MODULE 2

Economic System : The scope of a private business and the extent of government regulation of
economic activities depend to a very large extent on the nature of economic system, which is an
important part of business environment. Broadly the economic system is divided into three
groups.

(a) Capitalism
(b) Socialism
(c) Communism

(a) Capitalism
The system of capitalism stresses the philosophy of individualism believing in private
ownership of all agents of production, in private sharing of distribution processes that determine
the functions rewards of each participants, and in individual expression of consumer choice
through a free market place. In its political manifestation, capitalism may fall in a range between
extreme individualisms and anorchism (no government) and the acceptance of some state
sanctions. The capitalist system is also known as free enterprise economy and market economy.
Two types of capitalism may be distinguished, viz.,

(i) The old, laissez-fair capitalism, where government intervention in the economy is
absent or negligible; and
(ii) The modern, regulated or mixed capitalism, where there is a substantial amount of
government intervention.

(b) Socialism
Under socialism, the tools of production are to be organized, managed and owned by the
government, with the benefits occurring to the public. A strong public sector, agrarian reforms,
control over private wealth and investment and national self reliance are the other planks of
socialism. Socialism does not involve an equal division of existing wealth among the people, but
advocates the egalitarian principle. It believes in providing employment to all and emphasizes
suitable rewards to the efforts put in by every worker. Also called fabian socialism, this
philosophy is followed in our country and other social democratic countries in the world.

(c) Communism
Communism goes further to abolish all private property and property rights to income.
The state would own and direct all instruments of production. Sharing in the distributive process
would have no relationship to private property since this right would not exist. Alternatively
called maxism, communism was followed in Russia, China and East European Countries.

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The following table draws a comparison among three economic system.

Table. Capitalism, Socialism and Communism Compared

Industrial Policies

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Industrial Policy Resolution 1948

 Outlined the approach to industrial growth and development

 Emphasized the importance of securing a continuous increase in production and
ensuring its equitable distribution.
 Rest of the industrial field open to private enterprise though the State would also
progressively participate in this field.
 Progressively active role for the State in the development of Industries.
o State monopoly: Arms and ammunition, atomic energy and railway
transport
o State exclusively responsible for the establishment of new undertakings in
six basic industries-except where, in the national interest, the State itself
found it necessary to secure the cooperation of private enterprise.

Industrial Policy Resolution 1956

After the adoption of the Constitution and the socio-economic goals, the Industrial Policy
was comprehensively revised and adopted in 1956.

• Sought to accelerate the rate of economic growth and speed up industrialization to

achieve a socialist pattern of society.
• Capital was scarce & the base of entrepreneurship not strong enough. Hence, the gave
primacy to the role of the State to assume a predominant and direct responsibility for
industrial development.
• Objectives: – Improvement in living standards and working conditions for the mass of the
people. – Reduction in income and wealth disparities – Prevention of private monopolies
and concentration of economic power in different fields in the hands of small numbers of
individuals.
• Progressively predominant and direct responsibility for the State in setting up new
industrial undertakings and for developing transport facilities – Undertake State trading
on an increasing scale. – Equal opportunity for the private sector to develop and expand.
• Private sector to develop on the principle of cooperation; increasing proportion of the
private sector activities to develop on cooperative lines. – The adoption of the socialist
pattern of society as the national objective. – The need for planned and rapid
development.
• Public sector: All industries of basic and strategic importance, or in the nature of public
utility services. – The State can undertake any type of industrial production.
• Categorization of industries: i) Set of industries the future development of which will be
the exclusive responsibility of the State• ii) Category of industries which will be
progressively state-owned and in which the State will, therefore, generally take the
initiative in establishing new undertakings, but in which private enterprise will also be

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 expected to supplement the efforts of the State.iii) Rest of industries left to the initiative
and enterprise of the private sector.
• Stress the role of cottage and village and small scale industries in the development of the
national economy.
• Disparities in levels of development between different regions should be progressively
reduced.

