What do we understand by

business environment?
 It consists of all the factors that have
a bearing on the business.

external environment

Internal environment
 Internal environment consists
of….
 Mission, objectives
 Management structure

 Value system, ethical standards –EID

Parry Group was taken over by

Murugappa Group
 HR-Skill,quality,morale,attitude of

employees working in an organisation.

 Company Image-
 Mission :-
 Defines long term direction over the

next few years

 Who is customer?
 What are our products?

 The “DNA” of an organization

 Examples:-
 Ranbaxy:-
 TO BECOME A RESEARCH BASED
INTERNATIONAL PHARMACEUTICAL
COMPANY.
 Business domain-Pharma company

 Priority-research base

 Direction of develepment-globle
 The differentiating factor between
internal and external environment
is control over environment.
 External environment
 Micro Environment  Macro environment
 Immediate  Remote
 Operating  Larger societal
factors
 External micro environment
 Micro-Immediate environment
(affecting directly) also known as
Operating Environment.
 = Suppliers-

 = Customers

 = Competitors

 = Financiers

 = Marketing Intermediaries
 Suppliers:-
 very important
 delays may result into huge inventories

and high costs.

 do not depend on a single supplier.

 E.g. Nirma- Captive raw materials

plants.
 Marketing intermediaries
 In FMCG business, Coca Cola
acquired Parle mainly to access the
distribution network of the later.
 Macro-environment-
general/remote environment.
 Socio-Cultural Environment
 Political Environment

 Legal Environment

 Technological/Natural Environment

 Economic Environment

 Global Environment
Examples(socio-cultural factors)
 Language: e.g., in Canada  Time: e.g., Americans value
labels must be in both English punctuality and deadlines;
and French Latin Americans consider
deadlines rude and pushy
 Colors: e.g., in Japan black
and white are colors of
mourning and should not be  Business norms: e.g.,
used on a product’s package Americans are more verbose
than Japanese who prefer
 Customs and taboos: e.g., periods of silence in
McDonald’s in India serves negotiations
mutton hamburgers as beef
and pork are religiously  Religious beliefs: e.g., in
tabooed meat
conservative Islamic countries
women have less or no say in
 Values: e.g., Americans are household buying decisions
materialistic, Indians’
philosophy is non-materialism
 Social factors
 Religious Considerations – appropriateness of
some business ventures – e.g. selling
condoms in staunchly Catholic countries

 Impact on local communities of business

development – availability of jobs, training for
these communities

 Impact on the environment – can impact on

the businesses image- TAJ MAHAL IN AGRA.
 One more example of a
cultural/religious belief is of Islamic
Banking, where mainly the banks do not
charge interest on the loans.
 So, how do banks survive?

 They instead take share in the profit or

the loss the enterprise makes in which

they extend the money.
 So, they substitute equity financing for

debt financing.
 Political environment
• Political ideology:-Political philosophy of the
incumbent government also affects businesses.
1. role of market forces,
2. attitude towards a foreign firm
• Ranges from capitalism to socialism
Capitalism - private ownership of business
enterprises is encouraged
Socialism - public ownership of businesses is
common, with substantial government
regulations of the workings of a free market
 Political environment
 Political Change – regime change/
Change in government through democratic
election can influence future business
strategy.

• e.g. the opportunities that are now

available in Russia and Eastern Europe
following the collapse of communism

• Coke had to move out of India in 1977

after the Janata government came to
power.
 Political Uncertainty
 Political instability leads to the
downgrading of the credit rating of
the companies scrips (shares) and
the foreigners start pulling out their
money. –Typically happened in the
Asian crisis.
 WAR,TERRORISM
• Differences in political opinions and
strained relationships between
countries affects business

• Example, Muslim countries do not buy

goods from Israel.
 EXAMPLES:-
 Invasion of Kuwait.- large destruction,
businesses suffered.

 State of Jammu and Kashmir – due to

terrorists, (president rule for a long time)
tourism , the only source of livelihood
suffered.
 Legal Environment
 Certain laws which apply to
businesses, such as drugs and
cosmetics act etc.
 Herbal teas(for weight loss), creams

proclaiming to remove stretch

marks, fairness creams would be
come under scrutiny as these claims
will have to be proven scientifically.
(health and safety standards)
 Other examples…
Opening of power sector(electricity) for the
private players only recently. That’s why we
have Reliance Energy only now.
•employment practices- 8 hrs.
work etc., no child labor.
•environmental practices
•patents – new patent bill allows
for product patent.
 Marketing of products may be subjected to
the following controls:

Price controls.(Drugs and Essential

commodities Act)
• Advertising content (scantily clad
Caucasian models are not allowed in
Malaysia)
• Exclusive dealerships (e.g. It is very
difficult to change a dealer in South
Korea, once the appointment is made)
 Technological Factors:-
 EXAMPLES:-

 INTERNET- MARKETING.
 ATMs –revolutionised the banking.

