MMPC-003

Business Environment
School of Management Studies

BLOCK 1
INTRODUCTION TO BUSINESS ENVIRONMENT 5

BLOCK 2
OVERVIEW OF INDIAN ECONOMY 101

BLOCK 3
STRUCTURAL REFORMS 155

BLOCK 4
INTERNATIONAL BUSINESS ENVIRONEMENT 201
COURSE DESIGN AND PREPARATION TEAM
Prof. K. Ravi Sankar Prof. Srilatha
Director, School of Management Studies,
School of Management Studies, IGNOU, New Delhi
IGNOU, New Delhi
Prof. Neeti Agrawal
Prof. Arindam Banik School of Management Studies,
International Management Institute, IGNOU, New Delhi
Qutub Institutional Area, New Delhi
Prof. Nayantara Padhi
Prof. Sunitha Raju School of Management Studies,
Indian Institute of Foreign Trade IGNOU, New Delhi
Qutub Institutional Area, New Delhi
Dr. Anjali Ramteke
Prof. Madan Lal School of Management Studies,
Delhi School of Economics, IGNOU, New Delhi
University of Delhi, Delhi
Mr. T.V. Vijay Kumar
Prof. Bibek Ray Chaudhuri School of Management Studies,
Indian Institute of Foreign Trade IGNOU, New Delhi
Kolkata
Dr. Leena Singh
Dr. Kamal Singh School of Management Studies,
Department of Economics IGNOU, New Delhi
Central University of Himachal
Pradesh Prof. G. Subbayamma (Course
Coordinator & Editor)
Prof. Shailendra Singh Bhadoria School of Management Studies,
IGN Tribal University, Amarkantak IGNOU, New Delhi

Prof. Ritesh Gupta

Department of Management Studies
Chitkara University, Chandigarh
MATERIAL PRODUCTION
Mr. Y. N. Sharma Mr. Tilak Raj
Assistant Registrar Assistant Registrar
MPDD, IGNOU, New Delhi MPDD, IGNOU, New Delhi

September, 2021
© Indira Gandhi National Open University, 2021
ISBN:
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 Content
BLOCK 1: INTRODUCTION TO BUSINESS ENVIRONMENT 5
Unit 1: Introduction to Business and Environment 7
Unit 2: Economic Growth and Development 31
Unit 3: Socio-Cultural and Politico-Legal Environment 53
Unit 4: Business Ethics and Corporate Social Responsibility (CSR) 84
BLOCK 2: OVERVIEW OF INDIAN ECONOMY 101
Unit 5: Indian Financial System 103
Unit 6: Industrial Policy Framework 122
Unit 7: Agri-business Environment 140
BLOCK 3 STRUCTURAL REFORMS 155
Unit 8: New Economic Policy 157
Unit 9: Financial Sector and Fiscal Sector Reforms 179
BLOCK 4 INTERNATIONAL BUSINESS ENVIRONEMENT 201
Unit 10: International Financial System 203
Unit 11: Balance of Payments (BoP) 219
Unit 12: Foreign Trade 233
Unit 13: Sources of Global Financing 248
Unit 14: Technological Environment 264
MMPC 003: BUSINESS ENVIRONMENT

In view of the dynamic nature of environment and increasing interaction

between business and environmental factors/ forces a thorough understanding
of environment of business is essential for business enterprises to operate
successfully. A manager needs to have knowledge about various spectrums of
business, the policy measures and their implications with reference to legal
framework, taxation, budget, money market, capital market, corporate
governance, business ethics, corporate social responsibility (CSR), foreign
investment, exports and imports, balance of payments and technological
advancement.

Business organisations interact and transact with the business environment.

Therefore business organisation and business environment are directly
related. Business environment influences the scope and direction of business
activity.

This course which has four blocks thus focuses on the following:
• Concept, nature and scope of Business Environment;
• Types of environment and their impact on business;
• An overview of Indian Economy and the policy framework within
which business organisations operate;
• Challenges posed by structural reforms and major initiatives by the
government;
• International business environment to understand the developments at
global level.
 BLOCK 1
INTRODUCTION TO BUSINESS
ENVIRONMENT
BLOCK 1 INTRODUCTION TO BUSINESS
ENVIRONMENT
Business exists and operates within an environment. Business managers
arrive at decisions after examining the possible reactions from the
environment, be it internal or external.

This block focuses on Business Environment, impact of Socio-Cultural and

Politico- Legal environment on business, importance of business ethics and
Corporate Social Responsibility for business organisations.

This block has following four units:

Unit 1: Introduction to Business and Environment
Unit 2: Economic Growth and Development
Unit 3: Socio-Cultural and Politico Legal Environment
Unit 4: Business Ethics and Corporate Social Responsibility (CSR)
UNIT 1 INTRODUCTION TO BUSINESS Introduction to
Business and
AND ENVIRONMENT Environment

Objectives

After reading this unit you should be able to:

• define what you mean by environment;

• explain the concept of business environment;
• describe the scope of business environment; and
• understand the basic concepts of macroeconomics.

Structure

1.1 Introduction
1.2 Business and Environment
1.3 Basic Propositions
1.4 Nature and Scope of Business Environment
1.5 Types of Business Environment
1.6 Importance of Business Environment
1.7 Environmental Analysis
1.8 Basics of Macroeconomics
1.9 Summary
1.10 Key Words
1.11 Self-Assessment Questions
1.12 References/ Further Readings

1.1 INTRODUCTION
You may have a variety of reasons for studying this course, but the main
reason, we presume, is to become a successful manager. Your success or
failure as a manager depends on a number of factors and these factors may
not always be within your control; very often such factors constitute your
work environment. These include your job, your department, your
organisation, your nation and the world around you. After all, as a manager
you do not function in a vacuum. You exist and operate within and not
without, an environment. Therefore as a manager when you think, or take
decisions, you cannot neglect the limitations of your environment. Just think
for a while and then answer. Don’t you arrive at decisions after examining
the possible reactions from the environment in which you are placed ? Say,
as a marketing manager, would you not study your market environment
before launching a new product ? Or, as a finance manager, wouldn’t you
study how the capital and money markets of the country are structured and
7
Introduction to organised before deciding on the sources and uses of your funds ? Or, as a
Business
Environment personnel managers wouldn’t you care to find the rules and regulations laid
down by the government on subjects like reservation before undertaking
recruitment and selection of your required staff? When you have answered
these questions, you will discover that all your answers are in the affirmative
: “Yes, I would”. You can’t do without thinking about your environment. As
a business manager, you have to constantly evaluate your business
environment.

This opening unit aims to set you thinking about three ideas. It aims to help
you to: precisely define “environment”, classify your business
environment on the basis of some criteria; identify some of the critical
elements of environment of business;; and establish the nature of interaction
between environment and business.

In pursuing these aims and objectives, our focus will primarily be on the
Indian environment of business. We shall try to identify, describe and analyse
the Indian situation to understand its impact on our business. Our ultimate
purpose is to train our business mangers to face the macro-level environment
of business. As managers, wherever you are be it in the public or the private
sector, you have to remain alive and alert to your environment so that you are
successful in your day-to-day business operations.

1.2 BUSINESS AND ENVIRONMENT

The term “environment” refers to the totality of all the factors which are
external to and beyond the control of individual business enterprises and their
managements. Environment furnishes the macro-context, the business firm is
the micro-unit. The environmental factors are essentially the “givens” within
which firms and their managements must operate. For example, the value
system of society, the rules and regulations laid down by the Government,
the monetary policies of the central bank, the institutional set up of the
country, the ideological beliefs of the leaders, the attitude towards foreign
capital and enterprise, etc., all constitute the environment system within
which a business firm operates. These environmental factors are many in
numbers and various in form. Some of these factors are totally static, some
are relatively static and some are very dynamic – they are changing every
now and then. Some of these factors can be conceptualized and quantified,
while other can be only referred to in qualitative terms. Thus, the
environment of business is an extremely complex phenomenon.

The environmental factors generally vary from country to country. The

environment that is typical of India may not be found another countries like
the USA the (former) USSR, the UK, and Japan. Similarly, the
American/Soviet/British/Japanese environments may not be found in India.
There may be some factors in common, but the order and intensity of the
environmental factors do differ between nations. What to say of countries,
8 the magnitude and direction of environmental factors differ over regions
within a country, and over localities within a region. Thus, one may talk Introduction to
Business and
of local, regional, national (domestic) and international (foreign) Environment
environment of business. For example, the local custom of “coolie” labour,
the climate of the northern region of Assam, the policies of the State and
Central Governments in India and the size of the world market : all these
factors together will have an important bearing on tea industry. The
production, consumption and marketing of tea will be affected by
environmental factors.

The environment differs not only over space but also over time within a
country. As such, we can talk of temporal patterns of environment, i.e., past,
present and future environment. Future environment is the product of past
and present environments. The Indian economy of tomorrow will be
influenced by what the state of the economy is at present and what it was in
the past.

Sometimes the environment may be classified into market environment and

non-market environment depending upon whether a business firm’s
environment is influenced by market forces like demand, supply, number of
other firms and the resulting price competition, or non-price competition,
etc., or by non-market forces like Government laws, social traditions, etc.

Finally, we may classify the environment into economic and non-economic.

Non- economic environment refers to social, political, legal, educational
and cultural factors that affect business operations. Economic environment,
on the other hand, is given shape and form by factors like the fiscal policy,
the monetary policy, the industrial policy resolution, physical limits on
output, the price and income trends, the nature of the economic system
at work, the tempo of economic development, the national economic plan,
etc. The non-economic environment has economic implications just the
economic environment may have non-economic implications. Since the
environment is the sum total of the history, geography, culture, sociology,
politics and economics of a nation, the interaction between economic and
non-economic forces is bound to take place.

Definition of Business Environment

The word ‘Business Environment’ is defined by many authors in different

ways. Few of the definitions are as follows:

According to Keith Davis, “Business environment is the aggregate of all

conditions, events and influences that surround and affect it”.

According to Reinecke and Schoell, “the environment of a business consists

of all those external things to which it is exposed and by which it may be
influenced directly or indirectly”.

According to Barry M. Richman and Melvgn Copen “Environment consists

of factors that are largely if not totally, external and beyond the control of
individual industrial enterprises and their management. These are essentially 9
Introduction to the ‘givers’ within which firms and their management must operate in a
Business
Environment specific country and they vary, often greatly, from country to country”.

According to William F. Glueck “Business environment is the process by

which strategists monitor the economic, governmental, market, supplier,
technological, geographic, and social settings to determine opportunities and
threats to their firms”.

All these definitions give a better understanding of the business environment.

It can be concluded that a business environment is a combination of dynamic,
complex, and uncontrollable external factors within which a business is to be
operated. It is pertinent to scan all these forces. Hence, it is crucial to have a
thorough understanding of the basic idea of the business environment and the
nature of its different components. This interrelation assists the business
organisation to reinforce its capabilities and efficiently allocate its resources.

Business organisations interact and transact with the business environment.

Therefore business organisation and business environment are directly
related. Business environment influence the scope and direction of business
activity.

Business can be seen as a specific activity e.g. a retail business in which a

company is making use of the internet and social media for marketing of their
products. For example, Flipkart is a specific form of business and is a
private limited company. Business can also be seen as a broad activity like a
business system as a whole where we may refer it as a market system or
capitalism in which a whole range of activities including professional bodies,
trade unions, consumer groups, regulatory agencies and government bodies
are included.

In early 2015, Nestle’s famous product Maggi Noodles faced a setback in

India when food inspectors claimed to have found it unsafe, as the amount of
lead was more than its permissible limits. But Nestle tried its best to keep
consumer trust by continuously interacting with them on social media
platforms and ensuring that Maggi is safe and they are cooperating with the
authorities. Later Maggi was temporarily banned in India and Nestle was
asked by the Food Safety and Standards Authority of India (FSSAI) to recall
its Noodles products from the market and destroy them. It hugely impacted
their revenues and profits as Maggi was one of the most popular products in
India.

In the second half of 2015, fresh batch of Maggi was tested and it was
allowed to sell again. But lead controversy adversely affected the trust of
consumers and it took lots of promotional strategies to regain the lost
revenue. It launched emotional campaign # Wemissyoutoo on all social
media platforms to revive the bond between consumers and Maggi brand. It
took them sometime to revive from the losses and gain pre ban market share.

10
Activity 1 Introduction to
Business and
Environment
If you wish to set up an enterprise you must have a clear understanding of
business environment. Identify an enterprise and study whether the business
environment is conducive.

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

1.3 BASIC PROPOSITIONS

As a prelude to the description and analysis of the business environment in
any economy, you may examine the three basic propositions given below:

1) Business is an economic activity.

2) A business firm is an economic unit.
3) Business decision-making is an economic process.

These propositions may be examined separately or jointly to justify the study

of the environment of business in any country.

Business is an economic activity

An economic activity involves the task of adjusting the means (resources) to

the ends (targets), or the ends to the means. An economic activity may
assume different forms such as consumption, production, distribution, and
exchange. The nature of business differs depending upon the form of
economic activity being undertaken and organised. For example,
manufacture is primarily concerned with production; the stock exchange
business is mainly concerned with the buying and selling of shares and
debentures; the business of Government is to run the administration. The
Government may also own, control and mange public enterprises. The
business of banks is to facilitate transactions with short-term and long-term
funds. These examples can be easily multiplied. The point to be noted is
that each business has a target to achieve, and for this purpose each
business has some resources at its disposal. Sometimes the target has to be
matched with the given resources, and sometimes the resources have to be
matched with the given target, Either way, the task of business is to optimize
the outcome of economic activities.

A business firm is an economic unit

A business firm is essentially a transformation unit. It transforms input into

outputs of goods or services, or a combination of both. The nature of input
11
Introduction to requirements and the type of output flows are determined by the size,
Business
Environment structure, location and efficiency of the business firm under consideration.
Business firms may be of different sizes and forms. They may undertake
different types of activities such as mining, manufacture, farming, trading,
transport, banking, etc. The motivational objective underlying all these
activities is the same viz., profit maximization in the long run. Profit is
essentially “a surplus value”- the value of outputs in excess of the values of
inputs or the surplus of revenue over the cost. A business firm undertakes the
transformational process to generate this “surplus value”. The firm can grow
further if the surplus value is productively invested. The firm, therefore,
carefully plans the optimum allocation of resources (i.e., men, money,
material, machines, time, energy, etc.) to get optimum production. The entire
process of creating, mobilisation and utilisation of the surplus constitutes the
economic activity of the business firm.

Business decision-making is an economic process

Decision-making involves making a choice from a set of alternative courses

of action. Choice is at the root of all economic activity. The question of
choice and evaluation arises because of the relative scarcity of resources. If
the resources had not been scarce, an unlimited amount of ends could have
been met. But the situation of resources constraint is very real. A business
firm thinks seriously about the optimum allocation of resources because
resources are limited in supply and most resources have alternative uses. The
firm, therefore, intends to get the best out of given resources or to minimise
the use of resources for achieving a specific target. In other words, when
“input” is the constraining factor, the firm’s decision variable is the “output”.
And when “output” is the constraining factor, the firm’s decision variable is
the “input”. Whatever may be the decision variable, procurement or
production, distribution or sale, input or output, decision-making is
invariably the process of selecting the best available alternative. That is what
makes it an economic pursuit.

1.4 NATURE AND SCOPE OF BUSINESS

ENVIRONMENT
Every organisation operates in a certain kind of environment. Each
organisation has some opportunities and threats associated with various
forces which may be external or internal in nature.

Nature of Business Environment

1) Dynamic: Business environments such as internal and external business

environments are highly flexible and keep on changing. For example,
changing customer preferences, new competitors entering into the
market, novel technology, new marketing channels, new government
policies and changing demography.
12
2) Uncertain: It is very difficult to presume with any degree of certainty Introduction to
Business and
about the factors influencing the business environment because they Environment
continue to fluctuate very quickly.

3) Complex: The business environment is complex as it is continuously

exposed to uncertain challenges such as technological disruptions, global
competition, leadership change, shifting economic, social, and regulatory
conditions etc. It may be easy to scan the environment but its impact on
business decisions will be difficult to estimate. It is very difficult for a
firm to survive and prosper in such an uncertain environment.

4) Relativity: The business environment is associated with societal norms

and local conditions and this is the reason, why the business environment
varies from country to country, region to region which makes it more
complex.

5) Interrelation: All the factors and forces of the business environment are
related to each other. For instance, with the proclivity of youth towards
western culture, the demand for fastfood is also rising. Take another
example, change in political parties will result in changing monetary
policy, fiscal policies, government rules, market conditions, technology,
etc. Thus, all these factors are required to be scanned properly as these
factors are interrelated to each other.

Scope of Business Environment

a) Internal and external environment: Internal environment means those

factors that are within an organisation and influence the strength or
weakness of the business. For example, superior raw material, inefficient
human resources, etc. External environment means those factors which
are beyond the control of the business and are outside the organisation.
They provide opportunities and pose threats to business. For example,
changing political and economic conditions, technological changes, etc.

b) Micro-environment and macro-environment: Sometimes internal and

external environment are interchangeably reffered as micro and macro
environment respectively. Micro-environment affects the working of a
particular business. It directly impacts business activities and
incorporates customers, suppliers, market intermediaries, competitors,
etc. These factors are controllable to some extent. Macro-environment is
the general environment that impacts the working of all businesses. It is
uncontrollable and influences indirectly. Political conditions, economy,
technology, etc., are part of the macro environment. For example,
Technological advancement such as blockchain, Artificial Intelligence
(AI) have changed the face of business operations.

c) Controllable and uncontrollable environment: All those factors which

are governed by business come under a controllable environment.
Internal factors are also treated as controllable factors, such as money,
13
Introduction to men, materials, machines, etc. Uncontrollable factors are external and
Business
Environment are beyond the control of business namely global, technological, legal
and natural changes. For example, recent Corona pandemic is a major
example of uncontrollable factor. The pandemic has hugely impacted the
businesses and led to changes in strategies of operations.
d) Specific and general environment: Specific environment refers to
external forces that directly influence business enterprises’ decisions and
actions and are directly pertinent for the achievement of organisational
goals. The main forces that include the specific environment are customers,
suppliers, competitors and pressure groups. General environment refers to
the economic, politico-legal, socio-cultural, technological, demographic,
and global conditions that influence organisations. These external forces or
factors impact organisations indirectly and organisations must plan,
organise, lead and control their activities by incorporating these factors.

1.5 TYPES OF BUSINESS ENVIRONMENT

There are certain factors or forces internal and external to the organisation
influencing it in both positive and negative ways. These different components
of the business environment have been explained below as shown in Figure
1. 1.

Business
Environment

External Internal
Environment Environment

Micro Macro - Value System

Environment Environment - Mission and
Objectives
- Organisation
- Suppliers of - Economic Structure
Inputs - Politico- legal - Corporate Culture
- Customers - Technological - Human Resources
- Marketing - Global or - Physical Resouces
Intermediari International and Financial
es - Socio-cultural Capabilities
- Competitors - Demographic
- Public - Natural

Figure 1.1: Components of Business Environment

1) Internal Environment

This includes those factors or forces that exist within an organisation

influencing the performance of an organisation. These factors are controllable
14
in nature and organisations can attempt to change or modify these factors. Introduction to
Business and
Organisation’s resources like men, materials, money, and machines are part Environment
of the internal environment. The different internal factors are given below:

i) Values system: The values are defined as ethical beliefs that guide the
organisation in attaining its mission and objectives. These are formulated
by top-level managers such as the board of directors. The extent to which
these value systems are shared by all in the organisation is a significant
factor leading to its success.

ii) Mission and objectives: Mission reflects the overall purpose or reason
for organisation’s existence. A mission guides and affects the decisions
and economic activities of the organisation. Accordingly, an organisation
can change or modify its mission and objectives.

iii) Organisation structure: The organisational structure is the hierarchical

relationship explaining roles, responsibilities and supervision. The
structure of the board of directors, the professionalism of management,
etc., are the part of the organisation structure and are significant forces
affecting business decisions. For effective management and working of a
business organisation and for prompt decision making, the structure of
the organisation should be conducive.

iv) Corporate Culture: Shared values and beliefs in an organisation

determine its internal environment also known as corporate culture.
Organisation having strict supervision and control reflects the lack of
flexibility and unsatisfied employees. These sets of values assist the
employees to understand what organisation stands for, what it considers,
and how it works. Cultural values of business, thus determine the
direction of activities.

v) Human resources: Human quality of a firm is an important factor of

internal environment. Skills, qualities, capabilities, attitude,
competencies and commitment of its employees, etc., contribute to the
strengths and weaknesses of an organisation. Organisations may find it
difficult to carry out modernisation and redesigning because of resistance
by its employees.

vi) Physical resources and financial capabilities: Physical resources, like

machinery, plant and equipment facilities and financial capabilities of a
firm decides its competitive strength which is the significant factor for
examining its efficiency and unit cost of production. Moreover, research
and development capabilities of a company decides its ability to innovate
and thus increase the productivity of workers.

2) External Environment

This includes those factors or forces that exist outside an organisation

influencing the performance of an organisation. These external factors can
15
Introduction to be further classified into micro-environment and macro environment which
Business
Environment are defined below.

A. Micro-Environment: Those factors which have a direct impact on

business. The different components under micro-environment are as
follows:

i) Suppliers of inputs: The suppliers of inputs are a significant

constituent of the external micro environment of an organisation.
Suppliers give raw materials and resources to the firm. A firm
should have more than one supplier for efficient input inflows.

ii) Customers: Customers are the buyers of the firm's products and
services. Customers are an important part of the external micro-
environment as a firm’s survival and growth are dependent on sales
of a product or service. Thus, it is essential to keep the customers
satisfied.

iii) Marketing intermediaries: Intermediaries play an essential role in

selling and distributing products to the final customers. Marketing
intermediaries are an important link between a business firm and its
ultimate customers. Retailers and wholesalers buy in bulk and sell
business products and services to the ultimate consumer.

iv) Competitors: Competitors are the rivalry in business influencing

the business strategies of the organisation. For example, Zomato and
Swiggy are major competitors in food delivery business and their
strategies impact each other.

v) Public: Public or groups, such as media groups, women’s

associations, environmentalists, consumer protection groups, are
significant factors in the external micro-environment. The public can
be defined as any group affecting a company's ability to achieve its
objectives. Recently People for the Ethical Treatment of Animals
(PETA) India protested against Amul (dairy company) suggested
them to produce vegan milk.

B) Macro Environment: These are the factors or conditions which are

general to all businesses and are uncontrollable. Because of the
uncontrollable nature of macro forces, a firm needs to adjust or adapt
itself to these external forces. These factors are as follows:

i) Economic environment: Economic environment refers to all those

forces and factors which have an economic impact on businesses. It
consists of the role of the private and public sector, monetary and
fiscal policy, role of saving and investment, economic reforms,
agriculture, industrial production, infrastructure, planning, basic
economic philosophy, stages of economic development, trade
cycles, national income, per capita income, money supply,
16 international debt, etc. For example, an increase in Groos Domestic
 Product (GDP) will increase disposable income and thus further rise Introduction to
Business and
in demand for products. Environment

ii) Politico-legal environment: Politico-legal environment constitutes

all the factors related to the activities of legislature, executive and
judiciary which play a leading role in shaping, directing, developing
and controlling business activities. For example, rules and
regulations framed by the government, like licensing policy, Skill
India movement, Digital India, Swachha Bharat Abhiyan, polythene
ban, etc., affect the business. Higher business growth can be
achieved in a stable and dynamic politico-legal environment.
iii) Technological environment: Technology is defined as the
“Systematic application of scientific or other organised knowledge
to particular tasks”. The technology incorporates both machines
(hard technology) and ways of thinking (soft technology). These
organized knowledge and innovation provide new methods of
producing goods and services and latest ways of operating business.
Recent technological changes such as the online sale of grocery
items, online booking of air tickets, online payments, etc. have
changed the business strategies. As technology is changing fast,
organisations should keep a close look at these technological
fluctuations for their adaptation in their business activities.
iv) Global or international environment: The global environment
includes all environmental factors having a global impact which is
also important for shaping business activity. In the era of
globalisation, the whole world is a market. Business analyses the
international environment to cope up with the changes. Principles
and agreements of the World Trade Organisation (WTO), other
international treaties and protocols such as crude oil prices are
examples of the global environment.
v) Socio-cultural environment: The socio-cultural environment
reflects customs and values which influence business practices.
People’s attitude towards work and wealth, lifestyle, ethical issues,
religion, the role of family, marriage, education and also social
responsiveness of business impact the business. For example,
foreign brands like McDonalds were sensitive to Indian culture and
avoided selling beef burgers in India.
vi) Demographic environment: Demographic environment includes
the composition and characteristics of the population. For example,
Population size and growth, the life expectancy of the people, rural-
urban distribution of population, the technological skills and
educational levels of the labour force are part of the demographic
environment. These forces also impact the organisations’
functioning. For example, many MNCs are targeting Indian youth
because of the country’s demographic dividend.
17
Introduction to vii) Natural environment: Natural environment includes geographical
Business
Environment and ecological resources like minerals and oil reserves, weather and
climatic conditions, water and forest resources, and port facilities.
These are very important for many business activities. For example,
in places where climate conditions such as temperatures are high,
demand for coolers and air conditioners will also be high. Similarly,
demand for clothes and building materials is also conditioned upon
weather and climatic conditions. Natural calamities such as floods,
droughts, earthquakes, etc. greatly affect business activities.

1.6 IMPORTANCE OF BUSINESS

ENVIRONMENT
Business environment plays an important role in the functioning of
organisations in the following ways:

i) Enable the organisation to identify the business opportunities and

achieving first-mover advantage: Many opportunities are provided by
the business environment to the organisation. Scanning the business
environment will help the organisation to attain the first-mover
advantage.
ii) Help the firms to identify the threats and early warning signals: The
business enterprises that can scan the business environment and obtain
qualitative information on time will be able to get a warning signal to
deal with negative policies and constraints of the business environment.
iii) Help in tapping and assembling resources: Resources such as raw
material, capital, money, labour, etc., are the necessary inputs to the
business organisation. All these inputs are obtained through the
environment to the firms for carrying out their activities and also expect
something in return.
iv) Help in adjusting and adapting to rapid changes: Business
environment scanning assists the firms to scan and understand the rapid
changes in the environment and these changes are having important
implications on business strategies.
v) Assist in planning and policymaking: The major strategic plans and
policies in the organisation are formulated based on the business
environment because the policies and strategies have to be implemented
in the presence of these environmental factors.
vi) Help in performance improvement: Continuous scanning of business
environments can improve the performance of organisations. By
incorporating changes in the internal environment matching to external
environment, business organisations can prosper and enhance their
market share.

18
1.7 ENVIRONMENTAL ANALYSIS Introduction to
Business and
Environment
We know that all organisations perform within a framework of specific
factors of business environment. These can be internal as well external. A
proper environmental analysis of the business environment is very important.
There are different steps involved in the environmental analysis of a business.
These are:

1) Scanning the internal / external factors.

2) Grouping of the scanned factors.
3) Observation of internal factors.
4) Monitoring external factors.
5) Defining the variables for the analysis.
6) Identifying specific techniques for analysis.
7) Forecasting.
8) Strategy formulation.
9) Evaluation.

In this section we will discuss SWOT analysis to familiarize ourselves with

environmental analysis.

SWOT analysis

SWOT analysis is the business analysis process of examining both the

internal and external environment of an organisation. Here, S, represents
Strengths and W, represents Weaknesses. Both these terms are internal
constituents of an organisation. While O, represents available Opportunities
in the market and T, represents the possible Threats in the market. Both of
these are the external constituents of the organisation (Figure 1.2).

Environmental Scanning

Internal Analysis External Analysis

-Strengths -Opportunities
-Weaknesses -Threats

Figure 1.2: SWOT analysis Framework

a) Strengths: It reflects the core competencies or capabilities of an

organisation for which it can achieve strategic advantages over its
competitors. Even if the organisation does not gain any advantages over
its competitors, it indicates an organisation’s capacities in which the 19
Introduction to organisation is having affirmative aspects. For example, mobile payment
Business
Environment platform PhonePe has the strength of easy user interface.

b) Weaknesses: Weaknesses means those factors which prevent successful

results within the organisations. These are exact opposites of Strengths.
Strengths indicate competitive advantages while weaknesses indicate the
competitive disadvantages of an organisation.

c) Opportunities: These are favourable circumstances present in the

external environment, which should be grabbed by the organisation, to
enhance its strengths to gain competitive advantage. An organisation
strategist must be aware of the upcoming opportunity in the market so
that it could grab them on time and could raise revenues and profits.

d) Threats: The term ‘threat’ reflects exposing vulnerability to something

which leads to adverse impact. In an external environment, if sudden or
even gradual changes occur which are not in favour of the organisation,
then these represent threats to the organisation.

The SWOT analysis is a tool to evaluate the strengths, weaknesses,

opportunities and threats of an organisation. Every organisation should do
SWOT analysis very effectively to explore both internal and external factors
of an organisation and accordingly business strategy should be formulated.

Activity 2

1) Explain the need for environmental analysis. How can it enchance

organisational effectiveness?

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

2) Select any company of your choice and explain the SWOT analysis of
that company.

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………
20
1.8 BASICS OF MACRO ECONOMICS Introduction to
Business and
Environment
Since business is an economic activity, a business firm an economic unit, and
business decision-making an economic process, it is the economic
environment of business which is the primary consideration in evaluating the
business policies, business strategies and business tactics of a corporate entity
in any national economy.

Economic transactions are the lifeline of the business and in the preceding
sections, you have learnt how the business environment is influenced by the
economic policies and economic structure prevailing in the country. So,
students of business environment must have some understanding of the
working of an economy, what are different sectors of the economy, how they
interact with one another, how monetary and fiscal policies influence the
economy and so on. In the following sections, we shall study about basics of
macroeconomics.

Macroeconomics is primarily the study of the behaviour and performance of

the economy as a whole. The macroeconomic theories make use of
macroeconomic models to explain and establish the relationship among
different macroeconomic variables. Income determination, price level
determination, investment, employment, product and money market
equilibrium, exchange rate, the balance of payments, etc. are the main areas
of macroeconomic theories. Macroeconomics also analyses the working and
effects of major government policies like monetary and fiscal policies, on the
economy.

According to J.M.Culburtson

‘Macroeconomic theory is the theory of income, employment, price, and

money’

According to Paul Samuelson

‘Macroeconomics is the study of the behaviour of the economy as a whole. It

examines the overall level of a nation’s output, employment, prices, and
foreign trade’

Interaction of Business and Macroeconomics

You must be wondering that we are students of Management then why

should we worry about economics and especially macroeconomics. What is
the relationship between the two? On the contrary, the understanding of
macroeconomics, in particular, is of immense importance for the students of
Management. Let us understand this interaction with the help of an example.
Inflation is one of the prominent problems of macroeconomics. Inflation
refers to the situation in which prices of goods and services rises
continuously over a period of time. Inflation can affect both the consumer
and producer depending upon the cause of inflation whether it is demand-pull
or cost-push. If it is demand-pull or due to an increase in demand in relation 21
Introduction to to supply, then consumers are at a disadvantage. Cost-push or increase in the
Business
Environment cost of production (for example increase in input cost) affects the supplier or
producer. To alleviate the problem, the central bank of the country takes the
help of the Monetary Policy. One of the instruments of the monetary policy is
increasing the repo rates i.e. repo and reverse repo rate. This increase in repo
rates leads to both increases in the cost of borrowing for business and a
shortage of money supply in the system. These both affect the scale of
production. So, producers and enterprises keep a close eye on every move of
the government concerning any change in monetary policy and other policies.

