MS 105

MS 105
Business
Environment
Volume I
Block I Macro Economic Concepts and Macro Environment
Block II Economic Reforms and Industrial Policy
UTTARAKHAND OPEN UNIVERSITY

SCHOOL OF MANAGEMENT STUDIES AND COMMERCE
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Board of Studies
Professor Nageshwar Rao Professor R.C. Mishra
Vice-Chacellor, Director,
Uttarakhand Open University School of Management Studies and Commerce,
Haldwani Uttarakhand Open University, Haldwani
Professor Neeti Agarwal Dr.L.K. Singh

Department of Management Studies Depatment of Management Studies,
IGNOU, New Delhi Kumaun University, Bhimtal
Dr. Abhradeep Maiti, Dr. K.K. Pandey,

Indian Institue of Management, O.P. Jindal Global University,
Kashipur Sonipat
Dr. Manjari Agarwal Dr. Gagan Singh

Department of Management Studies Department of Commerce
Uttarakhand Open University, Haldwani Uttarakhand Open University, Haldwani
Dr. Sumit Prasad

Assistant Professor,
School of Management Studies and Commerce,
Uttarakhand Open University, Haldwani
Programme Coordinator
Dr. Manjari Agarwal
Assistant Professor, Department of Management Studies
Units Written by Unit No.

Dr. Sunil Purohit
M.Sc., LL.M., MBA, Ph.D., FICCE
Adv. Sandhya Purohit
M.A. (Economics), LL.B.
Editor
Er. Sumit Prasad
ISBN : 978-93-85740-11-4
Copyright : Uttarakhand Open University
Edition : 2016 (Restricted Circulation)
Published by : Uttarakhand Open University, Haldwani, Nainital – 263 139
Printed at : Himalaya Publishing House Pvt. Ltd
SYLLABUS
Course Name: Business Environment
Course Code: MS 105
Course Credits: 6
Course Objective:
This course aims at providing students the knowledge of basic framework and intricacies of Indian and
International business environment.

Unit I Contemporary Global and Indian Environment
Unit II Consumerism and Business
Unit III Macro Economic Environment and Modern Theories of Economic Growth
Unit IV Aggregate Demand and Supply
Unit V Inflation
Unit VI Unemployment

Unit VII Economic Reforms in India
Unit VIII Economic Planning in India and New Economic Policy
Unit IX Industrial Policy and Industry Licensing
Block III Industrial Financial Institutions

Unit X Public Sector Enterprises and Small and Medium Enterprises
Unit XI Industrial Financial Institutions: IDBI, IFCI, ICICI, IRBI, SFC
Unit XII Institutions for Investments and Small Industry: UTI, LIC, GIC, SSIDC, SIDBI and
Commercial Banks
Block IV Foreign Polices and Globalisation

Unit XIII Foreign Trade: Theories, Issues and Modern Context
Unit XIV FDI and FII
Unit XV Foreign Exchange Rates and Foreign Exchange Markets
Unit XVI Globalisation, Liberalisation and Privatisation
Unit XVII Regional Trading Blocks
Unit XVIII World Trade and Emerging Environment
CONTENTS
Block I: Macro Economic Concepts and Macro Environment
1. Contemporary Global and Indian Environment 1 – 25
1.1 Introduction
1.2 Meaning and Definition
1.3 Business Environment
1.4 The General Environment i.e., External Environment
1.5 Scope
1.6 External Environment
1.7 External Micro Environment: Factors
1.8 External Macro Environment: Factors
1.9 Internal Environment
1.10 Summary of the Unit
1.11 Glossary
1.12 Key Terms
1.13 Check Your Progress (Multiple Choice/Objective Type Questions)
1.14 Key to Check Your Answer
1.15 Terminal and Model Questions
1.16 Reference Books
2. Consumerism and Business 26 – 33
2.1 Introduction
2.2 Responsibilities of Business
2.4 Glossary
2.5 Key Terms
2.9 Reference Books
3. Macro Economic Environment and Modern Theories of Economic Growth 34 – 54
3.1 Introduction
3.2 Economic Growth
3.3 Development
3.4 Critical Elements
3.5 Money
3.6 Global Trade Environment
3.7 Host Countries
3.8 Meaning and Definition of Inflation
3.9 Features of Inflationary Economy
3.11 Glossary
3.12 Key Terms
4. Aggregate Demand and Supply 55 – 74
4.1 Aggregate Demand
4.2 Aggregate Supply
4.3 Macroeconomic Equilibrium
4.4 Changes in Aggregate Demand or Aggregate Supply
4.5 Factors Affecting Aggregate Supply and Aggregate Demand
4.6 Wealth and Wealth Expectations
4.7 Government Demand and Taxation
4.8 Demand-Supply and Employment
4.10 Glossary
4.11 Key Terms
5. Inflation 75 – 94
5.1 Introduction
5.2 Inflation – Index
5.3 Prices as Measures of Inflation
5.4 Inflation and Developing Economies
5.5 Demand-pull vs. Cost-push Inflation
5.6 Causes of Inflation
5.7 Effects of Inflation
5.8 Control of Inflation
5.10 Key Terms
6. Unemployment and Employment in India 95 – 102
6.1 Introduction
6.2 Growth of Employment in India: A Case of Jobless Growth
6.4 Glossary
6.5 Key Terms
6.9 Reference Books
Block II: Economic Reforms Industrial Policy
7. Economic Reforms in India 103 – 111
7.1 Introduction
7.2 Tax Reforms
7.4 Glossary
7.5 Key Terms
7.9 Reference Books
8. Economic Planning in India and New Economic Policy 112 – 126
8.1 Introduction
8.2 Domain of Public Finance
8.3 Basic Concepts
8.4 The International Monetary Fund
8.5 Economic Reforms and Control of Inflation
8.6 Economic Reforms and Their Impact on Poverty
8.7 Economic Reforms and Employment
8.8 Economic Reforms and Foreign Investment
8.9 Economic Reforms and India’s External Debt
8.10 Economic Reforms and India’s Foreign Trade
8.11 Neglect of Agriculture — The Major Sin of Economic Reforms
8.13 Glossary
8.14 Key Terms
9. Industrial Policy and Industry Licensing 127 – 153
9.1 Introduction
9.2 Foreign Investment Promotion Board (FIPB)
9.3 Project implementation
9.4 Impact of Industrial Policy 1991
9.5 Government – Machinery for Indian Industrial Economy
9.6 Overview of new Industrial Policy of 1991 in India
9.7 New Industrial Policy of 1991
9.9 Glossary
9.10 Key Terms
Block I: Macro Economic Concepts and Macro
Environment
CONTEMPORARY GLOBAL
UNIT 1
AND INDIAN ENVIRONMENT
Structure:
1.1 Introduction
1.2 Meaning and Definition
1.3 Business Environment
1.4 The General Environment i.e., External Environment
1.5 Scope
1.6 External Environment
1.7 External Micro Environment: Factors
1.8 External Macro Environment: Factors
1.9 Internal Environment
1.11 Glossary
1.12 Key Terms
Objectives
After reading this Unit, you will be able to:
 Define environment.
 Classify complex structure of environment.
 Understand critical elements.
Business Environment Uttarakhand Open University
NOTES  Analyse Indian and global perspectives.

 Explain the impact of ‘influences’ on business.
1.1 INTRODUCTION
Every business organisation has to interact and transact with its
environment. Hence, the business environment has a direct relation with
the business organisation. The effectiveness of interaction of an enterprise
with its environment determines the success or failure of a business.
The environment imposes several constraints on an enterprise and has a
considerable impact and influence on the scope and direction of its
activities. The enterprise, on the other hand, has a very little control over
its environment. The basic job of the enterprise, is to identify the
environment in which it operates and to formulate its policies in
accordance with the forces which operate its environment. Every business
organisation has to tackle its internal and external environment. For
example, a committed labour force provides an internal environment of
any business, whereas the ecological factors determine the external
environment. While the internal environment reveals an organisation’s
strengths and weaknesses, the external environment reflects the
opportunities available to the organisation and the threats it faces.
India has a developing economy with abundant natural resources, large
population, and a low level of per capita national income. Although a
substantial liberalisation has been envisaged for the country, the economic
activities are still considerably controlled by the government. A low
standard of living, backed by a vicious cycle of poverty, for a considerable
section of population and about 250 million people under the poverty line,
coupled with a considerable concentration of economic power in few
hands, characterise the Indian economy.
The environmental factors varies from country to country hence, we must
learn the local, regional, national and international environment of
business.
1.2 MEANING AND DEFINITION

“Environment” literally means the surroundings, external objects,
influences, or circumstances under which someone or something exists.
Keith Davis defines the environment of business as “the aggregate of all
Page 2 of 316 Unit 1: Contemporary Global and Indian Environment

conditions, events, and influences that surround and affect it” (Davis and NOTES
Blomstrom 1971).
1.3 BUSINESS ENVIRONMENT

Thus, the term “environment” refers to the totality of all the factors which
are external to and beyond the control of individual business enterprises
and their managements. Environment furnishes the macro-context, the
business firm is the micro-unit. The environmental factors are essentially
the “givens” within which firms and their managements must operate. For
example, the value system of society, the rules and regulations laid down
by the Government, the monetary policies the institutional set up of the
country, the ideological believes of the leaders, the attitude towards
foreign capital and enterprise, etc., all constitute the environment system
within which a business firm operates. These environmental factors are
many in numbers and various in form. Some of these factors are totally
static, some are relatively static and some are very dynamic – they are
changing every ‘now and then’. Some of these factors can be
conceptualised and quantified, while other can only be referred to in
qualitative terms. Thus, the environment of business is an extremely
complex phenomenon.
Global
The environmental factors generally vary from country to country. The
environment that is typical of India may not be found in another countries
like the USA, the (former) USSR, the UK, and Japan. Similarly, the
American/Soviet/British/Japanese environments may not be found in India.
There may be some factors in common, but the order and intensity of the
environmental factors do differ between nations. What to say of countries,
the magnitude and direction of environmental factors differ over regions
within a country, and over localities within a region. Thus, one may talk of
local, regional, national (domestic) and international (foreign) environment
of business. For example, the local custom of “coolie” (labour), the
climate of the northern region of Assam, the policies of the State and
Central Governments in India and the size of the world market: all these
factors together will have an important bearing on tea industry. The
production, consumption and marketing of tea will be affected by
environmental factors.
Unit 1: Contemporary Global and Indian Environment Page 3 of 316

NOTES The environment differs not only over space but also over time within a
country. As such, we can talk of temporal patterns of environment, i.e.,
past, present and future environment. Future environment is the product of
past and present environments. The Indian economy of tomorrow will be
influenced by what the state of the economy is at present and what it was
in the past.
Sometimes, the environment may be classified into market environment
and non-market environment depending upon whether a business firm’s
environment is influenced by market forces like demand, supply, number
of other firms and the resulting price competition, or non-price
competition, etc., or by non-market forces like Government laws, social
traditions, etc.
Finally, we may classify the environment into economic and non-
economic. Non-economic environment refers to social, political, legal,
educational and cultural factors that affect business operations. Economic
environment, on the other hand, is given shape and form by factors like the
fiscal policy, the monetary policy, the industrial policy, physical limits on
output, the price and income trends, the nature of the economic system at
work.
Meaning the Environment is boundless. It is a complex question where the
environment of a business starts, or where the boundaries of a business
environment ends. Any meaningful organisation has certain mission,
objectives and goals and a strategy to achieve them. Indeed, the mission
and goals themselves should be based on an assessment of the external
environment and the organisational factors. The survival and success of a
firm, thus, depend on two sets of factors, viz., the internal factors and
external factors. However, the term business environment, often refers to
the external factors.
Environment refers to all external forces which have a bearing on the
functioning of the business. Business environment refers to those aspects
of the surroundings of business enterprise which affect or influence its
operations and determine its effectiveness.
“The environment of a company is the pattern of all external influences
that affect its life and development”.
— Andrews
The environment poses threats to a firm or offers immense opportunities
for exploitation. Stressing this aspect,William F. Glueck and Lawrence
R. Jauch wrote thus: “The environment includes factors outside the firm
which can lead to opportunities for or threats to the firm. Although there NOTES
are many factors, the most important of the factors are socio-economic,
technological, supplier, competitors and government”.
Since the business environment is always capable of producing major
shocks and surprises, the success of a business enterprise depends on its
alertness and adaptability to changes in the environment.
It may be difficult to develop a neat classification of environmental types
because of considerable overlap from one type to the other. However, it is
not difficult to appreciate that there are certain factors which affect the
whole class of organisations, where they are broadly called as the External
Environment.
Whereas, the other factors which affect a particular organisation, in this
case they are called as the task specific or Internal Environment.
Internal factors are those which affect a particular firm and are generally
regarded as controllable factors because the company has control over
these factors; it can alter or modify such factors as its personnel, physical
facilities, organisation and functional means, such as marketing mix, to
suit the environment.
The external factors on the other hand, are by and large beyond the control
of a company. The factors included under this category are the economic
factors, socio-cultural factors, government and legal factors, demographic
factors, technological factors, ecological and educational factors,
geophysical factors, etc., are therefore, generally regarded as
uncontrollable factors.
The environmental factors may be classified into three different levels:
 Internal environment.
 Micro environment/Task environment/Operating environment.
These are very close to organisation.
 Macro environment/General environment/External environment.
Some of the external factors have a direct and intimate impact on the firm
such as the suppliers, customers, workforce of the firm. These factors are
classified as Micro environment, also known as the Operating environment.
There are other external factors which affect an industry very generally
like socio-economic, technological, Government and legal factors, etc.
They constitute as Macro environment/External environment.

NOTES The important internal factors which affect the strategy and other decisions
are explained.
(a) Mission and Objectives

The business priorities, the direction for the development, its philosophy
and policies, etc., are guided by the Mission and Vision of the company.
Where mission indicates the overall philosophy for which the company
stands, objective or goal refers to the operational side of the business. The
Mission statement, when translated into figures indicating yearly budgets,
we have the company’s goals. A series of such yearly goals, when
achieved, give the statement its relevance.Vision speaks of futuristic
ideology.
Ranbaxy’s thrust into the foreign markets and development have been
driven by its mission “to become a research based international
pharmaceutical company”.
Company sets the objectives and mission depending on its strengths,
weaknesses, opportunities and threats to its operation. For example, the
environment may provide many opportunities but a company might not
have the strengths to exploit all the opportunities. Here a case relating to
‘Raymond’ can be referred as under:
Raymond Case
Raymond has been a well-known fabric brand in India.The Raymond Ltd.
over time had made significant investments in process oriented businesses
such as cement, steel and polyester FIBRE, besides textiles.
Gautam Hari Singhania, who took over from Vijaypat Singhania as
chairman and managing director in 1998, sought to put Raymond on a
strong footing, restructuring its business portfolio based on a SWOT
analysis. So, in early 1999, says Singhania, “we started looking at our
business portfolio, and decided where we wanted to be as compared to
where we are today. We decided there were three areas that the company
did not want to be in, in our long-term strategy. One was filament yarn, the
second was cement, and the third, steel.” These businesses were either not
giving adequate returns or were making losses.The company also did not
have the expertise to run these units. Raymond, therefore, pulled out of
these businesses and decided to focus on the core business of textiles and
readymade apparel.
The divestment of these three businesses brought in about ` l,100 crore.
Out of this, ` 291 crore was used to repay outstanding debt and this helped
to substantially reduce the interest burden. The company also spent around NOTES
` 158 crores for buying back shares through the open market route and this
increased the Singhania’s share in the Raymond from 27% to 31%. The
company has been left with a large amount for investment for developing
the existing core business or entering into new businesses (including
acquisition).
In Singhania’s vision, Raymond must turn itself into a clean and efficient
company, before striking out to conquer new territory overseas. While
Raymond claims to be among the top three fabric brands in the world in
integrated worsted (wool-blended) fabrics, it certainly isn’t a household
name anywhere except South Asia. “The endeavour is to make it a truly
global brand,” says the chairman.
(b) Value System

The value system and ethical standards are also among the factors
evaluated by many companies in the selection of suppliers, distributors,
collaborators, etc. It is widely acknowledged fact that the extent to which
the value system is shared by all in the organisation is an important factor
contributing to success.
The value system of JRD Tata and the acceptance of it by others who
matter were responsible for the voluntary incorporation in the Articles of
Association of TISCO its social and moral responsibilities to consumers,
employees, shareholders, society and the people.
(c) Power
Business has vast resources at its command.These resources like money,
men, material, etc., confer enormous economic and political power on
owners and managers of business ventures.
Factors like the amount of support, the top management enjoys, from
different levels of employees, shareholders and board of directors have
important influence on the decision and their implementation.
Several enlightened businessmen have used their power for the betterment
of the society. It is hard to imagine what would have happened to the
industrial map of our country if J.N. Tata had not taken keen interest to
industrialise India.

NOTES (d) Human Resources

Concern for employees continues to be an important aspect of
Management. Caring for employee satisfaction and providing for their
development has been one of the objectives of enlightened business
enterprise as they could contribute to the strength and weakness of an
organisation.
The organisation culture and overall environment have bearing on the
characterstics of the human resources like morale, commitment, attitude,
involvement etc. The skill and quality of personnel is considered to be one
of the hallmarks of best managed and highly respected companies.
As per the new concept ‘knowledge workers’ are very important for
selling a brand image and large market share. The talent pool and not mere
quantity of employees decides.
Fig. 1.1: Environmental Constituents of Business (Environmental Scanning)

NOTES
1.4 THE GENERAL ENVIRONMENT I.E.
EXTERNAL ENVIRONMENT
The General environment refers to all those factors that may have impact
on an organisation. It includes factors like natural resources, economy,
demography, technology, culture, government, political developments and
the like which have varying degrees of influence on organisations. The
effect of a particular factor on an organisation may vary, but no particular
organisation is the focus of the general environment. For example, a
change in the Monetary Policy of the Reserve Bank of India does not
target a particular firm. It may be intended to curb credit in general.
1.5 SCOPE
A business organisation does not exist in a vacuum. It is in fact dependent
on external environment. For efficient and rational decision making a
business organisation must understand its relationship with its environment.
A business firm is an open system as it affects and is affected by outside
events and factors which make up the external environment. Apart from
external forces a business firm is affected by a number of internal factors,
that is, forces inside the business organisation. While top management is
generally concerned with external environment, middle level and lower
level managements are more intimately concerned with internal
environment. Thus, business environment consists of all those external and
internal factors that have a bearing on the business.
A business organisation is a part of a large system such industry to which
it belongs, the economy and the society. The relation of a business
enterprise with its environment can be better understood from the input-
output model of business system as shown in Figure. The task of the
management of a business enterprise is to receive inputs from external
environment, convert them into output which is then sold to the external
environment. However, this simple model of business organisation needs
to be further expanded into a model of operational management which
shows how the transformation process is planned, organised and controlled
by managers. This organisation and management of the transformation is
affected both by internal and external environment, the term business
environment is sometimes used in the sense of external environment.
However, it also includes internal environment. Let us scan the
environmental detail.

NOTES
Management
Transformation
Inputs Output
Process
External
Environment
Fig. 1.2: Business System: Input-Output Model
1.6 EXTERNAL ENVIRONMENT

External environment consists of those factors that affect a business
enterprise from outside. External environment includes shareholders,
competitors, customers, society, government laws and regulations, public
and technology. External environment is generally classified into micro
environment and macro environment. “The micro environment consists of
factors in the company’s immediate environment that affects the
performance of the company, these include the suppliers, marketing
intermediaries, competitors, customers and the publics.”
Thus, micro external environment includes all those players whose
decisions and actions have a direct bearing on the activities of business
firms. Since modern business firm has two aspects, namely, production
and sale of goods, micro-environment of business can also be divided into
two types of players. One, which affects the production of a firm such as
input suppliers. Second, the factors which influence sales of the firm and
includes customers, competitors and market intermediaries.
On the other hand, macro external environment includes larger social
forces such as economic, demographic, technological, political, natural and
cultural factors.
1.7 EXTERNAL MICRO ENVIRONMENT:

FACTORS
Micro external forces have an important effect on business operations of a
firm. However, all micro forces may not have the same effect on all firms
in the industry. For example, suppliers, an important element of micro
level environment, are often willing to provide the materials at relatively

lower prices to big business firms. They do not have the same attitude NOTES
towards relatively small business firms. Similarly, a competitive firm will
start a price war if its rival firm in the industry is relatively small. If the
rival firm is a big one which is a capable of retaliating any adverse action
from its rival, a competitive firm will hesitate to start a price war.
Following are important factors or forces of micro-level external
environment.
Suppliers of Inputs: An important factor in the external environment of a
firm is the suppliers of its inputs such as raw materials and components. A
smooth and efficient working of a business firm requires that it should
have ensured supply of inputs such as raw materials. If supply of raw
materials is uncertain, then a firm will have to keep a large stock of raw
materials to continue its transformation process uninterrupted. This will
unnecessarily raise its cost of production and reduce its profit margin.
To ensure regular supply of inputs such as raw materials some firms adopt
a strategy of backward integration and set up captive production plants for
producing raw materials themselves. Further, energy input is an important
input in the manufacturing business. Many large firms such as Reliance
industries have their own power generating plants so as to ensure regular
supply of electricity for their manufacturing business. However, small
firms cannot adopt this strategy of vertical integration and have to depend
on outside sources for supply of needed inputs.
Further, it is not a good strategy to depend on a single supplier of inputs. If
there is disruption in production of the supplier firm due to labour strike or
lock-out, it will adversely affect the production work of a firm. Therefore,
to reduce risk and uncertainty business firms prefer to keep multiple
suppliers of inputs.
Customers: The people who buy and use a firm’s product and services are
an important part of external micro-environment. Since sales of a product
or service is critical for a firm’s survival and growth, it is necessary to
keep the customers satisfied. To take care of customer’s sensitivity is
essential for the success of a business firm. A firm has different categories
of customers. For example, a car manufacturing firm such as Maruti
Udyog has individuals, companies, institutions, government as its
customers. Maruti Udyog, therefore, has cater to the needs of all these
types of customers by producing different varieties and models of cars.
Besides, a business firm has to compete with rival firms to attract
customers and thereby increase the demand and market for its product. In

NOTES the present day of intense competition a firm has to spend a lot on
advertisements to promote the sales of its product by creating new
customers and retaining the old ones. For this purpose, a business firm has
also to launch new products or models. With increasing globalisation and
liberalisation the customers’ satisfaction is of paramount importance for
which products can be imported also. For example, in the USA American
firms faced a lot of competition from the Japanese firms producing
electronic goods and automobiles. Similarly, the Indian firms are facing a
lot of competition from Chinese products. It is important to note that for
successful competition the Indian firms have to improve not only the
quality of the products but also to enhance their productivity so that cost
per unit can be reduced.
Consumer: Finally, public are an important force in external micro
environment. Public, according to Philip Kotler, “is any group that has an
actual or potential interest in or impact on a company’s ability to achieve
its objective”. Environmentalists, media groups, women associations,
consumer protection groups, local groups, citizens associations are some
important examples of public which have an important bearing on
environment of the firms. For example, a consumer protection firm in
Delhi headed by Sunita Narain came out with an amazing fact that cold
drinks such as Coca Cola, Pepsi Cola, Limca, Fanta had a higher contents
of pesticides which posed threat to human health and life. This produced a
good deal of adverse effect on the sale of these products in 2003-04. The
Indian laws are being amended to ensure that these drinks must not contain
pesticides beyond European safety standards. Similarly, environmentalists
like Arundhati Roy have been compaigning against industries which
pollute the environment and cause health hazards. Women in some
villages of Haryana protested against liquor shops being situated in their
localities. Many citizen groups are actively campaigning against cigarette
manufactures for their advertising campaigns luring the people to indulge
in smoking. Thus, the existence of various types of public, influence the
working of business firms and compel them to be socially responsible.
1.8 EXTERNAL MACRO ENVIRONMENT: FACTORS

Apart from micro-environment, business firms face large external
environmental forces. The external macro environment determines the
opportunities for a firm to exploit for promoting its business and also
presents threats to it in the sense that it can put restrictions on the
expansion of business activities. The macro-environment has thus both
positive and negative aspects. An important fact about external macro- NOTES
environmental forces is that they are uncontrollable by the management of
a firm. Because of the uncontrollable nature of macro forces a firm has to
adjust or adapt itself to these external forces.
External macro-environmental factors are classified into (1) economic,
(2) social, (3) technological, (4) political and legal, and (5) demographic.
We explain below all these factors determining external macro-
environment.
Economic Environment
Economic environment includes the type of economic system that exists in
the economy, the nature and structure of the economy, the phase of the
business cycle (for example, the conditions of boom or recession), the
fiscal and monetary policies of the Government, foreign trade and foreign
investment policies of the government. These economic policies of the
government present both the opportunities as well as the threats (i.e.
restrictions) for the business firms.
The type of the economic system, that is, socialist, capitalist or mixed
provides institutional framework within which business firm have to work.
For example, before 1991, the Indian economic system was of the type of
a mixed economy with pronounced orientation towards the public sector.
Prior to 1991 private sector’s role in India’s mixed economy was greatly
restricted. Many industries were reserved exclusively for investment and
production by the public sector. Private sector operations were limited
mainly to the consumer goods industries. Even in these goods the private
sector production and operation was controlled by industrial licensing
system, Monopolistic and Restrictive Trade Practices (MRTP)
Commission. The private sector was also subjected to various export and
import restrictions. High tariffs were imposed to protect domestic
industries and because the consumers have the option of buying imported
products. Therefore, to survive and succeed, a firm has to make continuous
efforts to improve the quality of its products.
Marketing Intermediaries: In a firm’s external environment marketing
intermediaries play an essential role of selling and distributing its products
to the final buyers. Marketing intermediaries include agents and merchants
such as distribution firms, wholesalers, retailers. Marketing intermediaries
are responsible for stocking and transporting goods from their production
site to their destination, that is, ultimate buyers. There are marketing
service agencies such as marketing research firms, consulting firms,
NOTES advertising agencies which assist a business firms in targeting, promoting

and selling its products to the right markets.
Thus, marketing is an important link between a business firm and its
ultimate buyers. A dislocation of this link will adversely affect the fortune
of a company. A few years ago chemists and druggists in India declared a
collective boycott of a lead-pharma company because it was providing a
low retail margin. They succeeded in raising this margin. This shows that a
business firm must take care of its intermediaries if it has to succeed in this
age of intense competition.
Competitors: Business firms compete with each other not only for sale of
their products but also in other areas. Absolute monopolies in case of
which competition is totally absent are found only in the sphere of what
are called public utilities such as power distribution, telephone service, gas
distribution in a city etc. More generally, market forms of monopolistic
competition and differentiated oligopolies exist in the real world. In these
market forms different firms in an industry compete with each other for
sale of their products. This competition may be on the basis of pricing of
their products. But more frequently there is non-price competition under
which firms engage in competition through competitive advertising,
sponsoring some events such as cricket matches for sale of different
varieties and models of their products, each claiming the superior nature of
its products. The readers will be witnessing how intense is the competition
between Coca Cola and Pepsi Cola. Sometimes there has been price war
between them to capture new markets or enlarge their market share.
Likewise, there is severe competition between the manufacturers of Arial
and Surf washing powders, and between manufacturers of various brands
of colour TV. This type of competition is generally referred to as brand
competition as it relates to producing and selling different brands of a
product.
But not only is there a competition among the producers producing
different varieties or brands of a product but also among firms producing
quite diverse products as all products ultimately compete for attracting
spending by the consumers of their disposable incomes. For example,
competition for a firm producing TVs does not come only from other
brands of TV manufacturers but also from manufacturers of air
conditioners, refrigerators, cars, washing machines etc. All these goods
compete for attracting disposable incomes of the final consumers.
Competition among these diverse products is generally referred to as

desire competition as all these goods fulfil the various desires of the NOTES
consumers who have limited disposable incomes.
As a consequence of liberalisation and globalisation of the Indian economy
since the adoption of economic reforms there has been a significant
increase in competitive environment of business firms. Indian firms have
to compete not only with each other but also with the foreign firms to
pursue import substitution strategy of industrial growth.
There has been significant changes in the economic policies since 1991
which have changed the macroeconomic environment for private sector
firms. Far-reaching structural economic reforms were carried out by
Dr. Manmohan Singh during the period 1991-96 when he was the then
Finance Minister. Industrial licensing has been abolished and private
sector can now invest and produce many industrial products without
getting license from the government. Many industries, except only a few
industries of strategic importance, which were earlier reserved for the
public sector have been thrown open for the private sector. Import duties
have been greatly reduced due to which domestic industries face
competition from the imported products. Incentives have been given to
boost exports. Rupee has been made convertible into foreign currencies on
current account. It is thus evident that new economic reforms carried out
since 1991 has significantly changed the business environment.
Social and Cultural Environment

Members of a society wields important influence over business firms.
People these days do not accept the activities of business firms without
question. Activities of business firms may harm the physical environment
and impose heavy social costs. Besides, business practices may violate
cultural ethos of a society. For example, advertisement by business firms
may be nasty and hurt the ethical sentiments of the people.
Businesses should consider the social implications of their decisions. This
means that companies must seriously consider the impact of its actions on
the society. When a business firm in their decision making take care of
social interests, it is said to be socially responsible. Social responsibility is
the felt obligation or self-enforced duty of business firms to serve or
protect social interests. By doing so they promote social well being. Good
corporate governance should be judged not only by the productivity and
profits earned by a business firm but also by its social-welfare promoting
activities.

NOTES It is worth noting that in modern management science a new concept of

social responsiveness has been developed. By social responsiveness we
mean “the ability of a corporate firm to relate its operations and policies to
social environment in way that are mutually beneficial to the company and
society at large”. It may be noted that social responsibility or social
responsiveness is related to ethics. The discipline of ethics deals with what
is good and bad, or right and wrong or with moral duty and obligation.
Further, even if managers enjoy full freedom to adopt actions and policies
in accordance with the conceived notion of social responsibility, they may
not do so if standards applied to evaluate their performance are quite
different. Every manager would like its performance to be positively
appraised. Therefore, if the performance of managers of business firms are
judged by the amount of profits they make for the owners of the firms, it is
then not proper to expect socially responsible actions from them.
Political and Legal Environment

Businesses are closely related to the government. The political philosophy
of the government wields a great influence over business policies. For
example, after independence under the leadership of Jawaharlal Nehru
India adopted ‘democratic socialism’ as its goal. In the economic sphere it
implied that public sector was to play a vital role in India’s economic
development. Besides, it required that working of the private sector were
to be controlled by a suitable industrial policy of the government. In this
political framework private business firms worked under various types of
regulatory policies which sought to influence the directions in which
private business enterprises had to function. Thus, Industrial Regulation
Act 1951, Industrial Policy Resolution 1956, Foreign Exchange Regulation
Act (FERA), Monopolistic and Restrictive Practices (MRTP) Act were
passed to control the business activities of the private sector. Besides, role
of foreign direct investment was restricted to only few spheres. However,
since 1991 several structural economic reforms have been undertaken
following a change in political philosophy in favour of a free market
economy. The collapse of socialism in Soviet Russia, China and East
European Countries has brought about a change in political thinking about
the roles of public and private sectors in India’s industrial development.
To encourage the growth of the private sector in India, licensing has now
been abolished, role of public sector greatly reduced and foreign capital,
both direct and portfolio, is being encouraged to raise the rate of capital

formation in the Indian economy. FERA has been replaced by FEMA NOTES
(Foreign Exchange Management Act).
It is evident from above that with the change in the nature of political
philosophy business environment for private firms has greatly changed.
Technological Environment
The nature of technology used for production of goods and services is an
important factor responsible for the success of a business firm. Technology
consists of the type of machines and processes available for use by a firm
and the way of doing things. The improvement in technology raises total
factor productivity of a firm and reduces unit cost of output. The use of a
superior technology by a firm gives it a competitive advantage over its
rival firms. The use of a particular technology by a firm for its
transformation process determines its competitive strength. In this age of
globalisation the firms have to compete in the international markets for
sales of their products. The firms which use outdated technologies cannot
compete globally. Therefore, technological development plays a vital role
in enhancing the competitive strength of business firms.
It has been generally observed that the competition between firms in the
domestic economy and in international markets ensures that the firms will
try to improve the technology they use because failure to do so would pose
a threat to their survival. In the protected markets, technological
improvements are slow and firms are able to survive for a long period
without making technological changes. This is quite evident from the
experience of automobile industry in India. Manufacturers of Ambassadors
and Fiat Cars not only made no significant changes in their models, but
also did not make any improvement in technology for decades because of
absence of competition. The users had no choice and Ambassador and Fiat
cars survived for decades in the protected environment. It is when Maruti
Udyog Ltd. was started in India using superior technology and introducing
more attractive models then there has been significant improvements in car
manufacturing. With libersalisation of the Indian economy new car
manufacturing firms have entered the industry and are producing different
varities and models of cars with improved technology.
Besides, the cotton textile industry is another important example of an
industry which due to protection provided to it by imposing high tariffs on
imports of cotton textiles became sick. Following trade libeilisation many
cotton textile firms have closed down because they could not withstand

NOTES competition. Technological environment affects the success of firms and

the need for technological advancement cannot be ignored.
Demographic Environment
Demographic environment includes the size and growth of population, life
expectancy of the people, rural-urban distribution of population, the
technological skills and educational levels of labour force. All these
demographic features have an important bearing on the functioning of
business firms. Since new workers are recruited from outside the firm,
demographic factors are considered as parts of external environment. The
skills and ability of a firm’s workers determine, to a large extent, how well
the organisation can achieve its mission. The labour force in a country is
always changing. This will cause changes in the work force of a firm. The
business firms have to adjust to the requirements of their employees. They
have also to adapt themselves to their child care services, labour welfare
programmes etc.
The demographic environment affects both the supply and demand sides of
business organisations. As mentioned above, firms obtain their working
force from the outside labour force. The technical and education skills of
the workers of a firm are determined mostly by human resources available
in the economy which are a part of demographic environment. On the
other hand, the size of population and its rural-urban distribution
determine the demand for the products of industrial firms. For example,
when there is good monsoon in India causing increase in incomes of rural
population dependent on agriculture, demand for industrial products
greatly increases.
In the wake of economic reforms initiated in the early nineties when
foreign investors were allowed to make investment in India, they were
prompted to invest in India by pointing out that the size of Indian market
was quite large. They were told that 200 million Indian people could
afford to buy the industrial products and this constituted quite a large
market which could be profitably exploited.
Besides, the growth rate of population and age composition of population
determine the demand pattern of goods. When the population of a country
is growing at a high rate, its child population will be relatively large. This
means demand for products such as baby food which cater to the needs of
children will be relatively high. On the other hand, if population of a
country is stable and life expectancy of the people is high, this will cause
greater proportion of elderly aged people in the population of a country.
This means different demand pattern of goods. Thus business firms have to NOTES
consider all these demographic factors in their planning for production of
goods and services and formulation of marketing strategies for sale of their
products.
Demographic environment is also important for business firms as it
determines the choice of technology by them. Other things being equal, if
labour is abundant and relatively cheaper than capital, business firms will
prefer relatively labour-intensive techniques for production of goods.
However, for various reasons such as rigid labour laws and low
productivity of labour, various tax concessions on investment in capital
equipment and machinery, business firms in India are generally seem to be
using capital-intensive technologies imported from abroad. This has
resulted in the increasing in unemployment of labour, especially among
the young workers. Therefore, social and government pressure is
increasing on the business firms to create more employment opportunities
for labour so as to render help in solving the problem of unemployment. It
is quite interesting to note here that to take advantages of relatively cheap
labour in India and China that foreign MNCs are setting up manufacturing
plants in these countries.
It is evident from above that demographic factors play a crucial role in
determining the productive activity of business firms.
Natural Environment
Natural environment is the ultimate source of many inputs such as raw
materials, energy which business firms use in their productive activity. In
fact, availability of natural resources in a region or country is a basic factor
in determining business activity in it. Natural environment which includes
geographical and ecological factors such as minerals and oil reserves,
water and forest resources, weather and climatic conditions, port facilities
are all highly significant for various business activities. For example, the
availability of minerals such as iron, coal etc. in a region influence the
location of certain industries in that region. Thus, the industries with high
material contents tend to be located near the raw material sources. For
example, steel producing industrial units are set up near coal mines to save
cost of transporting coal to distant locations.
Besides, certain weather and climatic conditions also affect the location of
certain business units. For example, in India the firms producing cotton
textiles are mostly located in Mumbai, Chennai, West Bengal, where

NOTES weather and climatic conditions are conducive to the production of cotton
textiles.
Natural environment also affects the demand for goods. For example, in
regions where there is high temperature in summer there is a good deal of
demand for dessert coolers, air conditioners, business firms set up
industrial units producing these products. Similarly, weather and climatic
conditions influence the demand pattern for clothing, building materials
for housing etc. Furthermore, weather and climatic conditions require
changes in design of products, the type of packaging and storage facilities.
It may, however, be noted that resource availability is not a sufficient
condition for the growth of production and business activities. For instance,
India though rich in natural resources remained poor and underdeveloped
because available resources had not been put to use due to lack of adequate
capabilities of Indian business class. Thus, it is not the availability of
natural resources alone but also the technology and ability to bring them in
use, that determines the growth of business and the economy.
Ecological Effects of Business

Until recently businesses had generally overlooked the serious ecological
effects of its activities. Driven purely by the motive of maximising profits,
they cause irreparable damage to the exhaustible natural resources,
especially minerals and forests. By their careless attitude they caused
pollution to environment, especially air and water which posed health
hazards for the people. By creating external detrimental diseconomies they
imposed heavy costs on the society. Thanks to the efforts by
environmentalists and international organisations such as World Bank, the
people and the government have now became conscious of the adverse
effects of depletion of exhaustible natural resources and pollution of
environment by business activity. Accordingly, laws have been formulated
for conservation of natural resources and prevention of environment
pollution. These laws have imposed additional responsibilities and costs
for business firms. But it is socially desirable that these costs are borne by
business firms if we want sustainable economic growth and also healthy
environment for human beings.
1.9 INTERNAL ENVIRONMENT

Having discussed various external environmental factors let us turn to the
factors which determine internal environment of a business firm. Some

management experts confine the term business environment to external NOTES

environment only. However, the recent view is to include both external
and internal factors for determining business environment. Internal
environment includes such factors as value system, mission and objectives
of the firm, management structure, quality of its human resources, physical
assets, technological development, financial position and capital structure
of the firm. It is worth noting that internal environmental factors are to a
good extent controllable factors because the firm can change or modify
these factors to improve its efficiency. However, the firm may not be able
to change all the internal factors. We explain below some crucial internal
environmental factors.
Value System: The value system of an organisation means the ethical
beliefs that guides the organisation in achieving its mission and objective.
The value system of a business organisation also determines its behaviour
towards its employees, customers and society at large. The value system of
the promoters of a business firm has an important bearing on the choice of
business and the adoption of business policies and practices. Due to its
value system a business firm may refuse to produce or distribute liquor or
it may think morally wrong to promote the consumption of liquor. The
value system of a business organisation makes an important contribution to
its success and its prestige in the world of business. For instance, the value
system of J.R.D. Tata, the founder of Tata group of industries, was its self-
imposed moral obligation to adopt morally just and fair business policies
and practices which promote the interests of consumers, employees,
shareholders and society at large. This value system of J.R.D. Tata was
voluntarily incorporated in the articles of association of TISCO, a premier
Tata company.
Infosys Technologies which won the first national corporate governance
award in 1999 attributes its success to its high value system which guides
its corporate culture. To quote one of its report, “our corporate culture is
to achieve our objectives in environment of fairness, honesty, transparency
and courtsy towards our customers, employees, vendors and society at
large.”
Thus value system of a business firm has an important bearing on its
corporate culture and determines its behaviour towards its employees,
shareholders and society as a whole.
Mission and Objectives: The objective of all firms is assumed to be
maximisation of long-run profits. But mission is different from this narrow

NOTES objective of profit maximisation. Mission is defined as the overall purpose

or reason for its existence which guides and influences its business
decision and economic activities. The choice of a business domain,
direction of its development, choice of a business strategy and policies are
all guided by the overall mission of the company. For example, “to
become a world-class company and to achieve global dominance has been
the mission of ‘Reliance Industries of India’. Similarly “to become a
research based international pharma company” has been stated as mission
of Ranbaxy Laboritories of India.
Organisation Structure: Organisation structure means such things as
composition of board of directors, the number of independent directors, the
extent of professional management and share-holding pattern. The nature
of organisational structure has a significant influence over decision making
process in an organisation. An efficient working of a business organisation
requires that its organisation structure should be conducive to quick
decision making. Delays in decision making can cost a good deal to a
business firm.
The board of directors is the highest decision making body in a business
organisation. It takes general policy decisions regarding direction of
growth of business of the firm and supervises its overall functioning.
Therefore, the managerial capability of the board of directors is of crucial
importance for the functioning of a business firm and for achievement of
its overall mission and objectives. For efficient and transparent working of
the board of directors in India it has been suggested that the number of
independent directors be increased.
Many private corporate firms in India are managed by family members of
their promoters which is not conducive to the efficient working of these
firms.
It is, therefore, highly desirable to increase the extent of professional'
management of private corporate companies. The share holding pattern has
also an important implication for business management. In some Indian
companies the majority of shares is held by the promotors of the company
themselves. In some others share-holding pattern is quite diversified
among the public. In India financial institutions such as UTI, LIC, GIC,
IDBI, IFC etc. have large share holdings in prominent Indian corporate
companies and the nominees of these financial institutions play a critical
role in making major business policy decisions of these corporate
companies.

Technically, shareholders elect directors who make up the board of NOTES

directors. The directors then appoint company’s top managers who take
various business decisions. However, most of the shareholders delegate the
voting rights to the management or do not attend the general body meeting.
Thus, most of the shareholders regard ownership of the company as a
purely financial investment. However, in recent years in developed
countries like the United States the shareholders have come to wield a
great influence. The bankruptcy of business giants such as Enron, World
Com. in the United States have created great awareness as well as mistrust
among shareholders. In the last few years there has been frequent law suits
filed by shareholders against directors and managers for ignoring the
interests of shareholders or in fact cheating them by not declaring
dividends. That is why there is worldwide debate on proper corporate
governance of business firms.
Corporate Culture and Style of Functioning of top Management:
Corporate culture and style of functioning of top managers is important
factor for determining the internal environment of a company. Corporate
culture is generally considered as either closed and threatening or open and
participatory. In a closed and threatening type of corporate culture the
business decisions are taken by top-level managers, while middle level and
work-level managers have no say in business decision making. There is
lack of trust and confidence in subordinate officials of the company and
secrecy pervades throughout in the organisation. As a result, among lower
level managers and work a political parties ruling, natural calamaties and
change its projects also implementation of the plans.
1.10 SUMMARY OF THE UNIT

The term environment consists of many sub levels external and internal.
The external environment has greater influence on business. The
environment differs from one country to another. Business is an economic
activity and hence it has impact on policy and planning.
Globalisation leads to new economy as there is a trade between various countries.
1.11 GLOSSARY
 Business Environment: The aggregate of all conditions and
influences that affect business.
 External Sector: International economy in terms of markets.
NOTES
1.12 KEY TERMS
 Environment: It means ‘surrounding’ with external and internal
levels that influences business activity.
 Decision: Selecting from set of alternative course of action.
 Economic Activity: Activity undertaken with financial
consideration.
 W.T.O.: World Trade Organisation.
1.13 CHECK YOUR PROGRESS (MULTIPLE

CHOICE/OBJECTIVE TYPE QUESTIONS)
(A) Fill in the Blanks
1. Cuba’s Capital is ____________.
2. Cuba is an example of ____________ economy.
3. Contribution of ____________ sector to GDP is more in Poland.
4. Impact of globalisation was on ____________.
5. ____________ is the second largest employment sector after
agriculture.
(B) True or False

1. India is an example of mixed economy.
2. Poland after 1990 is an example of mixed economy.
3. Globalisation is a term used to describe restrictions on foreign
trade.
1.14 KEY TO CHECK YOUR ANSWER

(A) 1. Havana, 2. Planned, 3. Service, 4. Economy, 5. Textile.
(B) 1. True, 2. True, 3. False.

NOTES
1.15 TERMINAL AND MODEL QUESTIONS
1. Give classification of business environment.
2. Explain the economic environment in India.
3. Discuss salient features of economic policy 1991.
4. What do you understand by global environment? Explain.
5. What is the importance of G.A.T.T. and WTO?
1.16 REFERENCE BOOKS

1. D.H. Buchanan: The Development of Capitalistic Enterprise in
India.
2. Ghosh Alok: Indian Economy, Calcutta.
3. Disrupt A: Government and Business ‘Vikas’ – Delhi.
4. Philip Kotler, Marketing Management, Prentice Hall of India,
New Delhi, 1998, p. 127.


CONSUMERISM AND
UNIT 2
BUSINESS
Structure:
2.1 Introduction
2.2 Responsibilities of Business
2.4 Glossary
2.5 Key Terms
2.9 Reference Books
Objectives
 Understand the link between Business and Consumer.
 Learn enactments by the Government.
 Understand ‘Business Responsibilities’.
 Know the role of professionals and woman in business.
NOTES
2.1 INTRODUCTION
There are two approaches to business - (i) product oriented and
(ii) consumer or customer oriented. ‘Abell’ recommends needs for
consumer orientation. Many business mislead the consumer. The interest
of the consumer must be protected. Government has more than 60
enactments for consumer safety. Management professional, have created
better environment based on knowledge, skills and ethical values.
What is our business? Derek F. Abell has suggested that a company should
define its business in terms of three dimensions: who is being satisfied
(what customer groups), what is being satisfied (what customer needs),
how are customer needs being satisfied (by what skills or distinctive
competencies). Following figure illustrates these three dimensions.
Definition
of
Business
How are customer

needs being satisfied?
DISTINCTIVE COMPETENCIES
Fig: Abell's Framework for defining the Business

Abell’s approach stresses the need for a consumer-oriented rather than a
product-oriented business definition. A product oriented business
definition focuses just on the products sold and the markets served. Abell
maintains that such an approach obscures the company’s function, which
is to satisfy consumer needs. In practice, the particular need of a particular
consumer group may be served in different ways. Identifying these ways
through, a broad, consumer-oriented business definition can safeguard
companies from being caught unawares by major shifts in demand. Indeed,
by helping anticipate demand shifts, Abell’s framework can assist
companies in capitalising on the changes in their environment.
Unit 2: Consumerism and Business Page 27 of 316
NOTES Losing a customer costs more to the company, than attracting the attention
of a new customer. So, in order to retain the customer, the company or the
organisation should conduct its business operations more clearly in a
fairway.
Consumerism is a movement to intimate and guide consumers and
safeguard them from the malpractices being followed by the businessman.
The focus of this movement is on the unfair business practices, inferior
and dangerous merchandise, and false or misleading advertisements. The
unfair practices being followed by the businessman may be listed as:
charging unreasonably high prices and preventing competition in the
production and distribution of goods, tending to lower the quality of goods
supplied, limiting the capital investment or technical development for the
production purposes and so on.
The examples of Inferior and dangerous merchandise may be considered
as: Practicing unbashed adulteration; increasing improper measurements,
breaking promise of delivering goods in time after accepting advance.
After sales services have just become the word of mouth.
The recent advertisements are aiming at making huge profits by
misleading the customers. They have been concentrated more on attracting
the customers instead of retaining them for longer period. Many labels on
the products supplied are false. The advertisements and labels have
become half truths as per the views of the customers.
In order to protect and safeguard the interest of the customers, the
consumerism has come into existence. The Government has passed many
major laws and amended the legislations as per the changes in the business
environment to protect the views and interest of the consumers in a
competitive market. For example, we have around fifty to sixty laws which
have been enacted to safeguard the consumer interest. The latest Act to be
enacted by the Government is the Consumer Protection Act 1986, which
mainly deals with:
1. Protecting the customers against deceptive practices, defective
goods and unsatisfactory services.
2. Consumer complaints and issues by setting up of special forums
exclusively at district, state and central levels.
3. Awarding and protecting the aggrieved consumer by effective
compensation.
4. Each and every customer by understanding the public as a whole.
Page 28 of 316 Unit 2: Consumerism and Business

In short, this is the effective legislation which is powerful enough to NOTES

protect and safeguard the interest of the consumer and the public as a
whole. This legislation makes clear the responsibility of businessmen and
his commitment to provide qualitative products and render effective
services.
Other than the enactment of legislations, the Government has also taken
effective steps in implementing various programmes. One can remember
an item of the 20 – Point programme undertaken by the government to
protect the consumer from the unfair trade practices. Many agencies,
including State governments, the Department of Science and Technology,
the textile committee, the department of R&D have set up Consumer
Advisory Councils to intimate about the false claims, hike in prices, etc.
and safeguarding the consumer from becoming victim under the deceptive
practices. The different media like Television, All India Radio are also
playing significant role in protecting the consumer interest by organising
competitive programmes. The Government can just intimate and protect
the interest of the consumers but it always lies with the consumer to
safeguard himself from unfair trade practices by exercising his own rights.
The basic theme of the consumerism is to protect the interest of the
consumers, as of reason many consumer movements have come up to
provide information about the false advertisements and labels etc., and
protect them from the deceptive trade practices.
Today’s consumer has become intelligent enough to find the false claims
and is aware of asserting his rights to protect himself from unabashed
practices and so on. As he is becoming more competitive in exercising his
rights and understanding his responsibilities we can expect more effective
movements under consumerism in the coming era.
2.2 RESPONSIBILITIES OF BUSINESS

Following are the responsibilities of business in addition for fulfilling the
needs of the consumer by producing goods and rendering services as per
their tastes and preferences.
1. Advertising: Advertising has become a vast apparatus of persuations
and inducements by which the eyes and ears of the public are constantly
asserted to do this or to buy that. In creating a demand for the product
many sellers are going for the false advertisements. The seller can retain
the consumer only when he is true in his performance and loyal in his
commitments. But unfortunately, the producer is just aiming at skimming
NOTES the cream before the entry of the competitor for his product, by immoral
and false advertisements.
The main purpose of advertising is to give information about the product
and the Brand and so on. It persuades the buyer to purchase the product.
So here exists the duty of the advertisement to be true enough. It should
not misguide the consumer just to increase the sales. Unfortunately there is
no such legislation passed by the government to check the misleading
advertisements. So an individual himself has to exercise an exact purchase
decision. But even then it is the role of the advertisement that the producer
has to exercise to bring in “increased awareness.”
The role of the advertisement should not be misused by the seller in
reaching new areas of new segments of population within existing areas.
Instead he should utilise the main purpose of advertisement in developing
overseas market.
2. Products and Services: Consumer can always expect the product he
wants as many competitors exist in the market. Earlier, the product
produced by the manufacturer was simple to operate and easy to use. But
now the very important feature of the product is “complexity.” As the
product becoming more complex leading to difficulties in its operation and
usage, the role of businessmen has to be exercised in providing proper
information about the operation and performance of the ‘complex’ product.
The complexity of product has increased because of more adoption to the
technological advancements. Responsibility for performance and safety
throughout the life of the product should be assumed by the producer.
Today’s consumer is enjoying the right in selecting the products as there
exists many substitutes in the competitive market. He also expects the
services to be offered by the sellers, together with the product that he
purchases. The consumers’ expectations are increasing making the
producer to spend more in manufacturing quality products. This process is
leading to hike in the following costs:
 Economic costs
 Social costs
 Opportunity costs and
 Total costs which is inclusive of R&D costs.
3. Women and Business: Women have been playing a crucial role in the
development process since the early stages of civilised life. It is said that it
was women who not only discovered fire, but also the use of fire the basic
cooking techniques like boiling, roasting, baking, steaming etc. The NOTES
Constitution has granted them equality of status and opportunity. The
Directive Principles of State Policy empowered the state to make special
provisions for the progress of women.
Women play a significant role as mothers, wives, sisters at home. In the
same way in recent years she has started showing her better performance
even at the corporate level as owners, managers, employers and employees.
It is the responsibility of Business to offer a helping hand to women by
contributing to their education and nourishing in depth capabilities in them.
Professional
Professionalisation has achieved importance because of growing demand
for management education and training. The growth of professionalisation
has affected positively to the growth of social orientation of business.
Professionalisation brings in to existence the dignity to management. It
also makes business more effective and efficient, dynamic and flexible to
adjust to the changing business environment.
The growth of management education in the country and the facilities
abroad to obtain management education have contributed to
professionalisation in the business field. A professional has innumerable
responsibilities. He has to support the society by following ethical values
in the operations of the business. Professionalisation imparts certain social
responsibilities. A professional shall not use his power, knowledge and
skill in a wrong route. He should not harm the feelings and emotions of the
customers knowingly. He shall not utilise his knowledge and skill to
maximise his own profits or the earnings. He is responsible to the
management as well as to the society. He shall do his work in such a way
that both shall be benefited to the maximum extent leading to ‘win-win’
situation.
Now, it is clear that a professional is one who possesses systematic
knowledge and skill to perform certain responsible functions with
authority.

The economic activity now has more emphasis on efficiency, quality and
interest of consumers. The consumers have also become conscious of their
rights e.g., consumers Movement. The Government has also enacted laws
to protect the interest of consumers.
NOTES
2.4 GLOSSARY
 Economy: System in which productive units use resources to
provide products.
 C.P.I: Consumer price index (Cost of buying goods).
 Exchange Rate: Price of one unit of currency in terms of other
currencies.
2.5 KEY TERMS

 Social Environment: This level includes social structure and its
truncation formation.
 Social Responsibility: Awareness of impact of business on
society.
 Consumer: Beneficiary of business activity.

(a) Fill in the Blanks
1. Rise in prices reduces the __________of wage earners.
2. Excess supply results in __________ demand for goods.
3. High rise in prices raises the cost of living and workers ask for
__________ wages.
(B) True or False

1. Consumerism is related to modern consumer movement.
2. Excise tax is imposed on export.
3. Import means to bring goods from another state.

(a) 1. Consumption, 2. Increased, 3. Higher.
(b) 1. True, 2. False, 3. False.

NOTES
1. What do you understand by social responsibility of business?
2. Explain social and cultural environment.
3. Explain the following:
(a) Consumer awareness
(b) Consumer protection
(c) Consumer movement
2.9 REFERENCE BOOKS

1. Economic Survey of India (2007-08).
2. Das, ‘Trade and Development’, New Delhi, Deep Publications.


MACRO ECONOMIC
ENVIRONMENT AND
UNIT 3
MODERN THEORIES OF
ECONOMIC GROWTH
Structure:
3.1 Introduction
3.2 Economic Growth
3.3 Development
3.4 Critical Elements
3.5 Money
3.6 Global Trade Environment
3.7 Host Countries
3.8 Meaning and Definition of Inflation
3.9 Features of Inflationary Economy
3.11 Glossary
3.12 Key Terms
Objectives
 Know major economic issues which are considered by business
firms.
 Understand economic growth and development.
 Understand the critical elements of ‘economy’. NOTES
 Explain money and planning for business.