 WLL – Satellite communication.

 Technological Environment
• IT and communications infrastructure
advance at different rates in different
countries and at different rates even
in the same country.
• TECHNOLOGY PROMOTION:-
• Singapore, for example, has
embarked on a major, government
sponsored research into life sciences.
 Internal Environment

Strengths Weaknesses
 External Environment

Opportunities Threats
 Segments of
external(general)environm
ent
Con ditions
c
Demography Economi

at ion Political/ L
o ba liz egal Forc
es
Gl

Techno Socio-c
logical ultural
Change Conditi
s on s
 TOPICS COVERED:-
 1.GDP:-
 2.GNP:-

 3.Real GDP:-

 4. Measurement of GDP:-

 5.Managerial Implications:-

 6. Exercise:-
 Goal:
 • Obtain a measure of the total
quantity of goods and services produced
in a country over a period of time.

 • Gross Domestic Production(GDP)-

 The( Rupee) market value of final output

(goods and services) produced within the

Indian borders in year’s time.
1) To compute the total value of different goods and services, the
national income accounts use market prices.
Thus, if
$0.50 $1.00

GDP = (Price of apples  Quantity of apples)

+ (Price of oranges  Quantity of oranges)
= ($0.50  4) + ($1.00  3)
GDP = $5.00

2) Used goods are not included in the calculation of GDP.i.e. The

second hand transactions are not be included.
3.No double counting-only final
goods are considered not thr
intermediate goods.

4. GDP is a measure of productive

activity alone. Therefore, transfer
payments do not form a part of
this.
 Stocks and Flows

A flow is a rate per unit of time.(eg.,

 GDP, investment)

 A stock is the quantity in existence of

some object at a point in time.(E.g.,
housing, wealth)
 Per Capita GDP

 Per Capita GDP calculations attempt to

give us additional information about how
we are doing as an economy.

 Per Capita GDP calculations may be a

better measure of the standard of living.
 Per Capita Nominal GDP

GDP2010
Per capita GDP2010 = --------------------------------
Population 2010
$12,378,000,000,000
Per capita GDP2010 = --------------------------------
297,000,000

Per capita GDP2010 = $41,677

The value of final goods and services measured at
current prices is called nominal GDP. (Y)

Real GDP is the value of goods and services measured

using a constant set of prices. (base year prices)
 Let’s see how real GDP is computed in our apple and
orange economy.

For example, if we wanted to compare output in 2002 and output

in 2009,or output in 2010, we would obtain base-year prices,
such as 2002 prices.

Real GDP in 2002 would be:

(2002 Price of Apples  2002 Quantity of Apples) +
(2002 Price of Oranges  2002 Quantity of Oranges).
Real GDP in 2009 would be:
(2002 Price of Apples  2009 Quantity of Apples) +
(2002 Price of Oranges  2009Quantity of Oranges).
Real GDP in 2010 would be:
(2002 Price of Apples  2010 Quantity of Apples) +
(2002 Price of Oranges  2010 Quantity of Oranges).
 GDP Deflator = Nominal GDP
Real GDP

Nominal GDP measures the current dollar value of the output

of the economy.

The GDP deflator, also called the implicit price deflator for
GDP, measures the price of output relative to its price in the
base year.
Use:- It reflects what’s happening to the overall level of
prices in the economy.
 GNP:Gross National Product
 It is the value of all final goods and
services produced by the nationals of
the country in a year’s time.
 GNP:Gross National Product
 GDP is the value of all output
produced @ home.
 GNP is the value of all output

produced using domestically-

owned factors of production.
 Hence, GNP = GDP + net factor

income from abroad

 GDP and GNP
 Gross domestic product is the value
of all domestically-produced final
goods and services.
 Gross national product is the value of

all final goods and services produced

by domestically owned factors of
production.
 Economic Growth:-
 Economic growth is an increase in
activity in an economy.

 It is often measured as the rate of

change of gross domestic product
(GDP).
 3 different methods of measuring
GDP:

• GDP(Y) = income approach

• GDP(E )= expenditure approach
• GDP(P) = production approach

 Statistical identity: Y=E=P

 Expenditure Approach-
 Calculate GDP as total spending on
all final goods and services produced
in the economy.

 GDP = C + I + G + NX
 The Expenditure Side of GDP
 GDP(E)=Aggregate Demand=Total
expenditures on final goods and
services=
 Private final C + I +Expenditure
G + (X-M) on consumer
Consumption (C) goods & services.
 Private Investment(I) Spending on capital goods.
 Govt Spending (G) Spending on final goods &
services by Government
 Net Exports ( X-M) Expenditure by foreigners
on our output as well as by
our own citizens on foreign
items
 Private Investment(I)

 Most volatile component .