Industrial Policy 1973

 Certain structural distortions called for policy changes in IPR 1956

 Provide for a closer interaction between the agricultural and industrial sectors
 Highest priority to the generation and transmission of power.
 Identify products to be reserved for the small scale sector: list of industries exclusively
reserved for the small scale sector expanded from 180 items to more than 500 items.
 Within the small scale sector, a tiny sector was also defined with investment in
machinery and equipment up to Rs.1 lakh & located in towns with a population < 50,000
according to 1971 census figures, and in villages.
 Proposal for special legislation to protect cottage and household industries
 Compulsory export obligations, merely for ensuring the foreign exchange balance of the
project, would no longer be insisted upon while approving new industrial capacity.
 In the areas of price control of agricultural and industrial products, the prices would be
regulated to ensure an adequate return to the investor.

Industrial Policy 1977

 Emphasis on
o – producing inputs needed by a large number of smaller units and making
adequate marketing arrangements.
o – upgrading the technology of small units.
o – Promoting the development of a system of linkages between nucleus large
plants and the satellite ancillaries
o – the development of small scale industries, the investment limit in the case of
tiny units was enhanced to Rs.2 lakh, of a small scale units to Rs.20 lakh and of
ancillaries to Rs.25 lakh.
o – building buffer stocks of essential raw materials for the Small Scale Industries
for operation through the Small Industries Development Corporations in the
States and the National Small Industries Corporation in the Centre.
o – Industrial processes and technologies involving optimum utilization of energy
or the exploitation of alternative sources of energy for giving special assistance,
including finance on concessional terms.

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The Industrial Policy Statement 1980

Formulated with respect to the Industrial Policy Resolution of 1956 to provide for

(i) Optimum utilization of installed capacity;

(ii) Maximum production and achieving higher productivity;
(iii) Higher employment generation;
(iv) Correction of regional imbalances;
(v) Strengthening of the agricultural base through agro based industries and promotion of
optimum inter-sectoral relationship
(vi) Promotion of export-oriented industries;
(vii) Promotion of economic federalism through equitable spread of investment and
dispersal of returns
(viii) Consumer protection against high prices and bad quality.

Govt . recognizes the need for social and economic justice, to end poverty and unemploy-
ment and to build a modern, democratic, socialist, prosperous and forward-looking India to grow
as part of the world economy and not in isolation. Greater emphasis placed on building up ability
to pay for imports through our own foreign exchange earnings and the development and
utilization of indigenous capabilities in technology and manufacturing as well as its up gradation
to world standards. This resulted in the sound policy framework encompassing encouragement of
entrepreneurship, development of indigenous technology through investment in research and
development, bringing in new technology, dismantling of the regulatory system, development of
the capital markets and increasing competitiveness for the benefit of the common man.

The spread of industrialization to backward areas of the country will be actively promoted
through appropriate incentives, institutions and infrastructure investments.Government will
provide enhanced support to the small-scale sector so that it flourishes in an environment of
economic efficiency and continuous technological up gradation. Foreign investment and
technology collaboration will be welcomed to obtain higher technology, to increase exports and
to expand the production base. Government will endeavor to abolish the monopoly of any sector
or any individual enterprise in any field of manufacture, except on strategic or military
considerations and open all manufacturing activity to competition. The Government will ensure
that the public sector plays its rightful role in the evolving socioeconomic scenario of the
country. Government will ensure that the public sector is run on business lines as envisaged in
the Industrial Policy Resolution of 1956 and would continue to innovate and lead in strategic
areas of national importance. Government will fully protect the interests of labour, enhance their
welfare and equip them in all respects to deal with the inevitability of technological change.
Labour will be made an equal partner in progress and prosperity. Workers’ participation
in management will be promoted. Workers cooperatives will be encouraged to participate in
packages designed to turn around sick companies. The major objectives of the new industrial
policy package will be to build on the gains already made, correct the distortions or weaknesses

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that may have crept in, maintain a sustained growth in productivity and gainful employment and
attain international competitiveness. There was urgent need to preserve the environment and
ensure the efficient use of available resources. Government’s policy will be in continuity with
change

In pursuit of the above objectives, Government have decided to take a series of

initiatives in respect of the policies relating to the following areas. A. Industrial Licensing. B.
Foreign Investment. C. Foreign Technology Agreements. D. Public Sector Policy. E. MRTP Act.

