Chairperson : Professor Madhurima Verma

Subject Co-ordinator : Prof. (Mrs.) Harsh Gandhar

Course Leader : Prof. (Mrs.) Harsh Gandhar

M.A. Sem.-IV ECONOMICS

Indian Economic Issues -II
PAPER : MA ECO – 402

CONTENTS
 Introductory Letter (i)
 Syllabus (ii)

L. No. Topic Author/Editor Page

UNIT-I (half)
1 Services Sector in India: Growth and Pattern Harsh Gandhar 1
2 Services Sector in India: Sub-sectors & Future Harsh Gandhar 22
Prospects
3 Competition Policy and Consumer Protection Act Harsh Gandhar 33
UNIT-II
4 Indian Financial System Yash Pal/ 50
Harsh Gandhar
5 RBI and Financial System Yash Pal/ 63
Harsh Gandhar
6 Indian Banking Sector and Financial Sector Reforms Harsh Gandhar 81
7 Financial Market Yash Pal/ 103
Harsh Gandhar
8 Capital Market in India-I Yash Pal/ 117
(Growth and Reforms) Harsh Gandhar
9 Capital Market, Reforms and SEBI - II Harsh Gandhar 142
UNIT-III
10 Fiscal Imbalances in Indian Economy (80s and 90s) ReenaBhasin/ 160
Harsh Gandhar
11 Fiscal Deficits and Sustainability of Public Debt Harsh Gandhar 179
(Post FRBM Period)
UNIT-IV
12 Trade Policy of India and Convertibility of Rupee Harsh Gandhar 204
13 Foreign Direct Investment in India Harsh Gandhar 223
14 India and WTO Harsh Gandhar 245
15 WTO and Indian Agriculture Harsh Gandhar 267
UNIT-I (half)
16 Special Economic Zones in India Harsh Gandhar 276
17 Infrastructural Development in India Harsh Gandhar 284
18 COVID-19, It’s Impact & Latest Trends Harsh Gandhar 316
Sample Paper 327

E-Mail of Department - Coordeco@pu.ac.in

Contact No. of Department - 0172-2534326
 INTRODUCTORY LETTER
Dear Distance Learners,
This Paper Indian Economic Issues- II is in continuation to Paper 2 titled Indian Economic
Issues- I of Semester III. By this time you have been aware of growth experience of Indian economy;
economic reforms; problems of poverty and unemployment; and growth of agricultural and industrial
sectors. In continuation to these issues, this paper concerns growth of services sector; structure,
problems and reforms in financial sector; fiscal imbalances, their management, provisions and
expenditure reforms; and trends and issues related to external sector especially in the post – WTO
period.
Due to change in the coverage of consumption basket and change in the base year to
2011-12, a consolidated picture has been provided for all the above mentioned issues for the period
1951-2012, using same source of data. Additional information has been provided separately for post
2012 period as per availability of data, mostly till 2014, for which revised estimates are available. For
Twelfth Plan period i.e. 2012-17, figures on some aspects are available on the website of NITI Ayog.
If interested, you may add recent information from any other reliable source also.
As discussed in the previous semester, you may brush up your knowledge on the syllabus
topics by reading any under-graduate level book. An essential reading of national dailies and
magazines like Yojna, Kurukshetra or books for competitive exams is a must. As you may not find all
issues in one book, you may refer to books on Indian economy by Uma Kapila, Misra & Puri Dutt and
Mahajan and other references provided in the end of study material and given at the end of syllabus.
Do attempt MCQ type assignments in the specified time as they fetch 20 percent of marks.
The Personal Contact Programme provides you with concise information and strategy to prepare for
exams, so try to attend classes.
With best wishes.
Course Leader.
Harsh Gandhar
 (ii)

M.A. Economics Semester IV

Syllabus
PAPER -MAECO-402: INDIAN ECONOMIC ISSUES– II
Max. Marks : 100
Theory : 80 Marks
Internal Assessment : 20 Marks
Time : 3 Hours
Teaching Hours : 50
Objectives:
The objective of this paper is to acquaint the students with the performance of different sectors of the
Indian economy and the policy framework governing them. This will provide them an insight into the
past, present and future functioning of the Indian economy and strengthen their analytical capability.
The time-tested method of imparting verbal instructions through lectures would be used. Examples, in
so far as possible, would be selected from everyday life/experience. The feedback would be sought
through the students writing assignments, tutorials and seminars.
The students would be evaluated at the end of each semester through subjective type
questions/answers (both short and essay type). The script would be evaluated by the examiners
having adequate postgraduate teaching experience in the paper/option concerned.
Pedagogy of the Course Work:
The course relies on a combination of lectures, solving problems, and discussing of academic articles
or real-life situations. Teacher will assign topic for assignments on contemporary themes and issues
from the syllabi. Special tutorials/contact hour for one-to-one student-teacher interactions.
INSTRUCTIONS FOR THE PAPER-SETTER AND CANDIDATES:
1. The syllabus of this paper has been divided into four units.
2. There shall be 9 questions in all.
3. The first question, would be compulsory, shall be short answer type (word limit 25-30 each). It
would carry 15 short questions, spread over the entire syllabus. The candidate will be required
to attempt any 10 short answer type questions. Each short answer type question would carry 2
marks (10 × 2 = 20).
4. Rest of the paper shall contain 4 units. Each unit shall have two questions and the candidates
shall be required to attempt one question from each Unit— 4 in all. Each question shall carry 15
marks (15 × 4 = 60).
UNIT - I
Service Sector and Infrastructure Development in Post-reform Era:
Service Sector in India – Growth, Pattern and Future Prospects.
Infrastructure Development - Need, Performance and Government Strategy on Infrastructure
Development. Special Economic Zones (SEZs): Policy, Features and Problems.
(iii)
Changes in Public Policy with Special Reference to Competition Policy and Consumer Protection Act.
 UNIT - II
Financial Sector in the Post-reform Era:
Structure and Features of the Financial System in India. Financial Sector Reforms.
Indian Money and Capital Markets — Structure, Features and Reforms.
Role of Securities Exchange Board of India (SEBI).
UNIT – III
Public Finance in the Post-reform Era:
Public Expenditure in India : Trends and Issues. Fiscal Imbalances and Public Debt Sustainability in
the Indian Economy.
Fiscal Responsibility and Budget Management Act, 2003. Approach and Recommendations of
Recent Finance commission.
UNIT- IV
External Sector the Post-reform Era:
Trade Policy during Post Reform Period. Liberalised Exchange Rate Management System. Foreign
Direct Investment – Trends and Issues. India and the World Trade Organisation.
Recommended Readings:
Books :-
Acharya, S. & Rakesh, M. (2011). India’s Economic Performance and Challenges (Essay’s in Honour
of Montek S Ahluwalia). New Delhi: Oxford University Press.
Ahluwalia, I.J. & Little, IMD. (2008). India’s Economic Reforms & Development (Essays in Honour of
Manmohan Singh). New Delhi: Oxford University Press.
Dhar, P.K. (Latest ed.) Indian Economy- Its Growing Dimensions. Kalyani Publisher.
Datt, G. & A. Mahajan. (Latest Edition). Indian Economy. New Delhi : S.Chand .
Fernando, A.C. (2016). Indian Economy. India: Pearson.
Kapila, U. (Latest Edition) Indian Economy since Independence. New Delhi: Academic Foundation.
Kapila, U. (Latest Edition) Indian Economy: Performance and Policies. New Delhi: Academic
Foundation.
Krueger, A.O. (2002). Economic Policy Reforms and the Indian Economy. New Delhi: Oxford
University Press.
Mishra, S.K. and Puri, V.K. ( Latest Edition) Indian Economy. Mumbai: Himalya Publisher House.
Economic and Political Weekly, Various Issues.
Economic Survey (Various Issues), Government of India. New Delhi: Oxford University Press.
Research Papers:-
Acharyya, Rajat. (1994). Liberalised Exchange Rate Management system and Devaluation in India:
Trade Balance Effect, Journal of Economic Integration, vol. 9, No. 4, December.
(iv)
Banga, Rashmi. (2006). Critical Issues in India’s Service led Growth, INRM policy Brief (2), Asian
Development Bank.
Gopalam, R. & M. C. Singh. (2015). Services Growth in India, Economic & Political Weekly, L( 41).
Kaur, B., Mukherjee, A., Kumar, N. & Ekka, A. P. (2014). Debt Sustainability at the State Level in
India, RBI working paper series, Department of Economic and Policy Research, RBI
Kaur, Balbir. (2012). Threshold Level of Debt and Public Debt sustainability: the Indian Experience,
RBI accessional paper, 33 (1 &2).
Meena, R.S. (2011). Financial Reformns: Realities and Myths.Ijmt, 19(1), 44-45.
Nagaraj, R. (2003). Foreign Direct Investment in India in the 1990’s - Trend and Issues, Economic &
Political Weekly, Vol.38, No.17, 26April.
Patil, R. H. (2006). Current state of the Indian capital market. Economic & Political Weekly, 41(11),
1001–1011.
Patil, R.H. (2010) Financial sector Reforms: Realities and myths, Economic & Political Weekly, XLV,
(19), 8 May.
Pattnaik, R.K. et.all. (2003). Exchange Rate Management: The Indian Experience, Economic &
Political Weekly, Vol. 38, no.2, 31 May.
Sahoo, P. (2015). Time to review the Special Economic Zone Act, Economic & Political Weekly,
L (14).
Sally, Razeen. (2011). Indian Trade Policy after the crisis, ECIPE occasional papers, (4).
Further Readings
“Essays from EPW-Quarter Century of Liberalisation in India” (2018).Oxford University Press.
Bhagwati, J.& Panagariya, A. (2012). India’s Tryst with Destiny. India: Harper Collins.
Drèze, J., & Sen, A. (2013). An uncertain Glory-India & its Contradictions. New Delhi: Penguin Books.
Singh, M. (2018). Changing India Vol. 1-5. Oxford University Press.
 Lesson-1

SERVICES SECTOR IN INDIA : GROWTH AND PATTERN

Structure
1.0 Objectives
1.1 Introduction
1.2 Sectors of Indian Economy
1.3 Importance of Services Sectors for Indian Economy
1.3.1 Services GDP
1.3.2 Services Employment in India
1.3.3 FDI in Services in India
1.3.4 Contribution to State GDP
1.3.5 Growing Exports of Services
1.4 Growth of Services Sector in India (1951-2010)
1.4.1 Contribution of Services Sector to Growth
1.5 Important Services for India (including Sub-sectors till 2014)
1.6 Fast Growing Services (1951-2010): A Backdrop
1.7 Performance of Sub Sectors
1.8 Recent Steps for Growth of Sectors
1.9 Conclusion
1.10 Summary
1.11 Glossary
1.12 References
1.13 Further Readings
1.14 Model Questions

1.0 OBJECTIVES

After going through this lesson, you shall be able to

 discuss the importance of services sector for Indian economy
 explain the growth of services sector in India and trends therein
 delineate the pattern of the growth of services sector
 elaborate which sub – sectors have contributed the most
1.1 INTRODUCTION
In the first semester, we have read about the growth of national income & per capita income,
growth of agricultural sector & related patterns; growth of industrial sector; and changes that took
place in the post – reforms period. Here in semester II we shall study about the growth of services
sector; infrastructures sector, financial sector, external sector and public finances of India. In this
lesson, we shall discuss the following issues :
  Growth of services sector in India, its share in GDP and its contribution to GDP growth; and its
importance.
 Share of services in employment.
 Comparative growth of different sub-sectors of the services sector; and reasons for rapid
growth of services.
 Information and Communication Technology; and the growth of IT-ITES sector.
1.2 SECTORS OF INDIAN ECONOMY
Before discussing the importance and growth of services sector in detail lets discuss the
activities covered under these sectors.
The Indian economy has three sectors (a) Primary/Agriculture Sector, (b) Secondary
/Industrial Sector, and (c) Services/Tertiary Sector.
1. Agriculture includes (i) agriculture, (ii) forestry and logging, and (iii) fishing.

2. Industry includes (i) mining and quarrying, (ii) manufacturing, (iii) electricity, gas and
water supply, and (iv) construction.

3. Services includes (i) trade, hotels and restaurant, (ii) transport, storage and
communication, (iii) financing, insurance, real estate and business services, and (iv)
community, social and personal services.

As we know that with the development taking place in economics, the shares of sectors
undergo change in the economies. As a result in most of the low income economies, agriculture is the
predominant sector. As these economies progress, the share of the industrial sector in economic
activities increases. The development of industries, in turn, promotes a wide range of activities in the
services sector like banking and insurance, transportation, trade, communication, etc. Gradually the
growth of services sector gets accelerated.
On the basis of this observed development pattern of countries, some economists like Fisher
(1939), Clark (1940), Rostow (1960) and Kuznets (1971) have suggested that development is a
three-stage process. The first stage is associated with the agricultural sector, second with the
industrial sector, and the dominance of the services sector in the growth process is associated with
the third stage of development.
However, in India, the acceleration in growth in recent years has been due to the dynamism of
the services sector while the contribution of industry has tended to stagnate over the last three
decades. Services now contribute almost 57 per cent to India’s GDP and have contributed to more
than 60 per cent of India’s growth during the period of the last decade and a half. This has led to
speculation whether India would present a unique growth path in which the country would leapfrog
from a predominantly agricultural economy to a directly service-dominated economy by skipping the
intermediate stage of rising share of industrial sector that was experienced by all the existing
industrialised countries. On the contrary, Some economists have expressed doubts regarding the
sustainability of the ‘services-led growth’. According to these economists, unless the real (or
commodity producing) sectors of agriculture and industry grow fast, the services-led growth cannot
be sustained for long.

1.3 IMPORTANCE OF SERVICES SECTOR FOR INDIAN ECONOMY

India stands out for the size and dynamism of its services sector. The contribution of the
services sector to the Indian economy has been manifold: a 55.2 per cent share in gross domestic
product (GDP), growing by 10 per cent annually, contributing to about a quarter of total employment,
accounting for a high share in foreign direct investment (FDI) inflows and over one-third of total
exports, and recording very fast (27.4 per cent) export growth through the first half of 2010-11.

The importance of the services sector can be gauged by looking at its contributions to
different aspects of the economy, which are discussed as follows:

The significance of services sector is best explained in the Economic Survey, 2015-16:

The services sector has emerged as the most dynamic sector of the world economy,
contributing almost one-third of world gross value added, half of world employment, one-fifth of global
trade and more than half of the world foreign direct investment flows. It remains the key driver of
India’s economic growth, contributing almost 66.1 percent of its gross value added growth in 2015-16,
important net foreign exchange earner and the most attractive sector for foreign direct investment
inflows. However the global slow down has cast a shadow even on this promising sector.

(Economic Survey 2015-16)

1.3.1 Share of Services in GDP

Because of the relatively high growth rate of services in recent times, their share in GDP has
registered a marked increase. This is clear from Table 2.

As is clear from this table the structure of the economy has undergone significant changes
over time. Between 1950-51 and 1980-81, the industrial sector registered as higher growth than the
services sector. The converse has been the case since then. This resulted in the share of the industry
sector in GDP increasing by around 9 percentage points from 16.6 p.c. to 25.9 p.c. during the period
1950-51 to 1980-81. The share of the services sector increased from 30.3 p.c. in 1950-51 to 38 p.c.
in 1980-81 (an increase of 8 percentage).

The share of the services sector started growing rapidly thereafter and this phenomenon
become more pronounced in the 1990s. Consequently the share of industry sector has remained in
the range of 26 to 28 pc of GDP only. The entire decline in the share of agriculture has been
balanced by an increase in the share of the services sector.

Thus the resilience of the economy to shocks owe to the services sector which has the larged
share and most consistent growth performance. The change in the selatove share these sectors in GDP
use shown in Table 1.2
Table 1
Sectoral Share of GDP in Per cent (Percent per annuam)

1950/51 1960/61 1970/71 1980/81 1990/91 2000/01 2004/05 2008/09 2009/10

(At 1999-2000 prices) (At 2004-2005 prices)

Agriculture 53.1 48.7 42.3 36.1 29.6 22.3 18.9 15.7 14.6
 Industry 16.6 20.5 24.0 25.9 27.7 27.3 28.0 28.0 28.1

Services 30.3 30.8 33.8 38.0 42.7 50.4 53.1 56.3 57.3

Source : Misra & Puri, 2011, Economic Survey, 2011–12

The share of services in India’s GDP at factor cost (at current prices) increased rapidly: from
30.5 per cent in 1950-51 to 55.2 per cent in 2009-10. If construction is also included, then the share
increases to 63.4 per cent in 2009-10.

The ratcheting up of the overall growth rate (compound annual growth rate [CAGR]) of the
Indian economy from 5.7 per cent in the 1990s to 8.6 per cent during the period 2004-05 to 2009-10
was to a large measure due to the acceleration of the growth rate (CAGR) in the services sector from
7.5 per cent in the 1990s to 10.3 per cent in 2004-05 to 2009-10. Hence the services sector growth
was significantly faster than the 6.6 per cent for the combined agriculture and industry sectors annual
output growth during the same period. In 2009-10, services growth was 10.1 per cent and in 2010-
11(advance estimates-AE) it was 9.6 per cent. India’s services GDP growth has been continuously
above overall GDP growth, pulling up the latter since 1997-98. It has also been more stable.

1.3.2 Services Employment in India

Although the services sector has grown at a fast rate during recent times and accounts for
more than half of GDP (presently it accounts for around 57-58 per cent of GDP), its share in overall
employment continues to be very low and is less than one-fourth of the total. In fact, during 1990s,
while the share of services in GDP rose from 42.0 per cent to 48.0 per cent, the share of services in
employment actually declined by about one percentage point (from 24.4 per cent in total employment
in 1990-91, the share of services fell to 23.5 per cent in 1999-2000). This indicates that India
witnessed a relatively jobless services sector growth during 1990s. According to Gordon and Gupta,
this is unlike the experience of other countries, where the services sector has also tended to gain a
larger share of employment overtime. When compared with other countries, India has an
exceptionally low share of services employment.

It has been observed by the Report on Currency and Finance, 2001-02 that the value added
growth in services sector was, on an average, higher than employment growth in services sector,
which confirms the finding of other studies that services sector has undergone a less than
proportionate increase in employment in relation to output. In other words, employment increased at
a slower rate as compared to output in the services sector.

Next the differences in productivity in the services sector, taken decade-wise. Growth in
services productivity for the whole of the period of study (1970-2000) was observed to be higher but
not statistically significant. The growth rate of productivity in services sector was higher during the
1990s. Thus, unlike many other countries, growth of average productivity of labour in India was
higher than employment growth in services sector during the period of 1990s. The empirical findings
are supported by the declining capital-output ratio in the services sector which can be interpreted as
efficient use of capital by skilled labour and low contribution of services to total employment in
contrast to its high contribution to overall GDP growth. This points towards a growth in total factor
productivity in services. (Misra & Puri, 2011)
 Given the size and growth of the services sector, it is a key area for employment generation –
however, this is not happening in India. For instance, finance, insurance, real estate and business
services, which accounted for 13 per cent of the GDP in 1999-2000, employed only 1.2 per cent of
the labour force.

Although the primary sector (agriculture mainly) is the dominant employer followed by the
services sector, the share of services has been increasing over the years while that of primary sector
has been decreasing. Between 1993-94 to 2004-05, there was a sharp fall in the share of the primary
sector in employment. The consequent rise in share of employment of the other two sectors was
almost equally divided between the secondary and tertiary sectors. In 2007-08 compared to 2004-05,
though the trend was similar, the fall in employment in primary sector was less (at -1.1 per cent) with
a small commensurate rise in employment in the other two sectors, which was again almost equally
divided between the other two sectors (Table 2).
Table 2 : Share of Broad Sectors in Employment (UPSS)

Shares Change in shares

Sectors 1993-94 2004-05 2007-08 2004-05 over 2007-08 over 2007-08
1993-94 2004-05 over
1993-94
Primary 64.5 57.0 55.9 -7.5 -1.1 -8.6
Secondary 14.3 18.2 18.7 3.9 0.5 4.4
Tertiary 21.2 24.8 25.4 3.6 0.6 4.2

Note: For the years 2004-05 and 2007-08 projected population at mid-point of these two rounds
was obtained by applying projected population figures from the Registrar General of India’s
(RGI) office. For the year 1993-94, the population at mid-point of the survey period was
obtained by interpolation of census population of 1991 and 2001. Work participation rates of
rural males, rural females, urban males, and urban females were obtained separately from
unit-level data of the National Sample Survey (NSS) and by multiplying them with the
respective population, the total numbers of Usual Principal and Subsidiary Status (UPSS)
workers for these four categories were obtained. Then the distribution of employment from
unit-level data for broad sectors (primary, secondary, and tertiary) was obtained. From the
number of workers in the four categories and sectoral distribution of employment, total
employment for three sectors for each of these four categories was obtained. From this,
overall employment distribution at broad sectoral level was calculated.

Source: Economic Survey, 2011.

1.3.3. FDI in Services in India
The measurement of the share of services in FDI inflows encounters problems as it is difficult
to clearly differentiate activities between services and goods in sectors such as computer hardware
and software, telecommunications, and construction. Nevertheless, the share of the four sectors
combined (services [financial and non-financial], computer hardware and software
telecommunications, and housing and real estate), predominantly consisting of services, in FDI equity
inflows in April 2000-December 2010 is around 44 per cent. If construction is included then the share
rises to 51 per cent. The financial and non-financial services sector which falls purely in the services
category is the largest recipient of FDI equity inflows with a 21 per cent share. This is followed by the
other two sectors, namely computer software and hardware, and telecommunications each with 8 per
cent share. Housing and real estate, and construction with 7 per cent share each were next in
importance (Table 6).

The year 2009-10 has seen a drying up of FDI inflows to India due to the global crisis with a
fall of 5.5 per cent. Mirroring this trend, FDI inflows in the services sector also fell by 29.1 per cent (in
US dollar terms). The first nine months of 2010-11 have also not shown any improvement on the FDI
front, overall and in services sectors.

1.3.4 Contribution to State GSDP (A State-wise Comparison)

A comparison of the share of services in the Gross State Domestic Product (GSDP) of
different States and Union Territories shows that the services sector is the dominant sector in most
States of India. States such as Delhi, Chandigarh, Kerala, Maharashtra, Bihar, Tamil Nadu and West
Bengal have shares equal to or above the all-India share.

State-wise growth of GSDP is also closely associated with faster growth of the tertiary sector.
Interestingly, Bihar which has the highest overall growth rate in 2008-09 also has the fastest growth
among States in services, in part due to its rapid progress from a low base (only Goa’s growth rate in
services is higher than that of Bihar, but this is for 2007-08). Even small States such as Chhattisgarh
and relatively low-income States such as Orissa and Rajasthan which have relatively low overall
growth rates have started piggy-backing on the good performance of their services sectors to climb
up the ladder of progress. Thus, the services revolution in India seems to be becoming more broad
based rather than being concentrated in only a few States.

Table 3 : Sectors Attracting Highest FDI Equity Inflows

(Rs. in crore)
Ranks Sector 2008-09 2009-10 2010-11 Cumulative % age to
(Apr.-Mar.) (Apr.-Mar.) (Apr.-Dec.) Inflows (Apr. Total Inflows
2000-Dec. (in US$ter-
2010) ms)
1. Services Sector 28,516 20,776 13,044 1,18,274 21%
(financial & non- (6,138) (4,353) (2,853) (26,454)
financial)

2. Computer Software & 7,329 4,351 3,054 47,144 8%

Hardware (1,677) (919) (670) (10,601)
3. Telecommunications 11,727 12,338 6,021 46,727 8%
(radio paging, cellular (2,558) (2,554) (1,327) (10,258)
mobile, basic telephone
services)
4. Housing & Real Estate 12,621 13,586 4,680 42,049 7%
(2,801) (2,844) (1,024) (9,380)
5. Construction 8,792 13,516 4,109 39,802 7%
Activities (2,028) (2,862) (911) (8,964)
(including roads &
highways)
Source : Department of Industrial Policy and Promotion, Eco. survey, 2011.
Note : Figures in parentheses are US$ million.

1.3.5 Growing Exports of Services

India is also moving towards a services-led export growth. During 2004-05 to 2008-09 as per
the Balance of Payments data, merchandise and services exports grew by 22.2 and 25.3 per cent
respectively. Services growth slowed in 2009-10 as a result of the global recession, but the decline
was less pronounced than the slowdown in merchandise export growth, and has recovered rapidly in
the first half of 2010-11 with a growth of 27.4 per cent. The overall openness of the economy
reflected by total trade including services as a percentage of GDP shows a remarkable increase from
29.2 per cent in 2000-01 to 53.9 per cent in 2008-09, though it dipped to 46.1 per cent in 2009-10 due
to the global crisis. The dip was more due to fall in share of merchandise trade to GDP to 35 per cent
in 2009-10 compared to 41 per cent in 2008-09. The fall in the share of services trade to GDP was
less than 2 percentage points from 12.9 per to 11.2 per cent. (see Table 7 under head 1.5 last line).

1.4 GROWTH OF SERVICES SECTOR IN INDIA (1951-2010)

The Indian economy has grown at a robust rate during the last few years and a striking
feature of this growth performance has been the strength of the services sector. This is clearly
brought out by a glance at Table 1.

Table 1

Sectoral Growth rates during the Planning Period (1951 – 2010)

(Per cent per annum)

Sector 1951-80 1981-90 1991-2000 1992-97 1997-02 2002-07 2007-08 2008-09 2009-10
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

Agriculture 2.1 4.4 3.1 4.8 2.5 2.5 4.9 1.6 0.2

Industry 5.3 6.8 5.8 7.3 4.3 9.2 8.1 3.9 9.3

Services 4.5 6.6 7.5 7.3 7.9 9.3 10.8 9.7 8.5

GDP at 3.5 5.8 5.8 6.6 5.5 7.8 9.0 6.7 7.3
factor cost

Source : Misra & Puri, 2011 & Eco. Survey 2011-12

Table 1 shows that, on average, services grew slower than industry between 1950 and 1990
although faster then the agricultural growth. Growth of services picked up in the 1980s, and
accelerated in the 1990s when it averaged 7.5 per cent per annum, “thus providing a valuable prop to
industry and agriculture, which grew on average by 5.8 per cent and 3.1 per cent respectively.”
Moreover, Gordon and Gupta argue that growth in the services sector was also less cyclical and
more stable than the growth of industry and agriculture. The slowdown in the Ninth Plan (1997-2002)
was confined to agriculture and industry with the services registering a remarkable rate of growth of
7.9 per cent per annum. The expansion of services accelerated further in the years after 2002-03.
Over the Tenth Plan period (2002-07), services grew at a rate of 9.3 per cent per annum. The first
year of the Eleventh Plan 2007-08 witnessed a rate of growth of 9.0 per cent in GDP but this growth
rate declined to 6.7 per cent in 2008-09 due to economic slow-down following global recession.
However, services grew at a robust rate of 10.8 per cent and 9.7 per cent respectively in these years.
The impact of economic slow-down on the industrial sector is very much in evidence in 2008-09 with
this sector recording a growth of only 3.9 per cent. Agriculture grew by a niggardly 1.6 per cent. It is
the services sector growth that enabled the economy to clock a 6.7 per cent growth rate in 2008-09.
In 2009-10, services sector recorded a rate of growth of 8.5 per cent. [Misra & Puri, 2011]

Table 1 and the above discussion clearly brings out the fact that what the Indian economy has
witnessed in recent period (especially the post-1991 period) is a ‘services-led growth’.

1.4.1 Contribution of Services Sector to Growth (1951-2010)

Table 3 presents information on the contribution of agriculture, industry and services to growth
of GDP. As is clear from Table 3 that in 1960-61, agriculture contributed almost half of the GDP
growth, industry contributed about 30 per cent and services about one-fifth. By 1990-91, the
contribution of agriculture to GDP growth had declined to less than one-fourth while that of services
had crossed 40 per cent. During the five years period 1991-92 to 1996-97, services contributed half
of total growth in GDP. In the subsequent five years to 2001-02, the contribution of services to GDP
growth was as high as 68 per cent and has remained at a high of 64 per cent in the six years
following 2001-02. The contribution of services to GDP growth would be still higher if construction
were included under services instead of industry. Another fact that needs specific mention (and would
be clear from Tables 1 and 3) is that after 1990-91, the contribution to GDP growth by the services
sector begins to outpace its sectoral share.

Table 4
Contribution of Different Sectors to GDP Growth
(in per cent)
Sector 1951/52 1960/61 1990-91 1991-97 1996-2002 2001-08
(1) (2) (3) (4) (5) (6) (7)
Agriculture 34.9 48.2 23.8 21.1 11.5 7.0
Industry 35.5 29.2 35.2 29.0 20.2 29.3
Services 29.6 22.6 41.0 49.8 68.3 63.6
GDP at
100.0 100.0 100.0 100.0 100.0 100.0
factor cost

Source : (i) For columns (2), (3) and (4), Sunil Jain and T.N. Ninan “Servicing India’s GDP Growth”, Table
10.2, p. 335 and (ii) For columns (5), (6) and (7) Shankar Acharya, “Macroeconomic Performance
and Policies, 2000-08”, in Shankar Acharya and Rakesh Mohan (Ed.), India’s Economy –
Performance and Challenges (New Delhi, 2010), Table 4.2, p. 120. c.f. Misra & Puri, 2011.

1.5 IMPORTANT SERVICES FOR INDIA

Some services have been particularly important for this improving performance in India.
Software is one sector in which India has achieved a remarkable global brand identity. Tourism-and
travel-related services and transport services are also major items in India’s services. Besides these,
the potential and growing services include many professional services, infrastructure-related services,
and financial services.

CSO’s classification of the services sector falls under four broad categories, namely a) trade,
hotels, and restaurants; b) transport, storage, and communication; c) financing, insurance, real
estate, and business services; and d) community, social, and personal services. Among these,
financing, insurance, real estate, and business services; and trade, hotels and restaurants are the
largest groups accounting for 16.7 per cent and 16.3 per cent respectively of the national GDP in
2009-10. The community, social, and personal services category accounts for a 14.4 per cent share,
while transport, storage, and communication accounts for a 7.8 per cent share. Construction, which is
a borderline services inclusion, has a share of 8.2 per cent (Table 5).

Table 5 : Share of different services categories in GDP at factor cost (current prices)

2004-05 2005-06 2006-07 2007-08 2008-09@ 2009-10*

Trade, Hotels & Restaurants 16.1 16.7 17.1 17.1 16.9 16.3
Trade 14.6 15.1 15.4 15.4 15.4 14.9
Hotels & restaurants 1.5 1.6 1.7 1.7 1.5 1.4
Transport, storage & 8.4 8.2 8.2 8.0 7.8 7.8
communication
Railways 1.0 0.9 0.9 1.0 0.9 1.0
Transport by other means 5.7 5.7 5.7 5.5 5.5 5.2
Storage 0.1 0.1 0.1 0.1 0.1 0.1
Communication 1.7 1.6 1.5 1.4 1.4 1.5

Financing, insurance, real estate 14.7 14.5 14.8 15.1 16.1 16.7
& business services
Banking & Insurance
Real estate, ownership of dwellings 5.8 5.4 5.5 5.5 5.7 5.4
& business services 9.0 9.1 9.3 9.6 10.4 11.4

Community, social & personal 13.8 13.5 12.8 12.5 13.3 14.4
services
5.9 5.6 5.2 5.1 5.8 6.3
Public administration & defence 8.0 7.9 7.6 7.4 7.5 8.1
Other services
Construction 7.7 7.9 8.2 8.5 8.5 8.2
Total Services (excluding
Construction) 53.0 52.9 52.9 52.7 54.1 55.2

Total Services (including 60.7 60.8 61.1 61.2 62.6 63.4

Construction)
Total GDP 100 100 100 100 100 100

Source : CSO, Eco Survey, 2011

@ provisional estimates * quick estimates

1.5.1 Recent Performance and Shares of different Services sub-sectors in India (Latest
Figures for Table-2)

Now we would look into the performance of different sub-sectors of services or different
categories of services sector in India in detail. India’s services sector excluding construction and
including construction grew by 9.8 and 9.8 percent respectively in 2010-11; by 8.2 per cent and 7.9
per cent respectively in 2011-12; and by 9.1 pc and 8.1 pc respectively in 2013-2014.

2011-2012

Broad category-wise, the ‘Trade, hotels and restaurants, transport, storage and
communications category had the growth at 6.2 per cent followed by financing insurance, real estate
and business services’ at highest 11.7 per cent in 2011-12. Table No. 2 (a) will clarify those category
wise growth positions. “Trade and Real estate, ownership of dwellings and business services’ are two
major sub sectors with shares of 16.6 per cent and 10.8 percent of GDP respectively in 2011-12. The
shares of these two brand sectors have been more or less stable over the years. In 2011-12, the
growth of the former has been moderate at 6.5 per cent and the latter was found good at 10.3 per
cent. Communications followed by banking and insurance are the fastest growing sub-sectors over
the years with 27.2 per cent and 14.5 per cent growth respectively in 2010-11 but then reduced to 8.3
per cent and 13.2 per cent respectively in 2011-12 as a result of global recession.

Regarding the shares and growth rate of different services categories in GDP at factor cost of
India (at current prices) the following Table 4 will clarify the position.

2013-2014

It is observed from the table 4 that among the various components or categories of services,
the contribution of the first category. Trade, hotels and restaurants remained high in recent period
and its shares as per cent of GDP ranges from 14.6 per cent in 2000-01 to 12.0 per cent in 2013-14.
Next, ‘Financing, insurance, real estate and business services’ category has also been contributing
13.8 per cent of GDP in 2000-01 to 19.8 per cent of GDP in 2013-14. The third category ‘community,
social and personal services’ contributed 14.8 per cent of GDP in 2000-01 and then the share
decreased to 12.9 per cent of GDP in 2013-14. ‘Construction’ is the next category which was
contributing 6.0 per cent of GDP both in 2000-01 and then its share increased to 8.3 per cent in 2013-
14. Finally, ‘Transport, storage and communication is the category which is also contributing 7.6 per
cent of GDP in 2000-01 and its share slightly declined to 6.6 per cent of GDP in 2013-14. Among
‘other services’ which have a share around 6.9 per cent in India’s GDP in 2013-14, education,
medical and health and personal services are the major items. Interestingly, the share of some now
items like coaching centres, recreation and entertainment services and custom tailoring are improving
steadily along with other services.

Table 6 Shares and Growth of India’s Services Sector (at factor cost) (per cent)
[For detail, please read it along with Table 4 (1950s to 2008-09)]

Year 2000- 2005- 2006- 2007- 2008- 2009- 2010- 2011- 2013-
01 06 07 08 09 10 11 12 14
Trade , hotels and 14.6 16.7 17.1 17.1 16.9 16.5 17.2 18.0 12.0
restaurants (5.2) (12.2) (11.1) (10.1) (5.7) (7.9) (11.5) (6.2) (13.3)
Trade 13.3 15.1 15.4 15.4 15.3 15.1 15.7 16.6 11.0
(5.0) (11.6) (10.8) (9.8) (6.7) (8.5) (11.5) (6.5) (14.3)
Hotels and restaurants 1.3 1.6 1.7 1.7 1.5 1.4 1.5 1.5 1.1
(7.0) (17.4) (14.4) (13.0) (-3.3) (1.9) (10.8) (2.8) (3.9)
Transport, storage and 7.6 8.2 8.2 8.0 7.8 7.7 7.3 7.1 6.6
communication (9.2) (11.8) (12.6) (12.5) (10.8) (14.8) (13.8) (8.4) (7.3)
Railways 1.1 0.9 0.9 1.0 0.9 0.9 0.8 0.7 0.8
(4.1) (7.5) (11.1) (9.8) (7.7) (8.8) (5.9) (7.5) (9.3)
Transport by other means 5.0 5.7 5.7 5.6 5.5 5.3 5.3 5.4 3.3
(7.7) (9.3) (9.0) (8.7) (5.3) (7.3) (8.2) (8.6) (5.5)
Storage 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1
(6.1) (4.7) (10.9) (3.4) (14.1) (19.3) (2.2) (9.4)
Communication 1.5 1.6 1.5 1.4 1.4 1.4 1.1 0.9
(25.0) (23.5) (24.3) (24.1) (25.1) (31.5) (25.4) (8.3)
Financing, insurance, real 13.8 14.5 14.8 15.1 15.9 15.8 16.0 16.6 19.8
estate and business services (4.5) (12.6) (14.0) (12.0) (12.0) (9.7) (10.1) (11.7) (8.5)
Banking and insurance 5.4 5.4 5.5 5.5 5.6 5.4 5.6 5.7 5.8
(-2-4) (15.8) (20.6) (16.7) (14.0) (11.4) (14.9) (13.2) (6.4)
Real estate, ownership dwelling 8.7 9.1 9.3 9.6 10.3 10.4 10.4 10.8 14.0
and business services (7.5) (10.6) (9.5) (8.4) (10.4) (8.3) (6.0) (10.3) (8.5)
Community, social and 14.8 13.5 12.8 12.5 13.3 14.5 14.0 14.0 12.9
personal services (4.6) (7.1) (2.8) (6.9) (12.5) (117) (4.3) (6.0) (6.8)
Public administration and 6.6 5.6 5.2 5.1 5.8 6.6 6.1 6.1 6.0
defence
(19) (4.3) (1.9) (7.6) (19.8) (17.6) (0.0) (5.4) (4.9)
Other services
8.2 7.9 7.6 7.4 7.5 7.8 7.9 7.9 6.9
(7.0) (9.1) (3.5) (6.3) (7.4) (7.2) (8.0) (6.5) (10.9)
Construction 6.0 7.9 8.2 8.5 8.5 8.2 8.2 8.2 8.3
(6.1) (12.8) (10.3) (10.8) (5.3) (6.7) (10.2) (5.6) (2.5)
Total Services 50.8 53.1 52.9 52.7 53.9 54.5 54.4 55.7 51.3
(5.4) (10.9) (10.1) (10.3) (10.0) (10.5) (9.8) (8.2) (9.1)
Total Services (including 56.8 61.0 61.0 61.2 62.4 62.7 62.6 63.9 59.6
construction) (5.5) (11.1) (10.1) (10.3) (9.4) (10.0) (9.8) (7.9) (8.1)
Total GDP 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
(4.3) (9.5) (9.6) (9.3) (6.7) (8.6) (9.3) (6.2) (5.0)
Source : Central Statistics Office (CSO).

Note : Shares are in current prices and growth in constant prices;

 Figures in parentheses indicate growth rate;

Source : Misra & Puri

* first revised estimates. @ second revised estimates. ^ third revised estimates,

Activity
Q. Mention the share of services sector in national income (or GDP) and in employment of
India India in the recent year.
_________________________________________________________________________
____ ________________________________________________________________________
________________________________________________________________________

1.6 FAST GROWING SERVICES SECTOR (1951-2010) : BACKDROP

Table 7 provides information on growth rate in different segments of the services sector.
Some segments grew at a rate much faster than their past average growth rates, while for some
other segments, growth rates were similar to the past trend, Gordon and Gupta term the former as
fast growers and the latter as trend growers.
Table 7
Growth Rates and Shares of Service Sub-sectors in GDP
Sector Average growth in 1950s- Average growth in Average growth in Average growth in
1970s (Share in GDP in 1980s (Share in GDP 1990s (Share in 2004-05 to 2008-09
1980) in 1990) GDP in 2000) (Share in GDP in
2008-09)
Trade, Hotels and Restaurant
Trade 4.8 5.9 7.3 9.5
(11.7) (11.9) (13.7) (15.0)
Hotels and 4.8 6.5 9.3 10.4
Restaurants (0.7) (0.7) (1.0) (1.5)
Transport, Storage and Communication
Railways 4.2 4.5 3.6 9.2
(1.5) (1.4) (1.1) (1.0)
Transport by 6.3 6.3 6.9 7.9
other means (3.6) (3.8) (4.3) (5.6)
Storage 5.5 2.7 2.0 7.7
(0.1) (0.1) (0.1) (0.1)
Communication 6.7 6.1 13.6 25.5
(1.0) (1.0) (2.0) (2.9)
Financing, Insurance, Real Estate and Business Services
Banking 7.2 11.9 12.7 16.7
(1.9) (3.4) (6.3) (6.3)
Insurance 7.1 10.9 6.7 18.2
(0.5) (0.8) (0.7) (1.4)
Dwellings, real 2.6 7.7 5.0 4.3
estate (4.0) (4.8) (4.5) (4.3)
Business 4.2 13.5 19.8 17.1
Services (0.2) (0.3) (1.1) (4.3)
Legal Services 2.6 8.6 5.8 8.2
(0.6) (0.0) (0.0) (0.4)
 Community, Social and Personal Services
Public 6.1 7.0 6.0 8.5
administration (5.3) (6.0) (6.1) (5.8)
defence
Personal 1.7 2.4 5.0 5.6
Services (1.6) (1.1) (1.1) (1.1)
Community 4.8 6.5 8.4 8.0
services (4.0) (4.3) (5.5) (6.1)
Other services 3.4 5.3 7.1 7.8
(1.1) (1.0) (0.7) (0.5)
Notes : 1. ‘Personal services’ include domestic, laundry, barber, beauty shops, tailoring, others.

2. ‘Community services’ include education, research, scientific, medical, health, religious

and other community.

3. ‘Other services’ include recreation, entertainment, radio, TV broadcast, sanitary services.

Source : Information in the last column has been computed from CSO, National Accounts
Statistics 2010, information contained in earlier columns is from Jim Gordon and Poonam Gupta,
“Understanding India’s Services Revolution”, IMF Working Paper, 2003, Table 5, p. 13. C.F. Misra &
Puri, 2011.
A perusal of Table 7 reveals that business services was the fastest growing sector in the
1990s with its growth averaging nearly 20 per cent a year. During 2004-05 to 2008-09 also, the
average rate of growth of this sector was almost 17 per cent per annum. The exceptionally fast
growth of this sector has been mainly on account of the IT sector. However, as correctly pointed out
by Gordon and Gupta, the contribution of the business services (particularly IT activity) to GDP has
been modest as it has grown off a low base. In fact, the share of business services in GDP was only
1.1. per cent in 1990s, though it rose to 4.3 per cent during the period 2004-05 to 2008-09.
Communication services which registered growth of 14 per cent per year during the 1990s,
have made a significant contribution to services growth. Growth in this sector has been propelled by
the fast growth of the telecom sector. In fact, the telecom sector accounted for 80 per cent of output
in communication services and registered a rate of growth of as high as 17 per cent per annum
during 1990s. Thereafter, the telecom sector has grown at a still faster rate with the result that the
growth rate in communication services rose to as high as 25.5 per cent per annum over the period
2004-05 to 2008-09 making it the fastest growing sector. Sunil Jain and T.N. Ninan have estimated
that the contribution of communication services to GDP growth which was just under 1 per cent in
1990-91 rose to more than 14 per cent in 2006-07.
In the banking sector, growth rate increased from about 7 per cent per annum over the
period 1950-1980 to 12 per cent per annum in the 1980s, 13 per cent per annum in the 1990s and
more than 16 per cent per annum during 2004-05 to 2008-09. With massive expansion in industrial
and business activities and easy availability of credit, this was very much expected. From a mere 1.9
per cent share in GDP during 1950-1980, the share of banking in GDP increased to more than 6.0
per cent in the post-1991 period. The insurance sector which grew at only 6.7 per cent per annum
over the decade of 1990s has shown a buoyancy in recent years and its rate of growth exceeded 18
per cent per annum over the period 2004-05 to 2008-09. Sunil Jain and T.N. Ninan has estimated
that the contribution of banking and insurance to GDP growth which was just 0.18 per cent in 1960-61
rose to as high as 13.7 per cent in 2006-07.
 Community services, and hotels and restaurants increased at the trend rate of growth in
the early 1990s, and experienced a pickup in growth in the latter half of the decade. Growth in these
sectors has picked up momentum in recent years as would be clear from a glance at Table 4. As
noted by Gordon and Gupta, the growth in community services is due to the rapid growth of
education and health services.
The largest services sub-sector in India is trade. As is clear from Table 4, the share of this
sector in GDP was almost 12 per cent or more throughout the period in planning and was as high as
15.0 per cent in 2008-09. This sector registered a growth of about 6 per cent per annum in the 1980s
and accelerated further to about 7 per cent per annum in the 1990s. thus, on the basis of the growth
registered during the decade of 1990s as a whole, trade could be classified as a ‘trend grower’.
However, as noted by Gordon and Gupta, growth in this sector picked up strongly during the latter
half of the 1990s. Over the period 2004-05 to 2008-09, trade registered a growth rate of more than 9
per cent per annum. Therefore, it now qualifies for being classified under the category of ‘fast
growers’, ‘Railways and transport’ by other means have also touched the rate of growth of 9 per cent
per annum and 8 per cent per annum respectively over the period 2004-05 to 2008-09. However,
railways’ share in GDP was only 1.0 per cent in 2007-2008 while the share of ‘transport by other
means’ was 5.6 per cent per annum.
The rate of growth of public administration and defence averaged 6.0 per cent per annum
in 1990s which was similar to the growth experienced in previous decades. Accordingly, Gordon and
Gupta classify this sector in the category of ‘trend growers’. However, average rate of growth of this
sector rose to more than 8 per cent of per annum over the period 2004-05 to 2008-09. This was due
to a massive growth of 22.1 per cent in 2008-09.
The rate of growth of personal services almost doubled in the 1990s as compared to the
1980s, but at 5 per cent average growth, it remained below the growth in most of the service
activities. Accordingly, Gordon and Gupta classify them under the category of ‘trend growers’. the
rate of growth of personal services stood at 5.6 per cent per annum over the period 2004-05 to 2008-
09.
According to Gordon and Gupta, the fast growing activities accounted for about a quarter of
services output in the 1980s but because of their relatively fast growth, these activities represented
one-third of the services output by 2000. During 1980s, the high services growth was primarily due to
the trend growing sub-sectors (these activities added about 1 percentage point of extra growth in the
1980s), while the contribution made by the fast growing activities was only about half the size. As
against this, fast growing activities made about the same contribution to services growth in the 1990s
as the trend growing sectors. In fact, argue Gordon and Gupta, “Since the trend growing sectors grew
at about the same rate in both decades, the fast growers collectively accounted for almost all of the
higher or growth in the 1990s. One of the important reasons for this is that a number of new activities
and industries have sprung up in the fast growth sub-sectors but not in the trend growth ones.
1.7 PERFORMANCE OF SUB-SECTORS
The two fast-growing broad services categories are: a) financing, insurance, real estate
and business services; and b) transport, storage, and communication. The latter overtook the
former in 2009-10 with a high growth of 15 per cent (Table 6). A third category, growth of trade,
hotels, and restaurants, slowed in 2008-09 and has recovered moderately in 2009-10. The fourth
category, community, social, and personal services, saw a sudden jump in 2008-09 to overtake the
growth of all other categories, reflecting the high growth in public administration and defence. This
category has continued to grow rapidly in 2009-10, despite a slowdown in growth in public
administration and defence (with the commitments for pay arrears under the new revised scale for
Government employees coming down), due to the offsetting rise in growth of other services reflecting
the fiscal stimulus to social sector activities. Among the sub-categories, in 2008-09, double-digit
growth was registered by communication (25.8 per cent), public administration, and defence (20.2 per
cent), banking and insurance (14 per cent) and storage (10.5 per cent). Negative growth was
registered only by hotels and restaurants (-3.1 per cent). Among business services, the two important
categories are computer-related services and the category consisting of many services like R&D
services, market research, business and management consultancy, architectural engineering, and
advertising, with shares of 3.26 per cent and 0.88 per cent respectively in the GDP. While computer-
related services, which grew by 21.2 per cent in 2008-09, registered a moderate growth of 5.2 per
cent in 2009-10 due to the global crisis, R&D services registered good growth of 19.6 per cent and
19.9 per cent in 2008-09 and 2009-10 respectively. Among other services, the two important ones in
terms of share of GDP are education and medical health, with the former growing at 13.9 per cent
and the latter at 5.3 per cent in 2009-10. All other services are of minor importance in India’s GDP.
While total services including construction grew by 9.7 per cent, total services excluding construction
grew by 10.1 per cent in 2009-10. In 2010-11 (Advance Estimate), they grew by 9.4 per cent and 9.6
per cent respectively.
The two broad service categories, namely (a) trade, hotels, transport and communication; and
(b) financing, insurance, real estate and business services, comprising many dynamic services have
performed well with growth of 11 per cent and 10.6 per cent, respectively in 2010-11 (AE)1. Only
community, social and personal services have registered a low growth of 5.7 per cent due to base
effect of fiscal stimulus in the previous two years, thus contributing to the slight declaration in the
growth of the services sector. Construction sector grew at a moderate 8 per cent.
A comparison of the different indicators related to different services in India shows good
performance in services like telecom, aviation, and railway. Storage services show a fall in the
number of warehouses which is a just a reflection of demand and supply id different places (Table 7).
The performance and outlook for the services sector based on the limited firm-level data, though
sketchy and based on estimates and forecasts also indicates a robust performance in services
activities in 2010-11 and 2011-12 (see Box 10.2).
1.7.1 Performance of Some Major Services (2005-10)
Major contribution has been made by following sub-sectors during 2005-10.
Table 8 : Annual Growth in India’s Services GDP at Factor Cost (in constant prices)
(percentage)
2005-06 2006-07 2007-08 2008-09* 2009-10**
Trade, Hotels & Restaurants 12.2 11.0 10.0 5.5 6.7
Trade 11.7 10.7 9.7 6.5 7.2
Hotels & Restaurants 17.5 14.4 13.1 -3.1 2.2
Transport, Storage & 12.2 12.7 12.9 11.1 15.0
Communications
Railways 7.5 11.1 9.8 7.6 9.4
Transport by Other Means 9.3 9.0 8.7 5.2 7.0
Storage 4.7 10.9 3.4 10.5 10.7

1 AE – Advanced Estimate.
 Communications 25.5 24.9 25.4 25.8 32.1
Financing, Insurance, Real 12.7 14.0 11.9 12.5 9.2
Estate, & Business Services
Banking & Insurance 15.9 20.6 16.7 14.0 11.3
Real Estate, Ownership of 10.6 9.5 8.4 11.2 7.5
Dwellings, & Business Services
Community, Social & Personal 7.0 2.9 6.9 12.7 11.8
Services
Public Administration & Defence 4.2 2.0 7.6 20.2 13.0
Other Services 9.1 3.5 6.3 7.4 10.9
Construction 12.8 10.3 10.7 5.4 7.0
Total Service(excluding 11.0 10.1 10.3 10.1 10.1
Construction)
Total Services (including 11.2 10.1 10.4 9.5 9.7
Construction)
Overall GDP 9.5 9.6 9.3 6.8 8.0
Source : CSO, Economic Survey 2010-11
Notes : *provisional estimates.
**quick estimates.

The first decade of 21st century witnessed acceleration in the growth rate of real GDP. It has
been in the range of 8-9 per cent during the last five years. This fast growth means rising disposable
income of the population in particular that of the middle class. With the growth in consuming
population (increase in consumption due to increase in population), the retail business also got a
boost. Employment in the retail trade at 35.06 million, which constitutes 7.3 per cent of the workforce
in the country.

(a) Trade
Trade is an important segment in India’s GDP. The GDP from trade (inclusive of wholesale
and retail in the organized and unorganized sectors) increased from 2004-05 to 2009-10, at a CAGR
of 9.1 per cent per annum. While the share of trade in the GDP, however, remained fairly stable at
around 15 per cent during these years.

(b) Tourism (including Hotels and Restaurants)

Tourism is one of the major engines of economic growth in most parts of the world including
India. According to the UN World Tourism Organization, tourism provides 6 per cent to 7 per cent of
the world’s total jobs directly and millions more indirectly through the multiplier effect in this sector. It
also plays an important role in the country’s foreign exchange earnings. Domestic tourism also plays
an important role in overall tourism development in the country.

The hotels and restaurants sector is an important sub-component of the tourism sector. The
share of the hotels and restaurants increased from 1.46 per cent in 2004-05 to 1.69 per cent in 2007-
08, and then decreased to 1.53 per cent and 1.45 per cent in 2008-09 and 2009-10 respectively. The
CAGR in the GDP contributed by the hotels and restaurants sector was 8.5 per cent in 2004-05 to
2009-10.
(c) Transport Related Services
 Please see chapter on Infrastructure.
(d) Telecom and Related Services

The telecom sector has grown very fast during the last two decades. It has grown from 22.8
million telephone subscribers in 1999 to 54.6 million in 2003, further to 764.77 million in November
2010. Wireless telephone connections have contributed to this growth. Tele-density, increased from
2.32 per cent to 64.34 per cent during the period.

Internet is another growing mode of communication. Broadband is often called ‘high-speed’

Internet. Broadband subscribers grew from 0.18 million to 10.71 million during 2005-2010.

(e) Real Estate Services

The Real Estate Sector includes development of commercial and residential real estates with
participation and involvement of both Government agencies and private developers. The policy
measures include permission for FDI in townships, housing, built-up infrastructure, and construction
of development projects including SEZs, which have attracted foreign investors to this sector.
However, FDI is not allowed in real estate business. National Housing Bank (NHB) was established
with the objective of promoting housing finance institutions; and it introduces the residential real
estate price index (RESIDEX).

Some Business Services

IT and ITES
India has gained a brand identity as a knowledge economy due to its IT and ITES sector. The
IT-ITES industry has four major components: IT services, business process outsourcing (BPO),
engineering services and R&D, and software products. It has literally become growth engine for the
economy, contributing to India around 4.1 per cent in 2004-05 to 6.1 per cent in 2009-10, to 6.4 per
cent in 2010-11.
Exports dominate the IT-ITES industry, and constitute about 77 per cent of total industry
revenue.
This sector has also led to employment generation. Direct employment in the IT services and
BPO/ITES segment was 2.3 million in 2009-10. Indirect employment have been generated in diverse
fields such as commercial and residential real estate, retail, hospitality, transportation, and security.
India continues to be the dominant player in the global outsourcing sector. However, its future
depends on how the challenges related to its continued competitiveness are tackled. These include
increasing competition, rising costs, talent shortfall, infrastructure constraints, increasing risk
perception, protectionism in key markets, and deteriorating business environment.

Table 9 : IT-ITeS Revenue and Exports (US $ billion)

Year 2009-10 2010-11 Growth Rate in CAGR (2005-06 to

2010-11 (%) 2010-11) (%)
Total IT-BPO Services Revenue 63.7 76.1 19.5 22.5
Exports 49.7 58.9 18.5 22.2
Domestic, of which 14.0 17.2 22.8 23.7
(i) IT Services 8.9 10.9 22.5 20.8
(ii) ITeS-BPO 2.2 2.8 27.3 29.3
(iii) Software Products 2.9 3.5 20.7 30.7

Source : Nasscom. C.F. Eco. Survey 2010-11.

  Accounting and Auditing Services :
Accounting, auditing, and book-keeping services are part of “business services”. The
accounting profession in India is highly developed with the potential to become internationally more
competitive. Indian accounting firms are increasingly getting integrated, and providing associated
services such as management consultancy, corporate finance, and advisory services, in addition to
their core business of accounting, auditing, and tax services.

There is need to tap outsourcing in niche areas like actuarial and accountancy services as
there is good scope for outsourcing actuarial services. But India services providers need high-quality
training in tax laws of US and other countries besides laws related to insurance, pension etc.

 Research & Development

India with R&D share of 0.8 per cent of GDP is far behind countries like South Korea (3.5 per
cent), Russia (1.1 per cent), China (1.5 per cent), and Brazil (1 per cent.)

As per estimates in 2009-10, the sectors which attracted largest R&D expenditures include
pharmaceuticals, electrical and non electrical machinery, transport equipment, electronics and
plastics. R&D intensity (R&D as per cent of sales) for the pharmaceuticals sector was much higher
than that for other sectors.

There is huge potential for R & D services, particularly in healthcare, biotech and electronics.
However, there are issues related to intellectual property rights (IPRs) in the sector. India has
amended the IPR laws in the past two decades and its laws are fully compliant with WTO regulations.
There is an impartial judicial process in India which implements the laws. The Government has taken
many measures to encourage R&D like enhancing the weighted deduction on expenditure incurred
on in-

Legal Services

India’s prominence in the legal process off-shoring (LPO) segment is being widely
acknowledged in the global market. Potential exists for India to tap a significant share of world LPO
business. India holds significant advantage in various parameters that work in favour of driving the
LPO industry towards India. Off-shoring legal work to India saves about 80 per cent of the cost that
may be incurred in a developed country like USA. It is estimated that the cost of employing a fresh
law graduate in the USA would be US $150,000 per annum as compared to US $15,000 per annum
in India.

 Consultancy
Consultancy is essentially a knowledge-based profession with an underlying developmental
role spanning a wide range of sectors. Not only do consultancy services play an important role in the
development of the economy, but such consultancy exports enhance the visibility of Indian technical
expertise abroad and boost the external sector in multiple ways, including foreign exchange
revenues, promotion of export of technology and merchandise (especially capital goods and raw
materials), and training of personnel, while contributing significantly to national development in the
host country.
 Over the past decade, India has emerged as one of the fastest growing consultancy markets
worldwide. This is largely attributable to increased investment activities due to liberalization of FDI
restrictions, entry of many new players into the Indian market, high growth in most key sectors, and
India being an emerging economy and a low-cost sourcing destination.

 Construction
The construction industry in India is an important indicator of development as it creates
investment opportunities across various related sectors. The construction industry has contributed to
national GDP in 2010-11, a share of around 8 per cent. The industry is fragmented, with a handful of
major companies involved in construction activities across all segment; medium sized companies
specializing in niche activities; and small and medium contractors who actually work on sub contract
basis and carry out the work in the field. The sector is labour intensive and, including indirect jobs,
provides employment to more than 35 million people.

Creation of physical assets is an important outcome of construction activity. Prior to

liberalization, the sector was dependent on Government spending on infrastructure as also
construction activity undertaken by the private sector for housing complexes. The sector was given
industry status in the year 2000. Since then, there are more initiatives by the Government to
undertake projects on PPP basis. These initiatives have resulted in more private ownership of build-
operate-transfer (BOT), build-operate-own-transfer (BOOT), and build-operate-lease-transfer (BOLT)
Projects. FDI is allowed upto to 100 per cent under the automatic route in townships, housing, built-
up infrastructure, and construction of development projects (which include housing, commercial
premises, educational institutions and recreational facilities).

Construction services have been brought under the ambit of services tax since the year 2004.
However, certain infrastructure projects like dams, roads, bridges, railways, and airports and projects
awarded by Government/local bodies are exempt from services tax. Construction service providers
have been allowed to avail of Central value added tax (CENVAT) credit on capital goods, inputs, and
input services since 2004. Moreover, excise duty on supply of goods to deemed export projects is
refunded. The existing VAT Act provides for deduction of subcontractor turnover based on
documentary evidence.

(g) Some Social Services

Healthcare and education are the two major social services. Besides these two, some other
social services like sports are gaining importance in India.

Conclusion
With an overall share of 68 per cent in world GDP in 2010 (Table 8), the services sector
across the globe has been playing a dominant role in the growth of economies, especially in high-
income economies which have transited to services-led economies.

India has made much progress in Trade in services, which is dominated by developed
countries, and has been among the top 12 service exporters of the world since 2009.

1.8 Recent Steps for Growth of Services

 India aims to position itself as a key player in world services trade. In the light of slow-down in
manufacturing exports in recent years, it is important to increase services exports (from currently 3
per cent to around 15 per cent of the world market share: To promote services exports, the
government has taken several policy initiatives –

 Services Exports from India Scheme (SEIS) – for increasing exports of notified services from
India;
 Organising Global Exhibition on Services (GES); and
 Services Enclaves
In Feb 2017, India also made a proposal presentation – Trade Facilitation in Services (TFS) to
the WTO for a global pact to boost services trade. It is mainly aimed at

 ‘ensuring’ easier norms for movement of foreign skilled workers/professionals across

borders for short-term work;
 Portability of social security contributions;
 Reasonable fees for immigration;
 Cross-border insurance coverage;
 Boosting medical tourism; and
 Publication availability of relevant information for cross-border supply of services.
Many bilateral agreements are signed by India in recent times –
 Comprehensive bilateral trade agreements including trade in services with the
governments of Singapore, South Korea, Japan and Malaysia.
 India has joined Regional Comprehensive Economic Partnership (RCEP) – a mega
regional FTA including 10 ASEAN countries and its six FTA partners (viz Australia,
China, India, Japan, South Korea and New Zealand).
 India is also engaged in bilateral FTA negotiations including trade in services with
Canada, Israel, Thailand, the EU, the EFTA (European Free Trade Association),
Australia and New Zealand.
1.9 CONCLUSION

We have read in this chapter that the contribution of services sector to India GDP is as high
as 57 p.c. Since 1990-91 the growth of services sector has been very rapid. All the decline in the
share of agriculture sector has been actually compensated by the growth of services sector in India.
During the decade 2001-10, India is the topmost country in terms of increase in its services share in
GDP (7 percentage terms) and the CAGR has been as high as 9.4 p.c. annum. The fastest
growing segments have been a) Financing, insurance real estate and business services; b) Transport
storage and communication; and c) trade sector. The recent data also supports it.

In the next chapter we’ll study about the contribution of services sector to foreign trade;
factors contributing towards the growth of services sector and future prospects in this regard.

1.10 SUMMARY

Services, Sector in India

Importance Growth of Services Pattern of Growth

Share in GDP Share in GDP International Perspective

Share in Emp. Contribution to GDP Growth (Add Recent Data)
Share in FDI, Exp. & Imp. Sub-sectors and their growth Performance of Major
Sub-sectors in Services
 Contribution to GDP Growth

1.11 GLOSSARY

 GDP- It is final value of goods & services produced in an economy in a financial year (Gross
Domestic Product)
 FDI – It is investment made by foreign entity in a country.
 Services Sector – It is third sector of an economy, other two being primary & secondary
sectors
1.12 REFERENCES

 Government of India (2016). Economic Survey, various issues since 2010.

 Datt, Gaurav and Mahajan, Ashwani (2016). Indian Economy, various issues, Himalaya
Publications, New Delhi.
1.13 FURTHER READINGS

 Kapila Uma (Ed) (2017). Indian Economy since Independence. Academic Foundation. New
Delhi (p 199-205).
 Ahluwalia, Montek S. (2011). “Prospects and Policy Challenges in the Twelfth Plan”,
Economic and Political Weekly XLVI (21), May 21.
1.14 MODEL QUESTIONS

 Comment upon the significance of services sector in Indian economy.

 Critically analyse the growth and pattern of services sector in India.
APPENDIX

FDI in Retail Trading in India and Other Countries

In India, retail trade is a state subject. There is no national framework for its regulation and
development and states have their own regulations. At central level, only the flow of FDI into the
sector is regulated. While FDI in cash and carry wholesale trading is permitted in India, FDI in multi-
brand retailing is prohibited. FDI in single-brand retailing up to 51 per cent has been allowed since
2006. A total of 94 proposals have been received till May 2010, of which 57 were approved. During
the period April 2006 to March 2010, FDI inflows valued at US $194.96 million have come into this
sector, accounting for 0.21 per cent of total FDI inflows during this period. FDI in retail trading is
permitted in Brazil, Argentina, Singapore, Indonesia, China, and Thailand without limits on equity
participation, while Malaysia has equity caps of FDI in the retail sector. Permitting FDI in retail in a
phased manner beginning with metros and incentivizing the existing retail shops to modernize
could help address the concerns of farmers and consumers. FDI in retail may also help bring in
technical know-how to set up efficient supply chains which could acts as models of development.
 (see chapter on FDI for details)
Source : Eco. Survey 2010-11.

Hints for Examination Preparation

1) While answering questions in the exam, the studies (or hypotheses) or reference quoted in
the lessons are not required to be mentioned. You are expected to just comment on the
issue in question, and not all the sources of information.

2) The performance in post – 2008 crisis years needs just a mention and not detailed study
explanation, in this topic and other topics.

3) From examination point of view you do not have to go by all the details rather need to
have a consolidated view of the growth of services sector in India, collecting information or
relevent points from both the lessons : Lessons 1 and 2.

4) Prepare answer approximately for 5 to 6 pages, using summarized form of data for the
period 1950-2010, specially 90s onward; and add recent data from next chapter and
reference books.

------------
 Lesson-2

SERVICES SECTOR IN INDIA: GROWTH AND FUTURE

PROSPECTS
(LATEST TRENDS)

Structure
2.0 Objectives
2.1 Introduction
2.2 Foreign Trade in Services
2.2.1 Composition of Service Imports
2.2.2 Composition of Service Exports
2.2.3 Trade Balance in Services
2.3 Liberalisation Measures
2.3.1 Trade Negotiations in Services
2.4 Factors Underlying the Services Growth
2.4.1 Splintering
2.4.2 Demand-Side Push
2.4.3 Impact of Liberalisation
2.4.4 Impact of Technological Advances
2.4.5 Mutual Dependence of Industry & Services
2.5 Sustainability of Services Led Growth
2.5.1 Well performing sub-sectors
2.6 Challenges and Outlook
2.7 Summary
2.8 Glossary
2.9 References
2.10 Further Readings
2.11 Model Questions
2.0 OBJECTIVES
After going through this lesson, you shall be able to :
 describe the growth services exports, services imports and the trade balance of
services sector in India.
 discuss the contribution of liberalisation measures in the foreign trade of services.
 explain the factors underlying the growth of services sector in India.
 discuss the present performance of services sector in India and the future prospects
2.1 INTRODUCTION
In continuity with lesson 1, this lesson pertains to the contribution of services sector in GDP,
employment export basket, import basket and finally trade balance, along with it we shall study the
various factors that have contributed towards the subnet growth of services sector since 1990-91.
Also we shall study about the future prospects and the challenges ahead.

2.2 FOREIGN TRADE IN SERVICES

Services, particularly finance (insurance) and transportation of goods, are traditional

complements to goods trade. With the spread of telecommunications and computer technologies,
virtually all commercial services have become tradeable across countries. The trend of globalisation,
reinforced by liberalisation policies and the removal of regulatory obstacles has fuelled steady growth
of international investment and trade in services.

The service & sector accounts for more than 50 per cent of the Gross State Value Added
(GSVA) in 12 out of 33 States and UTs with the Chandigarh standing out with 74 per cent share in
state GSDP. At country level, services generate 53 per cent of nominal Gross Value Added in 2021-
22.
2.2.1 Composition of Service Imports

During recent years, substantial changes in the composition of service imports have taken
place in India. Table 2.1 presents the relative share of different services in India’s service imports
over the period 2001-02 to 2009-10 and their respective growth rates.

Imports of services became important by 2008 reaching $52.0 billion in 2008-09 and $60-0
billion in 2009-10. However, the growth rate which was as high as 16.2 per cent in 2007-08
decelerated to 1.1 per cent in 2008-09 due to global recession but picked up to 15.3 per cent in 2009-
10. Business services is the most important category of services imports and its share in service
imports which was only 7.0 per cent in 2000-01 rose to as high as 29.7 per cent in 2008-09 and 30.1
per cent in 2009-10. The compound annual rate of growth of business services over the period 2000-
01 to 2007-08 was as high as 48.9 per cent. However, because of global recession, imports of
business services fell by 7.5 per cent in 2008-09 over 2007-08. The share of transportation remained
virtually constant over the period 2001-02 to 2008-09 but fell in 2009-10. The share of travel fell from
19.2 per cent in 2000-01 to 15.6 per cent in 2009-10. Although the share of communication services
in total service imports was only 2.3 per cent in 2009-10, they registered a high rate of growth of 24.6
per cent in this year.
2.2.2 Composition of Service Exports

India is moving towards services-dominated GDP growth with a 10 per cent CAGR for
services which is higher than the 6.7 per cent for non-services during 2004-05 to 2009-10. It is also
moving towards a services-dominated export growth with a CAGR of 16.7 per cent for the services
during 2004-05 to 2009-10 (The CAGR was 27.8 per cent during 2000-01 to 2007-08) which is
slightly higher than the 16.4 per cent for merchandise exports during the corresponding period. As
against imports of $52.0 billion in 2008-09, exports of services in this year were as high as $106
billion. Exports of services declined to $95.8 billion in 2009-10 because of global recession but even
this was substantially higher than the imports of $60 billion in this year. In fact, the continuous high
growth in exports of services has been an important factor in reducing the deficit in balance of trade.
Table 2.2 presents information on the composition of service exports. As is clear from this Table,
growth has been particularly rapid in the miscellaneous services category comprising software
services, business services, financial services and communication services over the period 2000-01
to 2007-08. The compound annual rate of growth of miscellaneous services was as high as 31.6 per
cent over this period. However, because of global recession, the rate of growth of exports of
miscellaneous services was negative in 2009-10 (the most drastic fall of 41.2 per cent was in non-
software services.)

The share of software exports in total services exports was 39.0 per cent in 2000-01 and this
rose to 51.9 per cent in 2009-10. The share of non-software services in total services exports was
21.3 per cent in 2000-01 which rose to 30.9 per cent in 2008-09 (but fell to 21.9 per cent in 2009-10).
Most prominent in this category have been business services. The compound annual rate of growth
of exports of business services over the period 2000-01 to 2007-08 was as high as 75.0 per cent and
they contributed 11.9 per cent of total earnings from exports of services in 2009-10.

The growing role of software and business services in India’s service-sector exports reflects
India’s comparative advantage in skill and knowledge-intensive labour-based services. On-site
services provided through the temporary cross border movement of service providers constitute
around 40 per cent of the country’s software service exports.

India’s growing presence in global BPO services is based on its huge labour endowment,
varied skill sets and low-cost but quality manpower coupled with a rapidly growing domestic IT
industry. According to the Financial Times, half of the world’s largest 500 companies and many
government agencies contract out information technology and business process work to India across
a wide range of services, including medical and legal transcriptions, customer support, human-
resource management and administration, financial and accounting processes, technical support,
logistics, sales, and research and development, to name a few. According to a 2004 AT Kearny
report, India ranks highest among offshoring destinations.

Apart from software and BPO services, there are emerging export opportunities in various
other services, such as health, education, and tourism. There are concerted efforts underway to
establish India as a hub for medical tourism services. Similarly, there is growing interest among
Indian higher-education institutions in exporting education services through establishment of offshore
campuses as well as twining and partnership arrangements. It is again worth noting that trade data
on services are subject to problems of coverage and classification. Information is not available from
the balance of payments at a sufficiently disaggregated level, particularly in the category of other
services, to gauge trends and prospects for individual activities.

There are, however, numerous domestic and external barriers to India’s services exports.
The main domestic barriers are in the form of infrastructural, financial, regulatory, technical, and
standard-related constraints. The main external barriers are in the form of immigration and labour-
market regulations, which limit India’s ability to deliver onsite services. In addition, there had been a
backlash against outsourcing in key markets like the US and introduction of domestic regulations
such as data privacy laws, which could affect India’s BPO exports adversely. (Chanda, 2007).

India has a dominant presence in service exports ─ among top ten service exporter countries
in 2020, with its share increasing from 3.4 pc in 2019 to 4.1 pc in 2020.

2.2.3 India’s Trade Balance in Services (2001-11)

Imports of commercial services have become important in recent years reaching US $ 60

billion in 2009-10. Business services are the most important category of services imports, followed
by transportation and travel. Import growth of business services declined by (-) 7.5 per cent in
2008-09 picked up by 17.8 per cent in 2009-10. It grew robustly at 62.9 per cent in the first half of
2010-11. Import growth of transportation and travel which fell in 2009-10 turned positive in the first
half of 2010-11. Financial services imports grew by 68 per cent.

Table 2.2

India’s Exports, Imports and Balance of Trade in Services

(US $ billion)

Exports Imports Balance

2000-01 16.3 14.6 1.7
2007-08 90.3 51.5 38.9
2008-09 106.0 52.0 53.9
2009-10 95.8 60.0 35.7
2009-10 43.8 24.7 19.1
(April-September)
2010-11 55.7 36.2 19.2
(April-September)
Source : Economic Survey 2010-11.

2.2.4 FDI in India’s Services Sector

There has been a significant growth in FDI inflows to the services sector in 2014-15 and 2015-
16. The total share of cumulative FDI inflows to the services sector would increase to 55.6 per cent
and 54.5 per cent respectively.

2.3 LIBERALISATION MEASURES

Services have been a critical part of the overall economic reform and liberalisation process in
India. Much of the recent structural and institutional reforms as well as the liberalisation/deregulation
strategies have involved the opening up of key services such as tele-communications, banking, and
insurance to attract much-needed foreign capital and technology, and to encourage competition and
efficiency in these areas to induce positive externalities for the rest of the economy. Many services,
including, construction, tourism, health, and computer-related services, for instance, have been put
on automatic approval route for FDI. Government monopoly in many critical services has been
eliminated, with further liberalisation planned or already announced.

Evidence suggests that services that have been liberalised most have typically experienced
higher growth rates. Areas such as business services (mainly IT and IT-enabled services),
communication, banking, and insurance, which have been liberalised, have exhibited higher growth
rates, with wider efficiency and growth benefits to the rest of the economy. On the other hand,
services where there has been limited opening, like air-transport, legal, and real-estate services have
grown much more slowly, with likely adverse effects on economy-wide competitiveness and growth
performance. (Chanda, 2007).

2.3.1 India and Trade Negotiations in Services

The preceding discussion clearly highlights that the service sector has not only outperformed
other sectors of the Indian economy, but has also played an important role in India’s integration with
world trade and capital markets. There is, however, growing debate within the country about the
sustainability of a services-led growth process. No country in history has been able to grow rapidly in
a sustained manner based on services alone. The manufacturing sector has always been part of the
growth success. Hence it remains to be seen whether this model of growth also holds for India or not.

2.3.2 Major Concerns

The prevailing view today is that India needs broad-based growth as its service sector is
largely driven by external demand. If high growth is to be sustained within services, then creation of
internal demand is necessary and this is only possible with a vibrant manufacturing sector. Moreover,
employment concerns cannot be addressed without concomitant growth in manufacturing since, as
highlighted earlier, the faster-growing services are those that are not generating sufficient growth in
employment opportunities for the masses. More broad-based growth within the service sector is
required. Services such as trade and distribution, tourism, and construction, which has high
employment intensities and large backward and forward linkages with other sectors need to grow
more rapidly. In this regard, further infrastructural and regulatory reforms and FDI liberalisation in
services can help diversify the sources of growth within India’s services sector and provide the
required momentum (Uma Kapila, 2011).

2.4 FACTORS UNDERLYING THE SERVICES GROWTH

This section comments on the factors contributing towards the growth of services sector in
India. The main reasons for rapid services growth in the Indian economy in recent years are generally
discussed under the following headings :
2.4.1 Splintering

It is argued that as an economy matures, increasing specialisation takes place. Industrial

units tend to outsource some activities which were previously undertaken by themselves. For
example, they may use greater services of specialist subcontractors to provide accounting, research
and development, legal and security services, etc., which were earlier undertaken by themselves.
Bhagwati (1994) calls this process of specialisation splintering. Kravis (1982) has argued that
splintering leads to a growth in the share of services in GDP, even when the GDP itself is not
growing. This is due to the reason that the jobs outsourced will now be counted as service sector
contribution to GDP, rather than being subsumed in manufacturing value-added or (Misra & Puri,
2008).

2.4.2 Demand-side Push to Growth

During recent period, the demand-side impetus to services growth is clearly visible. Till the
liberalisation of the early 1990s, the trend in private final consumption expenditure was a
straightforward one – the share of services in the total consumption basket (at 1999-2000 prices)
increased by about 3 percentage points each decade: that is, from around 8 per cent in 1950-51 to
11 per cent in 1960-61; 14 per cent in 1970-71; 17 per cent in 1980-81; and 20 per cent in 1990-91.
However, thereafter, this trend changed significantly and by 2000-01, the share of services in private
consumption rose to as much as 31 per cent, that is, up by 10 percentage points. By 2006-07, it rose
by another 8 percentage points, (i.e. 39 per cent) indicating that the pace had quickened up further in
the 2000s. These data clearly indicate a demand-side impetus to growth of services. Sunil Jain and
T.N. Ninan are of the view that this demand-side impetus will not only continue in future but will also
become stronger. They specifically mention increasing private expenditure on education,
communications, medical care and health services. (C.f. Misra & Puri, 2008).

The demand-side Push has also come from foreign sources particularly the IT/ITES
(Information Technology and Information Technology Enabled Services) sector as, due to cost
advantages in India, many companies in the developed world have started outsourcing certain
services to Indian companies on a large scale. This has enabled exports of services from India to
increase over time.

2.4.3 Impact of Liberalisation

During the post-reforms period there has been considerable liberalisation of the industrial and
trade policies and opening up of the banking, insurance, transport and communication sectors
to private participation. Many economists have argued that this liberalisation has boosted the growth
of the services sector significantly. Sunil Jain and T.N. Ninan have shown that the fast-growth areas
in services in the post-reform period have been those that have witnessed significant liberalisation.
(Misra & Puri, 2011). Even in the technology-driven sectors (such as IT and communication), the
removal of government-imposed constraints has been important, if not vital, for growth. In this
context, the examples of communication services, banking services, insurance services, and
computer related services clearly stand out. The share of communication services in GDP rose
considerably from 1.0 per cent in 1991 to as high as 5.7 per cent in 2007-08. This was primarily due
to telecom liberalisation which began in 1994 when the private sector was allowed entry. In 1999,
the share of the private sector in total telephone connections was a meagre 5 per cent. By November
2010, this had increased to as much 84.5 per cent. Similarly a revolution has taken place in the field
of mobile telephony with the number of wireless connections increasing at a compound annual
growth rate (CAGR) of 60 per cent per annum since 2004. This has been primarily due to increased
role of private players. The number of wireless connections rose from 35.62 million in March 2004 to
as high as 729.58 million at end-November 2010.

Even in case of banking sector, its share in GDP almost doubled in the post-reforms era
(from 3.4 per cent in 1990 to 6.3 per cent in 2000 and 6.0 per cent in 2007-08). As a result of the
policy of liberalisation, the private banks have started playing an important role in the spread of
banking facilities and this has given an impetus to the growth of the banking sector. While private
banks accounted for just over 5 per cent of all bank incomes in 1995, their share rose to almost 25
per cent in 2007. Similarly, within just seven years of the insurance sector opening up, there were 24
private firms (in 2006-07) who brought in Rs 9,625 crore as capital. Not only this, liberalisation had a
positive influence on computer related services (broadly the IT/ITES sector) whose share in GDP
rose from 0.96 per cent in 1999-2000 to 3.04 per cent in 2006-07, while its contribution to growth was
around 7.0 per cent.

Activity
Q. Mention the share of IT & ITES in GDP in recent year.
__________________________________________________________________________
__
___________________________________________________________________________
__
___________________________________________________________________________
__

2.4.4 Technological Advances & their Impact

Services sector growth has also been stimulated by technological advances (whereby new
activities or products emerge as a result of technological breakthrough). Such technological advances
have encouraged the use of internet in the case of the IT sector, expansion of cellular phone services
in the telecom sector and use of credit cards, ATMs, etc., in the case of the banking sector. Gordon
and Gupta have used a growth-accounting exercise to estimate a 1.25 percentage points contribution
of policy liberalisation and technology progress to services sector growth in India. (Misra & Puri,
2011).
2.4.5 Mutual Dependence of Industrial and Services Growth
Misra & Puri (2011) quote following studies to show mutual dependence of industrial and
services sector.
Gordon and Gupta find positive impact of industrial growth on services growth. The reverse
direction examines the impact of services on manufacturing production and productivity.
In this context, Nirvikar Singh quotes a study of Banga and Goldar (2003) which estimates
that, although service inputs contributed little to the production of the registered manufacturing sector
during the 1980s (only 1 per cent of output growth), the contribution of services increased
substantially in the 1990s (to about 25 per cent of output growth). This, in turn, implies that excluding
services inputs overstates the extent of manufacturing total factor productivity (TFP) growth in the
1990s. These results suggest that the increasing use of services in manufacturing in the 1990s
favourably affected TFP.
2.5 SERVICES LED GROWTH : HOW SUSTAINABLE ? (FUTURE PROSPECTS)
As stated earlier in the previous chapter (page 3), the services sector has registered a rapid
growth during the period of the last two decades and has contributed significantly to the growth of
GDP (as much as 68.3 per cent during the period 1996-2002 and 63.6 per cent during the period
2001-08). In fact, it is the high rate of growth of the services sector in the post-1991 period that has
allowed GDP to grow at the rate of around 6 per cent per annum over the decade of 1990s and 7.8
per cent per annum over the period of the Tenth Plan. Thus, the growth of the Indian economy in the
post-1991 period has been a services-led growth. Impressed by this growth performance of the
services sector, many economists have argued that the future of the Indian economy rests with this
pattern of growth, i.e., the services sector pushing ahead of agriculture and industry. In other words,
the dynamic services sector has the capacity to compensate poor agricultural and industrial growth in
the future as well and would thus play a crucial role in maintaining the growth momentum of the
economy. (Misra & Puri, 2011).
According to Ejaz Ghani, “A service-led growth is sustainable because the globalisation of
service is just the tip of the iceberg. Service is the largest sector in the world, as it accounts for more
than 70 per cent of the global output. The Service Revolution has altered the characteristics of
services. Services can now be produced and exported at low cost. The old idea of services being
non-transportable, non-tradeable, and non-scalable no longer holds for a host of modern impersonal
services. Developing countries can sustain a service-led growth as there is a huge room for catch-up
and convergence. Thus, according to Ghani, industrialisation is not the only route to economic
development. Service-led growth could be the other route. (Misra & Puri, 2011).
The Well Performing Sectors have been explained later in Section 2.5.1 and chapter 1 as sub-
sectors.
As economy continues to grow, many new services are likely to get added to the basket of
existing services while the network of many existing services is likely to expand considerably. For
example, due to the availability of world-class but cheap medical facilities, India is well poised to
attract a large number of patients from abroad, particularly from the developing countries. Demand for
education is also expected to expand considerably in years to come and education services could
well emerge as a driver of GDP growth in future. Another important potential area is financial services
and several empirical studies for India have shown that financial sector development would stimulate
growth.
2.5.1 Well Performing Sub Sectors of the Services Sector in India
The two sub-sectors of the services sector that have contributed significantly to its growth in
India in recent years have been telecommunications and IT. Teledensity, an important indicator of
telecom penetration, increased from 12.7 per cent in March 2006 to 47.9 per cent in December 2009.
This was due to the rapid expansion of mobile telephony aided by drastic cut in local and long
distance call rates. There is substantial scope for further expansion in the telecom sector as a vast
market still remains untapped. In the case of IT, the sustained conquest of external markets has
added significantly to the country’s trade in goods and services, with IT exports now accounting for up
to 20 per cent of the total. There are also substantial spillovers from the IT services industry to ITES,
as well as to knowledge-intensive sectors in general. As noted by Nirvikar Singh, there are linkages
and spillovers from ITES to sub-sectors such as construction and transportation, which not only
stimulate demand but bring in new expertise through creating a different set of requirements and
expectations. As IT applications spread to new areas of activity, scope for further expansion in the IT
sector is bound to happen.
Another important source of growth could be export of services. Since liberalisation began,
exports of services have increased manifold from $4.6 billion in 1990-91 to $106 billion in 2008-09
(exports of services stood at $95.8 billion in 2009-10). A survey conducted by FICCI (Federation of
Indian Chambers of Commerce and Industry) estimates that if the current growth continues, the share
of services in total exports would rise to 50.4 per cent by 2011-12, i.e., service exports will overtake
merchandise exports, powered by the booming software, BPO consultancy, engineering and tourism
sectors. The sharp rise in software and ITES-BPO exports from India would be clear from the fact
that their exports in 2009-10 stood at about $49.7 billion which was nearly 52 per cent of export of
services in this year. According to NASSCOM (National Association of Software Services
Companies), the global BPO market alone stands at around $150 billion so that the addressable
market is large enough to leave enough potential for growth for several years. (Misra & Puri, 2011).
The report on Currency and Finance, 2001-02, also highlighted the expansionary potential of
services sector in non-service industries and notes the presence of strong forward linkages, as 50 per
cent of the industries in the economy are found to be directly or indirectly service intensive. Thus, it
contends that “in general services sector appears to be highly growth inducing with positive
externalities for other sectors, making services a catalytic agent of growth. (Op. cit).
However, critics have pointed out that this emphasis on services and the hope that they can sustain
high rates of growth of GDP in future as well as misplaced. Writing in 2002, Shankar Acharya had stated,
“Services are hugely important, but they cannot, by themselves, assure rapid and sustained growth of the
Indian economy.” In this context, Acharya had made the following points (Misra & Puri, 2011).
 The historical record of Indian economy does not support the contention that the services
sector is the leading sector. As is clear from Table 3 of Lesson 1, the services sector grew at
a slower rate vis-a-vis the industrial sector during the first four decades of economic planning.
It is only in the 1990s that services growth (at 7.5 per cent per annum) was appreciably higher
than the industrial growth average of 5.8 per cent per annum. However, even during the first
decade after economic reforms, if we focus on the Eighth Plan period 1992-97 we find that
both the sectors recorded the same high growth rate of 7.3 per cent per annum. It is only in
the Ninth Plan period 1997-2002 that we find the unprecedented divergence of services sector
growth at 7.9 per cent per annum far outstripping industrial growth of 4.3 per cent per annum.
However, Acharya, has a different point of view when he mentions the high rate of growth
registered by the services sector in the Ninth Plan period was partly due to the ‘spurious’
growth attributable to massive government wage hikes and partly due to the rapid growth of
the IT sector from a low base. As table 1A reveals (see appendix), industrial growth rate
matched the services growth rate during the Tenth Plan period. The real divergence in the
rates of growth in the post Ninth Plan period is found only in one year, 2008-09.
 The services sector is marked by considerable heterogeneity (i.e. variations) and the
underlying data for this sector and the methodology of estimation of net output of this sector
are much weaker than for the commodity producing sectors. Therefore, questions can be
raised about the reliability of the official estimates of services output and their growth, as per
the view point of many economists.
  As far as the experience of high growth rate of services in the Ninth Plan is concerned, even
this could not generate high overall economic growth. Indeed, overall growth actually slowed
down in 1997-2002 to only 5.5 per cent per annum. Even when services (accounting for half
of GDP) grew fast at nearly 8 per cent per annum, it could not compensate for the slow
expansion (at just over 3 per cent) of the other half of GDP, made up about equally of
agriculture and industry. Therefore, services alone cannot do the job of giving India fast
economic growth.
2.6 CHALLENGES AND OUTLOOK
The growth of services sector in the decade 2001-10 aprises us of the latest trends, the
present barriers and on this basis the future outlook can be made.
Outlook
The outlook for the services sector which had slightly dimmed due to the fallout of the sub-
prime crisis in the US and the global financial crisis has once again brightened. Recent business
performance indicators of different services firms in different sub-sectors also support this healthy
prognosis. Even during the crisis year, annual growth of the services sector was around 10 per cent
mark, which it has maintained since 2005-06. This is in contrast to the overall GDP growth which fell
to 6.8 per cent in 2008-09 from 9.3 per cent in 2007-08 ans presently (2012-13 end) hovering around
6 p.c. Thus the resilience of the services sector has greatly contributed to the resilience of the
economy.
Challenges
Given the myriad (i.e. different types of) activities in services, supporting its growth will
definitely require careful and differentiated strategies. The opportunities in this fast-growing,
employment-oriented, FDI attracting sector, with vast export-potential are striking. However, the
challenges are also many. One of the challenges in this area is to retain India’s competitiveness in
those sectors where it has already made a mark such as IT & ITeS and Telecommunications. Their
deeper and broader use in the domestic sectors would also have a dramatic potential to increase the
efficiency and productivity of other goods and services. The second challenge lies in making inroads
into some traditional areas such as tourism and shipping where other countries have already
established themselves, but where the potential for India is nevertheless very high. The third
challenge is in making forays into globally traded services in the niche areas for India, such as
financial services, health care, education, accountancy, and other business services where India has
a large domestic market and has also shown recent signs of making a dent in the international
market, but only a very small part of the full potential has been tapped. There are also challenges
related to collecting better data (see Lesson 1 Appendix) and developing a better coordinated
strategy to pull together all the dispersed information. Regulatory improvements will also be important
as many domestic regulations and market access barriers could come in the way of fully tapping this
growth-accelerating sector. Since there are diverse sectors within services, the issues and policies
cannot be separated into watertight compartments. Addressing these challenges and issues could
further strengthen the services sector which is the driving force for India to realize double-digit growth
potential, both overall and at state level, while providing more and better jobs to help achieve more
inclusive and balanced growth.
2.7 SUMMARY
In this lesson, we have studied about growth of services sector and its subsectors, along with
their performance. In the next lesson we shall discuss the changes in the public policy on two issues
(a) Competition Policy and (b) Consumer Protection Act.
 Services Sector in India

Contribution to Liberalisation Factors Substainability

Foreign Trade Measure and Underlying of Services led
Growth of Growth growth (Future
Exports
services sector Prospects)
Imports
Splintering
Trade Balance Well performing
Liberalisation Demand side Push Sub – sectors
Liberalisation
Technology Advances Outlook
Interdependence of
Industry and Agriculture Challenges

2.8 GLOSSARY
 Liberalisation- It is reduction of state controls.
 Splintering- With increasing specialization, industry tends to outsource activities this is called
splintering.
2.9 REFERENCES
 Ahluwalia, Montek S. (2011) Prospects and Policy Challenges in the Twelfth Plan, Economic
and Political Weekly, XLVI (21), May 21.
2.10 FURTHER READINGS
 Government of India (2010). Economic Survey. Various issues since 2010.
 Kapila Uma (Ed) (2017) Indian Economy since Independence. Academic Foundation, New
Delhi, 2016-17.
 Misra and Puri (2011). Indian Economy, Himalaya Publishing House.
2.11 MODEL QUESTIONS

 Comment upon the factors underlying the growth of services sector in India.

 How far the services led growth is sustainable in India?

 Write short notes on

 Contribution of Services sector to foreign trade in India.

 Liberalisation measures and growth of services in India.

 Well performing sub – sectors of services sector in India.

 ------------

Lesson-3

COMPETITION POLICY AND CONSUMER PROTECTION ACT

Structure
3.0 Objectives
3.1 Introduction
3.2 Growth of Monopolies in India
3.2.1 Monopolies Inquiry Commission Report 1965
3.2.2 Growth of Business Houses (1965 – 90)
3.3 Causes for Concentration of Economic Power
3.3.1 Government Policy
3.3.2. Inter Company Investment
3.3.3 Grabbing of Business Opportunities
3.3.4 Financial Institutions
3.3.5 Technological Integration and Diversification
3.3.6 Commercial Banks
3.4 Changes in Public Policy (MRTP)
3.4.1 MRTP Act, 1969
I Features
II Liberalisation of Act (1973, 1982, 1985, 1986)
3.4.2 Competition Act, 2002
I Competition Commission of India (CCI)
II Objectives
III MRTP Act (1969) Vs. Competition Act (2002)
3.4.3 Competition (Amendment) Bill, 2007
3.4.4 Competition Act : An Appraisal
3.5 Consumer Protection Act
3.5.1 Rights Provided
3.5.2 Important Features
3.5.3 Standards
3.6 Conclusion
3.7 Summary
3.8 Glossary
3.9 References
3.10 Further Readings
3.11 Model Questions
3.12 Answer to SAQ

3.13 Appendix

3.0 OBJECTIVES
 After going through this lesson, you shall be able to :

 explain the provisions MRTP Act 1969 and its diminishing relevance in pro-market reforms
era.

 discuss the competition policy of India

 delineate the features of Consumer Protection Act and amendments therein.

3.1 INTRODUCTION

After Independence, Government of India accepted the concept of a mixed economy for India
with clearly defined roles for both public and private sectors. One important aspect of the
development of the private sector since independence has been tremendous rise of a few large
enterprises commonly known as monopolies and monopoly capital. The ‘monopoly capital’ refers to
the existence of an economic situation in the capital market of a country where number of units-
whether giant corporation or business houses – acquire a dominant share in the corporate private
sector’s stock of industrial capital and existence and growth of monopoly capital. There is
considerable evidence of the growth of monopoly capital in India.

3.2. GROWTH OF MONOPOLIES IN INDIA

Under the Industrial Policy Resolutions of 1948 and 1956 as well as through licensing
procedures and guidelines, the Government sought to restrict the scope and the growth of the private
sector. Later it was observed that many of the large enterprises in the private sector operated under
conditions of virtual monopoly and oligopoly. Taking advantage of the absence of foreign competition
and sheltered markets, the large enterprises entered into combinations, eliminated internal
competition openly or secretly, got effective control of the markets for their products and thus
exploited their helpless consumers. Many of them managed to create artificial scarcities (by
restricting their production) and created the impression of excessive demand for their products. They
influenced government policies to their own advantage and secured favourable tax measures and
fiscal incentives for exports and foreign collaboration agreements. They were able to mobilize vast
financial resources from the market and the public sector financial institutions and banks. Naturally,
these private sector enterprises enjoyed considerable economic power and demonstrated the same
through their monopoly power and restrictive trade practices in the market.

3.2.1 Monopolies Inquiry Commission (MIC)

The Government appointed the Monopolies Inquiry Commission to enquire into monopoly
power and restrictive trade practices of the private sector which submitted its report in 1965.

The Monopolies Inquiry Commission was concerned with the two manifestations of economic
power, viz., monopolistic practices and restrictive practices. “One such manifestation is the
achievement by one or more units in an industry of such a dominant position that they are able to
control the market by regulating prices or output or eliminating competition (monopolistic practice).
Another is the adoption by producers and distributors, even though they do not enjoy such a
dominant position, of practices which restrain competition and thereby deprive the community of the
beneficent effects of competition (restrictive practice).
3.2.2 Growth of Business Houses (1965 – 90)
The Monopolies Inquiry Commission (1965) found that 75 business houses controlled 1,536
companies. A business house or business group was defined to comprise all such concerns which
were subject to the ultimate and decisive decision-making power of the controlling interest in the
group. The Industrial Licensing Policy Inquiry Committee (Subimal Dutt Committee) accepted the
concept of large industrial houses which “should include those business concerns over which a
common authority holds sway”. While the day-to-day affairs of the concerns are independently carried
on by those with whom the authority rests under proper legal sanction, the ultimate source regulating
overall policies can be traced to a common authority. [Report of the Industrial Licenses Policy Inquiry
Committee]. The Dutt committee listed 2001 larger industrial houses in 1963-64 each with total
assets of Rs. 35 crores. By taking advantage of liberalization i.e. industrial licensing, the large
business houses have proliferated in a number of industries. The growth of large industrial houses is
shown in Table 1.
Table 1 : Assets of 20 Top Industrial Houses
Assets (Rs. Crore)

1972 1981 1989-90 Compound

Annual Rate of
Growth (1972
to 1989-90)
Tata 642 1,840 8,531 15.5
Birla 581 1,692 8,473 16.0
Reliance - 271 3,600 33.3
Thapar 136 430 2,177 16.7
JK Singhania 121 520 2,139 17.3
Larsen & Toubro 79 220 1,682 18.5
Modi 58 242 1,399 19.3
Bajaj 63 215 1,391 18.8
Mafatlal 184 535 1,344 11.7
MA Chidambaram - - 1,273 10.5
Hindustan Lever 78 247 1,209 16.4
United Breweries 36 - 1,189 21.4
TVS lyengar 51 227 1,177 19.1
I.T.C. 75 - 965 15.2
Shri Ram 121 269 934 12.0
ACC 134 343 903 11.2
Oswal Agro - - 870 -
Mahindra & Mahindra 58 408 774 15.5
Essar - - 756 173.0
 Kirloskar 86 398 736 12.7
Total 2,511 7,857 41,522 16.9
Source : CMIE, Basic Statistics Relating to the Indian Economy, August, 1993.