 Includes:
• all final purchases of machinery,
equipment and tools by business
enterprises
• all building and construction
• changes in stocks (or inventories)
 Approaches to measuring
GDP

 1) Value Added Approach- (Product

Approach)

Add the value of all goods and

services
produced less intermediated goods
used in production.
 Value added Approach(Production
Approach)

 Value added: Is the difference between

the value of a good as it leaves a stage of
production and the costs of that good as it
entered that stage.
Summing the ‘value-added’ gives the total
value of economic activity.
 MEASURING VALUE
ADDED….
Stage of production Value of Sales Value Added
Rs. Rs.
1 – Oil Drilling 0.50 0.50
2 – Refining 0.65 0.15
3 – Shipping 0.80 0.15
4 – Retail Sale 1.00 0.20
Total Value Added 1.00
 Income Approach
 – GDP is calculated by adding up all
incomes received by economic
agents who contribute to production.

GDP=Compensation of employees+
+profits+rental income+net
interest+indirect taxes+depreciation
 Points to remember when measuring GDP...
(a) a)Secondhand transactions are not
included (since merely exchanges of
previously produced goods).

(b) (b) Only final goods, intermediate

goods not included (e.g. bread yes,
flour no)
If any of these items were included
in the calculations, the measurement
of economic activity would be subject
to ‘double-counting’.
 Points to remember when measuring
GDP...
( c)Private or public transfer payments are
not counted (e.g. government transfer to
the unemployed – not made in exchange of
a service, no new production)

 When they are spent for final goods and

services they will go into GDP as consumer
spending.

 d) Financial transactions don’t go into GDP.

 Limitations of GDP:-
 Non-market transactions
• The ‘care’ economy (underestimation of women’s
work)
• Subsistence agriculture (India)
 Distribution, nature and quality of
goods produced
 Leisure time

 The hidden economy

• Illegal activities
• Informal sector
 GDP & Economic Well-Being

 Discuss:-

“Economic growth indicators are up, led by car

repairs, divorce costs, open heart surgeries,
and toxic waste clean-ups.”
Structure of banks
 Central bank
 Commercial banks:-
 Private

Indian

Foreign

Indian banks- old banks , new banks,

local area banks
 Public-
 1. SBI group – SBI and its subsidiaries

 2. Other nationalized banks

 COOPERATIVE BANKS
 Agriculture sector
 Three tier

 State cooperative banks (SCBs)

 District central cooperative banks (DCCBs)

 Primary Agricultural Credit societies(PACs)

 Non- Agricultural Sector-

 Urban cooperative banks

 DEVELOPMENT BANKS
 Give loans for Agricultural purpose
 And also for Non-agricultural purpose
 THE DIFFERENCE:-
 Functional specialisation-
 Principle-

 Regulated by-

 Financial help- by RBI,NABARD, central

government, state government.

 -RBI provides contribution to initial capital.

 Borrowers:-
 No tier versus three tier-
 It becomes imp.cos’ no direct contact

between the 1 st and the 3 rd tier

 Intra- sectoral funds are greater.e.g.

interbank deposits. Competition versus

cooperation.
 CRR, SLR requirements

 Scheduled versus non-scheduled banks

exist in both.
 Supervision-single,versus dual.-acts that

govern them
 RBI is lender of last resort and first resort.
 Commercial banks:-
 Private sector banks-old, new banks and local
area banks
 Old –Vysya bank

 First FI after 1991 to get approval to function

as a bank is HDFC.
 Also InduSind bank .
 Other examples:-
 UTI Bank
 ICICI Bank

 Ratnakar Bank

 Catholic Syrian Bank

 Dhanalakshmi

 Centurion Bank
 Foreign banks-
 RBI new rules, foreign banks can set up local
subsidiary., not necessarily acquire weak
banks.

Example:-BOA, Bank of Ceylone,

ANZ,HSBC,Duetsch Bank, ABN-AMRO
 BANKS AWAITING:-
 Credit Suisse Group
 Royal Bank of Scotland

 US-based GE capital
 SBI , its subsidiaries
 Other nationalised banks .
 Cooperative structure:-
 Nearly 28 SCBs at a state level
 DCCBs
 Middle tier in the cooperative banking
structure.
 Examples:-Pilbhit ,Tehri,Haridwar DCCBs.
 PACs
 Acting at the local level
 UCBs

 UCBs cater to non-agricultural finance.