• Industrial licensing: – Modified industrial licensing policy to ease restrictions on capacity

creation, respond to emerging domestic & global opportunities by improving productivity –
Abolished industrial licensing for most industries but for 18 categories – Small scale sector
reserved

• Foreign Investment: – FDI (up to 51% foreign equity) permitted in high priority industries
(high investment and advanced technology) & export oriented companies

• Foreign Technology Agreements: • Towards technological dynamism, automatic approval for

technological agreements related to high priority industries; eased procedures for hiring foreign
technical expertise

• Public Sector Policy: Restructuring pubic sector units, raise resources through pubic
participation PSUs, refer sick units to Board of Industrial & Financial Reconstruction

• MRTP Act: • Abolished scrutiny of investment decision of MRTP companies etc.

Monetary Policy

 Meaning….Reserve Bank of India states that,

“Monetary policy refers to the use of instruments under the control of the central bank to
regulate the availability, cost and use of money and credit.”
 Objectives
o • Maintaining price stability
o • Ensuring adequate flow of credit to the productive sectors of the economy to
support economic growth
o • Rapid economic growth
o • Balance of payment equilibrium
o • Full employment
o • Equal income distribution
 Methods
The RBI aims to achieve its objectives of economic growth and control of
inflation through various methods. These methods can be grouped as:
– General/ quantitative methods

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 – Selective/ qualitative methods

General/ Quantitative methods

These methods maintain and control the total quantity or volume of credit or money
supply in the economy.

– Open Market Operations: Open market operations indicate the buying/ selling of govt.
securities in the openmarket to balance the money supply in the economy

– Deployment of Credit: The RBI has taken various measures to deploy credit in different
sector of the economy. The certain percentage of the bank credit has been fixed for various
sectors like agriculture, export etc.

Direct Instruments

Cash reserve ratio (CRR): The money supply in the economy is influenced by CRR. It is
the ratio of a bank’s time and demand liabilities to be kept in reserve with the RBI. The RBI is
authorized to vary the CRR between 3% and 15%.

Statutory liquidity ratio (SLR): Under SLR, banks have to invest a certain percentage of
its time and demand liabilities in govt. approved securities. The reduction in SLR enhances the
liquidity of commercial banks.

Indirect Instruments

Liquidity Adjustment Facility (LAF): Consists of daily infusion or absorption of liquidity

on a repurchase basis, through repo (liquidity injection) and reverse repo (liquidity absorption)
auction operations, using government securities as collateral.

i. Repo Rate:– Repo rate is the rate at which the RBI lends shot-term money to the
banks against securities. When the repo rate increases borrowing from RBI
becomes more expensive.
ii. Reverse Repo Rate:– The rate at which RBI borrows from commercial banks.

Marginal Standing Facility (MSF): Instituted under which scheduled commercial banks
can borrow over night at their discretion up to one per cent of their respective NDTL at 100basis
points above the repo rate to provide a safety valve against unanticipated liquidity shocks.

Bank rate: Bank Rate is the rate at which central bank of the country (in India it is RBI)
allows finance to commercial banks. Bank Rate is a tool, which central bank uses for short-term
purposes. Any upward revision in Bank Rate by central bank is an indication that banks should
also increase deposit rates as well as Base Rate / Benchmark Prime Lending Rate.

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 Market Stabilization Scheme (MSS): Liquidity of a more enduring nature arising from
large capital flows is absorbed through sale of short-dated government securities and treasury
bills. The mobilized cash is held in a separate government account with the Reserve Bank.

Selective/ Qualitative Measures

The RBI directs commercial banks to meet their social obligations through selective/
qualitative measures. These measures control the distribution and direction of credit to various
sectors of the economy.

 Ceiling on credit
 Margin requirements
 Discriminatory rates of interest

Fiscal Policy

Meaning: Fiscal policy deals with the taxation and expenditure decisions of the government.
These include, tax policy, expenditure policy, investment or disinvestment strategies and debt or
surplus management.- Kaushik Basu ( Former Chief Economic Adviser )

Objectives of fiscal policy

• Increase in capital formation.

• Degree of Growth.
• To achieve desirable price level.
• To achieve desirable consumption level.
• To achieve desirable employment level.
• To achieve desirable income distribution.