Data given in Table 1 reveal that the total assets of top 20 industrial houses which were of the
order of Rs. 1,346 crores in 1963-64 increased to Rs. 2,511 crores in 1972. They further shot up to
Rs. 7,857 crores in 1981 and zoomed to Rs. 41,522 crores in 1989-90. The rate of growth of assets
of the top 20 houses during the period 1972 to 1989-90 works out to be 16.9 per cent per annum.

In 1989-90, Tatas were at the top with assets of the order of Rs. 8,531 crores, closely followed
by Birlas with assets of Rs. 8,473 crores. Among the top 20 business houses, the top five, viz., Birla,
Tata, Reliance, Singhania and Thapar, accounted for total assets of Rs. 24,930 crores in 1989-90
i.e., 60 per cent of the total assets of 20 business houses, while this proportion was 60.3 per cent in
1981. This was a high degree of concentration even among the top 20 business houses as also
among those who occupied the first five ranks. Reliance group showed a meteoric growth rate in its
assets from Rs. 271 crores in 1981 to Rs. 3,600 crores in 1989-90 an annual average compound
growth rate of 33.3 per cent. It improved its position to rank no. 3 among the top 20 business houses,
whereas it did not occupy any rank in 1972. It was at rank no.6 in 1981. Another business house M.A.
Chidambaram showed a growth of its assets from Rs. 44 crores in 1980 to Rs. 1,273 crores in 1989-
90, thus jumping from rank no. 47 in 1981 to rank no. 10 in 1989-90. With greater liberalization and
removal of MRTP and FERA restrictions, the business houses, specially the top 20, have shown very
high growth rates in their assets in recent years.

3.3 CAUSES FOR CONCENTRATION OF ECONOMIC POWER

In simple words concentration of economic power increases growth of monopolies. As the

size of the firm grows several economics of scale occur.

Economies of scale brought about largely by technological advances are responsible for the
growth of large industrial units. But the growth of big business houses was actually fostered by the
unique managing agency system under which powerful business families set up and managed a
series of concerns – Tata Sons, Birla Brothers, Shriram Associates, etc., were well- known managing
agencies at one time. Even after the system was legally abolished, the original business families
have continued to hold and manage a number of companies. Dutt and Sunderam (2011) present
following factors responsible for the concentration of economic power in India.

3.3.1 Government Policy: The greatest responsibility for the growth of large industrial
houses and concentration of economic power lies with the Government. As the Dutt Committee
pointed out, the Government never specified clearly to the licensing authority the objective of
preventing concentration of economic power of monopoly. A few industrial houses were able to take
multiple licenses from the same product. Thus system did not encourage the growth of new
enterprises outside the business groups. The MIC categorically concluded. “We are convinced that
the system of controls in the shape of industrial licensing however necessary from other points of
view, has restricted the freedom of entry into industry and so helped to produce concentration.”

Further, foreign collaborations also helped the strong and the entrenched industrialists vis-à-
vis the small industrialists.
 3.3.2 Inter Company Investment : An important cause of the growth of the large industrial
houses and concentration of economic power is the inter company investment. Economic
concentration may be in the same line of business (industry-wise concentration) or in non-competing
lines of business (inter- industry concentration). In both cases a large amount of resources come to
be controlled by a business group. The investor company acquires the status of a holding company
and other companies become its subsidiaries. Alongwith inter company investment interlocking of
directorship is also achieved so that the power of decision- making in a large number of companies is
monopolised by a few big business magnates, all closely related to one another.

3.3.3 Grabbing of Business Opportunities : Under the Second Five Year Plan, the
industrial houses which were already in the field were quick to seize the abundant opportunities for
their growth and expansion. They had the necessary knowledge, finance and personnel. They were
able to take advantage of the financial facilities and tax incentives provided by the Government. They
created monopolies and thus excluded new entrants into the industrial sector. They bribed licensing
authorities to get monopoly control of their products. By manipulating the loopholes of the Company
Law they were able to multiply the capital stock of the companies through issues of bonus shares.

3.3.4. Financial Institutions in Public Sector : An important factor for growing concentration
of wealth and economic power is the nature of the working of public sector financial institutions. The
Dutt Committee showed that about 56 per cent of the total assistance provided by the IFCL, the IDBI,
the ICICI, and other financial institutions had gone to the large industrial houses.

3.3.5. Technological Integration and Diversification : Proliferation of industrial units in

different industrial categories is commonly referred to as diversification. On the other hand, combining
the various stages of production under common ownership and controls referred to as technological
integration. Most of the big industrial houses have made use of both techniques for increasing their
monopoly power.

3.3.6. Commercial Banks : Prior to bank nationalization in 1969, the banking system was
controlled by large industrial houses. The bank deposits collected from the general public were used
almost exclusively for financing of industries owned and controlled by large industrial houses. It is
universally accepted that the commercial banks played a significant roles in the creation of industrial
empires. Even after bank nationalization, the situation has not changed very much.

According to the MIC the Birlas controlled 66 per cent of the production of cars, 75 per cent of
cotton textile machinery (looms), 27 per cent of electric fans, 24 per cent of railway wagons and 16
per cent of room air conditioners. Similarly, Tatas had their new widespread control in steel ingots,
special tools, industrial machinery, oils and soaps etc. on the basis of market share.

3.4 CHANGES IN PUBLIC POLICY

(The MRTP ACT, 1969, AND COMPETITION ACT, 2002 AND AMENDED ACT)

Mahalanobis Committee in 1964 and the Monopolies Enquiry Commission in 1965 revealed
the tendencies of increasing concentration in the industrial sector of the economy. To curb these
tendencies and control the monopolistic and restrictive trade practices of the large business houses,
the Government of India adopted the Monopolies and Restrictive Trade Practices (MRTP) Act of
1969 and the MRTP Commission was set up in 1970. In this section we’ll study about the MRTP Act
1969 i.e. its origin, its features, liberalisation doses etc. The next part will highlight its new shape that
is known as Competition Act which is less stringent in nature and is suitalbe for the changing
conditions of post reforms era.

3.4.1 Stage I : MRTP ACT, 1969

The preamble to the Act described it as follows:

An Act to provide that the operation of the economic system does not result in the concentration of
economic power to the common detriment for the control of monopolies, for the prohibition of
monopolistic and restrictive trade practices and matters connected therewith or incidental thereto.

I. Features of MRTP ACT

Following discussion would bringforth the functioning and purview of the MRTP Act of 1969 :

(a) Inter-Connected Dominant Undertaking : The MRTP Act covered two types of
undertakings, viz., national monopolies and product monopolies. National monopolies were covered
by section 20(a) of the Act and were either ‘single large undertakings’ or ‘ groups of inter-connected
undertakings’ (i.e. large houses) which had assets of at least Rs. 100 crores (prior to 1985, this limit
was Rs. 20 crores). Product monopolies covered under Section 20 (b) and called ‘dominant
undertakings’ were those which controlled at least one-fourth of production or market of a product
and had assets of at least Rs. 3 crore (earlier on, this limit was Rs. 1 crore). By the end of March
1990, 1,854 undertakings were registered under the MRTP Act. of these 1,787 belonged to large
industrial houses and the remaining 67 were dominant undertakings. The New Industrial Policy, 1991,
scrapped the assets limit for MRTP companies.

(b) Monopolistic, Restrictive and Unfair Trade Practices : According to the MRTP Act, a
restrictive trade practice (RTP) means a trade practice which has, or may have, the effect of
preventing, distorting or restricting competition in any manner. A monopolistic trade practice (MTP) is
a trade practice which has, or is likely to have, the effect of (i) maintaining prices at an unreasonable
level, or (ii) unreasonably preventing or lessening competition, or (iii) limiting technical development
or capital investment to the common detriment, or (iv) allowing the quality to deteriorate. Prior to
1984, the MRTP Act was restricted to monopolistic and restrictive trade practices only. In 1984 the
Act was extended to include unfair trade practices also.

(c) Purview of the MRTP Act : A large number of types of agreements were specified in the
MRTP Act which fell under its purview. Each one of these was required to be duly registered with the
Registrar of Restrictive Trade Practices including the names of parties to the agreement. Registered
undertakings were subject to the following control on their industrial activities: (a) if it was proposed to
expand substantially the activities of the undertaking by issuing fresh capital or by installation of new
machinery or in any manner, notice to the Central Government was required to be given and approval
taken (Section 21); (b) if it was proposed to establish a new undertaking, the prior permission of the
Central Government was required to be obtained (Section 22); and (c) if it was proposed to acquire or
merge or amalgamate with another undertaking, the sanction of the Central Government was
required to be taken (Section 23). The responsibility to see that there was so concentration of
economic power to the common detriment was that of the government.

II Impact of Liberalisation on the Act

With a view to expanding industrial production, the government considerably liberalized the
operations of the MRTP Act from time to time. The result was that the large business houses were
given the green signal to enter a number of industrial fields which were formerly closed for them.
Even the illegally set up industrial capacity was regularized. Some of the important liberalization
measures announced over time were as follows:

1. The 1973 industrial policy statement opened up a large number of industries to the large
houses. These included not only the core industries but also industries having direct linkages with
such core industries and industries with a long term export potential. Initially there were 19 such
industries (listed in Appendix I) and gradually their number rose to 35.

2. With a view to providing fillip to production in industries of high national priority and/or
those mean texclusively for export, the government introduced section 22-A in the MRTP Act
whereby it could notify industries or services to which Section 21 and 22 of the Act would not apply.
(a) In October 1982, all 100 per cent export- oriented industries established in the Free Trade Zone
were exempted from Sections 21 and 22 of the Act. (b) In May 1983, the government notified that
companies registered under the MRTP Act were eligible to set up, without the approval of the
government, new capacities in industries of high national priority or industries with import substitution
potential or those using sophisticated technology. However, the companies were required to fulfil
certain conditions to avail the exemptions.

3. The government identified some industries which were specially important from export
angle. These industries were allowed 5 per cent automatic growth per annum, up to a limit of 25 per
cent in a plan period over and above the normal permissible limit for 25 per cent excess production
over the authorized capacity. Large houses did not require separate approval under the MRTP Act for
such automatic growth.

4. In a major liberalization of the industrial licensing policy announced on December 24,

1985 the government permitted the unrestricted entry of large industrial houses and companies
governed by the Foreign Exchange Regulation Act (FERA) into another 21 high- technology items of
manufacture. With this permission, the large industrial houses falling within the purview of the MRTP
Act and FERA companies were allowed to freely take up the manufacture of 83 items (previously the
number of items was 60).

5. Under the provisions of the sick Industrial companies (Special Provisions) Bill 1985, the
government removed sick industrial companies from the purview of the MRTP Act for purposes of
modernization, expansion, amalgamation or merger.

6. For promoting the development of backward areas, the government extended the
scheme of delicensing in March 1986 to MRTP/FERA companies in respect of 20 industries in
Appendix-I for location in centrally declared backward areas. The scheme was later extended to 49
industries for location in any centrally declared backward area and to 23 non- Appendix–I industries
for location in category ‘A’ backward districts. The conditions permitting MRTP and FERA companies
to establish non-Appendix I industries were also liberalized.

7. The government announced a new scheme on April 7, 1988. Effective from April 1, 1988,
as per this scheme, the industrial licenses/registrations with technical authorities were to be
automatically re-endorsed at the highest level of production actually achieved by the industrial
undertaking in any of the financial years between April 1, 1988, and March 31, 1990. This was a
major concession as it implied automatic re-endorsement of capacity at the highest level of
production achieved during 1988 and 1990.

8. An important relaxation came in 1985 when the government raised the limit of assets for
the purpose of MRTP Act from Rs. 20 Crore of Rs. 100 crore. After the Government of India decided
to liberalise economic policy in 1991, provisions in respect of concentration of economic power were
deleted by omitting Part A of Chapter III of MRTP Act with effect from September 27, 1991. After
omission of these powers, MRTP Commission became a toothless tiger as it was now required to
look after cases relating to unfair trade practices and restrictive trade practices only.

3.4.2. STAGE II: COMPETITION ACT, 2002

Since the adoption of the economic reforms programme in 1991, corporates have been
pressing for the scrapping of the MRTP Act. The argument is that the MRTP Act has lost its
relevance in the new liberalized and global competitive scenario. In fact, it is said that only large
companies can survive in the new competitive markets and therefore ‘size’ should not be a constraint.
Thus, there is a need to shift our focus from curbing monopolies to promoting competition. In view of
this, the government appointed an expert committee headed by SVS Raghavan to examine the whole
issue. The Raghavan Committee submitted its Report to the Government on May 22, 2000 wherein it
proposed the adoption of a new competition law and doing away with the MRTP Act. Accordingly, the
government decided to enact a law on competition. Consequently, the Competition Bill, 2001 was
introduced in Parliament and was passed in December 2002. The Act is called competition Act, 2002.
The Act was amended in September 2007.

I. Formation of Competition Commission of India. The Act provides for the establishment of
the competition commission of India (CCI). According to Section 18, it shall be the duty of the
Commission to eliminate practices having adverse effects on competition, to promote and sustain
competition in markets in India, to protect the interests of consumers and to ensure freedom of trade
carried on by other participants in market in India. Some protagonists of private sector have argued
that there is no requirement of CCI because all that is required is removal of licensing requirements
and knocking down of entry barriers. However, the fact of the matter is that the market does not
always guarantee competition. There will always be some unfair and restrictive business practices.
Besides, mergers and acquisitions would need to be scrutinised. It is on account of this reason that
most countries have competition or free trade commissions. This explains the rationale of CCI in
India.

II. Objectives of the Competition Act, 2002

Competition Act, 2002 is designed for the following purposes :

(i) Prohibition of anti-competitive agreements;

 (ii) Prohibition of abuse of dominant position, and

(iii) Regulation of combinations.

1. Prohibition of Anti-Competitive Agreements : Section 3 of the Act makes provision for

prohibition of anti competitive agreements. According to Section 3 (I) of the Act, “no enterprise or
association of enterprises or person or association of persons shall enter into any agreement in
respect of production, supply, distribution, storage equitation or control of goods or provision of
services, which causes or is likely to cause an appreciable adverse effect on competition within
India.” Section 3(2) states that any agreement entered into in contravention of the provisions
containing in Section 3(1) shall be void.

2. Prohibition of Abuse of Dominant Position : Section 4(1) of the Act states that “no
enterprise shall abuse its dominant position”. It may be noted that ‘dominant position’ itself is not
prohibited. What is prohibited is its misuse.

‘Dominant position’ means a position of strength, enjoyed by an enterprise, in the relevant

market, in India, which enables it to : (i) operate independently of competitive forces prevailing in the
relevant market; or (ii) affect its competitors or consumers or the relevant market in its favour.

3. Regulation of Combinations : Section 5 of the Act defines combination while Section 6

is concerned with regulation of combinations. According to Section 5, the acquisition of one or more
enterprises by one or more persons or merger or amalgamation of enterprises shall be treated as
‘combination’ of such enterprises and persons or enterprises in the following cases : (a) acquisition by
large enterprises; (b) acquisition by group; (c) acquisition of enterprises having similar
goods/services; (d) acquiring enterprises having similar goods/ services by a group; (e) merger of
enterprises; and (f) merger in group company.

Section 6 of the Act relates to ‘regulations of combinations’. According to Section 6 (1), no

person or enterprise shall enter into a combination which causes or likely to cause an appreciable
adverse effect on companies within the relevant market in India and such a combination shall be void.

The definition and heading of the section itself means that it is ‘regulation of combination’.
Thus, combination itself, is not prohibited. It will be held void only if it adversely affects competition.

III. Competition Act, 2002 vs. MRTP Act 1969

While the focus of MRTP Act, 1969 was on controlling the concentration of economic power,
the focus of competition Act 2002 is on ensuring free and for competition in the markets. The spirit
behind the Competition Act is that big is no more bad, rather hurting competition and consumer
interest is. For instance S. Chakravarthy (a member of the Raghavan Committee) has pointed out
that size is no longer the issue. It could become only when consumer interest is compromised.
Moreover, while MRTP Act, 1969 frowned upon dominance, Competition Act, 2002 frowns upon
abuse of dominance. Thus ‘dominance’ is not prohibited in competition Act 2002. Only ‘abuse of
dominance’ is prohibited. The main points of comparison between the MRTP Act, 1969 and the
Competition Act, 2002 are given bellow in the form of table (cited from Dutt & Sundaram, 2011).
 Fostering Competition: Competition Act Versus MRTP Act
MRTP Act, 1969 Competition Act, 2002
1. Based on the pre-reforms scenario 1. Based on the post-reforms scenario
2. Based on size as a factor 2. Based on structure as a factor
3. Competition offences implicit or not 3. Competition offences explicit and defined
defined
4. Complex in arrangement and language 4. Simple in arrangement and language and
easily comprehensible
5. 14 per se offences negating the principles 5. 4 per se offences, all the rest subjected to
of natural justice rule of reason
6. Frowns upon dominance 6. Frowns upon abuse of dominance
7. Registration of agreements compulsory 7. No requirement of registration of
agreements
8. No regulation on combinations 8. Combinations regulated beyond a high
threshold limit
9. CCI appointed by the government 9. CCI selected by a collegium
10. No competition advocacy role for the CCI 10. CCI has competition advocacy role
11. No penalties for offences 11. Penalties for offences
12. Reactive and rigid 12. Proactive and flexible
13. Unfair trade practices covered 13. Unfair trade practices omitted
14. Very little administrative and financial 14. Relatively more autonomy for the CCI
autonomy for CCI

Source : S. Chakravarthy, “Competition Law : Not a Foe”, The Economic Times, August 21, 2001, p. 4. C.f.
Misra & Puri (2011).
Hence, a close perusal of the law reveals that there is merely a change of nomenclature.
Instead of Monopolies and Restrictive Trade Practices, there is substitution of “dominant position”
and “appreciable adverse effect on competition”. Whereas the MRTP Act precisely defined the
Monopolies and Restrictive Trade Practices, the Competition Law has listed factors which result in
dominant position, but left the determination of extent of dominant position extremely vague. Whether
more than 75 per cent control of the market share as conceived by MRTP Commission would be
considered a dominant position or a relatively small share (say 60 per cent) will be considered
monopolistic has been left totally undefined. This may result in different benches of the Competition
commission to set different norms. Such an eventuality will create hurdles in the working of the CCI.

Moreover, tie-in arrangement, exclusive dealing contracts, resale price maintenance, creating
barriers to new entrants, foreclosure, creating situations of monopoly, duopoly or oligopoly were all
part of the lexicon of the MRTP. Dutt and Sundaram (2011) wonder at the need to scrap an
established institution like MRTP Commission and replace it by another under a new name, the
Competition Commission of India with precisely same functions, duties and powers.

3.4.3. Competition (Amendment) Bill, 2007

The Competition (Amendment) Bill 2007 was introduced and passed in August- September
2007. The bill, piloted by Corporate Affairs Minister P.C. Gupta, said the Competition Commission of
India (CCI) would eventually replace the Monopolies and Restrictive Trade Practices Commission
(MRTPC). MRTPC would continue to deal with pending cases even two years after the establishment
of CCI and would be dissolved thereafter. However, MRTPC would not entertain any new cases after
the CCI is constituted. The main features of Competition (Amendment) Bill, 2007 are as follows :

The Supreme Court had held that if an expert body is to be created by the government, it
might be appropriate to create two separate bodies – one with expertise for advisory and regulatory
functions (CCI) and the other for adjudicatory functions (Competition Appellate Tribunal or CAT).
Accordingly, the Competition (Amendment) Bill, 2007 provides for constitution of both CCI and CAT.
The CCI will be an expert body, which would function as a market regulator to prevent and regulate
anti-competitive practices in the country. It would also have advisory and advocacy functions in its
role as regulator. It would have four members, with the chairman being the Chief Justice of India or
his nominee. The CCI will exercise its powers through various benches, including those designated
for mergers. CAT would be a three- member quasi-judicial body. It would be headed by a person who
is or has been a justice of the Supreme Court or the Chief Justice of a High Court and would hear
appeals against any direction issued by the Commission.

The new law has sought to make mergers and acquisitions (M & A) deals more transparent.
Companies will have to inform the CCI about the deal within 30 days. Companies could be penalized
if they fail to do so.

If any agreement between companies results in a cartel, they might have to pay hefty financial
penalties upto thrice the value of profits earned. This has been done to prevent corporations from
building dominant market positions artificially.

The new law seeks to empower the CCI to impose penalty of upto Rs. 25 crores or upto three-
year imprisonment or both in cases of continued contravention of its orders if the Chief Metropolitan
Magistrate deems fit.

While earlier it was voluntary for an enterprise proposing to enter into a combination to
intimate the Competition Commission, the new law makes such intimation of the combination to the
Commission mandatory. In fact, such a coupling shall not take effect until 210 days from the date of
notification or approval from the Commission, whichever is earlier.

3.4.4. Competition Act: An Appraisal

1. The new law focuses on the provision of a domestic nexus (a nexus with assets and
operations in India) in connection with the limits applicable to acquisitions in which a foreign entity
and an Indian entity are involved. According to critics, this would narrow down the scope for an
acquisition being covered under ‘combinations’ to be regulated by the Commission. Thus, if the
acquirer is a foreign company without any Indian presence, the Competition Act trigger will not apply
due to the provision of the Indian nexus.

2. As stated above, coupling shall not take effect until 210 days from the date of notification
or approval from the Commission, whichever is earlier. This is likely to result in a long gestation
period of about seven to eight months from the date of approval of a proposal. This long gestation
period will add a significant element of uncertainty and can be a drag on ‘big-ticket’ M&A activities in
India. According to Dalal, the uncertainty has several implications, including the following :

* Perception among customers.

 * Uncertainty as regards the ‘identity’ of the enterprise could create reluctance among
customers who could choose to shift to a more ‘stable’ competitor.

* Inability to make strategic and operational decisions. Strategic and operational

business issues could remain in ‘limbo’.

* Human resources : In any acquisition or merger, the human resources element is

crucial. This has dimensions relating to alignment to title, roles and responsibilities. A
long period of uncertainty could seriously dent morale and heighten attrition.

* Enterprise value(s) : As a result of the uncertainty, including the above factors, the
market value of both enterprises could be severely dented due to the long period of
uncertainty.

Threshold Limits under Competition (Amendment) Bill 2007

 The merged entity will inform the Commission if its turnover is above Rs. 1,000 crore.
 In case a foreign company buys a domestic one, the turnover and asset threshold limits of
the merged entity are fixed at $1.5 billion and $500 million respectively.
 If the merged entity’s turnover is less than the threshold limit, it would still have to inform
the Commission if the group turnover is above $6 billion or has an asset value of $2 billion.
Source : Misra & Puri, 2011

Self Assessment Question

Q. Mention the need for competition policy, year of its inception and amendments there after.
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________

All the Surveys given above indicate that the competitive spirit, which was unleashed after the
introduction of economic reforms, did not gather enough strength so as to curb monopolistic
tendencies in the Indian market.

However, a word of caution may be put here. Market forces, however, cannot be allowed to
have an unbridled sway as to undermine the economic and social welfare of the people. This
underlines the fact that promoting sustaining competition is not an end itself but only a means to
achieve the ultimate objective of protecting the interests of consumers and enabling entrepreneurs to
operate freely in their trade and business but they have to go by the coordinal principles of legitimacy,
economic and social justice so as to benefit the weaker sections of society.

3.5 CONSUMER PROTECTION ACT (COPRA) : A NOTE

Till the late 1970s, no systematic movement was there in India for protecting the interest of
the consumers. But now it is understood that one of the true indicators of a country’s development
and the progressiveness of civil society is consumer awareness and protection. With the rapidly
increasing number and variety of goods, the sleek mass marketing practices, the complexity of
production processes and distribution systems, personal interaction between buyers and sellers has
been drastically reduced. In the circumstances, consumer protection becomes necessary.

3.5.1 Rights Provided under COPRA

India enacted the Consumer Protection Act in December 1986. The Act applies to all goods
and services unless specifically exempted and covers the private, public and cooperative sectors and
provides for speedy and inexpensive adjudication. The rights provided under the Act are :

 The right to be protected against marketing of goods and services which are hazardous
to life and property
 The right to be informed about the quality, quantity, potency, purity, standard and price of
goods and services, as the case may be, to protect the consumer against unfair trade
practices.
 The right to be assured of access to a variety of goods and services at competitive prices.
 The right to be heard and assured that consumer interest will receive due consideration
at appropriate fora.
 The right to seek redressal against unfair or restrictive trade practices or unscrupulous
exploitation of consumers.
 The right to consumer education.
3.5.2 Major Features

Important features of the COPRA are mentioned below :

Under the Consumer Protection Act, 1986 a three-tier, simple, quasi-judicial machinery has
been established at the national, state, and district levels for hearing cases raised by consumers. The
Act was amended in 1991 and again in 1993. A comprehensive amendment was last made in 2002
for making the Act effective, functional and purposeful. The amended Act, inter alia, provides for the
attachment and subsequent sale of the property of a person not complying with an order.

There are serious shortfalls in achieving consumer welfare because of the deficiencies in
quality infrastructure in the country. First, there is a regulatory deficit in many products and services
which impact on the health, safety and environment of the consumers and mandatory standards have
not been prescribed for many products.

At present, the Quality Council of India (QCI) is the main accreditation body for conformity
assessment bodies taking up product or system certification or for inspection bodies, and the National
Accreditation Board for Laboratories performs the same function for laboratories. However, there is
no compulsion on the conformity assessment bodies, inspection bodies or laboratories to obtain
accreditation, thus creating a lack of certainty about the existence of quality products, systems,
inspections and laboratories.

There is absence of consumer demand for quality goods and services primarily because of
lack of awareness among them regarding quality issues.

3.5.3 Standards
 Standards are the essential building block for quality. They play a key role in consumer
protection. Standards could be on technical requirements (specifications), standard terminology
(glossary of terms), good practices (codes of practice) or test methods or management system
standards. Developed countries generally rely on management system standards like ISO 9001
(Quality Management System), ISO 14001 (Environmental Management Systems) and hazard
analysis and critical control points (HACCP) as an indicator of the ability of an organisation to meet
quality needs and address environmental concerns. These standards are set generally by
governmental or inter-governmental bodies but there are some private initiatives as well, which are
widely used such as OHSAS 18000 (Occupational Health and Safety), SA 8000 (Social
Accountability) and WRAP (Worldwide Responsible Apparel Production).

The Bureau of Indian Standards (BIS), set up under the BIS Act, 1986 functions as the
National Standards Body.

3.6 CONCLUSION

A competitive environment is needed to stimulate private investment. Studies have suggested

that competition enhances productivity at industry level, generates more employment and lowers
consumer prices. A pro-competitive policy environment has been found to be positively associated
with long-term growth. To enhance competition in the domestic markets and to generate/promote a
culture of competition in the country is part of the broader agenda on reforms. Competition policy is a
critical component of any overall economic policy framework. It also promotes creation of a business
environment, which improves efficiency, leads to efficient resource allocation and consumer welfare,
and in which abuse of market power is prevented/curbed. During the mid-term appraisal of the
Tenth Plan, it was recognized that there is an urgent need for articulating a National Competition Policy
(NCP) in India. The Planning Commission, in the context of the formulation of the Eleventh Plan,
constituted a Working Group on Competition Policy. The Competition Act came into the being in 2002
which was later ammended in 2007. Parallely to safeguard the interests of the consumers COPR Act was
framed in 1986.

Deceptive practices, including misleading advertisements need to be dealt with effectively.

Besides, there would be a gap in legislation to be caused by the proposed winding up of the
Monopolies and Restrictive Trade Practice Commission (MRTPC) with respect to unfair trade
practices. The gap can be filled in by establishing a National Consumer Protection Authority through
enactment of a National Consumer Protection Authority Act, says the Eleventh Plan document.

3.7 SUMMARY
In this lesson we have read about the changes that have taken place in the public policy on
the issues of growth of monopolies i.e. MRTP Act 1969 & Competition Act 2002 and Consumer
Protection Act 1986.

Monopolies in India and Policy

Growth of Monopolies Changes in Public Policy

(1965-90)
Causes for Concentration

of Eco. Power (1965-90) MRTP Competition Consumer

Act Act Protection
1969 2002 Act

Amendment
2007
3.8 GLOSSARY
 FDI- It is an investment in the form of controlling ownership in a business in one country by an
entity based in other country.
 Technology Integration- It is use of technology resources ─ computers, smartphones, mobiles
in the production process.
3.9 REFERENCES

 Chakravorty, S. (2001). “Competition Law not a Foe”. The Economic Times. Aug 21, 2001.
C.F. Misra & Puri (2001). Indian Economy.
 Sandesh J.C. (1994). “Restrictive Trade Practices in India. 1961-91 : Experience of Control
Agenda for Further Work”. Economic and Political Weekly 29 (32). p 2081-94.
 Misra and Puri (2011). Indian Economy : Since independence. Himalaya Publication.
 Singh J. (2000). Monopolistic Trade Practices and Concentration of Economic Power : Some
Conceptual Problems in MRTP Act. Economic and Political Weakly. 29 (32). p 2081-94.
 Datt and Sundaram (2011). Indian Economy. SChand Publications Pvt. Ltd.
3.10 FURTHER READINGS

 Centre for Monitoring Indian Economy (CMIE). Basic Statistics Relating to the Indian
Economy, August 1993.
 Kapila Uma (Ed) (2017). Indian Economy since Independence. Academic Foundation, New
Delhi.
3.11 MODEL QUESTIONS

 Comment upon the growth of monopolies in India

 Critically appraise the Competition Policy of India.

 Write short note on

 MRTP Act 1969 Vs Competition Act 2002

 Competition Act 2002

 Consumer Protection Act

3.12 ANSWER TO SAQ

In the absence of any policy check on the growth of monopolies and unfair policies and
introduction of privatization & Liberalization as economic reforms in 1991, Competition Policy was
started to check the exploitation of weaker parties. It was introduced in the year 2002 and was later
amended in the year 2007.

3.13 APPENDIX

Competition Policy and Competition Law

The Government of India appointed a committee on Competition Policy and Law under the
chairmanship of Mr. S V S Raghavan in October 1999 for shifting the focus of the law from curbing
monopolies to promoting competition in line with the international environment. The Committee
submitted its Report to the Prime Minister on May 22, 2000.

The Committee recommended enactment of Indian Competition Act, along with the setting up
of a Competition Commission of India (CCI), repeal of the Monopolies and Restrictive Trade
Practices (MRTP) Act, 1969, and the winding up of the MRTP Commission.

Competition Act 2002 : Main Provisions

Following the Report of the Raghavan Committee, the Government of India passed the
Competition Act in December 2002 which was enforced as an All-India Legislation. The main
provisions of the Act are :

1. No enterprise or association of enterprises or person or association of persons shall enter

into any agreement in respect of production, supply, distribution, storage, acquisition of goods and
services, which causes or is likely to cause an appreciable adverse effect on competition within India.
Any agreement in violation of the above shall be void.
However, this shall not apply to any agreement entered into by way of joint venture if such
agreement increases efficiency in production, supply, distribution, storage, acquisition or control of
goods or provision of services.
2. Any agreement made at any level of the production chain of goods and services will be
void if it makes :
a. tie-in arrangement;
b. exclusive supply agreement;
c. exclusive distribution agreement;
d. refusal to deal;
e. resale price maintenance.
No enterprise shall abuse its dominant position by : (a) directly or indirectly imposing unfair or
discriminatory price in the purchase or sale of goods and services; or by selling goods at a predatory
price.

Dominant position, according to the Act, means a position of strength enjoyed by an

enterprise in the relevant market which enables it to operate independently of the competitive forces,
thus adversely affecting its competitors or consumers.

Predatory price means the sale of goods or provision of services, at a price which is below
cost.

No enterprise or enterprises shall enter into a combination which causes or is likely to cause
an appreciable adverse effect on competition in the relevant market in India and such a combination
will be held void.

The combination would include acquisition of one or more enterprises or merger or

amalgamation of enterprises.

The maximum limit of assets above which a combination is declared void shall be :

(a) either in India, the assets of the value of more than Rs. 1,000 crores or turnover of
more than Rs. 3,000 crores, or

(b) in India or outside India, in aggregate, the assets of the value of more than $ 500
million or turnover of more than $ 1,500 million.

However, the provision of this section shall not apply to share subscription or financing facility
or any acquisition, by a public financial institution, foreign institutional investor, bank or venture capital
fund, pursuant to any covenant of a loan or agreement or investment agreement.

For the purposes of this Act, a Commission to be called “Competition Commission of India”
(CCI) shall be constituted which shall consist of a Chairperson and not less than two and not more
than 10 other Members to be appointed by the Government. The Chairperson and every other
member shall be a person who is qualified to be a judge of a High Court or has special knowledge or
professional experience of not less 15 years in international trade, economics, business, commerce,
finance, accountancy, management, industry, public affairs or administration. The Chairperson or
members shall hold office as such for a term of 5 years, and shall be eligible for re-appointment.

The Chairperson and other members shall not, for a period of one year on which they cease
to hold office, accept any employment in, or connected with the management or administration of,
any enterprise which has been a party to a proceeding before the Commission under this Act.

Duties powers and Functions of CCI

It shall be the duty of the Commission to be eliminate practices having adverse effect on
completion, (ii) promote and sustain competition, (iii) product to interests of consumers, and (iv)
ensure freedom of the carried on by other participants, in markets in India.

In order to determine whether an agreement has a appreciable adverse effect on competition,

the conversion will give due regard to the following factors.

(i) Creation of barriers to new entrant in the market.

(ii) Driving existing competitors out of the market.
(iii) Foreclosure of competition by hindering entry in the market.
(iv) Accrual of benefits of consumers.
(v) Improvement in production or distribution of goods or provision of services; or
 (vi) Promotion of technical, scientific and Economic development by means of productions
of goods a provision of services.
To inquire whether the enterprise enjoys domination position, the Commission shall give due
regard to the following :

(i) market share of the enterprise;

(ii) size and resources of the enterprise;
(iii) size and importance of the competitors;
(iv) economic power of the enterprise including commercial advantage over competitors;
(v) vertical integration of the enterprises or sale or service network of such enterprises;
(vi) dependence of consumers on the enterprise.
(vii) monopoly of dominant position whether acquired as a result of any statute or by virtue
of being a government company or a public sector undertaking or otherwise;
(viii) entry barriers;
(ix) countervailing buying power;
(x) market structure and size of the market;
(xi) Social obligations and social cost;
(xii) relative advantage, by way of the contribution of economic development, by the
enterprise enjoying a dominant position having or likely to have appreciable effect on
competition.
While determining ‘relevant market’, the Commission shall give due regard to the “relevant
geography” market” and “relevant product market.

The Competition Commission may institute an inquiry on : (a) the receipt of a complaint, (b)
on a reference by the Central Government or a State Government or a statutory authority and (c)
depending upon its own knowledge or information.

In case of matters referred to or initiated upon its own information by the Commission, if it
finds that there exists a prima facie case, it shall order an investigation into the case.

The Commission may constitute one or more benches to be called “mergers Benches” to
exclusively deal with cases referred to it.

The Commission may pass all or any of the following orders after inquiry :
(a) to discontinue an impugned agreement or to discontinue abuse of dominant position;
(b) to impose such penalty, as it may deem fit, which shall not be more than 10 per cent of
the average turnover for the last three preceding years, on enterprises which are
parties to such agreements or abuse;
(c) In case of a cartel, a penalty equivalent to three times of the amount of profits made
out of such agreements by the cartel, 10 per cent of the average turnover of cartel for
the last preceding three financial years, whichever is higher;
(d) To award compensation to affected parties.
 The Commission may order direct division of an enterprise enjoying dominant position to
ensure that such enterprise does not abuse its dominant position.
If the Commission does not pass orders or issue directions on a case within 90 days from the
initiation of an inquiry, the combination shall be deemed to have been approved by the Commission.
Even in case of agreement entered into outside India, the commission shall have the power to
inquire into it if such agreement has or is likely to have an appreciable adverse effect on competition
in the relevant market in India.
The Commission shall not be bound by the procedure laid down by the Code of Civil
Procedure, 1908, but shall be guided by the principles of natural justice and thus have the power to
lay down its own procedure.
Every order passed by the Commission shall be enforced by the commission in the same
manner as a decree or order made by a High Court or a principal civil court.

If any person contravenes, without any reasonable ground, any order of the Commission or
fails to pay the penalty imposed under this Act, he shall be liable to be detained in civil prison for a
term which may extend to one year and shall also be liable to a penalty not exceeding Rs. 10 lakhs.

If any person, being a party to a combination makes a false statement, he shall be liable to a
penalty which shall not be less than Rs. 50 lakhs, but which may extend to Rs. 1 crore.

Relation with Central Government

The opinion of the Commission on a reference made by a Central Government shall not be
binding on the Central Government in formulating competition policy.

The Central Government may, by notification and for reasons to be specified therein,
supersede the Commission for such period, not exceeding six months.

As a consequence of the passing of the Competition Act (2002), the Monopolies and
Restrictive Trade Practices Act, 1969, stands repealed and the Monopolies and Restrictive Trade
Practices Commission stands dissolved.

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 Lesson-4

INDIAN FINANCIAL SYSTEM

Structure

4.1 Objectives

4.2 Introduction

4.3 Meaning of financial system

4.4 Indian Financial System and its Constituents

4.5 Financial Sector development

4.6 Conclusion

4.7 Summary

4.8 Glossary

4.9 Further Readings

4.10 Model Questions

This lesson deals with the introduction to financial system by discussing its functions and
constituents. It also explains about the Inter-relationship between Financial System and Industrial
Efficiency Development Indicators of Financial System. Last part of the lesson deals with the financial
development ratios.

4.1 OBJECTIVES
 After going through this lesson, you should be able to:

 explain the concept of financial system with reference to India

 describe the functions and constituents of financial system.
 elaborate the inter-relationship between Indian Financial System and Industrial Development.
4.2 INTRODUCTION

Since every individual economic unit has different income and expenditure pattern. These
patterns do not match at point of time. Some may need money at one point of time and other
individual might have excess funds availability at the same time, Now if they are brought together,
they both be mutually benefitted. Bringing together the deficit economic unit and surplus economic
unit is done by financial sector of the country. It helps in bridging the gap between the two. It
reallocates financial resources between deficit and surplus entities. It provides framework for
management of cash flow situations of different economic units like individuals, corporate and
government agencies among others.

However, with little public information, any surplus economic unit (here it is individuals/
corporate/ governments) may not be able to evaluate investment decisions of the deficit economic
unit (companies/government/individuals) and so may refrain themselves from lending money to them.
This is where financial intermediaries (a part of financial system) like banks help in. They apprise and
monitor corporate/government/individual investment decisions and act as middle-men between
savers and investors. Even they assure the savers with regard to their finances by taking onus of
default risk with themselves.

A financial system is a system that aims at establishing and providing a regular, smooth,
efficient and cost effective linkage between surplus and deficit entities. Financial system makes it
easier to trade. People trade because they differ in what they have and in what they want. Trade may
be:
 Trade in lending (giving up purchasing power now in exchange for purchasing power in the
future),
 Trade in risk (reducing economic burden of risks through insurance and forward transactions,
for instance, if one economic unit wants to deploy its surplus fund for a short period of time
and another for a longer period, the financial sector devises mechanisms to assume certain
risks and transform the maturity of the short-term surplus of one economic unit and meet the
long-term funding needs of the other), and
 Trade in goods. Trade benefits everyone. An efficient financial system would devise a
framework which would help in mobilization of savings by efficient, effective and equitable
allocation of investments, which in turn would set the pace of progress of an economy as a
whole.
4.3 MEANING OF FINANCIAL SYSTEM AND ITS SIGNIFICANCE
Financial system is one of the vital institutional and functional vehicles for economic
transformation. To define, “financial system" implies a set of complex and closely connected or
interlinked institutions, agents, practices, markets, transactions, claims, and liabilities in the
economy.
 Definitions
According to Christy, the objective of the financial system is to “supply funds to various sectors and
activities of the economy in ways that promote the fullest possible utilization of resources without the
destabilizing consequence of price level changes or unnecessary interference with individual
desires.”
According to Robinson, the primary function of the system is “to provide a link between savings and
investment for the creation of new wealth and to permit portfolio adjustment in the composition of the
existing wealth”.
 Concept and Components
A well-knit financial system marks the economic growth and development of any country. Financial
system mainly comprises of:
 financial institutions, (the ones who deal in financial instruments)
 financial markets, (the ones where financial instruments are dealt)
 financial instruments (the ones which are claims to resources or financial assets)
 financial services (the ones rendered by financial instruments in a financial market for
exchange of financial instruments from surplus economic unit to deficit economic unit).
They all, together, are called financial intermediaries and provide a mechanism by which savings
are transformed into investments for the purpose of capital formation. They play a significant role in
economic growth of the country by mobilizing surplus funds and utilizing them for productive
purposes. They form a link between savings and investments by pooling in the savings (claims to
resources) of savers and giving it to those able and willing to invest.
Financial intermediaries create financial assets that have property of liquidity or convertibility
into a fixed amount of money on demand. Financial assets refers to the claims over physical assets in
the form of securities like equity shares, preference shares, debentures, bonds, loan agreements etc.
Property of liquidity refers to conversion of financial assets into cash or nearness to cash. Cash
creation in the Indian economy is done by the Central Bank of the country (RBI in India), while credit
creation is done by financial institutions through financial assets. Undoubtedly, this flow of finance is
routed through financial assets by financial institutions in a financial market where both the units i.e.
Surplus one and the Deficit one meet. The role of financial system is thus, to promote savings and
their channelization in the economy through financial assets that are made more productive than the
physical assets. The fund flows in an efficient financial system from less productive to more
productive purpose, from unproductive/less productive activities to productive activities and from idle
balance to active balances.
SAQ
Q. Differentiate between Financial Institutions and Financial Instruments.
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 Significance
Thus, ultimate objective of the financial system is to add value through flow of fund in the
system. This means that the operations of financial system are vital to the pace and structure of the
growth of the economy. It plays a significant role in accelerating the rate of economic development
which leads to improving general standard of living and higher social welfare along with improved
economic creditability in the world.

Therefore, the financial system is concerned with everyone and everyone is interacting with the
system, consciously or unconsciously. It is a composition of various institutions, markets, regulations
and laws, practices, money manager analyst, transactions and claims and liabilities.

4.3.1 Features of financial system

1. Encourages both savings and investments by providing an ideal linkage between

depositors and investors.

2. Facilitates expansion of financial markets over space and time.

3. Promotes efficient allocation of financial resources for socially desirable and

economically productive purposes.

4. Influences both the pace and quality of economic development.

4.3.2 Functions of Financial System

The important of the Financial System are as follows :

a) Mobilize and allocate savings for capital formation:

It increases the future productive capacity by the process of diversion of the productive capacity
of the economy to the making of capital goods. Process of capital formation involves three distinct but
inter-dependent activities including savings, finance and investment.
  Firstly, the current consumption has to be sacrificed in order to accumulate the capital
goods. It is so because if society consumes that all it produces and save nothing, future
productive capacity of the economy will fall as the present capital equipment wears out.
Hence, savings are created by sacrificing some part of current consumption. The other way
to have surplus funds without sacrificing current consumption is infusion of foreign capital
investment.
 Secondly, these savings are needed to be mobilized through financial intermediaries
whereby a pool of finance is created.
 Thirdly, it is provided to those entrepreneurs or business houses that require them for
investments.
b) Monitor Corporate Performance:

It inspires the operators to monitor the performance of the investment. Financial markets and
institutions help to monitor corporate performance and exert corporate control through the threat of
hostile takeovers for underperforming firms. Financial system attempts to bring transparency in
corporate results through various mandates and circulars getting issued through its regulators i.e. the
Ministry of Finance, SEBI and RBI, making the corporate functioning unbiased through
demutualization, curbing the insider trading, and in many more ways for achieving a transparent,
efficient, optimized, unbiased and flexible financial framework.

c) Provide payment and settlement systems:

It provides a payment mechanism for the exchange of goods and services and transfers
economic resources through time and across geographic regions and industries. Payment and
settlement systems play an important role to ensure that funds move safely, quickly, and in a timely
manner from one hand to another. An efficient payment and settlement system contributes to the
operating and allocation efficiencies of the financial system which ultimately drives the economy for
growth and prosperity.

d) Promotion of liquidity:

Liquidity refers to convertibility of monetary assets into money as and when required by the
investor. Financial system provides such framework that provides trading of financial assets on resale
in secondary markets. Secondary markets are those ones where you can sell or buy financial assets
for the second time. Financial assets, if sold for the first time, which is done in Primary markets.
Hence, any holder of financial assets who want to liquidate his financial assets would approach to
secondary markets for selling.

e) Availability of Information for Project Appraisal:

It provides not only price- related information but information regarding money supply in the
economy, prevailing interest rates, industry outlook by financial institutions, condition of financial
markets, availability of financial instruments etc. to those who need to take sound economic and
financial decisions for their various project requirements.

f) Allocation of risk:

Financial system helps achieve optimum allocation of risk bearing. It limits, pools, and trades the
risks involved in mobilizing savings and allocating credit. Risks can be classified in the following
manner particularly for the savers i.e. surplus units:

 Risk of Default
  Risk of meeting inflation cost
 Risk of getting return over inflation cost.
Similarly, for the corporate entities that use their money i.e. deficit one face following types of risks:

 Systematic risk (the ones which are not in the control of the business units. These are ones
which arise due to market conditions, changes in interest rates, political conditions of the
country, changes in foreign exchange markets etc.
 Unsystematic risk (the ones which are in the control of the business units. These are ones
which are due to strikes and lockouts in the company, management decisions, sales
fluctuations due to faulty decisions of the company etc.
Effective financial systems aims at minimizing risks of both the parties by being party to the deals or
exert controls in indirect manners for bringing trade-off between risk and return.

g) Reduce cost of transaction and borrowing:

When the deals are large in number, we know that economy of scale benefits. The same is done
in the financial system. Through reducing the cost of transaction and borrowing costs, financial system
focuses to increase the volume of trade and intends to convert savings with the
households/corporate/government(to the extent possible) to capital formation by providing it to the
business units at a reasonable cost. It even generates an impulse among the people/business units to
save more.

h) Financial deepening and broadening:

Process of financial deepening and broadening is promoted by a well –functioning financial system.
While, financial deepening refers to an increase of financial assets as a percentage of the gross domestic
product, financial broadening refers to building an increasing number and a variety of participants and
instruments.

4.4 Indian Financial System: Features and Constituents

Indian financial system comprises of formal and informal financial system. Co-existence and co-
operation between the formal and informal financial sectors mark the financial systems of most
developing countries.

 Formal financial sector: It is characterized by the presence of an institutional, organized and

regulated system.
 Informal financial sector: It is a non-institutional, unorganized and non-regulated system
dealing with traditional and rural spheres of the economy
Chart (given on next page) gives the detailed structure of Indian Financial System:
 CHART-INDIAN FINANCIAL SYSTEM

Indian Financial System

Formal (Organized) financial system Informal (Unorganized) financial

system

Regulators: Financial Financial Financial Financial

MOF, SEBI, Institutions Markets Instruments Services

RBI, IRDA (Intermediaries)

Money
lenders

Local
Bankers

Term: Short, Types Traders

Banking Non- Banking Mutual Insurance Medium, Long Landlords

Institutions Institutions Funds and

Housing

Finance Primary Secondary

Companies Securities Securities

Scheduled Scheduled

Commercial Cooperative Equity, Time Deposits,

Banks Banks Public Sector Private Sector Preference MF units,

and Debt Insurance Policies

Public Sector Banks

Private Sector Banks Depositories

Foreign Banks Custodial

Regional Rural Banks Credit Rating

Factoring

Merchant Banking
 Underwriting

Non- Banking Development Hire Purchase

Finance Companies Finance Institutions Portfolio

Management
Notes:

IDBI: Industrial Development Bank of India

All- India Financial State –level Other
SIDBI: Small Industrial Bank of India
Institutions: IFCI, institutions: institutions:
NABARD: National Bank for Agriculture and
IDBI, SIDBI, NABARD SFCs, SIDCs ECGC, DICGC Rural Development

SFC: State Financial Corporation

SIDC: State Industrial Development

Corporation
Capital Market Money Market
ECGC: Export Credit Guarantee
Corporation of India

DICGC: Deposit Insurance and Credit

Guarantee Corporation
Equity Market Debt Market:

PSU Bond market,

Government Securities Market Treasury Bills

Call Money Market

Primary Secondary Market: Commercial Bills

Market NSE, OTCEI, BSE Derivatives Market: Commercial Papers

- Public Issues Futures and Options Certificate of Deposit

- Private Placement

4.4.1 Components of Formal Financial System

Broadly the Indian Financial System is classified into four components as follows:

 Financial Institutions
 Financial Markets
 Financial Instruments
 Financial Services
The formal financial system comes under the regulations of the Ministry of Finance (MOF), Securities
and Exchange Board of India (SEBI), Reserve Bank of India (RBI), and other regulatory bodies.

The four segments or components of financial system are:

I. Financial institutions
 Financial institutions are intermediaries which mobilize savings & facilitate the allocation of
funds in an efficient manner and are classified as non-banking and banking financial institutions.
Banking institutions are creators of credit while non-banking financial institutions are purveyors of
credit. While the liabilities of banks are part of the money supply, this may not be true of non-banking
financial institutions.

The major institutional purveyors of credit in India among other non-banking financial institutions
are the Non-Banking Financial Companies (NBFCs) and the Developmental Financial Institutions
(DFIs), as well as Housing Finance Companies (HFCs). Financial institutions can also be classified
as term-finance institutions such as Industrial Credit & Investment Corporation of India (ICICI), the
Industrial Development Bank of India (IDBI), Industrial Financial Corporation of India (IFCI), Industrial
Investment Bank of India (IIBI) and Small Industries Development Bank of India (SIDBI).

Financial institutions act as intermediaries and facilitate smooth functioning of the financial system
by providing a common platform to deficit and surplus units of money supply. They promise a better
rate of return by mobilizing savings of the surplus units and allocating them in productive activities.
These institutions also provide services to entities seeking advice on various issues ranging from
diversification plans to restructuring and from sick units to healthy units.

II. Financial Markets

Financial markets are a mechanism enabling participants to deal in financial claims and all
deals are made on a price mutually agreed to both parties. Thus, the markets provide a facility in
which their demands and requirements interact to set a mutually agreed price for such claims. The
money market and capital market are the main organized financial markets in India (explained
below). While, money market is a market for short-term securities, the capital market is a market for
long-term securities. The money market deals with financial assets and securities which have a
maturity period limited within a year. As for as, the capital market is concerned, the maturity of
financial instruments ranges from one year to indefinite period. The main functions of financial
markets are:

1. to facilitate creation and allocation of credit and liquidity;

2. to serve as intermediaries for mobilization of savings;
3. to assist process of balanced economic growth;
4. to provide financial convenience.

A. Money market consists of:

 Call money market:

The call money market is a market for very short term funds. The funds are lent for one day or
from Saturday to Monday (call/overnight money) or for a period up to 14 days (notice money) in the
call/notice market. The call money market is a non-collateralized interbank dealer market for
overnight funds. No collateral security is required to cover these transactions. The call money market
is a highly liquid market with the liquidity being exceeded only by cash. Call money is required mostly
by banks. Commercial banks borrow money from other banks to maintain a minimum cash balance
with RBI known as the cash reserve requirement (CRR). The RBI stipulates this from time to time.
 Commercial bills market:
Commercial bills are short term, negotiable, and self-liquidating instrument with low risk. In
India banks mainly provide the funds for working capital requirement of business firms through cash-
credits / overdraft and purchase/discounting of commercial bills.

The bank discounts this bill by keeping a certain margin and credits the proceeds. Banks, when in
need of money, can also get such bills rediscounted by financial institutions such as UTI, LIC, GIC,
ICICI and IRBI. The maturity period of the bills varies from 30 days, 60 days or 90 days, depending
on the credit extended in the industry.

 Treasury bills market:

These are short term instruments issued by the Reserve Bank on behalf of the government to
tide over short term liquidity shortfalls. It is used by the government to raise short term funds to bridge
seasonal or temporary deficit occurred due to excess of expenditure over revenue. They form the
most important segment of the money market not only in India but all over the world as well. T-
bills are repaid at par on maturity. T-bills in India have maturities of 3 months, 6 months and 12
months, and are issued. T-Bills are negotiable securities, highly liquid as they are of shorter tenure,
have an assured yield, low transaction cost. T-bills are available for a minimum amount of Rs.25,000
and in multiples thereof. RBI, banks, mutual funds, primary dealers, provident funds, corporates are
some of the participants in the T-Bill market.

 Commercial Paper
A commercial paper is an unsecured short term promissory note, negotiable and transferable
by endorsement and delivery with a fixed maturity period. It is generally issued at a discount by highly
rated and leading creditworthy corporate to meet their working capital requirements. A commercial
paper, depending upon the issuing company, is also known as industrial paper, finance paper, or
corporate paper. A commercial paper is usually privately placed with investors, either through banks
or merchant bankers. It is essential for corporate to obtain credit rating of P2 from credit rating
agencies for issuing CP. The period of CP is 15 days to 365 days from the date of issue and is issued
at discount.

 Certificates of Deposit
A certificate of deposit is a document of title to depositors of funds that remain on deposit at
the bank for specified period at a specified rate of interest. They are unsecured, negotiable short term
instruments in bearer form. They are introduced in June 1989 and only scheduled commercial banks
were allowed to issue Certificates of deposit initially. It was only in 1992 that financial institutions were
permitted to issue certificates of deposits. The term of a CD generally ranges from one month to five
years.

B. Capital market consists of:

 Equity Market
The equity market (often referred to as the stock market) is the market for trading equity
instruments. It allows trading in shares, debentures, warrants, mutual funds and ETFs. It is a market
which deals in the trading of both public and private companies. These include securities listed on
a stock exchange as well as those traded privately.
 Debt Market
The debt market is one of the most critical components of the financial system of any
economy and acts as the fulcrum of a modern financial system. Debt market consists of Bond
markets, which provide financing through the issuance of Bonds, and enable the subsequent trading
thereof. Instruments like bonds/debentures are traded in this market. These instruments can be
traded in OTC or Exchange traded markets.

In India, the debt market is broadly divided into two parts- government securities market /gilt
edged market and Corporate Bond Market. The debt market plays a key role in the efficient
mobilisation and allocation of resources in the economy, financing the development activities of the
government, facilitating liquidity management, framing monetary policy and pricing of non-
government securities in financial markets.

III. Financial Instruments

Those documents which represent financial claims on physical assets are called financial
instruments. Financial assets refer to a claim to the repayment of certain sum of money at the end of
specified period together with interest or dividend. Examples: promissory notes, bills of exchange,
government bonds, treasury bills, deposit receipts, debentures, preference shares, equity shares etc.
Financial instruments are an important constituent of financial system. They represent a claim against
the future income and wealth of others. For the payment of the some of the money at a specified
future date, it is a claim against a person or an institution.

A. Classification

Also termed as financial securities, they can be classified into:

i. Primary or direct securities

ii. Secondary or indirect securities.

Primary securities

Securities which are directly issued by the ultimate investors to the ultimate savers are called
primary securities. Examples, shares and debentures issued directly to the public by the corporate
entities.

Secondary securities

Securities issued by some intermediaries called financial intermediaries to the ultimate savers are
called secondary securities. E.g. Mutual funds companies issue securities in the form of units to the
public and money pooled is invested in companies.

Secondary securities can be classified on the basis of duration:

 o Short-term securities: These are those which are having maturity period of one year. For
instance, treasury bills, bills of exchange etc.
o Medium-term securities: These are those which are having maturity period ranging from one
to five years. E.g. Debentures maturing within a period of 5 years.
o Long-term securities: These are those which are having maturity period of more than five
years. E.g. government bonds maturing after 10 years.
B. Features of Financial Instruments

1. Most of the financial instruments can be easily transferred from one hand to another without
many cumbersome formalities.
2. They have a ready market, i.e., they can be bought and sold frequently and so trading in
these securities is made possible.
3. They possess liquidity, i.e., some instruments can be converted into cash readily. For
instance, by means of discounting and rediscounting, a bill of exchange can be converted into
cash readily.
4. Most of the securities posses security value, i.e., they can be given as security for the purpose
of raising loans.
5. Some securities enjoy tax status, i.e., investment in these securities are exempted from
wealth tax as well as income tax subject to certain limits and conditions. E.g. magnum tax
saving certificates, public sector tax free bonds.
6. There is uncertainty with regard to the payment of principle/interest/dividend as the case may
be and so carry risk to the extent not reduced by financial system.
7. These instruments facilitate future trading so as to cover risks due to price fluctuations,
interest rates, market imperfections etc.
8. These instruments involve less handling costs since expenses involved in buying and selling
these securities are generally much less.
9. The return on these instruments is directly in proportion to the risk undertaken, therefore
leading to risk-return trade-off mechanism.
10. These instruments may be short-term or medium term or long term depending upon the
maturity period of these instruments.
IV. Financial Services

The term financial services can be defined as "activities, benefits and satisfaction connected
with sale of money that offers to users and customers, financial related value”. These are rendered by
the financial intermediaries in order to facilitate both the parties for complying with various mandates
and legal formalities due to increase in sophistication of financial instruments and markets. These
services are vital for industrial expansion, creation of firms and economic growth.

The investors need to be reassured that it is safe to exchange securities for funds before they
lend money. This reassurance is provided by the financial regulator who protects the investors’
interests by regulating the conduct of the market and intermediaries. The Reserve Bank of India
regulates the money market and Securities Exchange Board of India (SEBI) regulates capital market.

The quality and variety of financial services provided by financial intermediaries determine the
efficiency of any financial system. It includes leasing, hire-purchasing, merchant banking, credit
rating, factoring, securitization etc.
4.5 FINANCIAL SECTOR DEVELOPMENT

Financial sector development concerns overcoming “costs” incurred in the financial system.
By “cost” we mean the cost incurred in enforcing contracts, acquiring information, and executing
transactions which result in the emergence of financial contracts, intermediaries, and markets.

Distinct forms of contracts, markets and intermediaries across countries in different times. These are
motivated by different types and combinations of transaction, information, and enforcement costs in
conjunction with different legal, regulatory and tax systems.

Financial sector development takes place when markets, financial instruments, and intermediaries
work together to reduce the costs of enforcement, information, and transactions. A well-functioning
financial sector is a powerful engine behind economic growth. It generates local savings, which in
fuels productive investments in local business. Furthermore, international streams of private
remittances can be done by effective banks. The financial sector therefore provides the rudiments for
income-growth and job creation.

4.5.1 Importance of Financial Sector Development

By promoting economic growth through technological advancement and capital

accumulation and via delivering information about investment, optimizing the allocation of capital,
boosting savings rate, mobilizing and pooling savings, and facilitating and encouraging foreign capital
inflows, financial sector development plays a significant role in economic development.

Countries with better-developed financial systems tend to enjoy a sustained period of growth,
as has been evident that financial development is not simply a result of economic growth; it is also
the driver for growth.

The crisis had not only challenged conventional thinking in financial sector policies and started
debate on how best to achieve sustainable development, it also got one thinking as to how to
effectively reassess and re-implement financial policies, publications such as Global Financial
Development Report (GFDR) by the World Bank and Global Financial Stability Report (GFSR) by the
IMF.

The Global Financial Development Report, a new initiative by the World Bank, highlights
issues that have come to the forefront after the crisis and presents policy recommendation to
strengthen systems and avoid similar crisis in the future. By gathering data and knowledge on
financial development around the world, the GFDR report aims to put into spotlight issues of financial
development and hopes to present analysis and expert views on current policy issues.

4.6 CONCLUSION

After reading this lesson, one can conclude that:

A financial system is a life blood of any country. It refers to a framework which depends on market
regulators facilitating the market players, who are trading in financial instruments at a market place
governed to indicate the driving path of any economy. The driving path is reflected through financial
indicators which are qualitative as well as quantitative in nature. The need is to correlate both such
indicators for reaching at meaningful decision with regard to policy formation, sectoral development
measures and global economic creditworthiness.

4.7 SUMMARY

The flow chart given below summarises the issues concerning Indian Financial System
discussed in this chapter.

Financial System

Concept & Significance Features Functions Indian

Components Financial
System

Formal Informal

Regulators Financial Financial Financial Financial

Instruments Services Institutions markets

Banking Non-Banking Mutual Insurance and

Institutions Institutions Funds Housing Finance
Companies

4.8 GLOSSARY

 Non-banking financial companies (NBFCs): Non-bank financial companies (NBFCs)

are financial institutions that provide banking services without meeting the legal definition of
a bank, i.e. one that does not hold a banking license. These institutions are not allowed to take
deposits from the public.
 SIDBI: Small Industries Development Bank of India is an independent financial institution aimed
to aid the growth and development of micro, small and medium-scale enterprises (MSME)
in India.
 Developmental financial institutions (DFIs): A development finance institution (DFI) is an
alternative financial institution which includes microfinance institutions, community development
financial institution and revolving loan funds. These institutions provide a crucial role in providing
credit in the form of higher risk loans, equity positions and risk guarantee instruments to private
sector investments in developing countries DFIs are backed by states with developed economies
 Gross Domestic Product : Gross domestic product (GDP) is the market value of all officially
recognized final goods and services produced within a country in a given period of time. GDP per
capita is often considered as indicator of a country's standard of living.
 Global Financial Development Report (GFDR): Global Financial Development Report is the
first in a new World Bank series started in 2013. It provides a unique contribution to financial
sector policy debates, building on novel data, surveys, research, and wide-ranging country
experience, with emphasis on emerging-market and developing economies.
 Capital Adequacy Ratio: Capital Adequacy Ratio (CAR), also known as Capital to Risk
(Weighted) Assets Ratio (CRAR) is a ratio of a bank's capital to its risk. National regulators track
a bank's CAR to ensure that it can absorb a reasonable amount of loss and complies with
statutory Capital requirements.
4.9 REFERENCES/FURTHER READINGS

 L. M. Bhole and J. Mahukud, (2011). Financial Institutions and Markets. Tata McGraw Hill, 5 th
edition.
 M. Y. Khan, (2011). Indian Financial System. Tata McGraw Hill, 7th edition.
 F. S. Mishkin and S. G. Eakins (2009). Financial Markets and Institutions. Pearson Education,
6th edition.
 F. J. Fabozzi, F. Modigliani, F. J. Jones, M. G. Ferri, (2009). Foundations of Financial Markets
and Institutions. Pearson Education, 3rd edition.
4.10 MODEL QUESTIONS

1. What do you mean by financial system? Explain its constituents.

2. What do you mean by Financial Sector Development?

3. Explain the role of financial system in developing an economy.

4. What do you mean by financial instruments? Explain its link between financial markets
and financial intermediaries.

---------
 Lesson-5

RBI AND FINANCIAL SYSTEM

(A Part of Indian Money Market)

Structure

5.1 Objectives

5.2 Introduction

Section I : RBI and Monetary Policy

5.3 RBI : Characteristics and Functions

5.4 Monetary Policy : Objectives, Methods

Section II : Financial Sector Reforms

5.5 Financial sector Reforms in India

5.6 Globalization of Indian Financial System

5.7 Conclusion

5.8 Summary

5.9 Glossary

5.10 References

5.11 Model Questions

The present lesson deals broadly with role of RBI in Indian Financial System. RBI formulates
monetary policy to regulate the financial system in India. Monetary policy and its tools have been
studied to control the money supply in an economy. Also, the relationship between the financial
system and monetary policy has been discussed. Later part of this lesson discusses about the
financial sector reforms in India in reference to pre and post reform period.

5.1 OBJECTIVES
After going through this lesson your shall be able to:

 discuss the role of RBI in financial system.

 explain the monetary policy issued by RBI to control money supply.
 elaborate the relationship between the financial system and monetary policy.
 describe the reforms that took place in financial sector in reference of India.

5.2 INTRODUCTION
 The central bank of any country is the apex institution of its monetary system as well as financial
system because monetary system is the major constituent of the country’s financial system. As the
apex body, the central bank organizes runs, supervises, regulates and develops the monetary
system and thus the financial system of the country. Formulating and implementing the monetary
policy are the main responsibilities of the central bank.

SECTION - I : RBI AND MONETARY POLICY

Central banks, in general, are very old institutions. For instance, The Bank of England was set
up in 1694, and the Bank of France is more than 200 years old. As for the Federal Reserve Bank it
was set up in 1913. Coming to RBI it was set up in 1935. It though may appear young due to its late
inception when compared to developed world, but as …..Governor Dr Bimal Jalan, said though it may
appear like a ‘toddler or at most a young adult’, it is one of the oldest central banks among the
developing world.

The central bank of India, was established on April 1, 1935, under the Reserve Bank of India Act. It
was entrusted with the responsibility to create financial stability in India and is charged with regulating
the country's currency and credit systems. RBI uses monetary policy as major tool to discharge its
fundamental responsibilities stated above.

5.3 RBI CHARACTERISTICS AND FUNCTIONS

The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the
Reserve Bank of India Act, 1934. The Central Office of the Reserve Bank was initially established in
Calcutta but was permanently moved to Mumbai in 1937. The Central Office is where the Governor
sits and where policies are formulated. Though originally privately owned, since nationalization in
1949, the Reserve Bank is fully owned by the Government of India.
5.3.1 Characteristics of RBI
1) Monetary Authority:
RBI formulates implements and monitors the monetary policy. The objective of formulating monetary
policy is to maintain price stability and ensuring adequate flow of credit to productive sectors as well
as adequate money supply in the economy.

2) Regulator and supervisor of the financial system:

RBI prescribes broad parameters of banking operations within which the country's banking and
financial system functions. The objective of formulating common rules and regulation for the overall
banking industry is to maintain public confidence in the system, protect depositors' interest and
provide cost-effective banking services to the public.

3) Manager of Foreign Exchange

Adequate foreign exchange reserve and efficient foreign exchange rate establish sound creditability
status in the globalized world. RBI is responsible for managing foreign exchange reserves and its
conversion rates. This management of reserves is regulated under the Foreign Exchange
Management Act, 1999. The objective is to facilitate external trade, payment and promote orderly
development and maintenance of foreign exchange market in India.
4) Issuer of currency:
RBI is having the sole responsibility of issuing currency. Besides Issues only, it also exchanges or
destroys currency and coins not fit for circulation. The objective is to give the public adequate quantity
of supplies of currency notes and coins and in good quality.

5) Developmental role
RBI performs a wide range of promotional functions to support national objectives. For this Reserve
Bank has helped in the setting up of the various institutions such as Industrial Financial Corporation
of India (IFCI) and the State Financial Corporations (SFC); the Unit Trust of India (UTI) in 1964, the
Industrial Development Bank of India (IDBI) also in 1964, the Agricultural Refinance Corporation of
India in 1963, NABARD in 1982 and the Industrial Reconstruction Corporation of India in 1972. These
institutions were set up by the Reserve Bank directly or indirectly to promote saving habit among
individuals and mobilize these savings to provide industrial finance as well as agricultural finance.
The basic objective is to equal development of all sectors of an economy.

5.3.2 Functions of Reserve Bank of India

All the important functions of central bank, the Reserve Bank of India, are entrusted to it by
the Reserve Bank of India Act of 1934

1. Bank of Issue
Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank
notes of all denominations. Reserve Bank, as agent of the Government, distributes rupee notes and
coins of small denomination all over the country and issues them via a separate department called
Issue Department.

Issue Department keeps its assets and liabilities separate from those of the Banking
Department. The assets of the Issue Department, originally, were to consist of not less than two-fifths
of gold bullion, gold coins, or sterling securities provided the amount of gold was not less than Rs. 40
crores in value. The remaining three-fifths of the assets might be held in Government of India rupee
securities, rupee coins, eligible bills of exchange and promissory notes payable in India. These
provisions were modified due to the exigencies of the Second World War. The Reserve Bank of India
is required to maintain gold and foreign exchange reserves of Rs. 200 crores, of which at least Rs.
115 crores should be in gold since 1957. The system as it exists today is known as the minimum
reserve system.

2. Banker to Government
Reserve Bank of India acts as Government banker and adviser. Except Jammu and Kashmir,
Reserve Bank acts as agent of Central Government and of all State Governments in India. The
Reserve Bank has the obligation to transact Government business like to receive and to make
payments on behalf of the Government, to keep the cash balances as deposits free of interest, and to
carry out their exchange remittances and other banking operations. The Reserve Bank of India also
helps the Government (both the Union and the States) to float new loans and to manage public debt.
Advances to the Governments for 90 days can also be made by the bank. States and local authorities
also take loans and advances from RBI. Besides, RBI acts as adviser to the Government on all
banking and monetary matters.
3. Bankers' Bank and Lender of the Last Resort
The Reserve Bank of India acts as the bankers' bank. Every scheduled bank was required to
maintain with the Reserve Bank a cash balance equivalent to 5% of its demand liabilites and 2 per
cent of its time liabilities in India, according to the provisions of Banking Companies Act 1949.
However, the distinction between demand and time liabilities was abolished and banks have been
asked to keep cash reserves equal to 3 per cent of their aggregate deposit liabilities, by an
amendment of 1962. The minimum cash requirements can be changed by the Reserve Bank of India
on timely basis.

The scheduled banks can get financial accommodation in times of need or stringency by
rediscounting bills of exchange or can borrow from the Reserve Bank of India on the basis of eligible
securities or. Also, the Reserve Bank becomes not only the banker's bank but also the lender of the
last resort, as commercial banks can always expect the Reserve Bank of India to come to their help
in times of banking crisis.

4. Controller of Credit
RBI has the power to influence the volume of credit created by banks in India and so is called
the controller of credit. It influences the credit through open market operations or by changing the
Bank rate. According to the Banking Regulation Act of 1949, the Reserve Bank of India can ask any
particular bank or the whole banking system not to lend to particular groups or persons on the basis
of certain types of securities. Selective controls of credit are increasingly being used by the Reserve
Bank, since 1956.

The Reserve Bank of India has many powers to control the Indian money market. For
instance, to do banking business within India, every bank has to get a license from the Reserve Bank
of India. This license can be cancelled by the Reserve Bank if certain stipulated conditions are not
fulfilled.

To open a new branch every bank will have to get the permission of the Reserve Bank. Each
scheduled bank must send a detailed weekly return to the Reserve Bank showing of its assets and
liabilities. This power of the Bank to call for information is also intended to give it effective control of
the credit system. The accounts of any commercial bank can also be inspected by The Reserve
Bank.

As supreme banking authority in the country, the Reserve Bank of India has the following
powers:

(a) Cash reserves of all the scheduled banks are held by RBI.
(b) System of inspection, licensing and calling for information is also controlled in the
banking system.
(c) It also controls the credit operations of banks through qualitative and quantitative
controls.
5. Custodian of Foreign Reserves

It is the responsibility of Reserve Bank to maintain and manage forex reserves. According to the
Reserve Bank of India Act of 1934, the Bank was required to buy and sell at fixed rates any amount
of sterling in lots of not less than Rs. 10,000. In 1946, after India became a member of the
International Monetary Fund, the Reserve Bank has the responsibility of maintaining fixed exchange
rates with all other member countries of the I.M.F.
RBI has also to provide custody to India's reserve of international currencies. Further, the RBI has the
responsibility of administering the exchange controls of the country.
6. Supervisory functions
The Reserve bank has certain non-monetary functions of the nature of supervision of banks
and promotion of sound banking in India. The Reserve Bank Act, 1934, and the Banking Regulation
Act, 1949 have given the RBI wide powers of supervision and control over co-operative and
commercial banks, branch expansion, relating to licensing and establishments, liquidity of their
assets, management and methods of working, reconstruction amalgamation and liquidation.
Periodical inspections of the banks can be held by RBI and the Bank has the power to call for returns
and necessary information from them. The nationalisation of 14 major Indian scheduled banks in July
1969 has imposed new responsibilities on the RBI for directing the growth of banking and credit
policies towards realization of certain desired social objectives and more rapid development of the
economy. All these supervisory functions helped in improving the standard of banking in India and
also in improving the methods of their operation.

7. Promotional functions
The range of the Reserve Bank's functions has steadily widened after economic growth
assumed new urgency post Independence. For starters, it now performs a variety of developmental
and promotional functions, which, earlier were regarded as outside the scope of central banking. The
Reserve Bank was asked to extend banking facilities to rural and semi-urban areas, promote banking
habit, and establish and promote new specialised financing agencies. Accordingly, the Reserve Bank
has helped in the setting up of the IFCI and the SFC; it set up the Deposit Insurance Corporation in
1962, the Industrial Development Bank of India in 1964, the Unit Trust of India also in 1964, the
Agricultural Refinance Corporation of India in 1963 and the Industrial Reconstruction Corporation of
India in 1972. These institutions were set up indirectly or directly by the Reserve Bank to promote
saving habit and to mobilise savings, and to provide industrial finance as well as agricultural finance.

Though the Reserve Bank of India set up the Agricultural Credit Department in 1935 to
provide agricultural credit, it is only after 1951 the Bank's role became important in this field.

While, Co-operative credit movement was developed by the Bank to encourage saving, to route its
short term credit to agriculture and to eliminate moneylenders from the villages, Agricultural
Refinance and Development Corporation was set up by RBI to provide long-term finance to farmers.

8. Controller of money supply

One of the objectives of RBI is to control money supply in the economy. This objective can be
achieved through formulating monetary policy by RBI. There are the quantitative and qualitative
methods of monetary policy to control the money supply in the economy. In detail, monetary policy
has been discussed in later part of the lesson.

5.4 MONETARY POLICY

Monetary policy refers to the use of instruments under the control of the central bank to
regulate the availability, cost and use of money and credit. In India, the Reserve Bank of India is
vested with the responsibility of conducting monetary policy. This responsibility is explicitly mandated
under the Reserve Bank of India Act, 1934. The primary objective of Monetary Policy is to maintain
price stability, keeping growth in control. The current inflation targetting framework in India is flexible
in nature.
The goal: achieving specific economic objectives, such as low and stable inflation and promoting
growth.

5.4.1 Definition of Monetary Policy

Many economists have given various definitions of monetary policy. Some prominent definitions are
as follows.

According to Prof. Harry Johnson," A policy employing the central banks control of the supply of
money as an instrument for achieving the objectives of general economic policy is a monetary policy."

According to A.G. Hart, “A policy which influences the public stock of money substitute of public demand
for such assets of both that is policy which influences public liquidity position is known as a monetary
policy."

As per Shapiro, “The monetary policy of a nation involves the overall set of laws and practices that
control the quantity and quality of money in an economy.”

From these definitions, it is clear that a monetary policy is related to the availability and cost of money
supply in the economy in order to attain certain broad objectives. The Central Bank of a nation keeps
control on the supply of money to attain the objectives of its monetary policy.
5.4.2 Objectives of Monetary Policy
The objectives of a monetary policy are as follows:
 Rapid Economic Growth :
Amongst the most important objectives of a monetary policy is rapid economic growth. The monetary
policy by controlling real interest rate and its resultant impact on the investment can influence
economic growth. Also, the investment level in the economy can be encouraged if the RBI opts for a
cheap or easy credit policy by reducing interest rates. This increased investment can speed up
economic growth. If the monetary policy succeeds in maintaining income and price stability then
faster economic growth is possible.
Price Stability :
Inflation and deflation marks all economies – the situation is called Price Instability and is harmful to
the economy. Thus, the monetary policy having an objective of price stability tries to keep the value of
money stable, as helps in reducing the wealth and income inequalities. The monetary policy should
be an 'easy money policy' when the economy suffers from recession, but when there is inflationary
situation there should be a 'dear money policy'.
 Exchange Rate Stability :
Price of a home currency expressed in terms of any foreign currency is called exchange rate. The
international community might lose confidence in our economy, if this exchange rate is very volatile.
The monetary policy aims at maintaining the relative stability in the exchange rate. The RBI tries to
maintain the exchange rate stability by altering the foreign exchange reserves and tries to influence
the demand for foreign exchange.
 Balance of Payments (BOP) Equilibrium :
India, along with many other countries, suffers from the Disequilibrium in the BOP. The Reserve Bank
of India tries to maintain equilibrium in the balance of payments through its monetary policy. The BOP
has two aspects i.e. the 'BOP Surplus' that reflects an excess money supply in the domestic economy
and the 'BOP Deficit', that stands for stringency of money. BOP equilibrium can be achieved, if the
monetary policy succeeds in maintaining monetary equilibrium.
 Full Employment :
It was after the Keynes's publication of the "General Theory" in 1936 that the concept of full
employment was much discussed. It refers to absence of involuntary unemployment. To say, 'Full
Employment' stands for a situation in which everybody who wants a job, get a job. However, it does
not state that there is no unemployment and that full employment is actually full. Monetary policy can
be used to achieve full employment. If the monetary policy is expansionary then credit supply can be
encouraged and this in turn could assist in creating more jobs in different sector of the economy.
 Neutrality of Money :
Money has always been looked at as a passive factor by economists such as Wicksted and
Robertson. They feel that money should play only a role of medium of exchange and not more than
that and hence the monetary policy should regulate the supply of money. The change in money
supply creates monetary disequilibrium. Thus, to neutralize the effect of money expansion, monetary
policy has to regulate the supply of money. However, this objective of a monetary policy is always
criticized on the ground that it would be difficult to attain price stability, if money supply is kept
constant then.

 Equal Income Distribution :

The role of the fiscal policy is to maintain economic equality, felt many contemporary economists.
However, in the recent years economists have given the opinion that the monetary policy can also
help and play a supplementary role in attainting economic equality. Special provisions for the neglect
supply such as agriculture, village industries and small-scale industries can be provided by Monetary
policy, along with cheaper credit for longer term. This can prove fruitful for these sectors to come up.
Thus to reduce economic inequalities among different sections of society in the recent period,
monetary policy can be of great help.

5.4.3 Methods to control the credit by Monetary Policy of Reserve Bank of India

The Reserve Bank of India controls the credit through monetary policy. Credit is expanded or
contracted as per the need by the Reserve Bank. It is called credit control. For this purpose the R.B.I.
uses the different methods of monetary policy. After independence, the RBI has used the controlled
expansion policy so that the economic expansion and stabilization could be achieved.

The R.B.I. uses different methods to control the credit. These methods can be divided into two parts:

R.B.I.’s Methods of Credit Control

Quantitative Credit Control Qualitative Credit Control

Quantitative Methods Qualitative Methods

1. Fixing marginal requirements

2. Consumer Credit regulation
1. Bank Rate Policy
3. Publicity
2. Open Market Operations
4. Credit rationing
3. Variable in the Reverse Ratio
5. Moral Suasion
6. Control through directives
(A) Quantitative Instruments or General Tools

The Quantitative Instruments are also known as the General Tools of monetary policy. These
tools are related to the Quantity or Volume of the money. They are designed to regulate or control the
total volume of bank credit in the economy while Qualitative instruments regulate provide credit to
selected borrowers for selected purpose, depending upon the use to which the control try to regulate
the quality of credit - the direction towards the credit flows.

(B) Qualitative Instruments or Selective Tools

The Qualitative Instruments are also known as the Selective Tools of monetary policy. These
tools are not directed towards the quality of credit or the use of the credit. These methods are meant
to give the central bank as ability to affect particular segments of the economy on selective basis.
They are used for discriminating between different uses of credit. The Selective Tools of credit control
comprises of following instruments.

5.4.4 Stability of Financial System and Monetary Policy

Both monetary policy and the financial system are equally important for an economy and they
both are interrelated to each other. The objective of monetary policy i.e. price stability must be
achieved without adversely affecting the stability of the financial system. Similarly, it must also be
taken care that weaknesses of financial system do not affect the effective operation of monetary
policy.

The monetary authorities direct interest rate and credit policies towards a clearly defined
objective of price stability. Against a background of price stability, financial stability is seen to be
assured by rigorous prudential supervision, targeted at the risk management practices, and the
solvency of individual institutions. One of the researchers, Schinasi (2004) had explained the
relationship between monetary policy and financial system stability which is discussed below:

Schinasi (2004) emphasizes that the concept of financial stability is broad, encompassing the
role of financial infrastructure (legal system, financial regulation, supervision and surveillance),
institutions and markets.

According to him, a stable financial system should be “capable of facilitating (rather than
impeding) the performance of an economy and of dissipating financial imbalances that arise
endogenously or as a result of significant adverse and unanticipated events”.

“Financial stability” denotes the state in which a financial system is capable of absorbing shocks
without triggering cumulative processes that hamper the provision of savings for investment and the
smooth processing of payments in the economy.”

Monetary policy, in turn, can be seen as the institutional arrangements and the use of the
monetary authority instruments in order to maximize social welfare. The usual monetary policy
instrument is a short-term interest rate, which is set using open market operations and other
procedures that are part of the central bank operational framework.

Similarly to financial stability, monetary policy has several dimensions and also involves
financial infrastructure, institutions and markets. For monetary policy to be effectively conducted, the
central bank needs to have a great deal of influence on money market interest rates and changes in
such rates need to be transmitted to the rest of the economy.

Beyond the setting of interest rates, the broad monetary policy implementation framework has also
important implications for the financial system. Indeed, operational aspects, such as liquidity
management, the collateral framework and the counterparties of monetary policy, influence the
decisions of financial intermediaries and, consequently, financial stability, as has been clearly
illustrated in the recent financial crisis. Communication can also be seen as a monetary policy tool
which may influence financial stability through its impact on agents’ expectations.

Thus we can conclude that transmission of monetary policy is possible only when there is
stable financial system. An unstable financial system would hamper the transmission mechanism of
monetary policy. The following chart will show the relationship of monetary policy and financial
system in a better way.
 SECTION-II : FINANCIAL SECTOR REFORMS

Monetary policy refers to the use of monetary instruments under the control of the central bank to
regulate interest rates, money supply and availability of credit with a view to achieving objectives of
Economic policy.

Flexible Inflation Targetting Framework

Flexible Inflation
Targetting Framework
(FITTF)
 Monetary Policy Monetary Monetary Policy Committee hold office for
Framework Policy (MPC) = 4 members + every 4 years
(MPF) Governer. RBI + Deputy
Governer

Publishes a Report
every six months

Monetary Monetary Policy

Policy Process Instruments --- Repo Rate
(MPP) (MPI) --- Reverse Repo Rate
--- Liquidity Adjustment Facility (LAF)
--- Marginal Standing Facility (MSF)
--- CRR
--- SLR
--- OMO
--- MSS

 By the 2016 amendment to RBI Act 1934, India adopted flexible inflation targetting framework.
As a result, inflation target is set by Government of India (GOI) in consultation with RBI, once
every five years.
 GOI notified 4pc (CPI) inflation as target for the period 5th Aug, 2016 to 31st March, 2021 with
+ 2 tolerance limit (lower and upper i.e. 2 to 6 pc).
 If rate of inflation is beyond the upper range or lower range consecutively for three quarters, it
is called failure to achieve target.
 The Framework aims at - setting the policy (repo) rate (which is decided by MPC) based on an
assessment of current and evolving macroeconomic situation. MPC meets four times in a year
Repo rate changes transmit through money market to the entire financial system, which in turn
influences Aggregate demand a key determinant of inflation and growth.
 After announcement of repo rate, the operating framework designed by the RBI envisages
liquidity management on day to day basis.
Market Stabilisation Scheme (MSS) is an instrument for Monetary Management introduced in
2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed
through sale of short-dated government securities and Treasury Bills.
RESULT: The average inflation was 5.69 PC during five years preceding Inflation Targeting
Period has declined to 3.47 per cent in last five years.
CPI based inflation
 2010-15: 5.69 pc
2016-21: 3.47 pc
And growth rate has also improved. Now Government of India retains 4 pc target for RBI's rate panel
for 2021-26.
NOTE: In view of COVID-19 pandemic, the Insolvency and Bankruptcy (Amendment) Ordinance,
2020 was promulgated on 5th June 2020. It suspended initiation of the CIRP of a corporate debtor
(CD) for any default arising on or after 25th March, 2020. The Insolvency and Bankruptcy Code
(IBC) has created a cohesive and comprehensive insolvency ecosystem.
The code has opened possibilities of the resolution, including merger, amalgamation and
restructuring of any kind. The major objective of 1 BC Code is resolving the Corporate Debtors (CDs)
in distress. In value terms around 74 pc of the distressed assets were rescued.
5.5 FINANCIAL SECTOR REFORMS IN INDIA
Till the early 1990s the Indian financial sector could be described as a classic example of
“financial repression”. The financial system was characterised by extensive regulations such as
administered interest rates, directed credit programmes, weak banking structure, lack of proper
accounting and risk management systems and lack of transparency in operations of major financial
market participants. Such a system hindered efficient allocation of resources. Financial sector
reforms initiated in the early 1990s have attempted to overcome these weaknesses in order to
enhance efficiency of resource allocation in the economy.

Objectives Behind Financial Sector Reform

The main objectives, therefore, of the financial sector reform process in India initiated in the early
1990s have been to:

 Remove financial repression that existed earlier;

 Create an efficient, productive and profitable financial sector industry;
 Enable price discovery, particularly, by the market determination of interest rates that then helps
in efficient allocation of resources;
 Provide operational and functional autonomy to institutions;
 Prepare the financial system for increasing international competition;
 Open the external sector in a calibrated fashion;
 Promote the maintenance of financial stability even in the face of domestic and external shocks.

In the mid-1990s, the reforms were initiated for strengthening the financial system and
introducing structural improvements. These reforms were popularly known as second generation
reforms. They could be studied as following:

o Reforms in Banking sector;

o Reforms in Financial markets;
o Reforms in Government securities market;
o Reforms in Foreign exchange market.
5.5.1 Reforms in Banking Sector

The main objective of banking sector reforms was to promote a diversified, efficient and
competitive financial system with the ultimate goal of improving the allocative efficiency of resources
through operational flexibility, improved financial viability and institutional strengthening. The reforms
have focussed on removing financial repression through reductions in statutory preemptions, while
stepping up prudential regulations at the same time. Furthermore, interest rates on both deposits and
lending of banks have been progressively deregulated. The reforms in the banking sector are
discussed below:

 Introduction and phased implementation of international best practices and norms on risk-
weighted capital adequacy requirement, accounting, income recognition, provisioning and
exposure.
 Granting of operational autonomy to public sector banks, reduction of public ownership in
public sector banks by allowing them to raise capital from equity market up to 49 per cent of
paid-up capital.
 Transparent norms for entry of Indian private sector, foreign and joint-venture banks and
insurance companies, permission for foreign investment in the financial sector in the form of
Foreign Direct Investment (FDI) as well as portfolio investment, permission to banks to
diversify product portfolio and business activities.
 Roadmap for presence of foreign banks and guidelines for mergers and amalgamation of
private sector banks and banks and NBFCs.
 Sharp reduction in pre-emption through reserve requirement, market determined pricing for
government securities, disbanding of administered interest rates with a few exceptions and
enhanced transparency and disclosure norms to facilitate market discipline.
 Introduction of pure inter-bank call money market, auction-based repos-reverse repos for
short-term liquidity management, facilitation of improved payments and settlement
mechanism.
 Significant advancement in dematerialisation and markets for securitised assets are being
developed.
Note : See next Chapter for Banking Reforms in Detail

5.5.2 Reforms in Financial Markets

The success of a framework that relies on indirect instruments of monetary management such as
interest rates, is contingent upon the extent and speed with which changes in the central bank's
policy rate are transmitted to the spectrum of market interest rates and exchange rate in the economy
and onward to the real sector. Given the critical role played by financial markets in this transmission
mechanism, the Reserve Bank has taken a number of initiatives to develop a pure inter-bank money
market.

A. Reforms in Indian Money Market

1. Interest rates are deregulated and are determined by the working of market forces
except for a few regulations.
 2. Money Market Mutual Funds (MMMFs) was established in April 1991 in order to provide
additional short-term investment revenue.

3. The Discount and Finance House of India (DFHI) was set up jointly by the Public Sector
Banks, RBI and Financial Institutions in April 1988 to impart liquidity in the money
market.

4. The RBI operates liquidity adjustment facility (LAF) to help banks manage their liquidity
position.

5. The electronic dealing system has been started in order to impart transparency and
efficiency in the money market transactions.

6. The Clearing Corporation of India Ltd. (CCIL) was set up in April, 2001 for providing
exclusive clearing and settlement for transactions in Money, GSecs and Foreign
Exchange.

7. The government has consistently tried to introduce new short-term investment

instruments.

B. Reforms in Indian Capital Market

Note : Reforms in Detail in next Lesson

1. The Securities and Exchange Board of India (SEBI) was constituted on 12 April, 1988 as a
non-statutory body through an Administrative Resolution of the Government for dealing with
all matters relating to development and regulation of the securities market, investor
protection, and to advise the government on all these matters.

2. In the interest of investors, SEBI issued Disclosure and Investor Protection Guidelines which
contains a substantial body of requirements for issuers/intermediaries, the broad intention
being to ensure that all concerned observe high standards of integrity and fair dealing,
comply with all the requirements with due skill, diligence and care, and disclose the truth,
whole truth and nothing but truth.

3. In order to provide efficiency, liquidity and transparency, NSE introduced a nation-wide on-
line fully automated Screen-Based Trading System (SBTS) where a member can punch into
the computer quantities of securities and the prices at which he likes to transact and the
transaction is executed as soon as it finds a matching sale or buy offer from a counter party.
4. Derivatives Trading had been introduced in order to assist market participants to manage
risks through hedging, speculation and arbitrage, Demutualization
5. Dematerialization of securities had been started in physical share certificates of an investor
are converted to an equivalent number of securities in electronic form.

6. In order to preempt market failures and protect investors, the regulator has put in place a
comprehensive risk management system, which is constantly monitored and upgraded.
7. Indian companies have also been allowed to raise capital from the international capital
markets through issue of American Depository Receipts, Global Depository Receipts,
 Foreign Currency Convertible Bonds (FCCBs) and External Commercial Borrowings
(ECBs).
8. Permission was given to Foreign Institutional Investors such as mutual funds, country funds,
and pension funds to operate in the Indian market.
9. The following are the reforms which happen to be made by SEBI on time to time:
o It is mandatory for listed companies to announce quarterly results, as this enables
investors to keep a close track of the scrips in their portfolios. The declaration of
quarterly results is in line with the practice prevailing in the stock market in developed
countries.
o In November 2001 to check price manipulation, mandatory client code and minimum
floating stock for continuous listing were stipulated.
o To standardize listing requirements at stock exchanges, the government amended the
Securities Contracts (Regulation) Rules, 1957.
o From July 2, 2001 a 99 per cent value at risk (VAR) based margin system for all scrips in
rolling settlement was introduced.
o With effect from October 1, 2001 the central government notified the establishment of
Investor Education and Protection Fund (IEPF). The IEPF will be utilized for the
promotion of awareness amongst investors and protection of their interest.
o With effect from July 2, 2001, the restriction on short sales announced in March 7, 2001
was withdrawn, as all deferral products stand banned after the date.
5.5.3 Reforms in the Government Securities Market

• Administered interest rates on government securities were replaced by an auction system for
price discovery.

• Automatic monetisation of fiscal deficit through the issue of ad hoc Treasury Bills was phased
out.

• For ensuring transparency in the trading of government securities, Delivery versus Payment
(DVP) settlement system was introduced.

• Repurchase agreement (repo) was introduced as a tool of short-term liquidity adjustment.

• Market Stabilisation Scheme (MSS) has been introduced, which has expanded the
instruments available to the Reserve Bank for managing the enduring surplus liquidity in the
system.

• Effective April 1, 2006, RBI has withdrawn from participating in primary market auctions of
Government paper.

• Foreign Institutional Investors (FIIs) were allowed to invest in government securities subject to
certain limits.

• Setting up of risk-free payments and settlement system in government securities through

Clearing Corporation of India Limited (CCIL).
 • Phased introduction of Real Time Gross Settlement System (RTGS).

5.5.4 Reforms in the Foreign Exchange Market

• Evolution of exchange rate regime from a single-currency fixed-exchange rate system to fixing
the value of rupee against a basket of currencies and further to market-determined floating
exchange rate regime.

• Replacement of the earlier Foreign Exchange Regulation Act (FERA), 1973 by the market
friendly Foreign Exchange Management Act, 1999.

• Introduction of additional hedging instruments, such as, foreign currency-rupee options.

Authorised dealers permitted to use innovative products like cross-currency options, interest
rate swaps (IRS) and currency swaps, caps/collars and forward rate agreements (FRAs) in
the international forex market.

• Permission to various participants in the foreign exchange market, including exporters,

Indians investing abroad, FIIs, to avail forward cover and enter into swap transactions without
any limit subject to genuine underlying exposure.

• FIIs and NRIs permitted to trade in exchange-traded derivative contracts subject to certain
conditions.

• Foreign exchange earners permitted to maintain foreign currency accounts. Residents are
permitted to open such accounts within the general limit of US $ 25, 000 per year.

From the above it can be seen that since the early 1990s, India as well as the world economy
have undergone a structural transformation. An enduring development has been the changed
perception about India – both internally and from the rest-of-the-world. As envisaged by the 12th
Plan, India was targeted to attain 8.2 per cent per annum growth rate on a consistent basis. Which
was downgraded to 7.5 percent. This was even outside the realm of wishful thinking a few years
back. Appropriate sequencing and repackaging of reform measures with changed emphasis and
relative speed of reforms at various sectoral levels would ultimately determine whether India would be
able to leapfrog into the new growth trajectory.
5.6 GLOBALISATION OF INDIAN FINANCIAL SYSTEM
The reforms in 1991 aimed to create an efficient, productive and profitable financial sector
industry. With the introduction of liberalization and globalization in 1991, competition among the
financial sector has also been increased. The aim of introducing such reforms is to make India
globally competitive. Such reforms involved reorientation towards a market based economy for
fostering sustainable growth and stability.
Reforms in financial sector helped in increasing growth, removing crisis, enhanced efficiency
and imparted resilience to the system. And this is only achieved through reform process which was
properly coordinated with economic policies of domestic and international both.
In 1991 India embarked on reintegration into the world economy through trade and capital
account liberalisation. For this three major changes took place in Indian financial sector. These are:
A. Capital Account integration
In the early 1990s India faced a balance of payment crisis. This crisis was followed by an IMF
structural adjustment program, economic reforms and liberalisation of the trade and capital accounts.
Policy makers were, however, very cautious about opening up the economy to debt flows. The
experience of the BOP crises as well as the lessons learnt from other developing countries suggested
that debt flows, especially short term debt flows could lead to BOP difficulties if the country faced
macroeconomic imbalances and had an inexible exchange rate. The emphasis was, therefore, on
foreign investment - both FDI and portfolio investment. Even these were opened up slowly and a
complex administrative system of capital controls remained in place.
B. Internationalisation of firms
Firm internationalisation lies at the centre of India's engagement with financial globalisation. There is
sharp evidence of internationalisation at the firm level. Five dimensions of internationalisation can be
examined:
1. A firm could import, thus buying raw materials and/or capital goods from foreign
providers;
2. A firm could export;
3. A firm could obtain equity capital from external sources;
4. A firm could obtain debt capital from external sources (whether local- currency
denominated or foreign-currency denominated);
5. A firm could expand overseas, thus placing foreign assets on its balance sheet.
C. Foreign Direct Investment (FDI)
India opened up slowly to FDI in the 1990s. The limits on the share of foreign ownership was slowly
increased in every sector. By 2000, while most sectors were open upto 100 percent, sectors where
FDI was restricted include retail trading (except single brand product retailing), atomic energy, and
betting.