Some Important Concepts of Macroeconomics

Let us understand some of the major concepts used in macroeconomics.

Net National Product (NNP) at Factor Cost (NNPFC) is commonly known

as National Income. The Gross National Product (GNP) or NNP can also be
evaluated at factor cost. The basic cause of difference between the two
concepts is that NNP arises because some of the allocations of market value
do not go into the payments to the factors of production.

Gross Domestic Product (GDP)

GDP is defined “as the value of final goods and services produced within the
borders of a country during a fiscal year”. It also includes income earned
locally by foreigners and excludes income received by the nationals from
abroad.

GDP is calculated at two prices- market prices (i.e.current prices) and

constant prices.

GDP at Market Price (GDPMP): GDP at market price is the total value of
final goods and services produced within a year at current prices.

GDP at Constant Prices: GDP at constant prices estimates GDP in

reference to some base period.

For example, if we estimate GDP for 2020-21, then it will give us GDPMPfor
the fiscal year 2020-21. If we estimate GDP with reference to some base year
say 2004-05, then it is GDP at constant prices or real GDP. The distinction
between current and constant prices is important as GDP at current prices
could grow very rapidly if prices are rising. This increase will not tell
anything about the volume of production whether the total output is
increasing or not. On the other hand, growth in GDP at constant prices
indicates a rise in the total production/output of the country.

To obtain GDP at a constant price, GDP at market price is divided by GDP

deflator and multiplied by 100. GDP at constant prices is called real GDP.
While calculating GDP at a constant price, the base period is always
mentioned.

22
• Aggregate Demand and Aggregate Supply Introduction to
Business and
Environment
i) Aggregate Demand (AD):Aggregate Demand is one of the most
important concepts in macroeconomics. In simple words, it means total
demand for consumer and capital goods at a given price.

C= Consumption; I = Investment; G = Government Expenditure; X =

Exports; and M = Imports

This equation encapsulates the gist of Aggregate Demand. In the two-

sector model, there is an absence of G and (X-M) so the above equation
becomes AD= C+I and investment is assumed to be constant. Ultimately
aggregate demand function is largely dependent upon consumption
expenditure or consumption function.

ii) Aggregate Supply (AS): The Aggregate Supply (AS) shows the amount
of output firms plan to supply at different levels of prices or the total
supply of goods and services in an economy. Since firms like to sell
more output with increasing product prices, the AS has an upward
sloping supply curve. The intersection of AD and AS determines the
short-run equilibrium in the economy.

• Multiplier or Investment Multiplier

Investment multiplier is of much importance in macroeconomics. It is a ratio

of change in income/national income to change in investment.

m = investment multiplier; ΔY = change in national income ; ΔI = change in

investment. Multiplier indicates that with one unit change in Investment how
much national income will change. So, it indicates the level of investment
required to achieve the desired level of national income. For example, if the
value of m=2 and investment is increased by Rs 100 crore then with this
increase in investment level the national income will increase by Rs 200
crore.

The Four Macroeconomic Sectors

Macroeconomics has primarily four sectors and the interplay and the
interaction of these sectors give momentum to the economy.

1) Household Sector

This sector covers all the individuals in the economy. The major function of
this sector is to supply the factors of production to the different sectors. There
are four factors of production i.e. land, labour, capital, and entrepreneur. The
household sector is the ultimate consumer who consumes the goods and
services that are manufactured by the firms and in return makes payments to
23
Introduction to the firms. This sector also provides the savings and supply finance to the
Business
Environment firms.

2) Firms

This sector comprises all the businesses, firms, and corporations. The major
function of this sector is to manufacture goods and supply services for sale in
the economy. They hire the factors of production and pay them factor
payments namely rent, wages, interest, and profits.

3) Government Sector

This sector involves the centre, state, and local governments of a country.
The major function of this sector is the management and regulation of the
economy. It is mostly done by its monetary and fiscal policy. Monetary
policy is related to the regulation of the money supply in the economy. Fiscal
policy is related to taxes, public expenditure, and public debt. Tax and non-
tax sources are the major sources of revenue and revenue collected is spent
on public health, services, infrastructure, etc.

4) The Foreign Sector

This sector takes into account all the economic transactions with the rest of
the world. The foreign sector primarily consists of export and imports of
goods and services. When we sell domestically produced goods and services
to other economies, these are called exports. Imports are items that the
domestic country purchases from the outside world. Net Exports are exports
minus imports.

• The Three Markets

There are three major markets in an economy. These are 1) goods market, 2)
factor market, and 3) financial market or money market.

1) Goods Market

In this market, goods and services are exchanged among the different sectors.
The goods and services produced by the firms/industry are consumed by
households, the government, and the external sector.

2) Factor Market

The factors of production are traded in this market. The factor services are
demanded by the firms for the production of goods and services and these
factors are paid in the form of rent, wages and profits. For example, labour is
a factor of production and is owned by the household sector i.e. the workers.
Workers offer their services and they are hired by firms, the government, and
the foreign sector. In return for labour services, workers receive wages. This
equilibrium of demand for labour and supply of labour is part of the factor
market. Similar is the case for other factors of production.

24 3) Money Market
In this market, equilibrium is attained between demand for and supply of Introduction to
Business and
money. Primarily money is provided in the form of savings by the household Environment
sector and is channelized by financial institutions like banks. Firms borrow
from these financial institutions and equilibrium is attained in the money
market. The government regulates the money market by its monetary policy.

• Circular Flow of Income and Expenditure

The economic system can be viewed as the continuous flow of income and
expenditure. It is this flow that determines the size of the national income and
the overall worth of the economy. One of the major objectives of
macroeconomics is income determination, so it is important to understand the
circular flow of income and expenditure. This flow can be understood with
the interaction of two sectors, three sectors, and four sectors.

I) Two Sector Flow

In the two-sector flow, we have two sectors namely households and firms. we
have discussed the main characteristics of both these sectors in the previous
paragraphs. The two sector flow is depicted in Figure 1.3.

factors of production

Saving Investment
Households Firms
Banks

factor payments

Figure 1.3 : Two Sector Flow

Households supply factors of production viz land, labour, capital, and

entrepreneurs to the firms. Firms in return make factor payments rent, wages,
interest, and profits to the households. The flow from households to firms
represents the real flow however the flow from firms to households is money
flow as all payments are made in monetary form. The money flow from firms
to households ultimately becomes the total income (Y) of the households.
Similarly, there is a flow of goods and services from firms to households. In
return for goods and services, households make payments to the firms which
is again money flow. This continuous real and money flow gives momentum
to the economy.

Financial intermediaries like banks channelise the savings from the

households to the firms. The firms take the loans from the banks and other
financial institutions. The primary ingredient of loan creation by banks is the
savings from households. Households save their savings in the banks and
then banks lend to firms.
25
Introduction to In this circular flows of income and expenditure, there are certain leakages
Business
Environment /withdrawals and injections/additions. For example, savings by the
households represent leakages from the system. Saving is that part of income
that is not consumed. The amount of saving and the size of the circular flow
are inversely related. More the savings less will be the size of circular flow
and vice versa. On the other hand, additional spending by households from
past savings or borrowings acts as an injection or addition to the circular
flow. More the spending, bigger the size of circular flow.
II) Three-Sector Model
In the three-sector model apart from the above-mentioned model one more
sector i.e. government sector enters into the circular flow. This model is
depicted in Figure 1.4.

Government

Firms
Households

Figure 1.4 : Three Sector Model

Government affects the circular flow of income and expenditure through

monetary and fiscal policy. In our model, we will only consider the fiscal
policy effect i.e. taxation and government expenditure. Taxes both direct and
indirect paid by both households and firms act as a withdrawal from the flow
just like savings. Taxes reduce the disposal income of both households and
firms which leads to a reduction in consumption and savings. On the other
hand, government expenditure is like injection to the circular flow.
Government expenditure gives more income into the hand of households that
leads to an increase in consumption expenditure. Similarly, purchases of
goods and services by the government from firms increase the income of the
firms. Households also provide factors of production to the government and
in return receive factor payments.
III) Four-Sector Model
Let us now learn about the four-sector model of the economy. This model
includes households, firms, government, and the foreign sector.The four-
sector economy has exports as inflows/injections in the national income
whereas the imports are treated as leakages/ outflows from national income.

Let us briefly discuss the export function and import function.

26
i) Export Function Introduction to
Business and
Environment
The economic growth, economic development, and equitable distribution of
income depend upon the export levels of a country. Exports are needed for
maintaining foreign exchange reserves in an economy. Exports also play an
important role in increasing the internal trade and economic stability of a
country. The exports of a country depend upon several factors. Some are
listed as follows:

a) The prices of domestic goods in comparison to prices of similar goods in

importing countries.
b) Trade-policy and tariff policies of importing country
c) Export subsidies
d) Income elasticity for import goods in importing countries
e) Level of imports by the domestic country

Thus, while computing national income, exports is taken as an autonomous

variable and represented by X.

ii) Import Function

Imports represented by M, play an equally important role in the growth of an

economy. Imports help strengthen the global presence of a country. The
imports of a country depend upon the following factors:

a) Import prices in relation to domestic prices

b) Domestic tariffs
c) Domestic trade policy
d) Income elasticity of imports
e) Income levels
f) Export levels

When the value of exports is more than the value of imports (i.e. X > M) we
call it trade surplus. However, when the value of imports is more than the
value of exports (i.e. M > X) it is called a trade deficit and represents an
unfavourable situation for any economy. The four sector circular flow is
shown in figure 1.5.

Figure 1.5: Four Sector Flow

27
Introduction to Let us assume that Households only supply labour to the foreign sector and in
Business
Environment return, they receive foreign remittances (money sent by a person residing
abroad to their families in a domestic country). Firms make payments for
imports to the foreign sector and firms receive exports receipts. The foreign
sector provides different taxes and tariffs to the government and the
government in return formulates various schemes and policies which
facilitates trade. If the trade balance is positive (i.e,. X > M) then circular
flow increases as it increases the magnitudes of circular flows of income and
expenditure.

Activity 3

1) Visit the website of the Ministry of Statistics and Programme

Implementation and find out the value of GDP at both current and
constant prices for the last 5 years and notice the change in both the
series. Also, find out the change in the base year for the calculation of
GDP.

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

2) Read the Economic Survey of India for the year 2021-22 and make the
list of important exports and imports of India and also analyse the change
which has taken place in the composition of both exports and imports.

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

1.9 SUMMARY
The environment is a complex phenomenon. The term environment consists
of several subsets, e.g., economic environment, socio-cultural environment,
politico-legal environment, technological environment, etc. It thus represents
the totality of all kinds of environments which have an impact on business.
To a large extent, the environment is external to the firm. Business firms in
28
general have little influence on external forces. Depending upon the nature Introduction to
Business and
and composition of several subsets of the environments, the business Environment
environment varies from country to country, and may even vary in the same
country from one point of time to another. A number of problems are
involved in the identification, description, explanation and prediction of
environmental factors. The environmental factors are dynamic. It is difficult
to conceptualise and/or quantify the proportion of change as well as the
direction of change in environmental factors.

Since the environment and the economic institutional framework affect

business organisations, it is imperative on the part of the management to scan
the environment before taking any decisions. The success of any business
enterprise in a large measure, would depend upon the proper understanding
of the business environment.

Macroeconomics studies concepts like national income, nationwide

employment, aggregate demand, aggregate supply etc. It deals with the
aggregates of all quantities as opposed to microeconomics which deals with
individual quantities. There are four macroeconomic sectors, viz the
household sector, firm sector, government sector and foreign sector. The
concept of aggregate demand and aggregate supply is the total demand and
total supply of the entire economy. Further, the concept of investment
multiplier is of much importance to analyse the effect of investment on the
national income.

1.10 KEY WORDS

Environment : The totality of all factors or forces affecting business and
external to and often beyond the control or influence of individual
business enterprises. The environment comprises several subsets, e.g.,
economic environment, socio-cultural environment, politico-legal
environment, technigological environment, etc.

Internal Environment : Consists of factors existing within business

organisations and which are controllable.

External Environment: Refers to forces / factors outside an organisation

and which are by and large byond the control.

Economic Activity : Any activity undertaken with economic or financial

motive or consideration. In the business context, it is the task of adjusting
the means/resources to the needs/targets.

Decision-Making : Making a choice from a set of alternative courses of

action.

Environmental Analysis: The process through which an organisation

monitors and comprehends various environmental forces in order to identify
the opportunities and threats.
29
Introduction to
Business
1.11 SELF-ASSESSMENT QUESTIONS
Environment
1) Explain the concept and nature of business environment.
2) Distinguish between micro environment and macro environment.
3) What are the various elements of internal environment of business?
4) Explain the process of environmental analysis.
5) How environmental analysis can enhance organisational effectiveness?
Discuss in detail.

1.12 REFERENCES/ FURTHER READINGS

• N. Gregory Mankiw. Macroeconomics, Worth Publishers, 7th edition,
2010.
• Justine Paul, Business Environment: Text and Cases ; Tata McGraw –
Hill Publishing Company Ltd., New Delhi.
• Gupta C.B., Business Environment: Sultan Chand & Sons, New Delhi.
• IGNOU Study Material MS-3 Economic and Social Environment.

30
UNIT 2 ECONOMIC GROWTH AND Economic Growth
and Development
DEVELOPMENT

Objectives

After reading this unit you should be able to:

• explain the concept of economic growth and economic development;

• discuss the Harrod-Domar model, Solow model, Endogenous growth
theory and major theories of under-development;
• familiraize with national income accounting, Gross Domestic Product
(GDP), various concepts related to national income along with methods
of estimating national income; and
• discuss inflation and its effect on various aspects of the economy.

Structure

2.1 Introduction
2.2 Theories of Economic Growth
2.3 National Income
2.4 Inflation
2.5 Summary
2.6 Key Words
2.7 Self - Assessment Questions
2.8 References/ Further Readings

2.1 INTRODUCTION
Achieving a higher rate of economic growth is the objective of every nation
around the world. It is because of economic growth that production,
employment, income, saving and investment in the country increase. The
standard of living improves and the people of the country prosper. But how
can this objective be met? what are the major factors which contribute to
achieving higher rate of economic growth? The various growth models and
theories given by economists provide an answer to this problem. The
economic literature is full of many theories like classical, Marxist,
neoclassical and many others who have tried to investigate the reasons
behind underdevelopment and the possible solutions. In this unit, you will
learn about few models like Harrod-Domar, Solow and endogenous growth
theory along with some theories of underdevelopment. Harrod-Domar theory
highlights the role of saving and investment in achieving higher economic
growth, the Solow model talks about the importance of technology and
capital accumulation whereas endogenous growth theory emphasises the role
and importance of investment in human and physical capital. You will also
31
Introduction to learn about national income, various concepts related to national income and
Business
Environment various methods of estimating it. Further, you will get familiarised with the
concept of inflation and how does it impact different sections of society.

2.2 THEORIES OF ECONOMIC GROWTH

You must have heard or read at one time or another that some countries of
the world like USA, Germany, etc. are termed as developed countries. On the
other hand, countries like India, China, etc. are classified as developing. Now
you might be guessing how countries are labelled as developed, developing
or underdeveloped and why is it so that some are developed and other
underdeveloped. Well, the answer lies in the per capita income (PCY), Gross
Domestic Product (GDP) and Gross National Income (GNI). Countries are
classified into various categories of development and level of income based
on a certain level of income threshold. These thresholds are defined by
different world organisations like United Nations, World Bank, etc from time
to time.

Economic growth indicates an increase in the national income and total

output of the country. The growing GDP, Gross National Income (GNI) and
production capacity of the country are some of the indicators of economic
growth of a nation. Economic growth can be viewed as the material
wellbeing of a country. On the other hand, economic development implies an
upward trend in the real income of the country over a long period. According
to Schumpeter economic development is a change in the stationary state of
the economy. This change is erratic, spontaneous and discontinuous. It is a
movement from one equilibrium point to another. It is a steady and gradual
change that happens in long run and is a result of a general increase in the
rate of savings and population. It also implies a per capita increase in the
production of a country. Achieving a higher level of economic growth and
economic development are major planning goals of every nation. It is with a
higher level of total output that the standard of living, productive capacity
and overall efficiency of the nation increases. It is because of the increase in
GDP that employment increases and more people find jobs. With an increase
in employment level, income level improves and the problems of poverty and
deprivation can be eradicated.

Purchasing Power Parity (PPP)

Purchasing Power Parity or PPP is used to make comparisons between
economic growth and standard of living among nations. This task of
international comparison is led by World Bank through its statistical
initiative known as International Comparison Program (ICP). ICP provides
comparable price and volume measures of GDP and its expenditure
aggregates among countries and publishes PPP of the world’s economies.

PPP measures the purchasing power of the currency. It measures the total
amount of goods and services that a single unit of a currency of one country
32 can buy in another country. For example, if a pair of shoes cost Rs 3000 in
India and if the same pair of shoes cost $50 in the USA then the exchange Economic Growth
and Development
rate between the US dollar and Indian rupee is $1= Rs 60. It means $1 is
equal to Rs 60. PPP is used to convert the cost of a basket of goods and
services into common currency and in this process, the price difference is
eliminated across countries. PPP equalises the purchasing power of
currencies. It is important to discuss the PPP as data on various developed
indicators is published using the PPP approach.

Measurement of Economic Development

Economists are interested in measuring economic development because it can
help in ranking the countries and making meaningful comparisons. From
time to time attempt has been made to measure economic development with
some socio-economic indicators ranging from Social Development Index of
United Nations Research Institute on Social Development, Physical Quality
of Life Index (PQLI) of Morris D Morris to Human Development Index
(HDI). In Modern times HDI is one most widely accepted index. Let us
understand how does it work and rank countries. HDI is prepared by United
Nations Development Program (UNDP) and was developed by economist
Mahbub Ul Haq. It is a composite index made from 3 indicators measuring
key dimensions of human development. These three indicators are life
expectancy (life expectancy index), expected years of schooling and mean
years of schooling (education index) and a decent standard of living
measured by GNI per capita (PPP $) (GNI Index). The top 5 countries in the
HDI ranking of 2020 were Norway (1st), Ireland (2nd), Switzerland(3rd), Hong
Kong and Iceland (both 4th) and in the same ranking, India stood at 131 ranks
out of 189 countries.

World Bank has prepared the list of countries based on income level. World
Bank has divided countries into 4 categories namely low- income economies,
lower-middle-income economies, upper-middle-income economies and high-
income economies. The following table presents the summary of the World
Bank classification for the 2021 fiscal year.

Classification of Countries on the basis of Income

ClassificationIncome Level (Gross Countries *
of Economies National Income per
capita)
Low-income of $1,035 or less in 2019 Afghanistan, Haiti, Somalia,
Madagascar, Ethiopia
Lower middle- $1,036 and $4,045 India, Sri Lanka, Bangladesh,
income Bhutan, Myanmar, Pakistan

Upper middle- $4,046 and $12,535 China,Thailand, Cuba, Maldives,

income Tuvalu
High-income $12,536 or more USA, UK, Finland, France, New
Zealand, Germany, Norway,
Gibraltar, Oman
Source: World Bank
*The list include only major countries for more details visit World Bank website
33
Introduction to Now, we will briefly discuss major theories of economic growth namely the
Business
Environment Harrod-Domar model, Solow model, endogenous growth theory and theories
of underdevelopment.

HARROD-DOMAR MODEL OF ECONOMIC GROWTH

This model of economic growth was given by two economists namely Roy
Harrod and Evesey Domar in the early 1950s. This model highlights the role
of saving and investment in economic growth. According to this model, the
growth rate in an economy is dependent upon two factors. One is the saving-
income rate (S/Y) and the second, capital-output ratio (the amount of capital
required to produce a unit of output). The model is based on many
assumptions like no government interference in the working of the market
(Laissez-faire), full employment in the economy, closed economy, the law of
constant returns to scale, neutral technical progress, etc.

In this model, three growth rates are explained namely actual growth,
warranted growth rate and natural growth rate. The actual growth rate is
determined by the actual rate of saving and investment. It is expressed as
change in income divided by total income ( ). This growth rate is
determined by the saving-income ratio and capital-output ratio and its
relationship can be expressed in the following functional form.

or

In above equation ,

G = actual growth rate;

C = capital-output ratio;

or

I = investment and s = saving-income rate (

For example, if the saving rate of an economy is 10 % and the capital-output

ratio is 2, then the economy would grow at 5 % per annum.

Warranted Growth Rate

The warranted growth rate is also known as full capacity growth rate or
potential growth rate. If the economy is making optimum use of its resources
and working at full capacity then we can say that this is the warranted rate of
growth or Gw .

34
Natural Growth Rate Economic Growth
and Development
An economy can achieve this rate of growth with the help of natural
resources. Factors like capital equipment, technical knowledge, amount of
fertile land, minerals and forest cover, etc. determine the natural growth rate
of an economy. This is the upper limit or the ceiling beyond which we cannot
go. It is denoted by Gn.

Harrod-Domar model highlights that investment has a dual role to play. It

increases income on one hand via multiplier process and on the other hand, it
enhances the productive capacity of the country. Further, lack of saving and
deficiency of investment are major bottlenecks in the path of economic
growth. So there is a need to mobilise domestic savings or create a domestic
environment conducive for generating investment and achieving higher
economic growth.

SOLOW MODEL OF ECONOMIC GROWTH

Solow model is also known as neoclassical growth theory and was

propounded by Robert Solow of Massachusetts Institute of Technology in
1956, also awarded Nobel Prize for Economics in 1987. This model
propounds that changes in population growth rate, rate of technological
progress and saving rate bring about changes in the level of output. There are
three basic propositions of neoclassical growth theory. First, the growth of
output in the long-run steady state is determined by the rate of growth of the
labour force and the rate of growth of labour productivity. Second, the level
of per capita income (PCY) depends upon the rate of saving and investment
to GDP. Third, there will be convergence in the income levels of different
countries with certain assumptions related to labour force growth,
savings,depreciation andproductivity growth.

The major assumptions of the model are:

i) The labour force grows at a constant exogenous rate

ii) Constant returns to scale
iii) Output is a function of capital and labour and both factors are subjected
to diminishing productivity.
iv) The elasticity of substitution is equal to 1.
v) All of the saving is converted into investment i.e. no independent
investment function.
vi) Variable capital-output ratio.

Production Function

In the Solow model, the production function can be presented as

(1)

35
Introduction to Where Y = Output; K = capital ; L = Labour and F is the functional
Business
Environment relationship between output and inputs. The important property of the
production function is that it exhibits constant returns to scale. It implies that
if inputs increase by 10% then the output will also increase by 10%.

(2)

In the above equation, is some positive number and in our preceding

example the value of is 10 %. Now if you put = 1/L in equation 2, then

or = (3)

In the above equation, is output per worker and is capital per

worker. Equation 3 also states that output per worker is a function that
depends on the amount of capital per worker. The graphical representation of
the production is given in the Figure 2.1.

Figure 2.1: Production Function

The slope of the production function in Figure 2.1 shows how much extra
output per worker is produced from an extra unit of capital per worker. As
stated in the assumption that the diminishing return operates. It is because of
this reason that the production function assumes a flat shape as the amount of
capital per worker increases or k increases.

One of the major implication of neo-classical model is that there will be

conditional convergence in the level of income of various economies.

Endogenous Growth/ New Growth Theory

The central idea of endogenous growth theory is that the economic growth of
a nation is generated by the factors which are within the production process
or endogenous like technological change or increasing returns to scale rather
than exogenous factors. GNI growth is a natural consequence of long-run
equilibrium. This conclusion is in contrast to the famous belief of the neo-
classical theory. The major objective of this new growth theory is to explain
differences in the growth rate observed by developed and underdeveloped
countries. Further, the theory assumes increasing returns to scale in
production function which implies that proportionate change in output will be
36 more than proportionate change in inputs. Moreover, they have highlighted
the role of externalities and further propagated that these externalities do Economic Growth
and Development
impact the rate of return on capital investment. Externalities are the cost or
benefits that originate from either production or consumption of a good or
service. Heavy investment in human capital like providing training, imparting
skill, etc generate external economies which mitigates the negative effect of
diminishing returns, rather it leads to increasing returns to scale and a higher
level of productivity.

The simple equation explaining endogenous growth can be expressed as :

Here Y refers to output or growth and A is the constant marginal productivity

of capital i.e. K. Above type of production function is linear in nature. In the
above equation, K, not only includes physical capital alone but human capital
also. Endogenous growth theory propagates the important role of saving and
human capital investment in achieving a higher level of growth. The higher
the level of savings in the economy, the higher will be capital stock and
national income.

Similarly, this theory also explains that a higher level of the international
flow of capital widens the inequality gap between developed and
underdeveloped countries. According to theory, developing countries offer a
higher rate of returns on investment which lures the capital flow towards
these countries. But developing countries have much lower levels of
complementary investment in human capital ( investment that supplements
and support other productive factors). These countries are marred by a lower
level of investment in infrastructure, education, schooling, research and
development. So, these countries are unable to fully utilise the benefits of
international capital flows. Complementary investments create positive
externalities and when these private and social benefits are realised, the
government also contributes to efficient resource allocation. More and more
public goods (like roads, railways, etc.) are created by the government
agencies. Similarly, the government can encourage private investment in
knowledge-intensive industries like education, training, etc. which leads to
the creation of more and more human capital. These changes ultimately help
in mitigating the drawback of diminishing returns. Endogenous growth
theories suggest that government or public policy should work in the
direction of expanding the budget and expenditures on the creation of human
capital and promoting/creating a conducive environment that attracts foreign
private investment in the fields like software development, information
technology, telecommunication, etc.

Major Theories of Under-Development

In the economic literature, there are a vast number of theories related to

under-development. As discussing all of them are beyond the scope of this
unit, we present the details about major theories of underdevelopment namely
37
Introduction to vicious circle of poverty, low-level equilibrium trap, critical minimum effort,
Business
Environment big push and stages of economic growth.

The Vicious Circle of Poverty Theory: This theory is associated with Prof
Nurkse who propounded that the main reason for the backwardness of
underdeveloped countries is the vicious circle of poverty. According to Prof
Nurkse, the vicious circle of poverty is-

“ circular constellation of forces tending to act and react in such a way as to

keep a country in the state of poverty”

Figure 2.3 illustrates how this circle works from both supply and demand
side. From the supply side, low income, low rate of savings and investment,
low rate of capital formation which leads to low productivity and production.
From the demand side, low income leads to low consumption and demand for
goods and services which creates less incentive for investment and
production. Underdeveloped countries need to break this circle with the help
of entrepreneurship and the labour force.

Figure 2. 3: Vicious Circle of Poverty

Low Level of Equilibrium Trap Model: Richard Nelson (1956) gave this
theory of low level of equilibrium trap in which he highlights that
underdeveloped are trapped in a low level of income. He propounds that in
UDCs there is low per capita income. It is because of poverty that
individual's income levels are low which are the cause of low saving and
investment rate and ultimately low national income. Accordingly, a quantum
leap above minimum per capita income is required to above which people are
able to raise the level of savings and this results in a higher level of national
income and economic growth.

Critical Minimum Effort Theory: The critical minimum effort theory is

associated with economist Harvey Leibenstein. Leibenstein was of the
opinion that underdeveloped countries were entrapped in the vicious cycle of
38 poverty and to rise above this poverty trap a minimum level of investment or
critical minimum effort is needed. This minimum level of investment is of Economic Growth
and Development
paramount importance for raising per capita income and economic growth.
According to the theory in every economy there are two forces : a) income
depressing forces (or shocks) that lead to a fall in per capita income and b)
income-generating forces (or stimulants). The main feature of
underdeveloped economies is that income depressing forces are abundant and
are one of the main reasons for their underdevelopment and to overcome
these hurdles or to break the chain of underdevelopment a critical level of
investment is needed.

Theory of Big Push: Prof. Paul N. Rosenstein Rodan gave the theory of big
push in 1943. According to the theory of big push, ‘bit by bit’ investment
programme will not yield the desired result in underdeveloped countries and
they need huge and comprehensive investment package (big-push) to move
from the stage of underdevelopment towards development. Citing an example
of an aeroplane he says that an aeroplane needs some critical ground speed to
take off and become airborne. Same for an economy a big push is needed to
unshackle itself from chains of underdevelopment. He has identified three
kinds of indivisibilities intending to specify the areas where big push needs to
be applied namely indivisibilities in the production function, indivisibility of
demand and indivisibility of savings. Indivisibilities in the production
function may be due to inputs, output or processes and these lead to
increasing returns. An important form of indivisibilities is the social overhead
capital like infrastructure which are a major obstacle to economic
development and a large sum of investment is required to overcome this
obstacle. Indivisibilities in demand requires that investment be made in many
industries which could mutually support each other instead of just
concentrating on a few for the purpose of complementary demand. Lastly,
underdeveloped countries face a huge dearth of supply of savings due to low-
income levels and this leads to low investment.

Rostow’s Stages of Economic Growth: Rostow (1959) presented the 5

stages of economic growth which all countries must pass to become
developed. The 5 stages are traditional society, precondition to take off, take
off, drive to maturity and age of high mass consumption. Traditional society
is predominant agrarian and production function is primitive with no
scientific temper or perspective. In precondition to take off which is the
transitional phase, ideas begin to germinate for economic progress and better
lives for the present and future. Manufacturing began to develop along with
agriculture and the establishment of institutions for mobilising savings and
investment. Take off stage is marked by dynamic changes in society and a
substantial increase in the standard of living. Take off stage requires the rate
of investment which in the range of 5 to 10 % of GNP. Development of the
manufacturing sector and the existence of social, political and institutional
framework is another feature of the take-off stage. According to Rostow after
40 years of takeoff stage, there is a long interval. In this interval,
diversification takes place in all sectors of the economy. Multiple industries
39
Introduction to are set up and the process of industrialisation is highly sophisticated and
Business
Environment manufacturing of consumer durables picks up along with capital goods. A
large investment is taken up in infrastructure both physical and social. In the
age of high consumption, the industrial sector dominates the economy,
people have a large amount of disposable income and the urbanisation
process gain heavy momentum.

Activity 1

1) Discuss some of the features and limitations of Harrod-Domar Model of

growth.

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2) What are the various stages of economic growth as mentiond in Rostow

Theory? In your opinion, which stage Indian Economy is passing
through? Support your answer with data and figures.

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2.3 NATIONAL INCOME

Macroeconomics is the study of the economy as a whole and one of the most
important macroeconomic variables that represent the economy as a whole is
national income. In macroeconomics, the variables like aggregate
consumption, investment, employment and even price levels are determined
by the level of national income and hence, the study of national income is
important. Further, estimates of national income help in understanding and
measuring the standard of living and economic welfare of the citizens of the
country. The figures of national income are helpful in making international
comparisons about the economic status of the economy. The planning
process of the country is heavily dependent on national income as these
estimates help in shaping the future policies of the country. In nutshell,

40
national income helps us to understand the economic growth and trajectory of Economic Growth
the economy. and Development

In the context of National Income Accounting (NIA), Gross Domestic

Product (GDP) is one of the most essential components. The entire series of
national income revolves around this component. Most importantly figures of
national income are derived from the figures of GDP. So to understand
national income it is essential to understand GDP. In simple terms GDP is the
market value of all final goods and services which are produced by the
residents of a country within the domestic territory of a country in a given
period of time.

A few points about GDP needs to be understood. First, it is the market value
of final goods and services. Market value is reflected as market prices and
market prices indeed represent the willingness to pay by the consumers. So,
the value of goods and services are reflected by market prices. Second, it
includes only the value of the final goods. It means that the intermediate
goods are excluded when calculating GDP. It is because to avoid the problem
of double counting. Third, goods and services produced by the residents of
the country within the boundaries of the country are included. Fourth, it
measures the value of production which takes place within the specific time
period usually fiscal year or a quarter. GDP indeed measures total income
and total expenditure in an economy. However, they both are the same
because for an economy as a whole income must equal expenditure.