 Know about MNC’s GATT, and WTO.
3.1 INTRODUCTION
The important Macro economic issues are – rate of economic growth,
magnitude of employment generation and extent of unemployment. The
economic growth and development, though go together, must be treated
separately.
Having discussed the nature and scope of business environment, we will
now discuss the major macroeconomic issues which are considered by
business firms while taking business decisions. The important
macroeconomic issues are the economic growth rate of the country, the
magnitude of employment generation in the economy and the extent of
unemployment prevailing in the economy, the rate of inflation in the
economy, foreign exchange rate of the national currency and balance of
payments situation of the country. All these macroeconomic issues have an
important bearing on the business decision-making by the firms.
3.2 ECONOMIC GROWTH

Meaning
Economic growth has been defined in two ways. In the first place,
economic growth is defined as increase in an economy's real national
income or gross national product (GNP) over a period of time. In other
words, economic growth means rising trend of national product at constant
prices. This definition has been criticised by some economists as
inadequate and unsatisfactory. They argue that total national income may
be increasing and yet the standard of living of the people may be falling.
This can happen when the population is increasing at a faster rate than
total national income. For instance, if national income is rising by 1.5 per
year and population is increasing at 2% per year, the standard of living of
the people will tend to fall. This is so because when population is
increasing more rapidly than national income, per capita income will go on
falling.
Therefore, the second and better way of defining economic growth is to do
so in terms of per capita income. Thus, economic growth means the annual
Unit 3: Macro Economic Environment and Modern Theories of Economic Growth Page 35 of 316
NOTES increase in real per capita income of a country. Professor Arthur Lewis
writes that “economic growth means the growth of output per head of
population” Since the main aim of economic growth is to raise the
standard of living of the people, the second way of defining economic
growth which runs in terms of per capita income is considered to be better.
However, the concept of economic growth is generally used in both these
senses, that is, in the sense, of increase in GNP or in per capita real income
over a period. Economic growth of a country is a major measure of macro
economic performance of a country.
Another point which is worth mentioning in regard to the definition of
economic growth is that the increase in national income or increase in per
capita income must be a ‘sustained increase’ if it is to be called economic
growth. Sustained increase in per capita income is meant the upward or
rising trend in per capita income over a long period of time. A mere short-
period rise in per capita income, such as that occurs within a business
cycle, cannot be validly called economic growth.
Now, almost universally, rates of economic growth are measured both in
terms of increase in overall Gross National Product (GNP) or Net National
Product (NNP) and increase in per capita income. While Gross National
Product (GNP) measures the value of total output of goods and services
which an economy is capable of producing, per capita income measures
how much of the total value of goods and services which an average
person of the community will have for consumption and investment, that is,
average level of living of a citizen of a country.
Thus, world organisation such as World Bank, and IMF have been
employing both these measures of economic growth in their annual World
Development Reports for comparing growth and levels of living of the
developed and the developing countries. In India also our Planning
Commission, Central Statistical Organization (CSO), and Reserve Bank of
India have been measuring economic growth on the basis of both overall
GNP or GDP or NNP and per capita income. The recent estimates of
annual growth in GNP and per capita income are given in Table. This table
reveals an interesting feature that economic growth achieved in recent
years is higher in the developing countries than in the developed countries.
However, it should be noted that in the past several decades the present-
day developed countries recorded much higher growth rates than the
developing countries which remained static for a long period. As a result,
per capita income and levels of living of the people of the developed
countries are now much higher as compared to those of the developing
Page 36 of 316 Unit 3: Macro Economic Environment and Modern Theories of Economic Growth
countries. The problem of the developing countries is to catch up with the NOTES
developed countries through attaining rapid economic growth so as to
enjoy higher levels of living.
Table 3.1: GNP Per Capita, Growth Rate and Population in Some Developed and
Developing Countries
Country Populat- GNP Per Growth Rate of GNP

ion Capita in 1980-90, 1990-2000, 2000-04
(millions) 2004 (US
2004 Dollars)
Developed 293.7 41,440 3.0 3.5 2.5
Countries
U.S.A.
Australia 20.1 27.070 3.5 3.9 3.5
U.K. 59.9 33,630 3.2 2.7 2.3
Canada 32. 28,310 3.4 3.1 2.6
Japan 127.8 37,050 4.1 1.3 0.9
Developing 1080.0 620 5.8 6.0 6.2
Countries India
China 1296.2 1500 10.2 10.6 9.4
Pakistan 152.1 600 6.3 3.8 4.1
Bangladesh 139.2 440 4.3 4.8 5.2
Sri Lanka 19.4 1010 4.2 5.3 3.7
Source: World Bank, World Development Report, 2006.
3.3 DEVELOPMENT
No distinction was drawn between economic growth and development in
the beginning of the evolution of economics of development. However,
since the seventies it has been thought necessary to distinguish between
economic growth and economic development. There are two views even
about the concept of economic development. The traditional view has been
to interpret it in terms of changes in the structure of national product and
the occupational pattern of labour force and the institutional and
technological changes that bring about such changes or accompany such
changes. In this view share of agriculture in both national product and
employment of labour force declines and that of industries and services
increases.
NOTES
3.4 CRITICAL ELEMENTS
These critical elements may not always be mutually exclusive. But one
may treat them separately for analytical purposes.
List of the Critical Elements of Macro-Economic

Environments
 economic system
 nature of the economy
 anatomy of the economy
 functioning of the economy
 economic planning and programmes
 economic policy statements and proposals
 economic controls and regulations
 economic legislations
 economic trends and structure, and
 economic problems and prospects
3.5 MONEY
Money is the life and blood of business activity and of the economic
system. The flows of consumption, investment, saving, income,
employment and output are all affected by transactions of money.
Monetary transactions affect the price level, thereby influencing the real
value of all macro-economic variables. Significant developments have
taken place in macro-economics to define the role of money. The essential
question is: Does money matter?
There are different answers to this question: (1) Money does not matter at
all (Classical); (2) Money matters least (Keynesian); and (3) Money
matters most (monetarist). The theoretical debate is quite interesting. But
you have to examine its empirical relevance in the economic environment
of a country like India. This will provide you with a further insight into the
role of centralised planning in the present context, administered price
system as well as free market pricing, and central banking.
Economic planning is supposed to give a direction to the changes in the
economic environment. Most countries function today on the basis of
planning. Either it is planning by direction – typical of a socialist economy, NOTES

or it is planning by incentives, i.e., democratic planning typical of a mixed
economy, or it is indicative planning typical of the French economy. It is
through the system of a perspective planning, five-year planning and
annual planning that the economies try to overcome their environmental
constraints and optimise their achievements over a period of time.
India Consumer Protection

There are a wide range of enactments to protect the consumer. Some are of
general application covering particular aspects of a wide range of products;
Other apply only to specific products. The first category consists of the
Standard of Weight and Measures Act, 1956, the Sale of Goods Act, 1930,
the Trade and Merchandise Marks Act, 1958, the Display of Prices Order,
1973, the Packaged commodities (Regulation) Order, 1979, the Standard
Institutions Certificate Marks Act, 1952, etc. Some of the important
legislations relating to particular goods and transactions are the Essential
Commodities Act, 1955, the Prevention of Food Adulteration Act, 1959,
the Drugs and Magic remedies (Objectionable Advertisement) Act, 1954,
and the Cigarettes (Regulation of Production, Supply and Distribution) Act,
1975. Lately, our Government has brought in the Consumer Protection Act
1986. Through this Act, an attempt is being made to strengthen the
institutional framework to protect the consumer at the local; state and
central levels. There are various institutional factors which account for
growing concern about consumer protection in India.
Planning
Planning is a programme of action, it is not a guarantee in itself. The
formulation of plans and programmes must, therefore, be flowed by proper
implementation. This calls for economic policy statements and legislations.
Apart from having general policy statements affecting industry and
agriculture, the Government often formulates and executes fiscal-cum-
budgetary policies. The Resere Bank will work through the instruments of
money and credit policies, exchange rate policies, etc. Some sort of
physical policies of controls and regulations may also be needed. Price
control, trade control and exchange control are all moves in the same
direction. Sometimes legislations and enactments become necessary for
effective implementation of all these policy statements and proposals. The
national economic environment of business is determined by the existing
macro-economic policy framework.
NOTES Summary of Variables

These policies, planning and pricing together make the economy function
effectively. The functioning of a economy is reflected in short-period
fluctuations and long-term trends in macro-economic variables like income,
money supply, prices, production, employment, balance of trade and
payments, foreign exchange earnings, etc. These trends decide the course
of the prevailing economic environment. Some of these economic trends
may define the nature and dimension of various macro-economic problems
like inflation, unemployment, recession and the like.
3.6 GLOBAL TRADE ENVIRONMENT

Trade is the voluntary exchange of goods, services, assets or money
between one person or organisation and another. Because it is voluntary,
both parties to the transaction must believe they will gain from the
exchange or else they would not complete it. International trade is trade
between residents of two countries. The residents may be individuals,
firms, non-profit organisations or other forms of associations. Such
international trade has important direct and indirect effects on national
economies. On the other hand, imports can pressure domestic suppliers to
cut their prices and improve their competitiveness. Failures to respond to
foreign competition may lead to shutdown of factories and unemployed
workers. Because of international trades obvious significance to businesses,
consumers, workers, scholars have attempted to develop theories to
explain and predict the forces that motivate such trade. Governments use
these theories when they design policies they hope will benefit their
countries, industries and citizens. Business use them to identify promising
markets and profitable internationalisation strategies.
The global business environment is significantly influenced by the
principles and agreements of World Trade Organisation (WTO). Thanks to
Economic Reforms which have opened up opportunities to the Indian
businesses to compete with international business.
IMPACT
The concept of Multinationality has several dimensions, there is no single
universally accepted definition of multinational corporations. According to
an ILO report, “the essential nature of the multinational corporations lies
in the fact that its managerial headquarters are located in one country
(which can be referred to as home country) while the corporate carries out
operations in a number of other countries as well (which can be referred to NOTES

as Host Countries).”
The multinational corporations account for a significant share of the
world’s industrial investment, production, employment and trade as they
play an important role by operating in many host countries. Although the
MNCs took birth in the early 1860s, it was after the Second World War
that they grew rapidly. United States was the home of most of the MNCs
in the early days. Now there are a large number of Japanese and European
Multinationals.
MNCs of the US are more focused, wherein they confine their business to
one industry or product category. Whereas European companies
concentrate more on broader product line. Japanese companies, generally
have product lines that are much too broad.
MNCs can locate their different operations in different countries on the
basis of availability of raw materials, consumer markets, low cost labour
and host country government regulations.
The case explains the operations of Canara Bank branches being set up in
countries.
International Operations
Canara Bank started its International Operations in the year 1953 and
established its International Division in 1976, to supervise the functioning
of its various foreign departments and giving required thrust to foreign
exchange business, particularly exports and to meet the requirements of
NRIs. Though small in size, the Bank’s presence abroad has brought in
considerable foreign business, especially in the form of NRI deposits. The
Bank has its presence abroad, as follows:
1. Canara Bank, London, UK (branch)
2. Indo Hong Kong International Finance Ltd., Hong Kong
(Subsidiary) Canara Bank, Moscow (Representative Office). A
Joint Venture Bank is being established on 40/60 basis with SBI
in Moscow shortly.
3. AI Razouki Intl. Exchange Company, Dubai, UAE (Secondment
agreement and DD drawing facility on Canara Bank).
Eastern Exchange Establishment, Doha, Qatar (Management
Agreement and DD drawing facility on Canara Bank).
Ruwi Exchange Co. LLC, Muscat (Under our Management and
Supervision and DD drawing facility on Canara Bank.
NOTES In addition, following Exchange Companies have DD drawing

arrangements with Canara Bank:
UAE: 1. Al Razouki International Exchange Company LLC, Dubai. 2.
UAE Exchange Centre, Abu Dhabi. 3. AI Fardan Exchange Company,
Abu Dhabi. 4. Leela Megh Exchange Company LLC, Dubai. 5. Thomas
Cook AI Rostamani Exchange Co., Dubai. 6. Habib and AI Mansoor
Exchange Co., Abu Dhabi. 7. AI Ahalia Money Exchange Bureau, Abu
Dhabi. 8. AI Ansari, Abu Dhabi.
OMAN: l. Laxmidas Tharia Ved Exchange Co., Ruwi, Muscat.
2. Musandam Exchange, Ruwi, Muscat.
KUWAIT: 1. Kuwait Bahrain International Exchange Co., Safat.
2. Bahrain Exchange Co., Safat, Kuwait. 3. Dollarco Exchange Co. Ltd.,
Safat.
BAHRAIN: 1. Zenj Exchange Co., WLL, Bahrain. 2. Bahrain Financing
Co., Bahrain.
Source: Economic Times, 12th August, 2002.
Multinational Corporations may also be called as international
corporations, transnational corporations and global corporations, which are
used synonymously in practice. However, the interpretation of these terms
given by different authors are different. These corporations are
differentiated on the basis of salient characteristics as pointed out by
Bartlett and Ghosal. The features considered for the differentiation are
resources and responsibilities configuration, relationship between parent
and subsidiary and the mentality towards the overseas operations.
3.7 HOST COUNTRIES

Firms establishing operations beyond the borders of their home country
affect and are affected by the political, economic, social and cultural
environments of the host countries in which they operate to compete
effectively in these markets and maintain productive relationships with the
host country governments. Managers of MNCs must recognise this and
their firms should interact with the national and local environments.
Economic and Political Impacts

MNCs affect every local economy in which they compete and operate.
Many of their effects are positive. They may make direct investments in
new plants and factories, thereby creating local jobs. Such investments NOTES
also provide work for local contractors, builders, and suppliers. MNCs also
pay taxes, which benefit the local economy, helping to improve
educational, transportation and other municipal services. Technology
transfer can also have positive local effects.
However, MNCs may also have negative effects on the local economy. To
the extent MNCs compete directly with local firms, they may make those
firms to lose both jobs and profits. Also the local economy becomes more
dependent on the economic health of an MNC, the financial fortunes of
that firm takes an increasing significance when retrenchment by the MNC
is accompanied by layoffs, cutbacks, or a total shutdown of local
operations. The effects can be devastating to the local economy.
MNCs also may have a significant political impact, either locally or
internationally. Their sheer size, for example, often threat the country in
which they operate. There exists the possibility that this power may be
misused. They simply threaten to shift production and jobs to other
locations. For example when Spain passed new laws in the early 1990s
that raised labour costs, MNCs such as Colgate Palmolive, S.C Johnson
and Son, Kubota and Volkswagen closed some of their Spanish factories
and/or slashed pay rolls. The result was soaring unemployment that
reached 24.5% in the Mid 1990s.
Cultural Impacts
MNCs can also exert a major influence on the cultures in which they
operate. They raise local standards of living and introduce new products
and services previously unavailable locally. People in the host culture
develop new norms, standards and behaviours. Some of these changes are
positive. Such as the introduction of safer equipment and machinery, better
health care and pharmaceuticals and pure and more sanitary food products.
An important example is Nestle’s heavy promotion of infant formula in the
world’s developing countries.
It is to be emphasised that MNCs are considered as change agents and they
should be encouraged by the developing Nations where improving
standard of living is a top priority. However, MNCs must operate in host
countries in such a way that, their existence will encourage the interest of
economic sovereignty without affecting the long term development plans
of the country.
NOTES GATT
The predecessor of WTO (World Trade Organisation), is the General
Agreement on Tariffs and Trade (GATT) was born in 1948 as a result of
the international desire to liberalise trade.
The collapse of the international economy between the two world wars has
been blamed in part on countries imposing prohibitive tariffs, quotas, and
other protectionist mechanisms on imported goods. Trading and
investment opportunities for international businesses dried up as country
after country adopted such “beggar-by-neighbour” policies. By raising
tariff and quota barriers, each nation believed that it could help its own
industries and citizens.
How the GATT Works?

Many MNCs strongly support GATT objectives, for its goal is to promote
a free and competitive international trading environment that benefits
efficient producers. The GATT accomplishes this by sponsoring
international negotiations to reduce tariffs, quotas and other non-tariff
barriers (NTBs), as tariffs were initially the most serious impediments
towards trade. The GATT seeks to ensure that international trade is
conducted on a non-discriminatory basis by helping international
businesses to compete in world market. This is accomplished through the
use of Most Favoured Nation (MFN) principle. Under GATT rules, all
members must utilise the MFN principle in dealing with other members.
Because of MFN principle, Multilateral, rather than bilateral trade
negotiations have been encouraged, thereby strengthening GATT rule.
Ever since the GATT was established after the Second World War, it has
been striving hard to achieve international economic operations. Towards
this objective, GATT has been conducting several trade rounds, the latest
being the Uruguay Round which is the most expensive.
The Uruguay Round

The eighth and most recent, round of GATT negotiations began in
Uruguay in September 1986. UR agreement took effect in 1995. Like its
seven predecessors, the UR had cut tariffs on imported goods. Most
countries viewed Non Tariff Barriers (NTBs) as the major obstacles to
trade. So the UR addressed the more difficult task of reducing their use.
It is called as Uruguay Round as it was launched in ‘Puntadel Este’ in NOTES

Uruguay, a developing country. The basic concepts involved for
discussion in the Uruguay Round were:
 Improving and developing market access by reducing specific
trade barriers.
 Strengthening GATT disciplines
 Problems cf liberation of trade in services, trade related aspects of
intellectual property rights (TRIPs) and trade related investment
measures (TRIMs).
The traditional concerns of the GATT were limited to international trade in
goods whereas the UR went much beyond the coverage of goods to
services technology, investment and information.
Salient Features of UR Agreement
 Achieving liberalisation of trade in manufacturer by reducing
tariff and phasing out non-tariff barriers.
 Protecting agricultural sector by liberalisation of agricultural
trade.
 Encouraging the exports of non-agricultural goods by providing
subsidies.
Objectives of GATT
Expansion of international trade by liberalisation of trade was the primary
objective of GATT, in order to increase all-round economic prosperity.
Following were considered as its important objectives in the preamble to
the GATT:
 To increase standard of living.
 To maintain constant growth in real income and steady increase
in demand.
 To encourage and ensure full employment.
 To utilise minimum resources of the world to the maximum
extent.
 To encourage and expand the production activities and
international trade.
NOTES Rules or Conventions of GATT

The rules of GATT applicable to the international trade among countries
are:
Any change in the proposed tariff, or type of commercial policy of a
member country should be undertaken with the consultation of other
parties to the agreement.
The member country to GATT should work towards removal of barriers to
international trade and reducing tariffs by negotiating within the limits of
GATT.
Principles of GATT
General principles governing international trade embodied by GATT for
the realisation of its objectives are as follows:
1. Non-discrimination: This principle says that no member country
shall discriminate the conduct of international trade between the
members of GATT. The Principle of Most Favoured Nation
(MFN) to be applicable to all imports and export duties to ensure
non-discrimination, which in turn means that “each nation shall
be treated as Most Favoured Nation.”
There are certain exceptions to this principle. For instance, GATT
encourages economic integration like free trade areas or customs
union, which facilitate the trade without creating barriers to the
trade of other parties. The member countries are allowed to adopt
measures to counter dumping and export subsidies under the
principle of GATT. The application of such measures are,
however, limited to the offending Nations.
2. Discouraging Quantitative Restrictions: GATT principle seeks
to discourage and even to prohibit quantitative restrictions. This
principle ensures limiting restrictions on trade to the less rigid
tariffs. However, few developing countries and countries
confronted with balance of payment difficulties are allowed with
the exceptions to this prohibition. Again agricultural and fishery
products were granted with the application of import restrictions,
where restrictive production and marketing controls were present
with the domestic production of these articles.
3. Continuing Consultation: GATT sought to resolve
disagreements to the trade through consultation and negotiations.
GATT had gone through eight bigger rounds of trade negotiations NOTES
so far. Each round took several years for the completion. The
Uruguay Round, the eighth and the latest Round of the
multilateral trade negotiations (MTNs) took very long time to
conclude. The lengthy process of completion shows the complex
issues involved in negotiating international trade.
WTO
The principles and agreements of World Trade Organisation (WTO)
influence the global business and affect the domestic environment
significantly. The GATT was transformed into a World Trade
Organisation (WTO) with effect from January, 1995. Thus, after about five
decades, the original proposal of an International Trade Organisation took
shape as the WTO. The WTO, which is a more powerful body than the
GATT, has an enlarged role than the GATT.
The WTO is the Constituent of the Uruguay Round results and the
improvement to the General Agreement on Tariffs and Trade. The WTO
has a broader scope which enjoys larger membership than GATT. India is
one of the founder members of the IMF, World Bank, GATT and WTO.
International standards and quality have played an important role in both
protection of health and safety of consumers and facilitation of
international trade. However, with the establishment of the WTO and the
signing of the non-tariff agreements, the international scenario has rapidly
changed and opportunities are available to all countries to benefit from
greater access to world markets. In the given scenario, the role of standards
and conformity assessment procedures by member countries, it is
necessary that certain rules and disciplines are followed so that the
standards/regulations do not act as unreasonable barriers to trade. This
aspect has been taken care through the non-tariff agreements, which
basically lay down the rules and disciplines with regard to standards and
conformity assessment procedures for international trade.
Creation of the WTO

Another important facet of the UR was the creation of WTO, which is
changed with the implementation of the UR. In 1995 the WTO scheduled
to subsume the activities of the GATT and serve as the world’s advocate
and monitor more open and free international trade in goods, services, and
technology. The establishment of WTO is not without controversy.
However, some politicians are concerned that national government will
NOTES have less control over their trade policies. Environmental and human rights
advocates are worried that in the interest of promoting trade, the WTO will
override national laws.
WTO Agreements
The aspects relating to standardisation and certification of quality are
addressed in the following three agreements under WTO trade regime to
serve its overriding purpose of helping trade flow as freely as possible.
1. Agreement on Technical Barrier to Trade (TBT).
2. Agreement on Sanitary and Phytosanitary Measures (SPM).
3. Agreement on Pre-shipment Inspection (PSI).
These agreement basically aim at as free flow of trade as possible, by
adherence to international standards in respect of quality, safety
management systems, laboratory testing and conformity assessment
(inspection and certification) systems and mutual recognition by member
countries of each others systems. Such mutual recognition is further based
on establishment of accreditation mechanisms in each country for
inspection, certification or laboratory testing activities based on widely-
accepted international criteria (ISO 17020, ISO 17025, ISO/IEC Guide 62
for ISO 9000, ISO/IEC Guide 66 for ISO 14C00).
Both SPM and TBT agreement require countries to participate in
international standardisation work.
The Future of WTO

The GATT is generally given high praise for its success in lowering tariffs
on a wide range of goods over the past 50 years. In the Uruguay Round
GATT negotiators made significant progress in addressing subsidies, trade
in services, and protection of international property rights. Experts
recognise, however, that much work remains to be done in eliminating
Non Tariff Barriers (NTBs). Other analysts argue that GATTs multilateral
philosophy is disintegrating as individual countries bargain bilaterally to
resolve their conflicts. The US in particular has borne the brunt of sharp
criticism that its Super 301 actions are undermining the GATTs
multilateral framework. Finally, many international trade experts are
concerned that the strengthening of regional trading blocks, such as the EU
and NAFTA, may promote international trade among their members but
diminish trade among the regions of the world.
Role of WTO NOTES
Following points explain the role or the function of WTO:

1. To provide effective framework for implementing, administering
and operating plurilateral trade agreements.
2. To make an easy process of implementing, administering and
operating the multilateral trade agreements.
3. To observe and evaluate the rules and procedures governing the
settlement of disputes among the member countries involved in
the trade agreements,
4. To make availability of details regarding negotiations concerning
agreements among member countries undertaking multilateral
trade.
5. To administer the “Trade Review Mechanism.”
6. To meet greater coherence in global economic policy by
enhancing better cooperation with the IMF, IBRD and its
affiliated agencies.
The WTO is a powerful body having vast branch of functions as compared
to the GATT. To become a member of the WTO, a country has to accept
completely the results of the Uruguay Round. The WTO plays an
important role in the world economic affairs. In short, the WTO is GATT
plus a lot more.
Gains and Losses from the WTO

One factor where India gained considerably was the issue of TRIPS (Trade
Related Intellectual Property Rights). Originally conceived as a proposal to
fight counterfeit products, the law had threatened to become a
Frankenstein where India and other developing countries were concerned.
It was trying to be used by the developed world to strangulate indigenous
products like basmati rice and at the same time to prevent development of
cheap medicines for which the internal pharmaceutical industry has the
infrastructure and know how, all in the interests of Western patent rights in
an earlier age and where the products are priced exorbitantly by Indian and
Third World Standards.
NOTES Differences between GATT and WTO
Nature GATT WTO

1. Institution GATT was associated in a WTO is a permanent
small secretariat without institution with its own
institutional foundation. secretariat.
2. Agreements GATT agreements were WTO agreements are
provisional. permanent.
3. Commitments GATT was applied on a WTO commitments are full
“Provisional basis,” even if, and permanent.
after more than 40 years,
government choose to treat
it as a permanent
commitment.
4. Coverage GATT rules were applied to WTO is a wide aspect
trade in merchandise goods which covers not only trade
only. in goods but also in services
and intellectual property.
5. Instrument GATT was based on Agreements under WTO are

selective nature as it almost multilateral, leading
included both Multilateral to full commitments for the
and Plurilateral instruments/ entire membership.
agreements.
6.Dispute Disputes under GATT were WTO is based on more
Settlement not settled fast. automatic system which
System shall settle disputes very
fast.
7. Parties/ GATT had contracting WTO has members.
Members parties.
8. Power GATT was less powerful WTO is more powerful and
and narrow scope which broader in scope as it
concentrated only on trade consists of services and
in goods. intellectual property in
addition to goods.
The developing countries would be granted the right to break any monopoly,
which will almost inevitably mean a Western one, over patented drugs in
case of health emergencies like the outbreak of epidemics.
Indian companies have over the years developed cheap and effective drugs
for AIDS which can be used both domestically and exported to regions in
Africa where the problem is far more endemic. Indian drug companies
now need to co-ordinate with other similar companies in Africa to ensure
that there is no needless competition and that life-saving drugs are NOTES
available to the poor and needy at affordable prices.
Another vital sector where India gained was in agriculture — while the
developed world, especially the combined might of the European Union
(EU), wanted the Indian market to be opened up for its high-tech products,
it still insisted on providing massive subsidies for its own farmers to
develop those products.
3.8 MEANING AND DEFINITION OF INFLATION

“Inflation” is commonly understood as a situation of substantial and rapid
general increase the level of prices and consequent deterioration in the
value of money over a period of time. The behaviour of general prices is
measured through price indices. The trend of price indices reveals the
course of inflation or deflation in the economy. As Lerner says, “a price
rise which is unforeseen and uncorrected is inflationary”.
Thus, inflation is statistically measured in terms of percentage increase in
the price index, as a rate percent per unit of time—usually a year or a
month. Generally, the wholesale price index (WPI) numbers are used to
measure inflation. Alternatively, the Consumer Price Index (CPI) or file
cost of living index number can be adopted in measuring the rate of
inflation.
Inflation is like an elephant to the blind men. Different economists have
defined inflation differently. We may, thus, enlist a few important
definitions of inflation as follows, which would give us a comprehensive
idea about this intricate problem.
Harry Johnson defines inflation as a “sustained rise in prices”. Crowther,
similarly, defines inflation as “a state in which the value of money is
falling, that is, prices are rising”. The common feature of inflation is a
price rise, the degree of which may be measured by price indices. Edward
Shapiro puts it thus: “Recognising the ambiguities our words contain, we
will define inflation simply as a persistent and appreciable rise in the
general level of prices”.
Prof. Samuelson puts it thus: “Inflation occurs when the general level of
prices and costs is rising”. Authors like Thorp and Quandt, however, opine
that it is of great help to define inflation in terms of observable
phenomenon and, for this reason, the process of rising prices should be
considered as inflation. There are, at least, two distinct views on the
NOTES concept of inflation. To some economists, inflation is a pure monetary

phenomenon, while to others it is a post-full-employment phenomenon.
3.9 FEATURES OF INFLATIONARY ECONOMY

The following are the strategic features of an inflationary economy:
1. There is a continuously rising price trend, whether it is measured
through WPI or CPI.
2. The money supply is in excess of the requisite production and
exchange needs of the economy. There is an undeserving excess
of monetary liquidity adding fuel to the fire.
3. A good part of the flow of credit is supplied to unproductive
channels, speculative a ties, and sick and non-viable units of
production. In many cases, there is no direct relation between the
bank loans and the physical capacities of the enterprises.
4. There is a lack of financial discipline on the part of the
government. The budget is large with huge deficits on the
revenue and capital account.
5. A large number of commodities are in short supply paving ways
for the sectoral price disequilibrium.
6. Artificial scarcity is commonly caused by hoarding activities and
has become conspicuous for traders, producers, and consumers.
7. The rate of return of speculative hoarding of commodities,
precious metals like gold, silver, and investments in immovable
properties—land, buildings, flats, and so on, much high and
fascinating than the rate of returns on the shares and bonds in an
inflationary economy.
8. Interest rates in the unaccounted and unorganised sectors tend to
be higher than organised sectors of the money market.
9. Labour unrest, strikes, lock-outs, and so on, are common.
Organised labour force successful resists any reduction in the real
wages and pushes up the money-wages, they are accelerating the
process of cost-push inflation.
10. In an inflationary economy, the government is trapped in the
cobweb of an ever increasing public expenditure, larger budgets,
higher taxes, larger public debts, huge deficit financing, and a
large number of controls, which, in turn, encourage black money NOTES

a dual accounting system, black marketing, smuggling, and other
antisocial activities account of the deterioration of the
community’s morals, in general, caused by the inflationary
impact.
In short, an economy is inflationary because it is inflationary. There tends
to be a vicious circle of inflation when it is curbed immediately. In the
long period, the state of unchecked inflation becomes a built-in feature of
the economy and people expect the rate of inflation to accelerate further.

The environmental levels interact with one another. The external level has
forces which are difficult to control by business activity. At the micro level,
the policies, laws, competition etc., provide threats and challenges. This
interacts with external macro environment.
3.11 GLOSSARY
 LDC: Least Developed Countries
 G.D.P. (Gross Domestic Product): Total market value of goods
and services produced by a nation (in one year).
3.12 KEY TERMS

 Cultural Environment: It refers to customs, traditions and
beliefs in the society.
 Political Environment: Laws, Executive action and Judiciary
contribute in shaping business.
 Customers: Refers to buyers and ultimate consumers.

(a) Fill in the Blanks

1. _______ introduced Human Development Index.
2. GNP minus net factor income from abroad is equal to _______.
NOTES 3. The extent of poverty in a community with respect to quality of

life is measured using ______index.
(B) True or False

1. Growth rate of economy refers to rate at which the GDP is
increasing.
2. Economic growth is uni-dimensional and development is
multidimensional.
3. Gender development index of UNDP adjusts HDI for gender
equality.

(a) 1. UNDP, 2. GDP, 3. Human Poverty Index.
(b) 1. True, 2. True, 3. True.

1. What do you understand by economic growth and development?
Discuss.
2. How is the human development index helps as an indicator of
development? Explain.
3. Explain the indices – GDI and HDI.

1. Bedi: Business Environment ‘Excel’, Delhi
2. Cherunilam F.: Elements of business environment. HPH –
Mumbai.

AGGREGATE DEMAND AND
UNIT 4
SUPPLY
Structure:
4.1 Aggregate Demand
4.2 Aggregate Supply
4.3 Macroeconomic Equilibrium
4.4 Changes in Aggregate Demand or Aggregate Supply
4.5 Factors Affecting Aggregate Supply and Aggregate Demand
4.6 Wealth and Wealth Expectations
4.7 Government Demand and Taxation
4.8 Demand-Supply and Employment
4.10 Glossary
4.11 Key Terms
Objectives
 Explain what is meant by aggregate demand.
 Explain what is meant by aggregate supply.
 Define demand inflation.
 Explain what is supply shock.
NOTES When we analyse the demand for and the supply of an individual good, we
graph the quantity of the good and the price of that good. Now, we are
considering all goods and services. So, instead of the quantity of a
particular good, we show the quantity of all goods and services produced
in states. Macroeconomics is about aggregates.
The term ‘aggregates’ refers to large group of goods and services or of
people.
Here, we begin the analysis of aggregate demand and aggregate supply.
The concept must be clear ‘aggregate demand’ refers to total demand and
‘aggregate supply’ refers to total supply.
While plotting for individual good we considered the ‘price’ of the some.
Now, we show quantity of goods and services, produced in states. This
quantity is measured by Real GDP (Gross Domestic Product). Here, the
prices are measured by price index called GDP deflector.
4.1 AGGREGATE DEMAND

Aggregate demand is the demand for all goods and services produced in
the states. The graph below shows the aggregate demand curve. The graph
tells us that, as the prices of all goods and services (the GDP Deflator)
rise (fall), the demand for all goods and services (aggregate demand) will
fall (rise).
GDP
Aggregate
Demand
Real GDP
Fig. 4.1
Notice that the aggregate demand curve looks just like the demand curve
for an individual product. This is convenient. But one does not follow from
the other. There are several reasons for the downward slope of the
Page 56 of 316 Unit 4: Aggregate Demand and Supply

aggregate demand curve (that is, for the fact that people will buy fewer NOTES
goods and services if the prices of all goods and services rise). Some of
these reasons we will encounter later. But two of the reasons have already
been explained.
If prices rise local will buy more imported products and foreigners will
buy fewer export products. These will reduce aggregate demand.
As prices of all goods and services rise (this is inflation), people whose
wealth is in financial form are losers. That is, those with checking
accounts, savings accounts, FDs, bonds, bills, stocks, and so forth will see
their assets go down in value. If people become less wealthy, they are
likely to spend less, causing aggregate demand to fall. There are other
reasons for the downward slope of the aggregate demand curve.
The graph operates in the same manner as the graphs we have used earlier
in economics. What will cause a movement along the aggregate demand
curve? The answer is a change in the prices of all goods and services
produced in the States (that is, in the GDP Deflator). What will cause a
shift in the aggregate demand curve? The answer is a change in anything
other than the prices of all goods and services produced in the States.
Remember that aggregate demand is divided into – net exports. So,
anything that affects any of these categories (other than prices) will cause
the aggregate demand curve to shift. If aggregate demand increases, the
shift is to the right and if aggregate demand decreases, the shift is to the
left.
Later we will consider many factors that will affect consumer spending.
We already know about considered exchange rates. All of these factors
will cause the aggregate demand curve to shift. But most of our focus in
the course will be on fiscal policy and monetary policy. Fiscal
(government) policy involves changes in government spending and in the
tax system.
Government spending can involve either government purchases or
government transfers, such as Social Security. So, if the government
purchases increase, perhaps for an increase in defense spending, aggregate
demand increases. The aggregate demand curve would shift right, and if
the government transfers increase, perhaps for an increase in social
security payments, aggregate demand increases. Again, the aggregate
demand curve would shift right. And if the government increases taxes,
aggregate demand decreases. If the government takes the income from you,
you cannot spend it. The aggregate demand cure would shift left. Also,
Unit 4: Aggregate Demand and Supply Page 57 of 316

NOTES monetary policy changes in the money supply (the number of dollars in
existence). If the money supply increases, there are more dollars. Someone
with those dollars would spend them. Aggregate demand would increase.
The aggregate demand curve would shift to the right. If the money supply
decreases, the aggregate demand curve shifts left. The agency responsible
for changes in the money supply is called the Federal Reserve System
(Fed). i.e., Government.
Test your understanding
For each of the following, state whether there is a movement along or a
shift in the aggregate demand curve. If there is a shift, is it to the right or
left?
1. The Federal Reserve Decreases the Money Supply
2. Workers Receive Higher Wages
3. The American Dollar Depreciates
4. Taxes on Personal Incomes are Decreased
5. Taxes on Businesses are Increased
6. Government Purchases Decrease
7. Foreign Incomes Increase
8. The GDP Deflator Rises
4.2 AGGREGATE SUPPLY

Aggregate supply refers to the supply of all goods and services produced
in the states. The graph below shows the aggregate supply curve. The
graph tells us that, as the prices of all goods and services (the GDP
Deflator) rise (fall), the supply of all goods and services (aggregate
supply) will rise (fall).

GDP Deflator NOTES
Aggregate Supply
Real GDP
Fig. 4.2
Notice that this aggregate supply curve looks just like the supply curve for
an individual product. Again, this is convenient. But, again, one does not
follow from the other. The reasons for the upward slope of the aggregate
supply curve (that is, for the fact that companies will sell more of all
goods and services if the prices of all goods and services rise) requires
logic.
There is some disagreement about the shape of this aggregate supply curve.
Some people believe that the aggregate supply curve is actually vertical, as
shown below.
GDP Deflator
Aggregate Supply
0 Q* Real GDP
Fig. 4.3
According to this graph, the quantity of all goods produced in the states
will be the same whether the prices of these goods rise or fall. The quantity
that will remain unchanged (Q*) is the Potential Real GDP.

NOTES The Potential Real GDP is the amount of production necessary to have
unemployment equal full-employment (the natural rate of unemployment).
Today, we think this means the amount of production to generate enough
jobs so that the unemployment rate is only 4%. Those who argue that the
aggregate supply curve is vertical believe that the economy will always be
able to maintain the Potential Real GDP (the economy will never experience
a recessionary or inflationary gap).
The aggregate supply graph operates in the same manner as the other graphs.
What will cause a movement along the aggregate supply curve? The
answer is a change in the prices of all goods and services produced in the
states (that is, in the GDP Deflator). What will cause a shift in the
aggregate supply curve? The answer is a change in anything other than the
prices of all goods and services produced in the states. Let us focus on only
one factor that will shift the aggregate supply curve – a change in the costs
of production. Any change that increases costs of production will decrease
aggregate supply, shifting the aggregate supply curve to the left. Any change
that decreases costs of production will increase aggregate supply, shifting
the aggregate supply curve to the right.
Test your understanding
For each of the following, state whether there is a movement along or a
shift in the aggregate supply curve. If there is a shift, is it to the right or left?
1. The Productivity of Workers Increases at a more Rapid Rate
2. Workers Receive Higher Wages (Consider this now as a Cost of
Production)
3. An Increase in the Price of Oil, Which is used in the Production
of Most Products
4. A Government Subsidy to Business to Buy More Capital Goods
5. Government Regulations which Raise Costs of Production to
Businesses
6. A Depreciation of the Dollar (Which Affects the Prices of
Imported Parts and Materials used in Production)
7. Increase in the GDP Deflator

NOTES
4.3 MACROECONOMIC EQUILIBRIUM
Putting the aggregate demand and the aggregate supply curves together
provides us with equilibrium, as it did for individual products. This is
shown in the graph below. GDP Deflator.
Aggregate Supply
E
P1
Aggregate Demand
0 Q1 Real GDP
Fig. 4.4
The behaviors of all buyers (aggregate demand) and the behaviors of all
sellers (aggregate supply) have determined that the quantity (Real Gross
Domestic Product) will be Q1 and that the price index (GDP Deflator) will
be P1. In 2003, Q1 would equal $10,493 billion and P1 would equal 105.88.
We know that both aggregate demand and aggregate supply can change.
Each can increase and each can decrease. There are four possibilities. Let
us examine each in turn and then some recent development.
4.4 CHANGES IN AGGREGATE DEMAND OR

AGGREGATE SUPPLY
Case 1: Aggregate Demand Increases
Let us assume that something occurs to cause aggregate demand to shift to
the right (increase). This is shown in the graph below.

NOTES GDP Deflator
E2
P2 Aggregate Supply
E1
P1 Aggregate Demand2
Aggregate Demand1
0 Q1 Q2 Real GDP
Fig. 4.5
First, what happens to Real GDP if aggregate demand rises? As you can
see, Real GDP rises. Called an expansion. And during an expansion,
unemployment falls. The increase in goods and services being produced
and the reduction in unemployment are both good things. Second, what
happens to prices (the GDP Deflator) if aggregate demand rises. As you
can see, they rise. A rise in prices is, of course, called inflation. But since
the cause was an increase in aggregate demand, we call this “demand
inflation”. So there is a trade-off involved; we gain the benefits of greater
production and lower unemployment but bear the costs of higher inflation.
This situation is relevant to understanding several periods in recent
American economic history. First, there is the period from 1964 to 1969.
The increase in aggregate demand began with a tax decrease known as the
Kennedy Tax Cut of 1964. Then, there was a large increase in
government purchases.
This began with a series of government spending programmes known as
the War on Poverty in 1964. Then, there was a large increase in
government spending on health care as Medicare was passed in 1965.
Medicare provides health insurance coverage for people over age 65. Most
significantly, there was a large increase in government spending as the
Vietnam War spending rose significantly throughout the decade. As our
graph shows, there was an expansion in this period. The expansion lasted
1
8 years, which was the longest expansion in American history until the
2
1990s. Unemployment fell to a low of 3.2%, a rate that has not been
achieved since. But as the graph also shows, the result was inflation. The
period of steady inflation began in the decade of the 1960s.

The period from 1982 to 1990 also illustrates the effects of an increase in NOTES
aggregate demand. In this period, there was an increase in aggregate
demand caused by the large increase in defense spending, by a major tax
cut passed in 1981 and by and increase in the money supply by the Federal
Reserve. The increase in aggregate demand caused an expansion. Real
GDP rose. Unemployment fell from over 10% in the fall of 1982 to a low
of 5% in March of 1989. The Consumer Price Index (CPI) rose from 94.3
in January or 1982 to 127.4 eight years later.
Finally, the ten-year period from 1991 to 2001 illustrates the effect of an
increase in aggregate demand. Here, the major cause was an increase in the
money supply and resulting low interest rates. The low interest rates
caused business investment spending to greatly increase creating an
expansion – the longest in American history.
Unemployment fell to a low of 3.9% in 2000. But again, there was
inflation. The Consumer Price Index (CPI) rose again from 134.6 in
January of 1991 to 172.2 at the end of 2000.
Case 2: Decrease in Aggregate Demand

Now, let us assume that something occurs to cause aggregate demand to
shift to the left (decrease). This is shown in the graph below.
GDP Deflator
P1 E1 Aggregate Supply
E2
P2
Aggregate Demand1
Aggregate Demand2
0 Q2 Q1 Real GDP
Fig. 4.6
First, what happens to Real GDP if aggregate demand decreases? As you
can see, Real GDP falls. This period in which Real GDP is falling is called
a recession. And during a recession, unemployment rises. The decrease in
goods and services being produced and the increase in unemployment are
both bad things. Second, what happens to prices (the GDP Deflator) if
aggregate demand decreases. As you can see, they fall. A fall in prices is

NOTES called deflation. You know that the United States has not experienced
deflation since 1950s. In reality, in this situation, we would see
disinflation (not shown on the graph). Disinflation means that prices are
still rising, hut they are rising at a slower rate than previously. If prices
rise 4% one year and then rise 3% more the next year, we have disinflation.
We will consider later why the country experiences disinflation and not
deflation, when aggregate demand falls. Both deflation and disinflation
can be considered good. So once again, there is a trade-off. We gain the
benefits of deflation or disinflation. But we must bear the burden of falling
production and rising unemployment.
The graph illustrates several periods in recent American history. From
1969 to 1971, from 1974 to 1976, and again from 1979 to 1982, aggregate
demand fell due to a decrease in the money supply by the Federal Reserve.
In all three periods, the Federal Reserve decreased the money supply in
order to try to slow inflation. In all three periods, the Federal Reserve
succeeded. The United States experienced disinflation each time. However,
the United States also experience recession each time, with falling
production and rising unemployment. Unemployment reached its postwar
peak of over 10% in 1982. The graph also illustrates the period from 1990
to 1991. In this case, the decrease in aggregate demand was not caused by
a decrease in the money supply.
Instead, the causes were a decrease in consumer spending, as consumers
found themselves heavily in debt, and a decrease in government spending
on the military, as the Cold War came to an end. The decrease in spending
on military equipment, bases, and personnel caused the 1990 recession to
be particularly severe in southern California. Finally, the graph illustrates
the period from 2000 to 2001. In this case, aggregate demand fell because
of a decline in business investment spending. We will consider this near
the end of the course.
Case 3: Decrease in Aggregate Supply

Now let us assume there is a shift of aggregate supply to the left (a
decrease). This is shown in the graph.

GDP Deflator NOTES

Aggregate Supply2
Aggregate Supply1
P2 E2
E1
P1
Aggregate Demand
0 Q2 Q1 Real GDP
Fig. 4.7
What happens to Real GDP if aggregate supply decreases? As you can see,
Real GDP falls. A period in which Real GDP is falling is called a
recession. During a recession, unemployment rises. The decrease in goods
and services being produced and the increase in unemployment are both
bad. What happens to prices (the GDP Deflator) if aggregate supply
decreases, they rise. A rise in prices, is inflation. Why would aggregate
supply decrease? Aggregate supply decreases when something occurs to
increase the costs of production. Because this is so, the resulting inflation
is called “cost-inflation”, to differentiate it from demand-inflation. Notice
that there is no trade-off now. The decline in production is a bad thing. The
rise in unemployment is a bad thing. The rise in prices is a bad thing. This
is a “Murphy’s Law” situation: everything that could go wrong did go
wrong. A period with both recession and cost-inflation together is called
stagflation (a combination of the words stagnation and inflation).
There were two important periods in recent American economic history
that illustrate this graph. One began in 1973. The other began in 1979. In
both cases, aggregate supply shifted to the left because of a large increase
in costs of production caused by increases in the price of oil. In the 1973
period, oil prices rose from about $4 per barrel to about $14.50 per barrel
in a little over one year. (A barrel of oil is 42 gallons.) In the 1979 period,
oil prices rose from the $14.50 per barrel to almost $40 per barrel, before
settling in at around $28 per barrel. This meant that oil prices in 1980 were
seven times what they had been at the beginning of 1973. As oil is
involved in the costs of so many products, these costs rose greatly. (Oil is
used in power generation, in all transportation, in the development of
plastic materials, and so forth.) Because the costs of production rose

NOTES 1
greatly, consumer prices also rose greatly (as high as 13 % per year by
2
1980). Since the price rises were shocking, and since it was a decrease in
aggregate supply that caused them, they came to be called supply shocks.
In both periods, the supply shocks United States caused stagflation. This
went through both a severe recession and a severe Inflation. Both the
periods led up to Election in each period in which the incumbent President
was defeated (Ford in 1976 and Carter in 1980). Oil prices rose
dramatically again in 2000 and 2003.
Case 4: An Increase in Aggregate Supply

Finally, let us assume there is a shift of aggregate supply to the right (an
increase). This is shown in the graph below.
What happens to Real GDP if aggregate supply increases? As you can see,
Real GDP increases. A period in which Real GDP is increasing is called an
expansion. During an expansion, unemployment falls. The increase in
goods and services being produced and the decrease in unemployment are
both good things. What happens to prices (the GDP Deflator) if aggregate
supply increases — they decrease. A decrease in prices is deflation (in
reality, we would most likely see disinflation). This is a “win-win”
situation. The rise in production, the fall in unemployment, and the decline
in inflation rates are all good things.
GDP Deflator
Aggregate Supply 1
E1
P1 Aggregate Supply 2
E2
P2
Aggregate Demand
0 Q1 Q2 Real GDP
Fig. 4.8
What would make aggregate supply increase? We would like to know, as
the results of an increase in aggregate supply are all good. The answer is
that aggregate supply increases if something happens to make the costs
of production decrease. This graph likely characterises the period from
1995 to 2000 and again from late 2001 to the present. In this period,
aggregate supply has been rising because of a large increase in the NOTES
productivity of workers.
Generally, we do not know how to use public policy to make costs of
production decrease more than little. However, various groups have had
proposals that they believe would make aggregate supply increase
significantly. One group, known as supply side economics, focused on
effects of reducing tax rates on increasing aggregate supply.
4.5 FACTORS AFFECTING AGGREGATE

SUPPLY AND AGGREGATE DEMAND
Like the micro economic supply-and-demand model, changes in equilibria
in the AS/AD model are caused by changes in the variables that affect
supply and demand. Table below. Again, the variables that are likely to
affect supply or demand are listed. The presumed direction of influence is
shown with a (+) or (–) sign as was done with the microeconomics model.
The relationship between AS, AD and price are represented by the slope of
the AS and AD curves; changes in all other variables cause the curves to
shift right or left.
Factors that Affect Aggregate Supply and Aggregate Demand
Aggregate Demand Aggregate Supply

1. Income (+) 1. Costs (–)
2. Wealth (+) (a) Labour (wages)
3. Population (+) (b) Resource
4. Interest rate (–) 2. Investment (prior) (+)
5. Credit availability (+) 3. Productivity (+)
6. Government demand (+) 4. Interest rates (–)
7. Taxation (–) 5. Credit availability (+)
8. Foreign demand (+) 6. Foreign supply (–)
9. Investment (+) 7. Expectations
10. Expectations (a) Profits (+)
(a) Inflationary (+) 8.Taxation (–)
(b) Income (+)
(c) Wealth (+)
(d) Interest rate (+)
(+): An increase in this factor causes the curve to shift right.
(–): An increase in this factor causes the curve to shift left.
NOTES A review of the list shows some overlap or redundancy. For example, both
interest rates and credit availability are related of course, and one might be
used to the exclusion of the other. Despite the fact that these are related,
there is a difference between them. For example, credit extended by credit
cards became more readily available to consumers in the late 1970s and
throughout the 1980s because computerisation lowered transaction costs.
This is an institutional reason for credit availability and would be reflected
in a model concerned with showing the effects of this institutional change.
4.6 WEALTH AND WEALTH EXPECTATIONS

It should be obvious that income would be strongly correlated with
aggregate demand since that is primarily how demand is financed, but the
effect of wealth and expectations of future wealth (and for that matter
income expectations) is perhaps not so obvious. The argument here is that
consumer perceptions of their own wealth, which is linked to income but
not the same thing, and expectations of future wealth will effect their
consumption behaviour. A reasonable measure of wealth would certainly
include consumer savings (including bank deposits and ownership of
liquid financial assets, such as stocks and mutual funds) but would also
include more abstract and less liquid categories of wealth, such as home
equity, consumers, in other words, with considerable equity (the difference
between the market value and what is owed on the loan balance) in their
homes have more latitude for spending than consumers who do not. This is
especially true if they expect that equity to grow.
One might ask how consumers can increase their spending if the source of
wealth is illiquid (not easily converted to cash) or is based upon expected
rather than realised income and wealth. One source of potential demand is
obvious; savings. The general availability of consumer credit is another.
Consumers expecting an increase in income can finance purchases
immediately with credit cards or instalment credit (such as that used to
purchase automobiles) and make payments from future income. Likewise,
consumers living in states like New York and California, having
experienced substantial increases in home equity (at least up until 1989)
perceived that their wealth had grown and could raise their standard-of-
living with the popular home equity loans.
In summary, when savings are ample or credit is readily available,
spending is not directly restricted by immediate, realised income, and

aggregate demand can respond to consumer perceptions of wealth, NOTES

expected income, or expected wealth.
4.7 GOVERNMENT DEMAND AND TAXATION

Government demand in this context is the equivalent of Government
Purchases of Goods and Services in the national income account. The
treatment of transfer payments like Social Security, which merely pass
income from one private party, the taxpayer, to another, the recipient, must
depend on how, taxation, is treated. If transfer payments are excluded from
government demand, then the proportion of taxation used to finance
transfer payments.
Taxation has a negative sign for aggregate demand for two reasons:
(1) it reduces disposable income for consumers and, (2) because it lowers
business profits, it lowers any investment that might have been financed by
those profits. Because from the perspective of business, taxation is yet
another cost of doing business, at least to some degree, it has the same
effect upon aggregate supply as other cost categories. An increase in
taxation tends to reduce aggregate supply.
On net then, government spending tends to stimulate demand whereas
taxes tend to retard demand. Therefore, a government running a balanced
budget would have a roughly neutral effect on aggregate demand and a
government running a budget deficit (where expenditures exceed revenues)
would have a stimulating effect. There are considerable tax advantages of
using home equity loans to encourage this activity as well. Interest paid on
home equity loans are deductible from taxable income, reducing the
consumer’s income tax burden.
Unfortunately, nothing is ever quite so simple as this. Some theories claim,
for example, that even a balanced budget stimulates the economy.
4.8 DEMAND-SUPPLY AND EMPLOYMENT

Another important macroeconomic issue is what determines the level of
employment in the economy and what causes involuntary unemployment.
Involuntary unemployment is defined as the situation when in the country
there are a large number of workers who are willing to work at the current
wage rates but are unable to get employment. In times of depression, the
level of employment declines very low with the result that a large number
of persons become involuntarily unemployed.
NOTES Say’s Law and Employment

Classical economists were of the view that there was always full
employment in a free-market economy. According to them, if there are
lapses from the full employment level, then some forces would work
automatically to restore full employment. Their view was based upon their
faith in Say’s Law of Markets. According to Say’s law, there is always
enough expenditure or aggregate demand to purchase the total output
produced with full-employment of resources. In other words, in their
theory, the classical economists neglected the problem of deficiency of
demand for purchasing goods produced at full employment level of
resources. Even when deficiency of aggregate demand arises, according to
them, prices and wages would change in such a way that real production,
employment and income will not decline.
J.B. Say was the famous French economist of the 19th century. Say’s law
is based on the fact that every production of goods also creates income for
the factors of production equal to the value of goods produced by them.
Income earned by the factors are spent on purchasing goods produced. In
other words, production of goods creates purchasing power for itself.
Therefore, Say’s law is expressed as ‘supply creates its own demand’, that
is, the supply of goods produced creates demand for it equal to its own
value. As a result, the problem of general overproduction and
unemployment of resources do not arise. In this way, according to Say’s
law, the possibility of lack of aggregate demand had been ignored.
We thus see that according to Say’s law, aggregate demand for goods will
always be adequate so as to ensure that all resources are fully employed.
The factors which participate in productive activity and earn incomes from
it, spend a good part of their incomes on consumer goods and save some
part of them. But, according to classical economists, savings by the
individuals are automatic, industry would not significantly affect the
demand for the product of that industry because most of the demand for
the product of that industry comes from the workers and persons employed
in other industries. However, to assume that demand curve for output of
all industries will remain unchanged when a simultaneous cut in wages in
all industries together made is not valid. In other words, to apply the result
of micro analysis of the determination of price, output and employment in
an individual industry to the economy as a whole is quite misleading and
invalid. This is because wages are not only costs for the individual
industries, they also constitute incomes of the workers and these incomes
determine the demand for the products of various industries. When all-
round cut in wages is made in all industries, it will reduce aggregate NOTES
demand for the products because workers would have now less incomes
and therefore, would spend less on goods and services. With reduced
demand for the products of industries smaller output will be produced. As
a result, smaller amount of labour will be demanded and employed.
Keynes explained that level employment was determined by aggregate
demand and aggregate supply. He further showed that equilibrium level of
income and employment could well be established at less than full-
employment level of national income. Thus, according to him, lack of
aggregate demand can cause involuntary unemployment of labour and
unutilised productive capacity.

Macro economics is about aggregates. It refers to total supply of all goods
and services. This quantity is measured by real G.D.P. i.e., Gross Domestic
Product. This is linked to G.D.P deflator. Rise in prices is called inflation.
If the cause is increase in aggregate demand it is called demand inflation.
4.10 GLOSSARY
 Export: Sale of goods and services to another country.
 Nationalisation: Is the process of transforming private assets into
public assets by bringing them under the public ownership of
government.
 MFN: Most Favoured Nation
4.11 KEY TERMS

 GDP: Gross Domestic Product.
 Productivity: The effectiveness of productive effort as measured
in terms of output per unit of input.
 GDP deflator: A ratio of nominal GDP to real GDP expressed as
a percentage. Used to measure the inflation rate.

NOTES
(A) Fill in the blanks

1. Effect of increase in money supply depends on ________.
2. Inflation means sustained rise in ________.
(B) True or False

1. Black money encourages more spending and causes economic
growth.
2. Artificial scarcity in prices is caused by hoarding.
(C) Multiple Choice Questions

1. The aggregate demand curve slopes:
(a) Horizontally (b) Vertically
(c) Down and Right (d) Up and Right
2. Which of the following would cause movement along the
aggregate demand curve?
(a) an increase in government spending
(b) an increase in the money supply
(c) depreciation of the American dollar
(d) an increase in the GDP Deflator
3. Which of the following would cause the aggregate demand curve
to shift to the right?
(a) an increase in government spending
(b) an increase in the money supply
(c) depreciation of the American dollar
(d) all of the above
4. The aggregate supply curve is:
(a) horizontal (b) vertical
(c) upward-sloping (d) downward-sloping

5. Which of the following would cause the aggregate supply curve NOTES
to shift to the right?
(a) an increase in wages paid to workers
(b) productivity increases which lower costs of production
(c) depreciation of the American dollar which increases the costs
of imported materials
(d) all of the above
6. Assume that something occurs to cause aggregate demand to
increase. Which of the following should result?
(a) expansion and inflation (b) recession and deflation
(c) recession and inflation (d) expansion and deflation
7. Assume that something occurs to cause aggregate demand to
decrease. Which of the following should result?
8. Assume that something occurs to cause aggregate supply to
decrease. Which of the following should result?
9. Assume that something occurs to cause aggregate supply to
increase. Which of the following should result?
10. Stagflation is a combination of:

(A) 1. Liquidity, 2. prices.
(B) 1. False, 2. True.
(C) 1. (c), 2. (d), 3. (d), 4. (c), 5. (b), 6. (a), 7. (b), 8. (c), 9. (d), 10. (c).

NOTES
1. What do you understand by demand and supply?
2. What do you understand by supply shock? Explain.
3. What steps can be taken to counter inflation?

1. Avadhani V.A.: ‘Global Business’, HPH, Mumbai.
2. Misra S.K. & V.K. Puri: Indian Economy, HPH, Mumbai.


UNIT 5 INFLATION
Structure:
5.1 Introduction
5.2 Inflation – Index
5.3 Prices as Measures of Inflation
5.4 Inflation and Developing Economies
5.5 Demand-pull vs. Cost-push Inflation
5.6 Causes of Inflation
5.7 Effects of Inflation
5.8 Control of Inflation
5.10 Key Terms
Objectives
 Know the causes and effects of inflation.
 Understand how population and poverty effect welfare economy.
 Measures to fight inflation.
NOTES
5.1 INTRODUCTION
It means steep increase in prices, resulting in decrease in the value of
money over a period of time. To understand one has to study, the
impediments in ‘growth process.’ There are theories called – Demand pull
and cost push – inflation. There are causes such as – money supply, berk
credit, hoarding etc. that has effect on economic activity.
5.2 INFLATION – INDEX

Whereas economic growth is a major yardstick of macroeconomic
performance of a country, low rate of inflation is generally regarded as the
indicator of macroeconomic stability. By inflation we mean a general rise
in prices. To be more correct, inflation is a persistent rise in general price
level rather than a once-for-all rise in it. Rate of inflation is either
measured by the percentage change in Wholesale Price Index number
(WPI) over a period or by percentage change in Consumer Price Index
number (CPI). Opinion surveys conducted in India and the United States
reveal that inflation is the most important concern of the people as it
affects their standard of living adversely. A high rate of inflation erodes
the real incomes of the people. A high rate of inflation makes either on
grounds of a prior rise in productivity or cost of living. The employers in a
situation of high demand and employment are more agreegable to concede
to these wage claims because they hope to pass on these rises in costs to
the consumers in the form of rise in prices. Therefore, when inflation is
caused by rise in wages or hike in other input costs such as rise in prices of
raw materials, rise in prices of petroleum products, it is called cost-push
inflation. If this happens we have another inflationary factor at work, of
other inputs, there is another factor responsible for cost-push inflation.
This is the increase in the profit margins by the firms working under
monopolistic or oligopolistic conditions and as a result charging higher
prices from the consumers. In the former case when the cause of cost-push
inflation is the rise in wages it is called wage-push inflation and in the
latter case when the cause of cost-push inflation is the rise in profit
margins, it is called profit-push inflation.
In addition to the rise in wage rate of labour and increase in profit margin,
in the seventies the other cost-push factors (also called supply shocks)
causing increase in marginal cost of production became more prominent in
bringing about rise in prices. During the seventies, rise in prices of raw
Page 76 of 316 Unit 5: Inflation

materials, especially energy inputs such a hike in crude oil prices made by NOTES
OPEC resulted in rise in prices of petroleum products. For example, sharp
rise in world oil prices during 1973-75 and again in 1979-80 produced
significant cost-push factor which caused inflation not only in India but all
over the world. Now, in June-August 2004 again the world oil prices have
greatly risen. As a result, in India prices of petrol, diesel, cooking gas were
raised by petroleum companies; pushing inflation.
5.3 PRICES AS MEASURES OF INFLATION

Prices as measures of inflation – It is well recognised that inflation is a
structural as well as monetary Phenomenon. The trend in price indices
reveal the course of inflation. In long therm the movement of monetary
aggregates such as money supply have influenced aggregate demand. Thus
there are changes in price level in the economy.
The short term localised demand—supply imbalances in wage goods, often
due to season variations in production—coupled with market rigidities and
regulatory failures have supported inflationary expectations. That has
resulted in a more widespread impact, than the initial inflationary impulse,
on the consumers. In the medium to long term, the movement and outcome
of monetary aggregates, such as the money supply and reference interest
rates of the financial systems, have influenced aggregate demand and
consequently, changes in the price levels in the economy. The latter
considerations and the influence of global commodity prices on the
domestic, prices have become more important with the opening and
growing integration of the Indian economy with the rest of the world.
Indeed, the fiscal year (FY) 2007-08 has demonstrated this facet of the
economy more than ever before. With a huge surge in capital inflows, the
liquidity management with its underlying implications for inflation has
been a major challenge for the policymakers.
Housing Price Index
Delhi city 129 150 201

Mumbai metropolitan region 132 149 178
GMCC 136 159 198
CM 130 141 163
Kolkata metropolitan region 129 148 172
Kolkata MC 136 159 192
Unit 5: Inflation Page 77 of 316

NOTES Housing Price Inflation
City 2002 2003 2004 2005 Annual

Average
Delhi city 6.0 21.7 16.3 34.0 19.1
Mumbai metropolitan 16.0 13.8 12.9 19.5 15.5
region
GMCC 19.0 14.3 16.9 24.5 18.6
CM 14.0 14.0 8.5 15.6 13.0
Kolkata metropolitan 15.0 12.2 14.7 16.2 14.5
region
Kolkata MC 20.0 13.3 16.9 20.8 17.7
KMA 11.0 12.6 11.2 13.7 12.1
Bengaluru city 33.0 27.8 31.8 22.8 28.8
Bhopal city 20.0 13.3 13.2 16.2 15.7
Source: Economic Survey 2007-08, Government of India.
5.4 INFLATION AND DEVELOPING ECONOMIES

Inflation in the developed countries may be regarded as a full-employment
phenomenon and it may be well-linked with a full-employment policies.
But what about the underdeveloped or newly developing economies? To
explain the phenomenon of inflation in developing economies, champions
of Development Economics like Myrdal say that underdeveloped countries
like India are structurally backward with a lop-sided development,
characterised by sectoral imbalances due to market imperfections and
stagnancy, as may be caused by a dual nature of the economy with a high
fragmentation. As such, scarcity in some sectors may cause
underutilisation of the productive capacity of the economy and create the
problem of sectoral inflation, more serious than a general price rise. Hence,
the general aggregate demand-and-supply analyses are not suitable to such
types of situation. It should be replaced by the analyses of sectoral
demand-and-supply balances and the bottlenecks involved to study the true
nature of inflation in these economies.
In short, to understand the true nature of inflation in an underdeveloped
country, one has to examine the bottlenecks and gaps of various types,
which obstruct the normal growth process, causing prices to rise with the
generation of money income, without an appropriate rise in the real
income. These gaps and bottlenecks may be enlisted as follows:

Market Imperfections NOTES
Market imperfections like factor immobility, price rigidity, ignorance of

market conditions, rigid social and institutional structures and lack of
specialisation and training in underdeveloped economies do not allow an
optimum allocation and utilisation of resources. Hence, an increase in only
income remain unaccompanied by an increased supply of output, causing a
net price rise of inflationary nature. In these economies there are following
obstacles.
Entrepreneurial Block
Entrepreneurs in the underdeveloped countries lack skill, the spirit of
boldness and adventure. They prefer trading or safer traditional
investments rather than attempting risky innovations. Absence of adequate
industrial capital, prevalence of merchant capital and a colossal amount of
private investments in such unproductive fields like land, jewellery, gold,
and so on, which is a gross socio-economic waste, starve the developing
economy of its much-needed capital resources. Thus, the increased money
supply of savings in terms of money makes a little impact on the real
output, and monetary equilibrium is just obtained through a galloping price
rise in various sectors of the economy.
Food Obstacle
Due to the slow growth of agriculture, over pressure on land due to the
growing population, primitive methods of cultivation, defective land
tenure system, lack of adequate irrigation facilities, and many other
reasons, agricultural output—especially, food supply that constitutes a
large part of wage goods, has failed to keep in pace with the growing
demand for it, from the growing population, but has increased rural
employment in the rural industrialisation process in these countries. This
food bottleneck has created the problem of price rise of food grains, and it
has become the cornerstone in the whole of price structure in the
developing economies.
Infrastructural Bottleneck
This bottleneck refers to power shortages and inadequacies of transport
facilities in the underdeveloped economies. It obviously restricts the
growth process in industrial, agricultural, and commercial sectors and
causes underutilised capacity in the economy as a whole. The

NOTES underutilisation of resources does not absorb the full increase in money
supply but reflects upon the rising prices.
Foreign Exchange
The developing economies suffer from a fundamental, structural
disequilibrium in the balance of payments due to high imports and low
exports on unfavourable terms of trade; hence, they usually suffer from
foreign-exchange scarcity problem. In recent years, day by day, the rising
import bills due to high oil prices have aggravated the problem further.
This foreign exchange bottleneck comes in the way of necessary imports
to check domestic inflation. Again, the need to boost exports to meet the
growing deficits in the balance of payments, puts an extra pressure on the
marketable surplus that is meant for domestic requirements. This
eventually leads to a heavy price rise of exportable commodity in the
domestic market.
Resources Gap
When the public sector is widely expanded for industrial development in
the underdeveloped countries, the government aggravates the problem of
“resources gap”. Owing to the backward, socio-economic-political
structure of the less-developed country (LDC), the government always
finds it difficult to raise sufficient resources through taxation, public
borrowings, and profit of enterprises, to meet the ever increasing public
expenditure in intensive and extensive dimension. As such, under the
pressure of the resources gap, the government has to resort to a heavy dose
deficit financing, despite knowing its dangers. This makes the economy
inflation prone. Similarly, the resource gap in the private sector, caused by
low voluntary savings and high cost economy presses for an over-
expansion of money supply through bank credit which, by and large,
results an acceleration of inflationary spiral in the economy.
5.5 DEMAND-PULL VS. COST-PUSH INFLATION

There are two schools of thought regarding the possible causes of inflation.
One school views the demand-pull element as an important cause of
inflation, while the other group of economists holds that inflation is mainly
caused by the cost-push element.