When compared with other emerging markets, India has attracted relatively little FDI. The first phase
of financial globalisation primarily involved Indian firms obtaining equity and debt capital from abroad,
thus achieving a reduction in the cost of capital. This bolstered the competitive position of Indian firms
competing against foreign companies producing in India through FDI and competing in global
markets by exporting.

D. Foreign Portfolio Investment in the Equity Market

In the early 1990s, India opened investment into listed equities through the `FII framework'. This
involved the following key elements. Some, but not all, foreign investors were eligible to register with
the Indian securities regulator (SEBI). Once registered, FIIs could buy shares in India without
quantitative restrictions, or constrainsts.

The introduction of continuous economic reforms in Indian economy helped in achieved

growth rate of around 9 percent in the last decade prior to global financial curves which was only 0.8
in 1991. This makes India as one of the world’s fastest growing economies.

The core objective of the financial sector reforms in India is to improve and strengthen Indian
stock market, which is one of the most exciting and vibrant financial market in the world. In January
2008, Indian stock market reached a peak of 21000. This is possible through the major developments
that took place in Indian stock market. Interest rates have been fixed, statutory provisions have been
reduced and prudential norms have been strengthened in the financial sector. Such reforms altered
the organization structure, patterns and operations of financial institutions. These all reforms lead to
infusion of greater completion and integration in the Indian financial sector with the rest of the world.

SAQ
Q. Differentiate between FDI and FPI.
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________

5.7 CONCLUSION

After reading this lesson it can be concluded that

The central bank of any country is entrusted with twin jobs of regulating the financial
environment in short-run and acting as a banker/agent to any government. The success of
any political government largely depends upon the way central bank reacts in the given
economy. Its reactions are often seen in the form of monetary policy measures linked towards
curbing inflation, moderate money supply, economy suited interest rates and banking ratios.
The recent financial globalization has brought greater financial volatility posing challenges to
all central banks for balancing their financial framework in the short as well as in the long run.

5.8 SUMMARY

Let’s recapitulate the lesson using the chart given below :

RBI and Financial System

RBI and Monetary Policy Financial Sector Reforms Globalisation of Indian

Objectives Financial System

Monetary Policy Reforms in

RBI Functions
characteristics Definition
Objectives Banking Financial Govt Foreign
Sector Markets Securities Exchange
Methods of Credit Control Market Markets
Stability of Financial System

5.9 GLOSSARY

 Scheduled banks: Scheduled Banks in India are those banks which have been included in
the Second Schedule of Reserve Bank of India (RBI) Act, 1934. RBI in turn includes only
those banks in this schedule which satisfy the criteria laid down vide section 42 (6) (a) of the
Act.
 Monetary Policy: It is the macro economic policy laid down by the central bank.
  Balance of Payments (BOP): Balance of payments (BOP) accounts are an accounting
record of all monetary transactions between a country and the rest of the world. These
transactions include payments for the country's exports and imports of goods, services,
financial capital, and financial transfers.
 Wholesale Price Index (WPI): The Wholesale Price Index or WPI is "the price of a
representative basket of wholesale goods". Some countries use the changes in this index to
measure inflation in their economies. The purpose of the WPI is to monitor price movements
that reflect supply and demand in industry, manufacturing and construction. This helps in
analyzing both macroeconomic and microeconomic conditions. Inflation is based on
Wholesale Price Index.
 Industrial Financial Corporation of India (IFCI): The Industrial Finance Corporation of India
(IFCI) on July 1, 1948, as the first Development Financial Institution in the country to cater to
the long-term finance needs of the industrial sector. The newly established DFI was provided
access to low-cost funds through the central bank's Statutory Liquidity Ratio or SLR which in
turn enabled it to provide loans and advances to corporate borrowers at concessional rates.
 NABARD: It was established on 12 July 1982 by a special act by the parliament and its main
focus was to uplift rural India by increasing the credit flow for elevation of agriculture & rural
non farm sector and completed its 25 years on 12 July 2007.[4] It has been accredited with
"matters concerning policy, planning and operations in the field of credit for agriculture and
other economic activities in rural areas in India"
 Foreign Direct Investment (FDI) and FPI : Foreign direct investment (FDI) is a direct
investment into production or business in a country by an individual or company in another
country, either by buying a company in the target country or by expanding operations of an
existing business in that country. Foreign direct investment is in contrast to Foreign Portfolio
Investment (FPI) which is a passive investment in the securities of another country such as
stocks and bonds.
5.10 REFERENCES

 M. R. Baye and D. W. Jansen (2011). Money, Banking and Financial Markets. AITBS.
 Rakesh Mohan (2011). Growth with Financial Stability- Central Banking in an Emerging
Market. Oxford University Press.

 N. Jadhav (2011). Monetary Policy, Financial Stability and Central Banking in India.
Macmillan.
5.11 FURTHER READINGS

 Monetary Policy. Reserve Bank of India-https://www.rbi.org.in

 Financial Sector Reform: Review & Prospects-https://rbidocs.rbi.org.in
 Mohan, Rakesh (2009) Financial Sector Reforms in India: Policies & Performance Analysis,
P.851-878.
 https://rbidocs.rbi.org.in
 Patnaik, Illa and Shah, Ajay (2014) Reforming India’s Financial System, Carnegie Endowment
for International Peace.
https://carnegieendowment.org.
5.12 MODEL QUESTIONS (Short-answers Type)

1. Explain the role of RBI in the Management of Financial Sector.

2. Write a short note on Inflation Targetting Framework.
3. What are the various methods of RBI to control the credit in India or Monetary Policy
Instruments)?
4. How does financial system and monetary policy are related to each other?
(ESSAY TYPE)
5. Explain the financial sector reforms in India with special reference to post-reforms period.

---------

Lesson – 6

INDIAN BANKING SECTOR

(Nationalisation of Banks and Banking Sector Reforms)

Structure
6.0 Objectives
6.1 Introduction
6.2 Need for Nationalisation of Banks
6.2.1 Ownership and Control in Few Hands
6.2.2 Concentration of Wealth and Power
6.2.3 Failure to Mobilize Resources
6.2.4 Resources utilised by the Directors
6.2.5 Discrimination Against Small Business Units
6.2.6 Indifference to the Needs of Agriculture
6.2.7 Misuse of Funds
6.2.8 Five Year Plans and Commercial Banks
6.2.9 Uneven Regional Distribution
6.3 Social Objectives Behind Nationalisation of Banks
6.4 Working of Nationalised Banks
6.4.1 Branch Expansion
6.4.2 Deposit Mobilisation
6.4.3 Excessive Credit Expansion and Faulty Practices
6.4.4 Differential Rate of Interest (DRI) Schemes
6.4.5 Finance for Plans
6.5 Evaluation of Performance of Nationalised Banks
6.6 Indian Banking System
6.7 Banking Reforms
6.8 Capital to Risk Weighted Assets Ratio (CRAR) and BASEL NORMS
6.9 Summary
6.10 Glossary
6.11 References
6.12 Further Readings
6.13 Model Questions
6.0 OBJECTIVES
After going through this lesson you shall be able to :
 explain need and performance of nationalised banks.
 elaborate the banking reforms undertaken in the post 1991 period.

6.1 INTRODUCTION
The nationalisation of 14 major banks with deposits of Rs. 50 crores or more took place
through an ordinance promulgated on July 19, 1969 has since become an Act. The decision has
been described as "momentous” and "timely" by certain sections of people, while others had
vehemently criticized it as wrong and untimely and apprehended serious consequences to the
economy for its implementation. This step was taken in view of some of the serious short comings
noticed in their working which had put a great hindrance in the realisation of the objective of
‘Socialistic Pattern of society’ the main objective of our planning.
6.2 NEED FOR NATIONALISATION OF BANKS
There were certain weaknesses of banking system which needed to be taken care of, as
mentioned below :
1. Ownership and Control in Few Hands
The commercial banks were owned and controlled by a very small number of shareholders
who were able to determine the pattern of allocation and investment of bank finance according to
their own individual interests and convenience. They were helping only big Industrialist, traders and
plantation owners. They were reluctant to give loans to small industries and peasants.
2. Concentration of Wealth and Power
The use of funds by big industrial magnates to build up industrial empires has led the
concentration of wealth and economic power in the hands of a few persons. These banks because of
private ownership were more after profits and neglected social goal.
3. Failure to Mobilize Resources
Private commercial banks had failed to open branches in small towns and large villages. As a
result, they failed to mobilize the savings of the community, of specially of the rural sector, small
towns and lower income groups.
4. Resources Utilized by the Directors
The resources of bank were utilized by the director of the banks to promote their personal
interests as they have been used in those concerns in which the directors are interested.
5. Discrimination Against Small Business Units
It is pointed out that commercial banks have been used by those who had controlled and
managed them in favour of large industrial and business units. Small borrowers had not been able to
approach the banks and had been discriminated against. The lending policy of these banks were not
in conformity with the investment pattern envisaged under plans.
6. Indifference to the Needs of Agriculture
The banks remains largely indifferent to the credit needs of farmers for agricultural operations
and land improvement. This is regarded as a basic reason for the failure of planning in the agricultural
sector and consequently for the failure of general planning.
7. Misuse of Funds
The commercial banks were used for hoarding of essential articles and for speculation. That
is, the banks lent to anti-social elements who were able to get large profits through exploitation of
shortage of essential goods.
8. Planned Development : Lack of Funds
It was argued that the Indian commercial banking system had not fulfilled its proper role in the
planned development of the nation. It was controlled by a coterie of industrialists and business
magnates who used public funds to build private industrial empires. Small industrial and business
units were being continuously and consistently ignored. Agricultural credit was never seriously
considered. Public funds were used to support anti-social and illegal activities. Thus it was required
that commercial banking system be taken over by the government and the funds to carry out the
objectives of comprehensive planning.
9. Uneven Regional Distribution
The regional distribution of banking facilities were uneven. The banks were concentrated
more in urban areas.
6.3 OBJECTIVES OF NATIONALISATION
Based on above weaknesses, the main objectives behind nationalization of banks
were
(1) To mobilize savings and channelize them for production purpose.
(2) To fulfill the needs of all section of people.
(3) To cover up the backward areas and regions of the country.
(4) To bring the right atmosphere for development in the banking field.
Since nationalisation banking sector has registered a spectacular progress. The bank
deposits have risen, number of branches have grown both in Urban and Rural areas. No doubt
performance of banking sectors was impressive after nationalisation but it has negative side too. It
eroded the profit as well as efficient motives of the Banks. In light of these problems and due to
changed economic environment in the country i.e. liberalization the Govt. of India appointed a nine
member committee headed by Narsimhan Rao, the former Governor of R.B.I. in August 1991. The
committee was appointed to review the working of banking sectors and suggest remedial measures
for increasing the efficiency of banking sectors. This committee submitted its report and suggest
remedial measures for increasing the efficiency of banking sectors. This committee submitted its
report in December, 1991. In 1998 again we had Narsimhan Committee II Report for the furtherance
of economic reforms.
6.3.1 Social Objectives Behind Nationalisation of Banks
As was mentioned in the bill, social ownership or nationalisation of bank was essential
because the banking system touches the lives of millions of people and has therefore to be inspired
by a larger social purpose such as to serve national priorities and objectives. It is, in short, expected
to impact dynamism and new vigour to the process of our economic development.
It was expected that the nationalisation of banks will be helpful in achieving the social and
economic programmes outlined in the five-year plans in the following ways :
1. The nationalized banks lending policies will be determined by the broader social objectives
and not by narrow consideration of cost and benefit.
2. It was observed that the ownership and control of these banks was concentrated in the
hands of few big business houses. According to the Mahalnobis Committee, 75% of the
banking business was in the hands of 1 % population. Obviously, this is not in tune with
the avowed objectives of establishing a socialistic pattern of society.
3. The nationalized banks will adjust their policies according to the strategy of Indian five
year plans and lending for speculative and profiteering purpose will be restricted.
4. India is predominantly an agriculture country. Almost 49% of the total National output
came from agriculture but these banks were reluctant to advance credit to the farmers
because of the uncertain character of agriculture. No more than 10% of the total bank
credit was made available to the agriculture sector. Keeping this in view the nationalized
banks can give adequate credit facilities to agriculture.
5. The nationalized banks can provide finance for the export sector as well. Hitherto this
sector has been virtually monopolized by the exchange banks owned by foreign capitalists
because the commercial banks used to fix a limit on financial accommodation for exports
and were more concerned about the debt equity ratio of an exporting firm than its ability to
export. The nationalized banks will be able to assist this sector in a better way and
promote exports to earn valuable foreign exchange. They will also be in a position to
check the illegitimate use of foreign exchange.
6. The commercial banks were also not providing sufficient credit facilities for housing. The
nationalised banks can enter this field and cater to one of the basic need of the people.
7. The banking business is run with public money. At the end of 1977, the nationalised banks
had deposits equal to Rs. 3407 crores whereas their own funds amounted to Rs. 65.94
crores only. These banks were earning enormous profits out of the public money.
Obviously, this makes a strong case for their social ownership.
8. The nationalised banks, can advance credit to the educated unemployed who have the
potential for growth but have nothing to show as security to the privately owned banks.
9. The nationalisation of banks can rectify the lop-sided developments of banking in the
various areas hitherto. The branches of these banks were concentrated in a few big
industrial and trading centres and certain areas almost lacked banking facilities.
 10. As we all know how the loans advanced by the banks create money. The increase in
credit money has the same effect on prices as the increase in actual money issued by the
Reserve Bank. In view of inflationary pressure arising out of the huge public expenditure
incurred under the plans, the Reserve Bank had been exhorting them to limit credit. But in
spite of this, the credit creation remained excessive. The nationalised banks could extend
better cooperation in this regard.
But the nationalisation can fulfill these objectives only if the nationalised banks are run very
efficiently and the customers receive a prompt service. Modern methods like the teller system should
be introduced in all the banks to expedite service. Every effort should be made to avoid excessive
bureaucratisation, rigidity of rules and red-tapism. The banks should also be immune from political
interference, and their lending policies should be inspired by genuine purposes. Adequate facilities for
training of banks personnel should also be made to increase efficiency.
6.4 WORKING OF NATIONALISED BANKS
The commercial banking system in India has gained strength and cohesion after bank
nationalisation in 1969. A better environment has been created for the formulation and
implementation of monetary and banking policies. The major achievement of nationalised banks are
in the realm of branch expansion, and extension of credit to agriculture, small scale industry and to
other neglected sectors.
1. Branch Expansion
The commercial banks have followed a policy of systematic branch expansion designed to
achieve a progressive reduction in regional imbalances. While formulating a new comprehensive
branch expansion policy in 1978, the RBI kept in mind two points (a) the added emphasis given to
rural development, dispersal of industries and development of small-scale industries in the sixth plan,
and (b) the recommendations of James Raj Committee, the Dantwala Committee, and the Kamath
working group. The new branch expansion police provided for the opening of 6,500 additional bank of
offices during the period 1978-81 for semi urban areas in the deficit districts of the country. These
were defined as those where average population of bank office was less than the national average of
20,000 at the time. A time bound programme was also drawn up to ensure that all unbanked
community development block headquarters were provided with a bank office by June 1979.
2. Deposit Mobilisation
Deposit mobilisation has been of the order of 16 to 17 percent every year since
nationalisation. It has however, been observed that the foreign banks and the smaller private sector
banks have registered far higher increase in deposits, indicating thereby a possible diversion of
deposits from the nationalised banks to other banks.
3. Excessive Credit Expansion and Faulty Practices
The most disturbing aspect of functioning of banks is the expansion of bank credit in a
reckless manner, probably under implicit or explicit policy directives from the Government. Usually
expansion, of bank credit goes hand in hand with expansion of bank deposits. But initially soon after
bank nationalisation, credit expansion has been much larger at 24 percent as' compared to the
expansion of bank deposits (around 17 percent) later. For instance, the practice of taking personal
guarantees of directors as an additional security is responsible for excessive flow of credit, for the
impression that cheap credit is still available to well established name in trade and industry.
4. Differential Rate of Interest (DRI) Schemes
 The Government introduced the DRI scheme in April 1972 covering 162 districts. The public
sector banks have been giving loans at a concessional interest rate of 4% to the weaker sections of
the community who have no tangible security to offer but who can improve their economic condition
through financial assistance from banks.
6.5 EVALUATION OF BANKING SINCE NATIONALISATION
The period since bank nationalisation is of great importance from the point of view of banking
development as the size and the reach of the banking system registered spectacular progress in this
period. Aggregate bank deposits have risen from 11 per cent of GDP to around 67.8 per cent, and the
total number of branches from 8,262 to 76,518. Of these, 40.7 per cent are now in rural areas as
against less than 22.5 per cent at the time of nationalisation of major banks in 1969. Opening of rural
branches has improved mobilisation of savings in the rural sector. Presently rural deposits account
for about 15 per cent of total deposits. Since bank nationalisation in this country, priority sector credit
has increased from 14.6 per cent of total bank credit to around 33.5 per cent. Over the years
development of banking has been faster in relatively less developed regions of the country, and as a
result regional disparities have declined and the concentration of banking business is now less.
The performance of the banking system in India since the nationalisation of 14 banks is
definitely impressive. The achievements of the banking sector as stated above are, however,
nowhere near meeting the needs of the economy. Narasimhan Committee argued, that the directed
investment and directed credit programmes together with mounting expenditures completely eroded
the profitability of the banks. The new income recognition and provisioning norms, and accounting
procedures and formats which were announced in April 1992 and adopted in 1992-93 revealed the
extent of the deterioration in the profitability of the banks. In 1992-93 while State Bank of India and its
associates, seven other public sector banks and private sector banks as a group declared small
profits the remaining public sector banks and foreign banks reported net losses.
Considering overall situation, it may be argued that since in the later post-nationalisation
phase overall profitability of the banks was either low or even negative and their non-performing loans
both as a percentage of total advances and as a percentage of assets were fairly high, their financial
position was extremely weak. This situation improved only after implementation of various reform
measures during the 1990s.
Commercial banks during the post-nationalisation phase had a societal purpose and thus
directed credit programme was pursued, though it eroded profitability of the commercial banks. Banks
were not regarded as profit maximising institutions. Hence, it is wrong to assess their performance in
the terms of their profitability. Nevertheless in the process of ignoring profitability considerations,
many commercial banks lost their financial viability and by the end of 1980s, it had become clear that
further neglect of profitability considerations could ultimately send banking institutions to their
bankruptcy.
6.6 INDIAN BANKING SYSTEM AND REFORMS
During pre-independence days banking was not much developed and organised. No doubt
modern banking business was initiated by British Agency House set up in Calcutta and Bombay. The
first Bank called the Bank of Hindustan was established in 1770. The R.B.I. was established in India
in 1935. Initially it was established as a Joint Stock Bank with a share capital of Rs. 5 crore. But on
1st January, 1949, R.B.I. was nationalised by the Govt. of India by purchasing all its shares. So the
RBI started working as Central Bank of the country. At the time of freedom India had a fairly
developed banking system with 648 banks having 4819 branches spread all over the country. But
there were some lacunas.
 (1) The banking system was not developed according to the social needs of people. They
were more in favour of industrial sector.
They paid little attention to Agriculture and small scale sectors and exports.
Since independence a serious efforts have been made to develop fairly organized and
meaningful banking system in the country which could attend to the needs of all sections of the
people in the country. After 1947 banking system in country developed not only geographically but
structurally and functionally too.
The organized banking system in India can be classified broadly into three categories, i.e. (a)
Central Bank of India known as R.B.I., (b) Commercial Banks, (c) Co-operative Banks, (d) Later in
1970 Regional Rural Banks came into existence. The Central Bank is the supreme authority in the
country over all the banks in the country. It keeps the reserves of all commercial banks and of co-
operative banks and regional rural banks. Hence it is known as RBI.
Under the Reserve Bank of India Act, 1934 banks were classified into (a) Scheduled banks
and (b) Non-Scheduled Banks. The Scheduled Banks are those which enter in second schedule of
RBI Act, 1934. Such banks are those which have a paid up capital of Reserved of aggregate value of
not less than Rs. 5 lakhs and which satisfy the clause of RBI that they carry out the interest of
depositors. All commercial banks are Scheduled Banks. Non Scheduled Banks are those which have
not been included in the second schedule of R.B.I. Act, 1934.
In 1949 Banking Regulation Act, 1949 was passed. As per this Act R.B.I. was empowered
with extensive regulatory power over the Commercial Banks. In 1950-51, there were 430 Commercial
Banks in India. Their Joint Bank deposits in 1950-51 were equal to Rs. 820 crores and their credits
were equal to Rs. 580 crores. But the number of such banks declined later on due to amalgamation
of small banks with big banks.
There are many fa+ctors responsible for this unprecedented growth.
(i) Expansion of branches.
(ii) Increase in amount of cash with banks.
(iii) The Cash Reserve Ratio (C.R.R) and Statutory Liquiditory Ratio (S.L.R.) were
reduced. This encouraged banks to lend more.
(iv) The congenial atmosphere for economy to grow.
(v) High rates of interest encouraged depositors to deposit more.
6.6.1 Indian Banking System
Bank is an institution that accept deposits from the public, mobilise their savings and keeps
the same under its custody. These deposits are withdrawable by cheque. It lends money to those
who need it and also perform diverse agency functions. It also creates credit. In terms of India
Banking Companies Act : Banking company is one which transacts the business of banking which
means the acceptance for the purpose of lending or investment of deposits of money from the public
repayable on demand or otherwise and withdrawable by cheque, draft order or otherwise.
Indian banking system mainly includes Reserve Bank of India, Commercial Banks,
Cooperative Banks and foreign Banks. These are discussed below :
1. Reserve Bank of India (RBI)
Reserve Bank of India is the Central Bank of our country. It was estimated in 1935 and was
nationalized in 1949. Head office of the Bank is situated in Mumbai. Its main functions are as under :
1) Monopoly to Issue Currency : Issue currency notes and the denomination of rupees
2,5,10,20,50,100,500 and 1000.
2) Regulation of Credit : Reserve Bank announces the credit policy of the country and
also controls the volume of credit through various methods, listed below :
(i) Repo Rate is the rate of which RBI advances loans to other banks.
(ii) Open Market Operations refer to buying and selling securities by RBI in the open
market.
(iii) Cash Reserve Ratio means that all banks in the country must keep a minimum
percentage of their deposits with the Reserve Bank in cash.
(iv) Statutory Liquidity Ratio means that the banks must keep a certain percentage of
their deposits in liquid assets compulsory with themselves.
(v) Regulation of Consumer Credit i.e. how much credit is to be made available for
consumer loans.
(vi) Change in Margin Requirements on Loans : It means the difference between the
amount of loan given by the bank and value of the goods mortgaged.
(vii) Rationing of Credit : It means fixing maximum limit of loan.
3) Banker of Banks : when need be, banks borrow from the Reserve Bank. The latter
supervises and guides them.
4) Banker of the Government: It works on behalf of the Central Government.
5) Regulation of Foreign Exchange: It regulates the amount of foreign exchange in the
country.
Reserve Bank is the central bank of India. In conformity with government policy, it controls the
entire Indian Banking System and formulates as well as regulates Indian monetary policy.
2. Commercial Banks
Commercial banks are the institutions that accept deposits of the people and ordinarily
advance short-term loans. Commercial banks create credit also. In India, such banks alone are called
commercial banks as they are established in accordance with the provisions of Indian Companies
Act, 1913. Commercial Banks are divided into two categories :
A. Scheduled Banks : Scheduled banks are those banks whose minimum paid up
capital and reserve fund amount to Five Lakh Rupees. These banks have to submit details of their
activities to the Reserve Bank every week.
B. Non-Scheduled Banks : Paid-up capital of these banks is less than five lakh Rupees.
These banks are neither listed in the second schedule of the Reserve Bank, nor has the latter any
effective control over them. However, even these banks are required to submit weekly report of their
activities to the Reserve Bank.
 Structure of scheduled banks in India is shown in the following chart.
Chart-I
Scheduled Banks in India (Dec., 2015)

(46)
Public Sector Banks (27+86) Private Sector Banks (40) Cooperative Banks Foreign
Banks PACCBs
DCCBs
SCBs (425
branches)

Nationalised Bank State Bank of India Regional Rural Bank

& its Subsidiaries
(20-1) =19 7 86
Commercial banks include the following:
I. Public Sector Banks
Public Sector banks are those banks which are owned, controlled and managed by the
government. On March 2010, there were 113 public sector banks in India, out of which 86 were
Regional Rural Banks. Public sector banks in India are divided into following these categories.
(i) State Bank of India and Its Subsidiary Banks : State Bank of India is the first public
sector bank of the country. It was established in 1955. In the year 1959, State Bank of
India (subsidiary) Act was passed. By virtue of the provisions of this Act, seven banks
of the erstwhile princely states were made the subsidiary banks of the State Bank of
India. These seven subsidiary banks are :
(1) State Bank of Hyderabad,
(2) State Bank of Bikaner and Jaipur
(3) State Bank of Travancore,
(4) State Bank of Mysore,
(5) State Bank of Patiala,
(6) State Bank of Indore and
(7) State Bank of Saurashtra.
(ii) Nationalized Banks : In 1969, Government of India nationalized 14 banks. Later in
the year 1980, another lot of 6 banks was nationalized. Thus total number of
nationalised banks was twenty. However their number came down to 19 when New
Bank of India was merged with Punjab National Bank.
(iii) Regional Rural Banks : On the recommendation of the Banking Commission (1972),
on October 2, 1975, five Regional Rural Banks were established. Their main function
is to provide financial help to small and marginal farmers and rural workers in order to
develop rural economy. In March 2010, as many as 86 Regional Rural Banks were
 there in the country.
II. Private Sector Banks
Banks whose ownership vets in the private sector are called private sector banks. Since
1991, subsequent to economic reforms, Reserve Bank has been giving liberal sanction to the
establishment of banks in the private sector. As on March 31, 2008, 26 private sector banks were
working in India. The main private sector operating in India are ICICI Bank, HDFC Bank, IDBI Bank,
Axis Bank, Global Trust Bank etc. At present, the number has increased to around forty.
III. Cooperative Banks
Cooperative Banks is an important part of organized banking sector. Under the system,
people join voluntarily on equal basis for the betterment of their economic interest and these are
formed under Agricultural Credit Societies in 1904.
Main Cooperative Banks are as follows :
I. Primary Agricultural Credit Societies (First Tier) : In most of the state, more than ten
persons join to form a cooperative credit society for a village first tier. These societies accept deposits
from their members and provide them short-term and medium-term loans for a village (first tier).
Presently 95,633 primary cooperative credit societies are functioning in the country with membership
of 10 crore farmers.

II. Central Cooperative Banks (Second Tier) : These banks supervise primary
cooperative societies of a district or any part of it (second tier). These banks also provide financial
assistance to such societies. As on March 31, 2010 number of these banks was 371.
III. State Cooperative Bank (Third Tier): Every state has a main cooperative bank (three
tier) that runs all the central cooperative banks in that state. It also lends money to them. As on March
31, 2010 number of state cooperative banks was 31.
IV. Foreign Banks
In the post-reforms era, 34 foreign banks have started their branches in India, e.g. Citi Bank,
Standard Chartered Bank, ABN-Amro Bank, American Express Bank, Honkong and Shanghai
Banking Corporation (HSBC) Bank, Barclays Bank, Royal Bank of Canada, Deutsche Bank, etc.
3. Indian Banking and Credit Growth
Main trends in Indian banking are as follows :
1) Trends in Deposits and Credit of Scheduled Banks
Tremendous growth in bank deposits and bank credit has been witnessed, from year 1971
onwards. In the period from 1970-71 to 1990-91 bank deposits of Scheduled Commercial Banks
increased by more than 32 times. Growth of bank deposits from year 1990-91 to January 2009 is
more than 19 times. The data reflects increase in banking habits in India. In the period, bank credit
has also increased tremendously. Growth in bank deposits and bank credit is shown in table.
Table 4.1 : Deposit and Credit of all Scheduled Commercial Banks
(Amount outstanding in Rs. Crore)
Year Bank Deposits Bank Credit
1950-51 8,20 5,20
1970-71 5,910 4,690
 1990-91 1,92,540 1,16,300
2000-01 9,62,620 5,11,430
Feb. 2011 50,83,852 38,10,445
Source : RBI Bulletin, March 2009
2) Advance to Priority Sector (Commercial Bank)
The total credit extended by Public Sector Banks to priority sector (i.e. agricultural sector,
small Scale industries and other priority areas) has increased. In year 1960, 12 per cent of total credit
was made available to priority sector. While in year 2008, 44.6 per cent of total bank credit was made
available to priority sector. Priority sector includes agriculture, small scale industries, self-employed,
rural craftsmen, retail trade, education loans, housing loans micro, credit etc. Increase in percentage
of bank credit to priority sector promotes achieving the objective of growth with equity, Public Sector
Bank’s advances to priority sector are shown in table 4.2 below.

Table 4.2 : Public Sector Bank’s Advances to Priority Sector

Amounting outstanding in Rs. Crore
Priority Sector 1960 2008 2010
Total Priority Sector Advances 440 6,08,963 8,64,564
Percentage of Priority Sector
Advances to Total Bank 12 44.6 41.7
Advances
(Source : Trends and Progress of Banking in India, Dec. 2008, Eco. Survey 2010-11.
6.7 BANKING REFORMS
After the economic crises of 1991, Narsimham Committee was set up to review the banking
system of India. Under economic reforms of 1991, most of these recommendations were accepted as
reforms. The second phase of banking reforms started with Narsimham Committee of 1998.
6.7.1 Rehabilitation of Public Sector Banks
By 1991 the banking system had become extremely fragile due to the large proportion of Non-
Performing Assets. Overall non-performing assets were as large as 24.8 per cent of the total loan
portfolio in 1994. However, there were significant variations among banks. Even in the cases of
relatively stronger banks, the proportion of Non-Performing Assets was around 8-10 per cent and this
clearly reflected the malaise in the banking system. Further, half of the public sector banks made
huge losses and the net-profit to assets ratio varied between minus 6.8 per cent to plus 0.5 per cent.
A clean up operation was thus urgently required in the mid-1990s. The government decided to
follow the recapitalization route for the restoration of net worth. The recapitalisation requires direct
infusion of capital to the banks from the budget and the Non-Performing Asset are left on their books.
The government did not accept the recommendation of the Narasimhan Committee on the Financial
System for setting up the Asset Reconstruction Fund. The Narasimhan Committee had favoured
creation of such an institution so that banks could transfer their bad assets to it at a discount or at
book value. The enactment of ‘Securitisation, Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002’ enables the setting up of asset management companies for addressing
the problems of non-performing assets of banks and other financial institutions.
The banking system now looks much healthier. The capital adequacy ratio of all the banks
improved. By end-March 2002 only five banks (two public sector banks, two private banks and one
foreign bank) had failed to reach the capital adequacy ratio of 9 per cent. As per the prudential norms
banks were required achieve capital to risk-weighted assets ratio of 9 per cent as on March 31, 2000.
(See Basel III norms & CRAR)
6.7.2 Reduction in the SLR and the CRR
For a long time, the government intervention in India banking sector was in the form of high
SLR and CRR this manner the government pre-empted bank resources below market rates. This
policy benefitted the government as it reduced the cost of borrowing. But it was direct responsible for
eroding the profits of the banks. The Narasimhan Committee on the Financial System, therefore
recommended a reduction in the SLR to 25 per cent by 1996 and an unspecified reduction in the
CRR. The government accepted these recommendations and acted decisively as regards reducing
both the reserve ratios. By law the upper limit of SLR is 40 per cent. However, in 1970, the SLR was
25 per cent. In two decades, starting from this level, it had risen to 38.5 per cent in 1991. The
government has now succeeded in reducing it drastically. The effective SLR from November 8, 2008
on total net demand and time liabilities has been brought down to 24 per cent.
The CRR is an instrument of monetary policy and thus has to be reduced with some caution.
In India, until the government securities market develops sufficiently to enable open market
operations to become the prime instrument monetary policy, the CRR should not be reduced
drastically. Hence, some price in terms of efficiency has to be paid for ensuring effective monetary
control. These considerations notwithstanding, the CRR was reduced to 13 per cent by May 1996. It
was further reduced in stages and brought down to 4.5 per cent on June 14, 2003. Thereafter, it was
increased several times to check liquidity overhang in the system. It was raised to 9.0 per cent on
August 30, 2008. During the second half of the financial year 2008-09 as conditions of slowdown in
the economy appeared, CRR was reduced in stages to inject more liquidity into the system. It was
reduced to 5.0 per cent effective January 17, 2009.
6.7.3 Degradation of Interest Rates
The administered interest rate system in India had over the years become unduly complex
and had acquired features which reduced its ability to promote effective use of credit. This was not
realised in the official circles until its deficiencies were highlighted by the Chakravarty Committee of
the RBI.
On account of societal concerns, a system of concessional interest rates was developed in
this country. The Chakravarty Committee was in favour of providing credit at concessional rates to
target groups under the priority sector lending. The system of multiple concessional interest rates,
which was to begin with adopted due to genuine social concerns, over the years acquired certain
distortions. The political expediency often led the government to follow a populist policy whereby it
made various categories of borrowers eligible for borrowings at concessional rates of interest.
The policy of providing too many bank loans to different favoured groups at multiple
concessional interest rates not only contributed to the deterioration in the profitability of banks, but
also led to inefficient use of credit reflected in uneconomic creation of additional capacity and its
under-utilisation, heavy accumulation of inventories, and poor equality of project preparation and its
inefficient implementation. The Chakravarty Committee had, therefore, favoured a very selective
approach to the use of concessional interest rates. The Narasimhan Committee which ignored
societal concerns entirely argued that the system of Directed Credit programmes based on too many
concessional interest rates has acquired too many distortions and thus it would be desirable to phase
out concessional interest rates.
Under the administered interest rate system, interest rates on both bank deposits and bank
lendings were fixed by the RBI. These interest rates were often fixed ignoring economic rationality.
Let us first consider, the interest rates on deposits. Over the years there has been a phenomenal
growth of fixed deposits with banks, though in very few years even the maximum interest rate on
these deposits provided a positive real rate of return to the depositors. This growth of fixed deposits
at a spectacular rate in recent years has been considered an indicator of their popularity with the
savers.
The system of non-concessional lending rates has lacked flexibility, because there has been
too much regulation of these rates ignoring the changes in the market. The Chakravarty Committee
had recommended that the controlled competition among banks should be allowed implying that
banks should have some freedom to vary their lending rates of interest, subject to some minimum
rate fixed by the RBI and not the maximum. This was considered to be necessary for better allocation
of credit. The Narsimham Committee has forcefully argued that interest rates should be allowed
broadly to be determined by market forces.”
The government accepted this approach with respect to the role of interest rates in the Indian
economy and adopted the necessary measures to deregulate them. However, prior to 1990-91,
progress in this direction was very low. Starting in April 1992, the structure of interest rates has
become much freer and simpler. Now banks are allowed to set interest rates on all term deposits of
maturity of over 30 days and are free to determine the Prime Term Lending Rate for term loans of
three years and above. (Misra & Puri, 2011).
6.7.4 Phasing out of Directed Credit Programme
After nationalisation of commercial banks a strong case was made out in favour of directed
credit on the grounds of both efficiency and equity. In practice, however, the directed credit not only
undermined the profitability of the banks but also failed to promote efficiency and equity. It is claimed
that directed credit had only a mildly positive effect on output and a zero effect on employment in the
agricultural sector. The effects of directed credit on equity are not encouraging. In the agricultural
sector medium and large farmers have pre-empted a large part of such credit and have thus received
large subsidies.
The small-scale industries have received subsidised credit on ‘market failure’ grounds for
more than 25 years. This period is long enough to overcome market failures. Hence, there is no
justification to provide subsidised credit to this sector under the changed circumstances.
The Narasimham Committee which noted that the case for directed credit under existing
conditions is quite weak recommended a phasing out of the directed credit programme. As it would
need some time, some credit support was recommended in the medium term to the priority sector
which has been redefined. Further, the Committee suggested that the credit target for this sector is to
be reduced from 40 per cent to 10 per cent of the aggregate. The government, however, seems to be
lacking political will to implement this recommendation. Over the years large farmers, transporters
and small industrialists have greatly benefited from directed credit programmes. These economic
groups have powerful lobbies and would not allow the government easily to phase out directed credit
programmes.
6.7.5 Promoting Competition
Until 1991 there was little competition in the banking sector. The public sector banks
dominating the banking industry in terms of size of assets, acted as a monolith. The government has
now recognised the need to make banking industry more competitive. It has thus made certain policy
changes such as deregulation of interest rates and dilution of consortium lending requirements.
Moreover, banking has been opened up to the private sector. Response to this policy has been quite
encouraging. Ten new private sector banks have started functioning, out of the thirteen in principle
approvals given for setting up of new banks in the private sector. The RBI has pursued a restrictive
policy as regards allowing the new banks to pen branches. Vijay Joshi and I.M.D. Little are critical of
this policy of the RBI. They are in favour of “allowing new banks (which satisfy the initial entry
restrictions) to expand rapidly to increase competition for existing banks.” (Misra & Puri, 2011).
Various Reforms undertaken thereafter are mentioned below:

6.7.6 Differential Rate of Interest DRI

The differential rate of interest (DRI) is a lending programme launched by the government in
April 1972 which makes it obligatory upon all the public sector banks in India to lend 1 percent of the
total lending of the preceding year to 'the poorest among the poor' at an interest rate of 4 per cent
per annum. The total lending in 2005-06 was Rs. 351 crores.

6.7.7 Priority Sector Lending

All Indian banks have to follow the compulsory target of Priority Sector Lending (PSL). The
priority sector in India are at present the sectors— agriculture, small and medium enterprises (SMEs),
road and water transport, retail trade, small business small housing loans (not more than Rs. 10
lakhs) software industries, self help groups (SHGs), agro-processing, small and marginal farmers,
artisans, distressed urban poor and indebted non-institutional debtors besides the SCs, Sts and other
weaker sections of society. The five minorities, namely the Muslims, Christians, Sikhs, Buddhists
and Parsis have been included under the PSL. The PSL, target must be met by the banks operating
in India in the following ways :

(a) Indian Banks need to lend 40 per cent to the priority sector every year (public sector
as well as private sector banks, both) of their total lending. There is a sub-target also—
18 per cent of the total lending must go to agriculture and 10 per cent of the total
lending or 25 per cent of the priority sector lending (whichever be higher) must be lent
out to the weaker sections. Other areas of the priority sector to be covered in the left
amount, i.e., 12 per cent of the total lending.

(b) Foreign Banks have to fulfil only 32 per cent PSL target which has sub-targets for the
exports (12 per cent) and small and medium enterprises (10 percent). It means they
need to disburse other areas of the PSI, from remaining 10 per cent of their total
lending (lesser burden).

The Committee on Financial System (CFS, 1991) had suggested to immediately cut it down to
10 per cent for all banks and completely phasing out of this policy for the betterment of the banking
industry in particular and the economy in general. The committee also suggested to shuffle the sector
covered under PSL every three years. No follow up has been done from the government except
cutting down PSL target for the foreign banks from 40 per cent to 32 per cent. Meanwhile some new
areas have been added to the PSL, as mentioned below :
A. Revision in PSL

The Reserve Bank of India (RBI) panel on priority sector lending on February 21, 2012
proposed that the target (priority sector) for foreign banks to be increased to 40 per cent of net bank
credit from the current level of 32 per cent with sub-targets of 15 per cent for exports and 15 per cent
for the Medium and Small enterprises (MSE) sector, within which 7 per cent may be earmarked for
micro enterprises. The target of domestic scheduled commercial banks for lending to the priority
sector to be retained at 40 per cent of net bank credit.

B. The Nair Committee, (under the Chairmanship of M. V. Nair, Chairman, Union Bank of India),
has re-examined the existing classification and suggested revised guidelines with regard to priority
sector lending and related issues. Major suggestions by the committee are as given below :

(i) The target for 'agriculture and allied activities’ would be at 18 per cent.

(ii) A sub-target for small and marginal farmers within agriculture and allied activities is
recommended, equivalent to 9 per cent, in stages by 2015-16.

(iii) With the MSE sector a sub-target for micro enterprises equivalent to 7 per cent, which
would also be achieved in stages by 2013-14.

(iv) The loans to housing sector may continue to be under the priority sector : for
construction or purchase of one dwelling unit per individual up to Rs.25 lakh; loans up
to Rs.2 lakh in rural and semi-urban areas and up to Rs.5 lakh in other centres for
repair of damaged dwelling units may be granted under the priority sector.

(v) To encourage construction of dwelling units for Economically Weaker Sections and low
income groups, housing loans granted to these individuals may be included in the
weaker sections category.

(vi) All loans to women under the priority sector may also be counted under loans to
weaker sections.

(vii) The loans to education sector may continue to be under the priority sector. The limit
under the priority sector for loans for studies in India may be increased to Rs. 15 lakh
and Rs.25 lakh in case of studies abroad, from the existing limit of Rs.10 lakh and
Rs.20 lakh, respectively.

(viii) The committee has also recommended allowing non-tradable priority sector lending
certificates on a pilot basis with domestic scheduled commercial banks, foreign banks
and regional rural banks as market players.

6.8 CAPITAL TO RISK WEIGHTED ASSETS RATIO (CRAR) AND BASE NORMS
The Capital to Risk Weighted Assets Ratio or CRAR is the ratio used to protect depositors
and to promote the stability and efficiency of financial systems around the world.

6.8.1 Need to Maintain CAR?

 The basic question which comes to mind is as to why do the banks need to hold capital in the
form of CAR norms? Two reasons which are generally forwarded for the same (the Indian
Development Report 2004-05) are

(i) Bank capital helps to prevent bank failure, which arises in case the bank cannot satisfy
its obligations to pay the depositors and other creditors. The low capital bank has a
negative net worth after the loss in its business. In other words, it turns into insolvent
capital, therefore, acts as a cushion to lessen the chance of the bank turning insolvent.

(ii) The amount of capital affects returns for the owners (equity holders) of the bank.

The RBI introduced the capital-to-risk weighted assets ratio (CRAR) system for the banks
operating in India in 1992 in accordance with the standards of the BIS—as part of the financial sector
reforms. The RBI is a member of the Board of the BIS. As discussed in the previous section. The
financial sector reforms commenced in India in the fiscal 1992-93 after the report submitted by the
Narasimham Committee on financial system. In the coming years the Basel norms were extended to
term-lending institutions, primary dealers and non-banking financial companies (NBFCs), too.

6.8.2 Basel Accords (I, II and III)

The Basel Accords (i.e., Basel I, II and now III) are a set of agreements set by the Basel
(Committee on Bank Supervision (BCBS), which provides recommendations on banking regulations
in regards to capital risk, market risk and operational risk. The purpose of the accords is to ensure
that financial institutions have enough capital on account to meet obligations and absorb unexpected
losses. They are of paramount importance to the banking world and are presently implemented by
over 100 countries across the world. The BIS Accords were the outcome of a long-drawn-out initiative
to strive for greater international uniformity in prudential capital standards for banks' credit risk. The
objectives of the accords could be summed up as:

(i) to strengthen the international banking system;

(ii) to promote convergence of national capital standards; and

(iii) to iron out competitive inequalities among banks across countries of the world.

The Basel Capital Adequacy Risk-related Ratio Agreement of 1988 (i.e., Basel I) was not a
legal document. It was designed to apply to internationally active banks of member countries of the
Basel Committee on Banking Supervision (BCBS) of the BIS (Bank of International Settlements.) at
Basel, Switzerland. But the details of its implementation were left to national discretion.

The first Basel Accord, known as Basel I, was issued in 1988 and focuses on the capital
adequacy of financial institutions. The capital adequacy risk the risk a financial institution faces due to
an unexpected loss), categorises (the assets of financial institution into five risk categories (0 per
cent, 10 per cent, 20 per cent, 50 per cent, 100 per cent). Banks that operate internationally are
required to have a risk weight of 8 per cent or less.

The second Basel Accord, known as Basel II, is to be fully implemented by 2015. It focuses
on three main areas, including minimum capital requirements, supervisory review and market
discipline, which are known as the three pillars. The focus of this accord is to strengthen international
banking requirements as well as to supervise and enforce these requirements.

The RBI guidelines regarding the CAR norms in India have been as given below:

(i) Basel-I norm of the CAR was to be achieved by the Indian banks by March 1997.

(ii) The CAR norm was raised to 9 per cent with effect from March 31, 2000 (Narasimham
Committee-II had recommended to raise it to 10 per cent in I998).

(iii) Foreign banks as well as Indian banks with foreign presence to follow Basel-II norms,
w.e.f. March 31, 2008 while other scheduled commercial banks to follow it not later
than March 31, 2009. The Basel-II norm for the CAR is 12 per cent. (Eco. Survey
2006-07)

The third Basel Accord, known as Basel III is a comprehensive set of reform measures aimed
to strengthen the regulation, supervision and risk management of the banking sector. These
measures aim to:

(i) improve the banking sector’s ability to absorb shocks arising from financial and
economic stress, whatever the source be;

(ii) improve risk management and governance; and

(iii) strengthen banks’ transparency and disclosures.

SAQ & Activity

Q. Define CRR, SLR and Bank Rate and find its present level in India.

_________________________________________________________________________
________________________________________________________________________

________________________________________________________________________

6.8.3 Capital of Banks

The capital of the banks has been classified into three tiers as given below:

Tier 1 Capital: A term used to describe the capital adequacy of a bank—it can absorb loss
without a bank being required to cease trading. This is the core measure of a bank’s financial
strength from a regulator's point of view (this the most reliable form of capital). It consists of the types
of financial capital considered the most reliable and liquid, primarily stockholders' equity and
disclosed reserves of the bank- equity capital can't be redeemed at the option of the holders and
disclosed reserves are the liquid assets available with the bank itself.

Tier 2 Capital: A term used to describe the capital adequacy of a bank—it can absorb losses
in the event of a winding-up and so provides a lesser degree of protection to depositors. Tier II capital
is secondary bank capital (the second most reliable forms of capital). This is related to Tier I Capital.
This capital is a measure of a bank's financial strength from a regulator’s point of view. It consists of
accumulated after-tax surplus of retained earnings, revaluation reserves of fixed assets and long-term
holdings of equity securities, general loan loss reserves, hybrid (debt/equity) capital instruments, and
subordinated debt and undisclosed reserves.

Tier 3 Capital: A term used to describe the capital adequacy of a bank - considered the
tertiary capital of the banks which are used to meet/support market risk, commodities risk and foreign
currency risk. It includes a variety of debt other than Tier 1 and Tier 2 capitals. Tier 3 capital debts
may include a greater number of subordinated issues, undisclosed reserves and general loss
reserves compared to Tier 2 capital. To qualify as Tier 3 capital, assets must be limited to 250 per
cent of a banks Tier 1 capital, be unsecured, subordinated and have a minimum; maturity of two
years.

Disclosed Reserves are the total liquid cash and the SLR assets of the banks that may be
used any time. This way they are part of its core capital (Tier 1). Undisclosed Reserves are the
unpublished or hidden reserves of a financial institution that may not appear on publicly available
documents such as a balance sheet, but are nonetheless real assets, which are accepted as such by
most banking institutions but cannot be used at will by the bank. That is why they are part of its
secondary capital (Tier 2).

6.8.4 Basel III Provisions

The Basel Committee an Bank Supervision (BCBS) issued a comprehension reform package
entitled “Basel III” : A global regulatory framework for more resilient banks and banking system in
December 2010, with the objective to impress the banking sector’s ability to absents shocks
assigning from financial and economic stress. A revised version at thus document (Basel III) was
cause in June 2011.

Basel IIl capital regulations prescribe a minimum regulatory capital of 10.5 per cent for banks
by January 1, 2019. This includes a minimum of 6 per cent Tier I capital, plus a minimum of 2 per
cent Tier II capital, and a 2.5 per cent capital conservation buffer. For this buffer, banks are expected
to set aside profits made during good times so that it can be drawn upon during periods of stress.

The new provisions have defined the capital of the banks in different way - they consider
common equity and retained earnings as the predominant component of capital (as the past) but they
restrict inclusion of items such as deferred tax assets, mortgage-servicing rights and investments in
financial institutions to no more than 15 per cent of the common equity component. These rules aim
to improve the quantity and quality of the capital.

While the key capital ratio has been raised to 7 per cent of risky assets, according to the new
norms, Tier-I capital that includes common equity and perpetual preferred stock will be raised from 2
to 4.5 per cent starting in phases from January 2013 to be completed by January 2015. In addition,
banks as will have to set aside another 2.5 per cent as a contingency for future stress. Banks that fail
to meet the buffer would be unable to pay dividends, though they will not be forced to raise cash.

The new norms are based on renewed focus of central bankers on ‘macro-prudential stability’.
The global financial crisis following die crisis in the US sub-prime market has prompted this change in
approach. The previous set of guidelines, popularly known as Basel II focused on 'macro-prudential
regulation'. In other words, global regulators are now focusing on financial stability of the system as a
whole rather than micro regulation of any individual bank.

Preparing Indian PSBs for Basel Ill Capital Compliance

As capital is a key measure of bank’s capacity for generating loan assets and is essential for
balance sheet expansion, the Government of India (GOI) has regularly invested additional capital in the
PSBs to support their growth and keep them financially sound so as to ensure that the growing credit
needs of the economy are adequately met. A sum of Rs. 12,000 crore was infused in seven PSBs during
2011-12 to enable them to maintain a minimum Tier-I CRAR of 8 per cent and also to increase
shareholding of the GOI in them.

In 2012-13 also, the government has infused capital in PSBs to augment their Tier-I capital so
that they maintain their Tier-I CRAR at a comfortable level and remain compliant with the stricter
capital adequacy norms under Basel III. This will also support internationally active PSBs in their
national and international banking operations undertaken through their subsidiaries and associates.
An amount of Rs. 12,517 crore was allocated by the Government for the year 2012-13 on January 10,
2013.

The High Level Committee to assess the capitalisation of PSBs in the next 10 years, headed
by the Finance Secretary, has recommended various options for funding of PSBs. Given the
budgetary constraints, it may not be feasible for the government to infuse huge sums into the PSBs.
This is why the (Committee has recommended the formation of a ‘non-operating financial company’
(Hold Co) under a special Act of Parliament with the following key objectives :

(i) To act as an investment company for the GoI;

(ii) To hold a major portion of the GoIs holdings in all PSBs;

(iii) To raise long-term debt from domestic and international markets to infuse equity into
the PSBs; and

(iv) To service the debt from within its sources.

Due to weakening of the RRBs also their sponsor banks have been incurring huge NPAs.
RRBs have played a pivotal role in credit delivery in rural areas, particularly to the agriculture sector -
to enhance their outreach and provide banking services more effectively to rural masses, RRBs need
to undertake a continuous process of technology and capital upgradation, With a view to bringing the
CRAR of RRBs up to at least 9 per cent. Dr. K. C. Chakraborty Committee recommended
recapitalisation support to the extent of Rs. 2,200 crore to 40 RRBs in 21 states. Pursuant to the
recommendation of the committee, recapitalisation amount is to be shared by the stakeholders in
proportion to their shareholding in RRBs, i.e., SO per cent central government, 15 per cent concerned
state government, and 35 per cent concerned sponsor banks. The re-capitalisation continued upto
March, 2014.
Note 1 : Of the total Rs. 1.8 Lakh crore capital requirement for Basel III norms, the govt. through
Indradhanush, promised Rs. 70,000 crore. Over a 4 year period we 2018 – 19 and Rs. 1.1 Lakh crore
to be raised from the markets.

Note 2 : RBI introduced Base Rate System from July 1 2010, by replacing the Prime Lending Rate
Rate System from 1 April 2016. Again the Base Rate System has replaced by Marginal cost of Funds
based Lending Rate (MCLR) System from April 1, 2016.

Note 3 : Adopting a model followed in US and UK. The union govt. has constituted monetary policy
committee (MPC) with 6 emembers including 3 outside experts. The preamble in the RBI Act, as
amended by Finance Act, 2016, provides the primary objective of India’s monetary policy : “to
maintain price stability, while keeping in mind the objective of growth.”

6.9 GLOSSARY

 Repos : An instrument of money market, introduced in Dec.1992. Repo allows the banks and
other financial institutions to borrow money from the RBI for short-term (by selling govt. securities
to the RBI). ‘Repo’ is basically an acronym of rate of repurchase.
 Reverse Repos : Also dynamic instrument of money market, introduced in November 1996, In
‘reverse repo’, the banks and financial institutions purchase govt. securities from the RBI
(basically here the RBI is borrowing from the banks and the financial institutions).
The provision of ‘Repo’ and the ‘Reverse Repo’ have been able to sense the liquidity evenness in
the economy as the banks use able to get the required amount of funds out of it, and they can
pack surplus idle funds through it.
 Term Repo and Term Reverse Repo : Going by the recommendations of Urjit Patel Committee,
the Credit, Monetary Policy 2014-15 announced to introduce ‘Term Repo’ and ‘Term Reverse
Repo’ to bring in higher stability’ and better signalling of interest rates across different loan
markets in the economy.
 Cash Management Bills : The GOI in consultation with RBI decided to issue this short term
instrument since Aug. 2009. The CMBs are non-standard and discounted instruments issued for
maturities less than 91 days. CMBs have the generic characters of Treasury Bills (Issued at
discount to the face value). Investment in CMBs is considered as an eligible investment in
governments securities by banks for SLR.
 Mutual Funds (MF) : MF is fund that is created when a large number of investors put in their
money, and is managed by professionally qualified persons with experience in investing in
different asset classes shares bonds, money market instruments like call money, and other asset
such as gold and property.
Types of Assets of MF
i.e. Types of asset class a fund (MF) is
– ‘Diversified Equity Fund’ will invest in large no. of stocks.
– ‘Gilt Fund’ will invest in govt. securities.
– ‘Pharma Fund’ will mainly invest in stock of Companies from pharmaceutical and related
industries.
Fund House : It could be an individual, a company or even bank, which are qualified to sell
MFs, at a price that is fixed through a process approved by SEBI which is based on Net Asset
Value.
 Net Assets Value (NAV) – NAV is total value of investments in a scheme divided by total
number of units issued to investors in the same scheme.
Schemes offered by Mutual Funds : There are three types of schemes offered by Mutual
Funds:

– Open – ended Scheme : An investor can buy or sell as and when they intend to at a NAV–
Based price and NAV charges at daily basis.

– Close – ended Schemes : When Funds launch offers (called New Fund offer in India) these
limits are listed on the stock exchanges, where they are traded an daily bases.

As the name Suggest close ended scheme are managed by MF items for a limited number of
years.

– Exchange – Traded Funds (ETFs) : It is a mix of open–ended and close – ended schemes,
ETFs’ prices usually very close to NAV.

 CRAR : The Capital to Risk Weighted Assets Rates or CRAR is the ratio used to protect
depositors and to promote the stability and efficiency of financial Systems around the world. It
was introduced by RBI in 1992 for the banks operating in India in accordance with the
standards of BIS – as part of the financial sector reforms (introduced in 1992–1993), later
were extended to term lending institutions, primary dealers and NBFCs also.
 Based Accords (I, II & III) : These are a set of agreements by the Basel Committee on Bank
Supervision (BCBS) which provides recommendations on banking regulations with regard to
capital risk, market risk and operational risk. The purpose is to ensure that financial
institutions have enough capital on account to meet obligations and absorb unexpected
losses.
 Basel III. Provisions : RBI gave final guidelines for implementation of Basel – III capital
regulation in India and directed to make it effective from Jan. 1, 2013 in a phased manner.
Basel III norms prescribe a minimum regulatory capital of 10.5 pc for banks by 1st Jan. 2019
(to be fully implemented by this date). It includes a minimum of 6 pc of Tier I capital, plus a
minimum of 2 pc of Tier – II capital, and a 2 p.c. Tier II capital, and a 2.5 pc capital
conservation on buffer.
 MCLR : Prime Lending Rate system was replaced by Marginal cost of Landing Rate System
in April 1, 2016. The main components of MCLR calculation are :
 Operating expresses
 Cost of maintaining CRR
 Marginal cost of funds (after considering interest rates on savings/deposits on cost of
borrowing i.e. short – term borrowing (or repo rate) rates and long borrowing rates).
 Tenor Premium
 Payment Banks : Payments banks can accept deposits up to Rs. 1 Lakh, offer Current and
Savings account deposits, issue debit cards and provide internet banking.
India’s largest private sector lender, ICICI Bank, has launch an e-wallet called “Pockets which
can be everything a payment bank can do “Pockets” is a mobile applications.
As per RBI regulations, the maximum amount a consumer can keep in e-wallet is Rs. 10,000.
  NPAS : The advances give by banks are called assets, which generate income via interests
and instalments. If the instalments. If the instalment is net paid aster the due date, it is called
a bad loan. If it expands beyond 90 days, it is termed as Non – Performing Asset (NPA).
Govt. Infusion (Trainees) of capital in PSBs
Year Infusion for Recapitalising PSUS

12,000 cr. in 7 PSBs

2012 – 13
12, 157 cr in 8 PSBs
2013 – 14
6,990 cr in PSBs based on quality, efficiency & strength [3 Tranahes
2014 – 15 Tell March 2015]

19,950 cr to 13 PSBs (Eco Survey 2015 – 16)

2015 – 16
25, 000 cr proposed (Union Budget 2016–17)
2016 – 17

Source : Singh, Ramesh : Indian Economy, MC Graw Hill Education, New Delhi, 2017
Note : The capotes requirement up to 2018 – 19 is likely to be about Rs. 1,80,000 crore,
(exchding internal generated funds) out of which GOI proposes to makers. Rs. 70,000 cr
available).
6.10 SUMMARY

& Latest

6.10 GLOSSARY

CRAR : The Capital to Risk Weighted Assets Ratio is the ratio used to protect
depositors and to promote the stability and efficiency of financial systems
around the world.
CRR : Cash Reserve Ratio is the ratio of assets a commercial bank keeps with the
RBI.
 SLR : Statutory Liquidity Ratio is the ratio of assets a commercial bank keeps with
itself to meet with day to day transactions.
6.11 REFERENCES

Reddy, Y.V. (2002). Lectures on Economic and Financial Sector Reforms in India. Oxford University
Press New Delhi.

GOI (2007). Economic Survey. Ministry of Finance Govt. of India New Delhi various issues since
2006 – 07

6.12 FURTHER READINGS

 Kapila, Uma (2020). Indian Economy Since Independence. Academic Foundation. New Delhi.
 Banking Sector Reforms: Concept and Challenges (in Hindi). Unacademy.com
6.13 MODEL QUESTIONS
 Explain the need for Nationalising Banks in 1969. Evaluate the performance of Nationalised
Banks of India.
 Critically appraise the Banking Sector Reforms undertaken in the post 1991 period.
----------

Lesson-7
 FINANCIAL MARKET

Structure

7.1 Objectives

7.2 Financial Markets

7.3 Money Market

7.4 Capital Market

7.5 Foreign Exchange Market

7.6 Government Securities Market

7.7 Conclusion

7.8 Summary

7.9 Glossary

7.10 Further Readings

7.11 Model Questions

This lesson deals with the segments of financial market. Four segments are explained, i.e.
Money market, capital market, Foreign exchange market and Government securities market. It covers
the meaning, feature and instruments of each market in detail.

7.1 OBJECTIVES

After going through this lesson, you shall be able to :

 explain the concept of financial market

 discuss the various segment of financial market -
 describe the function and components of money market
 elaborate the nature, importance and types of Capital market
 discuss functions, participants and transactions in foreign exchange market
 explain the features, benefits and instruments of Government securities market
7.2 FINANCIAL MARKETS

Financial market is a place where buyers and sellers participate in the trade of financial assets
such as equities, bonds, currencies, derivatives, etc. Through these financial assets, Financial Market
helps in flowing funds from surplus sector to deficit sector. Financial market helps in mobilization of
funds from the person who has in excess money to those who need it. Thus, financial market acts an
intermediary between the borrowers and lenders of money.

Financial market can be defined as 'a transmission mechanism between investors (or lenders)
and the borrowers (or users) through which transfer of funds is facilitated'. This transmission is done
through individual investors, financial institutions and other intermediaries who are linked through a
formal trading rules and communication network for trading the various financial instruments.

The money market and capital market are the main organized financial markets in India.
While, money market is a market for short-term securities, the capital market is a market for long-term
securities. The money market deals with financial assets and securities which have a maturity period
limited within a year. As for as, the capital market is concerned, the maturity of financial instruments
ranges from one year to indefinite period.

7.2.1 Features of Financial Markets

 It acts an intermediary as helps in transferring of funds from surplus sector to the deficit
sector.
 Large volume of transaction are took place with speed which facilitate in moving financial
resources from one market to another.
 It is dominated by financial intermediaries who take investment and risk decision on the behalf
of their depositors.
 It is highly volatile as faster responsive to situation prevailing in the economy. One can see
such response in the prices of the financial instruments.
 It consists of various segments such as money market, capital market, foreign exchange market,
etc. It is the choice of savers who themselves decide when and where they should invest their
money.
7.2.3 Functions of Financial Markets

By the way of allocating resources in an economy, financial resources perform three important
functions:

1. Facilitates price discovery: Financial Market provide a facility in which buyers and
sellers interact to determine the mutually agreed price. The continual transactions between buyers
and sellers in well-organized financial markets help in discovering the prices of financial assets.

2. Provides liquidity to financial assets : Liquidity refers to convertibility of monetary

assets into money as and when required by the investor. Investors can readily sell their assets in the
financial markets. It is because of this liquidity-providing function of financial market that investors are
motivated to hold financial assets.

3. Reduce the cost of transaction : Two costs associated with transacting -- search
costs and information cost are considerably reduced. While, search cost comprises explicit costs
(expenses incurred on advertising when one wants to buy or sell an asset) and implicit costs (such as
the effort and time one has to put to locate a customer), Information cost refers to cost incurred in
evaluating the investment and merits of financial assets. Financial Market has the ability to set up toll
free hotlines, websites, etc. for their customers through which customers can check up their balances
of their accounts It also allows them to do transactions online, which greatly lowers broker fees. Thus
financial market helps in reducing cost.

4. Facilitates transfer of funds : Financial market facilitates the transfer of funds from
surplus sector to the deficit sector. It is the market where the person having surplus funds with them will
find the person who needs the finance and vice-versa. Thus, it acts as intermediary between the
investor and user of the funds. Investor by investing his surplus fund will also earn interest on the
invested amount.

5. Cater needs of the various individuals : Financial market helps in catering needs of
various individuals, firms and institutions. It is a place where one gets finance for every need whether
it is needed for investment purpose or for payment of debts or for any other purpose. Thus Financial
needs of all people satisfied in this market.
Segments of Financial Market

7.3 MONEY MARKET : Structure and Features

Money market refers to a market for short term financial assets that are close substitutes for
money. It is a market for overnight to short term funds where the instruments having high liquidity and
very short term maturities, generally for a period of less than or equal to 365 days are traded. Money
market is treated as a safe place because of its highly liquid nature of securities and their short term
maturities. Short term obligations such as commercial papers, treasury bills, bankers' acceptances,
etc. are bought and sold in the money market. Commercial banks are the leading players in the
money market.

According to the RBI, "The money market is the centre for dealing mainly of short character,
in monetary assets; it meets the short term requirements of borrowers and provides liquidity or cash
to the lenders. It is a place where short term surplus investible funds at the disposal of financial and
other institutions and individuals are bid by borrowers, again comprising institutions and individuals
and also by the government."

Money Market

Features Functions Instruments

7.3.1 Characteristics/Features of Money Market

• It is an inter-bank market which matches the deficit and surplus of banks.

• The market secures short term requirements of banks and financial institutions.

• It is a wholesale market of short term debt instruments.

• The Central Bank occupies a strategic position in the money market. Other players are :
Discount and Finance House of India (DFHI), mutual funds, banks, non-banking finance
companies (NBFCs), state governments, corporate investor, provident funds, Primary
dealers, public sector undertaking (PSUs), Securities Trading Corporation of India
(STCI), non-resident Indians and overseas corporate bodies.

• It is a market wherein the demand and supply of money shape the market.

7.3.2 Money Market Instruments

The instruments traded in money market are:

i) Treasury bills (T- bills)

ii) Call/notice money market

iii) Commercial paper

iv) Certificate of deposits

v) Commercial bills

i) Treasury bills

These are short term instruments issued by the Reserve Bank on behalf of the government to
tide over short term liquidity shortfalls. It is used by the government to raise short term funds to bridge
seasonal or temporary deficit occurred due to excess of expenditure over revenue. They form the
most important segment of the money market not only in India but all over the world as well.

The Reserve Bank of India, mutual funds companies, banks, financial institutions, satellite
dealers, primary dealers, provident funds, foreign banks, corporate and foreign institutional investors
are all participants in the T - bills market. The state governments can invest their surplus funds as
non-competitive bidders in T-bills of all maturities.

ii) Call/notice Money Market

Call money market is that part of the money market where day-to-day surplus funds, mostly of
banks, are traded. Since its inception in 1955-56, it is a key segment of the Indian money market and
has registered a tremendous growth in volume of activity.

It is a market for very short-term funds repayable on demand and having a maturity period
varying from one day to a fortnight. When money is borrowed or lent for a day, it is known as call
money. For this purpose, Intervening holidays and/or Sundays are excluded and money is lent
without any collateral security. The call money market is a highly liquid market as the liquidity being
exceeded only by cash. This market is extremely volatile and highly risky.

iii) Commercial Paper

A commercial paper is an unsecured short term promissory note, negotiable and transferable by
endorsement and delivery with a fixed maturity period. It is generally issued at a discount by highly
rated and leading creditworthy corporate to meet their working capital requirements. A commercial
paper, depending upon the issuing company, is also known as industrial paper, finance paper, or
corporate paper. A commercial paper is usually privately placed with investors, either through banks or
merchant bankers. It is essential for corporate to obtain credit rating of P 2 from credit rating agencies
for issuing Commercial Paper (CP). The period of CP is 15 days to 365 days from the date of issue and
is issued at discount.

iv) Certificates of Deposit

A certificate of deposit is a document of title to depositors of funds that remain on deposit at the
bank for specified period at a specified rate of interest. They are unsecured, negotiable short- term
instruments in bearer form. They are introduced in June 1989 and only scheduled commercial banks
were allowed to issue Certificates of deposit initially. It was only in 1992· that financial institutions were
permitted to issue certificates of deposits. The term of a CD generally ranges from one month to five
years.

v) Commercial Bills

According to the Indian Negotiable Instruments Act, 1881, bill of exchange is a written
instrument containing an unconditional order, signed by the maker, directing to pay a certain amount
of money only to a particular person, or to the bearer of the instrument. Bills of exchange are
negotiable instruments drawn by the seller (drawer) on the buyer (drawee) or the value of the goods
delivered to him. Such bills are called trade bills. When trade bills are accepted by commercial banks,
they are called commercial bills. Thus, a commercial bill enhances the liability to make payment on a
fixed date when goods are bought on credit. They are short term, negotiable, and self-liquidating
instrument with low risk. In India, banks mainly provide the funds for working capital requirement of
business firms through cash-credits/overdraft and purchase/discounting of commercial bills.

The bank discounts this bill by keeping a certain margin and credits the proceeds and when
bank needs money then they can also get such bills rediscounted by financial institutions such as
UTI, LIC, GIC, ICICI and IRBI. The maturity period of the bills varies from 30 days, 60 days or 90
days, depending on the credit extended in the industry.

7.4 CAPITAL MARKET

The institutional arrangements which facilitate the borrowing and lending of long term funds
are known as capital market. It transforms the individual savings to industrial and commercial
investments through new capital issues and new public loans floated by government/semi-
government bodies and public limited companies. A capital market is not a compact unit, but a highly
decentralized system made up of three major parts: (1) stock market, (2) bond market, and (3) money
market. It also works as an exchange for trading existing financial claims on capital in the form of
shares. The capital market is mainly regulated by SEBI (securities Exchange Board of India) and
Mutual funds companies, Life insurance Company, General insurance company, Foreign institutional
investors, corporate bodies and individuals are the main participants of this market. Capital market
can be divided into two segments on the basis of nature of issuance of securities: Primary market and
secondary market. The primary market deals in issue of new securities while the secondary market
deals in trading of existing securities.

Capital Market

Nature Types Functions Features

7.4.1 Nature of Capital Market

The nature of capital market is understood with the following:

1) It consists of a number of individuals and institutions that channelize the supply and
demand for long term capital claims.

2) It has three important components, namely, the suppliers of funds, the borrowers and the
intermediaries who deal with the suppliers on the one hand and the borrower on the
other.

3) It not only deals with the issue of new claims on capital, but also deals in existing financial
claims.

4) The efficient working of the capital market is the marketability of securities since investors
would be reluctant to make loans if their claims are not easily disposed of.

7.4.2 Functions of Capital Market

Capital Markets is a place where buyers and sellers of securities can enter into transactions to
purchase and sell financial instruments like shares, bonds, debentures etc. Further, it performs an
important role of enabling corporate houses, entrepreneurs to raise resources for their business
ventures through public issues. Transfer of resources from those having idle resources (investors) to
those having a need for them (corporate houses) is most efficiently achieved through the capital
market. Stated formally, capital market provides channels for reallocation of savings to investments
and entrepreneurship. Some of the functions of capital market are as follows :

1. Mobilization of savings and acceleration of capital formation

 In developing countries like India, the paucity of capital resources and increasing demand for
investments by industrial organizations and governments, the importance of the capital market is self
evident. In this market, various types of securities help mobilize savings from various sections of the
country. The twin features of reasonable return and liquidity in the capital market are definite
incentives to the people for investment in securities. These incentives accelerate the capital formation
in the country.

2. Promotion of industrial growth

The capital market is a central market through which resources are transferred to the
industrial sector of the economy. This types of institution encouraged people to invest their savings in
productive channels. Thus capital market stimulates industrial growth and economic development of
the country by mobilizing funds for investment in the corporate sector.

3. Raising long-term capital

The existence of a capital market enables companies to raise permanent capital. The
investors cannot commit their funds for a permanent period but companies require funds
permanently. The stock exchange resolves this clash of interests by offering an opportunity to
investors to buy or sell their securities while permanent capital with the company remains unaffected.
It is because those securities do change the hands as company funds cannot be withdrawn on the
option of the investors. Hence, company funds are permanently invested in the business operations.

4. Proper channelization of funds

An efficient capital market not only creates liquidity through its pricing mechanism but also
functions to allocate resources to the most efficient industries. The prevailing market price of a
security and relative yield are the guiding factors for the people to channelize their funds in a
particular company. This ensures effective utilisation of funds in the interest of economy.

5. Provision of a variety of services

The financial institutions, functioning in the capital market, provide a variety of services, the
more important ones being the following:

(i) Grant of long-term and medium-term loans to entrepreneurs to enable them to establish,
expand or modernize business units;

(ii) Provision of underwriting facilities;

(iii) Assistance in the promotion of companies (this function is done by the developing banks
like IDBI);

(iv) Participation in equity capital so as to keep the companies demutualised.

(v) Expert advice 'on management of investment in securities i.e. portfolio management
services.

7.4.3 Types of Capital Market

 As mentioned earlier, the capital market can be divided into two markets on the basis of
issuance of securities:

a) Primary Markets

b) Secondary Markets.

a) Primary Market

The primary market provides the channel for creation and sale of new securities. These
securities are issued by public limited companies/ corporate entities. Through the public issue or
private placement, the resources are mobilized in this market. Public issue refers to where anybody
can subscribe to the issue while private placement refers to where shared are issued to a selected
group of persons.

Features of a primary market are:

• This is the market where the securities are offered first time in the market. Therefore it is
also called New Issue Market (NIM)

• Primary issues are made by the company directly to investors for the first time as per the
guidelines under the various rules and bye laws governing such issues.

• The company receives the money and issue new security certificates to the investors.

• Such issues are used by companies for the purpose of setting up new business or for
expanding or modernizing the existing business units.

• It performs the important function of facilitating capital formation in the economy.

Raising Capital in the Primary Market

There are three ways in which a company raises capital in the primary market :
– Public Issue : A public offer is open for all Indian citizens, the broad – based method of raising
capital and the most prestigious too. The Reliance Industries Ltd. Is e biggest company in this
category.
– Right issue : It refers raising capital from the existing shareholders of a company.
– Private Placement : It means raising capital by selling shares to a select group of investors,
usually financial institutions (FIs) but may be to individuals also.
b) Secondary Market

The secondary market is the market where the securities that are already issued are traded in
this market. Such type of securities help investors in adjusting their holdings in response to changes
in their assessment of risks and returns. The instruments under secondary market can be operated
through any of the following mediums:

• the over-the-counter (OTC) rnarket and;

• the exchange-traded market.

 OTC markets are informal markets where trades are negotiated between the two parties.
Most of the trades in the government securities are in the OTC market.

The other option is to trade using the infrastructure provided by the stock exchanges. The
secondary market is a market in which existing securities are resold or traded. This market is also
known as the stock market.

In India, the secondary market consists of recognized stock exchanges operating under rules,
bye laws and regulations of regulators.

Functions of the Secondary Market:

1) To provide liquidity and marketability of the outstanding equity and debt instruments/
securities.

2) To mobilize funds from unproductive channel to productive channel and thus contribute to
economic growth.

3) To provide safety and fair dealing to investors' interest by building investor protection
funds.

4) To encourage companies to improve their performance since the market price at the
stock exchanges reflects the performance of a company and this market price is readily
available to investors.

7.5 THE FOREIGN EXCHANGE MARKET

The foreign exchange market is a market through which the currency of one country is
exchanged for that of another country, the rate of exchange between currencies is determined, and
foreign exchange transactions are physically completed. A foreign exchange transaction is an
agreement between a buyer and a seller stating that a given amount of one currency is to be
delivered for some other currency for a specified rate.

Presently, the foreign exchange (FX) market is one of the largest and most liquid financial
markets in the world, and includes trading between large banks, central banks, currency speculators,
corporations, governments, and other financial institutions.

Base Currency / Terms Currency : In foreign exchange markets, the base currency is the first
currency in a currency pair. The second currency is called as 'the terms currency. Exchange rates are
quoted in per unit of the base currency. e.g. the expression Dollar - Rupee, tells you that the Dollar is
being quoted in terms of the Rupee. The Dollar is the base currency and the Rupee is the terms
currency.

Exchange rates are constantly changing, which means that the value of one currency in terms
of the other is constantly in flux. Changes in rates are expressed as strengthening or weakening of
one currency vis-a-vis the second currency. Whenever the base currency buys more of the terms
currency, the base currency has strengthened / appreciated and the terms currency has weakened /
depreciated. Example: If Dollar - Rupee moved from 63.00 to 63.25, it signifies that the Dollar has
appreciated and the Rupee has depreciated.
 The bulk of the Foreign exchange market is OTC-over the counter trade i.e. trades are
affected on telephone/telex/swift through electronic dealing systems or intermediate brokers and not
on the floor of an exchange.

7.5.1 Functions of the Foreign Exchange Market

A mechanism by which a person or firm transfers purchasing power from one country to
another, minimizes exposure to foreign exchange risk and obtains/provides credit for international
trade transactions, is called a Foreign Exchange Market. Following are the functions of the foreign
exchange market:

a) Transfer of Purchasing Power:

Globalization has made the international trade easier. It has brought business entities at a
common platform in order to have mutually benefitted transactions all over the world. These
international transactions usually involve parties in countries with different national currencies and so
transfer of purchasing power is of vital importance. While, each party wants to deal in its own
currency, the transaction can be invoiced in only one of the currencies.

b) Provision of Credit:

Foreign trade involves trade between two countries where the payment is made in the form of
exporter country currency or the base currency as demanded by the exporter. As the movement of
goods between countries takes time, thus, for the time being, Inventory in transit must be financed
even payment deferral may be involved as per the terms of trade agreement. Thus foreign exchange
market provides credit to exporter.

c) Minimizing Foreign Exchange Risk:

Foreign exchange risk is a risk where loss due to changes in currency rates is derived. It can
be minimized by taking action well in time through hedging technique. Hedging facilities mutate the
foreign exchange risk by transferring such risk to someone else who is willingly agrees to bear it for
some consideration.

7.5.2 Participants in FX Market

1) Non Bank entities i.e. the customers who wish to exchange currencies to meet
contractual obligations i.e. arising out of exports, imports, remittances etc.

2) Commercial Banks which exchange currencies to meet client requirements.

3) Central Banks, which in most of the countries are charged with the responsibility of
maintaining the external value of the currency of the country. Apart from the intervention,
central banks deal in foreign exchange market for the purpose of Exchange Rate
Management and Foreign Exchange Reserve Management.

Authorised Foreign Exchangers:

 Apart from the users of the market i.e. the customers, other entities/institutions who wish to
deal in the Indian foreign exchange market require registrations as per the guidelines issued under
Foreign Exchange Management Act 2000 (FEMA) and Reserve Bank of India (RBI):

• Restricted Money Changers (RMC)

This is a license issued by RBI which permits them to only buy foreign exchange in the form of
Currency Notes and Travelers Cheque. Normally departmental stores, and star hotels which witness
heavy movement of foreign tourists obtain these licenses.

• Full Fledged Money Changers (FFMC)

This is a license issued by RBI which permits them to buy and sell foreign exchange in the
form of Currency Notes and Travelers cheque. Normally, travel agencies obtain these licenses to
offer single window service to the travel sector.

• Authorised Dealers (AD)

This is a license issued by the Reserve Bank of India, generally to Banks and Financial
institutions authorizing to deal in all types of foreign exchange i.e. Imports, Exports, Remittances, and
Travel Sector etc. After introduction of FEMA in 2000, all the above categories are referred to as
Authorised Persons (AP) by RBI.

• Brokers

Brokers wishing to operate in the Indian Foreign exchange Market need to get themselves an
accredited with FEDAI (Foreign Exchange Dealers Association of India).

7.5.3 Transactions in the Foreign Exchange Market

Transactions in foreign exchange market can be completed on forward, spot or swap basis.

a) Spot Transactions:

Foreign exchange spot trading is buying one currency with a different currency for immediate
delivery. The standard settlement convention for Foreign Exchange Spot trades is T+2 days, i.e., two
business days from the date of trade execution. Rates for days other than spot are always calculated
with reference to spot rate.

b) Outright Forward Transactions:

A specified amount of one currency is delivered for a specified amount of another currency at
a future value date in case of forward transaction. The exchange rate at the value date is decided at
the time of the agreement. However, the payment and delivery are not required till maturity. While,
forward exchange rates are usually stated for value dates of one, two, three, six, and twelve months,
the actual contracts can be arranged for other lengths too. Nine percent of all foreign exchange
transactions are outright forward transactions.

c) Swap Transactions:

A forward-type financial derivative contract in which two counterparties agree to exchange

cash flows determined with reference to prices of, say, currencies or interest rates, according to
predetermined rules. At inception, this instrument typically has zero market value, but as market
prices change the swap acquires value.
Activity
Q. Define Primary and Secondary Market.
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7.6 GOVERNMENT SECURITY MARKET

Regarded as the backbone of fixed income securities, this market provides the benchmark
yield and imparts liquidity to other financial markets. It is this market that is at the core of financial
markets in most countries, as it deals with tradeable debt instruments issued by the Government for
meeting its financing requirements. The government securities market also acts as a channel for
integration of various segments of the domestic financial market and helps in establishing inter-
linkages between the domestic and external financial markets. Furthermore, for development of the
corporate debt market, the existence of an efficient government securities market is seen as an
important precursor.

For starters, it serves as the backbone of fixed income markets through the creation of risk-
free benchmarks of a sovereign borrower. Also, for various segments of the financial government it
acts as a channel of integration.

The government securities are offering virtually credit risk-free highly liquid financial
instruments. Therefore, the market participants are more than willing to transact and take positions in
this market lending the feature of liquidity to the instruments. Many dealers use government securities
as a major hedging tool against interest rate risk and as underlying assets and collateral for related
markets, such as futures, repo, and options.

7.6.1 Players in the Government Securities Market

Commercial banks, primary dealers and institutional investors like insurance companies
are amongst the main players in the government securities. Here, while primary dealers play an
important role as market makers in the government securities market, other participants include
mutual funds, co-operative banks, provident and pension funds and regional rural banks. As
far as Foreign Institutional Investors (FIIs) are concerned, they are allowed to participate in
government securities market within the quantitative limits prescribed from time to time by the
government. Corporate houses too buy/sell the government securities to manage their overall
portfolio risk.

7.6.2 Instrument of Government Securities

In India, Government Securities are issued by the Central Government and State
Governments. Through these securities Government can raise money to finance the creation of new
infrastructure as well as to meet their current cash needs. Since these are issued by the government,
the risk of default is minimal and thus interest rates on these securities often serve as a benchmark
for the level of interest rates in the economy. These securities may have maturities ranging from five
to twenty years. These are fixed income securities, which pay interest every six months.

The Reserve Bank of India manages the issues of such securities. These securities are sold
in the primary market mainly through the auction mechanism. The biggest investors are commercial
banks who invest in Government Securities to meet the regulatory requirement to maintain a certain
percentage of Statutory Liquidity Ratio (SLR) as well as an investment vehicle. The Government of
India also borrows short term funds for up to one year. This is through the issue of Treasury Bills
which are sold at a discount to the face value and redeemed at the full face value.

Treasury Bills

Those are short term instruments issued by the Reserve Bank on behalf of the government to
tide over short term liquidity shortfalls. It is used by the government to raise short term funds to bridge
seasonal or temporary deficit occurred due to excess of expenditure over revenue. They form the
most important segment of the money market not only in India but all over the world as well.

Features of T-Bills:

1. They are negotiable securities.

2. They have high liquidity as Commercial banks, DFHI, STCI and other institutions provide
ready market for these bills.

3. There is zero default risk as these bills are guaranteed by the Government.

4. They have low transaction cost, an assured yield, and are eligible for inclusion in the
securities for SLR purposes.

5. These are readily available throughout the week at the rates announced daily.

6. There are 91 day and 364-day T-bills in vogue at present. The 91-day T-bills are
auctioned by RBI every Friday and the 364-day T-bills every alternate Wednesday (that
is, the Wednesday preceding the reporting Friday).

• 91-Days Treasury Bills

This is the oldest type of treasury bill which is issued by the Central Bank on behalf of
Government for three months at either a discount or face value, at a competitive auction on a weekly
basis.

At a discount means the instrument is sold to an investor, at below the face value and then
redeemed at maturity at the full face value. The difference between the discounted price and the face
value determines the yield/ interest earned. The yield on 91-day Treasury bills is the average
discount rate.

In India there were two types of 91-Days treasury bills: Ordinary and ad hoc. Ordinary Bills are
issue to the public and to the RBI to meet temporary government's short term requirement for .the
funds. On the other hand, ad hoc bills are created in favour of RBI. Ad hoc bills were introduced in
1937.

• 182-Days Treasury Bills

These bills were introduced in November 1986 to provide more outlets for temporary surplus
funds. These bills are issued by the Central Bank, on behalf of the Government for six months at
either a discount or face value, at a competitive auction on a weekly basis. These bills also provide
an additional avenue to raise financial resources by the government for its budgetary expenditure.

These bills were discontinued to be issued and traded from 16 October 1992.

Again in 1999-2000, these bills were reintroduced to enable the development of a market for
government securities. These bills were not allowed to be rediscounted with RBI they were offered for
sale on an auction basis. The bill was again discontinued in May 2001 but it was reintroduced again
in April 2005 with a notified amount of Rs 500 crore.

• 364-Days Treasury Bills

These bills are issued by the Central Bank, on behalf of the Government for one year at either
a discount or face value, at a competitive auction on a weekly basis. The authorities introduced 364-
Days treasury bills to replace the 182-Days T-bills in April 1992.

• 14-Days Treasury Bills .

These bills are issued by the Central Bank on behalf of Government for 14 days at either a
discount or face value, at a competitive auction on a weekly basis. These bills are of two types: one
introduced in April 1997 ih place of 91- Days T- bills known as Intermediary treasury bill (ITB) and the
second on May 1997 to facilitate the cash management requirements of various segments of the
economy.

7.7 CONCLUSION

After reading this lesson, one can conclude that:

The reason to study various segments of financial market lies in the fact that they all work in-
tune with each other. Any imbalance among segment(s) may impact driving forces of economy in
isolation as well as a whole. When short-term money supply mechanism lay the path for long-term
finances meant for capital formation equally supported by favorable global trade, it may be referred to
a dream come true situation for the economy. Then, the only challenge will be to sustain the
momentum in the coming times.

7.8 SUMMARY
Financial Market

Features and Functions

 1. 2. 3. 4.
Money Market Capital Market Foreign Govt. Security
Exchange Market
Instruments Nature Functions Market
Features Players
Types Functions
Instruments
Participants
Transactions

7.9 GLOSSARY

• Securities Trading Corporation of India (STCI) : STCI Finance Ltd. (formerly known as
Securities Trading Corporation of India Limited), is a systemically important non-deposit taking
NBFC registered with Reserve Bank of India. STCI Finance Limited was promoted by Reserve
Bank of India in May 1994 with the objective of fostering an active secondary market in
Government of India Securities and Public Sector bonds.

• Working Capital : It represents operating liquidity available to a business, organization or other

entity, including governmental entity. Along with fixed assets such as plant and equipment,
working capital is considered a part of operating capital. It is calculated as current assets minus
current liabilities.

• Foreign Exchange Management Act (FEMA) : The Foreign Exchange Management Act
(FEMA) is a law "to consolidate and amend the law relating to foreign exchange with the
objective of facilitating external trade and payments and for promoting the orderly development
and maintenance of foreign exchange market in India". It was passed in the winter session of
Parliament in 1999, replacing the Foreign Exchange Regulation Act (FERA).

• Foreign Institutional Investor (FII) : These are organizations which pool large sums of money
and invest those sums in securities, real property and other investment assets. They can also
include operating companies which decide to invest their profits to some degree in these types of
assets.
7.10 FURTHER READINGS

• Weithers, Tim (2001). “Foreign Exchange: A Practical Guide to the FX Markets”. Wiley
Finance.

• Choudhry, Moorad (2001). "Bond and Money Markets; Strategy, Trading Analysis”.
Ready Text Publishing Services.

• Walmsley, Julian, (Second Edition). “The Foreign Exchange and Money Markets Guide.
Wiley Finance.

• L. M. Bhole and J. Mahukud (2011). Financial Institutions and Markets. Tata McGraw Hill.
5th edition.
7.11 MODEL QUESTIONS
1. What do you mean by financial markets? Explain its various functions.
2. Explain the various segments of financial markets in India.

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 Lesson-8

CAPITAL MARKET IN INDIA-I

[HISTORY, FACTORS UNDERLYING GROWTH AND SEBI]

Structure

8.0 Objectives

8.1 Introduction

8.2 Capital Market

8.3 Indian Capital Market : An Introduction

8.4 History of Indian Capital Market

8.5 Segments of Indian Capital Market

8.6 Types of Capital Market

8.7 Secondary Market and Stock Exchange

8.8 Reforms in Indian Capital Market

8.9 Summary

8.10 Glossary

8.11 References

8.12 Further Readings

8.13 Model Questions

8.0 OBJECTIVES

After going through this lesson, you shall be able to :

 discuss the concept of capital market and its function, reform and structure
 explain the segments of capital market, i.e. primary market and secondary market
 describe the derivative market and its instruments
 elaborate upon the equity market and debt market
8.1 INTRODUCTION

This lesson starts with the capital market. Under it, history, reforms and structure of capital
market have been discussed. After that both primary market and secondary market has been
explained. Book building process has also been discussed in detail. Later on, cash market, derivative
market, equity and debt market has also been explained. Moreover instruments of derivative and debt
market have also been discussed in detail.

8.2 CAPITAL MARKET

The institutional arrangements which facilitate the borrowing and lending of long term funds are
known as capital market. It transforms the individual savings to industrial and commercial
investments through new capital issues and new public loans floated by government/semi-
government bodies and public limited companies. It also works as an exchange for trading
existing financial claims on capital in the form of shares. A capital market is not a compact unit, but a
highly decentralized system made up of three major parts on the basis of nature of financial
instruments:
1. Equity (stock) market: A market where financial instruments having claims on the ownership
of the company or securities having preference in terms of payment of dividend and capital
(preference shares) are dealt.
2. Debt market: A market where financial instrument of debt nature are dealt. It may include
issuance of debentures, corporate bonds or any other sort of loan instrument which may or
may not be secured/backed by the company assets. The only difference between equity and
debt market is that of nature of securities to be issued. The former market deals in equity
instruments while the later one deals in debt instruments
3. Derivatives market: A market created for minimizing the risk inherent in dealing of financial
securities popularly known as hedging. This market derives its value/price from underlying
securities under the contract to be dealt in future at a certain date.
The capital market is mainly regulated by SEBI (securities Exchange Board of India) and Mutual
funds companies, Life insurance Company, General insurance company, Foreign institutional
investors, corporate bodies and individuals are the main participants of this market. Capital market
can be divided into two segments: Primary market and secondary market. The primary market deals
in issue of new securities while the secondary market deals in trading of existing securities.
8.2.1 Nature of capital market
The nature of capital market is as follows:
1. It consists of a number of individuals and institutions that channelize the supply and
demand for long term capital and claims on capital.
2. It has three important components, namely, the suppliers of funds, the borrowers and the
intermediaries who deal with the lenders on the one hand and the borrower on the other.
3. The individuals, corporate, institutional investors and the government are the main
suppliers of funds to the capital market. The demand for capital comes mostly from
agriculture, industry, trade and the government.
4. It not only deals with the issue of new claims on capital, but also deals in existing claims
5. The efficient working of the capital market is the marketability of securities since investors
would be reluctant to make loans if their claims are not easily disposed of.
8.2.2 Functions of capital market
Capital Market is a place where buyers and sellers of securities can enter into transactions to
purchase and sell shares, bonds, debentures etc. Further, it performs an important role of enabling
corporate houses, entrepreneurs to raise resources for their companies and business ventures
through public issues. Transfer of resources from those having idle resources (investors) to others
who have a need for them (corporate houses) is most efficiently achieved through the capital
market. Stated formally, capital market provides channels for reallocation of savings to investments
and entrepreneurship. Some of the functions of capital market are as follows:
1. Mobilization of savings and acceleration of capital formation
In developing countries like India, plagued by the paucity of resources and increasing demand
for investments by industrial organizations and governments, the importance of the capital market
is self evident. In this market, various types of securities help mobilize savings from various
sections of the population. The twin features of reasonable return and liquidity in the stock
exchange are definite incentives to the people to invest in securities. This accelerates the capital
formation in the country.

2. Promotion of industrial growth

The capital market is a central market through which resources are transferred to the industrial
sector of the economy. The existence of such an institution encourages the people to invest in
productive channels rather than in the unproductive sectors like real estate, bullion etc. Thus, it
stimulates industrial growth and economic development of the country by mobilizing funds for
investment in the corporate sector.

3. Raising long-term capital

The existence of a capital market enables companies to raise permanent capital. The investors
cannot commit their funds for a permanent period but companies require funds permanently. The
stock exchange resolves this clash of interests by offering an opportunity to investors to buy or sell
their securities while permanent capital with the company remains unaffected.

4. Proper channelization of funds

An efficient capital market not only creates liquidity through its pricing mechanism but also
functions to allocate resources to the most efficient industries. The prevailing market price of a
security and relative yield are the guiding factors for the people to channelize their funds in a
particular company. This ensures effective utilization of funds in the public interest.

5. Provision of a variety of services

The financial institutions functioning in the capital market provide a variety of services, the more
important ones being the following:

(i) Grant of long-term and medium-term loans to entrepreneurs to enable them to establish,
expand or modernize business units;

(ii) Provision of underwriting facilities;

(iii) Assistance in the promotion of companies (this function is done by the developing banks
like IDBI);

(iv) Participation in equity capital

(v) Expert advice on management of investment in industrial securities.

8.3 INDIAN CAPITAL MARKET : AN INTRODUCTION

The long-term financial market of an economy is known as the 'capital market'. This market
makes it possible to raise long-term money (Capital, i.e. for a period of minimum 365 days and
above. Creation of productive assets is not possible without a string capital market - the market
gained more importance once most of the economics in the world started industralising. Across the
world, banks emerged as the first and the foremost segment of the capital market. In coming times
many other segments got added to it -

(i) Insurance industry

(ii) mutual funds, and

(iii) The most attractive and vibrant, the security stock market.

Organised development of capital market together needs putting in place the right regulatory
framework for it. For strong growth prospects in an economy, presence of a strong and vibrant capital
market is essential.

The capital market ct Indian has been stronger and better since India opted 'industry' as its
prime moving force. The first challenge was to raise long term funds for industrial establishment and
their expansion. As banks in India were weak, small and geographically unevenly distributed they
were not in a position to play the pivotal role they played in case of the industrialising Western
economies. This is why the government decided to set up 'financial institutions' which could play the
role of banks (till-banks gain strength and presence) and carry on the responsibilities of 'project
financing'.

8.3.1 Project Financing

After Independence, India went for intensive industrialisation to achieve rapid growth and
development. To this end, the main responsibility was given to the Public Sector Undertakings
(PSUs). For industrialisation we require capital, technology and labour, all being typically difficult to
manage in the case of India. For capital requirements, the government decided to depend upon
internal and external sources and the government decided to setup financial instructions (Fis). Trough
India was having banks, but due to tow saving rate and lower deposits with them, the upcoming
industries could not be financed through them. The main borrowers for industrial development were
the PSUs. To support die capital requirement of the 'projects' of the public sector industries, the
government came up with different types of financial institutions in the coming years. The industrial
financing supported by these financial institutions was known a - project financing' in India. Over the
time, Indian capital market started to have the different segment as discussed in next sections.

8.4 HISTORY OF THE INDIAN CAPITAL MARKET

The history of the capital market in India dates back to the eighteenth century when East India
Company securities were traded in the country. Until the end of the nineteenth century securities
trading was unorganized and the main trading centers were Bombay (now Mumbai) and Calcutta
(now Kolkata). Of the two, Bombay was the chief trading center wherein bank shares were the major
trading stock during the American Civil War (1860-61). As a result of the war, cotton supply from
United States to Europe was stopped; Bombay became the major source of supply for cotton and
thus the 'Share Mania' in India began. Hence, trading activities flourished during the period, resulting
in a boom in share prices. This boom, the first in the history of the Indian capital market lasted for a
half a decade. The bubble burst on July 1, 1865 when there was tremendous slump in share prices.

At this time, the brokers used to gather under a Banyan tree in Mumbai and under a neem
tree in Kolkata for the purpose. However the real beginning came in the 1850’s with the introduction
of joint stock companies with limited liability. The 1860’s witnessed feverish dealings in securities and
reckless speculation. This brought brokers in Bombay together in July 1875 to form the first formally
organised stock exchange in the country viz. The Bombay Stock Exchange, Mumbai. Ahmedabad
Stock Exchange in 1894, Calcutta in 1908 and Madras in 1937 and 22 others followed this in the 20th
century.