Fiscal Policy there are three possible positions

• A Neutral position applies when the budget outcome has neutral effect on the level of
economic activity where the govt. spending is fully funded by the revenue collected from the tax.

• An Expansionary position is when there is a higher budget deficit where the govt.
spending is higher than the revenue collected from the tax.

• An Contractionary position is when there is a lower budget deficit where the govt.
spending is lower than therevenue collected from the tax.

The Two Main instruments of fiscal policy• Revenue Budget• Expenditure Budget

Revenue Budget:

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 • Direct Tax• Individual Income Tax &Corporate Tax.• Wealth Tax @ 1%• Tax deducted
at source
• Indirect Tax• central excise (a tax on manufactured goods)• VAT @ 12.5%• service tax
@ 12%• customs duty• Educational cess @ 3%

Expenditure Budget

The central government is responsible for issues that usually concern the country as
awhole like national defence, foreign policy, railways, national highways, shipping,airways, post
and telegraphs, foreign trade and banking.The state governments are responsible for other items
including, law and order,agriculture, fisheries, water supply and irrigation, and public health.
Some items for which responsibility vests in both the Centre and the states includeforests,
economic and social planning, education, trade unions and industrialdisputes, price control and
electricity.

EXIM Policy

The Union Commerce Ministry, Government of India announces the integrated Foreign
Trade Policy (FTP) in every five year. This is also called EXIM policy. This policy is updated
every year with some modifications and new schemes. New schemes come into effect on the first
day of financial year i.e. April 1, every year. The Foreign trade Policy which was announced on
August 28, 2009 is an integrated policy for the period 2009-14.

1. To arrest and reverse declining trend of exports is the main aim of the policy. This aim will be
reviewed after two years

2. To Double Indias exports of goods and services by 2014.

3. To double Indias share in global merchandise trade by 2020 as a long term aim of this policy.
Indias share in Global merchandise exports was 1.45% in 2008.

4. Simplification of the application procedure for availing various benefits

5.To set in motion the strategies and policy measures which catalyze the growth of exports

6. To encourage exports through a "mix of measures including fiscal incentives, institutional

changes, procedural rationalization and efforts for enhance market access across the world and
diversification of export markets.

The policy aims at developing export potential, improving export performance, boosting
foreign trade and earning valuable foreign exchange. FTP assumes great significance this year as
Indias exports have been battered by the global recession. A fall in exports has led to the closure
of several small- and medium-scale export-oriented units, resulting in large-scale unemployment

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Target-:1. Export Target : $ 200 Billion for 2010-112. Export Growth Target : 15 % for next two
year and 25 % there after.EPCG schemes-:

1. Obligation under EPCG scheme relaxed.

2. To aid technological up gradation of export sector, EPCG Scheme at Zero Duty has been
introduced.
3. Export obligation on import of spares, moulds etc. under EPCG Scheme has been reduced by
50%.

Results:
 26 new markets added in this scheme.
 Incentives under FMS raised from 2.5 % to 3 %
 Incentive available under Focus Product Scheme (FPS) raised from 1.25% to 2%.
 Extra products included in the scope of benefits under FPS
 Market Linked Focus Product Scheme (MLFPS) expanded by inclusion of products like
pharmaceuticals, textile fabrics, rubber products, glass products , auto components, motor
cars, bicycle and its parts.etc. (However , benefits to these products will be provided, if
exports are made to 13 identified markets (Algeria, Egypt, Kenya, Nigeria , South Africa,
Tanzania, Brazil, Mexico, Ukraine, Vietnam, Cambodia, Australia and New Zealand).
 Focus Product Scheme benefit extended for export of ‘green products ’ and some
products from the North East.
 A common simplified application form has been introduced to apply for the benefits
under FPS, FMS, MLFPS and VKGUY.
 Announcement for MDA & MAI
 Towns of export excellence
 scheme for status holder Extension of income tax exemption to EOU and STPI
 Extension of ECGC
 Announcement for marine sector
 Announcement for gems and jewellery sector
 Announcement for agro exports
 Announcement for leather exports
 Announcement for tea exports
 Announcement for pharma export
 Announcement for handloom exports
 Scheme for export oriented unit
 Announcement for VAM
 Announcement for project exports
 Fuel included in DEPB scheme
 Easy import of samples