Demand-pull Inflation NOTES
According to the demand-pull theory, prices rise in response to an excess

of aggregate demand over the existing supply of goods and services. The
demand-pull theorists point out that inflation (demand-pull) might be
caused, in the first place, by an increase in the quantity of money, when
the economy is operating at the full-employment level. As the quantity of
money increases, the rate of interest will fall and, consequently, the
investment will increase. This increased investment expenditure will soon
increase the income of the various factors of production. As a result, the
aggregate consumption expenditure will increase leading to an effective
increase in the effective demand. With the economy already operating at
the level of full employment, this will immediately raise prices, and
inflationary forces may emerge. Thus, when the general monetary demand
rises faster than the general supply, it pulls up prices (commodity prices as
well as factor prices, in general). Demand-pull inflation, therefore,
manifests itself when there is an active cooperation, of passive collusion,
or a failure to take counteracting measures by monetary authorities.
However, the demand-pull inflation can also occur without an increase in
the money supply. This can happen when either the marginal efficiency of
capital increases or the marginal propensity to consume (MPC) rises, so
that investment expenditures may rise, thereby leading to a rise in the
aggregate demand, which will exert its influence in the raising prices
beyond the level of employment that was already attained in the economy.
According to the demand-pull theorists, during the process of demand
inflation, the rise in wages accompanies or follows price rise as a natural
consequence. Under the condition of rising prices, when the rate of profit
is increasing, producers are inclined, in general, to increase investment and
employment, in that they bid against each other for labour, so that labour
prices (i.e., wages) may rise. In short, the inflationary process, described
by the demand-inflation theory, implies the following sequences:
increasing demand, increasing prices, increasing costs, increasing income,
and so on.
Causes of Demand-pull Inflation

It should be noted that the concept of demand-pull inflation is associated
with a situation of full employment where an increase in the aggregate
demand cannot be met by a corresponding expansion in the supply of real
output. There can be many reasons for such excess monetary demand as
follows.
NOTES Increase in Public Expenditure

There may be an increase in the public expenditure (G) in excess of public
revenue. This might have been made possible (or rendered necessary)
through public borrowings from banks or; through deficit financing, which
implies an increase in the money supply.
Increase in Investment
There may be an increase in the autonomous investment (I) in firms, which
is in excess of the rent savings in the economy. Hence, the flow of total
expenditure tends to rise, causing a less monetary demand, leading to an
upward pressure on prices.
Increase in MPC
There maybe an increase in the MPC, causing an excess monetary demand.
This could be due to the operation of demonstration effect and such other
reasons.
Increasing Exports and Surplus Balance of Payments

In an open economy, an increasing surplus in the balance of payments also
leads to an excess demand. The increasing exports also have an
inflationary impact because there is a generation of money income in the
home economy due to export earnings but, simultaneously, there is a
reduction in the domestic supply of goods because products are exported.
If an export surplus is not balanced by increased savings, or through
taxation, the domestic spending will be in excess of the value of domestic
output, marketed at current prices.
Diversification of Goods
A diversion of resources from consumption goods sector to either to the
capital-good sector or the military sector (for producing war goods) will
lead to an inflationary pressure because while the generation of income
and expenditure continues, the current flow of the real output decreases on
account of high gestation period involved in these sectors. Again, the
opportunity cost of war goods is quite high in terms of consumption goods
meant for the civilian sector. This leads to an excessive monetary demand
for the goods and services against their real supply, causing the prices to
move up. In short, it is said that the demand-pull inflation could be averted
through deflationary measures adopted by the monetary and fiscal

authorities. Thus, passive policies are responsible for the demand-pull NOTES
inflation.
Cost-push Inflation
A group of economists hold the opposite view that the process of inflation
is initiated not by an excess of general demand but by an increase in costs,
as factors of production try to increase their share of the total product by
raising their prices. Thus, it has been viewed that a rise in prices is initiated
by growing factor costs. Therefore, such a price rise is termed as “cost-
push” inflation as prices are being pushed up by the rising factor costs.
Cost-push inflation, or cost inflation, as it is sometimes called, is induced
by the wage-inflation process. It is believed that wages constitute nearly
70% of the total cost of production. This is especially true for a country
like India, where intensive techniques are commonly used. Thus, a rise in
wages leads to a rise in the total cost of production and a consequent rise
in the price level, because fundamentally, the prices are based on costs. It
has been said that a rise in wages causing a rise in prices may, in turn,
generate an inflationary spiral because an increase would motivate the
workers to demand higher wages. Indeed, any autonomous increase in
costs, such as a rise in the prices of imported components or an increase in
the indirect cost-push inflation may occur either due to wage-push or
profit-push. Cost-push analysis assumes monopoly elements either in the
labour market or in the product market. When there are monopolistic
labour organisations, prices may rise due to wage-push. And, when there
are monopolies in the product market, the monopolists maybe induced to
raise the prices in order to fetch high profits. Then, there is profit-push in
raising the prices.
However, the cost-push hypothesis rarely considers autonomous attempts
to increase profits, as an important inflationary element. Firstly, because
profits are generally a small fraction of the total price, a rise in profits
would have only a slight impact on the prices. Secondly, there hesitation to
raise price monopolists generally hesitate to raise prices in the absence of
obvious demand-pull elements. Finally, the motivation for profit-push is
weak since, at least in corporations, those who make the decision to raise
the prices are not the direct beneficiaries of the price increase.
Hence, cost-push is generally conceived as a synonymous one with wage
push. When wage are pushed up, the cost of production increases to a
considerable extent so that the prices may rise. Since wages are pushed up

NOTES by the demand for high wages by the labour unions, wage-push may be
equated with union-push.
5.6 CAUSES OF INFLATION

Inflation is a complex phenomenon which cannot be attributed to a single
factor. We may summarise the major causes of inflation as follows:
Over-expansion of Money Supply

Many a times, a remarkable degree of correlation between the increase in
money supply and the rise in the price level may be observed.
Expansion of Bank Credit

Rapid expansion of bank credit is also responsible for the inflationary
trend in a country.
Deficit Financing
The high doses of deficit financing, which may cause reckless spending,
may also contribute to the growth of the inflationary spiral in a country.
Ordinary Monetary Factors

Among other monetary factors, influencing the price trend in an economy,
the major ones are listed as follows:
1. High Non-development Expenditure: The continuous increase
in public expenditure and especially, the growth of defense and
non-development expenditure.
2. Huge Plan Investment: The huge plan investment and its high
rate of growth in every plan may lead to an excess demand in the
capital goods sector, so that the industrial prices may raise.
3. Black Money: Some economists have condemned black money,
which is in the hands of tax evaders and black marketers, as an
important source of inflation in a country. Black money
encourages lavish spending, which causes excess demand and a
rise in prices.
4. High Indirect Taxes: Incidence of high commodity taxation.
The prices tend to raise on account of high excise duties imposed
by the government on raw materials and essential goods.

Non-monetary Factors NOTES
There are various non-monetary and structural factors that may cause a
rising-price trend in a country. They are as follows:
1. High Population Growth: Undoubtedly, the rising pressure of
demand, resulting from growing population and money income,
will cause a high price rise in an over-populated country
2. Natural Calamities and Bad Weather Conditions: Vagaries of
monsoon, bad weather conditions, droughts, and failure of
agricultural crops have been responsible for the price spurts from
time to time, in many underdeveloped countries. Agricultural
prices are most sensitive to inflationary forces in India. Natural
calamities also contribute occasionally to the inflationary boost in
a country. Events such as cyclones and floods, which destroy
village economies also aggravate the inflationary pressure.
3. Speculation and Hoarding: Hoarding and speculative activities,
that is, corruption at every level in both private and public sectors
and so on, are also responsible to some extent for aggravating
inflation in a country.
4. High Prices of Imports: Inflation has also been inflicted on
some countries through the import content used by their
industries. The prices of petroleum products have been increased
in many countries due to price hikes by the oil-producing
countries.
5. Monopolies: Monopoly profits and unfair trade practices by big
industrial houses are also responsible for the price rise in
countries like India.
6. Underutilisation of Resources: Non-utilisation of installed
capacities in large industries is also a contributory factor to
inflation.
Ration in a country may be regarded as a symptom of a deep-seated
malady, born of structural deficiencies involved in the functioning of its
economic system, which is characterised by inherent weaknesses, wastages,
and imbalances.
Gaps and Bottlenecks

To understand the true nature of inflation in an underdeveloped country,
one has to examine the bottlenecks and gaps of various types, which
NOTES obstruct the normal growth process, causing prices to raise with the
generation of money income, without an appropriate rise in the real
income. These gaps and bottlenecks may be enlisted as follows: market
imperfections, capital bottleneck, entrepreneurial bottleneck, food
bottleneck, infrastructural bottleneck, foreign exchange bottleneck, and
resources gap.
5.7 EFFECTS OF INFLATION

Inflation has direct socio-economic consequences. As such, inflation has
been taken to be a serious social and economic problem. The US
Presidents Ford and Carter have considered inflation as “public enemy
number one”.
Economic Effects of Inflation

The effects of inflation on the economic system may be classified into
three kinds as follows: (1) effects on production, that is, changes in the
tempo of economic activity, (2) effects on income distribution, that is, re-
distribution of income and wealth, and (3) effects on consumption and
welfare.
Effects on Production
Keynes argues that a moderate rise in prices, that is, a mild inflation, or
creeping inflation, as it may be called, has a favourable effect on
production when there are unutilised or underemployed resources in
existence in an economy. The rising prices breed optimistic expectations
within the business community in view of increasing profit margins,
because the price level moves up at a faster rate than the cost of production.
Businessmen are induced to invest more, and as a result, employment,
output, and income increase.
The tempo of economic activity starts raising. But, there is a limit to it—
this limit is set by the employment ceiling. Once the full-employment
stage is reached in an economy, a further rise in prices will not stimulate
production, employment, and real income, due to physical limitations.
Thus, when the inflation has reached an advanced stage, its brighter
aspects disappear and the evil aspects manifest themselves. The disastrous
consequences of inflation on the economic system may be stated briefly as
follows:

1. Maladjustments: Inflation leads to maladjustments in production NOTES

and disrupts the working of the price system, which is ruinous to
the entire system.
2. Hindrance to Capital Accumulation: Capital accumulation is
hindered by uncontrolled inflation, and the savings potentiality of
the community also declines due to the diminish purchasing
power of money.
3. Speculation: Since excessive inflation disturbs all economic
relationships and leads to uncertainty, the skills and energies of
the business community are concentrated on speculate and on
making quick profits rather than on genuine productive activity,
as a result. In short speculation takes the place of production in
the economy.
4. Hoarding and Black Marketing: During inflation, when prices
are rapidly rising, the holding of larger stocks of goods becomes
very profitable. Hoarding is encouraged, which further decreases
the available supply of goods in relation to increasing monetary
demand. Eventually, the phenomena of black marketing and
spiralling inflation develop.
5. Distortion of Production Pattern: Inflation not only adversely
affects the volume of production but also changes its pattern.
Generally, resources are diverted from the production of essential
goods to those of non-essential because the rich people, whose
incomes increase mid rapidly, make their demand for luxury
goods felt in the market. Production of undesirable lines is,
therefore, stimulated and finally, results in the breakdown of the
economic system.
6. Creation of a Sellers Market: Inflation tends to create a sellers
market. As a result, sellers have a command on prices because of
the excessive demand in the market. Anything can be sold in such
a market. The sellers do not care for quality as their interest is in
high profits only.
7. Distortions in Resource Allocation: Inflation will turn away
resource allocation from longer term productive investments and
towards unproductive assets like housing, real estate inventories,
gold, and so on. Such a diversification of savings tends to inhibit
the full capacity to grow.

NOTES 8. Disincentive Effect due to Income-tax Bracket Creep: During

inflation, with the rise money income in of the individuals under
progressive income tax system, the effective tax rate will raise
(called “Income-tax Bracket Creep”). This may cause a
disincentive effect on willingness to work, save, and invest, thus,
discouraging the productive activity.
Distributional Effects
Inflation redistributes income because prices of all factors do not rise in
the same proportion. Since the effect of inflation on the income of
different classes of earners varies, there are serious social consequences.
During inflation, the distributive share accruing to the profiteers increase
more than that of wage earners or fixed-income earners, such as the rentier
class. All product traders, and speculators gain during an inflation because
of the windfall profits which has arisen price rise at a faster and a higher
rate than the cost of production; wages, interest, and rent not increase
rapidly, and are more or less fixed. Moreover, profits increase because
there is a log between the rise in the prices and the rise in the cost of
production. Businessmen always find the money value of their inventories
going up because the general price level raises. Usually, inflation enlarges
the money income in the hands of the flexible groups, and adversely
affects the people in the fixed-income groups, such as pensioners,
government employees, and salaried classes, such as teachers, clerks, and,
to some extent, labourers or wage earners. Among the wage earners or
labour class, those who are well organised are effected less than others.
The changes in the value of money also cause redistribution of wealth,
partly because during inflation, there is no uniform price rise as prices of
some types of goods alone change more than others and (b) debts are
expressed in terms of money. Inflation is a sort of hidden tax, steeply
regressive in effect. The redistribution of wealth due to inflation is a
burden on these groups of people who are least able to bear it. Let us study
the concrete effects of inflation on various economic groups as follows:
Effect on Groups
Debtors and Creditors: Generally, debtors gain and creditors lose during
an inflation. Gain accrues to a debtor because he repays loan at a time
when the purchasing power of money is slower than when it was borrowed.
The creditor, on the other hand, is a loser during inflation, since he
receives, in effect, less in goods and services than he would have received

in times of low prices. Thus, the borrowers who borrowed funds prior to NOTES
inflation stand to gain by inflation, and creditors who lent funds lose.
However, this does not mean that debtors always welcome inflation
because, usually, they are members of one another group of people who
are adversely affected by inflation.
Business Community: Inflation is welcomed by entrepreneurs and
businessmen as they stand to profit by raising prices. They find that the
value of the then inventories and stock of goods is rising in money terms.
They also find that prices are rising faster than the costs of production, so
that their profit margin is greatly enhanced. The business community,
therefore, gets super normal profits during the period of inflation, and
those profits continue to increase as long as the prices raise. However, the
producers of conventionally priced goods and services, such as electricity
and transport services, gain very little or not at all during inflation, because
the prices of their goods are fixed by convention or by law. When the
prices in general raise, the cost of production of these commodities or
services also raises but their price remains constant, giving the producer a
continuously decreasing margin of profit.
Fixed Income Groups: Inflation hits wage earners and salaried people
very hard. Although wage earners, by the grace of trade unions, can chase
the galloping prices, they seldom win the race. Since the wages do not
raise at the same rate and at the same time as the general price level, the
cost of living index raises, and the real income of the wage earner
decreases. Moreover, in trying to push up wages to sustain their real
income, wage earners bring about a cost-push inflation and, in the process,
worsen their position. Those who depend exclusively on fixed salaries for
a living are severely affected by inflation. Among these people are
teachers, clerks, government servants, pensioners, and persons living on
past savings. The salaried groups are further handicapped by the fact that
they are less organised than the labour class, to press for higher pay in
order to compensate for a fall in the real income.
Investors: Those who invest in debentures and fixed-interest bearing
securities, bonds, and so on, lose during inflation. However, the investors
in equities benefit because more dividend is yielded on account of high
profits made by the joint-stock companies during inflation.
Farmers: Farmers usually gain during an inflation, because they can get
better prices for their harvest during inflation.

NOTES We may conclude that inflation redistributes income and wealth in favour
of businessmen, debtors, and farmers but hits consumers, creditors, small
investors, labour class, middle class, and fixed-income groups very hard.
Inflation favours one group at the expense of another. Besides, it is always
regressive in effect, that is, it hits hard all those who cannot protect
themselves.
Effects on Consumption and Welfare

Inflation implies an erosion of the consumers value of money. It is a form
of taxation. Due to deteriorating purchasing power, the real consumption
of the common people declines. The rising cost of living during inflation
implies falling standard of living and lowering of general economic
welfare of the community at large. A galloping inflation is, therefore,
described as the “cruelest tax of all”. In short, inflation is unfair on the
distribution side of economic activity.
Inflation other effects may lead to many adverse consequences as follows:
Deterioration in Savings: A continuous inflation reduces the real worth
of savings in the long run. Savers are also adversely affected when the
annual rate of inflation is exceeding the current rate of interest. During an
inflation, the real rates of interest tend to decline capacity to save, due to
the rising cost of living and the consequent money expenditure caused by
the rising prices. Persistent inflation also discourages individual savings.
Distortion of the Budget and Vicious Circle: The budgetary provision
for public spending proves to be inadequate, due to the rising costs caused
by inflation. A vicious circle is developed. When deficit financing leads to
inflation, more deficit financing may be needed to fill the resource gap
occurring in public spending, which further pushes up the prices, causing
further deficit financing and further inflation and so on, and thus, a vicious
circle is developed.
Disturbance in the Planning: Plan programmes and allocation of
resources may be get disturbed due to resource constraints caused by a
continuous inflation and rising factor. The investment allocation based on
the current price level at the beginning of a particular, obviously proves to
be inadequate in the later years of the plan. Thus, a severe resource
constraint may be experienced in the fulfilment of the plan targets.
Lowering of International Competitiveness: If the rate of inflation in a
country is more than in other countries, its international competitiveness in
foreign market is weakened.

Distortion of the Exchange Rate: A high rate of inflation in a country, NOTES

when compared to the inflation rates in other countries, it would ultimately
lead to a decrease in the external value of; its currency, that is, lowering of
its exchange rate in terms of foreign currencies or key currencies such as
Dollar. Even a key currency like the Dollar has lost its real worth and
reputation due to the high inflation rate in the US economy.
Irrationality of Consumption: Inflation enhances money incomes of
many. This fosters “consumerism” resulting in distorted consumption
patterns. Consumerism spurts the trend to consider all goods as non-
durable. Due to expensive labour, repair gives way to replacement of
parts/products. Modern society is, thus, becoming a “junk” society in
which nothing is durable. People fanatically crave for new models and new
things, which is by the consumer credit given by the banks. Today’s
inflation-oriented prosperity is based on credit-induced consumption in
many countries. Thus, to stop, credit involves a great unemployment and
recession.
5.8 CONTROL OF INFLATION

Data Management
The price policy since 1973-74 has relied predominantly on fiscal and
monetary measures view to check the demand of the general public for
goods and services.
Fiscal Measures
Since 1990-91, the government of India has woken up to the importance of
reducing fiscal deficit. The budget of July 1991-92 took the first decisive
action to limit the fiscal deficit by bringing it down from 8.4% of GDP in
1990-91 to 6.2% in 1991-92 and 4.9% in 93. Since then, the government
has failed to reduce the fiscal deficit which has remained 7% of GDP till
date.
Monetary Measures
In general, the RBI uses its monetary policy to achieve a judicious balance
between the growth of production and control of the general price level. RBI
uses Bank Rate, CRR (Cash Reserve Ratio) SLR (Statutory Liquidity Ratio),
and Open-market Operations to increase bank credit and expenditure of
business activity (in times of business recession), or to contract bank credit
and business and speculative activity (in periods of inflation).
NOTES However, some economists, especially Alwyn Young have found that
there are no ‘special tricks’ used by these countries to achieve remarkably
high rates of growth in Per Capita Income. Instead, they have relied on
well-known factors determining growth, namely, using more labour input,
saving and investing more, and expanding education of work force and
thereby building more human capital. An important fact about
determinants of growth which is noteworthy is that the growth in Total
Factor Productivity (TFP) (by which technical progress is generally
measured) has been high but not remarkably high. It will be seen that all
these countries have remarkably high growth rates in GDP per capita but
their growth is explained by increased inputs (that is, by use of more
labour input, more human capital, i.e. increase in education and
correspondingly more physical capital) and not by much higher increase in
total factor productivity (TFP). It may be noted that change in total factor
productivity measures the change in output per unit increase in inputs and
represents technological progress. Although the change in total factor
productivity in these countries (except Singapore) is high but not
remarkably high and therefore, cannot explain remarkably high growth
rate in per capita GDP achieved by them. Total factor productivity growth
rate in Singapore is very small but still its growth in per capita GDP has
been very high (6.8% per annum).
It will be seen that in all these countries there has been a very large
increase labour force participation rate indicating use of more labour input
in the production of goods and services. It is noteworthy that much of this
increase in labour force participation rate has been due to more women
joining the labour force. Each of these countries substantially increased its
human capital. In fact education level of these countries reached close to
those of rich industrialised countries.
Another important feature of these East Asian countries is that they have
pursued outward-looking economic strategy i.e. promoting exports to
generate growth and followed laissez-faire free market policies with
emphasis on competition as driving force of growth with the exception of
Singapore where Government played a significant role in regulating and
controlling private enterprise and direction of investment. Moreover,
Singapore relied on foreign direct investment to bring in new technologies.
To sum up, in the history of economic development these Asian Tigers
countries have achieved extraordinary high growth rates, and that too with
the well-known way through using more labour input, more investment in
capital, both physical and human, and fostering competition. It is
reassuring to note that these former poor countries will soon catch up with NOTES
the developed industrialised countries in Per Capita Income level.
Singapore has already achieved Per Capita Income level of the rich
industrialised nations of the world. It is important to note that since 1991,
China and India too have registered a higher growth rate and have
become the two fastest growing economies of the world. India achieved
6.2% growth in GDP during 1992-2006 and further its annual growth rate
during three-year period, 2004-2007 rose to over 9% per annum. In 2009-
10 and 2010-11, India’s growth of GDP has been 8% and 8.6%
respectively. In fact India is now the second fastest growing country of the
world, next only to China.

There are obstacles that curtail normal growth process. Inflation at best can
be defined as sustained rise in prices. To some it is a monetary phenomena
and to others it is an employment problem. Inflation in India can be
examined by studying poverty and unemployment.
5.10 KEY TERMS

 Demand Pull: Rise in prices in response to over all demand over
the existing supply.
 Cost Push: Rise in prices is initiated by growing factor cost.
 Deficit Financing: High amount of deficit financing causes more
spending that leads to increased inflation.
 Hoarding: During inflation hoarding large stocks leads to profit.

1. Inflation occurs when level of prices ____________.
2. Scarcity in products is created by ____________.

NOTES (B) True or False

1. Rapid expansion of Bank credit is responsible for inflation.
2. High population growth will cause high price rise.
3. Economic growth is because of black money.

(A) 1. Prices, 2. Increase, 3. Hoarding.
(B) 1. True, 2. True, 3. False.

1. Explain the causes of inflation.
2. Explain the measures to control inflation.

1. Misra S.K. & V.K. Puri - ‘Indian Economy’ Mumbai
2. Avadhani VA : ‘Global Business’ HPH Mumbai


UNEMPLOYMENT AND
UNIT 6
EMPLOYMENT IN INDIA
Structure:
6.1 Introduction
6.2 Growth of Employment in India: A Case of Jobless Growth
6.4 Glossary
6.5 Key Terms
6.9 Reference Books
Objectives
 Know about the growth of employment in India.
 Different theories and laws such as ‘Supply creates its own
demand’.
 You will understand about employment in organised private
sector.
 Learn about labour intensive technology.
6.1 INTRODUCTION
The unemployment in countries like India is quite different. The main
cause of unemployment is deficiency of stock of physical capital with
which to employ large number of people. Other reasons like, lack of
infrastructure, i.e. telecommunications, roadways and power. This works
as obstacle for productive employment.
NOTES The unemployment in developing countries like India is of quite different

nature. The main cause of unemployment and underemployment
prevailing in the developing countries such as India is deficiency of the
stock of physical capital with which to employ the growing labour force.
Due to the lack of physical capital, it has not been possible to absorb the
growing labour force in productive employment. The result has been the
emergence of long-term or chronic unemployment.
Apart from the relative low rate of capital formation as compared to the
growth in labour force, the use of capital-intensive techniques in the
industries mostly imported from the Western developed countries is
another important factor causing unemployment in developing countries
like India. Besides, in agriculture, despite the existence of surplus labour
reckless mechanisation of various agricultural operations has reduced the
employment opportunities in agriculture. Another important reason of
rural unemployment prevailing in the developing countries like India is
extremely unequal distribution of land so that many agricultural
households have no adequate access to land for production and self-
employment in agriculture.
Lack of infrastructure such as roads, power, telecommunications,
highways, irrigation facilities in agriculture is also responsible for the
existence of huge unemployment in India. Inadequate availability of
infrastructure is a great obstacle for the generation of opportunities for
productive employment.
6.2 GROWTH OF EMPLOYMENT IN INDIA: A

CASE OF JOBLESS GROWTH
An important objective of planning in India has been to generate enough
employment opportunities not only to provide jobs to the backlog of
unemployed but also to the new annual additions to the labour force. The
new economic reforms initiated in India in 1991 visualised that
acceleration of economic growth would also lead to rapid growth of
employment opportunities. The total growth rate of employment (on usual
principal status) which was 2 per cent per annum in the period 1983-94,
fell to about 1.57 per cent annum during the post-reform period, 1993-94
to 1999-2000. However, it recorded a higher growth rate of 2.48 per cent
per annum in 1999-2000 to 2004-05. The organised sector employment
which grew 1.2 per cent per annum during 1983-94 recorded less than half
of that growth (0.44 per cent) during (1994-2000).
Page 96 of 316 Unit 6: Unemployment and Employment In India

Inflation Index: Rate of inflation decides the environment low rate NOTES
indicates stability, rate is measured as Wholesale Price Index or Consumer
Price Index. A high rate is considered anti-poor. Inflation redistributes
income and wealth in favour of the rich. Thus, it makes the rich richer and
the poor poorer. Above all, a high rate inflation adversely effects output
and encourages investment in unproductive channels such as purchase of
gold, silver, jewellery and real estate. Therefore, it adversely affects long-
run economic growth, especially in developing countries like India.
Inflation has therefore, been described ‘as enemy number one’.
Measurement of Rate of Inflation

Inflation has been one of the important problems facing the economies of
the world. Precisely stated, inflation is the rate of change of general price
level during a period of time. And the general price level in a period is the
result of inflation in the past. Through rate of inflation economists
measures the cost of living in an economy. Let us explain how rate of
inflation is measured. Suppose Pt–1 represents price level on 31st March
2006 and Pt represents the price level on 31 st March 2007. The the rate of
Pt  Pt 1
inflation in year 2006-07 will be equal to:  
Pt 1
Pt = 275
Pt–1 = 250
Substituting
Pt  Pt 1 275  250 25
   100  100  10% .
Pt 1 250 250
Rate of inflation will be 10%. This is called point to point inflation rate
But excess of aggregate demand over aggregate supply does not explain
persistent rise in prices, year after year. An important factor which feeds
inflation is wage-price spiral. Wage-price spiral operates as follows: A rise in
prices reduces the real consumption of the wage earners. They will, therefore,
press for higher money wages to compensate them for the higher cost of
living. Now, an increase in wages, if granted, will raise the prime cost of
production and, therefore, entrepreneurs will raise the prices of their products
to recover the increment in cost. This will add fuel to the inflationary fire. A
further rise in prices raises the cost of living still further and the workers ask
for still higher wages. In this way, wages and prices chase each other and the
process of inflationary rise in prices gathers momentum. If unchecked, this
Unit 6: Unemployment and Employment in India Page 97 of 316

NOTES may lead to hyper-inflation which signifies a state of affairs where wages and
prices chase each other at a very quick speed.
Cause of Inflation: Monetarist View. We have followed the Keynesian
explanation of demand-pull inflation. It is important to note that both the
original quantity theorists and the modern monetarists, prominent among
whom is Milton Friedman, explain inflation in terms of excess demand for
goods and services. But there is an important difference between the
monetarist view of demand-pull inflation and the Keynesian view of it.
Keynes explained inflation as arising out of real sector forces. In his model of
inflation excess demand comes into being as a result of autonomous increase
in expenditure on investment and consumption or increase in government
expenditure. That is, the increase in aggregate expenditure or demand occurs
independent of any increase in the supply of money. On the other hand,
monetarists explain the emergence of excess demand and the resultant rise in
prices on account of the increase in money supply in the economy. To quote
Milton Friedman, a Nobel Laureate in economics. “Inflation is always and
everywhere a monetary phenomenon and can be produced only by a more
rapid increase in the quantity of money than in output.”
Friedman holds that when money supply is increased in the economy, then
there emerges an excess supply of real money balances with the public
over their demand for money. This disturbs the monetary equilibrium. In
order to restore the equilibrium the public will reduce the money balances
by increasing expenditure on goods and services. Thus, according to
Friedman and other modern quantity theorists, the excess supply of real
monetary balances results in the increase in aggregate demand for goods
and services. If there is no proportionate increase in output, then extra
money supply leads to excess demand for goods and services. This causes
inflation or rise in prices. Thus, according to monetarists Prof. Milton
Friedman, excess creation of money supply is the main factor responsible
for inflation.
Cost-Push Factors. Even when there is no increase in aggregate demand,
prices may still rise. This may happen if the costs, particularly the wage
costs, increase. Now, as the level of employment increases, the demand for
workers rises progressively so that the bargaining position of the workers
is enhanced. To exploit this situation, they may ask for an increase in wage
rates which are not justifiable.
The Organised Sector: In the organised private sector, the growth in
employment was not sufficient to make up for the loss of jobs in the public

sector till 1999. As a result, there was a decline in employment in the NOTES
organised sector in 1999-2000 to 2004-05 despite a quite high growth of
output in it. The much lower growth of employment opportunities is due to
the fact that the employment elasticity of output growth in the organised
private sector has sharply declined in the recent years as a result of
increase in capital intensity. It means fewer people have been able to
participate in and benefit from the growth process in the private organised
sector in the post-reform period.
The Tenth Five Year Plan (2002-07) estimated that there was backlog of
35 million persons unemployed in the beginning of the 10th Plan in April
2002 and additional about 35 million persons were estimated to enter the
labour force during 2002-07. The Tenth Plan aimed at creating
employment for 50 million persons during the Five Year Plan period, 30
million jobs from the normal process of economic growth and additional
20 million from special employment schemes during the five years period
(2002-2007). The results of the 61st NSSO round shows that about 47
million persons were employed during 2000 to 2005. Note that since, as
mentioned above, there was no any growth in employment in the organised
sector, all 47 million new employment opportunities were created in the
unorganised sector.
It may, however, be noted that despite higher growth in employment in the
10th plan period (though in the unorganised sector), unemployment rate
on Usual Principal Status (UPS) basis was higher at 3.06 per cent of the
labour force in 2004-05 compared to 2.78 in 1999-2000. Besides, average
daily status unemployment rate also increased from 7.3% in 1999-2000 to
8.3 per cent in 1999-2000. According to Approach to the 11th plan,
worsening of unemployment situation is due to faster growth in labour
force. However, the fact that there was decline in increase in employment
in the organised sector despite of higher growth in GDP shows the utter
failure of the strategy of employment generation. Employment growth in
the organised sector (both public and private combined) increased during
the post-reform period 1994-2008 at the rate of only 0.05 per cent per
annum as against 1.20 per cent during 1983-94 (see Table).
Table: Rate of Growth of Employment in the Organised Sector
(per cent per annum)

1983-94 1994-2008
Public Sector 1.53 -0.65
Private Sector 0.44 1.75

NOTES Total Organised Sector 1.20 0.05

Source: Planning Commission and Directorate General of Employment and
Training (DGET).
This lower rate of growth of employment in the organised sector has been
there even in the post-reform period despite the fact that there has been
very high rate of growth of output, both in the organised industrial and
services sector. Obviously, this is bound to increase the problem of
unemployment in the country.
Employment Strategy to Reduce Unemployment

The following measures should be adopted if unemployment problem is to
be solved Use of Labour-Intensive Technology. Both the organised and
unorganised sectors must adopt labour-intensive technology if sufficient
employment opportunities are to be generated in both the rural and urban
sectors of the economy. The decline in employment elasticity of output
growth is primarily due to the increasing trend in capital intensity in the
organised industrial sector as well as in agriculture. Increasing
mechanisation of agriculture in various states has lowered the employment
elasticity of growth of agricultural output. Therefore, for raising labour
intensity, suitable monetary and fiscal measures need to be adopted to
discourage the use of capital-intensive techniques. Of course, the use of
labour-intensive techniques with lower productivity of workers in the
industry and agriculture may lower the growth of output. Thus, there might
the same trade off between employment and growth of output. In general
due to the seriousness of unemployment problem some output growth
should be sacrificed for the sake of more employment.
Accelerating Investment in Agriculture. Second, and important reason for
slow growth of employment in agriculture and rural sector has also been a
shortfall in investment or capital formation in agriculture. Both the public
and private sector investment in agriculture has declined since the early
nineties. Of special importance from the viewpoint of employment
generation investment in irrigation, rural roads, flood control projects,
power generation and other infrastructure. It is worth noting that
investment not only generates employment directly but also has a
multiplier effect which operates through backward and forward linkages.
Therefore, UPA government’s Common Minimum Programme (CMP)
which provides for stepping up of investment in agriculture and rural
infrastructures is a greatly welcome step for employment generation. The
announcement by the government to furnish more credit to farmers at

lower than market rates of interest from commercial banks will also NOTES
ensure that the small and medium farmers will be able to buy fertilizers,
and other high-yielding inputs, arrange for their irrigation. This will raise
their productivity and tend to reduce under-employment and disguised
unemployment. Despite more than five decades of planned industrial
development, agriculture continues to be principal source of employment
in the Indian economy. Though the share of GDP from agriculture has
come down to around 22 per cent, still about: 58 per cent of labour force
continues to be employed in agriculture. In fact, agriculture continues to be
parking lot of the unemployed in the country. But a good number of
persons engaged in agriculture and related activities are not productively
employment. In fact there is widespread under-employment and disguised
unemployed. Economic reforms initiated in 1991 have by and large
neglected agriculture which even now does not get enough credit from
commercial banks.
No wonder that there has been a fall in investment or capital formation in
agriculture both by the private and public sectors. This is an important
reason why employment opportunities in agriculture have not risen much
causing increase in rural unemployment.

In growing economy it is important to provide work opportunities to
people. It helps them to earn income and create purpose in life. Efficient
job opportunities can lead to development and reduce poverty.
6.4 GLOSSARY
 Inflation: A process in which the general price index (GPI)
records a sustained and appreciable increase over a period of time.
 Recession: It is a period when there is significant reduction in
employment and production, trade and investment.
6.5 KEY TERMS

 Unemployment: One is not gainfully employed in productive
activity.
 White collar unemployment: Due to lack of facilities there are
educated unemployed.

NOTES

1. Involuntary unemployment means people are ready to accept
work but do not get ____________.
2. White collar job hunting leads to scramble for ____________ jobs.
3. Poor person cannot make any gainful use of existing ____________.
4. Unless population problem is ____________ unemployment will
remain.
(B) True or False

1. Economic planning alone cannot solve the problem of unemployment.
2. Unemployment in India is structural unemployment.
3. Unemployment is a chronic problem and hence cannot be solved.

(a) 1. salary, 2. clerical, 3. resources, 4. controlled.
(b) 1. True, 2. True, 3. False

1. Explain the nature of unemployment in India?
2. How can economic reforms solve unemployment problems? Discuss.
3. Explain the causes of unemployment.
6.9 REFERENCE BOOKS

1. World Development Report of World Bank. 2003-04.
2. Jalan Bimal: ‘Indian Economy’ – ‘Penguin’, Delhi.
3. Bhattacharya B.: ‘Indian Economic Crisis’ – B.R. Publication,
Delhi.


Block II: Economic Reforms Industrial Policy
ECONOMIC REFORMS IN
UNIT 7
INDIA
Structure:
7.1 Introduction
7.2 Tax Reforms
7.4 Glossary
7.5 Key Terms
7.9 Reference Books
Objectives
 Understand the term ‘Fiscal reforms’ which implies correction in
government’s budgetary policy toward better system.
 Understand cutting of unproductive expenditure.
 Know about the fiscal reforms in India.
 Understand the primary objective of industrial policy to achieve
international competitiveness.
7.1 INTRODUCTION
The need for comprehensive fiscal reforms in India was apparent during
the late 1980s, as there was rapid deterioration in Government finances.
During this period, the expenditure of the Central Government rose much
faster than its revenue leading to a steep rise in the Centre’s fiscal deficit to
GDP ratio. For the States, given the restrictions on their capacity to borrow,
NOTES the increase in expenditure was relatively aligned to the corresponding rise
in revenue. Consequently, the rise in the fiscal deficit of States was
relatively less steep. The sharp increase in revenue deficit of the Central
Government and the emergence of such deficits in State finances were the
most worrisome developments in the fiscal scenario during the 1980s.
Reflecting these developments, there was a sharp increase in the
outstanding liabilities of both Central and State Governments as ratio to
GDP from 41.6 per cent and 16.7 per cent, respectively, in 1980-81 to 55.3
per cent and 19.4 per cent, respectively, in 1990-91. The growing size of
liabilities eventually generated a considerable debt-service burden.
During 1980, there was rapid deterioration in Government finances. This
required comprehensive fiscal reforms, as there were outstanding financial
liabilities both at centre and state. Various economic measures were
introduced.
Fiscal Reforms in India

While the move towards fiscal adjustment was discernible in the
pronouncements made as a part of long-term fiscal policy announced in
the mid – 1980s a comprehensive fiscal reform programme at the Central
Government level was initiated only at the beginning of the 1990s as part
of the economic adjustment programme initiated in 1991-92. On the other
hand, in the case of States, efforts towards fiscal adjustment began only in
the late 1990s. Fiscal reforms in the States were necessitated by:
 Growing fiscal imbalances
 Sluggishness in Central transfers resulting from falling tax to
GDP ratio.
 Introduction of reform-linked assistance as a part of Medium-
Term Fiscal Reform Programme on the basis of the
recommendation of the Eleventh Finance Commission and
 Adjustment programme undertaken in some of the States, which
was linked to borrowings from multilateral agencies.
Fiscal reforms at the Centre covered tax reforms, expenditure pruning,
restructuring of PSUs and better coordination between monetary and fiscal
policies.
Page 104 of 316 Unit 7: Economic Reforms in India

Reforms in 2001-02 NOTES
 Various economy measures introduced including downsizing

some of the departments.
 Excise duty structure was rationalised to a single rate of 16 per
cent CENVAT (Central Value Added Tax) in 2000-01. The
Budget for 2001-02 replaced earlier three special rates of 8 per
cent, 16 per cent and 24 per cent by a single rate of 16 per cent.
 Peak level of customs duty reduced from 38.5 per cent to 35 per
cent with abolition of surcharge on customs duty. Customs duty
reduced on specified textile machines, information technology,
telecommunications and entertainment industry.
 Goods imported by 100 per cent EOUs and units in FTZs and
SEZs exempted from antidumping and safeguard duties.
 All surcharges abolished on personal and corporate income tax
rates except the Gujarat earthquake surcharge of 2 per cent
leviable on all non-corporate and corporate assesses except
foreign companies.
 Weighted deduction of 150 per cent of expenditure on in-house
R&D extended to biotechnology.
 Five-year Tax holiday and 30 per cent deduction of profits for the
next five years extended to enterprises engaged in integrated
handling, transportation and storage of foodgrains.
 Incentive Fund created for incentivising fiscal reforms in states.
Expenditure Reform
We have noted that the impact of Government expenditure on aggregate
demand and supply varies with each type of expenditure. Table shows the
long-term trend in the financing of Government expenditure in India.
Table Financing of Government Expenditure (As per cent of GDP)
Year Total Tax Revenue Borrowings Other

Expend- Tax Non-tax Total Domestic Abr- Total Sources
iture oad
1990-91 17.3 7.6 2.1 9.7 4.1 0.7 4.8 2.0
1996-97 13.9 6.8 2.4 9.2 3.1 0.3 3.4 1.0
1997-98 14.2 6.3 2.5 00 5.1 0.1 5.6 -0.1
Unit 7: Economic Reforms in India Page 105 of 316

NOTES 1998-99 14.7 6.0 2.6 8.6 5.6 0.2 5.8 0.0
1999-00 15.4 6.6 2.8 9.4 5.7 0.1 5.8 0.0
2000-01 15.3 6.5 2.7 9.1 5.7 0.1 5.8 0.1
2001-02 16.4 7.1 3.0 10.1 5.7 0.1 5.8 0.0
Source: Economic Survey 2001-02.
Government action is needed in reducing expenditure under four major
heads of current spending. With respect to internal public debt, there is one
important mechanism that could substantially ameliorate the fiscal
situation. Privatisation of public enterprises could raise significant funds as
a per cent of GDP, which could be used to buy down the public debt. Not
only would the stock of debt itself be reduced, but also the interest costs of
servicing the debt would surely decline as the debt stock itself was brought
under control. Interest payments account for as high as 4.9 per cent of
GDP in 2001-02. The cash value of these enterprises vastly exceeds the
present value of profit flows that the state now collects on these assets.
Public sector profits are dissipated in poor productivity, over manning,
excessive public sector salaries, soft budget constraints, and generally poor
public-sector management. For this reason, sales of the enterprises to
private sector buyers, if used to buy down the public debt, would yield
annual saving in interest costs that far exceed the government revenues
that are claimed by virtue of state ownership of the assets.
Income Tax Policy

The share of income tax general as well as agricultural has not increased
rapidly over the years. In the early eighties about 2 million people paid
income tax. By 1990-91 it increased to only 6 million. The number of tax
payers has remained very low partly because of large-scale tax evasion and
partly because of a continuous hike in the tax exemption limit. There are
two criticisms against personal income tax: first, it acts as a disincentive to
earn income and produce output, and, second, high rates of taxation induce
evasion and generate black income. Both the criticisms are valid in view of
the marginal tax rates which have been very high.
7.2 TAX REFORMS

In formulating its recommendations the Tax Reforms Committee (1994)
headed by R.J. Chellaiah enunciated the following goals which formed the
blueprint for tax reforms:

(i) reduction of rates of all major taxes viz., customs, income tax, NOTES
and central excise;
(ii) widening of the bases of all taxes by removing or curtailing
exemptions and concessions, drastic simplifications of the laws
and procedures;
(iii) replacement of the existing taxes on domestic production and
trade by a Value Added Tax (VAT);
(iv) a thorough revamping and modernisation of the administration.
Progress of Financial Sector Reforms (till March 2000)
1. Banking Banking industry in India in 1990 consisted of just 70

Market players, 27 of these were in the public sector, 24 in
private and 21 are the foreign banks. Ten years later,
banking industry is vastly expanded with the number of
foreign banks nearly doubling and ten more new banks
in the private sector. Banking industry today is
intensively competitive.
2. Banking At the time of reforms, most of the products offered by
Products banks are plain vanilla. Massive expansion of products
and services took place in the last few years driven by
rapid advances in technology that has dramatic impact
on the delivery systems and ability to service a greater
number of products.
3. Regulation Regulation is much more refined now. While banks are
given greater operational freedom, the quality of
regulation has heightened with stringent norms
prescribed in respect of capital adequacy, classification
of assets, provisioning, valuation of investments etc.
Regulation is evolved broadly on the emerging
international developments which while promotes
deregulation and liberation at the same time prescribes
stringent rules governing business operations and market
developments.
4. Supervision Increase in the quality of on-site and off site surveillance
and supervision. A new Board for Supervision came into
being which undertakes comprehensive banking
supervision on the lines of international better practices.
5. Ownership While public sector continues to account for a major part
of the banking, greater inroads are made by the private
sector in the form of new banks allowed in the private
sector, entry of a large number of foreign banks, partial
divestment of the government equity in the public sector
banks, allowing the public sector to dilute government
NOTES equity up to 33 per cent, allowing foreign direct

investment in banking etc.
6. Prudential International better practices covering a wide range of
Norms banking operations and practices prescribed in the post
reforms and are being introduced gradually in a number
of areas.
7. Disclosure The balance sheet of banks today is vastly different from
Standards what was in the beginning of reforms. Every year
additional disclosures are being made in the bank
balance sheets providing greater amount of information
to market players and participants.
8. Governance A code of governance in banking is yet to be evolved
but the implementation of prudential norms and
adoption of banking standards particularly in respect of
transparency and disclosure has significant impact on
the quality of governance in Indian banking.
9. Market Share There are sizeable shifts in the market share of domestic
banking institutions; but there is no perceptible increase
in the share of foreign banks. For instance in the total
assets, the share of the public sector banks has declined
from 90 per cent in 1990-91 to 80 per cent in 1999-
2000, whereas that of the private sector shot up from
3.62 per cent to 12.56 per cent during this period. The
share, of foreign banks in assets which was 6.05 per cent
in 1990-91 increased to 8.08 per cent in 1992-93 but
later softened to 7.30 per cent in 1990-2000.
10. Capital The equity of banks made a massive jump from ` 3,071
crores in 1990-91 to ` 18,448 crores in 1999-2000. All
the bank segments such as the public sector, private
sector and foreign banks showed impressive rise in the
equity levels. Reserves also showed rapid rise in the post
reform period.
11.Deposits Total Deposits of banks showed a massive jump from
` 2,31,975 crores in 1990-91 to ` 9,00,307 crores in
1999-2000.
12. Credit Bank advances shot up from ` 1,43,961 crores in
1990-91 to ` 4,43,661 crores in 1999-2000.
13. Income Income increased manifold from ` 27,448 crores in
1990-91 to ` 1,15,855 crores in 1999-2000.
14. Profit Net Profit of the banking sector showed an impressive
jump from ` 640 crores in 1990-91 in 1999-2000.

15. Profitability Net Profits as a per cent of Working Funds showed a NOTES
sharp rise from 0.22 in 1990-91 to 0.66 in 1999-2000.
16. Productivity Business per employee registered a robust growth
from ` 40.38 lakhs in 1990-91 to ` 140.93 lakhs in
1999-2000.
17. Non-Interest Non-Interest Income as a per cent to total income
Income increased from 9.85 percent in 1990-91 to about 13.70
per cent in 1999-2000
18. New Business Post reforms period in Indian banking unleased a wide
range of new products and services. Driven by
technology a number of new generation products such
as electronic fund transfers, debit cards, smart cards,
electronic clearing service, farm and consumer credit
cards etc., are introduced. Retail banking received
greatest thrust in the post reform period. Deregulation
of the insurance sector is envisaged to lead to further
proliferation of the products.
19. Competition Competition intensified with a larger base of players
and non-banking financial institutions emerging
stronger in a liberalised and deregulated environment.
20. Consolidation Evidence of consolidation is found in the private
sector with the merger of HDFC Bank and Times
Banks, ICICI Bank and Bank of Madura, UTI Bank
and Global Trust Bank (yet to be finalised) etc. The
only exercise of consolidation of the public sector
banks was at the beginning of the reforms with merger
of New Bank of India with the Punjab National Bank.
The pace of consolidation is expected to intensify in
the process of second generation reforms.
21. Globalisation Indian banking is gearing up for absorbing the
challenges of global finance. Starting with
harmonisation of the operational norms and
procedures, endeavours are being made to enhance the
quality and content of the efficiency parameters, which
is essential to withstand the impact of global
competition. The ushering in of the second-generation
reforms is envisaged to strengthen the role and
performance of Indian banking in this regard.

During early days Indian economy faced the problems of poverty and lack
of job opportunities. Even after 50 years we were in a position of

NOTES disadvantage in world economy Economic reforms were therefore required.

This was done in order to achieve international competitiveness.
7.4 GLOSSARY
 Import: It means to bring goods into the country from abroad.
 CENVAT: Central Value Added Tax
7.5 KEY TERMS

 Money supply: Total volume of money circulating in the
economy.
 Monetary policy: It regulates the supply of money and cost.
 C.R.R: Cash reserve ratio. It is the amount of cash that Banks
have to maintain with the Reserve Bank of India.


1. Economic planning helped development of _________ in India.
2. Development of industries lead to development of _________.
3. Setting of new industrial units created _________ opportunistic.
(B) True or False

1. Salient features of Indian Economy is low per capita GDP.
2. Increasing trade deficit was neutralised by surplus created due to
service exports.
3. The main objectives of Export Import Policy is to earn money.

(a) 1. Industries, 2. Markets, 3. Job.
(b) 1. True, 2. True, 3. False.

NOTES
1. Discuss the policy of Fiscal reforms in India.
2. What are the main functions of the policy?
3. Explain the importance of reforms on growth.
7.9 REFERENCE BOOKS

1. Pates I.G.: Economic Reforms – ‘Macmillan’, Delhi.
2. Misra and Puri: Economic Environment of Business, HPH,
Mumbai.


ECONOMIC PLANNING IN
UNIT 8 INDIA AND NEW ECONOMIC
POLICY
Structure:
8.1 Introduction
8.2 Domain of Public Finance
8.3 Basic Concepts
8.4 The International Monetary Fund
8.5 Economic Reforms and Control of Inflation
8.6 Economic Reforms and Their Impact on Poverty
8.7 Economic Reforms and Employment
8.8 Economic Reforms and Foreign Investment
8.9 Economic Reforms and India’s External Debt
8.10 Economic Reforms and India’s Foreign Trade
8.11 Neglect of Agriculture — The Major Sin of Economic Reforms
8.13 Glossary
8.14 Key Terms
Objectives NOTES
After reading this chapter, you will be able to:

 Understand the basic issues related to fiscal reforms.
 Review India’s fiscal system.
 Discuss basic concepts of public finance.
8.1 INTRODUCTION
The term Fiscal reforms means corrections in government policies for
betterment. There are public finance theories that help making reforms.
These are terms to grasp such as fiscal deficit, GDP, Revenue Deficit,
Public debt etc. The term fiscal reform implies corrections in the
Government’s budgetary policies towards a more efficient fiscal system. In
most cases it begins with cutting unproductive expenditure so taxes and
Government borrowing may be reduced to a tolerable limit. It may also
require rationalisation of the tax structure.
8.2 DOMAIN OF PUBLIC FINANCE

C. Pigou began his classic volume, Public Finance with the following
passage:
“In every developed society there is some form of Government
organisation which may or may not represent the members of society
collectively but certainly has coercive authority over them individually.
Public finance is the study of the financial activities of governments and
public authorities. It is a part of the study of economics and is, therefore,
concerned with the allocation of scarce resources. Also, it is not merely a
matter of public economics, since both the public and the private sectors
operate in an integrated fashion. Public finance is specifically concerned
with the effect of the activities of the Government (and also of public
enterprises) on the allocation of resources.
Some basic propositions about public finance are as follows;
 Public finance is that branch of economics, which deals with the
expenditures and revenues of the public sector.
 The basic norms of public finance are universal.
Unit 8: Economic Planning in India and New Economic Policy Page 113 of 316
NOTES  Fiscal deficit measures the difference between Government

revenue and expenditure.
 Excessive fiscal deficit is harmful for the economy.
 Fiscal reform is needed to improve the efficiency of
governmental budgetary allocation of both revenue and
expenditure.
8.3 BASIC CONCEPTS

This section deals with some of the basic tools, which help us in
understanding the fiscal system of an economy better.
Fiscal Policy
To quote the Seventh Five Year Plan (1985-90), “through it (i.e. fiscal
policy) the Government creates, sustains the public economy consisting of
the provision of public services and public investment; at the same time it
is an instrument for reallocation of resources according to national
priorities, redistribution, promotion of private savings and investments,
and the maintenance of stability”
Major Functions of Fiscal Policy

There are three major functions of a fiscal policy:
(i) The allocation function of budget policy, that is, the provision for
social goods. It is a process by which the total resources are
divided between private and social goods and by which the mix
of social goods is chosen.
(ii) The distribution function of budget policy, that is distribution of
income and wealth in accordance with what society considers at
‘fair’ or ‘just’ distribution.
(iii) The stabilisation function of budget policy, that is maintaining
high employment, a reasonable degree of price stability and an
appropriate rate of economic growth, with due consideration of
its effects on trade and the Balance of Payments.
Theory of Social Goods
Social goods are goods which are required for the welfare of society as a
whole, but for which the market fails to provide a value. People are
generally ignorant of the value or utility of social goods. An individual
knows that once one piece of social goods say a road, is constructed, he
Page 114 of 316 Unit 8: Economic Planning in India and New Economic Policy
cannot be denied its use whether he paid for its construction or not. NOTES
Everyone assumes that others would pay for it. It is these failures of the
market (i.e. provision of social goods), which bring the role of the
government in focus for providing social goods for the welfare of the
public in general.
Table 8.1: Major and Subsidiary Objectives of Economic Policy
Policy Objectives
A. Static Efficiency (Short run)
1. Satisfaction of private consumption wants
2. Satisfaction of public wants*
3. Balance of payments equilibrium.
4. Price stability.
5. Removal of market imperfections.
B. Social Justice
6. Increased employment*
7. Reduced inter-personal income inequalities*
8. Reduced inter-regional income inequalities
C National Cohesion
9. Economic independence
10. Provisions of economic symbols of nationhood
D. Economic Development
11. High savings
12. Maximum capital inflows from the rest of the world
13. Structural change (modernisation)
14. Reduced population growth*
* denotes a subsidiary objective that tends to promote more than one
major objective.
Categories of Revenue for the Government

To finance any proposed expenditure and purchases or pay off public debt,
governments need revenues. These revenues may be derived from taxes,
charges for the use of public goods and services, or borrowings. Taxes and
charges are raised from the private sector without any obligation to pay
them back.
A good tax structure has the following requirements:
1. Tax burden must be equitably distributed among citizens. Each
should pay his or her fair share.
NOTES 2. Excessive tax burden (which may interfere with the economic
decisions in otherwise efficient markets) should be avoided.
3. The cost of administration and compliance should be kept at the
lowest possible level.
4. The tax structure should facilitate the objectives of fiscal policy
of stabilisation and growth.
5. Where tax policies are used to achieve other objectives such as
encourage investment in certain sectors of the economy,
interference with the equity of the system should be minimum.
Public Expenditure Structure and Growth

The size of public expenditure may be defined in relation to the National
Income Accounts, such as Gross National Product (GNP), National
Income (NY) and Personal Income (PY). Public expenditure has risen
tremendously all over the world, developed as well as developing
countries. The reasons are not far to seek. There has been increasing
political pressure for social justice and progress. Changing social
structures, attitudes and political forces are also behind the rising share of
transfers and redistribution oriented programmes.
Expenditure in absolute as well as relative terms i.e. as a ratio of GNP, has
indeed risen over the years. Defence and civil expenditures have both risen.
However, the composition of civilian expenditure has been undergoing
changes.
Depending on the stage of a country’s economic development, the
structure of capital formation requires more public investment.
Demographic and technological factors are also responsible for a changing
public expenditure share in GNP.
Fiscal Crisis
A fiscal crisis is generally related to the excessive growth of public
expenditure. However, the size of public expenditure is not the root cause
of a fiscal crisis, it is the manner of financing public expenditure that is
more important. A fiscal crisis basically means that the Government is
unable to finance its expenditure out of its income, either because it has
made commitments to supply public goods and services far beyond its
means, or because it is unable to make people pay for the public goods and
services either through taxation or through user cost.
Fiscal Deficit NOTES
A fiscal deficit is the excess of Government expenditure over its revenue.

A fiscal crisis may result from excessive fiscal deficits. There are different
perspectives of fiscal deficit, and each has different implications for the
economy. In the present literature on public finance and policy, the gross
fiscal deficit is given prominent importance, though this is not the best
concept of fiscal deficit.
Gross Fiscal Deficit (GFD)

This is the difference between Government revenue, including the total
borrowing by the Government from various sources (households, financial
and external), and expenditure. It is well known that Government
expenditure increases aggregate expenditure or demand by the famous
Keynesian multiplier effect. Government tax revenue, on the other hand,
reduces aggregate demand also by a multiplier effect. The values of these
two multipliers, however, need not be equal.
8.4 THE INTERNATIONAL MONETARY FUND

International Monetary Fund (IMF) Structural Adjustment Policy loans,
for instance, are tied to the reduction of gross fiscal deficit.
Revenue Deficit
Revenue deficit measures the difference between Government revenue
expenditure and tax and non-tax current revenues. It measures the extent to
which the Government borrows to finance its current expenditure. At this
stage it is useful to distinguish between Government revenue (or current
expenditure) and capital expenditure. When Government expenditure
affects only the current income of the economy, it is called revenue
expenditure. In contrast, capital expenditure affects not only the current
but also the future income of the economy. Defence expenditure has no
impact on the future income of the economy and therefore, is a perfect
example of revenue expenditure. On the other hand, public investment in
industry would generate future income and therefore, it would be classified
as capital expenditure.
NOTES Monetised Deficit

This measures the monetary expansion on account of the Government
budget.
It is also popularly called deficit financing. It is generally the most
regressive form of public borrowing.
Public Debt-concept and Measurement

All forms of fiscal deficit increase public debt. Public debt can be defined
in various ways. In the narrowest sense it can be defined as the debt of the
Government proper. A somewhat wider definition would be the debt of the
Government plus the debt of the core (departmental) public enterprises.
8.5 ECONOMIC REFORMS AND CONTROL OF

INFLATION
Government’s inflation record has been quite satisfactory. India’s inflation
in the past has been triggered by exogenous shocks such as droughts and
adverse terms of trade exchanges and more particularly import bill of oil.
But a more reliable index which measures the cost of living is the
Consumers Price Index (CPI). The CPI for agricultural labourers which is
the most pervasive index for our country has shown a rise by 15.4 per cent
and that of industrial workers by 12.9 per cent during 1995-96 the year for
which the Government claims to have brought inflation under control.
8.6 ECONOMIC REFORMS AND THEIR IMPACT

ON POVERTY
A recent study shows that rural poverty declined from 31.6% in 1993-94 to
28.8% in 1999-2000 and urban poverty declined only by 0.5% during
1993-2000. Differences among various studies on decline in poverty range
from the official 10% to 3% during the period 1993-2000.
8.7 ECONOMIC REFORMS AND EMPLOYMENT

According to the Report of the Planning Commission (2003) “Targeting
ten million employment opportunities per year in the Tenth Five Year
Plan”, unemployment rate in India has increased significantly since 1993-
94 and was above 7.3% in 1999-2000 compared to 6 per cent in 1993-94 NOTES
on current daily status basis.
The Report sums up the employment strategy for future as follows: to meet
the Plan’s employment goals is to encourage the use of labour intensive
and capital saving technology, in general and to rejuvenate the growth of
the unorganised sector in particular, which at present contributes 92 per
cent to the country’s employment and enjoys more than 10 times labour
intensity per unit of production, as compared to the organised sector.
Table: Growth of Employment: Usual Status and Current Daily Status
Industry Usual Status Current Daily Status

(% annum)
Principal and
Subsidiary
(% per annum)
1983 to 1983 to
1993-94 to 1993-94 to 1999-2000
1999-2000
Agriculture 1.51 -0.34 2.23 0.02
Mining & Quarrying 4.16 -2.85 3.68 -1.91
Manufacturing 2.14 2.05 2.26 2.58
Electricity, Gas and Water 4.50 -0.88 5.31 -3.55
Construction 5.32 7.09 4.18 5.21
Trade 3.57 5.04 3.80 5.72
Transport, Storage and 3.24 6.04 3.35 5.53
Communication
Financial Services 7.18 6.20 4.60 5.40
Community, Social and 2.90 0.55 3.85 -2.08
Personal Services
Total Employment 2.04 0.98 2.67 1.07
Source: Planning Commission (2001) for usual estimates and Planning
Commission (2002) for current daily estimates.
8.8 ECONOMIC REFORMS AND FOREIGN

INVESTMENT
One of the major achievements of the new economic reforms was that it
provided a big boost to the inflow of foreign investment. Since 1991
NOTES continuous efforts have been made to liberalise and simplify the norms and
procedures pertaining to FDI. It would be desirable to make an objective
analysis of the facts in this regard.
Economic Reforms Since 1991

During the year 2001-02, computers, electronics, electrical equipments
accounted for 34%, while services accounted for around 38% of total FDI
(excluding NRI investments). Although India took significant steps
towards inviting FDI in pursuance of its policy of emphasising non-debt
creating capital inflows during the reform period, the actual FDI inflows in
India remained low compared to the other emerging market economies.
India’s failure to attract FDIs significantly clearly underlines the need for
further reforms in this context.
Table: Foreign Investment Flows by Category
(in US $ million)
Item 2000-01 2001-02 April - December

(P) 2001-02 2002-03
1 2 3 4
A. Direct Investment 2339 3904 2712 2256
(a) Government (SIA/FIPB) 1456 2221 1581 925
(b) RBI 454 767 564 598
(c) NRI 67 35 33 —
(d) Acquisition of Shares 362 881 534 733
B. Portfolio Investment 2760 2021 1343 386
(a) GDRs/ADRs 831 477 477 537
(b) Ffls @ 1847 1505 827 -151
(c) Off-shore funds and others 39 39 —
Total (A+B) 5099 5925 4055 2642
Source: Report on Currency and Finance 2001-02.
8.9 ECONOMIC REFORMS AND INDIA’S

EXTERNAL DEBT
Data about the growth of India’s external debt from 1991 to 2002 — the
period of intensive economic reforms — show that India’s external debt
rose from US $ 83.8bn in 1991 to US $ 98.5bn in 2002, indicating a
growth rate of 11.5 per cent per annum. Prudent external debt management
is also reflected in the proportion of short-term debt to total debt declining
from 10.2% in 1991 to 2.8% in 2002 and the ratio of short-term debt to NOTES
foreign exchange reserves from a high of 146.5% in the crisis period of
1991 to only 5.1 per cent in 2001 - 2002.
Total: Foreign Technology Agreements and Foreign Direct Investment Approvals
Year No of FTAs No of FDI Amount Actual inflow FDI

approved approvals Approved (` in crore)
(` in crore)
1991 661 289 534 351
1992 828 692 3888 675
1993 691 785 8859 1787
1994 792 1062 14187 3289
1995 982 1355 32072 6820
1996 744 1559 36147 10389
1997 660 1665 54891 16425
1998 595 1191 30814 13340
1999 498 1726 28367 16868
2000 418 1726 37039 19342
2000* 339 1494 32631 13810
2001* 247 1590 23266 16127
Total ## 7116 13640 270064 # 105413 @
Notes:
# includes approvals for Euro Lssues {American Depository Receipts
(ADRs)/Global Depositor) Receipts (GDRs)/Foreign Currency
Convertible Bonds (FCCBs)}
## Totals may not tally because of rounding off on an annual basis @
Includes SIA/FIPB/RBI/RBIs NRI Schemes, acquisition of shares,
ADRs/GDRs/Pending issues of shares, etc.,
* January - October
NOTES
8.10 ECONOMIC REFORMS AND INDIA’S
FOREIGN TRADE
Rightly sensing the necessity for moral bilateral trade arrangements to
ward off any hick ups due to the WTO agreement, the BJP-lead coalition
went into Regional Trade agreements with Sri Lanka, Malaysia, ASEAN
countries and Singapore etc. The strategy demonstrated the negotiating
strength of India with its neighbourhood and the recognition that India is a
country to reckon within international trade.
8.11 NEGLECT OF AGRICULTURE — THE

MAJOR SIN OF ECONOMIC REFORMS
Indian Agriculture has come a long way since independence. Its
performance over the last fifty years has, however, revealed both its
strengths and weaknesses. While its main success story has been output
growth, particularly of food grains (a record production of over 200mt in
2001), this achievement has been counterbalanced by several other factors:
declining growth rates in productivity for major crops, slow expansion of
irrigated areas, falling public investment in agriculture, inadequate
extension services, extremely low investment allocations for agricultural
research, ineffective utilisation of land and water resources along with
degeneration of the natural resource base, the problems of dry land
agriculture which accounts for 89m.ha. (63% of Net).
Economic Reforms Since 1991

A: Selected Economic Indicators
90-91 91-92 92-93 93-94 94-95 95-96 Average

Annual
Growth
Rate
Gross Domestic 212.6 214.2 224.9 236.1 251.0 266.5 4.7
Product (1980-81 (0.9) (5.0) (4.5) (6.7) (6.3)
Prices)
Industrial 212.6 213.9 218.9 232.0 252.0 262.3 4.3
Production (Trie. (0.6) (2.3) (5.6) (8.6) (4.0)
1980-81=100)
Agricultural 148.8 145.5 151.5 156.9 164.1 163.9 2.0 NOTES

Production Index (-2.0) (4.1) (3.5) (4.5) (-0.2)
(1980-81 =100)
Foodgrains 143.7 137.6 144.3 150.2 155.3 154.4 1.4
Production Index (-4.2) (4.8) (4.1) (3.4) (-0.6)
(Trie.
1980-81=100)
Wholesale Price 182.7 207.8 228.7 247.8 274.7 289.7 10.3
Index Average of (13.7) (10.1) (8.8) (10.8) (8.7)
Weeks (1981-
82=100)
Primary Articles 185 218 235 251 283 307 10.6
(17.8) (7.8) (6.8) (12.7) (8.7)
Food Articles 201 241 271 284 313 342 11.2
(19.9) (12.4) (4.8) (10.2) (9.3)
Non-food articles 194 229 229 249 299 320 10.5
(18.0) (0.0) (8.7) (20.1) (7.0)
Fuel, Power Light 176 199 227 262 280 284 10.0
& Lubricants (13.1) (14.0) (15.4) (6.9) (1.4)
Manufactured 183 203 226 243 269 297 10.1
Products (10.9) (11.3) (7.5) (10.7) (10.4)
Index Numbers of Wholesale Prices (1993-94 = 100)

(Variation per cent) : point to point
1998- 1999- 2000- 2001- 2002-

99 2000 01 02 03
All Commodities 5.3 6.5 5.5 1.6 6.5
Primary Articles 7.6 4.0 1.5 3.9 6.1
Food Articles 9.3 7.1 -0.2 5.2 0.8
Non-Food Articles 2.7 -3.5 5.7 0.6 22.1
Fuel, Power, Light and 3.2 26.7 15.1 3.9 10.8
Lubricants
Manufactured Products 4.9 2.4 4.0 0.0 5.1
Food Products 9.2 -0.3 -3.1 0.3 8.7
Food Index 9.3 4.0 -1.3 3.3 3.9
NOTES
The fiscal policy changes has a considerable impact on the economy. The
main thrust of 1991 reforms were to ensure credit to assist industrial
growth. However, there were advantages as well as some shortcomings.
 The three major functions of a fiscal policy are; the allocation
function, the distribution function and the stabilisation function.
 The objectives of economic policy are complementary as well as
conflicting.
 Social goods are goods, which are consumed by all citizens and
increase the welfare society.
 The market fails to provide the economy with social goods. The
state must take up this activity.
 Taxes, charges and borrowings are the three major sources of
revenue for a government.
 A good tax structure satisfies the requirements of equity,
efficiency and low administrative costs.
 The benefit principle is an approach to tax equity according to
which each individual pays in proportion to the benefits he/she
receives from the social goods in question. This principle is not
practicable (except in certain special cases).
 The ability-to-pay approach requires tax payers to pay according
to their economic capacity.
 The ability to pay principle requires the tax burden to be in
proportion to horizontal and vertical equity.
 Vertical equity can be measured in terms of the equal sacrifice
principle.
 Tax incidence refers to the distributional effects of the tax burden.
 Tax incidence has effects on the uses as well as sources.
 Public expenditure in all economies has exhibited an upward
trend.
 A fiscal crisis results from excessive fiscal deficits.
 Public debt is debt of the Government proper and the debt of
departmental public enterprises.
 It is internal as well as external in nature, the latter being a more NOTES

serious problem.
8.13 GLOSSARY
 Monetised deficit: This measures the monetary expansion on
account of the government budget, also known as deficit
financing.
 Public debt: Debt of the government.
 Capital asset: Property of any kind held by an assessee
connected with business.
8.14 KEY TERMS

 Monetary Supply: Supply of money in the economy.
 Stock Market: Place to trade shares and stocks.
 Bank Rate is the rate at which Reserve Bank of India provides
credit to the schedule Banks.