In order to promote the orderly development of the stock market, the central government
introduced a comprehensive legislation called the Securities Contract (Regulation) Act, 1956. The
Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the 1960’s. However,
during the later half of the 1960s the relative importance of the CSE declined while that of the BSE
increased sharply.

Till the early 1990s, the Indian secondary market comprising of various regional stock
exchanges was plagued with the many problems like uncertainty of execution price, uncertain
delivery and settlement periods, lack of transparency, absence of risk management, herd mentality of
brokers etc.

The period since 1992 witnessed several reforms in the securities market. Efforts were made
to strengthen and modernize legislative framework through the Government Securities Act, and
abolishment of stamp duty on transfer of dematerialized debt securities to promote dematerialization,
and mandating dematerialization of debt securities, setting up a clearing corporation to undertake
clearing and settlement of transactions in government securities, and mandating transparency to
trading. With the objective of improving market efficiency, enhancing transparency, preventing unfair
trade practices, and bringing the Indian market up to international standards, a package of reforms
consisting of measures to liberalize, regulate and develop the securities market was introduced. All
the reforms pertaining to Indian capital market has been discussed after explaining primary and
secondary markets due to the fact that these two markets are the basic pillars of Indian capital
market.

SAQ
Q. When was first capital market set up in India?
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8.4.1 Growth of Capital Market : Main Factors

 Before independence capital market in India was not much developed There were few
companies engaged in trading in stock market and the growth of industrial security market was very
much limited, Most of British Companies in India had their base in London capital market.
After independence capital market started to enlarge its activities. The main factors which
contributed to the growth of capital market in India are following :
1. Establishment of Development Banks and Industrial Financial institutions: These
financial institutions and setting up of development Bank contributed significantly in the
development of capital market.
2. Legislature Measures : The government passed Companies Act in 1956 empowering
government to control and direct the development of corporate enterprises in the
country. The Capital Control Act was passed in 1947 to investment in different
enterprises. But this Act was repealed in 1992 after seeing its activities m restrictive
sense.
3. Growth of Under Writing Business : The under writing business in India has been
growing rapidly. This has contributed significantly in the development of capital market in
India.
4. Growing Public Confidence: The post liberalisation phase witnessed tremendous
interest in stock market by general public. Earlier they were only dealing with post offices
and banks for investing their money.
5. Increasing Awareness Regarding investment Opportunities : The business papers
in India has contributed much awareness amongst people regarding alternative sources
of investment opportunities in lieu of traditional sources of investment i.e. Banks and
Post Office.
6. Setting up of SEBI : The SEB1 was set up in India in 1988 to monitor the activities of
stock market. This step also created confidence in general public to invest in stock
market.
7. Mutual Funds : These mutual funds became very attractive amongst general public
because of better Returns to people than tradition sources of investment.
8. Credit Rating Agencies : There are three credit rating agencies such as CRISIL, ICRA
and CARE and working in India. They provide guidance to investors/creditors for
determining the credit risk associated with debit instrument.
8.5 SEGMENTS OF CAPITAL MARKET
The requirement of project financing made India to go for a number of Fis from time to time,
which are generally classified info four categories.
8.5.1 Financial Institutions :
These Financial Institutions Include :
(A) All India Financial Institutions
(B) Specialised Financial Institutions
(C) Investment Institutions
(D) State Level Financial Institutions
A. All India Financial institutions (AIFls)
The all India Fis are IFCL (1948); ICICI (1955); IDBI (1964); SIDBl (1990), and HBI (1997). All
of them were public sector financial Institutions (Fis) except ICICI, which was a joint sector venture
with initial coming from the RBI, some foreign banks and Fis. The public sector Fis. were funded by
the Government of India.
By 1980s, all Indian banks acquired wider capital base and by early 1990s when the stock
market became popular, it became easier for the corporate would to tap cheaper capital from these
segment of the he capital market. The era of economic reforms had given the same option to PSUs to
tap new capital. As the All India Financial Institutions (AIFis) had more or less fixed rate of interest as
compared to the banks which could mobilize cheaper deposits to lend cheaper - the AlFis seemed to
become irrelevant. The AIFis witnessed a sharp decline in recent years.1 At this juncture the
government to convert them into Development Banks2 (suggested by the Narasimhan Committee-I)
to be known as the All India Development Banks (AIDBs).
In 2000, the government allowed ICICI to go for a reverse merger (when an elder enterprise is
merged with a younger one) with the ICICI Bank the first AIDB emerged with no obligation of project
financing - such entities in coming times will be known as the universal banks3 (allowed to set up as
many financial institutions they wish to - such as insurance, merchant banks, mutual funds, etc.) In a
similar move, the IDBl was reverse merged with the IDBI Bank in 2002 and the second AIDS
emerged. But it has still the obligation of carrying its project financing duties.
In 2002, the government, proposed to merge IFCI and IIBI with the nationalized bank PNB to
create a big Universal Bank. It is believed that PNB was unwilling to go for this merger as these Fis
were running at heavy losses. This move was part correct as per the recommendations of the
Narasimhan Committee-II (to the extent merger is concerned, following its 3-Tier Banking Structure of
India), but part against it (the committee has advised not to merge weak banks/Fis with either weak or
strong banks/Fis). Presently, the government is trying to make IFCI and llBI to turn around their
business and emerge as profitable entities - they are busy recovering their dues and improving their
balance sheet.
Meanwhile, at present, there are only four financial institutions operating in the country as AIF
is regulated by the RBI, viz, the NABARD, SIDB1 Exim Bank and the NHB.
B. Specialised Financial institutions (SFIs)
Two new Fis were set up by the Central Government in the late 1980s to finance risk and
innovation in the area of industrial expansion - this was India's trial in the area of venture capital
funding :
(a) IFCI Venture Capital funds Ltd (IPCI Venture), 2000

1.
Economic Survey 2006-07 MoFL Gol, N. Delhi.

2.
Narasimhan Committee on the Financial System (CFS), 1991 suggested for the conversion of the AIFts into
Development Banks.
3.
It was the S. H, Khan Committee on Development Financial Institutions (DFis). 1998 which forwarded the concept idea
of Universal Banking in India.
 It was promoted as a Risk Capital Foundation (RCF) in 1975 by IFCI Ltd., a society to provide
financial assistance to first generation professionals and technocrat entrepreneurs for setting up own
ventures through soft loans, under the Risk Capital Scheme.
In 1988, RCF was converted into a company - Risk Capital and Technology Finance
Corporation Ltd (RCTC) - when it also introduced the Technology Finance and Development Scheme
(TFDS) for financing development and commercialisation of indigenous technology. Besides, under
Risk Capital Scheme, RCTC started providing financial assistance to entrepreneurs by way of direct
equity participation. Based on IFCI Venture's credentials and strengths, Unit Trust of India (UTl),
entrusted RCTC with the management of a new venture capital fund named Venture Capital Unit
Scheme (VECAUS-lit) in 1991 with its funds coming from the (UTl and IFCI. To reflect the shift in the
company's activities, the name of RCTC was changed to IFCI Venture Capital. bunds Ltd. (IFCI
Venture) in February 2000.
In order to focus on Asset Management Activities, IFCI Venture discontinued Risk Capital and
Technology Finance Schemes in 200041 and continued managing VECAUS Ill. In 2007, as UTl had
ceased to carry out it activities and its assets vested Specified Undertaking of the Unit Trust of India
(SUUTl), the portfolio of VECAUS-Ill under management of IFCI Venture was transferred to SUUTI.
C. Investment Institutions (lIs)
Three investment institutions also came up in the public sector which are yet another kind of
Fis, i.e. the LIC (1956), the UTI (1984) and the GlC (1971).
In the present time they are no more considered as Fis. LIC is now the public sect, insurance
company in the life segment, G1C was been converted into a public sector re-insurance; company in
2000, while UTl was converted into a mutual fund company in 2002. Now these investment
institutions (lis) are no more like the past. LIC is now called an 'insurance company', part of the Indian
insurance industry and is the lone public sector playing in the life insurance segment competing with
the private life insurance companies. Similarly; the UTl is now part of the Indian Mutual Fund industry
and the lone such firm in the public sector competing with other private sector mutual funds. Similarly,
the earstwhile four public sector general insurance companies are part of India's general insurance
industry and competing with private companies in the area (they were Holding Companies of the GlC
- now these are owned by the Gol directly and GlC only looks after its 're-insurance' business). This is
why we do not get the use of the term 'lls' in recent times in any of the Gol official documents.
D. State Level Finance institutions (SLFIs)
In the wake of states involvement in the industrial development, the central government
allowed the states to set up their own financial institutions (after the states demanded so). In this
process two kinds of Fis came up:
(a) State Finance Corporations (SFCs): First coming up in Punjab (1955) and other states
followed-18 SFCs working presently.
(b) State industrial Development Corporations (S/DCs): A fully dedicated state public sector
FI to the cause of industrial development in the concerned states. First such Fis were set
up (1960) in % Andhra Pradesh and Bihar.
Almost all of the SFCs and SIDCs are at present running in huge losses They may be re-
structured on the lines of the AIFis, but there is lack of will from the states and private financiers who
are not interested to go in for their takeovers as such.
8.5.2 Banking Industry
With the passage of time, the banking industry saw two phases of nationalisation (1969 And
1980) and again opening up for private sector entry (1993-94) to emerge as the most dependable
segment of Indian financial system - in a way its mainstay. Presently, the industry consists of
commercial banks both in public and private sectors, Regional Rural Banks (RRBs) and co-operative
banks - a total of 171 Scheduled Commercial Banks (SCBs) out of which 113 are in the public sector
(19 nationalised banks, 7 banks in SBl group, one IDBI Bank Ltd. and 86 RRBs); with the rest of the
58 banks owned by private sector (domestic and foreign - FDI in banks is allowed upto 26 per cent).
The entry of new private-players in the banking sector has been slow, hapmering the growth
and expansion of the sector. But in a recent release the RBI has committed to allow new banks to
come up on regular basis - in April 2014 the RBI allowed two new private sector banks to start their
operations to make total of 40 private sector banks (Check m.rbi.org.in for number of banks in India).
8.5.3 Insurance Industry
After independence, for the purpose of expanding the industry, one after another the life and
non-life insurance businesses were nationalised by the government (in i956 and 1970. respectively),
and the public sector insurance companies did serve the better purpose in the areas of providing
safety net and nation-building. In the wake of the process of economic reforms a restructuring of the
sector was started and the industry was opened for entry of private players in 1999 and go
independent regulator was set up - the IRDA (domestic and foreign - with an FD1 cap of 49 per cent).
Since then many private players have entered the industry. Presently, Indian insurance industry
consists of 1 public sector life insurer (LIC) and 4 public sector general insurers; 2 specialised public
sector insurers (AIClL and ECGC); 1 public sector re-insurer (GIC) and 37 private insurance
companies (in collaboration with established foreign insurers from across the world). The expansion
and penetration insurance in the country have increased during the reform period.
8.5.4 Security Market
After the government’s attempts to formally organise the security and stock market of India,
the segment has seen accelerated expansion. Today, it is counted among the most vibrant share
markets of the world and has challenged the monopoly of banks in the capital market of the country.
The security market of India is regulated by SEBl. India has developed a regulated 'forward market'
also where hundreds of commodities and derivatives are traded on spot and non-spot basis -
regulated by FMC.
The security market is divided into A Gilt Edged Market (B) Corporate or Industrial Security
Market.
A. The Gilt Edged Market : This market is backed by R.B.I. In this type of market, the
value of securities remain stable. It is very much demanded by Banks and other Financial Institutions.
Main Features of Gilt Edged Market
1, It is risk free market
2. The Govt. security markets consist of two parts i.e. New issue Market and Secondary
Market. R.B.I. manages the entire public debt operations of central as well as state
governments.
3. The R.B.I. plays a dominant role in the government securities market.
 4. The investors in Gilt Edged market institutions are required statutorily to invest certain
portion of their funds in Government securities.
5. Govt. securities are the most liquid debt instrument.
6. The transactions in government securities are very large.
7. For several years the government security market in India has been an over the counter
market, but since 1992 government securities have been through sealed bid auctions.
B. The Corporate or industrial Security Market: It is another segment of the capital
market which deals with shares and debentures of old and new companies. The industrial Security
Market is again divided into.
(i) New lssue Market
(ii) Old Capital Market
(i) New issue Market : The new issue market indicates the system of raising new capital by
selling shares and debentures issued by the company.
(ii) Old Capital Market : The Old Capital market refers to the marketing set up of securities
already issued by companies.
The primary market borrowings of central government were Rs. 2871 crores in 1980-81 which
rose to which rose to Rs. 99630 crores in 1999-2000. The primary market borrowings of state
governments were Rs. 333 crores in 1980-81 which rose to Rs. 13706 crores in 2000-01 (Latest
progress in the next lesson).
8.6 TYPES OF CAPITAL MARKET
Different Types of Capital Market are Discussed Below :

Types of capital Market

On the basis of issuance of On the basis of financial

securities instruments

Primary Markets Equity Market

Secondary Markets Debt Market

Derivatives Market

8.6.1 Primary Market

The primary market provides the channel for creation and sale of new securities, while the
secondary market deals in securities previously issued. The securities issued in the primary market
are issued by public limited companies or by government agencies. The resources in this kind of
market are mobilized either through the public issue or through private placement route. It is a public
issue if anybody and everybody can subscribe for it, whereas if the issue is made available to a
selected group of persons it is termed as private placement. There are two major types of issuers of
securities, the corporate entities who issue mainly debt and equity instruments and the government
(central as well as state) who issue debt securities (dated securities and treasury bills).

A. Features of a primary market are:

This is the market for new long term capital. The primary market is the market where the
securities are sold for the first time. Therefore it is also called New Issue Market (NIM)
 In a primary issue, the securities are issued by the company directly to investors
 The company receives the money and issue new security certificates to the investors
 Primary issues are used by companies for the purpose of setting up new business or for
expanding or modernizing the existing business
 The primary market performs the crucial function of facilitating capital formation in the
economy
 The new issue market does not include certain other sources of new long term external
finance, such as loans from financial institutions. Borrowers in the new issue market may be
raising capital for converting private capital into public capital; this is known as ‘going public’
B. Intermediaries associated with Primary Market are :

 Merchant bankers: Merchant bankers are the key players in issue management process. A
merchant banker should be registered with SEBI as per the SEBI (Merchant Bankers)
Regulations, 1992. They have to act as a book running lead manager (BRLM) to an issue and
ensure that:
 All the information furnished in the offer document is correct.
 The proper compliance of all rules and regulations as given by SEBI Guidelines for
Disclosures and Investor Protection has been made.
 A due diligence certificate has been submitted to SEBI confirming that the disclosures
made in the draft prospectus or letter of offer are true, fair and adequate in order to
enable the prospective investors to make a well informed investment decision.
 Compliance to SEBI's guidelines issued time to time in any year to merchant bankers
primarily for addressing the need to enhance the standard of disclosures.
 Underwriters: Underwriters are required to register with SEBI as per the SEBI (Underwriters)
Rules and Regulations, 1993. They are the ones who guarantee the company for full subscription
of their shares. Apart from these underwriters, all registered merchant bankers in categories I, II
and III and stockbrokers and mutual funds entities registered with SEBI can also function as
underwriters.
 Bankers to an Issue: It refers to those banking units who become party in the issue of shares by
facilitating the company with various banking needs for such issue. Scheduled banks acting as
bankers to an issue are required to be registered with SEBI in terms of the SEBI (Bankers to the
Issue) Rules and Regulations, 1994. These regulations lay down eligibility criteria for bankers to
an issue and require registrants to meet periodic reporting requirements.
 Portfolio managers: Portfolio managers are required to register with SEBI in terms of the SEBI
(Portfolio Managers) Rules and Regulations, 1993. The registered portfolio managers exclusively
carry on portfolio management activities. In addition all merchant bankers in categories I and II
can act as portfolio managers with prior permission from SEBI.
 Debenture trustees: Debenture trustees are registered with SEBI under SEBI (Debenture
Trustees) Rules and Regulations, 1993. Since 1995-96, SEBI has been monitoring the working of
debenture trustees by calling for details regarding compliance by issuers as per terms of the
debenture trust deed, creation of security, payment of interest, redemption of debentures and
redressal of complaints by debenture holders regarding non-receipt of interest/redemption
proceeds on due dates.
 Registrars to an Issue and Share Transfer Agents: Registrars to an issue (RTI) and share
transfer agents (STA) are registered with SEBI under SEBI (Registrar to the Issue and Share
Transfer Agent) Rules and Regulations, 1993. Under these regulations, registration commenced
in 1993-94 and is granted under two categories:
 Category I - to act as both registrar to the issue and share transfer agent and;
 Category II - to act as either registrar to an issue or share transfer agent.
C. Ways of raising capital in Primary Market

 Public issue: when new securities are offered to public for investment is referred to as public
issue. Since, the public is involved; SEBI is strict with regard to regulations of this issue.
SEBI performs its obligation of investor protection by framing/modifying such regulations on
time to time basis.
 Rights issue: It is the method of raising further capital from the existing shareholders by
offering additional securities to them on pre-emptive basis. SEBI has prescribed the
prospectus contents and abridged prospectus requirements, which should be accompanied
by each application form, for both public issue and rights issue.
 Bought-out deals: A process whereby a group of investors or an investor buys out a
significant portion of the equity of an unlisted company with a view to taking it to the public in
an agreed time frame is called a bought-out deal.
 Private placement: It s a way of selling securities by a company to one or few investors, and
the terms of issue are negotiated between the company (issuing securities) and the
investors. Securities are sold, mainly to institutional investors like mutual funds, UTI,
insurance companies (LIC and GIC) etc in private placement market. SEBI has now
prescribed a lock-in period for securities which are privately placed.
8.6.1 Free Pricing Regime:

Before the establishment of SEBI in 1992, the controller of Capital Issues (CCI) was used to
regulate the new issues market under the capital Issues (Control) Act, 1947. All the companies
interested to bring new issue had to fulfill the following:

 Companies before raising funds from primary market had to take consent from the CCI.
 All the three elements of the issue, i.e. timing, quantum and pricing were decided by the CCI.
 Existing companies having the substantial reserves could issue shares at a premium where
as New companies could issue shares at par only.
  Moreover, premium was also calculated by set formula given by CCI. The formula was based
on balancing the two criteria i.e. the net assets value and price earnings value.
In 1992, the capital Issue Control Act 1947 was abolished and all controls relating to raising of
funds from the primary market were removed. After that, SEBI came into enactment to regulate the
financial market. Now the companies need not to take any prior approval from any authority regarding
the pricing of new issue. The promoter and merchant banker together decide the price of the issue.
Thus the companies both existing and new were free to decide the price of the issue. But the
companies start making wrong use of such free pricing regime. Dishonest promoters and greedy
merchant bankers brought issue with rosy but unreal projections and sold shares at very high
premium. Such projections were never materialized leading to steady fall in share prices. Most of
these issues were quoted below their offer price on the day they were listed at the stock exchange. In
1992-96, 4000 issues hit the market and more than 3000 quoted below their offer price on the very
day they were listed. The free market became a free falling market in most of the cases.

To safeguard investors against such frauds, the regulator brought in strict regulations for
merchant bankers, brokers and others and thus laid down guidelines for disclosure and investor
protection. In the present scenario, promoters are required to justify the issue price in the prospectus
and have to make material disclosures about the risk factors in the offer document. One of the
methods of fixing an offer price for IPOs is book building process which has been discussed in detail
in the next part.

 Allotment:
At the end of cut off period, lead manager consult with issuer and decides the price at which the
issue will be subscribed. Accordingly, the shares are allotted to investors who have bid at or
above the fixed price. All investors are allotted shares at the same fixed price.

 Participants:
All investor including individuals are eligible to invest in a particular issue of securities and hence
participate in the book building process. However, if the issue is restricted to qualified institutional
investors, as in the case of government securities, then, only those eligible can participate.

8.6.2 Secondary Market

The secondary market enables participants who hold securities to adjust their holdings in
response to changes in their assessment of risks and returns. Once the new securities are issued in
the primary market they are traded in the stock (secondary) market.

The secondary market operates through two mediums, namely, the over-the-counter (OTC)
market and the exchange-traded market.

 OTC markets are informal markets where trades are negotiated. Most of the trades in the
government securities are in the OTC market. All the spot trades where securities are traded
for immediate delivery and payment take place in the OTC market.
  The other option is to trade using the infrastructure provided by the stock exchanges and is
called secondary market. The secondary market is the market where the securities that are
already issued are traded in this market. Such type of securities helps investors in adjusting
their holdings in response to changes in their assessment of risks and returns.
According to Securities Contracts (Regulation) Act 1956, a stock exchange is defined as “anybody of
individuals, whether incorporated or not, constituted before corporatization and demutualization or a
body corporate incorporated under the Companies Act 1956 whether under a scheme of
corporatization and demutualization or otherwise for the purpose of assisting, regulating or controlling
the business of buying, selling or dealing in securities”.

The exchanges in India follow a systematic settlement period. All the trades taking place over a
trading cycle (day=T) are settled together after a certain time (T+2 day). The trades executed on
exchanges are cleared and settled by a clearing corporation. The clearing corporation acts as a
counterparty and guarantee settlement.

A. Functions of the Secondary Market:

 To facilitate liquidity and marketability of the outstanding equity and debt instruments
 To contribute to economic growth through allocation of funds through the process of
disinvestment to reinvestment.
 To provide instant valuation of securities caused by changes in the internal environment (that
is, companywide and industry wide factors). Such valuation facilitates the measurement of the
cost of capital and the rate of return of the economic entities at the micro level.
 To ensure measure of safety and fair dealing to protect investors’ interest
 To induce companies to improve performance since the market price at the stock exchanges
reflects the performance and this market price is readily available to investors.

B. Development of the Stock Market In India:

What is a Stock Market ?

In the secondary market, funds are exchanged through the sale and purchase of securities.
The stock exchange play an important role in the secondary market. They provide a plateform for he
organized trading of securities.

A stock Exchange is a formal trading place for the securities that have been add to the public
by issuing corporate entities.

The stock market (also known as Equity Market) is the market for trading equity shares
inatrements. It is a market which deals in the trading of shares of both public and mirals companies.
These include securities listed on a stock exchange as well as there trades priority.
 A well regulated equity market in a country shows the healthy capital market of that country.
The central (equity market) and the smooth operational of the financial system functions.

Stock Market in India

In India, stock exchange has been defined as any body of individuals whether corporate or not
constituted for the purpose of assisting, regulating or contradicting the business of buying, selling
dealing in securities.

The business in stock exchanges in India is highly regulated. The main Acts governing stock
exchanges in India are :

(1) The Securities Contract Regulation Act 1956

- came into force on Feb 20,195%

- It regulates the business trading on stock exchange provides for recongnition

of stock exchange, lesting of securities etc.

(2) Securities and Exchanges Board in India Act, 1992.

Pre Reform Period : Stock Market

The origin of the stock market in India can be traced back to 1830 when long term negotiable
securities were first issued. However, the real beginning of stock market started after the
establishment of the Companies Act in 1850 which introduced the feature of limited liability, and
generated investor interest in corporate securities.

The native Share and Stock Brokers’ Association, now known as Bombay Stock Exchange
(BSE) was formed in Bombay (now Mumbai) in 1875. This was followed by the formation of
association / exchanges in Ahmedabad (1874), Calcutta (now Kolkata) (1908), and Madras (now
Chennai) (1937). For the development of the stock market, the central government introduced a
comprehensive legislation called the Securities Contracts (Regulations) Act 1956.

The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the 1960s. In 1961,
there were 1,203 listed companies across the various stock exchanges of the country. Of these, 576
were listed on CSE and 297 on BSE. However, during the latter half of the 1960s, the relative
importance of CSE declined while that of BSE increased sharply.

Till the early 1990s, the Indian secondary market comprised regional stock exchanges with BSE
heading the list. The Indian stock market was plagued with many limitations, such as the following.

 Uncertainty of execution prices

 Uncertain delivery and settlement periods
 Lack of transparency
 Absence of risk management
 Systemic failure of the entire market and market closures due to scams
 High transaction costs
 And many more making it unattractive for investment by investors
Post reform period : Stock Market

After the initiation in 1991, the Indian secondary market now has a three tier form :

1. Regional stock exchanges

2. National Stock Exchange (NSE) and Bombay Stock Exchange (BSE)

3. Over the Counter Exchange of India (OTCEI)

The NSE was set up in 1994. It was the first modern stock exchange which came with new
technology, new trading practices, new institutions, and new products. The OTCEI was set up in 1992
as a stock exchange providing small and medium sized companies the means to generate capital.

In all, there are, at present 23 stock exchanges in India – 19 regional stock exchanges, BSE,
NSE, OTCEI and the Inter connected Stock Exchange of India (ISE). The ISE is a stock exchange of
stock exchanges. The 19 regional stock exchanges are located at Ahmedabad, Bangalore,
Bhubaneshwar, Kolkata. Cochin, Coimbatore, Delhi, Guwahati, Hyderabad, Indore, Jaipur, Kanpur,
Ludhiana, Chennai, Mangalore, Pune, Patna, Rajkot and Vadodara. They all are operated under the
rules and regulations approved by the government and SEBI.

C. Secondary Market Intermediaries

 Stock brokers All stock brokers dealing in securities are registered with SEBI in terms of
SEBI (Stock Brokers and Sub Brokers) Regulation 1992.
 Sub brokers In many cases, individual investors transact in securities through sub brokers.
But sub brokers are limited in success as brokers are reluctant to take responsibility of the
acts of the sub-brokers.
8.7 HOW THE STOCK EXCHANGE HELPS THE CAPITAL MARKET

Stock Exchange is the backbone of Capital Market.

Stock Exchange helps in the formation of the capital. It helps the corporate sector to raise
capital from the primary market and then facilitates the process of transfer of ownership from one
person to another. This way the Stock Exchange establishes a relationship between the two markets
i.e. Primary Market and secondary Market.

1. Nexus Between Savings and Investment: First and foremost, Stock Exchanges are the
nexus between the savings and the investment community. Savings of the community are mobilized
and channelized by Stock Exchange for investment into those sectors and units which are favoured
by the community at large on the basis of their judgment of good returns, application of capital etc.

2. Market Place for Sale & Purchase of Securities : The second important function
discharged by the Stock Exchange is that they provide a market place for purchase and sale of
securities thus enabling their free transferability through several portfolio to gear to the ever changing
market situation etc. This guarantees salability to the one who have already invested and surety of
purchase by the other two desires to invest.
 3. Barometer of Changing Demand and Supply Conditions : The third major function
related to the second, catered to by the Stock Exchange is the process of continuous price formation.
This ever changing demand & supply conditions result in a continuous revaluation of assets. The
Stock Exchange thus act as a barometer of the state of health of the nations economy: constantly
measuring the health progress or otherwise.

Like any management unit, the stock exchange market should be guided by its objectives.

The following are the major objectives

(a) Arrangements for listing of companies.

(b) Control and regulation of trading in securities, settlement and clearance.

(c) Regulations of members activities.

(i) Dispute with other members.

(ii) Dispute with clients and

(iii) Regulation of members activities.

(d) Other services to members and public, such as spread of information, corporate
disclosures.
SAQ
Q. Is there any difference between Stock Market and Capital Market? If so, mention any two.
________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

8.8 REFORMS IN INDIAN CAPITAL MARKET

Securities scam of 1991-92 prompted the governments to increase the pace of reforms in the
capital market. Since then many reform measures have been undertaken in both the primary and
secondary segments of the equity market.

 SEBI Act,1992
A major reform was the repeal of the Capital Issues (Control) Act, 1947. The Securities and
Exchange Board of India (SEBI) was constituted on 12 April, 1988 as a non-statutory body
through an Administrative Resolution of the Government for dealing with all matters relating to
development and regulation of the securities market, investor protection, and to advise the
government on all these matters. It was given statutory status and powers through an Ordinance
promulgated on January 30 1992. Finally, it was established as a statutory body on 21 February
1992. The Ordinance was replaced by an Act of Parliament on 4 April 1992. The preamble of the
SEBI Act, 1992 enshrines its objectives as to protect the interest of investors in securities market
 and to promote the development of and to regulate the securities market. The statutory powers
and functions of SEBI were strengthened through the promulgation of the Securities Laws
(Amendment) Ordinance on 25 January 1995, which was subsequently replaced by an Act of
Parliament.

The government created it as a regulator, empowered it adequately and assigned it with the
responsibility for:
a) protecting the interests of investors in securities.
b) promoting the development of the securities market, and
c) regulating the securities market.
Its regulatory jurisdiction extends over corporates in the issuance of capital and transfer of
securities, in addition to all intermediaries and persons associated with securities market.
 Disclosure and Investor Protection Guidelines
In the interest of investors, SEBI issued Disclosure and Investor Protection Guidelines. The
guidelines contain a substantial body of requirements for issuers/intermediaries, the broad
intention being to ensure that all concerned observe high standards of integrity and fair dealing,
comply with all the requirements with due skill, diligence and care, and disclose the truth, whole
truth and nothing but truth.
The disclosures prescribed for new issues in India, generate the fact that they are
comparable, in terms of contents and stringency, to those obtaining in most of the advanced
markets. Entry norms and track record criteria have also been attuned to ensure the quality of
new issues and to protect the investors. The continual disclosure requirements for listed
companies are also at par with any international standards.

These relate to publication of annual audited results and quarterly results in prescribed format
and time frame, consolidated results, segmental reporting, cash flow, auditors qualifications and
their impact quantification, and disclosures of certain transactions. To enable electronic filing of
information, Electronic Data Information Filing System has been set up in association with
National Informatics Center.

 Screen-based Trading
The trading on Stock Exchanges in India used to take place through open outcry without use
of information technology for immediate matching or recording of trades. This was time-
consuming and inefficient. In order to provide efficiency, liquidity and transparency, NSE
introduced a nation-wide on-line fully automated Screen-Based Trading System (SBTS) where a
member can punch into the computer quantities of securities and the prices at which he likes to
transact and the transaction is executed as soon as it finds a matching sale or buy offer from a
counter party. Today, India can boast that almost 100% trading takes place through electronic
order matching.
It has cut down the cost, time and risk involved. A large number of participants, irrespective of
their location, now trade with one another anonymously and simultaneously, it has provided equal
access to every player, with orders big or small, thus improving the depth and liquidity of the
market. The system provides perfect audit trail, facilitating dispute resolution. Given the size and
 complexity of the country, that we could click the system and stabilize it so successfully is, by no
means, a mean achievement.

 Trading Cycle
Gone are the days when the seller had to wait for weeks and perhaps a month for settlement.
Not long ago, the trading cycle used to be as long as 14 days for specified scrips and even 30
days for other scrips and settlement took another fortnight! Certain developments in the
intervening period between the trade and settlement could tempt the parties to roll back their
promises, leading to defaults, disputes and, in short, settlement risks. This risk has been
considerably minimized by introduction of compulsory rolling settlement and contraction of the
trading cycle. Rolling settlement on T+5 basis, was made compulsory, initially, for 200 actively
traded scrips on BSE and NSE, reducing the trading cycle to one day and settlement period to 6
days; this was extended to cover all the scrips in December 2001. Within a little over two years,
we moved to T+3 in April 2002 and then to T+2 by April 2003. The transition has been so smooth
and successful that it has received world wide acclaim. The efforts are on to make it on T+1 basis
or even Real Time Basis.
 Derivatives Trading
To assist market participants to manage risks through hedging, speculation and arbitrage,
Securities Contract (Regulation) Act (SCRA) was amended in 1995 to lift the ban on options in
securities. However, that time, trading in derivatives did not take-off, as there was no suitable
legal and regulatory framework to govern these trades.

After the legal framework for derivatives trading was provided by the amendment of SCRA in
1999, derivatives trading started in a gradual manner with stock index futures in June 2000. Later
on options and single stock futures were introduced in 2000-2001. The market presently offers
index futures, index options, stock options and stock futures.

Deferral products like carry forward, which encouraged leveraged trading by postponing
settlement stand banned; thus, the cash market has been isolated from derivatives. The
introduction of the derivatives in the market and the gradual enlargement of the basket of
products comprising Index Options, Index Futures, Stock Options and Stock Futures, has
enhanced the liquidity, efficacy of the market and also provided hedging opportunities, besides
tempering volatility in the cash market.

 Demutualization
The word “demutualization” refers to a form of stock exchange where the ownership,
management and trading is in the hands of three different sets of people. Historically, brokers
owned, controlled and managed Stock Exchanges. In case of disputes, the self often got
precedence over regulations leading inevitably to conflict of interest. On realization of this, the
regulator focused on reducing dominance of members in the management of Stock Exchanges by
bringing the Securities Laws (Amendment) Ordinance on 12th October 2004. They were advised
to reconstitute the governing councils to provide for at least 50% non-broker representation.
 NSE was the first to adopt a pure demutualised governance structure in the country, where
ownership, management and trading are with three different sets of people. It is owned by a set of
leading financial institutions, banks, insurance companies and other financial intermediaries and
is managed by professionals, who do not directly or indirectly trade on the Exchange.

BSE, however, submitted a Scheme for its Corporatisation and Demutualization, vide its letter
dated 9th March, 2005 to SEBI which was duly approved by the authority on 20th May, 2005.
Hence, making BSE, a demutualised exchange.

The other regional demutualised exchanges are Vadodara Stock Exchange, Jaipur Stock
Exchange, Magadh Stock Exchange, Ludhiana Stock Exchange, Saurashtra-Kutch Stock
Exchange, Bhubaneswar Stock Exchange, Inter-connected Stock Exchange of India and
Ahmedabad Stock Exchange.

 Dematerialization
Dematerialization is the process by which “physical share certificates of an investor are
converted to an equivalent number of securities in electronic form”.
Before dematerialization, settlement system on Indian stock exchanges gave rise to
settlement risk due to the time that elapsed before trades were settled. Trades were settled by
physical movement of paper. This had two aspects. First, the settlement of trade in stock
exchanges by delivery of shares by the seller and payment by the purchaser. The process of
physically moving the securities from the seller to the ultimate buyer through the seller’s broker
and buyer’s broker took time with the risk of delay somewhere along the chain. The second
aspect related to transfer of shares in favour of the purchaser by the company. The system of
transfer of ownership was grossly inefficient as every transfer involved physical movement of
paper securities to the issuer for registration, with the change of ownership being evidenced by an
endorsement on the security certificate. In many cases the process of transfer took much longer,
and a significant proportion of transactions ended up as bad delivery due to faulty compliance of
paper work. Theft, forgery, mutilation of certificates and other irregularities were rampant, and in
addition the issuer had the right to refuse the transfer of a security. All this added to costs, and
delays in settlement, restricted liquidity and made investor grievance redressal time consuming
and at times intractable.

To obviate these problems, The Depositories Act, 1996 was passed to provide for the
establishment of depositories in securities with the objective of ensuring free transferability of
securities with speed, accuracy and security by:

a) making securities of public limited companies freely transferable subject to certain

exceptions
b) dematerializing the securities in the depository mode; and
c) providing for maintenance of ownership records in a book entry form.
 In order to streamline both the stages of settlement process, the Act envisages transfer of
ownership of securities electronically by book entry without making the securities move from
person to person.
Today, the investing public has been saved from the risk of loss of securities in transit or in
custody, misplacement or mutilation, theft or destruction, bad delivery or delayed delivery, forgery
or duplicity, and also from irritating headaches of intimation of change of address, watching the
receipt of bonus or rights shares, etc.

 Risk Management
Market integrity is the essence of any financial market. To preempt market failures and protect
investors, the regulator has put in place a comprehensive risk management system, which is
constantly monitored and upgraded. The risk management process encompasses capital
adequacy of members, adequate margin requirements, limits on exposure and turnover,
indemnity insurance, on-line positions monitoring, and automatic disablement, etc. A number of
measures like on-line screen based trading, cent percent dematerialized trading, shortening of
settlement cycle from T+5 to T+2, risk mitigating prudential norms of capital adequacy and
exposure limits, value at risk based margining, real-time monitoring of positions and margins,
automatic disablement of the terminals, a central counterparty, and trade/ settlement guarantee
fund, index based market wide circuit breakers, segregation of cash and derivative markets,
enhancement of governance standards among corporates and stock exchanges, continual
disclosure requirements, registration and regulation of intermediaries are made in place to
manage and mitigate the risks in Securities Market.
Nonetheless, if one relaxes with the comfort of a feeling that the Securities Market is now
absolutely risk free, one runs the risk of deluding oneself. The market is large and still it has the
potential to grow. While the growth should be nourished, the attendant risks need to be contained.
In other words, the path to growth needs to be paved by clearing risky pebbles, if any. All
available tools - regulations, guidelines, surveillance, inspections and investigations are applied to
deal with market misconduct and enforce action against market manipulators. Still, there is no
denying the fact that some manipulators will keep on playing. Invariably, while manipulators play,
the retail investors fall a prey. Often, there is a fatal attraction to hypes and greed. On its part,
SEBI has started conducting Investor Awareness Programmes at various places across the
country in collaboration with different agencies. But it is for the retail investors to be diligent
enough not to be led by some invisible hands via garden path to prickly desert.
 Corporate Governance
According to the Economic Intelligence Unit Survey of 2003 regarding corporate governance
across the countries, “Top of the country class, as might be expected, was Singapore followed by
Hongkong and, somewhat surprisingly, India.” It is significant to note that Singapore and
Hongkong claiming the top positions, was not a matter of surprise, but India coming as third,
surprised the world! It shall be our collective endeavour to eliminate the “surprise element”.
 As part of its endeavour towards continual improvement, SEBI has got corporate governance
code and practice reviewed by Narayana Murthy Committee. The Committee’s recommendations
for refinement were evolved through consultative processes, transparent deliberations and
democratic approach.

The corporate governance standard is a crucial factor for ensuring investors’ confidence.
While the Company Law would take care of the basic requirement of the form of corporate
governance structure, SEBI is concerned with the corporate governance practices on on-going
basis. SEBI constituted a new committee on corporate governance under the Chairmanship of
Narayana Murthy to look into existing corporate governance practices and suggest improvements
wherever necessary. Based on this report, revised corporate governance standards have been
finalized. Disclosures on corporate governance standard observation would form part of the listing
agreement requirement. Simultaneously, SEBI encouraged the credit rating agencies- ICRA and
CRISIL, to evolve a suitable corporate governance index as a measure of wealth creation by the
corporates. Some of the companies have been rated against this index. It is our belief that the
economic compulsions would increasingly induce the companies to go in for the corporate
governance rating. Finally, corporate governance is essentially ethics-based phenomenon. No
amount of legislation or regulation will serve the purpose fully, unless there is an attitudinal
change on the part of the management of the corporate.

 Globalisation
Indian companies have also been allowed to raise capital from the international capital
markets through issue of American Depository Receipts, Global Depository Receipts, Foreign
Currency Convertible Bonds (FCCBs) and External Commercial Borrowings (ECBs). Companies
were permitted to invest all ADR / GDR proceeds abroad. Two way fungibility was announced for
ADRs/ GDRs in 2000-01 for persons residing outside India. Subject to sectoral caps wherever
applicable, converted local shares could be reconverted into ADRs / GDRs. The investments by
FIIs enjoy full capital account convertibility. Rolling settlement on T+5 basis was introduced in
respect of the most active 251 securities from July 2001 and in respect of the balance securities
from December31, 2001. Rolling settlement on T+3 basis commenced for all listed securities form
April, 2002. Now it has been reduced to T+2 basis. These developments in the stock market,
which support corporate initiatives and facilitate management of financial risks, hold out
necessary impetus for growth, development and strength of the emerging economy of India.
 Entry of Foreign Institutional Investors (FII): In permission was given to foreign institutional
investors such as mutual funds, country funds, and pension funds to operate in the Indian market,
was a significant step towards integrating the Indian capital market with the international capital
markets. Foreign institutional investors were initially allowed to invest only in equity shares; later,
they were allowed to invest in the debt market, including treasury bills and dated government
securities. The ceiling for investment by foreign institutional investors was increased in 2000-01
from 40 per cent to 49 per cent. This increase can be made with the approval of shareholders
through a special resolution in the general body meeting.
 Another important step to strengthen the Indian Capital Market is that banks have been allowed to
lend against various capital market instruments such as corporate shares and debentures.
 The following are the reforms which happen to be made by SEBI on time to time:
o It is mandatory for listed companies to announce quarterly results, as this enables investors to
keep a close track of the scrips in their portfolios. The declaration of quarterly results is in line with
the practice prevailing in the stock market in developed countries.
o In November 2001 to check price manipulation, mandatory client code and minimum floating
stock for continuous listing were stipulated.
o To standardize listing requirements at stock exchanges, the government amended the Securities
Contracts (Regulation) Rules, 1957.
o From July 2, 2001 a 99 per cent value at risk (VAR) based margin system for all scrips in rolling
settlement was introduced.
o With effect from October 1, 2001 the central government notified the establishment of Investor
Education and Protection Fund (IEPF). The IEPF will be utilized for the promotion of awareness
amongst investors and protection of their interest.
o With effect from July 2, 2001, the restriction on short sales announced in March 7, 2001 was
withdrawn, as all deferral products stand banned after the date.
8.9 SUMMARY
 Lets recapitulate with help of three charts

(Chart I, Chart II, Financial Institutions, Terms)

Chart I : Constituents of Capital Market

8.10 GLOSSARY

☻ Shares
 In every day language, when will talk of shares we normally refer to equity shares or ordinary
shares of a company. The term shares and stocks essentially mean the same thing, the latter being a
more common American usage.

An equity share is evidence of ownership in a company. The physical evidence of this

ownership is a document called the share certificate. It has your name endorsed on it, and is proof
that you are a partner of the company. Your ownership rights are proportionate to the number of
shares you won. Suppose you purchase 100 shares in a company called XYZ Ltd. which has issued
10,000 shares, then you would own 1% of the company. In short, it would mean that you won 1% of
its land, factory, equipment, patents, bank balances and all its other assets.

☻ Investment

Investment also refers to development of savings of your funds with the intention of earning
an income. For example, if you use your savings to buy a house, it will not only appreciate in value,
but it can also give you a monthly income in the form of rent. Similarly, investments in bank deposits,
company deposits, debentures and shares will also give you regular income. On the other hand,
investment in gold, jewellery or works of art appreciate in value but do not provide any income.

☻ Company Related Terms

A company is a form of business organization. It is basically an association of individuals

called, shareholders' who get together for the purpose of running a particular business. The company
is managed by a 'board of directors', which consists mostly of elected representatives of the
shareholders.

The money that a company raises for starting and running its business is called 'capital. This
is initially raised from the shareholders, who jointly own the company. The amount so raised is called
the 'equity capital of the company. Companies also raise funds by borrowing: from' the public, banks,
and from other financial institutions. They raise money from the public either through fixed deposits or
by selling debentures. The persons who buy debentures are called 'debenture holder', Debenture
holders are creditors of the company, i.e. They are owned money by the company - whereas
shareholders are owners of the company.

☻ The Stock Exchange

The stock exchange is basically a market place for sale or purchase of shares and other
securities. Just like any other market, it brings together the potential buyers and sellers of securities.
The term 'security' is a broad generic terms covering equity shares, debentures share, 'debentures
and bonds issued by government semi-government and local authorities. There are twenty three
recognized stock exchanges in India. These are located at Bombay (two stock exchange), Calcutta,
Delhi, Madras, Kanpur, Ludiana, Guwahati, Pune, Mangalore, Patna, Baroda, Bhubaneshwar, Rajkot,
Meerut, Coimbatore and Gangtok.

Unlike other market, you are not permitted to buy or sell shares directly in a stock exchanges.
According to the Stock Exchange Rules you have to do you buying and selling through a license.
 Organized stock exchange: A securities marketplace where purchasers and sellers regularly
gather to trade securities according to the formal rules adopted by the exchange.
 American Depository Receipts: An American depositary receipt (ADR) is a negotiable
security that represents securities of a non-US company that trades in the US financial markets.
Securities of a foreign company that are represented by an ADR are called American depositary
shares
 Global Depository Receipts: A global depository receipt or global depositary receipt (GDR) is
a certificate issued by a depository bank, which purchases shares of foreign companies and deposits
it on the account. GDRs represent ownership of an underlying number of shares. Global depository
receipts facilitate trade of shares, and are commonly used to invest in companies from developing or
emerging markets.
 Foreign Currency Convertible Bonds (FCCBs): Foreign currency convertible bonds (FCCBs)
are a special category of bonds. FCCBs are issued in currencies different from the issuing company's
domestic currency. Corporates issue FCCBs to raise money in foreign currencies. These bonds
retain all features of a convertible bond, making them very attractive to both the investors and the
issuers. These bonds assume great importance for multinational corporations and in the current
business scenario of globalisation, where companies are constantly dealing in foreign currencies.
 External Commercial Borrowings (ECBs): An external commercial borrowing (ECB) is an
instrument used in India to facilitate the access to foreign money by Indian corporations and PSUs
(public sector undertakings). ECBs include commercial bank loans, buyers' credit, suppliers' credit,
securitised instruments such as floating rate notes and fixed rate bonds etc., credit from official export
credit agencies and commercial borrowings from the private sector window of multilateral financial
Institutions.
8.11 REFERENCES

 Dutt and Mahajan (2017). Indian Economy. S Chand Publications Pvt. Ltd.
8.12 FURTHER READINGS

 Financial Markets Structure RBI downloaded from https://rbidocs.rbi.org.in.

 Adam, Mustafa Hassan Mohammed (2009) Financial markets. The recent experience of a
developing economy available at Researchgate researchgate.in.
8.13 MODEL QUESTIONS

Q. 1 Explain the role played by SEBI in the Capital Market in India.

Q. 2 Critically appraise the development of capital market in India.

Q. 3 Discuss various reforms undertaken in the capital market in India since 1990-91

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 Lesson-9
CAPITAL MARKET IN INDIA-II
[GROWTH, REFORMS, SEBI AND POST-90s PHASE]
Structure
9.0 Objectives
9.1 Introduction
9.2 Growth of Capital Market in India
9.3 Factors underlying the Growth of Indian Capital Market.
9.3.1 Institutions
9.3.2 Legislative Measures
9.3.3 Setting up of SEBI
9.3.4 Growth of Under Writing Business
9.3.5 Growth of Mutual Funds
9.3.6 Setting up of Credit Rating Agencies
9.3.7 Growing up of Public Confidence
9.3.8 Increasing Awareness of Investment Opportunities.
9.4 Reforms in Indian Capital Market (Primary, Secondary & Insurance)
9.4.1 Primary Market Reforms
9.4.2 Secondary Market Reforms
9.4.3 Insurance Reforms
9.5 Strengthening the capital market (Post Reforms Phase)
9.5.1 Steps to strengthen Government Securities Market.
9.5.2 Securities and Exchange Board of India (Empowered)
9.5.3 National Stock Exchange of India (Establishment)
9.5.4 National Securities Clearing Corporation (Establishment)
9.5.5 Dematerialisation
9.6 Steps taken by SEBI
9.7 Review of the Performance of SEBI
9.8. Summary
9.9. Glossary
9.10 References
9.11 Further Readings
9.12 Model Questions
9.0. OBJECTIVES
 After going through this lesson you shall be able to :
 discuss the growth of capital market in India.
 delineate the factors underlying the growth the Indian Capital Market
 explain the reforms undertaken to strengthen the Indian Capital Market
 review the functioning & performance of SEBI in India.
9.1 INTRODUCTION
The Indian capital market has witnessed a radical transformation within a period of just over
one and a half decade. During the early part of 1990s the ranking of Indian capital market with
reference to global standards regarding efficiency, safety, market integrity etc., was low. With
reference to the risk indices, in particular, the Indian capital market was regarded as one of the worst
as it figured almost at the bottom of the league. However, the scenario has now completely changed.
Because of extensive capital market reforms carried out over the period of the last decade and a half,
the setting up and extension of activities of NSE, and steps taken by SEBI, the Indian capital market
is now ranked in the top league. In fact, it is now considered to be way ahead of many developed
country capital markets.
A significant feature of the primary market activity after abolition of capital controls has been
that the corporates attempted to diversify the range of instruments. A wide variety of innovative/hybrid
instruments were introduced to suit varied needs of investors and issuers/borrowers. Some of the
instruments which became quite popular were secured premium notes (SPN) with detachable
warrants, non-convertible debentures with detachable equity warrants, zero-interest equity shares
with detachable equity warrants, fully convertible cumulative redeemable preference shares etc.
Despite set-back in some years due to stock market scams, the sentiments look positive due to
revival of retail investor interest in the market following encouraging corporate performance in recent
period. It is necessary to take adequate precautionary steps to brave the external shocks.
9.2 GROWTH OF INDIAN CAPITAL MARKET SINCE INDEPENDENCE
In the pre-independence period, Indian capital market was not properly developed. The
number of companies was very small and the securities traded was still smaller. A large part of the
capital market consisted of the gilt edged market for government and semi-government securities.
Besides, Government had placed many restrictions on the institutional savers such as banks and
insurance companies which necessarily had to purchase government securities.
Since 1951, the Indian capital market has grown rapidly and the volume of savings and
investments had shown steady improvement. A very important indicator of the growth of the capital
market is the growth of joint stock companies or corporate enterprises. In 1951, there were about
28,500 companies both public limited and private limited companies with a paid-up capital of Rs. 775
crores. It increased to 70,000 companies with paid-up capital of over Rs. 2,00,000 crores in the year
2000. In the last two decades (1990-2010) alone, the capital market has witnessed rapid growth.
Another important indicator of the growth of capital market is the growth of public borrowings
for investment purposes. By the year 2003-04, there were 250 non-departmental public enterprises of
the Central Government alone with capital investment of Rs. 1,50,000 crores.
Moreover, its functioning has been diversified. New financial instruments, such as fully and
partly paid convertible debentures (FCDs and PCDs) 364-day treasury bills, commercial paper, CDs
have appeared. The number of shareholders runs into several millions indicating the growth of the
culty of equity.
Historically, after Independence, all-India financial institutions like IFCI, ICICI, IDBI and others
played a very important role in providing medium and long term credit to various sectors of the
economy. By the beginning of the 21st century, these financial institutions-called variously as public
sector term lending institutions, development financial institutions etc.2 declined in importance. Some
of them disappeared (ICICI & IDBI) and some were wound up (IDBI). Some of them have grown in
importance like Export Import Bank of India, National Housing Bank (NHB), NABARD, SIDBI –
generally by providing refinance to banks and other financial institutions. Other notable public sector
financial corporations are LIC, SFCs, SIDC, NEDFI.
Essentially, these finance companies are banks, since they perform the basic twin functions
of attracting deposits from the public and making loans. Despite the fact, NBFCs are not regarded as
banking companies and they do not come under the control of RBI. Hence, there is no minimum
liquidity ratio or cash ratio.
The largest stock exchange in India is NSE : NSE has adopted fully automated screen based
trading system which allows trading members to trade from their office through a communication
network. The exchange has opened membership to a number of cities. The second largest stock
exchange in India is the Bombay Stock Exchange (BSE). It was the first organised stock exchange
established in India at Mumbai as far back as 1887. Presently, NSE and BSE account for almost the
entire trading of scripts on India stock markets and most of the regional stock exchanges have been
rendered redundant.
Key indicators on India’s equity markets are presented in Table 1.
Table 1
Indian Equity Markets : Key Indicators
Indicator BSE NSE
2006-07 2007-08 2008-09 2006-07 2007-08 2008-09
1. BSE Sensex/S&P CNX Nifty
(i) Average
(ii) End of the year 12,277 16,569 12,366 3,572 4,897 3731
13,072 15,644 9,709 3,822 4,735 3021
2. Listed companies 4,821 4,887 4,929 1,228 1,381 1,432
3. Cash segment turnover 9,56,185 15,78,858 11,00,074 19,45,285 35,51,038 27,52,023
(Rs. crore)
4. Derivatives segment 59,007 2,42,308 12,268 73,56,242 1,30,90,478 1,10,10,482
turnover (Rs. crore)
5. Market capitalisation* 35,45,041 51,38,215 30,86,076 33,67,350 48,58,122 28,96,194
(Rs. crore)
6. Market capitalisation to GDP 85.5 108.8 58.0 81.6 102.9 54.4
ratio
* As at end-March

Source : Reserve Bank of India, Annual Report 2008-09 (Mumbai, 2009), Table 2.67, p. 153. C.f. Misra & Puri, 2011.
Turnover in the stock market increased considerably in 2007-08 over 2006-07 but declined in

2
Note : Going by the Khan Committee’s (1998) recommendation of universal banking due to blurring of distinction between
commercial banking & development banking, the first universal bank in India was set up by ICICI merging with
ICICI Bank. IDBI disappeared with its merger with IDBI bank in 2004.
2008-09 due to economic slowdown. Cash segment turnover of the BSE and NSE together rose from
Rs. 29,01,470 crore in 2006-07 to Rs. 51,29,896 crore in 2007-08 – an increase of as much as 76.8
per cent. However, due to economic slowdown in 2008-09, the combined turnover of the BSE and
NSE declined to Rs. 38,52,097 crore in 2008-09 – a decline of 25.0 per cent. It can be calculated
from the information contained in Table 1 that a similar trend prevailed in the derivatives segment as
well. Turnover in this segment of the stock market increased by almost 80 per cent in 2007-08 over
2006-07 but fell by 17.3 per cent in 2008-09. Market capitalisation of BSE increased from Rs.
35,45,041 crore as at end-March 2007 to Rs. 51,38,015 crore as at end-March 2008 but fell to Rs.
30,86,076 crore as at end-March 2009. Market capitalisation of NSE rose from Rs. 33,67,350 crore
as at end-March 2007 to Rs. 48,58,122 crore as at end-March 2008 but fell to Rs. 28,96,194 crore as
at end-March 2009. Market capitalisation to GDP ratio exceeded 100 per cent as at end-march 2008
but fell considerably during the year 2008-09. Between end-March 2007 and end-March 2008, the
BSE Sensex moved in a wide range of 12,455 – 20,873. Following slowdown in the economy in the
latter half of the financial year 2008-09 due to global meltdown, the market sentiment was adversely
affected and the BSE Sensex fell below 10,000 level in the last quarter of this year.
The year 2009-10 saw improvement in market segment and cash segment turnover of the
BSE and NSE together which rose to Rs. 55,16,833 crore (from Rs. 38,52,097 crore in 2008-09)
while derivative segment turnover rose to Rs. 1,76,63,899 crore (from Rs. 1,10,22,750 crore in 2008-
09).
9.3 FACTORS UNDERLYING GROWTH OF CAPITAL MARKET IN INDIA
The massive expansion of the capital market in the Indian economy during the past two
decades can be attributed to the liberalisation of economic policy in the industrial, financial and
foreign trade sectors in 1991 (although there have been set-backs in certain years). Despite the
setbacks, the turnover and trading in the capital market is now much more than it was, say, a decade
back. The factors that have contributed to the growth of capital market in India, have been explained
as follows :
9.3.1. Institutions: It refers to the establishment of development banks and industrial
financing institutions. With a view to providing long-term funds to industry, the government set up the
Industrial Finance Corporation of India (IFCI) in 1948, i.e., soon after Independence. This was
followed by the setting up of a number of other development banks and financial institutions like the
Industrial Credit and Investment Corporation of India (ICICI) in 1955, Industrial Development Bank of
India (IDBI) in 1964, Industrial Reconstruction Corporation of India (IRCI) in 1971, various State
Financial Corporations (SFCs) at the State level, Unit Trust of India (UTI) in 1964, State Industrial
Development Corporations, Life Insurance Corporations of India etc. In addition, 14 major commercial
banks were nationalised in 1969. Another 6 banks were nationalised in 1980. These financial
institutions and development banks have contributed significantly to the widening and strengthening
of the capital market in India.
ICICI Ltd. ceased to be a development bank after its merger with ICICI bank with effect from
March 30, 2002 while IDBI was converted into a bank in October 2004.
9.3.2. Legislative Measures : The Capital Issues (Control) Act was passed in 1947 to
regulate investment in different enterprises, prevent diversion of funds to non-essential activities, and
to protect the interest of investors. The Government passed the Companies Act in 1956. This Act
gave considerable powers to the government to control and direct the development of the corporate
enterprises in the country. The Act was repealed in 1992 as it was felt that the Act had become too
restrictive and was hampering the growth of the capital market.
9.3.3. Setting up of SEBI : The Securities and Exchange Board of India (SEBI) was set up in
1988 and was given statutory recognition in 1992. Among other things, the Board has been
mandated to create an environment which would facilitate mobilisation of adequate resources through
the securities market and its efficient allocation.
9.3.4 Growth of Underwriting Business : The underwriting business in India has been
growing rapidly mainly due to the efforts of the public financial institutions and the commercial banks.
This has contributed significantly to the development of the capital market in India.
9.3.5. Growth of Mutual Funds : Presently the mutual funds operating in the country are -
UTI, 6 mutual funds sponsored by financial institutions (LIC, GIC and IDBI) and 45 mutual funds in
the private sector. Net mobilisation of resources in 2007-08 was as high as Rs. 1,53,802 crore (Rs.
10,677 crore by the UTI, Rs. 1,33,304 crore by private sector mutual funds and Rs. 9,820 crore by
mutual funds sponsored by public sector banks and financial institutions. However, because of global
liquidity squeeze in 2008-09, corporates withdrew their investments from the mutual funds. As a
result, net mobilisation in 2008-09 was negative at – Rs. 28,296 crore. There was a revival in 2009-10
because of easing of liquidity conditions and trends of market recovery. As a result, net mobilisation
by mutual funds during 2009-10 rose to Rs. 83,080 crore.
9.3.6 Setting up of Credit Rating Agencies : There are three credit rating agencies
operating in India at present CRISIL, ICRA and CARE, CRISIL (the Credit Rating Information
Services of India Limited) was set up in 1988, ICRA Ltd. (the Investment Information and Credit
Rating Agency of India Limited) was set up in 1991 and CARE (Credit Analysis and Research
Limited) was set up in 1993. Credit ratings by these agencies have been providing guidance to
investors/creditors for determining the credit risk associated with a debt instrument. This is likely to
help in the healthy development of the capital market in future.
9.3.7 Growing Public Confidence : The early post-liberalisation phase witnessed increasing
interest in the stock markets. The small investor who earlier shied away from the securities market
and trusted the traditional modes of investment (deposits in commercial banks and post offices)
showed marked preference in favour of shares and debentures. As a result, public issues of most of
the goods companies were oversubscribed many times. However, in the recent period, many retail
investors have withdrawn from the securities market due to the lacklustre performance of many
companies which has pushed down their share prices to low levels.
In recent times, with dividends being made tax free, investment in gilt-edged market (through
the various schemes floated by mutual funds) has attracted the attention of many individual investors
who now regard it as a better option than investment in fixed deposits of banks. This is due to the
reason that while investment in gilt-edged market is as risk-free as in the case of bank fixed deposits,
it is more liquid vis-a-vis the latter.
9.3.8. Increasing awareness of investment opportunities : With the changing scenario,
the last few years have witnessed increasing awareness of investment opportunities among the
general public. Business newspapers and financial journals (The Economic Times, The Financial
Express, Business Line, Business Standard, Business India, Business Today, Business world, Money
Outlook etc.) have made the people increasingly aware of new long-term investment opportunities in
the securities market.
9.4. REFORMS IN INDIAN CAPITAL MARKET (IN THE EARLY POST-REFORMS ERA)
 The Capital Issues (Control) Act, 1947 governed capital issues in India. The capital issues
control was administered by the Controller of Capital Issues (CCI) according to the principles and
policies laid down by the Central Government.
The functioning of the stock exchanges in India has shown many weaknesses, like lack of
transparency in procedures and vulnerability to price rigging and insider trading. To counter these
shortcomings and deficiencies and to regulate the capital market, the Government of India set up the
Securities Exchange Board of India in 1988.
The Narasimham Committee on the Reform of the Financial System in India (1991)
recommended the abolition of CCI and wanted SEBI to protect the investors and take over the
regulatory function of CCI. The Government of India accepted this recommendation, repealed the
Capital Issues (Control) Act, 1947 and abolished the post of CCI. Companies were allowed to
approach the capital markets without prior government permission subject to getting their offer
documents cleared by SEBI. In other words SEBI was given the power to control and regulate the
new issue market as well as the old issues market (commonly) known the stock exchange).
Initially, SEBI was set up as a non statutory body but in January 1992 it was made a statutory
body. SEBI was authorised to regulate all merchant banks on issue activity, lay guidelines and
supervise and regulate the working of mutual funds and oversee the working of stock exchanges in
India. SEBI, in consultation with the Government, has taken a number of steps to introduce improved
practices and greater transparency in the capital markets in the interest of the investing public and
the healthy development of the capital markets.
9.4.1 Primary Market Reforms
SEBI has introduced various guidelines and regulatory measures for capital issues.
Companies issuing capital in the primary market are now required to disclose all material facts and
specific risk factors with their projects; they should also give information regarding the basis of
calculation of premium (leaving the companies free to fix the premium). SEBI has also introduced a
code of advertisement for public issues for ensuring fair and truthful disclosures.
A. Money and Capital Markets in India
In order to encourage Initial Public Offers (IPO) SEBI has permitted companies to determine
the par value shares issued by them (i.e. SEBI has now dispensed with fixed par values of Rs. 10
and Rs. 100). SEBI has allowed issues of IPOs to go for “book building” – i.e. reserve and allot
shares to individual investors. But the issuer will have to disclose the price, the issue size and the
number of securities to be offered to the public.
In recent years, private placement market has become popular with issuers because of
stringent entry to disclosure norms for public issues. Low cost of finance, ease of structuring
investments and saving of one lag in issuance has led to the rapid growth of private placement
market. Total resource mobilisation through private placement market had increased sharply from
3,360 crores during 1995-96 to nearly Rs. 50,000 crores being 1998-99.
To reduce the cost of issue, SEBI has made to underwriting of issue optional, subject to the
condition that if an issue was not underwritten and was not able to collect 90% of the amount offered
to the public, the entire amount collected would be refunded to the investors. The lead managers
have to issue due diligence certificate which has now been made part of the offer document.
Mutual Funds : SEBI has raised the minimum application size and also the proportion of each
issue allowed for firm allotment of institutions such as mutual funds. SEBI has also introduced
regulations governing substantial acquisition of shares and take-overs and lays down the conditions
under which disclosures and mandatory public offers have to be made to the shareholders.
Merchant banking has been statutorily brought under the regulatory framework of SEBI. The
merchant bankers are now to be authorised by SEBI. They have to adopt the stipulated capital
adequacy norms, abide by a code of conduct which specifies a high degree of responsibility towards
investors in respect of pricing and premium fixation of issues. Merchant bankers have now a greater
degree of accountability in the offer document and issue process.
In order to induce companies to exercise greater care and diligence for timely action in
matters relating to the public issues of capital, SEBI has advised stock exchanges to collect from
companies making public issues, a deposit of one per cent of the issue amount which could be
forfeited in case of non-compliance of the provisions of the listing agreement and, non-despatch of
refund orders and share certificates by registered post within the prescribed time.
Listing Arrangement : SEBI has advised stock exchanges to amend the listing agreement to
ensure that a listed company furnishes annual statement to the stock exchanges showing the
variations between financial projections and projected utilisation of funds in the offer documents and
the actual utilisation. This would enable the share-holders to make comparisons between promises
and performance.
Private Mutual Funds : The Government has now permitted the setting up of private mutual
funds and a few have already been set up. UTI has now been brought under the regulatory
jurisdiction of SEBI. All mutual funds are allowed to apply for firm allotments in public issues. To
improve the scope of investments by mutual funds, the latter are permitted to underwrite public
issues. Further, SEBI has relaxed the guidelines for investment in money market instruments. Finally,
SEBI has issued fresh guidelines for advertising by mutual funds.
Disclosures and Issue Market : SEBI vets offer documents to ensure that all disclosures have
been made by the company in the offer document. All the guidelines and regulatory measures of
capital issues are meant to promote healthy and efficient functioning of the issue market (or the
primary market). Despite all these steps, there are flagrant breaches of issue procedures through
collusion between unscrupulous promoters and corrupt officials in the lead banks and even of the top
officials of SEBI, as was the case of the now famous or infamous M.S. Shoes East Ltd. whose mega
issue was literally aborted by SEBI in February-March 1995, soon after the issue was made public
and subscribed.
Global Depository Receipts (GDRs) : Since 1992, the Government of India allowed Indian
companies to access international capital markets through Dollar and Euro equity shares. Up to
January 1995, Indian companies had raised US $3.6 billion through launching GDR issues, and US
$1.1 billion through launching Euro Convertible Bonds (ECBs). Initially, the Euro-issue proceeds were
to be utilised for approved end uses within a period of one year from the date of issue. Since there
was continued accumulation of foreign exchange reserves with RBI and there were long gestation
periods of new investment, the Government required the issuing companies to retain the Euro-issue
proceeds abroad and repatriate only as and when expenditure for the approved end uses were
incurred.
Liberal Investment Norms : The Government of India has also liberalised investment norms
for NRIs so that NRIs and Overseas corporate bodies can buy shares and debentures without prior
permission of RBI subject to an upper limit of 10 per cent by any one FII in an Indian entity.
9.4.2 The Secondary Market Reforms
Following steps have been taken up by the SEBI to reform the secondary market in India:
SEBI has started the process of registration of intermediaries, such as the stock brokers and
sub-brokers under the provisions of the Securities and Stock Exchange Board Act, 1992. The
registration is on the basis of certain eligibility norms such as capital adequacy, infrastructure, etc.
There has been much opposition and resistance to this step of SEBI. SEBI has also made rules for
making client/broker relationships more transparent, in particular segregating client and broker
accounts.
To make the governing bodies of stock exchanges broad based, the governing body of stock
exchanges should have 5 elected members, not more than 4 members nominated by the
Government or SEBI and 3 or fewer members nominated as public representatives.
Since 1992, SEBI has constantly reviewed the traditional trading systems in Indian Stock
Exchanges. It is simplifying procedures and achieving transparency in costs and prices at which
customers’ orders are executed, speeding up clearing and settlement, and, finally transfer of shares
in the names of buyers.
SEBI has notified regulations on insider trading under the provisions of SEBI Act. Such
regulations are meant to protect and preserve the integrity of stock markets and, in the long run, help
inspire investor confidence in the stock exchange. Despite these regulations, insider trading is
rampant in our stock exchanges, and, rigging the market and manipulating stock market price
quotations are quite common. M.S. Shoes East Ltd. fiasco was an example of market rigging; SEBI
could do nothing about it.
The Government has allowed foreign institutional investors (FIIs) such as pension funds,
mutual funds, investment trusts, asset or portfolio management companies etc. to invest in the Indian
capital market provided they are registered with SEBI. Till Janurary 1995, as many as 286 FIIs have
been registered with SEBI – they were only 10 in January 1993 and 136 in January 1994. The
cumulative net investments of FIIs has increased from $200 million in January 1993 to $3 billion in
January 1995, reflecting the economic liberalisation policy of the country and to some extent, the
prevalence of low rates of interest abroad. The Government of India has now permitted joint venture
stock broking companies to have non-Indian citizens on their Board of Directors.
To prevent excessive speculation and volatility in the stock market, SEBI has introduced
rolling settlements from July 2, 2001, under which settlement has to be made every day. This,
however, has not succeeded extreme volatility in the stock market.
9.4.3 Insurance Reforms
The most notable event during 1999-2000 in the field of contractual savings has been the
passing of the Insurance Regulation and Development Authority (IRDA) Act despite stiff opposition
from trade unions and the Left parties. The IRDA Act ends the monopoly of the Government in the
insurance sector because it seeks to promote the private sector (including limited foreign equity) in
the insurance sector. It gives priority in the utilisation of policy holders funds for the development of
social and infrastructure sectors. The Government has given licences to a number of private sector
companies to do insurance business.
9.5 STRENGTHENING THE CAPITAL MARKET : THE POST-REFORMS PHASE
 In the post-reform phase (i.e. the period after 1990) the Government of India has initiated a
number of steps to strengthen the capital market. A brief discusison of important measures follows.
Steps to Strengthen the Government Securities Market (in chronological order)
 The auction system for the sale of Government of India, medium and long-term,
securities was introduced from June 3, 1992. Some innovative instruments, such as, conversion of
auction Treasury Bills into term securities, Zero Coupon and Capital Indexed Bonds, Tap Stocks and
partly paid stocks were introduced.
 364-day Treasury Bills auctions were introduced from April 28, 1992 and 91-day
Treasury Bills auctions from January 8, 1993. 14-day Treasury Bills were introduced on June 6, 1997,
while 182-day Treasury Bills were reintroduced on May 26,1999. Auctions of 14-day Treasury Bills
and 182-day Treasury Bills were discontinued from May 14, 2001. However, auction of 182-day
Treasury Bills was resumed from April 5, 2005.
 The Government of India set up the Securities Trading Corporation of India (STCI) to
develop institutional structure for a vibrant secondary market in government securities. STCI was set
up with total capital of Rs. 500 crore and it commenced operations from June 1994.
 The Delivery versus Payment system (DvP) was introduced in 1995 for the settlement
for transactions in government securities. A screen-based trade reporting system with the use of
VSAT Communication Network complemented by a centralised Subsidiary General Ledger (SGL)
accounting system was put in place.
 A system of Primary Dealers was established in March 1995 and the guidelines for
Satellite Dealers were issued in December 1996.
 Market orientation to issues of government securities paved the way for the Reserve
Bank to activate the open market operations as a tool of market intervention.
 The practice of automatic monetisation of the Central government budget deficit through
ad hoc Treasury Bills was replaced with effect from April 1, 1997 by a new scheme of Ways and
Means Advances (WMA).
 A Scheme of 14-day Intermediate Treasury Bills was introduced effective from April
1997 to enable State governments, foreign central banks and other specified bodies with whom the
Reserve Bank had an arrangement to invest their temporary surplus funds
 The Negotiated Dealing System (NDS) (phase I) was operationalised in February 2002
to enable online electronic bidding facility in the primary auctions of Central/State government
securities.
 Since timely information is a critical factor in evolving the efficient price discovery
mechanism, improvements were brought in transparency of operations and data dissemination.
 A practice of pre-announcing a calendar of treasury bills and government securities
auctions to the market was introduced.
 Foreign institutional investors were allowed to set up 100 per cent debt funds to invest in
government (Central and State) dated securities in both primary and secondary markets.
 Retail trading in government securities at select stock exchanges commenced in
January 2003.
9.5.2 Securities and Exchange Board of India : (Empowered)
The Securities and Exchange Board of India (SEBI) set up in 1988, was given statutory
recognition in 1992 on recommendations of the Narasimha Committee. The SEBI has also been
mandated to create an environment which would facilitate mobilisation of adequate resources through
the securities market and its efficient allocation. The purposes and aims of SEBI are as follows:
 regulating the business in stock markets and other securities markets;
 registering and regulating the working of stock brokers and other intermediaries associated
with the securities markets;
 registering and regulating the working of collective investment schemes including mutual
funds;
 promoting and regulating the self-regulatory organisations;
 prohibiting fraudulent and unfair trade practices relating to securities markets;
 promoting investors’ education and training of intermediaries of securities market;
 prohibiting insider trading in securities;
 regulating substantial acquisition of shares and takeover of companies; and
 performing such functions and exercising such powers under the provisions of the Capital
Issues (Control) Act, 1947 and Securities Contracts (Regulation) Act, 1956, as may be
delegated to it by the Central Government.
SEBI has been vested with wide-ranging powers. First, to oversee constitution as well as the
operations of mutual funds including presentation of accounts, following the decision to allow the
entry of private sector and joint sector mutual funds. Second, all stock exchanges in the country have
been brought under the annual inspection regime of SEBI for ensuring orderly growth of stock
markets and investors protection. Third, with the repealing of the Capital Issues (Control) Act, 1947.
SEBI has been made the regulatory authority in regard to new issues of companies. In May 1992, an
amendment to the SEBI Act (1992), carried out on March 25, 1995, has empowered SEBI to register
and regulate new intermediaries in the capital market. With this empowerment, all intermediaries
associated with the securities market are now regulated by SEBI.
Empowerment of SEBI
In January 1995, the Government of India promulgated an ordinance to amend SEBI Act,
1992 so as to arm SEBI with additional powers for ensuring the orderly development of the capital
market and to enhance its ability to protect the interests of the investors. The important features of
this ordinance are:
(a) To enable SEBI to respond speedily to market conditions and to reinforce its autonomy,
SEBI has been empowered to file complaints in courts and to notify its regulations without prior
approval of the Government.
(b) SEBI is now provided with regulatory powers over companies in the issuance of capital,
the transfer of securities and other related matters.
(c) SEBI is now empowered to impose monetary penalties on capital market intermediaries
and other participants for a listed range of violations. The amendment proposes to create adjudicating
mechanism within SEBI for leaving penalties and also constitute a separate tribunal to deal with
cases of appeal against orders of the adjudicating authority.
Earlier the SEBI Act provided for the suspension and cancellation of registration and for the
prosecution of intermediaries which led to the stoppage of business. The new system of monetary
penalties constitutes an alternative mechanism for dealing with capital market violations.
(d) While investigating irregularities in the capital market, SEBI is now given the power to
summon the attendance of and call for documents from all categories of market intermediaries,
including persons from the securities market. Likewise, SEBI has now the power to issue directions to
all intermediaries and persons connected with securities markets with a view to protect investors or
secure the orderly development of the securities market.
9.5.3 National Stock Exchange of India (NSEI) : Establishment
As stated earlier, NSE was set up in November 1992 and was owned by IDBI, UTI and other
public sector institutions. It commenced its operations in 1994. NSE is a securities exchange which
marks a radical break with the past. According to Ajay Shah, (c.f. Misra & Puri, 2010) the regime in
which trading on NSE operates is characterised by four key innovations: (1) the physical floor was
replaced by anonymous, computerised order-matching with strict price-time priority. (2) The
limitations of being in Mumbai, and the limitations of India’s public telecom network, were avoided by
using satellite communications. Now NSE has a network of 2,000 satellite terminals all over the
country. On a typical day, almost 3,500 traders log in to the trading computer over this network. “This
is larger than the capacity of the largest trading floors in the world”. (3) NSE is not ‘owned’ by brokers.
It is a limited liability company, and brokers are franchisees. Therefore, NSE’s staff is free of
pressures from brokers and is able to perform its regulatory and enforcement functions more
effectively. (4) Traditional practices of unreliable fortnightly settlement cycle with the escape clause of
badla were replaced by a strict weekly settlement cycle without badla.
As stated earlier, equity trading at NSE commenced in November 1994. The BSE responded
rapidly by moving to similar technology in March 1995. According to Ajay Shah, the improvements
that accompanied this regime are follows: (i) transparency – users could look at a price on a
computer screen before placing as order; (ii) anonymity - electronic trading is completely transparent
about prices and quantities, and completely opaque about identities; (iii) competition in the brokerage
industry - as a result of NSE, about 1,000 new brokerage firms have entered the market. This has
reduced transaction costs sharply (through lower brokerage fees); (iv) operational efficiency -
automation eliminated the vagaries of manual trading; and (v) gains outside Mumbai - NSE’s satellite
based trading gave equal access to the trading floor from all locations in India. This has helped the
users outside Mumbai and has been a major impetus to the development of financial sector outside
Mumbai. (Misra & Puri, 2010).
9.5.4 National Securities Clearing Corporation (NSCC)
As stated earlier, trading in the securities market in the pre-reform phase was fraught with
counterparty risks. Small counterparty risks could turn into large counterparty risks owing to
cascading effects, jeopardising the functioning of the entire market. To tackle this problem, the
National Securities Clearing Corporation (NSCC) was set up in 1996. Effective on July 4, 1996, the
NSCC started guaranteeing all trades on NSE. “This means that when A and B make a trade, NSCC
interposes itself between them. If A was supposed to buy from B, then NSCC buys from B and NSCC
sells to A. If either A or B default, the NSCC still meets the obligation for the other leg of the trade.
Thus every trade that takes place is freed from the risk of the counter party defaulting. This
automatically ends the risk of cascading failures generating a payments crisis.”
9.5.5 Dematerialisation
The final leg of a transaction is where the title on a security is changed from the seller to the
buyer. Since share certificates in India were printed on paper, trading in them was fraught with
operational cost and risk. Theft or counterfeiting of share certificates gave rise to a number of criminal
activities. To tackle this problem, National Securities Depository Limited (NSDL) was set up in
November 1996. This was followed by the setting up of the Central Securities Depository Ltd.
(CSDL). The depository maintains a computer record of ownership of securities and dispenses with
physical share certificates. This cuts down the hazards related with physical trading in share
certificates and also reduces the transactions costs substantially.

SAQ
Q. What do you know about the role of SEBI in the development of capital market in India.
___________________________________________________________________

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9.6 CAPITAL MARKET AND STEPS TAKEN BY SEBI (A SYNOPTIC VIEW)

To introduce improved practices and greater transparency in the capital markets in the
interest of healthy capital market development, a number of steps have been taken by SEBI, as
discussed below :
(a) Programme for inspecting stock exchanges : Under this programme, inspections of
some stock exchanges has already been carried out. The basic objective of such
inspections is to improve the functioning of stock exchanges.
(b) Broad-basing Governing Boards : Through an order under the Securities Contracts
(Regulations) Act, 1956, SEBI has directed the stock exchanges to broad-base their
governing boards and change the composition of their arbitration, default and
disciplinary committees. The broadbasing of the governing boards of the stock
exchanges would help them function with greater degree of autonomy and
independence so that they become truly self-regulatory organisations.
(c) Registration of Intermediaries : Such as stock brokers and sub-brokers has been
provided under the provision of the Securities and Exchange Board of India Act, 1992.
The registration is on the basis of certain eligibility norms such as capital adequacy,
infrastructure etc. According to the SEBI (Stock Brokers and Sub-Brokers) Rules 1992
announced on August 20, 1992, no person can act as a stock-broker for the purpose of
buying/selling or dealing in securities, unless he holds a certificate granted by SEBI and
conditions for grant of such certificates have been laid down in the rules. SEBI issued
regulations relating to stock-brokers and sub-brokers in October 1992 which, inter alia,
 cover registration of brokers and sub-brokers, their general obligations and
responsibilities, procedures for inspection of their operations and actions to be initiated
in case of default.
(d) Reforms the Primary Market : The objective is to strengthen the standards of
disclosure, introduce certain procedural norms for the issuers and intermediaries, and
remove the inadequacies and systemic deficiencies in the issue procedures. For
example, an advertisement code has been laid down to ensure that the advertisement
are fair and do not contain statements to mislead the investors; a system of appointing
SEBI representatives to supervise the allotment process has been introduced to
minimise malpractices in allotment of oversubscribed issues; prudential norms have
been laid down for rights issues, etc.
(e) Merchant Banking : It has been statutorily brought under the regulatory framework of
SEBI. The merchant bankers have to be authorised by SEBI. They will have to adhere to
stipulated capital adequacy norms and abide by a code of conduct which specifies a
high degree of responsibility towards inspectors in respect of the pricing and premium
fixation of issues.
(f) Mutual Funds : SEBI has notified the regulations for mutual funds. Mutual Funds raise
money by selling units to the public and funds so raised are invested in equities and
debentures of companies. For the first time mutual funds are governed by a uniform set
of regulations which require them to be formed as trusts and managed by a separate
asset management company (AMC) and supervised by a board of trustees or trustee
company. the SEBI (Mutual Fund) Regulations also provide for an approval of the offer
documents of schemes by SEBI. The regulations prescribe minimum amount to be
raised by each scheme. A close ended scheme with a fixed size of mutual fund must
raise a minimum of Rs. 20 crore and open ended scheme of Rs. 50 crore. The entire
subscription amount must be refunded within six weeks of the closure of the scheme in
case the amount collected by the scheme falls short of the prescribed amount. There will
also be certain investment restrictions for AMCs. The regulations are intended to ensure
that the mutual funds grow on healthy lines and investors’ interests are protected. On
January 30, 1997, SEBI allowed mutual funds to mention an indicative return for
schemes for fixed income securities with certain disclosures to draw investors’ attention.
Many private sector companies such as Tata, Reliance, Birla have set up Mutual Funds
through which they raise money from the public.
(g) Development Financial Institutions : SEBI issued a separate set of guidelines for
development financial institutions in September 1992 for disclosure and investment
protection regarding their raising of funds from the market. As per the guidelines, there is
no need for promoter’s contribution. Besides, underwriting is not mandatory. Moreover,
free pricing is permitted subject to consistent track record for three years and credit
rating is compulsory for debentures and bonds of more than 18 months.
(h) Insides Trading : SEBI issued regulations pertaining to “Insider Trading” in November
1992 prohibiting dealings, communication or counselling in matters relating to insider
trading. Such regulations will help in protecting and preserving the market’s integrity,
and in the long run inspire investor confidence in the market.
(i) Buy Back Shares : The Companies (Amendment) Ordinance (October 31, 1998 and
January 7, 1999) allows companies to buy back their own shares subject to regulations
laid down by SEBI. The new Sections (77A and 77B) in the Ordinance lay down the
provisions/restrictions concerning buy back of shares. A company can finance its buy
back out of (i) its free reserves, (ii) the securities premium account or (iii) proceeds of an
earlier issue other than fresh issue of shares made specifically for buy back purposes.
(j) Disclosures : To bring about greater transparency in transactions, SEBI had made it
mandatory for brokers to maintain separate accounts for their clients and for themselves.
They must disclose the transaction price and brokerage separately in the contract notes
issued to their clients. They must also have their books audited and audit reports filed
with SEBI.
(k) Capital Adequacy Norms : SEBI has issued directives to the stock exchanges to
ensure that contract notes are issued by brokers to clients within 24 hours of the
execution of the contract. Exchanges are to see that time limits for payment of sale
proceeds and deliveries by brokers and payment of margins by clients to brokers are
complied with. For ensuring the fulfilment of deals (safety of the deals) in the market and
protecting investors, SEBI has introduced capital adequacy norms for brokers.
(l) Regulatory Jurisdiction : The ‘Banker to the issue’ has been brought under purview of
SEBI for investor protection. Unit Trust of India (UTI) has also been brought under the
regulatory jurisdiction of SEBI.
(m) Book-building : In order to popularise the book building mechanism for public issues,
SEBI modified the existing framework for book building. It is optional for investors to use
either the existing framework or the modified framework. A few public issues came to the
market taking advantages of the book-building process.
(n) Demateralisation of Securities : With a view to expediting the process of
dematerialisation of securities and settlement of transactions in the depository, SEBI, on
October 22,1997, decided that with effect from January 15, 1998, settlement of trades in
the depository would be compulsory for domestic financial institutions, banks, mutual
funds and foreign institutional investors (FIIs) having a minimum portfolio of securities of
Rs. 10 crore as on their latest balance sheet. In the interest of small investors, SEBI has
allowed investors with very small holding to sell in the stock exchange in physical form
under a special scheme. Such securities are then dematerialised by the buyers.
(o) Collective Investment Scheme : SEBI’s regulations for Collective Investment Schemes
(CIS) were notified on October 15, 1999. Under the SEBI Act and Regulations framed
thereunder, no person can carry on any CIS unless he obtains a certificate of
registration from SEBI. All existing collective investment schemes were required to apply
for registration by December 14, 1999. An existing scheme which does not obtain
registration from SEBI shall have to wind up and repay the money to the investors.
(p) Exemptions on Public Issues : SEBI has exempted infrastructure firms from certain
norms while floating a public issue. In particular, they would be exempted from the
requirements such as, making a minimum public offer of 25 per cent of equity, five
shareholders per Rs. one lakh of offer, and minimum subscription of 90 per cent.
(q) Derivatives Trading : In keeping with international best practice, SEBI introduced
 compulsory rolling settlement in ten select scrips on January 10, 2000. Since then more
scrips have been brought under compulsory rolling settlement in a phased manner. In
June 2000, SEBI introduced derivatives trading.
(r) Amendment 2002 : An Ordinance promulgated on October 28, 2002 gave the following
four powers to SEBI : (i) SEBI can search an entity’s premises and seize documents; (ii)
It can impound cash proceeds and securities connected to any transaction it is
investigating and can even freeze bank accounts; (iii) Regardless of the nature or scale
of market violation, SEBI could earlier fine an offender a maximum of Rs. 5 lakh. The
Ordinance increased this limit manifold – in market manipulation or insider trading
violations, to Rs. 25 crore or three time the profits made by the entity concerned,
whichever is higher and for other violations like non-disclosures, upto Rs. 1 crore; and
(iv) The size of the SEBI Board has been increased. The idea behind this is to move
from individual-based to group-based decision making, thereby reducing the possibility
of errors or bias. Moreover, insider trading and market manipulation has been defined
clearly. The Ordinance was followed by the Securities and Exchange Board of India
(Amendment) Act, 2002 adopted in December 2002.
(s) Listed Companies : In order to provide an additional route for raising funds in the
domestic market, SEBI permitted listed companies in May 2006 to raise funds in the
form of ‘Qualified Institutional Placement’ (QIP).
(t) Foreign Institutional Investors : In September 2006, SEBI widened the range of
international entities that can invest in the stock market by including an institution
established as incorporate outside India as a pension fund, mutual fund, investment
trust, insurance company and reinsurance company as registered FIIs (Foreign
Institutional Investors). The list would also include international or multilateral agencies,
foreign government agencies or foreign central banks.
(u) Corporate Bond : In March 2007, SEBI allowed the National Stock Exchange of India
Ltd. (NSE) to set up and maintain a corporate bond reporting platform to capture all
information relating to trading in corporate bonds as accurately as close to execution as
possible. In this connection, SEBI ruled that trades executed by the members of BSE
and NSE shall be reported on the reporting platforms of their respective stock
exchanges who would host such information on their websites.
(v) Recent Measures
In August 2007, SEBI issued guidelines for overseas investment by VCF (Venture
Capital Funds).
 SEBI has stipulated that Permanent Account Number (PAN) would be the sole
identification number for all participants in the securities market, irrespective of the
amount of transaction with effect from July 2, 2007.
 During the year 2007-08 the investment limit for FIIs (Foreign Institutional Investors) in
Government securities was enhanced from $ 2 billion to $ 2.6 billion.
 In October 2007, SEBI prohibited FIIs and their sub-accounts from issuing or renewing
Participatory Notes using offshore derivative instruments like futures and options.
 With effect from January 8, 2008, entry load by mutual funds was waved for investors
 making applications for investment in mutual fund schemes directly.
 Venture Capital Companies (VCC) to give financial support to new ideas and to
introduction of new technology.
 Masala Bonds.
 Companies (Amendment) Bill, 2020.
9.7 A REVIEW OF PERFORMANCE OF SEBI (CRISES FACED)
It was thought that SEBI has all necessary powers to control and regulate the securities
market on the one side and effectively protect the interests of the shareholders on the other.
However, SEBI failed miserably to prevent a small coterie of brokers in Mumbai to hammer the
SENSEX in March 2001 and in May 2004. The stock markets in India went through one of the worst
and most prolonged crises in their history. NARCL (2022) in India is likely to serve as a time efficient
mechanism, while reviving investor interest in primary as well as secondary markets for stressed
assets & security receipts (SRs).
Participatory Notes, 2007 & steps taken
According to Securities and Exchange Board of India (SEBI), currently 34 Foreign Institutional
Investors (FIIs) sub-accounts issue ODIs (Offshore Derivative Instruments) such as participatory
notes (PNs). This number was 14 in March, 2004. The notional value of PNs outstanding which was
at Rs. 31,875 crores (20 per cent of the Assets under custody – AUC) of all FIIs in March 2004,
increased to Rs. 3,53,484 crores (51.6 per cent of AUC) by August 2007 – a sharp increase by 11
times in a short span of a little over 3 years. This implies that more than 50 per cent of the Funds are
flowing from this anonymous route – a kind of foreign black money flowing into India.
When in 1992, foreign institutional investors (FIIs) were permitted by SEBI, it was assumed
that they would make proprietary investments out of their own capital. But the FIIs started borrowings
at low rates of interest and without disclosing the identity of sub-accounts, assumed massive
portions. As a result they could exercise effective control over the Indian Stock Market.
The 34 brokers issued offshore derivatives to the tune of about $ 100 billion, or almost 10 per
cent of the country’s GDP. When it started PNs made up only a small portion of ownership by
foreigners, but this has now assumed alarming proportions.
PNs were discriminatory, while the Indian investors are regulated, the PNs were not.
Moreover, to know your customer (KYC) requirement, Indian brokers had to register their clients,
giving details of proof of address, PAN etc. The question was raised : why this step- motherly
treatment to Indians and red carpet welcome to FIIs who don’t even want to be registered and yet
participate in the Indian Stock Market. It was pointed out that one should not forget the Stock Market
crisis of 2001, when there was unprecedented flow of foreign money coming from OBCs (Overseas
Bodies Corporates). It was pointed out that PN was no different.
This compelled SEBI to take effective steps in October 2007 to issue directive that only
‘regulated’ entities can invest through PN route. It formalised a ban on sub-accounts of FIIs from
issuing participatory notes (PNs). Foreign investors used accounts in tax havens like Mauritius or the
Cayman Islands to trade in shares for their clients. These, designated as sub-accounts, issue
participatory notes (PNs) to clients as proof of purchase, thus allowing them to remain anonymous.
SEBI has given foreign funds 18 months to close such transactions. There is, however, no blanket
ban. Registered foreign funds can issue up to 40 per cent of their investment in India by using the
instrument of PNs. (Dutt & Sunderam, 2011).
SEBI’s decision to curb illegitimate and massive increase in PNs which assumed menacing
proportions has been welcomed by Indian investors. There is no need to feel alarmed that India will
thereafter lose foreign funds. It is often said that in the world today, funds are in search of markets,
and not the other way round. It is hoped that measures taken by SEBI will be beneficial in long term
sustainable growth of the Indian capital market.
9.8 SUMMARY
As discussed in this lesson, SEBI has introduced a number of measures to reform India’s
capital market in recent years. By improving market efficiency, enhancing transparency, preventing
unfair trade practices, it has succeeded to a considerable extent in bringing up the Indian market to
international standards. The important development can be highlighted as under : (1) the issuers
complying with the eligibility criteria are allowed freedom to issue the securities at market determined
rates; (2) the secondary market has overcome the geographical barriers by moving to screen-based
trading; (3) all kinds of securities – debt and equity, government and corporate – are traded on
exchanges, side by side; (4) trades enjoy counterparty guarantee; (5) the trading cycle has been
shortened to a day and trades are settled within 2 working days; (6) physical security certificates (and
dependent risks) have almost disappeared; (7) a variety of derivatives are permitted; (8) corporate
governance has improved significantly; (9) the confidence of international investors in the Indian
securities market has increased considerably and now more than 500 FIIs (foreign institutional
investors) are registered with SEBI; and (10) the Indian market is getting integrated with the global
market, though in a limited way, through euro issues.
9.9 GLOSSARY
 SEBI : Securities and Exchange Board of India (1988) is the statutory body set
up in 1992 to facilitate mobilisation of adequate resources through the
Securities market and act as watch dog.
 Credit Policy : Credit ratings by different agencies provide guidance to
investors/creditors for determining credit risk associated with debt
investments.
 Capital Market : It helps channelise surplus funds from savers to institutions which then
invest them into productive use.
It is a market where buyers & sector engage in trade of financial
securities like bonds, stocks etc.
9.10 REFERENCES
 Misra & Puri (2015). Indian Economy. Himalaya Publishing House.
 Dutt & Mahajan (2015). Indian Economy. S. Chand Publication. New Delhi.
9.11 FURTHER READINGS
 Misra & Puri (2015). Indian Economy. Himalaya Publishing House.
 Dutt & Mahajan (2015). Indian Economy. S. Chand Publication. New Delhi.
9.12 MODEL QUESTIONS
1. Comment upon growth of capital market in India?
2. Delineate the factors underlying the growth of Capital market in India.
3. Critically analyse the capital market reforms in India since 1991.

