.

Ø Consequently trade deficit short up to record levels.

Ø Average annual trade deficit in the 10^th plan was about the times that in the 9^th plan.

Ø During the period from 1992-93 to 2000-01 exports rose by 18.5% pre annum (compounded) but much of this export was owing to two steps: devaluation of the Indian rupee in 1991. Thus after this effect was over exports could not keep pace with imports in the 10^th plan.

Ø This devaluation had impact in the global market. It increased the value of imports in the market. Thus triggering deficit in the period subsequent to devaluation.

Ø Thus devaluation can have only short term positive results and may not be helpful in the long term.

Average annual Exports/Imports (1992-93 to 1999-97) Rs. in crores.

Year Exports (F.O.B.) Imports (C.I.F.) B.O.T.

1992-93 to 96-97 86257 97609 - 11352

1997-98 to ’01-02 168401 204764 - 36363

2002-03 to ’06-07 393789 543639 - 149841

Q. Composition of India’s Foreign Trade:

The classification of composition of imports until 1987-88 was done according to sectors and types of commodities. Since 1987-88 the directorate general of commercial intelligence and statistics classify imports and exports as bulk imports/exports and non-bulk exports/imports.

“Imports” 1947-48 to 1956-57

In the beginning years of independence the main items of imports were machinery of all kinds, oils [vegetable, mineral, animal] grains, pulses, flours, cotton raw and waste, vehicles [including locomotives] cutlery, hardware implements and instruments, chemicals, drugs and medicines, dyes and colours yarns and textile fabric, paper board and stationery and metals other than steel.

• These imports together constituted more than 70% of all imports.
• The initiation of planning in 1951 and the 2^nd five year plan brought about a considerable change in the composition of imports.
• Heavy industrialization in the 2^nd plan necessitated the imports of capital equipments in large quantities spare parts, materials and machinery know-how.
• And “the maintenance Imports” entered into the import structure of the country in a major proportion.

Imports since 1960-61

The main items of imports during this period included insignificant proportion of food and raw material items.

The imports during the decade beginning from 1960-61 can be divided into four broad groups:

1) Food and live animals chiefly for food.

2) Raw materials and intermediate manufactures.

3) Capital goods.

4) Others goods.

Imports in 1980s and after

• Oil and petroleum imports became glaringly important owing to the formation of OPEC and the rising petrol prices.
• Crude oil and petrol was imported even in the earlier periods but the sharp rise in price made it the most significant component of imports and it continues to remain so till the present times.
• From the 70s – these imports of non-electrical machinery started increasing which continued over the 80s and 90s. These imports constituted significant proportion even in 2006-07.
• During the 80s imports of edible oil remained high because of increasing domestic demand.
• Between the 70s and 90s despite increasing domestic production of iron & steel, substantial quantities had to be imported to keep pace with the rising demand.
• Since 1960s and early 70s i.e. the green revolution and post green revolution period the imports of fertilizers started increasing which continued until 1995-96. These imports decline in 2006-07.

1991 and 2000 onwards:

Due to globalization structural changes of the Indian economy and rapid economic development the composition of imports changed thus POL (Petroleum Oil and Lubricants) exports rose significantly. Fertilizer imports declined insignificance (as a percentage of total imports). Iron & steel imports again declined in the percentage of the total significantly after 1991.

• Chemical elements and compounds declined insignificantly whereas the imports of non-ferrous metals assumed greater significance after 2001. (Non-ferrous metals as percentage of the total imports increased.)
• Imports of pearls and precious stones declined as a percentage of total imports. Serial and serial preparations declined as a percentage of total imports significantly after 1908s and the trend continues.
• Significantly the imports of electrical and non-electrical machinery declined as a percentage of total imports.

Composition of Service Imports:

After the spread of telecommunication digital and computer technologies services have become easily tradable across countries. During the recent yeas more so after 2000-01 the service sector imports increased considerably. They constituted almost 28.7% of the total im0ports in 2006-07.

Service imports mostly include:

Ø Travel, transportation, insurance.

Ø GNP, soft wear, business services.

Ø Financial services, communication services.

Composition of Exports

A very clear trend in exports has been decline in the importance of agriculture and allied products and a significant increase in the importance of manufactured products. For example: the share of agricultural and allied products in the total export was 44.2% in 19060-61 which declined to 10.3% in 2006-07 while that of manufactured products which was 45.3%in 1960-61 increased to 68.6% in 2006-07

• The most important item in 1960-61 was jute and it contributed 21% of the total export earnings. It declined since 1907-71 and was only 0.2% of the total exports in 2006-07.
• Second most important exports item in 1960-61 was Tea (19.3% of the total exports) since then it started declining and tea exports were only 0.3% of the total exports in 2006-07.
• Exports of engineering goods rose substantially 3.4% of the total exports in 1960-61 to 23.3% in 2006-07.
• During the recent years India’s exports of petroleum products has started increasing significantly. In 2005-06 these exports accounted for 11.5% of the total exports and in 2006-07, 15% of the total exports.
• Exports of gems and jewelry constituted 4.5% of the total export in 1970-71 which increased to 12.6% in 2006-07.
• Exports of chemical and allied products ready made garments, iron-ore, leather and leather manufactures rise etc have increased insignificance while fish and dish production have shown unsteady trends.
• Food and fish exports since the WTO regimes face rigorous and severe phyto-sanitary measures.

Composition of Service Exports

Exports of services from India has increased at a rapid pace in the recent yeas. The continuous high growth in exports of services has been an important factor in reducing the deficit and balance of trade. The important services exports comprise of soft wear services, business services, financial services, and communication services.

Growth of exports of these services was 70.5% in 2004-05, 37.5% in 2005-06, and 36.7% in 2006-07. There was a significant rise in travel and transportation services also.

Direction of India’s Foreign Trade

In the pre-independence period, the direction of India’s foreign trade was determined not according to the comparative cost advantages of India, but by the colonial relations between India and Britain e.g. in 1950-51 the share of UK and USA was 42%. And the combined share of UK and USA in India’s import expenditure was 39.1% in 1950-51.

Direction of Imports

We classify countries that India imports to in the following categories:

1. OECD (Organization of Economic co-operation and Development countries).

1) European countries.

a) Belgium

b) Germany

c) U.K.

2) U.S.A.