 Examples are Kurla Nagrik Bank, Abhyudaya
Bank.
 Mainly working capital loans, recently term loans.
 These days, UCBs are giving home loans as well.
 Rs. 1 lakh to individuals, and Rs. 3 lakhs
scheduled UCBs.
 Can provide finances against the shares,
debentures.
 RRBs:-
 Cater to agro sector,small and marginal farmers.
 Banks choose 1 or 2 districts in a state which is
relatively unbanked area and sponser that RRB.
 SBI has 30 RRBs in 13 states and its branches
constitute 16% of the total.
 NABARD also sets up RRBs.
 Can be established with paid up capital of 25 lakhs
of which 50 % comes through CG, 15% through
SG and the rest 35% through the sponsoring bank.
 CRR, SLR requirements are the minimum.(3%
and 25 % respectively)
 Examples:-
 Bijapur Gramin Bank
 Surat baruch gramin bank

 Faizabad Khetriya Gramin bank.

Problems of cooperative banks:-
 Dual Supervision
 Deposit base is small and therefore

likely to fall pray to large banks.

 The difference….
 RBI  Commercial Banks
 Functions of RBI:-
 NOTE ISSUE-
 All denominations, and CG – coins, one rupee

notes are distributed on behalf of the government.

 Issue department and the banking department are

separate , assets and liabilities are separate.

 The assets of the issue department:-

Gold
Foreign securities
Rupee coins
GOI securities .
 It has to keep (since 1957)gold/ foreign securities

of Rs.200 crs. Of which gold must be Rs. 115 crs.

 This is called minimum reserve system.
 FOR THIS PURPOSE..
 Issue offices- 10 in major cities
 Thousands of Currency chests/receptacles in which
stock of new notes and coins is stored.

 To get people’s confidence, India has a public

monopoly of note issue.
 Hongkong, HSBC is responsible for the note issue.
 BANKER’S BANK:-
 The scheduled banks can borrow from the Reserve
Bank of India on the basis of eligible securities or get
financial accommodation in times of need or
stringency.

 Since commercial banks can always expect the

Reserve Bank of India to come to their help in times
of banking crisis the Reserve Bank becomes not only
the banker's bank but also the lender of the last resort.
 BANKER TO THE
GOVERNMENT:-
As a banker to the government, the Bank can make
“ways and means advances” to both the central
and state governments.

 (ways and means advances :- temporary

advances made in order to bridge the temporary
gap between receipts and payments)
 Maturity:-3 months

 State governments- limits are fixed.

 Three types:-
 (a) normal or clean advances i.e., advances
without any collateral security;
 (b) secured advances, i.e., those which are secured
against the pledge of central government
securities; and
 (c) special advances, i.e., those granted by the
Bank at its discretion.
 Overdraft facility:- in excess of the credit (ways
and
 means advances) limits granted by the RBI.

 In other words, overdrafts are unauthorised ways

and means advances drawn by the state

governments on the RBI.

 Persistently large overdrafts are drawn by the state

governments which is not a very healthy sign.
 FOREIGN EXCHANGE MANAGEMENT
AND CONTROL:-
 (a) to administer the Foreign Exchange Control;
 (b) to choose the exchange rate system and fix or
manage the exchange rate between the rupee and
other currencies;
 (c) to manage exchange reserves; and
 (d) to interact or negotiate with international financial
institutions such as the IMF, World Bank, and Asian
Development Bank.
 Controller of credit:-
 Qualitative (selective credit controls)
 Quantitative :

 1.CRR

 2.SLR

 3.Bank Rate
 Supervisory functions

The Reserve Bank Act, 1934,

 The Banking Regulation Act, 1949
 has given wide powers to RBI relating to :-
 licensing and establishments,
 branch expansion,
 management and methods of working,
 amalgamation,
 reconstruction,
 and liquidation.
 to carry out periodical inspections
 to call for returns and necessary information from them.
 Promotional functions
:- A unique function done in India.
 The Reserve Bank has helped in the

setting up of the following:-

 IFCI

 SFC

 UTI in 1964,

 IDBI in 1964,

 Agricultural Refinance Corporation of India,

 Industrial Reconstruction Corporation of

India(1972) provide long-term finance to

farmers.
 A SCHEDULED BANK:-
 Paid up capital and reserves totaling to
( Rs. 5 Lakhs,) Rs. 100 crs.

Must not be a single owner firm or a

partnership and must be a joint stock
company

Must convince RBI that it is conducting its

affairs in the interest of the depositors.
 So what?
 Privileges:- concessional borrwing
facilities from RBI
 Others are not entitled to borrow

form RBI for normal banking

purposes , and only in for
accomodation in abnormal
circumstances
 .
 Obligations:-

 Submit periodical returns to RBI

 subject to SLR requirements

GOVERNMENT BUDGET

Economic Environment of
Business

92
 Fiscal Policy
Government is trying to achieve economic
growth, provide public goods, promote
investment, reduce poverty through its
various activities.