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 Lesson – 10

FISCAL IMBALANCES IN THE INDIAN ECONOMY : A BACKGROUND

(Trends in Fiscal Deficit in Central and State Finances in the 80s and 90s)
Structure
10.0 Objectives
10.1 Introduction
10.2 Fiscal Policy 1990-91
10.2.1 Objectives of Fiscal Policy
10.2.2 Need for Changes
10.2.3 Fiscal Policy Reforms
10.3 Fiscal Imbalance
10.3.1 Reasons for Fiscal Imbalance
10.3.2 Suggestions for Improvement
10.3.3 Various concepts of Deficits
10.3.4 Calculation and Trends in Central Deficit
10.4 Trends of Fiscal Deficit in State Finances
10.4.1 State level Fiscal Reforms
10.4.2 Expenditure of State Government
10.5 Finance of State Government
10.6 Fiscal Reforms Programme for States
10.6.1 State level Fiscal Reforms
10.6.2 Fiscal Reforms of States
10.7 References
10.8 Summary
10.9 Glossary
10.10 Model Questions
10.0 OBJECTIVES
After going through this lesson, you shall be able to
 delineat Fiscal Reforms of 1991
 comment upon the reasons for fiscal imbalance
 list out trends in deficit of central government
  give provisions of FRBM Act
 list trends of fiscal deficit in state finances
 identify fiscal problems of states
 explain state level fiscal reform
10.1 INTRODUCTION
Fiscal and budgetary deficits have been a problem area in India's public finance for several
years. By the 1990-91, fiscal deficit had mounted to more than 8% of the GDP and the internal public
debt of the government to about 55% of the GDP. Interest payment in itself formed 4% of the GDP
and 20% of the total expenditure of the central government. Naturally, reduction of fiscal deficit
became a major item of reform agenda. Controlling fiscal deficit became important other reasons as
well, it had to serve as the instrument for inflation control. It had also a role in achieving other macro -
economic adjustment, required to put the economy back on the rails.
10.2 FISCAL POLICY 1990-91
The agile Fiscal Policy has been most important segment and its response adopted by
Government of India helped in encompassing a change. Lets study Fiscal Policy in detail.
10.2.1 Objectives of Fiscal Policy
Fiscal policy refers to the policy of the government regarding taxation, public expenditure and
public debt. Governments all over the world have been using fiscal measures to regulate their
economy and business activities in order to achieve specific objectives as :
(a) Achieving rapid economic development.
(b) Achieving full employment.
(c) Accelerating the rate of investment.
(d) Promoting socially desirable investment.
(e) Reducing inequalities of income.
(f) Promoting foreign trade.
(g) Establishing a welfare state.
The aim of fiscal policy is to check fiscal deficits in order to eliminate the inflationary pressure
emanating from the budget deficits. Other objectives of fiscal policy reforms are to stop further
accumulation of public debt, to reduce the level of subsidies in the economy, to restore the
Government's capacity to make strategic investment in infrastructure and human resources guide the
economy the look after the weal and less privileged.
Effectiveness of fiscal policy can be assessed from three angles :
(a) Fiscal policy and savings and capital formation.
(b) Fiscal policy and inflation control.
(c) Fiscal policy and economic inequalities.
 Indian fiscal policy has failed to produce enough savings for public investment. Also over the
years the chasm between the rice and poor has widened. On inflation front also the fiscal policy has
failed.
Indian economy entered the decade of the nineties with a number of major economic crises -
or what is known as "macro-economic imbalances." Foreign exchange reserves began to decline
since Sept. 1990. The reserves declined from Rs. 5480 crore on 31st Aug. 1990 to Rs.1666 crore on
10th Jan. 1991 in a period of less than 5 months.
10.2.2 Need for Changes
The balance of payment crisis of 1991 was due not only to a decline in trade account, it was
accompanied by other adverse development on the capital account reflecting the loss of confidence
in the Government's ability to manage the economic, environment. This led to disruption, which led to
serve and prolonged import compression, and resulted in shortage, Industrial dislocation, services
unemployment and higher inflation - a series of cries in the Indian economy.
Fiscal imbalances were reflected in growing budget deficits mainly because of escalating non-
plan expenditure in the face of sluggish revenue growth. Increasing budget deficit on the revenue
account indicated danger signal. As the deficits on the budget were financed by money creation, the
demand - pull inflation engineered. Also the cost push factors like hike in administered prices, poor
performances of public sector, alarming size of subsidy got together to throw our fiscal economy
totally out of gear.
Indian economy needed substantial reforms to overcome the crises. To implement a
programme of macro - economic stabilization, number of structural reforms of trade, industry and
public sector were initiated. Structural reformat were necessary to reverse various unhealthy
economic trends and tendencies. Without such reforms, our economy could not have been brought
back on the tracks of the country’s economy. These reforms fall under two basic categories.
 Stabilisation measures
 Macro - economic reforms and structural adjustments.
Various measures taken together aim at modernizing the country's industrial system removing
unproductive controls, encouraging private investment including foreign investment and integrating
India's economy with the global economy. All round opening up of the country's economy has been
the aim of the various reforms, which were initiated in 1991.
10.2.3 Fiscal Policy Reforms (in the Nineties)
To bring down the fiscal deficit, number of reforms were introduced in line with the Chelliah
Committee Report Further to keep non-plan expenditure in check following major measures were
initiated as per these recommendations.
(a) Corporate tax reduced from 45% for widely held companies 50% for closely held
companies to 40% for domestic companies and from 65% to 55% for foreign
companies.
(b) Major overhaul of the excise tax structure, including rationalization of rates, elimination
of most end use exemptions and general shift from specific to ad valorem duties.
(c) Import duties on capital goods reduced to 15% on exports and most capital goods, and
continuation of concession duties at 20% for power project and nil for fertilizer projects.
 (d) Modified Value Added Tax or MODVAT extended to capital goods and petroleum
products.
(e) Continues reforms in customs duties including reduction of the peak tariff rate,
elimination of most end use exemptions and removal of exemption form counter veiling
duties.
(f) Five Year tax holiday to new industrial undertaking initially allowed for industrially
backward states in the budget for 1993-94 extended to all backward areas to be
notified by the department of Revenue.
(g) State Government to withdraw all tax incentives given to industry form April 1, 1997.
10.3 FISCAL IMBALANCE
Both the Center and the States are facing the problem of fiscal deficit despite a decade of the
reforms. The centers that have worded florigens to creats fiscal imbalance are :
10.3.1 Reasons for Fiscal Imbalance in the Nineties
(a) The average rate interest on Central Government borrowing rose from 7.03% in the
eighties to 11.86% in 1998-99. Similarly, interest on State Government borrowings
also rose from 6.75% in the 1980s to 12.35% in 1998-99. As a result, interest on
borrowings consumed substantial part of tax revenue.
(b) Continuous growth of "subsidies" is another factor that contributed to Government's
increased expenditure although subsides accounted for 1.5% of GDP in 1999-2000
which was relatively lower as compared to 1.98% of GDF in 1991-92, yet still they
constitute 14.3% of center's revenue receipt. Same is the case of state government.
The volume of budgetary subsidies have always remained large.
(c) The implementation of the recommendations of the Fifth Pay Commission resulted in
increase of central government expenditure by 33.6% and pension bill by 35% all this
had a devastating effect on the fiscal imblance of the State Government as well.
(d) The government undertook reduction in personal and corporate taxes, reduction in
excise duties and customs with a view to widen the assesses and argued that widened
tax-base will bring in more amount. However the buoyancy of tax revenues of both the
center and states went further down in 1990s due to one or the other reason.
(e) Non-tax revenues of the center and states showed a virtual stagnation during the post-
reform period of 1990s on account of :
(i) Through the total investment in Public Enterprises (Center and State), State
Electricity Boards, State Road Transport Corporations and Government
Companies was of the order of Rs. 2,30,000 crores, returns of such
investments was much below the cost funds.
(ii) According to a study conducted by NIPEP (National Institute of Public Finance
and Policy) for the years 1995-96 and 1996-97 cost recovery of Public services
(Provided by the center). This implies about 91.6% subsidization in case of
social services and 91.6% subsidization in case of social services and 81.4% in
case of economic services. The situation of state is even worse. Fees in
educational Institutions and medical services charges remain unrevised or
 decades causing government revenues to remain stagnate against mounting
expenditure.
The Eleventh Finance Commission made a detailed analysis of the underlying causes of fiscal
deficit and concluded that "much of our budgetary ills, are at bottom-the product of action of
Government motivated by short sighted populism".
10.3.2 Suggestions for improvement
The shortcomings on the bases of fiscal policy during 1990-91 to 1999-2000. Following points
should be kept in mind.
(1) Reduction of fiscal deficit to a limit of 3% of GDP for the center and 2% of the states.
(2) To achieve zero revenue deficit during the next four years.
(3) To raise capital expenditure on rural infrastructure so as to stimulate growth of
agriculture and rural development.
(4) To carry forward the program of disinvestments of loss-making enterprises in the
public sector.
(5) To bring down subsidies on non-merit goods and also hidden subsidies benefiting the
more well to do section of the society.
(6) To create an environment for better-cost recovery in social as well as economic
services provided by the Centre and the State Government.
Before going into further details, let us discuss various concepts of Deficits as used in India.
10.3.3 Various concepts of Deficit (Concept/ Calculation/ Trend)
The budget of the Central Government is divided into two parts : revenue budget and capital
budget. Revenue budget covers those items which are of a recurring nature. Capital budget covers
those items which are concerned with acquiring and disposal of capital assets. Each account has, of
course, a receipts and expenditure side. Receipts in the revenue budget consist of those items that
leave no repayment liability, e.g. tax revenue, surpluses of the PSUs etc. Receipts in the Capital
budget consist largely, though not entirely, of internal and external borrowings net of repayment; they
also include recovery of loans and advances and some other receipts on capital account, such as by
sale of assets. On the expenditure side, revenue expenditure is divided into two categories:
development expenditure and non-development expenditure. Development expenditure consists of
expenditure on social and community services such as education and health an on economic
services, such a agriculture, industry, power, transportation and communication. Non-development
expenditure consists of expenditure on maintenance of existing levels of services. Capital
expenditure, on the other hand, is concerned with acquiring of capital assets i.e. for the expansion of
the present levels of services. Ideal fiscal management requires that revenue surplus should be
available to finance capital expenditure.
One may distinguish between three types of deficits viz. Revenue Deficit, Budgetary Deficit
and Fiscal Deficit.
The Budgetary Deficit denotes the difference between all receipts and expenditure, both
revenue and capital. This difference is met by drawing down of cash balances kept with the Reserve
Bank of India (RBI) and the net addition to the treasury bills issued by the Central government.
 The Revenue deficit refers to the difference between revenue receipts and revenue
expenditure. It reflects the failure of the government to meet its current expenditure out of its current
revenues.

The budgetary deficit and the revenue deficit are known as the conventional measures of
fiscal imbalance. They do not completely reflect operations of the government and cannot be
considered as appropriate measures of the resource gap. They indicate only a part of the gap which
is mainly financed by the issue of the treasury bills.

Actually a large portion of the gap in resources is financed by the market borrowings, small
savings, provident funds, external borrowings etc. and this does not get reflected in the conventional
indicators of the fiscal imbalances.

Hence, in contrast, the internationally used concept of fiscal deficit is a more complete
measure of fiscal imbalance. In India, this measure was recommended by Sukhmay Chakravarty
Committee which was constituted to review the working of the Monetary System and pointing out the
weakness of the definition of the budgetary deficit and the necessity to change the concept. The
Committee emphasized that the real deficit of the fiscal operations should include not only budgetary
deficit but also market borrowings and other liabilities. The fiscal deficit thus fully indicates the
indebtedness of the government.

The following table shows the calculation of Fiscal and other deficits :
10.3.4 Calculation and Trends in Central Deficit
The process of calculating Fiscal, Revenue and Budgetary Deficits is explained through
Table1.
Table 1 : Calculation of Fiscal Deficit and Other Deficits :

Rs. Crore
1990-91 2001-02
Actual Budget
1. Revenue Receipts 54,950 2,31,750
2. Capital Receipts of which 39,010 1,43,480
(a) Loans and Recoveries and other 5,710 27,150
Receipts
(b) Borrowing and other liabilities 33,300 1,16,320
3. Total Receipts (1 + 2) 93,960 3,75,200
4. Revenue Expenditure 73,510 3,10,570
5. Capital Expenditure 31,800 64,650
6. Total Expenditure 1,05,310 3,75,220
7. Revenue Deficit (1 ― 4) 18,560 78,820
8. Budgetary Deficit (3 ― 6) 11,350 Nil
9. Fiscal Deficit 44,560 1,16,320
[ 1 + 2(a) ― 6 ] = [ 8 + 2(b) ]
Note — Budget figures are rounded.
 Source — Ruddar Dutt and Sundaram – Indian Economy.

The Table 1 shows that the revenue deficit was Rs. 18,560 crores in 1990-91. The 2001-02 budget shows that
it would come to Rs. 78,220 crores. So far as Budgetary deficit is concerned, 2001-02 budget shows a nil
budget while it was Rs. 11,350 crores in 1990-91. But this conventional concept of budget has finally been
given up by the Finance Ministry from 1997-98 budget. It has so estimated the capital receipts of the
government are exactly equal to the total expenditure thus showing no overall budget deficit.
Fiscal deficit is thus the difference between total expenditure and total revenue receipts and
capital receipts; but capital receipts exclude borrowings and other liabilities.
Conventionally, government deficit have been measured in terms of budgetary deficits. The
overall budgetary position during the last five decades is presented in the Table 2.
Table 2 : Growth and Composition of Total Union
Budgetary Deficits (Rs. Crores)
1956-57 1961-62 Annual 1969-75 1974-75 to 1980-81 1985-86 1990- to 1992-97 **1997-
to to Plans to to 1978-79 to 1989-90 2001
1960-61 1965-66 1968-69 1978-79 1984-85

1. Deficit +220.00 +1018.74 +413.10 +411.20 +2671.70 – 9157.70 – 46905 – 31439 – –

or 145875 295315
Surplus
under
Revenue
Account

2. Deficit – –1791.70 – 1177.10 –2433.90 6327.90 – 1629.10 + 9557 + 12948 + +

under 1156.00 107680 295315
Capital
Account

3. Total –917.95 – 782.15 – 764.00 – 2046.30 – 3656.20 – 1076.80 – 37348 – 18491 – 38195 ---
Budgeter
Deficit

Source : Iswar C. Dhingra : The Indian Economy. Sultan Chand & Company : New Delhi, 2001, 1999-2000 – Revised Estimates : 2000-
2001 – Budgetary Estimates.

From the Table 2, it can be seen that till the end of seventies, the Union government used to
have surpluses under revenue account. Beginning with the eighties, revenue deficits have been the
routine order. They have continued to stay in the nineties also. Similarly till mid-eighties, the
government used to have a deficit on the capital account also. But since mid-eighties, surpluses have
appeared on the capital account. The share of capital expenditure in the total expenditure has gone
down significantly from 37 per cent during 1980-85 to less than 30 per cent in the early nineties. The
figure has come down to 16.95 per cent in 2000-01. It can also be seen from the table that prior to
1979-80, revenue expenditure was successfully kept under check by the central government, hence
leading to a surplus in revenue account which in its form was used to support capital budget. But
since early eighties, the inability to control the steep increase in conventional expenditure has led to
the reversal of the trend. Hence there has been a major diversion of the resources which could have
otherwise financed the creation of the tangible assets via development expenditure. The most
distressing aspect of the Indian Fiscal scene is the high level of fiscal deficit.
 Fiscal deficit can be decomposed into primary deficit and interest payments of/by government.
Primary deficit revenue would equal revenue deficit less net interest payments. Primary deficit is
determined by arriving at the gap between the governments total income and expenditure after
excluding interest earning as well as interest payments. Primary deficit can be decomposed into
revenue and capital deficit. Primary deficit on capital account would equal capital expenditure less
loan repayments. The following table (Table 3) shows the fiscal and budgetary developments in
Indian (Central Government) during the first decade after reforms i.e. 1991-2001.
Table 3 : Trends in Deficits
(As percent of GDP)
1990-91 1995-96 1996-97 1978-79 1998-99 1999-00 2000-01
1.Revenue receipts (2+3) 9.7 9.3 9.2 8.8 8.5 9.3 9.3
2.Tax Revenue Net of 7.6 6.9 6.8 6.3 6.0 6.6 6.7
State share
3.Non-Tax Revenue 2.1 2.4 2.4 2.5 2.6 2.7 2.6
4.Revenue Expenditure 12.9 11.8 11.6 11.8 12.4 12.8 12.9
of which
(a)Interest Payment 3.8 4.2 4.3 4.3 4.4 4.7 4.6
(b)Major Subsidies 1.7 1.0 1.0 1.2 1.2 1.2 1.0
(c)Defence Expenditure 1.9 1.6 1.5 1.7 1.7 1.8 1.9
5.Revenue Deficit 3.3 2.5 2.4 3.1 3.9 3.5 3.6
6.Capital Receipts of which 5.6 4.1 3.7 5.4 6.1 6.1 6.2
(a)Recovery of loans 1.0 0.5 0.6 0.5 0.6 0.5 0.6
(b)Other receipts 0.0 0.1 0.0 0.1 0.3 0.1 0.5
(Mainly PSU disinvestments)

(c)Borrowing & Other liabilities 4.6 3.4 3.1 4.8 5.1 5.5 5.1
7.Capital Expenditure 4.4 2.4 2.3 2.4 2.2 2.5 2.6
8.Total Expenditure on 17.3 14.2 13.9 14.2 14.6 15.3 15.5
which
(a) Plan Expenditure 5.0 3.9 3.9 3.9 3.8 15.3 4.0
(b)Non-Plan Expenditure 12.3 10.3 10.0 10.3 10.8 4.0 11.5
9.Fiscal Deficit 6.6 4.2 4.1 4.8 5.1 5.5 5.1
10.Primary Deficit 2.8 0.0 -0.2 0.5 0.7 0.8 0.5
10.1 Primary Deficit 1.1 -0.0 -0.2 0.0 0.7 0.8 0.5
Consumption
10.2 Primary deficit 1.7 0.0 -0.1 -0.1 -0. -0.1 -0.1
investment
Source : Datt and Sundaram, 2004
It can be seen from the table 3 that the Fiscal Deficit (FD) as a proportion of GDP is budgeted at 5.1 per cent in
2000-2001 a level lower than the 5.5 per cent in 1999-2000. The Revenue Deficit (RD), a measure which
shows the excess of current expenditure over the current receipts is budgeted at 3.6 per cent of the GDP in
2000-01 (B.E.) revenue. Compared with 3.5 per cent in 1999-2000. The Primary Deficit (PD) i.e. the fiscal
deficit net of interest payments which reflects the current fiscal stance of the government is budgeted at 0.5
per cent of GDP in 2000-01 as against 1.1 p.c. in1990-91 and 0.8 per cent in the previous year.
The fiscal deficit is the outcome of the growth in aggregate expenditure and revenue trend. Revenue receipts
(tax and non-tax), net to center, are budgeted to grow by 12.3 per cent from
Rs. 181434 crores in 1999-2000 to Rs. 203673 crores in 2000-2001 (B.E.).
The following table shows trends in Select Fiscal Parameters of the Central Government Gross Fiscal Deficit and
the financing of the Gross Fiscal Deficit during the two decades 1981-92 and 1993-2000.
TABLE 4
Trends in Select Fiscal Parameters of the Central Government :
1980-81 to 1991-92 and 1992-93 to 1999-2000
As per cent of GDP Growth rate
(Annual Average) (Annual Average)
1980-81 to 1992-93 to 1980-81 to 1992-93 to
1991-92 1999-2000 1991-92 1999-2000
(Period-I) (Period-II) (Period-I) (Period-II)

Total 17.6 14.9 15.5 13.9

expenditure
(a) Revenue 11.7 12.2 17.7 15.0
expenditure
(b) Capital 5.9 2.7 11.1 9.9
expenditure
Gross tax 10.0 9.1 15.5 12.7
revenue
Direct taxes 1.1 1.3 16.4 18.6
(a)Corporation tax 1.1 1.3 16.4 18.9
(b) Income tax 0.9 1.2 14.8 18.6
Indirect taxes 7.9 6.3 15.4 10.9
(a) Customs 3.2 2.7 18.7 11.1
(b) Union excise 4.5 3.4 13.8 10.6
duty
Revenue 9.8 9.1 16.1 13.7
receipts @
(a) Revenue @ 7.4 6.6 15.9 12.9

Revenue deficit 1.9 3.1

Gross fiscal deficit 6.6 5.0
@ Net to Centre
Note : 1. Ratios to GDP at current market prices (New Series, Base : 1993-94).
2. Figure for 1990-91 onwards are exclusive of the transfer of states’ share of small saving collections.
 3. Figure used for 1999-2000 are provisional and unaudited figures of Controller General of Accounts, Department of
Expenditure, Ministry of Finance.
Table 4A
Financing of the Gross Fiscal Deficit ( per cent share)
1980-81 to 1991-92 1992-93 to 1999-2000
Period I Period I
Market Borrowings 26.2 49.7
Budget deficit* 22.6 12.7
Other liabilities 40.9 32.4
External financing 10.3 5.2
* Variation in 91 day Treasury bills issued not of change in cash balances with RBI up to end March, 1997. From April, 1997
these figures represent draw down of cash balance.

The following observations can be made on the basis of Table 4A.

1. The total Government expenditure as a proportion of GDP declined from an average of 17.6 per cent in Period-I to
14.9 per cent in Period-II. However, the ratio of capital expenditure and revenue expenditure as per cent to GDP
over the same period showed divergent trends. The fall in the share of capital expenditure as per cent to GDP in
Period-II reflects deceleration in the growth of capital expenditure.

2. The share of gross tax revenue (net tax revenue) as a proportion of GDP had fallen from 10.0 per cent (7.4 per cent)
on an average in period-I to 9.1 per cent in Period-II. This was accompanied by some significant structural change as
regards composition of tax revenue. Over the same period, the share of direct taxes of GDP has increased and that
of indirect taxes fallen. Direct taxes are less distortionary and more equitable in impacts vis-a-vis indirect taxes.

3. Revenue deficit as a proportion of GDP on an average basis swelled from 1.9 per cent in Period-I to 3.1 per cent in
Period-II while similar ratio of Gross Fiscal Deficit (GFD) show a decline. This reflects that borrowing during Period-II
were mainly used for current consumption rather than investment.

4. There are perceptible shift towards market related borrowings in the financing of GFD in Period-II. The share of
market borrowing in the financing of GDP increased from an average of about 26 per cent in Period-I to about 50 per
cent in Period-II.

From the tables we can see through Gross Fiscal Deficit has declined from the previous years
but still it was high and this level of fiscal deficit was clearly unsustainable.
The necessary conditions for stability are :
(h) the real interest rates on public debt must be lower than the GDP growth rate;
(i) the primary deficit must be lower than what can be absorbed through ‘siegnorage’;
(j) obtaining fiscal deficit are clearly unsustainable.
To achieve fiscal balance, three pronged strategy needs to be launched.
(i) On the revenue side the tax base needed to be expanded. This would further need
(a) better tax administration so as to plug evasion and leakages.
 (b) bringing in tax net larger sections of the society who till now have managed to remain out
of it.
(ii) On the expenditure side, government action has needed in following areas.
(a) Privatisation of PSUs could raise significant funds as a percentage 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 cost of serving the debt would surely declined as the
debt stock itself is brought under the control.
(b) Subsidies can be gradually reduced with a phased increase in user charges in sector,
such as power, transport, irrigation, agriculture and education.
(c) A reasonable reduction in the size of public administration can be achieved by putting
freeze on new employment, matched by normal attrition through retirement and death.
(iii) Vigorous efforts need to be made to attain and sustain higher growth rates and out of these
more important can be
(a) Greater openness of the economy, (b) dereservation of items from the reservation list of
the small scale sector; (c) deregulation of India’s private sector, including liberalization of labour laws
and exist policies; (d) demonoplisation of infrastructure and (e) decentralization of economy policy
making.
10.4 Trends of Fiscal Deficit in State Finances
Like Union budgets, one of the most distressing features of the State finances is the emergence of the substantial
and growing volume of the deficit on current account. The following table shows this deficit.
Table 5 : Current Revenues and Expenditure of the State
(Rs. Crores)

1951-52 1980-81 1990-91 2000-2001 Budget

Accounts Accounts Accounts
Total Receipts 396 16,290 66,470 2,44,920
Total 392 14,810 71,790 2,90,620
Expenditure +4 + 1,480 ― 5,310 ― 45,700
Surplus (+) and
Deficit ( ― )
Source - Ruddar Dutt and K.P.M. Sundaram, Indian Economy, S. Chand & Co. Ltd. 2001.
It can be seen from the table that there is a continuous increase in revenues and expenditure of these states.
The necessity for this huge increase in revenue arises from the fact that they have to finance the continuously
rising expenditure which is mainly caused by expansion in civil administration, higher wages and salaries
demanded in order to cover the rise in prices and cost of living, increase in the provision of government
services in the form of education, public health etc. as well as increase in development expenditure.
It is clear from the table that in recent years, states too have been incurring deficits in their
current account and a deficit of Rs. 45,700 crores is anticipated in the budget of 2000-2001. The
picture of states Revenue and Fiscal Deficit in recent years become more clear from the following
table.
Table 6 : States’ Revenue and Fiscal Deficits
(Rs. Crores)
Year Revenue Deficit Fiscal Deficit
1980-81 1485 (1.08) 3613 (2.7)
1985-86 654 (0.24) 7521 (2.7)
1990-91 5309 (9.9) 18787 (3.3)
1994-95 6156 (0.65) 27697 (2.7)
1995-96 8201 (0.75) 31426 (2.6)
1996-97 16114 (1.2) 37426 (2.7)
1997-98 16333 (1.1) 44200 (2.9)
1998-99 43912 (2.5) 74129 (4.2)
1999-2000 56815 (2.0) 94383 (4.8)
2000-2001 43942 (2.0) 85771 (3.9)
* Figures in bracket indicate percentage of GDP at current market prices.
Source – Ishwar C. Dhingra – The Indian Economy. Sultan Chand & Sons. New Delhi, 2001.
According to a recent study made by P.R. Panchmukhi, on social Impact of Economic
Reforms in India, states that there is a positive correlation between the deficit of the state government
and the deficit of the central government.
10.4.1 Revenue of the State Government
The following table shows the important sources of revenues for the State which are :
(a) State tax revenue including States’ share in Central taxes; (b) Grants-in-aid and other
consolations from the Centre and (c) other non-tax revenue.
Table 7 : Revenue of State Government on Revenue Account
(Rs. Crores)
Items 1951-52 1980-81 1990-91 2000-2001
Accounts Accounts Accounts Accounts
1. Tax Revenue 280 10,400 44,590 1,76,410
2. Non-tax Revenue 120 5,890 21,880 68,510
of which
(a) Grants from the 30 2,620 12,640 36,960
Centre
(b) States own non- 90 3,270 9,240 31,550
tax revenue
Total Receipts (1 + 2) 400 16,290 66,470 2,44,920
Sources – Ruddar Dutt and K.P.M. Sundaram – Indian Economy. Op Cit. p. 895.
There are two components of the revenue of the States. Viz. (a) revenue from States taxes,
comprising broadly taxes on income, taxes on property and capital transactions and taxes on
commodities and services and (b) share in Central taxes. In budget of 2000-2001, the tax revenue of
the States which is placed at Rs. 1764. 10 crores will be comprised of revenue from States’ own
taxes worth Rs. 1,25,600 crores and the States’ share in Central taxes worth Rs. 50,810 crores.
 The second source i.e. non-tax revenue is expected to bring Rs. 68,510 crores to the State
which will be coming from two sources viz. Grants from the Central Government and States’ own
non-tax revenue consisting of interest receipts, dividend and profits, general services including State
lotteries and social services & economic services.
10.4.2 Expenditure of State Government
There are two main constituents of the expenditure of the State Governments viz.
development expenditure and non-development expenditure. A study of the expenditure of the State
since 1951-52 reveals the importance given by them to development expenditure and other
requirements. Development expenditure is divided into two parts viz. social and community services
and economic services. In social and community services, expenditure is incurred on such services
as education, family planning and public health, housing, labour employment, social security and
welfare and natural calamities. Expenditure on economic services consists of expenditure on
agriculture, veterinary and co-operation, irrigation, electricity and community development projects,
civil works, industries and minerals etc. Single most important item of development expenditure is
education, which accounts for about 34 to 35 percent of the total development expenditure.
For a long time since 1951-52, development and non-development expenditure accounted for
50 percent each of the total expenditure which is clear from the following table shows the trends in
revenue expenditure of the State Governments since 1951-52.
SAQ
Q. Differentiate between Development and Non-Development Expenditure and comment with respect to
India.
_______________________________________________________________________

_______________________________________________________________________

_______________________________________________________________________

Table 8 : Revenue Expenditure of the States

(Rs. Crores)
Item 1951-52 1980-81 2000-2001
Accounts Accounts Budget
1. Development Expenditure 196 10,510 1,67,090
2. Non-Development Expenditure 196 4,090 1,23,530
3. Others** - 200 -
Total Expenditure 392 14,800 2,90,620
It consists of compensation and assignment to local bodies and Panchayati Raj institutions.
Source - Ruddar Dutt and Sundaram, Indian Economy, Op. cit. p. 899.
Fiscal consolidation, a key element in the package of economic reforms remains an
unfinished task of the components of economic reforms, inadequate progress has been made in
consolidation the fiscal deficit. After showing some signs of reduction in the mid-nineties, the fiscal
started rising from 1997-98. The fiscal deficit from 6.6 percent of GDP in 1990-91 to 4.1 percent in
1996-97 and then rose to 4.8 per cent in 1997-98 and further to 5.6 percent in 2001-02 (Prov.) (Table
9). Higher fiscal deficits, besides maintaining growth resulted in higher Government borrowings. The
change in the composition of fiscal deficit of the Centre is an equality worrisome feature. The revenue
deficit, which constituted 49.4 percent of fiscal deficit in 1990-91 accounted for 70.2 percent of fiscal
deficit in 2001-02. This is reflective of the fact that a large portion of fiscal deficit goes to finance
public investment. A number of factors have contributed to this deterioration.
The main factors are rising expenditure on salaries, unfunded pensions interest payments,
improperly targeted subsidies and stagnation in the tax - GDP ratio. The share of wages and salaries
to total Central Government expenditure increased from 9.7 percent in 1996-97 to 10 percent in
2000-01 and remained at 10.3 percent in 2000-01 as per economic and functional classification. The
share of pensions in total Govt. expenditure increased from 2.2 percent in 1996-97 to 37 percent in
1999-2000 and remained at 3.6 percent in 2000-01 interest payment as a proportion of GDP
increased from 3.8 percent to 4.7 percent in 1999-2000 and remained at 4.6 percent in 2000-01.
Fiscal Deficit = Primary Deficit + Interest payments
Primary deficit Refers to the amount by which a Government total expenditure excess, including interest
payment on debt.
Table 9
Trends in deficits of Central Government
Year Revenue deficit Primary deficit Fiscal deficit
1990-91 3.3 2.8 6.6
1991-92 2.5 0.7 4.7
1992-93 2.5 0.6 4.8
1993-94 3.8 2.2 6.4
1994-95 3.1 0.4 4.7
1995-96 2.5 0.0 4.2
1996-97 2.4 -0.2 4.1
1997-98 3.1 0.5 4.8
1998-99 3.8 0.7 5.1
1999-2000 3.5 0.7 5.4
2000-01 4.1 0.9 5.6
Sources : Eco. Survey, 2002-03
10.5 FINANCE OF STATE GOVERNMENT
The deterioration of State finance is more pronounced. The Fiscal deficit of State Government
inceased from 3.3 percent of GDF in 1990-91 to 4.6 percent in 2001-02 (RE). Higher growth of
revenue a expenditure has largely contributed to this deterioration. The revenue deficit has nearly
trebled from 0.9 percent of GDP in 1990-91 to 2.6 per cent of GDP in 2001-02 (RE). Revenue from
State own taxes witnessed a marginal improvement from 5.3 percent in GDP in 2001-02. The
shortfall in growth of central tax revenue has partly contained the growth of total revenue receipts of
State in the State Budgets for 2002-03 the fiscal deficit is budgeted to come down to 4.2 percent of
GDP as compared with the fiscal deficit of 2.6 percent of GDP in the previous year. The revenue
deficit is budgeted to come down from 2.6 per cent in 2001-02 (RE) to 2.0 percent in 2002-03 (Table
10).
A number of Initiatives have been taken to address the problem of fiscal deterioration at the
State level. These are indicated in the following sections.
Table 10
Receipts and disbursement of the State Government (As percent of GDP)
1990-91 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01
1. Total 16.0 15.1 15.1 16.0 16.6 17.2 17.4
receipts(A+B)
2. Revenue 11.7 11.2 10.1 10.1 11.3 11.8 12.5
receipts(1+2)
1. Tax receipts 7.8 8.0 7.4 7.6 8.0 8.2 8.8
of which
States own tax 5.3 5.3 5.1 5.3 5.6 5.8 6.2
revenue
2. Non-tax 3.8 3.2 2.8 3.1 3.3 3.6 3.7
receipt of which
Interest receipt 0.4 0.5 0.4 0.5 0.5 0.4 0.4
3. Capital 4.3 3.9 5.0 5.3 5.3 5.4 4.8
receipts of which
Recovery of 0.3 0.4 0.2 0.2 0.3 0.3 0.1
loans & adverse
4. Total 16.0 15.0 15.3 16.2 16.5 17.5 17.6
disbursements
(A+B+C)
(a) Revenue 12.6 12.3 12.6 13.5 13.9 14.4 14.5
(b) Capital 2.4 2.0 2.0 1.9 2.1 2.4 2.5
(c) Loans and 1.0 0.7 0.7 0.8 0.6 0.7 0.6
advances
Revenue deficit 0.9 1.1 2.5 2.8 2.5 2.6 2.0
Gross Fiscal 3.3 2.9 4.3 4.7 4.3 4.6 4.2
deficit
The ratios to GDP at current market price for 2002-03 (BE) are based on CSO’s Advance
released in February, 2003.
Source : Reserve Bank of India.
10.6 FISCAL REFORMS PROGRAMME FOR STATES
The main objective of Fiscal Reforms Programme for State was to improve the Balance on
Current Revenues and reduce revenue deficit in the medium term. Thirteen States - Andhra Pradesh,
Assam, Himachal Pradesh, Jammu and Kashmir, Madhya Pradesh, Manipur, Mizoram, Nagaland,
Orisa, Punjab, Rajasthan, Sikkim and Uttar Pradesh evolved and undertook their own Fiscal Reform
Programme and also exerted into' an agreement with the Central government in 1999-2000.
The Fiscal Reforms Programme and Fiscal Reforms Facility was one-time programme which
was implemented in 1999-2000. Under the Fiscal Reform Facility extended ways and means advance
of Rs. 21570 crore was provided to these State, In addition, seven States were also allowed addition
borrowing of Rs. 1,920 crore. The Eleventh Finance Commission has suggested a monitorial fiscal
reforms programme for the State in its Supplementary Report.
10.6.1 State level fiscal reforms
The State of Karnataka has enacted the Fiscal Responsibility Act. The Government of
Maharashtra and Punjab have introduced a Fiscal Responsibility and Budget Management Bill in their
State legislatures the government of Kerela has expressed its intention to introduce the Fiscal
Responsibility Bill the State Legislature. These legislations aim at providing a statutory backing of the
fiscal reform process initiated in the State Government.
The Eleventh Finance Commission had recommended a monitorable fiscal reforms
programme of all the State Fifteen percent of the revenue deficit grant meant for 15 State during
2000-05 and a notching contributions by the Central Government were recommitment to be credited
into an incentive fund the distribution as grants far all the 25 (which subsequently became 28) States
based an their fiscal performance. Accordingly the Government of India has drawn up the States
Fiscal Reforms Facility 2000-01 to 2004-05 and an incentive fund of Rs. 10,607 crore was earmarked
to encourage State to implement fiscal reforms programme. So far, 18 States have drawn up medium
term fiscal programmes, in consolation with the Central Government. The fiscal reforms cover areas
such as consolidating public interpose reform, power sector reforms etc.
The State of Andra Pradesh, Delhi, Haryana, Karnataka, Madhaya Pradesh Orissa,
Rajasthan, Uttar Pradesh and Uttranchal have enacted State Electricity Reform Acts, providing for
unbundling/corporatisatian of State Electricity Boards (SEBs) setting up of State Electricity Regulatory
Commission (SERCs) etc. The SEBs of the above mentioned State have been
unbundled/corporatised. Twenty two States have signed the supartitile Agreement envisaged under
the scheme for not the time settlement of outstanding dues payable by the SEBs to the Central Public
Sector Undertakings. The States of Andhra Pradesh, Karnataka, Madhya Pradesh, Maharashtra,
Uttar Pradesh and West Bengal have enacted anti-theft legislation making stringent provision for theft
of electricity.
In order to address the growing debt burden of States and to supplement the efforts of states
in the action of evolving their Medium Term Fiscal Reforms Programme (MTFRP) a Debt Swap
Scheme facilitated by the Government of India has been formulated. This scheme is focused on
liquidation high cost loans given by the Government of India to the States. States have agreed to the
revised Debt - Swap Scheme wherein 20 percent of net small savings proceeds releasable from
September 2002 are envisaged to the utilized for enabling States to pre-pay high cost Government of
India loans and advances as on March 31, 2002. The participation State would be enabled to further
entire high cost Government of India loans and advance through allocation on additional market
borrowings.
It can be seen from the table that in the budget 2000-2001, development expenditure of the
State, in percentage terms, account for 57 percent of the total expenditure and non-development
expenditure constitutes only 43 percent. This non-development expenditure includes the expenditure
 on (a) the organs of the State; (b) fiscal services i.e. collection of taxes and duties; (c) interest
payment and servicing of debit which include appropriations for reduction or avoidance of debt; (d)
administrative expenditure including pensions is the single largest them amounting to Rs. 56,600
crores. This is closely following by interest payment and servicing of debt (Rs. 54,270 crores). The
high increase in the non-development expenditure since 1951-52 reflects that there is increasing
problem of law and order, expansion in government activities and accountings rise in price level
which necessitates the consequent upward revision of salaries and dearness allowances.
1.1.1.1 10.6.2 Fiscal Problems of States
The fiscal problems of States are three fold;
(a) While the Centre’s fiscal deficit in relation to the GDP has come down by about 30%
over the past five years, the State Government’ combined fiscal deficit has gone up to
4% of GDP. This deficit would have been much higher in case the States had access
to more market borrowings and direct access to international capital market.
(b) The States have paid little attention to the main financial drains, the uneconomic tariffs
charged for providing water, electricity and transport.
(c) The State government have by and large failed to deliver on their primary charge;
improving the social indicators of their population.
Looking at these problems, it becomes a dire need to bring about some reforms in State
finances. It is because (i) State government play a predominant role in the delivery of social and
economic services. Since they spend 85 percent on economic services, their financial and
institutional weaknesses could pose a serious constraint on the infrastructure; (ii) the essence of
reform is to improve the enabling environment for which systematic change are required in the policy
regime which should encompass all the departments and ministers at central and state levels.
Conclusion
In light of the above, Union government and the State governments together have formulated
a strategy to address fiscal problem of the States. The strategy has taken the form of a package of
advance financial assistance which is provided by the Centre along with an appropriate time bound
programme of a medium terms fiscal reform to be undertaken by the concerned State. The main aim
of these programmes is promoting the (a) reduction in non-plan revenue expenditure through
appropriate taxation and expenditure measures and downswing the government where possible and
(b) pricing/subsidy reforms, to reduce fiscal burden of the State and improve allocation efficiency, (c)
institutional reforms, to improve regulation and efficiency in delivery of public services.
10.7 SUMMARY
Let us quickly revise the issues concerning fiscal deficit of central and State Government that
we have discussed in this lesson. For easy comprehension, a few chart has been designed as follows
:
10.8 GLOSSARY
 Fiscal Deficit = Primary Deficit + Interest payments
 Primary deficit Refers to the amount by which a Government total expenditure exceeds income,
including interest payment on debt.
Fiscal Deficit = Revenue Receipts (Net tax revenue + non tax revenue)
+ capital receipts (only recoveries of loans and other receipts)
―Total expenditure (Plan and Non-Plan)
OR
= Budget deficit + Government’s market borrowing and liabilities.
 Budget Deficit refers to difference between total budgeted receipt and expenditure. It was abolished
in 1997.

10.9 REFERENCES
  Kapila Uma (2011). Indian Economy since independence Academic Foundation, New Delhi.
 Dwivedi (2011). Indian Economy MAG Book. Arihant Publication Ltd.
10.10 FURTHER READINGS
 Kapila Uma, (2021). Indian Economy since independence. Academic Foundation, New Delhi.
 Dwivedi (2011) Indian Economy, Mag Book. Arihant Publication Ltd.
 Misra & Puri (2020). Indian Economy. Himalaya Publishing House.
10.11 MODEL QUESTIONS

 List out trends in central and state level fiscal deficit during the nineties.
 Explain the need for and provisions of the Fiscal Responsibility and Budget Management Act.

-----------
 Lesson – 11

FISCAL DEFICITS AND SUSTAINABILITY OF PUBLIC DEBT

Structure
11.0 Objectives
11.1 Introduction
11.2 Public Debt : Meanings & Introduction
11.3 Public Debt and other Liabilities of the Central Government
11.4 States and their Debt Position
11.5 Public Debt in the States and Related Crisis
11.6 Public Debit Policy : Trends and Problems
11.6.1 Deficit Trends in recent years (1991 onward)
11.6.2 Combined Debt of Central and State Governments
11.7 Fiscal Responsibility in India
11.7.1 (FRBM) Bill
11.7.2 Original Bill
11.7.3 The FRBM Act
11.8 Appraisal of the FRBM Legislation
11.9 Trends in Deficit of Central Government
11.9.1 Government Debt Report
11.10 State-level Finances in the post-FRBMA period
11.10.1 Fiscal Reforms Programme for States
11.10.2 State-level Reforms and Thirteenth Finance Commission (ThFC)
11.11 Nature of Fiscal Consolidation
11.12 Summary
11.13 Glossary
11.14 References
11.15 Further Readings
11.16 Model Questions
11.0 OBJECTIVES
After going through this lesson, you shall be able to
 explain the central govt’s public debt and public debt position of states
 discuss the provisions of FRBM Act
 evaluate the performance of centre & state public debt in post-FRBM period

11.1 INTRODUCTION
 Global public debt is estimated as 98 pc of GDP in end 2020. [IMF’s Jan, 2021 Fiscal Monitor
Update]. India’s debt to GDP ratio has risen to 87.8% in 2021. Fiscal Policy must support a
sustainable recovery. A country’s public debt is considered sustainable if government is able to meet
all present and future payments obligations without exceptional financial assistance. In this lesson we
shall study about the trends in public debt of Centre and States, the enactment of FRBM Act and its
provisions and their performances (of deficit indicators) in the post-FRBM period.
11.2 PUBLIC DEBT : MEANING & INTRODUCTION
The public debt of the Government of India is composed of (a) internal debt and (b) external debt.
“Internal debt” comprises of market loans, compensation bonds, prize bonds and 15-year
annuity certificates. It also includes borrowings of a temporary nature, viz., treasury bills issued to the
RBI, commercial banks etc., and also non-negotiable, non-interest bearing securities issued to
international financial institutions like the IMF, World Bank and the Asian Development Bank (A.D.B).
External debt figures represent borrowings by Central Government from external sources and
are based upon historical rates of exchange.
11.3 PUBLIC DEBT AND OTHER LIABILITIES OF THE CENTRAL GOVERNMENT
Vigorous efforts were made to achieve the target and Government could nearly get the
targeted amounts in all the Plans. Borrowing from the market and mobilizing small savings from the
people were used since 1951 as a method of financing economic development in India. The Planning
Commission liked ambitious targets and resorted to raise large funds from the market and through
small savings schemes. This was how public borrowing and public debt came to be used to finance
development. Thus, the basic reason for expansion of public debt was the need for raising funds for
rapid economic development. In recent years, however, the Government is borrowing to meet its
current expenditure. Table 1 provides the related figures.
Table 1 : Public Debt and Other Liabilities of the Central Government
At the end of the year
(Rs. Crores)
1950-51 2002-03 2011-12 (BE) 2022 **
A. Public Debt 2,054 10,80,300 32,81,465 152,17,910
(a) Internal 2,022 10,20,690 31,10,618 147,48,876
(b) External 32 59,610 1,70,847 4,69,034
B. Other Liabilities 511 4,78,600 10,71,224
Total Public Debt & 2,565 15,58,900 13,32,689 1,52,17,910
other liabilities
* Excludes Rs. 300 crores which is the amount due from Pakistan on account of its share of pre- partition debt.

Note **
Source : Government of India, Receipts, Budget, Union Budget 2011-12 and (previous issues)
Public Debt Statistics (2022), Reserve Bank of India.
Table 2 summarizes India’s public debt position since 1961. Four significant points may be
noted as regards the public debt of India since 1950-51 (Dutt & Sundaram, 2011) :
 (i) Initially, the Central Government borrowed mainly for financing development schemes.
What is really alarming now is that the Central Government is forced to borrow even to meet its
current revenue expenditure. In other words, the Government has been living beyond its means.
(ii) External debt had increased from 1.0 per cent of the total debt and other liabilities of the
Central Government in 1950-51 to 3 per cent now. The increase in the share of external debt is
explained by the rapid rate at which external assistance had been obtained and utilized in recent
years. By far the largest share of India’s external debt is provided by the United States of America.
Dollar loans constitute over 30 per cent of India’s external debt.
Table 1 shows how the public debt of the Government of India had increased from
Rs. 2,054 crores in 1950-51
Rs.10,80,300 crores in 2002-03
Rs. 31,10,618 crores in 2011-12
Rs. 15217910 crores in 2022
(iii) In addition to the public debt, the Government of India has certain other liabilities for
instance, the Government owes to the general public for funds raised through small savings
schemes, provident funds, deposits under the Compulsory Deposit Scheme, Income Tax Annuity
Deposit Schemes, Reserve Funds of the Railways and Posts and Telegraphs, etc. All these
constitute the “other” liabilities of the Central Government.
The Government has to pay interest on its other liabilities – often quite high as in the case of
public provident fund. The Central Government’s other liabilities have also been increasing fast in
recent years, as for example :
Rs. 511 crores in 1950-51
Rs. 4,78,600 crores in 2002-03
Rs. 10,71,224 crores in 2011-12
The total public debt and other liabilities of the Indian Government would come to
Rs.43,52,389 crores by end March 2012; it was only Rs.230000 crores in March 2003 Central
Government’s public debt and other liabilities had increased by nearly 9 times. The annual compound
rate of growth of public debt between 2003 and 2012 works out to be 27.8 per cent.
(iv) The outstanding liabilities of the Central Government, comprising internal and external
liabilities, as proportion of GDP were 55 per cent in 1990-91. They showed declining trend till 1998-99
when it touched 51 per cent. Since then, they have started rising – as, for instance, 58 per cent in
2001-02 and around 60 per cent in 2011-12.
The increasing trend in internal liabilities is a matter of serious concern. This has not only
raised the interest burden but also raised concerns about the sustainability of the growing internal
debt. At present, net borrowings from the market finances 70 per cent of the gross fiscal deficit.
(v) The burden of servicing of public debt and other liabilities is becoming heavier with every
passing year. Interest payment of the Centre was Rs.90,250 crores in 1999-2000 and is likely to
touch Rs.267986 crores in 2011-12.
According to an agreement concluded in December 1947, all the public debt of undivided
India was taken over by the Indian Government. Pakistan was allotted a share, estimated at Rs. 300
crores but it was permitted to return the amount in 50 equal instalments starting from 1952. Pakistan
was not returned even one instalment of its share of public debt. Considering the political relations
between the two countries, there is no chance of India receiving Pakistan’s share of undivided public
debt. However, for certain reasons, this amount is always included as part of the total capabilities of
the Government of India; it would be better if it is written off. (Dutt & Sundaram, 2011). Higher public
debt can be harmful for government finances due to higher interest burden. Interest expenses rose
to 45% as share of revenue receipts, according to revised estimates for Financial Year 2021. A rising
interest burden could squeeze the space for capital expenditure. India’s debt to GDP ratio raise to 85-
90% by 2021.
11.4 STATES AND THEIR DEBT POSITION
Earlier, the total debt of the States was classified into public debt and unfunded debt. This
classification has now been given up and, in the new classification, the major heads of debt are (Dutt
& Sundaram, 2011) :
(i) Internal Debt. This comprises (a) current market loans and bonds issued in connection with
the zamindari abolition, (b) ways and means advances and overheads payable within seven days
from the RBI, and (c) loans from banks, other institutions such as loans from State Bank of India, and
other commercial banks, National Credit Long-term Operations) Fund of NABARD, Employees’
States Insurance Corporation, etc.
(ii) Loans and advances from the Central Government. These comprise loans and advances
from the Central Government for Plan and non-Plan purposes.
(iii) Provident Funds, etc. These include State provident funds, Insurance and Pension Fund,
Trusts and Endowments, etc.
(i) In a matter of 4 decades, total debt of the States has risen from about Rs. 2740 crores in
end-March 1961 to over Rs. 18,20,155 crores in end-March 2011. The aggregate public debt of State
Governments as ratio of GDP is now around 28 per cent. The increasing trend in state debt-GDP
ratio has been significant since 1997.
Table 2 : Debt Position of the States (in crores)
Item As at the end of March
1961 1971 2008 2011(BE)
1. Internal Debt 590 1,850 1,81,623 12,17,959
2. Loans and 2,020 6,360 2,38,655 1,55,698
Advances from
the Central
Government
3. Provident fund 130 540 1,73,869 4,46,498
and other
liabilities
Total liabilities 2,740 8,750 5,79,147 18,20,155
(1+2+3)
Source : RBI, Handbook of Statistics on Indian Economy 2008-09 and RBI Bulletin, June 2009, State Finances : A Study of
Budgets 2010-11 c.f. Dutt & Sundaram, 2011.

From Table 2, the following observations can be made :

(ii) Internal debt of States was around 22 per cent of all states’ total liabilities in the 1960s. It
has grown, however, over the years, and was around 67 per cent in 2011-12.
 (iii) The share of Central loans and advances in the total debt of State Governments has
been steadily declining – from about 74 per cent in 1961 to 8.6 per cent in 2011. The heavy
indebtedness of States to the Centre was due to such diverse factors as block loans for State
development plans, special accommodation, clearing overdrafts of States with RBI, etc.
(iv) State Governments were gradually shifting towards higher-cost sources. The interest
burden (i.e. ratio of interest payments to revenue receipts) of States and steadily risen from about 15
per cent during 1960-61 to about 30 per cent during the 2009-10 (budget).
(v) Ways and means advances from RBI which include normal and special ways and means
advances and overdraft from RBI repayable within seven working days frequently assumed serious
proportions. Often State Governments request the Central Government to convert their overdrafts
into loans.
11.5 PUBLIC DEBT IN THE STATES AND RELATED CRISIS
In the last few years, heavy public debt and large interest payments have crippled many
states which are unable to undertake socially necessary expenditure. The states have the
responsibility to maintain law and order, build and maintain infrastructure, provide health and
sanitation, education and other essential services. Many states are unable to incur these necessary
types of public expenditure. Many others are in a serious financial crisis and are literally limping
along.
On the one hand, public debt is mounting and on the other, states have been forced to pay
high rates of interest. There are many reasons for this sad state of affairs. Till 1997-98, the fiscal
deficit of the States as a proportion of GDP was around 3 per cent and was under control. Since then,
states were forced to run into huge fiscal deficits essentially because of rise in revenue deficits –
state expenditure on salaries and pensions sky-rocketed directly due to Central Government
measures arising out of the salary hikes on the basis of recommendations of the Fifth Pay
Commission.
Secondly, the Centre has been directly responsible for the high interest rates of State public
debt. Under the Indian Constitution, the Centre has the power to determine both the extent and the
terms of borrowing by States from all sources, including the Centre itself. This power has been
used/abused by the Centre against the states for the last many decades in various ways. One way is
that the Centre charges high rates of interest on debt which it issues to the states – in fact, invariably
the rate of interest for the states is higher than the rate at which the Centre itself has been paying.
Further, when State Governments raise debt provided by multi-national institutions like World
Bank and ADB, they are charged a higher rate by the Central Government which is the intermediary –
than the rate of interest charged by the international institutions.
Again, the Central Government has abused its constitutional powers to limit the ability of
States to borrow from the market and from commercial banks and financial institutions.
Finally, State Governments which have a revenue deficit have to seek special permission
from the RBI to borrow from commercial banks.
The result of these factors is that the average rate of interest which the states have to pay on
their debt has remained relatively high – around 10 to 11 percent. At the same time, the average rate
of interest paid by the Centre on its own debt has come down from about 9 percent to 6.5 per cent. In
other words, the Centre has always played the usurious moneylenders to the States.
 In the past, Finance Commissions have recommended schemes to reduce the volume of
Central Government loans to the States.
The growing debt burden of the States has been a source of serious concern for the States
and the Centre. With the active help of the Government of India, a Debt Swap Scheme was been
formulated to liquidate high cost loans given by the Government of India to the States. The States
have agreed to utilize 20 percent of net small savings proceeds released from September 2002 to
pre-pay high cost Government of India loans and advances.
The Twelfth Finance Commission has recommended a scheme of Debt Relief for the period
2005-10. The scheme envisages the rescheduling of all Central loans contracted till end-March 2004
and outstanding as on end-March 2005 into fresh loans for 20 years carrying 7.5 per cent interest.
This provision is conditional to a State enacting the Fiscal Responsibility Legislation. The implication
are : (a) the States are irresponsible in their expenditure (b) they do not mobilize resources
themselves and (c) they themselves are responsible for their mounting public debt. RBI Paper (2020)
states that for states, debt is increasing at double-digit rate, at a pace higher than nominal GDP
growth. After UDAY scheme, states debt increased sharply in 2016 and 2017. They curtailed capital
expenditure to meet high revenue expenditure dragging growth.
11.6 PUBLIC DEBT POLICY : TRENDS & PROBLEMS
The Union Government is in a position to raise loans at slightly more favourable terms than
the States. It is able to offer a lower rate for loans of longer maturity than the States. Further, there is
a slight disparity in the terms at which different States can borrow. It has been suggested that the
Union Government alone should raise loans from the market and should distribute the proceeds
among the States according to their requirements.
Since independence, the Central Government has set up a series of banking and financial
institutions which indeed constitute a captive market for Government loans. We mean here the
nationalized banks, statutory and public provident funds, LIC, GIC etc. This captive market is forced
to absorb the huge amount of loans raised by the Centre.
11.6.1 Deficit Trends in recent years
Table 3 brings out the deficit trends (of Central Government) in India in recent years, as
explained below :
(a) Revenue deficit has been rising quite fast from Rs. 18,560 crores to Rs. 3,07,270 crores between
1991 and 2012. As percentage of GDP, revenue deficit had ranged between 3.5 to 4.7 per cent which was
regarded as quite high. Such huge revenue deficit indicated clearly that the Government had been living
beyond its means and that it had to cut its current expenditure – specially its non-plan expenditure – instead
of looking for sources of additional taxation. Effective Revenue deficit (ERD) is new term introduced in 2011-
12 (Union Budget) which is the RD ‘excluding’ those revenue expenditures of GOI which were done in the form
of GOCA (Grants for creation of Capital assets), as they are indeed in asset creations of they can it be
considered completely.
(b) Originally, budget deficit was calculated to show RBI lending to the Government. Since
1997, RBI lending to Government through ad hoc Treasury Bills has been given up. The concept of
budget deficit has lost its relevance now.
(c) The Finance Ministry has so estimated the capital receipts that the total receipts of the
Government are exactly equal to the total expenditure; there is, therefore, no over all budget deficit.
 (d) The Government has discontinued the issue of ad hoc treasury bills to RBI, but instead, it
will tap 91 days treasury bills from the market. This would be part of the capital receipts under the
heading “borrowings and other liabilities.”
(e) Fiscal deficit has been growing rapidly (and dangerously) – from Rs.27,040 crores in 1988-
89 to Rs. 44,630 crores in 1990-91 and to Rs.400996 crores in 2007-08 budget. The international
financial institutions such as the World Bank and the IMF objected to the high rate of fiscal deficit
(7.7% of GDP) in 1990-91 and asked the Government of India to reduce it over the next few years.
Accordingly, the Government reduced fiscal deficit as a percentage of GDP to 5.9 and 5.7 per cent in
1991-92 and 1992-93 respectively. During 1993-94, however, fiscal deficit rose to 7.4 per cent of
GDP.
Table 3 a : Deficit Trends (Rs.
Crores)
Year Revenue deficit Fiscal deficit Primary deficit
1990-91 18,560 44,630 23,130
(3.2) (7.7) (4.0)
2007-08 52,569 1,26,912 -44,118
(1.1) (2.5) (-0.9)
2008-09 2,53,439 3,36,992 1,44,788
(4.5) (6.0) (3.2)
2009-10 3,29,061 4,14,041 1,94,541
(5.3) (6.7) (3.2)
2010-11 2,69,844 4,00,998 1,60,241
(-3.4) (-4.6) (-1.6)
Note : Figures in brackets are estimated percentages of GDP.

Source : Misra & Puri, 2011, Kapila, 2017.

For many years, the Finance Minister of the Government of India were not worried, as they
could raise funds from the market, from the captive banks and other financial institutions. The RBI,
however, has been warning the Government regularly of the impending debt trap. It was only when
the World Bank and International institutions refused to bail out India in 1990-91 unless it reduced its
fiscal deficit, that the Government was forced to take stringent measures to control non-plan
expenditure.
The uncontrolled growth of revenue deficit is due to the sharp rise in non-plan expenditure,
mainly on account of higher interest payments, rise in major subsidies and increase in pensions
payments. It was the NDA Government that made a two-pronged attack in reducing revenue and
fiscal deficits through augmenting revenue on the one side and controlling non-plan expenditure on
the other. According to 2008-09 budget, fiscal deficit was projected to be 2.5 percent of GDP. But in
revised estimates for 2008-09, fiscal deficit turned out to be 6.0 per cent of GDP. For Budget 2011-
12, Fiscal Deficit has been debt at 4.6 percent of GDP.
 To conclude in the decade, fiscal deficit was rising very fast and consequently, the public debt
and other liabilities of the Government of India were literally multiplying. The annual average growth
rate of public debt was around 13.3 p.c. during 1990-91 and 2011-12. For instance, the total amount
of public debt and other liabilities of the Government of India were:
Rs. 3,14,560 crores in 1990-91
Rs. 9,90,260 crores in 1999-2000
Rs. 43,52,389 crores in 2011-12
In a matter of just 21 years, the volume of public debt and other liabilities of the Government
of India has risen nearly 13.8 times or 1380 per cent. As a direct result of this growth of Government’s
total liabilities, the annual interest burden of the Government of India is also mounting as for instance.
Burden of Interest payments of the Government of India increased from Rs. 3,500 crores
in1980-81 to Rs.21,500 crores in 1990-91 to Rs. 88,000 crores in 1999-2k to Rs. 2,67,986 crores in
2011-12.
Table 3b : Fiscal Indicators (as percent of GDP)
Year Fiscal Deficit Revenue Deficit Primary Deficit
2008 – 09 6.0 4.5 2.6
2009 – 10 6.5 5.2 3.2
2010 – 11 4.8 3.2 1.8
2011 – 12 5.7 4.4 2.7
2012 – 13 4.8 3.6 1.8
2013 – 14 4.6 3.3 1.3
2014 – 15 4.1 2.9 0.8
2015 – 16* *3.9 2.5 0.7
2016 – 17 3.5 2.1 0.3
2021 - 22 10.2

Source : Kapila 2016, P

* Pratiyogita Darpan * Eco Survey 2021.
** April-Nov 2021
Select Fiscal indicators for the central government are summarised in Table 3(b). Tables 3(a) and Tables 3(b)
indicate three phases of policy since 2000 s (Kapila, 2016)
 Phase I : 2002 – 2007 : All improvement in fiscal indicators stemmed from rapid growth, which averaged
about 8 pc.
 Phase II : 2008–2011 : With Lehman Crisis of 2008 – 09, the second and deficient phase of Indian fiscal
bustary began and lasted for 4 years. All positive trends of Phases I revised – FD increased by 4 p.c.,
enssent expenditures increased (due to increased subsides by 1 p.c. of GDP), MGNREGA (0.3 % of GDP)
 Phase III : 2012–13 to 2014–15 : It is characterised by sharp growth slow downs. The fiscal stimulus
during post – Lehman Crisis phase was unwound, bringing the F.D. close to the levels of 2000 s i.e. 4 pc
of GDP. Indian experienced a near crisis during July/Augst 2013 due to.
(i) US tapering off monetary stimulus
 (ii) growing current a/c deficit
(iii) high inflation
(iv) large fiscal defiats leading to out fight of capital.
It is observed by many economists that India needs to create fiscal space in order to (a) ensure macro
stability and (b) create buffers for economic growth slowdowns in future (Economic Survey 2014 – 15)
In 2016 – 17, it has come down to PRBM limit of 3 pc of GDP FRBM committees has recommended 3%
FD for next three years, keeping in mind the sustainable target and need for public investment, fiscal
deficit for 2017 – 18 is targeted at 3.2% of GDP (Pratiyogita Darpan, 2017). A Study [by Sajjid Z. Chinoy,
Chief India Economist, JP Morgan] on growth and debt sustainability [in Economic Survey, 2021] stated
that higher growth is key to easing the public debt burden and also reduction in interest burden.
11.6.2 Combined Debt of Central and State Governments (& Respective Shares)
Table 4 provides information on the combined outstanding liabilities of the Central and State
Governments.
Table 4
Combined Liabilities of the Centre and States
Combined Total Debt-GDP ratio (Per cent)
Liabilities of
Centre States Combined
Centre and
End-March States (Rs.
Crore)
1990-91 368824 55.22 22.50 64.75
1995-96 728208 50.87 20.94 61.10
2000-01 1484106 55.58 28.26 70.59
2003-04 2233748 63.05 32.79 81.09
2005-06 2859556 60.98 30.97 77.15
2006-07 3181455 59.26 28.98 74.26
2007-08 3561737 57.35 26.85 71.99
2008-09 RE 3991793 56.26 26.24 71.61
2009-10 BE 4509981 56.10 26.26 72.38
RE : Revised Estimates BE : Budget Estimates

Source : Reserve Bank of India, Handbook of Statistics on Indian Economy 2009-10 (Mumbai, 2010), Table
122, p. 211 and Table 237, p. 425. c.f. Misra & Puri, 2011.
As is clear from the Table, debt-GDP ratio has increased considerably in the post – 1991
period – from 64.7 per cent as at end-March 1991 and 61.1 per cent as at end-March 1996 to as high
as 81.1 per cent as at end-March 2004 (it declined somewhat in later years and stood at 71.6 per
cent as at end-March 2009). This raises questions regarding ‘debt sustainability. To rein in the public
debt, serious efforts at reducing expenditures and increasing revenues are required to be made.
However, because of economic slowdown, the government was forced to adopt fiscal stimulus
packages in 2008-09. Massive government expenditures continued in 2009-10 as well. Therefore,
debt sustainability will remain a cause for concern.
11.7 FISCAL RESPONSIBILITY IN INDIA
Public debt is one way to raise money for development. To assess a country’s debt
sustainability, it is important to cover all types of debt that pose risk to a country’s public finances.
The fashion of legal restraints on government fiscal behaviour was set by the United States,
where in the mid-1980s the Balanced Budget and Emerging Deficit Control Act (Gramm-Rudman-
Hollings Act) required a steady decline in the federal government's deficit to zero within a stipulated
and fairly short timeframe. Such a legal binding on government in fiscal matters is extreme by any
standard. Nevertheless, besides the USA, some other countries have opted for such an extreme
measure and a few other countries preferred to pursue balanced budget policies without legal
stipulation. India opted for the legal course in 2000 after having failed to restore fiscal balance for
about a decade in the form of FRBM.
11.7.1 The Fiscal Responsibility and Budget Management (FRBM) Bill
The Committee on Fiscal Responsibility Legislation was constituted on January 17, 2000 to
look into various aspects of fiscal system and recommend a draft legislation on fiscal responsibility of
the government. It was announced in the Budget for 2000-01 that the government intended to create
a strong institutional mechanism embodied in Fiscal Responsibility Act to restore fiscal discipline at
the level of the Central government. Accordingly, the Fiscal Responsibility and Budget Management
(FRBM) Bill 2000 was introduced in Lok Sabha in December 2000.
The FRBM Bill attempted to fix up responsibility on the government to strengthen the
framework for adopting a prudent fiscal policy and paves the way for accomplishing macroeconomic
stability.
11.7.2 Original Bill of objectives
The original Bill in operational terms has aimed at the following :
1. Revenue deficit. Reducing revenue deficit by an amount equivalent to 0.5 per cent or more
of the GDP at the end of each financial year, beginning on April 1, 2001. The revenue deficit thus
should be reduced to nil within a period of five years ending on March 31, 2006. Once revenue deficit
becomes zero, the Central government should build up surplus amount of revenue which it may
utilise for discharging liabilities in excess of assets.
2. Fiscal deficit. Reducing gross fiscal deficit by an amount equivalent to 0.5 per cent or
more of the GDP at the end of each financial year beginning on April 1, 2001. The Central
government should thus bring down gross fiscal deficit to less than 2 per cent of the GDP for that
year, within a period of five years ending on March 31, 2006.
3. Public debt. Ensuring that within a period of 10 financial years beginning from April 1, 2001
and ending on March 31, 2011, the total liabilities (including external debt) of the Central government
at the end of a financial year do not exceed 50 per cent of the GDP for that year.
4. Borrowing from the RBI. The Central government shall not borrow normally from the RBI.
However, the Central government may borrow from the RBI by way of advances to meet temporary
excess of cash disbursement over cash receipts during any financial year in accordance with the
agreements which may be entered into by the government with the RBI.
 Box : Fiscal Deficit in 2009-10 and 2010-11
Central Government's Fiscal Imbalance
 Revenue deficit - 5.2 per cent of GDP in 2009-10 and 3.4 per cent of GDP in 2010-11.
 Gross fiscal deficit - 6.4 per cent of GDP in 2009-10 and 5.1 per cent of GDP in 2010-11.
 Primary deficit - 3.1 per cent of GDP in 2009-10 and 2.0 per cent of GDP in 2010-11.
 Revenue expenditure - 13.9 per cent of GDP in 2009-10.
 Capital expenditure - 1.7 per cent of GDP in 2009-10.
 Interest payments - 3.2 per cent of GDP in 2009-10.
 Major subsidies - 1.9 per cent of GDP in 2009-10.
 Defence expenditure - 1.4 per cent of GDP in 2009-10.
Central and State Governments' Combined Fiscal Imbalance
 Revenue deficit - 4.1 per cent of GDP in 2008-09.
 Gross fiscal deficit - 8.5 per cent of GDP in 2008-09.
FRBM Approach
Neo-classical ideology emphasises balanced budget approach.
For restoring fiscal soundness - The Central government introduced FRBM Bill in Lok Sabha in 2000:
FRBM Act passed in 2004. FRBM Act anti-democratic.
FRBM Act mandates for the Central government:
1. Revenue deficit to fall to zero by 2009
2. Fiscal deficit to be reduced to 3 per cent of GDP by March 2009.
Because of slowdown in the economy since the latter half of the financial year 2008-09, these
deadlines laid down in the FRBM Act were postponed.
Source : Misra & Puri, 2011.
Note : See Table 3b here and Section 11.7.4
11.7.3 The FRBM Act
The FRBM Bill was totally undemocratic in its approach as it denied freedom to future
governments in respect of fiscal management. The Parliamentary Standing Committee that had
studied the original Bill made certain recommendations to dilute various provisions in the Bill. The
diluted version of the original Fiscal Responsibility and Budget Management Bill was passed by the
UPA government immediately after assuming power in July 2004.
The FRBM Act which became effective from July 5, 2004 mandates the Central Government
to eliminate revenue deficit by March 2009 and subsequently build up a revenue surplus. The Act
also mandates the Central government to reduce fiscal deficit to an amount equivalent to 3 per cent
of GDP by March 2009.
The rules made under FRBM Act specify the annual targets for reduction of fiscal and revenue
deficits. The rules also prescribe the formats for medium term fiscal policy statement, the fiscal policy
strategy statement and the macroeconomic framework statement to be presented to Parliament along
with the annual financial statement. For formulating annual targets and drawing up the framework for
fiscal policies a Task Force headed by Vijay Kelkar was constituted by the Central Government.
The FRBM Act provides for greater transparency in fiscal operations, quarterly review of fiscal
situation and regulating direct borrowing from the RBI in a bid to check borrowing and control
expenditure to effect fiscal discipline. The original version of the FRBM Bill had prohibited direct
borrowing from the RBI after three years of the passage of the bill except to meet temporary needs.
The present FRBM legislation has done away with this provision.
The FRBM legislation has now made it mandatory for the Finance Minister to make an annual
statement to Parliament on the fiscal situation besides explaining any deviation in meeting the fiscal
obligations cast on the Centre. The legislation provides for responsibility of the Central government to
ensure inter-generational equity in financial management and long term macroeconomic stability by
achieving sufficient revenue surplus.
11.7.4 FRBM Review Committee [Union Budget 2017 – 18]
In the backdrop of uncertainly and volatility which have become the new current of global economy the
government in 2016 constituted a 5 member committee to review the implementation of the FRBMA, its
important recommendations are
 Sustainable debt path must be principal macro-economic anchor of our fiscal policy.
 Debt to GDP ratio for the General Government should be 60 pc by 2023 i.e. 40 pc for central Govt. and
20 pc for state govt.
 Fiscal Deficit : 3 pc for the next 3 years
 Escape Clauses : It has provided for Escape clauses :
(i) Deviations up to 0.5 pc of GDP from the stipulated F.D. target.
(ii) Among the triggers, it has included for-reaching structural reforms in the economy with
unanticipated fiscal implications’.
Note : The budge informed that appropriate decision will be table after careful examination of the
report.
11.8 Appraisal of the FRBM Legislation
The Fiscal Responsibility and Budget Management legislation is an attempt on the part of the
Central government to commit itself to fiscal discipline. The desirability of fiscal discipline is generally
accepted, yet there are serious misgivings about the coverage of the legislation and its chosen
t a r g e t s .
 Target of revenue deficit. There is broad consensus that the revenue deficit is to be brought
down to zero. In the past, despite general agreement on this issue successive Central governments
had failed to reduce revenue deficit during the 1990s. In fact, the revenue deficit of the Central
government was 3.6 per cent of the GDP in 2003-04 as against 2.4 per cent in 1996-97. This
appalling situation developed on account of two reasons, First, Central tax revenue (net) to GDP ratio
declined from 7.6 per cent in 1990-91 to 6.8 per cent in 2003-04. Second, interest payments, revenue
subsidies, defence expenditure and other non-plan expenditures rose substantially. Whenever
restrictions are imposed on the government to reduce revenue deficit, the real possibility is that the
government may cut down social sector spending – especially on basic health and basic education –
very severely. Which could surely be disastrous for large sections of the Indian population.
 Low levels of capital expenditure. One of the major defects of government finances during
the post reform period has been the declining capital expenditure-GDP ratio. The capital expenditure-
GDP ratio which was 5.6 per cent of GDP in 1990-91 fell to 2.7 per cent in 2001-02. After registering
some increase in 2003-04 and 2004-05 (it was 3.6 per cent in 2004-05), it fell to just 1.6 per cent in
2006-07 and stood at 1.7 per cent of GDP in 2009-10. This situation may deteriorate still further
under the FRBM regime. The targets for reduction of fiscal deficits and the programme for using
revenue surpluses in order to retire part of the public debt may prevent any increase in government
investment over the next decade.
 Financing public expenditure. The Fiscal Responsibility and Budget Management
legislation does not address the problem of financing public expenditure in a serious manner. During
the 1990s the tax-GDP ratio declined significantly. Hence, the need to raise this ratio should have
received top priority under the legislation. But this was not to be. There is no target under the
legislation for the tax-GDP ratio. As a matter of fact, a large number of tax concessions continue to be
given most of which cannot be justified by the economists. The problem of financing public
expenditure is callously dealt with by imposing a restriction on the Central Government to borrow
from the RBI to finance government expenditure, current or capital. This forces the government to
incur enormously high interest cost on all its debt. Moreover, the legislation does not seem to
recognize that borrowing from the central bank on a moderate scale for financing government
investment serves useful purpose in an economy like ours. As a matter of fact, it has an important
role to play in promoting the basic objectives of economic growth and equity and minimizing the
adverse effects of debt and deficits.
 Assumptions of the FRBM legislation. The FRBM legislation is based on the following
assumptions. (c.f. Misra & Puri, 2011)
(i) Lower fiscal deficits lead to higher and more sustained growth.
(ii) Large fiscal deficits necessarily lead to higher inflation.
(iii) Large fiscal deficit increases external vulnerability of the economy.
Because of slowdown in the economy during the second half of the financial year 2008-09, tax
collections in this year fell. At the same time, the government was obliged to undertake massive
expenditure programmes to raise demand to boost the economy. As a result, target deadlines under
the FRBM Act have been ignored. In fact, fiscal deficit in 2008-09 was as high as 6.0 per cent of GDP
which rose further to 6.4 per cent of GDP in 2009-10. This is the position when 'oil bonds' issued to
oil-marketing companies and 'fertiliser bonds' issued to fertiliser companies are not included in the
calculation of fiscal deficit. If these 'off-budget liabilities' are also included, figure for fiscal deficit
would be much higher. For example, the Prime Minister's Economic Advisory Council reported in end-
July 2008 that "total off budget liabilities of the Centre could exceed 5 per cent of GDP". This is over
and above the Central fiscal deficit of 6 per cent of GDP in 2008-09. Accordingly, the 'true' fiscal
deficit of the Centre in 2008-09 probably exceeded 10 per cent of GDP. If the fiscal deficits of the
States are also considered, the true challenge of fiscal consolidation in the coming years can be
easily imagined. According to Shankar Acharya, "In some ways, the task ahead is harder because it
may be unreasonable to expect the kind of revenue buoyancy experienced in recent years".
As a proportion of the GDP (purchasing power parity [PPP]), the overall fiscal balance of the
world was estimated by the International Monetary Fund (IMF) (Fiscal Monitor 2010) to have risen
from - 0.4 per cent in 2007 to - 2.0 per cent and - 6.8 per cent respectively in 2008 and 2009; it was
estimated to have moderated to - 6.0 per cent in 2010 and projected at - 4.9 per cent in 2011. At a
major grouping level, advanced economies accounted for the bulk of the fiscal expansion. Among the
emerging economies, India had one of the largest fiscal expansions of the order of about 10 per cent
of the GDP in both 2009 and 2010.
11.9 Trends in Deficit of Central Government (Post FRBM Act Period)
In actual terms, the Budget for 2010-11 had estimated the level of fiscal deficit at Rs. 3,81,408
crore and revenue deficit at Rs. 2,76,512 crore. As proportions of the nominal GDP, fiscal and revenue
deficits were estimated at 5.5 per cent and 4.0 per cent respectively. As proportions of the GDP as per
the AE, budgeted fiscal and revenue deficits work out to 4.8 per cent and 3.5 per cent for the current
fiscal. Thus, as proportions of the GDP, the recent trends in deficit indicators, post-crisis, have been
influenced to some extent by the swings in the levels of aggregate demand (Table 5 and Figure 1).

Source: ECO. Survey, 2011

Table 5 : Trends in Deficits of Central Government

(As per cent of GDP)
Year Revenue Fiscal Primary Revenue
Deficit (RD) Deficit (FD) Deficit (PD) Deficit as
%age
of FD
Enactment of FRBM Act
2003-04 3.6 4.5 0.0 79.7
2004-05 2.4 3.9 0.0 62.3
2005-06 2.5 4.0 0.4 63.0
2006-07 1.9 3.3 -0.2 56.3
2007-08 1.1 2.5 -0.9 41.4
2008-09 4.5 6.0 2.6 75.2
2009-10(P) 5.1 6.3 3.1 80.7
2010-11(BE) 3.5 4.8 1.7 72.5
Source: Eco. Survey 2010-11
BE-Budget estimates
P: Provisional actuals (unaudited)
FRBM : Fiscal Responsibility and Budget Management
Note: The ratios to GDP at current market prices are based on the CSO’s National Accounts 2004-05 series.
Table 6 : Outstanding Liabilities of the Central Government
(As per cent of GDP)
(end-March)
2005-06 2006-07 2007-08 2008-09 2009-10 2010-11
(RE) (BE)
(Rs. crore)
1. Internal Liabilities 58.7 56.7 54.7 54.4 51.5 48.0
a) Internal Debt 37.6 36.0 36.3 36.3 35.7 34.7
i) Market Borrowings 23.4 22.7 21.9 23.8 26.5 26.4
ii) Others 14.3 13.3 14.4 12.6 9.2 8.3
b) Other Internal Liabilities 21.0 20.7 18.4 18.0 15.9 13.3
2. External Debt (Outstanding)* 2.6 2.4 2.2 2.2 2.1 2.1
3. Total Outstanding Liabilities 61.2 59.1 56.9 56.6 53.7 50.1
Memorandum Items
(a) External Debt (Rs. crore)@ 194078 201204 210083 264076 249311 272779
(as per cent of GDP) 5.3 4.7 4.2 4.7 3.8 3.5
(b) Total Outstanding Liabilities
(adjusted) (Rs. crore) 2359980 2637084 2935477 3300208 3625636 4055332
(as per cent of GDP) 63.9 61.4 58.9 59.1 55.4 51.5
(c) Internal Liabilities(Non-RBI)( Rs. crore)## 1969106 2217671 2471396 2687037 3041134 3447362
(as per cent of GDP) 53.3 51.6 49.6 48.1 46.4 43.8
(d) Outstanding Liabilities
(Non-RBI)( Rs. crore)## 2163184 2418875 2681479 2951113 3290445 3720141
Outstanding Liabilities (Non-RBI)
(as per cent of GDP) 58.6 56.3 53.8 52.9 50.2 47.2
(e) Contingent Liabilities of
Central Government (Rs. crore) 110626 109826 104872 113335 n.a. n.a.
Contingent Liabilities of
Central Government
(as per cent of GDP) 3.0 2.6 2.1 2.0 n.a. n.a.
(f) Total Assets (Rs. crore) 1194446 1339119 1571668 1569043 1590027 1754040
Total Assets
(as per cent of GDP) 32.3 31.2 31.5 28.1 24.3 22.3
Source: Economic Survey, 2010-11.
n.a. : not available
* External debt figures represent borrowings by Central Government from external sources and are based upon historical
exchange rates.
@ Converted at year end exchange rates. For 1990-91, the rates prevailing at the end of March,1991; For 1999-2000, the
rates prevailing at the end of March, 2000 and so on.
# Internal debt includes net borrowing of Rs. 29,062 crore for 2005-06, Rs. 62,974 crore for 2006-07,
Rs. 1,70,554 crore for 2007-08, Rs. 88,773 crore for 2008-09, Rs. 2,737 crore for 2009-10(RE) and Rs. 50,000 crore for
2010-11(BE) under the Market Stabilisation Scheme.
## This includes marketable dated securities held by the RBI.
Note : The ratios to GDP at current market prices are based on the CSO’s National Accounts 2004-05 series.
11.9.1 Government Debt Report : Salient Features (c.f. Economic Survey, 2011)
In pursuance of the announcement made in the Budget for 2010-11 to this effect, a status
paper on Government debt was presented in November 2010. The paper made a detailed analysis of
the situation and chalked out a roadmap for reduction in overall debt as a percentage of the GDP for
the General Government during the period 2010-11 to 2014-15. The salient features of the report are
detailed as follows :
 The objectives of the debt management policy are to meet Central Government’s financing
need at the lowest possible long-term borrowing costs and also to keep the total debt within
sustainable limits. Additionally, it aims at supporting development of a well-functioning and
vibrant domestic bond market.
 The three important attributes of Government debt include source of financing, fixed interest
nature of debt, and long residual maturity. Of the overall Central Government debt, about 92
per cent is internal debt and 8 per cent is external debt. Internal debt largely consists of
market loans in the form of dated securities which are contracted through auction. Most of the
dated securities (97 per cent) are fixed coupon and only the balance 3 per cent are floating
rate bonds. The weighted average maturity of these dated securities is about 10 years while
the weighted average interest rate is about 7.8 per cent per annum.
 Subsequent to the Report of the Thirteen Finance Commission which had estimated debt to
GDP ratios and a roadmap for its reduction, the CSO revised the nominal GDP significantly
and as per the revised data the reduction in the levels of debt as proportion of the GDP could
be made even with higher than recommended fiscal deficits. As such, a higher than Thirteenth
Finance Commission recommended target was preferred whereby the fiscal deficit of the
Centre would be reduced to 3 per cent of the GDP by 2014-15 and accordingly debt as a
proportion of the GDP would come down from 50.5 per cent in 2009-10 to 43 per cent in
2014-15.
 The outstanding debt of State Governments is estimated at 26.3 per cent of the GDP for
2009-10. However, after netting of the liabilities on account of investments made in 14-days
treasury bills of Central Government, this comes down to 24.8 per cent of the GDP. The
roadmap for States has been prepared with fiscal deficit as a percentage of the GDP at the
level recommended by the Thirteenth Finance Commission. With the foregoing assumption on
fiscal deficit, consolidated debt for State Governments is estimated to reduce from 24.8 per
cent of the GDP in 2009-10 to 23.1 per cent in 2014-15.
 After factoring in the impact of Central loans to States, the consolidated debt of General
Government has come down from 79.3 per cent in 2004-05 to 68.7 per cent in 2007-08.
However, it has subsequently increased during the global economic crisis period to 71.1 per
cent in 2008-09 and further to 73 per cent of the GDP in 2009-10. It may be recalled that the
12th Finance Commission had recommended a consolidated debt for the Centre and State
Governments at 74 per cent of the GDP for the year 2009-10. Even with slippage in 2008-09
 and 2009-10 on fiscal deficit targets, the overall General Government debt at 73 per cent of
the GDP in 2009-10 has remained within the recommended target.
 The suggested roadmap for consolidated General Government debt sets a target of reduction
from 73 per cent of the GDP in 2009-10 to 64.9 per cent in 2014-15. This shows a reduction of
8.1 per cent of the GDP in the consolidated debt for the General Government.
 In the roadmap suggested for debt reduction during the period 2010-11 to 2014-15, the
Government’s commitment towards fiscal consolidation has been reiterated. With the
reduction in fiscal deficit for 2010-11, the trend witnessed in the last two years of increasing
debt has been arrested. The Government has undertaken concerted efforts to reduce the
fiscal deficit gradually so as to bring down the debt as a proportion of the GDP to the pre-crisis
level of 68.7 per cent by 2013-14 and further improve to about 65 per cent of the GDP in
2014-15.

Source : Economic Survey, 2011

 Fourteenth Finance Commission (2012 – 2017)
Head & Members :
 The FFC is headed by YV Reddy, former RBI Governor.
Members – Abhijit Sen, M Govinda Rao, Sushma Nath and Sudipto Munale ; recommendations of the
FFC were accepted by GOI on 24th February 2015.
 Major Contribution :
More power to states – increase in the share of states in the central taxes to 42% (from current 32%) It
has been the largest increase since the beginning.
It shows compositional shift in transfers' from grants to tax devolution.
 Other Recommendations :
 Grants to states are divided into two – (a) grant to duly constituted Gram Panchayats – (b) grant to
duly constituted municipal bodies.
 It (FFC) has divided grants into two parts – A basic grant and a performance–based.
 The ratio of basic to performance grant is 90 : 10 for Panchayats and 80 : 20 for municipalities
11.10 State-level finances in the post FRBMA Period
In the post-FRBMA period the performance of combined States was impressive with fiscal
deficit declining to 2.4 per cent of the GDP in 2005-06 and further to 1.5 per cent in 2007-08. With the
exception of 2009-10 (RE), the level of fiscal deficit had remained below the 3 per cent of GDP mark.
In 2010-11 (BE), it has been estimated at 2.5 per cent of the GDP (Table 3.11 and Figure 3.11). A
more noteworthy feature has been that a surplus on revenue account has been recorded in the three-
year period 2007-08 and 2008-09. Revenue receipts grew at the rate of 17.6 per cent and 10.7 per
cent for 2007-08 and 2008-09 respectively. Buoyant revenues of the States (as also Centre) and non-
tax receipts combined with a moderate growth in revenue have helped in this regard. However, there
are significant variations among States in respect of these indicators.
11.10.1 Fiscal Reforms Programme for States
With a view to improving their fiscal position, many State governments have also undertaken
fiscal adjustment programmes. Even prior to the Twelfth Finance Commission. (TFC) recommending
enactment of FRBM Act as a pre- requisite for States to claim the benefits under the Debt Waiver and
Relief Facility, a few States had already enacted their FRBM Acts. TFC's Debt Consolidation and
Relief Facility (DCRF) had a two-stage benefit scheme as incentive to the States: first, a general
scheme of debt relief applicable to all States, which provided for consolidation of Central loans (from
Ministry of Finance) contracted by States till March 31, 2004 and outstanding as on March 31, 2005
for a fresh term of 20 years at an interest rate of 7.5 per cent, prospectively, from the year in which
they enact FRBM Acts; and second, a Debt Write-off scheme (after consolidation of Central loans)
linked to fiscal performance, subject to the following conditions:

(i) Enactment of FRBM Act (required, in any case, for debt consolidation),
(ii) Reduction of revenue deficit every year starting from 2004-05, when compared to the
average of the preceding three years (i.e., 2001-02, 2002-03 and 2003-04). In the
process, if revenue deficit is eliminated completely by 2008-09, the State gets the full
benefit of waiver,
(iii) Reduction in revenue deficit should be equal to at least the interest rate relief on account
of consolidation, and
(iv) Containing fiscal deficit/GSDP (Gross State Domestic Product) ratio at the 2004-05 level
in all the subsequent years.
In the post-FRBM Act period, the performance of combined States was impressive with fiscal
deficit declining to 2.4 per cent of GDP in 2005-06 and further to 1.5 per cent of GDP in 2007-08.
With the exception of 2009-10, the level of fiscal deficit had remained below the 3 per cent of GDP
mark. A more noteworthy feature has been that a surplus on revenue account has been recorded
during 2007-08 and 2008-09.
11.10.2 State-level Reforms and Thirteenth Finance Commission (ThFC)
Given the exceptional circumstances of 2008-09 and 2009-10, the fiscal consolidation process
of the States was disrupted. States would be able to get back to their fiscal correction path by 2011-
12, allowing for a year of adjustment in 2010-11. The stimulus packages of the Central Government
as well as those announced by individual States coupled with the increased transfers recommended
by the ThFC have implications for the financial position of the States in the medium term. The
recommendations of ThFC for the period 2010-15 are presently under implementation. The
recommendations take into account the current and likely macroeconomic and fiscal scenarios so as
to secure fiscal stability and adequate resource availability for the Centre, the States, and the local
bodies. The higher levels of devolution of taxes and the inter-se sharing thereof together with higher
levels of non-Plan grants under Article 275 of the Constitution which include specific grants like
grants for elementary education, outcomes and environment related grants, maintenance grants, and
state-specific grants are likely to bring the combined deficit of the States down to the targeted levels
faster. The borrowing ceiling for each State for the year 2010-11 has been fixed by the Government
of India, keeping in view the recommendations of the ThFC based on targets for fiscal deficit.
Besides, the ThFC has also provided a basis for the finances of local bodies through a basic grant
and a performance grant based on a percentage of the divisible pool of the preceding year. The
estimated total grant recommended for local bodies aggregates to Rs. 87,519 crore over the award
period of the ThFC.
In this year’s Budget, measures were also taken to facilitate movement towards a goods and
services tax (GST). These included unification of rates between central excise (goods) and service
tax (services) at 10 per cent; removal of certain exemptions in central excise; widening of service tax
base through inclusion of eight new services and expansion of scope of some of the existing ones;
reduction in excise duty from 16 per cent to 10 per cent on medicines and toilet preparations
containing alcohol (excise duty on medicinal and toilet preparations is one of the taxes to be
subsumed under the GST); approval of a Mission Mode Project for the computerization of State
Commercial Tax Departments.
Though considerable progress has been made in moving towards a comprehensive GST, the
timeline of April 2011 for its introduction has not been met. This is because the convergence of views
between the Centre and States needed for the introduction of legislation for a constitutional
amendment in this regard is yet to be achieved. In the meantime, the working groups involved in
developing the IT architecture, business processes, and draft legislations for the effective
implementation of GST are continuing their work. An empowered group under the Chairmanship of Dr
Nandan Nilekani, Chairman UIDAI, worked out the modalities for creation of a special purpose
vehicle (SPV) which envisages the setting up of a common portal for the Centre and State
Governments through which taxpayers could interact with the two tax administrations. Work is also under
way to create and strengthen the IT infrastructure in State VAT(value-added tax) departments so that their
transition to the GST becomes easier.
Table 7 : Receipts and Disbursements of State Governments* (Sample for details)
2005-06 2006-07 2007-08 2008-09 2009-10 2010-11
(RE) (BE)
(Rs. crore)
I.Total Receipts(A+B) 595,628 673,605 765,735 886,875 1,049,437 1,149,031
A.Revenue Receipts (1+2) 431,021 530,556 623,748 690,581 802,708 906,495
1.Tax Receipts 306,332 372,841 437,948 481,854 529,740 624,380
of which:
State’s Own Tax Revenue 212,307 252,548 286,546 321,351 364,997 426,014
2.Non-tax Receipts 124,690 157,714 185,799 208,727 272,968 282,114
of which:
Interest Receipts9, 380 11,825 12,637 16,594 16,782 16,331
B.Capital Receipts 164,607 143,049 141,987 196,294 246,728 242,536
of which:
I. Recovery of Loans & Advances 8,904 7,579 7,770 11,068 7,960 4,208
II.Total Disbursements 561,682 657,280 752,324 877,747 1,073,800 1,167,404
(a+b+c)
a)Revenue 438,034 505,699 580,805 678,856 849,571 932,683
b)Capital 109,224 137,793 157,258 183,013 207,073 220,022
c)Loans and Advances 14,424 13,789 14,261 15,879 17,155 14,699
III.Revenue Deficit 7,013 -24,857 -42,943 -11,725 46,863 26,189
IV.Gross Fiscal Deficit 90,084 77,508 75,455 134,245 214,137 198,097
(As per cent of GDP)
I.Total Receipts(A+B) 16.1 15.7 15.4 15.9 16.0 14.6
A.Revenue Receipts (1+2) 11.7 12.4 12.5 12.4 12.3 11.5
1.Tax Receipts 8.3 8.7 8.8 8.6 8.1 7.9
of which:State’s
Own Tax Revenue 5.7 5.9 5.7 5.8 5.6 5.4
2.Non-tax Receipts 3.4 3.7 3.7 3.7 4.2 3.6
of which:
Interest Receipts 0.3 0.3 0.3 0.3 0.3 0.2
B.Capital Receipts 4.5 3.3 2.8 3.5 3.8 3.1
of which:
Recovery of Loans & Advances 0.2 0.2 0.2 0.2 0.1 0.1
II.Total Disbursements (a+b+c) 15.2 15.3 15.1 15.7 16.4 14.8
a)Revenue 11.9 11.8 11.6 12.2 13.0 11.8
b)Capital 3.0 3.2 3.2 3.3 3.2 2.8
c)Loans and Advances 0.4 0.3 0.3 0.3 0.3 0.2
III.Revenue Deficit 0.2 -0.6 -0.9 -0.2 0.7 0.3
IV.Gross Fiscal Deficit 2.4 1.8 1.5 2.4 3.3 2.5
Source: Reserve Bank of India.
*: Data from 2008-09 onwards pertain to 27 State Governments.
RE: Revised Estimates.
Note: (1) Negative (-) sign indicates surplus in deficit indicators.
(2) The ratios to GDP at current market prices are based on the CSO’s National Accounts 2004-05 series.
(3) Capital receipts include public accounts on a net basis.
(4) Capital disbursements are exclusive of public accounts.
11.11 Fiscal Consolidation in India
The average combined F.D. of the centre and state remained 10 pc of GDP between 1975 to 2001,
largely due to high R.D. The RBI Planning Commission, IMF and WB cautioned about the unsustainability of the
fiscal deficits. Higher Public Debt can be harmful due to high interest burden. It can also lead to crowding out
of private borrowings. Interest rate expenses have increased to 44.6 pc of Revenue receipts. At the behest of
IMF, India started fiscal reforms as discussed below :
1. Policy Initiatives towards cutting Revenue Deficits
Following steps have been taken to reduce the revenue deficit in India
A. Cutting Down expenditure
(i) Cutting down the burden of salaries pensions and PFs (down sizing the government for every 3,
filling up one, interest cut on PF, pension reforms etc.)
 (ii) Cutting down the subsides : Mixed success in rationalising Administered Price Mechanism in
Petroleum, fertilisers, sugar, drugs.
(ii) Interest burden to be cut down (by going for lesser borrowings, esp. extermal borrowings).
(iv) Budgetary support to loss making PSUs.
(v) Postal Deficits to be checked with the involvement of Post Offices.
(vi) General Services : targeted subsides eg railways, power, water etc. so as to generate profit.
(vii) higher education categorised as non-merit good i.e. non-priority sector fills of institutions of
professional courses revised upwards etc.
B. Increasing Revenue Receipts
(i) Tax Reforms
(ii) Disinvestment and Privatisation of PSUs
(iii) Surplus Forex reserves to be used in external lending and purchasing high quality sovereign bond.
(iv) State governments allowed to go for market borrowings for their plan expenditure, etc.
2. Borrowing Programme of the Government
(i) The ways and Means Advances (WMA) scheme commended in 1997 under which the government
commits to the RBI about the amount of money it will give as part of its market borrowing
programmme. The major aim is to bring (a) transparency in public expenditure and (b) to put
political responsibility on the government.
(ii) RBI will not continue to be the primary subscriber to government securities (as committed in 1997)
3. Fiscal Responsibility of the Governments
(i) FRBM Act was passed in 2003 which puts constitutional obligation on the government to commit
so many things as fiscal responsible comes in the public finance.
– fixing targets to cut RD and FD;
– Govts. not to borrow from RBI except by the WMA; and
– Govt. to bring in greater transparency in fiscal operations
(ii) 12th Finance Commission advised a mechanism by which state governments to go for market
borrowing (without central permission) for their need of plan development provided they pass
their FRBM Acts regarding cutting then RD and FD. By march 2016, all states and UTs implemented
their FRAs
11.11.1 Nature of Fiscal Consolidation
The impact of the global financial crisis in 2011 brought to the fore the criticality of fiscal
policies in combating economic shocks. With little monetary headroom in advanced economies and
given the transmission lags in emerging market economies, fiscal policies were the preferred policy
instruments across the globe. As per international institutional research on the subject, advanced
economies were able to put in place large doses of fiscal stimuli as they had the advantage of
automatic stabilizers while emerging markets, including India, had large fiscal expansion given the
very low discretionary fiscal stimuli. In the fiscal consolidation phase in the post-FRBMA period
(2004-05 to 2007-08), there was considerable fiscal space generated that facilitated the high levels of
expansion that India had. It is therefore instructive to analyse the nature of fiscal deficits in India
through their decomposition into structural and cyclical components in Appendix.
Recent Changes : FRBM Acts has been amended twice – in 2004 and 2012. A group of economists felt fixing
fiscal deficits Ds may go counter productive So GOI proposed through Union Budget 2016–17 to go for a fixed
range for F.D.s in place of a fixed number.
SAQ
Q. Mention the change in the share of States in Tax Revenue, as recommended by the Fourteenth Finance
Commission.
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 _______________________________________________________________________________
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Activity
Q. What is the level of Fiscal Deficit of India in the current year?
___________________________________________________________________________
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11.12 Summary
Fiscal Deficits and Sustainability
(calculation)

Trends Need for Changes Sustainability Fiscal Consolidation

Central Public State Public Fiscal FRBM Act Performance in

Deficit Deficit Policy and Provisions Post-FRBM
Reforms Period
Combined
Centre State

11.13 GLOSSARY
Debt Instrument : A debt instrument is a financial claim that requires payments of interest,
principal or both by the debtor and provides capital to an entity that promises to repay e.g. Credit
cards, credit lines, loans and bonds. It can be in paper or electronic form.
 Fiscal Deficit = Primary Deficit + Interest payments
 Primary deficit Refers to the amount by which a Government total expenditure exceeds income,
including interest payment on debt.
Fiscal Deficit = Revenue Receipts (Net tax revenue + non tax revenue)
+ capital receipts (only recoveries of loans and other receipts)
―Total expenditure (Plan and Non-Plan)
OR
= Budget deficit + Government’s market borrowing and liabilities.
 Budget Deficit refers to difference between total budgeted receipt and expenditure. It was abolished
in 1997.
11.14 REFERENCES
 Kapila, Uma (2012). Indian Economy: Performance and Policy. Academic Foundation, New Delhi.
 Dwivedi and Kumar (2012). Indian Economy. MAG Book. Arihant Publication Pvt. Ltd.
 Chandrasekhar C.P. & Jayati Ghosh Jayanti. ‘The Market that Failed – A Decade of Neo–Liberal
Economic Reforms in India’ New Delhi.
 Kapila Uma (Ed) (2016). Indian Economy: Economic Development and Policy. Academic Foundation.
New Delhi.
 Government of India (2020). Economic Survey, Various issues 2006, 2007, 2008, 2009,
2010–2020, Ministry of Finance. New Delhi.
 Misra & Puri (2011). Indian Economy. Himalaya Publication. New Delhi.
11.15 FURTHER READINGS
 Kapila, Uma (2020). Indian Economy Since Independence. Academic Foundation. New Delhi, Recent
issue.
 Government Debt (2016). States Paper Min. of Finance GOI. New Delhi.
11.16 MODEL QUESTIONS
 Write short notes on
a) GST
b) VAT
 Comment upon the public debt indicators of centre and states in India since independence.
How far are they sustainable?
 What do you know about FRBM Act in India.
 Discuss the performance of Centre State deficits in Post-FRBM period in India.
APPENDIX
I Decomposition of Fiscal Deficit into Structural and Cyclical Components
The Government budget balance is basically influenced by both cyclical (temporary) and
structural (permanent) factors, entailing that change in the fiscal deficit could arise either in response
to cyclical changes in output or to structural factors. The cyclical changes in output have a transitory
effect on the fiscal deficit, whereas the structural factors have a more durable impact. A structural
deficit occurs when a country generates a deficit even when the economy of the country is operating
at its full employment level. On the other hand, a cyclical deficit occurs when an economy is not
performing to its potential, for example if an economy is struggling through a recession. A structural
deficit means that a deficit will be posted regardless of how well an economy if functioning-–recession
or boom. When the economy is functioning strongly, revenue generation is higher due to more jobs,
more spending, etc. but with structural deficit the good and strong health of the economy is irrelevant-
-a deficit will be generated regardless.
Structural deficit could be further decomposed into three parts that is (a) fiscal drag,
(b) discretionary fiscal policy action, and (c) base year balance, to gain still more insight into the
determinants of the structural deficit. Of the three listed components, the first two are important from
the point of understanding fiscal stance.
II Fiscal Drag
 Among the components of the structural deficit, the fiscal drag is important and normally
refers to increase in average tax rates in a progressive income tax scheme as a consequence of
increase in nominal income over time-- either on account of higher levels of inflation or real GDP
growth. It has been observed that fiscal drag is the dominant contributory factor for structural deficit of
Central Government balances.
III Discretionary Fiscal Policy Action
On the other hand, the second component, i.e. discretionary fiscal policy actions, after
remaining relatively weak up to 2007-08, had shown increases in 2008-09 and 2009-10 which can be
attributed to revenue losses due to slowdown in the economy and duty cut together with higher
expenditure to provide fiscal stimulus to sustain economic growth.
Traditional deficit indicators normally do not discriminate between these two effects, and
hence fail to correctly evaluate and portray the impact of fiscal operations on the economy as a
whole. The decomposition of the budget balance into its structural and cyclical components is
obtained normally through the application of two important methodologies, namely the IMF and
Organization for Economic Cooperation and Development (OECD) methodologies. The earlier
research on the subject that had been done mostly in the pre-FRBMA period had indicated the
presence of the large structural rigidities in the composition of fiscal deficits in India and a very small
cyclical component. The preliminary findings of the study on this subject commissioned in the post-
FRBMA period using OECD methodology too have indicated continued dominance of the structural
component in the budgetary balance of the Government; this observation holds good in the
decomposition of primary deficits of the Centre, combined States, and consolidated General
Government.