1. The reforms failed to solve the problems of ______and _______.
2. The reforms failed to maintain stability in ________.
3. Internal debt is the amount of Loan raised by the government
within the_________.
(B) True or False

1. The economic reforms suggested reduction in Bank Rate.
2. The reforms had considerable impact in the economy.
3. Reforms induced development of Production.
NOTES
(A) 1. unemployment and poverty, 2. prices, 3. country.
(B) 1. True, 2. True, 3. True.

1. Explain the meaning of monetary policy.
2. What are the objectives of the monetary policy.
3. Why reforms in the economic policy were necessary?
4. Explain the merits of fiscal policy.

1. Misra S.K: ‘Indian Economy’, ‘H P H’, Mumbai.
2. Paul H.: “Economic way by thinking”, Pearson, Delhi.

INDUSTRIAL POLICY AND
UNIT 9
INDUSTRY LICENSING
Structure:
9.1 Introduction
9.2 Foreign Investment Promotion Board (FIPB)
9.3 Project implementation
9.4 Impact of Industrial Policy 1991
9.5 Government – Machinery for Indian Industrial Economy
9.6 Overview of new Industrial Policy of 1991 in India
9.7 New Industrial Policy of 1991
9.9 Glossary
9.10 Key Terms
Objectives
 Understand Industrial policy 1991
 Know the requirement for international competitiveness
 Understand the scope of private sector
 You will know the importance of different types of reforms.
NOTES
9.1 INTRODUCTION
Foreign Investment Promotion Board (FIPB) was set up with the purpose
of speeding up the approval process for foreign investment. Its approach is
liberal for all sectors and all types of proposals. Automatic approval for
technological agreement has been made possible in high priority industries.
This is done under Foreign Trade Agreement (F.T.A). There are various
approvals necessary to set up an industrial unit.
9.2 FOREIGN INVESTMENT PROMOTION

BOARD (FIPB)
Objective
FIPB is set up with the purpose of speeding up the approval process for
proposals relating to foreign investment in India.
Composition
FIPB was initially headed by Principal Secretary to the Prime Minister and
the members comprised, the Finance Secretary, the Commerce Secretary
and the Secretary of Industrial Development. Secretaries of the ministries
concerned with the specific investment proposals were also invited.
Application Procedure
No special application form is needed for applying to FIPB. Proposals can
be sent directly or through any India’s diplomatic missions abroad.
Scope and Methods

FIPB has the flexibility to examine all proposals in totality, free from
predetermined parameters or procedures. Its approach is liberal for all
sectors and all types of proposals. A large number of proposals cleared till
date by FIPB involved 100 per cent equity participation by the foreign
investor. FIPB clearance for foreign investment proposals is based on the
investment proposed, the technology to be inducted, the export potential or
the import substitution factors, the foreign exchange balance sheet and the
employment potential. The totality of the package proposed is examined
and approved on merits.
Page 128 of 316 Unit 9: Industrial Policy and Industry Licensing

Foreign Trade Agreements (FTA) NOTES
To inject the desired level of technological dynamism, automatic approval

for technology agreement has been made possible in high priority
industries. R.B.I. accords automatic approval to foreign technology
agreements within prescribed monetary limits:
 Lump sum payment up to ` 10 million.
 Royalty payments up to 5 per cent of domestic sales and 8 per
cent of exports over a period of 10 years from the date of the
agreement or over a period of 7 years from the date of
commencement of production.
 These payments are subject to an overall ceiling of 8 per cent of
total sales over a period of 10 years from the date of agreement of
commencement cf commercial production.
The prescribed rates are net of Indian taxes.
Repatriation of Capital
Foreign capital invested in India is allowed to be repatriated with capital
appreciation, if any, after the payment of taxes due to them. The
disinvestment is permitted in accordance with terms of the letters of
approval granted at the time of approving the foreign collaboration.
Repatriation of Sale Proceeds

Repatriation of sale proceeds of assets held in India is allowed with prior
RBI approvals subject to the payment of applicable taxes.
Indian companies that enter into agreements with foreign companies are
permitted to remit payments towards know-how and royalty in terms of the
foreign collaboration agreement approved.
Technical Service Fees

Companies can hire the services of foreign technicians, and make
remittances for technical services fees, subject to the terms approved by
RBI. On the whole, IP 1991, introduced radical changes in India’s foreign
investment policy. As a result, the entry of foreign enterprises into the
Indian market has been made much easier. Thus, Indian industry has been
exposed not only to domestic competition but to foreign competition as
well. This is likely to exert more pressure on domestic industrial units to
raise quality as well as productivity. The liberalised foreign investment
Unit 9: Industrial Policy and Industry Licensing Page 129 of 316

NOTES policy is aimed at augmenting foreign investment inflow and bridge the
technology gaps between Indian industry and that of the international. The
liberalisation with respect to industrial licensing and foreign investment
has made implementation of a project far easier.
9.3 PROJECT IMPLEMENTATION

The implementation of a project in India, whether domestic investor or
foreign investor (after obtaining approvals for investing in India) has to
undergo the same regulations.
Incorporating a Company in India

Companies incorporated in India and branches of foreign enterprises are
regulated by the Companies Act, 1956. The name of the company can be
registered and the company incorporated as a private or a public limited
company with the Registrar of Companies (R.O.C). A certificate of
commencement of business is obtained from ROC on the fulfilment of
certain conditions.
Industrial Licence/Industrial Entrepreneurs

If an Industry, in which investment is sought, comes under the purview of
licensing, an application has to be submitted for an industrial licence. A
foreign investor can submit such an application along with the foreign
investment proposal. In such cases, they are considered in a composite
manner by the FIPB and a composite approval is granted.
In the case of delicenced industries, companies are required to file an
Industrial Entrepreneurs Memoranda with the Secretariat of Industrial
Approvals and another memorandum at the commencement of commercial
production.
Raising Finances in India

Investors can raise a substantial portion of funds in India through debt and
equity instruments. Long term loans can be obtained from state and
national financial institutions and working capital from commercial banks
or through instruments such as participation certificates, commercial paper,
fixed deposits etc. Investors can also raise finances through capital markets
through shares and debentures.

Starting Operations NOTES
There are various approvals necessary from different authorities to set up

an industrial unit. Legislative provisions differ from state to state.
However, they are similar in relation to fundamental aspects.
Clearances Required
(A) Clearances required by all Industrial units
Land for Project
Allotment of plot/shed in Industrial estate
Allotment of Government land Notified Authority Permission.
Construction of Building
Plan approval in Industrial Estate Plan approval in other area.
Water Requirement in Industrial Estate River/Public sendee.
Power Requirement
(B) Other Clearances — Environmental Clearance
No objection Certificate applicable to polluting industries like,
chemicals, pharmaceuticals etc.
Site Clearance Certificate
Applicable to 22 highly polluting Industries.
Incentives
Investment subsidy for industrial units coming up in the
backward areas of the state Sales tax exemption/eligibility
certificate.
Clearance for Specific Projects

Pharmaceuticals and Cosmetics Project
Permission under Boilers Act

Permission to be obtained for installation of boiler to meet safety
requirements.
Mining
Permission for extraction of minerals: Permission to be obtained for lease
and setting up mineral based industry.

NOTES Port location

Permission to locate a project near the seashore
(c) Clearance before going into production Registration as
Factory
Under the Factories Act, for the safety of the workmen.
Sales Tax Registration
Authority
State Industrial Development Corporation (SIDC)
District Collector or District Development Authority
Local authority SIDC
Department of Water Resources State Electricity Board
State Pollution Control Board
Office of the Industries Commissioner (IC)
District Industries Centre (DIC)
Food and Drugs Control Administration
Chief Inspector of Steam Boilers
Director, Geology & Mining
Port Department/State Maritime Board
Chief Inspector of Factories
Sales Tax Officer with obtaining conditions of competition with free entry.
In order to improve competition, and thus contain the distortions caused by
monopoly power, the Competition Act, 2002 has been enacted in
December, 2002. It is a landmark legislation that aims at promoting
competition through prohibition of anti-competitive practices, abuse of
dominance and through regulation of companies beyond a particular size.
This Act has replaced MRTP Act.
9.4 IMPACT OF INDUSTRIAL POLICY 1991

The all-round changes introduced in the industrial policy framework have
given a new direction to the future industrialisation of the country. The
industrial reforms resulted out of the Industrial policy 1991 have already
led to encouraging trends on diverse fronts. Industrial growth, which

decelerated in 1991-92 due to measures like high interest rate, import NOTES
compression and credit squeeze, has been picking up from year to year.
Industrial growth was 1.7 per cent in 1991-92, 4.4 per cent in 1992-93,
4.3 per cent in 1993-94, 8.6 per cent in 1994-95, and 11.7 per cent in
1995-96.
A convincing impact of industrial reforms is reflected in multiple increase
in investment envisaged, both domestic and foreign. Project investment
plans have more than doubled during 1990-93. This is due to encouraging
response from the private sector. As a result, the ownership pattern of
investment projects is undergoing a transformation.
Investments in power generation in power sector surged from players of
various sizes in different states depending on the environment created by
the respective states through the well-drafted power purchase agreements
and the pricing mechanisms.
Net inflow of FDI, which was just $133 million in 1991-92 has increased
to $5025 million in 1997-98.
Table 9.1: Foreign Direct Investment
(in US $ million)
1991- 1992- 1993- 1994- 1995- 1996- 1997- 1998-

92 93 94 95 96 97 98 99
Direct 129 315 586 1314 2133 2696 3197 1562
investment
Portfolio 4 224 3567 3824 2748 3312 1828 -682
investment
Total foreign 133 559 4153 5138 4881 6008 5025 880
investment
An interesting feature of foreign investment inflow is that it has flowed
into different segments of industry such as:
(a) basic goods industries comprising of aluminium, cement,
chemicals, fertilizers, metallurgy, power generation etc.
(b) capital goods industries comprising of engineering, telecom,
machine tools, computer hardware, textiles machinery, etc.
(c) intermediate goods industries consisting of paper and paper pulp,
petrochemicals, plastics, refineries, rubber, glass, industrial gas,
electrodes etc.

NOTES (d) consumer goods industries which include, among others,

detergents, domestic appliances, electronics, food processing,
textiles, pharmaceuticals, etc.
(e) automobiles, consisting of auto ancillaries, automobiles, tyres and
tubes.
The total inflow of FDI during July, 1991 to March 1996 amounted to
more than ` 10,000 crores (Table). Of these, more than 50 per cent is
accounted for by basic goods, capital goods, automobiles and intermediate
goods industries. Such an investment pattern will have a far reaching
impact in further diversifying the industrial structure of the country for
accelerated industrialisation. Another noteworthy feature is that India has
attracted most of the prominent Multi National Corporations (MNCs) from
all over the world. Some of the MNCs which have entered in 90s are
General Electric, Kellogs, McDonalds, Daewoo, Dupont, Electrolux,
Daimle-Benz, Marubeni, Seagram, among others. As a result the image of
India as the investment destination for foreign investors is likely to get a
further boost.
Table 9.2: Total inflow of FDI
Sector ` Crores % to Total

Basic goods 125.24 12.3
Capital goods 1,928.21 19.2
Intermediate goods 1,248.48 12.5
Consumer goods 2,549.31 25.4
Service Sector 2,111.33 21.1
Automobiles 711.06 7.1
Miscellaneous 244.95 2.4
Total 10,028.58 100.00
9.5 GOVERNMENT – MACHINERY FOR INDIAN

INDUSTRIAL ECONOMY
Form the standpoint of having an idea about the non-market institutional
environment within which Indian industry and business operates, we may
refer here to a few selected organisational set ups.

The Ministry of Industry NOTES
The Ministry of Industry was constituted on August 24, 1976. It comprises

of two Departments:
(i) Department of Industrial Development
(ii) Department of Heavy Industry/Public Sector Undertakings.
The Department of Industrial Development is the primary Government
agency for the formulation and implementation of Government’s industrial
policy including the promotion and Industrialisation of the country in
accordance with the Government’s industrial policy, the national priorities
and the objectives the five-year plans. The Department reviews from time
to time the measures which are needed for the promotion of
industrialisation including balanced regional development, promotion of
small-scale. Village and rural industries as also for securing higher
employment generation and maximising production. One of the
instruments employed for securing these objectives is industrial licensing
which stems the Industries (Development and Regulation Act, 1951) and
the rules made hereunder. The Act and the rules are also administered by
this Departments. A number of promotional regulatory, technical and
advisory functions are also discharged by this Department.
The principal functional division/desks in the Department is also
administering certain industries as allocated to it under the Allocation of
Business Rules of the Government of India.
The principal functional divisions/desks in the Department of Industrial
Development are:
 Secretariat for Industrial Approvals
 Policy Desk for the Formulation and Implementation of Industrial
and Licensing Policies
 Industries Division
 Finance Division
 Administration and General Division
Let us describe each of them separately
 The Secretariat for Industrial Approvals is functioning as an
unified agency for processing applications for (a) industrial
licenses, (b) foreign collaboration, and (c) import of capital

NOTES goods. This division is also an Entrepreneurial Assistance Unit

for assisting entrepreneurs and for redressal of public grievances.
 The Policy Desk for Formulation and Implementation of
Industrial and Licensing Policy oversees, the effect of the policy
measures taken from time to time and formulates the changes that
may be called for in the licensing policy, procedures for industrial
approvals, protective measures needed for the small-scale sector,
reduction of disparities in regional development, promoting of
investment in the desired channels, etc.
 The Industries Division is concerned with promotion of industrial
growth in the large, medium and small scale sectors for industrial
productivity and industrial management. Besides, it deals with
certain industries specifically allocated to the Department.
 The Finance Division is headed by a Financial Advisor of the
status of additional secretary and handle work relating to budget
and accounts, financial advice, methods and work measurement
studies, etc. This division also conducts internal audit to ensure
both accuracy in accounts and efficiency in operation.
 The Administration and General Division deals with personnel
and establishment functions and allied matters such as Career
Management and Training, Vigilance, Security, Welfare, etc.
The Department of Heavy Industry or what is now called the Department
of Public Sector Undertakings is exclusively concerned with basic and
capital goods industries. One of the important activities of the Department
relates to coordination with other ministries and agencies responsible for
the growth of the infrastructure or of producer goods industries. An
important piece of our Government’s control mechanism is the CG
(Capital Goods) clearance effected through this department.
There are other developmental and promotional organisations under the
Ministry of Industry. The organisational set up and functions of some of
these units are on follows.
The Directorate-General of Technical Development (DGTD)

The Directorate-General of Technical Development (DGTD) is the
technical advisory organisation in the industrial field to various
ministers/departments of the Government. It gives technical advice on
matters relating to industrial technology and licensing, foreign
collaboration, capital goods requirements, import and export policy, tariff
structure and other related matters in respect of most of the industries NOTES
excepting iron and steel, textiles, jute, sugar and vanaspati.
The organisation has two functional wings — Engineering and non-
Engineering including Chemicals. Each wing has two Deputy Directors —
Generals and a number of Industrial Advisers who look after different
industries disciplines.
Regional offices of the DGTD have been established at Chennai and
Kolkata. These offices render technical assistance to entrepreneurs and
advise the Joint Chief Controller of Imports and Exports, the Department
of Customs and other organisations regarding import of capital goods up to
the value of ` 20 lakhs. In conjunction with the state directorates of
industries, they also provide information to the headquarters on the
progress of various schemes and provide feedback information on
technology, quality upgradation, standardisation and development of
ancillaries.
The Technology Information Centre in the DGTD collects data on
technology, R&D and consultancy. Such data are utilised in processing
proposals for foreign collaboration, entrepreneurial guidance, choice of
technologies, etc.
The Technology Development Division of the DGTD acts as the
secretariat for the Technical Evaluation Committee for examining all
proposals for foreign collaboration and technical consultancy services, etc.
In order to take an objective view of foreign collaboration proposals from
the angle of availability of indigenous know-how, and the feasibility for
horizontal transfer or indigenous technology.
The Office of the Economic Adviser

It is an attached office under the Department of Industrial Development in
the Ministry of Industry. It assists in the formulation of Industrial and
Import policies and renders advice and assistance on allocation of foreign
exchange for the import of raw materials and other maintenance inputs.
The office of the economic Adviser deals with macro-aggregates such as
industrial production and trends in industrial growth and capacity
utilisation. The office prepares monthly review of industrial production
and examines and monitors trends in industrial production and capacity
utilisation.
Relevant issues concerning industrial finance and resource availability and
mobilisation with reference to plan targets for the industrial sector are delt
NOTES by this office. Matters pertaining to credit policy, credit planning and
availability with reference to the industrial sector and specific industries
are examined in this office. Fiscal proposals in general and duty levies in
particular are examined, keeping in view the need for stimulating
investment and industrial production in the context of overall economic
development.
This office complies and publishes the official Wholesale Price Index in
India and also reviews trends in wholesale prices periodically. It brings out
weekly and monthly indices of wholesale prices, a quarterly Bulletin of
Industrial Statistics and a monthly Economic Review.
Additionally this office collects compiles and analyses information on
employment of Indians and non-Indians in companies with foreign
majority shareholding and of non-Indians in public and private sector
companies in India. Finally, the office prepares from time to time
analytical notes on different aspects pertaining to the Industrial sector.
Bureau of Industrial Costs and Prices (BICP)

In pursuance of a recommendation made by the Administrative Reforms
Commission, the Government of India established in 1970 the Bureau of
Industrial Costs and Prices (BICP). It is an attached office under the
Department of Industrial Development. It advices the Government on a
continuing basis on various aspects of the price structure in relation to
industrial costs, cost reduction and productivity.
The Directorate General of Industrial Contingency

The Directorate General of Industrial Contingency (DIGC) was established
in December 1976 so that industrial production in the country does not
suffer on account of strikes, threats of strikes, lay-offs and lock-outs, etc.
Contingency plans are drawn up on the advice of this directorate in public
sector and important private sector undertakings and the Director-General
of Industrial Contingency ensures effective implementation of these plans.
The Directorate keeps a close watch on the labour situation to repent any
interruption in production by getting the genuine grievances of the workers
redressed by the management initiative. It helps provide effective
assistance from state, civil and police administrations, so also from the
Labour Department for the implementation of the contingency plans.

Directorate-General of Supplies and Disposals (DGS &D) NOTES
India’s huge government machinery is a potentially important and of

growing customer. The DGS & D is the Government’s central purchasing
organisation. It buys all kinds of products from brooms to heavy
machinery on behalf of all Central Government ministries and agencies.
State, local, quasi-public, statutory, and public sector may also use DGS D,
if they so wish.
Certain products (e.g., food, leather goods, coal and wooden furniture) fall
outside the scope of DGS&D, and several Government or quasi-
government bodies (e.g. Air India, Indian Airlines, and the Oil and Natural
Gas Corporation do their own buying.
The DGS & D uses the following four basic contract types:
1. Fixed quantity contracts, usually termed “Acceptance to Tender”,
call for the firm to supply a specific quantity of items at agreed-
upon prices and delivery schedule.
2. Rate contracts set specific rates and contract period but do not
mention quantities. The contractor is bound to fill any order
placed during the contract period.
3. Running contracts set quantity, price and a fixed term of usually a
year, but the ordered quantity may vary usually by 25 per cent of
the contracted quantity. Some contracts include price variation
clauses.
4. Price agreements specify prices for monthly rate of supply and
serve as a standing offer to the purchaser.
Development Commissioner (Small-Scale Industries)

This is an office attached to the Ministry of Industry. It is the nodal agency
to coordinate the policies and programmes for the development of small-
scale industries. It provides a wide range of facilities and services
including consultancy in the techno-managerial aspects to small units
through the network of Small Industries Service Institution (SISI),
Production Centres, Testing Centres, Product-cum-Process Development
Centres, etc.
The Ministry of Civil Supplies

The current strategy of industrial development in India is to place heavy
emphasis on heavy industry and at the same time to ensure large-scale

NOTES production (or distribution) of mass-consumption goods. Production is

conducted by the availability of required inputs, and form this point of
view, the purchase function is important. We have already referred to the
role of the purchasing organisation which functions under the above
ministry, i.e., DGS & D.
The Ministry of Commerce

Here is another Government organ affecting the politico-economic
environment of business indicia. The ministry is vested with the task of
formulating and guiding India’s trade policy. The ministry consists of the
Department of Commerce and the Department of Textiles.
The Department of Commerce is the primary Government agency
responsible for India’s foreign trade introducing commercial relations with
other countries state trading, trade promotional measures, and regulation of
certain export-oriented industries and commodities.
The functional division of the department of Commerce are:
(i) Administrative and General Division;
(ii) Finance Division;
(iii) Economic Division;
(iv) Trade Policy Division;
(v) Foreign Trade Territorial Division;
(vi) Export products Division;
(vii) Export Industries Division;
(viii) Export Services Division, and
(ix) Vigilance Division
There are a number of autonomous bodies under the Department, like
Commodity Boards, Export Promotion Council’s Export Inspect Council,
Trade Development Authority, Trade Fair Authority, etc.
A number of public sector undertakings are functioning under the direct
administrative control of the department like the State Trading Corporation
(STC), the Minerals and Metals Trading Corporation (MMTC), the Project
and Equipment Corporation, The Export Credit and Guarantee Corporation,
etc.
Some of the attached and subordinate offices under the Department are:
(i) Office cf the Chief Controller of Imports and Exports, (ii) Directorate
General of Commercial Intelligence and Statistics, (iii) Development NOTES

Commissioner, Kendal Free Trade Zone, etc.
 Factory Legislations.
 Social Security Enactments.
 Laws for Consumers’ Protection.
This list is not exhaustive, it is just illustrative. There are many more
legislations which are important from the standpoint of business and
industry in India.
9.6 OVERVIEW OF NEW INDUSTRIAL POLICY

OF 1991 IN INDIA
Introduction
In India as early as the First Five Year Plan the economic policy adopted
was that the State must not only assume the responsibility for providing
the infrastructure facilities, but also undertake direct production work. The
need for the intervention of the state in the industrial field was recognised
and the development of basic and strategic industries was earmarked for
the public sector. At the same time, policy of nationalisation of the private
sector was given up; as it was clear that the task before the country was so
large that the initiative of both public private sectors was necessary to
secure maximum growth. A complementary role was assigned to the
private sector and a large field of operation was left open for private sector
activities. The concept of mixed economy was evolved, envisaging the
operation of both public and private sectors with an expanding role to the
former. Over a greater part of the activities including not only the
organised industries but also agriculture, small-scale industries, trade and
construction, individual effort and private initiative were regarded as
necessary and desirable.
Industrial Policy Resolution 1956

The concept of mixed economy was given a concrete shape and policy
direction at the commencement of the Second Five-Year Plan by the
announcement of the Industrial Policy Resolution of April 1956. This
Policy Resolution with same amendments made from time to time
continued till 1991 when the policy of liberalisation was adopted.

NOTES The basic consideration underlying Industrial Policy Resolution of 1956

was that public sector should venture into new field and to provide the
country with the foundations of economic development by strengthening
the basic industrial structure of the country. This implied long-term
programme and substantial investment by the State not only for the
development of basic and heavy industries such as iron and steel, machine
building, fertilizers and chemicals, but also providing essential
infrastructure such as irrigation, power, transport and communications.
The Government was also to undertake direct promotional work of
providing finance, marketing facilities, technical advice and other
assistance to promote industrial development in the private sector.
The Industrial Policy Resolution, 1956 spelt out the role expected to be
played by the private and public sectors. As the Resolution puts it, ‘the
need for planned and rapid development requires that all industries of
basic and strategic importance or in the nature of public utility services
should be in the public sector. Other industries which are essential and
require investment on a scale which only the State, in the present
circumstances, could provide, have also to be in the public sector. The
State has, therefore, to assume direct responsibility for the future
development of the industries over a wide area”.
Two schedules were drawn up: Schedule ‘A’ consisting of 17 industries,
the future development of which was the exclusive responsibility of the
State and Schedule ‘B’ containing a list of 12 industries which were to be
progressively State-owned in which the State would, therefore, generally
take the initiative in establishing new industries. But in this schedule ‘B’
private enterprise was also expected to supplement the efforts of the State.
All the remaining industries were in general left to the initiative and
enterprise of the private sector. This classification was, however, not rigid.
The Resolution had left open considerable flexibility so as to permit the
entry of the private sector wherever necessary in the fields which were
generally allotted to public sector, and vice versa.
Within the broad framework of the Industrial Policy Resolution 1956, the
Industries (Development and Regulation) Act, 1951 provided the main
instruments through which the development of the industries in the Private
Sector was regulated. The industrial licensing system was designed to
canalise investment in the desired directions in accordance with Plan
priorities and targets, so as to prevent concentration of economic power
and to bring about progressively economic and technological
improvements in the industries in the Private Sector.
The roles of public sectors as described in the Industrial Policy Resolution NOTES
of 1956 continued for 35 years though some modifications and
amendments, especially in the licensing policy, were made from time to
time. In the industrial policy statements of 1980 and 1985 licensing system
was liberalised so that it should not work as an obstacle to the industrial
production in the private sector. But in 1991 when Congress Party came
into power again under the leadership of Narasimha Rao with Dr. Manmohan
Singh as Finance Minister, industrial policy was drastically revised. As
shall be discussed below, in the Industrial Policy 1991, the role of public
sector has been greatly reduced and policy of liberalisation has been
adopted. Under the policy of liberalisation, private sector has been given
greater role in the industrial development of the Indian economy.
Need for Revision of Industrial Policy in 1991

It is important to know why industrial policy had to be revised drastically
in 1991. In the late eighties it was felt that importance given to the public
sector in the strategy of industrial development and stiff controls over the
working and expansion of the private sector were obstructing economic
growth and promoting inefficiency. Further, India experienced serious
problems of a high rate of inflation on the one hand and huge deficit in the
balance of payments on the other. To overcome these problems some
economists such as I.M.D. Little, Jagdish Bhagwati, Bela Balassa who had
been advisors of World Bank and IMF argued for the adoption of the
policy of economic liberalisation by India and other developing countries
to promote growth, check inflation and solve the problem of balance of
payments. They advocated that free markets and greater role of private
sector (including foreign investors) would ensure efficiency by
encouraging competition.
The experiment of a mixed economy as described in the Industrial Policy
Resolution of 1956 and later amendments made in it wherein public sector
was given a prominent role in industrial development of the Indian
economy seemed to be a success in the beginning. It was through public
sector investment a lot of infrastructure such as irrigation, transport, power
was developed. Many basic and basic heavy industries such as steel,
fertilizers, machine-making industries were built by the public sector. But
during the eighties several shortcomings of the working of public sector
were observed. First, the public sector which was expected to generate
adequate resources for the growth of the economy not only failed to do so
but in fact was incurring huge losses which raised the expenditure of the

NOTES Government. The losses of the public sector were said to be due to the
inefficiency of the public sector enterprises. Secondly, the problem of
macroeconomic imbalances, both in the internal and external sectors,
emerged and assumed serious proportions in 1990-91. The huge budget
deficits of the Government and expansion in money supply led to the
serious problem of inflation. On the external front, higher commercial
borrowing from abroad at higher rates of interest resulted in the serious
problem of persistent deficit in the balance of payments. This caused a
sharp decline in the foreign exchange reserves. The foreign exchange
reserves fell to such a meagre amount that it could meet the payments for
imports only for 15 days. This compelled the Government to approach
IMF, and World Bank for necessary help to tide over the foreign exchange
crisis. IMF and World Bank agreed to help only if policy of economic
liberalisation is adopted and accordingly greater role be assigned to the
private sector in boosting industrial investment and production in a
competitive environment. It was believed that competition would ensure
efficiency and stimulate economic growth.
Thus the year 1991 is a landmark in the economic history of India. The
country faced a severe economic crisis triggered in part by a serious
economic situation. Through fundamental changes in economic policy, this
crisis was converted with an opportunity. The objective of new industrial
policy was to improve the efficiency of the economic system by
eliminating the regulatory mechanism that involved various licenses and
permits which reduced competition even in private sector. To quote Dr. C.
Rangarajan, “The thrust of the new economic policy was towards creating
a more competitive environment in the economy as a means to improving
the productivity and efficiency of the system. This is to be achieved by
removing the barriers to entry and restrictions on growth of the firm.
While the industrial policy seeks to bring about a greater competitive
environment domestically, the trade policy seeks to improve international
competitiveness subject to the protection offered by tariffs which are
coming down”.
9.7 NEW INDUSTRIAL POLICY OF 1991

We discuss below the new industrial policy decisions regarding industry
announced in 1991 under the following heads:
1. Abolition of Licensing and Role of Private Sector.
2. Public Sector and Privatisation.
3. MRTP Policy and Role of Large Business Houses. NOTES
4. Foreign Investment and Foreign Technology.

1. Abolition of Industrial Licensing
Until the early 1980s, the Indian industrial sector had functioned under a
system of tight controls and regulations, represented by industrial licensing
which was meant to allocate the scarce resources towards building the
industrial base of the economy. Now that the Indian Industrial economy
had acquired quite a wide and diversified base, the new industrial policy of
1991 abolished all industrial licensing irrespective of the level of
investment except for 18 industries for which licence was still required.
Later, in April 1993 more industries were dereserved and thrown open to
the private sector. These three industries dereserved later were: 1. motor
cars, 2. white goods (such as domestic refrigerators, working machines,
microwave ovens, airconditioners) and 3. raw hides, skins and leather. The
remaining fifteen industries which remain reserved for the public sector
are those which are essential for security and strategic reasons, safety
purposes and for protection of environment. For granting of licences for
even these 15 industries procedure has been greatly simplified. For getting
licences only certain vocational guidelines are to be fulfilled so that
polluting industries should not cluster around the major urban centres.
The 15 specified industries which continue to be subject to compulsory
licensing are:
1. Coal and Lignite
2. Petroleum (other than crude) and its distillation products
3. Distillation and Brewing of Alcoholic drinks
4. Sugar
5. Animal Fats and Oils
6. Cigars and Cigarettes of Tobacco and Manufactured Tobacco
Substitutes
7. Asbestos and Asbestos based Products
8. Raw hides and skins, leather
9. Tanned or dressed furskins
10. Paper and Newsprint except bagasse based units
11. Electronic aerospace and defence equipment (all types)

NOTES 12. Industrial explosives, safety fuse, gun powder and matches
13. Drugs and Pharmaceuticals
14. Plywood and other wood-based products
15. Hazardous chemicals.
Industrial policy, 1991 hoped that with the removal of licensing control for
most of the industries, the Indian industries would benefit by becoming
more competitive, more efficient and modern which would ensure its
rightful place in the world of industrial progress.
 Freedom to Create new Capacity and Manufacture any Product. It
is worth noting that with the abolition of licensing control,
existing private industrial enterprises have been allowed to
expand and create new capacity according to the demand in the
market without obtaining prior permission or capacity clearance
from the Government. Further, in the earlier licensing system
existing private enterprises were required to produce specific
products. With the abolition of industrial licensing, firms will
now be free to manufacture any article in response to market
demand (except for those subject to compulsory licensing). Big
industrial houses have been allowed to expand, diversify, merge
and takeover.
2. Role of Public Sector and Privatisation
In the earlier industrial policy public sector investment was a crucial
element in the strategy of industrial development. It was planned that
public sector would occupy the commanding heights of the Indian
economy Public Sector was originally given importance because it was
required to make adequate investment in infrastructure (power, irrigation,
transport and communication) and basic heavy industries so as to lay the
basis for future industrial growth. Besides, role of Public sector was
considered essential to prevent the concentration of economic power in a
few private hands, and to promote balanced regional development.
But after the initial success in its original role some problems emerged in
the working of public enterprises. Low productivity and inefficiency, poor
project management, overstaffing, lack, continuous upgradation, lack of
concern for R&D are some of the problems faced by public sector
enterprises. But the most important problem was that public sector
enterprises suffered heavy losses and were yielding a very low rate of
return. As a result, instead of being a source of investible surplus for

industrial development, public sector enterprises became a burden on the NOTES

Government rather than being an asset.
It may also be noted over a period of time public sector made a departure
from its original role. First, for protecting the interests of workers, the
Government had to takeover the sick industrial units from the private
sector. This category of public sector enterprises accounts for about one-
third of the losses of the central public sector enterprises. Second, the
public sector had also entered into the production of consumer goods and
service sectors such as cars, hotels etc.
In view of the above, Industrial Policy of 1991 adopted a new approach to
the public sector. According to this new approach, the priority areas for
future growth of public enterprises are:
1. Production of essential infrastructure goods and services.
2. Exploration and exploitation of oil and mineral resources.
3. Technological development and investment in manufacturing
capabilities in areas which are essential for long-term
development of the economy and where private sector will not
make adequate investment.
4. Manufacturing products which are of paramount importance on
account of strategic considerations.
De-Reservation of Industries of the Public Sector. The new industrial
policy 1991 far-reaching structural reforms had been initiated to lead
industries away from excess direct controls and regulations to a free,
market oriented economic system. The list of industries reserved for the
public sector has been pruned. In the Industrial Policy of 1956,
17 industries were reserved for investment by the public sector. Now, only
8 industries remain reserved for the public sector. Among the industries
reserved earlier included many core industries like iron and steel,
electricity, air transport, ship building, heavy machinery industries such as
heavy chemical plants and telecommunication cables and instruments. The
new industrial policy of 1991 threw open all these industries for the private
sector for investment and growth. Thus the new policy of 1991 indicates
the Government’s intentions to invite a greater degree of participation by
the private sector in important areas of the economy. From March 1993,
the two more industries, namely, (1) mining of iron ore, manganese ore,
sulphur, gold and diamond and (2) mining of copper, lead, zinc, tin etc.
were dereserved. The six remaining industries reserved for the public

NOTES sector are (1) Arms and Ammunition, other defence equipment, warships,
aircraft (2) Atomic Energy, (3) Coal and Lignite (4) Mineral Oils
(5) Minerals used for producing atomic energy (6) Railway transport. Thus,
six industries which continue to be reserved for the public sector are in
areas where security and strategic considerations predominate. According
to new policy, as stated above, the resources in the public sector are now
to be used for strategic, high technology and essential infrastructure areas.
New Industrial Policy 1991 stipulated that the Government would
strengthen those public enterprises which fall in the reserved areas for
public sector operation or belong to high priority areas or are yielding
reasonable profits. To strengthen them, such public enterprises will be
given a much greater degree of management autonomy through the system
of Memorandum of Understanding (MoU). Competition will also be
induced in these areas by inviting private sector participation.
Public Sector Disinvestment. Another important decision of Industrial
Policy of 1991 was that in case of selected public sector companies, a part
of the Government holdings in the equity share capital of these will be
disinvested. Apparently this disinvestment was to subject them to market
discipline so that they can increase their efficiency. These selected
enterprises would be those which are non-essential and commercial in
nature. In accordance with this year, beginning from 1991 a target of
realising an amount through public disinvestment is set. Revenue so raised
is used to reduce budget deficit. So far disinvestment in BALCO, Modern
Bread, Indian Tourism Development Corporation, Asoka Hotel, Hotel
Corporation of India, Maruti Udyog Limited, IPCL etc. has been carried
out and more are in queue for this purpose.
3. MRTP Policy and Large Business Houses
Removal of Investment Controls on Large Business Houses. Under the
Monopolies & Restrictive Trade Practices Act (MRTP Act), all firms with
assets above a certain size (` 100 crores since 1965) were classified as
MRTP firms. Such firms were permitted to enter selected industries only
and this also on a case-by-case approval basis. In addition to control
through industrial licensing separate approval from MRTP Commission
was required by such large firms for any investment proposals. This
produced a significant adverse effect on the freedom of many of the large
private firms in their planning for growth and diversification. In the
Industrial Policy 1991, the threshold limits of assets in respect of MRTP
and dominant undertakings were removed. These firms will now be at par

with others and no prior approval from the Government for investment in NOTES
the delicensed industries was required.
This is a significant change in the policy regarding the Government control
on growth of big business and private monopolies through MRTP Act
1991. According to this policy, to achieve economies of scale by the firms
and thereby to ensure higher productivity and competitive advantage, the
check by the Government through Monopoly and Restrictive Trade
Practices Act (MRTP) was not needed. Therefore, Industrial Policy 1991
limited and restricted the role of MRTP Act. The following decisions were
taken in this regard:
1. Prior Government approval of investment proposals regarding
expansion of present undertaking and establishment of new
undertaking by big industrial companies which came within the
purview of MRTP Act was not required.
2. It was decided to repeal the provisions which prohibited the
companies for merger, amalgamation and takeover other firms by
a firm.
3. It was decided that emphasis would now be on controlling
monopolistic, restrictive and unfair trade practices. In accordance
with this, provisions of MRTP Act were strengthened in order to
enable MRTP Commission to take appropriate action in respect
of monopolistic, restrictive and unfair trade practices.
Accordingly, the newly appointed monopoly commission would be asked
to investigate the complaints received from industrial consumers or
various other specific classes of consumers.
Foreign Trade Liberalisation

Prior to 1991 India followed the policy of import substitution under which
goods were produced within the country instead of importing them. A
significant policy reform was to free trade, that, is to reduce tariffs on
imports and remove tight quantitative restrictions on imports. Besides,
export-oriented industrial policy was adopted so as to boost exports of
India to raise growth of both output and employment. Prior to 1991
imports of consumer goods were banned. Capital goods, raw materials and
intermediates were freely importable, subject to indigenous unavailability.
The criteria for issuing of licences were non-transparent; delays were
endemic and corruption to unavoidable. The first series of economic

NOTES reforms sought to phase out import licensing and also to reduce import
duties.
Import licensing was abolished relatively early for capital goods and
intermediates in 1992 simultaneously with the switch to a flexible
exchange rate regime. “Import licensing had been traditionally defended
on the grounds that it was necessary to manage the Balance of Payments,
but the shift to a flexible exchange rate enabled the government to argue
that any balance of payments impact would be dealt with through
Exchange Rate Flexibility”. Removing quantitative restrictions on finished
goods was much more difficult because the number of domestic produce’s
was very large. Quantitative restrictions on imports of consumer goods and
agricultural produce were finally removed on April 1, 2001 in phases
primarily because of a ruling of WTO Dispute Panel on a complaint
brought by the US.
4. Foreign Capital and Foreign Technology
The new Industrial Policy 1991 also made a significant change towards the
approach to foreign capital and technology. Till 1991 the import of foreign
technology was strictly regulated. In case of Foreign Technology Transfer
Agreements sought by the Indian firms, it was necessary to obtain specific
prior approval from the Government for each project. This involved delays
and hampered business decision making for the import of technology by
Indian firms. With a view to promoting technological advancement of the
Indian industry, Industrial Policy 1991 announced that now the
Government would provide automatic approval to technological
agreements relating to high-priority industries within specified guidelines.
Similar facilities will also be available for other industries as well if
technology agreements do not require expenditure offered foreign
exchange. Indian companies were given freedom to negotiate the terms of
technology transfer with the foreign companies according to their own
commercial judgement.
The new Industrial Policy 1991, emphasised that opportunities for foreign
investment in India should also be utilised to ensure rapid industrial
growth. It welcomed foreign capital to supplement domestic efforts for
mobilisation of resources. In keeping with this approach Government
liberalised its policy regarding foreign investment. To attract foreign direct
investment (FDI), it decided to grant automatic approval to private foreign
investors to hold equity in Indian companies up to 51 per cent of the total
equity shares of a company in 34 high priority industries. This facility

would be available to those firms which are able to finance their capital NOTES
equipment imports through their foreign equity. This is a major departure
from the previous policies which required a case-by-case approval of
foreign investment normally limited to 40 per cent equity participation.
The priority sector industries include power generation and petroleum
refining. Further, the Government has given a guarantee 16 per cent return
on foreign investment in priority sectors.
Foreign capital flows are not only of the type of foreign direct investment
(FDI) but also of portfolio capital type. Under portfolio capital Foreign
Institutional Invertors (FIIs) invest in our equity (i.e., shares) of the Indian
companies and also in bonds or securities of government and corporate
sector. Portfolio capital flows are generally volatile, they come in when
market conditions in a country are favourable and go out when uncertainty
prevails in the domestic economy or in the international business
environment.

The primary objective of Industrial Policy of 1991 is to achieve
international competitiveness, in addition to that of IPR 1956. To achieve
these objectives the policy introduced far reaching changes with respect to
licensing, foreign investment and technology, MRTP Act, public sector
enterprises, etc. The scope for private sector, both domestic and foreign, is
widened dramatically; licensing is virtually scrapped; threshold limit on
assets of large undertakings is removed; mergers, acquisitions and
amalgamations are allowed, financial performance of public sector is
accorded prominence, and retrenchment and redeployment of labour
wherever necessary to improve industrial efficiency is encouraged. These
reforms have started yielding positive results. Industry has reached double
digit growth and the growth is likely to get further momentum. There is a
spurt in domestic and foreign investments across the industry.
9.9 GLOSSARY
 MRTP: Monopolies and Restrictive Trade Practices
 Licence Raj: A period restrictions, red-tapism and corruption
 FIPB: Foreign Investment Promotion Board

NOTES
9.10 KEY TERMS
 Foreign Investment: Investment from foreign corporate,
individuals and NRIs
 Licensing: Industrial development through regulations and
controls
 EOU: Export Oriented Units
 TDC: Technology Development Cell

1. Industrial Licensing act applies to whole of India including
____________.
2. Government continues to provide ____________ to small scale
sector.
3. The control on public sector was through ____________ Act.
(B) True or False

1. NRI holding up to 100% was permitted in all sectors.
2. The industries of different categories were held in water tight
compartments.
3. The basis of national economic policy recognised mixed
economy.

(a) 1. Jammu and Kashmir, 2. protection, 3. M.R.T.P.
(b) 1. False, 2. False, 3. True.

1. Explain the salient features of Industrial policy 1977.
2. Discuss the Industrial policy statement 1991.

3. Explain the role of private sector. NOTES
4. Discuss the merits and demerits of licensing.

1. Sen Gupta A. K.: Government & Business, ‘Vikas’, Delhi.
2. Mankar V. G.: Business Economics, ‘Macmillan’, Delhi.


MS 105
Business
Environment
Volume II
UTTARAKHAND OPEN UNIVERSITY

SCHOOL OF MANAGEMENT STUDIES AND COMMERCE
University Road, Teenpani By pass, Behind Transport Nagar, Haldwani- 263 139
Phone No: (05946)-261122, 261123, 286055
Toll Free No.: 1800 180 4025
Fax No.: (05946)-264232, e-mail: info@uou.ac.in, som@uou.ac.in
http://www.uou.ac.in
www.blogsomcuou.wordpress.com
Board of Studies
Professor Nageshwar Rao Professor R.C. Mishra
Vice-Chacellor, Director,
Uttarakhand Open University School of Management Studies and Commerce,
Haldwani Uttarakhand Open University, Haldwani
Professor Neeti Agarwal Dr.L.K. Singh

Department of Management Studies Depatment of Management Studies,
IGNOU, New Delhi Kumaun University, Bhimtal
Dr. Abhradeep Maiti, Dr. K.K. Pandey,

Indian Institue of Management, O.P. Jindal Global University,
Kashipur Sonipat
Dr. Manjari Agarwal Dr. Gagan Singh

Department of Management Studies Department of Commerce
Uttarakhand Open University, Haldwani Uttarakhand Open University, Haldwani
Dr. Sumit Prasad

Programme Coordinator
Dr. Manjari Agarwal
Assistant Professor, Department of Management Studies
Units Written by Unit No.

Dr. Sunil Purohit
M.Sc., LL.M., MBA, Ph.D., FICCE
Adv. Sandhya Purohit
M.A. (Economics), LL.B.
Editor
Er. Sumit Prasad
ISBN : 978-93-85740-11-4
Copyright : Uttarakhand Open University
Edition : 2016 (Restricted Circulation)
Published by : Uttarakhand Open University, Haldwani, Nainital – 263 139
Printed at : Himalaya Publishing House Pvt. Ltd
SYLLABUS
Course Name: Business Environment
Course Code: MS 105
Course Credits: 6
Course Objective:
This course aims at providing students the knowledge of basic framework and intricacies of Indian and
International business environment.

Unit I Contemporary Global and Indian Environment
Unit II Consumerism and Business
Unit III Macro Economic Environment and Modern Theories of Economic Growth
Unit IV Aggregate Demand and Supply
Unit V Inflation
Unit VI Unemployment

Unit VII Economic Reforms in India
Unit VIII Economic Planning in India and New Economic Policy
Unit IX Industrial Policy and Industry Licensing

Unit X Public Sector Enterprises and Small and Medium Enterprises
Unit XI Industrial Financial Institutions: IDBI, IFCI, ICICI, IRBI, SFC
Unit XII Institutions for Investments and Small Industry: UTI, LIC, GIC, SSIDC, SIDBI and
Commercial Banks

Unit XIII Foreign Trade: Theories, Issues and Modern Context
Unit XIV FDI and FII
Unit XV Foreign Exchange Rates and Foreign Exchange Markets
Unit XVI Globalisation, Liberalisation and Privatisation
Unit XVII Regional Trading Blocks
Unit XVIII World Trade and Emerging Environment
CONTENTS
Block III: Industrial Financial Institutions
10. Public Sector Enterprises and Small and Medium Enterprises 154 – 168
10.1 Introduction
10.2 Forms of Organisation of Public Enterprises
10.3 Importance of Public Sector Enterprises
10.4 Small Scale and Medium Enterprises
10.6 Glossary
10.7 Key Terms
11. Industrial Financial Institutions: IDBI, IFCI, ICICI, IRBI, SFC 169 – 176
11.1 Introduction
11.2 Objectives and Functions of Industrial Finance Corporations of India
(I.F.C.I.)
11.3 State Financial Corporations (SFCs)
11.5 Glossary
11.6 Key Terms
12. Institutions for Investments and Small Industry: UTI, LIC, GIC, SSIDC, 177 – 228
SIDBI and Commercial Banks
12.1 Introduction
12.2 Role for Funding Enterprises
12.3 Development Function
12.4 Industrial Finance Corporation of India (IFCI)
12.5 The Industrial Development Bank of India (IDBI)
12.6 Finance for Industry
12.7 The National Bank for Agriculture and Rural Development: (NABARD)
12.8 The Small Industries Development Bank of India (SIDBI)
12.9 Investment Trusts
12.10 Unit Trust of India (U.T.I)
12.11 Nature of the Trust: Unit Trust of India: UTI
12.12 Industrial Credit and Investment Corporation of India (ICICI)
12.13 Life Insurance Corporation of India (LIC)
12.14 General Insurance Corporation of India (GIC)
12.15 Export-Import Bank of India — EXIM
12.16 Khadi and Village Industries Commission (KVIC)
12.17 National Small Industries Corporation Ltd. (NSIC)
12.18 State Industrial Development Corporations (SIDCs)
12.19 State Small Industries Development Corporations (SSIDCs)
12.21 Commercial Banks
12.22 Indian Financial System: An overview (RBI)
12.23 Structure
12.24 Industry assistance
12.25 Non-banking Financial Institution
12.27 Glossary
12.28 Key Terms
Block IV Foreign Policies and Globalization
13. Foreign Trade: Theories, Issues and Modern Context 229 – 254
13.1 Introduction
13.2 India’s Foreign Trade: Trends
13.3 India’s Foreign Trade: Composition
13.4 India’s Foreign Trade: Direction
13.5 Theory of International Trade
13.6 Some Implications of Traditional Trade Theory
13.7 Confrontation with Reality
13.8 Scale Economies
13.9 Product Differentiation
13.10 Oligopoly
13.12 Glossary
13.13 Key Terms
14. Foreign Direct Investment and Foreign Institutional Investors 255 – 273
14.1 FDI – Introduction
14.2 Foreign Direct Investment (FDI) in Multi-brand Retail Sector
14.3 Foreign Direct Investment
14.4 FDI Policy
14.5 Industrial Credit
14.6 Industrial Relations
14.7 The Securities and Exchange Board of India Act of 1992
14.8 Foreign Institutional Investors (FII)
14.10 Glossary
14.11 Key Terms
15. Foreign Exchange Rates and Foreign Exchange Markets 274 – 285
15.1 Introduction
15.2 Foreign Exchange Markets in India – a Brief Background
15.3 Features of the Forward Premium on the Indian Rupee
15.4 Intervention in Foreign Exchange Markets
15.5 The Foreign Exchange Market
15.6 The Market for Foreign Exchange
15.7 The Demand for Currency
15.8 The Supply of Currency
15.9 Exchange Rates
15.10 Changes in Exchange Rates
15.11 Exchange Rates and Interest Rates
15.13 Glossary
15.14 Key Terms
16. Globalisation Liberalisation and Privatisation 286 – 296
16.1 Introduction to Economics Policy – Reforms
16.2 Globalisation
16.3 Liberalisation
16.4 Privatisation
16.5 Conclusion
16.7 Glossary
16.8 Key Terms
17. Regional Trading Blocks 297 – 305
17.1 Introduction
17.2 Regional Trade Blocks
17.3 Trading Blocks
17.4 The Main Advantages for Members of Trading Blocks
17.5 The Main Disadvantages of Trading Blocks
17.6 Development
17.8 Glossary
17.9 Key Terms
18. World Trade and Emerging Environment 306 – 316
18.1 Introduction
18.2 Foreign Trade Policy of India
18.3 Salient Features of EXIM Policy
18.4 Emerging Environment
18.5 Foreign Exchange Reserves (QR – Quantitative Restrictions)
18.6 Phased Removal of QRs
18.7 Removal of QRs: Implications
18.8 Special Provisions of WTO Agreement
18.9 Conclusion
18.11 Glossary
18.12 Key Terms
Block III: Industrial Financial Institutions
PUBLIC SECTOR
UNIT 10 ENTERPRISES AND SMALL
AND MEDIUM ENTERPRISES
Structure:
10.1 Introduction
10.2 Forms of Organisation of Public Enterprises
10.3 Importance of Public Sector Enterprises
10.4 Small Scale and Medium Enterprises
10.6 Glossary
10.7 Key Terms
Objectives
 Understand the basic character of Public Sector.
 Know the aim of the industrial policy to protect public interest.
 Know the importance of statutory corporation such as LIC, UTI,
IFC etc.
10.1 INTRODUCTION
In the past business activities were in the hands of individual and private
organisations. Government held important services e.g. railways,
electricity, postal, etc. Slowly the Government went into direct
participation in business and set up private enterprise. The regulation of NOTES

the private enterprises, was with the Government. The public sector was to
protect public interest. The concept of small scale industry was a result of
the Industrial Policy Resolution 1956.
Traditionally, business activities were left mainly to individual and private
organisations, and the government was taking care of only the essential
services such as railways, electricity supply, postal services etc. But, it was
observed that private sector did not take interest in areas where the
gestation period was long, investment was heavy and the profit margin was
low; such as machine building, infrastructure, oil exploration, etc. Not only
that, industries were also concentrated in some regions that had certain
natural advantages like availability of raw materials, skilled labour,
nearness to market. This led to regional imbalances. Hence, the
government while regulating the business activities of private enterprises
went in for direct participation in business and set up public enterprises in
areas like coal industry, oil industry, machine building, steel
manufacturing, finance and banking, insurance etc. These units are not
only owned by central, state or local government but also managed and
controlled by them and are termed as Public Sector Enterprises.
Meaning
Thus, the business units owned, managed and controlled by the central,
state or local government are termed, as public sector enterprises or public
enterprises. These are also known as public sector undertakings.
A pubic sector enterprise may be defined as any commercial or industrial
undertaking owned and managed by the government with a view to
maximise social welfare and uphold the public interest.
Public enterprises consist of nationalised private sector enterprises, such as,
banks, Life Insurance Corporation of India and the new enterprises set up
by the government such as Hindustan Machine Tools (HMT), Gas
Authority of India (GAIL), State Trading Corporation (STC) etc.
Basic Characteristics
Looking at the nature of the public enterprises their basic characteristics
can be summarised as follows:
 Government Ownership and Management: The public
enterprises are owned and managed by the central or state
government, or by the local authority. The government may
Unit 10: Public Sector Enterprises and Small and Medium Enterprises Page 155 of 316
NOTES either wholly own the public enterprises or the ownership may
partly be with the government and partly with the private
industrialists and the public. In any case the control, management
and ownership remains primarily with the government. For
example, National Thermal Power Corporation (NTPC) is an
industrial organisation established by the Central Government
and part of its share capital is provided by the public. So is the
case with Oil and Natural Gas Corporation Ltd. (ONGC).
 Financed from Government Funds: The public enterprises get
their capital from Government Funds and the government has to
make provision for their capital in its budget.
 Public Welfare: Public enterprises are not guided by profit
motive. Their major focus is on providing the service or
commodity at reasonable prices. Take the case of Indian Oil
Corporation or Gas Authority of India Limited (GAIL). They
provide petroleum and gas at subsidised prices to the public.
 Public Utility Services: Public sector enterprises concentrate on
providing public utility services like transport, electricity,
telecommunication etc.
 Public Accountability: Public enterprises are governed by public
policies formulated by the government and are accountable to the
legislature.
 Excessive Formalities: The government rules and regulations
force the public enterprises to observe excessive formalities in
their operations. This makes the task of management very
sensitive and cumbersome.
Objectives
The public sector refers to economic and social activities undertaken by
public authorities. The enterprises in public sector are set up with the main
aim of protecting public interest. Profit earning comes next.
Besides the difference in the objective, the enterprises in both these sectors
also differ in many other aspects, This section let us know The differences
between the enterprises of public sector and private sector.
Page 156 of 316 Unit 10: Public Sector Enterprises and Small and Medium Enterprises
Basis of Private Sector Public Sector Enterprises NOTES

Difference Enterprises
 Ownership Owned by individuals. Ensures balanced
Government Management.
 Management Managed by owner and Owned by Government.
professional managers. Managed by Government.
 Capital Raised by owners’ Raised from Government
sources and public issues. funds and sometimes
through public issues.
 Area of Operates in all areas with Operates in basic and
Operation adequate return on public utility sectors.
investment.
 Objective Maximum profit Development
10.2 FORMS OF ORGANISATION OF PUBLIC

ENTERPRISES
There are three different forms of organisations used for the public sector
enterprises in India. These are (1) Departmental Undertaking; (2) Statutory
(or Public) Corporation, and (3) Government Company.
Departmental Undertaking form of organisation is primarily used for
provision of essential services such as railways, postal services,
broadcasting etc. Such organisations function under the overall control of
ministry of the Government and are financed and controlled in the same
way as any other government department. This form is considered suitable
for activities where the government desires to have control over them in
view of the public interest.
Statutory Corporation (or public corporation) refers to a corporate body
created by the Parliament or State Legislature by a special Act which
define its powers, functions and pattern of management. Statutory
corporation is also known as public corporation. Its capital is wholly
provided by the government. Examples of such organisations are Life
Insurance Corporation of India, State Trading Corporation etc.
Government Company refers to the company in which 51% or more of
the paid-up capital is held by the government. It is registered under the
Companies Act and is fully governed by the provisions of the Act. Most
business units owned and managed by government fall in this category.
NOTES Public Enterprises
Departmental Statutory Government

Undertakings Corporations Companies
Example Example Example

1. Posts and Telegraph 1. Food Corporation of India 1. Hindustan Machine Tools
2. Industrial Finance Corporation Limited
2. Railways
of India 2. Steel Authority of India
3. All India Radio (AIR) Limited
3. Life Insurance Corporation of
4. DoorDarshan (TV) India 3. Hindustan Shipyard Limited
5. Ordnance Factories 4. Unit Trust of India
5. State Trading Corporation
Departmental undertakings are the oldest among the public enterprises. A

departmental undertaking is organised, managed and financed by the
Government. It is controlled by a specific department of the government.
Each such department is headed by a minister. All policy matters and other
important decisions are taken by the controlling ministry. The Parliament
lays down the general policy for such undertakings.
Features of Departmental Undertakings