Let us take an example. In every economic transaction, there are two parties
namely buyer and seller so one person’s income is the other’s expenditure.
For example, Mehta decorator and painters were given the order to paint the
courtyard of Mr. Verma and the deal was signed off with the contract of Rs
10,000 for doing this work. In this example, Mr. Verma is a buyer of the
service and Mehta decorator and painters is the seller. The company earns Rs
10,000 and Mr. Verma spends Rs 10,000. In this example, the amount of Mr.
Verma expenditure is equal to Mehta decorator and painters income. Further,
both the expenditure and Income in the above is same i.e. Rs. 10,000.
Major concepts and measures of National Income

Gross National Product or GNP: It is the market value of all final goods and
services produced in the year alongwith net factor income from abroad (NFIA).
NFIA is the difference between factor income received (like rent, interest and profit)
from abroad and factor income paid abroad.

Net National Product or NNP = It is the market value of all final goods and
services produced by country citizens both domestically and internationally in a
given period. NNP is indeed national income that is available to the economy for

41
Introduction to consumption and investment. NNP divided by total population gives per capita
Business
Environment income.

Net Domestic Product or NDP = It refers to the economic output of the country
adjusted for depreciation (or consumption of fixed capital).

Market Price: When any measure of national income like NNP is calculated at a
market price it includes the cost of production and also various taxes/subsidies
which are imposed/provided by the government. Net Indirect tax is the difference
between indirect tax (like Goods and Services Tax or GST, Value-Added Tax or
VAT, etc) and subsidies.

is net national product at market price; is net national product at

factor cost

NNPMP and NNPFC are net national product at market price and factor cost
respectively.

Factor Price: In contrast to market price, factor price excludes the effect of Net
Indirect Tax.

Personal Income or PI: Personal income is the income which an individual or

households receive from all the sources before paying taxes. It includes income from
factor services like wages, rent and interest along with transfer payments like
pensions, social security benefits. The personal income includes transfer payment
which is not included in national income.

Disposable Income: It is income that is left with individuals after paying taxes and
other compulsory payments to the government. It is the actual amount of money that
is in the hands of the individual for undertaking consumption and other
expenditures.

42
 Economic Growth
Different Approaches of Estimating National Income and Development

There are primarily three approaches of measuring national income namely:

• Product method or value added method,

• Income method, and
• Expenditure method

Any one of the three methods can be used to estimate the national income of the
country but on the assumption that necessary data is fully available. Let us now
understand these methods in brief.

Product Method or Value Added Method

In this method, we calculate the aggregate annual value of goods and services
produced in a year. Here GDP is the sum of Gross Value Added by the entire
production units in the economy. Value added of a firm is the value of production of
the firm – the value of intermediate goods used by the firm. In simple words,

How to go about the aggregating annual value of goods and services? Does it mean
we add up the value of all goods and services produced by all the firms in an
economy?

Let us understand this with the help of an example. Suppose there are two producers
in the economy, one producing cotton and the other producing cloth. For simplicity,
we assume that the cotton producer uses only one input i.e. human labour and he
sells some part of the cotton to the cloth maker. The cloth maker does not need any
other raw materials besides cotton to produce cloth.

Let us assume that in a year the total value of cotton that the cotton producer has
produced is Rs 500. Out of this, he has sold Rs 300 worth of cotton to the cloth
maker. The cloth maker having used cotton worth Rs 300 has produced cloth worth
Rs 1000. Based on the example cited above, what is the value of total production in
the economy? If we were to simply add up the contribution of each producer then
the value of total production would be Rs 500 (value of production of cotton
producer) + Rs 1000 ( value of the output of cloth maker). The result would be total
production of Rs 1500. However, this estimate is not correct and the value of
aggregate production is not Rs 1500. The value of production which the cotton
producer has generated is indeed Rs 500 as he has not paid any amount for the use
of intermediate goods (raw material). Though the same is not true for cloth maker.
43
Introduction to The cloth maker has bought cotton worth Rs 300 for making cloth. Hence, the Rs
Business
Environment 1000 worth of cloth that he has produced is not entirely his own contribution. To
calculate the net contribution of the cloth maker, we need to subtract the value of
cotton that he has bought from the cotton producer. If we don’t do this exercise then
we commit the error of ‘double counting’ (counting the value of good more than
once). In this case, Rs 300 worth of cotton will be counted twice. One as part of total
output produced by cotton producer and second as the value of input while
producing cloth.

Therefore, the net contribution made by cloth maker is Rs 1000 - Rs 300 = 700.
Hence, the aggregate value of goods produced in this example is Rs 500 ( net
contribution by the cotton producer) + Rs 700 ( net contribution by the cloth maker )
= 1200. We can use the term value-added to denote the net contribution made by a
firm. Therefore the value added of a firm is the value of production of the firm
minus the value of intermediate goods used by the firm. If we add the gross value
added by all the firms in the economy in a year, we arrive at a measure of the value
of the aggregate amount of goods and services produced in the economy in a year.
Such an estimate is called GDP or gross value added. The value of net national
income (NNP) and gross value added or GDP can further be easily calculated by the
following steps.

= GDP at market price;

= Net domestic product at factor cost; depreciation is the regular wear and
tear of the capital also called as consumption of fixed capital;

NIT = net indirect taxes.

Income Method

In the production process, the producer makes use of factors of production

namely land, labour, capital and entrepreneur. In return for their services
rendered they receive rent, wages, interest and profit combinedly called
factor payments. Under the income method, national income is measured by
aggregating these factor incomes generated by different producing units
within the domestic territory of the country in one fiscal year.

The different components of the income method are the compensation of

employees, rent, interest, profit and mixed-income. Wages and salaries paid
44
in cash and kind and the contribution made by the employer to the social Economic Growth
and Development
security scheme of employees are the major components of compensation of
employees.

Rent is the payment that accrues from ownership of land and building.
Interest is the payment that one receives from lending his funds. Profit is
earned by an entrepreneur and it has three components corporate tax,
dividend and retained earnings. Corporate tax is the tax paid to the
government. The dividend is paid to the shareholders of the company and
some part of the profit is retained as the reserves to meet unforeseen
contingencies or for business expansion and growth is termed as retained
earnings. Income earned by self-employed persons is termed as mixed-
income.The sum of these five components gives us the value of the net
domestic product at factor cost (NDPFC).

NDPFC = Compensation of employees+ Rent + Interest+ Profit + Mixed

Income of self employed

Further adding net factor income from abroad NFIA (difference between
factor income which is received from abroad and paid abroad) gives the value
of the net national product at factor cost (national income).

NNPFC = NDPFC + NFIA

Expenditure Method
Under the expenditure method, national income is measured as the sum of all
final expenditures. Final expenditure consists of expenditure on private
consumption, gross investment incurred by both private and public sector,
government expenditure, foreign expenditure on our exports and net of our
expenditure on imports. The process of estimating national income

( from expenditure is as follow:

= GDP at the market price, C = private consumption expenditure, I =

Investment made by households and business, G = Government expenditure, X =
Exports of goods and services, M = Imports of goods and services.

NNPfc = NDPfc + Net factor income from abroad

Major Components of the Expenditure Method

i) Private consumption expenditure: It includes expenditure by the

households on both durable and non-durable goods along with different
services.

45
Introduction to ii) Investment or gross fixed capital formation : It includes expenditure
Business
Environment undertaken by both households and government for investment purposes.

iii) Government expenditure: Expenditure undertaken by the government on

the purchase of goods and services along with expenditure on building
infrastructure, payment for salaries, etc.

iv) Net export: It is the difference calculated by substracting total imports

from total exports. It represents the contribution of the foreign sector to
the GDP.

Some Precautions While Estimating National Income

Following items must be excluded while measuring national income.

• The expenditure of intermediate goods and services otherwise it leads to

the problem of double counting.
• Transfer payments like scholarships, pension, etc.
• Income earned from second-hand goods.
• Income from sales of shares, bonds, windfall gains like lotteries.

Activity 2

1) Visit the website of the National Statistical Office, Ministry of Statistics

& Programme Implementation, Government of India and analyse the
trends in GDP, GNP, depreciation and other estimates of national income
for one fiscal year.

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2.4 INFLATION
In this section, you will study the meaning of Inflation, its measurement and
how does it affect different sections and dimensions of an economy.

Definition of Inflation

Many economists have given different definitions. According to Coulborn

“Inflation can be understood as a situation whereby “too much money chases
too few goods”.

According to Crowther “A situation in which the value of money falls and

price rises is inflation”.

46
Samuelson says that “Inflation denotes a rise in the general level of prices”. Economic Growth
and Development
The above and many other definitions have one or another deficiency but
Economists are unanimous that inflation refers to a ‘persistent’ and
‘appreciable’ rise in the general price level. However, the word persistent
and appreciable are not clearly defined so there is space for ambiguity.
Whether 5%, 10% or 30% rise in price per month or per annum is
considerable or there is some other rate that is deemed to be appreciable.

The issue of inflation is of utmost importance because it has both positive

and negative consequences. A rise in prices is necessary for producers to
induce them to maintain a regular supply of goods and services in the market.
But higher prices lead to more burden on the consumer pocket. So, what an
economy needs is a moderate rate of inflation. This takes us to another
question, what is a moderate rate of inflation? The answer to this question
varies from country to country depending on the level of development. For
instance, in the case of India, a committee set up by the Reserve Bank of
India (RBI) to review the monetary system which is popularly known as
Chakravarty Committee (1985) recommended that 4 percent rate of Inflation
is desirable for India’s economic growth.

Different Methods of Measuring Inflation

There are two common methods of measuring inflation.

• Changes in Price Index Number (PIN)

• Gross National Product (GNP) deflator

Changes in Price Index Number (PIN)

The rate of inflation can be estimated by measuring the change in the price
index number. The formula for this change is:

is the price index number in the current year or the period selected for
measuring inflation and preceding year
or period.

Consumer Price Index (CPI) and Wholesale Price Index (WPI) are two
popular price indexes that are used to measure inflation. Further in India, CPI
has 3 sub-components namely CPI rural, urban and combined. Let us
understand with the example how to measure inflation using a price index
number. Let us assume that Consumer Price Index (CPI) on March 31, 2020,
was 300 and it increased to 320 on March 31, 2021, then the rate of inflation
between 2021 and 2020 will be:

47
Introduction to GNP Deflator
Business
Environment
GNP deflator is known as GNP implicit price deflator. It is called implicit as
it is not directly obtained like CPI and WPI. It can be obtained by the
following formula

Nominal GNP is the GNP at the prevailing prices and Real GNP is GNP at
constant prices of the base year.We can calculate the GNP deflator for any
year by this formula. Assume that we want to calculate India’s GNP deflator
for the year 2015-16. Let India’s nominal GNP in 2015-16 be Rs 150 crore
and her real GNP be Rs 100 crore (i.e GNP at some constant price of the base
year, say 2010-11). Now, India’s GNP deflator for 2015-16 can be estimated
as follows.

In percentage terms, it would be 1.5 ×100 = 150 %. It means that India’s

nominal GNP in 2015-16 was 150 percent higher than her real GNP in 2010-
11. Similarly, the GNP deflator can be worked out for different years. Once
the GNP deflator is worked out for different years, the rate of inflation can be
measured. The rate of inflation can be measured by the percentage change in
the GNP deflator between any two years. For example, let us assume that the
GNP deflator for the year 2018-19 is 125.4 and for the year 2019-20 is
135.6. Given the value of GNP deflators, the rate of inflation between 2018-
19 and 2019-20 will be:

Out of these two indexes, the GNP deflator is considered to be better because
of its broadest coverage.

Different Types of Inflation

The major types of Inflation (on the basis of rate or percentage change) are:

• Creeping /Moderate Inflation

• Galloping Inflation
• Hyper Inflation

Creeping /Moderate Inflation

Generally, when the rate of inflation is single-digit it is termed as the

creeping or moderate rate of inflation. This type of inflation is mostly
expected by both consumer and producer and they plan economic activities
accordingly.
48
Galloping Inflation Economic Growth
and Development
When inflation is in the double-triple digit range in a year it is termed as
galloping. This type of inflation erodes the savings of the economy and has a
disastrous effect on the fixed income group.

Hyperinflation
Under hyperinflation price rises by more than 50 % a month. During this
period paper currency loses its value drastically and the monetary authorities
print the currency of the highest possible denomination. Hyperinflation
mostly occurs in times of war and economic turmoil in the economy. A
heavy surge in prices for basic goods such as food and fuel is witnessed
during hyperinflation. World history has many examples when economies
witnessed the episode of hyperinflation. For example in Germany, the
wholesale price index increased by 100 million percent between December
1922 and November 1923. Similarly, Zimbabwe experienced hyperinflation
between 2004 and 2009.

Causes of Inflation

The main causes of inflation are clubbed under two major headings:

• Demand-Pull Inflation
• Cost-Push Inflation

Demand-Pull factors

Demand-pull inflation is due to the increase in demand or aggregate demand

(in Keynesian terms). According to Keynes, Aggregate Demand (AD)
consists of four major components i.e. consumption, investment, government
expenditure and net exports i.e. (this equation is
same as in the expenditure method of estimating national income also). If
aggregate demand outweighs the aggregate supply, prices rise. If any of the
components of AD increases then it will lead to an increase in AD, which
will further lead to a rise in prices. For example, when the government
spends excessively or there are sudden jumps in the export of the country,
prices go up.

Cost-Push Inflation

The increase in the cost of production is the major cause of cost-push

inflation. Whenever the cost of production increases, producer tends to shift
the burden on to consumers in the form of higher prices. An increase in
money wages due to pressure of trade unions, decrease in the supply of raw
material, increase in the prices of inputs like raw materials etc. are some of
the major constituents of cost-push inflation.

49
Introduction to EFFECTS OF INFLATION
Business
Environment
Inflation affects almost all the economic agents of the economy be it,
consumers, producers or government. The favourable or unfavourable effect
depends upon the rate of inflation. Let us understand how does it impact the
distribution of income and wealth, producers, wage earners, borrowers and
lenders and other segments of the economy.

Impact on income distribution

How will inflation affect income and wealth distribution depends upon the
prices of the output which the producer produces and the prices of the inputs
like labour and land. If output prices rise more than input prices, then income
will be distributed in the favour of the producer or the profit earner or the
employer. The plausible explanation is when the price of output rises, it
translates to higher revenue and profit of the producer. So the revenue-wage
gap increases and the larger share of the national income goes to the
employer/producer. The overall impact is that firm/producer who was already
rich they get even richer and the poor (especially labour) get poorer.

Fall in the value of money

Inflation erodes the purchasing power of money. It also implies that the real
wages or real income decline with a rise in prices. For example, let us
suppose that the price of good X was Rs 10 per piece and you have Rs 500 as
your money income. So if you spend your entire income on good X, you
could buy 50 pieces of good X. Now keeping other things constant,if the
price of good X rise to Rs 20 per piece the same Rs 500 can fetch you only
25 pieces of good X. So the currency denomination remains the same i.e. Rs
500 but its purchasing power reduces. You can buy fewer goods with the
same currency note or money income. So the money income of the consumer
is the same i.e Rs 500 but the real income (i.e. the amount of goods and
services which can be purchased with money income) has reduced with the
rise in prices. This type of effect is most harmful to daily wage earners,
persons with fixed income and employees working in the unorganised sector,
as they do not have any safeguard against such price rise.

Impact on borrowers and lenders

It is the borrowers which tend to gain due to inflation and lender lose. Now
suppose you are a borrower and you borrow money at the prevailing rate of
inflation. Now when you repay the same amount to your lender no doubt you
are paying the same amount with the rate of interest but the real value of
money has reduced. More specifically you pay less in terms of purchasing
power or goods and services. So you (borrower) gain and your lender losses.

Methods of controlling Inflation:

Monetary policy is one of the policy options and direct methods of

controlling inflation. Reserve Bank of India makes use of monetary policy to
50
regulate the supply of credit in the market. The various tools and methods Economic Growth
and Development
used within the monetary policy are discussed in The Indian Financial
System (in Unit-5) in detail.

Activity 3

Read the chapter on Prices and Inflation in the Economic Survey of the
current year and analyse the situation of inflation and the major steps
undertaken by the government to control the problem.

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

2.5 SUMMARY
This unit has given a detailed account of economic growth and development.
A clear understanding of the difference between economic growth and
development is of paramount importance. The different theories of growth as
discussed in the preceding sections has equipped us with ideas as to variables
like saving, investment, capital accumulation, human capital are necessary
for the economy to achieve higher levels of growth.

Similarly, the unit discussed in detail about GDP and national income and the
various methods with which the national income estimates can be calculated.
The value added method calculates national income from the production side.
Income method combines the factors of income (like wages, rent, interest and
profit) along with income received from abroad to arrive at national income
figures. The expenditure method takes the route of the expenditure side of the
economy to calculate national income.

In the last section of the unit, you have learnt about the meaning of inflation.
The different methods of measuring inflation like CPI, WPI and GNP
deflator along with various reasons for inflation and the effect of inflation on
income distribution, wage earners, fixed income groups, borrowers and
lenders.

2.6 KEY WORDS

Gross Domestic Product (GDP): Market value of all final goods and
services which are produced by the residents of a country within the
domestic territory of a country in a given period of time.
Capital-Output Ratio: The units of capital needed to produce one unit of
output.

51
Introduction to Per capita Income: It is the total income of the country divided by the total
Business
Environment population.
Production Function : It is functional relationship between output and
various inputs.

2.7 SELF- ASSESSMENT QUESTIONS

1) Highlight the major assumptions of the Harrod-Domar model of
economic growth.
2) What are the major conclusions of the Solow model of economic
growth?
3) What are the major ideas of Endogenous growth theory?
4) Differentiate between galloping and hyperinflation?
5) Explain some of the methods of estimating inflation.

2.8 REFERENCES/ FURTHER READINGS

• Dwivedi, D.N (2015). Macroeconomics : Theory and Policy, Tata
Mcgraw Hill, New Delhi.
• Thirwall. A.P. (2006). Growth and Development with Special Reference
to Developing Economies. 8th Edition, Palgrave, Macmillan, New York.
• Todaro, M.P. and Smith, S.C. (2003). Economic Development, Pearson
Eduction Limited, New Delhi.

52
UNIT 3 SOCIO-CULTURAL AND Socio-Cultural
and Politico-Legal
POLITICO-LEGAL ENVIRONMENT Environment

Objectives

After reading this unit you should be able to:

• describe the social and cultural environment;

• identify the elements of socio-cultural environment;
• analyse the recent changes in socio-cultural environment;
• describe the political and legal environment;
• identify the elements of politico-legal environment; and
• understand the recent changes in politico-legal environment.

Structure

3.1 Introduction
3.2 Social Environment
3.3 Elements of Social Environment
3.4 Cultural Environment
3.5 Elements of Cultural Environment
3.6 Political Environment
3.7 Elements of Political Environment
3.8 Legal Environment
3.9 Elements of Legal Environment
3.10 Government Framework for Promoting Business
3.11 Understanding the Legal Environment of Business
3.12 Summary
3.13 Key Words
3.14 Self- Assessment Questions
3.15 References/ Further Readings

3.1 INTRODUCTION
Every economy has certain kind of environmental surroundings within which
every organisation functions. This environment is termed as the business
environment. This environment exists for each and every organisation,
whether commercial or non-commercial. There are several factors which
constitute the business environment. These factors are social, economic,
technological, cultural, political, legal and environmental factors. This unit

53
Introduction to deals with the socio-cultural and politico-legal environment and the different
Business
Environment elements influencing these environments.

The business environment is not stagnant and keeps evolving. Therefore, it is

important to monitor the changing events in the environment on a continuous
basis. The unit discusses the impact of these environments on business and
economy along with the present changes affecting the social, cultural,
political and legal environment.

3.2 SOCIAL ENVIRONMENT

Businesses operate in a society and thus their continuous interaction with the
society is natural. Businesses require the support from the society in terms of
manpower, capital, facilities, etc. while the businesses owe to fulfill their
obligations back to the society as they have a social purpose. This in-turn
enables them fulfill their responsibility and obligations towards the society as
per their accepted levels of social commitment. This becomes an integral
part of operating the business for a businessman and thus the understanding
of the social environment of business becomes imperative.

Social environment is one of the elements of macro environment of the

business. Social environment comprises of social institutions, relationships,
beliefs and social structure of the society. In terms of business, social
environment of an organisation includes the social values of the workforce
along with the society within which the organisation functions. It consists of
all the beliefs, customs and practices followed in the society. A business
operating within the parameters of a society has to deal with the distinctive
values and customs which formulate the factors of social environment
affecting a business organisation. In case of a country like India, with diverse
cultural backgrounds, the social environment becomes more complex. The
social factors are usually influenced by family, friends, co-workers and even
the social media. Proliferation of social media influence in present day
modern life has increased the perimeter of social environment.

3.3 ELEMENTS OF SOCIAL ENVIRONMENT

Let us identify the various critical elements of social environment and the
reciprocal relationship between the business and the society.

• Social problems, prospects, social institutions and systems along with

their social values and attitudes.
• Education and culture and their impact on social groups and activities.
• Socio-economic order and corresponding role and responsibilities of the
Government.

Though the above list is suggestive, not exhaustive but it enables you to
identify the socio-cultural environment of business.
54
Let us now discuss the different elements of the social environment. Socio-Cultural
and Politico-Legal
Attitudes and Beliefs Environment

Attitudes are the perception which people have towards certain situations or
commodities. Attitudes are primarily formed on the values and beliefs of a
person. Consumer attitudes towards a product or service can influence the
demand and supply of that particular product or service. For example,
favourable attitude towards a low sugar diet has led to increased demand for
sugar free products in the market. This shows that the attitudes and beliefs of
people have an impact on the social environment.

Social Class

Each society has a certain extent of social and economic inequality. Social
inequality deals with the discrimination based on caste in a society. The caste
system in India resulted in social differentiation and has created a difference
in the number of opportunities available to people. In other words, social
class signified the social status of an individual. Consumer choices differ on
the basis of their social status. Another way of class distribution is based on
the wealth and income of the individuals and are divided into lower class,
lower middle class, upper middle class and upper class. The lower class is
considered to have the least earning and upper class is considered to have the
most earnings amongst all. These income groups often coincide with the
social status of an individual. For instance, people belonging to higher
income group usually have a higher social status and vice versa.

Lifestyle

Adopted lifestyle is another element which affects the attitude and behavior
of the people. Lifestyle is fundamentally concerned with how the people live
and spend their money. The lifestyle pattern has changed in the recent times.
People are opting for more simplified and natural ways of life. The awareness
towards sustainable practices has changed the way of life. With the pandemic
this practice has become all the more prevalent.

Preferences

Preferences are the personal taste of individuals about a product or service.

These preferences are directed by other social elements such as friends,
neighbours, family, education and income. The preferences change with time.
This is correlated with the change in the income status thereby the shift in the
lifestyle of people. If we go back few decades back then TV was considered
to be a luxury and now it is considered to be a necessity. The preferences
result in a dynamic shift for a social environment.

55
Introduction to
Business
Environment
Social Communities

Social communities include the circle of friends and co-workers. The need of
social belongingness compels an individual to adhere to practices followed
amongst the community members. In many cases people decide upon
purchasing a product based on the reviews of his/her social circle. The social
community in which the individual lives has a great impact on his/her
decisions be it the buying behavior, lifestyle status, education, etc.

Social Institutions

Social institutions refer to social structures in a society under which an

individual assumes certain roles for the fulfillment of social needs. People
under these social institutions are required to follow certain norms and
beliefs. There are five kinds of social institutions namely family, economics,
religion, education and government. They are referred to as primary
institutions which are further divided into secondary level institutions.
Family gives rise to secondary institution as marriage and divorce.
Hierarchical structure of a family affects an individual’s choice of goods and
services. Further, secondary institutions of economics are property, trading,
credit banking, etc. The secondary institutions also consider temples,
churches, mosques, etc. on the basis of religion.

Education and Culture

Education and culture is another important element of social environment.

You also would agree to the statement that the percolation of education has
gained foothold and this may be attributed to the increasingly positive
attitude towards education, especially from the rural areas. Age-old
education, made way to technical or skill based education and then to the
structured business education. All were poised to increase the employment
opportunities aiming at increased manpower utilisation arising from a
meaningful industry interaction.

Role of Government

Yet another important contributory element is the government and its role as
‘a welfare state’. It is an ‘apex social institution’ and carries much
importance in a democratic set-up where it is assumed to be maintaining
social order and harmony in the society. Business organisations and
Government play a complementary role. In pursuit of performance driven
cultures, organisations strive to bring in social cohesion. So terms like
consumerism, trade unionism, the cooperative movement, professional
management, and shareholders’ associations, etc. become the associated
keywords for the social business environment.

56
 Socio-Cultural
and Politico-Legal
Activity 1 Environment

a) Having understood business environment in the social context, you visit

a business organisation in your vicinity and identify the various social
groups active there.

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

b) Enlist various social environment factors detailing how they have

impacted your purchase decision?

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

3.4 CULTURAL ENVIRONMENT

Culture is a range of human actions which are socially transmittable. Culture
can be explained as a complex combination of morals, customs, law, art,
beliefs, knowledge and habits acquired by any individual member of a
society. Culture is embedded in the way of life. In other words, Culture is a
product of social interaction among humans and determines the human
behavior. Cultural environment is concerned with the culture within which
the organisation operates and includes the culture of its target market and the
workforce.

3.5 ELEMENTS OF CULTURAL

ENVIRONMENT
Cultural environment contains a number of important elements.

Knowledge and Beliefs

Knowledge and beliefs deal with the pre-existing concepts and philosophies
possessed by an individual about his or her surrounding reality. They consist
of myths, philosophical thoughts, abstract concepts as well as scientific facts.
It is often witnessed that people belonging to a specific culture have set
57
Introduction to beliefs about a particular thing apart from those permissible within that
Business
Environment culture and this may result in not accepting the other view point.

Religion

Religion is an important element of cultural environment. People belonging

to different religions have different religious principles, beliefs, thoughts,
customs, rituals and traditions. A business organisation should take into
consideration every aspect of religious sentiments while marketing their
products.

Language

India has a vast number of languages and dialects out of which 22 are
officially recognized languages as per the Government of India. Apart from
these officially recognized languages, there are regional languages which are
spoken within communities only. Variances in the language can be a major
concern for business organisation. Different words have different meanings
in different languages. This can be extremely crucial before deciding upon a
brand name in foreign country. Beyond words, non-verbal communications
can also create issues for an organisation. Body language such as gesture and
posture has different meanings across different cultures. A same symbol may
have different interpretation in different nations or different regions of a
country. Verbal or non-verbal language, both have an impact on the overall
cultural environment.

Ethnicity

Ethnicity refers to the fact of belonging to a particular cultural tradition. An

ethnic group’s domination in an area can influence the decisions and
strategies of the local businesses operating in that area. Such domination can
also influence the choice of trade opportunities. In case of international
markets, ethnicity plays a bigger role. For example, Indian citizens belonging
to different cultures within the country belong to a single national ethnicity
are referred to as Indians.

Evaluation of Socio-Cultural Environment

Socio-cultural elements are one of the most important factors of the business
environment which can influence the managerial decision-making process
and strategic goals of a business organisation. Business organisations do not
exist in a vacuum. Each and every firm in the industry is surrounded by an
environment. Changes in the factors of social and cultural environment can
have an effect on the commercial activities across the nations. In other words,
shifts in the social and cultural elements of the environment can lead to
fluctuations in the demand and supply of an economy. In order to survive in
the market a business organisation needs to adapt to the shifts of socio-
cultural environment.

58
The earlier concept of business was limited to profit-making. However, in Socio-Cultural
and Politico-Legal
recent times business is seen as a societal institution working for the Environment
betterment of society. Business organisations are considered to be an integral
part of the social systems. These businesses have the capacity to influence the
life styles of their consumers and the way society works.

Likewise, preferences and attitudes of the people can also influence the
business strategies. For example, rising health concerns amongst individuals
has resulted in option for a healthy diet. This has forced the organisations to
be more cautious about the quality and choice of the ingredients they use in
their products. Change in income and education level leads to fluctuations in
demand for products and service. A rise in income level led to increased
demand for high-end products. For instance, people earning more generally
prefer to buy more expensive range of FMCG products as compared to low
price brands.

Cultural dynamics also affects the functioning of the business organisations,

internally as well as externally. Culture affects many things in an
organisation such as pace of business, decision-making and negotiations,
employee management, risk-taking capacity and sales and marketing. Culture
is responsible for developing trust amongst employer and employees as well
as between organisation and its consumers. For example, in India one of the
Food and Beverages Company has to customize its menu as per the customs
and traditions of the consumers.

A prime example of effect of socio-cultural environment on business can be

seen in the promotional campaigns during festive seasons. The campaigns
show families celebrating festivals together as a part of their cultural
traditions and how the product or service fit into their traditions.

Current Scenario of Socio-Cultural Environment

Change in Fashion Trends

Fashion trends changes every few years. What might be popular ten years
ago might not be popular today. Social media influence has rapidly increased
the pace of changes in trends. Such changes lead to shift in consumer
preferences and attitudes. For instance, clothing brands has to be aware of
most recent fashion trends while launching new collection. Another example
of this can be change in advertising patterns. Television and print media were
considered to be the most popular method of promoting products in the past
decade. However, with a rise in users of smart phones and social networking
sites, advertising through social media has been a new rage in the field of
marketing (Quain, 2019).

Social Issues

Socio-cultural elements not only impact the business strategies of an

organisation but also affect the internal policies of the organisation. Raising
concern around gender issues has forced organisations to incorporate equal 59
Introduction to policies and practices for male and female employees. For instance,
Business
Environment flexibility in gender roles among husband and wife has led to creation of
policies for paternity leave alongside maternity leave. Further, awareness
about gender sensitivity has led to change in attitudes towards workplace
harassment and gender discrimination. Another instance of such cultural
changes is non-resistance towards racial discrimination at workplace (Quain,
2019).

Population

Rise in population in India has resulted in the constant need of urbanization.

About one third of the population in India lives in urban areas. India has seen
a constant rise in the number of urban population (O’Neill, 2021). Rapid
growth in urbanization strengthened the need for urban infrastructure such as
transportation, hospitals, schools, sanitation facilities and power supply. A
major concern behind the rise in urbanization is migration of population due
to industrialization. Moreover, India has major portion of working-age
population or young population. This construct has created a labour class at
cheap rates. Besides, this young population has created demands for digitized
economy. Urban working professional are more interested in digital banking
and saving options (UK Essays, 2018).

Multi-Diversity

In present times, a majority of the organisations have a mixed culture

workforce, especially in case of multinational organisations. India is a multi-
diversity nation with mixed culture race. In order to deal with people from
different cultures one must be careful about their business practices,
communication style and management style as they might vary among
different cultures. For targeting a consumer segment from other culture, an
organisation must keep aside preconceived notions and put in efforts to learn
about them (Saylor Academy, 2012).

Activity 2

The socio-cultural environment has been affecting our business. Explain how
Mc Donald’s food chain has modified its product portfolio to match the
socio-cultural environment of India.

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

60
 Socio-Cultural
and Politico-Legal
Environment
3.6 POLITICAL ENVIRONMENT
You understand that business, though by its very nature is an economic
activity, but the business managers, in order to stay effective, have to
consider the non-economic environment of the business too. In this direction,
we have understood the socio-cultural environmental component in the
previous part of this unit. Here, we would understand another important
component i.e. the politico-legal environment of business.