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 Lesson – 12

FOREIGN TRADE POLICY OF INDIA AND

CONVERTIBILITY OF RUPEE
Structure
12.0 Objectives
12.1 Introduction
12.2 Pre-Reforms Export Policy (upto 1985)
12.2.1 Phase I : 1952 - 73
12.2.2 Phase II : 1973 - 79
12.2.3 Phase III: 1980 - 85
12.3 Foreign Trade Policy in Post Reforms Period
12.3.1 Concession and Exemptions : 1992 - 97
12.3.2 Exim Policy 1997 - 2002
12.3.3 Exim Policy 2001-02
12.3.4 Exim Policy 2002 - 03
12.3.5 Foreign Trade Policy 2004 - 2009
12.4 Convertibility of Rupee
12.4.1 Partial Convertibility
12.4.2 Full Convertibility on Trade Account
12.5 Full Convertibility on Current Account
12.6 Capital Account Convertibility
12.7 Tarapore Committee's Report
12.8 Summary
12.9 Glossary
12.10 References
12.11 Further Readings
12.12 Model Questions
12.0 OBJECTIVES
After going through this lesson you shall be able to :
 discuss the trade policy of India in the post independence period.
 explain convertibility of rupee in India.
12.1 INTRODUCTION
In the pre-independence period India did not have any clear cut trade polity but in specific
cases adopted only import restriction viz., discriminating protection since 1923. After independence
the Government adopted a trade policy as a component of policy on economic development of the
country.
In the initial stage in order to protect Indian industries from foreign competition the
Government imposed restriction as a part of protective policy. Accordingly, the Government of India
restricted the foreign competition through the system of import, licensing, import quotas, import duties
and import ban on extreme cases. After the adoption of Mahalnobis Model of development since the
Second Plan a clear cut import policy became imperative on the following grounds : (a) Complete or
partial ban on the import of consumer good, (b) extensive control of various items of imports (c)
liberal imports of capital goods for industrialisation, and (d) developing a suitable environment for
adopting import substitution.
In respect of export, the Government adopted various decisions for promotion of exports
through various fiscal and other incentives, and also by setting up some trading institutions. After the
Second Plan, the Government undertook various export promotion measures in order to overcome its
foreign exchange crisis and to attain the objective of self reliance.
Phases of Trade Policy of India
For analytical purpose, the foreign trade policy of the Government can be divided in four
phases : Phase I (1952-53 to 1956-57), Phase II (1956-67 to June 1966), Phase III (Devaluation of
rupee and after) and Phase IV (after 1975-76), according to Mishra & Puri.
During the first phase of the trade policy, liberalisation measures were taken both for imports
and exports. As a result, imports increased remarkably but exports failed to keep pace with imports.
During the second phase (1956-66) trade policy of the country was redesigned for meeting
the requirements of planning. Import controls and import substitution measures were incorporated
and vigorous export promotion drive was launched through the diversification of exports. In this
phase, the trade policy was reviewed by Mudaliar Committee.
During the third phase (after the devaluation of 1966), when the Government failed to achieve
a good result in export promotion, the Government took resort to devaluation in June, 1966 in order to
control imports and to boost its exports. Although the policy was not successful initially but started to
show result since the Fourth Plan. This type of situation continued till 1975-76.
During the fourth and final phase (1975-76 and after), the Government adopted the policy of
import liberalisation for encouraging export promotion. Again during the Janata rule, the Government
adopted the policy of import liberalisation as a part of the programme of anti-inflationary import. The
import export policy of the Government aimed at (a) providing incentive for export promotion,
(b) providing support to the growth of indigenous industries, (c) optimum utilisation of resources
(d) upgradation of technologies, (e) providing stimulus to export-oriented industries, and (f) imposing
control on non-essential imports in order to save foreign currency.
Inspite of all attempts, the country has to face huge deficit in its balance of payments since
1979-80 onwards. Surprisingly the Tandon Committee (1981), under such a situation advocated for
export promotion and further import liberalisation for achieving export promotion. As this strategy was
continued for tackling the balance of payments crisis of the country, thus in the absence of any fruitful
result the country merged into a debt trap. In the post-reform period, numerous changes have taken
place, which we shall study in detail in this lesson.
Foreign trade policy of any country has two constituents - Import Policy and Export Policy. Let
us discuss these two aspects in a little detail in the case of India.
Import Policy (Pre-Reform Period)
The import policy of the Government of India during 1955-1985 had two important
constituents. (i) Import restrictions and (ii) import substitution. It was formulated keeping in view the
limited foreign exchange reserves of the country, shortages of essential consumer goods in the
economy and requirements of capital goods for the building up of heavy, basic industries.
Import Restrictions :- The strategy of development of large scale industrialization in the
country was started during the Second Five Year Plan and for these the government had to import
capital equipment, machinery, industrial raw materials, technical know-how etc. in large quantities
and this led to a substantial increase in foreign exchange expenditure. As against this, the export
earnings continued to be stagnant. Thus the government had no option but to severely curtail import
expenditure. Therefore, the history to severe import restrictions in the country starts from the year
1956-57. More and more items were brought under import restrictions over a period of time. Imports
were classified under the categories of banned items, restricted items, canalized items and items
under Open General Licence (OGL). Canalized items were those items that were canalized through
the public sector agencies like State Trading Corporation (STC). Severe restrictions were imposed
on the import of non-essential goods, so that foreign exchange resources could be released for the
imports of capital goods and other essential imports. The Government also resorted to import
substitution in order to achieve self-reliance in the production of more and more import – competiting
goods.
12.2 EXPORT POLICY
12.2.1 Pre Reforms Export Policy – (Upto-1985)
The Three Phases of Export Policy : Bimal Jalan classifies the export policy of the
Government of India in the pre-reform period into three distinct phases : Phase I (up to the first oil
shock of 1973), Phase II (covering the period from 1973 up to a decade or so), and Phase III ( the
period covering 1983 to 1997). Phase I was characterized by export pessimism and, following
Prebisch, Singer and Nurkse, it was believed that export from developing countries faced a stagnant
world demand and nothing much could be done to increase them. It was also believed that the terms
of trade of these countries were destined to deteriorate over time regardless of the policies of
developing countries. According to Bimal Jalan, “This was assumption as it firmly established a case
for discouragement of exports and for policies which encouraged production for the domestic market.”
However, the ‘export pessimism’ was not borne out by post-war developments in international trade.
In fact, trade in the 1950s and 1960s grow faster than world income and several developing countries
showed a sharp increase in their share in world trade. Exports of manufactures from developing
countries grew twice as fast as the developed countries’ income in the 1960s and four times as
rapidly in the 1970s.
Phase I : Export Policy
The period of Phase I can be divided into two sub-periods : (a) 1952-66, and (b) 1966-73.
The first sub-period covers the first three five year plans and was characterised by an essentially
passive export policy though some steps to increase exports were undertaken in the Third Plan.
Except for a few items such as iron ore, stagnation of export earnings in this period is to be largely
attributed to domestic policy which often led to the falling share of India’s traditional exports and
insufficient expansion in the case of not-traditional exports. Some of these policies as underlined by
Bhagwati and Desai were as under :
(i) Export controls which were started during the Second World War and carried over for
much of the early part of the decade in the case of important foreign exchange earning
commodities like jute, tea, cotton textiles, oil seeds and vegetable oil, raw cotton, hides
and skins, etc.
(ii) Export duties which affected several export commodities through most of the decade ;
and
(iii) The growing strength of domestic demand accentuated in some cases by
Government’s promotional activities.
The second sub-period in Phase I starts with the devaluation of rupee by 36.5 percent in
terms of gold in June 1965. The government expressed the hope that the devaluation would lead to
expansion in export earnings as Indian goods would now be cheaper in international markets. On the
other hand, imports will decline as the prices of imported goods would increase. In addition, many
foreign investors would feel encouraged to invest capital in those fields which required foreign capital
earnestly. Devaluation would encourage foreign tourists into India and discourage Indian tourists
abroad. These developments would have a favourable effect on India’s balance of payments
situation.
Since devaluation was accepted in place of export subsidies as the means of keeping down
the prices of exports, the post-devaluation period was accompanied by a substantial elimination of
export subsidies and a marked reduction of the tariffs. However, the failure of export earnings to
increase soon made the reintroduction of subsidization schemes inevitable. Export subsidies were
introduced for some non traditional goods in 1966 itself and by 1967 they covered the bulk of
engineering goods, chemicals, sports goods, paper products, steel scrap, prime iron and steel, cotton
textiles and some other products.
Phase II : Export Policy
Phase II can be considered to have begun in 1973 and lasted for about a decade. “In this
phase, although this was not explicitly stated, it was recognized that import substitution policies by
themselves could not bring about a viability in India’s balance of payments. In this second phase
exports were, therefore, accorded a high priority”. The government accordingly, undertook a number
of steps to increase exports. Moreover, as pointed out by Deepak Nayyar, the nominal effective
exchange rate (NEER) of the rupee depreciated continuously in the 1979’s. Given the lower rate of
inflation at home as compared to the outside world, this also meant a sharp down-ward movement in
the real effective exchange rate (REER) of the rupee. In fact, the REER declined from 107.83 in
1974 to 82.66 in 1979 (1975 = 100). As a result, the relative profitability of exports increased. These
policy measures coincided with some favourable external factors. Nayyar particularly highlights three
such factors. “First there was a remarkable expansion in world trade, which was associated with an
increase in world import demand for most of India’s exportable. Second there was a boom in the
prices of primary commodities, which led to a sharp in average unit values realized for exports. Third,
the oil prices increase led to the emergence of new markets in the oil exporting countries, which
constituted a new addition. Thus export growth picked up considerably in Phase II. In fact, it was
quite robust in the second half of the seventies. However, this could not last long as export
promotion policies continued to be pursued as exceptions to normal development policies.
Phase II had more positive approach to export promotion strategy. While incentives for export
production were enhanced on the one hand, export themselves were no being seen as an integral
part of industrial and development policies.
Phase III : Export Policy
Export policy in Phase III has emphasized “technological upgradation, increase in the size of
plants, freer imports and domestic and international competition for the entire industrial sector as
being essential for export promotion.”
Export Promotion Policies :- Important export promotion measures undertaken by the
Government of India during 1970-90 were as follows :
(a) Cash Compensatory Support (C.C.S.) : This was introduced in 1966. It was designed
to provide compensation for unrebated indirect taxes paid by exporters on inputs, higher freight rates,
and market development costs.
(b) Duty Drawback System : The object of the duty drawback system is to reimburse
exporters for tariff paid on the imported materials and intermediates and central excise duties paid on
domestically produced imputes which enter into export production.
(c) Replenishment Licences : In order to provide the export sector of the economy with
access to importable inputs that enter into export production at international prices, the import policy
allows special import facilities for registered exporters. In 1957, the Government introduced the
Import Entitlement Scheme (IES) to help the exporters in producing import raw materials and other
components necessary for export production. Exporters were granted import licenses.
12.2.2 Export Policy in the Post-Reform Period (Post – 1985 Period)
(a) Blanket Exchange Permit Scheme : A new Blanket Exchange Permit Scheme was
introduced by the government in June 1987. The scheme aims to give a major thrust to the country’s
export promotion drive. Under the scheme exporters are allowed, barring a few products, to utilize 5-
10 per cent of their foreign exchange earnings for undertaking export promotion activities.
(b) Concessions and Exemptions : A large number of tax benefits and exemptions have
been granted during the nineties to liberalise imports and promote exports with the Five Year Exim
policy 1992-97 serving as the basis for such concessions. These policies, in turn have been
reviewed and modified on an annual basis in the Exim Policies announced every year. Successive
annual Union Budgets have also extended a number of tax benefits and exemptions to the exporters.
For example, some of the measures announced in the Union Budget, 1999-2000, were as follows :
(i) reduction in the prevailing 7 major advalorem rate of customs duty to 5 basic rates and
rationalization of both import duty and excise structures.
(ii) significant reduction in duty rates for critical inputs for the information and technology sector
which is an important export sector.
(iii) extension of facilities and tax benefits available to exporters of goods and merchandise under
section 80 HHC to the entertainment industry to facilitate its development and exports, etc.
(iv) The Union Budget, 2000-01, has withdraw the surcharge and has thus reduced the peak rate
of custom duty to 35 percent. A number of tax benefits have also been announced for the
three integral part of the ‘convergence revolution’ – the Information Technology sector, the
Telecommunications sector, and Entertainment industry.
(c) Exim Policy – 1997-2002 : The Commerce Minister presented the new export policy for
five years 1997-2002 (conterminus with the Ninth Plan) on March 31, 1997. The main objectives of
this policy are as under :
(i) To accelerate the country’s transition to a globally-oriented vibrant economy to derive
maximum benefits from expanding global market opportunities.
(ii) To enhance the technological strength and efficiency of Indian agriculture, industry and
services, thereby improving their competitiveness while generating new employment
opportunities, and encourage the attainment of internationally accepted standards of quality.
To provide consumers with good quality products at reasonable prices. major aspects of the
policy to achieve the above objectives were as under :
(1) The Restricted List of imports was substantially proned. Import of 542 items was
liberalized which included about 150 items that could now be imported against Special Import Licence
(SIL). About 60 items were moved from SIL to the Open General Licence (OGL) list.
(2) The Exports Promotion Capital Goods (EPCG) Scheme was streamlined. The tariff rates
for the import of capital goods were reduced from 15 percent to 10 percent. Zero-duty imports under
EPCG scheme were allowed in those cases where the e.i.f. value of imports was Rs. 20 crore or
more subject to export obligations. This threshold limit was brought down to Rs. 5 crore from zero-
duty import of capital goods for exports in agriculture and allied sectors.
(3) (i) Deemed exports benefits were extended to oil and gas sectors in addition to power
sector. Norms for domestic sales by EOUs and EPZs in agro and allied sectors were liberalized.
These units could now sell 50 per cent of their production in domestic tariff area. The 1997-2002
Exim Policy proposed to give double weightage for agro exports in calculation of the eligibility of
export houses and trading houses. It also announce 1 percent SIL in total value of exports of fruits,
vegetables, floriculture and horticulture produce if such exports constitute 10 percent of the total
exports.
The new policy aims to give a boost to the software industry. Software exporters were
allowed to undertake exports using online data communication links or in the form of physical export
through courier services : imports of good from clients on loan for a specified period was also
permitted; on line data communication for DTA sales was permitted.
Electronic hardware units were allowed to sell up to 50 per cent in DTA on an annual basis
while exporting 50 per cent.
Rupee depreciation norms were provided for electronic goods up to 70 per cent in three
years.
Exim Policy, 2001-02 : The main measures announced in the Exim Policy, 2001-02, are as follows :
1. After the announcement of the Exim Policy, 2001-02. On March 31, 2001 quantitative
restrictions on 715 items remained. In line with India’s commitment to the WTO, the Exim
 Policy, 2001-02 as announced on March 31, 2001 removed quantitative restrictions on these
items also. Thus quantitative restrictions on all items were withdrawn.
2. Withdrawal of quantitative restrictions on all items implies that India’s can now import anything
they want. However, of the 715 items freed by the Exim Policy, 2001-02, sensitive items have
been put in a special list. These include wheat, rice, maize, petrol, diesel and urea. These
items can be imported only by designated State trading agencies.
3. The Government has retained 520 items in the prohibited list. These 520 items were notified
to the WTO in 1997. With this, the number of import lists is now three – the prohibited list,
the special list and the free list. Prior to Exim Policy, 2001-02, there were five import lists :
the prohibited list, the special import license list, the restricted list, the canalized list and the
free list.
4. To ensure that scrapping of quantitative restrictions does not flood the domestic market, as
many as 300 items (out of the 715 items) have been shifted to a ‘watch list’ and classified
‘sensitive items of importance to the public’. Major products in the new list include cars and
motor vehicles, both new and second hand, poultry and meat products, dairy products, fruits,
coffee, tea, spices, grains, edible oils, alcoholic beverages, rubber products, toys, and
stationery etc. This watch list will be monitored by a panel.
5. The Special Economic Zone (SEZ) scheme has been strengthened by permitting the setting
up of offshore Banking Units, hedging of commodity price risks and sourcing of short terms
External Commercial Borrowings. Supplies by domestic units to SEZs would entitle the former
to avail of Duty Entitlement pass book Scheme benefit. The policy has also ensured
procedural simplification in the process of subcontracting carried out by the SEZ units. To
ease the power situation in and around the SEZ, units for generation and distribution of power
have been permitted to be set up in the SEZs.
6. The Policy gives a major thrust to agricultural exports by removing export restrictions on
designated items. The efforts to promote exports of agro and agro-based products in the
floriculture and horticulture sector have been sustained with the notification of 32 Agri-Export
Zones across the country. Non-actionable subsidies such as transport subsidy for the export
of fruits, vegetables, floriculture, poultry and dairy products. Quantitative restrictions on
exports (except a few sensitive items) removed with a few items being retained for export
through State Trading Enterprises. A package of incentives including exemption from
maintaining the average export obligation under the Export House status, Preferential access
to market access, Initiative funds and duty free access to trimming and embelishment for
achieving value added exports. The towns of export excellence to be regional rural motors of
economic development for the small scale sector, focusing on plugging critical infrastructure
bottlenecks and enhancing quality of support services for industrial development.
7. To provide the necessary impetus to star achieves, Exim Policy provides a strategic package
for status holders comprising of new/special facilities like issuances of License of self-
declaration basis, fixation of inputs-outputs norms on priority exemption from compulsory
negotiation of documents through banks, cent percent retention of foreign exchange in
Exchange Earners' Foreign Currency Account, enhancement in normal repatriation period
from 180 days to 360 days and not mandating exports in each of the three licensing years for
achieving the status. The Policy has operationalised the procedure for duty free import of fuel
under the Advance Licensing Scheme, provide the license holder as a captive power plan.
8. In view of phasing out of all restrictions on textile products by 2005 under the Agreement on
Textile and Clothing (ATC). The Exim Policy has focused on measures to encourage value
added exports in the garment sector. Electronic Hardware Technology Part (EHTP) scheme
has been modified to enable hardware sector to face the zero duty regime under Information
Technology Agreement (ITA-I), mandating only a positive net foreign exchange as a
percentage of exports criteria and obviating any other export obligation for units for Electronic
Hardware Technology Parks. The change carried out in the gems & jewelry schemes include
abolition of the licensing regime fore the import of rough diamonds. Reduction in the value
addition norms for export of jewelry and permitting personal carriage of jewelry.
9. The medium terms Policy continues with all the duty exemption/remission schemes, along
with existing dispensation of not having any value caps. Procedural simplifications introduced
in the policy include polition of DEEC Book and withdrawal of Annual Advance License under
the Advance License scheme, dispensation with technical characteristics for audit purposes
under the Duty Free Replenishment Certificate scheme 12 years export obligation period with
5 years moratorium for Export Promotion Capital Goods licenses of Rs.100 crore or more and
supplies under deemed exports to be eligible for export obligation fulfillment along with
deemed export benefits.
10. In addition to the above, a number of safeguards have been erected in 'sensitive' sectors to
give domestic industry a change to survive and build its competitiveness. For instance,
second hard car imports have been allowed but to ensure that this does not kill the domestic
car companies,
11. Export exemption scheme were started nearly a decade ago to give fillip to exports. However,
they are required to be phased out on account of their non-compatibility of the WTO. The
government is currently retaining schemes such as the Duty Exemption Pass Book Schemes
(DEPB), which is not WTO compatible. However, it had been announced in the Exim Policy,
2001-02, that DEPB would be phased out be 2002. Only the duty drawback scheme and other
schemes which reimburse exporters on actual can be retained after April, 2002. The Exim
Policy 2001-02, has capped export sops at 2001-02 level of Rs. 20,000/- crore. Thus no new
export exemptions schemes have been introduced under this policy. This is significant
considering that even last Exim otted up sops worth Rs. 600 crore.
12.2.3 Highlights of Foreign Trade Policy 2004-09
Objective and strategy
The new Foreign Trade Policy (FTP) takes an integrated view of the overall development of
India's foreign trade and essentially provides a roadmap for the development of this sector. It is built
around two major objectives of boubling India's share of global merchandise trade by 2009 and using
trade policy as and effective instrument of economic growth with a thrust on employment generation.
Key strategies to achieve these objectives, inter include: unshackling of controls and creating an
atmosphere of trust and transparency; simplifying procedures and bringing down transaction costs:
neutralizing incidence of all levies on inputs used in export product; facilitating development of India
as a global hub for manufacturing, trading and services; identifying and nurturing special focus areas
to generate additional employment opportunities, particularly in semi -urban and rural areas;
facilitating technological and infrastructural up-gradation of the Indian economy especially through
import of capital goods and equipment; avoiding inverted duty structure and ensuring that domestic
sector are disadvantaged in trade agreements; upgrading the infrastructure network related to the
entire foreign trade chain to international; revitalizing the Board of Trade by redefining its role and
inducting into it experts on trade policy; and activating Indian Embassies as key players in the export
s t r a t e g y .
 Special Focus Initiatives
The FTP 2004 has identified certain thrust sectors having prospects for export expansion and
potential for employment generation. These thrust sectors include agriculture, handlooms and
handicrafts, gems & jewellery and leather and footwear sectors. Sector specific policy initiative for the
thrust sectors include, for agriculture sector, introduction of a new scheme called Vishesh Krishi
Upaj Yojna (Special Agricultural Produce Scheme) to boost exports of fruits, vegetables, flowers,
minor forest produce and their value add products. Under the scheme, exports of these products
qualify for duty free credit entitlement (5 percent of f.o.b. value of exports) for importing inputs and
other goods. Other components for agriculture sector include duty free import of capital goods Export
Promotion Capital Goods (EPCG) scheme, permitting the installation of capital goods imported under
EPCG for agriculture anywhere in the Agri-Export zone (AEZ), utilizing funds from the Assistance to
States for Infrastructure Development of Exports (ASIDE) scheme for development of AEZs,
liberalization of import of seeds, bulbs, tubers and planting materials, and liberalization of the export
plant portions, derivatives and extracts to promote export of medicinal plant and herbal products. The
special focus initiative for handlooms and handicraft sectors include extension of facilities like
enhancing (to 5 percent of f.o.b. value of exports) duty free import of trimmings and embellishments
for handlooms and handicrafts, exemption samples from countervailing duty (CVD), authorizing
Handicraft Export Promotion Council to import trimmings, embellishments and samples for small
manufacturers, and establishment of a new Handicraft Special Economic Zone. Major policy
announcements under gems and jewellery sector. Value of exports and that for duty free import of
specified items for leather sector to 5 percent of f.o.b. value of exports; import of machinery and
equipment for Effluent Treatment Plants for Leather industry exempted from customs duty; and re-
export of unsuitable imported materials (such as raw hides and skin and wet blue leathers) has been
permitted. The threshold limit of designated 'Towns of Export Excellence' has also been reduced from
Rs.1,000/- crores to Rs. 250 crores in the above thrust sectors.
 New Export Promotion Scheme
A new scheme to accelerate growth of exports called 'Target Plus' has been introduced.
Under the scheme, exporters achieving a quantum growth in exports are entitled to duty free credit
based on incremental exports substantially higher than the general actual export target fixed.
Rewards are granted based on a tiered approach. For incremental growth of over 20 percent, 25
percent and 100 percent, the duty free credits are 5 percent, 10 percent and 15 percent of f.o.b. value
of incremental exports. Another new scheme called Vishesh Krishi Upaj Yojana has been
introduced to boost exports of fruits, vegetables, flowers, minor forest produce and their value added
products. Export of these products qualify of duty free credit entitlement equivalent to 5 percent of
f.o.b value of exports. The entitlement is freely transferable and can be used for import of a variety of
inputs and goods. To accelerate growth in export of services so as to create a powerful, and unique
'Servev from India' brand instantly recognized and respected the world over, the earlier duty free
expert credit (DFEC) scheme for services has been revamped and re-cast into the 'Served from India'
scheme. Individual service providers who earn foreign exchange of at least Rs. 5 lakhs, and other
service providers who earn foreign exchange of at least Rs. 10 lakhs are eligible for a duty-credit
entitlement of 10 percent of total foreign exchange earned by them. In the case of stand-alone
restaurants, the entitlements 20, whereas in the case of hotels, it is 5 percent. Hotels and restaurants
can use their duty credit entitlement for import of food items and alcoholic beverages. To make India
into a global trading-hug, a new scheme to establish Free Trade and Warehousing Zone (FTWZs)
has been introduced to create trade-related infransaction to facilitate the import and export or goods
and services with freedom to carry out trade transactions in convertible currencies. Besides
permitting FDI up to 100 percent in the development and establishment of these zones, each zone
would have minimum outlay of Rs.100 crores and five lakh sq. mts. builts up area. Units in the
FTWZs quality for all other benefits as application for SEZ unites.
 Simplification/Rationalization/Modifications of Ongoing Schemes
EPCG scheme has been further improved upon by providing additional flexibility for fulfillment
of export obligation, facilitating and providing incentives for technological upgradation, permitting
transfer of capital goods to group, companies and managed hotels, doing away with the requirement
of certificate from Central Excise (in the case of movable capital goods in the service sector) and
improving the viability of specified projects by calculating their export obligation based on
confessional duty permitted to the. Import of second hand capital goods without any restriction on age
has been permitted and the minimum depreciated value for plant and machinery to be re-located into
India has been reduced from Rs. 50 crore to Rs. 25 crore. The new policy has allowed transfer of the
import entitlement under Duty Free Replenishment Certificate (DFRC) scheme in respect of fuel to
the marketing agencies authorized by the Ministry of Petroleum and Natural Gas to facilitate sourcing
of such imports by individual exporters. The Dury Entitlement Passbook (DEPB) scheme will continue
until replaced by a new scheme to be drawn up in consultation with exporters. Additional benefits
have been provided to export oriented units (EOU), including exemption from service tax in promotion
to their exported goods and services, permission to retain 100 percent of export earnings in Export
Earners Foreign Currency (EEFC) accounts, extension of income tax benefits on plant and machinery
to DTA units which convert to EOU/Electronic Hardware Technology Park (EHTP)/Software
Technology Park (STP)/Bio-technology Park (BTP) units, allowing import of capital goods on self-
certification basis and permission to dispose of (for EOU in textile and garment manufacture) leftover
materials and fabrics up to 2 percent of c.i.f value or quantity of import on payment of duty on
transaction value only. Minimum investment criteria has been also waived for brass hardware and
hand-made jewellery EOUs (this facility already exists for handicrafts, agriculture, floriculture,
aquaculture, animal husbandry IT and services). The FTP proposes setting up of BTPs by granting all
facilities of 100 percent EOUs. The FTP 2004 has introduced a new rationalized scheme of
categorization of status holders as Stat Export Houses, with benchmark for export performance
(during the current and previous three years) varying from Rs. 15 crore (for One Star Export House)
to Rs. 5000 crore (for Five Star Export House). The new scheme is likely to bestow status on a large
number of hitherto unrecognized small exporters. Such Star Export Houses will be eligible for a
number of privileges including fast-track clearance procedures, exemption from furnishing of bank
guarantee, eligibility for consideration under Target Plus Scheme, etc.
Conclusion
The series of trade policy reforms in the form of Annual Exim Policy announced by the
Government during the 1990s and thereafter has been able to change the conditions of trade
conducive towards its growth. Trade policy reforms over the last decade have provided an export
friendly environment with simplified procedures conducive to enhancing export performance. The
focus of these reforms have been on liberalization, openness, transparency and globalization with
basic thrust on outward orientation focussing on export promotion activity moving away from
quantitative restrictions and improving competitiveness of Indian Industry to meet global market
requirements. Over the years, significant changes in the EXIM Policy have helped to strengthen the
export production base, remove procedural irritants, facilitate input availability besides focussing on
quality and technological upgradation and increasing competitiveness. Steps have also been taken to
promote exports through multilateral and bilateral initiatives, identification of thrust areas and focus
regions. Thus it can be finally observed that the trade policy introduced in India in the form of annual
Exim policies have become successful in bringing the conditions of trade in right directions.

SAQ
Q. Mention important features of Recent Foreign Trade Policy of India. (2015-20)
________________________________________________________________________
________________________________________________________________________
_________________________________________________________________________

PART-II : CONVERTIBILITY OF RUPEE : LERMS

The exchange rate is largely determined by market demand and supply forces. Before 1966,
one US dollar was equal to Rs. 4.76. After the devaluation in 1966, one US dollar became equal to
Rs. 7.50. The system of fixed exchange rates was abandoned by most countries in 1973. The
Government of India also pagged Indian rupee to a basket of currencies of the countries which are
her major trading partners. Under this floating exchange rate system, the rupee started dipping
against the dollar and other major currencies. By the end of 1990 there was a depreciation in the
value of the rupee against the five major international currencies by roughly 22 per cent.
Activity
Q. What is the current exchange rate between rupee and dollar?
____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________

The term convertibility of a currency indicates that it can be freely converted into any other
currency. Convertibility can also be identified as the removal of quantitative restrictions on trade and
payments on current account. Convertibility establishes a system where the market place determine
the rate of exchange through the free interplay of demand and supply forces.
It would be appropriate to discuss the concept of Balance of Payments to differentiate
between current and capital account.
Balance of Payments :
BOP comprises current account, capital account, errors & omissions, and changes in Forex reserves.
Under current account of the BOP, transactions are classified as merchandise (or goods) and invisibles (or
services). Under capital account capital inflows can be classified by instruments (debt or equity) and maturity
(short & long term).
The main components of capital account are :
(a) Foreign investment
(b) Lonas
 (c) Banking Capital
Foreign investment includes Foreign Direct Investment and Portfolio investment.
In India, hawala trade normally handle about 4 billion dollars a year. Until recently, this was
traceable to the increasing differential between official and hawala exchange rates. This convertibility
of rupee has bridged this gap and can check the hawala trade effectively.
12.4 PARTIAL CONVERTIBILITY OF RUPEE
The Finance Minister announced the liberalized exchange rate mechanism system (LERMS)
in the in the Budget for 1992-93. This system introduced partial convertibility of rupee. Under this
system a dual exchange rate was fixed under which 40 per cent of foreign exchange earnings were to
be surrendered at the official exchange rate while the remaining 60 per cent were to be converted at
a market determined rate. The foreign exchange surrendered at official rate was to be used for the
import of essential items (like crude oil, petroleum products, fertilizers, life saving drugs, etc.) and the
foreign exchange converted at the market rate, this system meant taxing the exporters to subsidize
the government’s bulk imports. The implicit export tax was between 8-12 per cent and was highly
resented by exporters.
Moreover, exporters receiving remittances from abroad was allowed to sell the bulk of their
forex receipts at market determined rates. The foreign exchange surrendered at official exchange
rate is utilised to import essential items. All other imports of raw materials, components and also
capital goods have been made freely importable on OGL but foreign exchange for these imports has
to be obtained from the market. Foreign exchange required for other payments on private account
including travel debt service payments, dividends, royalties and other remittances has to be obtained
at the market rate. This partial convertibility has resulted number of benefits for the economy. Under
this system, imports become expensive but exports are encouraged with an added incentive of 60
percent forex at market determined rate against the hitherto 30 percent earned through the EXIM
Scrip System. Moreover, the system has also attracted foreign investment in a significant way.
The system was introduced as transitional arrangement towards a unified exchange rate with
current account convertibility. The partially converted rupee showed enough strength to justify a move
to a fully unified market determined exchange rate system.
12.5 FULL CONVERTIBILITY ON CURRENT ACCOUNT (TWO STAGES)
12.5.1 Full Convertibility on Trade Accounts :- The 1993-94 Budget introduced full convertibility
of the rupee on trade account. As a result, the dual exchange rate system was dispensed with
a unified exchange rate system introduced. Under the unified exchange rate regime, the 60-40 ratio
was extended to 100 per cent conversion. This 100 per cent conversion was extended for (i) almost
the entire merchandise trade transactions and (ii) all receipts, whether on current or capital account of
balance of payments. In addition, various exchange controls norms of the Reserve Bank remained in
operation all along.
12.5.2 Full Convertibility on Current Account :- Current account convertibility is defined as the
freedom to buy or sell foreign exchange for the following international transactions :
(i) all payment due in connection with foreign trade, current business, including services,
and normal short-term banking and credit facilities;
(ii) payments due as interest on loans and as net income from other investment;
 (iii) payments moderate amount of amortization of loans or for depreciation of direct
investments; and
(iv) moderate remittances for family living expenses.
India achieved full convertibility on current account on August 19, 1994 when the Reserve
Bank further liberalized invisible payments and accepted to forsake the use of exchange
restrictions on current international transactions as an instrument in managing the balance of
payments. Many other relaxations of restrictions on current transactions were announced in
subsequent years. Such as on studies abroad, medical expenses, casual (gift) remittances,
donations, release of exchange for persons proceedings on employment abroad.
In pursuance to the 1994-95 Budget announcement for such move towards current account
convertibility on February 8, 1994, the RBI has announced the liberalisation of exchange control
regulations upto a specified limit relating to : (a) exchange earners foreign currency accounts; (b)
basic travel quota, (c) studies abroad, (d) gift remittances, (e) donations, and (f) payments of certain
services rendered by foreign parties.
Current account convertibility is the next phase for attaining full convertibility of Rupee.
Current account convertibility relates to the removal of restrictions on payments relating to the
international exchange of goals, services and factor incomes, while capital account convertibility
refers to a similar liberalization of a country's capital transactions such as loans and investment, both
short term and long term.
The International Monetary Fund which works towards the establishment of multilateral
system of payments, requires member countries to move towards restoration of current account
convertibility, but permits them to restrict convertibility for capital transactions.
The unification of the exchange rate and the removal of exchange restrictions on imports
through the abolition of foreign exchange budgeting in the beginning of 1993-94 constituted the first
major step towards current account convertibility. The Budget for 1994-95 also indicated the next step
in this direction and accordingly, the RBI announced relaxations in payment restrictions in the case of
a number of invisible transactions. The final step towards current account convertibility was taken in
August 1994 by further liberalisation of invisible payments and acceptance of the obligation under
Article VIII of IMF, under which, India is committed to forsake the use of exchange restrictions on
current international transactions as an instrument in managing the balance of payments.
Current Account Convertibility Provision of IMF
The international monetary arrangement after the Bretton Woods conference required
members of the IMF to restore current account convertibility. The obligation is defined in Article VIII,
Section 2.3 and 4 which stipulates that member countries should : (a) have no restrictions on current
payments (capital account restrictions are allowed); and (b) avoid discriminatory currency practices
(including multiple exchange rates). If a member country does not meet the obligations of Article VIII
when joining the Fund, the country is allowed to have transitional arrangements under Article XIV.
Current account convertibility has been defined as the freedom to buy or sell foreign
exchange for the following international transactions :
(a) all payments due in connection with foreign trade, other current business, including
services and normal short term banking and credit facilities;
(b) payments due as interest on loans and as net income from other investments;
 (c) payments of moderate amount of amortization of loans or for depreciation of direct
investment; and
(d) moderate remittances for family living expenses.
Further Steps taken by the Government for Current Account Convertibility
The further steps were taken by RBI on August 19, 1994 which included : (a) more relaxation
on current account payments; (b) clarification that limits specified earlier were only indicative in nature
and the RBI will favourably consider bona-fide requests for additional exchange facilities; (c) the
Foreign Currency Non-Residents Accounts (FCNRA) scheme, under which maturities were gradually
discontinued, was terminated with effect from August 15, 1994; (d) interest accrued under Non-
Resident (Non-Repatriable) Rupee Deposit Scheme was made repatriable from the quarter beginning
October 1, 1994; (e) Foreign Currency (ordinary) Non-Repatriable Deposit Scheme (FCON) was
discontinued with effect from August 20, 1994; (f) the interest on existing FCONR deposits was made
eligible for repatriation upto the maturity date of the existing deposits from October 1, 1994; and (g)
repatriation of investment income by non resident Indians would now be repatriable in a phased
manner over a 3 year period after the payment of tax as per the provisions of the Income Tax Act.
Thus by undertaking all the above mentioned steps, India acquired Article VIII status on August 20,
1994.
12.6 CAPITAL ACCOUNT CONVERTIBILITY
The next and final step in this line is the convertibility of rupee on capital account. But we must
draw a sharp distinction between currency convertibility in the current and capital accounts. Capital
account convertibility refers to a liberalization of a country's capital transactions such as loans and
investment, both short term and long term as well as speculative capital flows. When it comes to
capital account convertibility, one has to be more prudent and be very much sure about its capacity to
launch such a system. If the country can build a large stock of international reserves, then only this
system could provide a bonus. Confidence in the financial system and a steady macro-economic
environment are very much essential to the introduction of capital account convertibility of Rupee in
near future.
Capital account convertibility in India can be introduced in stages by gradually widening
access to resident Indians to external financial markets. In the light of historical experience, the
general view is that opening up of the capital account should occur late in the sequencing of
stabilisation and structural reforms.
Capital account convertibility is likely to be sustainable only if it is supported by credible
macro-economic policies, listing reduction in fiscal deficit, moderation in inflation and a flexible
financial system which can adapt to changing situations as some of the essential pre-conditions for
capital account convertibility.
Recently, the decks have been cleared for capital account convertibility following the
government's decision to ease restriction on foreign institutional investors. non-resident Indians
(NRIs) and Overseas Corporate bodies (OCBs) to subscribe to equity of Indian companies engaged
in any activity. A recent circular of Reserve Bank of India allows Indian companies to hold 24 per cent
equity shares of new issues where the rupee is fully convertible on the current account. As per the
new circular, the entire amount of capital and profit was repatriable to foreign investors and there was
no lock in period.
 Addressing a two day global conference on "Indian Trade and Investment," the then Finance
Minister Dr. Manmohan Singh observed that the rupee was "Virtually" convertible on capital account
as no restrictions exist on repatriation of dividend and interest incomes and portfolio investments.
Full convertibility is absent only as far as investment by Indians abroad is concerned, but it does not
have "terrible impact" in any way as investments in the country are needed.
Thus capital account convertibility implies the right to transact in financial assets with foreign
countries without restrictions. Although the rupee is not fully convertible on the capital account,
convertibility exists in respect of certain constituent elements. These are as follows :
(a) Capital account convertibility exists for foreign investors and Non-Resident Indians
(NRIs) for undertaking direct and portfolio investment in India.
(b) Indian investment abroad upto US $ 4 million is eligible for automatic approval by the
RBI subject to certain conditions.
(c) In September 1995, the RBI appointed a special committee to process all applications
involving Indian direct foreign investment abroad beyond US $ 4 million or those not
qualifying for fast track clearance.
But in the context of the need for attracting higher capital inflows into the country, it is also
important for the Government to introduce convertibility on capital account, as foreign investors may
enter confidently only when there is an assurance that the exit doors will always remain open.
Although the Indians, habituated with the reign of controls and regulations may feel some
relief with the half opening of windows with the introduction of current account convertibility but the
foreign investors may not feel so as they have several other options. Contrary to our perceptions,
India ranked 120 out of 150 countries in the index of economic freedom, computed by a reputed
international agency. It is for this reason, the capital inflows have been low. In this context, the
introduction of full convertibility may help to change this perception.
The Budget 2002-03 has adopted a cautious step towards Capital Account Convertibility by
allowing NRI to repatriate their Indian income.
Considering the present condition along with the comfortable foreign exchange reserve of the
country at present, the Government is now favouring a make towards fuller capital account
convertibility in the context of changes in the last two decades. For the mean time on 1st March, 2006
Prime Minister Dr. Manmohan Singh asked the Finance Ministry and RBI to work out a roadmap for
fuller capital account convertibility based on current realities. Dr. Singh in of the view that such
roadmap for fuller capital account convertibility would attract greater foreign investments into the
country. Thus it is expected that the Government of India and the RBI are going to announce a
roadmap soon for the attainment of fuller capital account convertibility of the country. However, while
taking decision for full convertibility of rupee, the Government should take adequate care of its
possible consequences. In the mean time on 29th March, 2006, 160 renowned Indian economists
asked the government to desist from mowing towards full convertibility of rupee as it was brought with
dangerous consequences. They argued, "We urge the UPA government from such an unnecessary
and dangerous measure……. This (full float of rupee) would expose Indian economy to extreme
volatility".
The statement made by about 160 leading economists from various institutions across the
country expresses apprehension that to expose the country to unpredictable movements in capital
flows would create a potential for fragility and crisis and particularly when the stock market is
witnessing a speculative boom.
12.7 TARAPORE COMMITTEE'S REPORT ON CAPITAL ACCOUNT CONVERTIBILITY (CAC)
The Reserve Bank of India appointed Tarapore Committee on Capital Account Convertibility
(CAC) headed by former Deputy Governor, Mr. S.S. Tarapore to recommend the problem of
implementation of capital account convertibility in India. Accordingly, the Tarapore Committee
submitted its report on June 3, 1997 and thereby recommended implementation of CAC by 1999-
2000 in three annual phases starting from 1997-98. The Tarapore Committee provides a
comprehensive package to lead India on the road to convertibility by the beginning of the next
millennium and integrate and globalize the Indian foreign exchange market with the world economy.
The recommendations aim to integrate both real and financial sectors with the financial
markets. But the questions still persist in the minds of people whether full convertibility is achievable,
given the stringent pre-conditions imposed to achieve the convertibility goal.
The committee, in its report, observed that the gross fiscal deficit ratio should be reduced to
3.5 per cent by 2000, mandated rate of inflation for the three-year period should be an average of
three to five per cent, and effective strengthening and monitoring of the financial system should be
done in the period proposed for switching to CAC.
The committee observed that a level playing field between participants in the financial
systems, improving the risk management system and strict capital adequacy standard and prudential
standards must be introduced. The controls on capital outflows and inflows should be liberalised in a
phased manner, the committee has also stated that the timing and sequencing CAC would be greatly
facilitated with the proposed changes in foreign exchange transactions as envisaged to the Foreign
Exchange Management Act (FEMA).
Tarapore Committee's Second Report (July 2006)
With the growing strength of balance of payments in the post-1991 period and with external
sector remaining robust and gaining strength every year and the relative macro economic stability
with high growth providing a conducive environment relaxation of capital controls, RBI, in pursuance
of the announcement by the Prime Minister constituted a committee on March 20, 2006 with Mr. S.S.
Tarapore as its chairman for setting out a roadways towards fuller capital account convertibility. The
committee submitted its Report to the RBI on July 31, 2006.
Keeping itself conscious of the risks involved in the movement towards fuller convertibility of
the Rupee as emanating from cross country experiences in this regard the committee calibrated the
liberalisation road map to the specific contexts of preparedness-namely, a strong macroeconomic
framework, sound financial systems and markets and prudential regulatory and supervisory
architectures. After making review of the existing capital controls, it detailed a broad five year time
frame for movement towards fuller convertibility in three phases.
Phase-I (2006-07);
Phase-II (2007-08 to 2008-09) and
Phase-III (2009-10 to 2010-11).
The report recommended the meeting of certain indicators/targets as a concomitant to the
movement in : meeting FRBM targets; shifting from the present measures of fiscal deficit to a
measure of the Public Sector Borrowing Requirement (PSBR); segregating Government debt
management and monetary policy operations through the setting up of the office of Public Debt
independent of the RBI; imparting greater autonomy and transparency in the conduct of monetary
policy; and slew of reforms in banking sector including a single banking legislation and reduction in
the share of Government/RBI in the capital of public sector bank. Keeping the current account deficit
to GDP ratio under 3 per cent; and evolving appropriate indicators of adequacy of reserves to cover
not only import requirements, but also liquidity risks associated with present types of capital flows,
short-term debt obligations and broader measures including solvency.
Activity
Q. Look out for Govt. of India’s stand on Capital Account Convertibility.
____________________________________________________________________________
____________________________________________________________________________
____________________________________________________________________________

Conclusion
Hence the committee recommended a three phase strategy for moving towards capital
account convertibility. Although, RBI has not been taken any final decision on acceptance of the
recommendations in totality but it has initiated measures on an on-going basis beginning with the
announcement in its Mid-term Review of the Annual Policy Statement for 2007-08.
The Tarapore Committee has also suggested that the inflation rate be brought down between
3 and 5 per cent and be sustained at that level thereafter. Though the present rate of inflation is
within the limits set by the Committee the economy's ability to maintain a low profile in inflation
around 5 per cent is closely linked with the fiscal deficit, the level of government borrowing and the
growth of money supply. Given the present trends and political compulsions, it seems unlikely that
the government will be able to enforce adequate fiscal discipline to ensure low rate of inflation for a
reasonable period of time.
The Tarapore Committee has also proposed financial sector reforms prior to full convertibility
of the rupee. These include total deregulation of interest rates, strengthening of the banking system
through reduction in average effective cash reserve ratio (CRR) and non-performing assets, grant of
autonomy to banks etc.
12.8 SUMMARY
In this lesson, we have studied that there is strong need to promote exports and earn requisite
amount of foreign exchange to make payment for imports. The policy of the Government of India has
undergone numerous changes in its features as well as in its nomenclature like - export promotion
and import substitution (before 1990s), Exim policies (during the 1990's and early 21st century) and
Foreign Trade Policies (since 2002).
 Stage I : 1992 – 93 Partial Convertibility on Trade Account
Stage II : 1993 – 94 Full Convertibility on Trade Account.
Stage III : 1994 – 95 Full Convertibility on Current Account
Stage IV (Budget 2002 – 03) Progress Towards Further Liberalisation of Capital Controls
(Cautious step towards it)

(Tarapore Committee, Phases)

12.9 GLOSSARY
 Convertibility of : Equivalence between Rupee and Foreign Currency mainly $
Rupee dollar.
 Partial Convertibility It refers to partial freedom of getting domestic currency (rupee
:
hire) converted into foreign currency i.e. 40% at official rate of
exchange and 60% at market rate of exchange.
 LERMS
: Liberalised Exchange Rate Management System (lesser
government/RBI intervention to decide exchange rate)
12.10 REFERENCES
 Misra & Puri (2018) : Indian Economy. Latest edition Himalaya Publications.
 Mahajan & Sundaram (2018). Indian Economy. S. Chand Publications.
12.11 FURTHER READINGS
 Kapila, Uma (2018). Indian Economy, Policy & Perspectives. Academic Foundation.
 Foreign Trade Policy 2015-20 : Key Highlights ibef.org.
12.12 MODEL QUESTIONS
 Critically appraise the trade policy of India in the post independence period.
 Explain, what do you know about the convertibility of rupee on trade current and capital
account in India.
 Write a short notes on
a) LERMS
b) Vishesh Krishi Upaj Yojna
c) Partial & Full Convertibility of Rupee
d) Short note on Latest Foreign Trade Policy (2015-20).

--------------
 Lesson – 13

FOREIGN DIRECT INVESTMENT IN INDIA

Structure
13.0 Objectives
PART- I (Till 2000)
13.1 Introduction
13.2 Need for FDI
13.3 FDI - The Indian Scenario
13.3.1 Private Foreign Capital
13.3.2 Global Inflows of FDI : Trends
13.3.3 Trends in Approvals
13.3.4 Foreign Direct Investment : Recipients
13.4 FDI Approvals: Ranking State-wise
PART- II (2000 Onwards)
13.5 FDI and Major Policy Initiatives
13.5.1 Policies on FDI: 2002-2003
13.5.2 Foreign Direct Investment 2003-2004
13.5.3 Recent Data (2004-2010)
13.6 A Comparison with China
13.7 FDI Inflows in India 1991-2004
13.8 Policies Concerning FDI Since 1991
13.9 Retail Trade and FDI in India
13.10 Summary
13.11 Glossary
13.12 References
13.13 Further Readings
13.14 Model Questions
13.0 OBJECTIVES
After going through this lesson, you shall be able to :
 state the need for foreign direct investment
 comment upon the progress of FDI in India in the post-Reforms period.
 suggest measures to increase FDI levels in India
 enlist various policy measures undertaken for the growth of FDI in India.
 differentiate performance of FDI between India and China
 [Paper presented by Dr. Parminder Khanna at a seminar held in the UBS, Panjab University,
Chandigarh. (Part I) Recent developments are added to this paper in the second part of the lesson.
(Part II)]
PART I
13.1 INTRODUCTION
With Trade Liberalization becoming the order of the day, imports have become imperative to
growth resulting in a widening Payments Gap, obviously to be bridged by Increased Exports to the
developed World, which in turn, is characterized with sluggish markets, protectionism and adverse
terms of trade. Thus, for accelerating the slow growth momentary foreign direct investment has a
crucial role to play in the capital-starved Indian economy. Setting up special economy zones on the
Chines-Shenzhen model to boost exports at competitive prices are integral to the framework of our
economic policies.
13.2 NEED FOR FDI
With liberal trading regimes throughout much of the developing world, imports have become
imperative to growth. The result, widening payments gap to be closed obviously by increased exports
to the developed countries. The latter, in turn are characterised by:
Sluggish markets,
Adverse movements in the terms of trade, and
Protectionism.
The obvious way out is Dependence on Foreign Capital for maintaining growth momentum.
An attempt has been made to analyses the Course and Destination of Foreign Direct
Investment in India since the post Liberalisation Era (2001) and its Role in the setting up of Special
Economic Zones in the Domestic Market in order to revive the otherwise sluggish demand
detrimental to the Implementation of Mega projects.
The close link between the shift in Market Reforms and Macro-Economic Stability, on the one
hand, and Capital Flows, on the other, is evident from the direction of Capital Flows.
Foreign Direct Investment in India in the post-Liberalisation Era (1991-2001)
TABLE 1
Developing Countries: India, China, Brazil (1999-2000)
Countries Population Population below GNP Per capita
(in million) poverty line (%) ($ billion) GNP
India 980 35.0 421.3 430
China 1239 22.2 928.9 750
Brazil 166 28.6 758.0 4570
GNP = Gross National Product.

Source: World Development Report, 1999-2000

13.3 FDI - THE INDIAN SCENARIO

The new liberalised regime since 1991 consisting of Privatisation and Globalisation of the
economy was based on expectations that foreign investment would bring about benefits which a
near-sterile pursuit of state regulated economic policies had failed to achieve of lending by :

1. Generation of incomes and employment.

2. Elimination of mass poverty.

13.3.1 Private Foreign Capital

Private Foreign Capital is in the form of :

1. Loans, or

2. Investment,

The Loans Component consists of lending by :

1. Commercial Banks

2. Bonds Issued by Companies,

The investment component compromises of :

1. Foreign Direct Investment, and

2. Portfolio Equity,

An analytical study of Foreign Direct Investment-the Private Foreign Capital Component since
1991 follows next.

13.3.2 Global Inflows of FDI-Trends

FDI inflows, over the seven year period (1991-98) exhibited a positive trend increasing from
U.S $ 150 mn. to U.S. $ 3557 mn. Thereby followed a significant decline to U.S. $ 2155 mn. by the
turn of the century.
13.3.3 Trends in Approvals

The Trend in approvals of FDI proposals vis-a-vis inflows is depicted in Table 2. However,
actual inflows as a proportion of approvals improved from 21 per cent in 1997 to 32 percent in 1998.
The reduction in inflows, therefore, has followed from a substantial reduction in approvals.

Table 2

Foreign Direct Investment

Actual Flows vs. Approvals

(U.S. $ Million)
 Year Approvals Actual Inflows

1991 325 155

1992 1781 233

1993 3559 574

1994 4332 958

1995 11245 2100

1996 11142 2383

1997 15752 3330

1998 6975 2230

Source: Economic Survey, 1999-00.

13.3.4 Foreign Direct Investment - Recipients

The Engineering industry is the largest recipient of FDI inflows followed by the Electronics and
Electrical Equipment Industries in the year 1999-00. Food and Dairy products recorded a sharp
increase in inflows from U.S. $ 121 million in 1999-00. The Pharmaceutical industry has also
witnessed increasing. FDI inflows, U.S. $ 54 million in 1999-00 compared to U.S. $ 28 million in the
corresponding year, 1998-99.
TABLE 3
Recipients-Foreign Direct Investment, 1999-00
(U.S. $ Million)
Industry FDI Inflow
Engineering 326
Electronic 182
Food and dairy products 121
Pharmaceutical 54
Source : Economic Survey, 2000-01.
13.4 FDI APPROVALS- Ranking State-wise
So, although quality Infrastructure is the most important factor in Investment decisions over
financial incentives, we find that Punjab is way behind relative to Maharashtra and Gujarat in the
context of proposed domestic investment between 1991 and 2000. Evidence suggests that apart from
Infrastructure, the following factors are imperative to FDI decisions more than incentives:
1. Market characteristics
 2. Production costs in case of export-oriented off-shore production.
3. Availability of resources.
4. Tariffs and trade barries.
5. Transport costs.
6. Exchange rates.
7. Administrative and institutional arrangements.
Part II
13.5 FDI and MAJOR POLICY INITIATIVES
13.5.1 Policies on FDI: 2002-03
2002-03 Foreign direct investment (FDI) directly impacts on output growth in India by
augmenting the available investible capital. However, a far more important impact of FDI is through
externalities leading to higher efficiency and productivity. FDI typically serves it increase competition
in markets, bring new technology into India, and foster skill acquisition amongst domestic labour. FDI
by international corporations is also central to the process of India being utilised as a platform for
global production chains, which would pave the way for strong exports growth.
Major initiatives to attract FDI during 2002-03
 FDI upto 100 percent permitted under the automatic route in the advertising sector.
 FDI upto 100 percent allowed in tea sector, including tea plantations, permitted subject to
compulsory disinvestment of 26 percent equity in favour of Indian partner within a period of
five years and prior approval of the state government in case of any future land use change.
 Re-issuance of ADR/GDR permitted to the extent of ADRs/GDRs which have been redeemed
into underlying shares and sold in the domestic market.
 FDI upto 100 percent permitted with prior approval of the government for development of
integrated township, including housing, commercial premises, hotels, resorts and regional
level urban infrastructure facilities such as roads and bridges and mass rapid transit system,
 Automatic route of FDI upto 100 percent allowed in all manufacturing activities in Special
Economic Zones, except some of the activities such as arms and ammunitions, explosives
and allied items of defence equipment, defence aircrafts and warships, automatic substances,
narcotics, distillation and brewing of alcoholic drinks and cigarettes and cigars.
 FDI in print media sector allowed upto 26 percent of paid-up equity capital of Indian entities
publishing periodicals and newspapers dealing with news and current affairs.

13.5.2 Foreign Direct Investment 2003-04

Foreign direct investment (FDI) gives opportunities to Indian industry for technological
upgradation, gaining access to global managerial skills and practices, optimizing utilisation of human
and natural resources, and competing international with higher efficiency. Most importantly, FDI is
central for India's integration into global production chains, which involve production by multinational
corporations spread across locations allover the world.
13.5.3 Recent Data on Foreign Direct Investment [2004-10]
Domestic savings in India have not been large enough to wholly meet investment
requirements. Capital inflows from other countries, particularly of an investment nature, have become
important. The ratio of domestic savings to GDP has generally been lower than that of GCF to GDP.
During 2004-08, this gap was 1.3 per cent of GDP. Equity inflows are more stable and bring in
managerial skills and technological know how together with the investment. To encourage FDI
inflows, FDI policy has continued to be fine tuned and progressively liberalized, allowing FDI in more
and more industries under the automatic route. In the year 2000, Government allowed FDI up to 100
per cent on the automatic route for most activities; a small negative list was notified where either the
automatic route was not available or there were limits on FDI. Since then, the policy has been
gradually simplified and rationalized and more sectors have been opened up for foreign investment.
There has been tremendous growth in FDI inflows to India since 2003-04. Equity inflows have
risen nearly thirteen-fold, from US$ 2.23 billion in 2003-04 to US$ 27.31 in 2008-09 and US$ 25.89
billion in 2009-10. Total FDI inflow into India since the onset of the liberalization process (August
1991- May 2010) is nearly US$ 136.86 billion. This represents only the equity capital component.
Under international practices of reporting, i.e. including equity capital, reinvested earnings, and
intracompany loans, the figure comes to US $168.94 billion as against US$ 6.13 billion in 2001-02,
US $ 35.18 billion in 2008-09, and US $ 37.19 billion in 2009-10. While the FDI inflows have
somewhat flattened out over the course of the last three years, the pace of inflows has been stable,
including during 2009-10. This is despite the fact that the United Nations Conference on Trade and
Development (UNCTAD) World Investment Report (WIR), 2009, had noted a fall in global FDI inflows
from a historic high of US$1.979 trillion in 2007 to US$1.697 trillion in 2008, a decline of 14 per cent.
UNCTAD had subsequently predicted a fall in global FDI investment flows by 30 per cent, from US $
1.7 trillion in 2008 to US$ 1.2 trillion in 2009. The Organization for Economic Cooperation and
Development (OECD), in its report on investment, released in March 2010, had also noted significant
stagnation in global investment activity due to the global economic crisis.
Table 4 : Growth in FDI inflows
(US$ billion)
Financial As per Per- FDI Per-
Year International centage Equity centage
Practices* Growth Inflows# Growth
2003-04 4.32 (-) 14% 2.23 (-) 18%
2004-05 6.05 (+) 40% 3.78 (+) 69%
2005-06 8.96 (+) 48% 5.97 (+) 58%
2006-07 22.83 (+) 155% 16.48 (+) 176%
2007-08 (P) 34.84 (+) 53% 26.86 (+) 63%
2008-09 (P) 35.18 (+)1% 27.99 (+)4%
2009-10 (P) 37.18 (+)6% 27.15 (+)3
2010-11 (April-
Oct 2010) 14.9 - 12.62 -
Source : Eco. Survey 2010-11.

Note: * As per Reserve Bank of India (RBI) estimates.

# As per DIPP estimates.

*=includes Non-conventional energy sector

FDI equity inflows, as a percentage of the GDP, grew from 0.37 per cent in 2003-04 to nearly
2.21 per cent in 2008-09. As a percentage of the GCF, they grew from 1.35 per cent to nearly 6.32
per cent during the same period. The 2009 survey of the Japan Bank for International Cooperation
(JBIC), conducted among Japanese investors, continued to rank India as the second most promising
country for overseas business operations, after China. The WIR, 2010, in its analysis of global trends
and sustained growth of FDI inflows, has ranked India as the second most attractive location for FDI
for 2010-12.

Table 5 : Sector-wise FDI Inflows into industry and infrastructure

(US $ million)
1991 2002-07 2007-08 2008-09 2009-10 2010-11

-2002 (Apr.-
Nov)

Food Products 972.6 392.2 80.7 150.5 348.2 166.0

Fermentation Industries 51.1 216.3 270.1 144.7 112.0 18.0

Textiles 249.2 327.2 186.0 157.4 140.6 56.2

Wood Products 0.1 0.6 0.4 11.3 6.5 0.7

Paper 327.2 139.0 104.2 310.1 85.9 28.1

Leather 43.4 16.8 7.5 3.3 5.1 0.3

Chemicals 1810.4 1934.1 582.3 992.5 611.8 500.6

Rubber, Plastic, &

Petroleum Products

(including oil exploration) 342.1 464.7 1441.9 497.2 296.2 542.2

Non-metallic Minerals 515.8 877.9 143.0 944.2 45.6 279.1

Metals and Metal Products 223.0 548.7 1176.9 960.9 406.7 960.3

Machinery and Equipments 3092.4 6854.4 2645.7 2528.1 2515.3

1317.1

Transport Equipments 431.1 1130.8 674.8 1151.7 1176.6 533.0

Others Manufacturing 2834.2 1184.7 704.3 1566.1 1079.4
1232.6
Mining

(including mining services) 7.8 55.8 458.3 34.4 174.0 75.1

Power* 1885.8 398.5 1011.2 1070.1 1935.2

1028.0

Telecommunications 2140.4 1505.9 1261.5 2558.4 2554.0

1029.8
Total 14,926.0 16,047.6 10,748.5 13,080.8 11,493.0 7831.2

Source: Eco. Surveys 2010-11

Note : Total excludes inflows to services sector and other NRI schemes;

In FDI equity investments, Mauritius tops the list of first ten investing countries followed by the
US, the UK, Singapore, Netherlands, Japan, Germany, France, Cyprus, and Switzerland. Among the
sectors attracting highest FDI are services, telecommunications, computer software and hardware,
housing and real estate, and construction. Sectors like agricultural services, sea transport, and
electrical equipment have shown a quantum jump in FDI inflows during 2009-10. Sector–wise FDI
inflows into some of the key industrial and infrastructure sectors are given in Table 5.

13.6 A COMPARISION WITH COMPETITOR (CHINA)

FDI has contributed to the rapid growth of China's merchandise exports, at an annual rate of
15 percent from 1989 to 2001.
 In India, by contrast, FDI has been much less important in driving export growth, except in
information technology. FDI in Indian manufacturing has been and remains domestic market-
seeking. FDI accounted for only 3 percent of India's exports' in the early 1990s (World
Investment Report 2002, pp. 154-163). Even today, FDI is estimated to account for less, than
10 percent of India's manufacturing exports.
 On the basic economic determinants of inward FDI, China does better than India. China's total
and per capita GDP are higher than India's, making it more attractive for market seeking FDI.
China has higher literacy and education rates making it more attractive to efficiency-seeking
investors. China has large natural resource endowments. In addition, China's physical
infrastructure is more competitive, particularly in the coastal areas (CUTS 2003, Marubeni
Corporation Economic Research Institute 2002). But, India may have an advantage in
technical manpower, particularly in information technology. It also has better English language
skills.
 Some of the differences in competitive advantages of the two countries are illustrated by the
composition of their inward FDI flows. In ICT, China has become a key centre for 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 Trans National
 Corporations (TNCs). India, on the other hand, specializes in IT services, call centers,
business, back-office operations and R&D.
 Rapid growth in China has increased the local demand for consumer durables and non
durables, such as home appliances, electronics equipment, automobiles, housing and leisure.
This rapid growth in local demand, as well as competitive business environment and
infrastructure, have attracted many market-seeking investors. It has also encouraged the
growth of many local indigenous firms that support manufacturing.
 Other determinants related to FDI, attitudes, policies' and procedures also explain why China
does better in attracting FDI. China has "more business-oriented" and more FDI friendly
policies than India (AT Kearney 2001). 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.
 A recent business environment survey indicated that China is more attractive than India in the
macroeconomic environment, market opportunity and policy towards FDI. India scored better
on the political environment, taxes and financing. A confidence tracking survey in 2002
indicated that China was the, top FDI destination, displacing the United States for the first time
in the investment plans of the TNCs surveyed; India came 15th (AT Kearney 2002).
Source: World Investment Report, 2003, UNCTAD
13.7 FDI INFLOWS IN INDIA: DESTINATION (1991-2004)
Table 6 shows the share of top ten countries in India’s FDI inflows (in US$ terms) during
January, 1991 to March, 2004. The biggest contributing countries are Mauritius (34.48 percent)
followed by USA (16.56 percent), Japan (7.63 percent), Netherlands (7.04 percent) and U.K. (6.88
percent).
Table 6: Share of top investing countries in FDI inflows to India
(January, 1991 to March, 2004)
Amount in Rs. Crore (US $ in Billion)
Country Jan-1991 2000 2001 2002 2003 2004 Amount Percen
to (Jan.- of FDI tage to
Dec.1999 March) Inflows in total in
Rupees rupee
(in US $) terms
(In US $
terms)
1. Mauritius 12465.90 3568.65 7503.61 7284.46 2585.93 412.18 33820.73 35.21

(3.42) (0.83) (1.67) (1.52) (0.56) (0.09) (8.09) (34.48)

2. USA 8354.23 1799.31 1654.13 1357.20 1904.00 341.05 15409.92 16.05

(2.31) (0.42) (0.37) (0.28) (0.41) (0.07) (3.89) (16.56)

3. Japan 2969.37 985.69 996.54 1980.46 434.39 64.19 7430.60 7.74

(0.82) (0.23) (0.22) (0.41) (0.09) (0.01) (1.79) (7.63)

4. UK 2227.90 281.48 1284.02 1698.81 862.90 293.45 6648.56 6.92

 (0.66) (0.07) (0.29) (0.35) (0.19) (0.06) (1.61) (6.88)

5.Netherland 2174.33 546.80 1031.55 747.56 1161.88 1277.31 5969.43 6.22

(0.61) (0.13) (0.23) (0.16) (0.25) (0.28) (1.65) (7.04)

6. Germany 2351.08 371.47 598.13 662.93 362.50 165.99 4512.30 4.70

(0.66) (0.09) (0.13) (0.14) (0.08) (0.04) (1.13) (4.83)

7. France 963.81 341.58 595.13 530.15 164.25 61.65 2656.57 2.77

(0.27) (0.08) (0.13) (0.11) (0.04) (0.01) (0.64) (2.74)

8. Korea 2092.09 76.17 20.30 181.44 112.86 3.40 2489.66 2.59

(South) (0.57) (0.12) (0.01) (0.04) (0.02) (0.00) (0.66) (2.80)

9. Singapore 1239.32 501.52 160.66 226.23 168.05 52.26 2348.04 2.44

(0.34) (0.12) (0.04) (0.05) (0.04) (0.01) (0.59) (2.52)

10.Switzerland 795.12 187.22 178.02 251.69 428.96 1.72 1842.79 1.92

(0.23) (0.04) (0.04) (0.05) (0.09) (0.00) (0.46) (1.97)

Total of all 41380.64 10092.38 15841.80 16132.36 9564.04 3034.11 96036.33 N.A.
Countries

(excluding (11.49) (2.35) (3.52) (3.36) (2.08) (0.66) (23.45) N.A.

ADRs/GDR
etc)

Note : 1. Total amount includes FDI inflows received through FIPB+SIA+RBI routes, acquisition of shares, RBI’s NRI
schemes, stock swapped amount on account of ADRs/GDRs & advance pending for issue of shares

2. Ranking of above countries is worked out on the basis of cumulative FDI inflows during January 1991 to March
2004.

3. Percentage figures do not take into account the amount of FDI inflows for ADRs/GDRs/FCCBs, RBI’s-NRI
Schemes acquisition of existing shares (for the period 1996-1999 only), stock swapped & advance pending for
allotment of shares, as these are not categorized country-wise during the year 1991-2004 (upto March)

4. Country-wise FDI inflows figures during the year 2000-2003 (upto March) includes FDI inflows received
FIPB/SIA route, RIB’s automatic routes and acquisition of existing shares only.

Source : Economic Survey 2003-04

Table 7 shows the breakup of inward FDI in terms of industries.
Table 7: Sectors attracting highest FDI approvals with inflows
(January 1991 to March 2004)
Amount Rupees in crore (US $ in billion)
Rank Sector No. of FDI Percen- FDI Percentage Percentage
FDI approved tage of inflows of total FDI of Inflows
approval total FDI inflows* (in over
approved rupees approval (in
terms) terms of
rupees)

1. Energy 701 77828 26.62 9802 10.21 12.59

Of which (20.99) (2.32)

Power 362 43703 14.95

(11.90) - - -

Oil Refining 339 34125 11.67

(9.09)

2. Telecommunication 803 57328 19.61 10725 11.17 18.71

(15.43) (2.56)

3. Electrical Equipment 4495 28072 9.94 13930 14.50 47.92

(including computer (7.29) (3.32)

software & electronics)

4. Transportation 1069 21966 7.51 11517 11.99 52.43

(5.73) (2.78)

5. Services sector 1102 19261 6.59 8134 8.47 42.23

(5.12) (2.04)

6. Metallurgical 407 15534 5.31 1254 1.31 8.07

industries

(4.27) (0.31)

7. Chemicals (other 1053 13090 4.48 5692 5.93 43.48

than fertilizers)

(3.73) (1.49)

8. Food & food 771 9620 3.29 4346 4.53 45.18

processing
 (2.77) (1.09)

9. Hotels & Tourism 504 5215 1.78 899 0.87 17.24

(1.45) (2.14)

10. Textiles 641 3517 1.20 1163 1.21 33.07

(1.02) (0.31)

Note: * Percentage figures do not take into account the amount of FDI inflows for ADRs/GDRs /FCCBs, RBI’s-NRI
Schemes, acquisition of existing shares (upto 1999), stock swapped & advance pending for allotment of shares,
as there are not categorized sector-wise.

Table 8 shows that the five top states attracting major shares of FDI approvals were Maharashtra
(17.48 percent), Delhi (12.06 per cent), Tamil Nadu (8.58 percent), Karnataka (8.26 percent) and
Gujarat (6.44 percent).

Table 8: Share of top five states attracting FDI approvals

(January 1991 to March 2004)

Rank Name of State No. of FDI approvals Amount of FDI Percentage

with total
Total Tech. Financial Rupee in US $ in FDI
crore billion approved

1. Maharashtra 4816 1308 3508 51114.68 13.18 17.48

2. Delhi 2638 304 2334 35250.74 9.78 12.08

3. TamilNadu 2607 613 1994 25071.77 6.52 8.58

4. Karnataka 2467 494 1973 24138.44 6.15 8.26

5. Gujarat 1204 556 648 18837.30 4.81 6.44

Conclusion : The role of FDI is well recognized in India. In this liberalized and globalised world, FDI
can play a significant role in the industrial growth of our country.
13.7.1 Recent FDI inflows & Policy Steps
 As per Economic Survey 2016 – 17, boosted by the government initiatives, during first half of 2016 – 17,
FDI inflows improved to US $ 21.7 billion (US $16.6 billion of previous year 2015 – 16) showing a growth of
30.7 per cent.
 The Union Budget 2017 – 18 announced to abolish FIPB (Forging Investment Promotion Board) and
Promised to further liberalise the FDI policy further. As more than 90 percent of the FDI inflows come
 under automatic route, the inter-ministerial nodal body (i.e. FIPB) which is meant for FDI approval, has
lost much of its relevance.
 The few areas in which FDI needs a government approval (such as defense, telecom, insurance, banking,
retail trade etc) in future, the approval will be given by concerned ministries or the regulatory bodies.
Activity
Q. Name the country which has the highest share of FDI in India at present?
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________

13.8 POLICIES CONCERNING FDI IN INDIA SINCE 1991

Kapila (2011) divides the features of FDI policies into four phases : (a) 1950-67 (b) 1967-80
(c) 1980-90 & (d) 1991 onwards. The important features of these phases have been summarized
through Flow Chart I. Now we shall study the most relevant phase i.e. the fourth phase. Transparency
and openness have been the most significant features of FDI policies in the fourth phase. The degree
of openness is reflected in: (i) the sectors open to FDI, (ii) higher level of foreign equity participation,
and (iii) transparency in approval procedures: One striking aspect of the present iberalization policy is
that unlike the previous phases, it is not necessary that FDI is accompanied by foreign technology
agreements. There is a liberal approach towards investment by non-resident Indians (NRIs): NRIs
and overseas corporate bodies can invest up to 100 per cent in high priority industries. Another
distinctive feature of the policy is the simplification of procedures.
Thus, the ongoing measures taken since 1991 are focused towards a virtual elimination of the
both direct and indirect barriers to foreign direct investment (indirect barriers in the form of investor
protection, differences in accounting standards, legal and regulatory structure). In short, the evolution
of FDI policies in India are iberalizatio by receptive attitude till the mid-sixties to a policy of restrictions
and controls till 1980 and then to gradual iberalization till 1990 and finally to a policy of full-fledged
iberalization since 1991.
Flow – Chart : I
Major Features of FDI Policies during the Four Phases
Phase I Phase II Phase III Phase IV
1950-1967 1967-1980 1980-1990 1991 onwards
Receptive Attitude or Restrictive Attitude Gradual Liberalisation Open Door Policy
Cautious Welcome
 Non- discriminatory  Restriction on FDI  Higher foreign  Liberal policies
treatment to FDI. without technology. equity in export- relating to
oriented units technology
allowed. collaboration,
foreign trade and
 foreign exchange.
 No restrictions on  Above 40 per cent  Procedure for  Encouraging FDI in
remittance of profits stake not allowed. remittance of core and
and dividends. royalty and infrastructure
technical fees industries.
liberalized.
 Allowed only in  FERA replaced
priority area. with FEMA.
 Ownership and  FDI controlled by  Fast channel for  Procedure
control with FERA FDI clearance. transparent.
Indians.
 Liberal approach
for NRI
investments.
 Discretionary power  FDI need not be
is sanctioning the accompanied by
projects. technology.
 FDI through
mergers and
acquisitions.

 FDI in services and

financial sector-
banks, NBFCs,
insurance.

13.8.1 Latest Trends and Patterns in FDI Inflows Since 1991

The economic reforms in general and liberalisation of FDI policy in particular have affected the
magnitude and pattern of FDI inflows received by India. During the 1990s, they showed a marked
increase until 1997, when they peaked at US $ 3.6 billion. However, after stagnating for a few
subsequent years at around US $ 2.5 billion, they rose again to a level of about $ 3.4 billion and to $
4.5 billion in 2003.
Since 2005-06 FDI flows assumed greater significance. High inflows indicate India as an
attractive investment destination as a consequence of its liberalised investment climate, stable and
sound economic and political base, opportunities for economic growth, while capital investment
abroad reflects the growing global competitiveness of the Indian corporate sector. The two-way flow
of FDI, therefore, means that while the world is taking note of India's market potential. Indian
companies are also constantly looking for synergistic acquisitions abroad.
With the reforms in policies, better infrastructure and vibrant financial sector. FDI inflows into
India have accelerated since 2006-2007. On a gross basis, FDI inflows into India increased from US
$ 8.9 billion in 2005-06 to US $ 22.8 billion in 2006-07 and further to US $ 34.4 billion in 2007-08. FDI
inflows are spread across a range of economic activities like financial services, manufacturing,
banking services, information technology services and construction.
 In an analysis of the role of liberalisation in explaining the rising inflows of FDI till 1997, it
was Kumar (1998b) found that only a part of the increase in FDI inflows could be attributed to
liberalization, and a part of the rise was explained in terms of a sharp expansion in the global scale of
FDI outflows during the 1990s. Secondly, the decline in inflows since 1997 despite continued
liberalisation suggested that policy liberalisation is not an adequate explanation of FDI inflows.
Macroeconomic fundamentals of the host economies that emerge as the most powerful
explanatory variables in the inter-country analysis of FDI inflows also explain the year-to-year
fluctuations in FDI, although with a lag. This becomes clear from Figure 13.1 which plots FDI inflows
during the 1991-2003 against the fluctuations in the annual rates of growth of industrial output. One
finds a good correspondence between industrial growth rate in a year and the FDI inflows in the
following year. The industrial growth seems to signal to the foreign investors about the prospects of
the economy. Therefore, it appears that policy liberalisation may be a necessary but, not a sufficient
condition for FDI inflows (Kumar, 2009).

Figure – 13.1

Source : Nagesh Kumar (2009) “Liberalisation. Foreign Direct Investment Flows and Development”. Ch. 17 m
K.I. Krishna and Uma Kapila (eds.)Readings in Indian Agriculture and Industry. C.f. Kapila, 2011
13.8.2 Changes in Sectoral Composition : Areas/Sectors
In tune with the government’s priorities with respect to FDI, sectoral composition of FDI has
undergone significant changes during the last two decades. Till 1990, the government policy was to
channel FDI inflow in technology-intensive branches of manufacturing. Thus, more than four fifth of
FDI stock in 1990 was in the manufacturing industries. The share of petroleum and power and
service sectors were only marginal. However, with the changes in the FDI policies in the nineties, the
share of manufacturing has been more than halved to 40.1 per cent. Within the manufacturing
industries, FDI is shifting away from heavy capital goods industries to light industries. With the
opening up of the infrastructure industries, on the other hand, the share of petroleum and power
sector rose substantially to 30.6 per cent in 1999 from just 0.1 per cent of FDI stock in 1990.
Similarly, the share of service sector rose to 27.8 per cent from just 5.2 per cent, respectively, during
the above period (Kumar, 2009).
 Three high priority industries, namely, power, telecommunication and oil refinery accounted
for nearly half of the total amount of FDI approvals during 1991 to 1999. Among the different
industries, power and telecommunication accounted for the highest share (17.5 per cent each) of FDI
approvals during the nineties. They are closely followed by oil refinery, which accounted for 13.1 per
cent of FDI approvals. Transportation industry and financial sector were the other two prominent
sectors accounting for larger share of FDI approvals. Thus, what is noticeable in the nineties is the
rise of FDI inflows in the priority infrastructure sectors like power, telecommunication, oil refinery,
transportation, finance and banking. Perhaps, this is on account of the opening up of these industries
for FDI in recent times. (Kumar, 2009).
13.8.3 Changes in the Sources of FDI
Over the years, there has been diversification of sources of FDI. Until 1990, European
countries have been the major sources of FDI inflows in India. They accounted for nearly two-third of
total stock of FDI in 1990. However, their share drastically declined to around one-fifth during the
nineties. Among the European countries, the decline was significantly high in case of the UK from
48.8 per cent in 1990 to just 7.6 per cent during the nineties. The share of European countries,
America and Japan taken together accounted for nearly 90 percent of total stock of FDI in 1990,
however, it has declined to 46.6 per cent during the nineties. The decline in the share of the above
group is essentially due to the rise in the inflows from other countries. What is more striking is the fact
that after USA, Mauritius is the second largest source of FDI in India. Because of lower taxes in
Mauritius, they are able to attract foreign capital from different parts of the world, which is in turn
invested in countries like India. (Kapila, 2011)
13.8.4 FDI Liberalisation
Foreign Direct Investment (FDI) is preferred to the foreign portfolio investments (PIS) primarily
because FDI is expected to bring modern technology, managerial practices and has a long-term
nature of investment. The government liberalized FDI norms overtime. As a result, only a bandful of
sensitive sectors now fall in the prohibited zone and FDI is allowed fully or partially in the rest of the
sectors.
Despite successive moves to liberalise the FDI regime, India is ranked fourth on the basis of
FDI Restrictiveness Index (FRI) compiled OECD. FRI gauges the restrictiveness of a country's FDI
rules by looking at the four main types of restrictions:
(i) Foreign equity limitations;
(ii) Screening or approval mechanism;
(iii) Restrictions on the employment of foreigners as key personnel; and
(iv) Operational restrictions.
A score of 1 indicates a closed economy and 0 indicates openness. FRI for India in 2012 was
0.273 (it was 0.450 in 2006 and 0.297 in 2010) as against OECD average of 0.081. China is the most
restrictive country as it is ranked number one with the score of 0.407 in 2012 indicating that it has
more restriction than India. As there is moderation in FDI inflows to India in 2012-13 than the last it is
imperative therefore to rationalise FDI norms further (as is suggested by the Economic Survey 2012-
13).
 In order to become a flourishing industry in right spirit, retail sector in India needs to cross or
meet the following hurdles or challenges :
1. Automatic approval is not allowed for foreign investment in retail,
2. Regulations restricting real estate purchases and to withstand cumbersome local laws.
3. Taxation policy favouring small retail business.
4. Absence, of developed supply chain and integreted IT management.
5. Low skill level for managing retail sector.
6. Lack of trained work force.
7. Lack of retailing courses and proper study options for the promotion of retail sector.
8. Intrinsic complexity of retailing in India—like rapid price changes, constant threat of
product obsolescence and low margins.
Thus the challenges faced by the retail sector in India is quite serious and important.
13.9 RETAIL TRADE AND FDI IN INDIA
With the liberalisation of these rules it is now expected that investment in retail business from
multi- national players may now increase in near future.
13.9.1 Retail Trade in India
Indian retail market has its own diversities and complexities. Indian retail market has high
diversities as it covers wide spectrum of goods produced by different sectors. Again it has high
complexities in terms of a wide geographic spread and distinct consumer preferences usually varying
by each region and thereby necessitating a need for localization even within the geographic zones.
India is now having the highest number of outlets per person (7 per thousand). Indian retail space per
capita at 2 sq. ft (0.19 m2)/person of 6 per cent is highest in the world. In India, 1.8 million households
in India have an annual income of over Rs. 45 lakh (US $ 81,900). Thus India presents a large
market opportunity given the number and increasing purchasing power of consumers. There are also
significant challenges faced by the retail sector as over 90 per cent of trade is conducted through
independent local stores. Such challenges include : geographically dispersed population, small ticket
sizes, complex distribution network, little use of IT systems, limitations of mass media and existence
of counterfeit goods.
A McKinsey study of Indian retail sector claims that retail productivity in India is very low as
compared to international peer measures. It is observed that the labour productivity in Indian retail
was just 6 per cent of the labour productivity of United States in 2010. India's labour productivity in
food retailing is about 5 per cent in comparison to that of Brazil's 14 per cent; while India's labour
productivity in non-food retailing is nearly 8 per cent in comparison to Poland's 25 per cent.
Retail sector in India has also generated large number of employment. Total number of retail
employment in India, both in organized and unorganized retail, account for about 6 per cent of Indian
labour or work force currently, most of which are engaged in unorganized retail. This is about a third
of levels engaged in United.
13.9.2 Retail Trade in India and Mixed responses on the entry of FDI in Retail Trade
 Entry of foreign direct investment (FDI) into retail business has evoked mixed responses
throughout the country. It includes both positive and negative arguments.
Positive Arguments in favour of Entry of FDI In Multi-brand Retail Sector : Opportunities
The following are some of the arguments advanced in favour of entry of FDI in multi-brand
retail sector ;
1. Address Supply side problem. Entry of FDI in multi-brand retail trade will address
supply side problem. Growth of Income has brought about much larger gap between
production and consumption. Such gap can be met by larger volume of investment in
infrastructure like intergreted storage, transport linkages, cold storage, technological
upgradation etc.
2. Generation of employment opportunities. Entry of FDI into multi-brand retail sector
is likely to generate large number of employment opportunities in India. Organised
large scale retail trade has scope for larger number of jobs. FDI in multi-brand and
single brand retail sector is likely to create as many as 10 million jobs in a span of 10
years, making it the largest sector in organised employment. According to India
staffing Federation, an apex body of the flexi staffing industry in India, FDI in retail can
create around 4 million direct jobs and almost 5; to 6 million indirect jobs including
contractual employment within a span of 10 years. In USA, Walmart, the giant retailer,
employed 1.4 million people. In India, Walmart is likely to employ 5.6 million Indian
people if they can do same scale of business in India. More additional jobs will be
created during building of retail stores cold storages, software makings, electronic
cash register entry and other works. Thus FDI in multi-brand retail would in no way
endanger the jobs of people employed in the unorganised retail sector of the country.
Rather, it would create millions of job opportunities as massive infrastructure
capabilities would be requried to meet the changing life style needs of urban people of
India v/ho is quite keen on allocating a good portion of their disposable income
towards organised retailing over and above their purchase from local Kirana stores.
These Kirana stores would be able to survive in retaining its customers because-of
their unique characteristics of convenience, close proximity and relations and skills in
retaining customers. In smaller towns and in rural areas, these Kirana stores would be
able to spread its base deeply. Thus FDI in the fast growing retail sector wall
significantly boost hiring activities and has the potential to create about 80 lakh jobs in
the country.
3. Boost Investment in Agricultures. FDI in multi-brand retail sector will boost
investment in agriculture Noted farm scientist and father of green revolution in India
M.S. Swaminathan supported the government decision to allow 51 per cent FDI in
multi-brand retail on the ground that it v/ill open scope for raising investment in rural
areas. He recently observed that "Agriculture in rural India is crying for investment.
Whether home investment, international investment, UN bodies, World Bank
agriculture and rural occupations ore caving for those investment. Any investment that
can stimulate agriculture is welcome." He also suggested that the states going for it
should devise safeguards to protect the interests of the farmers. In order to get the
regular and sufficient supply of farm products for their stores, the multi-brand retailers
are likely to establish link with farmers and go for contract to produce and supply their
 required products and also advance loan FO the fanners to produce those goods in
required format and quality.
4. Investment in Back-end infrastructure. Entry of FDI into multi-brand retail will lead
to flow of investment in back-end infrastructure. As per the Government policy
announcement, at least 50 per cent of FDI should be invested in 'back-end
infrastructure' within three years of the first tranche. Thus entry of FDI in retail sector
will develop cold storage chain, strengthen supply chain infrastructure for all products,
ranging from integrated storage to processing and manufacturing infrastructure,
transport linkages, technological upgradation etc. which would stop wastage of
agricultural produce at farm level or can reduce post-harvest losses, As a result of
such entry of FDI, logistics and supply chain companies are expected to grow as they
will he (he link between small manufactures, producers and farmers and the organized
retail chains and thereby help them to get higher returns for their supplies. Moreover, it
is not possible for the government to make such a volume of investment for the
development of such hack and infrastructure on retail sector as it has to invest a lot in
infrastructure, hospitals housing, education etc. Thus in this regard, FDI in retail has no
alternative.
5. Knowledge and global integration. Indian retail industry needs knowledge and
global integretion. Leading global retail players can bring it and can also open global
export market for Indian farmers and producers.
6. Reducing inefficiency. FDI in multi-brand retail will help reduce inefficiency in retail
business and thereby benefit both consumers and farmers. Thomas Lairson, Professor
of international business, Rollins collage, US argued that India should learn from the
experience of China, Japan and Brazil, whose economics have benefitted from FDI in
retail Opening of retail sector in India will lead to potential reduction of inefficiencies in
that sector. Referring to the Chinese experience Prof. Lairson noted that FDI
intensified the competition in China's market, improved the efficiency of the economy,
and propelled state-owned enterprises to reform and China's transition to a market-
oriented economy. In 1970, imports and exports together constituted just 5 per cent of
China's' GDP but it rose significantly to 65 per cent of GDP in 2005 due to significant
opening of the economy. China thus shifted from extremely closed to the most open
large economy in the world and attracted cumulative FDI of over $ 1 trillion between
1979 and 2011. Again referring to the Japanese experience, Prof. Lairson noted that
significant protection of small and inefficient retailers and small farmers raised prices of
the products and created a large and in inefficient sector of the economy.
7. Reducing Price Level. FDI in retail can reduce the price level in a country if its works
under competitive scenario. Large number of global retail companies (350 retail
companies) viz. Walmart, Carefour, Tesco, Target, Metro, Coop etc. working since last
30 years in different countries could bring competition in the market. It could keep food
prices lower. As for example, Canada could altain lower inflation due to Walmart effect.
Price inflation in these countries has remained much lower than in India.
8. Benefit to Consumers. As a result of entry of FDI in retail sector, consumers in
general will be benefited due to reduction in prices and they will get the access of
better quality products. Consumers will have more options and Choices.
9. Remunerative Prices. FDI in retail can assure better or remunerative prices to
farmers of their products and can eliminate middlemen from agricultural market. Until
2010, intermediaries and middlemen have dominated the value Chain in India, flouting
all norms. Small farmers in India realize only 1/3rd of the total price paid by final Indian
consumers as compared to 2/3rd of the price realised by farmers of those nations
having higher share in organized retail.
10. Knowledge and technology transfer. Global retail players will arrange transfer of
better knowledge and technology to formers for improved farming and Organic farming
practices resulting improvement in both yield and quality of farm products.
11. Benefit to small producers. Entry of FDI by treans-national corporations (TNCs) in
retail sector will also benefit small producers and businessmen Giant retailers will buy
cosmetics, toiletries, garments, leather products, processed foods, spices, pickles, jam
etc. from small producers. Thus there will be increase in the demand for products
produced by these domestic small producers and thereby the retailers will establish
free trade and provide marketing support to these producers both within and outside
the country to sell their products at remunerative, prices.
12. Benefit by integreting. By welcoming FDI in retail seel or, India will benefit by
integreting with the world rather than isolating itself. China with over 57 million square
feet of retail space owned by foreigners, employing millions of Chinese Citizens lias
not become a Vassal of imperialists. It enjoys considerable respect from all global
players. Other Asian countries like Malaysia, Taiwan, Thailand and Indonesia also see
or consider foreign retailers as catalysts of new technology and price reduction and
they have been benefitted immensely by allowing FDI in retail sector:
13. Ploughing back profit. With the entry of 51 per cent FDI in multi-brand retailing half of
the total profits earned thereby will remain in India. Moreover, taxes on profit will also
improve the revenue receipts of the government and thereby can reduce its budgetary
deficit. Moreover, half of the profit remaining within the country may be ploughed back
for further investment within the country.
14. Checking wastage in distribution. In India, die problem of inbuilt inefficiencies and
wastage in distribution and storage is quite serious in nature. As per some estimates,
as much as 40 per cent of food production does not reach consumers. Food often rots
at farms level, in transit or in antiquated state-run warehouses but large number of
children in India are malnourished. Thus organized and cost conscious retail
companies will be able to avoid such waste and losses making food available to the
weakest and poorest segment of Indian society at an affordable price and can also
increase the income of the poor farmers. Moreover, healthy food will become available
to more households.
15. Better job conditions in retail. Workers engaged in Indian small shops are employed
without proper contracts, making them to work long hours and at lower wages. Many
 unorganized small shops depend on child labour. Thus a well-regulated retail sector
can be able to reduce those abuses and jobs in the organized retail can also pay well.
For all these possible opportunities, to be attained from the entry of FDI in retail sector, the
government have to be proactive for bringing necessary changes with the changing situations.
(b) Threats or Negative Arguments against the entry of FDI in Retail Sector
Critics of Indian retail reforms have forwarded the following negative arguments against the
entry of FDI in retail sector of the country.
1. Job losses. Entry of FDI and opening of Global multi-brand retail outlets (GMBRO)
will lead to massive job losses as independent small stores will have to close their
operation. As a result, there will be loss of job to unskilled workers. Thus allowing
Walmart like companies to expand their business may create few thousand jobs
millions of job may be lost in the small trading sector.
2. Drop in prices. Big players like Walmart's efficiency at supply chain management
leads to "direct" procurement of goods from the supplier. This may pave the way for
deliberately droping prices which may not benefit the farmer or the suppliers of
Walmart.
3. Monopoly Power. Big players in retail trade can afford to lower prices in initial stages
even by dumping goods and may become monopoly at later stage and then raise
prices. But as number of TNCs or big retailers will work together so establishment of
monopoly will be difficult. Moreover, the competition commission will also look into the
matter to control such menace.
4. Killing local economy. With the entry of large efficient retailers, the corporate profits,
so earned, may not be spent in the areas where they are generated which may lead to
killing of the economy.
5. Destroying Consumer Choice. Entry of giant retail players gradually destroy the
consumer choice and the market may be reduced to competition between a handful of
brands and logos.
6. Predatory pricing. Corporate big retailers way resort to predatory or below cost
pricing to attract customers initially but then jack up prices at a later stage so as to
transfer the burden to the consumer.
7. Market distortions. Entry of TNCs in retail sector can distort the market by absorbing
the big initial losses hut may resort to non-competitive practices, Thus it would not
eliminate middleman rather introduce new ones like buying agents, processors,
standardises packagers, quality checkers and certification agencies.
8. Abuse of the "buyer power". There are constant fears of abuse of the "buyer power"
of giant retailers which are not imaginary. The centre for Research on Multinational
Corporations in its report observed such widespread abuse in the European Union,
There are instances of "retro-active payments", "late payments" etc. which enable
 super markets to gain profits at the cost of suppliers. The same buyer power may also
affect consumer interest.
9. Private labels. Supermarkets in India are increasingly selling goods under "private
labels", i.e., products with their own brand labels that has created new opportunities for
suppliers. This products are mostly cheaper. Accordingly, supermarkets can threaten
both branded products supplier and private label producers through delisting. They
decide on their own interest, 'what product will be sold."
10. Liability of Repatriation. FDI in retail will be a liability of foreign exchange as the
profits so earned will have to be repatriated. Such large scale repatriation may lead to
current account deficit in trading accounts.
11. Large scale entry of foreign goods. FDI in retail will lead to large scale entry of
foreign goods, from cheaper destinations like China with a set of logistical
management process and thereby help China to keep their industries running. As a
result our domestic product will lose market. However, this may not be true for India as
government can fix the extent of procurement of imported products and domestic
products by the global retailers (as in case of India 30 per cent procurement of Indian
products by global retailer has been made mandatory. However, this issue needs to be
monitored very carefully.
12. Initial burden to Poor. Entry of global retailer may pose as problem to the very poor
people, handlers farmers, petty small traders in the initial transition period. In order to
protect this class of people both the government as well as big retail players will have
to take responsibility to protect the interest of this poor people and also to engage
them effectively.
Conclusion
In spite of mixed responses, the FDI in retail trade has been working with success in different
South East Asian Countries over and above other developed countries of the world. FDI in retail in
China, Thailand, Singapore, Japan etc. have proved to be a boon. It brings technology and equity
and thus created a good impact in those countries.
Various farmer associations in India have announced their support for the retail reforms.
Shriram Gadhve of All India Vegetable Growers Association (AIVGA), which operates in nine major
states of India, claims his organisation supports retail reform. Bharat Krishak Samaj, (BKS), a farmer
association with more than 75,000 members also supported retail reform. A.V. Jakhar, Chairman of
BKS demanded that the government make it mandatory for organized retailers to buy 75 per cent of
their produce directly from farmers, bypassing the middlemen monopoly and India's 'sabzi mandi
auction system'. Chengal Reddy, Secretary General of Consortium of Indian, Farmers' Association
(CIFA) announced its support for retail reforms. Shared Joshi, founder of Shetkari Sangathana
(farmers association) also announced his support for retail reforms and claims that FDI in retail will
help the farm sector to improve critical infrastructure and integrate farmer-consumer relationship.
 Whatever may be the arguements advanced against retail reforms, one thing is very clear that
farmer groups across India are seriously demanding retail reforms as the farmer is being exploited
under the current retail system. They argue that Indian farmers usually get only one third of the price
consumers pay.
13.10 SUMMARY

13.11 GLOSSARY
FDI – Foreign investment, made directly with outsiders
13.12 REFERENCES
Kapila, Uma (2018). Indian Economy since independence. Academic Foundation.
13.13 FURTHER READINGS
Kapila, Uma (2018). Indian Economy Policy and Perspectives. Academic Foundation. Latest issue.
Datt, Gaurav and Mahajan, Ashwani (2018). Indian Economy since independence. SC Chand
Publications, New Delhi.
13.14 MODEL QUESTIONS
1. Explain the need for FDI in India, and its progress in the post-Reforms Period.
2. Appraise the FDI absorption amongst various states of Indian.
3. Suggest measures to increase levels of FDI in India.