Fiscal Policy:- Government sector

activities related to above are represented
and formulated through budget.

93
 Annual Financial Statement
Legal backing :- section - 112 of the
Indian Constitution
 Government presents a statement of

estimated receipts, expenditure and a

detailed plan that is presented for
every financial (1st of April to 31st
March) year

94
 Three divisions of budget:-
 Contingency Fund,
 Consolidated Fund (CFI)

 and Public Account.

95
 Contingency Fund :-
 Is used to in case of unforeseen contingencies.

 The contingency fund is generally used when

the government cannot wait for long for the
parliament to authorize the expenses on the
expenditure. (parliament approval not
required)

 The fund (Rs 500-crore fund)is at the disposal

of the President

96
 Consolidated fund of India

CFI

Revenues by the
Loans raised Recoveries of loans
government

97
 Public account
 This fund is to account for flows for those
transactions where the government is merely acting
as a banker.

e.g. provident funds, small savings and so on.

 These funds do not belong to the government.

 They have to be paid back at some time to their
rightful owners.
 Expenditure from it is not required to be approved
by the Parliament.

98
 BUDGET
 TWO SIDES:-

 1. RECEIPTS
 2. EXPENDITURE

EACH OF WHICH AGAIN IS OF TWO

TYPES:-
REVENUE AND CAPITAL

99
 Revenue/ Capital budget (account)
Revenue budget  Capital budget

Revenue/
capital budget

Revenue/ Revenue/
capital receipts capital expenditure
100
 Revenue account/budget :-

• All receipts and expenditure that in

general do not entail a sale or creation
of assets are included under the
revenue account.

101
 CAPITAL
RECEIPT/EXPENDITURE:
-
All receipts and expenditure that liquidate or
create an asset would in general be under capital
account.

- For instance, disinvestment proceeds (like it did

in the case of Maruti, it is in effect selling an
asset.) The receipts from the sale would go under
capital account.
- Alternatively,

102
 BUDGET
Revenue receipts Revenue
expenditure

Capital receipts Capital expenditure

103
Revenue receipts

Revenue receipts

Tax revenue Non tax revenue

104
 Tax

Direct taxes Indirect taxes

FBT(Fringe STT
BCTT(Banking cash
Income tax Corporate tax benefit (Securities
transaction TAX)
tax) Transaction Tax)

105
 Indirect taxes

Customs duties Excise duties Service taxes

106
 Direct taxes
DIRECT TAX:
1. These are taxes where the burden of tax falls
on the person on whom it is levied.

2. These are largely taxes on income or wealth.

a. INCOME TAX:-
b.CORPORATION TAX:
tax on profits of companies.

C. FBT, d. STT and BCTT are direct taxes.

107
 INDIRECT TAX:

In the case of indirect taxes the incidence of

tax is usually not on the person who pays the
tax.

e.g. Customs, excise and service tax.

They are regressive.

It means the burden on the rich and the poor
is alike. That is why governments strive to
raise a higher proportion of taxes through
direct taxes.
108
 TAX COLLECTIONS 2009-10

2008-09 (Budget) 2008-09 (Revised) 2009-10(Budget)

Name of Tax Rs. Crors Rs. Crors Rs. Crors

Gross Tax Revenue 6,87,715 6,27,949 6,41,079

Corporation Tax 2,26,361 2,22,000 2,56,725

Income Tax 1,38,314 1,22,600 1,12,850

Union Excise Duties 1,37,874 1,08,359 1,06,477

Customs Duties 1,18,930 1,08,000 98,000

Service Tax 64,460 65,000 65,000

109
 NON-TAX REVENUE:

Components:-
1. Interest payments (received on loans given by
the government to states, railways and others)
2. Dividends and profits received from public sector
companies.

3. Revenue from THREE types of services :-

a. General services such as police and defence
b. Social and community services such as medical
services
c. Economic services such as power and railways

110
 Revenue expenditure
 1. Expenditure incurred for the
normal functioning of the
government departments
 2.Interest charges on debt incurred

by the government
 3.Subsidies

111
 Capital receipts
RECEIPTS in the capital account of
the consolidated fund are grouped
under three broad heads.
 1. Public debt

 2. Recoveries of loans and advances

 3. Miscellaneous receipts.

112
 Public debt

Public debt(components):-
1. Loans raised by the Center from the
market
2. Government borrowings from the RBI
and other parties
3. Sale of Treasury Bills
4.Loans received from foreign
governments

113
Recoveries of loans and advances

Central government gives loans to

States and Union Territories .

The recovery of the same is a capital

receipt.

114
 Miscellaneous receipts
 primarily receipts from disinvestment in
public sector undertakings.

What is disinvestment ?