3) Switzerland

4) Japan

2. OPEC (Organization of Petroleum Exporting Countries)

1) U.A.E.

2) Indonesia

3) Saudi Arabia

3. Eastern Europe

1) Russia

4. Developing Countries.

1) Asia

a) China

b) Honking

c) South Korea

d) Singapore

e) Malaysia

5. Other.

Ø The importance of OECD as a group declined considerably from 1960-61 to 2006-07.

Ø India’s import expenditure was 78% of the total expenditure with OECD in 1960-61 which declined to 36.5% in 2006-07.

Ø The importance of OPEC increased considerably over time.

Ø Total import expenditure from OPEC comprised 46% of the total import expenditure in 1960-61 which increased to 29.4% in 2006-07.

Ø USSR (Russia) has been a significant partner since early years.

Ø Russia was the only country with which India had entered into Bilateral-Rupee-Trade-Agreement.

Ø In 1960-61 import expenditure with Eastern Europe as a whole was 3.4% which became 13.5% of the total expenditure in 1970-71 and 10.3% in 1980-81.

Ø However trade with these countries and Russia suffered a set back after the disintegration of USSR and political instabilities in their countries in the 90s.

Ø And it declined and in 2006-07 import expenditure with Eastern Europe was only 2.4% of the total imports.

Ø In 1950-51 the share of UK in India’s imports was 14.4% and that of USA 29.2% of the total imports. The combined shares of these two countries were 39% of the total imports.

Ø However their share declined and in 2006-07 imports from UK only 2.2% and from USA 6.6% of the total imports.

Ø New trade partners were Germany, Canada, and USSR emerged.

Ø Later Japan, Saudi Arabia, China, Switzerland, Malaysia, Singapore, were also became our partners.

Ø In 2006-07 China occupied 1^st position in India’s imports.

Ø During the planning period as a whole India has obtained maximum import from USA. There is a reason behind that India has imported a lager scale quantity of capital goods, intermediate goods, food grains (PL 480 agreement) from USA.

Direction of India’s Exports

The OECD group accounts for a major position of India’s exports – this of course includes the formerly the major partners USA and UK.

• The share of OECD group in India’s exports in 1960-61 was 66.1% and in 2006-07 it was 41.2% of the total exports.
• Almost 50% of these exports in 2006-07 were made to the E.U. countries (European Union).
• The OPEC group accounted for 4.1% of exports in 1960-61 while this increased to 16.3% of India’s total exports in 2006-07.
• Trade with Eastern Europe particularly the erstwhile USSR accounted for 7% of the earnings in 1960-61 which shot up to 22.1% in 1980-81.
• The share of Eastern Europe in total exports slumped to a mere 2% in 2006-07.
• In the later years of planning direction of India’s exports changed to or shifted significantly to developing nations of Africa, Asia and Latin America and 2006-07 exports to these countries accounted for 40% of our total exports earnings.
• Countries of Asia I 2006-07 accounted for 29.7% of the total exports earnings.
• UK share in our exports earnings in 1960-61 was 26.8% which came down to 4.4% in 2006-07. USA share in our total exports earning was 16% in 1960-61 which more of less remained stable and in 2006-07 it was 14.9%.

Q. Write a note on India’s BoP? (Analyze India’s BoP/position/trends?)

A balance of payment a BoP statement is essentially a double entry system of record of all economic transactions between the residences “of a country and the rest of the world carried out in a specific period of time.”

The BoP of India is classified into:

1) Current account

2) Capital account

3) The reserved account

The current account consists of:

a) Visible trade relation to exports & imports.

b) Invisible items

c) Unilateral transfers, such as donations.

Ø The visible items are generally the merchandise items of exports & imports. Ø The invisibles are services such as travel, transportation, insurance, investment income; Govt. services not included elsewhere, miscellaneous, patience loyalty, official transfer payment and private transfer payment. Ø He IMF manual classifies 21 items as invisible while India lists the above 8.

Each receipt under any of the three accounts is put as credit entry and each payment under any of the three accounts put as a debit entry. However, sometimes there are non risible transactions either on receipt or payment side which is listed as error items in the BoP. This is an essential item in the double entry system to exactly balance to the credit & debit side.

The capital account consists of:

1) Private capital

2) Banking capital

3) Official capital

Private capital is sub-divided into: a) Long term b) Short term Banking capital covers: Movements in the external financial assets and liabilities of commercial and co-operative banks authorized to deal in Foreign Exchange. Official private transactions, RBI holding Foreign Currency assets and monetary gold “SDRs held by govt.” are classified into: a) Loans b) Amortization c) Miscellaneous (Receipts & payments.)

Reserved account:

This account basically deals with sale and purchase of foreign exchange by central bank of a country from its foreign exchange reserves. The apex bank indulges into such transactions when generally a foreign exchange crisis emerges.

Trends in India’s BoP (1956-57 – 1975-76)

Current account: -

Ø This period witness 3 wars (1962 with China, 1965 with Pakistan)

Ø There were several droughts

Ø Oil shortage in 1979.

Ø Heavy industrialization and imports of spare pats, know-how, machinery since the 2^nd plan.

Ø Food grains and large scale import of food grains in the 3^rd plan.

Ø Increased in international prices of all goods owing to oil-shock, 4^th plan increased the value of Indian imports.

Ø In the 4^th plan govt. took several export measures and imports restrictions. At the same time there was extraordinary favorableness in the invisible account in 1973-74 on the disposition of PL480 and other funds. This caused surplus in the BOP for the first time.

Capital account: -

Ø In this period the entire BoT deficit was financed through in flows of concessional assistance and this dept the debt service burdens low.

Ø However the current receipts could not compensate the debit side of the current account and invisible together.

Plan BOP deficit (in crore)

1^st - 42

2^nd - 1725

3^rd - 1151

Annual plan - 2015

4^th + 100

1976-77 – 1979-80: -

Current account: -

Ø Golden period for……… the………balanced situation in the country. India possessed foreign exchange reserves equivalent to about 7 months imports.

Ø This was a period when large number Indian workers temporally migrated to the oil rich Middle East countries to work as unskilled workers to be remitted large amount of foreign exchange.

Ø There was a strong growth in exports.

Ø Strong measures to conserve oil and to increase domestic production were undertaken which reduced the oil imports bills.