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  Convertibility of shipping bills
 Reduction in transaction cost
 Disposal of manufacturing wastes
 Announcement for sports weapon
 Announcement for medical devices
 Announcement for automobile industry
 Announcement for EDI initiatives
 Set up of directorate of trade remedy measures announced
 Duty credit scrips
 Import of restricted items
 Dollar credits

Economic Reforms
The reform process in India was initiated with the aim of accelerating the pace of
economic growth and eradication of poverty. The process of economic liberalization in India can
be traced back to the late 1970s. However, the reform process began in earnest only in July 1991.
It was only in 1991 that the Government signaled a systemic shift to a more open economy with
greater reliance upon market forces, a larger role for the private sector including foreign
investment, and a restructuring of the role of Government.
The reforms of the last decade and a half have gone a long way in freeing the domestic
economy from the control regime. An important feature of India's reform programme is that it
has emphasized gradualism and evolutionary transition rather than rapid restructuring or "shock
therapy". This approach was adopted since the reforms were introduced in June 1991 in the wake
a balance of payments crisis that was certainly severe. However, it was not a prolonged crisis
with a long period of non-performance.
The economic reforms initiated in 1991 introduced far-reaching measures, which
changed the working and machinery of the economy. These changes were pertinent to the
following:
 Dominance of the public sector in the industrial activity
 Discretionary controls on industrial investment and capacity expansion
 Trade and exchange controls
 Limited access to foreign investment
 Public ownership and regulation of the financial sector
The reforms have unlocked India's enormous growth potential and unleashed powerful
entrepreneurial forces. Since 1991, successive governments, across political parties, have
successfully carried forward the country's economic reform agenda.
Reforms in Industrial Policy
Industrial policy was restructured to a great extent and most of the central government industrial
controls were dismantled. Massive deregulation of the industrial sector was done in order to
bring in the element of competition and increase efficiency. Industrial licensing by the central
government was almost abolished except for a few hazardous and environmentally sensitive

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industries. The list of industries reserved solely for the public sector -- which used to cover 18
industries, including iron and steel, heavy plant and machinery, telecommunications and telecom
equipment, minerals, oil, mining, air transport services and electricity generation and distribution
was drastically reduced to three: defense aircrafts and warships, atomic energy generation, and
railway transport. Further, restrictions that existed on the import of foreign technology were
withdrawn.
Reforms in Trade Policy
It was realized that the import substituting inward looking development policy was no longer
suitable in the modern globalising world.
Before the reforms, trade policy was characterized by high tariffs and pervasive import
restrictions. Imports of manufactured consumer goods were completely banned. For capital
goods, raw materials and intermediates, certain lists of goods were freely importable, but for
most items where domestic substitutes were being produced, imports were only possible with
import licenses. The criteria for issue of licenses were non-transparent, delays were endemic and
corruption unavoidable. The economic reforms sought to phase out import licensing and also to
reduce import duties.
Import licensing was abolished relatively early for capital goods and intermediates which
became freely importable in 1993, simultaneously with the switch to a flexible exchange rate
regime. Quantitative restrictions on imports of manufactured consumer goods and agricultural
products were finally removed on April 1, 2001, almost exactly ten years after the reforms
began, and that in part because of a ruling by a World Trade Organization dispute panel on a
complaint brought by the United States.
Financial sector reforms
Financial sector reforms have long been regarded as an integral part of the overall policy reforms
in India. India has recognized that these reforms are imperative for increasing the efficiency of
resource mobilization and allocation in the real economy and for the overall macroeconomic
stability. The reforms have been driven by a thrust towards liberalization and several initiatives
such as liberalization in the interest rate and reserve requirements have been taken on this front.
At the same time, the government has emphasized on stronger regulation aimed at strengthening
prudential norms, transparency and supervision to mitigate the prospects of systemic risks.
Today the Indian financial structure is inherently strong, functionally diverse, efficient and
globally competitive. During the last fifteen years, the Indian financial system has been
incrementally deregulated and exposed to international financial markets along with the
introduction of new instruments and products.

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