 The dilution of the government’s stake

in Public Sector Undertakings is called
as disinvestment.

115
 Capital expenditure

1.Expenditure for acquiring fixed assets

such as land, building, machinery and
equipment.
2. Loans and advances sanctioned by the
Center to the State governments,union
territories and public sector undertakings.

116
 Source: http://indiabudget.nic.in/ub2009-10/rec/annex5.pdf

2007- 2008  2008- 2009 2008- 2009 2009- 2010

(Figures in Rs Crore) Actuals Budget Estimate Revised Estimate Budget Estimate

Revenue Receipts 5,41,864 6,02,935 5,62,173 6,14,497

Capital Receipts 1,70,807 1,47,949 3,38,780 4,06,341

Total Receipts 7,12,671 7,50,884 9,00,953 10,20,838

Non- Plan Expenditure 5,07,589 5,07,498 6,17,996 6,95,989

Plan Expenditure 2,05,082 2,43,386 2,82,957 3,25,149

Total Expenditure 7,12,671 7,50,884 9,00,953 10,20,838

Revenue Expenditure 52,569 55,184 2,41,273 2,82,735

Fiscal Deficit 1,26,912 1,33,287 3,26,515 4,00,996

Primary Deficit -44,118 -57,520 1,33,821 1,75,485

117
 CENTRAL PLAN:

Central or annual plans are essentially the

five year plans broken down into five annual
installments.

Through these annual plans the government

achieves the objectives of the Five-Year
Plans.

The government's support to the central plan

is : budget support.

118
 TOTAL EXPENDITURE
PLAN EXPENDITURE: NON-PLAN
EXPENDITURE:
This is essentially the
Budget support to the This is largely the revenue
central plan and the central expenditure of the
assistance to state and government. The biggest
Union Territory plans. item of expenditure are
interest payments,
subsidies, salaries, defence
Like all Budget heads, this and pension. The capital
is also split into revenue component of the non-plan
and capital components. expenditure is relatively
small with the largest
allocation going to defence.

119
 REVENUE DEFICIT:
The excess of
disbursements(Expenditure) over
receipts on revenue account is called
revenue deficit.

revenue deficit=revenue receipts-

revenue expenditure

120
 Importance of revenue deficit:-
 This is an important control indicator.

 In case of revenue deficit , the

government would have to borrow.
Such borrowing is considered regressive
as it is for consumption and not for
creating assets.
 It results in a greater proportion of

revenue receipts going towards interest

payment and eventually, a debt trap.
121
 FISCAL DEFICIT:

 The excess of total expenditure over total

non borrowed receipts is called the fiscal
deficit.

Fiscal deficit = Revenue receipts + loan

repayments received by the government +
disinvestment proceeds - entire expenditure
(Revenue expenditure+Capital expenditure)

122
 importance of fiscal deficit:-
It shows the borrowing requirement
of the government.
It has to borrow money from the
public to meet the shortfall.

123
 PRIMARY DEFICIT:
 The revenue expenditure includes interest
payments on government's earlier
borrowings.

 The primary deficit = fiscal deficit - interest

payments.

 A shrinking primary deficit would indicate

progress towards fiscal health.

124
 CESS
 CESS:
This is an additional levy on the basic
tax liability.
 Governments resort to cesses for

meeting specific expenditure.

 E.g. education cess of 2%.
Both corporate and individual income
is at present subject to an education
cess of 2%.
125
MONEY MARKET:-
 What is a money market?
 Market :-
 Money:- market for money and

financial assets which are close

substitutes of money
 Close substitutes here means the

assets that can be converted into

money with minimum transactions
cost without any loss in value.
 The definition…
 It is a market for short term funds.

 How short?

 With assets maturing lower than a

year.
 PARTICIPANTS:-
 RBI plays a very important role.
 Commercial banks, financial

institutions, corporate etc.

 Features:-
 It is a whole sale market; volume of
funds traded are very huge.
 Large number of participants.

 Finances working capital

requirements.
 Objective:-
 Money market is an equilibrating
mechanism for evening out surpluses
and deficiencies etc.
 A focal point for central bank

intervention for influencing liquidity

in the economy.
 Money market  Capital market
 SHORT term funds  LONG term funds

 Finances working
 Finances fixed
capital requirements investments

 Wholesale market
 Not a wholesale
market ,as retail
buyers can participate
 Sub-markets:- call or notice
money
 Call Money market:- Overnight
money
 Short notice money:- funds are

provided for less than 14 days.