Ø In the mid 70s the gap between domestic and international price of gold narrowed down. Therefore smuggling of gold reduced.

Ø AID …..receipts were buoyant in this period.

Ø As a result 0.6% of GDP occurred in the BOP.

Capital account: -

Ø There wasn’t much deficit, rather surplus occurred in the BOP and the capital inflows were mainly in the form of concessional grants.

1980-81 – 1990-91: -

Current account: -

Ø This was a period marked by severe BOP difficulties.

Ø The 1^st 4 year of the 5^th plan BOT deficit was about 6000 crores per annum.

Ø Though earnings from invisibles during the 6^th plan were also good.

Ø In the subsequent period after the 6^th plan invisible declined.

Ø And during the 7^th plan the private remittances from Middle East countries flattened out.

Ø The Gulf crisis of 1991 increased the petrol oil import bill and worsened India’s BOP situation.

Capital account: -

Ø This was a period when almost the entire incremental deficit in dolor terms had to be financed through non-concessional loans obtained, operated on market related term.

Post 1991: -

The balance of payment situation since 1991 has been difficult from the situation that prevailed earlier. However, in 1991-92 and 1992-93 are considered exceptionally periods.

Ø Consequently the analysis of post 1991 period actually begins from 1992-93. In 1992-93 imports grew by 15.4% on BOP basis while exports increased by only 3.3% on BOP basis.

Ø The imports cover of foreign exchange results was also of only 4.91%.

Ø However, BOP situation improved considerably in 1993-94.

Ø In 1993-94 external assistance was substantially higher than the current account deficit and export performance was exceptionally good. Export recorded of 20.2% on BOP basis.

Ø Thus 1993-94 became a period of marked termed around in the BOP.

Ø The current account deficit was only 0.4% of the GDP.

Ø The BOP situation of 1994-95 was more or less satisfactory. Current account deficit was 1% of the GDP. And the import cover of foreign exchange result was 8.41%.

Ø However, after the period of 1995, import started rising owing to increased industrial activity.

Ø Export accelerated a little in 1994-95 import dolor value grew by 21.6% in 1995-96.

Ø Current account deficit in 1991-96 became 1% of GDP and foreign reserves saw decline.

Ø The current account deficit in 1996-97 was 1.2% of the GDP i.e. the situation was better than 1995-96.

Ø Foreign exchange reserves increased to some extent. In 1997-98 current account deficit was 1.4% of GDP but the reserve position was comfortable. And in 1998-99 there was sharp decline in POL & ………distance imports. And current account deficit declined just 1% of BOP. And the foreign exchange reserves were also comfortable. Then in 1999-2000 import and export growth rates both bounced back.

Ø The trade deficit increased but there was a good inflow of invisibles. Foreign exchange reserves were comfortable.

Ø Current account deficit in 1999-02 was 1% of GDP.

Ø In the year 2000-01 the BOP situation still improved and current account deficit was only 0.5% of the GDP.

Ø The foreign exchange reserve accumulation in 2000-01 stood at $ 5.84 billion which is significantly large.

Ø In the year 2001-02, 2002-03, 2003-04 there was a surplus in the current account.

Ø It was for the 1^st time in the post independence period that there was a current account surplus for 3 consecutive years.

Ø This surplus also accompanied by strong net capital inflows.

Ø In 2002-03 the foreign exchange reserves amounted to as much as $ 31.42 billion.

Ø The current account recorded deficit in 2004-05 which was 0.4% of the GDP. However, because of the strong increase in the capital inflows the reserve position was comfortable.

Ø The year 2005-06 registered a very high current account deficit because of rise in oil prices. (deficit of 1.2% of GDP)

Ø This trend continued in 2006-07.

Q. Discuss the causes of India’s imbalances in India’s BOP?

Before 1991, India seldom experienced a surplus in the current account of BOP. In other words BOP was characterized by increasing of deficits.

Ø After 1991 there often occur a surplus in current account but this was not a regular feature. Even after 1991 BOP show an imbalance.

	BoP deficit/surplus table (as % of GDP) is to be created by your own.

Ø The following are the reasons for imbalance in the BOP before 1991 high imports of food grains, oil, machinery, spare parts, know-how etc.

Ø India was struggling in the development process in the early year of planning. Industrialization had just begun, agricultural production was erratic, the shortage of food grains, droughts and finance aggravated the shortage and therefore imports were much higher than exports.

Ø Relatively lesser inflows of invisibles in the forms of loans, increasing debt – service burdens.

Ø In the initial year invisibles were limited. After the 60s, remittances by Indians working abroad started increasing. But at the same time the govt. borrows from IMF, World Bank. This increased the interest payment burdens.

Foreign Investment

Introduction to Foreign Investment

Foreign capital can be obtained in the form of concessional assistance or non-concessional assistance foreign investment. Concessional assistance includes grants and loans obtained at low rate of interest with long maturity period.

Non-concessional borrowings, loans from other govts./multinational agencies or market terms and deposits obtained from non-residence. Foreign investment is generally in the form of private foreign participation in certain sectors of the domestic economy.

Foreign capital is used by govt. for the following:

1) Sustaining a high level of investments.

2) To bridge the technological gap.

3) Exploitation of natural resources.

4) Undertaking the initial risks in certain advance sectors, business and technologies.

5) Development of basic economic infrastructures.

6) Improvement in the balance of payment position.

I. Foreign Direct Investment

FDI means investment made by foreigners in Indian businesses. This investment is more participatory and is made generally when foreigners want to have more than 10% stake in an Indian business. FDI gives some decision making and managing control to the investor whereas it gives capital and technologies to the host country business.

• In a control regime prior to 1991 FDIs were restricted.

§ However, after the announcement of new industrial policy in 1991 automatic permission was granted for FDI up to 51% or (49% for some businesses) of foreign equity in specified list of high investment and priority industries.

§ Later on this limit was raised from 51% to 71% and subsequently 100% for many more industries.

§ Some industries are still facing 74% foreign equity limit in terms of FDI.

§ For example: in aviation industry the scheduled airlines have a cap of 49% while for the non-scheduled airlines, chartered airlines and cargo airlines it is raised up to 74%.

§ FDI limited petroleum refining for the public sector units has been raised from 26% to 49%.