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 Lesson – 14

INDIA AND WTO

Structure
14.0 Objectives
14.1 Introduction
14.2 Proposals of Dunkel Draft
14.2.1 Agriculture
14.2.2 Multilateral Trading System
14.2.3 Trade Related Investment Measures
14.2.4 Agreement on TRIPs
14.2.5 Agreement on Market Access
14.2.6 Multi-Fibre Agreement
14.3 Advantages of Dunkel Draft
14.4 Disadvantages of Dunkel Draft
14.5 GATT and India
14.6 Formation of WTO and Its Functions
14.7 India’s stand on various issues
14.8 Looking Beyond India
14.9 WTO : BALI Conference
14.10 Nairobi Package
14.11 Benefits and Fears
14.11.1 Areas of Benefits for India (Opportunities)
(i) income effects
(ii) exports of textile sector
(iii) exports of agricultural products
(iv) dispute settlement
14.11.2 Area of Fears (Challenges)
(i) TRIPs
(ii) TRIMs
(iii) Services
14.12 Conclusion
14.13 Summary
14.14 Glossary
14.15 References
14.16 Model Questions
14.0 OBJECTIVES
 After going through this lesson, you shall be able to
 discuss various proposals of dunkel draft and formation of WTO in 1995.
 explain functions of WTO.
 describe the advantages and disadvantages of India working as a member of WTO.
14.1 INTRODUCTION
The GATT was signed in Geneva in 1948 by 23 countries including India. This was an effort to
reshape the world economy which was in very bad shape particularly after depression of 1929-32 and
second world war i.e. 1939-45. The aim of GATT was to promote multilateral trading system in an
environment of free trade with least tariff barriers. The agreements took place among member
countries to prevent recurrence of protectionism policies of the industralised states which had earlier
resulted in prolonged recession in the war prior to second world war. GATT not an organisation like
U.N.O. World Bank, W.H.O. etc. It is rather a Trade and Tariff Agreement among member countries
of evolve certain set of rules and regulations for the conduct of world trade. Since its inception GATT
has held eight round of talks. The latest round was held in Uruguay. It lasted for seven years from
1986-93.
It covered wide range of agreements. Negotiations covered not only traditional GATT subjects
such as tariff and Non Tariff measures and the improvement of GATT rules and disciplines on
subsidies, safeguards etc. but also extended to new area which were not deal by GATT earlier such
as Trade Related Intellectual Property Rights, Trade related Investment measures and trade in
services. The GATT accord was signed by 120 countries as Marrakesh on 15th April, 1994. This was
known as Dunkel Draft covering 28 areas concerning International Trade. This is perhaps the
greatest achievement of second half of 20th century. The establishment of U.N.O. was the greatest
achievement of first half of 20th century. The setting up to GATT was perhaps more taller than setting
of U.N.O. This is mainly because of the following reasons.
(1) Number of countries involved in GATT is three times more than setting up the U.N.O. In
addition it covered wide range of agreements compared with U.N.O.
(2) The GATT accord was worked out during the worst recession the world has ever seen. In the
absence of GATT accord the world would have headed first for an economic war and then
actual war.
(3) In the GATT accord in spite of China significant absence 2/3 of total members of 120 strong
GATT club belonged to developing countries whereas in the founding of U.N.O. there were
hardly any developing countries. But unfortunately in spite of such a big participation by
developing countries, they could not extent exert much pressure. It is mainly because of the
following reasons – (a) Exist of Soviet Russia as the leading supporter of developing countries
particularly India; (b) OPEC no longer is a powerful player; (c) UNCTAD has totally been
marginalized; (d) Significant absence of China who is standing in Geneva to become its
member.
14.2 PROPOSALS OF DUNKEL DRAFT
In spite of limitations Indian delegation participated with able administrator like A.V. Ganeshan
and B.K. Zutshi succeeded in extracting number of concessions for India after seeing the very poor
influence of this country in world’s economy. India contributes only 1.3 percent of the world S.N.P.
and has contribution in world exports in merely 0.5 percent. In order to discuss the impact of GATT
on Indian economy, it is imperative to know the main proposals of GATT or Dunkel draft which have
very close bearing on Indian economy.
14.2.1 Agriculture
The Dunkel draft suggested that in the field of agriculture, there are three types of provisions
i.e. trade in Agriculture, Agriculture’s Policies, Patenting of Seed plants and Imports of agriculture
products. Regarding trade in Agriculture goods, it was for the first time Agriculture goods were
brought on international negotiations with a view to reduce or eliminate barriers to trade in this field.
In regard to there barriers, a provision has been made to allow certain trade in this field. In regard to
there barriers, a provision has been made to allow certain concessions to the least developed
countries like Bangladesh, Bhutan and Nepal. But these concessions have not been allowed to
developing countries except to improve Balance of Payment crisis. Regarding expansion of Trade in
Agriculture goods, a minimum access opportunity is to be achieved. In case where imports or
agriculture goods is not significant a minimum 3 percent of corresponding domestic consumption in
the base years 1993 will be provided. This will be raised to 5 percent by 1999. In case current
access to opportunities are in excess of the minimum, then these shall be maintained.
The market access is ensured by reducing domestic support i.e. subsidies or by reducing tariff
barriers and by abolishing Non-Tariff barriers. In order to provide access to U.S.A., European
countries agreed to cut down farm subsidies by 20 percent. The developing countries agreed to
reduce by 10 percent of the value of agricultural produce. The developing countries have been given
the benefit of exemption in respect of generally available investment subsidies and input subsidies for
low income farmers. Dunkel Draft also provides provision for food security under Public Distribution
system for needy persons. The Dunkel Draft makes a provision in its draft that MFA (Multi fibre
Agreement) will be phased out during 10 years period i.e. 1993-2002. As a result trade in Textile and
clothing shall be free from all restrictions. Till 1993 importing countries specially developed were
imposing discriminatory restrictions on their imports.
The Dunkel Draft stipulates that countries are free either to give patent or adopt an effective
sin genesis system of protection for plant breeder rights. It implies freedom of multiplication and
exchange of indigenously produced seed or plants in the country. In other words farmers are free to
retain seeds from their own harvest. The only exception in seeds evolved genetically through the
tools of high Tech. The patent fee would be payable on branded seeds imported from developed
countries. The Dunkel Draft provides potency for Micro organisms which includes small forms of life
that grows near water. These Micro organisms in future will produce Bio-Fertilisers and Pesticides.
14.2.2 Multilateral Trading System
Dunkel draft encourages Multi lateral trading system. It has brought into focus the clause of
M.F.N. (Most Favoured Nation) to discourage bilateral Trading system.
14.2.3 Trade Related Investment Measures
Dunkel draft has also proposed to remove various restrictions which are imposed in respect of
investment in foreign companies in various countries of Third World. With the removal of these
hurdles, multi-national companies will get easy entry in Third World Countries. The draft ensures
that govt. should not discriminate against foreign capital. The following are some of the important
features.
1. Restrictions on foreign capital be abolished.
2. The foreign investors should have the same rights as national investor – has.

3. No area for investment should be restricted.

4. No ceiling on investment by foreigners on equity.
 5. Elimination of Restrictions on resatsiation of dividend, interest and Royalty.
6. General Agreement on Trade in services Gatt applies to services to be internationally
traded in tourism, Banking, Insurance, shipping etc. The draft feels trading in goods is not enough.
For the smooth functioning of trade, it is necessary to remove barriers on services.
14.2.4 Agreement on TRIPs
Prior to the TRIPs Agreement, the intellectual property rights concerning the trade (that
included patents, utility models, trade marks and industrial designs) were governed by the Paris
convention of 1863, which was revised up to 1967. The Paris Convention was fairly liberal and left the
subject matter of patent, terms of patent and the duration of protection to be decided by the
concerned national government. The maximum divergence was observed in the case of the
pharmaceutical sector where some countries protected neither. Under these 'loose' patent laws, the
trade interests of the developed countries were affected adversely. Therefore, under TRIPs (Trade
Related Intellectual Property Right) Agreement as accepted in the Uruguay Round, these countries
forced the adoption of stringent condition for the protection of the intellectual property rights (IPRs).
Moreover, the scope of the Agreement was also widened to cover patents, copyrights and related
rights, geographical indicators, industrial design, layout designs of integrated circuits, the TRIPs
Agreement provides for granting products patent (Whereas, earlier on, process patents were used to
be granted). Such product patents will be available for 20 years. In the case of copyright and related
rights, protections will be' available for 50 years.
A transition period of five years was allowed to all developing countries to give effect to the
provision of the TRIPs Agreement. Countries that do not provide product patents in certain area could
delay the provision of product patents by another two years. However, they were required to provide
exclusive marketing rights for products which obtain patents after January 1, 1995.
14.2.5 Agreement on Market Access
The member nations will cut tariffs on industrial and farm goods by an average of about 37
percent. The USA and the European Union will cut tariff between them by one-half.
14.2.6 Agreement on Trade in Textiles and Clothing (Multi-Fibre Arrangement)
This provides for phasing out the import quotas on textiles and clothing in force under the
Multi-Fibre Arrangement since 1974, over a span of 10 years, i.e. by the end of the transition period
on January 1, 2005.
14.3 ADVANTAGES OF DUNKEL DRAFT
1. Export expansion.
2. It will strengthen multilateral trading.
3. It will enlarge market.
4. Going in Efficiency.
14.4 DISADVANTAGES OF DUNKEL DRAFT
1. This gives advantages to developed countries more as compared with developing
countries particularly in services. The services in which developing countries are more
efficient have not been included.
2. The M.F.A. is also discriminatory to developing countries.
3. Inadequate provisions for Agriculture subsidy.
4. In appropriateness of Patenting living organisms : The provision relating to patenting of
all life forms do not got well with common sense. The products in this case are natural
and they are not discoveries. These are not eligible for patenting.
 5. Unequal competition.
6. The Dunkel draft on Agriculture products suffers from Ambiguities.
14.5 GATT AND INDIA
The Dunkel draft evoked a lot of controversy in India. Indian parliament debated the issue in
1991. More than 250 M.P.S. from all parties as well as eminent citizen of the country, felt that signing
the proposals would amount of selling the country too. The overall approach of Dunkel and his team
mates has been extremely helpful to developing countries. GATT has not opened the doors of
paradise for India in all cases but it almost certainly prevents us from going into the reverse direction
of hell. No doubt if GATT is a dirty four-letter word but these is no alternative to it too. It was
expected that India would benefit on the following frens :
(1) The world’s total export is about 3800 billion U.S. dollars of which India’s exports are
only 19 billion i.e. 0.5 percent of world’s export. Against his China’s exports are 85
billion, Hongkong 120 billion, U.S.A. 450 billion, Germany 430 billion, Japan 350
billion. Dunkel agreement is likely to result in significant expansion in world trade as a
result of removal of trade barriers.
(2) In textiles Industry, we shall be major gainers.
(3) Developed countries are notorious for heavy farm subsidies they will have to reduce
export subsidies. India’s subsidy has worked out to be very less. Therefore India
stands to gain.
(4) The proposed agreement in respect of trade in services makes provisions for a
multilateral framework for negotiating concessions, inter alia in the area of movement
of personnel. India shall have the opportunity of send skilled and professional
personnel to supply services in their countries.
(5) The draft incorporated Trade Related intellectual Property Rights, which provides for a
ten years transition period for the introduction of product patents in respect of those
countries which are presently not granting such patents in certain areas.
(6) The flow of foreign direct investment would be enhanced by the adoption of
international standards in I.P.R. protection.
(7) The clubbing of Product and Non-Product Agriculture subsidies will allow much greater
flexibility to provides subsidies for Agriculture production. The consumer subsidies
under the public distribution system for the rural and urban poor are permitted by Gatt
accord. Therefore P.D.S. will not be affected.
Drawbacks of Dunkel Draft for India
Indian govt. has been accused of complete surrender and sell out of national sovereignty. Our
Agriculture would be raised, our farmers would have to buy their seeds every year from
multinationals, our genetic wealth would be frittered, drug prices would sky rocked, our market would
become heaven for foreigners.
(1) The general agreement on trade in services has excluded the whole area of labour
and labour intensive services.
(2) The draft fails to improve the rules of Anti dumping sufficiently.
(3) The Dunkel draft on Agriculture is suffering from ambiguities.
(4) The Dunkel Draft on Textiles, the phase out process is backloaded.
(5) The Dunkel draft on TRIM may lead to infringing of financial sovereignty of India.
 (6) The volume of world trade will go up in the wake of dunkel draft is beyond questions
but gains from increased trade will be equally shared between developed and
developing countries is certainly doubtful.
(7) The Dunkel Draft in the area of Potent has not provided sufficient flexibility.
In ultimate analysis agreement is not as much a challenge to our economic sovereignty as it is
a challenge to our ability to compete in international market.
14.6 FORMATION OF W.T.O. AND ITS FUNCTIONS
The signing of Final Act of Uruguay round after a great amount of discussion by member
nations in April, 1994 paved the way for setting up W.T.O. this was set up in 1955, India became a
founder member of W.T.O. The W.T.O. is a new international organisation set up as a permanent
body to play the role of watchdog in spheres of trade in goods and services, foreign investment,
Intellectual property rights etc. This organisation will administer new global trade rules.
Peter Southland was its first Director. According to him W.T.O. binds nations in a global
cooperative endeavour to raise income and create good jobs through fair and open trade. The
functions of W.T.O. are mentioned below :
(1) The W.T.O. administers through various councils and committees, the 28 agreements
contained in the final round of urguary Round.
(2) The W.T.O. shall provide the forum for negotiations among its members concerning
their multilateral trade relations.
(3) The W.T.O. acts as a watchdog on international trade among member countries.
(4) The W.T.O. provides its services in reconciliation in case of any dispute among
member countries.
(5) The W.T.O. provides a dispute settlement court.
(6) It provides security to multilateral trading system.
The W.T.O. is an improvement over GATT.
(1) It is more global than gatt i.e. W.T.O. has more members than GATT
(2) Its scope is more wider than GATT
Currently W.T.O. is passing through various challenges. No doubt it is in a position to show
its teeth. In coming days trade between different countries is bound to increase. This will also
increase various types of disputes. Their settlement will require more maturity on the part of W.T.O.
is trying its best to evolve a conscious on all important issues.
Working under WTO
The WTO inherited many of GATTs guiding principles. These fundamental principles are
incorporated in the numerous agreements that comprise the Agreement Establishing the World Trade
Organization. In its Understanding the WTO (2003), the World Trade Organization identified five core
principles.
The first principle is “trade without discrimination”, which involves most-favoured-nation (MFN)
status and national treatment. MFN states that a trade concession granted to one WTO member
automatically applies to all members. National treatment guarantees equal treatment of imported
goods with domestically produced output in nations’ markets.
The second principle is free trade through the progressive liberalization of trade regimes.
 The third principle is the predictability of trade rules. Predictability in this context, prevents
governments from arbitrary raising existing tariffs or non-tariff trade barriers.
The fourth principle is fair competition. Fair competition attempts to level the playing field in
international trade and minimize the market distortions caused by export subsidy, dumping and other
disruptive trade practices.
The fifth principle is economic development through trade. Economic development for the
world’s poorer countries should be enhanced by trade assistance and increased market access
through preferential trade arrangements.
The WTO’s dispute settlement process is the enforcement arm of the organization. The
WTO’s apparatus for dispute settlement is stronger and more defined than GATT’s dispute settlement
procedures. The WTO’s dispute settlement process is the essence of multilateralism. That is, a
country or group of countries can air trade grievances in a global forum. A trade complaint is made to
the WTO’s Dispute Settlement Body (DSB), which consists of the entire WTO membership. The DSB,
in turn, establishes a panel of three to five experts to hear the evidence and render a ruling. The
panel’s ruling can only be reversed by a unanimous vote of the DSB. Under normal conditions, the
entire process takes one year or less to complete. One or both sides in the dispute can appeal the
panel’s decision. A seven-member Appellate Body considers an appeal and renders a decision.
Again, only a unanimous vote of the DSB can reverse the Appellate Body’s ruling. The appellate
process could add as much as three month to the dispute settlement process. A member country
found guilty breaking WTO trade rules is required to correct the violation with due speed. The DSB is
empowered to initiate retaliatory tariffs or other trade sanctions for non-compliance with a WTO
ruling.
India and the WTO
India was one of the 23 founding contracting parties to the General Agreement on Tariffs and
Trade (GATT) that was concluded in October 1947. India has often led groups of less developed
countries in subsequent rounds of multilateral trade negotiations (MTNs) under the auspices of the
GATT.
In the last round (8th) of the multinational trade negotiation under the auspices of the GATT,
the World Trade Organization was created to subsume the GATT in 1995. Even after the, inception of
WTO in 1995, till the Doha Ministerial (2001), the developing countries were not very active at the
negotiating table. It is indeed ironic, as free trade is much more favourable for a developing country
than its developed counterparts. However, a new trend emerged from Cancun (2003) onwards and
since then, the former group has become much more vocal at the multilateral trade forums on the
protectionist policies of the latter.
Despite being a founder member of GATT, India was never very active in various negotiating
rounds until late eighties. Since the Indian economy followed the import substitution led growth
strategy during sixties and seventies, gaining from the import liberalisation at principal export markets
(the EU and US) was never a prime objective. In addition, a considerable proportion of India's trade
was directed to the Soviet bloc countries, and the presence of this assured market weakened the
incentive to search for newer outlets. On the other hand, opening the domestic market to foreign
competition through progressive tariff cuts was perceived harmful for the local industries. Instead, the
country was more willing to discuss trade and development related issues at UNCTAD forums in
collaboration with other developing countries like Brazil (primarily through the G-77 network). Despite
adoption of a proactive approach at WTO. India still feels comfortable to discuss trade-related issues
at UNCTAD forums for coalition building among developing countries on areas pertaining to mutual
interest.
14.7 INDIA’S PARTICIPATION IN WTO MEETINGS
Table illustrates India’s participation in WTO meetings :
Table India at the WTO Meetings
S. No. Place Year Outcome India’s Role
1. Singapore 1996 Information Technology Agreement was Mere presence
signed. In addition, four new issues were
discussed, Trade and investment,
Competition Policy, Transparency in
Government Procurement, and Trade
Facilitation.
2. Geneva 1998 Global E-commerce Agreement was signed. Mere presence
Also, the implementations issues were
discussed.
3. Seattle 1999 The negotiations failed as several developed Was vocal against
countries wanted to incorporate introduction of
environmental and labour-standard related environmental and
issues under the wings of WTO. The move labour-standard related
was strongly opposed by developing issues under WTO.
countries.
4. Doha 2001 A new round was launched and the Mostly signed out in its
concerns for developing countries like India protest. However,
(e.g. TRIPS and Public Health) were made its presence and
attended. The market access and position felt for the first
implementation issues were also given due time.
notice.
5. Cancun 2003 The members could not arrive at a common Actively protested
viewpoint even on the last date of the against EU-US draft on
conference. The ministerial decided to take agriculture jointly with
stock of progress in negotiations and other other developing
work under the Doha Development Agenda. countries.
The developing country solidarity at the
ministerial was formed for the first time.
6. Geneva 2004 Five member countries came forward to Played a constructive
create an atmosphere for initiating role in the process
multilateral negotiations once again. while protecting
developing countries
interests.
Source : Songupta et al 2006 c.f. Kapila (2010)
The first two ministerial meetings were held at Singapore (1996) and Geneva (1998)
respectively, where various provisions of the agreement were discussed and the state of their
implementation was reviewed. In addition, two new agreements, namely Information Technology
agreement and Global E-Commerce agreement were signed in these meetings. This was at a time
when India' s IT exports started to take off. Fortunately, the agreements inked on these issues have
actually helped e-commerce and not gone contrary to India's interests. The Singapore ministerial was
particularly important as it agreed to discuss in future on four issues: (1) Government Procurement,
(2) Trade and In vestment, (3) Trade and Competition Policy, and (4) Trade Facilitation-collectively
known as Singapore issues.
The road between Singapore and Seattle was not a rosy one for India owing to a number of
reasons. (kapila, 2010) First of all, the export growth rate decelerated in the second part of the
nineties. The disadvantages faced by the export sector were intensified after the East Asian crisis,
when the exchange rates of a number of countries in that region were devalued. On the other hand,
the service sector fast emerged as a major foreign currency-earner, and the urgency to ensure free
trade in this arena (or, at least in Mode 4, i.e., movement of professionals) was intensely fell. It was
noticed that while tariff barriers decreased to some extent in the post-WTG period, several WIG-
compatible non-tariff barriers through usage of higher standards (e.g., SPS- TBT measures) and
contingency provisions (e.g., anti-dumping measures, safeguard provisions) have sprung up, limiting
the impact of elimination of traditional NTBs (e.g., import quota). Non-realisation of proposed level of
market access in developed countries emerged as a major source of dissatisfaction. In addition, the
developed countries wanted to incorporate labour and environmental issues under the wings of WTO,
much to the annoyance of their developing counterparts.
However, the most important factor responsible for enhancing India's participation in WTO
negotiations was the outcome of the dispute settlement cases involving her. In general, the period
between 1995 and 1998 witnessed a substantial rise in the number of cases in WTO's dispute
settlement mechanism. India was among one of the victim of this provision as a number of developed
countries moved to the dispute settlement body complaining about the WTO-compatibility of Indian
policies.
In the Seattle Ministerial (1999), India was vocal at the multilateral forum for the first
time, protesting against a developed country initiative to incorporate labour and environmental
standards under the aegis of the WTO. Due to the protests of the developing countries. The
developed countries were not successful in incorporating this element in the agenda. The Ministerial
meeting ultimately ended in failure as the members could not arrive at a mutually agreeable solution.
The then Commerce Minister Mr. Maran viewed the Seattle outcome as a success for India as for the
first time, developing and poorer countries were united in mutual interest. (Kapila, 2010)
During the Seattle-Doha period, India, for the first time, started communicating its
dissatisfaction over several issues and sharing its position with other countries at various appropriate
forums of WTO and other international bodies. Broadly speaking, a clearly distinguishable and
proactive stand emerged before the Doha ministerial, and India became particularly concerned with:
(i) non-realisation of anticipated benefits (e.g., Agreement on Textiles and Clothing and Agreement
on Agriculture), (ii) inequities and imbalances in WTO (TRIPSs, Subsidies, Anti-dumping. etc.), and
(iii)-non-binding nature of special and differential provisions (market access, DSB, etc.). In short, India
strongly objected to the inclusion of any new issue in the negotiating agenda before realisation of
Uruguay round promises, the non-implementation of which was costly to developing countries.
Buoyed by the success achieved at Doha, India tried to utilise the two-year period before
Cancun in a much productive manner and coalition-formation experience with other developing
countries were fruitful. In Cancun, India principally negotiated over liberalisation of agricultural trade
and trade in services. In addition, there was sharp increase in the number of joint submissions at
WTO, ranging from agriculture to services. Interestingly, the Indian submissions to WTO, both joint
and individual, stressed both export promotion (enhancement of market access) and domestic
protection (e.g. provision of special products, special safeguard mechanism in agriculture) much
vigorously. On the other hand, domestic reforms have been regularly undertaken in order to enhance
compliance with WTO. The adoption of the 2005 Patents Ordinance and its subsequent tabling in the
Parliament, in spite of the domestic opposition, is the best example of it. (op. cit.)
However, if we are to measure the trajectory of India's learning curve by a sector-by-sector
basis, two areas stand out immediately. The first is anti-dumping, where India has transformed itself
from the major affected country to an aggressor becoming quick to intiate investigations. While in the
mid-nineties, it was one of the major affected countries, during the last two years, it has topped the
list by being the initiator of the maximum number of anti-dumping investigations.
The second area where India has evolved is with regards to its outlook towards regional
trading arrangements. From 2003 onwards, i.e., from Cancun days, it has initiated negotiations on
preferential access with a number of developing, countries, which would clearly help it in
guaranteeing an assured export market on one hand, and an ally in future negotiations on the other.
Kapila (2010) points out that what the WTO does for India by supplementing India's internal
market with global market it offers India the opportunity to utilise its most abundant factor labour, both
skilled as well as not so skilled. It also :
a) offers India the opportunity to supplement its meagre capital with investment from the
rest of the world to enhance growth, and
b) allows Indian entrepreneurs to plan for global markets given the fact that their export
destinations have to be governed by laws that are WTO compatible and thus, are rule
based and not run by administrative fiat.
How India utilises this opportunity is a separate matter. For example, India's export
performance depends a great deal on what the state delivers on the infrastructure front. India's
infrastructure is inadequate to cater to industry as well as agriculture, and erodes competitiveness in
both sectors. This can be remedied by a) investment by the state and/or b) by instituting reforms to let
the market participate in the solution of this problem.
The problem areas on freeing international trade are yet to be resolved although the 10-year
transitory phase of WTO came to an end on December 31, 2004. While tariff barriers have declined
over the last 10 years, newer standard-related and procedural non-tariff barriers have been devised
to protect the market. Ever the effectiveness of tariff reduction in strategic areas has been subjected
to questions. In agriculture, the debate over subsidisation issue is far from over, and the tussle
between developed and developing countries is likely to intensify in coming days. In industry the
increasing use of contingency and safeguard measures has turned out to be another major source of
dispute especially – pharmaceutical and textile sector. While the public health related concern in case
of TRIPS is quite high in developing countries like India, especially in a product patent regime, the
MFA phase-out might turn out to be a boon (if India responds swiftly enough). In case of services, the
conflict of interests between developed and developing countries in liberalisation of various modes is
playing the key role with no global agreement in sight. Finally, the effectiveness of WTO rules like
special and differential treatment and dispute settlement procedures in protecting the interest of
developing country members has often been questioned.
The Sixth WTO Ministerial Conference
(Hong Kong, December 13-18, 2005)
While the discussions held at Hong Kong resulted in a much more acceptable Ministerial
Declaration as compared to the "Derbez Draft" circulated at Cancun, the developing countries are yet
to reach their goal (especially over the last two -years)-reduction in agricultural subsidisation level in
developed countries. Similarly, there exists enough scope for expanding market access in other
areas in the developed country markets (e.g. Mode 4 of services trade for India). At best, it could be
argued that some deal is probably better than a Cancun-type no-deal, thereby portraying the result of
the ministerial as a second best outcome.
It was argued that the selection of right partners in negotiating groups for pursuing a goal,
given the national interest of a particular member, is of extreme importance. Stated alternatively,
whenever surrounded by partners with a diverse interest pattern, a country might need to downplay
some of its focus areas to keep everyone in the group happy. (Kapila, 2010)
Now developing countries are in no way homogeneous; nor are their developed counterparts,
for that matter. But disparities-are visibly greater in the former group, which consists of advanced
developing economies, small and vulnerable economies, landlocked countries and least developed
countries (LDCs) thrown in together. As a matter of fact, only 31 out of the 49 LDCs are members of
the WTO. The developing countries and LDCs are scattered in various groups. There are the 77 ACP
(African, Caribbean and Pacific) countries, beneficiaries of preferential trade with EU, whose interest
revolves around preference erosion in items like sugar and bananas. The 41-member strong African
Group, APEC (Asia-Pacific Economic Cooperation) and ASEAN could also be mentioned in this
regard. The Cancun Ministerial witnessed the evolution of G-20, with Brazil, China, India and South
Africa -constituting the core. There is also the G-33 with a defensive interest in agriculture through
special products and the special safeguard mechanism (SSM). There is the G-9O, a coalition of the
African Group, the ACP countries and member LDCs. In addition, the Hong Kong Ministerial
witnessed the emergence of the NAMA-11, focusing on non-agricultural market access. Some
developing countries are also members of the agro-exporting Cairns Group.
The G-20 has gained recognition as a credible negotiating entity in the negotiations- The
Ministerial Declaration adopted at Hong Kong addresses some of the concerns of developing
countries related to agriculture. It has been agreed, that development programmes of developing
countries that have minimal distorting effects will be incorporated into the green box. It has further
been agreed that the three heaviest subsidizers, namely, the EC, the US and Japan, will attract the
highest levels of cuts in their trade-distorting domestic support entitlements, and that these cuts must
be effective.

Key Outcomes and Timelines of Hong Kong Ministerial Declaration

 Resolve to complete the Doha Work Programme fully, and to conclude negotiations in
2006.
 To establish modalities in agriculture and non-agricultural market access (NAMA) by
April 30, 2006 and prepare draft Schedules by July 31, 2006.
  To eliminate export subsidies in agriculture by 2013, with substantial part in the first
half of the-implementation period. Developing countries without Aggregate-
Measurement of Support (AMS), such as India. Will be exempt from reductions in de
minimis and the overall cut in trade-distorting domestic support, consisting of AMS, the
Blue Box and de minimis, that is entitlement to provide Amber Box subsidies up to 10
per cent of value.
 To submit a second round of revised services' offers by July 31, 2006 and submit-final
draft schedules by October 31, 2006.
 Amendment to TRIPS Agreement reaffirmed to address public health concerns of
developing countries.
 Duty-free quota-free market access for all LDCs' products to all developed countries.
Developing country declaring itself to be in position to do so, to also provide such
access, though flexibility in coverage and in the phase in of their commitments is
provided.
 In cotton, export subsidies to be eliminated by developed countries in 2006 and trade-
distorting domestic subsidies to be reduced more ambitiously and over a shorter
period of time.
Source : Economic Survey 2005-06. c.f. Kapila (2010)
Among other decisions taken in the Hong Kong Ministerial, it was agreed that all developed
country members, and those developing countries declaring themselves in a position to do so, shall
provide duty free and quota-free market access on a lasting basis to all products originating from all
LDCs. Agreement was also reached on some other outstanding S&DT (Special and Differential
Treatment) proposals by LDCs. On the issue of relationship between Trade Related Intellectual
Property Rights (TRIPS) and Convention on Biological Diversity (CBD) and protection of traditional
knowledge, the Declaration calls for intensification of the consultation process. On implementation
issues, the ministers agreed to redouble their efforts to find appropriate solutions to them and it was
agreed that the Council shall review progress and take appropriate action no later than July 31, 2006.
The fresh time line for reaching results on S&D cluster is December 2006.
DOHA TALKS
However, the Doha round of free-trade talks collapsed on July 24, 2006 after nearly five years
of haggling. The.G-6 Comprises the US. The EU, Japan, Brazil, India and Australia. The EU and
India accused US of "Stonewalling" by demanding too high a price for cutting the $20-billion it spends
on farm subsidies. The US was adamant and neither the ED nor India were prepared to offer the sort
of access to their' markets that Washington needed to make a deal on subsidies worthwhile. The
commerce minister (Kamal Nath) remarked. "Developing countries could not permit their farmers to
lose their livelihoods and food security to provide market access to subsidized agriculture products
from developed countries."
After the suspension in negotiations during July 2006 due to the wide gaps in the positions of
WTO members, especially on agricultural domestic support and market access, there was a soft
resumption of negotiations on November 16, 2006.
While safeguarding the interests of India’s low income and resource poor agricultural
producers (which cannot be traded off against any gains elsewhere in the negotiations) remains
paramount for india making real gains in services negotiations where it is a demander is no less
important. In the case of industrial tariffs, India's growth and development concerns need to be
addressed where India has taken a stand along with NAMA-11 coalition (a group of 11 nations
fighting together). These concerns are reflected in India's position on different WTO issues for
negotiations.
India’s Stand on Various Issues
India’s stand on various issues have been explained under three main main heads –
1. Agriculture
2. Services
3. Non Agricultural Market Access; and
4. Rules
1. Agriculture
 Overall tariff reductions on bound rates for developing countries of not more than 36 per cent.
 Thresholds of the four band tariff formula with linear cuts to be adequately higher for
developing countries to take into account their ceiling bindings.
 Self-designation of an appropriate number of special products (SP) guided by indicators
based on the three fundamental and agreed criteria of food security, livelihood security and
rural development needs. The G-33 has proposed 20 per cent agricultural tariff lines as
special products, of which 40 per cent must be exempted from any tariff cut. India cannot
accept TRQ commitments on SPs since it would entail necessarily going below current
applied rates on the most sensitive products, viz., SPs.
 An operational and effective Special Safeguards Mechanism (SSM) to check against global
price dips and import surges, which is more flexible than the existing safeguard mechanism
available mainly to developed countries. The G-33 and India remain firm that a priori exclusion
of any product, particularly SPs from the amit of the SSM cannot be justified or accepted.
 Substantial and effective cuts in overall trade-distorting domestic support by the United States
(70-75 per cent cut) and by the European Union (75-80 per cent cut), including resolving the
issues of product specific caps on Aggregate Measurement of Support (AMS) and in the new
Blue Box.
2. Services
 Commitments by the developed countries on substantial openings for India’s contractual
service suppliers (CSS) and independent professionals (IPs) in Mode 4 relating to movement
of natural persons.
 Developing of disciplines in Domestic Regulations in Mode 4 involving qualification and
licensing requirements and procedures.
3. Non agricultural Market Access
 A fair markup on the unbound tariff lines.
 Flexibilities that are adequate and appropriate to address the sensitivities of developing
countries.
4. Rules
 Strengthening of disciplines in anti-dumping include mandatory application of lesser duty rule,
prohibition of zeroing, stronger rules on reviews, including sunset review.
 Against the enlargement of the scope of the Agreement on Subsidies and Countervailing
Measures (ASCM) and/or limit existing flexibilities for the developing countries.
  Effective special and differential (S&D) treatment in any new disciplines on fisheries subsidies,
particularly in the light of employment and livelihood concerns for small, artisanal fishing
communities and for retaining sufficient “policy space”.
Resumption of Doha Round of Talks
In the year 2008-09 there was an intensive process of negotiation following the resumption of
the Doha Round of talks 10 February 2007. To facilitate the process the Chair of the WTO's
Committee on Agriculture and the Chair of the Negotiating Group on Market Access, brought out four
draft proposals so far beginning with a first version on July 17, 2007. The fourth revision of the draft
was issued on December 6, 2008. A mini-ministerial meeting was held from July 21-29. 2008 in the
WTO to discuss the modalities in agriculture and non-agricultural market access (NAMA). In
agriculture, the issues discussed included reductions in overall trade distorting domestic support by
developed countries, tariff cuts, designation of sensitive products, special products, the special
safeguard mechanism (SSM) for developing countries, etc. While in the end, discussion focused
almost exclusively on the SSM which could not be resolved, this was not the only contentious issue.
Several issues in agriculture and NAMA were not discussed at all and remained unresolved.
Multilateral discussions on agriculture resumed at the WTO in October 2008. The Chair of the WTO
Agriculture Negotiating Group has specifically identified certain dements in the Fourth Revised Draft
Modalities Text of December 6, 2008, as areas where large negotiating gaps remain to be bridged.
These are Sensitive Products (SEPs), tariff quota creation, non-SEPs with tariffs higher than 100 per
cent, tropical and diversification products, preference erosion and the SSM, proposals for reduction in
subsidies for cotton and tariff simplification.
The Doha Round of WTO negotiation is a Development Round and development concerns
are at the core of the Round. The major issues for negotiations are related to agricultural
negotiations. NAMA services negotiations and rules negotiations. In the context of recent
developments, self-designation of an appropriate number of special products (SPs) to take care of
India's food security, livelihood security and rural development needs were considered in the revised
draft text of December 6, 2008. It proposes an average tariff cut of 11 per cent for a 12 per cent of
total tariff lines to be designated as SPs with 5 per cent of tariff lines taking zero or no tariff cuts.
Although the issue was discussed during the mini-ministerial meeting, there are a number of
elements yet to be resolved to the full satisfaction of India and its coalition partners in the G-33. The
revised text of December 6, 2008, on NAMA incorporates some of the numbers proposed on formula
coefficients, flexibilities and anti-concentration by the Director General of the WTO on July 25, 2008
during the mini ministerial meeting.
Other Intiatives
The leaders of G-20 met in London on April 2, 2009 at the backdrop of the worst economic
and financial crisis, a crisis which has deepened further since the Washington Summit held on
November 15. 2008.
To ensure early, amongst other things. India has strongly emphasized the need to continue
with coordinated contracyclical policies within an overall framework of fiscal sustainability and
restoration of the banking system in the industrialised countries to full functionality; to avoid
protectionist sentiments in the trade of both goods and services emerging in the industrialized
economic.
Further, India has stressed upon the need for longer term reform of the global financial
architecture including increasing the representation of developing and emerging market economies,
reform of the global financial system through stronger regulation and improved supervision, especially
of systemically important financial institutions, through among other things, developing an effective
early warning system which can spot a build up of risks threatening global financial stability. India has
also endorsed sharing information and bringing tax heavens and non-cooperating jurisdictions under
closer scrutiny.
It was also resolved to restore confidence in growth and jobs; repair the financial system to
restore lending; strengthen financial regulation to rebuild trust; fund and reform the international
financial institutions; promote global trade and investment and reject protectionism; and build an
inclusive and sustainable recovery.
As per the London communiqué, the leaders had agreed to treble resources available to the
IMF to US$ 750 billion to support a new SDR allocation of US$ 250 billion, to support at least US$
100 billion of additional lending by the multilateral development banks (MDBs), to ensure US$ 250
billion of support for trade finance, and to use the additional resources from agreed IMF gold sales for
concessional finance for the poorest countries constituted an additional US$ 1.1 trillion programme of
support to restore credit growth and jobs in the world economy. (Kapila, 2010)
The other major initiatives agreed upon are :
 For strengthening the financial system, a new Financial Stability Board (FSB) with a
strengthened mandate, as successor to the Financial Stability Forum (FSF), including
all G-20 countries, FSF member, Spain and the European Commission, which should
collaborate with the IMF to provide early warning of macroeconomic and financial
risks, and actions needed to address them. Extend regulation and oversight to all
systemically important financial institutions, instruments and markets, including
systemically important hedge for the first time.
 For strengthening global financial institutions, leaders committed to implement the
package of IMF quota and voice reforms agreed in April 2008 and to complete the next
review of quotas by January 2011. For World Bank also, similar reform should be
completed on an accelerated time scale, to be agreed by the 2010 Spring Meetings.
 For resisting protectionism and promoting global trade and investment, members have
committed to refrain from raising new barriers to investment or to trade in goods and
services, imposing new export restrictions, or implementing World Trade Organization
(WTO) inconsistent measures to stimulate exports and will not retreat into financial
protectionism, particularly measures that constrain worldwide capital flows, especially
to developing countries.
 For ensuring a fair and sustainable recovery, all leaders reaffirm their commitment to
meet the Millennium Development Goals and achieving respective ODA pledges,
including commitments on Aid for Trade, debt relief and the Gleneagles commitments,
especially to Sub-Saharan Africa.
To conclude, while India, so far, may not have been able to gain a lot from the negotiations, it
certainly came out of seclusion during the Doha Ministerial (2001) Meet and is currently leading the
developing country coalitions at WTO. Furthermore, expansion of the negotiating agenda (e.g.
environmental services) in recent years depicts an evolving learning curve, which is no less
important. A similar ‘learning through trading’ is observed in the case of several other developing
countries as well. On the other hand, the aversion of several developed countries towards ensuring
free trade is becoming quite obvious in recent years.
14.8 LOOKING BEYOND DOHA
 At the Eighth Ministerial Conference (MC8) of the WTO in Geneva, December 15-17 , 2011
three Working Sessions were held in parallel (the NGOs were not allowed to take part in it), directed
to three topics:
(i) Importance of the Multilateral Trading System and the WTO;
(ii) Trade and Development; and
(iii) The Doha Development Agenda negotiations.
As had been expressly stated in the run-up to the MC8 both from the WTO, from capitals, and
in media reports, the Doha Round negotiation generally had come to an impasse. The impasse was
made especially clear from the outcome of the so-called Easter Package in April 2011 - which
comprised the collected reports of the WTO negotiating bodies in all the different areas involved in
the Doha Round negotiations. Pascal Lam, Director General of the WTO, said in a statement March
29, 2011, that the 'biggest stumbling block was what is called ‘NAMA. Sectorals’. This is about
proposals for major trading countries, including emerging economies, to allow duty-free or lower than-
normal duty on imports in particular sector within the non-agricultural market access (NAMA)
negotiations.
That assessment was also made very clear in the statement by the US Trade Representative
at the MC8, the current impasse in many ways come down to one single, vexing quandary: the WTO
has not come to terms over core questions of shared responsibilities among its biggest and most
successful Members. The world has changed profoundly since the negotiations began a decade ago,
most obviously in the rise of the emerging economic. The results of our negotiations thus far do not
reflect the change, and yet they must if we are to be successful.'
TRIPS issues had already earlier in 2011 been placed in what was called a 'slow lane’ in the
negotiations. For the 'Easter package’ in April 2011, the status of the GI (Geographic Indication)
issues and of the TRIPS/CBD issue was reported by the Director-General, document TN/C/W/61
dated April 21,2011. On the TRIPS CBD issue a submission was made in the context of the Easter
Package from a number of WTO Members including Brazil India, and China in April 2011, requesting
a revised version of the TRIPS Agreement calling for disclosure of origin of general resources and/or
associated Traditional Knowledge, involved in patent applications. Noteworthy in that this submission
was not sponsored by the EU and Switzerland, two of the original sponsors of the 2008 'mini-
ministerial' proposal for a TRIPS package on GIs and disclosure of origin of genetic sources.
Nevertheless, of tie decisions taken, at the MCB, two are TRIPS related:
(i) Extending until the next Ministerial Conference, to be held in 2013, the moratorium on
what is called “non-violation homplaints” under the TRIPS Agreement; and
(ii) Instructing the TRIPS Council to extend, [under TRIPS Article 66.1], the transition
period expiring June 30, 2013, for LDCs, for implementing the TRIPS Agreement.
14.8.1 Future Directions
At the MC8 the WTO members acknowledged the concerns on the global economic climate
and agreed that:
(i) There is no credible alternative to the rules based multilateral trading system; and
(ii) Protectionist trade measures must be avoided.
The Chairman, in his summary report, stressed that the future work of the WTO must give
priority to the development issues of LDCs, in particular cotton. Further, that the WTO needs to take
into account the views of all its members. Despite the uncertainty surrounding the Doha negotiations,
the MC8 has sent a clear message that the WTO remains relevant and important to world trade, as
illustrated by the accessions of the Russian Federation, Montenegro, Samoa and Vanuatu. In his
concluding remarks, Pascal Lamy stressed that despite these worrying economic times ‘don’t chop
off the branch you're sitting on..,'(a Russian proverb). The multilateral trading system is vital to world
economic stability. Finally, the Doha negotiation impasse has led to members exploring new
approaches to negotiating. Members were asked to have political courage and goodwill in concluding
the DOHA round.
14.9 WTO : BALI CONFERENCE
At the Ninth Ministerial Conference, held in Bali, Indonesia, from 3 to 7 December 2013,
ministers adopted the ‘Bali Package’, a series of decisions aimed at streamlining trade, allowing
developing countries more options for providing food security, boosting least-developed countries'
trade and helping development more generally. They also adopted a number of more routine
decisions and accepted Yemen as a new member of the WTO. The major parts of the Bali
Declaration are as given below:
(i) The round is historic because the WTO reached its first ever global trade reform deal,
approved by 160 ministers (including the newly added member Yemen) after 12 years
of negotiations. The conference has successfully managed to push for a deal, which
while representing a tiny fraction of what was set to be inked in the Doha round of talks
stalled since 2001, paves way for significant trade reforms. This agreement rescues
the WTO from a threat of obsolescence that was anticipated with several regional
trade pacts being pursued by countries.
(ii) The deal seeks to lower barriers to trade worldwide through a global Trade Facilitation
Agreement (FTA) that seeks to reduce red tape, cut costs and improve efficiencies by
taking measures such as digitisation of procedures etc. (some estimates suggested,
the deal could boost global gross domestic product by $1 trillion, increase exports by
$570 billion and create 20 million jobs for developing countries).
(iii) India was not eager to compromise on food security.
14.10 NAIROBI PACKAGE
The “Nairobi Package” was adopted at the WTO’s Tenth Ministerial Conference, held in
Nairobi, Kenya, from 15 to 19 December 2015. It contains a series of six Ministerial Decisions on
agriculture, cotton and issues related to least- developed countries (LDCs). A Ministerial Declaration
outlining the package and the future work of the WTO was adopted at the end of the five-day
Conference.
14.11 BENEFITS & FEARS
Lets analyse how far India is benefitted but of this. Now following the areas of benefit textile
and agriculture; and area of fear-TRIPS, TRIMS and services.
14.11.1 Areas of Benefits for India (Opportunities)
(i) It is estimated (GATT secretariat) that the income effects of the implementation of the
Uruguay Round package will add between 213 and 274 billion U.S. dollars annually to world income.
The GATT Secretariat further projects that the largest increases will be in the areas of clothing (60
percent), agriculture, forestry and fishery products (20 percent) and processed food and beverages
(19 percent). According to the Government of India, since our country's existing and potential export
competitiveness lies in these product group, it is logical to believe that India will obtain large gains in
these sectors. It is to be noted that increase in world trade depends not only on trade liberalization
but a number of other factors. like quality consciousness proper infrastructure for export production,
assured supply of export products, level of technology, etc. and India suffers from relative
disadvantage vis-a-vis the developed countries in most of these factors.
(ii) Export from Textile Sector: The phasing out of the MFA (Multi-Fibra Arrangement) by
2005 will benefit India as the exports of textiles and clothing will increase. However, the phasing out
schedule favours the developed countries and a major proportion of quota regime to the extent of 49
percent is going to be removed only during the tenth year, i.e. by 2005. Thus the Uruguay Round
does not provided an immediate market access for the Third World textile exports. By the time the
MFA is completely passed out in 10 years, the developed countries council gear themselves to effect
improvement in quality, efficiency and competitiveness. When quotas are removed, they will be
eliminated not only for India, but for everyone else. There will therefore, be considerable competition
from China, Vietnam, Pakistan, Bangladesh, Indonesia and Malaysia. The question of evaluating the
competitiveness of India's garment exports. There are a number of constraints like higher costs and
prices, poor quality and unreliability of the end product.
(iii) Export of Agricultural Products: India expects relates to the improved prospects for
agricultural experts as a result of likely increase in the world prices of agricultural products due to
reduction in domestic subsidies and berriers to trade. While on the one hard earning from agricultural
exports are likely to increase, on the other hand India has ensured that all major programmes for the
development of agriculture will be exempted. Thus the public distribution system will not be affected
by the provisions of the Agreement. Agricultural subsidies granted by developing countries need to be
withdrawn till such time they remain within the prescribed limits specified in the Agreement. It is
proposal the protection necessary for developing the agricultural sector in the under developed
countries might be continued. In fact as stated above, India hopes that the reduction of subsidies in
the USA and the European Community will enable it to increase its earning from agricultural exports.
(iv) The Uruguay Round Agreement has strengthened multilateral rules and disciplines. The
most important of these relate to safeguards and disputes settlement.
14.11.2 Areas of Fears (Challenges)
The above mentioned probable gains to India are suspect and the projections may prove
wrong. Few economist prospects of increase in agricultural exports from India due to the very limited
extent of agricultural liberalization. Moreover, there will hardly be any liberalization of our textile
exports till 2005, with most of the liberalization expected to come at the end of this period.
The most serious disadvantages to India are likely to flow from the Agreements pertaining to
the TRIPs, TRIMs and services all we have discussed in detail.
(I) TRIPs: The argument in favour of protection of intellectual property rights (patents, copy rights
trademark etc.) is that it encourages innovation by rewarding the inventors with the grant of monopoly
rights over the commercial exploitation of their inventions for a specified period. However the TRIPs
agreement is bound to favour a handful of developed countries. This is due to reason that just 10
countries account for the bulk of all technological activity in the world. The top 10 countries account
for a much as 84 percent of global resources spent taken out in the USA. It is obviously these
countries that are bound to corner most of the benefits flowing form TRIPs Agreement. Moreover the
Agreement itself highly weighted in favour of the multinational corporations and the developed
countries. According to him, partition of IPRs (intellectual property rights) is, in itself anti-competion
and anti-liberalization and goes against the spirit of opening up the world economy and global
integration it amount to 'legalizing' the monopoly of MNCs. Thus protection of IPRs is, itself, a barrier
to trade. Under the Indian Patents Act only process patents were granted in food chemical and
medicines. TRIPs Agreement provides for granting product patents also in these areas, (1) Under the
TRIPs Agreement methods of agriculture and horticulture and bio-technological process (including
living organism like plants and animals) are patentable (2) The Indian Patent Act modified for term of
14 years for both product as well as process patents.(3) under TRIPs no ceiling can be placed on
royalty demanded on patents like in the Indian Patents Act (4) The Patent Act of India, 1970 granted
only process patents to drugs and medicines, which means that an Indian company way only
required to develop and patent its own process for producing a drug, it was not required to invent the
drug itself. The company could then legally manufactures this drug, even if it was protected under a
product patent abroad.
The effect of these laws have been positive for India. Indian drug prices are considered to be
among the lowest in the world, and this is not the expense of quality. In addition, the indigenous
pharmaceutical: industry has grown rapidly after the passage of the 1970 Act. Not only this, the
market share of Indian drug companies in the local drug market went up from 30 percent in 1970 to
61 percent in 1993. Today, India is, in fact, an exporter of drugs to other parts of Asia, Europe, and
even USA.
All this will change in the new order. The granting of product patents will effectively place the
reins of the Indian pharmaceutical industry in the hand of MNCs who will exploit this advantage to the
full by hiking the prices of drugs and medicines considerably. A study estimated that the weighted
mean drug price in India could increase between 26 percent and 242 percent a result of the
Introduction. of Product Patents. The extension of intellectual property rights to agriculture (via the
patenting of plant varieties) has serious consequences for India. In India, plant breeding and seed
production are largely in the public domain. Plant breeding is undertaken by agricultural universities
and units of ICAR of Agricultural on research whereas seed multiplication is in the hands of the
National and State Seed Corporations. This is due to the reason that India being a poor country
where agriculture is the livelihood of the majority of the population, the government must bear the
responsibility of ensuring the supply of adequate quantities of seeds at reasonable prices to the
farmers. The aim is not to maximize profit as would be the case in the private sector but to sustain the
livelihood of the majority of the population of the one hand, and to achieve self sufficiency in food
grains on the other hand. Patenting of plant varieties will transfer all the gains to the multinational
companies. Almost all new varieties will belong to MNCs simply by virtue of their massive financial
resources.
Under TRIPs, Patenting has been extended not only to plant varieties but to the large area of
micro-organisms as wel1. Micro organisms refer to very small forms of life. In this category are
included such living creatures as bacteria, virus, algae (the green scum that grows near water), small
plants and animals and even genes. The most important sectors are agriculture, pharmaceuticals and
industrial biotechnology. In the field of agriculture, efforts are on worldwide to develop bio-substitute
(which are based to a large extent on micro organisms) for chemical fertilizer and pesticides as the
latter are not ecologically sustainable and will poison our land and water. In the field of
pharmaceuticals, seven kinds of drugs are derived from micro organisms. The patenting of life forms
will strike at the very roots of indigenous manufacturing of such drugs. As far as industrial
biotechnology is concerned, it is estimated that in the coming two to three decades, 60 to 70 percent
of the global economy would rest on biotechnology because fields (agricultural, pharmaceutical and
industrial biotechnology) linked to micro organisms are either already with the machinating
companies and very media to dominate the global economy that will emerge in the coming years.
(II) TRIMs: In order to make the Agreement balanced from the point of view of the developing
countries, it was necessary to formulate international rules for controlling restrictive business
practices of foreign investors. However, the TRIMs Agreement is totally silent on this vital question
and is concerned mainly with provisions for elimation of trade related investment measures which are
designed to protect the interest of foreign invertors in the developing countries. For the developing
countries, the provisions of the TRIMs Agreement will most likely have the effect of undermining and
plan or strategy of self-reliant growth based on the technology and other resources available locally. It
could also prove a drain on the foreign exchange reserves of the developing countries, adversely
affecting their balance of payments position.
(III) Services: There is a vast level of difference in the development of services like banking,
insurance, telecommunications and shipping as between the developed countries and the developing
countries. In fact the very inclusion of trade in services in Uruguay Round negotiations was on
persistent insistence on the developed countries. The principal exporters of services are the USA,
France, Japan and Netherlands in that order and together they account for about 60 percent share of
the world trade in services. It is these countries that will benefit most from the new agreement on
services as arrived at in the Uruguay Round and the share bf the developing countries will decline
further. The service industrial is in an incipient state in many developing countries and its progress
will not be throttled under the new Agreement. As far as India is concerned, services sector is not as
underdeveloped as in many other developing countries (Yet, in terms of the new Agreement, it will be
required to denationalize insurance and banking. Foreign firms will now be free to expand their
network in the Indian services sector. They will also be free to remit resources to their parent country
in the form of profits, interest, royalties etc. All this will involve a foreign exchange burden on India. As
far as Indian firms are concerned, they will find it difficult to compete with the firms supplying services
in the developed countries.
Activity
Q. Name the latest WTO ministerial conference that has taken place in recent past. Name the major
issues raised by India.
_____________________________________________________________________________
_____________________________________________________________________________
_____________________________________________________________________________

14.12 CONCLUSION
To conclude, India may not have gained much from the negotiations it certainly care out of seclusion
during the course of Doha Ministerial (2001) and began to lead, even currently, the developing countries at
WTO. The expansion of negotiation agenda (e.g. through inclusion of environmental services) in the recent
past depicts an evolving learning curve. Furthermore, the aversion of many developed countries towards
ensuring free trade has also come to the fore.
14.13 SUMMARY
In this lesson, We have read about the formation of WTO, its functions and its working in
India. After studying about various rounds of WTO and discussions & decisions at the various
ministrial meets, we have read about the impact of WTO on India. The areas of benefit for India are
mainly textile and agricultural exports while the area of fears are TRIPs, TRIMs ans services sector.
Let us explain this all through a flow chart.

(Participation, Meeting and Stand on Various Issues)

14.14 GLOSSARY
 GATT : General Argument on Trade and Tariffs formed in 1948. India is one of its founder members and
has often led group of less developed countries in the round in the rounds of Multilateral Trade, AFI
Negotiations under GATT.
 WTO : World Trade Organization is an international organisation that oversees the operation of rules –
based multilateral trading system. WTO is based on a series of trade agreements negotiated under the
eighth and final trade Round conducted under the GATT. WTO began its operations on 1 Jan. 1995 V. Its
headquarters is located in Geneva Switzerland, comparing 148 member.
 Treaty of Marrakesh : WTO was established under this treaty at the close of Uruguay round in 1994.
 GATS : Article 2 of WTO i.e. General Agreement on Trade in Services pertains to the trade of commercial
services.
 TRIPS : Article 4 of WTO i.e. the Argument on Trade - related expect of Intellectual Property Rights,
provides uniform legal protections for scientific, technological and artistic achievements.
 DSB : Every trade complaint of the aggrieved member – nation is made to the WTO’s Dispute Settlement
Body which consists of the entire WTO membership. Generally a seven member Appellate body considers
an appeal and renders a decision with in a year.
 NAMA : Non-Agricultural Market Access.
14.15 REFERENCES
 Puri, Misra (2016). Indian Economy Since independence. Himalaya Publishing House. New Delhi.
 Kapila, Uma (2014). Indian Economy, Performance & Polices. Academic Foundation. New Delhi.
 Kapila, Uma (2016). Indian Economy Since independence. Academic Foundation. New Delhi.
14.16 MODEL QUESTIONS
 Comment upon the formation, functions and working of WTO in India.
 Critically examine the impact of WTO on the various dimensions of WTO in India.
 Write a short note on
a) TRIPS
b) TRIMS
c) AOA
d) Trade in Services

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 Lesson 15

WTO AND THE INDIAN AGRICULTURE:

PROSPECTS AND CHALLENGES
Structure
15.0 Objectives
15.1 Introduction
15.2 Provisions of WTO
15.3 Expectations
15.4 Challenges Ahead
15.5 Way to Fight Challenges
15.6 Agricultures Subsides and WTO
15.6.1 AMS
15.6.2. Boxes (Amber, Blue and Green)
15.7 Glossary
15.8 Summary
15.9 Glossary
15.10 References
15.11 Model Questions
15.0 OBJECTIVES
After going through this lesson, you shall be to :
 explain provisions of WTO (1995) and explications from joining WTO
 discuss challenges ahead and ways to fight them
 describe that status of Agriculture subsides under WTO
15.1 INTRODUCTION
The previous chapter highlighted the prospects of Indian joining WTO and challenges ahead. This
lesson highlights the issues relating to agriculture sector after joining WTO, which includes agriculture
subsidies in the main. We shall study AMS, Amber Box, Blue Box and Green Box.
Introduction to the topic
With the operationalisation of the provisions of the world Trade Organisation (WTO), the
process of globalization commenced in the major parts of the world - the non-member countries, in
the coming few years, also started negotiating for entry into the club. There has always been an air
of confusion among the members and the non-members of the WTO in assessing the pros and cons
of globalisation on the health of their economics. The sector winch has created the highest number of
deliberations in the WTO as well as views and counterviews has been agriculture—an area of utmost
concern for die developed and the developing worlds alike. India is no exception to it, better say it has
been among the few countries in the world spear-heading the campaign against the biased provisions
of the WTO concerning agriculture.
India was skeptical about the issue even before joining the organisation, but once it became a
part of it, it started assessing die situation objectively and moved towards crisis mitigation.
Globalisation as such opened unlimited prospects for the economies but at the same time brought
several challenges, too. The challenges are different in nature for the developed and the developing
countries. We need to enquire the prospects and the challenges brought be WTO for Indian
agriculture.
Had the agriculture of the leading and politically vocal developing economies not be of
subsistence level, the course of the work would have been completely different. It is the biggest
hurdle in the process of globalisation and the success of the World Trade Organisation. The process
of converting the sector into an industry has already started in most of the leading developing
economics though amidst tough resistance from the farmers, political parties and the NGOs alike.
15.2. PROVISIONS OF WTO
The oldest and the first document regarding the impact of the implementation of the provisions
of the WTO, Uruguay Round (1995-2005) was prepared jointly by the World Bank, the GATT1 and the
OECD2,According to the joint document, the WTO provisions were supposed to have the following
positive impacts on the world trade:
(i) By 2005 there will be an addition of $745 billion in the world merchandise trade.
Merchandise trade does not include services.
(ii) The GATT Secretariat provided a full break-up of the above-projected trade increase
in the following way:
(a) The clothing sector to have a share of 60 per cent.
(b) The agricultural, forestry and fisheries products to have a share of 20 per cent.
(c) The proposed found, beverages and drinks to have a share of 19 per cent.
It means that due to the implementation of the WTO provisions, there will be only one per cent
increase in the trade of all other goods excluding the above-cited sectors. It was a highly inflated view
and became a matter of debate around the world. But the areas which were projected to have very
high increase in their trade were not mere projections either. Member countries went home and
started going for their own studies, estimations and projections—India being no exception. Let us see
the assessment of India in the forthcoming section.

1. General Agreement on Trade and Tariff (GATT) was a multi-lateral arrangement (not an organization like WTO whose
deliberations are binding on the member countries) promoting multi-lateral world trade. Now the GATT has been replaced
by the WTO (since Jan. 1995).
2. Organisation for Economic Cooperation and Development (OECD) was set up as a world body of the developed
economies from the Euro-American region which today includes countries from Asia, too (such as Japan, S. Korea). The
first idea of ‘globalisation’ was proposed by the OECD in the early 1980s at one of its Annual Meet (at Brussels).
15.3. EXPECTATIONS
Following points tell about the objectives of Indian agriculture at the time of joining WTO : for
Indian Agriculture at the time of WTO formulation :
15.3.1 The products which were projected to have the maximum increase in their trade, India had a
traditional great export potential in them. It means the WTO has a great prospect for agriculture in
store as maximum goods fell in the agriculture sector. Assuming that India's share in the world
exports improves from 0.5 per cent to 1.0 per cent, and India is able to take advantage of the
opportunities that are created, the trade gains may conservatively be placed at $2.7 billion extra
exports per year. A more generous estimate will range from S3.5 to $7 billion worth extra exports. 3
15.3.2 The NCAER (National Council for Applied Economic Research) survey of the WTO on the
Indian economy is cited as the best document in this area. The survey4 had all important things to say
on this issue, as follows :
(a) The exports of agricultural products will be boosted by the WTO accepted regime.
(b) Only the foodgrains trade that too of wheat and rice were projected to be around $ 270
billion.
(c) The survey also pointed out that almost 80-90 per cent of the increased supply of
foodgrains to the world is going to orginate from only two countries China and India as
they are having the scope for increasing production.
(d) But the survey painted a very wretched picture about the preparedness of Indian
agriculture sector to exploit the opportunities. It concluded China to be far far better
than India is this matter.
(e) It suggested almost every form of preparedness for the agriculture sector (its glance
we may have been on the second Green Revolution in India—basically the revolution
is modelled on the findings and suggestions of the survey).
(f) Lastly, the survey ended at a high note of caution and concern that if India fails in its
preparations to make agriculture come out as a winner in the WTO regime the
economy will emerge as the biggest importer of agricultural products. At same time the
cheaper agri-imports might devastate Indian agricultural structure and the import-
dependence may ruin the prospects of a better life for millions of poor Indians.
(g) Even if India does not want to tap the opportunities of the globalising world it has to
gear up in the agriculture sector since the world market will hardly be able to fulfil the
agri-goods demands of India by 2025. It means, it is only India which can meet its own
agri-goods demand in the future.
There is no doubt that the WTO has brought probably the last opportunity to make our
masses have better income and standard of living via better income coming from agriculture. But
provided we go for the right kind of preparation at the right time. There are enough prospects.
Undoubtedly.

3. Economic Survey 1994-95, MoF, GoI, N. Delhi

4. NECAER Survey headed by its chairman Rakesh Mohan, GoI, 1994.

15.4. THE CHALLENGES AHEAD

The challenges and their possible remedies discussed in this sub-topic are based on some of
the finest and timely debates and articles which appeared in many renowned journals and
newspapers between the period 1994-2007. For better understanding of the readers only the
consensual as well as the less-complex parts have been provided here:
If the WTO brings high prospects for the Indian agriculture, it also brings in some hard-boiled
challenges in front of it. These could be seen as individual challenges of the similar economies as
well as joint challenges of such economies the first category of challenges pertains to the area of
relevant preparations, investment and restructuring of agriculture. And the second category of
challenges are nothing less than a revision in the very agricultural provisions of the WTO itself
(around which today revolves the success and failure of the organisation itself). The Challenges
before the Indian agriculture are as follows:
(i) Self-sufficiency of Food: Due to inflow of cheaper foodgrains from the world it would
not remain economically viable in India to ffc produce them and farmers might incline
in favour of the profitable agri-products. This H will make India heavily dependent upon
the world market for its food supplies, marring its achievement of food self-sufficiency.
This will have serious political and ethical outcomes for India.5
(ii) Price Stability: Dependence on the world market for the supply of agricultural
products and specially for foodgrains will never be sate for India. As the international
market for the products is highly speculative and full of variations (due to natural
factors) the price stability will be always in danger--fluctuations hamper the producers
and consumers of agri-goods in India. It would be very tough fighting damping of
surplus agri-goods from other countries.
(iii) Cropping Pattern: The cropping pattern of agriculture might take a very imbalanced
shape which will be highly detrimental to the ecology at large6 as the farmers will
always be in favour of going for the crops and commodities which have comparative
price advantage.
(iv) Weaker Sections: The benefits of globalisation may not be neutral to areas, crops
and the people. There wall never prevail a certainty as to which area/region or crops or
the people are going to benefit from globalisation in which year. At the same time
globalisation is a process where profits can be made, but it is a marker-based concept.
Those who are unable to produce due to lack of capital, investment and
entrepreneurship will have-no gains from it. They will be net consumers or buyers.
Since India has a vast population of the weaker sections (as other third world countries
have) this population will neither be able to increase its income nor be able to
purchase the agri-goods having no price stability.
5. Almost 50 per cent of the Indian population spends 75 per cent of its total income on the purchase of foodgrains-this is
why their standard of life and nutrition depends on the indigenously grown food in a great way. Once the self-sufficiency is
lost their lives will depend upon the diplomatic uncertainties of its regular supply. It will have serious political outcomes for
the political scenario of India. Similarly, irregular supply of the foodgrains will create a high ethical dilemma, too.
6. Farmers might go for highly repetitive kind of cropping pattern creating problems for soil fertility, water crisis, etc. This will
have highly adverse effects on the agriculture insurance companies, too.

It means that the weaker sections of India might miss this chance of growth
and development. We need to make the benefits of globalisation reach these people,
too. This could be done by a timely and society -orientied public police which is a big
challenged.7
(v) WTO Commitments: There are certain time-bound obligatory commitments of India
towards the provisions of the WTO in the area of agriculture which are highly
detrimental to the people and the economy. We may see this challenge from two
angles-
(a) According to the agricultural provisions, the total subsidies forwarded by the government to
the sector must not cross 10 per cent of the total agricultural outputs. At the same time, exemptions
to farmers are to be withdrawn-hampering the Public Distribution System badly. India's subsidies are
still far below this limit but pose a threat to the sovereign decision of need to be increased.
(b) The subsidies (with different names) to agriculture which are forwarded by the developed
countries are highly detrimental to Indian agriculture and they are very high, too.8
15.5 WAYS TO FIGHT CHALLENGES
None of the above-given challenges are easy to fight. These are not to be fought by India
alone but almost all developing countries are to face it. Once the WTO comes into operation, many
experts from India and abroad have provided ways to fight these challenges which may be summed
up in the following way-
(i) To fight the challenges related to self sufficiency in food, the price stability and the
cropping pattern a judicious mix of suitable kind of agricultural and trade policies will
be the need of the hour. To the extent agricultural policy is concerned, India has a
limited level of freedom. Hut the WTO regime does not allow the member countries to
impose higher tarrif or tarrif itself to ward off cheaper agri-goods from entering the
economy-this is the main reason behind the above challenges. It means it is essential
to modify, change or revise the provisions of the WTO.
Similarly, the issue of agricultural subsidies (the Boxes) need to be equitably defined so that
they do not look biased. Here also the provisions of the WTO need revision.

7. The primary examples of corporate and contract farming have given enough hints that economically weaker sections of
society have meagre chances of benefitting from the globalisation of agriculture-with major profits going to the corporate
houses. Naturally, the governments (centre and states) will need to come up with highly effective policies which could take
care of the economic interests of the masses.

The policies may focus on areas such as healthcare, education, insurance, housing, social security, etc Already the
governments have started emphasising the delivery and performance of the social sector but in the future, more focused
and accountable programmes in the sector will be required.

8. Some of the developed economies are still forwarding subsidies to the agricultural areas to the tune of 180-220 per cent!
Again, the justification for such high subsidies have been provided by defining agriculture subsidies according to their ease-
highly blurring and confusing.

To fight out this typical challenge, experts suggested that the WTO is not God-given. Its
provisions may go in for change if concerted efforts are made by the member countries in this
direction. Like-minded nations who face the same kind of crises should come together and go for a
joint effort, from inside the WTO, for the revisions or relaxations in its provisions. Morality related and
ethical issues might be used as eve-openers and a handy tool to have the attention of the developed
nations and the WTO alike.
Prima facie this suggestion looked as a preach easier said than done. But post-1995 times
saw a polarisation of like-minded countries inside the WTO that finally culminated into failure of the
Seatle Round of the WTO deliberations. The most powerful country in the world failed to convene a
meeting that too in its most distant region (the Alaska) – a moral triumph of the poor over the rich.
This incidence while indicating a possible failure of the WTO itself, boosted the morale of the
developing countries to go for stronger groupings and even sub groupings under the WTO.
After the Doha Round the USA had hinted to forget multilateralism and indicated its intentions
towards bilateralism. The European Union had the same intentions, but it did not show it as openly as
the USA. The year 2002 came as a watershed period for the WTO when the EU in its new diplomatic
move announced to hear the agriculture-related issues of the developing nations. The USA
announced the intentions few days after the EU announcement-just few days before the Cancun
Meet of the WTO. The Hongkong deliberation of the WTO, though it did not give anything concrete to
the develolping world, provided enough hope, there is no doubt in it. The real picture emerges the
next meet for which the different pressure groups had serious meets and deliberations on their
alternatives of bargaining power.
The second level suggestion to India was in the area of its preparedness for the WTO regime.
India was required to set new and internationally best Standards in the area of production by boosting
areas such as-research and development, biotechnology, information technology, health and
phytosanitary matters. This will make Indian goods and services compete in the international market. 9
15.6. AGRICULTURE SUBSIDIES AND WTO
Various subsidies permissible under WTO regimes are explained here.
15.6.1 AMS
The subsidies provided by the government to the agricultural sector (i.e., domestic support) is
termed by the WTO as Aggregate Measure of Support (AMS)10. It is calculated in terms of product and
input subsidies. The WTO argues that the product Subsidies like minimum support prices and input
subsidies (non-product) like credit, fertilisers, irrigation and power will cut the production cost of farming
and will give undue advantage to such Countries in their access to the world market-such subsidies are
called to cause 'distortions' to the world trade. Such subsidies are not permitted in one sense as they
have a minimum permissible limit de minimis under the provisions which is 5 per cent and 10 per cent
of their total agricultural output in the case of developed and developing countries, respectively.
15.6.2 The Boxes
The agricultural subsidies, in the WTO terminology have in general been identified by 'boxes'
which have been given the colours of the traffic lights-green (means permitted), amber (means slow
down, i.e., to be reduced) and red (means forbidden).
In the agriculture sector, as usual, things are more complicated. The WTO provisions on
agriculture has nothing like red box subsidies, although subsidies exceeding the reduction
commitment levels is prohibited in the 'amber box’. The 'blue box' subsidies are tied to programmes
that limit the level of production. There is also a provision of some exemptions for the developing
countries sometimes called the ‘S & I) box’.11
We may see them individually thought they are very much connected in their applied form.
The objective meaning of each one of them becomes clear, once one has gone through all of them.
(i) Amber Box
All subsidies which are supposed to distort production and trade fall into the amber box, i.e.,
all agricultural subsidies except those which fall into the blue and green boxes. 12 These include
government policies of minimum support prices (as MSP in India) for agricultural products or any help
directly, related to production quantities (as power, fertilisers, pesticides, irrigation, etc).
Under the WTO provisions, these subsidies are subject to reduction commitment to their
minimum level--to 5 per cent and 10 per cent for the developed and the developing countries,
respectively, of their total value of agricultural outputs, per annum accordingly. It means, the
subsidies directly related to production promotion above the allowed level (which fall in either the blue
or green box) must be reduced by the countries to the prescribed levels.
 In the current negotiations, various proposals deal with issues like deciding the amount by
which such subsidies should be reduced further, and whether to set product-specific subsidies or to
continue with the present practice of the 'aggregate' method.
(ii) Blue Box
This is the amber box with conditions. The conditions are designed to reduce distortions. Any
subsidy that would normally be in the amber box, is placed in the blue box if it requires farmers to go
for a certain production level. These subsidies are nothing but certain direct payments (i.e., direct set-
aside payments) made to farmers by the government in the form of assistance programmes to
encourage agriculture, rural development, etc.
At present there are no limits on spending on the blue box subsidies. In the current
negotiations, some countries want to keep blue box as it is because they see it as a crucial means of
moving away from distorting the amber box subsidies without causing too much hardship. Others
want to set limits or reduction commitments on it while some advocate moving these subsidies into
the amber box.
(iii) Green Box
The agricultural subsidies which cause minimal or no distortions to trade are put under the
green box. They must not involve price support.
This box basically includes all forms of government expenses which are not targeted at a
particular product and all direct income support programmes to farmers which are not related to
current levels of production or prices. This is a very wide box and includes all government subsidies
like-public storage for food security, pest and disease control, research and extension! and some
direct payments to farmers that do not stimulate production like restructuring of agriculture,
environmental protection, regional development, crop and income insurance, etc.

10. Defined in Article 1 and Annexures 3 & 4, Agreement on Agriculture (AoA), WTO, 1994

11. Article 6.2, AoA, WTO, 1994

12. Article 6, AoA, WTO, 1994

The green box subsidies are allowed without limits provided they comply with the policy-
specific criteria. It means, this box is exempt from the calculation under subsidies under the WTO
provisions because the subsidies under it are not meant to promote production thus do not distort
trade. That is why this box is called "production-neutral box' But the facts tell a different story.13

In the current negotiations, some countries argue that some of the subsidies forwarded under
this box (by the developed economies) do serious distortion to trade (opposed to the view of minimal
distortion as used by Annexure 2)- it is the view of the developing countries. These countries have
raised their fingers on the direct payments given by the developed countries to their farmers via
programmes like income insurance and income-safety schemes, environmental protection, etc Some
other countries take the opposite view and argue that the current criteria are adequate, and advocate
to make it more flexible (so that it could be increased) to take better care of non-trade.

15.7 SUMMARY
Lets Summarise though the flow – chart
 WTO and Indian Agriculture

Provisions, Expectations Agricultural

Challenges and ways to Fight
Challenges
Aggregate

15.8 GLOSSARY
 WTO : World Trade Organisation was formed in the year 1995 (see p. 244) as a watch dog in the
spheres of global trade of goods services.
 AMS : The subsidies provided by the government to the agricultural sector (i.e., domestic support) is
termed by the WTO as Aggregate Measure of Support (AMS)
 Amber Box : All subsidies which are supposed to distort production and trade fall into the
amber box. These include government policies of minimum support prices (as MSP in
India) for agricultural products or any help directly, related to production quantities (as
power, fertilisers, pesticides, irrigation, etc).
 Blue Box : This is the amber box with conditions. The conditions are designed to reduce
distortions. Any subsidy that would normally be in the amber box, is placed in the blue box
if it requires farmers to go for a certain production level. These subsidies are nothing but
certain direct payments (i.e., direct set-aside payments) made to farmers by the
government in the form of assistance programmes to encourage agriculture, rural
development, etc.
 Green Box : The agricultural subsidies which cause minimal or no distortions to trade are
put under the green box. They must not involve price support.
13. Basically, a large part of this box is used by the farmers in the USA and the European Union as basic investments in
agriculture. India as well as other like-minded countries have this view and want this box to be brought under the AMS i.e.
under the reduction commitments. The USA at the Hongkong Ministerial meet (December 2005) announced to abolish such
subsidies in the next 12 year commencing 2008. The EU also proposed to reduce its 'trade distorting subsidies' by 70 per
cent. None of them used the name green box which shows some internal vagueness.

15.9 REFERENCES
Misra & Puri (2017). Indian Economy. Himalaya Publications. New Delhi.
Kapila, Uma (2017). Indian Economy. Performance and Policies. Academic Foundation. New Delhi.
15.10 MODEL QUESTIONS
1. Discuss the impact of WTO on Indian Agriculture.
2. Write short notes
(a) AMS (b) Agriculture Subsidies and WTO.

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 Lesson – 16

SPECIAL ECONOMIC ZONES (SEZs) IN INDIA

(Syllabus : Unit I)
Structure
16.0 Objectives
16.1 Introduction
16.2 History of SEZs
16.3 Objectives Behind Setting up to SEZs
16.4 Facilities Provided in SEZs and SEZs Rules
16.4.1 Regulations
16.4.2 Special Incentives for SEZs
16.4.3 SEZ Land area and other Regulations
16.4.4 Investment Criterion
16.5 Growth and Performance of SEZs in India
16.6 Problems Faced and Concerns
16.7 Agri Export Zones ; A Special SEZ
16.8 Summary
16.9 Glossary
16.10 References
16.11 Model Questions
16.0 OBJECTIVES
After going through this lesson, you shall be able to :
 delineate the objectives of setting up SEZs in India
 discuss the growth and performance of SEZs in India
 explain the problems faced by SEZs in India
16.1 INTRODUCTION
This lesson pertains to the establishment of special Economic zones in India, regulations concerning
them, facilities, special incentives, land issues, investment criterion etc. Moreover, we shall study growth and
performance of SEZs, their problems and policy instruments.
16.2 HISTORY OF SEZs
India has been undertaking numerous policy measures in order to increase its volume of
exports. Earlier the objective was of self-suffciency which transformed to self-reliance fourth plan
onwards. Then came the policies of export promotion and import substitution under various EXIM
policies. In the post reforms period we had policies for external sector under new name Foreign
Trade policies with focus on the promotion of exports in order to make payments for all the imports
thus deciding about the surplus or deficit on foreign trade. Along with it came the Foreign Direct
Investment, Moreover, India has been one of the first country in Asia which recognised the
effectiveness of the Export Processing Zones (EPZs) model for promoting its exports. Accordingly,
India set up Asia's first EPZ at Kandla in 1965. However, the EPZs were not able to emerge as
effective instruments for export promotion on account of many structural rigidities like multiplicity of
controls and clearances, lack of world class infrastructure and unstable fiscal regime etc. Recently a
major policy issue and new development has come up in trade sector i.e. setting up of SEZs. The
Special Economic Zones (SEZ) Act, 2005 came into effect on Feb. 10, 2006. In this lesson, we shall
study about SEZs in India.
Prior to the enactment of SEZ Act, 2005, the Export Processing Zones (EPZs) located at Kandla
and Surat (Gujarat), Santa Cruz Mumbai (Maharashtra), Chennai (Tamil Nadu), Vishakhapatnam
(Andhra Pradesh), NOIDA (Uttar Pradesh) and Falta (West Bengal) were converted by the Government
into SEZs to reap maximum benefit. There are all total 19 SEZs in all which were setup prior to coming
into force of SEZ Act, 2005. The Export Processing Zones were faced with numerous problems in the
90s.
With a view to overcome these short comings and attract larger foreign investments in India,
the Special Economic Zones (SEZs) Policy was announced in April 2000. This policy was intended to
make SEZs an engine for economic growth supported by quality infrastructure complemented by an
attractive fiscal package both at the Centre and the State level, with minimum possible regulations.
16.3 OBJECTIVES BEHIND SETTING UP OF SEZs
To instill confidence in investors and signal the Government's commitment to a stable SEZ
policy regime and with a view to impart stability to the SEZ regime thereby generating greater
economic activity and employment through the establishment of SEZs, the Special Economic Zones
Act, 2005, was passed by Parliament in May, 2005. The SEZ Act, 2005, supported by SEZ Rules,
came into effect on February 10, 2006. The main objectives of the SEZ Act are generation of
additional economic activity, promotion of exports of goods and services, promotion of investment
from domestic and foreign sources, creation of employment opportunities and development of
infrastructure facilities. Various incentives and facilities are offered to both units in SEZs for attracting
investments into SEZs (including foreign investment) as well as for SEZ developers. It is expected
that these incentives and facilities will trigger a large flow of foreign and domestic investment in SEZs,
in infrastructure and productive capacity, leading to generation of additional economic activity and
creation of employment opportunities.
16.4 FEATURES OF SPECIAL ECONOMIC ZONES
(FACILITIES PROVIDED IN SEZs AND SEZ RULES)
The main purpose to establish SEZ is to promote exports through concentration of resources
into a pocket area known as SEZ. Under a SEZ, units producing goods and rendering services can
be set up. These units must be a net foreign exchange earner. SEZ can be set up both in public
sector, private sector or joint sector and also by state governments in collaboration with a corporate
house which offers equal opportunity to both Indian and foreign private developers.
16.4.1 Regulations
The SEZ Rules provides for different minimum land requirements for different classes of
SEZs. Every SEZ is divided into a processing area where alone the SEZ units are set up and a non-
processing area where the supporting infrastructure is to be created. The SEZ Rules also provide for
simplified procedures for development, operation and maintenance of the SEZ and setting up of units
in SEZs, single window clearance both relating to Central as well as State Governments for setting up
a SEZ and units in a SEZ and simplified compliance procedures/documentation with emphasis on
self-certification. Cent per cent FDI is also permitted for all investments in SEZ excepting those
activities included under the negative list.
16.4.2 Special Incentives for SEZs
SEZs are a kind of duty free zone and arc considered as foreign territories for the purpose of
trade duties and tariffs. The SEZ policy offers various fiscal and regulatory incentives to the
developers of SEZ along with units of establishment set up within such zone. Units established under
a SEZ will get complete exemption of income tax on their profits for the first five years and only 50 per
cent of tax for two years thereafter. Such 50 per cent, exemption facility of income tax can also be
extended for another three years term provided half of the profit is reinvested in the corporation.
Moreover, units working within SEZ will also be eligible to get exemption from number of other taxes
and duties such as excise duty, customs duty, value added tax (VAT), dividend tax etc. Similarly, SEZ
developers are also entitled to get exemption from any tax or duties on all procurements of raw
materials and implements such as cement, steel, electrical items etc. and will also get exemption
from customs duty on all imports required for development, operation and maintenance of SEZ.
16.4.3 SEZ Land area and other Regulations
For developing SEZ the government has framed different rules and regulations. In order to
develop multi-product Greenfield SEZ, the government has specified a minimum requirement.
For developing SEZ, initially Government decided to acquire vast tract of land and allot it to
the SEZ developers. But after lot of protests from the farmers in different states, the Government has
decided that SEZ developers will have to purchase land directly from the farmers after giving due
compensation and rehabilitation package. As per present rule, at least 25 per cent of the area of SEZ
must be utilised for export related activities; 50 per cent of the area be utilised for production areas
and the remaining 50 per cent area can be used for economic and social infrastructure. The list of
authorised operations within SEZ include roads, housing apartments, convention centres, restaurants
and cafeterias, airconditioning, telecom and other communication facilities and basic recreation
facilities. Sector specific SEZs will also be allowed to set up additional operations including hotels,
schools, educational and technical institutes. Multi-product SEZs are also given permission to have
ports, airports etc.
16.4.4 Investment Criterion
Regarding financial implications sector specific SEZs must have net work of minimum
Rs. 50 crore and the minimum investment criterion is Rs. 250 crore. Again for developing a multi-
product SEZ, the net worth must be at least Rs. 250 crore and the minimum investment criterion in
the project be Rs. 1000 crore. For an IT SEZ, the net worth of the applicant has to be Rs. 100 crore.
SEZs are exempted from the application of labour laws so as to attract entrepreneurs for
setting up industrial units. All industrial and other units established within SEZs shall be declared
"Public Utility Service" and therefore, strike will be illegal in these units. Thus the SEZs will not comply
with the provisions of Industrial Disputes Act, 1947.
The Special Economic Zones are primarily modeled on the Chinese pattern. In 1980, China
established SEZs in 14 coastal cities. In China SEZs played dual role, i.e., to act as "Windows in
developing the foreign oriented economy and thereby earn foreign exchange by boosting exports and
also to import advanced technologies. As incentives China provided all tax and duty exemption to
SEZ units resulting accelerated economic development in its coastal regions attracting foreign
investors to invest more than $ 30 billion in China and also attracted about 5000 domestic enterprises
of these country to invest more than 20 billion Yuan in SEZ regions. As a result, six important
industries could develop its strong base in China. These include micro electronics and computers,
automobiles and spare parts and components, household electrical appliances, mechanical and
electrical products and bio-medical and optical products. However, the rapid development of its
coastal areas could not have its spread effects to the provinces of hinterland resulting widening of the
disparities between the rich coastal regions and other backward regions. Considering this problem,
Chinese Government has undertaken steps in its Eleventh Plan to balance the rural-urban divide.
A recent ASSOCHAM study reveals. that exports from Special Economic Zones are set to
make a quantum jump to Rs. 5,15,891crore (USD 116.40 billion) in the next three years (2008-11),
despite controversies surrounding the tax free enclaves.
16.5 GROWTH AND PERFORMANCE OF SEZS IN INDIA
SEZs exports have grown by a whoping 192 per cent from Rs. 22,840 crore in 2005-06 to Rs.
66,638 crore in 2007-08. India's total exports in 2007-08 stood at 155.5 billion dollar, increasing
SEZ's contributions to total domestic exports from 5 per cent in 2005-06 to 13.93 per cent in the first
nine months of 2007-08. On employment provided by the tax-free zones (SEZs) the study projected
that by 2011-12, the SEZs in totality are expected to create direct employment opportunity for 10
million skilled work force. The official figure shows that by March 2008, the SEZs have created direct
employment opportunities for 1 million people which should go up to more than 2 million by the year
end. The report further said that since the SEZ Act come into being in 2005 their success ratio has
been observed much higher in North and Eastern part of the country.
In short span of five tears since the SEZs Act and Rules were notified in Feb. 2006, 583 SEZs
have been accorded formal approval out of which 380 SEZs have been notified. The benefits derived
from SEZs have been notified. The benefits derived from SEZs are evident from the export,
employment and investment generated (see Table 1)
Table 1
Performance of SEZs
 Export from SEZs in (Rs. Cr.)
3,15,868
 Overall Export Growth in 2003-04 to 2010-11 2180
p.c.
 Total employment generated as on 31.03.2011 (persons)
8,15,308
 Total incremental employment generated since Feb. 2006 (persons)
9,80,609
 Total investment on 31.12.11 (Rs. Cr)
2,99,631
 Incremental private investment after coming into force of SEZs Act, 2005 (Rs. Cr.)
Source: Eco Survey 2011-12
 As per the provisions of the SEZ Act 2005, 100 p.c. FDI is allowed in SEZs through the automatic route.
A total of 154 SEZs were making exports out of which 88 were IT/ITeS, 17 multi product and 49 other sector
specific SEZs and out of 347 SEZs which have received all requisite clearance certificate and been notified as of
November 30, 2015 only 204 were operational. Nearly
Rs. 3.77 lakh crore investments have been made in SEZs currently with Rs. 1.5 lakh crore additional proposed
investment with employment of 1.59 million till 2016 (Commerce & Industry, Ministry, 2016).
16.6 PROBLEMS FACED AND CONCERNS
Some points of criticism has been raised against SEZ policy both from political parties as well
as from independent sources.
First, Concerns have been expressed regarding acquisition of agricultural land for setting up
SEZs. The State Governments have been advised that in land acquisition for SEZs, first priority
should be for acquisition of waste and barren land and if necessary single crop agricultural land could
be acquired for the SEZs. If perforce a portion of double cropped agricultural land has to be acquired
to meet the minimum area requirements especially for multi-product SEZ, the same should not
exceed 10 per cent of the total land required for the SEZ. Various issues relating to setting up of
SEZs in the country including issues raised by various political parties are being addressed by the
Empowered Group of Ministers.
In the backdrop of controversies over setting up of SEZs and land acquisition for it, the
Central government has unveiled a new policy which provides for discouraging acquisition of
agricultural land for non-farming purposes and setting up a commission to look into resettlement
aspects. The National Rehabilitation and Resettlement Policy, 2007 also entails setting up a special
committee to review and monitor the progress of implementation of rehabilitation and resettlement
schemes introduced across the country, The policy states, "Acquisition of agricultural land for non-
agricultural use in a project may be kept to the minimum; multi-cropped land may be avoided to the
extent possible for such purposes, and acquisition of irrigated land, if unavoidable, may be kept to the
minimum……..Waste land, degraded land or un-irrigated single crop land should be the option for
acquisition." Thus this policy statement assumes significance as acquisition of farming land for SEZs
has triggered violent protests in various states, including that in Nandigram in West Bengal.
Second, concerns has also been raised over the loss of revenue arising out of tax and duty
concessions given to SEZ units.
Third, question has also been raised about the pattern of land use in SEZs, especially for non-
production related activities. However, the government has already made some correction by
enhancing the minimum land use for production activities to 50 per cent.
Fourth, question has also been raised about the exemption of SEZ units from labour
laws may raise problem of exploitation of workers.
Last, as a result of SEZ policy, the country may face a problem of double standard as the
country is being divided into two separate zones, i.e., SEZ and non-SEZ zones.
It has been often argued that the Eleventh Plan in its Approach Paper sets its primary goal as
"Towards Faster and More Inclusive Growth"; but the SEZ policy decision may lead to setting up of
"inequitous enclaves" of development which may finally result in "Exclusive growth”. (Business Line,
Editorial, Sept. 26, 2006).
 Thus the Special Economic Zones, modeled in the Chinese pattern, is likely to attract foreign
investment, create huge employment opportunities and raise the GDP growth rates. However, as a
testing ground for implementing liberal market economy principles, SEZs have been established in
many countries. In those countries SEZs are viewed as instruments to enhance the acceptability and
credibility of transformation policies to attract both domestic and foreign investment and more
specifically for the opening up of the economy. Interestingly, SEZs in India, with its genesis in the
Export Processing Zones (EPZs), want to promote value addition component in exports, generate
employment opportunities and mobilize foreign exchange. Likewise, EPZs and SEZs were set up with
considerable success by China and some other ASEAN countries in the 1970s and 1980 so as to
create regional Islands, where export-oriented manufacturing activities could be undertaken.
But the India is facing a serious debate over the formation of SEZs. In this connection the
Economic Survey, 2006-07, rightly observed :
"The recent debate about Special Economic Zones (SEZ) illustrates the kind of
considerations that have to be taken into account in the formulation of policies. Some of the
apprehensions against SEZ, are-(a) generation of little new activity as there may be relocation of
industries to take advantage of tax concessions, (b) revenue loss, (c) large scale land acquisition by
the developers which may lead to displacement of farmers with meagre compensation, (d) acquisition
of prime agricultural land having serious implications food security, (e) misuse of land by the
developers for real estate and (f) uneven growth aggravating regional inequalities. Many of these
apprehensions, however, could be addressed through appropriate policies and safeguards."
However, the prospect of establishing a good number of SEZs has faced with a great problem
in connection with the acquisition of land required for the purpose. Recently, West Bengal faced a
serious problem in acquisition of land at Nandigram and other areas where farmers boldly opposed
the move. Other states have also been facing similar problem which include Maharashtra, Haryana,
Orissa etc.
Keeping Such problems, the Empowered Group of Minister related to SEZs in its meeting held
on 5th April, 2007 has decided to bring certain changes in its SEZ policy. These changes include-(i)
the state governments authority for acquisition of land for SEZs. will be nearly non-functional and land
so required will have to be purchased by the industrialists interested in. setting up SEZs however, in
case of small and subdivided lands, state govts. may also acquire land; (ii) earmarking of productive
areas within SEZs has been enhanced from 35 per cent to atleast 50 per cent; (iii) displaced farmers
and persons will be given compensation and job for one person per displaced family in the project
itself; (iv) the maximum size of land to be acquisitioned or purchased for SEZs is fixed at 5 thousand
hectares (12,355 areas) and the state government concerned can also be able to reduce the size of
SEZ, if so desired.
Various issues related to setting up og SEZs in the country including issues raised by various
political parties, have been addressed by Empowered Group of Ministers (EGOM). Pursuant to the
decision taken by the EGOM, all state Governments have also been informed that the board of
Approval will not approve any SEZs where the State Governments have carried out or propose to
carry out compulsory acquisition of land for such SEZs after April 5, 2007.
Accordingly, the amendment of land acquisition act and the rehabilitation policy will be
finalised by Rural Development Ministry of the Central Government. However, the state government
can act as a mediator for meeting the problem arising out of land acquisition.
 The RBI has observed that SEZs would act as catalysts for growth and facilitate large flow of
foreign and domestic investments. Moreover, RBI has also noted that simplification of procedures for
development, operation and maintenance of the SEZs and the fiscal incentives would spur
investment and industrial activity to a considerable extent.
However, the Economic Survey, 2007-08 observes in this connection, "Apprehensions have
been expressed on misuse of the scheme and relocation of existing industries into SEZs. However,
experience has shown that these apprehensions are ill founded and fresh investments and
employment have been flowing into the Special Economic Zones." In the mean time, some new SEZs
has already provided or projected good number of employment potential viz., Nokia Electronics
Hardware SEZ in Sriperumbudur (6,637 persons) with a projection of employment of 30,000 persons;
Apache SEZ (4,500 persons) being set up in Andhra Pradesh is expected to employ 20,000 persons;
Brandix Apparels, a Sri Lankan FDI project is expected to provide employment to 60,000 workers
over a period of three years. Even in the services sector, 12.5 million sq. metres space is expected to
be created in the IT/ITES SEZs which is estimated to translate into 12.5 lakh jobs.
"The benefits derived from multiplier effect of the investments and additional economic activity
in the SEZs along with employment generated is estimated to far outweigh the revenue losses on
account of tax exemptions given to SEZs. These SEZs are freshly developed industrial clusters and
are not relocated from elsewhere.”
CONCLUSION
Thus considering the huge prospects of SEZs and its success story in other countries. a
coordinated effort needs to taken for implementing the policy of SEZs effectively with a special care
for handling the problem of displaced persons with adequate compensation and job opportunities.
16.7 AGRI-EXPORT ZONES : A SPECIAL TYPE OF SEZ
In the EXIM Policy 2001-02, the Government announced the proposal to set up Agri-Export
Zones for the purpose of developing and sourcing raw materials and their processing/packaging
leading to final exports. The concept essentially embodies a cluster approach of identifying the
potential products and the geographical region in which such products are grown and adoption of an
end to end approach of integration of the entire process, right from the stage of production to
consumption.
Under the Scheme, the State Governments would identify products with export potential which
have comparative advantage in local production. Agricultural and Processed Food Products
Development Authority (APEDA) is the nodal agency of the Central Government to promote setting
up of Agri-Export Zones.
Till December 2002, the Central Government has sanctioned and notified 41 Agri-Export
Zones (AEZs) which are being set up in 17 States-West Bengal. Uttaranchal, Karnataka, Punjab,
Uttar Pradesh, Tamilnadu, Maharashtra, Andhra Pradesh, Tripura, J&K, Madhya Pradesh, Bihar,
Gujarat, Sikkim, HP. Orissa and Jharkhand--covering products like Lychee, Pineapple, Potatoes,
Onion, Garlic, Mangoes (Kesar, Chausa, Dusshari, Alphonso, etc.). Grapes, Flowers, Apples,
Vegetables. Walnuts, Gherkins, Wheat, Ginger and Turmeric, Basmati Rice and Seed Spices.
These 41 AEZs will entail an estimated investment of around Rs. 1,142.53 crore, out of which
around Rs. 333.68 crore will flow from various Central Government agencies like APEDA, National
Horticulture Board, Ministry of Food Processing Industry and Ministry of Agriculture with contribution
of Rs. 168.61 crore from State Governments and Rs. 640.24 crore from private bodies.
A projected export of more than Rs. 3000 crore during the next 5 years and a substantial
amount of direct and indirect employment was expected to be generated as a consequence of setting
up these zones.
A web-based monitoring system has been evolved to monitor more than 120 activities in each
Agri-Export Zones. Under this monitoring system, each activity is defined, the agency responsible for
undertaking the activity is indicated and the time for performing that activity is specified.
16.8 SUMMARY
In this lesson we have studied about special zones created for the growth of exports, facilities
provided to them, rules & regulations governing them and their performance.
16.9 GLOSSARY
 EPZ : Export Promotion Zones are areas with special infrastructural and financial facilities to promote
trade (pre-1991 period).
 SEZ : Special Economic Zones came into being in 2006 by a special Act.
 Green Field SEZ
 Agri Export Zones : Special Zones established for growth of agriculture exports.
16.10 REFERENCES
 Government of India, (2007-08) Economic Survey, Ministry of Finance, New Delhi. p. 146.
 Government of India (2006-07) Economic Survey, Ministry of Finance, New Delhi. p. 123.
 Misra & Puri (2015) Indian Economy. Himalaya Publications. New Delhi.
16.11 FURTHER READINGS
 Government of India (2021). Economic Survey 2021-22. Ministry of Finance. New Delhi
 Dutt, R and Mahajan G. (2021). Indian Economy. S Chand (P) Ltd. New Delhi.
 Misra & Puri (2021). Indian Economy. Himalaya Publication. New Delhi.
 Kapila, Uma (2021). Indian Economy Since Independence Academic Foundation. New Delhi.
16.12 MODEL QUESTIONS
 Write a short note on SEZs in India
 What do you know about the growth and performance of SEZs in India?
 Discuss the objectives, performance and problems faced by SEZs in India.