 No collateral is required to cover

these transactions
 functions:- 1. to even out day to day
surplus and deficit.
 2.helps to adjust their cash reserve

requirements.
 Interest rates are market

determined.
 Very volatile market.
Till 1971,LIC,UTI only as lenders.
RBI enlarged the list to include in
1991, to include
GIC,IDBI,NABARD, DFHI
etc.
Min. size of operation for the non-
bank entities was brought down to
3 crs. From 20 crs.
 Based on the recommendation of the
Narasimhan committee report
(1998),
the non-bank partcipants are
disallowed in the market.
They only exist for treasury bills.
 Now, it is purely an inter-bank

market.
 While lending, RBI prudential
norms apply.
 Lending not to exceed 25% of the

owned funds (paid up capital plus

reserves) as fortnightly average.
 On any single day, bank can lend

upto 50% of owned funds.

 Factors that affect call money
rates:-
 Reserve requirements
 Volatile forex market-banks fund

foreign currency position by

withdrawing form the call market.
 Tight/ easy liquidity position of

banks.
 Interest paid on call loans is call
money rate.
 Market determined. Depends upon

demand and supply conditions in the

country.
 Earlier, 1974-1989, the IBA had

control over it.

 Treasury bills market:-
 T-bills ( Treasury bills):-A short term
instrument of borrowing by GOI to
bridge the temporary gaps between
receipts and expenditure.
 They are issued at a discount to the

face value. (Rightly called zero

coupon bonds.)
 OTHER FEATURES:-
 Negotiability
 High liquidity

 Absence of default risk

 Eligibility of inclusion in SLR

 Transaction through SGL account

 Issued by RBI through AUCTION
method.
 It declares the auction calendar at

the start of financial year

mentioning the amount of issue,
date of auction and day of
payment.
 Two maturities:-
 91 days and

 364 days T-Bills

 The former are issued every

Wednesday. The later are issued
on 2nd and 4th Wednesdays.
 Types of Auction:-
 Multiple price based auction or
French auction for 91 day T –Bill

 Uniform price based auction or

Dutch auction for 364 day T –Bill
Auctions process:-multiple price
(FRENCH)
 For these the RBI invites bids
 The bidders have to quote the price(per
Rs. 100).
 RBI then decides the cut-off price at
which the issue would be exhausted.
 All the bids above the cut-off are allotted
securities.
 Each winning bid pays the price it bids-
Winner’s curse
 Primary dealers/ banks bid for it.
Auctions process: uniform price
auction(DUTCH)
 RBI invites bids in descending order
and accepts those that fully absorb
the issue amount.
 Each winning bid pays the same

price as decided by the RBI.

 Repo market
 Repo market:-repurchase agreement
 Two types of repo transactions are

conducted.
 1. Inter-Bank repos

 2. RBI repos.
 Repo ????/
 Is a transaction in which two parties
agree to sell and repurchase the
same security.
 The seller sells the specified

securities with an agreement to

purchase the same at a mutually
decided price and date.
 Repos will have maturity between to
days.
 Repos take place in the market lot of 5 crs.
 The difference between the price at which
securities are bought and sold is the
lender’s profit.
 The annual interest rate for the funds
transferred by the lender to the borrower
is the repo rate.
 Short and call money market is not
collateralized but repos are, and
hence safer.
 Inter bank repos were banned after
their misuse in the 1992 scam.
Again they are allowed since 1995.
 Repo transactions are allowed in all

treasury bills and GOI securities,

State government securities etc.
 The aim of conducting repo

transactions is to allow secondary

sale in these securities.
 The interest paid for the use of funds
is
called the repo rate.
 Non- bank participants deal with only

the reverse repo. i.e.

 They can lend money to the eligible

participants.
 CP(Commercial Paper)
 CP is short term negotiable instrument.
 Issued by companies.
 Issued at a discount to face value or a
fixed interest bearing terms.
 When companies directly deal with
investors- Direct Paper.
 When companies indirectly deal with
investors through a dealer- Dealer Paper
 Participants in the market are corporates,
LIC,GIC, UTI, Banks and mutual funds,
NRIs, FIIs.
 Who can issue the CP?
 Companies having Networth as high as 5
crores.
 Minimum credit rating of P-2 .
 Is issued in multiples of Rs.5 lakhs subject
to the minimum issue of Rs. 1 crore.
 Maturity is between 15 days to 12
months.
 Rate of interest was between 4.6% to
6.3% in 2003.
 After Nov. 2001, CPs are held in the
dematerialized form.
 CDs:-
 Issued by :-
 commercial banks.and FIs of All

India Nature.
 Min. 1 lakh and in multiples there

off. No lock in period for the CDs and

are freely transferable by
endorsement and delivery.
 Loans against CDs is not permitted.
 Subscribers:-
 Individuals/corporates/trusts/funds/

 associations etc.

 Maturity:- between 15 days and 1

year.
 FI can issue them for 1 to 3 years.
 Primary dealers:-
 In 1994, the system of PDs started.
 Applicant must have net owned

funds of a minimum 50 crs.

consisting of paid up equity capital,
free reserves etc.
INFLATION
 What is inflation?
 Inflation is persistent rise in
the level of prices.