§ In the telecom industries FDI investment have been raised from 49% to 100% in case of ISPs, not providing gateways, infrastructures providers, providing dark fiber, electronic mail and voice mail.

§ FDI in the telecom sector increased from 49% to 74% in basic and cellular services.

§ 100% FDI is allowed in petroleum product marking by private companies.

FDI Trends:

It is difficult to give precise date on FDI because FDIs in India are recorded under 5 heads:

1) RBI’s automatic approval rout for equity holding up to 51%.

2) Foreign Investment promotion capital board or secretarial industrial approval or discretionary approval rout for larger projects with equity holding greater than 51%.

3) The inquisition of shares routs.

4) RBI’s NRI Schemes.

5) External commercial borrowings.

· Europe equity

· American deposits

· Receipts

· Global deposits

· Euro equities

FDIs generally come in the form of 1^st 4 categories mentioned above.

Foreign Investment Flows to India (in US million $)

(Provisional)

1991 2000-01 2006-07

1. Direct Investment 129 4029 19531

a) SIA/FIB rout 66 1456 2156

b) RBI’s automatic

rout --- 454 7151

c) NRI 63 67 ---

2. Portfolio Investment 4 2760 7003

a) GDRs/APRs/Euro

equities --- 831 3776

b) FII --- 1847 3225

c) Offshore funds

and others 4 82 2

• According to RBI India has now emerged as a 2^nd preferred FDI destination after China.
• Reason for sharp increase for FDI were expansion in domestic activity, positive investment climate, progressive liberalization of the FDI policy regime, simplification of procedures, rising pace of mergers and inquisitions in sectors such as financial services, manufacturing, banking services information technology and constructions.
• It can however be observed the dramatic expansion of FDI is not only because of India’s progressive policies but it reflects in parts the dramatic expansion of investment to the developing countries.

Sources of FDI in India

Largest inflows of FDI over the period from 1991-91 to 2006 have been receive from Moricious, 2^nd largest share was of USA and 3^rd of Japan.

Country wise actual inflows of FDI (from 1991 to March 2004) as % of the total FDI (SIA data)

Country actual inflow %

Moricious 35.2

USA 16.1

Japan 7.7

UK 6.9

Netherlands 6.2

Germany 4.7

France 2.8

South Korea 2.6

Singapore 2.4

Switzerland 1.9

The total inflow of FDI was Rs. 96036 crores out of which the above 10 country brought in 83129 crores. A lot of disinvestment is NRI investment.

The major destination of FDI inflows have been the following (Jan. 2000 to Oct. 2006)

RBI’s regional office state/regions Rs. Crores % share

1) New Delhi Delhi, part of UP and Hariyana 30674 25.2

2) Mumbai Maharashtra, Dadar, Nagar Haweli

Damon and Dueep 25685 21.1

3) Bangalore whole of Karnataka 8485 7

4) Chennai Tamil Nadu, Pondecheri 7691 6.3

5) Hyderabad Andhra Pradesh 4825 4

6) Ahmedabad Gujarat 4113 3.4

7) Others 40293 33

Sectoral Composition of FDI

Over the period from 1991 to 2006 the largest recipient of FDI investment was the sector electrical equipment – including computer soft wear and electronics. The share of this sector in cumulative FDI inflows over the given period was 17.54% (1.6^th). The 2^nd important share was of the service sector (12.69%)

→ Service sector:

• Telecommunications 10.39%
• Transportation industry 9.3%

→ Power and Oil refining: (7.45%)

• Chemical excluding fertilizer 5.49%
• Food processing 3.12%
• Drugs & Pharmaceutical 2.9%
• Metallurgical 2.14%
• Cement & Gypsum 2.14%

These 10 sectors accounted for more than 70% of FDI in India.

Portfolio Investment

During the period from 1992 to 2006-07 of the total foreign investment flows, 52.8% were in the form of FDI and 42.7% were in the form portfolio investment. This clearly shows that preference of foreign firms was more clearly in favour of portfolio investment. India was growing as a destination to park funds and make profits but the flowing aspects are very important to draw FDI whereas the investors don’t have to bother about these aspects in portfolio investments.

Ø Infrastructure

Ø Govt. policies – implementation

Ø Education – skills

Ø Political stability

Ø Professionalism – socio-economic outlook.

Ø Social – rest

As a response to the policies of liberalization, the foreign investors were keen to undertake portfolio investments that included GDRs, ADRs, EURO Equities and FIIs.The portfolio investments were $244 millions in 1992-93 which rose sharply to $ 3824 millions in 1994-95 and declined to $ 1828 in 1997-98.

Ø Portfolio investment became negative in 1998-99 but again improved to $ 2.76 billion in 2000-01 but again declined to nearly $1 billion in 2002-03.

Ø However the portfolio investments touched a record level of $ 11.4 billion in 2003-04 and $ 12.5 billion in 2005-06.

Ø This trend again reverse in 2006-07, and out of the total foreign investment of $ 29.1 billion, FDI contributed about 76% while, portfolio investment contributed 24% - This is a healthy development and must continue.

The above mentioned trends show that portfolio investment takes a short and easy flight. They fluctuate very easily. Such fluctuations are not sometimes healthy for developing economies. Foreign capital comes in for a short term creation inflation in a short expand and all of us sudden an outward flight of such investments create a shortage of capital.

Foreign Investment Flows to India (in US million $)

(Provisional)

1991 2000-01 2006-07

3. Direct Investment 129 4029 19531

d) SIA/FIB rout 66 1456 2156

e) RBI’s automatic

rout --- 454 7151

f) NRI 63 67 ---

4. Portfolio Investment 4 2760 7003

d) GDRs/APRs/Euro

equities --- 831 3776

e) FII --- 1847 3225

f) Offshore funds

and others 4 82 2

Foreign Capital and Indian Stock Market

Listing of Indian companies in the stock market is essential to draw FDI based on their performances. Today Indian companies are able to increase their share of foreign equity by showing good performances on the Stock Exchanges.

[The pre-liberalization situation was different. It was important for the Govt. to have a policy of listing foreign companies operating in India in the India Stock Market. – this was important not to rose public money for the foreign company but to dilute the power the foreign investment while having Indian public invest into these companies.]