A political system is assumed to be having the qualitative prerequisites such

as being stable, honest, efficient and dynamic. Democracy brings in the
political participation of the citizens thereby providing them personal security
which in-turn contributes for growth of any business in a country. In a
political system the role of Government as a political institution is to
formulate social policies aimed to deliver on high social benefits at minimum
social costs. The government thus facilitates business by making decisions
and supporting the economic activity in form of health, infrastructure,
education, law and order etc. implemented on different levels like local,
regional, national or international.

The political environment comprises of many political factors which effect

the business activities at various times and impact, like the bureaucracy
levels, corruption, freedom of media and press, tariffs and related measures
of trade control, employment regulation, environmental and pollution control
laws, health and social safety laws, Competition regulation and cartelization,
Tax policy (tax rates and incentives), Trade unionism and related laws,
consumerism, e-commerce and related laws about the quality and quantity of
the product, Intellectual property law (Copyright, patents etc.). All this is
done based on the ideology of the ruling party in the government which
attains it by formulating and executing them under a set of policies and
programmes. This is attained through legislations and enactments, rules and
regulations, systems and procedures, policies and plans, statements and
announcements, directives and guidelines by the Government, which is the
essence of the politico-legal environment.

3.7 ELEMENTS OF POLITICAL

ENVIRONMENT
Let us identify the crucial elements of political environment.

Political Ideologies

Political ideologies are the mix of multifaceted ideas, philosophies and

objectives which is the foundation of the political parties. Most of the
political organisations are politically diverse due to the members of
organisation having diverse backgrounds. Political ideologies can differ due
61
Introduction to to multi-culture environment in the country. People belonging to different
Business
Environment social groups, ethnicities, communities, economic class or religion can have
different ideologies. These variations impact people to join or support
different political parties. Harmony among different political ideologies is
necessary to maintain peace and stability within a country.

Democracy

Democracy has been a fundamental part of India’s progress and growth story
and has helped in binding people from different cultural background and
regions. A democratic environment ensures equal political and legal rights to
each and every citizen of a nation. It ensures freedom of speech, expression
and opinion. Since every citizen cannot decide for himself / herself therefore,
countries practice a system of elected representatives. The elected
representatives formulate laws for a nation. These representatives are elected
by the people of the nation. Democracy also ensures a fair and independent
judiciary.

Civil Liberties

Civil liberties ensure the provision of freedom and fundamental rights to

every citizen. These include freedom to press, equality before law, personal
and social freedom and freedom from biased government policies. Countries
with high civil liberties are considered to be free and are more preferred by
companies for investments. More liberal countries ensure fair judicial trials in
case of disputes and hence are preferred by business organisations.

International Political Relations

Political relations and diplomacy with foreign nations results in more

avenues for trade and business which in turn creates multi-lateral or bilateral
trade opportunities. For example, trade pacts between USA and India have
resulted in several development opportunities for both the nations. Political
friendship among different nations creates a favourable environment for
international trade and commerce.

Political Stability

Political stability is crucial for growth and development of any economy.

Political instability can hinder the flow of foreign capital and adversely
affects foreign investment in the country. For instance, clashes between two
groups in a region can cause adverse effects on the economic activities in that
area.

Government Policy

Stable policies are better for planning corporate strategies and building-up
confidence in the industry. Policies formulated with clear directions can
support better economic development.

62
3.8 LEGAL ENVIRONMENT Socio-Cultural
and Politico-Legal
Environment
Legal environment of any country deals with rules, regulations, policies and
the law of the land as whole. These laws are made for the protection of
consumers, investors, environment and national interest. For example, there
are several organisations like SEBI, Consumer Commissions or National
Green Tribunal (NGT) in India for the enforcement of such laws. Further, the
legal environment of a country also includes taxation laws and annual
budgets.

The changes in government policies such as trade policies, industrial policies,

fiscal and monetary policies can have a great effect on the business. For
example, by increasing the limits of permissible FDIs in the retail sector has
led to the emergence of global e-commerce companies. While at the same
time, it has been seen as the threat to local vendors with increasing markets
for e-commerce.

3.9 ELEMENTS OF LEGAL ENVIRONMENT

Elements of the legal systems include the laws, rules and regulations
applicable in the country. As per Rao (2008) it includes the following:

• Common law – Law is implemented according to the situation and the

prevailing customs, traditions, culture, etc.
• Civil Law – They are the detail set of laws formulated, discussed and
passed by the parliament e.g., contract act, company law and civil codes.
• Theoretical law – These are the laws derived out of the religious laws in
the country.
• Property rights
• Intellectual property rights
• Labour laws and codes
• Fiscal and monetary policy
• Competition Law
• Foreign exchange laws – FEMA and FERA Act

We will discuss the above legal framework in the following section in detail.

Evaluation of Politico-Legal Environment

Political and legal environment plays an integral role in the economy. A

favourable politico-legal environment is crucial for growth and survival of
business. These factors govern the entry of foreign firms in the domestic
market of the country. Government and allied agencies act as a regulator of
foreign companies where government policies are considered to be
gatekeepers. Political ideologies of the ruling party are also important for
creating a favourable business environment. A pro-business ideology will
63
Introduction to lead to more opportunities for foreign investment in the country. Likewise,
Business
Environment legal environment draws the perimeter of the permissible trade and
commerce activities within the geographical boundaries of a country.

Business organisations are required to operate within the legal framework.

Due to the rapid increase in globalization and flexible FDI policies, several
laws are created to protect the interest of domestic traders in India. Business
organisations are required to have full knowledge about the trade laws, rules
and related policies. Moreover, the increasing complexity of legal
environment can cause difficulties in the business operations. Increased
concern about the environmental protection and sustainability has led to
creation of environmental protection laws. Failure of implementing these
laws will not only lead to governmental actions but will also affects the
image of the business adversely. Hence, favourable politico-legal
environment is necessary for a stable economic growth and development.
Political instability can create social unrest which in turn can hamper local
businesses in the area. For example, roadways, being blocked as protest-sites
can hamper the supply chains.

Current Scenario of Politico-Legal Environment

Boost to Manufacturing

Government has given a boost to manufacturing activities in the country

through ‘Make in India’ campaign. Under this campaign, government created
conducive environment for doing business. In order to boost manufacturing
in India, government has set up panels to fast-track investment proposals,
addressing problems in investment process and creating an investor-friendly
environment in the country. Efforts are being made to make India a
manufacturing hub and crating more employment opportunities for the locals.
In the recent times, several multinational companies have setup production
facilities in India.

Changes in Industrial Policies

Several policy changes have been made in the recent past to ease the entry of
foreign investments in the country. Department of Industrial Policy and
Promotion (DIPP) has made efforts to make policies more flexible and
simplified including infusing technology into various processes for effective
and efficient governance. For instance, application for industrial licenses has
been made online which has made it more accessible.

Business Reforms

Several reforms are being undertaken at state as well as centre level to make
significant improvements in way business operates in India. The government
has introduced various initiatives to ease doing business in India. India has
been placed at 63rd position on World Bank’s Doing Business 2020. For
instance, Government of India has increased the limits of FDIs in insurance
64 and defense sectors and thereby attracting more foreign capital in the country.
This will lead to creation of employment and overall economic development Socio-Cultural
and Politico-Legal
(“Doing Business in India”, 2020). Environment

Bank Mergers

In the past few years, government has decided to merge certain public sector
banks to reduce the number of nationalized banks and improve the quality of
governance. The number of national banks has been reduced from 27 banks
to 12 public sector banks (Singh, 2019).

Infrastructure Development

The current government has taken several steps for the modernization and
development of infrastructure in the country. The focus is not only on the
urban cities but several tier I and tier II cities have also been developed as the
part of a scheme named as ‘Smart Cities’. The government has announced to
develop 100 cities as smart cities under which many industrial corridors are
to build. Several other projects in different sectors like green energy,
transportation and real estate have been planned. These planed projects will
create future business opportunities and foreign collaborations (Yadav,
2015).

Skill Development Programmes

Indian government launched ‘Skill India’ movement in 2015 with an aim to

provide skill based education to the youth of the country. The programme
focussed at imparting vocational training with a vision to empower workforce
suitable for skill-based jobs. For example, ‘SeekhoaurKamao’ was scheme
launched for the youth of union territories of Jammu and Kashmir and
Ladakh under which they were trained according to their qualifications and
given employment opportunities in the state (NSDC, 2017). Such initiatives
were planned to reduce the dependency on white collar jobs and encourage
skill-based employment.

Activity 3

How does politico-legal environment impact the business decision making?

Explain.

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…………………………………………………………………………………

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65
Introduction to
Business
3.10 GOVERNMENT FRAMEWORK FOR
Environment PROMOTING BUSINESS
In the role of the government to support business and related economic
activity, a robust supportive mechanism is required to be provided in
promoting a sustainable institutional structure. Let us understand the selected
government supported organisational set ups.

The Ministry of Commerce and Industry

The Ministry of Commerce and Industry has the responsibility to manage and
promote the industrial and commercial activity in the country. It formulates
Industrial policy which provides with the planned framework of promoting
industrial development in sync with the economic goals of the nation. The
Niti Aayog, Ministry of Micro, Small and Medium Enterprises, Ministry of
Skill development and Entrepreneurship all contribute in the attainment of
their individual (promotional regulatory, technical and advisory) goals.

The Department for Promotion of Industry and Internal Trade (DPIIT)

The department was earlier called Department of Industrial Policy &

Promotion and was renamed as DPIIT in January, 2019.The Department
functions on matters related to Internal Trade, welfare of traders and their
employees and start-ups. The role of DPIIT is to promote/accelerate
industrial development of the country by facilitating investment in new and
upcoming technology, foreign direct investment and support balanced
development of industries.

The Department for Promotion of Industry and Internal Trade (DPIIT)

spearheads ‘the Ease of doing business’ initiative which provides a ‘carpet
welcome’ to the foreign investments to India. This involved providing time-
based and ‘single window clearances’ towards establishing business in our
country. The department also promotes Startup India Initiative and
Production Linked Incentive (PLI) Scheme.

The Department of Commerce regulates the following:

i) International Trade: Policy related matters involving various tariff and

non-tariff barriers, issues related to the WTO, their interpretation and
implementation besides the dispute settlement/redressal mechanism. This
further involves strengthening the bilateral and multilateral trade by
International Commodity Agreements.

ii) Foreign Trade (Goods & Services): tasks related to external trade and
relevant matters import and export of feature films, as well as unexposed
cine-films. This also involves establishing Agricultural Export Zone
(AEZ) and 100% Export Oriented Units (EOUs) for boosting
manufacturing and promoting external trade by suitably amending the
related policy and regulatory framework from time to time.
66
 Aimed at promoting international trade relations it attains the objective Socio-Cultural
and Politico-Legal
through bodies like Export Promotion Board, Board of Trade and Environment
International Trade Advisory Committee and Export Promotion
Councils/Export Promotion Organisations. State Trading Corporation
(STC) also facilitates the said objective of trade promotion.

iii) Special Economic Zones (SEZs): Fostering economic development with

SEZs is a relatively new way of attaining industrial as well as foreign
trade growth. This includes providing a favourable policy environment,
further comprising a conducive foreign trade policy, a supportive fiscal
regime, and an attractive investment policy, etc. This is achieved by an
organised structure and subordinate offices under this Department-

1) Directorate General of Anti-Dumping and Allied Duties (DGAD).

2) Directorate General of Foreign Trade (DGFT).
3) Directorate General of Supplies and Disposals (DGS&D).

iv) Statutory/Autonomous Bodies/Public Sector Undertakings/Other

Organisations: Agricultural & Processed Food Products Export
Development Authority (APEDA),

Coffee Board, Export Inspection Council of India (EIC), Rubber Board,

Spices Board, Tea Board, The Marine Products Export Development
Authority (MPEDA), Tobacco Board. Public Sector Undertakings
include: ECGC (Export Credit Guarantee Corporation of India Limited),
ITPO (India Trade Promotion Organisation), MMTC Limited (formerly
Minerals and Metals Trading Corporation of India Limited), PEC
Limited (formerly The Projects and Equipment Corporation of India
Limited), STC Limited (State Trading Corporation of India Ltd.), STCL
Limited (formerly Spices Trading Corporation Ltd.).

Of the many acts applicable under the Ministry of Commerce and

Industry regime, ‘Special Economic Zones Act, 2005’, carries a mention
here.

The Tariff Commission

Tariff Commission in India got created by the union of the Tariff Board,
Tariff Commission (old) and Bureau of Industrial Costs & Prices (BICP).
BICP got combined with it for better functioning with effect from 1st April,
1999.

Activity 4

You wish to start a manufacturing and distribution of edible oils and similar
FMCG products. How you can get support from the above government
bodies? Explain.

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67
Introduction to …………………………………………………………………………………
Business
Environment
…………………………………………………………………………………

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NITI AAYOG (NATIONAL INSTITUTION FOR TRANSFORMING

INDIA)

It was in 2014, that the NITI Aayog (National Institution for Transforming
India) constituted for enhancing the developmental process; nurture an
overall business enabling environment extending from the realms of Public
Sector and Government of India. This involved more coordinated role with
the state governments thereby strategically fostering good governance, best
practices, providing strategic expertise and coordination with all levels of
government (central as well as the state) for the collective attainment of
developmental goals.

Public Private Participation (PPP)

The PPP Vertical is assigned with the various activities involving the policy
formulation for ensuring that the desired objectives for timely creating the
infrastructure to promulgate the economic growth and development. Such
projects being capital intensive in nature requires regular capital infusion and
management thus the PPP becomes the choice for Construction, Operations
and Management of the infrastructure projects. For Niti Aayog, the PPP
remains evolutionary, in terms that it remains reform-oriented by suggesting
institutional, regulatory and procedural changes. By process and document
standardization, the subsequent appraisal of PPP projects becomes easy thus
resulting in higher FDI in such developmental projects.

The Ministry of Finance

It was re-organized in the year 1949 in two departments namely, the

Department of Revenue and Expenditure; and Department of Economic
Affairs. Presently, the Ministry of Finance has the following five
Departments: -

a) Department of Economic Affairs

b) Department of Expenditure
c) Department of Revenue
d) Department of Financial Services
e) Department of Investment and Public Asset Management
f) Department of Public Enterprises

The Department of Economic Affairs, assists the Central Government in

maintaining sound public finances through efficient use of the nation's
economic resources, promoting conditions that accelerate sustainable
68
economic growth through developing sound economic policies and preparing Socio-Cultural
and Politico-Legal
for future economic challenges and opportunities, and leading India’s Environment
bilateral and multilateral economic and financial engagements. It manages
the matters with its institutions like:

i) Security Printing and Minting Corporation of India Ltd.

ii) National Savings Institute.
iii) Securities and Exchange Board of India.
iv) Securities Appellate Tribunal.
v) Specified Undertaking of the Unit Trust of India/National Financial
Holding Company Ltd.
vi) National Skill Development Corporation.
vii) National Skill Development Fund/Trust.
viii) National Skill Development Agency.
ix) Delhi Mumbai Industrial Corridor Trust.
x) Forward Markets Commission

FISCAL AND MONETARY POLICY

These two policies formulate the financial framework of the nation.

Monetary and Credit Policy, is formulated by the Reserve Bank of India by
which it aims at bringing in price stability, control inflation and regulate
liquidity of the nation’s economy. This is achieved through various
instruments like managing the money supply and other policy matter changes
from time to time. Through the banking system it regulates liquidity and
interest rates and loan off takes for spurring industrial growth. With the
Monetary Policy, the RBI strikes the balance between maintaining liquidity
and credit/ loan off take by regulating between lending and borrowing rates
of interest for the commercial banks. This is achieved through careful
assessment of the business environment and then attaining the objectives
with deployment of its instruments like Bank Rate of Interest, Cash Reserve
Ratio, Statutory Liquidity Ratio, Open market Operations, Margin
Requirements, Deficit Financing and printing of currency and credit
regulation. It strives for establishing a price stability to overcome the
fluctuations which may deter the market sentiments, especially in the foreign
trade. This generates national economic growth and aids in employment
generation too.

The fiscal policy is the nation’s revenue and expenditure policy by which it
plans to strike the balance between the ever growing needs and the limited
resources availability in the country. It indicates the prioritization in the
several governmental purchases and taxes. It is done by virtue of its ‘thrifty
nature’ by promoting saving and investments in order to maximize the
demand which stands important in not only providing economic stability but
also aids in the time of recession. This is achieved through careful
assessment, budget provisioning and limiting the Govt. expenditure, Tax
69
Introduction to management (Direct, indirect and new taxes), Wage Control, Public Debt and
Business
Environment maintaining surplus budget etc.

On one side the Monetary policy acts by altering money supply and the
interest rates; the fiscal policy aims for bringing in much needed price
stability by carefully and continuously managing between the incomes and
the expenditures of the country in order to provide a conducive and stable
environment for providing economic growth, overcoming recession and
generating opportunities for employment, infrastructure building, law and
order, education, etc.

3.11 UNDERSTANDING THE LEGAL

ENVIRONMENT
For describing and analyzing the legal environment of business in India, we
present here briefly an overview of some specific socio-economic legislation.
We may list these legislations which define the legal environment of
business.

A) Company Laws

For smooth governance of the business, the company laws play a crucial role.
These become the focal laws which impact the commercial environment and
subsequent decision making. These important set of laws are governed by the
Ministry of Corporate Affairs through the Companies Act, 1956, 2013 and
other allied acts, bills and rules. The underlying object is to safeguard the
interest of various investors, stakeholders and customers. Two primary
bodies ensure its execution namely the Serious Fraud Investigation Office
(SFIO) and the Competition Commission of India (CCI). Different acts
which are constituted in this direction are “Companies Act 2013, Limited
Liability Partnership Act, 2008, Insolvency and Bankruptcy Code, 2016,
Competition Act, 2002, Partnership Act, 1932, Chartered Accountants Act,
1949, Cost and Works Accountants Act, 1959, Company Secretaries Act,
1980, and Societies Registration Act, 1860” etc. It is regulated through
National Company Law Tribunal (Tribunal or NCLT), National Financial
Reporting Authority (NFRA), and the Serious Fraud Investigation Office
(SFIO).

COMPANIES ACT 2013

Meant at improved corporate governance and increased accountability, this

act aims at improving the ‘ease of doing business’ in India. It brings forth
conceptions like one–person company, small company, dormant company
and corporate social responsibility (CSR) etc. It hosts noteworthy
modifications in the ways of doing business, including the technologically
advanced ways such as improved governance (e-governance), e-management,
timely and orderly compliance, legal enforcement, self-disclosure and related

70
norms, role of auditors, mergers and acquisitions, class action suits and Socio-Cultural
and Politico-Legal
registered valuers. Environment

a) The One Person Company: requires having minimum paid up capital

of INR 1 Lac without any legal obligation for holding Annual General
meeting (AGM).

b) Small Company (other than a public company) with a paid-up share

capital of maximum fifty lakh rupees or upto five crore rupees (if
prescribed) or its last reported profits is not more than two crore rupees
and turnover of maximum twenty crore rupees (if prescribed).

c) Minimum members for private company –maximum member heads can

be 200 now from the earlier 50.

d) All official communications, should bear the full name of contact person,
address of company’s registered office, Corporate Identity Number (CIN
No. which is a 21-digit number allotted by Government), Telephone
number, fax number, Email id, contact website (if any).

e) All companies (public/private) under the Companies Act 2013 to comply

with the Registrar of Companies (RoC) for beginning their business
operations. They require submitting the Performa with the director’s
declaration mentioning the subscribers/ promoters, with the number of
paid-up shares or agreed to be taken by them. The company also requires
verifying its registered office with the RoC.

f) The new Companies Act 2013 mandates closing the financial year by the
31stMarch. Also the eligible age for Managing Director or whole time
Director is decreased from 25 to 21 years.

g) The Indian company requires constituting a ‘CSR committee’ and 2% of

the average net profits of the last three financial years be compulsorily be
spent on the CSR activities subjected to fulfilment of certain conditions
like the minimum net worth of INR 500 cr. Or minimum annual turnover
of INR 1000 cr. or net profit of Rs. 5 crore or more.

h) Financial Statements are now defined under the act as comprising of all
companies (except one person company, small company and dormant
company) are now mandatorily required to maintain the following,
which may not include the cash flow statement), a balance sheet as at the
end of the financial year, a profit and loss account / an income and
expenditure account for the financial year, as the case may be Cash flow
statement for the financial year, a statement of changes in equity (if
applicable) etc.

B) Capital Market

Let us understand the legal framework, structure and working of the Indian
Capital markets.
71
Introduction to The Securities Contracts (Regulation Act, 1956)
Business
Environment
SCR Act 1956 is the core law which governs the activities of the Indian stock
exchanges. Besides safeguarding the investors, it aims to curb unsolicited
transactions/dealings of securities and formulate a transparent mechanism.
This act recognizes various stock exchanges’ memberships and the rules
governing thereof; lays down processes for trading activities, including that
of security contracts and listing of the securities at the bourses.

By definition, “A stock exchange has been defined as a body of individuals,

whether incorporated or not, constituted for the purpose of assisting,
regulating or controlling the business of buying, selling, or dealing in
securities”. Our country had a separate mechanism to operate the stock
exchanges across the nation but now we have nine recognised stock
exchanges namely, the Bombay Stock Exchange (BSE), Calcutta Stock
Exchange (CSE), India International Exchange (India INX), Indian
Commodity Exchange Limited, Metropolitan Stock Exchange of India Ltd.,
Multi Commodity Exchange of India (MCX), National Commodity &
Derivatives Exchange Ltd., National Stock Exchange Ltd. (NSE) and NSE
IFSC Ltd.

Securities and Exchange Board of India Act, 1992

Enacted on 4thApril, 1992, the SEBI Act aims developing the securities
market in transparent and disciplined manner for providing investor
protection. It attains for providing fairness in dealings, high governance and
institutionalization of standard business practices aimed at fostering
efficiencies by an integrated system offering the services at genuine costs
thereby building trust in investors and issuers, both; flexible to continuously
match the emerging requirements.

SEBI is a statutory regulatory body established under this act. The SEBI
board comprises of the chairman, two members of finance and law
background nominated by the Central Government, one member from the
RBI, and two more members appointed by the Government of India. They
ensure the investors security in various ways. Cumulatively, the SEBI
pursues the following functions:

a) Manage the stock exchanges’ and security markets’ business operations.

b) Registering and supervising various capital market entities like stock

brokers, sub-brokers, share transfer agents, bankers to public issues,
trustee of trust deeds, registrars to public issues, merchant bankers,
underwriters, portfolio managers, investment advisers and similar
intermediaries or self-regulatory organisations having roles in the capital
markets. This also includes recording and managing the combined
investment schemes like the mutual funds.

72
c) Curbing prohibitive, fraudulent, unfair and unethical trade practices by Socio-Cultural
and Politico-Legal
promoting investors’ education, training and awareness initiatives of Environment
intermediaries and customers.

d) Prohibiting ‘insider trading’. It also regulates the acquisition of shares,

mergers and takeovers.

e) Periodic audits of the bourses and related intermediaries, seeking

information, inspections, enquiry matters etc. The board may levy
underlying fee or similar charge for it. Besides, the board carries
research for the above purposes to coordinate and regulate the control
over the activities performed.

Over-the-Counter Exchange of India (OTCEI)

OTCEI was established in 1990 (started functioning in 1992) as an electronic

stock exchange without a proper trading floor. The Exchange was established
with an objective of supporting enterprising promoters for securing cost
effective project finance besides offering its investors with transparent
transaction systems. It went further in the capital markets by providing
technologically enabled mechanisms like screen-based nationwide trading,
market making and scrip-less trading. The OTCEI performs the following
functions:

i) Extend services to small companies for generating cost effective funds

from the capital market;

ii) Provide easy access for the small investors to the capital market. Also,
facilitating investors’ by boosting their confidence;

iii) Smooth, transparent investor grievance redressal mechanism even to the

far geographical areas; and providing much required liquidity.

Activity 5

Differentiate between a traditional stock exchange like BSE and OTCEI?

Cite how OTCEI has its advantages?

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C) Foreign Exchange Management Act (FEMA)

Under the guidance from the central government which articulates the
foreign trade policy, the central bank i.e. the Reserve bank of India carries the
responsibility of implementing it by deploying the foreign exchange control
73
Introduction to act, known as “Foreign Exchange Regulation Act 1947”. This act stood
Business
Environment updated in the year 1974 by FERA. Thereafter in 1991, the globalization saw
the requirement of newer policy measures and thus FERA made way for the
Foreign Exchange Management Act (FEMA), 1999. It carries significance in
the view point of foreign trade and foreign exchange. It is applicable on any
business entity involving an Indian resident. Significant features of FEMA
are enlisted below:

i) Limitations concerning assets owned by the non-residents and

transactions pertaining to bringing in and taking out of the currency and
precious metals stood abolished. Limitation pertaining to the acquisitions
of immovable property and its holding etc. in India also has been done
away with.

ii) Hospitality to non-residents on Indian visits stood allowed. On similar

lines, the Indian residents visiting outside India for related activities
stood allowed too.

iii) Lowered restrictions for holding the immovable property outside India.

iv) Cases pertaining to seeking funds, deposits or loans in India from the
Indian residents stand simplified. Also, foreign nationals need not seek
approval for taking up employment in India; appointment of people as
agents, advisors on technical/ management profiles relaxed. The new act
encourages setting up of branch offices/ liaison offices encouraged and
foreign travel permissions have been relaxed.

This act aims at consolidating and amending the legal forex related
impediments to promote international business and external trade besides
regulating the Indian forex market.

Activity 6

Study the recent cases of Reliance Infrastructure, Flipkart and Naresh Goyal
of Jet airways on the topic and share your views on each.

…………………………………………………………………………………

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D) The Sick Industrial Companies (Special Provisions) Act 1985,

(SICA, 1985)

The rapid industrialization clubbed with the multinational corporations

influencing the business environments in India, there was a growing need for
institutionalizing an act to govern the menace of growing industrial sickness.
74
On one hand the government puts efforts to promote the industrial setups and Socio-Cultural
and Politico-Legal
on the contrary when these setups are graded ‘sick’ it causes multiple damage Environment
in terms of employment, production loss, locking of funds etc. So reviving
these companies to salvage and monetise the assets becomes important. Thus,
the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) was
legislated for appropriate recognition of sick (and potentially sick)
companies. In the same direction the SICA proposed the constitution of the
Board for Industrial and Financial Reconstruction (BIFR) for identifying the
industrial sickness reason, its extent and putting forward remedial measures
to limit the sickness. Besides it aims to contain this sickness and take
measures to revive these industrial units. From 1st December’ 2016, the SICA
stood repealed by the Sick Industrial Companies (Special Provisions) Repeal
Act, 2003 (“Repeal Act”), thereby diluting the BIFR and its constituent/
related bodies.

SICA and its Repeal

Broadly, the functioning of BIFR and AAIFR (Appellate Authority for

Industrial and Financial Reconstruction) was not only much time consuming
but stood uncertain too. It was therefore decided to solve the ambiguities and
single entity be formed to handle and dispose all such company related
matters.

Thus, the National Company Law Tribunal (NCLT) and the National
Company Law Appellate Tribunal (NCLAT) were formed under the
guidelines of the Companies Act, 2013 (Companies Act). The NCLT works
on the company management issues and it got further strengthened by the
Insolvency and Bankruptcy Code, 2016 (Bankruptcy Code) thus obsoleting
the BIFR and AAIFR besides the pending proceedings only.

SICA has the following objectives:

i) identification and timely perusal of sick and potentially sick business

entities;
ii) initiation of the ‘Redressal mechanism’ for fast resolvance, either
preventive or remedial process by the expert panel;
iii) accelerate the desired corrective actions;
iv) apprehend, review and coordinate for future scope.

With the increasing complexities in the politico-legal business environments,

SICA became obsolete in combating corporate sickness.

THE INSOLVENCY AND BANKRUPTCY BOARD OF INDIA

The board, established on 1st October, 2016 under the Insolvency and
Bankruptcy Code, 2016 (Code), is one of the important pillars in the
corporate business system which relates to the various laws pertaining to re-
organisation/ restructuring, insolvency of the company and resolution
pertaining to corporate board and stakeholders, partnership firms on 75
Introduction to scheduled timelines. It aims at asset maximization (both in quality and
Business
Environment quantity), encouraging entrepreneurship, leveraging assets, etc.

Being a one of its kind entity, it strives to aim at business governance by

enhancing its processes. It oversees the Insolvency Professionals, Insolvency
Professional Agencies, Insolvency Professional Entities and Information
Utilities by regularly administers the processes pertaining to corporate
insolvency resolution, corporate liquidation, individual insolvency resolution
and individual bankruptcy. It has recently been tasked to promote and
manage corporate insolvencies.

The function of the Chapter XIX (sections 253 to 269) in Companies Act,
2013, particularly pertains to the revitalization of the sick units. In the
initiatives towards ‘Ease of Doing Business’ 27 Sections have been amended
in the Companies (Amendment) Act, 2017including redefining the Associate
Company by bringing in the Joint venture perspective. The voting powers of
subsidiary company was also changed. Disclosures by the companies at the
time of prospectus to SEBI were added to. Other modifications involved
loans, audits and qualifications and powers of the directors.

Insolvency and Bankruptcy Code, 2016

The competitive business environments, particularly resulting from the

evolving technologies and increasing competition have served to be an
enabler for new businesses but on the other hand, the weaker ones
increasingly demonstrated tendencies towards sickness thus seeking
amendments in repealing the SICA Repeal Act. This was executed by
substituting the section 4, sub-clause (b), the following sub-clause shall be
substituted, namely—

“(b) On such date as may be notified by the Central Government in this

behalf, any appeal preferred to the Appellate Authority or any reference
made or inquiry pending to or before the Board or any proceeding of
whatever nature pending before the Appellate Authority or the Board under
the Sick Industrial Companies (Special Provisions) Act, 1985 (1 of 1986)
shall stand abated:

Provided that a company in respect of which such appeal or reference or

inquiry stands abated under this clause may make reference to the National
Company Law Tribunal under the Insolvency and Bankruptcy Code, 2016
within one hundred and eighty days from the commencement of the
Insolvency and Bankruptcy Code, 2016 in accordance with the provisions of
the Insolvency and Bankruptcy Code, 2016:

Provided further that no fees shall be payable for making such reference
under Insolvency and Bankruptcy Code, 2016 by a company whose appeal or
reference or inquiry stands abated under this clause.

The provisions of the Code dealing with amendment to the SICA Repeal Act
76 came into force from November 1, 2016; however, the Ministry has
appointed December 1, 2016 as a date on which the provisions of the SICA Socio-Cultural
and Politico-Legal
Repeal Act shall come into force. A question may arise as to which date shall Environment
be considered i.e. November 1, 2016 or December 1, 2016. On careful
reading, one may note that clause (b) of section 4 states as follows:

The Central Government, vide notification dated November 25, 2016 has
notified the provisions of the SICA Repeal Act. Therefore, any reference
made to BIFR, any inquiry pending before BIFR, any appeal preferred to
AAIFR, or any proceedings pending before BIFR/AAIFR shall automatically
stand abated w.e.f. December 1, 2016.”

Defining a ‘Sick Company’

The sick company thus is defined as “Where on a demand by the secured

creditors of a company representing fifty per cent or more of its outstanding
amount of debt, the company has failed to pay the debt within a period of
thirty days of the service of the notice of demand or to secure or compound it
to the reasonable satisfaction of the creditors, any secured creditor may file
an application to the Tribunal in the prescribed manner enclosing relevant
evidence for such default, non-repayment or failure to offer security or
compound it, for a determination that the company be declared as a sick
company”.