 It is expressed as a rate per

cent per unit of time (per
month or per year)
 Effects of Inflation:-
 Purchasing power gets affected
adversely.

 Creates uncertainty, discourages

investment.

 Redistribution of income in favor of

borrowers class from the creditors
class.

 Causes of Inflation:-
 Supply shocks (cost push inflation):-
 raw materials price increase
 import prices rise


 Demand pull inflation

 increase in government spending
 tax cuts
 increase in the borrowing

Inflation is measured as a
change in the price level. The
representation of the price level
is done using three types of
indices.
 Index Number
An Index Number is developed
with an arbitrary base (usually
starting with 100) that indicates
a change in magnitude relative
to its value at a specified point in
time.
 Three types of Indices:-
 CPI- CONSUMER PRICE INDEX

 WPI- WHOLESALE PRICE

INDEX

 GDP deflator-
 The Consumer Price Index (CPI)
is used to monitor changes in
the cost of living (i.e. the
selected market basket) over
time.

 When the CPI rises, the typical

family has to spend more dollars
to maintain the same standard
of living.
 Consumer Price Index
 “ Consumer Price Index is the
main measure of price
changes at the retail level.”
 It measures Price changes of fixed
market basket of goods and
services of constant quality and
quantity.

 It tells how much cost of living has

risen or fallen due to price
changes irrespective of changes in
consumer behaviour or quality of
goods.
 “It measures changes in the
cost of buying a
representative fixed basket of
goods and services and is
generally accepted as a
measure of inflation in the
country”.
 Main groupings are:-
 Urban Industrial Workers:-

 Agricultural Laborers:-

 Urban Non- Manual Laborers:-

 Steps in the construction of
CPI:-
Determine what goods are most important
to the typical consumer: Fix the Basket
Find the prices of each of the goods and
services in the basket for each point in
time: Find the Prices
Use the data on prices to calculate the
cost of the basket of goods and services at
different times: Compute the Basket’s
Cost
Designate one year as the Base Year,
which is the benchmark for yearly
comparison.
The final step includes using the CPI to
calculate the Inflation Rate, which is:
• the percentage change in the price index
from the preceding period
 Example:
• Base Year is 2002
• Bundle of goods in 2005 = Rs.1,200
• The same bundle in 2005 cost =
Rs.1,272
• CPI = (Rs.1,272 ÷ Rs.1,200) X 100 =
106
• Prices between 2002 & 2005 increased
by 6%
 Data:-
 Consumption basket data
come from family budget
surveys.

 Price data is obtained from

the retail outlets by a large
staff of field investigators.
 Publication:-
 CPI for various population
groups are calculated and
published by Bureau of
Labour.
Hypothetical example for CPI for
an Urban Working Class family:-
 Item Qty. Prices Prices Prices
 (01-02) (04-05)
Relatives

 Rice 15 Kgs. Rs. 9 Rs. 12

 Wheat 10 Kgs. 15 20
 Milk 30 Ltrs. 17 24
 Cotton Cloth 5 M. 20 30
 Housing Two Room House 300 600
Price Relatives:-
 Price relative for rice for 2004-05

 = Price in 04-05/Price in 2001-02*

100


 Weights:- Total Expenditure on an

item in the base year/ Total
expenditure in that year.
 LASPEYRE’S CPI

P1
CPI =  wi --------------------- x 100  
  Po
 Real and Nominal Interest
Rates
 Example — Assume:
• You borrow Rs.1,000 for one year.
• Nominal Interest rate was 15%.
• During the year inflation was 10%.
 The real interest rate is:
15% - 10% = 5%
 When comparing rupee values from
different times, it is necessary to
keep in mind that a rupee today is
not the same as a rupee in the past.
 The CPI illustrates one way that

prices are measured and how to

make adjustments for these price
changes.
 WHOLE SALE PRICE INDEX
(WPI)
  
 Wholesale price index ( WPI) is

designed to measure the change of

price in the primary and wholesale
markets.

 WPI can be interpreted as the index of

prices paid by the producers for their
inputs.
  
 WPI:-
 WPI for individual
commodities,commodity
groups, and the overall WPI
is published monthly by the
Office of Economic Advisor to
the Government of India.
 THE MAIN GROUPS OF ITEMS
ARE:-
 Primary articles-
 Food(Rice, Wheat), Non Food ( Raw

Cotton, Jute) , Minerals( Iron Ore,etc.)

 Manufactured Articles:- 270 Items

 Fuel, Power, Light, Lubricants :- 10

Items
 GDP Deflator:-
 It is the ratio of Current price GDP
to constant price GDP.