The main features of departmental undertakings are as follows:
 It is established by the government and its overall control rests
with the minister.
 It is a part of the government and is managed like any other
government department.
 It is financed through government funds.
 It is subjected to budgetary, accounting and audit control.
 Its policy is laid down by the government and it is accountable to
the legislature.
Merits of Departmental Undertakings

The following are the merits of departmental undertakings:
 Fulfilment of Social Objectives: The government has total
control over these undertakings. As such it can fulfil its social and
economic objectives. For example, opening of post offices in far
off places, broadcasting and telecasting programmes, which may NOTES

lead to the social, economic and intellectual development of the
people are the social objectives that the departmental
undertakings try to fulfil.
 Responsible to Legislature: Questions may be asked about the
working of departmental undertaking in the parliament and the
concerned minister has to satisfy the public with his replies. As
such they cannot take any step, which may harm the interest of
any particular group of public. These undertakings are
responsible to the public through the parliament.
 Control Over Economic Activities: It helps the government to
exercise control over the specialised economic activities and can
act as instrument of making social and economic policy.
 Contribution to Government Revenue: The surplus, if any, of
the departmental undertakings belong to the government. This
leads to increase in government income. Similarly, if there is
deficiency, it is to be met by the government.
 Little Scope for Misuse of Funds: Since such undertakings are
subject to budgetary accounting and audit control, the
possibilities of misuse of their funds is considerably reduced.
10.3 IMPORTANCE OF PUBLIC SECTOR

ENTERPRISES
All enterprises in our country are not public enterprises. There is mixed
economy in our country and the private as well as the public sector
contribute to the development of our economy. However, there are only
some selected areas in which the government establishes its enterprises for
a balanced development of the economy and promote public welfare.
There are several areas where huge investment of capital is necessary but
the margin of profit is either small or it can be obtained only after a long
period as in case of generation and supply of electricity, machine building,
construction of dams, etc. The private businessmen hesitate to establish
their enterprises in these areas but they cannot be neglected in public
interest. As such these enterprises are established and run by the
government. Similarly the public enterprises also help in balanced regional
development by promoting industries in every part of the country. For
NOTES example, with the establishment of Bhilai Steel Plant in Madhya Pradesh,
several new small industries have come up in that state.
Industrial progress is of utmost importance for the development of the
country and for this, it is necessary that some basic industries like oil, coal,
gas, iron, steel, production of heavy electrical goods, etc., are to be fully
developed. Public enterprises give impetus to the development of these
basic industries and also help in the development of the private sector with
their products and services. There are some industries which require heavy
capital investment on account of technical reasons. Electricity, power,
production of gas, heavy machinery tools, production of telephone etc., are
such industries.
The development of public enterprises also prevents concentration of
economic power in the hands of an Individual.
Overview of Performance and Policy

The public sector has been central to India’s Industrialisation within the
mixed framework. The Industrial policy Resolution, 1956 accorded a
strategic role to public enterprises. Accordingly, areas of strategic
importance and core sectors were exclusively reserved for public sector
enterprises. Public enterprises were accorded preference even in areas
where private investments were possible. Public enterprises grew
dominantly in terms of units and investment, both at the Central and state
levels. In 1992, number of Central Public Enterprises stood at 237 with an
investment of ` 1,47,000 crores.
However, the performance of public sector enterprises has been far from
satisfactory. Its protected growth over a period of time, has resulted in
many shortcomings:
 insufficient growth in productivity
 poor project management
 inadequate attention to research and development
 low rate of return on investment
As a result, many public enterprises became a burden rather than an asset.
Nationalised sick units accounted for one-third of the public enterprises. A
number of public enterprises had come up in non-strategic, non-core,
consumer goods and service sectors. By 1993, only about 60% of the total
investment in public enterprises was in areas originally envisaged as the
“commanding heights”. All these necessitated a change in approach. IP,
1991, emphasised that the public enterprises must be growth oriented and NOTES
technologically dynamic. Therefore, IP 1991 set the future priorities for
public enterprises as follows:
 essential infrastructural goods and services for exploration and
exploitation of oil and minerals.
 manufacturing of goods of strategic importance such as defence
equipments etc.
 development of technology and manufacturing capabilities in
crucial areas for long-term economic development.
Thus, public sector would be confined to strategic, high tech industries and
essential infrastructure. Chronically sick and unviable public sector units
would be referred to Board for Industrial and Financial Reconstruction
(BIFR).Workers of such units would be protected. In February, 1992, the
government established a Non-statutory National Renewal Fund (NRF) to
provide assistance to cover the cost of retraining and redeployment of
labour and also provide compensation to labour affected by the closure of
unviable public sector units, etc.
Government’s share holding in public enterprises would be brought down.
The shares would be offered to mutual funds, financial institutions,
workers and the public to raise resources and to encourage wider public
participation.
As a part of the measures to improve the performance of public enterprises,
more and more of public sector units would be brought under the purview
of Memorandum of Understanding (MoU) system. A memorandum of
understanding is a performance contract, a freely negotiated document
between the Government and a specific public enterprise. MoU aims at
moving management of public enterprises from management by controls
and procedures to management by result and objectives. MoU was started
in 1987-88 with 4 public enterprises. As of now, more than 100 central
public enterprises are covered by MoU system, accounting for more than
90% of the total public sector turnover. In 1995-96, financial performance
was accorded 60% weightage in MoUs.
Many areas previously reserved for the public sector have been opened up
to the private sector. Although its share has declined in the past ten years,
the public sector still accounts for 25% of India’s GDP, 31% of capital
investment and 17% of the final consumption expenditure in the country.
At the start of the reforms 18 important industries, including iron and steel,
NOTES heavy plant and machinery, telecommunications and telecom equipment,

mineral oils, mining of various ores, air transport services, and electricity
generation and distribution, were reserved for the public sector. This list
has been reduced to 6, covering industries on arms and ammunition,
atomic energy, mineral oils, atomic minerals, hazardous chemicals and
industrial explosives, and railway transport. Because of this liberalisation,
private investment including foreign investment has flown into areas such
as steel, telephone services, electricity generation, petroleum exploration
development and refining, coal mining and air transport, none of which
would have been possible earlier because of public sector reservation. Part
of the government equity in selected public sector enterprises is being
disinvested. While such disinvestment helps reduce the fiscal deficit, it
does not indicate a change in management as government intends to
remain a majority stakeholder in public sector enterprises.
Public sector reforms have done little in the cases of units that have been
loss making. These units have been making losses for a very long period of
time and are very unlikely candidates for revival. The successive
governments have ruled out closure of these units and decided instead that
the scope for reviving each unit would be carefully examined and only
those units where revival was found to be economically feasible would be
revived while others would be closed down. Many sick public sector units
have been referred to the Board for Industrial and Financial Reconstruction
(BIFR) for rehabilitation or, where necessary, for winding up. The latter
option has been rarely exercised. The public sector is still hamstrung by
excessive government and bureaucratic controls. The option of
privatisation has not yet been seriously considered. Several public sector
units have been identified as fit for closure through this process, and
subsequently the government has even decided on closure in many cases,
but no unit has been actually closed because the decision has been
challenged in the courts by labour unions.
An important area where domestic liberalisation has made some progress
is the policy of reserving certain items for production in the small-scale
sector. The policy that used to “protect” small-scale units by barring the
entry of larger units into reserved areas, also in a way preventing existing
small-scale units from expanding beyond a maximum permissible value of
investment in plant and equipment, has been modified to reduce the area of
protection by two measures: by redefining small-scale in sectors like
apparels, garment manufacturing etc., and by withdrawing reservation to a
few. As of June 2002, the number of such reserved items for this sector NOTES
stood at 749.
The present regulations for retrenchment of surplus labour are far too rigid.
While the government has made some progress on this front by proposing
to allow companies with no more than 1000 employees to retrench labour
without prior permission of the government, but this amendment to the
Industrial Disputes Act (IDA), 1947, is yet to get Parliamentary approval.
Similarly, industrial units require government permission before they can
close down and such permission is rarely secured. There has been no
progress whatsoever on putting in place an exit policy for firms. In this
context, it is noteworthy that while the industrial policy reforms in India
have removed virtually all the entry barriers that had existed prior to 1991,
however, not allowing firms to exit, if their business conditions so demand,
is an entry barrier in itself.
Objectives of MRTP Act

 Prevention of concentration of economic power and control of
monopolies.
 Prohibition of monopolistic, restrictive and unfair trade practices.
The thrust of Industrial policy, 1991 is more on controlling unfair or
restrictive business practices. The provisions relating to merger,
amalgamation and takeover have been repealed. Threshold limits of assets
on private sector companies have been removed.
Accordingly MRTP Act has been restructured and pre-entry restrictions
have been removed with respect to new undertaking, expansion and
amalgamation, merger, takeover registration etc. under sections 20-26 of
part A of chapter III of the act.
Under section III of the act 1969 the act shall now apply to all
undertakings and financial institutions, both public and private. However,
units, which are owned by or controlled by a Government company or
Government engaged in the production of arms, ammunition, atomic
energy, minerals, etc. are exempted.
The basic objective is to curb and regulate monopolistic, restrictive and
unfair trade practices, which are prejudicial to public interest.
To summarise, though Industrial policy 1991, renewed its commitment to
the basic objectives of IPR 1956, the policy brought out substantial
changes on the industrial policy framework. The regulatory and controlling
NOTES mechanism has been largely diluted towards creating a competitive

environment in domestic industry. Protective barriers have been removed
and industry has been exposed to competition, both internal and external.
Industrial delicensing liberal foreign investment policy, removal of
threshold limits on the assets of dominant firms, drastic reduction on the
number of industries reserved for public sector, steps towards granting
more autonomy to the public enterprises, measure to reduce the
Government share holding in public enterprises etc. formed the significant
features of industrial policy, 1991. These marked a clear deviation from
the path adopted in the earlier decades of Industrialisation. The IP 1991
recognised the growth of private sector in terms of size, resources and
ability to play a more significant role in industrialisation; the vital role of
foreign investment and technology in supplementing India’s ingestible
resources and overcoming technology deficiencies; and the importance of
public sector restructuring and functioning on commercial lines to generate
resources.
Accordingly, vast areas of economic activities have been thrown open to
private sector investments, both domestic and foreign and steps have been
initiated to confine the role of public sector and strategic areas and to
improve its financial performance.
In recent decades, the focus of industrial policy has increasingly
emphasised the importance of competition as a tool for disciplining firms,
and fostering allocative efficiency. However, in many industries, there are
innate problems.
10.4 SMALL SCALE AND MEDIUM

ENTERPRISES
Small Scale Industries (SSI)
The concept of Small Scale Industries (SSIs) was brought to fore by the
Industrial Policy Resolution, 1956. The various arguments that were put
forward for the SSIs were as follows:
1. More Employment per Unit of Capital: The emergence of SSI
was propagated through the principle of self-employment. Small
enterprises are labour-intensive and thus create more employment
per unit of capital. Even as SSIs have low output employment
ratio than the large sector, its employment generation capacity
has been found to be 8 times that of the large sector.
It is not only the employment but also the productivity per unit of NOTES
capital in SSIs which have been found to be higher than that of
large sector.
2. Ensures More Equitable Distribution of Wealth: Also, it was
found that income generated by SSIs are more widely dispersed
in the community than the income generated in a few large
enterprises.
3. Regional Dispersal of Industries: Large enterprises are
normally concentrated in the metropolitan cities. However, the
industrialisation of a country can be completed only if it
permeates into the remote areas of the country. Hence, the
development of SSIs has been given major thrust in all the
industrial policies.
Various industries such as watches, food processing, animal feeds
and textiles were reserved under the SSIs. The contribution of
these industries to total SSIs output can be seen from Table 10.1
below.
Over the years, significant support was given to the SSI sector
and village industries in the five years plans.
Table 10.1: Allocation of Resources for SSI Sector Under Plan Periods
Plan Allotment
First Plan ` 42 crores allotted to SSI and village industry
Second Plan ` 187 crores allotted to SSI and village industry
Third Plan ` 241 crores were spent on the SSIs
Annual Plans (1966-69)
Fourth Plan ` 251 crores allocated
Fifth Plan ` 388 crores allocated
Sixth plan ` 1952 crores allocated
Seventh plan Increase in production with very high annual average growth
rate achieved
Eighth Plan Provided growth impetus in infrastructure facilities, financial
support measures, etc.
Source: Ministry of Small Scale Industries document, Government of India.
NOTES Statistics on Small Scale Industries in India

Third
sensus of
Small Scale
Characteristics ASI
Industries
(2001-2002)
No. of Units as per ASI 2001-02 128866 5897321
Employment as per ASI 2001-02 7915960 16710510
Output ( ` Lakhs) as per ASI 2001-02 94076302 7901536
Fixed Capital (` Lakhs) as per ASI 2000-01 39960422 6255660
Per Unit Employment 61 3
Per Unit Output (` Lakhs) 730 422
Per Unit Investment (` Lakhs) as per ASI 2000-01 304 2.04
Employment per ` One Lakh Investment as per ASI 0.2 1.39
2000-01
Output per Employee as per ASI 2001-02 11.88 1.49
Investment to Output as per ASI 2000-01 0.43 0.48
Annual Survey of Industries.

Source: Final Results: Third All India Census of Small Scale Industries,
2001-2002, Ministry of Small Scale Industries, Govt, of India.
Comparison of Small Scale Industries Sector with Organised Sector in India

(2001-2002)
Percentage Distribution of Gross Output by Industry (Registered SSI
Sector) in India (2001-2002)
Description Percentage of Gross Output
Manufacture of Grain Mill Products, Starches and Starch Products, 13.64
and Prepared Animal Feeds
Manufacture of Other Chemical Products 6.32
Manufacture of Basic Iron & Steel 6.15
Production, Processing and Preservation of Meat, Fish, Fruits, 5.98
Vegetables,
Manufacture of Other Fabricated Metal Products 5.36
Metal Working Service Activities 5.00
Manufacture of Plastic Products 4.63
Manufacture of Wearing Apparel, Except fur Apparel (Includes 3.31
Tailoring)
Manufacture of Structural Metal Products, Tanks, Reservoirs and 2.99 NOTES

Steam
Manufacture of Non-metallic Mineral Products n.e.c. 2.9
Spinning, wearing and finishing of textiles 2.67
Others 46.05
Total 100
Source: Handbook of Statistics on Indian Economy, RBI, 2003.
SSIs have been handicapped due to an inequitable allocation of scarce raw
materials and imported components, lack of provision of credit at low
interest rate, low technical skill and managerial ability and lack of
marketing contracts. This resulted in sickness of SSIs.

The Indian industries had potential to meet production targets but it
required protection from government. Both private and public sectors were
encouraged by the government by providing facilities.
10.6 GLOSSARY
 Public welfare: Public enterprises not guided by profit motive
e.g. GAIL.
 Public utility services: Transport, electricity, telecommu-
nications
10.7 KEY TERMS

 Private sector: Entrepreneurs who are invited to invest in basic
industries.
 Infrastructure: The basic requirements to conduct business i.e.
Power, water, technology and transport.
 Industrialisation: From traditional way to technological way of
production.
NOTES

1. Departure from agriculture makes Indian economy
____________.
2. About ____________ % of population in India depends on
agriculture.
3. Small enterprises are ____________ intensive, therefore creates
more jobs.
(B) True or False

1. India ranks No.1 in terms of advances in science and technology.
2. The private sector dominates in industries in India.
3. More strikes means better economic status.

(A) 1. uastable, 2. 60%, 3. Labour.
(B) 1. False, 2. True, 3. False.

1. Write short notes on:
(a) Industrial sickness
(b) Industry empowerment
(c) Role of small sector in employment
2. What do you understand by industrialisation? Explain.

1. Justin Paul: ‘Foreign Direct Investment, ‘Udyog Pragati’, Delhi.
2. Pramod Verma – ‘Competitiveness of Indian Industries’,
‘Wisdom’, Delhi.

INDUSTRIAL FINANCIAL
UNIT 11 INSTITUTIONS: IDBI, IFCI,
ICICI, IRBI, SFC
Structure:
11.1 Introduction
11.2 Objectives and Functions of Industrial Finance Corporations of
India (I.F.C.I.)
11.5 Glossary
11.6 Key Terms
Objectives
 Understand difficulties faced by Industrial sector.
 Explain that the gap between demand and supply for finance was
filled by these institutions.
11.1 INTRODUCTION
SFIs – i.e. Specialised Financial Institutions were set up by Government
mainly to provide medium and long term financial assistance to industries.
These are called development banks – These Institutions raise funds from
Capital Markets.
SFIs are institutions set up mainly by the government for providing
medium and long-term financial assistance to industry. As these
NOTES institutions provide developmental finance, that is, finance for investment
in fixed assets, they are also known as ‘development banks’ or
‘development financial institutions’. These institutions receive funds for
their financing operations primarily from the government or other public
institutions. These institutions also raise funds from the capital market.
Objectives
The need for establishing SFIs arose mainly because of the following
reasons:
1. It was difficult for industry in general to procure sufficient long-
term funds in the capital markets. There were no other institutions
to supply long-term finance to industry. Traditionally, only short
term finance could be availed from commercial banks. SFIs were
established to ensure that industry get sufficient long-term funds
and in the desired sectors in accordance with planned priorities.
2. Certain particular sections of the industry faced greater
difficulties than others in procuring long-term finance. These
included (a) Small and medium sized concerns, (b) new concerns
set up by new entrepreneurial groups, (c) specific industries, such
as cotton and jute, which required funds for modernisation,
(d) concerns involved in innovation and new technological
developments, (e) concerns requiring extraordinarily large
amounts of finance with a long gestation period, (f) concerns in
backward regions. SFIs were established to meet the long-term
financial requirement of such concerns, on economic and social
ground.
In general it can be said that the gap between the demand for and supply of
industrial finance is sought to be filled through term loans by development
financial institutions. Due to this role, they have been called gap-fillers.
Importance of SFIs
The importance of SFIs may be attributed to the following:
1. They constitute an important source of long-term finance to
industry. Over a period of time, there has been a steady growth in
the number of industrial units assisted, and in the amount of loan
sanctioned and distributed by SFIs.
2. SFIs have played an important role in the development of
(a) Small scale industry, and (b) Projects in backward areas.
Page 170 of 316 Unit 11: Industrial Financial Institutions: IDBI, IFCI, ICICI, IRBI, SFC
3. They have helped new and small entrepreneurs in setting up NOTES

industry.
4. Through their operations involving underwriting of and direct
subscription to the issue of shares and debentures, they have been
important players in the capital market. These operations have a
favourable impact on the ability of industrial concerns to raise
funds from capital market.
5. These institutions have improved the allocation of funds to
industry and thus, have aided in better use of the available
resources for the economic development of the country.
6. SFIs have been a source of technical and managerial advice to the
industry. They have also helped in identification, evaluation and
execution of new investment projects.
7. These institutions have been helpful in the establishment of
concerns which require extraordinarily large amounts of finance
for their projects with a long gestation period.
Types of Specialised Financial Institutions

Specialised financial institutions may be divided into the following types:
(a) All India Development Banks
1. Industrial Development Bank of India (IDBI)
2. Small Industries Development Bank of India (SIDBI)
3. Industrial Finance Corporation of India (IFCI)
4. Industrial Credit and Investment Corporation of India (ICICI)
5. National Bank for Agriculture and Rural Development
(NABARD)
6. Industrial Investment Bank of India Ltd. (previously,
Industrial Reconstruction Bank of India)
(b) State-level Institutions
1. State Financial Corporations (SFCs)
2. State Industrial Development Corporations (SIDC)
3. State Industrial Investment Corporations (SIIC)
Unit 11: Industrial Financial Institutions: IDBI, IFCI, ICICI, IRBI, SFC Page 171 of 316
NOTES (c) Investment institutions

1. Unit Trust of India (UTI)
2. Life Insurance Corporation of India (LIC)
3. General Insurance Corporation (GIC)
11.2 OBJECTIVES AND FUNCTIONS OF

INDUSTRIAL FINANCE CORPORATIONS
OF INDIA (I.F.C.I.)
IFCI was established as a statutory corporation on 1st July 1948 by a
special Act of Parliament, IFCI Act, 1948. It was converted into a public
limited company on July 1, 1993. Its main object is to provide medium and
long term credit to eligible industrial concerns in corporate sectors of the
economy, particularly to those industries to which banking facilities are
not available.
Objectives
The primary role of IFCI is to provide ‘direct financial assistance’ on
medium and long term basis to industrial projects in the corporate and co-
operative sectors. Over the years, the scope of activities of the corporation
has widened. The objectives of the corporation are stated below:
(a) To provide long and medium-term credit to industrial concerns
engaged in manufacturing, mining, shipping and electricity
generation and distribution.
(b) The period of credit can be as long as 25 years and should not
exceed that period;
(c) To grant credit to a single concern up to a maximum amount of
rupees one crore. This limit can be exceeded with the permission
of the government under certain circumstances;
(d) Guarantee loans and deferred payments;
(e) Underwrite and directly subscribe to shares and debentures issued
by companies;
(f) Assist in setting up new projects as well as in modernisation of
existing industrial concerns in medium and large scale sector;
(g) Assist projects under co-operatives and in backward areas.
Functions NOTES
The main functions of I.F.C.I. are as under:

1. Granting loans and advances for the establishment, expansion,
diversification and modernisation of industries in corporate and
co-operative sectors.
2. Guaranteeing loans raised by industrial concerns in the capital
market, both in rupees and foreign currencies.
3. Subscribing or underwriting the issue of shares and debentures by
industries. Such investment can be held up to 7 years.
4. Guaranteeing credit purchase of capital goods, imported as well
as purchased within the country.
5. Providing assistance, under the soft loans scheme, to selected
industries such as cement, cotton textiles, jute, engineering goods,
etc.
6. Providing technical, legal, marketing and administrative
assistance to any industrial concern for the promotion,
management and expansion of the industrial concern.
7. Providing equipment (imported or indigenous) to the existing
industrial concerns on lease under its equipment leasing scheme.
8. Procuring and reselling equipment to eligible existing industrial
concerns in corporate or co-operative sectors.
9. Rendering merchant banking services to industrial concerns.
In 1995-96, 67% of the total financial assistance distributed by IFCI was in
the form of rupee term loans, while foreign currency loans accounted for
approximately 17% of total financial assistance. Thus the two types of
assistance accounted for a total of 84% of the total financial assistance by
IFCI. The remaining 16% of financial assistance, was in the form of
underwriting, direct subscription, guarantees and equipment leasing.
11.3 STATE FINANCIAL CORPORATIONS (SFCs)
Objectives and Functions

IFCI was established to cater to the financial needs of industrial concerns
in large scale corporate and co-operative sectors. Small and medium sized
enterprises were outside the purview of IFCI. To meet the financial needs
NOTES of small and medium enterprises, the government of India passed the State
Financial Corporation Act in 1951, empowering the State governments to
establish development banks for their respective regions. Under the Act,
SFCs have been established by State governments to meet the financial
requirements of medium and small sized enterprises. There are 18 SFCs at
present.
Objectives
The objectives of state financial corporations are as under:
1. Provide financial assistance to small and medium industrial
concerns. These may be from corporate or co-operative sectors as
in case of IFCI or may be partnership, individual or joint Hindu
Family Business. Under SFCs Act, “industrial concern” means
any concern engaged not only in the manufacture, preservation or
processing of goods, but also mining, hotel industry, transport
undertakings, generation or distribution of electricity, repairs and
maintenance of machinery, setting up or development of an
industrial area or industrial estate, etc.
2. Provide long and medium-term loan repayable ordinarily within a
period not exceeding 20 years.
3. Grant financial assistance to any single industrial concern under
corporate or co-operative sector with an aggregate upper limit of
rupees Sixty lakhs. In any other case (partnership, sole
proprietorship or Joint Hindu Family) the upper limit is rupees
Thirty lakhs.
4. Provide Financial assistance generally to those industrial
concerns whose paid up share capital and free reserves do not
exceed ` 3 crore.
5. To lay special emphasis on the development of backward areas
and small scale industries.
Functions of State Financial Corporation (SFCs)
The functions of SFCs include:
1. Grant of loans and advances to or subscribe to debentures of,
industrial concerns repayable within a period not exceeding 20
years, with option of conversion into shares or stock of the
industrial concern.
2. Guaranteeing loans raised by industrial concerns which are NOTES

repayable within a period not exceeding 20 years.
3. Guaranteeing deferred payments due from an industrial concern
for purchase of capital goods in India.
4. Underwriting of the issue of stock, shares, bonds or debentures by
industrial concerns.
5. Subscribing to, or purchasing of, the stock, shares, bonds or
debentures of an industrial concern subject to a maximum of 30
per cent of the subscribed capital, or 30 per cent of paid up share
capital and free reserve, whichever is less.
6. Act as agent of the Central government, State government, IDBI,
IFCI or any other financial institution in the matter of grant of
loan or business of IDBI, IFCI or financial institution.
7. Provide assistance for management and expansion
8. Planning and assisting development.

Specialised Financial Institutions (S.F.I) were set up to finance industry.
Since the finances were provided for development, they are also called
development Banks. They are IDBI, ICICI, IFCI and SFC. They provide
finance to industries where banking facilities are not available.
11.5 GLOSSARY
 NTP: New Trade Policy
 NDC: National Development Council
11.6 KEY TERMS

 SFC: State Financial Corporations.
 ICICI: Industrial Credit and Investment Corporation of India.
 IDBI: Industrial Development Bank of India.
 IFCI: Industrial Finance Corporation of India.
NOTES

1. ________is the apex Bank for financing in agriculture.
2. _______Bank looks after export import trade.
3. ICICI provides loans in rupees and _________currency.
(B) True or False

1. SFI do not finance small scale industries.
2. SFI acts as agent of Central Government.
3. Credit period given by IFCI cannot be more than 10 years.

(a) 1. NABARD, 2. EXIM, 3. Foreign.
(b) 1. False, 2. True, 3. False.

1. Explain the importance of Industrial Financial Institutions.
2. Give the objectives of Financial Corporation of India (FCI).
3. Write short note on various financial institutions.

1. Gupta S.B.: Monetary Planning, ‘Chand’, Delhi.
2. RBI reports.

INSTITUTIONS FOR
INVESTMENTS AND SMALL
UNIT 12 INDUSTRY: UTI, LIC, GIC,
SSIDC, SIDBI AND
COMMERCIAL BANKS
Structure:
12.1 Introduction
12.2 Role for Funding Enterprises
12.3 Development Function
12.4 Industrial Finance Corporation of India (IFCI)
12.5 The Industrial Development Bank of India (IDBI)
12.6 Finance for Industry
12.7 The National Bank for Agriculture and Rural Development:
(NABARD)
12.8 The Small Industries Development Bank of India (SIDBI)
12.9 Investment Trusts
12.10 Unit Trust of India (U.T.I)
12.11 Nature of the Trust: Unit Trust of India: UTI
12.12 Industrial Credit and Investment Corporation of India (ICICI)
12.13 Life Insurance Corporation of India (LIC)
12.14 General Insurance Corporation of India (GIC)
12.15 Export-Import Bank of India — EXIM
12.16 Khadi and Village Industries Commission (KVIC)
12.17 National Small Industries Corporation Ltd. (NSIC)
12.18 State Industrial Development Corporations (SIDCs)
12.19 State Small Industries Development Corporations (SSIDCs)
NOTES 12.20 State Financial Corporations (SFCs)

12.21 Commercial Banks
12.22 Indian Financial System: An overview (RBI)
12.23 Structure
12.24 Industry assistance
12.25 Non-banking Financial Institution
12.27 Glossary
12.28 Key Terms
Objectives
 Know about the requirement of the small scale industries for
financial support.
 To understand the structure of these institutions.
 To know the objectives for which the institutions provide finance.
 To understand the banking structure in India.
 To understand the differentiation between different types of
financial institutions.
12.1 INTRODUCTION
The development, scope of operation of Entrepreneurs in small scale
industry has necessitated assistance at different levels. These institutions
play a key role in providing finance. There is an institutional framework
for funding.
Page 178 of 316 Unit 12: Institutions for Investments and Small Industry: UTI, LIC, GIC, SSIDC, SIDBI...
NOTES
12.2 ROLE FOR FUNDING ENTERPRISES
Introduction
With the quickened pace of economic development under the impetus of
the Five-Year Plans, the most striking change in the Indian economy has
been the initiation of an industrial revolution and the re-emergence of
small-scale industries. Further, during the past decade, there has been a
deepening as well as widening of the entrepreneurial structure as well as
the small-scale pre-industrial structure. Not only have the established small
industries increased their installed capacity and output, but a wide range of
new small industries has also come into being. During the last two decades,
there is a boom of entrepreneurial activities in the country. Thus, in the
field of capital and product goods industries, enterprises manufacturing
such items as machine tools, electrical and engineering equipment,
chemicals etc., which provide the foundation for a self (sustained growth
of the economy have been set-up. Amongst the consumer goods industries,
small units producing such items as—bicycles, sewing machines, plastic
products, etc. are forgoing ahead.
These far reaching developments and the scale and scope of operation of
entrepreneurs, particularly in small-scale industries, have brought to the
importance of provision of administrative and institutional assistance at
various levels.
Over the years, financial institutions are playing a key role in providing
finance and counselling to the entrepreneurs to start new ventures as well
as more diversify and even rehabilitate sick enterprises. In this context, we
shall discuss the scale and scope of operation of various development
banks (institutions) that have been rendering financial assistance, directly
or indirectly, to entrepreneurs and their various ventures.
12.3 DEVELOPMENT FUNCTION

Development being the function of capital, as the tempo of development
grows, so does the requirement for capital. The need for capital is
continuous and also boundless. However, capitals is not only necessary for
development but capital, also generated by development. Economic
progress creates its surpluses with which further deployment is achieved,
often at an accelerated rate. India’s Five-Year Plans are a proof in
themselves that substantially larger resources used is each successive plan
Unit 12: Institutions for Investments and Small Industry: UTI, LIC, GIC, SSIDC, SIDBI... Page 179 of 316
NOTES same from the economic growth resulting from investment in the
preceding plans. Only a relatively small part of the resources came from
external sources though they were crucial to development. Similarly, in
consonance with the development activities in the country, the
development banks activities are on higher scale as well as diversified in
multi-directional way.
Institutional Finance
With the launching of the Five Year Plans, in the absence of a sufficiently
broad domestic capital market, there was need for adopting and enlarging
the institutional structure to meet the medium and long-term credit
requirements of the industrial sector. It was in this context that the RBI
took the initiative in setting-up statutory corporations at the all-India and’
regional levels to function as specialised financial agencies purveying term
credit.
SIDBI IDBI RBI NABARD Government
Nationalised Other Regional SFCs

SBI NSIC SSIDC KVIC
Banks Banks Rural
Group
Banks
Commercial Cooperative
Banks Banks
Industries
Institutional Framework for Industry

Institutional finance for — large, medium, small and tiny industries by
commercial banks — the State Bank of India group, nationalised banks,
private sector banks and development corporations which have been
especially established to provide industrial finance. In addition, the
Reserve Bank of India gives credit guarantees and the ECGC gives export
guarantees to the small-scale sector. By its refinance operations, the
Industrial Development Bank of India, too, plays a significant role in the
promotion of the small scale-sector for it has enabled the SFCs
SSIDC/SSIACS and commercial banks to extend a large quantum of
financial assistance to this sector. The National Small Industries
Corporation offers financial assistance is the form of its hire-purchase
schemes.
This apart, a host of newly cropped up institutions such as mutual funds, NOTES
lease companies, financial service institutions, investment companies,
merchant banks, asset management companies etc. provide financial
assistance and financial services to industries. Some of them go to the
extent of conceiving a project and see through its progress till the end.
In India, long-term loans are provided for a host of financial institutions of
the five all-India develop merits IDBI and SIDBI are apex banks providing
refinance facilities to other institutions. Likewise, NABARD is an apex
bank for agricultural finance and Exim Bank of export import trade. Then
industrial development banks, special institutions, saving and investment
institutions, financial service institutions and regulatory institutions. RBI,
SEBI, and NSEIL are three regulatory bodies.
In the cumulative sanctions by AFIs up to end-March 1998, IDBI
(including resource support to other FIs) claimed the largest share (33.6%),
followed by ICICI (25.7%), IFCI (11.1 %), SIDBI (8.2%) and LIC (1.4%).
UTI and LIC (including resource support to other FIs) accounted for
11.6% and 4.8% respectively, followed by GIC (1.7%). Of the state-level
institutions, SFCs and SIDCs claimed 6.5% and 3.5% respectively.
The area of operation of development almost covers all key sectors of the
economy, i.e., agriculture, small industries, rural industries medium and
large industries, infrastructure, housing, export and import trade, shipping,
‘capital market stock exchange, saving, investment, insurance, credit
guarantee, financial service etc. Special institutions have cropped up to
foster development a special area of activities. The financial institutions
have even setup institution to rehabilitate sick enterprises.
By and large, a greater slice of domestic savings are mopped up by
commercial banks (` 4,75,000 crores), Unit Trusts of India (` 65,000
crores), Life Insurance Corporation (` 90,000 crores), General Insurance
(` 20,000 crores), and mutual funds and other financial companies
(` 1,00,000 crores). Even IDBI, ICICI, SIDBI have commenced mopping
up deposits from the public. The aggregate resources available for
investment with financial institutions adds up to over 7,50,000 crores.
Sources of funds (long-term funds) for development are given in the
following:
(I) Financial assistance to entrepreneurs is granted by commercial
banks, State Financial Corporations, State Directorate of
Industries, National Small Industries Corporation, state Small
Industries Corporations, and all-India development banks.
NOTES (II) Credit facilities granted, by commercial banks and State Financial
Corporations are covered under the Credit Guarantee Scheme for
Industries, which offers protection to credit institutions against
possible loss on their lending to this sector.
(III) Institutional agencies grant financial assistance to SSI all-scale
industrial units for:
1. Participation in equity capital.
2. Acquisition of fixed assets by way of term loans; and
3. Working capital.
12.4 INDUSTRIAL FINANCE CORPORATION OF

INDIA (IFCI)
Incorporation and Purpose

The Industrial Finance Corporation of India (IFCI) was established in 1948
under an Act of Parliament with the object of providing medium and long-
term credit to industrial concerns in India. IFCI transformed into a
corporation from 21st May, 1993 to, provide greater flexibility to respond
to the needs of the rapidly changing financial system.
Management
The Board of Directors consists of a whole-time Chairman and twelve
directors.
The Chairman is appointed by the Central Government after consultation
with the IDBI. Two directors are nominated by the Central Government
and four by the IDBI. Six Directors are elected by shareholders other than
the IDBI.
Financial assistance provided by the IFCI can be in one or more of the
following forms:
 Rupee and foreign currency term loans.
 Underwriting of share and debenture issues.
 Direct subscription to equity.
 Guarantees.
 Soft loans.
 Equipment financing.
Projects costing up to ` 300 lakh are financed by the State Financial
Corporations, State Industrial Development Corporations and Commercial
banks under the refinance scheme of the IDBI. Only projects costing in NOTES
excess of ` 300 lakh are considered for assistance by the IFCI.
Forms of Assistance
Section 23 of the IFCI Act outlines the types of activities, which the
Corporation is authorised, to undertake. These are indicated below with the
year in which it was authorised to undertake each type of activity shown
within the brackets.
1. Granting loans on subscribing to debentures repayable within a
period not exceeding 25 years. (1948).
2. Underwriting the issue of stock, shares, bonds or debentures by
industrial concerns provided that it does not retain any shares, etc.,
which it may have had to take up in fulfilment of its underwriting
liabilities beyond a period of 7 years except with the permission
of the Central Government (now the IDBI).
3. Guaranteeing loans raised by industrial concerns, which are
repayable within a period not exceeding 25 years and are floated
in the market. raised by industrial concerns from Scheduled
Banks or State Cooperative Banks (1960).
4. Guaranteeing deferred payments due from any industrial concern
(a) In connection with the import of capital goods from outside
India.
(b) In connection with the purchase of capital goods within India.
5. Guaranteeing loans (with the prior approval of the Central
Government) raised from, or credit managements made with, any
bank or financial institution in any country outside India by
Industrial concerns in foreign currency (1960).
6. Acting as agent for the Central Government or, with its approval,
for the International Bank for Reconstruction and Development
(IBRD) in respect of loans granted or debentures subscribed by
either of them (1952).
7. Subscribing to the stock or shares of any industrial concern
(1960).
Functions and Lending Policies

Any limited company or co-operative society incorporated and registered
in India which is engaged, or proposes to engage itself, in the manufacture,
preservation or processing of goods, or in the shipping, mining or hotel
NOTES industry, or in the generation or distribution of electricity or any other

form of power, is eligible for financial assistance from the Cooperation on
the same basis as industrial projects in the private and joint sectors.
Public sector projects are also eligible for financial assistance from the
Corporations on the same basis as industrial projects in the private and
joint sectors.
The assistance may take the form of long-term loans both in rupees and
foreign currencies, the underwriting of equity, preference and debenture
issues; subscribing to equity, preference and debenture capital;
guaranteeing of deferred payments in respect of machinery imported form
abroad or purchased in India. And guaranteeing of loans aided in foreign
currency from foreign financial institutions, financial projects and for the
expansion, diversification, renovation or modernisation of existing ones.
Financial assistance on concessional terms is available for the setting-up of
new industrial projects in industrially less developed districts in the
States/Union Territories notified by the Central Government.
Sources of Funds
The main sources of funds of the Corporation other than its own capital
retained earnings, repayment of loans and sale of investments are
borrowings from the market by the issue of bonds, loans from the Central
Government and foreign credits.
In its development role, the Industrial Finance Corporation has undertaken
various promotional activities. The resources for financing such activities
come from the benevolent ‘Reserve Fund which was created in terms of an
amendment of the IFC Act in 1972, and from the allocation of the Interest
Differential Funds by the Government. The Interest Differential Funds are
received in the form of loans and grants on a 50:50 basis under an
agreement entered into by the Government of India with the Government
of the Federal Republic of Germany in respect of lines of credit from the
Kreditrnstalt für Wiederaufbau allocated to the Corporation from time to
time. The promotional activities undertaken by the Corporation which are,
no doubt, still modest in their scope are in consonance with the measure
which need to be taken to achieve the objective of broadening the
entrepreneurial bases in the country, particularly in less developed areas.
The promotional activities, undertaken by the Corporation are briefly
reviewed here.
The Corporation’s Technical Assistance Scheme for training middle level NOTES
executives of the State financial and development agencies and the senior
executives of these organisations continues to elicit a good response
because it has been found to be very useful. Since the inception of the
scheme in 1971, 78 middle level executives from 33 state level institutions
and 43 senior executives from 28 state level institutions have availed
themselves of the scheme, which aims at acquainting them with the
policies, procedures and practices of the Corporation.
New Promotional Schemes

In 1989, the Corporation framed two new schemes of promotional
activities, which encourage new entrepreneurs and technologists to set up
their own industries, and which assist in the growth of indigenous
technology and small industries. The scheme for encouraging the
development of ancillary industries was liberalised.
The present positions is that IFCI has fourteen Promotional Schemes, of
which eight are consultancy fee subsidy schemes, four interest subsidy
schemes and two entrepreneurship development schemes, as per details
given below:
Consultancy Fee Subsidy Schemes

 Scheme of subsidy to small entrepreneurs in the rural, cottage,
tiny and small sectors for meeting cost of feasibility studies, etc.
 Scheme of subsidy for consultancy to industries relating to
animal husbandry, dairy farming, poultry farming and fishing.
 Scheme of subsidy for consultancy to industries based on or
related to agriculture, horticulture, sericulture and pisciculture.
 Scheme of subsidy for promotion of ancillary and small-scale
industries.
 Scheme of subsidy to new entrepreneurs for meeting cost to
market research surveys.
 Scheme of subsidy for Providing Marketing Assistance to Small
Scale Units.
 Scheme of subsidy for Consultancy on Use of Non-Conventional
Sources of Energy and Energy Conservation Measures.
 Scheme of Subsidy for Control of Pollution in the Village and
Small Industries Sector.
NOTES  Own generation by way of repayment of past borrowings and

plough-back of profits.
Interest Subsidy Schemes

 Scheme of Interest Subsidy for Self-Development and Self-
Employment of Unemployed Young Persons.
 Scheme of Interest Subsidy for Women Entrepreneurs.
 Scheme of Interest Subsidy for Encouraging Quality Control
Measures in Small Scale Sector.
 Scheme of Interest Subsidy for Encouraging the Adoption’ of
Indigenous Technology.
Entrepreneurship Development Schemes

 Scheme for Encouraging Entrepreneurship Development in
Tourism and Tourism-related Activities.
 Scheme for Encouraging Self-Employment amongst Persons
Rendered Jobless due to Retrenchment or Rationalisation in a
Sick Industrial Unit in the Organised sector Undergoing a Process
of Rehabilitation/Revival.
The Consultancy for Subsidy Schemes is aimed at providing subsidised
consultancy services to industrial units, largely in Village and Small
Industries’ (VSI) Sector through Technical Consultancy Organisations
(TCOs). The Interest Subsidy Schemes are intended to provide
encouragement to self-development and self-employment to unemployed
youths, women entrepreneurs adoption of quality control measures,
amassing the indigenously available technology etc. The Entrepreneurship
Development Schemes envisage ‘giving impetus to self-employment in
tourism related activities in the small scale sector, and help in mitigating
the suffering of people, who have to face retrenchment due to
implementation of modernisation, rehabilitation and revival plans in the
case of potentially viable sick units, by process of retaining or self-
employment avenues.
12.5 THE INDUSTRIAL DEVELOPMENT BANK

OF INDIA (IDBI)
The Industrial Development Bank of India (IDBI) was established on
1 July, 1964 under the Industrial Development Bank of India act, as a
wholly owned subsidiary of the reserve bank of India. In terms of the NOTES
public financial institutions laws (Amendment) Act, 1975, the ownership
of the IDBI has been transferred to the Central Government with effect
from 16th February 1976. The most distinguishing feature of the IDBI is
that It has been assigned the role of the principal financial institution for
co-ordinating, in conformity with national priorities, the activities of the
institutions engaged in financing, promotion or developing industry. The
IDBI has been assigned a special role to play in regard to industrial
development.
Objectives
 To serve as an apex institution for term finance for industry, to
co-ordinate the working of institutions engaged in financing,
promoting or developing industries and to assist in the
development of these institutions.
 To plan, promote and develop industries to fill gaps in the
industrial structure in the country.
 To provide technical and administrative assistance for promotion,
management or expansion of industry.
 To undertake market and investment research and surveys.
 Co-ordination, regulation and supervision of the working of other
financial institutions such as IFCI, ICICI, UTI, LIC, Commercial
Banks and SFCs.
 Supplementing the resources of other financial institutions and
thereby widening the scope of their assistance.
 Planning, promotion and development of key industries and
diversifications of industrial growth.
 Devising and enforcing a system of industrial growth that
conforms to national priorities.
Function
1. The IDBI has been established to perform the following functions
2. To grant loans and advances to IFCI, SFCs or any other financial
institution by way of refinancing of loans granted by such
institutions which are repayable within 25 year.
NOTES 3. To grant loans and advances to scheduled banks or state co-

operative banks by way of refinancing of loans granted by such
institutions which are repayable in 15 years.
4. To grant loans and advances to IFCI, SFCs, other institutions,
scheduled banks, state co-operative banks by way of refinancing
of loans granted by such institution to industrial concerns for
exports.
5. To discount or rediscount bills of industrial concerns.
6. To underwrite or to subscribe to shares or debentures of industrial
concerns.
7. To subscribe to or purchase stock, shares, bonds and debentures
of other financial institutions.
8. To grant line of credit or loans and advances to other financial
institutions such as IFCI, SFCs, etc.
9. To grant loans to any industrial concern.
10. To guarantee deferred payment due from any industrial concern.
11. To guarantee loans raised by industrial concerns in the market or
from institutions.
12. To provide consultancy and merchant banking services in or
outside India.
13. To provide technical, legal, marketing and administrative
assistance to any industrial concern or person for promotion,
management or expansion of any industry.
14. Planning, promoting and developing industries to fill up gaps in
the industrial structure in India.
15. To act as trustee for the holders of debentures or other securities.
Subsidiaries
The following are the subsidiaries of IDBI
1. Small Industries Development Bank of India (SIDBI)
2. IDBI Bank Ltd.
3. IDBI Capital Market Services Ltd.
4. IDBI Investment Management Company
Capital Structure and Operations NOTES
As on September 30, 1996, the authorised Capital of IDBI was ` 2,000

crores. Issued, subscribed and paid up share capital was ` 828.76 crores.
Reserves were ` 6,309 crores. Loan funds were ` 35,450 crores. The total
outstanding loans, investments and guarantee of IDBI stood at ` 39,221
crore as on 31st March 1996.
Functions: Specials
(A) To act as lender of last resort and to finance all types of industrial
concerns which are engaged, or which propose to be engaged, in
the manufacture, processing or preservation of goods, or in
mining, shipping, transport, hotel industries, or in the generation
distribution of power, in fishing or in providing shore fishing, or
in the maintenance, repairs, testing or servicing of machinery or
vehicles, vessels, etc., or for the setting-up of industrial estates.
The Bank may also assist industrial concerns engaged in the
research and development of any process or product or in
providing special or technical knowledge or other services for the
promotion of industrial growth. Besides, it provides finance or
the export of engineering goods and service on deferred payment
basis.
(B) The IDBI has been playing a significant role in the promotion of
small-scale industries. Its assistance has been channelled through
its scheme for the refinance of industrial loans, and to a limited
extent, through the Bills Rediscounting Scheme. Since its
inception, the lost has been playing a significant role in the
promotion of small scale industries.
Its assistance has been channelled through its scheme for the
refinance of industrial loans, and to a limited extent, through the
Bills Rediscounting Scheme. Since its inception, the IDBI has
been operating a special scheme of concessional assistance to the
small-scale sector. The procedure in respect of loans to the small-
scale sector has been put on a semi automatic basis under the
Liberalised Refinance Scheme (LRS). As a result of the
progressive liberalisation and simplification of its refinance
operations, its assistance to the small-scale sector has increased
substantially since 1971-72. Its assistance to the small and
medium industrial units flows through 18 SFCs and 28 SIDCs,
commercial banks and regional rural banks.
NOTES IDBI Schemes

IDBI is having the following schemes for the benefit of enterprise and
entrepreneurs in the small and medium scale sector:
Direct Assistance
Project finance scheme (loans, underwriting, direct subscription and
guarantees); Project Finance Scheme (loans, underwriting, direct
subscription and guarantees).
Modernisation Assistance Scheme for all industries;
Textile Modernisation Fund Scheme;
Technical Development Fund Scheme;
Venture Capital Fund Scheme;
Energy Audit Subsidy Scheme;
Equipment Finance for Energy Conservation Scheme;
Equipment Finance Scheme;
Foreign Currency Assistance Scheme.
Indirect Assistance
Refinance Scheme for Industrial Loans for Small and Medium Industries;
Refinance Schemes for Modernisation and Rehabilitation of Small and
Medium Industries;
Equipment Refinance Scheme;
Bills: Discounting/Rediscounting Scheme;
Seed Capital Scheme;
Scheme for Concessional Assistance for Development of New-Industry in
Districts and Other Backward Areas;
Scheme for Concessional Assistance for Manufacture and Industrialisation
of Renewable Energy Systems;
Scheme for Investment Shares and Bonds of Other Financial Institutions.
Sources of Funds
Capital Contribution from Government;
Loan Capital from Government;
Loan Capital from RBI out of National Industrial Credit (Long Term NOTES
Operation) Fund created out of its annual profits;
Borrowings by way of Government-guaranteed bonds from domestic
market;
Borrowings in foreign currency from international capital market;
Deposits under Investment Deposit Account Scheme in lieu of investment
allowance under Section 32-AB of Income-tax Act;
3-year IDBI Capital Bond Scheme. Own generation by way of repayment
of past borrowings and plough-back of profits.
Soft Loan Scheme

The IDBI extends soft loans to units in selected industry groups, namely,
cotton textiles, jute, cement, sugar and specified engineering industries to
enable them to overcome the backlog in modernisation, replacement and
renovation of plant and machinery so that they may achieve higher and
more economic levels of production and improve their competitiveness.
The scheme is operated in participation with the IFCI and the ICICI, with
the overall responsibility vesting in the IDBI. The IFCI is the lead
institution for jute and sugar industries, the ICICI for engineering and the
IDBI for cotton textiles and cement industries.
The loans under the Soft Loan Scheme are extended on concessional terms
not only in regard to the interest but also in regard to the promoter’s
contribution, debt equity ratio, initial moratorium and repayment period. In
pursuance of the decision taken by the Government of India, loans under
this scheme have been exempted from the convertibility stipulation.
ICICI The Industrial Credit and Investment Corporation of India:
The ICICI (Industrial Credit and Investment Corporation of India) was
conceived as a private sector development bank in 1955 with the primary
function of providing development finance to the private sector. Its
objectives now include:
 assisting in the creation, expansion and modernisation of such
enterprises;
 encouraging and promoting the participation of private capital,
both internal and external, in ownership of industrial investment
and the expansion of investment markets.
NOTES  Apart from its head office at Mumbai, the ICICI has four regional
offices located at Mumbai, Kolkata, Chennai and New Delhi.
Financial assistance is being provided by ICICI in the following forms:
 Rupee and foreign currency term loans
 Underwriting of share and debenture issues
 Direct subscription to equity
 Guarantees
 Soft loans
 Suppliers line of credit for promoting sale of industrial equipment
on deferred payment terms
 Lease financing
 Financial Indo-US joint ventures in research and development.
 In practice only such projects costing in excess of ` 300 lakhs are
considered for financial assistance by the ICICI. However, for
purpose of foreign currency loans, no minimum project cost
restriction is imposed.
12.6 FINANCE FOR INDUSTRY

Over the past thirty years, the ICICI, in pursuit of its objective of
promoting industrial development, has provided financial assistance in
various forms, such as:
 Underwriting of public and private issues and offers of sale of
industrial securities ordinary shares, preference shares, bonds and
debenture stock;
 Direct subscription to such securities;
 Securing loans in rupees, repayable over periods up to 15 years.
 Providing similar loans in foreign currencies for the payment for
imported capital equipment and technical services;
 Guaranteeing payments for credits made by others;
 Providing credit facilities to manufacturers for the promotion of
the sale of industrial equipment on deferred payment terms.
The primary purposes for which assistance is extended is the purchase of
capital assets in the form of land, buildings and machinery. Of the
alternative types of assistance provided by the ICICI, the one best NOTES
calculated to assure the success of enterprise is chosen in each case.
Any company with a limited liability (or the promoter of such a company),
any sole proprietary concern, partnership firm or any cooperative society
may approach the ICICI for assistance in financing a sound proposal for
the establishment, expansion or modernisation of an industrial enterprise.
The applicant may be an Indian or foreigner; his plans may provide for
invent in any part of India; he may require assistance in any form. He must,
however, be prepared to make a reasonable contribution to the resources
required for the implantation of his proposal. The enterprise should have,
or should undertake to obtain, experienced management and expert
technical personnel and advice. Special consideration is given to projects
promoted by new entrepreneurs and those who desire to set up industries
in backward areas.
There are neither firm limits to the size of the enterprise the ICICI is
prepared to assist, nor is there a maximum or a minimum limit to the
assistance that it may offer. In practice, the lower limit of the finance
provided by the ICICI is set at ` 5 lakh because there are other institutions
which provide assistance for smaller amounts. However, to meet the
requirements of industry for loans in foreign currency, the ICICI may offer
assistance for smaller amounts. However, to meet the requirements of
industry for loans in foreign currency, the ICICI may offer assistance
below this limit. At the upper end, prudence requires that it limit the
proportion of its resources, which it can safely invest in a single enterprise.
However, no proposal is too large for the ICICI to handle, it is prepared to
enlist the cooperation of other financial institutions, in India and abroad, to
share in the investment.
In promoting industrial investment, the ICICI is anxious not only to invest,
but also to encourage others to invest. Accordingly, it seeks to encourage
other financial institutions and individuals, both Indian and foreign, to co-
operate with it in its investment and lending operations.
In order to promote new industries, to assist in the expansion and
modernization of existing industries, and to furnish technical and
managerial assistance, the ICICI grants long term and medium term loans,
subscribes to shares, underwrites new shares and debentures, guarantees
loans from other private investment sources, and provides managerial and
technical advice. ICICI also provides assistance by way of suppliers credit,
equipment, leasing, installment sale and venture capital and renders merchant
banking services. Technology, Development and Information Company of
NOTES India Ltd. (TDICI), established by ICICI in 1988, provides technological

information and finances technology intensive development activities
including commercial R&D schemes. It also manages the venture capital fund
of ` 20 crores that ICICI had established along with UTI in 1988.
12.7 THE NATIONAL BANK FOR AGRICULTURE

AND RURAL DEVELOPMENT: NABARD
The Preamble of the National Bank for Agriculture and Rural
Development Act sets out the objectives for establishing the new
institution. To quote, an Act to establish a bank to be known as the
National Bank of Agriculture and Rural Development for providing credit
for the promotion of agricultural, small-scale industries, cottage and
village industries, handicrafts and other rural crafts and other allied
economic activities in rural areas with a view to promoting integrated rural
development and securing prosperity of rural areas, and for matters
connected therewith or incidental thereto.
Establishment of the National Bank

The establishment of the National Bank for Agriculture and Rural
Development (commonly known as ‘NABARD’ and referred to as the
National Bank in this book) was the outcome of the acceptance of the
recommendation in this behalf contained in the - Interim Report of the
Committee to Review Arrangements for Institutional Credit for
Agriculture and Rural Development constituted by the Bank in
consultation with the Central Government in 1979. The Bill for setting up
the institution was passed by the Parliament in December 1981 and the
National Bank came into existence on July 12, 1982.
The Committee envisaged that the new apex bank would be an
organisational service for providing undivided attention, forceful direction
and pointed focus to the, credit problem arising out of the integrated
approach to rural development. The committee recommended that the new
bank take over from the Reserve Bank the overseeing of the entire rural
credit system, including credit for rural artisans and village industries, and
the statutory inspection of co-operative banks and Regional Rural Banks
on an agency basis; the Bank continuing to retain its essential controls.
The new bank was to have organic links with the Reserve Bank by virtue
of the latter contributing half of its share capital (the other half being
contributed by the Central Government), and three members of the Central
Board of Directors of the Reserve Bank being appointed on its board, NOTES
besides a Deputy Governor of the Reserve Bank being appointed as its
chairman. The Committee envisaged the role of the Reserve Bank as one
of spawning, fostering and nurturing the new bank, in much the same way
as it did earlier in the case of the Agricultural Refinance and Development
Corporation.
On its establishment, the National Bank has taken over the entire
undertaking of the Agricultural Refinance and Development Corporation
and has taken over from the- Reserve Bank its refinancing functions in
relation to the State Cooperative Rural Banks. This Bank is now the
coordinating agency in relation to the Central Government, planning
Commission, state government institutions at all-India level and State level,
engaged in the development of small-scale industries, village and cottage
industries, rural crafts, etc., for giving effect to the various policies and
programme relating to rural credit.
Capital and Management

The capital of the National Bank is ` 500 crores, subscribed by the Central
Government and the Reserve Bank in equal proportions. In terms of the Act,
the Board of Directors will consist of fifteen members to be appointed by
the Central Government in consultations with the Reserve Bank may
maintain and will comprise, besides the chairman and the managing
director, three directors from the Central Board of the Reserve Bank, three
officials of the Central Government, two officials of the State Governments
and five directors from among experts in rural economics, rural
development, handicrafts and village and cottage industries, etc., and
persons with experience in the working of co-operative banks and
commercial banks. The Act provides for constitution by the Board of an
Advisory Council consisting, of the directors of the National Bank and
other persons having special knowledge of subjects which is considered
useful to the bank, to tender advice and discharge many functions allotted
to it. In effect, the Advisory Council will perform functions similar to those
entrusted to the Agricultural Credit Board set up by the Reserve Bank.
Operations
The National Bank is empowered to provide short-term refinance
assistance for periods not exceeding 18 months to State co-operative banks,
Regional Rural Banks and any financial institutions approved by the
Reserve Bank in this behalf, for a wide range of purposes, including
NOTES marketing and trading, relating to rural economy. These short-term loans
granted to State cooperative banks and Regional Rural Banks, intofar as
they relate to the financing of agricultural operations or marketing of crops,
can be converted by the National Bank into medium term loans for periods
not exceeding seven years under conditions of drought, famine or other
natural calamities, military operations or enemy action.
Likewise, the National Bank may also provide assistance by way of loans
and advances up to seven years to the financing institutions where it is
satisfied that owing unforeseen circumstances the rescheduling of any
short-term loans and advances made to artisans, small-scale industries,
village and cottage industries etc., by the financing institutions is necessary.
The, National Bank can grant medium-term loans to the State cooperative
banks and Regional Rural Banks for periods extending from 18 months to
7 years for agriculture and rural development and such other purposes as
may be determined by it from title to time subject, in the case of loans to
State co-operative banks, to their, being fully guaranteed by the State
Governments as to the repayment of principal and payment of interest.
Such guarantees can, however, be waived by the National Bank in certain
circumstances.
The national bank is empowered to provide by way of refinance assistance,
long term loans extending up to a maximum period of 25 years including
the period of rescheduling of such loans, to the state land development
banks, regional rural banks, scheduled commercial banks, state co-
operative banks or any other financial institutions approved by the reserve
banks, for the purpose of making investment loans, as well as for give
short term loans along with long term loans where such composite loans
are considered necessary. Loans for periods not exceeding 20 years can be
made to the state governments to enable them to subscribe directly or
indirectly to the share capital of co-operative credit societies. Moreover,
the new bank can contribute to the share capital or invest in the securities
of any institution concerned with agriculture and rural development.
The outstanding amounts, as on the date of transfer of business to the
national bank, in respect of loans and advances granted by the Reserve
Bank to the state co-operative banks and regional rural banks under section
17 of the Reserve Bank of India. The outstanding loans and advances
granted by the Reserve Bank out of the National Agricultural Credit (Long
Term Operations) Fund and the National Agricultural Credit (Stabilisation)
Fund to the State Governments, State co-operative banks and the
Agricultural Refinance and Development Corporation have been NOTES

transferred to the National Bank.
Resources
For its short-term operations, the National Bank will borrow funds from
the Reserve Bank in the form of a line of credit under Section 17 (4E) of
the Reserve Bank of India Act, which permitted the Reserve Bank to grant
short-term loans to the Agricultural Refinance and Development
Corporation earlier, and which has now been amended suitably by the
National Bank for Agriculture and Rural Development Act. For its term
loan operations, the National Bank will draw funds, as the Corporation
was doing earlier, from the Central Government, the World Bank/IDA and
other multilateral and bilateral aid agencies the market and the National
Rural Credit (Long Term Operations).
The balance in the National Agriculture Credit (Stabilisation) fund has
been similarly transferred by the Reserve Bank to the National Bank for
credit to the newly established National Credit (Stabilisation) Fund which
will be maintained by annual contributions by both the Reserve Bank and
the National Bank as well as by contributions from the Central and state
Governments from time to time.
The methods of raising funds include sale of bonds and debentures, direct
borrowing, acceptance of deposits, and receipt of gifts, grants, etc. The
national bank may borrow foreign currency from any bank or financial
institution in India or abroad with the approval of the Central Government
which will guarantee such loans.
12.8 THE SMALL INDUSTRIES DEVELOPMENT

BANK OF INDIA (SIDBI)
The idea of setting up Small Industries Development Bank of India
(SIDBI), in response to a long standing domain from the small scale sector
as an apex level national institution for promotion, financing and
development of industries in the small scale sector, embodied an
opportunity to set up proactive, responsive and forward looking institution
to serve the current and emerging needs of small scale industries in the
country. As a precursor to the setting up of the new institution, the small
industries development fund was cleared by industrial development fund
created by Industrial Development Bank of India (IDBI) in 1986
exclusively for refinancing, bills rediscounting and equity support to the
small scale sector.
NOTES The outstanding portfolio of the order of ` 4,200 crore from IDBI was
transferred to SIDBI in March 1990. SIDBI started off from a strong base;
percentage of IDBI, banking of a special statute, the Small Industries
Development Bank of India act of 1989, a large capital base of ` 450 crore,
availability of experienced manpower endowed with development banking
skills carved out of IDBIs professional staff and ready availability of a cast
network of institutional infrastructure and enduring financial linkages with
State Financial Corporations (SFCs), commercial banks and other
institutions; all these augured well for the growth of the nascent institution.
SIDBI became operational on April 2, 1990.
The Environment
Indian economy has been in transition for most part of the last five years:
the industrial policy, fiscal policy, public sector policy, foreign investment
policy, trade policy and monetary and credit policies have been in various
stages of liberalisation. Decontrol, deregulation and delicensing have given
enormous scope for private initiative and market forces to come to play.
New relationships within and between different sectors in the economy are
being evolved; the small-scale sector has been an important constituent of
such a liberalisation in the country. Government of India formulated a set
of new policies aimed at harnessing the potential of the small-scale sector
in August 1991 a year and-half after the establishment of SIDBI. The
prescriptions of the policy focused at removal of implements affecting the
growth of small-scale sector together. With consolidation of the strengths,
in the context of the emerging economic order, SIDBI has been refining its
strategies and business policies in alignment with the policy, changes that
have been taking place at the national level.
Operational Strategy
Stepping up of flow of credit to the units in the small scale sector through
direct and indirect financing mechanisms and ensuring speedy
disbursement have remained the, main plank of the operational strategy of
SIDBI. Over the years, the share of direct assistance in the total assistance
has steadily gone up.
Share: %
1990- 1991- 1992- 1993- 1994- 1995- 1996- 1997-

91 91 93 94 95 96 97 98
Indirect 95 91 79 59 41 66 64 64
assistance
Direct 5 9 21 41 59 34 36 36 NOTES
assistance
Shift in Business Mix

The new schemes designed and implemented were directed at filling the
gaps in the existing credit delivery system focusing on new target groups
and activities. These are targeted at addressing some of the major problems
of SSIs, in areas such as marketing, infrastructure development, delayed
realization of bills, ancillarisation, obsolescence of technology, quality
improvement, export financing and venture capital assistance. The terms
of assistance under various schemes have been substantially liberalised
based on ongoing review process. The procedures have been simplified
with gradual decentralization and progressive levels of operational
efficiency and better customer service.
[SSIs on account of delayed payments, two factoring companies, viz., SBI
factors and Commercial Services Pvt. Ltd. And can bank factors Ltd. have
been established with SIDBI as a partner with 20% shareholding, SIDBI]
12.9 INVESTMENT TRUSTS

Meaning
Investment Trusts are investment institutions which are formed to provide
to investors, particularly smaller ones having small savings, the benefits of
diversified investment and skilled management in the sphere of investment
in industrial securities.
These institutions sell their shares or units to small investors to mobilise
their savings. These savings are invested in shares, debentures, bonds and
loans of profit-making joint stock companies. The investments are
diversified, that is, made in securities of a sufficiently large number of
companies, generally from different industries, using professional
management skills. This reduces the investment risk and ensures
reasonable income from the investments. The trust receives income from
investments by way of dividend on shares, interest on debentures, bonds
and loans and profit on sale of securities. After meeting the management
expenses, the income of the trust is distributed among the investors.
Thus the investment trusts, on the one hand, enable small investors to
participate in the industrial prosperity of the country, and on the other hand,
NOTES enable joint stock companies to obtain financial resources from wider
sources.
Types of Investment Trusts

Investment trusts are basically of the following two types:
1. ‘Open-end’ Investment Trusts
In U.K, such trusts are known as ‘Unit Trust’ while in USA, they
are commonly known as ‘Mutual funds’. The distinguishing
characteristics of such trusts are:
There is a definite arrangement under which the trust
continuously offers to sell fresh shares or units at a price based on
the net asset value of the underlying securities.
There is also a definite arrangement under which the trust buys
back its own shares or units at a price based on the net asset value
of the underlying securities.
The income of the trust is divided among the unit holders or
shareholders of the trust after meeting management expenses.
2. ‘Closed-end’ Investment Trusts
The distinguishing characteristics are as under-
These Trusts do not continuously sell their shares or units;
They also do not buy back their shares or units;
The shares or units of the trust are listed on stock exchanges and
can be bought and sold like shares of any other company;
The market value of shares or units of these trusts depends upon
the market forces of demand and supply;
Such institutions can also raise loans to make investments;
They may plough back a part of their profits.
12.10 UNIT TRUST OF INDIA (U.T.I.)