E) Monopolies and Restrictive Trade Practices (MRTP) Act 1969

(MRTP ACT)

The MRTP act has its roots arising out of the Directive Principles of State
Policy embodied in the Constitution of India. Article 39(b) and (c) which
says to ensure:

i) “that the ownership and control and material resources of the community
are so distributed as best to sub serve the common good, and

ii) that the operation of the economic system does not result in the
concentration of wealth and means of production to the common
detriment”.

Monopolies generally benefit a few but harm many as they tend restricting
the competition mainly controlling the prices of commodities in the market
thereby resulting manipulation by a few.

The MRTP (Amendment) Act, 1991, has omitted provisions regarding the
Central Government’s permission for substantial expansion, establishment of
a new undertakings, mergers, take-over, etc. Establishments, howsoever big
or small, are now free to expand, or establish new undertakings, or effect
mergers.

Monopolistic Trade Practices

“Any trade practice which leads or is likely to lead to any of the following
effects is regarded as a monopolistic trade practice:
77
Introduction to i) Unreasonably high price;
Business
Environment ii) Unreasonably high cost of the production of goods or the provision of
services;
iii) Unreasonably high profits;
iv) Prevention or reduction of competition;
v) Limited technical development;
vi) Limited capital investment; and
vii) Deterioration in the quality of goods”

Restrictive Trade Practices

The term restrictive trade practice is defined t mean a trade practice which
has or may have the effect of preventing, distorting or restricting competition
in any manner and in particular if it:

i) tends to obstruct the follow of capital or resources into the stream of

production; or

ii) tends to bring about manipulation of prices or conditions of delivery or

to affect the flow of supplies in the market relating to goods or services
in such manner as to impose on the consumers unjustified costs or
restrictions.

Every agreement falling within the one or more of the following categories is
deemed to be an agreement relating to restrictive trade practices and is
subject to registration under the Act:

• Refusal to deal and/ or Boycott

• Tie-up sales and Exclusive dealing and/or Discriminatory dealings or
Territorial restriction/restrictions or withholding of output or supply
• Concert in prices and terms and conditions of purchase or sale
• Resale price maintenance and controlling manufacturing process
• Agreement having the effect of eliminating competition/competitors etc.

Unfair Trade Practices

They have been defined as per the Act “to mean a trade practice which for
the purpose of promoting sales, use or supply of any goods or for the
provision of any services, adopts any unfair method or deceptive practice,
including: i) bargain sale, ii) bait and switch selling, iii) offering gift or prizes
in promotional contests, and not providing them etc”.

F) Consumer Protection Act, 1986

Our country has been a large market and has attracted traders from the
business and commercial perspective. Owing to the large geographical spread
and low level of education amongst the people, the fraudulent practices were
witnessed and in order to curb them many legislations were enforced like the
78
Sale of Goods Act, 1930; Essential Commodities Act, 1955; the Prevention Socio-Cultural
and Politico-Legal
of Food Adulteration Act, 1954; Prevention of Black Marketing and Environment
Maintenance of Supplies of Essential Commodities Act, 1980; Standards of
Weights and Measures Act, 1956; Agricultural Products Grading and
Marketing Act (AGMARK),1937; Indian Standards Institution Certification
Act, 1952; MRTP Act, 1969, etc.

MRTP Act though was able to put a check on the rapidly increasing
consumer fraudulent practices the need for an inclusive consumer protection
legislation was much required, thus making way for the Consumer Protection
Act, 1986 for providing fast and cheap redressal to consumer grievances.

The Act recognizes the following six rights of consumers namely:

1) “Right to safety, i.e., the right to be protected against the marketing of

goods and services which are hazardous to life and property.

2) Right to be informed, i.e., to be informed about the quality, quantity,

potency, purity, standard and price of goods or services, as the case may
be, so as to protect the consumer against unfair trade practices.

3) Right to choose, i.e., the right of access to a verity of goods and services
at competitive prices. In case of monopolies, say railways, telephones,
etc., It means right to be assured of satisfactory quality and service at a
fair price.

4) Right to be heart, i.e., the consumers; interests will receive due

consideration at appropriate forums. It also includes the right to be
represented in various forums formed to consider consumers’ welfare.

5) Right to seek redressal, i.e., the right to seek redressal giant unfair
practices or restrictive trade practices or unscrupulous exploitation of
consumers.

6) Right to consume education, i.e., the right to acquire the knowledge and
skill to be an informed consumer.”

G) Competition Commission of India

The informal activity of regulating the market rivalry by business houses is

traditional however it surfaced in the year 2002 when the government
recognised the need to regulate this market competition and thus the
Monopolies and Restrictive Trade Practices Act of 1969 was repealed
thereby making way for the Competition Act of 2002. This act was
subsequently amended in 2007 and 2009. The act proposes for a legitimate
framework be articulated and practiced in the competition policies (thereby
curbing the anti-competitive practices with punitive action). CCI was formed
under this Act which makes way for providing an environmental culture
imbibed with free, fair and healthy market competition, clubbed with trade
freedom and customer and societal orientation. This forms the three structural
79
Introduction to pillars to deter the unhealthy competition namely, anti-competitive
Business
Environment agreements, their combination meanings and abuse of dominance. The
commission stands empowered to levy penalty on the offenders amounting
“up to 10 per cent of the average turnover of the company” during the last
three financial years upon all offending enterprises and/or alleged
individuals. Further, the entities found involved in cartelization by the
Commission can be penalized for the higher amount of ‘up to three times of
the profit’ for the found period, or ten per cent of the turnover for the period
in the agreement.

H) The Environment Protection Act, 1986

The Indian Constitution mentions Indian citizens compassionately protecting

and improving the natural environment including forests, lakes, rivers and
wild life. In this direction, the Environment Protection Act, 1986, envisaged
with two complementing acts namely the Water (Prevention and Control of
Pollution) Act,1974, and Air (Prevention and Control of Pollution) Act,
1981, have an objective to lay down a framework for environmental
protection and its subsequent preservation. The components of the natural
environment comprise of water, air and land besides their interactive
relationships with humans and other living elements and the ecosystem. This
act enables the Central Government with certain powers to protect and
improve the environmental quality by curbing and abating the environmental
pollution. This involves constituting and delegate authoritative office to
achieve the abovementioned objectives.

I) A Few Other Legislations

We have understood by now that the legally structured environment stands

robust enough and we have gone through certain laws and enactments
influencing the said environment. Besides them, there are certain more
legislations which impact the Indian business environment in various other
conditional circumstances:

1) The Essential Commodities (Amendment) Act, 2020. Encapsulates tough

penal action for the alleged entities or people. The act proposes stringent
legal framework for antisocial elements like hoarders, profiteers,
smugglers and black-marketers.

2) The Trade Marks Act, 1999.

3) The Patents (Amendment) Act, 2005.
4) The Urban Land (Ceiling and Regulation) Act, 1976.

Activity 7

1) Study the case of NCLT- Tata Sons Vs Cyrus Mistry. Share your views.

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80
 ……………………………………………………………………………. Socio-Cultural
and Politico-Legal
……………………………………………………………………………. Environment

…………………………………………………………………………….

2) Posco, a steel business conglomerate, had plans to enter India in 2005

and had a MoU to establish a steel plant in Odisha. The investments were
in tune of USD 5 Billion but it faced several issues in this regard.
Mention the point wise details of what went wrong with Posco deciding
to abandon the business there in 2017.

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

3.12 SUMMARY
Socio-cultural environment consists of social and cultural elements affecting
the growth and development of an economy. They include knowledge,
beliefs, values, morals, behavior, attitudes, religion, ethnicity and language.
Politico-legal environment is a combination of political environment and
legal environment. It consists of laws, governments, statutory bodies,
judiciary, executive council and legislature. Politico-legal environment
changes with each political development in the country. Sometimes, legal
reforms are based on the changes in the ideologies of the ruling government.
These elements can lead to either threat or opportunities for a business
organisation. Any organisation desiring to operate in a country need to
undertake socio-cultural as well as politico-legal elements into consideration
before planning a strategy.

The Ministry of Commerce and Industry promulgates the policy support to

the businesses besides playing a pivotal role in ‘ease of doing business’
initiatives. Other legal and policy support extended by law enactments like
the Competition Commission of India, SICA, Consumer Protection Act,
Environment Protection Act bolsters the business functions in other
perspectives arising from time to time.

3.13 KEY WORDS

Expansion: The government can both provide business house, the
opportunity to expand as well as restrict their expansion activities. Earlier,
through the MRTP Act the government restricted the expansion of big
houses, besides which various restrictions were imposed on increasing
production capacity or launching new variants.

81
Introduction to Foreign Direct Investment (FDI): FDI is an investment made by a firm or
Business
Environment individual in one country into business interests located in another country.

Incentives: The government also regulates the industry by providing

incentives in the key thrust areas. For instance, it gives tax breaks if an
industrial unit is established in a backward area. It also grants subsidies under
various schemes to the small scale sector.

Legal Role: The Parliament is the law making authority and it is the council
of ministers that presents the proposed law on the table of parliament.

A Special Economic Zone (SEZ) is a demarcated area which carries out

activities to promote export by granting subsidies and tax relaxations on
exports, import licenses and less import duty for exporters, and easy
financing through banks.

3.14 SELF-ASSESSMENT QUESTIONS

1) What are the important elements of socio-cultural environment? Explain.

2) How politico-legal environment does impact various businesses?

Discuss.

3) Discuss how the government regulates business.

4) Share your views on the MRTP Act? Enlist the various amendments
being made in the said act.

5) Explain the objective for the formation of SEBI by the government of

India.

6) Share your views on the statement “The best protection to consumer is

the full and fair play of market forces”.

3.15 REFERENCES/ FURTHER READINGS

• Bedi Suresh, Business Environment, Excel Books, 2006.
• Mishra, Puri, Economic Environment of Business, Himalaya Publication
House, 2006.
• Mittal Vivek, Business Environment, Excel Books, 2007.
• 8 Critical Elements of Socio Cultural Environment. Commerce Mates.
(2020, September 13).
• https://commercemates.com/elements-socio-cultural-environment/.
• Cherunilam, F. (2016). Business Environment (25th ed.). Himalaya
Publishing House.
• Doing Business in India: Advantages and Disadvantages, Wolters Kluwer.
(2020, March 12).
82
• https://www.wolterskluwer.com/en/expert-insights/doing-business-in- Socio-Cultural
and Politico-Legal
india. Environment

• Explain the critical elements of the Politico-Legal environment of

business. Owlgen. (2020, November 24).
• https://www.owlgen.in/explain-the-critical-elements-of-the-politico-legal-
environment-of-business/.
• Farooq, U. (2018, March 21). How Social Factors Affect Business
Environment. Marketing Tutor.
• https://www.marketingtutor.net/how-social-factors-affect-business-
environment/.
• Kumar, V. (2019, June 5). Socio-cultural Environment: Factors of Socio-
cultural Environment.
• Roarwap.https://www.roarwap.com/business-environment/sociocultural-
environment/.
• NSDC. (2017). Seekhoaur Kamao. National Skill Development
Corporation (NSDC).
• https://nsdcindia.org/seekhoaurkamao.
• O’Neill, A. (2021, July 1). India – Urbanization 2020. Statista.
• https://www.statista.com/statistics/271312/urbanization-in-india/.
• Quain, S. (2019, February 14). The Effects of Socio-Culture on Business.
Small Business – Chron.com. https://smallbusiness.chron.com/effects-
socioculture-business-10602.html.
• Rao, P.S. (2008). International Business environment. In International
Business Environment (2nd ed., pp. 34-85). Essay, Himalaya Publishing
House.
• Saylor Academy, (2012). Understanding How Culture Impacts Local
Business Practices.
• https://saylordortog.github.io/text_international-business/s07-03-
understanding-how-culture-impa.html.
• Sharma, M.K., & Singh, K. (2015). Impact of Changing Socio-Economic
Environment on Business in India. International Journal of Research in
Business Studies and Management, 2(4), 21-28.
• Singh, S.G. (2019, December 31). Year in Review: 12 policy decisions
that affected Indian economy in 2019. Business Standard.
• IGNOU Study Material MS-3 Economic and Social Environment.

83
Introduction to
Business UNIT 4 BUSINESS ETHICS AND
Environment
CORPORATE SOCIAL
RESPONSIBILITY (CSR)

Objectives

After reading this unit you should be able to:

• define the concept of Business Ethics;

• explain the need for Business Ethics;
• define Corporate Social Responsibility;
• discuss the benefits and drivers of Corporate Social Responsibility
(CSR); and
• identify CSR initiatives by the companies.

Structure

4.1 Introduction
4.2 Business Ethics
4.3 Sources of Ethics
4.4 Importance of Business Ethics
4.5 Ethical Issues in Business
4.6 Corporate Governance and Corporate Sustainability
4.7 Corporate Social Responsibility (CSR)
4.8 Benefits of CSR
4.9 Drivers of CSR
4.10 CSR Initiatives in Indian Companies
4.11 Summary
4.12 Key Words
4.13 Self-Assessment Questions
4.14 References/ Further Readings

4.1 INTRODUCTION
For organisations while ensuring growth is important, ensuring that it takes
place in an ethical, just and inclusive manner is even more important. They
have to also ensure that the conduct of business activities conform to the
existing norms of accepted behavior and are run in a socially responsible
manner. Corporate governance plays an important role in the way businesses
are directed and controlled.

84
This unit focuses on the significance of business ethics and corporate Business Ethics and
Corporate Social
governance in business. It discusses the concept and benefits of Corporate Responsibility (CSR)
Social Responsibility (CSR) and some of the CSR initiatives by the
companies.

4.2 BUSINESS ETHICS

Business ethics are a kind of applied ethics. It is the application of moral or
ethical norms to business. The term ethics has its origin from the Greek word
‘ethos’, which means character or custom- the distinguishing character,
sentiment, moral nature, or guiding beliefs of a person, group, or institution.
Ethics are a set of principles or standards of human conduct that govern the
behaviour of individuals or organisations.

Ethics can be defined as the discipline dealing with moral duties and
obligations, and explanation regarding what is good or not good for others and
for us. Ethics is the study of moral decisions that are made by us in the course
of performance of our duties. Ethics is the study of characteristics of morals
and it also deals with moral choices that are made in relationship with others.
Business ethics comprises the principles and standards that guide behaviour
in the conduct of business. Businesses must balance their desire to maximize
profits against needs of its stakeholders. Maintaining this balance often
requires trade-offs. To address these unique aspects of businesses, rules,
articulated and implicit, are developed to guide the businesses to earn profits
without harming individuals or society as a whole.

Difference between Ethics and Law

While law is obligatory and violation of law attracts penalties from the justice
system, ethics are more voluntary in nature. However, not acting ethically
might lead to violation of laws, as most laws are in one way or the other a
codification of ethics.

Business ethics can be said to begin where the law ends. Business ethics is
primarily concerned with those issues not covered by the law, or where there
is no definite consensus on whether something is right or wrong. Business
ethics is about the grey areas of business, where values are in conflict. In such
scenarios,there might not be a definitive ‘right answer’.

4.3 SOURCES OF ETHICS

1) Genetically imbibed: Traits like cooperation and selflessness stand
centric to the ethical system and it has been witnessed to be carried from
one generation to the other. Schooling focuses on ethics to be core of the
child development. This is complemented with the learning from the
parents and the society.

2) Religion: The acceptance of religion as ‘law’ has its roots before the
onset of the legal system. Psychologically, this belief or faith in the 85
Introduction to religion which makes people comply to the imposed restrictions to
Business
Environment accept any unsolicited behaviour in the society.

3) Culture: Culture also drives ethics. Customs, societal norms, traditions

and standards get passed on to next generations. Culture varies from one
religion to the other but the ethical essence doesn’t differ much.
Unethical practices are not supported by the culture irrespective of the
wide geographical differences.

4) Philosophical System: It is culturally initiated to affect ethical conduct

of a person or society. There have been many thinking personalities in
India who have postulated their experiences for actions into the society.
Mahatma Gandhi, Swami Vivekanand, Subhash Chandra Bose, Raja
Ram Mohan Roy, Bhagat Singh and Swami Dayanand Saraswati had
varied philosophical perspectives which modulated to form and govern
the ethical conduct of people from inspiration and learning.

5) The Legal System: It has been rightly said that “Laws represent a rough
approximation of a society's ethical standards”. The prevailing societal
evils like hoarding of essential commodities, exorbitant charging,
concealing facts, deceiving, falsified statements, etc. amount to unethical
behaviour and need to be curbed by necessary formulation, amendment
and implementation of a stringent legal framework.

6) Code of Conduct: The society plays a crucial role in framing the code of
conduct for ethics. The workplace ethics are based on common beliefs
and are broader in nature. To further enhance them, the company
formulates a framework of operating policies which direct the decision
making from the ethical perspective. This framework indicates the
ethical decision making in matters pertaining, but not limited to,
customer complaint handling, stakeholders, employee and vendor hiring,
etc. Besides the organisational level, ethics are framed for a particular
industry level also irrespective of the number of companies being served
by that industry. For example, the advertising vertical encompasses
extending services to various companies and this vertical has formulated
‘Indian Association of Advertising Agencies’ to develop an ethical code
of conduct for advertising agencies, firms etc. which is to be followed by
the concerned professional and industry associations.

4.4 IMPORTANCE OF BUSINESS ETHICS

Now, let us understand why Corporate Ethics matter to business. Ethics
matter because ethical conduct is the right conduct. However, in the absence of a
time-culture, and context-neutral definition of ‘right’, it is very difficult to
develop a code of conduct on this basis alone. It basically says that
businesses avoid many risks and gain reputation by acting in an ethical
manner.

86
A good ethics process, operationalised in such a way that all decision making Business Ethics and
Corporate Social
procedures and structures support it on a day-to-day basis, will give an Responsibility (CSR)
organisation the best chance possible for finding out potential problems early
so that they can be dealt with before they become a disaster. There are also
market advantages to be gained from an ethical reputation.

Ways in which Ethics are Important -

Major scandals such as WorldCom, Enron, Lehman Brothers etc., in the US

and Satyam in India tell us why ethical business practices are becoming
increasingly important. There are several reasons why ethics are important to
business:

• To understand reasons behind increasing influence of corporates in

society.
• To ensure that no harm is done to society.
• To meet ethical expectations more effectively.
• To enable companies to identify employee and customer concerns at an
early stage.
• To improve the quality of a firm’s relationship with its key stakeholders.

The government is interested in ensuring ethical business practices to ensure a

basic level of integrity in the market place. This promotes international
competitiveness of the economy and improves a country’s image concerning ease
of doing business.

Even domestically, predictable levels of ethical behaviour ensures that costs of

business such as transaction costs, hedging and insurance etc., are kept to a
minimum.

Unethical behaviour imposes costs on the government and taxpayers. Bad

behaviour by a few impacts all businesses and might also have an adverse impact
on the country’s international competitiveness.

Ethics can help improve decision making by providing managers with the
appropriate knowledge and tools that allow them to correctly identify,
diagnose, analyse, and provide solutions to the ethical problems and
dilemmas they are confronted with.

Ethics help in analysing the reasons behind this, and the ways in which such
problems might be dealt with by managers, and regulators in improving business
ethics.

Business ethics can provide us with the ability to assess the benefits and
problems associated with different ways of managing ethics in
organisations.

Business ethics also equips us with knowledge that goes beyond the
traditional boundaries of business studies.
87
Introduction to Activity 1
Business
Environment
Illustrate a business case in which ethical practices have created a strong
public image for the corporate.

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

4.5 ETHICAL ISSUES IN BUSINESS

You have understood that business has various motives. Some of the motives
are: wealth motive, profit motive, societal benefit and overall benefit of
shareholders and stakeholders. The dilemma remains between striking the
balance between profits and ethics. The organisations practice ethics as it
bolsters their goodwill and reputation of being fair, honest and integral both
at the business and the corporate level thereby, fortifying their image.
Organisations expect the employees at all levels carry this legacy of identity
with utmost care. Ethics provide the framework within which the
organisation makes ethical investment. Ethical investment is followed in
management of investment portfolio which consists of company shares.
Profit is an inherent motive of business. But various economic thinkers have
propagated various business motives varying from profitability, wealth,
utility maximization, etc. But there are differences of opinion too. On the one
hand there is the ideology of Karl Marx, according to which it is unethical to
do business to accumulate wealth. On the other hand, Mahatma Gandhi
believed in business but preached trusteeship according to which a
businessman should look after the welfare of his employees.

Let us discuss this further with examples from various companies. In the
early 1980s the Indian automobile industry had two leading brands namely
the Ambassador from HM and the FIAT. The Japanese entered with Suzuki
and Maruti became a household name. Subsequently we saw a lot of foreign
brands like the Daewoo, Hyundai, General Motors, Toyota, etc. entering the
fray. Each of these multi-national companies had their own management
style and ethic orientation. Few worked on vendor relations, Research and
Development aiming at cost reduction, while others worked on advertising
and creating a robust distribution network. Within all this high level
marketing impact the Indica model from the national brand Tata was
launched. Though the model didn’t compete much with the elite MNC brands
but it was able to create a significant presence for the customers who
believed in Tata’s ethical philosophy. So a low advertised product also

88
garnered a market share as the word of mouth from the customers spread fast Business Ethics and
Corporate Social
thereby creating a brand identity for Tata. Responsibility (CSR)

The advantages of being ethical:

1) Preferred by prospective employees and creation of quality talent pool.

2) Less number of employees leaving the organisation i.e lower attrition

rate.

3) Less number of employee strike or labour unrest.

4) Corporate goodwill enables bargaining power which results in cost

reduction increase in production achieving economies of scale
more revenue and profits longer business viability.

Activity 2

Study the business ethics of any two leading conglomerates and mention
which one, according to you, is more ethic centric and why? Support your
answer with relevant examples.

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

4.6 CORPORATE GOVERNANCE AND

CORPORATE SUSTAINABILITY
To influence the corporate path to sustainable development, following
approaches are advocated namely:

• The Triple Bottom Line Approach (People, planet and profits), 1995
• United Nations Global Compact (UNGC), 1999
• OECD (1999) – guidelines are addressed to MNCs
• ISO Standards
• Global Reporting Initiative, 1997 – guidelines are for all organisations.
• Sustainable Development Goal, 2015
• World Bank GRI Index, 2020 – World Bank sustainability disclosure
index prepared with core option of the GRI standards.

In addition to the Triple Bottom Line approach which originated from

Elkington’s the planet- people- profit (environmental, social and economic)

89
Introduction to framework. Elkington argued business can be sustained by fulfilling
Business
Environment stakeholders’ interest, environmental protection policies and public welfare.

Global Reporting Initiative (GRI) is an international organisation founded in

1997. GRI has its roots in the US not for profit organisations, the coalition
for Environmentally Responsible Economies. United Nations Environmental
Programme (UNEP) was involved in the establishment of GRI. GRI enjoys
strategic partnership with Organisation for Economic Corporation and
Development (OECD), the UN Global Compact, United Nations
Environmental Programme (UNEP) and International Organisation for
Standardisation (ISO). GRI has designed the world’s standard guidelines in
sustainability reporting. GRI’s mission is to make sustainability reporting a
standard practice and to enable all companies and organisations to report
their performance on the following criteria: 1) Economic, 2) Environmental,
3) Social and 4) Governance.

The G3 is “Third Generation” of the GRI’s sustainability reporting guidelines

launched in 2006. G3 reports only on impact study. G4 reports on broader
aspect of impact study which includes general standard disclosure on
organisation profile, stakeholder and governance. Global Reporting Initiative
includes governance criteria in addition to the Triple Bottom Line, economic,
social and environmental criteria.

The Organisation for Economic Cooperation and Development (OECD),

in 1999, defined Corporate Governance as “a set of relationships between a
company’s management, its board, its shareholders and other stakeholders. It
provides the structure through which the objectives of the company are set,
and the means of attaining those objectives and monitoring performance are
determined. Good corporate governance should provide proper incentives for
the board and management to pursue objectives that are in the interests of the
company and shareholders, and should facilitate effective monitoring thereby
encouraging firms to use recourses more efficiently.”

The purview of Corporate Governance includes:

1) Rights of and equitable treatment of shareholders: Organisations

should respect the rights of shareholders and help shareholders exercise
those rights.

2) Interests of other stakeholders: Organisations should recognise that they

have legal and other obligations to all legitimate stakeholders.

3) Role and responsibilities of the board: The board needs a range of skills
and understanding to be able to deal with various business issues and to
have the ability to review management performance. It needs to be
sufficiently sized and have an appropriate level of commitment to fulfill
its responsibilities and duties.

90
4) Integrity and ethical behaviour: Organisations should develop a code of Business Ethics and
Corporate Social
conduct for their directors and executives that promote ethical and Responsibility (CSR)
responsible decision-making.

5) Disclosure and transparency: Organisations should clarify the role of

the board and the management and the same should be conveyed to the
public. They should also implement procedures to independently verify
and safeguard the integrity of the company's financial reporting.
Disclosure of financial matters concerning the organisation should be
timely and balanced to ensure that all investors have access to clear,
factual information. Transparency is the best principle of corporate
governance.

Role of Corporate Governance

You would have understood that the role of corporate governance is largely
significant to the society and impacts various internal and external
stakeholders. Corporate Governance aims at the following aspects:

a) It fosters an efficient use of resources and curtails wastages.

b) It aims at resource allocation to those verticals for bringing in

efficiencies in the production of goods and services which further
generates interest of the shareholders.

c) It chooses best effective managers to manage scarce resources to derive

optimal results.

d) It enables the managers to remain attentive and focused for enhanced

performance continuously.

e) It brings in investor’s attractiveness and also increases the shareholders'

value.

f) It fosters increased consumer satisfaction which aids in growing market

share, besides the sales.

g) It results in higher employee satisfaction, low turnover rate and lower

HR costs. Further, satisfied employees bring customer satisfaction.

h) It also attracts vendors and brings an efficient inventory management

system with reduced purchase/production costs.

i) It brings down the marketing costs by developing good rapport with the
channel partners, distributors, etc.

4.7 CORPORATE SOCIAL RESPONSIBILITY

(CSR)
The CSR has become one of the standard business practices of our time. For
companies, the overall aim of CSR is to have a positive impact on society as
91
Introduction to a whole while it engages in maximizing the creation of shared value for the
Business
Environment owners of the business, its employees, shareholders and stakeholders.
“Corporate Social Responsibility is a management concept whereby
companies integrate social and environmental concerns in their business
operations and interactions with their stakeholders. CSR is generally
understood as being the way through which a company achieves a balance of
economic, environmental and social imperatives (‘Triple-Bottom-Line-
Approach’), while at the same time addressing the expectations of
shareholders and stakeholders” (UNIDO).

The initial definition of CSR was given by Horward R. Bowen who defines
CSR as “Obligations of businessmen to pursue those policies, to make those
decisions, or to follow those lines of action which are desirable in terms of
the objectives and values of our society”.

In the 1960s, one of the most prominent definitions of CSR was given by
Keith Davis who defines social responsibility as “businessmen’s decisions and
actions taken for reasons at least partially beyond the firm’s direct economic or
technical interest”.

The concept of CSR evolved and extended to beyond economic and legal
components to encompass ethical and voluntary aspects as well. Caroll in
1979 gave a definition containing all four components. “The social
responsibility of business encompasses the economic, legal, ethical, and
discretionary expectations that society has of organisations at a given point in
time”.

Corporate Social Responsibility (CSR) in its essence fosters the business

accountability from the stakeholder, shareholder and investor perspective
which may include factors such as environmental protection, care for
employees, the society and public at large not only in the present context but
in future too. It is a result of continuous interaction between the business and
the society.

Regulatory Mechanism for CSR

With the enactment of Section 135 of the Companies Act 2013, India became
the first country to make CSR spending and disclosure mandatory for large
companies with specific turnovers.

The Companies Act 2013 and CSR

The inclusion of the CSR mandate under the Companies Act, 2013 is an
attempt to supplement the government’s efforts of equitably delivering the
benefits of growth and to engage the Corporate World with the country’s
development agenda. The Companies in India are governed by Clause 135 of
the Companies Act 2013 for performing their CSR activities.

92
Section 135 Business Ethics and
Corporate Social
Responsibility (CSR)
Section 135 of the Companies Act 2013 lays down that:

• The companies with an annual turnover of 1,000 crore INR and more, or
a net worth of 500 crore INR and more, or a net profit of 5 crore INR
and more shall constitute a CSR Committee of the Board consisting of 3
or more directors of which one will be an independent director.
• The CSR Committee will be responsible to

i) formulate and recommend to the Board, a Corporate Social

Responsibility Policy which shall indicate the activities to be
undertaken by the company as specified in Schedule VII;

ii) recommend the amount of expenditure to be incurred on the

activities referred to in (i); and

iii) monitor the Corporate Social Responsibility Policy of the company

from time to time.

• The Board of every company shall

i) after taking into account the recommendations made by the

Corporate Social Responsibility Committee, approve the Corporate
Social Responsibility Policy for the company and disclose contents
of such policy in its report and place it on the company’s website, if
any, in such manner as may be prescribed; and

ii) ensure that the activities as are included in Corporate Social

Responsibility Policy of the company are undertaken by the
company.

It is also the duty of the Board to ensure that the company spends two
percent of the average net profits made by the company in the preceding
three financial years and while spending the CSR amount giving
preference to local areas where it operates.

If the company fails to spend the amount, the Board in its report shall
specify the reasons for not spending the same.

Though section 135 makes CSR spending and reporting mandatory, it gives
flexibility to the companies to choose the CSR activities from the list of
activities that the corporate can potentially undertake.

Source: mca.gov.in

Companies Amendment Act, 2019- Section 135.

Any amount unspent shall be transferred within 30 days to special account in

scheduled bank and spent within 3 financial years.

93
Introduction to For company- if company contravenes the company shall be punishable
Business
Environment with a fine of 50,000 INR - to 25 lakhs INR.

For officer- Who are defiant are punishable with imprisonment for a term
which can extend to three years or fine of 50,000 INR - 5 lakhs INR or with
both.

4.8 BENEFITS OF CSR

Businesses can no longer limit their focus to profit maximization and be
satisfied just by creating employment and paying their taxes. They are also
required to address the needs of other stakeholders like creditors,
employees, shareholders, consumers, government and public. Companies these
days are more vulnerable to consumer boycotts and campaigns. The
companies need to be socially accountable to the communities among whom
they operate. Hence, CSR as a strategy and in fact as a necessary activity, is
becoming increasingly important for businesses due to the following benefits:
(CII, 2013)

Communities provide the license to operate: The CSR behaviour of

corporate is not just driven by their values but are also influenced by the
stakeholders like government, investors, customers and community. Todays
corporate understands that the license to operate in any particular area is not
just given by the government but also by the communities that get impacted
by the activities of these companies. A strong CSR programme provides the
companies with the license to operate and to maintain the trust of the local
community.

Attracting and retaining employees: CSR interventions that help the

employees to participate give them a sense of belongingness to the company.
Good CSR initiatives can attract employees to the company and give them the
incentive to remain motivated and committed to the company.

Communities as suppliers: There are instances wherein as a part of CSR

activities, the communities have been incorporated into the supply chain to
enhance their livelihood. Such initiatives have helped in increasing their
incomes and ensuring the companies with a steady and secure supply chain.

Enhancing corporate reputation: When the companies position

themselves as responsible corporate citizens, it creates good will and a
positive image, thereby helping them to enhance their brand image in the
market.