---------
 Lesson – 17

INFRASTRUCTURAL DEVELOPMENT IN INDIA :

A CONSOLIDATED PICTURE
[Note : You may update the data with Twelfth Plan Progress (using any UG level book) -
Syllabus Unit - I – as recent data is in different form]

Structure
17.0 Objectives
17.1 Introduction
17.2 Importance of Infrastructure (Need)
17.3 Growth of Infrastructure (Performance)
(Growth in India : Energy & Transport)
17.4 Energy Development in India
17.5 Power Development in India
17.6 Transport System in India
17.6.1 Railways
17.6.2 Road Transport
17.6.3 Water Transport
17.6.4 Civil Aviation
17.6.5 Co-ordination
17.7 ‘Financing of and Private Investment’ in Infrastructure
17.7.1 Foreign Investment
17.7.2 Reforms
17.7.3 Investment
17.7.4 Financing Infrastructure
17.7.5 Public Private Partnerships and Infrastructure
17.8 Conclusion
17.9 Summary
17.10 References
17.11 Model Questions
17.0 OBJECTIVES
 After going through this lesson, you shall be able to :
 explain the importance of infrastructure for an economy
 discuss the growth of infrastructure in India
 elaborate the development of power, transport, telecommunication etc.
 discuss the private investment in infrastructure e.g. foreign investment, public private
investment etc.
17.1 INTRODUCTION
This lesson deals with the importance of infrastructure in India. The infrastructure cosists of
social infrastructure & physical infrastructure. The social infrastructure refers to health, education,
sanitation etc. While physical infrastructure comprises transport, power, telecommunication, energy
etc. The investment in infrastructure is pre-requisits for faster economic development. In this lesson
we will study about the economic infrastructure its components, growth etc.
17.2 IMPORTANCE OF INFRASTRUCTURE
The prosperity of a country depends directly upon the development of agriculture and
industry. Agricultural production, however, requires irrigation, power, credit, transport facilities, etc.
Industrial production requires not only machinery and equipment but also skilled man power,
management, energy, banking and insurance facilities, marketing facilities, transport services which
include railways, roads, and shipping, communication facilities etc. All these facilities and services
which help in industrial and agricultural production constitute collectively the infrastructure of an
economy. The development and expansion of these facilities are an essential per-condition for
increasing agricultural and industrial production in a country. In the last 200 years or more, industrial
and agricultural revolutions in England and in other countries were accompanied by a revolution in
transport and communications, the extensive use of coal and later oil as source of energy,
tremendous expansion in banking, insurance and other financial institutions to finance production and
trade, an explosion of knowledge of science and technology, and so on.
17.3 GROWTH OF INFRASTRUCTURE IN INDIA
Inrastructural facilities – often referred to as economic and social overheads – consist of:
(a) Irrigation, including flood control and command area development.
(b) Energy : coal, electricity, oil and non-conventional sources.
(c) Transport : Railways, roads, shipping and civil aviation.
(d) Communications : Posts and telegraphs, telephones, telecommunications, etc.
(e) Banking, finance and insurance.
(f) Science and technology.
(g) Social overheads : health and hygiene and education.
There has been the rapid expansion of these facilities right from the First Plan itself. The plans
have generally devoted over 50 per cent of the total plan outlay on infrastructure development. As a
result, there has been phenomenal increase in infrastructural facilities.
 For instance, coal production including lignites rose from 32 million tones to 566 million tones
between 1951 and 2010. During the same period, power generation from public utilities, excluding
power generation from captive and non-conventional power plants rose from 5 billion kwh in to 768
billion kwh; and production of petroleum crude rose from an insignificant 0.4 million tones to over 34
million tones. Likewise, there has been tremendous expansion in the other infrastructural facilities.
(Table 1) We should however, note basic features of infrastructural development here :
Table 1. Trends in the Performance of Infrastructure Sectors As on September 2008
Sector & Unit 1950-51 2009-10
Energy
1. Coal m. tones 32 566
2. Electricity generated b. kwh 5 768
3. Petroleum
Oil crude m tonnes 0.4 33.7
II Finished Steel (m. tonnes) 1.0 59.7
III Cement (m. tonnes) 2.7 200.7
Transport and Communication
1. Raiway goods traffic m. tonnes 73 887.8
2. Cargo handled at major ports m. tonnes 19 561
3. Telecommunications
Total telephones provided (millions) NA 6212
Source : Economic Survey (2009-2010) c.f. Dutt & Sundaram, 2011.
(i) The heavy investments by the Government on infrastructural facilities could be easily
justified since they had provided the necessary impetus for rapid agricultural development and
industrial expansion. In fact, without the rapid development of the infrastructure, it would have been
impossible to register the threefold rise in agricultural production and seven fold rise in industrial
production during the last six decades.
(ii) Though infrastructural facilities were not altogether neglected for the rural areas – for
example, expansion of irrigation, rural electrification, etc. – the overwhelming emphasis was on the
provision of infrastructural facilities mainly for the urban areas. It is the people in our cities and towns
who could take full advantage of the development of power, transport, communications, banking and
such social overheads as education and health. The concentration of the infrastructure in urban areas
and their relative neglect in rural areas resulted in inadequate development and, therefore, of
inadequate employment opportunities in the rural areas.
17.4 ENERGY DEVELOPMENT IN INDIA
Sources of Energy
Broadly, there are two Sources of energy, viz., commercial energy and non-commercial
energy. Commercial energy, or more correctly. commercial sources of energy, consist of coal,
petroleum and electricity. These sources are commercial in the sense that they command a price and
the users have to pay for them. Commercial energy accounts for over 50 per cent of an energy
consumption in India.
Non-commercial sources of energy - also known as traditional sources of energy - consist of
firewood, vegetable wastes and dried dung. These are caned non-commercial sources, as they are
supposed to be free and command no price. Actually, the non-commercial sources such as firewood
and dried dung have started commanding a price in urban areas and to some extent in rural areas as
well. While commercial sources of energy are generally exhaustible-exception being, hydro-electric
power, non-commercial sources of energy are renewable. More than 60 per cent of Indian
households depend on traditional sources of energy for meeting their cooking and heating needs.
Non-conventional sources of energy in India
While the above sources of energy--both commercial and non-commercial are known as
conventional sources of energy, there are three other sources of energy which are commonly called
as non-conventional sources of energy. They are: solar energy, wind energy and tidal power. Solar
energy potential is almost unlimited in India, a tropical country, Likewise, wind energy is available in
abundance, especially in coastal areas and in hilly regions, but both solar energy and wind energy
are not so far utilised in the absence of cost effective technologies. However, in the context of acute
shortage of conventional sources of energy, many countries are exploring the possibilities of using
these non-conventional sources of energy. Accordingly, they would assume more significance in the
years to come.
Production of commercial energy : Trends
As energy is an essential input for economic development, the production and the
consumption of commercial energy has increased steadily after the introduction of economic planning
in 1950-51.
Between 1951 and 2007, coal production had increased by nearly 14 times, crude oil
production by 120 times and electricity (installed capacity) by over 106 times. (see Table 2)
Table 2. Growth of Commercial energy since 1950-51
1950-51 1970-71 2009-10
Coal (m. tones) 33 76 566
Oil crude (m. tones) 0.3 7 33.7
Electricity* 9 17
Installed Capacity (000MW) 2.3 16.3 188
Generation (billion kwh) 7 61 877.5
* (Utilities and non-utilities)
Source : Economic Survey, 2010-11
Commercial Energy
First we shall study the sectoral pattern of consumption of commercial energy (i.e. coal
including lignite. oil and gas and electric power) is given in Table 3.
The transport sector was the largest consumer of commercial energy (44%) in 1953-54,
However, there has been a continuous fall in the share of the transport sector in the total commercial
energy consumption. For instance, its share declined to 22 per cent in 2OO5-06. The industrial sector
is now the largest consumer of commercial energy in the country.
During this period, the agricultural sector has, however, registered sharp increase in the
consumption of commercial energy, i.e., from one per cent to 9 per cent.
Table 3. Sectoral trends in commercial energy consumption
(in percentage)
1953-54 1970-71 2005-06
Household sector 10 12 12
Agriculture 1 3 9
Industries 40 50 42
Transport 44 28 22
Others 5 7 15
100 100 100
Source: Dutt & Sundaram, 2011
Table 4 brings out the percentage share of different fuels in commercial energy consumption.
Table 4. Percentage share of different fuels in commercial energy consumption
(in percentage)
1953-54 1970-71 2005-06
1. Coal 80 56 29
2. Oil and gas 17 35 54
3. Electricity 3 9 17
100 100 100
Source : Dutt & Sundaram, 2011
Moreover (a) the share of coal in the total commercial energy consumption has
declined steadily over the years: and (b) the share of oil and electricity, however, has steadily
increased.
These figures do not really reflect the real significance of coal. As these figures relate to final
energy consumption, only the direct consumption of coal in industry, household sector, transport, etc.,
is considered and the use of coal in power generation has been excluded. But it is important to
remember that about 65 per cent of the total coal produced in India is used for thermal power
generation.
Energy Crisis: The genesis
Industrial development in the 18th and 19th centuries was based on coal as the leading
source of energy. Towards the end of the 19th century, however, oil replaced coal as the leading
energy source. Accordingly, the industrial development everywhere in the 20th century was based on
low cost oil. After Independence, India followed the example of other leading industrialised countries
and imported Arab oil to accelerate her industrial development. So long as crude oil flowed cheaply,
there was no problem.
In 1973, however, the OPEC (Organisation of Petroleum Exporting Countries) hiked the oil
price for the first time. Since then, the price of petroleum crude was regularly hiked up from $ 2.1 per
barrel in 1973 to $ 27.3 per barrel in 1980. The price of crude had hovered between $ 50 and $ 60
per barrel in the last two decades of the last centry. Then the price of all crude was rising upward
regularly it crossed $147 per barrel during 2008-09.
As a consequence of this sharp increase in oil prices, the value of India's oil imports rose
sharply, from Rs.1110 crores in 1973-74, to over Rs. 5,620 crores in 1982-83, and to Rs. 4,11,579
crores in 2008-09.
In relative terms, oil imports were just equal to 12 per cent of India's exports in 1970-71 but
rose dangerously to be equal to 76 per cent in 1982-83. Currently imports of petroleum, oil and
lubricants (POL) account for about 30.6 per cent of India's exports (in 2008-09).
Due to regular mark up in crude oil prices, India's trade gap between imports and exports
widened with every passing year, creating serious problem of adverse balance of trade and of
payments. Since 1973-74, the adverse trade balance was just Rs. 430 crores; this rose dramatically
to Rs. 5,840 crores in 1980-81, and to Rs. 511,344 crores in 2009-10.
India has, however, been saved from serious adverse balance of payments crisis only
because of large inward remittances of foreign currencies by Indians working abroad.
There has been continuous rise in international price of oil crude and gas and consequently
rise in the price of POL. For instance, since the middle of 2004, the international price of petroleum
rose smartly and has exceeded $ 147 per barrel. The prices of petrol, diesel kerosene etc. are fixed
by the Government and changed according to changes in international prices of oil crude. But the
UPA Government at the Centre is finding it difficult to adjust retail prices of petrol, diesel etc.
according to international price of oil crude. Now the price of petrol in India varies with change at
international level.
Energy Crisis
The energy crisis of the seventies and eighties was basically an oil crisis; it was not just a
national issue affecting India alone but it was a global problem. In the context of India, however,
energy crisis has certain peculiar features, as described by Dutt & Sundaram (2011).
(a) India's energy problem is not one of demand-supply imbalance in oil only. In fact, demand-
supply imbalance is widening rapidly in all commercial fuels, basically because demand for
commercial fuels has been increasing tremendously. With a projected higher rate of economic growth
in India, the demand for commercial energy would continue to rise over the years.
While demand for petroleum products has been rising in India, the supply of crude oil has also
been rising but not adequately. Oil and Natural Gas Commission (ONGC) and Oil India Limited (OIL)
have been following vigorous policies of exploration and increase of indigenous crude. But the
consumption of petroleum and oil products has far exceeded the indigenous production and refining
capacity, thus forcing the country to depend upon imports.
(b) At the same time, the coal industry which was expected to meet the growing energy crisis
in India by stepping up coal production substantially has been faring badly in recent years. Besides,
coal reserves are poor, both in quality and in quantity.
 (c) The demand-supply gap for electricity too has been widening while the demand for power
has been growing rapidly; the supply side, has faced too many constraints, creating severe shortage
and bottlenecks in generation and distribution of electric power in the country. Erratic and inadequate
power supply constitutes a major dimension of energy crisis in India.
Thus, in the context of India's economic development, energy crisis has taken the form of oil
shortage, coal shortage and electric power shortage.
17. 5 POWER DEVELOPMENT IN INDIA
Power development during the last 50 years has been significant. The total installed power
capacity from all sources - utilities and non-utilities-had increased from 2,300 MW in 1950 to 1,88,000
MW by 2009-10. (see Table 6)
Table 5. Power generation targets and achievements
Additions to Installed Capacity Percentage
(in MW) Shortfall
Target Achievement
First Plan 1,300 1,100 15
Second Plan 3,500 2,300 36
Third Plan 7,000 4,500 36
Fourth Plan 9,300 4,600 50
Sixth Plan 19,670 14,230 28
Seventh Plan 22,250 21,500 4
Eighth Plan 30,540 16,420 46
Ninth Plan 40,250 19,015 53
Tenth Plan 41,110 23,250 40
Source : Various Five Year Plans.
Besides enlargement of generating capacity, the last five decades witnessed the growth of
power systems from the rudimentary stage of isolated stations to fairly well integrated systems in
most of the states and emergence of grids. Construction of inter-state and inter-regional lines has
also made headway. Despite this tremendous growth, India has always faced chronic power shortage
since
1950-51. (see Table 5)
Table 6. Installed Power Capacity 1950 to 2009
(Thousand MW)
Year Public Non-utilities Total
1950-51 1.7 0.6 2.3
1970-71 14.7 1.5 16.2
1990-91 66.1 8.6 74.7
2008-09 148.0 27.0 175.0
2009-10 159.4 28.5 188.0
 Source : Economic Survey, 2009-2010, Table 5.27.

Note : Add Recent Data

Reasons for Power Shortage

Basically, there are two reasons for this: (Dutt & Sundaram, 2011)
First, the demand for electric power has been rising continuously, as for instance, during the
1980's, if has risen at the annual rate of 9 to 10 per cent. This rise in demand is at all levels, viz.
public lighting and domestic use, railway traction, industrial use and lift irrigation in agriculture (the
demand in agriculture actually goes up when the monsoon is delayed or fails altogether, which is
precisely the period when the generation of hydro-electric power declines sharply).
Second, while the demand for electric power has been rising continuously, the generation
and distribution of power has not risen proportionately. A variety of factors have affected the
performance of the power sector and these have been examined in depth by many committees:
(a) The generation of hydel power has been fluctuating from year to year, depending upon the
nature and intensity of monsoons. Failure of monsoons adversely affects the generation of hydel
power. For example, the generation of hydel power in 2009-l0 declined to 106.7 billion kwh, from
120.4 billion kwh in 2007-08.
(b) The commissioning of new capacity has often considerably fallen short of targets.
(c) Power cuts have also been due to sub-optimal performance of a considerable number of
thermal units. This has been aggravated by teething troubles in commissioning newly installed
thermal generating units.
(d) The plant load factor (PLF) is an important indicator of operational efficiency of thermal
power plants. The average PLF in capacity utilisation of thermal power plants of the SEBs has been
low because of deficiencies in management and operation, lack of proper maintenance and non-
availability of coal of appropriate quality.
In this connection, we should refer to the increasing role played by captive power plants, also
known as non-utilities. Because of the tight power situation for many years, the Government has
been encouraging large industrial units specially in the fields of sugar, paper, cement, petrochamicals
and fertilisers to set up their own captive power plants. (Table 10)
The generation of power in these plants is around 12.7 per cent of the total power production
in the country in 2009-10 and it is steadily increasing. This has helped to ease the pressure of
demand on power generation in public sector electricity units (known as utilities) to some extent.
By the end of 12th FYP, the country would be importing nearly 25–30 pc of its natural gas, 75 pc of its
oil and 23 pc of its coal requirements. The electricity (Amendment) Bill 2014 has been introduced in Lok Sabha
for reforms in power sector, promote competition and efficiency in operation and improve the quality of
supply of electricity. (Economic Survey, 2014 – 15, Vol. 2).
Rural Electrification Policy
The Government of India notified its Rural Electrification Policy in April 2006, under sections 4
and 5 of the Electricity Act, 2002. The policy aims at :
(a) provisioning of electricity to all households by year 2009;
 (b) quality and reliable power supply at reason able rates; and
(c) minimum lifeline consumption of one unit per household per day as a merit good by the
year 2002.
Conclusion
India’s energy security – defined as the three as of availability, access, and affordability – confronts
four barriers normally (i) Limited fiscal room (ii) Systemic inefficiencies (iii) competition from China and (iv)
challengers posed to India’s conventional energy by climate change (Kapila, 20)
17. 6 TRANSPORT SYSTEM IN INDIA
Introduction
In the last lesson script of the syllabus, we shall study about the progress of transport sector
in India. In the 21st Century, it is emerged as the lifeline if the nations. The growing inter-dependence
of the economics has necessitated the spurt in the growth of transport sector.
A. Importance of Transport Sector
Transport plays and important role in the economic and social advancement of various
countries. In the words of Marshal, “the transport industries which undertake nothing more than the
mere movement of persons and things from one place to another have constituted one of the most
important activities of men in every stage of advance civilization.” Transport by carrying goods from
the place of production to the various places of consumption facilities specializations and division of
labour. The mobility, which it help to provide, adds the place and time utility to various commodities. It
also plays an important role in promoting economic growth. Investment in transport during the First
five Year Plan of India amounted to Rs. 5320 million. In the Second, Third, Fourth, Fifth and Sixth
Five Year Plan it increased to Rs. 13,000 million Rs. 21,130 million, Rs. 32,450 million, Rs. 68500
million and Rs. 12420 million respectively. It has kept increasing always.
The transport system comprised transport services such as Railways, Road Transport, Inland
Water Transport Shipping and Air Transport. During the past several years, there have been shifts in
the relative emphasis on different modes of transport in Indian and share of different methods of
transport in total traffic has undergone a change. In 1960-61 railways accounted for 83.8% of the
goods traffic in the country. In 1983-84 this percentage was reduced to 68%. Similarly, Railways
carried 57.8% in 1983-84. Road transport increased its shares of good traffic from 16.2% in 1960-61
to 31% in 1983-84 and that of passenger traffic from 42.2% in 1960-61 to 51% in 1983-84. By the
year 2010, percentage share of railways in goods traffic has increased to 67 percent.
17.6.1 Significance of Transport :
If agriculture and industry are regarded as the body and the bones of the India economy,
transport and communications constitute its nerves which help the circulation of men and materials.
The transport system helps to broaden the market for goods and by doing so, it makes possible
large-scale production through division of labour. It is also essential for the movement of raw
materials, fuel, machinery etc., to the places of production. The more extensive and continuous the
production in any branch of activity, the greater will be the need for transport facilities. Transport
development helps to open up remote regions and resources for production. Regions may have
abundant, agricultural forest and mineral resources but they cannot be developed if they continue to
be remote and inaccessible. By linking the backward regions with the relatively more advanced,
transport development helps in the better and fuller utilization of resources. Finally, expansion of
transport facilities, in turn, helps industrialization directly. The demand for locomotives, motor
vehicles, ships etc. leads to the start of industries which specialize in the production of these goods.
Expansion of transport is thus of fundamental importance for a developing country like India.
B. Growth of Transport System since 1951
Rail and road transport systems dominate but other forms of transport are also important
within their specialised areas considering the size of the country and its geographical features. Table
13 shows that the transport sector has recorded a substantial growth since the introduction of
economic planning in 1950-51. Railways have recorded a growth of 3 per cent per annum in freight
originating tonnage, though the growth in route length was indeed low. The road network has
expanded at an annual rate of 5 per cent while road transport fleet has increased by 7 per cent per
annum in respect of goods vehicles. About 70 per cent of the Indian villages have been connected by
a net work of rural roads and over 40 per cent of our villages are served by all weather roads.
Shipping tonnage has increased by an impressive 11 per cent while coastal shipping could register
only a meagre rise of 1.4 per cent. Airlines passenger traffic has rise smartly by 9 per cent per
annum. The traffic handled major ports has increased from 19 million tonnes 562.7 million tonnes
between 1951 and 2010, at In annual rate of over 5 per cent. The growth of transport sector in
general is indeed quite impressive, and it reflects the enormous outlay allocated to the development
of the transport system during the planning period.
Table 7. Growth of the Transport System
1950-51 1970-71 2005-06 2009-10
1. Railways : Route length (‘000 km) 53,600 59,800 63,300 64000
Freight Traffic originating 93 196 680 888
(million tones)
2. Roads : Total length (‘000 km) 400 915 2713 4236
surfaced 160 400 1510 2090
No. of goods vehicles (‘000) 82 343 4782 NA
3. Shipping : Overseas shipping (million 0.2 2.2 7.0 9.7
tones GRT)
ports Traffic in m. tones 19 - 424 562.7
4. Civil Aviation : Number of passengers (lakhs) - 26 318 569
Source : Dutt & Sundaram, 2011.
Note : Add recent data.
17.6.2 Railways
A. Development of Railways Before Independence
The Railway train in India was inaugurated on the 16th April, 1853. As the private companies
were not prepared to invest huge capital in railways construction because of the then prevailing
uncertainty of demand of railway service, the railways construction in India started under the State
guarantee and assistance. Government relieved the share holders of all risks, gave them come
expectation of profit, over and above the interest, and in return claimed reasonable power of control
and the right of purchase. The system of guarantee, though desirable due to uncertainty of demand
for railway service period to be uneconomic and extravagant; placed a heavy burden on the Indian
tax prayer, was responsible for non resident, multiple and inactive management, ignored Indian tax
payer, was responsible for non resident, multiple and inactive management, ignored Indian interest
and resulted in slow progress of railways in India. To remedy these defects, state deconstruction and
administration of India railways was started in 1869. However, due to financial difficulties faced by the
government of India, guarantee system was revived in 1881 and new contracts were made with some
new old guaranteed companies. The Twentieth century brought an era of prosperity for India railways
because of the development of trade, industries and agriculture which made them a paying
proposition.
First World War, which led to an enormous increase in goods passenger traffic-resulted in
over crowding causing delays and inconvenience to the traffic. The condition of Indian railway
deteriorated on account of lack of proper replacement and renewals. This led to overhauling policy on
the recommendations of Acworth Committee which was appointed in 1920. Many for reaching
changes were effected in railway management and financing, the period of depression from 1931 to
1936 when traffic considerably declined proved to be very trying for Indian railways. Recovery came
in 1936.
In 1936 when the Second World War broke out, railways were put to heavy strains as the
military movements to strategic points and the transportation of war materials increased heavily. On
account of the war emergencies, proper maintenance and replacement could not be undertaken.
Further, nearly 48% of the metre gauge locomotives, 15% of the metre gauge wagons, 4000 miles of
track and 4 million sleepers had been sent abroad particularly to the Middle East. There was
inadequacy of power and rolling stock and excessive accumulation of deferred maintenance,
renewals and replacement and serious depreciation of assets resulting from an intensive use of
equipments. Indigenous capacity for repair and rehabilitations was extremely limited. Locomotive
machinery tools and other equipments had to be obtained at greatly increased cost from foreign
countries, which themselves were heavily engaged in rehabilitation and recoveries to place time
needs of their own.
At the end of Second World War, a Post War reconstruciton plan was formulated. The plan
included :
(i) construction of 5000 miles of railway lines in under-developed area.
(ii) establishment of engineering works for producing engines and boilers.
(iii) provision for more passenger amenities at the stations and in the compartments.
(iv) provision for increased facilities for transporting material
(v) replacement of old rolling stock,
(vi) establishment of welfare oganization and
(vii) regrouping of railways. Partition of the country in 1947 created new problems for
Indian railways. There was a tremendous increase in work load due to the heavy
migration of population caused by communal riots. Partitions also led to a division of
railway mileage assets and railway staff between India and Pakistan. After partition
India has 34,083 route mileage and capital of Rs. 66.43 crores in Railways.
 It may be added that a number of committees examined the working of Indian railways during
the 20th century. These included Robertson Committee (1901) Mackey Committee (1906), Acworth
Committee (1920), Dickinson Committee (1926), Retrenchment sub Committee (1931), Pope
Committee (1932), Wedgewood Committee (1926) and railways Enquiry committee (1946).
B. Railways Development Under the Five Year Plans
First Five Year Plan :- The first Five Year Plan of India was mainly devoted to the
rehabilitation and modernization of rolling tock and fixed assets. “Other objects of the Plan were to
create as for possible, additional facilities for meeting some of the new needs which would arise from
the implementation of scheme of production and development, and to provide better amenities of the
traveling public and better housing and welfare for the staff.
Recent Plans : Eighth Five Year Plans
A decision has been taken to introduce uniguage system in the phased manner. During 1992-
93 to 1995-96, Railways have completed more than 5000 km of gauge conversion. Till the end of
1995-96 Railways, lifted only 391 million tones of freight traffic against the target of 398 million
tonnes. The revenue carrying capacity has been growing only at 2.5 per cent a year. There is no
modern signaling system. Freight carrying trams suffer from delays. The World Bank suggested
Privatisation which is not possible in one go. It may be feasible privatize some railway operations.
Ninth Plan : During Ninth Plan Rs. 50,611 crore were spent on the development of railways.
Tenth Plan : Rs. 60,500 crore were on the development of railways. Following main steps
were taken during the tenth plan for the development of railways.
(i) Highest priority was given to electrification of the railways.
(ii) Encouraging private sector participation in projects like gauge conversion doubling the
existing single lines, electrification, etc.
(iii) Speedy completion of ongoing projects.
(iv) Increasing productivity by technological upgradation.
(v) Improving customer satisfaction through safe, reliable and quality services.
Eleventh Plan : In Eleventh Plan, an amount of Rs. 1,94,263 crore, is proposed for the
development of railways. Indian railways are expected to carry 1100 million tonnes freight traffic
annually and 840 crores passengers annually by the end of eleventh plan. Following main steps are
proposed during the eleventh plan of the development of railways.
(i) Delhi-Mumbai and Delhi- Howrah freight corridors will be constructed to increase
goods transport and better connectivity with pots.
(ii) Public private partnership will be encouraged to improve railways infrastructure.
(iii) Provision of quality passenger amenities at railway stations and improvements in
sanitation will be made.
(iv) More intensive utilization of available assets and technological upgradation will be
done.
(v) Improvement in safety standards.
(vi) Development of high speed corridors to reduce transportation time.
Present Position : The railways are the principal means of inland transport in India, carrying about
80% of the goods traffic and 70 percent of the passenger traffic. They constitute the country’s biggest
national undertaken with total investment exceeding Rs. 5,000 cores. It is the second largest single
railways system in the world and the biggest nationalized undertaking in the country. At present init
runs about 12000 trains a day caries 75 lakh passengers and about 6 lakh tonnes of goods daily and
yields an annual revenue of over Rs. 1250 crores. IN March 1985 total number of locomotives were
10128. Number of coaches with Indian Railways were 38551 and number of wagons 365390.
Though in the point of railway mileage Indian Railways is largest in Asia and the fourth among
the countries of the World; Yet considering the size as compared with the other countries of the world
out total railway mileage is inadequate. While in India we have 2.8 miles of the railway per 100 sq.
miles of area, the U.K. and Western Germany have 20 miles each Belgium as many 44 miles.
Canada has 455 railways miles against India’s 95 miles per lakh of population (1 mile = 1.6 kms).
Total earnings from railways during 1986-87 are shown as Rs. 681 cr and total expenditure as
Rs. 6230 crores. Net earnings will be of the order Rs 589 crores.
C. Problems of Indian Railways : The history of financial problems of Indian railways is very old.
Before 1924 railways finances were a part of the general finances of the Central Government. In
1924 these were separated from the general finances. The position of railway finances has been
revised though conventions of 1943, 1947, 1950 and 1960. Indian railways, which were once a losing
concern and failing to meet their commitments to the general revenue, have now become a paying
proposition. However one cannot say that deficits have been completely ruled out from the railways
budget. Indian railways have been running into regular deficit in the near past. It may be observed in
this context that railway freight policy in India is not solely devised from the point of view of
augmenting the railway finances. There are many other economic and social considerations before
independence the railway charged flat rates on uniform basis without regard to distance. Thee was
also a wide disparity of rates of different commodities. The freight as well as fare rates are said to be
low, when compared to those of advanced countries. In these circumstances, it is not unusual of
financial interests of railway are resulting at times in losses. There have also been the problems of
over crowding, lack of punctuality, accidents, ticketless, travelling multiplicity of gauge corruption and
problems relating to fuel etc. There is inadequate investment in Railways, use of outdated
technology, inadequate wagon capacity and inadequate linkage with roads. Great improvements are
being effected in all these direction now.
D. Performance of Railways
Railways : The Indian Railways consist of an extension network spread over 64015 km, comprising
Broad Gauge (88%), Meter Gauge (9%) and Narrow Gauge (3%).
Electrification networks are available with 29.0 percent of the total route.
The Railways employ about 15 lakh workers, the largest number for any undertaking in the
country. A comprehensive plan for human resource development is required to upgrade skills, retrain
workers and achieve higher productivity. While staff productivity in terms of the number of traffic units
per employee, asset productivity in terms of net tonne kilometer per wagon day, wagon turn-around
time, loco-utilisation etc. have improved over the years, there is still scope for further improvement.
The Railways have so far met the challenge by relying less on budgetary support and more on
internal generation of resources which, in future may have limitations with increased outlay, on
account of the Pay Commission recommendations and growing lease rentals, etc. Alternative
sources of funding based on market borrowing are also being looked at although the servicing costs
would be higher.
E. Features of Railways New Marketing Strategies
 The Container Corporation of India (CONCOR), a public sector undertaking, will provide doo
to door service for domestic users, transportation in bulk for small customers and international
transport in International Standards Organisation (ISO) containers.
 Introduction of trains connecting Tuglakabag with Mumbai, Jawahar Lal Nehru Port Trust and
Madras to the movement of export container on scheduled time.
 Leasing out brake vans space to customers so that they can have assured transportation
between fixed points.
 Introduction of long distance special parcel service between Mumbai-Delhi, Delhi-Mughalsarai
and WA Bunder-Shalimar.
 Introduction of own Your Wagon Scheme to invite private sector investment of the ownership
of Railway wagons and there by supplement the resources available with the Railways for
meeting the transport requirements of various sectors of the economy.
 Simplification of rules in key areas like free acceptance of indents, supply of wagons, single
window boo system and faxing of invoices to the destination.
 Rebate of freight for utilization of wagons in the employ flow direction.
 Closure of yards to facilitate faster movement.
Private sector participation through scheme like Build-Own Lease-Transfer (BOLT) and Own-
Your-Wagon Scheme (OYWS) are also being explored. However, only limited success has been
achieved in these areas till now.
F. Railways and Recent Changes
Railways are an extremely efficient form of transportation. The energy consumption for freight
movement on railroads, which is 440 Joules/Kg km, is about one quarter of the consumption of 1,836
joules /kg km required for tucks. In addition, the railways generate less pollution, and involve fewer
accidents.
At end 2004, the network of Indian Railway (IR) was spread over 63221 route kilometers
(RKM), comprising broad gauge (46807 RKM), metre gauge (13,290 RKM) and narrow gauge (3.124
RKM). Around 28 per cent of this network is electrified.
(i) Fare & Freight
There has been significant effort at ‘tariff rebalancing’ and rationalization of fare and freight
structures in the Railways Budgets for 2002-03 and 2003-04. These includes reducing the number of
classes of freight tariff from 59 to 27, and reducing the ratio between the highest and the lowest
freight rates from 8.0 to 2.8 and reduction in freight rate for certain high-rates commodities such as
petroleum products iron, and steel and cement.

(ii) Rail Vikas Nigam Limited

 Rail Vikas Nigam Limited (RVNL) was set up in January 2003, as an effort to create a new
institutional mechanism for implementing important and long-pending railway projects through a blend
of budgetary support and non-budgetary initiatives. The projects form a part of National Rail Vikash
Yojana. An outlay of Rs. 717 crore has been provided for RVNL during the year 2004-05, to execute
38 projects, which form part of the Golden Quadrilateral and port connectivity routes.
a. State Initiatives
Indian railways, in partnership with State Government of Andha Pradesh, Jharkhand,
Karanataka, Maharashtra, Tamil Nadu and West Bengal, is executing various projects in the
respective States eight through cost sharing or formation of joint ventures. A Special Purpose Vehicle
(SPV) named Pipavay Railway Corporation Limited (PRCL) was formed with equal equity
participation from the Ministry of Railways and Gujarat Pipavay Port Limited (GPPL) for construction,
operation and maintenance of Surendranagar Pipavay broad gauge line. The construction of this line
has been completed and thrown open for goods traffic Since March 2003.
17.6.3 Road Transport
The importance of roads in the economic development of a country is in no manner
insignificant. Roads initiate and accelerate the development of rural areas and integrate rural
economic life with urban economic life. Road transport is also an important employment generating
sector. It has been estimated that every crore of rupees invested on road development leads to the
creation of 12,000 jobs. Moreover the agricultural and industrial revolution in a country cannot be
fruitful without a revolution in road development. The foodgrants and other agricultural goods
produced in farms cannot reach the markets and factories without the facilities of road transport.
Again the manufactured goods from factories and the imported goods from ports also require road
service to reach the consumers. Labour is mobile only with the transport facilities Jermy Bentham has
rightly said that “Roads are veins and arteries of a country through which every improvement takes
place.” Over all these considerations, roads are indispensable for an effective defence of the country.
A. Category of Roads
There are four categories of roads in India :
(i) National Highway : These roads run to the length and breadth of the country. They connect
state capitals and pass through important towns and then terminate national boundaries.
(ii) State Highways : The roads run through a state connecting district headquarters and other
cities with national highways.
(iii) District Roads : These roads are within a district connecting market and production centres
with highways and railways.
(iv) Village Roads : These connect the villages with one another and with the roads.
The responsibility of construction, maintenance and expansion of national highways state
highways, district roads and village roads is of central government, state governments, local bodies
and Village Panchayats respectively.

B. Development of Roads
 The Indian road system is one of the largest in the world. In 1917 there was 3.88 lakh kms of
roads in India. IN 1947, roads length increased to 12 lakh kms. Assessed in terms of areas and
population, the road, length for every 100 sq. kms of area is 34.5 kms and for every one lakh
population, it is 210 kms. Till late, road development remained a neglected subject. In 1928, a Central
Road Fund was created on the recommendation of a committee. In 1943, a long term road
development programme was prepared which came to be known as “Nagpur Plan.” The basic context
of the Plan was that no village in well developed agricultural area should be more than 5 miles from
the main road.
Road transport industry in India suffers from a number of problems. In addition to the
inadequate development of roads, road transport industry is generally ill-organised. Most of the
operator own less than five passenger vehicles. In truck transport single truck owners predominate.
Inadequacy of funds, inadequate India maintenance, higher taxes, cumbersome regulations are other
important problems faced by road transport in India.
C. Progress of Road Transport
India has a road network covering 2.7 million kilometers which makes it the third largest road
network in the world. However this network is not adequate for speedy and deficient transportation.
Half of this is made up of unsuraced roads. The National Highways which are arterial routes have
currently a network of 34,298 km. Although they carry nearly 40 per cent of the goods and traffic, the
national highway network constitutes less than 2 per cent of the total road network.
Road transport is the dominant form of transport for people and goods in India. Over 80
percent of passengers and over 60 per cent of freight move by roads. It is estimated that by the year
2000 road traffic will account for 87 and 65 per cent of passenger and goods traffic respectively. Its
quality and capacity of national highways network be enhanced consistent with the traffic express and
overall economic growth of the country. Movement on the highways is suffering frequent stopovers
and congestion as almost 75 per cent of national highways and state highways are single lane
roads.
The magnitude of the task on hand and volume of funds required for this purpose are beyond
the capacity of the public sector. In the other, roads have generally been financed from budget
sources and constructed by the Public Health Department. as the budgetary allocation is adequate to
meet the challenges stated above, National Highways Act has been amended to earn the levy of a
toll on selected improved section National highways. The amendment of the National Highways Act to
allow the private sector to construct and charge a fee or toll will permit the private sector to participate
the construction, maintenance operation of roads on Build, Operate and Transport (BOT) basis.
Several reforms/measures are taken by the Government to attract private sector participation in
Highways Development are summarised in the next section. These measures are comprehensive
and encompany land acquisition environmental clearance, simplification of procedures, tolling of 4
lanes passes and bridges, equity participation in highway sector.
After the amendment of national Highways Act in 1995 to allow private sector participation
measures have been taken to initiate national highway project though private sector participation.
Two projects by passes (Thane-Bhiwandi in Maharashtra and Udaipur in Rajasthan) and one project
of Road on Bridge (at Chalthan in Gujarat) involving an investment of Rs. 42 crore have been
awarded on BOT.
D. Public Private Partnership in Road Sector
 To encourage private sector participation, several initiatives have been taken by the
government which include :
(i) Declaration of road sector an as industry.
(ii) Provision of capital subsidy upto 40% of project cost.
(iii) 100% tax exemption for a period of 10 years.
(iv) Governmental shall bear all expenditure of land and will provide free site for work.
(v) 100% foreign Direct Investment is allowed in road sector.
(vi) Private partner is allowed to recover the entire cost alongwith the interest and a return on
investment out of feature toll collection.
E. Major Initiatives of Highway Development
1. The government has promulgated a separate ordinance for land acquisition for development
and maintenance of national highways. The ordinance provides that once the Government declares
that the land is required of the purpose of development of National Highways, it would deem to have
been vested in the central Government. Only compensation can be settled through arbitration.
2. Project for widening of the existing National Highways have been exempted from
environmental and forest rules.
3. The Government had decided to levy a user fee (toll) on completed 4-lane sections including
those which would be needed though the budget. The rate of fee will be fixed taking into account the
savings in vehicle operating costs. The revenue generated from such use fees will be utilised for
future road development.
4. In order to encourage private sector participation the National Highways authority of India has
been permitted to participate in the equity of a company promoted by the private or the public sector.
5 In the case of BOT projects the financial liability of the government would be the least except
in cases where continued collection of tolls is frustrated by changes in the policy of the government.
In the cases, it has been decided to compensate the entrepreneur suitably and this would be
consistent with national norms and practices.
6. The provisions relating to foreign investment in private sector have been considerably
liberalised. Domestic approval will be accorded for foreign equity participation upto 74 per cent in
construction of root bridges. In addition to this, automatic level would be given for majority foreign
equity 51 percent in support services to land tansport operation of highways bridges, toll and roads.
7. External assistance is being obtained of the movement of National Highways though national
agencies such as the World Bank, Asian Development Bank and Overseas Economic Bank of Japan.
The Government of India has stated the National Highway Authority, which is body created through
an Act of Government Bank Project costing about Rs. 800 crores in states viz. Haryana, Rajasthan
Bihar, Bengal and Andhra Pradesh.

F. Roads and NHDP

 Indian roads carry 85 percent of the passenger and 70 percent of the freight traffic of the
country. The highways, even though they make up only 2 per cent of the road network by length carry
40 percent of this traffic. For many years, India lagged behind many countries of the world which built
expressways capable or sustained speeds of over 100 kilometre per hour (kph). In recent years, a
concerted efforts has been undertaken, through new institutional arrangements and improved
highway engineering, founded on a revenue model comprising tolls and cess on fuel, to build roads
which deliver 80 kph sustained performance. Under the National Highways Development Project
(NHDP) the largest highway project ever undertaken by the country and with the Shortest test time
span for completion 14,279 kilometer of National Highway are to be converted to 4/6 lanes, at a total
estimated cost of Rs. 65,000 crore (at 2004 prices). The NHD consists of the following components.
NHDP - Phase - I & II include -
(i) The Golden Quadrilateral (GQ 5,846 kilometer) connecting four major cities Delhi,
Mumbai, Chennai and Kolkata.
(ii) The North-South and East West Corridors NS – EW – 7,300 kilometer) connecting
Srinagar in the North to Kanyakumari in the South and Silchar in the East to
Porbandar in the West.
(iii) Total length of 14,357 km road will be upgraded.
NHDP Phase III involves 4-laning of 12,109 km of national highways connecting state capitals and
important tourist places.
NHDP Phase IV comprises of 2-laning of 20,000 km of national highways.
Port connectivity and other projects – 1,133 kilometer. NHDP Phase IV is a new initiative
proposed with a view to provide balanced and equitable distribution of improved/widening highway
network throughout the country by upgrading 21,000 kilometer of single – lane roads to 2-lane roads
with paved shoulders, and for strengthening of 17,000 kilometer of the existing 2 lane highways and
construction of paved shoulders.
NHDP Phase V comprises six laning of 65,000 km of important national highways.
NHDP Phase VI involves development of 1000 km of expressways.
NHDP Phase VII involves construction of ring roads, flyovers and bypasses on selected stretches.
G. Problems of Road Transport and Suggestions
1) Roads are inadequate compared to the need. There are only 34 km. of roads per 100 sq. km
of the area, compared to 270 km. in Japan and 16.7 km in West Germany. The government
should spend lot of more money on the construction of roads.
2) Granting Licences for motor vehicles is often too much delayed. This affects the growth of
transport. Licence issuing should be fast and efficient.
3) There is Heavy Tax Burden on motor transport industry in India. Incidence of motor tax in
India comes to nearly Rs. 3500 per motor vehicle, while in U.S.A. it is Rs.860 and in U.K. just
Rs.470 burden on motor vehicle should be reduced.
4) Maintenance of Roads is severely lacking. Less than 0.1% of national income is spent on
the maintenance of roads compared to 3% in Japan, Bad roads enhance operational cost.
Steps should be urgently taken for the maintenance of roads.
5) Road and Rail Transportation have emerged to be competitive in nature and coordination
between the two is lacking which needs urgent attention of the government.
6) Less Roads in Rural Areas : Nearly 60% of villages in India area sill devoid of metalled
roads. This has an adverse effect on economic activity in rural areas. Priority must be
accorded to link rural area with the urban areas through metalled roads.
7) Single Lane Roads : Result in traffic jams and large number of stoppages. About 32 per cent
of national highways and 75 percent of state highways are single lane. There is an urgent
need of converting national highways from single lane to double lane and the double lane
roads into four lane roads.
17.6.4 WATER TRANSPORT
Water transport is a very primitive mode of transport. However, it enjoys a number of
advantages over other forms of transport. Water ways being free gift of nature, require a nominal
capital investment cost of operation is also very low. Further, vehicles have vast carrying capacity.
Again, at certain places these are the only means of transport. It is particularly so during rainy
season. Water transport also helps in carrying troops and war supplies. Ships also play a unique role
in the foreign trade. Nevertheless water transport has certain limitations also. These relate to Limited
area of operation zig zag routes, slow speed blockade of waterways, storm, hurricanes, seasonal
character, higher intensity and frequency of accidents, international rules and political domination.
A. Types of Water Transport
Waterways in India may be divided into two main kinds.
a) Inland waterways
b) Ocean or marine transport
As on 1 January, 2011, in all 122 companies with a fleet of 1040 ships were operating in the
country – both in public (45% of capacity) and private (55% of capacity) sector. Shipping corporation
of India is the largest public sector company in the country with a fleet of 75 merchant ships. Its share
comes to 29 p.c. of total shipping industry capacity.
Inland Waterways
Inland water transport was in a developed stage during the Muslim period in India, it continued
to play a significant role in the transportation system of the country till the introduction of railways.
The use of steamers in India started in 1812. In 1812 there was a regular fortnightly steam service
between Calcutta and Agra on Ganga and Yamuna. However, with the advent of Indian railways,
inland water transport suffered. It was part due to government policy favoured railway more than
other means of transport, partly due to inherent advantages of railways over inland water transport
and partly due to faulty organization and limitations of inland water transport itself.
Partition of the country in 1947, when many rivers in North-East India and East India were
considerably untamed further give a set bank to the development of inland water transport. After the
partition however the position had improved and development of inland water transport has received
encouragement forth government. An important step taken during the First Five Year Plan was the
setting up of the Ganga - Brahamputra Board. During the First Five Year Plan period, Government
spent Rs. 34 crores on the development of inland water transport. In Tenth Plan Rs.5418 crore were
spend for development of ports in Public sector.
In 1961, government merged Eastern and Western shipping Corporation and established
‘Shipping Corporation of India’. It has collaborated with Iran in joint venture shipping company named
‘Irano-Hind Shipping Company’.
B. Shipping in India (90s and beyond)
Indian vessels carried about 29 per cent of the total sea-borne cargo during 1994-95. The
share of Indian vessels in 1994-95 in Petroleum Oil and lubricants (POL) was 54 per cent, in bulk
carriers 17 per cent, in liner traffic 9 per cent. Long term targets for Indian shares in bulk carriers and
liner traffic are 50 and 40 percent, respectively. The fleet strength at the end of October, 1996 was
481 vessels of 7.02 million crores Registered tonnage (GRT), against 468 vessels of 6.9 million CRT
in October, 1995. Overseas trade during 1994-95 was 147 million tonnes against 137 million tonnes
during 1993-94.
The Shipping Corporation of India (SCI) showed a better financial performance during 1980 to
1995. It has earned record net profit after tax of Rs. 323 core in 1995-96 registering an increase of 61
per cent over 1994-95. SCI’S gross internal resource rose to Its. 554 crore in 1995-96. The period
1995-2002 showed tendency of fall in GRT. Record GRT of 71 lakh fall to 69 lakh in 2002. At the end
of Tenth plan, GRT increased to 82.9 lakh. In 2009-10 GRT increased to 101.1 lakh.
C. Reforms in the Shipping Sector
 Introduction of Automatic Approval Scheme for the Shipping Companies for.
(i) acquisition of all categories of ships, except crude oil tankers and OSV’s by private
shipping company.
(ii) acquisition of replacement tonnage and
(iii) acquisition of ships from an Indian shipyard.
 No approval is required for sale of ships.
 Ship building and ship-repairing units have been allowed to import items figuring in the restricted
list of 1922-97 EXIM policy subject to actual user condition. No licence will be required for this
purpose.
 The Committee for slotting of ships which used to decide about the yards where the ships are
required to be repaired has been abolished.
 Shipping companies have been permitted to retain sale proceeds of Indian ships abroad for
utilizing them for fresh acquisition.
 There is freedom to time charter out Indian ships to foreign companies for employment in
international cross trade.
 Shipping companies allowed to acquire vessels on charter-cum demise-method.
 Certain provisions of the Merchant Shipping (MS) Act, 1958 have been amended to facilitate
Indian Shipping companies to raise foreign exchange loans abroad by mortgaging their vessels.
 In order to attract foreign mainline vessels to the Indian Ports, Cabotage Laws have been relaxed
for a period of 5 years up to 1997 for container vessels and lash barges.
 Age norms for acquisition of second hand vessels, have been further relaxed in 1995.
 Shipping rates for carriage of passengers or cargo by any ship engaged in coastal trade are no
longer administered.
 Section 21 of the MS Act has been amended, thereby doing away with the requirement that the
Chairman of the Board of Directors and Managing Director should be a citizen of India. Similarly,
“the minimum percentage of share capital of the companies to be held by a citizen of India for
owning a ship in India has also been deleted;
 FDI up to 100% has been permitted for the construction and maintenance of ports on a harbor.
 Rail and connectivity with ports is to be improved.
 Shipping companies can avail loan in foreign currency by pledging their ships.
There are two major public sector ship building yards, Hindustan Shipyards Limited
(Vishakhapatnam), and Cochin Shipyards Limited (Cochin). Due to various reasons i.e. high
construction cost, heavy interest burden on borrowings, low order book position, excessive
manpower etc. these yards had been incurring losses. However, as a result of revival measures
initiated by the Government in September 1993 the two yards have shown an improved performance.
Cochin Shipyard limited had earned a net profit of Rs.18.46 crores in 1995-96 as against a profit of
Rs. 11.16 crores during the previous year. Hindustan Shipyard incurred a net loss of Rs.118 crores in
1995-96. In 2010, India had nine shipyards in public sector and about 21 in private and state
government sectors.
The International Safety Management (ISM) code, was adopted by the International Maritime
Organization (IMO) in November, 1993. This code is to come into force in 1998 for passenger ships
and tankers and by 2000 for other vessels. The shipping companies are required to provide special
training to on shore staff and crew on board in order to implement this Code. The Directorate General
of Shipping constituted a Sub-Committee which is to dialogue with the shipping companies to
implement the Code well before its due date.
D. Ports [Ocean or Marine Transport]
Ports are a crucial part of the transportation infrastructure of the country. The international
experience with economic development has emphasized the development that has taken place near
the coast through “gains from trade”.
India has around 6000 km of natural peninsular coastline. There are 12 major ports and 185
minor ports. Ports in India are divided into “major parts” (a list of named ports where the central
government plays policy and regulatory functions) and which are guided by the state government). As
of today, the 12 major ports of the country handle about 75 percent of the traffic. They are Chennai,
Cochin, Indore, Jawaharlal Nehru (Mumbai), kandla, Kolkata, Murmuao, Mumbai, New Mangolore,
Paradip, Tuticorin and Visakhapatnam. There are 85 minor ports, with a prononuned accent Diu (2),
Karnataka (9), Kerala (13), Lakshadweep (10), Tamil Nadu (14), Pondicherry (1), Andhra Pradesh
(12), Orissa (2), West Bengal (1) and Andaman and Nicobar Islands (23).
17.6.5 Civil Aviation
A. History of Air Transport in India
1. In Asia, India was the first country to introduce air service in 1914 through it progressed only
after the Second World War. On the eve of independence ten air companies were working in country.
However, owing to severe competition the companies started dwindling. In 1950 Air Transport
enquiry Committee was established. On its recommendations air transport was nationalized in 1953,
and two corporations were established viz., Air India and Indian Airlines. But now Air Corporation Act,
1953 has been repealed and monopoly of Air India and Indian Airlines ended. Now private airlines
have been allowed in Air Transport.
B. Following are the main airline services available in India :
i) Air India : Air India is the international air service of India. It owns a fleet of 16 aircrafts and has
taken 20 air crafts on lease, making the total number of 36 aircrafts with Air India. Air India operates
200 flights per week. In the year 2005-06, government accorded approval to Air India for acquiring
68 more aircrafts.
ii) Indian Airlines : Indian Airlines is the domestic air service of Indian government. It operates at 58
domestic airports. It has a fleet of 73 air crafts in the year 2005-06. Keeping in view the increased
domestic traffic, government gave approval to Indian Airlines in the year 2005-06 for acquiring 43
airbus aircrafts. These air traffic are expected to be delivered by April 2010.
iii) Pawan Hans Helicopter Limited : This is one of the India’s leading helicopter company. It was
incorporated in 1985 with the objective of providing helicopter services to petroleum sector,
inaccessible areas of the country and to promote tourism. It owned 36 helicopter in the year 2007.
iv) Air India Express : During 2006 air India express started its operations. It is subsidiary of Air
India to provide low cost air service. Air India has leased its 7 aircrafts to Air India Express Ltd.
Presently it has a fleet of 7 leased and 6 owned aircrafts.
v) Private Airlines : In April 1997 private airlines have been allowed to provide air lines service in
India. These airlines provide service within the country but if it owns more than 20 aircrafts and has
background of 5 years domestic services, then with the prior approval of government, it can provide
airlines services even at international destinations except gulf nations. In the year 2005-06, private
airlines were holding 69% of domestic traffic. The main private airlines are – Air, Sahara, Air Deccan,
Jet Airways, Paramount Airways, Kingfisher Airlines, Go Airlines, Go Airways, Indigo etc. In private
sector one cargo airline, viz., Blue Dart Aviation Pvt. Let is providing cargo service in the country.
3. In tenth plan period (2002-07) the growth in international passengers was 13.38% while
growth in domestic passengers was 21.78% per annum. In 2007-08, 21.25 lakh passengers were
handled at international terminals and 488.81 lakh passengers were handled at domestic terminals.
In 2007, India had bilateral Air services Agreements with 101 countries.
4. The activities of Civil Aviation are broadly divided into three areas; operational, infrastructural
and regulatory-cum-development. On the operational side, Indian Airlines Ltd. And private airlines
(scheduled and non-scheduled) provide domestic air services. Air India Ltd. Provided international air
services. Indian Airlines Ltd. Also provided air services to neighbouring countries. Pawan Hans
Helicopter Ltd. provides helicopter support services primarily to the petroleum sector. Infrastructural
facilities are provided by the Airport Authority of India (AAI). The two authorities viz. International
Airports Authority of India (IAAI) and the National Airports/Authority (NAA) were merged on April 1,
1995 to form single authority viz. Airports authority of India (AAI) as a result of enactment of Airport
Authority of India Act, 1994. The regulatory and development functions are looked after by the
Ministry of Civil Aviation and the Directorate General of Civil Aviation.
With the repealing of the Air Corporation Act, 1953, on March 1, 1944, the monopoly of Indian
Airlines, Air India and Vayudoot over scheduled air transport service came to an end. Seven private
operators, who were hitherto operating as air taxi have been granted the status of scheduled airlines.
In addition, 21 air taxi operators have been given the permit of charter/non-Schedule air transport
services. A new policy for private investment in civil aviation has been announced allowing for 40 per
cent foreign equity in domestic airlines.
C. Airport Authority of India (AAI)
AAI was established on 1 April 1995. It manages 133 airports including 17 international 88
domestic airports and 25 civil enclaves at defence airfields. It controls and manages the entire Indian
air space and is responsible for providing safe and efficient Air Traffic Services constructing and
maintaining runway terminal building; providing Air Safety Services and arranging search and rescue
facilities. International airport in Delhi and Mumbai have been modernized and upgraded through
private sector participation. Two Greenfield airports of international standards at Hyderabad and
Bangalore have become operational in 2008. Approval has been given to construct 3 more Greenfield
airports of international standard at Goa. Ahmadabad and Thiruvananthapuram. In addition Kolkata
and Chennai airports will be substantially upgraded.
D. Air Transport and Plans
Air Transport has made progressed well during planning ear. In the First Plan Rs.23.2 crore
were spent on an transport Rs. 43 crore in the Second, Rs. 50 crore in the Thirds, Rs. 185 crore in
the Fourth, Rs. 295 crore in the Fifth, Rs. 850 croreb in the Sixth Rs. 758 crore in the Seventh Plan
and Eighth Plan spent Rs. 4083 crore During this Plan many private airways companies sprang up
and thousand RS. 7249 crore on air transport. During Ninth Plan Rs. 9432 crore were spent on air
transport. During Tenth Plan Rs. 12928 crore were spent on the development of air transport. In
eleventh plan, Rs. 43560 crore are proposed to be spent for the development of civil aviation sector.
E. New Policy Air Transport
As mentioned earlier, since 1953 transportation India has been the monopoly of the
government. Two companies of the government namely. Air India and Indian Airlines used to control
the entire air transport of the country. Keeping in view the success of competition in air transport in
other countries of the world, government of India has also taken the following measures to liberalise
air transport to much extent.
In November 1979, Open Skies Policy was announced. Some small Airlines had started air
taxi flights. But owing to some causes these could not succeed and so had to wind up.
With the enforcement of new economic policy many air companies of private sector entered in
to air transport service. First among these companies was East-West Airlines. It launched its
operation in February 1992, But now it has closed its operations.
In the year 1994, by an Act government revoked forty year old Air Corporation Act. In this way
transport was denationalized. On 29th January, 1994 Air Corporation (Transfer of Undertaking and
Repeal) ordinance was passed. It subjective was to end the monopoly of public sector in domestic air
transport service and to allow sector to participate in air transport. Under this Act, Air India and Indian
Airlines were also to be re-organised as public limited companies.
With the trend towards privatization, nearly 60 per cent shares of Air India and 40 per cent
share of Indian Airlines were sold to private investors. At present main private sector air companies in
the field are : Jet Airways, Sahara Airways, Air Deccan, Kingfisher Airlines, Spice Jet, etc. Since
2005, private airlines with a fleet of atleast 20 aircraft have also been allowed to fly to international
destinations.
International Airports in Delhi and Mumbai are being modernized through private sector
participation. It is expected that modernization of these airports will be complete by 2010.
A new company National Aviation Company of India Limited has been incorporated. Both Air
India and India Airlines are included in this new company. The brand name of the new airlines will be
Air India and its logo will be ‘Maharaja’. The technical formalities of the merger are underway and it is
hoped that the new company will start functioning shortly. In year 2007, Air Sahara was also merged
with Jet Airways.
The important of features of the Eleventh Plan were to provide world class infrastructure
facilities, safe, reliable and affordable air services so as to encourage growth in air passengers and
air cargo traffic.
Domestic air services are operating in a competitive environment and this has effectively been
in existence since April, 1993.
F. Regulatory Framework Governing the Airlines Industry : Recent Changes
In order to ensure sufficient availability of seats, a limited open sky policy was adopted by the
Government for November 2004 to March 2005, under which designated airlines can operate
additional services to/from India subject to the existing terms of commercial agreement with Air India /
Indian Airlines. A number of airlines have responded to the offer and have requested for operation of
over 2400 additional flights (equivalent to over 5 lakh seats) to different airports in the country during
this five-month period. This will assist greater connectivity to/from India and easy availability of seats.
G. Air Traffic
Policy initiatives have had a marked impact upon airline traffic. Domestic traffic grew by 24.7
percent in calendar 2004 over calendar 2003. The international traffic saw a growth of 18 per cent in
the same period. Private airlines accounted for 61.1 per cent of domestic traffic in 2003.
H. Airports
Efforts to restructure and modernize the Mumbai and Delhi airports through the joint venture
route are underway. An Empowered Group of Ministers has been constituted to oversee the process
of restructuring. A request for proposal (RFP) document is expected to be release shortly to pre
qualified bidders for selection of the joint venture partner. Two new green field airports with private
sector participation are porposed at Bangalore and Hyderabad. In these Greenfield airports, private,
partners will hold 74 per cent equity in the joint venture and State Governments and Airport Authority
of India (AAI) will together hold the balance 26 per cent. The State Governments of Andhra Pradesh
and Karnataka have selected the private sectors partners for Hyderabad and Bangalore airports
respectively. The Bangalore and Hyderabad International Airports and Airports Authority of India have
signed the respective shareholders agreements. The two joint ventures are Bangalore international –
airport Ltd. (BIAL) and Hyderabad international Airport Ltd. (HIAL).
Financing : The demand/needs of India’s infrastructure capacity are exported to double every decade,
according to the Planning Commission. The 12th FYP calls for total investment in infrastructure of Rs. 50 lakh
crore (2012 – 17) of which about 40 p.c. is selected for sector.
17.6.6 Co-ordination
According to K.G. Fenelon, “Coordination implies that each form of transport would be used in
economic conjuncture best suited to its characteristics.” Coordination seeks to regulate competition,
tries to bring about balance in the total demand and supply of transport services, and aims at
maximum utilization of transport services, proper control of all the transport agencies. It can be
affected voluntarily statutorily through State ownership or by making all other means of transport
dependent on mode of transport.
Before Independence the problems of transport coordination in India mainly related to rail and
road coordination with a view to save railways from competition from road transport. It was effected
mainly through regulation of road transport. The main efforts made in this connection related to
setting up enactment of the Mitchell-Kirkners Committee on co-ordination (1932), Rail Road
Conference (1932), Railways (Amendment Act, 1933 etc. Transport Advisory Council 1935,
Wedgwood Committee 1936, Motor Vehicles Act, 1939 etc.
After Independence coordination efforts were made mainly through proper planning of
development of various means of transport under the five year plans and through the committees.
First Five Year Plan observed, “Plan for different forms of transport cannot be considered in isolation.
They must fulfill the fundamental objectives of matching transport development with various industrial
and agricultural plans, and they must be so built that one form of transport is correlated with another,
and ensures its development in each sphere and effective services.” Second Five Year Plan
emphasized on the setting up of road transport corporations for achieving co-ordination were
expected to have a say in the of these corporations. Third and Fourth Plan also sought to correlate
the development of various means of transport Policy and coordination (1966) made various
suggestions for effecting coordination between various modes of transport.
17.7 FINANCING OF (AND PRIVATE INVESTMENT IN) INFRASTRUCTURE
In the past, the responsibility for providing infrastructure services was vested with the
Government-the reasons being: heavy capital investments, long gestation periods, externalities, high
risks and low rates of return on investment. The infrastructure under government ownership and
management has, however, proved thoroughly inefficient and corrupt. The demand for infrastructure
facilities and services has always outpaced supply; besides, the quality of the existing supply is
extremely poor. The consequent shortfalls in capacity and inefficiencies in infrastructure facilities are
patent in the increasingly congested roads, chronic transport bottlenecks, frequent power failures and
load shedding, long waiting lists for installation of telephones and shortage of drinking water. The
widening gap between demand and supply of infrastructure and the extremely poor quality of the
existing supply raises important questions concerning the sustainability of economic growth of the
country in the coming years.
In order to achieve and maintain a high annual GDP growth rate (of 7 per cent) it is imperative
to accelerate the rate of investment in infrastructure. According to the Finance Ministry's Expert
Group on Commercialisation of Infrastructure Projects (June 1996) the total infrastructure investment
requirements would be about Rs. 40,000 crores to Rs. 45,000 crores during 1996-2001 and another
Rs. 75,000 crores during the next 5 years ( 2001- 06). This order of massive investment requirements
is clearly beyond the capacity of the Government. The financial resources available to the
Government are very limited. At the same time, public debt and other government liabilities are
increasing by leaps and bounds. Accordingly, the creation of quality infrastructure will need the
infusion of private capital, both domestic and foreign. At the same time, technological and
organisational innovations have made it possible for the private sector to enter the infrastructure.
Since 1991, Government strategy attaches high priority to the development of efficient
infrastructure and towards creating an enabling environment for private participation in the
infrastructure sector. Besides, Public-private partnership can also encourage better risk sharing,
accountability cost recovery and management of infrastructure. Some of the important steps in this
direction are (Dutt & Sundaram, 2011).
(a) The Government set up the Infrastructure Development Finance Company in January
1997, under the Indian Companies Act, with an authorised capital of Rs. 5.000 crores.
(b) The Government has announced a tax holiday to companies developing, maintaining and
operating infrastructure facilities, such as roads, bridges, new airports, ports and railway projects and
also those dealing with water supply, sanitation and sewerage projects.
(c) The Government has permitted income tax exemption on dividend, interest or long term
capital gains earned by funds or companies set up to develop, maintain and operate an infrastructure
facility.
(d) The Government has raised the corpus of the National Highways Authority of India Ltd
(NHAI) by Rs. 200 crores to enable it to leverage funds from the domestic and international capital
markets.
(e) The Government has enhanced tax rebate limits for investments in shares and debentures
offered by infrastructure companies; this is to channelise domestic savings into such investments.
(f) India Infrastructure Finance Company Limited (IIFCL) by the Ministry of Finance in consultation with
Planning Commission for providing long term Loans for financing infrastructure projects. That typically involve
any gestation periods. In 2013-14, IIFCL mobilised long term resources from Asian Development Bank (ADB),
world Bank and KFW with Rs. 1605 crores.
Infrastructure investments are, by their very nature, long gestation activities. If private
participation has to be encouraged to enter the infrastructure, there is the need to develop domestic
capital markets which will make funds available for long periods through long term debt instruments.
The Asian Development Bank (ADB) has provided a loan of $ 300 million for the Public Sector
Infrastructure Facility (PSIF) in order to support private sector infrastructure projects through the
development of the long-term debt market.
It needs to be mentioned here that in many developed and developing countries, contractual
savings in the form of pension and provident funds are being tapped for infrastructure financing, since
these savings are long term in nature and could act as a source of funds for debt instruments with
long term maturities. The Government will have to introduce appropriate reforms in public provident
funds, pension funds and insurance companies so that the private sector can have access to these
funds for infrastructure development.
17.7.1 Foreign Investment :
 The Government of India has put in place liberal foreign investment policy under which FDI up to 100
pc is permitted under the automatic route in most sectors. Sectors recording positive growth included railway
rated components, telecommunications air transport, and power.
17.7.2 Reforms :
In recent years, the Government has undertaken many sector-specific reform measures. For
instance telecom projects are to be treated as infrastructure and are to receive all the fiscal
concessions available for infrastructure projects - like tax holiday and concessional project import
duty.
The Government of India has promulgated an ordinance to facilitate private investments in
the transmission of electricity, as distinct from generation and distribution of electricity.
The Government has also announced guidelines for private investment in highway
development through the Build-Operate-Transfer (BOT) route - these would provide more financial
concessions and also facilitate the preparation of detailed feasibility reports, clearance for the right of
way of land, relocation of utility services, resettlement and relocation of the affected establishments,
environmental clearance and equity participation in the highway sector.
Similar guidelines have been given for private participation in ports.
The Expert Group on Commercialisation of Infrastructure Projects has also recommended the
setting up of an autonomous regulatory body for each infrastructure sector on the lines of SEBI to
ensure fair competition among public and private operators, protect consumer interests, particularly
the needs of vulnerable and weaker sections, ensure public safety, environmental sustainability, etc.
The role of public sector enterprises in the field of infrastructure after the entry of the private
sector would not change. The public sector enterprises will continue to shoulder the major burden of
providing critical infrastructure services but public sector reforms would be necessary to broad-base
their management, to upgrade their technology, to improve their performance and quality of services
and to generate adequate in vestible resources through rationalisation of service charges and better
recovery of costs.
17.7.3 Investment
For stepping up GDP growth, it is vitally necessary to increase investment in infrastructure.
This investment may be made by the public sector or the private sector. It is quite well known that the
private sector undertakes investment in such areas in which it expects a high rate of return. It is,
therefore possible that certain very important sectors of economy which do not promise high rate of
return may not attract the private sector investment. This gap has to be filled by the public sector.
Gross capital formation in infrastructure investment at current prices increased from Rs.
45,940 crores in 1993-94 to Rs. 289466 crores in 2009-10. However, expressed as percentage of
GDP, total investment in infrastructure declined from 5.88 per cent in 1993-94 to 4.7 per cent in 2009-
10. This is a very unhealthy trend. There has been a cutback in capital expenditure in Central
Government. Not only that, many state governments are using plan funds ear-marked for capital
projects to finance escalation in non-plan expenditure. Although the government has been
emphasizing expansion in infrastructure to boost growth, the fact of the matter is that there is a strong
retardation experienced in infrastructure investment which needs immediate remedial action.

17.7.4 Financing Infrastructure

 Infrastructure development plans require matching sources of finance. In this regard Table 9
gives details of sector wise incremental flow of bank credit investment by insurance companies,
external commercial borrowings and flow of FDI to infrastructure sector.

Table 9. Financial of Infrastructure Project

Rs. Crore

2006-07 2007-08 2008-09

Incremental Flow
of bank credit 30122 61745 64852
Investment by
insurance companies 28906 10400 13089
External Commercial
Borrowing ... 10156 5225
Foreign Direct Investment
Flow 961 5179 5400
Source: Economy Survey 2009-10

Apart from these sources of financing infrastructure, private placement and capital raised
through public and rights issues also are some other sources. The major portion of financing was
coming from domestic sources. These figures break the myth that foreign investment is primary to
raise infrastructure in the country.

Table 10 : Gross Capital Formation in Infrastructure (at current prices)

1993-94 1997-98 2000-01 2007-08 2008-09@ 2009-10**

A. Gross Capital Formation in 45950 62903 94226 202738 268777 289466

infrastructure

1. Electricity, gas and water 23170 30756 36907 96939 114340 126110
2. Transport, storage and 22770 32147 57319 105749 154437 163356
communication

2.1 Railways 5580 5069 5491 22229 29661 32337

2.2 Transport by other means * 11304 10460 25802 50093 59778 56720

2.3 Storage 136 456 1362 947 1675 1717

2.4 Communication 5750 10162 24664 32480 63323 72582

B. Gross Domestic Product 781345 1390148 1902998 4581422 5282086 6133230

C. A as % B 5.88% 4.45% 4.95% (4.4%) (5.1%) (4.7%)

* Include roads, civil aviation, seaports and inland water. ** Quick Estimates @ Provisional Estimates.
Source : Dutt & Sundaram, 2011.

17.7.5 Public Private Partnership and Infrastructure

Infrastructure services used to be predominantly provided by the public sector in almost all countries
for most of the 20th century. Rakesh Mohan Committee (RMC) (GOI, 1997) set the agenda for reforms in
infrastructure sector. The RMC Report highlighted the importance of private investment in most areas of
infrastructure (Kapila, 2017).
Given the need of mega infrastructure required, public sector cannot cope with the need of the
hour. Though the Government has been emphasizing the importance of infrastructure for the
development of the economy, we witness a cut back in the investment by the government in the
infrastructure, both at the central and state level. In the last few years, public private partnership in
the infrastructure sector is gaining importance.
Economic Survey 2009-10, underlines the importance of PPP projects and says, “PPPs offer
a number of advantages in terms of leveraging public capital to attract private capital and undertake a
larger number of infrastructure projects, introducing private-sector expertise and cost-reducing
technologies as well as bringing in efficiencies in operation and maintenance, Hence, more than their
fiscal implications, PPPs are tools to fulfill the basic obligations of Governments to provide better
infrastructure services (with large externalities), by increasing the accountability of the private sector
as a service provider. "
But it is not an automatic or easy task. Economic Survey further says, "A key pre-requisite is
to lay down a policy, legal and regulatory framework that assures a fair return for investors, protects
the interests of users, especially the poor, and assures quality supply at reasonable cost. For this
purpose, it is important that issues related to the adopted, procurement strategies and templates to
be employed and mechanisms for financial structuring to be considered, are clearly outlined ab initio
at the level of the sponsoring agencies, including State Governments."
The entry of private sector operators in ports, civil aviation and telecom has led to a very rapid growth
of these sectors, and in no-conversational and renewable energy sources such as wind energy and small hydro
projects.
Sector wise description of PPP (in 2009-10) both at state and central level projects is given in
Table 11.
Table 11
Sector Number Below Rs.250 Between More than Value of
crore Rs.251 to 500 Rs.500 crore contacts (in
crore crore)
Airports 5 0 303 18808 19111
Energy 24 734 2669 13708 17111
Ports 43 1066 2440 62993 66499
Roads 271 8689 32862 60454 102005
Urban 73 2753 2404 10132 15288
Development
Other sectors 34 1613 905 1644 4162
Economic Survey, 2009-10
The PPP project proposals costing less than Rs. 100 crore seek approval from existing EFC
mechanism and costing more than Rs. 100 crore received from Govt. departments will be considered
by Public Private Partnership Approval Committee (PPAC).
17.8 ELEVENTH PLAN (PROJECTIONS AND) PROGRESS
The Planning Commission has openly accepted the fact that lack of infrastructure is a major
constraint in India's economic performance. The developmental rural infrastructure is a high priority in
the 11th Plan with critical targets for irrigation, rural road connectivity, rural drinking water etc. There
are huge gaps in general infrastructure encompassing power, roads, railways, ports, airports,
telecommunications and the 11th Plan proposed to address these vigorously by targeting total
expenditure on infrastructure at 9.0 percent of GDP against the recent 4.5 percent in the Tenth Plan.
Consistent with the above projection, the investment in physical infrastructure alone during the
Eleventh Five Year Plan had estimated to about Rs. 2,002 thousand crores (at 2006-07 prices) which
is equivalent to about US $ 500 billion. Of this amount, the share of the Central government is
estimated to be 37 percent, of the state governments to be about 33 percent and that of the private
sector to be 30 percent. Obviously, the Government has adopted the strategy of public private
partnership in the infrastructure structure.
Today, PPPs have become the preferred mode for construction and operation of infrastructure
services such as highways, airports, ports etc. They offer significant advantages in attracting private
capital in construction of public infrastructures as well as in improving efficiencies in the provision of
services to users.
During recent years, the UPA Government at the Centre has adopted such an approach in the
construction of roads, ports, airports and in railways. Naturally, the people would expect state
governments too to adopt a similarly transparent approach to ensure that the PPP projects succeed.
However, public private partnership can some times run into controversy if the private sector
partner is seen to have received unduly favourable treatment. It is essential that the general public is
convinced that PPPs are in the public interest.
17.9 RECENT POSITION
India spends 5 percent of its GDP an infrastructure development compared to China's
9 percent. China with its higher growth rates and higher saving rates, was able to allocate much larger
resources for investments in general. In China, the subsidy implicit in the infrastructure financing chain is
intended not so much to protect the end-user but to incentives the creation of new capacity. In India, the
Subsidy is intended primarily to make infrastructure services affordable to a wider class of consumers. As a
consequence, subsides also cover up for inefficiencies and operating losses of state – owned enterprises e.g.
power, railways etc. (Kapila, 2017).
The role for private sector in infrastructure building has increased substantially in areas which were
earlier managed solely by the public sector. The transition has required numerous changes in the institutional
framework, in policy and in monitoring of progress. There has been progress in attracting private investment
into the infrastructure sectors; first in telecommunications, then in ports and roads, and in individual projects
in other sectors (Kapila, 2017).
There have also been technological developments that have made infrastructure development faster
and more cost-effective namely, construction, gas – based power generation etc. The growing international
experience in Public Private Partnership (PPP) in the supply of infrastructure services has also inflamed the
strategic shift to a greater rate for the private sector in infrastructure (lbid.)
17.10 CHALLENGES FACING INFRASTRUCTURE DEVELOPMENT
The infrastructure sector in India is faced with many bottlenecks at all stages of development, form
project approval to construction to contract implementation to management. There are significant hurdles in
achieving the targets set by government :
(a) Regulatory Framework :
Most of the large projects involve dealings with various ministries and coordination amongst them
remains inefficient (World Bank, 2006) e.g. Gujarat Pipavav Port Project delayed by for 2 years to get
necessary clearances moreover after achieving financial closures.
Delays in the exclusion of projects lead to short falls in achieving targets, widening the availability
gaps, further leading to time and cost overruns of projects.
(b) Lack of Proper Dispute Resolution Mechanisms epically adequate checks and balances and efficient
process of land acquisition.
(c) State Capacity to Monitor and Evaluate the Infrastructures
Projects : They are relatively large and many of these are outsourced. There is need to strengthen capacity at
state level and lower levels.
The infrastructure has large multiplier effects due to its strong linkages with various sectors of the
economy. Therefore, inadequate infrastructure will adversely affect manufacturing sector and retail growth.
17.11 SUMMARY
The following flow chart explains the summary of this lesson.

17.12 GLOSSARY
1. Physical infrastructure : It comprises transport, power, telecommunication energy etc.
2. Social Infrastructure : It comprises health, education, sanitation etc.
3. Non Conventional Energy : Both commercial and non-commercial energy are known as conventional
energy. They are, solar energy, wind energy and tidal energy.
4. Commercial Energy : It includes coal, oil (crude), i.e. thermal and hydel electricity etc.
5. NHDP : National Highway Development Programme : This pertains to development of national and
state highways in different phases.
6. BOLT : ‘Build Operate Lease and Transfer’ is a mode of Public Private Partnership, used in building
roads.
7. BOT : ‘Build Operate and Transfer’ is also a mode of Public Private Partnership, mainly used in the
development of highways.
8. PPP : Public Private Partnership is a mode of investment where Public and Private involvement is
made in sharing under different modes and arrangements namely BOLT, BOT.
17.13 REFERENCES
 Kapila Uma (2017). Indian Economy Since Independence. Academic Foundation New Delhi & Later
Issues.
 Kapila Uma (2014). Indian Economy, Policy and Perspectives. Academic Foundation, New Delhi & Later
issues.
 Gaurav and Mahajan (2014). Indian Economy. Himalaya Publications. New Delhi & Later issues.
17.14 FURTHER READINGS
 Kapila Uma (2021). Indian Economy Since Independence. Academic Foundation New Delhi & Later
Issues
 Kapila Uma (2021). Indian Economy : Policy and Perspectives. Academic Foundation, New Delhi &
Later issues.
17.15 MODEL QUESTIONS
 What is the importance of infrastructure in India. Comment upon its progress problems, and
government policy measures.
 Write short notes on (a) Civil Aviation (b) Water Transport problem (c) Growth & Problems of
road transport (d) Importance of Railways growth (e) Problems of Railway.
 What is the need and importance co-ordination of means of transport ?
 Examine the success of transport policy in achieving proper co-ordination among various
means of transport.

-----------
 Lesson – 18

COVID-19, It's Impact & Latest Trends.

Source: Economic Survey 2021-22
Structure
18.0 Objectives
18.1 Introduction
18.2 Consolidated Picture
18.3 Sectoral Trends
18.4 Performance of Fiscal Indicators
18.5 External Sector
18.6 Inflation
18.7 Financial Sector
18.8 Role of Government
18.8.1 Government Slips
18.8.2 Government Reforms
18.9 Summary
18.10 Reference
18.11 Further Readings
18.12 Model Question
18.0 OBJECTIVES
After going through this lesson, you shall be able to

 Comment on latest trends of various sectors of economy.

 Explain the current situation of macro fundamental.
 Discuss the present status of i) financial ratios ii) Fiscal balance & iii) external sector of
balance.
18.1 INTRODUCTION
Dear Distance Learners

As per nature of the paper, all topics need to be updated with latest information, but due to
Covid-19, the Indian economy is passing through bad phase like other nations of the world. The latest
information on the topics in your syllabus has been taken from economic survey 2021-22 and shared
here for your reference. The critical time would become a short pause after sometime and hence
would not be the main focus for long. So information pertaining to Covid-19 has been discussed in
this lesson.
18.2 CONSOLIDATED PICTURE
On account of Covid-19 and two issues of economic survey have been published by Ministry
of Finance every year. The last two years have been difficult for the world economy on Covid-19 only.
Indian economy is estimated to grow by 9.2 pc in real terms in 2021-22 after contraction of 7.3
pc in 2020-2021. With the vaccination programme having covered the bulk of the population,
economic momentum building back and the likely long-term benefits of supply-side reforms in the
pipeline, the Indian economy is in a good position to witness GDP growth of 8.0-8.5 percent in
2022-23.
Nonetheless, the global environment still remains uncertain. At the time of writing, a new wave
in the form of the Omicron variant was sweeping across the world, inflation had jumped up in most
countries, and the cycle of liquidity withdrawal was being initiated by major Central Bank. This is why
it is especially important to look at India's macro-economic stability indicators and their ability to
provide a buffer against the above stresses.
Despite all the desruptions caused by the Global pandemic, India's balance of payments
remained in surplus throughout the last two years. This allowed the Reserve Bank of India to keep
accumulating foreign exchange reserves (they stood at US$ 634 billion on 31st December 2021).
This is equivalent to 13.2 months of merchandise imports and is higher than the country's external
debt. The combination of high foreign exchange reserves, sustained foreign direct investment, and
rising export earnings will provide an adequate buffer against possible Global liquidity tampering in
2022-23.
The fiscal support given to the economy as well as to the health response caused the fiscal
deficit and government debt to rise in 2020-21. However, a strong rebound in government revenues
in 2021-22 has meant that the government will comfortably meet its targets for the year while
maintaining the support, and ramping up capital expenditure. The strong revival in revenues (revenue
receipts were up over 67 per cent YoY in April-November 2021) means that the government has
fiscal space to provide additional support if necessary.
The financial system is always a possible area of stress during turbulent times. However,
India's capital markets, like many global markets, have done exceptionally well and have allowed
record mobilization of risk capital for Indian companies. More significantly, the banking system is well
capitalized and the overhang of Non-Performing Assets seem to have structurally declined even
allowing for some lagged impact of the pandemic.
Vaccination is not merely a health response but is critical for opening up the economy,
particularly contact-intensive services. Therefore, it should be treated for now as a macro-economic
indicator. Over the course of a year, India delivered 157 crore doses that cover 91 crore people with
at least one dose and 66 crore with both doses. The vaccination process for boosters and for the 15-
18 year group was also gathering pace at the time of writing.
Inflation has reappeared as a global issue in both advanced and emerging economics. India's
Consumer Price Index inflation stood at 5.6 per cent YoY in December 2021 which is within the
targeted tolerance band. Wholesale price inflation, however, has been running in double-digits.
Although this is partly due to base effect that will even out,
 Source: National Accounts Statistics (NSO), MuSPI c.f. Economic Survey 2021-22 P4

Source: Data accessed from Ministry of Health and Family Welfare (MoH&FW)
Note: DMA stands for Daily Moving Average c.f. Economic Survey 2021-22, P4

18.3 SECTORAL TRENDS

Not surprisingly, the agricultural sector was the least impacted by the pandemic-related
disruptions (Figure 3). It is estimated to grow 3.9 per cent in 2021-22 on top of 3.6 per cent and 4.3
per cent respectively in the previous two years (Table 1). This sector now accounts for 18.8 per cent
of GVA.
 Figure 3: Area Sown under Food grains Figure 4: Production of Wheat and Rice

In contrast to the steady performance of the primary sector, the industrial sector went through
a big swing by first contracting by 7 per cent in 2020-21 and then expanding by 11.8 per cent in this
financial year. The manufacturing, construction and mining sub-sectors went through the same swing
although the utilises segment experienced a more muted cycle as basic services such as electricity
and water supply were maintained even at the height of the national lockdown. The share of industry
in GVA is now estimated at 28.2 per cent (Table 2).

Source: (NSO), c.f. Economic Survey 2021-22, P6

Note: RE: Revised Estimates, PE: Provisional Estimates, AE: Advance Estimates
 Service account for more than half of the Indian economy and was the most impacted by
the COVID-19 related restrictions, especially for activities that need human contact. Although the
overall sector first contracted by 8.4 per cent in 2020-21 and then is estimated to grow by 8.2 per cent
in 2021-22, it should be noted that there is a wide dispersion of performance by different sub-sectors.
Both the Finance/Real Estate and the Public Administration segments are now well above pre-COVID
levels. However, segments like Travel, Trade and Hotels are yet to fully recover. It should be added
that the stop-start nature of repeated pandemic waves makes it especially difficult for these sub-
sectors to gather momentum.
Rising capital expenditure by the government on infrastructure and an uptick in housing sector
have been responsible for reviving the construction sector.
 Despite contact sensitive services still being impacted by COVID, there has been a strong
recovery of the Purchasing Managers' Index-Services since August 2021. In this context, it is
important to know the role of new forms of High Frequency Indicators to gauge real-time trains. for
Example, the Google mobility indicators for retail and recreation (i.e., restaurants, cafes, shopping
centres, etc.) and transit stations (public transport hubs such as subway, bus and train stations),
measuring percentage deviation from pre-pandemic levels of mobility, has exceeded pre-pandemic
levels in December 2021 before the Omicron wave again led to restrictions. (Figure 5) Similarly, the
hotel occupancy rate has recovered substantially reaching 56-58 per cent in October 2021, from 30-
32 per cent in April 2021.
In contrast to contact-based services, distance enabled services have increased their share
with the growing preference for remote interfaces for office-work, education and even Medical
Services. Indeed there has been a boom in Software and IT enabled services exports while earnings
from tourism have declined sharply.
Figure 5 : Trends in Mobility

Source: Google Mobility

Note: Baseline corresponds to Jan-Feb 2020 Level
18.4 PERFORMANCE OF FISCAL INDICATORS [DURING 2021-22]
This section analyses the performance of fiscal indicators and their components for the period
April to November 2021. The data on Government accounts for April to November 2021, released by
the Controller General of Accounts, show that the fiscal deficit of the Central Government at end
November 2021 stood at 46.2 per cent of the BE compared to 135.1 per cent during the same period
in 2020-21 and 114.8 per cent during the same period in 2019-20 (Figure 7). During this period both
fiscal deficit and primary deficit stood at levels much below the corresponding levels in the previous
two years. The primary deficit during the period April to November 2021 turned up at nearly half of the
level it had reached during April to November 2019 (Figure 6).

Figure 6: Trends in Fiscal deficit and Figure 7: Fiscal deficit as a per cent of
primary deficit Budget estimate

12 10.8
160
10
8.1 140
8 7.0 6.9
120
6 4.7 100
4 2.4 80
60 135.1
2 114.8
0 40
Fiscal Deficit Primary Deficit 20 46.2
0
Apr-Nov 2019 Apr-Nov 2020 Apr-Nov 2021

Source: CGA Monthly Accounts c.f. Economic Survey 2021-22, P 48

On account of a sustained revenue collection and a targeted expenditure policy by

Government of India, the Fiscal Deficit (Ap-Nov 2021) is at 46.2 pc of Budget estimate while Primary
Deficit
(Ap-Nov 2021) is half of what is attained in 2019.
18.5 External Sector
Despite all the disruptions caused by the global pandemic, India's balance of payments
remained in surplus throughout the last two years. This allowed the Reserve Bank of India to keep
accumulating foreign exchange reserves, which stands at US$ 634 billion on 31st December 2021.
This is equivalent to 13.2 months of imports and higher than the country's external debt. As of end
November 2021, India was the fourth largest foreign exchange reserves holder in the world after
China, Japan and Switzerland. A sizable accretion in reserves led to an improvement in external
vulnerability indicators such as foreign exchange reserves to total external debt, short-term debt to
foreign exchange reserves, etc.
India's exports of both goods and services have been exceptionally strong in 2021-22. India's
total exports are expected to grow by 16.5 pc in 2021-22 surpassing pre-pandemic level. Imports
have also recovered strongly with revival of domestic demand.
Resultantly, India's next exports have turned negative in the first half of 2021-22, compared to
surplus in corresponding period of 2020-21 with modest Current Account Deficit of 0.2pc of GDP in
first half.
However, robust capital flows in the form of continued inflow of foreign investment were
sufficient enough to finance the modest current account deficit: With increase in prices and economic
activity Current Account deficit may increase rapidly.
This implies that the government has the fiscal capacity to maintain the support and ramp up
capital expenditure when required. The strong revival in revenues also provides Government with
fiscal space to provide additional support.

Source: NSO, MoSPI, RBI, CGA, CDSL, Ministry of Finance, IMF. c.f. Economic Survey 2021-22,
Tables
Note : The taper tantrum happened in 2013. In the table above, 2012-13 is used to show the position
just prior to taper tantrum as this is analogous to the present situation prior to withdrawal of liquidity in
financial markets.
18.6 Inflation
Inflation has reappeared as global issue in both advanced and emerging economies. In India,
CPI inflation moderated at 5.2pc in 2021 (Ap-Dec) from 6.6pc in the corresponding period in 2020.
The decline in retail inflation in 2021-22 was led by a decline in food inflation.
However, WPI have been running in double digits (around 12pc).
India needs to be wary of imported inflation, especially from elevated global energy prices.
18.7 Financial Sector
The Financial Sector is always a possible area of stress during turbulent times.
The capital markets have done exceptionally well in India and have allowed record
mobilisation of risk capital for Indian companies. The Sensex & Nifty scaled up to touch its peak at
61,766 & 18,472 on October 18, 2021 and out performed its peers among emerging economics.
The 2021 year has been exceptional for primary markets with boom in fund raising through
IPOs by many tech start-ups/uni-corns/new-age companies: Via 75 IPO issues. $ 89066 crores were
raised. (higher than in any year in the last decade).[P. 29]
The Indian banking system is well capitalized and the overhang of Non Performing Assets
seems to have structurally declined.
 The NPA ratio of Scheduled Commercial Banks (SCBs) declined since 2018-19 [from 7.5pc in
Sep 2020 to 6.9 pc in Sep 2021].
 The Capital Adequacy Ratio has continued to improve since 2015-16.
The capital to risk weighted asset ratio (CRAR) of SCBs increased from 15.84pc at end Sep 2020 to
16.54 pc at end Sep 2021, on account of improvement for both public and private sector banks.
18.8 Role of Government
18.8.1 New Steps
(A) FDI Policy Reforms
These reforms were undertaken to improve foreign participation in the following sectors
(i) 74% FDI in defence sector allowed; 74-100 PC through government route.
(ii) FDI limit in insurance sector companies increased from 49pc to 74pc.
FDI up to 100pc under automatic route in Insurance companies.
(iii) Foreign investment up to 100pc under automatic route in Telecom services sector.
(iv) Strategic Disinvestment of PSU in Petroleum and Natural Gas sector has decided foreign
investment of 100pc through automatic route. FDI Monitoring Cell has been formed to
expedite FDI proposals.
(B) Disinvestment of PSEs
The government has approved a policy of strategic disinvestment of Public Sector Enterprises
that will provide a clear road map for disinvestment in strategic areas and non strategic areas.
The non-strategic CPSEs will be privatised - the idea of Minimum Government - Maximum
Governance.
(C) Infrastructure: National Infrastructure Pipeline
 On the basis of Public Private Partnership, a source of disinvestment in the sector, World
Bank has ranked India at Number 2 among developing economies.
The PPP Appraisal Committee (PPPAC) cleared 66 projects worth Rs 1,37,218 crores from
2014-15 to 2020-21. The Govt. Scheme of Viability Gap Funding (VGF) for socially/ economically
desirable projects worked well during 2014-15 to 2020-21 and scheme is revamped through financial
support till 2024-25.
(D) National Monetisation Pipeline- Infrastructure
NITI Ayog has developed NMP with budget allocation of $ 6 lakh crore over four year period.
(E) Infrastructure: National Railway Plan
It lays down road map for capacity expansion of the railway network by 2030 to cater to
growth up to 2050.
(F) Civil Aviation
India has emerged as one of the fastest growing aviation markets in the world. Disinvestment
of Air India (Eco Survey, P297) and Privatisation of Airports (under NMP) are bold steps this year.
18.8.2 GOVERNMENT REFORMS
The distinguishing features of India's economic response has been an emphasis on supply
side reforms rather than a total reliance on demand management.
Supply Side Reforms
 Deregulation of numerous sectors like space/ drones/ geo-spatial mapping, etc
 Simplification of Processes [Govt. Procurement & in Telecom Sector]
 Removal of legacy issues like retrospective tax, privatisation, production-linked incentives and
so on.
 Sharp increase in capital spending by the Government (both demand and supply response
actually) as it creates infrastructure capacity for future growth.
18.9 Summary
Covid 19 is unprecedented crisis and has far reaching consequences. So the performance of
Indian economy till date can not be assessed correctly while looking from this bad patch. Therefore,
for all topics of your syllabus, the latest information of Covid times is presented in this lesson.
18.10 References
 Government of India (2022). Economic Survey 2021-22. Ministry of Finance, New Delhi
18.11 Further Readings
 Government of India (2022). Economic Survey 2021-22. Ministry of Finance. New Delhi
 The Economic Times (1 Feb 2022 and later on) https://economictimesIndiatimes.com

18.12 Model Question:

1. Write the current state of Indian economy with regard to:
(i) Fiscal Balance
(ii) Financial Sector
(iii) External Sector
(iv) Macroeconomic fundamentals

-----------
 Sample Question Paper - I
M.A. 2nd Semester, Economics
Paper : 202 : Contemporary Issues in Indian Economy–II
Time Allowed : Three Hours Maximum Marks : 80
Note :- (i) Attempt five questions in all including question no. 1 which is compulsory and select at
least one question from each unit.
(ii) Each short answer type question carries 2 marks in question 1 and each long answer
type question carries 15 marks.
1. Attempt any 10 parts from the following :
(i) What do you understand by infrastructural development ?
(ii) Define the concept of SEZs.
(iii) What do you know about the pattern of service sector these days ?
(iv) What is capital market ?
(v) Explain SEBI.
(vi) Highlight some problems of capital market in India.
(vii) Explain variations in exchange rate.
(viii) Bring out causes of fiscal imbalance.
(ix) What are the main causes of fiscal deficit ?
(x) What is the need of expenditure reforms ?
(xi) What is the difference between public debt and public borrowing ?
(xii) Write a short note on Trade policy of India.
(xiii) Explain the concept of foreign financial collaborations.
(xiv) What do you understand by IPRs in WTO agreements ?
(xv) What is the need of Foreign Direct Investment ?
UNIT–I
2. What is Consumer Protection Act ? Analyse its importance for the protection of consumer in
general.
3. What is the need of infrastructural development ? Evaluate performance of infrastructural
development in India.
UNIT–II
4. Analyse causes of backwardness of capital market in India. Suggest some remedial
measures.
5. What do you know about the structural changes in financial system in India ?
 UNIT–III
6. Write a detailed note on Budget Management Act, 2003.
7. Critically analyse causes and consequences of Fiscal imbalance in Indian economy.
UNIT–IV
8. Discuss various forms and sources of foreign direct investment in India. Analyse policy
framework and performance.
9. Analyse the impact of WTO on Indian Agriculture.
 Sample Question Paper - II
M.A. (Economics) 2nd Semester
Paper - 202 : Contemporary Issues in Indian Economy-II

Time Allowed : 3 hours Max. Marks : 80

Note : Attempt five questions in all, including Q. No. 1, which is compulsory and taking one from
each unit.
I. Attempt any ten short answer type questions from the following (in 125 words each)
(10x2=20)
i) Special Economic Zones (SEZ)
ii) Securities Exchange Board of India (SEBI)
iii) Nationalisation of the Indian Banks (1969)
iv) Problems of priority sector lending
v) Expenditure Reforms
vi) Capital Market Reforms
vii) Foreign Direct Investment
viii) India’s trade policy during the pre reform period
ix) FRBM
x) Fiscal Imbalance
xi) PPPs
xii) Subsidies o Ag under WTO
xiii) Will Performing Services Sub-sectors
xiv) Competition Policy
xv) Structure of Financial Sector
Unit-I
II. Discuss in details the pattern and growth of the Services Sector in India. (15)
III. Discuss the changes in Public Policy of India with special reference to Competition Policy and
Consumer Protection Act.
(15)
Unit-II
IV. Critically evaluate Banking Sector Reforms in India since 1991.
(15)
V. Analyse the impact of financial sector reforms on India’s Capital Market since 1991. (15)
 Unit-III
VI. Discuss in detail the problems of India’s Public Debt Policy. (15)
VII. Write a brief note on Fiscal Reforms and Budget Management Act, 2003 in the Indian economy.
(15)
Unit-IV
VIII. Write a detailed note on the Liberalised Exchange Rate Management System (LERMS). (15)
IX. Evaluate the Impact of World Trade Organisation (WTO) on India’s various sectors. (15)