The Unit Trust of India is a statutory public sector investment institution
established under the Unit Trust of India Act, 1963. From 1st July 1964.
Capital : Source.
NOTES
Industrial Development Bank of India
Industrial Finance Corporation of India
ICICI
Industrial Investment Bank of India
Life Insurance Corporation of India
Unit Trust of India
General Insurance Corporation
L State Financial Corporations

O
N
State Industrial Development Corporation
G
T Commercial Banks
E
R HDFC
M
HUDCO
F
U IFO (W)
N Risk Capital Foundation
D
S Shipping Development Fund
Committee
Export-Import Banks of India
NABARO
SIDBI
Foreign Collaborators
With the amendment of the Public Financial Institutions Laws, the

contribution made by RBI to the initial capital and the control exercised by
it are vested in the IDBI with effect from 16th Feb. 1976.
12.11 NATURE OF THE TRUST: UNIT TRUST

OF INDIA: UTI
The Unit Trust of India is an investment trust. It mobilises the savings of
people through sale of units. The savings as collected are invested in the
shares and debentures of profit-making companies. The income received
by the trust by way of interest and dividend is passed on to the unit holders
by way of dividend after meeting management expenses of the trust. The
NOTES small savers get benefit by participating in the investment schemes of UTI
and thus in the industrial prosperity of the country. Investment through
UTI results in lower risk of loss and higher return on investments due to
professional management by UTI.
What are units?

The total investment made by UTI in industrial securities (shares,
debentures and bonds) is divided into smaller parts called ‘units’. The Unit
Trust of India sell units under different schemes and also buys back its
own units at the purchase price fixed by it from time to time. Units have a
face value of ` 10 each.
Objectives
The main objectives of UTI are as under:
 To encourage savings of people belonging to middle and low
income groups;
 To mobilise savings from the small savers;
 To channellise savings to industrial growth;
 To allow investors to participate in the prosperity of the industries.
Functions
The main functions of UTI are as follows:
 To mobilise the savings of the community through sale of units;
 To invest the savings so mobilised in corporate securities such as
shares and debentures, etc;
 To serve unitholders along the length and breadth of the country;
 To underwrite the issue of shares and debentures.
12.12 INDUSTRIAL CREDIT AND INVESTMENT

CORPORATION OF INDIA (ICICI)
Industrial Credit and Investment Corporation of India was established as a
joint stock company in the private sector in 1955. Its share capital was
contributed by banks, insurance companies and foreign institutions
including the World Bank. Its major shareholders now are Unit Trust of
India, Life Insurance Corporation of India and General Insurance
Corporation and its subsidiaries. They together hold approximately 50% of NOTES
the paid up share capital of ICICI.
Objectives
The ICICI has been established to achieve the following objectives:
 To assist in the formation, expansion and modernisation of
industrial units in the private sector;
 To stimulate and promote the participation of private capital
(both Indian and foreign) in such industrial units;
 To furnish technical and managerial aid so as to increase
production and expand employment opportunities;
 To assist in the development of the capital market through its
underwriting activities.
Functions
The primary function of ICICI is to act as a channel for providing
development finance to industry. In pursuit of its objectives of promoting
industrial development, ICICI performs the following functions:
 It provides medium and long-term loans in Indian and foreign
currency for importing capital equipment and technical services.
Loans sanctioned generally go towards purchase of fixed assets
like land, building and machinery;
 It subscribes to new issues of shares, generally by underwriting
them;
 It guarantees loans raised from private sources including deferred
payment;
 It directly subscribes to shares and debentures;
 It provides technical and managerial assistance to industrial units;
 It provides assets on lease to industrial concerns. In other words,
assets are owned by ICICI but allowed to be used by industrial
concerns for a consideration called lease rent.
 It provides project consultancy services to industrial units for new
projects.
 It provides merchant banking services.
NOTES  The corporation is empowered to provide any amount of financial

assistance to any business unit in the private sector, public sector,
joint sector or co-operative sector. Any company with limited
liability, any sole proprietary concern, partnership concern and
any co-operative society may approach the corporation for
assistance in financing a sound project. Normally it provides such
assistance within the range of self imposed limits. Accordingly,
` 5 lakhs is the minimum amount sanctioned by it to a single
concern and normally it does not go beyond the maximum limit
of Rupees one crore. However, no project is too large for ICICI to
handle. In promoting industrial investment, ICICI seeks to
encourage other financial institutions, both Indian and foreign, to
collaborate in its lending operations.
 Financial assistance granted and disbursed by ICICI over the
years have grown steadily. ICICI has disbursed a total financial
assistance of ` 4,225 crores during the three months period from
1st April 1998 to 30th June 1998. The total amount sanctioned
during this period is ` 9,135 crore.
ICICI has promoted the following institutions in recent years, showing
widening scope of activities of ICICI:
1. ICICI Securities and Finance Co. Ltd.
2. ICICI Asset Management Co. Ltd.
3. ICICI Investors Services Ltd.
4. ICICI Banking Corporations Ltd.
5. Credit Rating Information Services of India Ltd. (CRISIL)
6. Technology Development and Information Company of India Ltd.
(TDICI)
7. Programme for the Advancement of Commercial Technology and
(PACER)
12.13 LIFE INSURANCE CORPORATION OF

INDIA (LIC)
The Life Insurance Corporation of India. (LIC) was set up under the LIC
Act in 1956, as a wholly-owned Corporation of the Government of India,
on nationalisation of the life insurance business in the country. LIC took
over the life insurance business from private companies to carry on the NOTES
business and deploy the funds in accordance with the Plan priorities. LIC
operates a variety of schemes so as to extend social security to various
segments of society and for the benefit of individuals and groups from the
urban and rural areas. The Committee on Reforms in the Insurance Sector
set up by the Government has recommended privatisation and
restructuring of LIC with Government retaining 50% stake. The
Committee has also suggested that foreign companies be allowed to
conduct life insurance business in the country through joint ventures with
India partners.
According to the investment policy of LIC, out of the accretion to its
Controlled Fund, not less than 75% has to be invested in Central and State
Government securities including Government-guaranteed marketable
securities in the form of shares, bonds and debentures. LIC extends loans
for the development of socially-oriented sectors and infrastructure,
facilities like housing, rural electrification, water supply, sewerage and
provides financial assistance to the corporate sector by way of term loans
and underwriting/direct-subscription to shares and debentures. LIC also
extends resource support to other financial institutions by way of
subscription to their shares and bonds and also by way of term loans.
12.14 GENERAL INSURANCE CORPORATION OF

INDIA (GIC)
The General Insurance Corporation of India (GIC) was established in
January 1973 on nationalisation of general insurance companies in the
country. GIC has four subsidiaries, viz., National Insurance Co. Ltd., New
India Assurance Co. Ltd., Oriental Fire & General Insurance Co. Ltd. and
United India Insurance Co. Ltd. GIC and its subsidiaries operate a number
of insurance schemes to meet the diverse and emerging needs of various
segments of society. In the recent past, GIC and its subsidiaries devised
several need-based covers to keep pace with the new liberalised economic
environment. The investment policies of GIC and its subsidiaries have
been evolved within the ambit of the provision 27(B) of the Insurance Act
1938 and guidelines issued by the Government from time to time.
According to Government guidelines, 70% of the annual accretions to their
investible funds are required to be invested in socially oriented sectors of
the economy. Since April 1976, GIC has been participating with other
financial institutions in extending term loans to industrial undertakings and
NOTES providing facilities for underwriting/direct subscription to their shares and

debentures.
12.15 EXPORT-IMPORT BANK OF INDIA — EXIM

The Export Import Bank of India (Exim Bank) was set up on January 1,
1982 by an Act of Parliament as the principal financial institution for
promotion and financing of India’s International Trade. Exim Bank
finances exporters and importers, co-ordinates the working of institution
engaged in financing export and import of goods and services, finances
export-oriented units and undertakes promotional activities necessary for
international trade. It has a menu of 23 major programmes to meet the
needs of different customer groups, viz., Indian exporters overseas entities
and commercial banks. Exporters can avail of pre-shipment credit,
suppliers credit, and overseas investment finance; export product
development loans, loans for export marketing, bulk import finance and
investment vendors development finance. Foreign Governments and
agencies are offered buyers credit and lines of credit. To commercial banks
in India, Exim Bank offers export bills rediscounting facility, refinance of
suppliers credit and refining of term loans in respect of export-oriented
units. It also participates in guarantees issued by commercial banks on
behalf of Indian project exporters.
Besides providing finance, EXIM Bank promotes exports through advisory
and information services to exporters on procurement practices and
bidding procedures of multilateral institutions, country risk analysis,
merchant banking and marketing focused on catalysing exports of non-
traditional products to developed countries.
12.16 KHADI AND VILLAGE INDUSTRIES

COMMISSION (KVIC)
The Khadi and Village Industries Commission (KVIC), established by an
Act of Parliament in 1956, is engaged in the development of khadi and
village industries in rural areas. It has under its purview 26 village,
industries besides khadi. After amendment to the KVIC Act in July 1987,
the scope for coverage of activities was widened and as a consequence 70
more new village industries were identified and brought under its fold for
implementation. The main objectives of the KVIC are providing
employment in rural areas, skill improvement, transfer of technology,
building up of strong rural community base and rural industrialisation. The NOTES
significant characteristics of khadi and village industries under the purview
of KVIC lie in their ability to use locally available raw materials, local
skills, local markets, low per capita investment, simple techniques of
production, which can be easily adopted by the rural people, short
gestation period and above all production of consumer goods. KVI
activities serve the poorest of the poor comprising scheduled castes,
scheduled tribes, women, physically handicapped and minority
communities in difficult, inaccessible hill and border areas.
The development programmes of khadi and village industries are
implemented through 30 State Khadi and Village Industries Boards which
are statutory organisations, set-up under State legislation. 2,320
institutions registered under Societies Registration Act, 1860 and 29,813
Cooperative Societies registered under State Co-operative Societies Act.
KVIC also assists individuals through State KVI Boards. KVI programmes
now cover more than 2.1 lakh villages in the country.
Some of the notable developments in KVI activities during 1991-92 are
extension of special programme aimed at intensive development of KVI
through area approach under tie up with District Rural Development
Authority (DRDA) to more number of districts, improvement and up
gradation of KVI technology and quality of products, establishment of
linkage with an export company for exporting KVI technology on hand-
made paper and gur khandsari on turn-key basis, initiation of steps for
tapping distribution network of big business houses for marketing KVI
products, introduction of fabric-painted Khadi ready-made garments,
development of modified version of new model charkha by replacing all
its metal parts with high quality nylon and reinforced fibre material and
development of mini honey processing unit.
12.17 NATIONAL SMALL INDUSTRIES

CORPORATION LTD.: (NSIC)
The National Small Industries Corporation Ltd. (NSIC) was setup by the
Government of India in 1955 with the objective of promoting and
developing small scale industries in the country. Various activities
undertaken by NSIC include supply of indigenous and imported machines
on easy hire-purchase and lease terms, marketing of the products of small
industries on consortia basis, export marketing of small industries products,
developing export worthiness of small-scale units, enlistment of small
NOTES scale units for participation in Government stores purchase programme,

development and modernisation of prototypes of machines, equipment and
tools, supply and distribution of indigenous and imported raw materials,
training in various technical trades and co-operation with other developing
countries in setting-up of small scale projects on turn-key basis.
Activities of National Small Industries Corporation (NSIC)

Formerly, the Corporation had four subsidiary corporations at Delhi,
Mumbai, Kolkata and Chennai. However, since 1961, all the subsidiary
corporations have been amalgamated with the main Corporation, and three
Branch Offices have been set-up at Mumbai, Kolkata and Chennai. The
Delhi subsidiary corporation has been merged with the parent Corporation,
and its work is looked after by a separate Delhi Cell setup in it. The
National Small Industries Corporation provides a complete package of
financial assistance and support in the following areas:
 Supply of both indigenous and imported machines on easy hire-
purchase terms. Special concessional terms have been introduced
for units promoted by entrepreneurs from weaker sections of the
society, women entrepreneurs, ex-servicemen and those units
located in the backward areas.
 Marketing of small industries products within the country.
 Export of Small Industries products and developing export
worthiness of Small Scale Units.
 Enlisting competent units and facilitating their participation in
Government Stores Purchase Programme.
 Developing prototypes of machines, equipment and tools which
are then passed on to Small-Scale Units for commercial
production.
 Technical training several industrial trades, with a view to create
technical culture in the young entrepreneurs.
 Development and up gradation of technology and implementation
of modernisation programmes.
 Supply and distribution of indigenous and improved raw
materials.
 Supply of both indigenous and imported machines on easy lease
terms to existing units for diversification and modernisation.
 Providing of Common Facilities through Prototype Development NOTES

& Training Centres.
 Setting-up Small-Scale Industries in other developing countries
on turnkey basis.
NSIC
Machines on Hire- Quality Control & Technical

Purchase Marketing Standardisation Know-how
Foreign Government
Stores Purchase Training Assistance
Programme
With a view to giving a fillip to development efforts and to supplement the

activities of State Small Industries Corporations and District Industries
Service Institutes, the NSIC has opened its offices in some of the States in
which the (NSIC) Corporation has been hitherto under-represented. In the
central region, offices have been opened in Bhopal and Raipur in Madhya
Pradesh. Four development executives and six field inspectors have been,
recently posted in the backward areas of the western region to serve as
“contact points” and to work in close co-operation with DICs and other
developmental agencies in the area. Of these, three field inspectors have
been posted in Raigad, Ratnagiri, Satara, Yeomen, Chandrapur, Bhandara,
Buldhana, Aurangabad, Nanded, Seed, Osmanabad, etc. all backward
districts in Maharashtra.
NOTES A Unique Package of Assistance for Small Entrepreneurs

The NSIC has taken up the challenging task of promoting and developing
small industries almost from the scratch and has adopted an “integrated
approach” to achieve its socio-economic objectives. It has created a proper
“industrial” atmosphere and has infused confidence in the small
entrepreneurs to prepare schemes for the manufacture of products or
identify the balancing equipment for purposes of modernisation and or
diversification. The small unit, because it is small, is always short of
resources. The NSIC therefore, supplies machinery and equipment,
marketing inputs and technical support to small units. And so the seedling
comes up as a “factory” which provides jobs for the unemployed or
underemployed.
Over the years and particularly during this decade, the NSIC, with its
deliberate and concentrated efforts, has developed an unsurpassed
reputation of an effective and efficient nodal agency for providing
assistance to the vibrant Small-Scale sector. All these years, through, its
dynamic approach and the package of assistance, it has been significantly
contributing to the development of entrepreneurs, building up of strong
industrial base, spreading of technical culture, promoting balanced
regional growth, development of rural and backward areas, etc. as well as
in employment generation, in all parts of the country.
12.18 STATE INDUSTRIAL DEVELOPMENT

CORPORATIONS (SIDCs)
The State Industrial Development Corporations (SIDCs) were established
under the Company Act, 1956 in the sixties and early seventies as wholly-
owned State Government undertakings for promotion and development of
medium and large industries. SIDCs act as catalysts for industrial
development and provide impetus to further investment in their respective
States. SIDCs provide assistance by way of term loans, underwriting and
direct subscription to shares/debentures and guarantees. They undertake a
variety of promotional activities such as preparation of feasibility reports,
industrial potential surveys, entrepreneurship development programmes
and developing industrial areas/estates. SIDCs are also involved in setting
up of medium an large industrial projects in the joint sector in
collaboration with private entrepreneurs or as wholly owned subsidiaries.
The SIDC’s activities have now widened to include equipment leasing,
providing tax benefits under State Government’s Package Scheme of
Incentives, merchant banking services and setting-up of mutual funds. NOTES

Some of the SIDCs also offer a package of developmental services such as
technical guidance, assistance in plant location and coordination with other
agencies.
Of the 28 SIDCs operating in the country, nine are twin-function SDICs
functioning also as SFCs to provide assistance to small-scale units as well as
act as promotional agencies. The twin-function SIDCs are in Arunachal
Pradesh, Manipur, Meghalaya, Mizoram, Nagaland, Tripura, Goa, Pondi-
cherry and Sikkim. Seven SIDCs are also involved in infrastructure
development and other extensions services for the small sector.
The SIDCs are agent of IDBI and SIDBI for operating its seed capital
scheme. Under the scheme, equity type assistance is provided to deserving
first generation entrepreneurs who possess necessary skills but lack
adequate resources required towards promoter’s contribution.
The major functions of these Corporations include:
 Providing risk capital to entrepreneurs by way of equity
participation and seed capital assistance;
 Grant of financial assistance to industrial units by way of loans
and guarantees.
 Administering incentive schemes of Central/State Governments;
 Promotional activities such as identification of project ideas
through industrial potential surveys, preparation of feasibility
reports, selection and training of entrepreneurs; and
 Developing industrial areas/estates by providing infrastructure
facilities.
 Since the actual range of activities being undertaken by
individual SIDC depends upon the specific responsibilities
entrusted by the respective State/Union Territory, there is
considerable diversity in activities among the different SIDCs.
NOTES Risk Capital
Equity Participation
Financial Assistance
R
I
S
Developing Industrial Areas
K
Incentives
Functions of: SIDCS
12.19 STATE SMALL INDUSTRIES

DEVELOPMENT CORPORATIONS (SSIDCs)
The State Small Industries Development Corporations (SSIDCs)
established under the Companies Act, 1956, are State Government
undertakings, responsible for catering to the needs of the small, tiny and
cottage industries in the State/Union Territories under their justification.
SSIDCs enjoy operational flexibility and can undertake a variety of
activities for development of the small sector. As at present, 18 SSIDCs
are in operation.
Some of the important activities undertaken by SSIDCs includes:
(i) procurement and distribution of scarce raw materials, (ii)supply of
machinery on hire-purchase basis, (iii) providing assistance for marketing
of the products of small scale units, (iv) construction of industrial
estates/sheds, providing allied infrastructure facilities and their maintenance,
(v) extending seed capital assistance on behalf of the State Governments,
and (vi) providing management assistance to production units.
A change in the role of SSIDCs has been prompted by the new Industrial
Policy.
SSIDCs are gearing up to change themselves from raw material
distributors to organisations that will take care of various aspects of small
industry development, especially marketing. SSIDCs would, thus, help the
tiny and small industries increase their market share. The new policy calls
for establishment of counselling and common testing facilities and
provision of a mechanism to allow corporation of the latest technology in
the small sector. SSIDCs are also planning to set-up centres for display
of/and information dissemination on SSI products, and for providing small
office spaces for SSIs in need.
Information for the analysis/discussion that follows, pertains to 11 SSIDCs NOTES

located in Andhra Pradesh, Assam, Bihar, Goa, Gujarat, Jammu &
Kashmir, Himachal Pradesh, Kerala, Punjab, Rajasthan and Tamil Nadu.
12.20 STATE FINANCIAL CORPORATIONS (SFCs)

State Financial Corporations (SFCs), operating at the State-level, form an
integral part or the development financing system in the country. They
function with the objective of financing and. promoting small and medium
enterprises for achieving balanced regional socio-economic growth,
catalysing higher investment; generating greater employment opportunities
and widening the ownership base of industry.
At present, there are 18 SFCs in the country, 17 of which were set up
under the SFCs Act, 1951. Tamil Nadu Industrial Investment Corporation
Ltd., set up in 1949 under the Companies Act as Madras Industrial
Investment Corporation functions as a full-fledged SFC. SFCs extend
financial assistance to industrial units by way of term loans, direct
subscription to equity/debentures, guarantees, and discounting of bills of
exchange. SFCs operate a number of schemes of refinance and equity type
of assistance formulated by IDBI/SIDBI which include schemes for
artisans, special target groups like SC/ST, women, ex-servicemen, physical
handicapped, etc. and for transport operators, setting up hotels, tourism-
related activities, hospitals and nursing homes, etc. Over the years, the
SFCs have extended their activities and coverage of assistance.
Concerns Eligible for Assistance

Industrial concerns eligible for financial accommodation under the State
Financial Corporation Act, 1951 are those which are engaged in the
following activities (a) Manufacture of goods; (b) preservation of goods;
(c) processing of goods; (d) mining; (e) generation of distribution of
electricity or any other form of power; (f) hotel industry; (g) transport of
passenger or goods by road or by water or by air; (h) maintenance; repair,
testing or servicing of machinery of any description of vehicles or vessels
or motor boats or trawlers or tractors; (i) assembling, repairing or packing
any partied with the aid of machinery or power; (j) the development of any
contiguous area of land as an industrial estate; (k) fishing or providing
shore facilities for fishing or maintenance thereof; (l) providing special or
technical knowledge or other services for the promotion of industrial
growth.
NOTES SFCs extend financial assistance to industrial units buy way of term loans,
direct subscription to equity/debentures, guarantees and discounting of
bills of exchange. SFCs operate a number of schemes of refinance and
equity type of assistance formulated by IDBI/SIDBI which include
schemes for artisans, social target groups like SC/ST, women,
ex-servicemen, physically handicapped, etc. and for transport operators,
setting up hotels, tourism-related activities, hospitals and nursing homes,
etc.
Objectives and Functions

 The main function is to provide term loans for the acquisition of
land, building, plant and machinery.
 Promotion of self-employment.
 To encourage new and technically/professionally qualified
women entrepreneurs in setting up industrial projects.
 To finance expansion, modernisation and upgradation of
technology in the existing units.
 To provide financial assistance for the rehabilitation of sick units
financed by the Delhi Financial Corporation.
 To assist for the promotion or expansion of industry by the rural
and urban artisans.
 To provide financial assistance for transport vehicles strictly for
captive use, depending on the requirement of the projects.
 Providing seed capital assistance under the scheme of Industrial
Development Bank of India.
 Providing short-term loan to cover the equity gap to help small-
scale industrial units.
 Undertaking the various promotional activities, including the
organisation of entrepreneurial development programmes and
seminars etc.
 Interest subsidy for self-development, self-employment of young
persons, adoption of indigenous technology in small and medium
sector and encouraging quality control measures in small-scale
industry is also admissible to the extent of ` 5 lakhs.
 To promote development institutions in the state/region which
will accelerate the process of socio-economic growth.
Assistance NOTES
The state financial institutions offer a package of assistance to

entrepreneurs to enable them to translate their project idea into a reality.
The package of assistance may be broadly classified into two types of
services, developmental and financial. In addition, some SFCs also
implement package schemes of incentives to motivate and encourage
entrepreneurs.
12.21 COMMERCIAL BANKS

The Scheduled Commercial Banks (SCBs) in the country (299) comprise
State Bank of India and its associate-banks (8), nationalised banks (19),
private sector banks (34:) regional rural banks (196) and foreign banks,
(42). During 1994-95, ten more banks were given the status of SCBs status
entitles the banks to avail of certain over by Bank of India was excluded.
The SCB status entitles the banks to avail of certain facilities from RBI
such as refinance, loans and advances as also grand of authorised dealers
licenses to handle foreign exchange business. Correspondingly, banks also
have certain obligations such as maintenance of Cash Reserve Ratio,
Statutory Equinity Ratio and follow various banking regulations. As on
March 31, 1998, the total number of branches of SCBs stood at 64,267; of
these 32,890 (51.1 %) of the total) were in rural areas.
Total outstanding gross bank credit (food and non-food) at ` 3,24,079 crore
on March 31, 1998 was higher by 16.4% over the outstanding credit of
` 2,78,402 crore as on March 18, 1997 mainly due to marked expansion in
non-food credit which rise by 15.1 % to ` 3,11,594 crore forming 96.1% of
total outstanding gross bank credit as against 93.4% on March 18, 1994.
Outstanding investments of banks in Government and other approved
securities stood at ` 2,18,705 crore as on March 31, 1998. The outstanding
gross bank credit to industrial sector at ` 1,61,038 crore as on March 31,
1998 was higher by 16.2% over ` 1,38,548 crore on March 18,1997.
12.22 INDIAN FINANCIAL SYSTEM: AN

OVERVIEW (RBI)
The structure of the Indian financial system may be summarised in the
following schematic representation. Broadly the Indian financial system
may be divided into organised and unorganised segments. The organised
market consists of commercial banks, development banks, co-operative
NOTES banks, post-office savings bank operations, stock markets etc. Unorganised
financial market operations consist of hundis, money-lending, chit funds
etc. They operate mainly in the rural areas. However in the urban areas
also unorganised money market activities are quite significant. There is no
precise estimate of the size of the unorganised money market. It is
generally expected that the relative size of the unorganised money market
transactions would decline over time.
12.23 STRUCTURE
The primary role of the RBI is to maintain a monetary equilibrium and
balance in the economy by fonnulating various policies from time to time
and controlling the financial instruments of the economy. The balance
sheet identity for the RBI is as follows:
Monetary liabilities (ML) + Non-Monetary liabilities (NML) (High Powered)
= Financial assets (FA) + other assets
If Net Non-monetary liabilities (NNML) = NML – other assets, then
ML = FA – NML
The monetary liabilities of the RBI are also called Reserve Money. In
some text books on monetary economics it has also been referred to as
high- powered money.
The monetary liabilities of RBI consist of currency in circulation (CUR)
and commercial banks’ deposits with the RBI (RES, also known as bank
reserves). As against these the financial assets of the RBI consist of RBI
(credit to the Government (RBCG)).
RESERVE BANK OF INDIA
Organised Sector Unorganised Sector
Non-Banking Banking Money Indigenous

Institutions Institutions Lenders Bankers
LIC GIC UTI Private Development Cooperative Commercial

Finance Banks Banks Banks
Companies
Structure of Indian Financial System
RBI (RBCB), RBI credit to the development banks, such as National Bank NOTES
for Rural Development (NABARD), National Housing Bank etc., and net
foreign exchange assets of the RBI.
The variations in the reserve money, therefore, depend essentially on the
RBI’s financial assets and liabilities, which in turn are influenced by the
government’s fiscal policy and various other rules and regulations.
1. Net RBI Credit to the Government
As banker to the government, RBI provides credit to both the
Central Government and the State Governments. This it done by
investing in government securities (including treasury bills of the
Central Government) and through short-term advances to State
Governments. Until recently the Central Government was
empowered to borrow any amount from RBI through treasury
bills and rupee securities. In recent years the government has
made some restrictions on the amount of borrowing from RBI. In
the case of state governments, however, RBI had put restrictions
on borrowing even earlier.
2. RBI Credit to Commercial Banks
RBI provides credit to commercial banks through loans and
advances against government securities, use of bills or
promissory notes as collateral and through purchase or
discounting of internal commercial bills as well as treasury bills.
However, the RBI does not regard its purchase or rediscounting
of bills for banks as a part of its credit to banks. Instead it
classifies it as RBC to whatever sector, commercial or
government, which issued these bills in the first instance.
3. RBI Credit to Development Banks
A large number of development banks had been established in the
country through the initiative and help of RBI for the provision of
long and medium term finance to industry and agriculture. RBI
provides them credit by investing in their securities and through
loans. Prominent development banks created through RBI are:
Industrial Development Bank of India (IDBI), Industrial
Financial Corporation of India (IFCI) and National Bank for
Agriculture and Rural Development (NABARD).
NOTES 4. Net Foreign Assets of RBI

These assets constitute foreign currency reserves of RBI and
therefore represent RBC to the foreign sector (because of the
financial liabilities of the foreign governments). Most of these
assets held abroad are in the form of foreign securities and cash
balances. The RBI comes to acquire them as the custodian of the
country’s foreign exchange reserves. As the controller of all
foreign exchange transactions, whether on private or government
account, it regularly buys and sells foreign exchange against
Indian currency.
5. Net Non-Monetary Liabilities of the RBI
The net RBC to the above four sectors viz, Government,
commercial banks, development banks and foreign sector, is
financed by RBI partly by creating its monetary liabilities and
partly by its Net Non-Monetary Liabilities (NNML).
FA or net RBC = ML + NNML
NNML basically consists of the owned funds of RBI (capital and
reserves and accumulated contributions to the National Funds)
and compulsory deposits of the public. The larger these non-
monetary resources of RBI, the lesser its dependence upon the
creation of new H (high-powered money) (Reserve money) to
finance its credit to various sectors. Hence this factor enters with
a negative sign in the equation.
The current magnitude of different components of reserve money is shown,
in table.
Reserve Requirements
By the technique of varying the reserve requirements the central bank at its
initiative can change the amount of cash reserves of banks and affect their
credit creating capacity. It may be applied on the aggregate outstanding
deposits or the increments after a base date or even on certain specific
categories of deposits depending mainly on the origin of deposit expansion.
Direct regulation of the liquidity of the banking system is made by the
Reserve Bank by two complementary methods: depositing in cash with
Reserve Bank of an amount equal to the percentage of deposits with each
bank as prescribed from time to time (known as cash reserve ratio or CRR),
and maintenance by the bank of a proportion of its deposit liabilities in the
form of specified liquid assets (known as the statutory liquidity ratio or
SLR). As a result of the application of reserve ratios, the free liquidity at NOTES
the disposal of banks at any time for lending would be the difference
between the total deposits and the total of the sums equivalent to the cash
reserve ratio and the statutory liquidity ratios.
Cash Reserve Ratio (CRR)

The RBI has been pursuing its medium-term objective of reducing the
CRR to its statutory minimum level of 3.0 per cent by gradually reducing
the CRR from 5611.0 per cent in August 1998 to 7.5% in May 2001. In
October, 2001 mid-term review the CRR of scheduled commercial banks
excluding RRBs and Local Area banks was reduced by 200 basis points to
5.5 per cent of their Net Demand and Time Liabilities (NDTL). All
exemptions were withdrawn, except inter-bank liabilities, for the
computation of NDTL (for requirement of CRR) with effect from the
fortnight beginning Nov 3, 2001. In the Annual policy the CRR was furher
reduced to 5% of NDTL. The CRR would continue to be used in both
directions of liquidity management in addition to other instruments.
As on July 2014 CRR was 4% of total net demand and time liabilites.
Liquidity Adjustment Facility (LAF)

In recent years, the thrust of monetary management has shifted towards
development of indirect instruments of monetary policy to enable the
Reserve Bank of India to transmit liquidity and interest rate signals in a
flexible maimer. The LAF operated through daily repo and reverse
auctions, is assigned the objective of meeting day to day liquidity
mismatches in the system but not the funding requirements, restricting
volatility in short-term money market rates and steering these rates
consistent with monetary policy objectives. With effect from 12 July 2014
SLR for SCB and CCB reduced from 25% to 22.5%(NDTL)
Statutory Liquidity Ratio (SLR)

The effective SLR of the scheduled commercial banks is estimated to have
fallen to 25.0 per cent of their total net demand and time liabilities (NDTL)
at end March 2002. Bank Rate has fallen to 6 per cent with effect from
April 2003. All these measures have generated sufficient liquidity in the
system.
Benchmark rate for the Prime Lending Rates was also worked out by the
Indian Banks Association consequent on which the PLRs of various banks
NOTES have come to signal a new approach to lending rate policy of the various
players in the lending system.
Development Banks
As the name suggests, development banks are development oriented.
Development banks are specialised financial institutions which perform
the twin functions of providing medium and long term finance to private
entrepreneurs and of performing various promotional roles conducive to
economic development. They are different from commercial banks in three
ways:
They do not seek or accept deposits from the public
They specialise in providing medium and long-term finance (commercial
banks specialise in providing short-term finance).
Their functions are confined to providing long-term finance.
The distinguishing role of development banks is the promotion of
economic development by way of providing investment and enterprise in
their chosen spheres (manufacturing, agriculture, etc.). The factors which
led to the growth of development banks are the inability of the normal
institutional structure to keep pace with the requirements of funds and
entrepreneurship of the growing industrial sector.
1. Industrial development banks
2. EXIM (export-import) bank
3. Agricultural development banks (NABARD)
4. Housing Development banks
Except Land Development Banks (LDB) the rest are a post-independence
phenomenon.The development banking institutions as a group have played
a significant part in the economic development of India via the investment
market and have emerged as the backbone of the financial system.
DEVELOPMENT BANKS NOTES
Housing Exim Agricultural

Industrial
Development Bank Development
Development
Bank (HDFC) Banks
Bank
(NABARD)
All-India State Level Local level State Land

(SFCs, SIDC/SIIC) Development
Banks (SLDBs)
For Small-scale For Large Scale Primary Land Development

Industries (SIDBI) Industries (IDBI) Banks and Branches of SLDBs
Development Banks
12.24 INDUSTRY ASSISTANCE

(a) term loans and advances
(b) subscription to shares and debentures
(c) underwriting of new issues
(d) guarantees for term loans and deferred payments
The first two forms place funds directly in the hands of companies as
subscription to shares and debentures. The last two forms facilitate the
raising of funds from other sources.
Aggregative Role of Development Financing Institutions

Development Financing Institutions consist of Development Banks like the
IDBI, SIDBI, NABARD and the State Finance Corporations. Three of the
development financing institutions has exited from the market after the
RBI announced its policy of harmonisation of the development and
banking functions. They are: ICICI with a reverse merger with its
offspring ICICI Bank Ltd., impending merger of IFCI with the Punjab
National Bank, and the winding up of the IRBI due to its unsustainable
nature. The IDBI is also slated for conversion to a Bank and the Parliament
already gave its approval. The process is yet to commence.
The role played by development banks is of two broad types.
NOTES (A) Quantitative Role

This is the part played by development banks as a constituent of the
industrial financing system in India and refers to the magnitude of funds
provided by them jointly to industrial enterprises. The magnitude of
industrial financing by these development banks has been considerable.
1. These banks have emerged as the single most important source of
institutional finance to industry and have come to occupy a
pre-eminent position in the institutional structure of the financial
system. The annual average of sanctioned assistance by all the
development banks during the three year period 1978-79 to
1980-81 touched an all time high of ` 1808 crores. At present, as
much as one-third of the gross fixed capital formation in private
industry is being contributed by development banks.
2. In India, their operations have the effect of improving the
allocative efficiency of the financial system. The development
banks perform the function of being a substitute for the capital
market. When industrial enterprises are unable to raise funds
from the normal channels, development banks fill the gap as well
as restore or resuscitate the capital market.
3. As integral part of their lending operations, they thoroughly
appraise projects as regards the priority aspect, financial viability
and economic soundness and so on. The rigorous and exacting
scrutiny by development banks tones up the quality of industrial
projects and enables a more efficient use of available project
resources.
4. Appraisal by the development banks is impersonal and objective.
This results in financial assistance to diverse enterprises for a
wide variety of purposes which would not otherwise have been
possible. Included in this category are; new enterprises, small or
medium-sized firms, enterprises in backward regions, and non-
traditional industries.
(B) Qualitative Role

Development banking in India has an overwhelmingly qualitative
dimension too in terms of the recent orientation towards promotional or
innovative functions in their operations. With the evolution of a
meaningful strategy of industrial development, a more positive role has
been assigned to, and it.being played by, development banks in India since
1969-70. The essential elements of these are: (i) development of backward NOTES
regions, (ii) encouragement to a new class of small entrepreneurs and
enterprises, and (iii) rehabilitation of sick mills.
Commercial Banks
Commercial banks are the single most important source of institutional
credit in India.
There are two essential functions which make a financial institution a bank:
(i) Acceptance of chequeable deposits from the public, and (ii) lending.
Acceptance of chequeable deposits is the most distinctive function or its
unique function. Chequeable deposits have the following features;
 These are deposits of money and non-financial assets
 Deposits are accepted from public at large
 Deposits are repayable on demand and withdrawable by cheque
The second essential function related to the use of deposits (Lending
includes direct lending to borrowers and indirect lending through
investment in open market securities).
Branches of Public Sector Banks and other Commercial Banks
Bank Group Branches 2013

(as on 30th June 2001)
A. State Bank of India & Associates 13416 14000
B. Nationalised Banks 32663 70421
C. Regional Rural Banks 14452 17007
Total of Public Sector Banks 60531 –
(A+B+C)
D. Other Indian Scheduled 5206 –
Commercial Banks
E. Foreign Banks 194 331
All Scheduled Banks 65931 –
F. Non-scheduled Banks 0 –
All Commercial Banks 65931
NOTES 1. Indian Banks

The bulk of the banking business in India is done by the commercial banks
owned and operated from India. Some Indian banks also operate in a few
foreign countries. The Indian banks constitute both public and private
sector banks.
Public Sector Banks

They constitute the dominant part of commercial banking in India. The
public sector banks constitute both nationalised commercial banks and
Regional Rural Banks (RRBs). The public sector banks may also have
some private by-owned shares.
(a) Nationalised Banks: In 1955, when the Imperial Bank of India
became SBI. In addition, this bank has seven other state banks as
its subsidiaries. By April 1980, 28 banks were nationalised in the
public sector. Together they control more than 90 per cent of
bank deposits.
(b) Regional Rural Banks: Regional Rural Banks are the newest
form of banks that have been set up in the country on the
sponsorship of individual nationalised commercial banks. These
were set up with the express objective of developing the rural
economy by providing credit and other facilities for agriculture
and other productive activities of all kinds in rural areas. The paid
up capital of a rural bank is ` 25 lakhs, 50 per cent of which is
contributed by the Central Government, 15 per cent by the state
government, and the remaining 35 per cent by the sponsoring
commercial public sector bank.
(c) Local Area Banks (LABs): As a follow up of the Narasimham
Committee Report - I, LABs were to be set up under Private or
NGO initiative. It granted three licenses — one in Karnataka, and
two in Andhra Pradesh in 2000. But their functional data is not
available under separate head. It has become part of rural
financial data.
2. Foreign Banks
These are banks which have been incorporated and have their head offices
outside India. They occupy a place of importance in the Indian banking
industry, especially in financing foreign trade and in the field of merchant
banking.
3. Co-operative Banks NOTES
Co-operative banks are so- called because they have been organised under
the provisions of the co-operative societies law of the states. Under the law,
co-operative societies may be organised for credit or for non-credit
purposes. The co-operative banking system is much smaller than
commercial banking. The major beneficiary of co-operative banking is the
agriculture sector in particular and the rural sector in general. Despite
several organisational weakness, village level primary cooperative credit
societies are best suited to the socio-economic conditions of Indian
villages.
Deposits of Public Sector Banks and other Commercial Banks
(As at end March)
(` in crore)
Bank Group 2002 2003 2011
Public Sector Banks 968623.57 1079393.81 –
Nationalised Banks 617550.78 688361.12 –
State Bank Group 351072.79 391032.69 1245862
Private Sector Banks 169432.92 207173.57 –
Source: Report on Trend and Progress of Banking In India 2002-03.
The State Cooperative Banks (SCBs) and Central Cooperative Banks
(CCBs) are also called the higher or central financing agencies (for the
primary societies). At the apex are the SCBs. Primary Agricultural Credit
Societies (PACS) lend to their individual borrowing members. An SCB
does not lend directly to primary societies in areas where a CCB exists and
the CCB lends only to primary societies and not to their members or other
individuals (except in a few cases). This is in the interest of functional
specialization, manageability and cost-effectiveness which is the rationale
of the three-tier structure. The basic need for higher financing agencies
arises because the PACS are not able to raise enough resources or funds by
way of deposits from the public. In fact about 60 per cent of their working
capital comes as loans from the CCBs who in turn borrow about from
higher financing agencies.
Contrary to popular belief, the government is actually the net debtor to the
co-operative banking system because:
A large part of the government’s financial assistance (about 50 per cent) in
the form of its contribution to the share capital of societies is advanced by
NABARD.
NOTES The cooperative banking system (including LDBs) provides funds to the
government by way of investment in its securities. For SCBs and CCBs
such investment is required by RBI under its SLR requirement. Hence,
there is a net withdrawal of funds by the government from the co-operative
banking system.
12.25 NON BANKING FINANCIAL INSTITUTION

There are four categories of non-banking financial institutions or
investment institutions in India, viz.
1. UTI (Unit Trust of India)
2. LIC (Life Insurance Corporation of India)
3. GIC (General Insurance Corporation of India)
4. Private Finance Companies.
The Reserve Bank of India (Amendment) Ordinance, 1997 confers wide-
ranging powers on RBI for controlling the functioning of non-banking
financial companies. The ordinance has defined an NBFC as a financial
institution, which is a company, or a non-banking institution, and which
has, as its principal business, the receiving of deposits under any scheme
or arrangement or in any other manner, or lending in any manner. As per
the ordinance, no NBFC can commence or carry on business (a) without
obtaining from RBI a certificate of registration; and (b) having net owned
funds of ` 50 lakhs or such other amount, not exceeding ` 200 lakhs, as
RBI may specify. As the UTI, has now become a part of SEBI mutual fund
discipline, its loan sanction and disbursement functions are being
eliminated, as per SEBI guidelines relating to mutual funds.
COMMERCIAL BANKS
Indian Banks Foreign Banks
Private Sector Public Sector

Banks Banks
Nationalised Banks Regional Rural Banks & Local

(including SBI and its 7 Area Banks (LABs)
Associated Banks)
Commercial Banks
CO-OPERATIVE BANKS
NOTES
Agricultural Non-Agricultural
Long-term Credit Short and Medium term Credit State Co-

(Land Development Banks) operative Banks (SCB-State Level)
Central Co-operative Banks (CCB-District Level)
Primary Agricultural Credit Societies (PACS-Village Level)
Co-operative Banks

Under the Ordinance of 1997 RBI provided powers to non-banking
institutions such as UTT, LIC & GIC. Under the ordinance the business
could not be carried out without certification from RBI.
12.27 GLOSSARY
 LDC: Leas Developed Countries
 Public Sector Units: Units Controlled by Government
 SEBI: Securities and Exchange Board of India.
12.28 KEY TERMS

 Capital: Funds required to start up business
 Term Loans: Finance required for Land, Buildings, Plant etc.
 Modernisation: Means upgradation of technology.

(A) Fill int the Blanks
1. RRB means__________Bank.
2. LAB means __________ Bank.
NOTES 3. Exim Bank regulates _______ and import.

4. NABARD is the development Bank for __________Sector.
(B) True or False

1. RBI, the government banker provides credit only to the Central
Government.
2. RBI gives credit to commercial banks without collateral.
3. RBI has no control over the deficit finance of the Government.

(a) 1. Regional Rural, 2. Local Area, 3. Export, 4. Agricultural.
(b) 1. False, 2. False, 3.True.

1. Explain the funding by non-banking financial institutions.
(Any one)
2. Explain briefly the four categories of investment institution in
India.
3. What are the functions of RBI?

1. Pramod Verna: ‘Competitiveness of Indian Industry’ - ‘Wisdom’,
Delhi.
2. Ramgarajan: ‘Indian Economy’ - ‘UBSPD’, Delhi.

Block IV: Foreign Policies and Globalisation
FOREIGN TRADE: THEORIES,

UNIT 13 ISSUES AND MODERN
CONTEXT
Structure:
13.1 Introduction
13.2 India’s Foreign Trade: Trends
13.3 India’s Foreign Trade: Composition
13.4 India’s Foreign Trade: Direction
13.5 Theory of International Trade
13.6 Some Implications of Traditional Trade Theory
13.7 Confrontation with Reality
13.8 Scale Economies
13.9 Product Differentiation
13.10 Oligopoly
13.12 Glossary
13.13 Key Terms
Objectives
 Know the components, trends and direction of foreign trade
 Know the theories of trading practices
NOTES  Understand the product differentiation, scale of economics and

their impact.
13.1 INTRODUCTION
Our foreign trade dates back to the Indus Valley civilisation. Trade got
impetus during British rule. To promote foreign trade, an organised effort
was made after independence. As we know, international trade means
trading of goods between countries. It helps in development of skills and
entrepreneurship. This has profound impact on employment, technology
and economy.
Foreign trade or international trade refers to the trading of goods between
countries. Thus, international trade is an extension of internal trade i.e.,
trade between two different regions within a country. Just like as single
region within a country cannot produce everything it needs by itself, one
single economy cannot produce every commodity all by itself. This could
be due to differences in the availability of natural resources, skills of
people, etc. Therefore, it would be advantageous for a country to indulge
in trade with other countries, by exporting those commodities which it
produces cheaper in exchange for what others can produce at a lower cost.
Foreign trade also facilitates the dissemination of technical knowledge,
transmission of ideas, and import of know-how/skills, managerial talents
and entrepreneurship. In addition, foreign trade encourages movement of
foreign capital. In totality, foreign trade can have a profound impact on the
growth of an economy in terms of production, employment, technology,
resource utilisation and so on.
13.2 INDIA’S FOREIGN TRADE: TRENDS

The origin of India’s foreign trade can be traced back to the age of the
Indus Valley civilisation. But the growth of foreign trade gained
momentum during the British rule. During that period, India was a supplier
of food stuffs and raw materials to England and an importer of
manufactured goods. However, organised attempts to promote foreign
trade were made only after Independence, particularly with the onset of
economic planning. Indian economic planning completed five decades.
During this period, the value, composition and direction of India’s foreign
trade have undergone significant changes.
Page 230 of 316 Unit 13: Foreign Trade: Theories, Issues and Modern Context
India’s foreign trade has come a long way since 1950-51. The values of NOTES
both exports and imports have increased several times over the period
(Table). The value of exports rose from ` 606 crore in 1950-51 to
` 1,06,465 crore in 1995-96. The value of imports, during the same period,
increased from ` 608 crore to ` 1,21,647 crore. With the exception pf
1971-72 and 1976-77, the value of India’s imports has always been higher
than that of exports.
Year Exports Growth Imports Growth Trade

Rate Rate Balance
1950-51 606 608 — -2
1951-52 716 18.2 890 46.4 -174
1952-53 578 -19.3 702 -21.1 -124
1953-54 531 -8.1 610 -13.1 -79
1954-55 593 11.7 700 14.8 -107
1955-56 609 2.7 774 10.6 -165
1956-57 605 -0.7 841 8.7 -236
1957-58 561 -7.3 1035 23.1 -474
1958-59 581 3.6 906 -12.5 -325
1959-60 640 10.2 961 6.1 -321
1960-61 642 0.3 1122 16.8 -4S0
1961-62 660 2.8 1090 -2.9 -430
1962-63 685 3.8 1131 3.8 -446
1963-64 793 15.8 1223 8-.1 -430
1964-65 816 2.9 1349 10.3 -533
1965-66 810 -0.7 1409 4.4 -599
1966-67 1157 42.9 2078 47.5 -921
1967-68 1199 3.6 2008 -3.4 -809
1968-69 135S 13.3 1909 -4.9 -551
1969-70 1413 4.1 1582 -17.1 -169
1970-71 1535 8.6 1634 3.3 -99
1971-72 1608 4.8 1825 11.7 -217
1972-73 1971 22.6 1867 2.3 104
1973-74 2523. 28.0 2955 58.3 -432
Unit 13: Foreign Trade: Theories, Issues and Modern Context Page 231 of 316
NOTES 1974-75 3329 31.9 4519 52.9 -1190

1975-76 4036 21.2 5265 16.5 -1229
1976-77 5142 27.4 5074 -3.6 68
1977-78 5408 5.2 6020 18.6 -612
1978-79 5726 5.9 6811 13.1 -1085
1979-80 6418 12.1 9143 34.2 -2725
1980-81 6711 4.6 12549 37.3 -5838
1981-82 7806 16.3 13608 8.4 -5802
1982-83 8803 12.8 14293 5.0 -5490
1983-84 9771 11.0 15831 10.8 -6060
1984-85 11744 20.2 17134 8.2 -5390
1985-86 10895 -7.2 19658 14.7 _ -8763
1986-87 12452 14.3 20096 2.2 -7644
1987-88 15674 25.9 22244 10.7 -6570
1988-89 20232 29.1 28235 26.9 -8003
1989-90 27681 36.8 35416 25.4 -7735
1990-91 32553 17.6 43193 22.0 -10640
1991-92 44042 35.3 47851 10.8 -3809
1992-93 53688 21.9 63375 32.4 -9687
1993-94 69547 30.4 72806 15.7 -3259
1994-95 82338 18.4 88705 21.8 -6375
1995-96 106465 29.3 121647 37.1 -15182
1996-97 118817 138920 -20103 11.7 13.2
1997-98 130100 154176 -24076 9.5 11.0
1998-99 139752 178332 -38580 7.4 15.7
1999-2000 159561 215236 -55675 14.2 20.7
2000-2001 203571 230873 -27302 27.6 7.3
2001-2002 209018 245199 -36181 2.7 6.2
Source: Economic Survey, 1995-96 & 2002-03.
As a result, India has been a trade deficit country. Another aspect of
India’s foreign trade is the fluctuating growth rates of exports and imports.
The growth rate for exports ranged from as low as - 19.3% in 1952-53 to
42.9% in 1966-67. Similarly, the growth rate of imports varied from NOTES
21.1% in 1952-53 to 58.3% in 1973-74.
Imports: During 1950s, the value of trade increased only marginally. The
value of exports, remained the same, more or less. But the value of imports,
with certain fluctuations, increased by about 60% during the decade. The
significant rise in imports was largely due to the increase in the quantum
of imports of food grains, raw materials, capital equipments and machinery.
The emphasis on heavy industries during the second Five Year Plan
necessitated the imports of machinery and capital equipments which
contributed to the increase in the value of imports.
The emphasis on heavy industries continued during the third Five Year
Plan and the three Annual Plans. This resulted in increased imports of
machinery and machine products. The bad weather conditions in the
sixties led to more imports of food grains and agricultural raw materials.
Added to these, the devaluation of the Indian rupee in 1966 further raised
the value of imports. As a result, the value of imports rose by about 40%
during 1960.
It was during the seventies that the value of imports went up sharply. This
was largely due to the hike in the prices of petroleum and petroleum
products effected by the Organisation of Petroleum Exporting Countries
(OPEC) in 1973-74 and then in 19*79 and 1980. That is why the value of
imports registered an increase of 58% in 1973-74, 53% in 1974-75, 34% in
1979-80, and 37% in 1980-81. During 1970-71 to 1979-80, the value of
imports increased by more than 500%. In addition to the oil price hike, the
general inflationary trends prevailing in the international market also
contributed to the increase in the value of imports.
The increase in domestic production of crude oil in the eighties slowed
down the increase in the value of imports, as the relative share of
petroleum products in the country’s import bill marked a decline. However,
during the late eighties, partly due to an increase in the quantum of
petroleum products imported and partly due to a rise in the international oil
prices, the value of imports once again increased sharply. The ‘Gulf crisis’
in 1990 and the currency devaluation in 1991 further pushed up the
country’s import bill. On the whole, in the post Independence period,
during the sixties and seventies, import of food items and capital goods
contributed to the growth of imports. But since the eighties Petroleum
products and capital goods determined the growth trends in the value of
imports, to a large extent.
NOTES However, the growth of imports in the nineties has been characteristically
different from the earlier period, especially from the policy point of view.
In 1991, the Indian Government initiated a major import liberalisation
programme as part of its what is now commonly known as the New
Economic Policy. Import liberalisation consisted of gradual reduction
of import tariffs and elimination of import restrictions.
Major reductions in tarrifs have been introduced in the nineties. The
import- weighted average tariff for the whole economy fell from 76.7% in
1990-91 to 40% in 1993-94, which further fell in 1994-95. The peak rate
of tariff which was as high as 220% in 1991 has now been brought down
to 65%.
Import licensing has been virtually scrapped for new materials,
intermediate components and capital goods. These can now be freely
imported subject to a “negative list” which is under constant review and
has been substantially pruned in the nineties.
Due to these policy measures, the relative share of raw material,
intermediate and capital goods imports went up particularly in 1993-94.
However, due to slowdown in industrial growth, capital goods imports
have declined in the first quarter of 1996-97. Another aspect of import
growth during the current year is that due to (i) a fall in domestic crude oil
production, (ii) a sharp rise in domestic demand and (iii) the recent spurt in
world oil prices, imports of petroleum products are likely to push up the
import bill in a big way.
Exports: Exports were more or less stagnant at around ` 600 crore during
the fifties. The introduction of some export promotion measures led to the
rise of exports in the sixties. Significant rise was seen in the exports of
gems and jewellery, readymade garments and engineering goods. After the
devaluation of 1966, exports of iron ore, leather and leather manufactures,
chemical and allied products, etc. received a further boost. During 1960-61
to 1969-70, exports grew, on an average, by 10.2%.
It was in the 1970s, however, that exports grew significantly. On an
average, exports grew by more than 19% during 1970-71 to 1979-80. A
sizeable contribution, again came from gems and jewellery, readymade
garments, engineering goods, chemicals, leather products, etc.
The high growth rate of India’s exports in the 70s were mainly due the
increase in the unit value index of exports o the increase in the quantum
index of exports so new markets for India’s exports in oil producing
countries with the boom in oil prices increase in the price competitiveness
of Indian exports as a result of a rise in the world prices of all commodities NOTES
boom in the value of agro-based exports such as oil cakes, marine products
and sugar; and increase in project exports to the Middle East countries.
During the 80s, particularly in the early 80s, the growth of exports slowed
down. Exports grew by about 11% in the first half of eighties but the
growth picked up later and exports grew by almost 27% in the second half
of eighties. The sluggishness in export growth in the early eighties was
mainly due to decline in demand for Indian exports abroad - adoption of
protective measures by developed countries – fall in the value of the US
dollar, among others.
The reorientation of the industrial and trade policy regime in the 1980s to
release the supply side constraints was combined later in the decade with a
more activist policy on the exchange rate so as to attain a steady
depreciation in the real effective exchange rate. The improvement in
productivity performance and the loosening of the tight import control
regime created a better environment for exports. New incentives for
exports, notably the exemption from tax of profits on export operations,
also encouraged export growth. As a result, the growth of exports went up
both in terms of value and volume.
In 1990-91, export growth once again declined but only marginally to
about 18%. This deceleration in exports was attributed to:
1. A slow down in the expansion of world trade. The volume of
world trade decelerated from 7.3% in 1989 to 4.2% in 1990 and
further to 9% in 1991.
2. Loss of export markets in the Middle East due to the Gulf crisis.
3. Political and economic upheavals in Eastern Europe, which
earlier provided a sheltered market to Indian exports.
4. Import curbs introduced during 1990-91 in response to foreign
exchange shortage and intensified after the Gulf crisis, affecting
export-related imports.
5. Movement in the exchange rate which was broadly supportive of
exports since 1986-87 becoming adverse thus affecting
competitiveness of exports; and
6. Internal law and order problems in some states.
The currency devaluation in 1991 and the subsequent liberalisation of
export- import regime particularly full convertibility of rupee on current
NOTES account have given a boost to the growth of exports. As a result, exports
grew more significantly during the early ’90s as compared to the earlier
decades.
Table13.1: Growth of Exports: 1960-61—2001-02
Year Growth of Rate (%)

1960-61 to 1969-70 10.2
1970-71 to 1979-80 19.3
1980-81 to 1989-90 14.9
1990-91 17.6
1991-92 35.3
1992-93 21.9
1993-94 30.4
1994-95 18.4
1995-96 29.3
1996-97 11.7
1997-98 9.5
1998-99 7.4
1999-00 14.2
2000-01 27.6
2001-02 2.7
Source: 1. India: Towards Globalisation, UNIDO, 1995.
2. Economic & Political Weekly, September 28, 1996.
3. Economic Survey, 2002-03
However, the trends in foreign trade in April-August in 1996-97 have been
discouraging as exports have only increased modestly. This was mainly
due to a sharp fall in exports in July 1996 (2.66%) and in August 1996
(2.3%). During April-June 1996, exports grew at 26.7% which is quite
comparable to the performances of the previous years. The rising cost of
production, bottlenecks in ports and heavy rain in some regions are stated
to be the factors responsible for the drop in export earnings in the months
of July and August. With the easing of the latter two factors, export growth
is likely to increase in the subsequent months.
Thus, India’s exports have grown considerably both in terms of value and NOTES
volume, over a period of time. However, a significant indicator of India’s
export performance is India’s share in world exports. Despite the
significant growth, India’s share in world exports was negligible and the
relative share remained more or less at the same level. This is attributed to
India’s failure in improving its competitiveness in terms of price and
quality in the international market.
Table13.2: India’s Share in World Exports
Year Exports in US $ Million India’s share in

World India World Exports
(%)
1970 313706 2026 0.6
1975 875500 4355 0.5
1980 1989867 8378 0.4
1985 1932387 8750 0.5
1990 3137485 18178 0.6
1992 3218905 18145 0.6
1995 4946096 31117 0.6
1998 5091105 32700 0.6
1999 5522372 32639 0.6
13.3 INDIA’S FOREIGN TRADE: COMPOSITION

The composition of foreign trade refers to the kinds of goods imported and
exported by a country. It is essential to understand the composition of
imports and exports as it reveals the economic status of a country. The
changes that may occur in the composition of trade over a period of time
reflect the economic transformation of a country.
In general, a developing country’s imports comprise mainly heavy
manufacturing goods like machinery, transport equipments, iron and steel,
etc. whereas exports comprise mainly primary commodities like
agricultural products, natural resources such as iron ore, and light
manufactures consisting of textiles, leather products, processed foods etc.
But in the process of industrialisation and economic development, the
composition of trade undergoes a transformation. As a consequence, a
NOTES developed country’s imports would include mostly primary commodities

and light manufactures and exports would consist mainly of heavy
manufactured goods.
Imports: At the beginning of the 1950s, India’s imports consisted mainly
of food grains, machinery, transport equipment, iron and steel, petroleum
and petroleum products, etc.
The announcement of the Industrial Policy Resolution, 1956 and the
subsequent emphasis on the development of heavy and basic industries in
the second five year plan had an impact on import composition. The policy
of import substitution necessitated the setting up of a wide variety of
industries to produce various manufactured goods such as machine-tools,
sugar mill machinery, cement machinery, railway wagons, commercial
vehicles, automobile tyres and tubes, etc. All these led to an increase in the
import of capital goods and equipments in the late fifties.
The relatively underdeveloped agriculture and the demand-supply gap for
good grains caused the import of food items, particularly cereals and cereal
preparations. Food items accounted for about 15% of the Import bill in
1950-51. Since then food imports ranged between 15% and 17% for
almost two decades. However, since the eighties, the relative share of food
imports has declined considerably. This largely reflects the near self-
sufficiency in food grains attained by India over the period.
A significant portion of India’s imports comprised raw materials and
intermediates. These accounted for ` 527 crore out of the total imports of
` 1,122 crore in 1960-61, thereby accounting for 47% of the value of
imports. In 1970-71, raw materials and intermediates accounted for more
than 50% of the value of imports. In 1980-81, their relative share peaked
to about 78%. This was largely due to a rise in the quantum and prices of
petroleum products. In 1985-86, the share of raw materials and
intermediates relatively declined to 71%.
Table13.3: Structure of India’s Imports: 1960-61 — 2001-02 (% Share in value)
Major Items 1960-61 1970-71 1980-81 1990-91 1994-95 2000-01 2001-02
I Food and
19.0 14.8 3.0 N.A. N.A. 3.7 4.5
related items
II Raw materials
and Intermediate
47.0 54.4 77.8 N.A. N.A. N.A. N.A.
Manufactures of
which:
(a) Petroleum, oil

and lubricants 6.1 8.3 41.9 25.0 20.7 31.0 27.2
(POL)
(b) Fertilisers and NOTES

chemical 7.8 13.2 11.9 N.A. N.A. 8.2 8.9
products
(c) Pearls, precious

and semi- 0.1 1.5 3.3 8.7 5.7 9.6 9.0
precious stones
(d) Iron and steel 11.0 9.0 6.8 4.9 4.1 1.4 1.5
(e) Non-ferrous
4.2 7.3 3.8 2.6 3.3 1.1 1.3
Metals
III Capital Goods 31.7 24.7 15.2 24.2 22.2 11.0 11.4
IV Other items
2.3 6.1 4.0 N.A. N.A. 20.1 22.2
(unclassified)
Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Source: Economic Survey, 1995-96 & 2002-0-03