Activity 3

Enumerate various CSR activities taken by an Indian business conglomerate

of your choice. Which one according to you is the most mutually beneficial?
Why?

…………………………………………………………………………………
94
………………………………………………………………………………… Business Ethics and
Corporate Social
Responsibility (CSR)
…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

4.9 DRIVERS OF CSR

According to the KPMG Survey of Corporate Responsibility Reporting 2011,
around the world, corporate responsibility reporting has become a
fundamental imperative for businesses. According to the KPMG survey, the
top ten motivators driving corporations to engage in CSR for competitive
reasons, the following have emerged:

• Economic considerations
• Ethical considerations
• Innovation and learning
• Employee motivation
• Risk management or risk reduction
• Access to capital or increased shareholder value
• Reputation or brand
• Market position or share
• Strengthened supplier relationships
• Cost saving

In simple words, the underlying reasons for business organisations to be

involved in CSR are as follows:

Public Image

CSR creates a positive brand image in the minds of the potential consumers.
Effective communication of CSR activities boosts the purchase intentions of
the prospective consumers. Business can earn goodwill and reputation by
performing the activities towards the welfare of the society. People prefer to
purchase products of the company that engage in various social welfare
programs.

For example: Levi Strauss practices CSR in three areas i.e. the masses,
climate, and its products. It’s non-profit Red Tab Foundation provides aid to
its employees and retirees in case of financial emergency. As a part of its
contribution to the environment, it has signed the Climate Declaration and
aims to use 100 percent renewable energy in order to reduce carbon
emissions and other greenhouse gases. In addition, in a bid to save water, it has
started production of its new denim cloth-line which has helped them save
more than 1 billion litres of water since its inception in 2011.
95
Introduction to Government Regulation
Business
Environment
Most companies prefer to remain a step ahead of government regulations in
identifying the social needs and formulating policies to address them, out of
the fear that if they don’t, the government may take the responsibility, which
might prove costly for the employers. To avoid government regulations
businessmen should discharge their dutiesvoluntarily.

For example, Coca-Cola, USA continues to make strides towards the

alleviation of environmental issues. After realizing that its fleet of delivery
trucks accounted for 3.7 million metric tons of greenhouse gases (GHGs) in
2014, Coca-Cola made significant changes to its supply chain like investing
in trucks that are powered by alternative fuels. Those changes support the
company’s goal of reducing its carbon footprint by25 percent by 2020.

Survival and Growth

Every business is a part of society. It utilizes the available resources of

power, land, water, etc. of the society, therefore it should be the
responsibility of every business to spend a part of its profit for the welfare of
the society.

For example, Amul Dairy has launched a novel scheme “Rural Sanitation
Campaign” for total rural sanitation. The dairy with the support of District
Rural Development Agency (DRDA) will provide interest free loans to its
milk producers in the districts of Anand and Kheda, to set up ‘pucca’ toilet
blocks, which will not only help women milk producers avoid embarrassment
but will ensure hygiene as well.

(For more details visit http://www. amuldairy.com/ index.php/

component/ content/category/13-csr- initiatives)

Employee Satisfaction

Besides getting good salary and working in healthy atmosphere, employees

also expect other facilities like proper accommodation, transportation,
education, and training.

For example, Lemon Tree Hotels Group (LTH) believes that people with
disabilities (whether physical, social or economic disabilities leading to an
opportunity deprivation) must be provided the same opportunities as others to
realize their full potential and live with dignity. Lemon Tree has defined the
goal as mainstreaming ‘Opportunity Deprived Indians’ i.e. ODIs into its
workforce. By creating a supportive environment in the organisation that
allows them to deliver their best, LTH helps in bringing social inclusiveness
through livelihood creation. (For more details visit https://
www.lemontreehotels.com/factsheet/LTH_CSR_Policy.pdf)

96
Consumer Awareness Business Ethics and
Corporate Social
Responsibility (CSR)
Nowadays consumers have become very conscious about their rights. They
protest the supply of inferior and harmful products by forming different
groups. This has made it obligatory for businesses to protect the interest of
the consumers by providing quality products at competitive prices.

For example, Burberry announced banning fur in its products along with
other ladies’ bag manufacturing companies like Gucci, Versace, Armani,
Stella McCartney and others after a long campaign from the animal rights
group PETA.

4.10 CSR INITIATIVES IN INDIAN COMPANIES

Some of the CSR initiatives of Indian companies are listed below:

Tata Chemicals Ltd.

Tata Chemicals Ltd. has spent 25.68 crores for CSR in 2018-2019 which was
much higher than the prescribed amount of 19.86 crores. Improving the
quality of life and fostering sustainable and integrated development in the
communities where it operates is central to Tata Chemicals’ corporate
philosophy. In order to do so Tata Chemicals established Tata Chemicals
Society for Rural Development(TCSRD) in 1980 as a society and trust. It lays
emphasis on the spirit of participatory development by involving the
beneficiaries at each stage of the development process which ensures viability
and sustainability of the programmes (Fernandes, 2019). Around 30 percent
of the TCSRD funds are spent on wildlife conservation. The amount is
distributed over three places the company operates - Mithapur in Gujarat,
Haldia in West Bengal and Babrala in Uttar Pradesh.

Infosys Ltd.

Infosys Limited had established the Infosys foundation in 1996 to implement

its social development projects. During 2019, the company had spent INR 342
crores against the prescribed 340 crores towards various CSR schemes. The
major works of the Foundation included the introduction of Aarohan Social
Innovation Awards, restoration of water bodies in Karnataka, supporting the
construction of a metro station in partnership with Bangalore Metro Rail
Corporation Limited, enabling the pursuit of access and excellence in sports
through the GoSports Foundation, and relief efforts in Tamil Nadu,
Karnataka, and Kerala (Fernandes, 2019).

Bharat Petroleum Corporation Ltd.

BPCL as a part of its CSR initiatives, focuses on imparting holistic education

by facilitating usage of technology and infrastructural facilities. Additionally,
BPCL’s CSR philosophy also includes participation in projects of national
importance like the Swachh Bharat Abhiyan involving creation and
97
Introduction to maintenance of toilets, associated sanitation facilities, waste management
Business
Environment initiatives leading to overall health and hygiene for the communities.

Mahindra & Mahindra Ltd.

Among the various development programmes supported by Mahindra and

Mahindra Ltd. are Nanhi Kali programme to provide educational support to
underprivileged girls in India. It sponsors Lifeline Express (hospital on train)
to provide medical care, treatment, and surgical intervention to individuals.
Through Mahindra Hariyali 0.95 million trees were planted which contributed to
improving green cover and protecting bio-diversity in the country.

Vedanta Ltd.

The CSR portfolio of Vedanta Ltd. has diverse projects based on 10 broad
thematic areas running across various locations. The Nandghar project is the
flagship initiative which aims at rebuilding Anganwadis to ensure health and
learning of children in rural areas and for skilling and empowering women.

Indian Oil Corporation Ltd.

Indian Oil Co. Ltd. has been involved in various social development
activities across the nation. Most of these projects are for improving the
quality of life of the marginalized and underprivileged sections of the society.
The key thrust areas of the company include Safe drinking water and
protection of water resources, Healthcare and sanitation, Education and
employment-enhancing vocational skills, Empowerment of women and
socially/economically backward groups.

Hindustan Unilever Ltd.

Hindustan Unilever Limited (HUL) believes in long term sustainable growth

achieved by reducing environmental footprints and increasing its positive
social impact. The various CSR programmes of the company include
Handwashing Behaviour Change Programme, Plastic Waste Management,
Project Prabhat, Water Conservation Project, Swachh Aadat Swachh Bharat,
Project Shakti, Domex Toilet Academy, Asha Daan, Sanjeevani and
Supporting Healthcare.

4.11 SUMMARY
Business ethics discusses the extent of exhibited behaviour (correct or
incorrect) on moral standards rather than banking on the financial and
operational management perspective only. The defined ethical framework in
decision making is sought in conducting smooth business operations.

Business has deep ramifications to the natural environment and they must be
resolved on moral grounds. The case of the Korean conglomerate Posco’s
investment plans in Orissa is the relevant example of such concern which not
only involves morality but social and legal aspects too.
98
Corporate governance has been witnessed garnering attraction by the society Business Ethics and
Corporate Social
of its virtue to address company’s profitability from shareholder’s Responsibility (CSR)
perspective, as well as societal advantages. An organisation exhibiting higher
standards of the corporate governance becomes benchmark for others to
follow and builds investors’ faith and confidence resulting in financial
prosperity of the organisation.

The concept of Corporate Social Responsibility (CSR) has evolved from

being voluntary practices to regulatory mechanism. CSR helps in building
brand image, attaining competitive advantages and facilitates long term
business interest. CSR is growing in terms of its importance and recognition
across the globe where small, medium sized and large companies are
adopting CSR guidelines to make effective social contributions.

4.12 KEY WORDS

Business Ethics: comprises the principles and standards that guide behavior
in the conduct of business.

Corporate Governance: represents the value framework, the ethical

framework and moral framework under which business decisions are taken.

Corporate Social Responsibility (CSR): an obligation of businesses to

invest for social good in the societies in which they operate and earn their
profits.

Drivers of CSR: factors that encourage companies to be more socially

responsible.

4.13 SELF-ASSESSMENT QUESTIONS

1) What do you understand by the term business ethics? Discuss the
importance of business ethics to business citing examples.

2) Define Corporate Social Responsibility (CSR) and discuss the benefits

of CSR.

3) Discuss the key motivating factors driving organisations to engage in

CSR activities.

4) Write a detailed note on the CSR initiatives undertaken by Indian

companies.

4.14 REFERENCES/ FURTHER READINGS

• Fernando, A.C., Corporate Governance: Principles, Policies and
Practices. Pearson Education India, 2011.

• Bhattacharya D., Encoded Ethics- Social Responsibility of Indian

Business. Akansha Publishing House, 2015.
99
Introduction to
Business
• Bhattacharya Debasis, Corporate Social Development- A Paradigm
Environment Shift, Concept Publishing Company, New Delhi, 2006.

• Sharma, J.P., Corporate Governance: Business Ethics and CSR, Ane

Books Pvt. Ltd., 2016.

• IGNOU Study Material, MEDS-051, Fundamentals of CSR.

• IGNOU Study Material, MEDS-052, CSR Process.

100
 Business Ethics and
Corporate Social
Responsibility (CSR)

BLOCK 2
OVERVIEW OF INDIAN ECONOMY

101
Introduction to
Business
BLOCK 2: OVERVIEW OF INDIAN ECONOMY
Environment
Economic Transactions are the lifeline of business. Business environment is
influenced by the economic policies and economic structures prevailing in
the country. Business managers therefore, must have understanding of the
working of an economy, different sectors of the economy and how they
interact with each other; how monetary and fiscal policy influence the
economy and so on. The purpose of this block is to acquaint you with the
above aspects. This block has following three units:

Unit 5: Indian Financial System

Unit 6: Industrial Policy Framework

Unit 7: Agri-business Environment

102
UNIT 5 INDIAN FINANCIAL SYSTEM Indian Financial
System

Objectives

After reading this unit, you should be able to :

• explain the importance of the financial system;

• describe the structure and working of the money market and capital
market;
• outline the structure of the banking system; and
• examine the working of the capital market along with its various
instruments and intermediaries.

Structure

5.1 Introduction
5.2 Financial System and Working of Financial Markets
5.3 Structure of Money Market
5.4 Banking Structure in India
5.5 Reserve Bank of India (RBI)
5.6 Scheduled Banks in India
5.7 Structure of Capital Market
5.8 Summary
5.9 Key Words
5.10 Self -Assessment Questions
5.11 References/ Further Readings

5.1 INTRODUCTION
Before dwelling into the various intricacies of the financial system you need
to understand capital accumulation and its importance. In the previous units,
you have read about different theories of economic growth and have realised
that for an economy to achieve higher levels of both economic growth and
indeed economic development, the role of capital formation is indispensable.
Capital formation means an addition/increment in the existing stock of real
capital available in the country. Capital in economics terminology does not
mean money alone. It is a wider term that encompasses both physical and
human capital. Physical capital like machines, tools, infrastructure, raw
material, etc. leads to more production, profits and the creation of assets in
future. Human capital on the other hand includes skills, training, education,
etc. which improves the productivity of individuals and especially labour.

Saving and investment are two core components of capital formation. Saving
in the simplest sense means the part of income that is not consumed. When 103
Overview of saving is used in such a manner that it gives returns in future and it becomes
Indian Economy
an investment. For example, you saved a certain proportion of your income
and bought a piece of land. So buying land is an investment because if you
sell it then the sale price of land will be higher than your purchase price and
the margin between the two will be the profit. Now, instead of selling that
land, you constructed a building on that land and then you gave it on rent. So,
this rent will be an extra income for you and it will add to your current level
of income or profit. So when savings are properly channelised it increases the
stock of income or capital. As saving is important for an individual it is of
paramount importance for an economy. A higher level of savings leads to
more investment and capital formation which in turn becomes the source of
economic growth. So, it is the creation of savings, mobilisation of savings
and conversion of savings into capital assets that leads to capital formation.

There are large number of factors that affect the rate of capital formation in
the country like income levels of the people, institutional factors like
availability, number and coverage of financial institutions, the monetary and
fiscal policy of the country, prevailing rate of interest, population, size of the
market, etc.

5.2 FINANCIAL SYSTEM AND WORKING OF

FINANCIAL MARKETS
A financial system consists of a set of institutions, instruments and markets
which brings the savers and the investors to a common platform and provide
the means by which savings are translated to investment. The principal
objective of the financial system or financial markets is to channelise the
savings into the most productive opportunity/avenues. In financial markets,
there are two players namely lenders and borrowers. Individuals/ Households
generate savings and have surplus funds. They can either put this amount of
money in gunny bags and hide it or keep it under lock and key as was done in
yester years. This form of savings did not yield any return and the constant
fear of theft always lured upon the savers. On the other hand, capitalists/
entrepreneurs could not undertake new projects of production or expand the
existing production capacity of the plant due to a dearth of capital. The major
role of the financial system of the financial market is to bring these two
together. Those who have savings (savers or lenders) put funds into banks
and other financial institutions and those in need of money or finance
(borrower) take the money from these financial institutions. In this
interaction both the lenders and borrowers gain and ultimately due to
increased efficiency, production and exchange the whole economy gets
benefitted.

The working of financial markets can be understood from the flow chart
(Figure 5.1). The households save money in the financial system and these
funds channelised in the form of loans are provided to the borrowers.

104
 Savings Indian Financial
Lenders Loans
System
Individuals/ Financial System Borrowers
households

Figure 5.1 : Working of Financial Markets

Financial markets perform many functions like:

• To connect borrowers and lender of funds and to lead to the process of

price discovery/determination.
• To provide liquidity in the system by allocation of funds in an efficient
manner.
• Easy access of funds to the borrowers which in turn reduces the cost of
the transaction.
• Provides a way for managing uncertainty and controlling risks.

5.3 STRUCTURE OF MONEY MARKET

Financial markets have two main components money market and capital
market and they both are essential for the economic development of the
country. In the following section, you will read about the money market, its
importance and various instruments. The money market is a market for short-
term financial assets and assets which are close substitutes of money. Short
term implies time period of less than one year and close substitutes of money
refer to those financial assets that can be converted to money with
minimum/no transaction cost and without loss in value. The major
participants in the money market are scheduled commercial banks (excluding
regional rural banks or RRBs), cooperative banks (excluding land
development banks) and primary dealers (PDs).

Objectives

The broad objectives or functions of the money market are :

• To provide equilibrating mechanism between short term surpluses and

deficiencies.
• Maintaining liquidity in the system.
• Providing access to short term funds to the borrowers at minimum or
realistic cost.
• To enable the central bank of the country for intervention to influence
and regulate liquidity in the economy.

Instruments of the Money Market

The main instruments traded in the money market and the sub-market are:

• Call Market/ Notice Market

105
Overview of • Commercial Papers (CPs) Market
Indian Economy
• Treasury Bills (T-Bills) Market
• Commercial Bills Market
• Certificate of Deposits (CDs) Market
• Money Market Mutual Funds (MMMFs)

Let us now discuss them in brief.

• Call Market/ Notice Market

It is a market for short term financial funds that are payable immediately and
in full when the lender demands them. It is for this reason that call money is
also known as “money at call”. The maturity period varies from one day to a
fortnight (14 days). When the funds are browed/lent for a day it is called call
(overnight) money. If the duration of funds borrowed/lent is more than a day
and upto 14 days it is called notice market. For conducting transactions in the
call/notice market there is no need for any collateral security.The major
players in the call market are banks and primary dealers.The interest rate
payable on call loans is known as the call rate.

• Commercial Papers(CPs) Market

CPs are short term unsecured instruments issued by companies to raise short
term debts. They are issued in the form of promissory notes and in India they
were introduced in 1990. Large corporations, primary dealers and Financial
Institutions (FI) are authorised to issue CPs. The maturity duration of CPs is
a minimum of 7 days and a maximum of up to one year from the date of
issue. They are typically issued to short term financial obligations like
funding of the new project. They can be issued in denomination of Rs 5 lakh
or multiples thereof. Further, all eligible participants need to obtain a credit
rating for the issuance of CPs. They need to have a minimum credit rating of
A2 as per the Securities and Exchange Board of India (SEBI) definition and
rating symbol. CPs are issued discount to face value basis (as discussed in
the T-bills example below). They have many advantages like the option of
diversification for the source of finance, higher returns and liquidity.

• Treasury Bills or T- Bills

T-bills are short term borrowing instruments by the government of India.

These are a form of a bill that does not arise from any genuine transaction in
goods. They are a kind of promissory note issued by the Reserve Bank of
India (RBI). The government uses T-bills to raise short term funds to bridge
the temporary/seasonal gaps when a deficit arises due to shortfall ( situation
when receipts fall short of expenditure). At present T-bills of 91 days, 182
days and 364 days are issued. These bills are bought and sold on a discount
basis means they are zero-coupon securities and yield no interest. For
example, a 91 days T-bill of Rs 200 (which is the face value) may be issued
at say Rs 198.20. So the discount on this T-bill is Rs. 1.80 and at the time of
106
redemption it will be redeemed at the face value (i.e. Rs. 200). The return Indian Financial
System
which investors gain is the difference between the face value (maturity value)
and the issue price. T-bills are issued by RBI through auctioning. RBI
conducts auctions of T-bills with a maturity period of 91 days, 182 days and
364 days every Wednesday. The date and place of auction, maturity time
period and the method of auction is announced by the RBI from time to
time.There are two main types of auctions namely multiple-price auction and
uniform-price auction.The main features of T-bills are- they are negotiable
instruments, highly liquid because of the short time period, secured as they
are backed by the government guarantee, assured yield and low transaction
cost. The net short term market borrowing of the government through 91
days, 182 days and 364 days, T bills stood at Rs. 37,528 crore during 2019-
20.

• Commercial Bills Market

Commerical bills include bills of exchange and promissory notes. A

promissory note is a form of financial instrument in which the note’s issuer
and the note’s payee undertake a written promise whereby the issuer promise
to pay a definite sum of money either on demand or at a specified future date
to a particular person or to the bearer of the instrument. Commerical bills
originate due to original trade transactions. There are many types of bills like
trade bills, commercial bills, inland bills, foreign bills, indigenous bills and
others. Rediscounting of bills is an important segment of the bill market.
Commercial banks often make use of such facilities.

Let us understand the concept of rediscounting with a help of an example.

Suppose a commercial bank buys 91 -days T-Bill at Rs 1000 and receives Rs
1100 at the time of maturity. In this case, the difference between the purchase
price and face value of the bill is Rs 100 is called the discount. Re-
discounting occurs when the short-term negotiable debt instrument is
discounted for a second time. In continuation with the above example, let's
assume that the same bank needs money urgently for say 30 days, it will
approach the central bank of the country and the central bank can purchase
some of the bills from the bank say for Rs 1050 for a period of next 30 days
but before 90 days the date of maturity. In this case, the rediscount or the
difference between the purchase price and the face value is Rs. 50.

• Certificate of Deposits (CDs) Market

CDs are negotiable money market instrument against funds deposited in a

bank or other financial institutions for a fixed time period at a specific rate of
interest. They are the bearer documents and issued in dematerialised form.
Scheduled commercial banks ( except RRBs and local area bank) and
selected all India Financial Institutions can issue CDs in a minimum amount
of Rs. 1 Lakh and in the multiples of Rs. 1 Lakh. The maturity period of CDs
is a minimum of 7 days and a maximum up to one year. They are issued at a
discount on face value. Banks have to maintain appropriate reserve
107
Overview of requirements i.e., Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio
Indian Economy
(SLR) on the issue price of CDs.

• Money Market Mutual Funds (MMMFs)

To increase the participation of individuals and small investors in the money

market and to provide additional short term funds avenues to the investors
MMMFs were introduced in April1991 and the detailed scheme of MMMFs
was announced by RBI in 1992. A mutual fund is an investment scheme
mostly run by an asset management company. Money is collected from a
large number of investors and this pool of money is invested in stocks, bonds
and other securities. MFs are mostly beneficial for small investors like the
salaried class who park their funds in MMMFs and can gain better returns.
They offer diversification of short term assets in terms of issues, maturity and
volume, thereby spreading the risk. Whenever investor buys mutual funds
they are allotted units/share of the mutual fund. These MFs are professionally
managed and investors earn income in the proportion to the number of units
owned by them. Initially, only banks, FIs and their subsidiaries were allowed
to set up MMMFs but corporates and others were allowed for the same from
1996. All MMMFs are governed and regulated by SEBI.

Structure of Money Market in India

The structure of the money market in India is presented in Figure 5.2. The
money market is divided into two parts: i) Organised and ii) Unorganised.

Money Market

Organised Unorganised

RBI Indigeneous
banks

Commercial
Banks Non Banking
Companies

Financial
Institutions Money
Lenders
Figure 5.2 : Structure of Money Market in India

The organised sector consists of the central bank of India or RBI, commercial
banks both nationalised and private. Further, foreign banks, cooperative
banks, the discount and finance house of India and other financial institutions
like IFCI, ICICI, LIC, GCI and mutual funds also operate in the money
market. The unorganised sector consists of non-bank financial intermediaries,
indigenous bankers and money lenders.
108
5.4 BANKING STRUCTURE IN INDIA Indian Financial
System

As discussed previously banks are one of the most important segments of the
money market. Let us read about the banks, their functions, the structure of
the banking system in India with special reference to RBI.

Definition of Bank

According to the Banking Regulation Act 1949, a banking company is a

company that transacts the business of banking in India and banking means
accepting deposit of money from the public for the purpose of lending or
investment however with the promise of repayment on the demand by the
depositor with the facility of withdrawal by cheque, draft, order or otherwise.

The functions of banks have changed from traditional (accepting deposit and
lending credit) to many more functions like collection and payment of
cheques, bills and promissory notes, sale and purchase of securities,
remittances of funds, merchant banking, services of automated teller
machines (ATM), electronic fund transfer system, dealing in foreign
exchange, and others.

Reserve Bank
of India (RBI)

Scheduled
Banks in India

Scheduled Scheduled
Commercial Banks Cooperative Banks

Public Private Sector Foreign Banks Regional Rural

Sector Banks Banks Banks

Nationalised State Bank of Old Private New Private

Banks India and its sector banks sector banks
associates

Figure 5.3: Banking Structure in India

The structure of banking in India is presented in Figure 5.3. At the helm of

the affairs, there is RBI which is the regulator of the banking sector and
supervises the monetary policy of the country. After that, we have scheduled
banks that are further classified as scheduled commercial banks and
scheduled cooperative banks. Scheduled commercial banks further classified
as public sector banks, private sector banks, foreign banks and Regional
Rural Banks (RRBs). Within the Public sector, there are nationalised banks
and the State Bank of India (SBI) and its associates. Private sectors banks
109
Overview of have two categories old and new private sector banks. In the following
Indian Economy
sections, you will briefly read about them.

5.5 RESERVE BANK OF INDIA (RBI)

RBI is an apex bank of the country and acts as the regulator of the financial
and monetary system in the country. It was established after the
recommendation of the ‘Hilton- Young Commission’. It was established as a
banker to the central government by the Reserve Bank of India Act 1934 and
it began its operations from April 1935 as a private shareholders bank with
the paid-up capital of Rs.5 crore and in 1949, RBI was nationalised.

Functions of the RBI

Some of the major functions of RBI are:

• Note Issuing authority

• Banker to the Banks
• Banker of the Government and Debt Manager
• Banking Sector Regulator
• Foreign Exchange Manager
• Maintaining Financial Stability
• Development Role
• Regulator of the Monetary Policy

Note Issuing Authority

RBI has a monopoly over note-issuing in India other than one rupee
notes/coins and coins of smaller denomination. RBI ensures that both
currency notes and coins are available in an adequate amount in the country.
The currency notes issued by RBI are legal tender in the length and breadth
of the country. RBI can issue currency notes up to the denomination of Rs.
10,000. At present notes in the denomination of Rs 2, Rs 5, Rs 10, Rs 20, Rs
50, Rs 100, Rs 200, Rs 500 and Rs 2000 are issued. Similarly, coins in
circulation comprise Rs 1, Rs 2, Rs 5 and Rs 10.

Banker to the Banks

All the banks in the country have an account in the RBI via which banks
settle inter-bank transaction and customer transactions. It also enables banks
in maintaining statutory reserve requirements like Statutory Liquidity Ratios
(SLR) and act as lenders of the last resort. It also provides short term loans
and advances to banks as and when the need arises.

Banker of the Government and Debt Manager

RBI acts as a banker to the central government of the country along with
those state governments which have agreed with RBI. It maintains the
government accounts and does financial transaction from this account along
110
with the transfer of government funds. It manages the government domestic Indian Financial
System
debt and raises the money both from the public and financial market to bridge
the shortcoming of revenue.

Banking Sector Regulator

RBI regulates and supervises the banking system of the country in

accordance with the various provisions of the RBI Act and Banking
Regulation Act. RBI as a regulator does a wide range of activities like
providing licenses, prescribing capital requirement like capital adequacy
norms, paid-up capital and lending to the priority sectors of the economy like
farmers, women, etc. Regulation of interest rate, an inspection of the banks
and bank branches, setting of different regulatory norms and also to initiate
new regulation in accordance to changing circumstances.

Foreign Exchange Manager

As you are aware trade is very essential for any economy. For conducting
trade adequate stock of foreign exchange reserves are an important
requirement. RBI plays an important role in both the development and
regulation of the foreign exchange market. It regulates the transactions which
are related to both exports and imports and ensure smooth conduct in the
domestic foreign exchange market. It is the custodian of foreign exchange
reserves and the gold reserves of the country. The banks and selective
institutions which wish to deal in the foreign exchange need to have a license
from RBI.

Development Role

RBI aims at promoting financial literacy and education among the public and
also ensures that credit is available to the productive sectors of the economy.
For the development purpose RBI has established many institutions like the
National Bank for Reconstruction and Rural Development (NABARD), Unit
Trust of India (UTI), Deposit Insurance and Credit Guarantee Corporation,
Industrial Development Bank of India (IDBI) among others.

Regulator of Monetary Policy

Monetary policy is the policy of RBI through which it regulates the financial
market of the country and most importantly it is used for credit control.
Credit creation is one of the chief functions of the bank. Before we move
forward let us understand what is credit creation. Whenever the bank accepts
a deposit from the customer, it retains some proportion( which is mandatory)
of this deposit for the requirement of the depositor and the rest is given as a
loan to the buyer. So bank creates money out of money and this process is
called credit creation. It is through credit creation that money flows into the
system. However, both the excess and deficiency of money circulation is
damaging for the economy. If the supply of money is more than the demand
then we have the problem of inflation which you have read in previous units.
In contrast, if the money supply is less than demand then we have the 111
Overview of problem of deflation. So, RBI uses monetary policy to control credit.
Indian Economy
Methods adopted by RBI for credit control are classified as i) Quantitative
and ii) Qualitative. Lets us discuss these methods in detail in the following
sections and once we have discussed these methods we can understand with
the help of illustration how these methods are adopted for credit control.

Quantitative Methods

Quantitative methods are used to control total quantity or volume and the
cost of the credit created by banks. Within Quantitative methods, we have
direct and indirect instruments. Cash Reserve Ratio (CRR), Statutory
Liquidity Ratio (SLR) and Refinance facilities are direct tools. Bank rate,
Repo and Reverse repo rate, Liquidity Adjustment Facility (LAF), Open
Market Operations, Market Stabilisation Scheme (MSS) and Marginal
Standing Facility (MSF) are indirect instruments.

Cash Reserve Ratio (CRR)

It is the minimum amount that banks keep with RBI as a proportion of their
Net Demand and Time Liabilities (NDTL). The CRR percentage is notified
from time to time by RBI. CRR ensures that banks have sufficient cash for
their depositor's requirement.

Statutory Liquidity Ratio (SLR)

It is the percentage of NDTL that banks have to mandatory maintain in safe

and liquid assets like cash, gold or government securities. SLR restricts the
expansion of bank credit, increases bank’s participation in the security
markets especially government securities, and it also ensures the solvency of
banks.

Refinance Facility

This facility is used by RBI to provide adequate credit to selective sectors

like the export sector.

Bank Rate Policy

According to RBI Act, 1934, a bank rate is “the standard rate at which RBI is
prepared to buy or rediscount bills of exchange or other commercial paper
eligible for purchase under this act”. The bank rate has been aligned to the
Marginal Standing Facility (MSF) and it changes automatically when MSF
changes.

Repo Rate

It is the rate at which RBI lend to the banks overnight against the collateral of
government and other approved securities under the arrangement of Liquidity
Adjustment Facility (LAF). In simple terms, it is the fixed interest rate at
which banks borrow from RBI for the short term. At present, Monetary

112
Policy Committee (MPC) decides this policy rate along with the reverse repo Indian Financial
System
rate.

Reverse Repo Rate

It is a fixed interest rate at which RBI borrows from the banks in order to
absorb liquidity for the short term (overnight basis). RBI borrows against the
collateral of eligible government securities under the LAF.

Liquidity Adjustment Facility (LAF): This facility was introduced by RBI

after it was suggested by the Narasimham Committee on Banking Sector
Reforms of 1998. It is a mechanism for managing the liquidity needs of the
bank. It aims to inject/absorb liquidity from the system in the situation of
shortages and excess. The repo, reverse repo, term repo (auction), overnight
variable rate repo (auction), overnight variable rate reverse repo (auction) are
the components of LAF.

Policy Rates as on April, 2021

Cash Reserve Ratio (CRR): 3.50 % Repo Rate: 4.00 %
Reverse Repo Rate: 3.35 % Marginal Standing Facility Rate: 4.25 %
Bank Rate: 4.25 % Statutory Liquidity Ratio: 18%

Source: Reserve Bank of India.

Open Market Operations

It refers to buying and selling of government securities by RBI in the money
market. Both the purchase and sale of these securities may lead to expansion
and contraction of the money supply. For example, at the time of inflation,
RBI sells these securities and banks buy them. When banks buy these
securities then bank credit is directed away from the public to RBI which
leads to less credit creation and less supply of money in the market.

Market Stabilisation Scheme

In 2004 this scheme of RBI was launched in order to withdraw excess

liquidity from the market by selling government bonds. The problem of
excess liquidity was due to RBI purchase of foreign currency. The bonds
which the RBI sells are called Market Stabilisation Bonds (MSBs) and they
are owned by Government of India.