Foreign investors’ attention in Indian companies helps in bringing technology through various kinds of association. However,

Ø In the post liberalization period the attention drawn by the Indian stock exchange got 47% of the foreign investments in the nature of portfolio investment.

Ø The wisdom of permitting foreign companies to trade in the Indian market punctuated by question mark.

Ø This is led to an artificial boom in the share market.

Ø The BSC sensitive index touched a record high in 1994 and all of us sudden busted.

Ø Millions of small share holders who had entered share market to have buck suffered very heavy losses but the big sharks corner big gain.

Ø Even during 2001 the activity of MNCs resulted in wild fluctuation in the BSE index which tumbled down after the budget of 2001-02.

Ø The Govt. realized the MNCs are able to manipulate the Indian stock market and the Govt. intervened to boost investors’ confidence.

Ø This again happened in 2008 when sensex sleep down from a high of 20000 to 14800 billion in January and March 2008 FIIs withdrew $ 30 billion (Rs. 12000 crore) from the Indian stock market.

Foreign Aid

FDI means investment made by foreigners in Indian businesses. This investment is more participatory and is made generally when foreigners want to have more than 10% stake in an Indian business. FDI gives some decision making and managing control to the investor whereas it gives capital and technologies to the host country business.

• In a control regime prior to 1991 FDIs were restricted.

§ However, after the announcement of new industrial policy in 1991 automatic permission was granted for FDI up to 51% or (49% for some businesses) of foreign equity in specified list of high investment and priority industries.

§ Later on this limit was raised from 51% to 71% and subsequently 100% for many more industries.

§ Some industries are still facing 74% foreign equity limit in terms of FDI.

§ For example: in aviation industry the scheduled airlines have a cap of 49% while for the non-scheduled airlines, chartered airlines and cargo airlines it is raised up to 74%.

§ FDI limited petroleum refining for the public sector units has been raised from 26% to 49%.

§ In the telecom industries FDI investment have been raised from 49% to 100% in case of ISPs, not providing gateways, infrastructures providers, providing dark fiber, electronic mail and voice mail.

§ FDI in the telecom sector increased from 49% to 74% in basic and cellular services.

§ 100% FDI is allowed in petroleum product marking by private companies.

During the period from 1992 to 2006-07 of the total foreign investment flows, 52.8% were in the form of FDI and 42.7% were in the form portfolio investment. This clearly shows that preference of foreign firms was more clearly in favour of portfolio investment. India was growing as a destination to park funds and make profits but the flowing aspects are very important to draw FDI whereas the investors don’t have to bother about these aspects in portfolio investments.

Portfolio investment is investment by foreigners or foreign financial institutions in certain shares, stocks, equities and official bonds and receipts in India these investments are made to make quick profit/short term profits or gains from the Indian financial markets. Such capital does not involve management responsibility on part of the investor. Such capital takes an easy flight into an out side the country.

Ø Foreign aid becomes almost inevitable in and synonymous with India’s growth process.

Ø In absolute terms India has received large amount of foreign aid for development purposes during the last 55-60 years.

Ø During the first plan period India had received on an average of total external assistance of Rs. 40 crores pre annum. This was a modest amount of any standard.

Ø But thereafter there was a steady increasing in the external assistance.

Ø Foreign aid in India has come mainly in the form of:

§ Loans

§ Grants

§ PL 480/665

The 4^th 5yr plan marked a distinct change in the pattern of aid. This change was induced because of:

• The US cut down aid to India drastically. As India refused to tow its lines on a number of political issues because of the increasing uncertainty of aid and rising debt servicing charges the Govt. of India adopted a policy of self increasing reliance.

The 5^th 5year plan: self reliance was again recorded a high priority

• In 5^th plan India received about 10.2%of the public sector plan outlay a net inflow of foreign resources Rs. 5889 crores as net aid and Rs. 4040 crores as other inflows from abroad.
• 7^th plan again received a similar percentage of aid and foreign resources.
• 8^th plan dependence of foreign aid was 5% of the plan outlay.
• One striking feature of foreign aid in India is that utilization of foreign in India is much less than the authorization.

Foreign Aid to India Authorization and Utilization: - (in Rs. crores)

Upto the end of 4^th plan 7^th plan 1990-91 to 2006-07

Authorization: 13056 44971 295581

Utilization: 11922 22700 234704

Impact of Foreign Aid on India’s Economic Development:

1. Foreign aid has helped to raise the level of investment: - The rate of investment substantial increased on the annual level of 10% of the NI in the 1^st plan to nearly 36% of NI by 2006-07.
2. Aid used to stabilize food prices and to import raw material. India faced food shortages frequently and foreign aid was used to stabilize food inflation as significant par of the aid was used to import necessary items. Under the PL 480 India imported wheat.
3. Aid used for enlargement for irrigation and power potential significant aid was utilizes in importing to modernize these sectors.
4. Aid for improving transport: - Transport absorbed almost 14% of the total utilized aid in the country of which 12% has gone to the railways.
5. Aid used for building up the steel industries: - Over 80% of the amount of aid utilized was on the manufacturing industries of which significant proportion went to expansion and creation of the steel industry. The necessary aid was received from West Germany, USSR, and UK.
6. Aid to develop petro-chemical & electronic industries: - These are today’s “Sun shine” industries and are the harbingers of the new age industrial growth. In the present time significant aid is utilized for these sectors.
7. Aid to enlarge technical researches: - Aid has been used to enlarge through: -

a) The provision of expert services.

b) Training of Indian personnel. Helping establishment of new or further development of the existing educational research and training institutes across the country.

However, there are several problems of foreign aid like: -

a) Political pressures from the donor country.

b) Uncertainty.

c) Capacity to absorb foreign aid.

d) Burden of servicing the debts.

Problems of Foreign Aid

1) Political pressures from the donor country:

Ø There have been instances when India was not able to resist pressures from country like America. American influences score in the shift from capital goods to consumer goods.

Ø The USA Govt. threatened India to stop aid during the Indo-Pak conflict.

Ø All developed countries of the world threatened to stop aids when India tested missiles.

Ø The recent visit of presidents of USA and France to India clearly brought out their wish to sell nuclear and war equipments to India.

2) Uncertainty:

Ø An advanced knowledge of the recourses that are to become aid is very important.

Ø If donors can not give advanced knowledge about these resources or if they do not send the aid timely the development activity can lot suffer.