Of the raw materials and intermediates, (i) Petroleum, Oil and Lubricants
(P.O.L) Fertilisers and chemical products (iii) Pearls, precious and semi-
precious stones (iv) Iron and steel (v) Non-ferrous metals are the major
items of imports. The very composition of raw material and intermediate
imports has undergone a change since the fifties. In 1960-61, iron and steel
and non-ferrous metals formed a significant part of the value of imports.
However, their importance has declined steadily and gradually since then.
POL formed about 1/8 of the value of imports in 1960-61. But their
relative share has risen considerably both due to a consistent rise in the
quantum imported and in the prices of petroleum products in the
international market.
Since the late ’80s, POL imports account for about quarter of the import
bill of the country. The recent liberalisation measures introduced with
respect to the automobile industry in the country will further push up the
domestic demand for petroleum products. The scope for increased
domestic production being limited, increased quantum of P.O.L. imports
will become indispensable. As a result, the relative share of P.O.L. imports
might go up further in the coming years.
The process of agricultural development necessitated a gradual increase in
fertiliser imports. Chemical imports comprised mainly of chemical
elements and compounds.
The import of pearls, precious and semi-precious stones is done mainly as
a raw material for the gems and jewellery industry, which was/is a
significant export item of India.
The capital goods imports comprise electrical and non-electrical
machinery and transport equipments. The growing industrialisation has
NOTES only led to increased demand for capital goods of various kinds. The
policy of import substitution had little impact on the growth of capital
goods imports. In fact, the industrial liberalisation of the nineties, has
further pushed up these imports in the first half of nineties. However, there
is a remarkable fall in the capital goods imports during April-June, 1996
which is attributed to a likely slow down in the industrial growth of the
country’. On an average, capital goods have been accounting for about a
quarter of the value of imports. Unless and until, India develops its own
technology base, its capital goods import requirements will only go up in
the future. Thus, P.O.L and capital goods, which together form about a
half of the total imports would determine the future growth of India’s
imports.
Rise in non-POL imports in 2001-02 was contributed by higher imports of
food and related items (mainly pulses, edible oil and spices), capital goods
imports and imports of other intermediate goods. Imports under the fuel
group, fertilizers and paper board, manufactures & newsprint, however,
contracted in 2001-02. A significant feature of the performance in 2001-02
was the reversal in trend in imports of capital goods, which increased by
6.3% as against substantial declines in the preceding two years. Another
highlight was the turnaround in export related imports that increased by
1.6% in 2001-02 as against a decline of 10.9% in 2000-01.
Exports: The structure of India’s exports has undergone a considerable
change since independence. Exports started growing considerably only
since the sixties. India’s exports are broadly classified under:
(i) agriculture and allied items which includes coffee, tea, oil cakes,
tobacco, cashew kernels, spices, sugar, raw cotton, rice, fruits and
vegetables, etc.
(ii) ores and minerals which include mica and iron ore, among others,
(iii) manufactured goods consisting of gems and jewellery, ready
made garments, engineering goods, chemicals, leather products,
jute manufactures, etc.
(iv) mineral fuels and lubricants (including coal); and
(v) others.
The major value of India’s exports emanated from agricultural products on
the one hand, and manufactured goods on the other. Among the
agricultural items, tea was a prominent foreign exchange earner for the
country. In 1960-61, tea exports earned about ` 124 crore out of the total
exports revenue of ` 643 crore (thereby it accounted for about 20% of the NOTES
total value of exports). However, the relative contribution of tea exports to
total exports has come down gradually. In 1990-91, tea export contribution
to total exports amounted to only 3.3%. Some of the major agricultural
items whose exports have increased over the period, are cashew kernels,
spices, rice, fish and fish preparation, tobacco, oil cakes and more recently,
fruits and vegetables.
Though the export value of agriculture and allied products has consistently
increased since the ’60s, their relative share in the total value of exports
declined steadily. This could be broadly attributed to two factors:
Despite agricultural development (which has been confined to certain
regions within the country) commercialisation of agriculture has not taken
place on a significant scale. Subsistence farming, which largely, prevails in
India constrains the scope for export growth.
Exports from the manufacturing sector have grown more significantly.
However, in the ’90s agricultural development has been gaining increased
attention from the policy markers:
1. The Government of India has brought out an Agricultural Policy
which lays more thrust on agricultural development and exports.
2. The food processing industry has been accorded a ‘sun rise
industry’ status for its promotion, in order to prevent the wastage
of fruits and vegetables due to lack of processing facilities and to
promote exports of processed foods.
3. The export obligation of Export Oriented Units (EOUs) related to
agriculture and allied products has been brought down to 50%.
This enables these EOUs to sell the remaining 50% of the
production in the domestic market thereby enabling them to settle
down quickly.
4. Some of the state governments have taken policy decisions to
enable food processing units to acquire agricultural land for
cultivating the required raw materials for in house consumption.
5. Even ‘contract farming’ is encouraged to promote agriculture
industry linkages.
All these are aimed at giving a new turn to agriculture development and
exports in the nineties. However, the relative share of agriculture and
allied items in total exports has declined further in the nineties. If the
NOTES potential of Indian agriculture is harnessed appropriately, agriculture and

allied items exports could be stepped up more significantly in the future.
The exports of manufactured goods have grown at a much faster rate than
that of agriculture. As a result, the relative share of manufactured goods in
the total value of exports has gone up steadily from 45% in 1960-61 to
78% in 1994-95. This reflects a positive outcome of India’s industrial
development.
Even within manufacturing exports, the composition has changed over the
period. In 1960-61, jute manufactures was the most prominent
manufactured item of exports (by contributing more than 46% of the total
value of manufactured exports which amounted to 21% of the total value
of exports). However, with the emergence of substitutes for jute goods in
the international market and the decline of jute industry domestically, the
share of jute goods in the total value of exports decreased continuously, In
1990-91, jute manufactures’ exports accounted for hardly 1% of the total
value of exports and in 1994-95 it declined further to 0.6%.
Table 13.4: Structure of India’s Imports : 1960-61 - 2001-02 (% Share in value)
Major Items 1960-61 1970-71 1980-81 1990-91 1994-95 2000-01 2001-02
I Agriculture and 44.2 31.7 30.7 19.4 16.6 13.5 13.4

allied products
II Ores and 8.0 10.7 6.2 4.6 3.1 2.6 2.9

Minerals
III Manufactured 45.3 50.3 55.8 72.9 78.2 78.0 76.1

Goods
- Gems & 0.1 2.8 9.6 - 16.1 17.1 16.6 16.7

Jewellery
- Readymades 0.1 1.9 8.4 12.3 12.5 12.5 11.4
- Engineering 2.0 12.0 13.0 11.9 13.2 — —

Goods
- Chemicals 1.1 2.3 3.5 6.5 9.2 — —
- Leather 3.0 4.7 5.0 8.0 6.1 3.8 3.7

Products
- Jute 21.0 12.3 4.9 0.9 0.6 — —

manufactures
- Other 21.0 14.2 11.3 17.2 — — —

manufactures
IV Minerals/Fuels 1.1 0.8 0.4 2.9 2.0 2.6 2.9

and Lubricants
V Others 1.4 6.5 6.9 0.2 0.1 1.7 2.8
Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0
The export of (1) readymade garments, (2) leather and leather products NOTES
(3) gems and jewellery (4) engineering goods and (5) chemicals has
increased gradually. In 1994-95, these five items together had a share of
more than 58% of the total value of exports. In 1960-61, these same items
contributed hardly 8% of the total value of exports.
The decline in value of exports in 2001-02 was spread across both the
agricultural and manufactured commodity groups. Under manufactured
goods, major exports like gems & jewellery, engineering goods, textiles
including ready made garments, chemical and related products, leather and
manufactures recorded sharp decelerations or even decline in exports. The
decline in agricultural and allied exports (including plantation) in 2001-02
was mainly on account of lower exports of tobacco, marine products,
spices and cashew nuts. While the decline in exports of tobacco and
cashew nuts was due to lower volume of these exports, decline in unit
value contributed to lower exports of spices and marine products.
The share, in total exports, of manufactured goods and agriculture and
allied products declined from 78.0% and 13.5% respectively in 2000-01 to
percent and 13.4% respectively in 2001-02. Correspondingly, share of
exports of petroleum products and ores and minerals, in total exports,
increased to 4.8% and 2.9% respectively during the year.
This brings out the fact that the export composition of India has grown
more in terms of non-traditional items than traditional items. But non-
traditional items are largely confined to light manufactures. The share of
only light manufactures went up from year to year.’ Thus, though the
export composition got diversified in terms of faster growth of non-
traditional items, these are largely confined to light manufactures. The near
absence of heavy India’s Foreign Trade manufactures in India’s exports
reflects the inadequate indigenous technology base for the development of
heavy manufactured goods. Unlike industrialising countries like South
Korea and Singapore, India’s export composition has not yet started
diversifying in the form of significant emergence of heavy manufactured
goods and consumer durables.
13.4 INDIA’S FOREIGN TRADE: DIRECTION

India’s foreign trade relations cover the countries all around the world. To
understand the regional direction of India’s foreign trade and its progress,
countries of the world are classified under five broad groups :
NOTES 1. Organisation for Economic Co-operation & Development (OECD)

Countries which, in turn, comprise:
(a) The European Economic Community (EEC):
United Kingdom, Germany, France, Belgium, etc.
(b) North America : Canada, USA
(c) Asia and Oceania : Japan and Australia
2. Organisation of Petroleum Exporting Countries (OPEC)
3. Eastern Europe
4. Developing Countries
5. Others
Imports: Most of India’s imports originate from the industrialised (OECD)
countries (Table 13.5). In 1960-61, about four-fifths of the imports were
from the OECD countries. Of these, the UK and the USA together
accounted for as much as 50% of the total value of India’s imports.
However, since then, the relative importance of OECD countries in India’s
imports has declined to some extent (thought it has increased marginally in
the 90s). This is reflected in the gradual fall in the share of UK and USA in
the value of India imports.
In 1993-94, UK and USA together accounted for hardly 19% of the total
value of imports. But countries like Belgium and Japan have become more
important trading partners as far as India’s imports are concerned. By and
large, India imports capital goods, raw materials and intermediates from
OECD countries.
India imports mainly Petroleum, Oil and Lubricants (P.O.L) from the
OPEC. Both in terms of value and volume, POL had a minor presence in
India’s import structure in the 60s and 70s. OPEC accounted for hardly 5%
of the value of imports in 1960-61 and hardly 8% in 1970-71. But
thereafter, due to the sharp rise in oil prices as well as increase in the
quantity of India’s imports, the share of OPEC in the value of India’s
imports went up steeply. As a result, imports in 1980-81 from OPEC
accounted for almost 28% of the import bill. The subsequent fall in
international oil prices resulted in a relative fall but went up again as a
result for the Gulf crisis in 1991.
Table 13.5: Direction of India’s Imports 1960-61 - 2001-02 (% Share in value) NOTES
Countries 1960-61 1970-71 1980-SI 1990-91 1995-96 1999-00 2000-01 2001-02
I OECD: 78.0 63.7 45.7 54.0 52.4 43.0 39.9 40.1
1. EEC: 37.1 19.6 21.0 29.4 26.7 21.2 19.8 19.1
-
1.4 0.7 2.4 6.3 4.6 7.4 5.7 5.4
Belgium
- East
10.9 6.6 5.5 8.0 8.6 3.7 3.5 3.9
Germany
- UK 19.4 7.8 5.8 6.7 5.2 5.5 6.3 5.0
2. North
31.0 34.9 14.7 13.4 11.6 7.9 6.8 7.2
America
- USA 29.2 27.7 12.9 12.1 10.5 7.2 6.0 6.1
3. Asia &
7.1 7.4 7.4 11.2 9.7 7.5 5.9 6.9
Oceania
- Japan 5.4 5.1 6.0 7.5 6.7 5.1 3.6 4.2
II OPEC: 4.6 7.7 27.8 . 16.3 20.9 22.5 5.4 5.8
III Eastern
3.4 13.5 10.3 7.S 3.4 1.6 1.3 1.4
Europe
- USSR 1.4 6.5 8.1 5.9 2.3 1.3 1.0 1.0
IV Developin
g 11.7 14.6 15.7 18.4 18.3 20.7 17.5 19.1
Countries
- Asia 5.7 3.3 11.4 14.0 14.4 15.7 14.4 15.3
V Others 2.2 0.5 0.5 3.5 5.0 12.2 35.9 33.6
Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Source: 1. India: Towards Globalisation, IINIDO, 1995. 2. Economic Survey,

2002-03.
The growing domestic demand for P.O.L and increasing oil prices in the
international market will make OPEC all the more important in terms of
India’s imports in the future.
Eastern Europe, particularly, the former USSR was a significant source of
India’s imports for nearly two decades: mid-sixties to mid-eighties. The
main items of imports from these countries were iron and steel, non-
ferrous metals, chemicals, capital equipment, pharmaceuticals and
petroleum products. However, with the transformation of the economic
system of East-European countries and the disintegration of the USSR,
imports from Eastern Europe declined drastically.
The regional shares in sourcing of imports in 2001-02 reveal enhanced
shares from all the major regions, with a corresponding reduction in share
of residual category. This was contributed by an increase in imports from
OECD, OPEC Eastern Europe and from other developing countries.
NOTES A significant development in the direction of India’s imports is with

reference to developing countries, particularly Asia. The imports generated
from Asian countries have increased significantly since the ’80s. This
could be attributed to (i) rapid economic development of many Asian
countries, specially South East Asian-countries and (ii) greater trade co-
operation among the members of SAARC (South Asian Association for
Regional Co-operation).
On the whole, India has experienced increasing regional diversification in
the process of the growth of imports.
Exports: A major share of India’s exports goes to industrialised (OECD)
countries. In 1960-61, more than 66% of the value of exports were absorbed
by OECD countries. But the relative share of OECD countries in India’s
exports declined in 1970-71 and again in 1980-81.
Thereafter, the share has increased again. In the ’90s, the exports to OECD
countries stood at around 57%. Within the OECD countries, UK and USA
were the major destinations for India’s exports, which accounted for as
much as 43% of the value of exports in 1960-61. However, the pre-
eminent position of these two countries, particularly the UK has declined
considerably since then. Of course, in the nineties, the USA is emerging as
a major trade partner in terms of India’s export destination. In 1990-91,
exports to the USA accounted for almost 15% of the value of exports.
Table 13.6: Direction of India’s Exports 1960-61 - 2001-02 (% Share in value)
Countries 1960-61 1970-71 1980-81 1990-91 1995-96 1999-00 2000-01 2001-02
I OECD: 66.2 50.1 46.6 53.5 55.7 57.3 52.7 49.3
1. EEC: 36.2 18.4 21.6 27.5 26.5 24.7 22.7 21.8
-
0.8 1.3 2.2 3.9 3.5 3.7 3.3 3.2
Belgium
- East
3.1 2.1 5.7 7.8 6.2 4.7 4.3 4.1
Germany
- UK 26.9 11.1 5.9 6.5 6.3 5.5 5.2 4.9
2. North
18.7 15.2 12.0 15.6 18.3 24.4 22.4 20.8
America
- USA 16.0 13.5 11.1 14.7 17.4 22.8 20.9 19.4
3. Asia &
10.1 15.2 10.6 10.4 8.3 5.8 5.1 4.5
Oceania
- Japan 5.5 13.3 8.9 9.3 7.0 4.6 4.0 3.4
II OPEC: 4.0 6.4 11.1 5.6 9.7 10.6 10.9 12.0
III Eastern
7.0 21.0 22.1 17.9 3.8 3.1 2.4 2.3
Europe
- USSR 4.5 13.7 18.3 16.1 3.3 2.6 2.0 1.8 NOTES
IV Developin
g 14.8 19.9 19.2 16.8 25.7 25.6 26.7 28.0
Countries
- Asia 7.0 10.8 13.4 14.3 21.3 20.9 21.4 22.4
V Others 8.0 2.6 1.0 6.2 5.1 3.4 7.3 8.4
Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
Source: 1. India: Towards Globalisation, IINIDO, 1995. 2. Economic Survey,

2002-03.
Today, India’s exports within OECD are not confined to only UK and USA but
more evenly spread among other countries such as Belgium, France, Germany,
Japan, the Netherlands, etc. This implies that India’s export penetration has been
diversified among the OECD countries over the period.
The share of OPEC in India’s exports has always been minimum and showed no
definite trends over time.
India’s export trade with Eastern Europe like that of imports peaked during
the ’70s and ’80s. But since then, due to the factors described earlier, exports to
the region have declined rapidly.
Direction of exports over the 1990s show greater consistency in our exports to
Organisation for Economic Cooperation and Development (OECD) countries,
including the European Union (EU) region and larger fluctuations/dispersal to
areas like the Organisation of Petroleum Exporting Countries (OPEC), Eastern
Europe and other developing countries. In 2001-02, exports to OECD countries
declined due mainly to lower exports to major countries like USA, Japan, Canada,
UK., Germany, France and Belgium. Decline in exports to Eastern Europe was
due to lower exports to Russia. The rise in exports to OPEC region was mostly
contributed by higher exports to Nigeria, Indonesia and Iraq. Overall, while the
OECD countries’ and Eastern Europe region share in total exports declined to
49.3% and 2.3% respectively, the shares, in total exports, increased to 12.0% for
OPEC region and 28.0% for other developing countries in 2001-02.
A significant development in the direction of India’s exports, is the emergence of
Asian Countries as the major buyers. Since 1960-61, the share of Asian Countries
in India’s exports has steadily gone up. The growing economic prosperity in
South East Asia and greater trade Co-operation among Asian Countries,
particularly South Asian countries, may have contributed largely to this
development.
The destination of India’s exports and imports has some important implications:
 Despite relative decline in importance, OECD countries are the
major destination for Indian exports and major source of imports.
 Among the OECD countries, the USA has emerged as the leading
trade partner of India.
 The importance of developing countries, particularly Asian
countries as trade partners is growing gradually.
NOTES  The trade relations with East European countries including Russia
have declined drastically since 1990-91.
 Due to P.O.L. imports, the OPEC is an indispensable trade
partner but its importance in terms of trade exports is not too
significant.
 India’s trade relations with South American and African countries
are negligible.
13.5 THEORY OF INTERNATIONAL TRADE

Traditional trade theory was well settled and accepted.
However the implications of traditional trade theory were found to be at
odds with data.
A lot of data did not seem to fit traditional trade theories gave rise to the
new trade theory.
Fundamental Ideas of Traditional Trade Theory
Comparative Advantage and Gains from Trade

Comparative advantage is one of the most fundamental ideas in trade
theory.
A country has comparative advantage in a good if has a lower opportunity
cost of producing the good than another country.
Countries are expected to export goods for which their autarky (no trade)
relative prices are lower than other countries.
Countries gain from trade when they have different autarky relative prices
of goods.
Hecksher-Ohlin Theory(H.O)
One of the reasons why a country might have comparative advantage in a
good is that countries differ in their factor endowments.
There are two factors capital and labor.
The home country is the capital abundant one, the one with more capital
per unit of labor.
One of the goods is more capital intensive than the other: it uses more
capital per unit of labor than the other good.
Countries have access to same technologies–factor endowments only NOTES

difference between countries.
Under free trade, the capital abundant country (home) is expected to
produce relatively more of the capital intensive good than the other
country.
Capital abundant country (home) therefore, is expected to export the
capital intensive good if no strong bias in consumption.
Owners of capital in the capital abundant country (home) benefit due to
seeing their rents rise relative to prices of goods, while owners of labour
(home workers) suffer due to seeing their wage fall relative to prices of
goods.
As long as capital endowments in the two countries are not too different
and which good is capital intensive is the same in both countries, the wage
and rent will be the same across countries under free trade with no
transport costs.
13.6 SOME IMPLICATIONS OF TRADITIONAL

TRADE THEORY
1. Trade should be greatest between countries with the greatest
differences between them.
2. Gains from trade should be greatest between countries with the
greatest differences.
3. Trade should cause countries to specialise more in production and
to export goods distinctly different from what they import.
4. Countries should export goods that make relatively intensive use
of their relatively abundant factors.
5. Factor prices should be more similar between countries with
more liberal trade policies between them.
6. Free trade should equalise factor prices being countries with
similar enough relative factor endowments but not between
countries with very different factor endowments. Countries with
similar enough factor endowments to have equal factor prices
under free trade should use similar techniques and produce
similar goods.
NOTES 7. Domestic interest groups should be identified by factors rather

than industries.
8. International investment should be stimulated by differences in
factor endowments.
9. International trade and international investment should be
negatively correlated.
10. Trade policy should take the form of trade restrictions rather than
trade stimulants.
13.7 CONFRONTATION WITH REALITY

According to traditional trade theory, one might think that United States
should trade more with Mexico than with Canada because we have greater
factor endowment and technology differences with Mexico than Canada.
But most trade is between countries at similar stages of development
countries with similar factor endowments and similar technologies.
These developed countries also are the ones who seem to gain the most
from international trade. Average tariffs are highest in developing
countries.
What developed countries trade with each other look very similar, there
are not substantial differences in the factor composition of a developed
country’s imports and exports with another developed country. There is a
cleares factor endowment basis for trade between developed and
developing countries.
While factor prices are not equalised across countries, do not observe free
trade yet in the world. Factor prices do become closer to being equalised as
trade is liberalised. The convergence of factor prices appears to be greatest
for countries with the most similar factor endowments. Predictions
regarding factor price equalisation fairly well supported by the data.
Objections to trade liberalization appear to be aligned according to
industry affiliation and not according to factor identities (capital vs labor).
Traditional trade theory suggests international investments should flow
from capital abundant countries to capital scarce countries. While there is
some foreign direct investment (FDI) from developed countries to
developing countries and that share is growing, the bulk of FDI still occurs
from one developed country to another and back again. Similar to trade in
goods, international investment occurs primarily between similar
developed countries and among similar goods such that factor endowments NOTES
do not appear to be major motive for FDI among developed countries.
13.8 SCALE ECONOMIES

HO Theory would predict little gains from trade between similar countries,
yet these countries seem to have prospered due to their openness.
Need other models of gains from specialisation, where countries are able
to produce more at lower cost through international trade.
Scale economies provide a basis for trade logically independent of (pre-
existing) comparative advantage.
13.9 PRODUCT DIFFERENTIATION

Each variety of a good is produced by a single firm operating under
monopolistic competition.
Vertically differentiated products (quality) have all consumers agree on
what brand is best; horizontally differentiated products (variety) have
consumers disagree on what brand is best.
Ideal variety approach equivalent to having consumers love variety for its
own sake.
Even if national IRS, product differentiation is sufficient to ensure that no
country loses from international trade (and so Graham case requires
homogeneous goods).
13.10 OLIGOPOLY
Suppose each country has a single monopolist in autarky economically
independent and countries identical. Duopoly two suppliers when trade
opened.
In Cournot-Nash, firms choose quantity and total quantity increases with
increased competition. Free trade price below both autarky prices.
Can have gains from trade even though no trade actually occurs; gains are
from potential competition.
If firms choose quantity for each market get two-way trade.
If impose transport costs, get wasteful two-way trade of identical products.
NOTES Interesting welfare conclusions because oligopoly profits contribute to

national income. Assume all output sold to a third country to eliminate
consumer surplus effects in welfare.
If government can credibly commit to subsidising, exports can increase
profits.
Explains why trade policy might take form of promotion rather than
restriction.
Uncertainty over correct policy limits usefulness in practice.
As number of domestic firms increases, optimal policy shifts from subsidy
to tax; also if firms choose price instead of quantity, optimal policy
becomes a tax.
A common resource available in fixed supply limits profit shifting ability
of export subsidies for symmetric firms.

India’s foreign trade has grown remarkably, both in terms of value and
quantity, since the beginning of economic planning. The policy of
industrial and trade liberalisation introduced in 1991 has given a new turn
to the growth of both imports and exports. However, imports have always
exceeded exports which means that India has become a perennially trade
deficit country.
India’s imports mainly comprise capital goods like machinery and
equipments, raw materials and intermediates like P.O.L., iron and steel,
non-ferrous metals, precious stones, etc. Thus, India’s imports are crucial
in nature for the functioning of the economy. India’s export composition
has transformed with the faster growth of manufactured goods and the
relative decline of agricultural and allied products. But, manufactured
exports are largely confined to light manufactures. India’s imports as well
as exports have also undergone diversification in terms of destination.
As a result of all these, the share of foreign trade in India’s Gross National
Product (GNP) has been increasing steadily. But it is still lower than that
of East Asian and Latin American countries. The share of foreign trade in
GNP in India accounted for 17% in 1992 whereas it was 54% in South
Korea, 36% in China and 23% in Mexico. Further, the share of India’s
exports in world exports has been negligible which is the outcome of the
lack of competitiveness of Indian goods in the international market.
All these show clearly that, despite remarkable growth, India has to go a NOTES
long way in:
 attaining economic self-sufficiency in the form of paying for
imports through exports
 improving the competitiveness of its goods in terms of price and
quality to increasingly penetrate the world market
 diversification of exports, specially in terms of heavy
manufactures orealising foreign trade as a major sector of the
economy in terms of GNP.
Every country has its trade policy to protect their own products. It also
restricts imports. Indian Trade development had to face stiff competition
and it was difficult to protect domestic trade, consequently our import
increased. With the economic reforms of 1991 our trade has grown and the
Gross National Product (G.N.P) has increased.
13.12 GLOSSARY
 OECD: Organisation of Economic Cooperation and
Development.
 Foreign Collaboration: It is an agreement between two or more
companies from different countries.
 Free Trade Area: Countries come together and remove duties
among themselves while maintaining them with outsiders.
13.13 KEY TERMS

(i) Balance of Trade (or trade balance) Refers to the difference
between the values of exports and imports. If the value of exports
is more than the value of imports, the trade balance is said to be
positive or favourable. If the value of imports is more than the
value of exports, the trade balance is said to be unfavourable or
negative.
(ii) Negative List Refers to list of items whose imports are totally
banned.
(iii) Trade Deficit: When a country imports more than it exports, the
resulting negative number is called a trade deficit.
NOTES (vi) Import substitution: It means replacing foreign imports with

domestic production.

1. __________sector contributes more than 50% of India’s national
Income.
2. EPCG means Export Promotion Capital _________.
(B) True or False

1. Removal of Q.R’s means duty free imports.
2. W.T.O stands for World Trade Officer.
3. Export can be direct or indirect.
4. There are no new technologies in Globalisation.

(A) 1. Service, 2. Goods
(B) 1. False, 2. False, 3. True, 4. False

1. Explain the salient features of trade policy 1991.
2. What do you understand by QR’s?(Quantitative Restrictions)
3. What were the impediments for the trade growth in India?

1. Frances Cherunilam: International Trade, H.P.H. Mumbai.
2. Singh R.K: Economic Reforms - Abhijeet, Delhi.

FOREIGN DIRECT
UNIT 14 INVESTMENT AND FOREIGN
INSTITUTIONAL INVESTORS
Structure:
14.1 FDI – Introduction
14.2 Foreign Direct Investment (FDI) in Multi-brand Retail Sector
14.3 Foreign Direct Investment
14.4 FDI Policy
14.5 Industrial Credit
14.6 Industrial Relations
14.7 The Securities and Exchange Board of India Act of 1992
14.8 Foreign Institutional Investors (FII)
14.10 Glossary
14.11 Key Terms
Objectives
 Understand policies, objectives, and procedures of F.D.I.
 Understand the impact of FDI on development and growth.
NOTES
14.1 FDI – INTRODUCTION
FDI is Foreign Direct Investment and it refers to investment in real assets
by foreign enterprises. After independence we decided on an economic
model that was required at that time with the New Economic Policy it was
possible for the foreign institutional Investors to invest. There were no
restrictions on the volume of investment and there was no lock-in period.
Foreign Direct Investment refers to investment in real assets like factories,
sales offices, distribution channels etc. by foreign enterprises. Equity
investment exceeding 10% of stake in a company by a foreign investor
with long-lasting interest is also known as FDI. [As per US Dept, of
Commerce definition]
The economic model followed by India after independence relied on
import substitution and selective foreign capital inflow, both through
portfolio investment and the Foreign Direct Investment (FDI) route. This
changed radically with the liberalisation measures announced in 1991.
Both portfolio and FDI were not only allowed but also actively encouraged.
The Foreign Investment Promotion Board (FIPB) was created to approve
FDI proposals. Similarly, the Reserve Bank of India gives automatic
approvals for foreign direct investment in industries, particularly in the
infrastructure sector.
During the 1990s, the ‘ceilings’ on FDI in different sectors were
progressively raised and presently, 100% foreign investments is allowed in
several industrial sectors.
Modes of Foreign Direct Investment

FDI can enter India through two channels:
 The automatic route under which companies receiving Foreign
Direct Investment need to inform the Reserve Bank of India
within 30 days of receipt of funds and issuance of shares to the
foreign investor.
 For sectors that are not covered under the automatic route, prior
approval is needed from the Foreign Investment Promotion Board
(FIPB).
Page 256 of 316 Unit 14: Foreign Direct Investment and Foreign Institutional Investors
FDI Ceiling on Various Sectors According to the FIPB Regulations NOTES

(per cent)
Automobiles 100
Telecom 72
Electricity generation, transmission and distribution
(except nuclear power) 100
Roads and Highways 100
Ports and Harbors 100
Civil Aviation (in Greenfield airport ventures) 100
Multilateral agencies such as the World Bank, the Department for
International Development (DFID), Japan Bank for International
Cooperation (JBIC) and Asian Development Bank (ADB) have financed
projects in India across infrastructure sectors such as power, roads and
highways, telecom and irrigation.
Source: Compiled from the Economic Survey, Ministry of Finance,
Government of India, 2004, 2005 & 2007 issues.
China and India–What Explains their Different FDI

Performance?
It is important to understand the reasons why China has been so successful
in obtaining FDI.
Even today, FDI is estimated to account for less than 10% of India’s
manufacturing exports. For China, the lion’s share of FDI inflows are to a
broad range of manufacturing industries. Meanwhile, for India, services,
electronics and electrical equipment and engineering and computer
industries get a major share of the FDI.
China’s total and per capita GDP are higher, making it more attractive for
market seeking FDI. Reasons for high FDI in China:
 Higher literacy and education rates suggest that its labour is more
skilled, making it more attractive to efficiency-seeking investors.
 China also has large natural resource endowments.
 China’s physical infrastructure is more competitive, particularly
in the coastal areas.
 China has more “business-oriented” and FDI-friendly policies
than India.
Unit 14: Foreign Direct Investment and Foreign Institutional Investors Page 257 of 316
NOTES  China’s FDI procedures are easier, and decisions can be taken
rapidly.
 China has more flexible labour laws, a better labour climate and
better entry and exit procedures for business. China opened its
doors to FDI in 1979 and has been progressively liberalising its
investment regime. India allowed FDI in 1980s in some sectors,
but did not take comprehensive steps towards liberalisation till
1991.
However, India may have an advantage over China in technical manpower,
particularly in information technology. It also has better English language
skills.
The two countries focused on different types of FDI and pursued different
strategies for industrial development. For long, India followed an import-
substitution policy and relied on domestic resource mobilisation and
domestic firms encouraging FDI only in higher technology activities.
Some of the differences in competitive advantages of the two countries are
illustrated by the composition of their inward FDI flows.
Country FDI flows in following (Major areas):
China Information & communication technology, hardware
design and manufacturing by such companies as Acer,
Ericsson, General Electric, Hitachi Semiconductors,
Hyundai Electronics, Intel, LG Electronics, Microsoft,
Mitac International Corporation, Motorola, NEC, Nokia,
Philips, Samsung Electronics, Sony, Taiwan Semiconductor
Manufacturing, Toshiba and other major electronics
TNCs India IT services, call centres, business back-office
operations and R&D
Source: Compiled from the annual reports of Reserve Bank of India and
People Bank of China.
China’s accession to the WTO in 2001 has led to the introduction of more
favourable FDI measures. With further liberalisation in the services sector,
China’s investment environment may be further enhanced. For instance,
China has allowed 100% foreign equity ownership in such industries as
leasing, storage and warehousing and wholesale and retail trade,
advertising and multi model transport services.
Is is important to note that the heavy FDI inflows to China are not 100%
true. China’s ability to attract phenomenal amount of foreign investment is
a puzzle for many. “About 40% of China’s FDI represents its domestic NOTES
savings, recycled as foreign investment, via Hong Kong, to take advantage
of economic incentives, popularly called ‘round trapping’. Another 25% or
so seems to represent investment in real estate by overseas Chinese. This is
potentially problematic, as such investment could easily give rise to
property bubbles. Thus, the quantum of foreign investment from advanced
economies, that could improve domestic production capability, is perhaps
not very different from that in India, in relation to its domestic output”.
[Nagraj R, 2006—‘Foreign Direct Investment in India—Trends & Issues'
(Eds, Raj Kapila & Raj Uma, Economic Developments in India, Vol 100,
Page 326)].
Future Outlook
India’s rising growth process requires rapidly expanding infrastructure
facilities to support it.
The government realises the fact that domestic resources alone may not be
adequate to sustain the required expansion in infrastructure. Thus, it has
followed a strategy to create incentives for Foreign Direct Investment.
India, today, has an extremely liberal regime for FDI in terms of entry
norms. International experience shows that there can be a number of other
barriers for those willing to invest in infrastructure projects. The
government has taken systematic initiatives to address these problems
largely through comprehensive reforms in sectors like power and
telecommunications. The combination of domestic private foreign
investment and multilateral investments is likely to propel India’s
economic growth momentum in future.
14.2 FOREIGN DIRECT INVESTMENT (FDI) IN

MULTI-BRAND RETAIL SECTOR
Introduction
In a significant, decision on Nov. 24, 2011, the Central Government gave
approval to the proposal to allow 51% foreign direct investment FDI in
multibrand retail as well as 100% FDI in single brand retail. The decision
was hailed as a big reform measure adopted by the Government which will
benefit both consumers and farmers. It was pointed out that this would
lead to the creation of supply chains, logistic support, storage facilities,
and cut middlemen to ensure better prices for farmers’ products and
cheaper goods for the consumers and generate for employment for 10
NOTES million persons in three years. It will bring not only foreign capital so
badly needed for the growth of the Indian economy but also superior
technology and better managerial techniques.
At present 100% FDI is permitted under the automatic route for wholesale
trade subject to certain end-sale limitations and restrictions while in single
brand retail it is permitted up to 51% with government approval. But due
to stiff opposition by the opposition parties FDI is multi-brand retail was
not permitted for it is feared that it would hit small shopkeepers and
neighbour stores. In March 2010, the Central Government came out with a
blue print for discussion describing the merits of throwing open the multi-
brand retail trading to foreign direct investment (FDI). The policy of
allowing FDI in multi-brand retail trade will permit global giants such as
Wall-Mart, Tesco and Carrefour to set up huge market stores in India with
back-end infrastructure. It is contended that FDI in multi-brand retail
trading will help both farmers and consumers. Government proposal
provides for safety clauses and appointment of a regulator to protect
various interests.
The government decision regarding entry of FDI in retail comes with
certain conditions to address the fears of small traders that the global
giants setting up big stores selling multi-brand products would drive them
out of business and render them unemployed. These conditions are stated
below:
1. Minimum investment by the big global retailers setting up stores
in India should be $ 100 million.
2. 50% of the investment by multibrand retail giants must be in
back-end infrastructure such as cold chains, storage facilities (i.e.
ware housing), logistic support and transportation.
3. At least 30% of goods purchased for sale in these multi-brand
stores must be sourced from small-scale and medium enterprises
(SME).
4. These giant multi-brand retail stores can only be opened in cities
with at least 10 lakh population. India has about 43 such cities.
The Government will have the first right of procurement of
agricultural produce.
5. Since retail trade is a state subject, the different states are free to
allow or not for the opening up retail shops by these international
retail giants.
Against the opening up of multi-brand to foreign investment (FDI) it is NOTES

pointed out that it would adversely affect the large unorganised sector
which will not stand up to the competition of FDI in this sector.
The government proposal contains enacting a law called Multi Regulation
Act to protect small retailers and setting up a centrally administered
agency to monitor compliance with the rules. It is mentioned that despite
without any restrictions at present only 5% of the nearly $ 500 billion or
about ` 23 lakh crore of retail trade is in the organised sector.
Case for FDI in Multi-brand Retail

The inter-ministerial committee headed by chief economic advisor
favoured the opening up of multi-brand retail trade on the ground that it
will help to fight inflation, especially food inflation. Today it is estimated
that about 40% of all farm products get rotten by the time they reach the
final point of sale. Apart from the enormous waste that this generates, it
creates upward pressure on food prices, hitting consumers hard with no
benefit to the farmers. The lack of organised storage and transport chains
is the main culprit behind these losses. To quote the DIPP paper “there is
the need to address issues relating to the farmers through removal of
structural inefficiencies, as also to improve post-harvest management that
requires investment in back end logistics and storage infrastructure. A
week supply chain result in large-scale wastage and more often than not,
the ultimate consumer pays a lot more than what reaches the farmer. It is
important to provide for steadier incomes to farmers either through direct
marketing or contract farming programmes. Further, allowing FDI on this
multi-brand retail sector will not only bring financial capital into the
Indian economy, it will also bring in new technologies for storage and
transport”.
The DIPP paper further mentioned that to ensure the advantages of
opening up of the multi-brand retail trade to FDI, the government could
make 50% total FDI for multi-brand retail mandatory to be invested in
creation of back-end infrastructure and reserve half of all in the retail
sector for rural youth. Besides, this will help in boosting investment in
warehouses and cold chains to cut wastes of agricultural products. Foreign
investment in multi-brand retail will eliminate high margins of middlemen
that will not only benefit farmers but ensure lower prices to the consumers.
Thus from the perspective of consumers there is urgent need to check food
inflation and control the demand -supply imbalances.
NOTES The retail sector needs large-scale investments. A substantial portion of

these investments are expected from private enterprises, hence, it is
imperative to make it financially worthwhile for them. It has long been
argued that the entry of foreign retailers through joint ventures would help
develop backward linkages to sources of supply and thus develop a
domestic supply chain of international standards. Eventually, this would
improve productivity benefiting the farmer, and the competition may
eventually help bring down prices for consumers. The government
believes that permitting FDI in the sector will also help bring in technical
and management know how which is in India’s long-term interest.
Addressing people’s concern about opening up the multi-brand retail
sector to foreign direct investment the department of Industrial Policy and
promotion or DIPP moved its amended proposals for approval by the
cabinet in this regard. In its 24 November 2011 decision the cabinet
approved these proposals. According to these proposals 51% of foreign
direct investment (FDI) in multi-brand retail shall be permitted subject to a
minimum investment of $100 million. It is also proposed that state
governments will have the final say in whether they have front-end retail
stores in their states. Further the Government claims that draft framework
for FDI in multi-brand retail has been prepared keeping adequate
safeguards to protect small shopkeepers and to ensure that FDI in multi-
brand retail actually helps in development of back-end infrastructure.
According to the Government framework, at least 50% of FDI in multi-
brand retail projects should be in infrastructure. Multinational retailers will
have to file a statement of account with the RBI and Foreign Investment
Promotion Board showing the investment in back-end functions.
The government is very clear that FDI in multi-brand retail should create
large scale employment and bring quality investment into the country
leading to development of back-end infrastructure. According to industry
estimates, lack of cold chains leads to a loss of about 40% of the country’s
farm produce or ` 50,000 crore, every year. Because of this, Dr. Kaushik
Basu, Economic Adviser, Ministry of Finance, asserts that FDI in multi-
brand retail will serve as an important measure to fight food inflation
which arises due to supply-side bottlenecks, one of them being lack of
back-end infrastructure such as cold chain and warehouses to store food
grains.
For easier monitoring, the government will also allow back-end
infrastructure to be executed through a dedicated entity. Multi-brand retail
stores would be required to source at least 30% of their products, including
food items, from small and medium enterprises, according to the draft NOTES
framework. These stores will be allowed only in cities with a population of
more than 1 million.
At least 30% of the turnover of these ventures will have to come from
small traders through wholesale cash-and-carry stores set up for the
purpose. In order to address concerns of some States that multi-brand FDI
will drive out local shops, the draft framework proposes powers to State
governments to impose additional conditions on MNC retailers, such as
measures to integrate ‘kirana’ or local retailers into the value chain.
Case Against FDI in Multi-brand Retail

But the Government’s decision to allow global retail giants to open their
shops in India has met with a stiff opposition. The reasons for which the
decision have been opposed are stated below:
First, the crucial disadvantage of opening up to multi-brand retail sector to
foreign direct investment (FDI) by global retail giants is that it will badly
hurt small traders and shopkeepers who would be competed out by these
giant retailers. It is because of the economies of scale and procuring goods
from cheaper sources, even from abroad, they will be able to sell goods at
cheaper prices. It is pointed out that retail sector in India employs over 40
million people, next only to agriculture. Being unable to compete with the
giant retailers, they would be forced out of business and thus deprived of
their livelihood. As a result there will massive loss of jobs. This has been
the experience of most countries which have permitted the entry of FDI in
retail.
Besides, not only will the small traders and shopkeepers who are engaged
in self-employment in retail business will lose their jobs but also other
workers who are employed in these relatively small shops and retail outlets
will be rendered unemployed as due to deficient in skills, the majority of
them are unlikely to be absorbed in the global giant retail stores. As a
result, unemployment in the country will increase.
The government and the supporters of its decision to allow entry of global
giants in retail business point out that 10 million jobs will be created by
them in three years. This is quite a tall claim without any evidence. Of
course, they will employ people in retail shops, in cold chain, warehousing
etc. but they will displace more than they employ. It may be noted that
many workers who do not find employment in agriculture find jobs in the
unorganised service sector (i.e. retail business) to make meagre earnings as
NOTES they fail to get employment in the organised sector at higher wages. A
majority of them are unskilled and are therefore unlikely to get jobs in the
supermarket shops set up by the global giants. The entry of big giants in
the organised retail sector will add to their miseries and send them below
the poverty line.Former Prime Minister Manmohan Singh was of the view
that there was no reason why the small traders will not be able to compete
with retail giants. This is only a wishful thinking without any facts and
evidence.
Another outcome of the entry of FDI multiband retail giants is that the
supermarket stores set up by them will source most of their manufactured
goods from abroad to sell in their stores in India. Already crazy of foreign
goods, a major chunk of middle class in India will bring foreign goods
which are supposed to be of better quality. This will lead to more imports
of manufactured goods which will hurt the Indian manufacturing industries,
especially small-scale and medium enterprises. The Government has
stipulated that for their big retail stores, foreign global giants must source
30% of the goods from local small and medium enterprises. However, this
will be difficult to enforce.
Thus, with FDI retail giants setting up shops in India will not only displace
small traders they will also cause loss of jobs in their manufacturing sector
as these supermarkets opened with FDI by global giants will source their
goods internationally and not from domestic sources. This will hurt small
Indian investors and producers who cannot compete will these global
giants. This will lead to greater loss of jobs. This has been the actual
experience of most countries which have allowed the entry of FDI in retail.
Country and the largest supplier of manufactured goods to Wall-Mart and
other international retail giants. It obviously cannot say no to these
international chains opening stores in China when it is global supplier to
them. India, in contrast, will lose both retail services and manufacturing
jobs.
The claim that opening up of multi-brand retail trade spur competition and
improve farm productivity has been contested. The obstacle to growth of
agricultural productivity are tiny farm holdings and that too are fragmented.
Agricultural productivity per hectare in India is one of the lowest in the
world, Besides small and fragmented land holdings, there is a lack of
irrigation facilities.
Even after sixty years of planning and rural development only 40% of
arable land is irrigated, the remaining 60% of the arable land is still rained.
Increasing fluctuations in rainfall, depleting ground water level and lower NOTES
and improper fertilizer usage are also issues of great concern. So, who is
going to benefit from efficient back-end operations and improved
infrastructure of business? Certainly not the common Indian farmers.
There would be further land consolidation in favour of the already rich and
resourceful farmers, creating conditions for further widening of the gap
between the well-to-do and poor farmers.
Rural infrastructure is another area of worry. One cannot drive high speed,
air-conditioned trucks carrying fresh perishable fruits or milk products on
roads unsuitable even for bullock-carts. During the monsoon, when a
considerable amount of agriculture inputs is expected to be moved to
villages, more than 30% of the villages in flood prone states become
unapproachable by road. How FDI in multi-brand retail trade will help in
building rural infrastructure is open to question?
Lastly ‘farming is the riskiest profession’ observes Dr. M.S. Swaminathan,
eminent agriculture scientist. In spite of being an agricultural country, our
farmers are not insulated from risk. The existing insurance system is either
beyond their reach or too complicated to be relied upon. The arrival of
retail in a big way will certainly make farming riskier. Meeting customers’
(mostly urban) demands and quality specifications require more resource-
intensive farming. We need to learn lessons from the innumerable
incidents of farmers’ suicides being reported across the country. Only time
will tell how much risk these big retail players will be willing to shoulder.
Finally the argument advanced by the Government in favour of its decision
permitting FDI in retail giants that it will create the supply chain, back-end
infrastructure such as storage facilities, refrigeration, transportation for
farm’s produce is quite misleading. Foreign multinational giants cannot be
expected to make large investment in rural infrastructure including power
generation and transportation. Why plan after plan in the 60 years of
planning (1951-2011) which has been allocating quite a good chunk of
resources to them has failed to accomplish this task. Further, why to rely
on foreign multinationals for building up cold chain infrastructure and
warehousing.
To conclude, the Government argument that FDI in retail will solve all
problems like back-end infrastructure, generate employment on a large
scale and check inflation, especially food inflation is making a tall claim.
In fact, FDI in retail is no solution for these fundamental problems of
supply-side bottlenecks and of rising inflation and unemployment. They
NOTES have to be solved through prudent resource allocation in development

planning for India.
There is a fear that opening up multi-brand retail trade to FDI is not a
panacea for the problems of Indian agriculture. It will create more distress
not only for our retail shopkeepers and create large-scale unemployment
but will also not benefit farmers.
14.3 FOREIGN DIRECT INVESTMENT

During April-November 2007, foreign direct investment (FDI) equity
inflows stood at ` 45,098 crore (US$11.14 bn) against ` 33,030 crore
(US$7.23 bn) during April-September 2006, signifying a growth of 36% in
terms of rupee and 54% in terms of US dollar.
From April 2000 to November 2007, Mauritius remained the predominant
source country for FDI to India, accounting for 44.24% share of the
cumulative total, followed by the United States (9.37%), the United
Kingdom (7.98%), and the Netherlands (5.81%).
During April-November 2007, the position of Mauritius remained still
prominent (42.77%). While the shares of the United States (5.45%), the
United Kingdom (2.19%), and the Netherlands (4.51%) were lower, those
of Japan (5.72%) and Singapore (8.73%) were higher. In the sectoral
distribution of FDI inflows, financial and non-financial services secured a
growth of more than seven times during 2006-07, to secure the first spot in
cumulative inflows, displacing computer software and hardware. Along
with services, the shares of sectors like telecommunications, construction,
housing, and real estate have buoyed during April-November 2007.
Of the total FDI received, about 53.57% came through the automatic route
of the RBI, while 20.15% came through the government-approval route,
and the rest in the form of acquisition of existing shares. Among the
destinations of FDI inflows, Mumbai, New Delhi, Bengaluru and Chennai
maintained the first four positions in that order. During the period of
August 1991-November 2007, India received about 7,898 approvals for
foreign technology transfer, of which 81 were obtained during 2006-07
and 52 during April-November 2007.
NOTES
14.4 FDI POLICY
As a result of the comprehensive review of the FDI policy, wide-ranging
policy changes were notified in 2006, like extending automatic routes,
increasing equity caps, removing restrictions, simplifying procedures, and
extending the horizon of FDI to vistas like single-brand product retailing
and agriculture. Of late, several steps have been initiated to facilitate FDI
inflows which, among other things, include: raising the equity cap in civil
aviation, organising Destination India events in association with CII
(Confederation of Indian Industry) and FICCI (Federation of Indian
Chambers of Commerce & Industry), with a view to attract investments,
activating the Foreign Investment Implementation Authority (FIIA)
towards a speedy resolution of investment-related problems; setting up of
National Manufacturing Competitiveness Council (NMCC) to provide a
continuing forum for policy dialogue, to energize the growth of
manufacturing; regular inter-actions with foreign investors through
bilateral/regional/international meets and meetings with individual
investors; and making the website of The Department of Industrial Policy
& Promotion (www.dipp.nic.in) more user-friendly with an online chat
facility. About 4,500 investment-related queries have been replied during
2007-08.
14.5 INDUSTRIAL CREDIT

The overall industrial credit, which slackened in the first half of 2007-08,
is now showing signs of recovery. During April-August 2007, the
outstanding gross deployment of bank credit increased only by 2.8% from
end-March 2007, while the corresponding increase stood at 8.5% during
2006. However, the gap between the rates of credit growth between April-
November 2006 and April-November 2007 has substantially narrowed.
The Data further shows that there is a strong sectoral pattern to the growth
of industrial credit Among the sectors that experienced high rates of
production growth during April-November 2007, credit growth also has
been robust for jute textiles, leather and leather products, basic metals, and
engineering goods. The slackening of the credit growth in mining and
quarrying, and wood products has occurred over a high base achieved by
the end-March 2007. Encouragingly, the outstanding credit to “transport
equipment” group, which has witnessed a slowdown in production, has
grown significantly from the end-March 2007. Besides, the near-doubling
NOTES of the rate of credit growth to infrastructure augurs well for many
infrastructure-dependent industrial groups and for the economy as a whole.
14.6 INDUSTRIAL RELATIONS

The continued decline in the number of strikes and lockouts indicates
improved industrial relations. The number of strikes and lockouts, taken
together, was down by 5.7% in 2006. As per the available information,
during the current year till November 2007, West Bengal experienced the
maximum instances of strikes and lockouts followed by Tamil Nadu and
Gujarat. Industrial disturbances were concentrated mainly in textiles,
financial intermediaries (excluding insurance and pension fund),
engineering, and chemical industries.
14.7 THE SECURITIES AND EXCHANGE BOARD

OF INDIA ACT OF 1992
The Securities and Exchange Board of India Act, 1992 (hereinafter
referred as “The SEBI Act is having retrospective effect, and is deemed to
have come into force on January 30, 1992. Relatively, a brief Act
containing only 35 sections, the SEBI Act governs all the stock exchanges
and securities transactions in India.
A Board by the name of the Securities and Exchange Board of India (SEBI)
consisting of one Chairman and five members, one each from the
Department of Finance and of the Central Government, one from the RBI,
and two other persons; and having its head office in Mumbai and regional
offices in Delhi, Kolkata, and Chennai, has been constitute under the SEBI
Act to administer its provisions. The Central government has the right to
terminate the services of the Chairman or any member of the Board. The
Board decides all questions in its meeting by a majority vote, with the
Chairman having a second or a casting vote.
Section 11 of the SEBI Act provides that it shall be the duty of the Board
to protect the interest of investors in securities, to promote the
development of, and to regulate, the securities market by such measures, as
it thinks fit. It empowers the Board to regulate the business in stock
exchanges, to register and regulate the working of stockbrokers, sub-
brokers, share-transfer agents, bankers ; to an issue, trustees of trust deeds,
registrars to an issue, merchant bankers, underwriters, portfolio managers,
investment advisors, and so on, to register and regulate the working of
collective investment schemes, including mutual funds, to prohibit NOTES

fraudulent and unfair trade practice sf and insider trading, to regulate
takeovers, to conduct enquiries and audits of the stock exchanges, and so
on.
As all stock exchanges are required to be registered with SEBI under the
provisions of the Act under Section 12 of the SEBI Act, all the
stockbrokers, sub-brokers, share-transfer agents, bankers to an issue,
trustees of trust deed, registrars to an issue, merchant bankers,
underwriters, portfolio managers, investment advisors, and such other
intermediary, who may be associated with the securities markets, are
obliged to register with the Board, and the Board has the power to
suspender cancel such registration. The Board is bound by the directions
given by the Central government, from time to time, on questions of policy,
and the Central government has the right to supersede! the Board. The
Board is also obliged to submit a report to the Central government every
year giving true and full account of its activities, policies, and programmes.
Any one aggrieved by the Boards decision is entitled to appeal to the
Central government.
14.8 FOREIGN INSTITUTIONAL INVESTORS (FII)

Foreign Institutional Investors (FIIs) including institutions such as pension
funds, mutual ; funds, investment trusts, asset management, or their power
of attorney holders (providing discretionary and non-discretionary
portfolio management services), are invited to invest in the securities
traded on the primary and secondary markets, including the equity and
other securities/instruments of companies, which are listed/to be listed on
the stock exchanges in India—including the OTC(Over The Counter)
Exchange of India. These would include shares, debentures, war-rants, and
the schemes floated by domestic mutual funds. To be eligible to do so, the
FIIs would be required to obtain registration with Securities and Exchange
Board of India (SEBI). FIIs are also required to file with SEBI and another
application addressed to RBI, for seeking various permissions under FERA.
SEBI shall be granting registration to the FII, taking into account the track
record of the FII, its professional competence, financial soundness,
experience, and such other relevant criteria. FIIs seeking registration with
SEBI should hold a registration from the Securities Commission, or the
regulatory organisation for the stock market, in its own country of
domicile incorporation.
NOTES SEBI’s registration and RBI’s general permission under FERA to an FII
will be for five years, renewable for similar five-year periods later on.
RBI’s general permission under FERA enable the registered FII to buy,
sell, and realise capital gains on investments, made through initial corpus
remitted to India, subscribe/renounce rights offerings of shares, invest on
all recognised stock exchanges through a designated bank branch, and to
appoint a domestic custodian for the custody of investments held.
The general permission from RBI shall also enable the FII to
1. Open foreign currency denominated account(s) in a designated
bank. (These can even be more than one account in the same bank
branch, each designated in different foreign currencies, if it is
required so by FII for its operational purposes.)
2. Open a special non-resident rupee account to which could be
credited all receipts from the capital inflows, sale proceeds of
shares, dividends, and interests.
3. Transfer sums from the foreign currency accounts to the rupee
account and vice versa, at the market rates of exchange.
4. Make investments in the securities in India out of the balances in
the rupee account.
5. Transfer repatriable (after tax) proceeds from the rupee account to
the foreign currency accounts.
6. Repatriate the capital, capital gains, dividends, incomes received
by way of interest, and so on, and any compensation received
towards sale/renouncement of rights offerings of shares, subject
to the designated branch of a bank/the custodian being authorised
to deduct withholding tax on capital gains, and arranging to pay
such tax and remitting the net proceeds at market rates of
exchange.
7. Register FII’s holdings without any further clearance under
FERA.
There is no restriction on the volume of investment, either minimum or
maximum, for the purpose of entry of FIIs, in the primary/secondary
market. Also, there is no lock-in period for the purpose of such
investments made by FIIs.
The portfolio investments in primary or secondary markets will be subject
to a ceiling of 24% of issued share capital, for the total holdings of all
registered FIIs, in any one company. The ceiling would apply to all NOTES
holdings, taking into account the conversions, out of the fully and partly
convertible debentures issued by the company. The holding of a single FII
in any company would also be subject to a ceiling of 5% of the total issued
capital. For this purpose, the holdings of a FII ground will be counted as
holdings of a single FII.
The maximum holding of 24% for all non-resident portfolio investments,
including those of the registered FIIs, will also include NRI corporate and
non-corporate investments, but will not include the following:
1. Foreign investments under financial collaborations (direct foreign
investments), which are permitted up to 51% in all priority areas
and
2. Investments by FIIs through the following alternative routes:
(i) Offshore single/regional funds,
(ii) Global depository receipts, and
(iii) Euroconvertibles.
The disinvestment will be allowed only through stock exchanges in India,
including the OTC Exchange. In exceptional cases, SEBI may permit-sales,
other than through stock exchanges, provided the sale price is not
significantly different from the stock market quotations, where available.
All secondary market operations would be only through the recognised
intermediaries on the Indian Stock Exchange, including the OTC
Exchange of India. A registered FII will not engage in any short-selling in
securities but will take a delivery of the purchased and give a delivery of
the sold securities.
A registered FII can appoint an agency approved by SEBI, to act as a
custodian of securities and for confirmation of transactions in securities,
settlement of purchase and sale, and for reporting information. Such
custodian shall establish separate accounts for detailing on a daily basis the
investment capital utilisation and securities held by each FII for which it is
acting as a custodian. The custodian will report to the RBI and SEBI,
semi-annually, as part of its disclosure and reporting guidelines.
The RBI shall make available to the designated bank branches, a list of
companies where no investment will be allowed on the basis of the upper-
prescribed ceiling of 24%, having been reached under the portfolio
investment scheme. The RBI may, at any time, request by an order a
registered FII, to submit information regarding the records of utilisation of
NOTES the inward remittances of investment capital and the statement of securities
transactions. RBI and/or SEBI may also, at any time, conduct a direct
inspection of the records and accounting books of a registered FII. FIIs
investing under this scheme will benefit from a concessional tax regime of
a flat rate tax of 20% on dividend and interest income and a tax rate of
10% on long term (one year of more) capital gains.

In the early phase of independence we had open policy towards foreign
investment in India, however, there was growing apprehension that the
controls may go in the hand of foreign players therefore the ‘License Raj’
was introduced. However, the New Economic Policy of 1991 did away
with the License Raj and the economy was once again opened to Flls.
14.10 GLOSSARY
 TNC: Trans National Corporations
 Trade Policy: Policy Regarding Export and Import
 TRIMs: Trade Related Investment Measures
 QR: Quantitative Restrictions
14.11 KEY TERMS

 F.D.I: Foreign Direct Investment.
 Flls: Foreign Institutional Investors.
 SMEs: Small and Medium-sized Enterprises
 DIPP: Department of Industrial Policy and Promotion.

1. Government carries out monetary policy through __________.
2. Minimum investment by foreign multinational company is
_________dollars.
(B) True or False NOTES
1. Government policy has no impact on quality of development.

2. Foreign companies in India enjoy less profit as compared to local
enterprise.
3. Flls were invited to improve transport and power sector.

(A) 1. RBI, 2. 100 Million
(B) 1. False, 2. False, 3. True.

1. Write a short note on growth of FDI in India.
2. Explain the modes of FDI inflows in India.
3. Compare the development of China and India vis-a-vis FDI.

1. Kuman Sanjeev: FDI in India, B.R.P.C, Delhi.
2. Guha Ashok: Economic Liberalisation, Oxford, Delhi.
3. Khan A: Strategy of foreign investment, Kitab, Allahabad.