Marginal Standing Facility

It is a facility for banks that can be used in an emergency. Under this facility
scheduled commercial banks can borrow up to one percent of their Net
Demand and Time Liabilities (NDTL) at 100 basis points (1 percent) more
than the repo rate for the short term (overnight) from RBI. It provides a
safety value to banks against unanticipated liquidity shocks.
113
Overview of Qualitative Methods/ Selective Methods
Indian Economy
These methods focus on certain sectors only. By using these methods RBI
can divert the flow of credit from one sector to another. The different
qualitative methods used by RBI are credit rationing, consumer credit
regulation, increasing margin requirement, moral suasion, direct action and
others. We will discuss some of them in this section.

Credit Rationing

Under this method, RBI controls and regulates the purpose for which credit is
granted by banks. The central bank can put a ceiling on the amount of loans
that can be advanced to the banks.

Consumer Credit Regulation

This method helps in controlling excess spending by the consumers. RBI can
direct banks to fix a minimum percentage of down payment, instalment
amount, loan duration, etc.

Margin Requirement

Margin requirement is the difference between the market value of the

security which is pledged for taking a loan and the maximum amount of loan
which can be disbursed against this security.

Moral Suasion

RBI requests or persuades commercial banks to behave in a particular

manner according to the financial situation of the economy. For example,
during inflation RBI requests commercial banks to restrict bank advances. It
is a sort of advice and there is no compulsion by RBI. The effectiveness of
this policy depends upon coordination between RBI and commercial banks.

Direct Action

It refers to the direction and the controls which RBI enforces on particular or
all banks in case of default or no adherence to advise of RBI. RBI can reject
the request of banks for grants or rediscounting facilities or it may levy penal
rate of interest on loans that banks borrow beyond the prescribed limit.

5.6 SCHEDULED BANKS IN INDIA

Scheduled banks are those banks that are included in the second schedule of
the RBI Act, 1934. These banks need to have paid-up capital and reserves of
not less than Rs 5 lakhs. These also need to maintain CRR balance with RBI
and they can raise debts and loans from RBI at the bank rate. Scheduled
commercial banks are further classified as public sectors banks, State Bank of
India (SBI) and its associates, old and new private sector banks and foreign
banks.

114
Public Sector Banks (PSBs) Indian Financial
System
PSBs are those banks in which more than 50 percent of shares are held by the
Government of India. These are the major type of banks in India. At present
(2021) there are 12 PSBs namely SBI, Bank of Baroda, Bank of India,
Punjab National Bank (PNB), Indian Overseas Bank, Punjab and Sind Bank,
Indian Bank, UCO Bank, Bank of Maharashtra, Central Bank of India,
Canara Bank and Union Bank of India.

SBI and its Associates

SBI is the biggest commercial bank in the country with nearly 25 percent
market share and has over 22000 branches and 58500 ATMs. SBI came into
being on 1 July 1955 when the Government of India passed the State Bank of
India Act, 1955 by taking over assets and liabilities of the Imperial Bank of
India. Imperial Bank of India was formed in 1921 through the amalgamation
of three presidency banks namely Bank of Madras, Bank of Bombay and
Bank of Bengal. At present, SBI is a Fortune 500 company and is
headquartered in Mumbai. SBI initially had 7 associates namely State Bank
of Bikaner and Jaipur, Hyderabad, Indore, Mysore, Patiala, Saurashtra and
Travancore. However, in 2008 and 2009 State Bank of Saurashtra and Indore
was merged with SBI and the remaining 5 associate banks were merged in
2017.

Private Sector Banks

Private sector banks are those banks in which the majority of the stake is
owned by private shareholders. In India, private sector banks are classified as
Old and New private sector banks. The private banks which were not
nationalized (in the year 1969) are collectively known as the old private
sector banks and include banks such as The Jammu and Kashmir Bank Ltd.,
Lord Krishna Bank Ltd. etc. As of April 2021, the number of private sector
banks in India was 22. Some of the famous private sector banks are ICICI,
HDFC,etc.

Foreign Banks

Foreign banks are those banks which have headquarter in a different country
but has branches in India. As of July 14, 2020, there are 46 foreign banks in
India. These banks have to follow rules both of home and host country. Bank
of America, Bank of Ceylon, National Australia Bank, BNP Paribas, etc. are
some of the foreign banks in India.

Regional Rural Banks (RRBs)

They were established in 1975 to develop the rural economy and creation of
additional channel to the cooperative credit structure to enhance the reach of
institutional credit for the rural and agriculture sector. There were 43 RRBs
as of April 2021.

115
Overview of Scheduled Co-operative Banks
Indian Economy
Cooperative banks function on the concept of cooperative credit societies
wherein the members of the society join together to extend a loan to each
other at a subsidised rate of interest. Scheduled Co-operative Banks are of
two types Scheduled State Co-operative Banks and Scheduled Urban
Cooperative Banks. There are 23 Scheduled State Co-operative banks and 53
Scheduled Urban Cooperative banks.

Narasimham Committee on Banking Sector reforms

Government of India set up two expert committees under the
chairmanship of M.Narasimham for the restricting of Banking sector
popularly known as Narasimham Committee-1 (1991) and Narasimham
Committee-II (1998).

Activity 1
1) Suppose you are hired as an advisor to the finance minister and the
country is witnessing a high rate of inflation. What advice would you
offer regarding changing the policy rate like CRR, Repo Rate, etc. and
why?

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

2) The Govermnet of India is planning for more mergers of banks. How do

you look about this decision?

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……………………………………………………………………………

5.7 STRUCTURE OF CAPITAL MARKET

In the previous section, you have read about the money market which
provides short term funds to investors for less than one year. However,
business units and investors need funds for a longer duration also for
undertaking business expansion or technology upgrading and in this regard
they approach the capital market. A capital market is a market for long term
116
securities or financial instruments having a maturity period of more than one Indian Financial
System
year. Capital markets are important for channelising savings, capital
formation and industrial growth. The structure of the capital market in India
can be better understood with the help of Figure 5.4

Capital Market

Markets Instruments Intermediaries Regulator

Primary Securties and

Exchange Board
of India (SEBI)
Secondary

Figure 5.4: Structure of Capital Market in India

Capital market comprised of two markets i) Primary Market and ii)

Secondary Market. The primary market is also known as the New Issue
Market (NIM) where the issuer of the securities (shares and bonds) sell the
new securities to the investors directly without any intermediaries. Whenever
the securities are offered for sale for the first time by the companies they are
called Initial Public Offering (IPO). IPO is issued to raise capital for funding
purpose. Both the companies and government raise funds by the sale of new
stocks in the primary market.

The secondary market is also known as the stock market. It is a place where
shares, bonds, options, etc. which were sold earlier are sold and purchased. In
India, the Bombay Stock Exchange (BSE), National Stock Exchange (NSE)
are some examples of stock exchanges. The secondary market can be either
an auction market or Over-the-Counter. In the auction market, trading of
securities is done through the stock exchange. In Over-the-Counter the
trading is conducted without using the platform of stock exchange, it does not
have any physical location and trading is done electronically.

Financial Instruments

Some of the major financial instruments used in capital markets are discussed
below.

Shares

A share indicates a unit of ownership by the buyer of shares called

shareholder/holers of the company. A shareholder has ownership in the
company and has voting rights and shares the company profit or loss. The
benefit which a shareholder receives out of company profit is called a
dividend. Let us understand it with an example. Assume that there is a
company know as XYZ limited and it needs funds (Rs 100 crore ) for further
expansion. For raising this fund the company will go to the public. This
capital of Rs 100 crores is divided into 10,00,000 shares of Rs. 1000 per 117
Overview of share. Now assume that there are two investors A and B and they want to
Indian Economy
invest in this company so they will buy some shares. Investor A buys 500
shares and investor B buys 800 shares so they are investing Rs 5,00,000 and
Rs 8,00,000 in this company and have become the shareholders and will
share the profit or loss of the company in the proportion to their holdings.
Further, shares are of two types namely equity shares and preference shares.

Bonds

Bonds are issued by state and central governments, companies and

municipalities to raise money for a variety of projects and activities. They are
debt instruments in which the entities borrow the funds for a defined period
of time at a variable or fixed interest rate. It is fixed-income security and
essentially a loan agreement between a bond issuer and an investor. The
bondholders unlike shareholders do not have any ownership of the company
or have voting rights.

Debentures

Debentures are also a type of debt instrument which is issued by companies

for raising funds but they are not secured by physical assets or collateral. An
investor buys debentures based on the reputation and the creditworthiness of
the issuer. The interest rate on debentures is higher than that of bonds.

Capital Market Intermediaries

There is a large number of intermediaries in the capital markets some of

Gilt Edge Market : The gilt-edged market refers to the market for Government and
semi-government securities and is backed by the RBI. Government securties are
called Gilt -edged means ‘of the best quality’ because they are highlighy liquid and
risk free

which are discussed below:

Merchant Bankers

Merchant Bankers are intermediaries between the investors and the company.
They act as an advisor who advises the entrepreneurs from the stage of the
conception of the project till the production begins. SEBI defines merchant
bankers as “any person who is engaged in the business of issue management
either by arranging for buying, selling or subscribing to securities or acting as
manager, consultant or rendering corporate advisory services in relation to
such issue management”.

Underwriters

When a company decides to go public to raise funds all of its securities may
not be fully subscribed by the public, so there is a need for someone who can
subscribe to those securities. This work is done by the underwriter, he agrees
with the issuer company that he would subscribe to the unsubscribed
118 securities himself or by others. He is paid a fee called ‘underwriting
commission’ for this job. Underwriters can be both institutional (for example Indian Financial
System
IDBI, UTI) or non-institutional. All underwriters need to be registered with
SEBI.

Portfolio Managers or Portfolio Management Services (PMS)

Portfolio managers are professionals who enter into a contract with the client
to advise or direct or undertake investment decisions on behalf of the client.
They are of two types: 1) discretionary portfolio managers and 2) non-
discretionary portfolio managers. When the portfolio manager manages the
funds of the client independently according to the needs of the client they are
called discretionary portfolio managers. Whereas non-discretionary portfolio
manager manages the funds following the directions of the client. Some of
the examples of major Portfolio Management Services in India are Motilal
Oswal PMS, Kotak PMS, ICICI Prudential PMS, etc.

Stock Brokers

A stock broker is an individual or firm which is an intermediary between an

investor and a securities exchange. The stock broker trades in the stock
exchange on the behalf of their clients. In return for their services, they are
paid commissions of fees. They handle all the paperwork and maintain
records of all transaction, manages their client's portfolio and advise the
investors on formulating different investment strategies in the dynamic world
of financial markets. All stock brokers are registered with the SEBI.

Regulator of the Capital Market /SEBI

In India, the capital market is regulated by the Securities and Exchange

Board of India (SEBI). SEBI was established in 1988 as a non -statutory
body but with the passing of SEBI Act 1992, it was accorded statutory
power. The major objectives of SEBI are to protect the interest of investors
and development and regulation of stock exchange, to prevent deceitful
malpractices and to regulate and develop a code of conduct for intermediaries
such as brokers, underwriters, etc. SEBI performs various functions like
registration of stock exchanges, mutual funds, underwriters, brokers and sub-
brokers, levys various fees and other charges, promote investors education,
audit and inspection of stock exchanges and various intermediaries, prohibits
unfair trade practices relating to the securities market and insider trading.

Activity 2

1) Conduct a field survey of your neighbourhood and assess the awareness

level of the stock market.

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119
Overview of ……………………………………………………………………………
Indian Economy
……………………………………………………………………………

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2) Nowadays there is a trend of investment among common man in Mutual

Funds through Systematic Investment Plan (SIP). Try to collect some
information in your neighbourhood about the factors which affect
individuals decision to invest in MF.

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5.8 SUMMARY
In this unit we discussed the importance of the financial system whereby it
brings the suppliers and the borrowers of funds in the common platform.
Further, the important functions and instruments of the money market were
discussed. One of the major components of money markets is banks. In India,
RBI is the apex bank. It formulates and regulates monetary policy. Monetary
policy has two instruments namely quantitative and qualitative. Quantitative
instruments include various policy rates like CRR, Repo and Reverse repo
rate, bank rate, etc. which aims at controlling the quantum of credit.
Qualitative methods like moral suasion, direct action and others aim at
directing the credit flow to a particular sector or to prohibit the credit flow.
RBI uses both instruments but quantitative methods are more visible and easy
to administer.

In the next section, you developed an understanding of banks and the various
functions of the banks along with the structure of banking in India. The
different categories of banks like the public sector, private sector, foreign
banks were discussed in detail. In the last section, the working of the capital
market was highlighted with the emphasis on the meaning of capital market,
its various instruments, intermediaries and SEBI.

5.9 KEY WORDS

Financial System: It consists of a set of institutions, instruments and markets
which brings the savers and the investors to a common platform and provide
the means by which savings are translated to investment.

Cash Reserve Ratio (CRR): It is the minimum amount that banks keep with
RBI as a proportion of their Net Demand and Time Liabilities (NDTL).
120
Statutory Liquidity Ratio (SLR): It is the percentage of NDTL that banks Indian Financial
System
have to mandatory maintain in safe and liquid assets like cash, gold or
government securities.

Bonds: Bonds are issued by state and central governments, companies and
municipalities to raise money for a variety of projects and activities.

5.10 SELF-ASSESSMENT QUESTIONS

1) Differentiate between money market and capital market.
2) Differentiate between shares and bonds.
3) What are the major functions of RBI?
4) Write about some of the instruments of the money market.
5) Write a note on SEBI.

5.11 REFERENCES/ FURTHER READINGS

• Mishkin, Frederic. S. (2007) Financial Markets and Institutions. New
Delhi, Pearson Education Ltd.

• Khan, M. Y. (2007). Indian Financial System. New Delhi. Tata McGraw

Hill.

• Machiraju, H.R. (2006). Indian Financial System. New Delhi. Vikas

Publication.

• Bhole, L.M. (2008). Financial Institutions and Markets. New Delhi. Tata
McGraw Hill.

121
Overview of
Indian Economy UNIT 6 INDUSTRIAL POLICY
FRAMEWORK

Objectives

After reading this unit, you should be able to:

• trace the evolution of Industrial Policy in India;

• describe the framework of Industry Policy Formulation in India;
• identify the gaps in previous industrial policies and the need for New
Industrial Policy;
• analyse the benefits and gaps of the present Industrial Policy;
• draw a comparison between State Specific Industrial Policies in India;
and
• assess the importance of other policies supplementing the Industrial
Policy.

Structure

6.1 Introduction
6.2 Industrial Policy Framework and Features
6.3 Stages of Industrial Policy Prior to1991
6.4 New Industrial Policy 1991
6.5 Analysis of the New Industrial Policy
6.6 State Specific Industrial Policies
6.7 Other Important Policies Focusing on Industrial Promotion
6.8 Summary
6.9 Key Words
6.10 Self-Assessment Questions
6.11 References/ Further Readings

6.1 INTRODUCTION
Industrial development is aimed to achieve economic prosperity and
improving the lives of its people. India left no stone unturned to brace and
strengthen its industrial development for which the quest started after
independence in 1947. The initially conceived policy - The Industrial Policy
Resolution of 1948 outlined and defined the role of the State in industrial
development both as an entrepreneur and authority. For a stringent
framework and better implementation of the Industrial Policy, enactment of
Industries (Development & Regulation) Act, 1951 (referred as IDR Act)
followed. This also allowed Union Government to direct investment into
122
preferred areas of industrial activity through the mechanism of licensing and Industrial Policy
Framework
keeping abreast with national development objectives.

To fast-track industrialisation and to place India among global competitors, it

was imperative to achieve sustainable growth, optimum utilisation of
resources and growth in production with a focus on best possible utilisation
of human resources and international competitiveness. To achieve
sustainable growth, the policy explored prospects to deregulate Indian
industry while easing restrictions. Since 1991, economic reforms envisioned
new and substantial role for private entities. In view of this, the policy has
been progressively liberalized over the years. You will learn more about it in
the following sections.

6.2 INDUSTRIAL POLICY FRAMEWORK AND

FEATURES
Indian economy was being built into a self-reliant and self-sustained unit
with an aim to achieve industry-led-growth. The policy environment relied
on import substitution, inward growth and subsidisation. Public sector in
India soon witnessed a phenomenal expansion and economic prosperity.

However, it came to be afflicted with infirmities. At this point in time, it was

realised that there was a need to make the public sector market-oriented.
Hence, well-balanced improvements were needed to reformulate the policy
accordingly. Public sector played a supportive role in the new policy
framework but the initiative for growth was to be commenced from the
private capital and enterprise. And so, the actual reformation started after
1995 and was influenced by three factors:

• Young entrepreneurs entered a competitive economy.

• Tariff rates started dropping down along with quantitative import
restrictions becoming history.
• MNCs started entering India in greater numbers and created a
competitive landscape from within.

Not just these factors but there are handful of other aspects that affected the
industrial policy thereby impacting investment and production. Some of these
were industrial licensing policy, control of monopolies and economic
concentration, policies regarding technology import along with financial and
fiscal policies affecting the provision of industrial finance, development of
the capital market, as well as fiscal incentives/ disincentives to investment
and production. It is in this context that we have to understand the evolution
of industrial policy in India and know how it has worked as an effective tool
to comprehend the objective of planned development. A look through the
features of industrial policy will be focused upon.

123
Overview of
Indian Economy
6.3 STAGES OF INDUSTRIAL POLICY PRIOR
TO 1991
The model of development and growth and the changes with time demands
changes in economic policies and the need to create institutions for
successful implementation of polices and to achieve growth. This means
involvement of State is essential.

Industrial Policy and Strategy

From the time of Second Five Years Plan, Industry-led-growth strategy was
adopted and this strategy was based on the Industrial Policy Resolution (IPR)
of 1956.

A number of changes had taken place during this time. So the IPR 1956 laid
emphasis on the following:

• Fast-track expansion of heavy machine industry to lay the ground work

for ‘capital goods industries’.
• Involve private sector and make them co-partners.
• Expand heavy industry’s base in the public sector.
• Promote and enhance growth of cottage and small scale industries by
establishing large co-operative sector.

The IPR 1956 was commonly referred as the ‘Economic Constitution’ of

India which established a base for cottage and small-scale industries and
aimed to enhance their growth. A classification was made specifying
industries into different groups while stating that both public and private
sector was at the same time anticipated to be a part of the course of
industrialisation in India. The demarcations of the industries were based on
the following three schedules:

• Schedule A: Barring the industries for which permissions had already

been given, 17 new industries to be set up by the State.

• Schedule B: Private sector industries - 12 in number to be set up with an

aim to supplement the efforts of the State; and

• Schedule C: The developmental initiative was left entirely to the private

sector except for the 29 industries above. Despite difference, it was
always left open to the State to undertake industrial production in any of
the areas keeping the national interest in mind.

Industrial Licensing

Industrial Licensing formed the backbone of State policy. The government

initially insisted upon a written permission to an industrial unit allowing
manufacturing of only those goods which were itemized in the permission
letter was an important instrument which allowed the State to ensure that the
124
manufacturing units follow the set of rules in place. The licence allotted to a Industrial Policy
Framework
manufacturing unit basically specified the whereabouts of the unit including
site of the plant, merchandise to be manufactured, period within which the
industrial capacity is to be established, etc.

The key objective behind licensing was the idea to work in unison or in
agreement with the industrial policy. Any important alterations and
modifications in industrial policy would need corresponding changes in the
framework of Industrial Licensing.

The legislative framework for industrial licensing was represented in three

different Acts:

• Industries Development and Regulation (IDR) Act, 1951 – This was

ordained to ensure that all industrial units obtain compulsory certificate
of registration and new industrial units to be recognized as industrial
units only after obtaining a license from the central government.

• Monopolies and Restrictive Trade Practices (MRTP) Act, 1969 – The

primary role of this framework was to control and curtail the
concentration of economic influence and discourage monopolies. It
enforced restrictions on the acquisition and transfer of shares of, or by,
certain corporate bodies, control monopolistic trade practices and restrict
unfair trade practices. Another primary objective was to control
monopolistic trade practices by promoting healthy competition.

• Foreign Exchange Regulation (FERA) Act, 1973 –This was enacted to

control the acquisition of foreign exchange or holding foreign exchange
in any form. Basically, FERA 1973 was an extension of the Foreign
Exchange Regulation Act, 1947. This Act empowered the Reserve Bank
of India and the central government to ensure that foreign exchange
earned by exports or otherwise are properly accounted for.

It was obligatory to take the permission from the Reserve Bank of India to
carry out any trade activity either commercial or industrial in nature. Even
the purchase of shares of any company required permission and this scrutiny
was applied to any acquisition of any undertaking in India.

Phase of Liberalisation

Four decades after independence, the industrial landscape underwent a drastic

change. The industrial policy’s initial approach was to safeguard and protect
the Indian industry during the initial stages of development and economic
fluctuations. But this approach did not allow the industry to expand and
adapt. Therefore, far-reaching expansions to the initial idea were made:

• Mid-1970s Onwards: During mid-1970’s advancements and

experimentations within internal trade witnessed liberalisation. This
decade marked liberation from controls including an increase in license

125
Overview of capacities and ease in licensing restrictions. Licensing policy underwent
Indian Economy
constant changes on complex features during 1970s and 1980s.

• Mid-1980s Onwards: To keep a check on fiscal, monetary and trade

policies, industrial policy was reoriented and gained a push after the mid-
1980s. Accelerated Growth and an improvement in domestic resources
was the primary aim for this momentum.

Need for an Accelerated Growth: To meet the accelerated growth,

expansions were made as follows:

• An improvement in imports meant improvement in production and hence

imports was given attention;

• Amplified exports to pay for increased imports and avoid risks of heavy
debt burden, a trait associated with large scale commercial borrowings;

• Progresses in terms of sharpening the competitive edge of exportable

goods; and

• Revisions in industrial, trade and fiscal policies to increase benefit for

exportable goods.

Domestic Resource Condition and the Need to Improve: There was an

urgent need felt to improve the condition of domestic resources and there are
few reasons listed below to understand why this was needed.

• Government budgets were no longer enough sources of investment and

finances.

• Any reduction in defence spending was not an option for the

government;

• Subsidies can be reduced only at a slow pace to avoid any major social
and political hitches; and

• Now the only way to raise additional funds was to make tax system more
comprehensive and ensure that public sector enterprises generate more
and more resources.

The above two proposals were immensely helpful in establishing the role of
market and helping expand the concepts like broad banding, minimum
economic capacity and de-licensing.

Moving further, let’s keep in mind that the period beginning with 1985
witnessed development of rule based industrial policies. This included tax
and tariff based interventions and dual pricing making direct price, output or
capacity controls obsolete.

126
Activity 1 Industrial Policy
Framework
1) Briefly enumerate the key features of evolution of India’s Industrial
Policy.

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2) Briefly explain the framework for devising the industrial policy.

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6.4 NEW INDUSTRIAL POLICY 1991

By now when economic imbalances reached precarious levels, it was
understood that the growth strategy pursued earlier was not sustainable as it
led to deficit financing. A rise in Balance of Payments (BoP) deficit cannot
be sustained with domestic resources. All these fluctuations led to a loss of
foreign exchange capital and other funds and resources.

This was a call to adapt and modify while adopting measures to adjust
budgetary deficits. The new amendments and sudden changes led to a
slowdown of economy. What added to the problem were resource constraints
in the public sector which could not provide the much needed support for
demand creation. Hope for the revival of growth process was undermined due
to the twin deficits - fiscal and BoP deficit.

This required immediate consideration and the government responded with a

suitable set of macro-economic policies along with a new industrial policy.
The new industrial policy was essentially based on the neo-classical
paradigm which was designed to push growth and help restore macro-
economic and financial stability.

A new set of policy structure and new objectives gave birth to a revised
policy and a new industrial policy was announced on July 24, 1991. The
principal objective of the new industrial policy (NIP 1991) was to
amalgamate the assets and advances gained during the four decades of
economic planning over 1951-91 and ensure that the weaknesses majorly low
127
Overview of productivity with high production costs are paid close attention. The new
Indian Economy
policy focussed on improving and maintaining a sustained growth in
industrial productivity with ample employment opportunities. A major area
of attention was to achieve international competitiveness. It was also
emphasised that these objectives will keep a check on sustainability concerns
vis-a-vis protection of environment and efficient use of available resources.

Alterations in Policy

This section will discuss the major changes in the NIP 1991 and the
preceding changes:

a) Industrial Licensing Policy: With a new wave, Industrial licensing was

eliminated for all projects excluding some industries. These industries
were primarily those industries which were of security and strategic
concern, involved in production of hazardous substances, leading to
environmental degradation or destruction etc. Industries specifically
cited to procure industrial licensing are:

• Distilleries and alcoholic drinks breweries;

• Defence equipment, electronic aerospace and defence aircraft
• Warships
• Aerospace substitutes;
• Industrial explosives including detonating fuses, safety fuses, gun
powder, nitro-cellulose and matches.
• Tobacco products.

There were three more industry groups exclusively reserved for the public
sector. These were recognised due to security and strategic concerns:

• Generation of atomic energy;

• Substances notified by the Department of Atomic Energy; and
• Railways (private funds permissible to limited amount)

There was no need for permissions and approvals from the central
government for any other industries except for the ones mentioned above.
However, it specified the locations of industries based on the level of
pollution and distance from the cities with minimum thresholds of
population.

b) Foreign Investment: The new wave witnessed new features, some of

them are:

• Barring a few sensitive sectors, automatic approval is available to

Foreign Direct Investment (FDI) in almost all sectors. The industries
are classified into groups and automatic approval is available for up
to 100 percent in specified industry groups.
128
 • Companies which are involved in export of products, majority Industrial Policy
Framework
foreign equity holding of up to 51 percent will be allowed for an
easy access to international markets.

• For the purpose of negotiations with international firms and for

approval of direct foreign investments, a Foreign Investment
Promotion Board was constituted.

c) Foreign Technology Agreements: For foreign technology agreements

in high priority industries, automatic permission be given while on a
lump sum payment of $ 2 million, 5 percent royalty for domestic sales
and 8 percent for exports. This was subject to a total payment of 8
percent of sales over a 10 year period from the date of agreement or 7
years from commencement of production (Department of Industrial
Policy and Promotion (DIPP).For all other industries - other than those
specifically mentioned, automatic permission will be given subject to the
same guidelines as in cases where no foreign exchange is required for
any payment.

d) Public Sector: The new policy was a breath of fresh air for public
sector. It was specified that public sector investments will be made in
strategic areas. Public sector was given more freedom in terms of
entering in areas not reserved for it. Also, reservations were made for the
public sector. All those public enterprises which were in a bad shape had
to be referred to the Board of Industrial and Financial Reconstruction
(BIFR) for revival schemes. Furthermore, attention was given to
encourage wider public involvement in order to increase resources. A
new view on shareholding was offered. In the public sector, a part of the
government’s shareholding was opened to mutual funds, financial
institutions, general public and workers.

e) MRTP Act: The MRPT Act allowed more freedom in terms of

removing pre-entry restrictions, prior approvals from the government for
establishing a new undertaking or while getting involved in
amalgamations or merging of industrial units. It also removed the
threshold limits of assets in respect of MRTP companies and dominant
undertakings.

6.5 ANALYSIS OF THE NEW INDUSTRIAL

POLICY
With advancement and an entry into a new and a more liberalised era
popularly referred to as economies of scale and quality, it was realised that
the Indian industry has become far more unstable than earlier. The burden
was mostly felt on the marginalised sections of the society. At this point in
time, it was important to understand and focus specifically on the weaknesses
of the new industrial policy and how the changes made it unstable and weak.
Before we proceed, let’s understand the strengths first.
129
Overview of Announcement of NIP 1991 opened up avenues and liberalisation got a
Indian Economy
robust push with major reforms but it was also realised that

• A suitable export policy was missing

• Distortions in investment patterns, some industries were booming while

others were struggling with a slow pace of investments.

• A bond between new sectors with that of older ones was missing and
thus there was a need realised in order to encourage modernisation and
new product development.

• Modernisation, deviations and reformations often lead to displacement of

labour. Labour displacement and rehabilitation issues were equally
concerning.

• Lack of technological and innovative efforts intertwined with an absence

of incentives based policy to encourage efficiency.

• Failure to designate or define a proper industrial location policy.

• Highly skewed income distribution and its related consequences

The major strengths of the new policy can be identified as:

• Changes in industrial licensing system were a major breakthrough and a

key step towards liberalisation. Abolishment of extensive physical
controls, lowering of taxes combined with better administration of
revenue collection to attract investment were some of the best changes
made to achieve growth. It also expanded the role of financial incentives
in directing investments.

• For efficiency and to strengthen domestic firms, internal deregulation

was encouraged. This is expected to inject much more competition in to
the system, creating incentives for cost reduction.

• It also looked at strengthening legal framework with the formulation of

Reconstruction of Financial Assets and Enforcement of Security Interest
Act, 2002. This act basically allows banks and financial institutions to
enforce their claims on collateral for delinquent secured credit, without
judicial intervention.

• At the same time, the Competition Act, 2003 prohibited anti-competitive

practices and abuse of power through healthy competition and regulation
of companies beyond a particular size.

• This in turn allowed internal liberalisation via open access to imports and
other interventions such as technological advancement, modernisation
and overall improvement in the industry with an aim to reduce costs and
maintain a progressive environment.

130
• Although the system was in pressure to maintain, efficiency, Industrial Policy
Framework
advancement and adapt to modern technological solutions but the
rationale to justify this was the view that pressure commensurate with
the ability of the system to respond helps maintain efficiency. However,
pressure beyond one’s ability will only be disruptive.

All in all, the aim of the policy changes aimed to introduce an integrated
economic package and to create a suitable environment for promotion of
efficiency, productivity and industrial growth through a well-coordinated
structure.

Activity 2

1) Briefly state the key features of New Industrial Policy.

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

2) Briefly enumerate the pros and cons of New Industrial Policy.

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

6.6 STATE SPECIFIC INDUSTRIAL POLICIES

With technology and innovation, India is catching up with its global
counterpart while pioneering business models and strategies. The state
governments have shown immense progress. Policies of states in Southern
region are a perfect example of how consistent compliant policy helped the
region in developing private enterprises and making investments beneficial
while nurturing MSMEs. This helped in curtailing unemployment at a drastic
rate. The state specific industrial policies have focused on simplification and
developments in the following areas:

• Single window clearance

• Labour regulation
• Online tax return filing
• Inspection reform
131
Overview of • Commercial dispute resolution
Indian Economy
• Availability of land
• Construction permit
• Access to information and transparency
• Obtaining electricity connection
• Environment registration

A Brief Comparison of State specific Policies is outlined below:

State Policies adopted

Andhra • Single Window System to setup industry within 21 days
Pradesh • Spot Registrations under Professional Tax, Registration of
Shops and Establishments Approval on self- certification
• Incentive for Subsidisation of GST, Stamp Duty
• Simplification in Land Allotment and Labour Laws
• Setting up of Skill Development Centres
Karnataka • Registrations/ approvals of 10 departments provided online
• Commercial Tax related Services provided Online
• Online Information on Availability of Land in Industrial
Areas
• Timelines fixed for providing most of the Industry related
Services
• Property Registration fully Computerized
• Online Consent for Establishment
• Online Project Monitoring System for Tracking the
Application
• Interest free Loans
• Exemption of Stamp Duty
• Concessional Registration Charges
• Setting up of Skill Development Centres
Kerala • Single Window Clearance for Industrial Units
• Setting up of Industrial Development Zones
• Incentives only to New Entrepreneurs
• Relocation of Industries to Mitigate rising Pollution
• Eco-friendly Transportation Modes
• Allotting of Land through Government Portals
• Encouragement of Women Entrepreneurs
• Employing Skilled Labourers
Puducherry • Single Window Application has been developed Online
• Interest Subsidy
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 • Fixed Power Cost Industrial Policy
Framework
• Environment Related Reforms
• Skill Development
Tamil Nadu • Single Window Facilitation for Pre- project Clearances
• Employment Intensive Subsidy
• Environmental Tax Reforms
• Skill Development
Telangana • Strengthening of Existing Single Window Clearance
System
• Reimbursement of 50% net VAT/CST or SGST
• Women owned Enterprises Additional 10% Investment
Subsidy
• 25% Subsidy on specific cleaner Production Measures

The above comparative analysis helps in understanding the initiatives of

various states in terms of industrialisation and thus also suggests way forward
for other states to devise and implement industrial policies in each state.