3) Capacity to absorb Foreign Aid:

Ø Aid comes with political pressures and therefore it should be responsibly utilized.

Ø If we can not absorb all aid received productively and efficiently then we should not take this aid.

Ø Besides, if loan is coming in the form of loans or repayment condition it will involve a huge repayment charges/interests and therefore we should create a capability to absorb such loans.

4) All form of debt except unconditional aid has to be repaid with an interest.

Ø In the 9^th plan India amortized Rs. 48483 crores of loans and paid an interest of Rs. 26152 crores. The debt of future generation has increased more and more.

Foreign collaboration:

In recent years there has been joint participation of foreign aid domestic capital. India has been encouraging this form of import of foreign capital.

There are 3 types of foreign Collaboration: -

1. Joint participation between private parties.
2. Between foreign firm and Indian govt.
3. Between foreign govt. and Indian govt.

Needs and advantages of foreign collaboration:

1. India has to rely heavily upon imported technologies and imported goods.

Ø This proved to be costly and does not help diffusion of technological knowledge in a developing country like India.

Ø But foreign collaboration brings in technology that is jointly owned by on Indian company and this slowly helps in diffusion of technology in India.

Ø Foreign collaboration helps expansion and innovation of businesses in India. Foreign capital is essential for Indian businesses as until the era of LPG, India experienced shortage of capital and shortage of skilled personnel.

Ø Foreign collaboration helps to generate greater or large employment opportunities in India through greater capital, expansion and innovations.

Ø Collaborations also help diversification for business, diversity in variety of products for consumers and a diversified direction of trade for the country. Collaboration in businesses existed in the pre-LPG era but in the post LPG era the FDI & FII investment norms became simpler & more relaxed and became easier for foreign capital to come to India in various forms.

Chapter: 9

Division of revenue resources between the centre and the states.

OR

Finance commission’s recommendations.

Ans:-According to Article 280 of the constitution, the president of India can constitute a finance commission for the proper flow of funds between the centre and the states. Traditionally finance commissions have e to make the following recommendations-

1. Net division of resources between the centre and the states and the proportion in which the divisions to be made.
2. The bases for grants-in-add to states.
3. To settle any kind of dispute between the centre and the states regarding revenue resources.

The working of the first 10 finance commissions regarding:-

1. Sharing of income tax revenues with the states.
2. Grants –in-aid.
3. Loans to the states is given below-

1. Sharing of incomes from income tax and other taxes-

A. Income tax: - Regarding the sharing of income tax revenues, the finance commission/ commissions made and suggestions.

§ The percentage of total income tax revenue to be shared with the states.

§ And the basis on which different states are given their shares.

§

Table-

Finance commission %share of states on the basis on the basis of

in Y tax revenue of population contribution of

states to taxes.

1^st 55 80 100-80=20

2^nd 60 90 100-90=10

3^rd 65 80 100-80=20

4^th 75 80 100-80=20

5^th 75 90 100-90=10

6^th 80 90 100-90=10

7^th 80 90 100-90=10

8^th 85 90 100-90=10

9^th 85 90 100-90=10

10^th 77.5 90 100-90=10

11^th

12^th

Most of the commissions have not made major changes in the basis of sharing. They have only changed the percentage share of states.

§ However during the 8^th finance commission under the leadership of Y.B. Chauhan some new methods.

a. 25% on the basis of population.

b. 25% on the basis of following- (P.C.I of the state and population of states.)

c. 50% on the basis of (difference between the P.C.I of the state with the highest P.C.I for any state in the country and population of the state.)

§ The 9^th finance commission introduced one more criterion to the above that was an index of the backwardness of various states.

§ The 10^th finance commission revised these criteria and gave the following:-

a. 20% on the basis of the 1971 population for the state.

b. 60% on the basis of difference between the P.C.I of the state and the highest P.C.I of the country.

c. 5% on the basis of geographical area of the state and 5% on the basis of infrastructural facilities in the state.

B. Other Taxes (Excise Duties)

Every finance commission attempts to give more and more share to the states from excise duties. In the initial years excise revenues from selected items was only shared with the states but the 7^th finance commission and thereafter suggested sharing of excise revenues from all the items under excise.

Again in the initial years the % share was quite low which went on increasing.

The 9^th finance commission introduced a number of changes in the sharing of excise duties.

Finance Share of On the basis On the basis of

commission states in % of population backwardness

poor pop.etc.

in the state.

1^st 40% of 3 comdtys 40% 60%

2^nd 25% of 8 comdtys 40% 60%

3^rd 20% of 35 ,, ,, 40% 60%

4^th 20% of 45 ,, 80% 20%

5^th 20% of 45 ,, 80% 20%

6^th 20% of 45 ,, 75% 25%

7^th 40% of all ,, 25% 75%

8^th 45% of all goods 25% 75%

9^th 45% of all ,, 25% 75%

10^th 45% of all ,, 20% 80%

11^th

12^th

B. Additional sharing from excise duties in lue of sales tax:-

Certain items like sugar, tobacco, cotton, cloth, woolen garments and other handmade garments are very important for inter-state trading the centre levies additional excise duties on these commodities.

According to the meeting of national desks council in 1956 the states should refrain from sales tax of such commodities and instead the centre would levy additional excise duties on these.

However, the revenues from these additional excise duties were to be shared with the states.

The 2^nd, 3rd and 4^th finance commissions recommended that the sharing should be done mainly on the basis of revenues that the respective states earned from the sales tax on these commodities and the remaining amount to be shared on the basis of other criteria.

The 6^th finance commission suggested that according to the criteria mentioned above the share of sales tax earning from such commodities and therefore the sharing should be done on the basis of the consumption of these commodities by respective states.

However it is very difficult to know the consumption by each state of these commodities and therefore the 6^th and the later finance commissions mad e state domestic product a case for sharing.

C. The centre gets revenues from Railways, Forces and Transportation:-

The constitution provides for sharing these revenues with the states in the form of grants. The different finance commissions have made different recommendations regarding these.

D. Major recommendations in excise duties:-

The 2^nd and 3^rd finance commissions recommended that from the total collection of estate duties, 1% should go to the union territories and the remaining amount to the state.

The 4^th finance commission increased the share of union territories to 2%.