FOREIGN EXCHANGE RATES
UNIT 15 AND FOREIGN EXCHANGE
MARKETS
Structure:
15.1 Introduction
15.2 Foreign Exchange Markets in India – a Brief Background
15.3 Features of the Forward Premium on the Indian Rupee
15.4 Intervention in Foreign Exchange Markets
15.5 The Foreign Exchange Market
15.6 The Market for Foreign Exchange
15.7 The Demand for Currency
15.8 The Supply of Currency
15.9 Exchange Rates
15.10 Changes in Exchange Rates
15.11 Exchange Rates and Interest Rates
15.13 Glossary
15.14 Key Terms
Objectives NOTES

 Know about trade theory
 Understand demand and supply of currency vis-a-vis exchange
rates.
 Understand the speculative flow of funds from one country to
another and its importance of short term on exchange.
15.1 INTRODUCTION
During 2003-04 the average monthly turnover in the Indian foreign
exchange market touched about 175 billion US dollars. Compare this with
the monthly trading volume of about 120 billion US dollars for all cash,
derivatives and debt instruments put together in the country, and the sheer
size of the foreign exchange market becomes evident. Since then, the
foreign exchange market activity has more than doubled with the average
monthly turnover reaching 359 billion USD in 2005-2006, over ten times
the daily turnover of the Bombay Stock Exchange. As in the rest of the
world, in India too, foreign exchange constitutes the largest financial
market by far.
Liberalisation has radically changed India's foreign exchange sector.
Indeed the liberalisation process itself was sparked by a severe balance of
Payments and foreign exchange crisis. Since 1991, the rigid, four-decade-
old, fixed exchange rate system replete with severe import and foreign
exchange controls and a thriving black market is being replaced with a less
regulated, market driven arrangement.
While the rupee is still far from being “fully floating” (many studies
indicate that the effective pegging is no less marked after the reforms than
before), the nature of intervention and range of independence tolerated
have both undergone significant changes. With an over-abundance of
foreign exchange reserves, imports are no longer viewed with tear and
skepticism. The Reserve Bank of India and its allies now intervene
occasionally in the foreign exchange markets not always to support the
rupee but often to avoid an appreciation in its value. Full convertibility of
the rupee is clearly visible in the horizon. The effects of these
developments are palpable in the explosive growth in the foreign exchange
market in India.
Unit 15: Foreign Exchange Rates and Foreign Exchange Markets Page 275 of 316
NOTES Exchanging currency means trading one currency for another. The value at
which an exchange takes place is called exchange rate. The two main
functions of a foreign exchange markets are (1) to determine the price of
different currencies in terms of one another and (2) to transfer the currency
risk to the one who is willing to bear it. The growth of foreign exchange
market in the last few years has been phenomenal. Trading is regulated by
Foreign Exchange Dealers Association of India (FEDAI).
15.2 FOREIGN EXCHANGE MARKETS IN INDIA –

A BRIEF BACKGROUND
The foreign exchange market in India started in earnest less than three
decades ago when in 1978 the government allowed banks to trade foreign
exchange with one another. Today over 70% of the trading in foreign
exchange continues to take place in the inter-bank market. The market
consists of over 90 Authorized Dealers (mostly banks) who transact
currency among themselves and come out “square” or without exposure at
the end of the trading day. Trading is regulated by the Foreign Exchange
Dealers Association of India (FEDAI), a self regulatory association of
dealers. Since 2001, clearing and settlement functions in the foreign
excliange market are largely carried out by the Clearing Corporation of
India Limited (CCIL) that handles transactions of approximately 3.5
billion US dollars a day, about 80% of the total transactions.
The liberalisation process has significantly boosted the foreign exchange
market in the country by allowing both banks and corporations greater
flexibility in holding and trading foreign currencies. The Sodhani
Committee set up in 1994 recommended greater freedom to participating
banks, allowing them to fix their own trading limits, interest rates on
FCNR deposits and the use of derivative products.
The growth of the foreign exchange market in the last few years has been
nothing less than momentous. In the last 5 years, from 2000-01 to 2005-06,
trading volume in the foreign exchange market (including swaps, forwards
and forward cancellations) has more than tripled, growing at a
compounded annual rate exceeding 25%. The inter-bank forex trading
volume has continued to account for the dominant share (over 77%) of
total trading over this period, though there is an unmistakable downward
trend in that proportion (Part of this dominance, though, results from
double-counting since purchase and sales are added separately, and a
Page 276 of 316 Unit 15: Foreign Exchange Rates and Foreign Exchange Markets
single inter-bank transaction leads to a purchase as well as a sales entry.) NOTES

This is in keeping with global patterns.
In March 2006, about half (48%) of the transactions were spot trades,
while swap transactions (essentially repurchase agreements with a one-
way transaction – spot or forward – combined with a longer-horizon
forward transaction in the reverse direction) accounted for 34% and
forwards and forward cancellations made up 11% and 7% respectively.
About two-thirds of all transactions had the rupee on one side. In 2004,
according to the triennial central bank survey of foreign exchange and
derivative markets conducted by the Bank for International Settlements
(BIS (2005a)) the Indian Rupee featured in the 20 position among all
currencies in terms of being on one side of all foreign transactions around
the globe and its share had tripled since 1998. As a host of foreign
exchange trading activity, India ranked 23,d among all countries covered
by the BIS survey in 2004 accounting for 0.3% of the world turnover.
Trading is relatively moderately concentrated in India with 11 banks
accounting for over 75% of the trades covered by the BIS 2004 survey.
15.3 FEATURES OF THE FORWARD PREMIUM

ON THE INDIAN RUPEE
The Indian rupee has had an active forward market for some time now.
The forward premium or discount on the rupee (vis-a-vis the US dollar, for
instance) reflects die market’s beliefs about future changes in its value.
The strength of die relationship of this forward premium with the interest
rate differential between India and the US - the Covered Interest Parity
(CIP) condition - gives us a measure of India's integration with global
markets. The CIP is a no-arbitrage relationship that ensures that one cannot
borrow in a country, convert to and lend in another currency, insure the
returns in the original currency by selling his anticipated proceeds in die
forward market and make profits without risk through this process.
Chakrabarti (2006) reports that between late 1997 and mid-2004 the
average discount on the rupee was about 4% per annum. During the period
the average difference between 90-180 days bank deposit rates in India
and the inter-bank USD offer rate was about 4.5% for 3 months and 3.5%
for the 6 months period. With these two figures in the same ballpark
(particularly given that bank deposit rates and inter-bank rates are not
strictly comparable), annual averages of interest rate differences and the
NOTES forward exchange premium also indicate a moderate degree of co-

movement between the two variables.
The interest rate differential explains about 20% of the total variation in
the forward discount. The deviation of the Indian rupee-US dollar from the
covered interest parity, however, exhibits long-lived swings on both sides
of the zero line, This would indicate arbitrage opportunities and market
imperfections provided we could be sure of die comparability of the
interest rates considered. Therefore, while the behaviour of the forward
premium on the Indian rupee is broadly in lines with the CIP, more careful
empirical analysis involving directly comparable interest rates is necessary
to measure the strength of the covered interest parity condition and the
efficiency of the foreign exchange market.
Under market efficiency, the forward exchange rate is considered to be an
unbiased predictor of the future spot rate, with random prediction errors.
While the prediction errors of forward rates on the rupee appear to show
some degree of persistence, any conclusion in this matter too must await
more rigorous analysis.
15.4 INTERVENTION IN FOREIGN EXCHANGE

MARKETS
The two main functions of the foreign exchange market are to determine
the price of the different currencies in terms of one another and to transfer
currency risk from more risk-averse participants to those more willing to
bear it. As in any market essentially the demand and supply for a particular
currency at any specific point in time determines its price (exchange rate)
at that point. However, since the value of a country's currency has
significant bearing on its economy, foreign exchange markets frequently
witness government intervention in one form or another, to maintain the
value of a currency at or near its “desired” level. Interventions can range
from quantitative restrictions on trade and cross-border transfer of capital
to periodic trades by the central bank of the country or its allies and agents
so as to move the exchange rate in the desired direction. In recent years
India lias witnessed both kinds of intervention though liberalisation has
implied a long-term policy push to reduce and ultimately remove the
former kind. It is safe to say that over the years since liberalisation, India
has allowed restricted capital mobility and followed a “managed float”
type exchange rate policy.
During the early years of liberalisation, the Rangarajan Committee NOTES

recommended that India’s exchange rate be flexible. Officially speaking,
India moved from a fixed exchange rate regime to “market determined"
exchange rate system in 1993. The overt objective of India’s exchange rate
policy, according to various policy pronouncements, has been to manage
“volatility” in exchange rates without targeting any specific levels. This
has been hard to do in practice.
The Indian rupee has had a remarkably stable relationship with the US
dollar. Meanwhile the dollar appreciated against major currencies in the
late 90s and then went into an extended decline particularly during 2003
and 2004. The lock-step pattern of the US dollar and the Rupee is best
reflected in the movements in the two currencies against a third currency
like the Euro. The correlation of the exchange rates of the two currencies
against the Euro during 1999-2004 was 0.94. Several studies have
established the pegged nature of the rupee in recent years (see Chakrabarti
(2006) for a more detailed discussion). Based on volatility, India had a de
facto crawling peg to the US dollar between 1979 and 1991 which changed
to a de facto peg from mid-1991 to mid-1995, with a major devaluation in
March 1993. From mid-1995 to end-2001, the rupee reverted to a crawling
peg arrangement in practice. An analysis of the ratio of the variance of the
exchange rate to the sum of the variances of the interest rate and the
foreign exchange reserves reveals a move even closer to the fixed
exchange rate system. A comparison of the sensitivity (beta) of the Dollar-
rupee rate with the Euro-rupee rate for a three-year period (1999 through
2001), indicates that India had a dollar beta of 1.01 — tenth highest among
the 53 countries considered. More importantly, the US dollar-Euro
exchange rate explained about 97% of all movements in the Indian rupee-
Euro exchange rate — highest among all the 53 countries considered.
Clearly the Indian rupee has been an excellent “tracker” of the US dollar.
It is instructive to consider the Rupee-Dollar exchange rate in the light of
the Purchasing Power Parity (PPP) holding that the exchange rate between
two currencies should equal the ratio of price levels in two countries. In its
dynamic form PPP holds that that the rate of depreciation of a currency
should equal the excess of its inflation rate to that in the other country.
Over a reasonably long period of time, die devaluation in the Indian Rupee,
vis-a-vis the US dollar does seem to have an association with the
difference in the inflation rates in the two countries. Between 1991 and
2003, the two variables have had visible co-movements with a correlation
of about 0.57 (Chakabarti (2006)). This may be a result of Indo-US trade
NOTES flows dominating the exchange rate markets but it is perhaps more likely
that it reflects the exchange rate management principles of the monetary
authorities.
The Reserve Bank of India lias used a varied mix of techniques in
intervening in the foreign exchange market — indirect measures such as
press statements (sometimes called “open mouth operations” in central
bank speak) and, in more extreme situations, monetary measures to affect
the value of the rupee as well as direct purchase and sale in the foreign
exchange market using spot, forward and swap transactions. Till around
2002, die measures were mostly in the nature of crisis management of
saving-the-rupee kind and sometimes the direct deals would be repeated
over several days till the desired outcome was accomplished. Other public
sector banks, particularly the SBI often aided or veiled the intervention
process.
15.5 THE FOREIGN EXCHANGE MARKET

Exchanging currency means trading one currency for another. The value at
which an exchange takes place is called the exchange rate, which can be
regarded as the price of one currency expressed in terms of another one,
such as £1 (GBP) exchanging for US$1.50 cents.
When nations are formed, they commonly introduce their own currency as
a mark of independence, rather than share the currency of another country.
For example in 1792, shortly after independence from Britain, the USA
introduced the dollar as its official currency in preference to the British
pound. The word dollar is derived from ‘thaler’ a European word for the
silver coinage which was commonly used across Europe between the 15th
and 18th century. The British pound itself is at least 1300 years old and is
the world’s longest surviving currency. However, it is the Chinese who
can claim the world’s first coins, some 3000 years ago, and its first paper
money, used about 1200 years ago, although paper money disappeared in
China in the 15th Century. The most recent currency to be added to the
stock of world currencies is the European euro, which came into existence
in 1999.
Today, currencies are issued and controlled by central banks, such as the
European Central Bank (ECB), the US Federal Reserve, and the Bank of
England. The two main global currencies are the US Dollar ($) and the
European Euro (€). The Euro is shared by sixteen European countries as
part of European integration that dates back to the 1950s.
NOTES
15.6 THE MARKET FOR FOREIGN EXCHANGE
Currencies are bought and sold, just like other commodities, in markets
called Foreign Exchange Markets. The world’s three most common
transactions are exchanges between the dollar and the euro (30%) the
dollar and the yen (20%) and the dollar and the Pound Sterling (12%).
How currency values are established depends upon whether they are
determined solely in free markets, called freely floating, or determined by
agreements between governments, called fixed or pegged. Like most
currencies, the pound has at times been both fixed, and floating. Between
1944 and 1971, most of the world’s currencies were fixed to the US Dollar,
which in turn was fixed to gold. After a period of floating, the pound
joined the European Exchange Rate Mechanism (ERM) in 1990, but
quickly left in 1992, and has floated freely ever since. This has meant that
its value is largely determined by the interaction of demand and supply.
15.7 THE DEMAND FOR CURRENCY

The demand for currencies is derived from the demand for a country’s
exports, and from speculators looking to make a profit on changes in
currency values.
15.8 THE SUPPLY OF CURRENCY

The supply of a currency is determined by the domestic demand for
imports from abroad. For example, when the UK imports cars from Japan
it must pay in yen (¥), and to buy yen it must sell (supply) pounds. The
more it imports the greater the supply of pounds onto the foreign exchange
market. A large proportion of short-term trade in currencies is by dealers
who work for financial institutions. The London foreign exchange market
is the World’s single largest international exchange market.
15.9 EXCHANGE RATES

The equilibrium exchange rate is the rate which equates demand and
supply for a particular currency against another currency.
NOTES £/S
Exchange
rate
£1/S1.50
D
Quantity
Q
Example-1
If we assume the UK and France both produce goods that the other wants,
they will wish to trade with each other. However, French producers require
payment in Euros and the British producers require payments in pounds
Sterling. Both need payment in their own local currency so that they can
pay their own production costs in their local currency. The foreign
exchange market enables both French and British producers to exchange
currencies so that trades can take place.
The market will create an equilibrium exchange rate for each currency,
which will exist where demand and supply of currencies equates.
15.10 CHANGES IN EXCHANGE RATES

Changes in the value of a currency like Sterling reflect changes in demand
and supply. On a demand and supply graph, the price of Sterling is
expressed in terms of the other currency, such as the US$.
An increase in the exchange rate
For example, an increase in exports would shift the demand curve for
Sterling to the right and push up the exchange rate. Originally, one pound
bought $1.50, but now buys $1.60, hence its value has risen.
£/S NOTES
Exchange
rate
£1/S1.60
£1/S1.50
D1
D
Q Q1 Quantity
15.11 EXCHANGE RATES AND INTEREST RATES

Changes in a country ’ s interest rates also affect its currency, through its
impact on the demand and supply of financial assets in the UK and abroad.
For example, higher interest rates relative to other countries, makes the
UK attractive the investors, and leads to an increase in the demand for the
UK’s financial assets, and an increase in the demand for Sterling.
Conversely, lower interest rates in one country relative to other countries
leads to an increase in supply, as speculators sell a currency in order to buy
currencies associated with rising interest rates. These speculative flows are
called hot money, and have an important short-term effect on exchange
rates.

Exchanging currency means trading one currency for another. The value at
which the exchange takes place is the exchange rate, this means the price
of one currency expressed in terms of another. Foreign exchange
constitutes the largest financial market in India.
NOTES
15.13 GLOSSARY
 FEMA: Foreign Exchange Management Act.
 Foreign Affiliate: A foreign enterprise which invests in a host
country in cash or kind.
 FEDAI: Foreign Exchange Dealers Association of India.
 ECB: European Central Bank
15.14 KEY TERMS

 B.O.T: Board of Trade
 SEZ: Special Economic Zones
 OGL: Open General License
 EPZ: Export Processing Zones

1. Major source of industrial finance, apart from capital market
includes ___________.
2. S.S.I considers a ‘Sick’ unit when it is net in production for at
least _________years.
(B) True and False

1. R.B.I uses varied mix techniques in intervening in Foreign
Exchange Markets.
2. The demand for currencies is derived from the demand for a
country’s imports.

(A) 1. FDI, 2. three,
(B) 1. True, 2. False.
NOTES
1. Write a short note on foreign exchange market.
2. What do you understand by exchange rate Explain?
3. Liberalisation has boosted foreign exchange. Discuss.

1. Raltod J.S.- ‘Export Marketing’ H.P.H. Mumbai.
2. Sury Niti - ‘FDI’, NCP, Delhi.

GLOBALISATION,
UNIT 16 LIBERALISATION AND
PRIVATISATION
Structure:
16.1 Introduction to Economics Policy – Reforms
16.2 Globalisation
16.3 Liberalisation
16.4 Privatisation
16.5 Conclusion
16.7 Glossary
16.8 Key Terms
Objectives
 Develop a clear understanding about the concepts of liberalisation,
globalisation and privatisation.
 Understand and appreciate the interrelationship between
liberalisation, globalisation and privatisation.
 Understand the merits and demerits of the economic reforms
undertaken in relation to liberalisation, globalisation and
privatisation.
 Know about the reforms in the new economic policy.
 Understand how reforms lead to industrial development and NOTES

growth.
 Understand the important of opening the economy to private
sector.
16.1 INTRODUCTION TO ECONOMIC POLICY –

REFORMS
Economic Reforms in India commenced during the year 1985 after Rajiv
Gandhi took over as Prime Minister. The Prime Minister in his first
national broadcast said: “The public sector has entered into too many areas
where it should not be. We shall open the economy to the private sector in
several areas hither to restricted to it.” Consequently, a number of
measures were taken to remove controls, open areas to private sector
players. This may be described as the first phase of liberalisation. Some of
the measures initiated by his government were:
 Cement was decontrolled and a number of licenses were issued to
private sector units to produce cement.
 The share of free sale sugar was increased to help the sugar
industry.
 The ceiling on asset limit of big business houses was raised from
` 20 crores to ` 100 crores.
 94 drugs were delicensed and brought out of the purview of the
MRTP Act.
 Electronics industry was freed from the restrictions of the MRTP
Act.
 Foreign firms were welcomed in this area.
 A Scheme of broad banding was introduced. This implies that
within the overall capacity, firms were free to produce a range of
commodities.
For instance, in lieu of the license to produce up to 350 c.c. engines
capacity, firms were allowed to produce two- wheelers of any type -
scooter; motor-cycles, mopeds etc. The process of broad banding was
extended to 25 categories of industries. These industries included four-
wheelers, chemicals, pharmaceuticals, petro-chemicals, and typewriter of
all types- manual and electronic. The industrialists were not required to
Unit 16: Globalisation, Liberalisation and Privatisation Page 287 of 316

NOTES take a license of each and every item in a group, but were entitled to the
production of a range of products within a group. However, Rajiv Gandhi
did not take a very strong and categorical position on the issue of
privatisation and globalisation, though some liberalisation of the economy
did take place. It was only when P.V. Narasimha Rao took over as Prime
Minister in 1991 that a new industrial policy was announced which
marked a sharp departure from the earlier policy of 1956.
An unprecedented balance of payments crisis emerged in early 1991. The
current account deficit doubled from an annual average of $2.3 billion or
1.3% of GDP during the first half of the 1990s, to an annual average of
$5.5 billion or 2.2% of GDP during the second half of the 1990s. For the
first time in modem history, India was faced with the prospect of
defaulting on external commitments since the foreign currency reserves
had fallen to a mere $1 billion by mid-1991. The balance of payments
came under severe strain from one liquidity crisis experienced in mid-
January 1991 and another in late June 1991.
There were three aims of Economic policy:
 Globalisation,
 Liberalisation, and
 Privatisation.
In 1990 for the first time there was a crisis of payment default to
International institutions. There was a severe strain on liquidity crisis.
Hence there were reforms on economic policy in terms of globalisation,
liberalisation and palatalisation. It means dismantling the regine of
industrial licensing and controls. This benefited the foreign exchange
market in India.
16.2 GLOBALISATION
Globalisation is primarily economic phenomenon, involving the increasing
interaction, or integration of national economic systems through the
growth in international trade, investment and capital flows. A rapid
increase in cross- border social, cultural and technological exchange is part
of the phenomenon of globalisation.
It has four parameters :
 Reduction of trade barriers so as to permit free flow of capital and
services across national frontiers;
Page 288 of 316 Unit 16: Globalisation, Liberalisation and Privatisation

 Creation of an environment in which free flow of capital can take NOTES

place;
 Creation of an environment permitting free flow of technology
among nation-states; and
 Creation of an environment in which free movement of labour
can take place in different countries of the world.
The advocates of globalisation, especially from the developed countries,
limit the definition of globalisation to only three components viz.,
unhindered trade flows, capital flows and technology flows. They insist
that the developing countries accept their definition of globalisation and
conduct the debate on globalisation within the boundaries set by them. But
several economists and social thinkers in developing countries believe that
this definition is incomplete. If the ultimate aim of the globalisation
movement is to integrate the world into one global village, then the fourth
component of unrestricted movement of labour cannot be left out. But
whether the debate about globalisation is earned out at the World Trade
Organisation (WTO) or at any other international forum, there is a
deliberate effort to black out ‘labour flows’ as an essential component of
globalisation.
To pursue the objective of globalisation, the following measures, have
been taken.
(i) Reduction of import duties: There has been a considerable reduction
in import duties. A reduction in import duties and the extension of
MODVAT credit on taxes paid on inputs have been important measures
for improving efficiency of the tax system. By 1990 import duties were
300% or more for several items and above 200% for many items. Peak
rates were progressively reduced during the 1990s to reach 35% in 2001.
The median tariff rate was brought down to 25% in the 2003-04 budget. It
has come down to 15% during 2004-05.
Besides this, the government has attempted to rapidly dismantle
quantitative restriction on imports and exports. It has also undertaken
adjustment of exchange rate so as to remove over-valuation of currency.
This has helped in stepping up exports.
On the 8th February, 1997 the Commerce Ministry removed restrictions on
162 items for imports. Out of them, 69 items were moved from Special
Import License (SIL) to free imports. Among these items are escalators
and moving walkways, cable cars, burglar and fire alarms, cameras of all

NOTES kinds, auto-bank note dispensers, industrial vacuum cleaners and various
kinds of glassware. Besides this, 93 items were moved from industrial to
SIL (Special Import License) list which included photographic films
rubber stoppers, aluminium beverage cans, car air-conditioning machines,
cosmetic perfumes, picture tubes below 14 inches and a wide range of
office machines. By April 2001, all the quantitative restrictions on imports
were removed. Only a few items have been retained for exports through
State Trading enterprises.
(ii) Encouragement of foreign investment: The government has taken a
number of measures to encourage foreign investment. The main measures
taken in this regard are:
(a) Approval would be given for direct investment up to 51% foreign
equity in high priority industries as per Industrial Policy of 1991.
There shall be no bottlenecks of any kind in this process. Such
clearances will be given if foreign equity covers the foreign
exchange requirements for imported capital goods.
On the 31st of December, 1996 the Cabinet gave its assent to a
new list of industries whereby joint ventures with up to 74%
foreign equity would be cleared automatically. Among the
industries listed for the purpose are: Mining services such as oil
and gas fields services., basic metals and alloy industries, other
manufacturing industries related to the items based on solar
energy like solar cells, cookers, air and water heating systems,
small hydro-equipment, construction and maintenance of roads,
bridges, tunnels, pipelines, ropeways, ports, harbours and
runways, electric generation and transmission and other
infrastructure. The basic purpose of this move is to facilitate
direct foreign investment in India.
(b) To provide access to international markets, majority foreign
equity holding up to 51% equity would be allowed for trading
companies primarily engaged in export activities.
(iii) Encouragement to foreign technology agreement: The Industrial
Policy of 1991 undertook the following measures:
(a) Automatic permission will be given for foreign technology
agreements in high priority industries up to a lump sum payment
of ` l crore, 5% royalty for domestic sales and 8% for exports,
subject to total payments of 8% sales over a 10-year period from

the date of the agreement or 7 years from commencement of NOTES

production.
(b) In respect of other industries, automatic permission would be
given if no free foreign exchange were required for any payments.
No permission will be necessary for hiring of foreign technicians
and foreign testing of indigenously developed technologies.
(c) No permission will be necessary for hiring of foreign technicians
and foreign testing of indigenously developed technologies.
16.3 LIBERALISATION
The main aim of the liberalisation was to dismantle the excessive
regulatory framework that curtailed the freedom of enterprise. Over the
years, the country had developed a system of “licence-permit raj’. The aim
of the new economic policy was to save the entrepreneurs from
unnecessary harassment of seeking permission from Babudom (the
bureaucracy of the country) to start an undertaking.
Similarly, the big business houses were unable to start new enterprises
because the Monopolies and Restrictive Trade Practices (MRTP) Act had
prescribed a ceiling on asset ownership to the extent of ` 100 crores. In
case a business house had assets of more than ` 100 crores, its application
after scrutiny by the MRTP Commission was rejected. It was believed that
on account of the rise in prices this limit had become outdated and needed
a review. The second objection by the private sector lobby was that it
prevented big industrial houses from investing in heavy industry and
infrastructure, which required lump sum investment. In order that the big
business could be enthused to enter the core sectors–heavy industry,
infrastructure, petrochemicals, electronics etc., with big projects, the
irrelevance of MRTP limit was recognised and hence scrapped.
The major purpose of liberalisation was to free the large private corporate
sector from bureaucratic controls. It, therefore, started dismantling the
regime of industrial licensing and controls. In pursuance of this policy, the
industrial policy of 1991 abolished industrial licensing for all projects
except for a short set of 18 industries.
On April 14, 1993, the Cabinet Committee on Economic Affairs decided
to remove three more items from the list of 18 industries reserved for
compulsory licensing. The three items were; motor cars, white goods
(which include refrigerators, washing machines, air-conditioners,

NOTES microwave ovens etc) and raw hides and skins and patent leather. In the
case of cars and white goods, the basic puipose of dereservation was to
increase investment in industries in procuring cars and white goods so that
the demand of the large middle class ranging from 250 to 300 million can
be satisfied. These commodities are no longer considered as luxury goods,
but are considered domestic gadgets to reduce the drudgery of domestic
work. Liberalising the automotive sector led to better designs in two
wheelers, unleashing the urge to compete in global markets and widening
the domestic markets through better quality and standards. It should be of
interest to know that a car has 20000 components— all manufactured in
the small industry sector. The automotive component manufacturing in the
small-scale sector suddenly started looking up and by the turn of the
decade of reforms, the component manufacturing captured global markets.
The government, in response to the market demand, liberalised the
industries producing these goods and freed them from industrial licensing.
Therefore, liberalisation led to globalisation.
The abolition of licensing for raw hides and skins and patent leather is
motivated by the desire to push up exports. Since the potential for leather
and good quality shoe exports is very large, the government decided to
abolish licensing so that large-scale units could realise this potential by the
use of modem technology.
The List of Industries in which Industrial Licensing is Compulsory:
1. Coal and Lignite,
2. Petroleum (other than crude) and its distillation products,
3. Distillation and brewing of alcoholic drinks,
4. Sugar,
5. Animal fats and oils,
6. Cigars and Cigarettes of tobacco and manufactured tobacco
substitutes,
7. Asbestos and asbestos-based products,
8. Plywood, decorative veneers and other wood-based products,
9. Raw hides and skins, leather, chamois leather and patent leather,
10. Tanned or dressed furskins,
11. Paper and newsprint except bagasse-based units,
12. Aerospace and defence equipment:all types,
13. Industrial explosives, NOTES
14. Hazardous chemicals,

15. Drugs and pharmaceuticals.
This long list also got truncated to six by 1999.
16.4 PRIVATISATION
Privatisation deals with the transfer of businesses from the state to the
private sector. This commonly involves complex contractual structures to
be put in place, and the industries concerned are usually closely regulated.
Privatisation in narrow sense indicates transfer of ownership of a public
sector undertaking to private sector, either wholly or partially. But in
another sense, it implies the opening up of the private sector to areas,
which were hitherto reserved for public sector. Such deliberate
encouragement of investment to the private sector in the economy, will
over a period of time increase the overall share of the private sector in the
economy. This is the broader view in which privatisation of the economy
can be effected. The basic purpose is to limit the areas of the public sector
and to extend the areas of private sector operation including heavy
industries and infrastructure.
Privatisation is, therefore, a process of involving the private sector in the
ownership or operation of a state owned or public sector undertaking. It
can take three forms: (i) Ownership measures; (ii) Organisational measures;
and (iii) Operational measures.
(i) Ownership measures: The degree of privatisation is judged by the
extent of ownership transferred from the public enterprises to the private
sector. Ownership may be transferred to an individual, co-operative or
corporate sector. This can have three forms:
(a) Total decentralisation implies 100% transfer of ownership of a
public enterprise to private sector.
(b) Joint Venture implies partial transfer of a public enterprise to the
private sector. It can have several variants – 25% transfer to
private sector in a joint venture implies that majority ownership
and control remains with the public sector. 51% transfer of
ownership to the private sector shifts the balance in favour of the
private sector, though the public sector retains a substantial stake
in the undertaking. 74% transfer of ownership to the private

NOTES sector implies a dominant share being transferred to private sector.

In such a situation, the private sector is in a better position to
change the character of an enterprise.
(c) Liquidation implies the sale of assets to a person who may use
them for the same purpose or some other purpose. This solely
depends on the preference of the buyer.
(d) Workers’ co-operative is a special form of decentralisation. In
this form, ownership of the enterprise is transferred to workers
who may form a co-operative to run the enterprise. In such a
situation, appropriate provision of bank loans is made to enable
workers to buy the shares of the enterprise. The burden of
running the enterprise rests on the workers in a workers’
Co-operative. The workers become entitled to ownership
dividend besides getting wages for their sendees.
(ii) Organisational measures include a variety of measures to a limited
state control. They include:
(a) A holding company may be designed to taking top-level major
decisions with sufficient degree of autonomy for the operating
companies in its hold in their day-to-day operations. A big
company like the Oil & Natural Gas Commission (ONGC), Steel
Authority of India (SAIL) or Bharat Heavy Electricals Limited
(BHEL) may acquire a holding status, thereby transferring a
number of functions to its smaller units. In this way, a
decentralised pattern of management emerges.
(b) Leasing: In this arrangement, the government agrees to transfer
the use of assets of a public enterprise to a private bidder for a
specified period, say of 5 years. While entering into a lease, the
bidder is required to give an assurance of the quantum of profits
that would be made available to the state. This is a kind of tenure
ownership. The government reserves the right to review the lease
to the same person or to grant the lease to another bidder
depending upon the circumstances of the case.
(c) Restructuring is of two types: financial restructuring and basic
restructuring.
— Financial restructuring implies the writing off of accumulated
losses and rationalisation of capital composition in respect of

debt-equity ratio. The main purpose of this restructuring is to NOTES

improve the financial health of the enterprise.
— Basic restructuring is said to occur when the public enterprise
decides to shed some of its activities to be taken up by
ancillaries or small-scale units.
16.5 CONCLUSION
Liberalisation has transformed India’s external and a direct beneficiary of
this has been the foreign exchange market in India. From a foreign
exchange- starved, control-ridden economy, India has moved on to
position of $150 billion plus in international reserves with a confident
rupee and drastically reduced foreign exchange control. As foreign trade
and cross-border capital flows continue to grow, and the country moves
towards capital account convertibility, the foreign exchange market is
poised to play an even greater role in the economy.

globalisation is a process that increases interactions with foreign countries,
this leads to better opportunities and influx of new technologies. However,
there can be adverse impart on society, culture and growth. The country
had great expectations with liberalisation for improved economy which
has not materialised.
16.7 GLOSSARY
 Globalisation: A process of global integration of products,
technology labour etc.
 Foreign Investment: Investment from foreign corporate bodies,
NRIs .
 Privatisation: A process by which major economic decisions are
taken by a large ho of individuals and private units.
16.8 KEY TERMS

 Globalisation: The process involving increase interaction with
foreign countries.

NOTES  Privatisation: The transfer of business from state to private

sector.
 liberalisation: Means removal of excess regulations and freedom
for business.


1. Economic Liberalisation means ________ of economy.
2. Important source of foreign investment in India is _________.
3. Generally _______and democracy are widely believed to help
globalisation.
(B) True or False

1. Unemployment increases due to increased industrialisation.
2. With Liberalisation there are no threats to the economy.
3. The performance of public sector was noteworthy after
independence.

(A). 1. Opening, 2. NRI, 3. free trade
(B). 1. True, 2. False, 3. False.

1. Write a brief account on globalisation.
2. Explain the meaning of privatisation.
3. Explain the impact of foreign trade on growth and development.

1. Patel I.G. Economic Reforms and Global Change, Macmillan,
Delhi.
2. Michael: Globalisation, HPH, Mumbai

UNIT 17 REGIONAL TRADING BLOCKS
Structure:
17.1 Introduction
17.2 Regional Trade Blocks
17.3 Trading Blocks
17.4 The Main Advantages for Members of Trading Blocks
17.5 The Main Disadvantages of Trading Blocks
17.6 Development
17.8 Glossary
17.9 Key Terms
Objectives
After reading this Unit, you will be able to understand:
 Know about the meaning and necessity of trading blocks.
 Understand the advantages of free trade market access and
protection.
17.1 INTRODUCTION
Trade Blocks are Free Trade Zones designed to encourage trade activities.
This provides their members with mechanism for competing in an
aggressive global market. There are advantages for the members such as
NOTES free trade, market access, protection and job opportunities. The
disadvantages in terms of loss of benefits and distortion of trade.
The Internet and technological advances in telecommunications link trade
partners across the globe. Yet, this does not mean that trade barriers are
non-existent. While the World Trade Organisation (WTO) promotes
global multilateral free trade, regional trade blocks provide their members
with the mechanisms for competing in an aggressive global market.
Regardless of the size of your business, it is essential to know the
international trade regulations that govern your import and/or export
operations.
17.2 REGIONAL TRADE BLOCKS

In general terms, regional trade blocks are associations of nations at a
governmental level to promote trade within the block and defend its
members against global competition. Defense against global competition is
obtained through established tariffs on goods produced by member states,
import quotas, government subsidies, onerous bureaucratic import
processes, and technical and other non-tariff barriers.
Since trade is not an isolated activity, member states within regional
blocks also cooperate in economic, political, security, climatic, and other
issues affecting the region.
In terms of their size and trade value, there are four major trade blocks and
a larger number of blocks of regional importance.
The four major regional trade blocks are, as follows:
As discussed earlier -
1. E.U: European Union.
2. NAFTA: North American Free Trade Agreement.
3. SCM: Southern Common Markets.
4. ASEAN: Association of southeast Asian Nations.
Regardless of the size of your business, it is essential to know the
international trade regulations that govern your import and/or export
operations.
The concept of trade blocks is crucial in the context of international trade.
Trade blocks are free trade zones designed to encourage trade activities
Page 298 of 316 Unit 17: Regional Trading Blocks

across nations. The formation of trade blocks involves a number of NOTES

agreements on tariff, trade and tax. The activities of trade blocks have
huge importance in the economic and political scenarios of the
contemporary world. Over the years trading blocks have played a major
role in regulating the trend and pattern of international trade.
Regional Trade Blocks at a Glance

Regional trade blocks protect the interests of the member countries. The
primary aim of trade block activities is to create a favourable economic
framework for promotion of cross border trade among the member
countries.
Different regional blocks have come up in the period of economic
liberalisation in various parts of the world.
Activities of Trade Blocks

It is true that the principal objective of all trade blocks is promotion of
trade; however, the difference lies in their modes of operation. The
activities of trade blocks can be evaluated by using three basic measures.
The number of latest agreements, meetings and other activities undertaken
by the regional trade blocks. The pattern of future planning regarding trade
promotion and focus on intergovernmental associations and quicker time
frame for policy implementation. Number of practical achievements
attained by the member countries. In practice, the success of trading blocks
crucially depends on the performance of the member countries. To ensure
effective trade promotion the trading blocks need to be more flexible and
accommodation. Besides trade promotion, the regional blocks are also
expected to take part in other domains of the member countries. Effective
management of trade block activities ensures all-round development of the
member nations.
17.3 TRADING BLOCKS

A regional trading Blocks is a group of countries within a geographical
region that protect themselves from imports from non-members. Trading
Blocks are a form of economic integration, and increasingly shape the
pattern of world trade. There are several types of trading Blocks:
Unit 17: Regional Trading Blocks Page 299 of 316

NOTES Preferential Trade Area

Preferential Trade Areas (PTAs) exist when countries within a
geographical region agree to reduce or eliminate tariff barriers on selected
goods imported from other members of the area. This is often the first
small step towards the creation of a trading blocks.
Free Trade Area

Free Trade Areas (FTAs) are created when two or more countries in a
region agree to reduce or eliminate barriers to trade on all goods coming
from other members.
Customs Union
A customs union involves the removal of tariff barriers between members,
plus the acceptance of a common (unified) external tariff against non-
members. This means that members may negotiate as a single block with
3rd parties, such as with other trading blocks, or with WTO.
Common Market
A ‘common market’ is the first significant step towards full economic
integration, and occurs when member countries trade freely in all
economic resources – not just tangible goods. This means that all barriers
to trade in goods, services, capital, and labour are removed. In addition, as
well as removing tariffs, non-tariff barriers are also reduced and eliminated.
For a common market to be successful there must also be a significant
level of harmonisation of micro-economic policies, and common rules
regarding monopoly power and other anti-competitive practices. There
may also be common policies affecting key industries, such as the
Common Agricultural Policy (CAP) and Common Fisheries Policy (CFP)
of the European Single Market (ESM).
17.4 THE MAIN ADVANTAGES FOR MEMBERS

OF TRADING BLOCKS
Free Trade within the Block
Knowing that they have free access to each others markets, members are
encouraged to specialise. This means that, at the regional level, there is a
wider application of the principle of comparative advantage.

Market Access and Trade Creation NOTES
Easier access to each others markets means that trade between members is
likely to increase. Trade creation exists when free trade enables high cost
domestic producers to be replaced by lower cost, and more efficient
imports. Because low cost imports lead to lower priced imports, there is a
'consumption effect', with increased demand resulting from lower prices.
Economies of Scale
Producers can benefit from the application of scale economies, which will
lead to lower costs and lower prices for consumers.
Jobs
Jobs may be created as a consequence of increased trade between member
economies.
Protection
Firms inside the block are protected from cheaper imports from outside,
such as the protection of the EU shoe industry from cheap imports from
China and Vietnam.
17.5 THE MAIN DISADVANTAGES OF TRADING

BLOCKS
Loss of Benefits
The benefits of free trade between countries in different blocks is lost.
Distortion of Trade
Trading blocks are likely to distort world trade, and reduce the beneficial
effects of specialisation and the exploitation to eomparative advantage.
Inefficiencies and Trade Diversion

Inefficient producers within the bloc can be protected from more-efficient
ones outside the block. For example, inefficient European farmers may be
protected from low-cost imports from developing countries. Trade
diversion arises when trade is diverted away from efficient producers who
are based outside the trading area.

NOTES Retaliation
The development of one regional trading block is likely to stimulate the
development of others. This can lead to trade disputes, such as those
between the EU and NAFTA, including the recent Boeing (US)/Airbus
(EU) dispute. The EU and US have a long history of trade disputes,
including the dispute over US steel tariffs, which were declared illegal by
the WTO in 2005. In addition, there are the so-called beef wars with the
US applying £60m tariffs on EU beef in response to the EU’s ban on US
beef treated with hormones; and complaints to the WTO of each others
generous agricultural support.
During the 1970s many former UK colonies formed their own trading
blocks in reaction to the UK joining the European common market.
17.6 DEVELOPMENTS
Agricultural Sector
The agricultural sector has remained relatively untouched by the reform
programmes except the thrust given in the Export-Import Policy 2002-
2007. Some progress has also been made in terms of the removal of:
(i) controls on the inter-state movement of certain grains and
(ii) administered prices. However, controls on the export and import of
certain products remain. The government of India has identified potential
commodities in various states and Agricultural Export Zones (AEZ) have
been set up in order to promote exports.
Food Processing Sector

In the food processing sector, tariff reforms have resulted in the average
duties being halved since 1993 (currently, ranging between 15 and 25%).
Import licensing restrictions have also been removed. The food processing
sector has witnessed increased foreign investment, wherein up to 51 and
100% of participation is allowed automatically for foreigners and non-
resident Indians respectively.
Mining and Petroleum Sector

India heavily depends on the import of petroleum. Prices, until recently,
were administered but the government has recently placed an emphasis on
increased oil exploration domestically to reduce import dependence and is

encouraging new explorations by offering investment incentives like tax NOTES

holidays to companies.
Major policy changes since 1991 include automatic permission for foreign
equity participation in the mining activity of 13 minerals. However, the
Foreign Investment Promotion Board (FIPB) must approve foreign equity
participation in case of over 50% share of participation. Trade reforms
include a reduction in tariff rates to around 10% (from 46% in 1993-94)
for non-ferrous and iron ores and 13% (from 65% in 1993-94) for coal.
Manufacturing Sector
Reforms have been implemented in the manufacturing sector, including
(i) reductions in average tariff rates, (ii) removal of import licensing
restrictions, (iii) relaxations in compulsory industrial licensing, and
(iv) liberalisation of foreign investment policies. The rules governing
foreign investment have also been considerably simplified with an
enlarged list of industries, including the automobile sector. (Refer to the
website of Engineering Export Promotion Council for more details).
Services Sector
Services sector contributes more than 50% of India’s national income. Its
overall growth has been fueled by rapid expansion of activities in the area
of finance, information technology, commerce and tourism. The software,
BPO and KPO sectors have contributed to the growth of the Indian
economy in the recent past. Global outsourcing of services has been an
important segment of the service sector for many years. Steps have been
taken in liberalising telecommunications sector. Many value-added
services-including cellular mobile telephone are now open to foreign
equity participation. In the area of financial services, the insurance sector
that had been monopolised by the government till, now has been made
open to domestic private investors and foreign tie-ups. Under the Financial
Services Agreement, the government has offered to remove restrictions on
foreign firms in the banking sector.
India has a large pool of well-qualified professionals capable of providing
services abroad. GATS (General Agreement on Trade in Services)
recognises “movement of natural persons” as one of the modes for supply
of services. However, the commitments shown by the developed countries
have very little to offer to the developing countries. The present
commitments are largely restricted to business visitors and intra-corporate
transferees.

NOTES
The association of nations have created areas for regional trade Blocks, to
promote trade. It also acts as buffer against competition Common market
have been created by four major trade blocks.
1. E.U- European Union
2. NAFTA - North American Free Trade Agreement
3. SCCM - Southern Common Markets
4. ASEAN - Association of Southeast Asian Nations
17.8 GLOSSARY
 Trade Policy: Policy regarding Import/Export
 Tariffs: Duties on import of goods and service
 PTA: Preferential Trade Area.
17.9 KEY TERMS

 Anti dumping: Action against dumping
 Trade Blocks: Inter governmental agreement where regional
barriers to trade are reduced or eliminated.
 Custom Valuation: Set of rules for valuation that ensures trade
objectives.


1. Customs union involves ________ of tariff barriers between
members.
2. In Custom market the members trade freely in all ________.
3. ‘Scale economies lead to lower _______for consumers.

(B) True or False NOTES
1. Regional Trading Block is group of nations within the region.

2. In a common market member countries are not allowed to trade
freely.
3. Trade Blocks do not create jobs.

(A) 1. Removal, 2. Resources or Goods, 3. Prices
(B) 1. True, 2. False, 3. False

1. Explain the purpose of creating blocks.
2. Write a note on advantages of trading blocks.

1. Das K - Trade & Development, ‘Deep’, Delhi.
2. Balagopal - Export Management, HPH, Mumbai.


WORLD TRADE AND
UNIT 18
EMERGING ENVIRONMENT
Structure:
18.1 Introduction
18.2 Foreign Trade Policy of India
18.3 Salient Features of EXIM Policy
18.4 Emerging Environment
18.5 Foreign Exchange Reserves (QR – Quantitative Restrictions)
18.6 Phased Removal of QRs
18.7 Removal of QRs: Implications
18.8 Special Provisions of WTO Agreement
18.9 Conclusion
18.11 Glossary
18.12 Key Terms
Objectives
 Understand the importance of World Trade and trading
environment.
 Explain The importance of GATT and WTO.
 Discuss the Importance of export promotion initiatives.
NOTES
18.1 INTRODUCTION
The most important initiatives of the EXIM policy were (1) the removal of
restrictions on agricultural export (2) setting up of twenty export zones in
twelve states. The policy also made Special Economic Zones (SEZ), there
were attractive because of benefits of income tax. However, there were
quantitative restriction, such as import and export. Eventually the
quantitative restrictions were phased out. This had an impact on prices in
the free trade environment.
18.2 FOREIGN TRADE POLICY OF INDIA

The focus of trade policy reforms in India have been on liberalisation,
openness and globalisation with a basic thrust on export promotion activity,
removal of Quantitative Restrictions and making Indian industry more
competitive to meet global requirements. Although the EXIM Policy of
India is primarily a five-year policy, commerce ministry announces
appropriate amendments every year, keeping in mind the latest national
and international developments. This is usually done on 31st March every
year. The last five-year EXIM policy was effective till 2002.
Although the 2002 EXIM policy was supposed to last for 5 years, the UPA
government announced new five-year ‘Foreign Trade’ Policy from 2004
by changing the name ‘EXIM’ policy. There is a special emphasis on
certain areas like the industrial clusters, Agri-Export Zones, gems and
jewellery and hardware in 2004-09 policy. It attempts to build on what has
already been announced earlier.
Taking into account the important sectors, an attempt has been made to
highlight the salient features of EXIM policy 2002 in comparison with the
1997-2002 policy and the changes introduced in 1999, 2000 and 2001.
Export-Import (EXIM) Policy—Comparative Perspectives

2002
Features 1997-2002 Export Import Policy
EXIM
Amended on Amended on Amended in Presented
Policy
March 31, 2001 March 31, 2000, 1999 in 1997
Unit 18: World Trade and Emerging Environment Page 307 of 316
NOTES
18.3 SALIENT FEATURES OF EXIM POLICY
The EXIM Policy 2002 was described as pro-growth and positive with
certain concrete measures. The most important initiatives of the policy
were: (i) removal of Quantitative Restrictions on agricultural exports and
(ii) setting up of 20 Agri-export Zones in 12 states. The policy also made
the Special Economic Zones (SEZs) more attractive by extending income
tax benefits to the units in SEZs.
Commendable steps announced in the 2002 policy were:
(a) The setting up of OBUs (Overseas Banking Units) in the Special
Economic Zones. It would lead the SEZs to have access to money
at internationally competitive rates thereby reducing the cost of
capital;
(b) Continuation of all the existing exports promotion schemes. For
example, continuation of Duty Entitlement Pass Book (DEPB)
scheme with further simplification;
(c) Relaxation of minute verification of technical characteristics;
(d) Reduction in interest rate from 24% to 15% in case of non-
fulfilment of export obligation by exporters under the various
schemes. This measure is likely to tap immense export potential;
(e) Sectoral focus on leather, textiles, electronics, and gems and
jewellery and this is expected to tap the immense untapped export
potential that would get a boost;
(f) Focus on Latin American, African and new Soviet republic
countries;
(g) More freedom to bring in foreign exchanges remittances within
360 days instead of the earlier limit of 180 days, and
(h) Permission to exporters to keep 100% export proceeds in
Exchange Earner’s Foreign Currency (EEFC) account.
Focal Issues
Some of the issues pertaining to the EXIM policy 2002 were:
(a) No scheme was announced for remission of indirect taxes for the
exporters.
(b) The funds allocated for the states could have been much more to
meaningfully address the needs of infrastructure development.
Page 308 of 316 Unit 18: World Trade and Emerging Environment
(c) The Cluster Development issue needs to be looked at in a greater NOTES

detail as most of the clusters lack basic infrastructure facilities
necessary for exports.
18.4 EMERGING ENVIRONMENT

The NDA government in India was replaced by the UPA government in
2004. The UPA government changed the name of EXIM Policy, to
Foreign Trade Policy and the new five year ‘Foreign Trade Policy’ was
announced in 2004 by the Commerce Minister. With a view to doubling
percentage share of global trade within 5 years and expanding employment
opportunities, especially in semi urban and rural areas, certain special
focus initiatives have been identified for the agriculture, hand looms,
handicraft, gems & jewellery and leather sectors (given below).
(a) A new scheme called the Vishesh Krishi Upaj Yojana (Special
Agricultural Produce Scheme) for promoting the export of fruits,
vegetables, flowers, minor forest produce, and their value-added
products has been introduced.
(b) Funds shall be earmarked for the development of Agri Export
Zones (AEZ).
(c) Units in AEZ shall be exempt from bank guarantee under the
EPCG scheme.
(d) Capital goods imported under EPCG shall be permitted to be
installed anywhere in the AEZ.
(e) Import of capital goods shall be permitted duty free under the
EPCG scheme.
(f) New towns of export excellence with a threshold limit of ` 250
crore have been notified.
(g) Specific funds earmarked under Market Access Initiative Scheme
for promoting hand loom and handicraft exports.
(h) New handicraft SEZs shall be established which would procure
products from the cottage sector and do the finishing for exports.
(i) The Handicraft Export Promotion Council has been authorised to
import trimmings, embellishments and consumables on behalf of
those exporters for whom direct importing may not be viable.
NOTES (j) Import of gold of 18 carat and above shall be allowed under the
replenishment scheme.
18.5 FOREIGN EXCHANGE RESERVES

(QR – QUANTITATIVE RESTRICTIONS)
Quantitative Restrictions (QRs) refer to limits set by countries to restrict
imports (or exports). These are generally in the form of quotas, licensing
requirements or in the form of canalising of imports — i.e., allowing only
a few players or entities to import specific things. QRs are thus measures,
other than tariffs or duties, imposed to restrict imports (or exports). Under
the GATT, imports have to be controlled only through tariffs or customs
duties. There are, however, some exceptions to the rule. One exception is
that a country can take recourse to QRs on grounds of Balance of
Payments (BoP) difficulties. It was under this exception that India had
maintained QRs. Till 1993, India’s BoP situation had been quite unhealthy.
Since 1994-95, there has been steady improvement in the BoP status as
indicated by foreign exchange reserves position of the country.
Table 18.1: Foreign Exchange Reserves and Total Imports in India
Year ending on Total Foreign Total imports during

Exchange Reserves the year (Billion US $)
(Billion US $)
31st March 1993 9.8 21.88
31st March 1994 19.3 23.31
31st March 1995 25.2 28.65
31st March 1996 21.7 36.68
31st March 1997 26.4 31.13
31st March 1998 29.4 41.48
31st March 1999 32.5 42.39
31st March 2000 38.0 42.20
31st March 2001 47.4 46.5
31st March 2002 54.1 51.4
31st March 2003 75.4 59.4
31st March 2004 112 75.3
Source: Compiled from Handbook of Statistics on Indian Economy, RBI,
Mumbai, 2002 & RBI Annual Report 2004-2005.
The Table 18.1 presents the data on India’s foreign exchange reserves and NOTES
total imports for the period 1993 to 2004. From the table, it can be noted
that foreign exchange reserves became quite healthy over the years as
compared to the trends in India’s total imports. With the improvement in
the balance of payments position in the mid 1990s, in general, members of
the WTO raised question about India’s need to continue Quantitative
Restrictions.
By 1997, India had negotiated with most of the trading partners, to arrive
at a mutually agreeable solution for phasing out the QRs. Under the
Agreements, the QRs were to be withdrawn over a six- year period ending
31st March 2003. USA, however, felt that the period was too long and
filed a dispute against India with the WTO. The Dispute Settlement Body
of WTO, which was constituted in November 1997, gave its adjudication
against India. Although India filed an appeal before the Appellate Body of
WTO against the verdict of the panel, they upheld the findings of the
dispute settlement body. Accordingly, QRs on the 1429 tariff lines were
removed by 1st April 2001 under the agreement (of which QRs on 714
were removed with effect from 1st April 2000).
18.6 PHASED REMOVAL OF QRS

India had been following consistent policy for gradual removal of
restrictions on imports ever since the economic reforms were initiated.
There used to be a fresh list of items allowed for importing under OGL
(Open General License) every year. The process gathered momentum
during the second half of 1990s. Year-wise details on type of non- tariff
barriers and progress towards their removal is given in Table 18.2. As
given in the table, on 31 March 1997 import of 6649 tariff lines (as per
Harmonised System of India Trade Classification) out of total number of
10,202 was already free. It can be further seen from the table that
consequent to improvement in Balance of Payment (BoP), import
restrictions on 488 tariff lines were removed in 1996-97, 132 in 1997-98
and 1274 in 1998-99. The process of removal of import restrictions on
BoP grounds completed on 31.3.2001.
NOTES Table 18.2: Different Types of Non Tariff Barriers (NTB) imposed on India’s
Imports (1996-97 to 2001-02*)
NTV/Year 1.4.1997 1.4.1998 1.4.1999 1.4.2000 1.4.2001

Prohibited 59 59 59 59 59
Restricted 2322 2314 1183 968 479
Canalised 129 129 37 34 –
SIL 1043 919 886 226 –
Free 6649 6781 8055 8854 9611**
Total 10202 10202 10220 10141 10149
Source: Indian Economic Survey 2001-02, Government of India, Page 142.
*As per Harmonised System of India Trade Classification, HS-ITC classification
of export and import.
** Including 29 tariff lines, which are shifted to state trading.
India’s imports have been progressively liberalised. The level of tariff
lines, which were made ‘free import’ category, as on 1.4.1996, was 61%.
This percentage has increased to around 95% as on 1.4.2001. Action has
been completed on removal of restrictions on tariff lines (2714 items), and
has been notified to WTO under the BoP cover. Table 18.2 shows that the
number of freely importable tariff lines had increased from 6649 to 9611
as on 01.04.2001 over a period of five years from 1996.
There were 2,984 tariff lines under the restricted list on 01.04.1996, which
got reduced to 1183 on 01.04.1999, 968 on 01.04.2000, and finally 479 on
01.04.2001. Further, Special Import License (SIL) has become part of
history with effect from 01.04.2001. QRs are, however, still being
maintained on about 5% of tariff lines (538 items) as permissible under
Article XX and XXI of GATT on grounds of health, safety and moral
conduct.
18.7 REMOVAL OF QRS : IMPLICATIONS

With the removal of QRs on imports into India, consumers benefit as they
get a wider choice of goods and services at a lower cost. Secondly, freer
trade brings down prices and helps in keeping the level of inflation low as
an advantage to the society. Thirdly, the government gets revenue from
customs duties on imports—e.g. things, which were being bought in the
markets abroad and brought into the country through undisclosed channels,
can be brought through legal channels, thus generating revenue for the
country. (A case in point could be that of freeing of gold imports, which NOTES
has resulted in gold now being imported through legal channels, resulting
in substantial revenue earning through customs duty for the government).
Fourthly, it would lead to easier access to imported raw materials and
capital goods for the domestic manufacturers leading to faster industrial
growth. Finally, competition from imports can lead to upgradation in the
quality of even domestic products and increased productivity.
As mentioned above, removal of quantitative restrictions will have an
impact on prices. When the movement is from regulated regime to free
trade environment, imports increase and the market share of domestic
producers tend to decline. With the increase in imports, there is a
possibility of the domestic prices being depressed to the advantage of
consumers. Competition from imports can lead to an increase in the quality
of even the domestic products. However, it is widely suggested that Indian
industry has to be on a sound footing to face the competition from the rest
of the world, especially from the MNCs. A large number of companies
may sink and others, who are quality-conscious and competent, may
emerge as leaders.
The reservation of items for the Small Scale Industry sector has become
meaningless after the lifting of quantitative restrictions on imports. On this
ground, many people have generally expressed the concern for the small
enterprise development in India. However, government’s decision to
reduce customs duties on a host of inputs used in the manufacture of final
products by the small-scale sector is expected to improve its price
competitiveness. It may, thus, help the industry to compete against cheaper
imports, particularly from countries like China.
As a matter of fact, in order to offset the adverse implications of removal
of QRs, duties on some items have been revised upwards to safeguard the
interests of the domestic industry.
The applied rates of duties have also been raised to the bound levels for
most of the items. India has generally bound its tariffs on primary
agricultural commodities at 100%; on processed items at 150% and on
edible oils at 300% and can raise its applied rates in case of any surge in
imports. But import duties have to be fixed keeping in mind domestic
availability of the goods under consideration and also the interests of the
consumers.
NOTES
18.8 SPECIAL PROVISIONS OF WTO
AGREEMENT
There is need for balance between the interests of the consumers and that
of the domestic producers, which has to be maintained by government. For
this purpose, WTO has made special provisions based on which the
member countries will have to take action.
18.9 CONCLUSION
The salient observations emerging from the different discussion points,
covered in the chapter, are listed below:
1. Though the negotiations conducted under the aegis of GATT and
WTO have helped in reducing tariff rates, many countries use
Non-tariff barriers such as standards and countervailing duties to
restrict the flow of trade. This aspect continues to hamper the
prospects of India’s export performance.
2. Quantitative Restrictions on imports of 95% tariff lines have been
removed as part of trade liberalisation in India. Also, the customs
duties on most of the items have been brought down. At the same
time, there is special emphasis on export promotion activity,
according to the EXIM policy. These policy measures have been
expected to have significant impact on the industrial sector in the
country.
3. While trade liberalisation measures have gained significant
momentum over the recent years, there is also a need for
maintaining balance between the interests of consumers and
domestic producers. Taking this aspect into account, the
government has to monitor the price and quantity of commodities
being imported. This necessitates that the government resorts to
appropriate action, on the basis of special provisions and
permitted actions in the WTO agreement.

WTO is an international organisation of 153 member countries, It was
created in 1995. WTO unlike GATT is empowered to enforce rules with
economic sanctions. The nature of trade environment is changing. The
primary factors that will shape future world trade and global trading NOTES
systems are, technological innovations, shifts in production and
consumption patterns and finally demographic change.
18.11 GLOSSARY
 EEFC: Exchange Earner’s Foreign Currency Account.
 OBUs: Overseas Banking Units.
 SEZ: Special Economic Zones.
18.12 KEY TERMS

 W.T.O: World Trade Organistion.
 GATT: General Agreement on Tariffs and Trade.
 TRIPS: Trade Related Intellectual Property Rights.


1. As per WTO requirements patents are for________years.
2. Quantitative restrictions can be set on the grounds of balance of
_______difficulties.
3. TRIM—Trade related investment measures do not apply to
restrictions in_________.
(B) True or False

1. WTO helps to promote Trade.
2. Free trade decreases cost of living.
3. Primacy objective of GATT was to expand international trade.
4. W.T.O. is not the only body dealing with trade among nations.
NOTES
(A) 1. 20, 2. Payment, 3. Quantity
(B) 1. True, 2. True, 3.True, 4. True

1. Explain the role of WTO in dispute settlement.
2. Write a short note on Administrative procedures of WTO.
3. What are the salient features of W.T.O agreement.

1. Bhandani: WTO - Deep, Delhi.
2. Gupta K.R -WTO - Atlantic, Delhi.
3. Suryakant B - WTO - Palak, Mumbai.

NOTES
(A) 1. 20, 2. Payment, 3. Quantity
(B) 1. True, 2. True, 3.True, 4. True

1. Explain the role of WTO in dispute settlement.
2. Write a short note on Administrative procedures of WTO.
3. What are the salient features of W.T.O agreement.

1. Bhandani: WTO - Deep, Delhi.
2. Gupta K.R -WTO - Atlantic, Delhi.
3. Suryakant B - WTO - Palak, Mumbai.


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MS 105

UTTARAKHAND OPEN UNIVERSITY

Professor Neeti Agarwal Dr.L.K. Singh

Dr. Abhradeep Maiti, Dr. K.K. Pandey,

Dr. Manjari Agarwal Dr. Gagan Singh

Dr. Sumit Prasad

Units Written by Unit No.

Block I Macro Economic Concepts and Macro Environment

Block II Economic Reforms and Industrial Policy

Block III Industrial Financial Institutions

Block IV Foreign Polices and Globalisation

NOTES  Analyse Indian and global perspectives.

1.2 MEANING AND DEFINITION

Page 2 of 316 Unit 1: Contemporary Global and Indian Environment

1.3 BUSINESS ENVIRONMENT

Unit 1: Contemporary Global and Indian Environment Page 3 of 316

Unit 1: Contemporary Global and Indian Environment Page 5 of 316

(a) Mission and Objectives

(b) Value System

Unit 1: Contemporary Global and Indian Environment Page 7 of 316

NOTES (d) Human Resources

Fig. 1.1: Environmental Constituents of Business (Environmental Scanning)

Page 8 of 316 Unit 1: Contemporary Global and Indian Environment

Unit 1: Contemporary Global and Indian Environment Page 9 of 316

Fig. 1.2: Business System: Input-Output Model

1.6 EXTERNAL ENVIRONMENT

1.7 EXTERNAL MICRO ENVIRONMENT:

Page 10 of 316 Unit 1: Contemporary Global and Indian Environment

Unit 1: Contemporary Global and Indian Environment Page 11 of 316

1.8 EXTERNAL MACRO ENVIRONMENT: FACTORS

NOTES advertising agencies which assist a business firms in targeting, promoting

Page 14 of 316 Unit 1: Contemporary Global and Indian Environment

Social and Cultural Environment

Unit 1: Contemporary Global and Indian Environment Page 15 of 316

NOTES It is worth noting that in modern management science a new concept of

Political and Legal Environment

Page 16 of 316 Unit 1: Contemporary Global and Indian Environment

Unit 1: Contemporary Global and Indian Environment Page 17 of 316

NOTES competition. Technological environment affects the success of firms and

Unit 1: Contemporary Global and Indian Environment Page 19 of 316

Ecological Effects of Business

1.9 INTERNAL ENVIRONMENT

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management experts confine the term business environment to external NOTES

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NOTES objective of profit maximisation. Mission is defined as the overall purpose

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Technically, shareholders elect directors who make up the board of NOTES

1.10 SUMMARY OF THE UNIT

1.13 CHECK YOUR PROGRESS (MULTIPLE

(B) True or False

1.14 KEY TO CHECK YOUR ANSWER

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1.16 REFERENCE BOOKS

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How are customer

Fig: Abell's Framework for defining the Business