The 7^th finance commission recommended that the sharing should be done on the basis of the value to fixed property in their respective states, minus the value of total land under agriculture.

2. Suggestions regarding grants-in-aid:-

Different finance commissions laid down different criteria for grants-in-aid to the states.

Grant-in-aid were suggested too be given for welfare activities in the states, deficit in their budgets, improving administrative machinery in the state, to tackle natural calamities and to give aids to the local governments.

Almost all finance commissions suggested an increase in the grants to states while the 7^th, 8th and 9^th commissions suggested increased share in income tax and excise duties instead of larger grants.

3. Suggestions regarding loans to states:

There has always been an increase in the loans sought by the states from the centre.

The 2^nd finance commission suggested that in order to create fiscal discipline among the states the centre should give only three types of loans namely:--

a. For two years.

b. For medium term.

c. For long term.

And the rates of interest charged on these loans should be fixed up in accordance with the market rates of interest.

The 4^th finance commission suggested the formulation of a separate committee to tackle the problems of loans but this suggestion was not implemented.

The 5^th finance commission suggested that lower the fiscal discipline amongst states lower should be the amount to loans given to them.

It also suggested immediate recovery of previous loans.

The 6^th commission suggested a period of 15 to 30 years for recovery of old loans.

The 7^th and 8^th finance commissions made suggestions regarding forgiving the recovery of some loans but the 9^th finance commission suggested instead of forgiving the loans the states should inculcate grater and greater fiscal discipline.

Discuss the conflict/ debate/issues of concern regarding financial relations between the centre and the states.

Ans: The federal system of finance has the following features:-

1) Distribution of functions between the centre and the states for which three lists are provided.

a. Functions of the central government.

b. Functions of the state government.

c. The current list.

2) Distribution of sources of revenues between the centre and the states for which two lists are provided.

a. Taxes of central government.

b. Taxes of state governments.

3) Provision for constituting finance commissions to keep the financial relationships between centre and states cordial and solve disputes as amicably as possible.

The above features automatically suggest that there are many issues of debate or conflict in the centre-state financial relationships.

The main areas of debate can be given as under:-

1. The centre should have enough sources of revenues because the unity, integrity and defense of a nation fall in the domain of the centre. Besides the centre has to maintain good external relations and undertake responsibility of overall economic development.

2. The states should have enough and stable sources of revenues for welfare and agricultural development.

3. In the distribution of sources of revenues the center’s needs should be catered to first and the states needs second.

4. The centers’ needs are so important that all the productive and stable sources of revenues go to the centre leaving very few sources for the states.

5. Hence the centre should share some of its revenues with the states as also give financial aid to the states.

Measures suggested to solve the debate:

a. The centre should share enough revenues with the states.

b. The criteria for sharing the revenues and distributing revenues among the states should be well laid down.

The conflict between the Centre and State;

1. Grievances of the states:-

1) The main assumption of a federal system of finance was laid down as a strong/ or a powerful centre and weaker states dependent upon the centre. This assumption clearly mentions the centre will always remain more powerful than the states and as a result states will always be dependent on the centre. But powerful states like west Bengal, Maharashtra and Andhra Pradesh argued that this very assumption should be change. If only states are made stronger the centre will be strong.

2) States have functions to perform within diverse environments of society, demography, geographical area and climate etc. fulfilling responsibilities in these diverse require lots of finances and therefore states should be given these sources of revenues which make them self reliant.

3) During the period from 1970-80 when there was the Congress govt. at the centre and in most of the states the central govt. extended its functions in such a manner that the states became more and more dependent o the centre.

4) Certain functions according to the states are not justifiably put in the concurrent list. For e.g. Education, Public Health etc are responsibilities of both centre and state according to the list but when it comes to fulfilling these responsibilities the state govts. have a greater pressure and therefore they should greater all the money for these functions.

5) Law and order is the primary responsibility of the states. However the states argue that the centre maintains its own force to interfere in the states there by not leaving enough financial resources for law and order in the state. For the C.R.P.F. Central Reserve Police Force, Border Security Force, Industrial Security force, N.S.C. National Security Commandos.

6) The centre has fewer functions to perform and more elastic sources of revenue while the states have more functions to perform and inelastic sources of revenue.

7) The states have regular grievances towards the shares that they get from excise duties, railways fares and freight, surcharge on income tax etc.

8) Kerala’s grievance is that the center has not made enough efforts to bring about balance regional development of industries.

2. Center’s argument:

1. The centre argues that each state is different from the other in terms of administrative requirements, approach, philosophy of development, population, geographic conditions and so on. Therefore each state will try to unnecessarily compete with the others if they are made financially more and more independent.

They may even demand autonomy and thus separate from the centre.

This is not good for national interest.

2. The centre says that the state govts. are made up of men and women who are narrow minded, short sighted, self centered and corrupt therefore if they are more independent in terms of finances, they are likely to perform in a highly inefficient way and hinder the process of economic development.

3. The states have enough independency in areas like irrigation, power ad agriculture, administration, social welfare, law and order and therefore they may steer the state as they want in terms of development.

4. The Centre claims that the states demands for additional finances are not justified because they have got enough resources of their own but they are not managing their finances properly. For eg. Agricultural sector in states is left to the states but the states have not worked out any methods on collecting taxes on agricultural incomes.

5. All these years states have displayed a lot of fiscal indiscipline taken lots of grants-in-aid, taken undue OVERDRAFTS from the R.B.I and pressurized to make loan structure more and more relaxed.

Ø And thus created inflation in the states and thus they should not be given more sources of finance.

The Sarkaria Commissions (suggestions) regarding the conflict:

Ø In 1983 when there was demand for separate Khalistan state and the Southern states formed a “regional council” the relationship between the Centre and state worsened.

Ø And during this time the “Sarkaria Commission” was appointed. It submitted its report in 1988 and made the following suggestions:-

a. To have meaningful discussion on changes in the concurrent list.

b. Share the revenues from corporate taxes with the states.

c. It is not wise to change the functions or reduce the power of the centre.

d. The other undue ads of the states for more sources of revenue were ruled out.

Chapter 10

Industrial Labour & Issues in India

Industrial labour stands for all labour engaged in large & small industrial establishment including cottage industries. However, in India the term is use in a restricted sense to refer to those workers who are employed in organized industries i.e. in those industrial establishments which are covered by the “Factories Act.”

→ Thus in India those workers work in unorganized area & in cottage industries are excluded.

Issues pf industrial labour pertains to:

- Labour supply and employment.

- Trade Union movement/distributes.

- Industrial relations policies of the govt.

- Social security legislation in India etc.

Employment & Labour Supply in India:

According to the annual survey of industries total number of factories in 1997-98 was 13.6 lakhs;

- But in 2002-03, the total number of factories declined to 12.9 lakhs.

- In 1997-98 the number of worker employed in factories was 7.65 million.

- In 2003-04 it declined to 6.09 million.

- According to 61^st round of NSS the total employment in both the organized & unorganized was estimated around 423 million in 2004-05.

- This implies that the total organized factory employment if industrial workers were 23% of the estimated workers in the country in 2003-04.

- This is a very small proportion of organized labour in India; however, on account of its competition to and to national income and production, industrial labour occupies an important place in the economy of the country.

Industrial relations & Trade Union

Issues pertaining to industrial movement and trade union: -

The progress of industrialization in India has been accompanied by industrial dispute. This is a national outcome of the condition prevailing in the country. The industrial workers under the factory act are free to form their unions.

Ø Trade unions are voluntarily organization as workers formed to promote and protect interest of the workers through collectivity.

Ø The 1^st quarter of the 20^th century shows the birth of trade union in India. Unions support workers’ strikes and unrest to fight for their rights.

Agricultural Finance

Agriculture in India is an unorganized activity. Excess dependence upon climatic support, govt. support for seeds, irrigation and technology and on irrigation credits/finance facilities.

Needs for Agricultural Finance & Credit: -

Credit needs of farmers can be examined from two angles:

1. On the basis of time.
2. On the basis of purpose.

On the basis of time: -

Farmers need credit for short term, medium term and long term. Short term loans are required for purchase of seeds, fertilizers, pesticides, Feeds & fodder for livestock, marketing of agricultural produce, payment of wages for hired labour, variety of consumption and unproductive purposes.

Short term: - The period of short term is less than 15 months.

Sources: - Sources for short term loans are money lenders and co-operative societies.

Medium term: - Medium term loans are generally obtain for the purchase of cattle, small agricultural equipments, repairing, constructions of wells, litigation etc. The period of medium term loans are 15 months to 5 years.

Sources: - The sources of medium term loans are generally money lenders, relatives of farmers, co-operative societies and commercial banks.

Long term: - Long term loans requirements are effective permanent improvement on land, digging of tube wells, purchase of larger agricultural equipments and machinery like tractor, livestock etc and for repayments of old debts.

The period of such loans extends beyond 5 years. Such loans are normally depends on Primary, co-operative, Agricultural Co-operation, Rural Development banks (PCARDB’s).

On the basis of Purpose: -

The credit needs of farmers can be classified on the basis of purpose as: -

- Productivity need.

- Consumption need.

- Unproductive need.

Productive needs pertain to all types of agricultural activity requirement.

Unproductive needs pertain to social obligations, like marriage, religious functions, birth & death litigation of family etc.

Consumption needs pertain to housing, survival, buying of livestock.

Sources of Agricultural Finance:

The sources of agricultural finance are divided in 2 categories.

- Non institutional sources.

- Institutional sources.

The non-institutional sources are: -

1. Money lenders.
2. Relatives.
3. Traders.
4. Commission agencies.
5. Landlords.

The institutional sources comprises of

1. Co-operatives.
2. Scheduled commercial banks.
3. Regional Rural banks.

Co-operative Credit generally comes from:

§ Primary Agricultural Credit societies (PACs) provides namely short term and medium term loans.

§ PCARDB’s provides long term credit to agriculture.

§ The commercial banks RRB’s provides both short term & medium term loans for agriculture and alike activities.

§ NABARD is the epics institution at the national level and it provides refinance assistance to the agencies mentioned above.

§ The RBI plays a crucial role in providing the overall directives to all scheduled banks. RRB’s, cooperative societies and NABARD’s.

The small and marginal farmers have dependent largely upon non-institutional sources of finance because they are easily accessible, do not require a lot of paper work and is known sources since generation.

However, the non-institutional sources have exploitative in various ways.

Because of the exploitative nature of unorganized money market/non-institutional sources the govt. promoted a “multi-agency” approach consisting of all institutions mentioned above to provide to cheap and adequate credit to farmers.

The basic objectives are such multi agency approaches were:

a) To ensure timely & adequate flow of credit to the farming sector.

b) To reduce and gradually eliminate money lenders from the rural scene.

c) To make available credit facilities i.e. to reduce imbalances.

d) To provide larger credit support to areas covered especially programmes like Pulses Development Programme, Rice Production Programme, the National Oil Seeds Development Projects and so on.

The growth of institutional credit is shown in the table below:

Institutional Credit to Agriculture (Rs. crores)

Year Cooperative RRB’s Commercial Total institutional

banks % banks % banks% credit

amount amount amount %amount

1984-85 3440 – 55% - - 2790 – 45% 6230 - 100%

1997-98 14090 – 44% 2040 - 6% 15830 – 50% 31960 – 100%

2002-03 24300 – 34% 5470 – 8% 41010 – 58% 70810 – 100%

2005-06 39400 – 22% 15220 – 8% 125860 – 70% 180480 – 100%

Shortcomings of Institutional Finance:

In 1950 institutional credit did not meet more than 3% requirements of rural credit which means 97% of the rural credit came from unorganized sources.

However, with progressive institutionalization of rural credit today 60% rural credit requirement for short term and medium term purpose is met by cooperatives, RRB’s, and commercial banks.

However, so much expansion has still failed to make dent on rural poverty because of the following:

1. Most of the institutional credit is appropriated by 30% of the middle affluent farmers in the country.

2. Even those credit facilities exclusively created for marginal & small farmer and economically backward classes do not reach them, but are misappropriated by rich farmers in collusion with officials and local politicians.

The weakest points bonded labourers, landless labour, tribals, SC, population etc. these people constitute about 25%-30% of the rural population but are cruelly exploited by rich money lenders & landlords.

The institutional credits have somehow failed to cater to these people. This has led to extensive suicide by farmers all over the country especially Andhra Pradesh, Karnatka and Maharashtra.