Case-1

The state of Tamil Nadu is an example to look and learn from. This is one
state which can boast of an impeccable infrastructure in terms of road and
railway connectivity. With 3 major and 23 minor ports along with 7 airports,
Tamil Nadu also has the most prosperous automobile industry reflecting on
how it is an epitome of effective government policy.

According to the Annual Survey of Industries Report, there is three digit raise
in employment rate between 2007-2008 and 2014-2015. Their manufacturing
of motor vehicles, trailers and semi-trailers, saw a 170 per cent increase in
the same time period. The state has a remarkable share of employment which
saw a jump from 7 per cent in 2007-2008 to 12 per cent in 2014-2015.

Building of Automotive Suppliers Parks and new auto cluster districts was a
smart move which helped create auto cities, design and tech parks and
logistics hubs while keeping a check on costs. This highlighted how shared
facilities and technological advancement help in growth and building
sustainable models to enhanced growth in the sector. The government is
involved in developing two major corridors namely Chennai-Kanyakumari
corridor with an aim to spur growth across the state.

6.7 OTHER IMPORTANT POLICIES FOCUSING

ON INDUSTRIAL PROMOTION
India being an agriculture based economy has built and helped evolve small
scale enterprises and is known across Asia and the world for building the
most elaborate development programmes for small enterprises and for 133
Overview of providing assistance both on an individual and institutional level. These
Indian Economy
developmental programmes are not confined to certain areas but have been
rolled out both for urban as well as rural settings.

With an era of advancement during the post-reform period, the focus shifted
to promotion and up gradation. The quest for promotion demanded
modernisation of Small Scale Industry (SSI) units, an improvement in quality
of output and technological advancement which needed massive funding.
Therefore, access to technology, finances and innovation were few pre-
requisites to sustain competition.

Moreover, access to marketing opportunities and assistance in marketing are

key requisites apart from these three core areas - quality, finance and
technology. So, a broad policy package was announced for small-scale
industry in March 1994. These new sets of policies were based on the
recommendations of S.P. Gupta Committee with inputs from others in June
1998. The success of the new SSI policy was intertwined with many other
linked schemes such as quality control, technology up-gradation, introduction
of better marketing schemes besides single window clearance scheme for
composite loans, etc.

To ensure this, various other policies played an important role. The

Competition policy was an important intervention to ensure healthy
competition and promotion of SSI’s.

Competition Policy

As discussed earlier, there were many constraints on competition in the pre-

reforms era:

• Apply for and procure license which restrained investments;

• Restrictions to enter for new enterprises;
• There were restrictions on acquisition of economic control through
MRTP;
• Widespread monopolies due to reservation for public sector and other
industries;
• Small scale industries were under constraints of product reservation;
• High tariffs and other policy interventions to restrict trade.
• Foreign direct investments were under strict scrutiny.

For a healthy competitive environment and to ensure efficient production,

two factors were recognised as vitally important. One was to allow Indian
players become independent and competitive globally and second was to
create an accessible atmosphere in the domestic market. This was introduced
to help increase competitive edge of Indian players and boost competitive
strength of Indian economy.

134
To achieve this, encouraging competition to achieve efficiency, better Industrial Policy
Framework
allocation of resources and at the same time ensuring consumer well-being
was the key. This can be achieved only when other policies and laws are in
sync.

To bring the different aspects of economic growth and to ensure strong

market presence, a single law was much needed which could help bring
mutually supporting laws, other economic policies and institutional structures
under one umbrella including those relating to FDI, infrastructure and
international trade.

It was realised that there was an urgent need to promote competition in view
of the international developments. This necessitated comprehensive design,
thinking and a policy structure in place. So, under the chairmanship of Shri
S.V.S. Raghavan, the Government of India set up a nine-member committee
in October 1999 to recommend a judicial and administrative framework.

On recommendation of the expert committee, the government passed the

Competition Act, 2003 replacing the MRTP Act. This came into existence
with a key aim of supporting and promoting competition while prohibiting
anti-competitive practices.

The Competition Commission of India (CCI) was soon established and set up
under the Competition Act, 2003 with an aim to promote spirited competition
while preventing abuse of dominance.

Some major objectives of the Competition Commission of India are:

• To stop practices which adversely affect competition

• Encourage and endure competition in market
• Ensure quality of products and services is up-to mark.
• Consumer welfare
• Allow freedom of trade in the markets of India

For CCI to work as a market regulator, other bills were passed such as the
Competition Amendment Bill (2007).

It was laid to ensure

• good quality products and services are available

• promote fair and healthy competition
• easy and fast mergers and acquisitions
• regulation of acquisitions and mergers within the threshold limits
• preventing abuse while allowing control

Despite concerns, the new competition law in India is based on a robust

competitive market model which is consistent and in sync with fresh
competition ready to meet the new challenges. India appears to have taken a
significant step but the measurement of success depends on implementation.
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Overview of The Special Economic Zone (SEZ) Act, 2006
Indian Economy
The Special Economic Zone (SEZ) Act, 2006 emphasised on the
development of specific areas for promoting manufacturing and exports. The
main incentives are:

• Duty-free import of capital goods, raw materials, consumables and

spares
• Tax exemption on export profits for the first five years
• Exemption from minimum alternate tax (MAT)
• Goods purchased from domestic tariff area (DTA) are exempt from sales
and service tax
• Exemption from stamp duty, registration fee and electricity duty
• No tax on income from dividends and long-term capital gains tax
• 100% FDI allowed for developers.

Activity 3

1) Briefly enumerate State Specific Industrial Policies.

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

2) Briefly explain the importance of other policies supplementing industrial

policy framework in India.

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

6.8 SUMMARY
India opted for Industrial development and initially conceived the Industrial
Policy Resolution, 1948. Industries (Development & Regulation) Act, 1951
(referred as IDR Act) was also enacted to keep abreast with national
development objectives. To achieve sustainable growth, the policy explored
prospects to deregulate Indian industry while easing restrictions. Since 1991,
economic reforms envisioned a new and substantial role for private entities.
136
Since Industrial Policy Resolution (IPR) of 1956, Industry-led-growth Industrial Policy
Framework
strategy was adopted and led to involvement of private sector, expansion of
heavy industry’s base in the public sector and further promoting and
enhancing growth of cottage and small scale industries by establishing large
co-operative sector.

In 1991 when economic imbalances reached precarious levels, it was

understood that the growth strategy pursued earlier was not sustainable as it
led to deficit financing. A new set of policy structure and new objectives
gave birth to a revised policy and a New Industrial Policy, 1991. The
principal objective of the New Industrial Policy (NIP) 1991 was to
amalgamate the assets and advances gained during the four decades of
economic planning over 1951-91 and ensure that the weaknesses majorly low
productivity with high production costs are paid close attention. The new
policy focused on improving and maintaining a sustained growth in industrial
productivity with ample employment opportunities.

With technology and innovation the state governments have shown immense
progress. Southern region is a perfect example of how consistent compliant
policy helped the region in developing private enterprises and making
investments beneficial while nurturing MSMEs. This helped in curtailing
unemployment at a drastic rate. With an era of advancement during the post-
reform period, the focus shifted to promotion and up gradation. The quest for
promotion demanded modernization of SSI units, an improvement in quality
of output and technological advancement which needed massive funding.
Therefore, access to technology, finances and innovation were few pre-
requisites to sustain competition. Moreover, access to marketing
opportunities and assistance in marketing are key requisites apart from these
three core areas - quality, finance and technology.

6.9 KEY WORDS

Broad-banding: This was one concept introduced to give flexibility to
licensed units. Under this, the product-mix within the overall ceiling was
sanctioned to licence holders.

Minimum Economic Capacity: An efficient scale of production was

recognised - production at a scale which allows overall low average costs.
More generally, there was no ceiling but only a threshold floor level
prescribed.

Delicensing: Exempted from licensing requirements.

Public Sector: It includes public goods and governmental services such as

the military, law enforcement, infrastructure, transport, education, healthcare,
etc.

Tariff Rates: A tariff is a tax imposed by a government on goods and

services imported from other countries that serves to increase the price and
137
Overview of make imports less desirable, or at least less competitive, versus domestic
Indian Economy
goods and services.

Monopolies: A monopoly refers to when a company and its product offerings

dominate one sector or industry.

Liberalisation: Removal or reduction of restrictions or barriers on the free

exchange of goods between nations.

Single Window Clearance: It is a trade facilitation concept which allows to

provide information required by various official agencies via one regulatory
body.

Small Scale Industries: Those industries in which the manufacturing,

production and rendering of services are done on a small or micro scale.
These industries make a one-time investment in machinery, plant, and
equipment, but it does not exceed Rs. 10 crore and annual turnover does not
exceed Rs. 50 crore.

Special Economic Zones (SEZs): An area in a country that is subject to

different economic regulations than other regions within the same country.
The economic regulations of Special Economic Zones tend to be conducive
to—and attract—Foreign Direct Investment (FDI)

Domestic Tariff Area: An area within India that is outside the Special
Economic Zones and EOU/EHTP/STP/BTP. The units operating under
certain specific schemes such as EPZ/SEZ/EOU are expected to carry out
their activities within a customs bonded area.

Foreign Direct Investment (FDI): FDI is an investment made by a firm or

individual in one country into business interests located in another country.
Generally, FDI takes place when an investor establishes foreign business
operations or acquires foreign business assets in a foreign company.

The Goods and Services Tax (GST): GST is a value-added tax levied on
most goods and services sold for domestic consumption. The GST is paid by
consumers, but it is remitted to the government by the businesses selling the
goods and services.

6.10 SELF-ASSESSMENT QUESTIONS

1) Critically compare the pre and post New Industrial Policy 1991 in India.

2) Give a roadmap for adoption of State Specific Industrial Policies by all

states of India.

3) Suggest changes in the present trade and industrial policy of India to

ensure adequate growth of the country.

138
6.11 REFERENCES/ FURTHER READINGS Industrial Policy
Framework

• Bhaduri, Amit, (2009): The Face You were Afraid to See: Essays on the
Indian Economy, Penguin.

• Deshpande, Ashwini (ed.), (2007): Globalisation and Development,

Oxford Unviersity Press, New Delhi.

• Gregory, Neil, (2009): New Industries From New Places, Stanford

University Press.

• Gokarn, Subir et. al. (eds.), (2004): The Structure of Indian Industry,
Oxford University Press, New Delhi.

• K.L. Krishna and Uma Kapila (ed.), (2009): Readings in Indian

Agriculture and Industry, Oxford, New Delhi.

139
Overview of
Indian Economy UNIT 7 AGRI-BUSINESS ENVIRONMENT

Objectives

After reading this unit you should be able to:

• analyse the trends in agricultural production, sales and exports in India;

• explain the framework of evolution of Farm Policies in India;
• analyse the Farm Reforms 2020;
• identify the gaps and key players in the Agriculture Sector; and
• assess the role and importance of Agriculture Marketing.

Structure

7.1 Introduction
7.2 Trends in Agricultural Production, Sales and Exports
7.3 Evolution of Farm Policies in India
7.4 Farm Reforms 2020
7.5 Key Players in the Agriculture Sector
7.6 Role and Importance of Agricultural Marketing
7.7 Summary
7.8 Key Words
7.9 Self-Assessment Questions
7.10 References/ Further Readings

7.1 INTRODUCTION
Since independence, the agricultural sector has witnessed a mixed path with
significant progress in agricultural development in India. The progress can be
witnessed through increase in crop production, productivity, diversification,
and technological developments. During the initial years, there were some
hiccups and growth stagnated. However, since the mid-1960s, growth rate
started moving up and gained momentum especially during the mid-1980s
but started losing the pace in 1990s and this was tilted towards foodgrains to
address the issue of food security. In recent years for those dependent on
agriculture as a key source of livelihood, it is turning un-sustainable in terms
of economic and social consequences - majorly agrarian crisis with a
sweeping migration to the cities and farmers’ suicides etc.This cast doubt on
the future growth prospects of the Indian economy, which is majorly
dependent on the growth performance of agriculture. Besides, our import
needs are well-established when it comes to essential food products such as
pulses and edible oils.

140
So, to understand the various trends and factors responsible in shaping Agri-Business
Environment
India’s agricultural landscape, it is essential to know the economic reforms
and regeneration with a sustained and broad-based agricultural development.
This calls for an understanding of the factors that may have contributed to
shaping past trends and will also help in designing the future strategy of
development. This unit brings forth some of the important issues in order to
understand the agriculture environment in detail.

7.2 TRENDS IN AGRICULTURE PRODUCTION,

SALES, AND EXPORTS
More than half of the country is reliant on agriculture since it is the prime
source of living and employment for about 58% of Indian population. The
latest data highlights that growth in Gross Value Added (GVA) in agriculture
and allied sectors stood at 4% in 2020. Considering this, the Indian food
industry is on the threshold of massive growth, increasing its contribution to
world food trade every year. The food industry has a huge potential for value
addition with a bright prospect, where the Indian food processing industry
accounting to 32% of the country’s total food market. It is one of the largest
industries in India and is ranked fifth in terms of production, consumption,
export and expected growth (IBEF 2020).

Currently, the food and grocery market in India is the sixth largest globally,
with retail contributing to 70% of the sales and the agriculture, forestry and
fishing growth is predicted to be 3% in the 2021.

India is one of the leading exporters of agricultural products globally. The

food grain production was estimated to reach a record 295.67 million tonnes
(MT) during the year 2019-20 and the government has set a higher food grain
production target in 2020-2021. According to Indian Sugar Mills Association
(ISMA), the production of sugar in India reached 26.46 MT between October
2019 and May 2020 whereas horticulture crops in India stood at a record
320.48 million metric tonnes (MMT) in 2020.The organic food sector is
pacing at an advanced rate and is expected to reach Rs. 75,000 crore (US$
10.73 billion) by 2025.

Various government initiatives, investments and interventions have helped

the Indian food processing industry to attract Foreign Direct Investment
(FDI) inflow. The business has attracted US$ 10.20 billion between April
2000 and September 2020 according to the figures released by Department
for Promotion of Industry and Internal Trade (DPIIT). Few other initiatives
in the sector that helped boost growth are subsidiaries in agricultural loans,
introduction of forest fresh organic products, Pradhan Mantri Fasal Bima
Yojana which collates data infrastructure for farmers. Another initiative is the
introduction of animal husbandry infrastructure and launch of National
Animal Disease Control Programme (NADCP), which aims to eradicate foot
and mouth disease. Launch of various mega food parks including one in
141
Overview of Punjab, launch of PM Matsya Sampada Yojana, e-Gopala App and several
Indian Economy
initiatives in fisheries production, dairy, animal husbandry and agriculture,
along with a Transport and Marketing Assistance (TMA) programme to
provide financial support for transport and marketing of agriculture products
(IBEF 2020).Other major intervention was the approval of the Agriculture
Export Policy, 2018 which aims to increase India’s agricultural exports to
US$ 60 billion by 2022. Enhancing the aptitude of food processing sector in
India and allowing 100% FDI in promotion and marketing of food products
and in food product E-commerce under the automatic track are other major
interventions to escalate productivity and growth.

There have been many notable achievements in the sector such as in line of
mega food parks and other sectors. Of the total 37 food parks, 21 mega food
parks are operational, coffee export has shown promising results and stands
at US$ 742.05 million in 2020 while tea exports stand at US$ 709.28 million
in FY 2020. After the launch of Electronic National Agriculture Market (e-
NAM) in April 2016, more than a thousand market places (mandis) are
linked to e-NAM. This was an initiative to create an integrated market for
agricultural products.

The farming and food production in India is expected to fast-track its pace of
growth in the coming years and is expected to achieve its aspiring aim of
amplifying farm income by 2022. This has become possible because of
increased investment in agricultural infrastructure such as irrigation facilities,
ware-housing and cold storage. An overall increase in usage of genetically
modified crops will likely improve the yield for Indian farmers with the help
of concerted efforts of scientists. Self-reliance in pulses in next few years
with the help of minimum support price will be another step. Other areas
focussing on adoption of good manufacturing, food safety and quality
assurance mechanisms is essential for development and enhancement. This
will immensely help in achieving Quality Management and Good Hygienic
Practices by the food processing industry and will in turn open more avenues
and offer benefits.

7.3 EVOLUTION OF FARM POLICIES IN INDIA

Legislative powers are distributed between the centre and the states through
the Seventh Schedule of the Indian Constitution. Agriculture is part of the
State List therefore only individual states have the power to legislate on such
matters, but the Central Government has residual powers.

Domestic Agricultural Policies

1947-1965

During the initial years, achieving self-sufficiency was the primary objective
of India’s agricultural policies which was aimed to improve food security.
Since the principal aim of the land reforms was to get rid of challenges
142
imposed by middlemen with an improvement in production while focussing Agri-Business
Environment
on establishing worker ownership and equity in rural society. In view of this,
the first major reform that was enacted by the states post-Independence was
the Zamindari Abolishment Act (1950s). To place an upper limit on the size
of agricultural land holdings, establishing state control on vacant lands and to
distribute the acquired idle land to the disadvantaged rural population was
established to provide security to the renters.

1965-1980

The era marked Green Revolution, launched in 1965. It focussed on using

innovative techniques and increasing crop productivity with the help of
technology. India started importing high yielding varieties (HYVs) of wheat
and rice and adopted improved pesticides, fertilisers and irrigation methods
which led to increased food grain production. For further amendments, the
government set up important institutions in 1965. One was the Commission
for Agricultural Costs and Prices (CACP) previously called the Agricultural
Prices Commission and the Food Corporation of India (FCI).

To lend money to farmers and increase lending by enhancing flow of credit

to the agriculture sector, new financial institutions including the National
Bank for Agriculture and Rural Development (NABARD) and Regional
Rural Banks (RRBs), were set up and 14 largest commercial banks were
nationalised in 1969 in view of this.

1980-1991

The focus was on improving crop production during the Green Revolution,
so the corresponding years focussed on expansion in the use of green
revolution technologies to other crops and regions. As agricultural output
rose, production began to diversify into high value commodities, such as fish,
poultry, milk, fruits, and vegetables.

1991 onwards

The agricultural reforms lagged the general economic reforms but over time
the policies regulating agricultural trade were relaxed. A major step was the
transition from the Public Distribution System (PDS) to the Targeted Public
Distribution System (TPDS) in 1997 aimed to ensure that impoverished
people get access to food at subsidised prices. In July 2000, the Government
of India announced the country’s first ever National Agriculture Policy
(NAP). This policy aimed at achieving a growth rate more than 4% per
annum in the agriculture sector. The objectives of this policy were to create
employment opportunities for rural population, accelerate the growth of agro
businesses, explore and realise the massive untapped growth potential of
Indian agriculture, promote better standard of living for rural population,
discourage relocation from rural to urban population and to overcome the
trials arising due to economic reforms of 1991.

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Overview of Marketing Policies
Indian Economy
The National Policy for Farmers (NPF) approved by the Government in 2007
recognized a need to emphasise on increasing farmer’s incomes along with
production. The five-year plans also recommended policy initiatives to
enhance the working of the agricultural sector. The National Food Security
Act (NFSA) was enacted on 12 September, 2013 with the objective to
provide for food and nutritional safety by guaranteeing access to a good
amount of quality food at affordable prices.

Essential Commodities Act (ECA)

An earlier amendment to the Indian Constitution granted the Union

Government a statutory right to standardise and regulate the production,
pricing, and delivery of essential commodities.

The most fundamental policy instrument is the Essential Commodities Act,

1955 (ECA), which aims to control production, supply, distribution, and
pricing of essential commodities to ensure that essential commodities are
made available to the consumers at fair prices. Under this Act, Centre and
State Governments have the power to impose stock limits on the identified
commodities to prevent hoarding. They can also direct a stockholder to
compulsorily sell their stock to the government, regulate prices and ban the
holding back of a product or good for sale.

Agricultural Produce Market Regulation Acts (APMC)

During the 1960s and 1970s, most of the states passed Agricultural Produce
Markets Regulation (APMR) Acts. These Acts are popularly called the
APMC Acts since they regulate markets through Agricultural Produce
Market Committees (APMCs). A State’s APMC Act authorizes the state to
set up regulated wholesale markets (mandis or APMC markets) for
agricultural products. The APMCs have the power to control agricultural
markets and regulate all features of marketing, including the imposition of a
mandi tax for trade taking place both on and off the wholesale markets.

The Act covers the entire state and makes these mandis the required channel
for trading farm produce, and does not allow private players from setting up
markets. In 2003, the Ministry of Agriculture created a model APMC Act
and circulated into the states so that they could modify their individual acts.
This was followed by the model APMC rules in 2007.

Minimum Support Price

The pricing policy defined in the ECA and APMC Acts aims to ensure that
farmers receive lucrative prices for their produce while also ensuring that it is
affordable for consumers. In order to do so, the central government sets a
Minimum Support Price (MSP) for 24 crops every year. The FCI and several
state level agencies working in support of the FCI are required to procure the
specified commodities from farmers at the notified prices (MSP). But this
144
mechanism operates effectively only for a few commodities (primarily for Agri-Business
Environment
wheat, rice and cotton) and only in a few states. A large number of farmers
are required to trade with other buyers at prices lower than the specified
MSP, especially in eastern India due to ineffective procurement and lack of
alternative buyers.

Activity 1

1) Briefly enumerate the key trends in India’s Agri-Business Environment.

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2) Briefly explain the framework for evolution of the farm policies in India?

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7.4 FARM REFORMS 2020

On 27th September 2020, Ram Nath Kovind, the President of India gave his
acceptance to the 3 farm bills that were earlier passed by the Indian
Parliament. These Farm Acts are as follows:

Farmers' Produce Trade and Commerce (Promotion and Facilitation)

Act, 2020

This Act permits farmers to sell their produce outside the APMC regulated
mandis but it does not abolish them. It aims to provide lucrative prices to
farmers via alternative trade channels. It also prohibits state governments
from imposing any tax on the trade of produce outside the mandis.

Farmers’ (Empowerment and Protection) Agreement on Price

Assurance and Farm Services Act, 2020

It creates a national framework for contract farming. Although contract

farming was legal prior to the enactment of this act as well, this act aims to
provide a complete comprehensive outline for such an arrangement. This will
enable farmers to contract a guaranteed price for their produce prior to
production/sowing. 145
Overview of Essential Commodities (Amendment) Act, 2020
Indian Economy
The ECA has been amended to state that the Government of India will list
few commodities as essential and control their supply and prices only in
cases of war, famine, extraordinary price rises, or natural calamities. Other
produce including cereals, pulses, potato, onion, edible oilseeds, and oils
have been deregulated. The amended act also states that the government will
impose stock limits on essential commodities only when the rise in price is at
least 100% for horticultural produce and 50% for non-perishable agricultural
produce.

The enactment of these acts has created fear in the minds of farmers and has
led to widespread protests. Despite several rounds of talks, the government
and the farmers have not been able to arrive at a mutually agreeable solution.
The farmers fear that increased private sector participation will lead to
exploitation and that their interests will not be safeguarded. Although the
government has made several attempts to pacify the farmers, they have all
been in vain.

Activity 2

1) Briefly enumerate the key features of India’s new farm policies.

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2) Briefly compare the old agricultural policies with farm laws 2020.

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7.5 KEY PLAYERS IN THE AGRICULTURE

SECTOR
With growth and increase in production, the active role of middlemen in the
movement of agricultural commodities which specialise in performing
marketing roles and are involved in marketing of products has increased. The
number of mediators can be classified into five groups as follows.
146
 Agri-Business
Environment

Merchant Middlemen

Merchant middlemen are the ones who take title of the goods they deal in
while buying and selling. Their earning or loss depends on the sale and
purchase prices. They are of four types:

a) Wholesalers: Those who buy agricultural commodities in large

quantities directly from farmers or from other wholesalers. They mainly
assemble the goods from various localities and store produce and often
release them in the off-season since they store them in the peak arrival
season.

b) Retailers: They buy from wholesalers and sell it directly to consumers

in small quantities. Retailers are the closest to consumers in the
marketing channel.

c) Village merchants: The vendors or retailers who move from village to

village to directly purchase the produce from the cultivators. Village
merchants purchase the produce of those farmers who have either taken
finance from them or those who are not able to go to the market. Village
merchants also supply essential consumption goods to the farmers. They
often act as the financers of poor farmers and sell the collected produce
in the nearby market or the villages.

d) Mashakakhores: It is a colloquial term for big retailers who often act as

small wholesalers and majorly deal in fruits and vegetables. They usually
sell to bulk consumers like hotels, para-military units or small
retailers/vendors. Over the years, they have started dealing with all types
of customers without the condition of a minimum quantity and are
working like ordinary retailers.

Agent Middlemen

They are basically representatives of clients and do not own the products.
They act as negotiators between sellers and buyers and help them in sale and
purchase of products. They usually receive commission or brokerage on sale.
Agent middlemen are of two types:

147
Overview of a) Commission Agents: A commission agent generally operates in the
Indian Economy
wholesale market and acts as the proxy of either a seller or a buyer by
representing them in buying and selling of products.

b) Brokers: They act as communicators between buyers and sellers to bring

them on the same platform while facilitating personal services to their
clients in the market. They may claim brokerage from buyer, sellers or
both depending upon the market situation as they simply wander to
render their services to clients.

Speculative Middlemen

These middlemen are the ones who buy products at a low price when arrivals
are sizable usually in off-season when prices are high. They take claim of the
product and risk associated with an aim to make a profit on it.

Processors

Processors are the ones who hire agents to buy for them from areas where
production is high and bring on their businesses either on their own or on
custom basis. Agents may also store the products and may deal with it
throughout the year on continuous basis. They often are involved in
advertising to generate demand for their managed goods and add farm utility
to farm goods.

Facilitative Middlemen

As the name suggests, these middlemen facilitate buying and selling while
assisting in the marketing process. They get their income in the form of fees
or service charge since most of them are labourers who help in physical
movement of goods and products while loading and unloading them.
Weighmen and graders also fall into this category since they facilitate
weighing of produce and grade products according to different categories.
They are often termed as the core of the marketing wheel.

Transporters who assist in movement of the produce from one market to

another and communication agencies including advertising agencies that
majorly help in decision making about the purchase of goods are a part of this
group. Auctioneers who help in exchange of produce by putting the produce
for public sale and bidding by the consumers or buyers are equally important
and help in ironing out the marketing system.

7.6 ROLE AND IMPORTANCE OF

AGRICULTURAL MARKETING
Agricultural marketing has a vital role as it helps in encouraging the process
of production and consumption. It equally helps in accelerating the pace of
fiscal development since it is an important multiplier of agricultural
development.
148
A shift from traditional to modern agriculture system has been a challenge Agri-Business
Environment
and marketing has been a big experiment in the entire process. But the role of
marketing remains utmost important. The importance of agricultural
marketing is revealed from the following:

Optimization of Resource use and Output Management

The key role of an efficient marketing system is to help the market in pulling
down the losses and accelerating the marketable surplus. The marketing
losses often arise due to inefficiency in processing, storage and transportation
of products. An efficient marketing wheel will help in optimization of
resources and output management and a well-thought out system of
marketing can help in even distribution of available stocks. Taking
everything into account, it is indeed a modern approach to sustainable growth
and sustains it.

Increase in Farm Income

Reducing the number of middlemen while ensuring higher level of income to

restrict the cost of marketing services and the malpractices is what a good
marketing system would aim at achieving. An efficient system assures
improved prices for farm products and encourages them to invest their
surpluses in buying modern inputs so that yield and produce may increase.

Widening of Markets

When a system widens the market by taking the products to remote corners
both within and outside the country is considered profitable since it increases
the demand on a continuous basis while guaranteeing a higher income to the
producer.

Growth of Agro-based Industries

Agri-dependant industries rely on the supply of raw materials such as cotton,

sugar, edible oils, food processing and jute on farm produce and therefore
require an efficient system to help in the growth to encourage the overall
development process of the economy.

Price Signals

Efficient marketing systems allow farmers in scheduling and arranging their

production in accordance with the needs of the economy. This work is carried
out through transmitting price signals.

Adoption and Spread of New Technology

Adapting to demands and adopting latest technologies and scientific

knowledge always leads to growth. But a technology upgrade requires greater
investment and farmers would invest only if they are guaranteed of ago-
ahead at remunerative price.

149
Overview of Employment Creation
Indian Economy
This is a system of marketing which focuses on employment generation and
engages millions of people in activities, such as wrapping, packing,
transferring, storing and doling out.

Persons like commission agents, brokers, traders, retailers, weighmen,

hamals, packagers and regulating staff are directly employed in the marketing
system. Apart from them, several others are able to look for employment
opportunities when dealing with supply of goods and services.

Addition to National Income

Marketing events are value additions to the product since they increase the
nation's gross national product and net national product.

Improved Living

Development that adds to growth while diminishing poverty of the

population and adds to foreign exchange while eliminating economic waste
should be given special attention. The development of an efficient marketing
for food and agricultural products is also vital to overall economic
development. The marketing system is the key for the success of the
development programmes which are aimed to uplift people.

Activity 3

1) Briefly enumerate the key stakeholders in the Agriculture Sector in

India.

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2) Briefly explain the importance of agricultural marketing.

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150
7.7 SUMMARY Agri-Business
Environment

The agriculture sector in India has come a long way since Independence in
India. With initial roadblocks post independence to major reforms in 1960s
which escalated growth to a downfall in mid 1980s and 1990s to a shift in
production pattern to food grains to cater to growing food security issues.
Majority of the population in India depends on the agrarian sector as a prime
source of livelihood but shift in patterns of employment and migration to
cities has caused a doubt on the growth prospects of Indian agriculture sector.
In 2020, it was seen that 58% of India’s population depends on agriculture as
the primary source of livelihood and growth of the sector stood at 4 percent.
India is one of the leading exporters of agricultural products globally. A
number of government initiatives, investments and interventions have helped
the Indian food processing industry to attract Foreign Direct Investment
(FDI) inflow. In the coming years, the Indian agricultural sector aims at
doubling farm income and introducing better infrastructural facilities for
irrigation and storage. The minimum support price also aims at making each
sub sector of the agricultural sector self sufficient.

From 1947-1965, achieving self sufficiency was the key objective and thus
improving food security along with abolishing of the Zamindari System. In
1965, Green Revolution was launched and a number of innovative
techniques, irrigation methods, pesticides and setting up of key institutions
were introduced. To strengthen flow of credit to the agricultural sector,
Banks were nationalised and new financial institutions were set up
specifically for the agricultural sector. In the 1980s, production in the
agricultural sector diversified to high value commodities like poultry,
fisheries and dairy. In 1997, a major step was the transition from the Public
Distribution System (PDS) to the Targeted Public Distribution System
(TPDS). The National Agriculture Policy was announced in July 2000 in
order to create employment opportunities for rural population, accelerate the
growth of agro businesses, explore and realise the massive untapped growth
potential of Indian agriculture, promote better standard of living for rural
population and to discourage relocation from rural to urban population. In
2007, National Policy for Farmers (NPF) and in 2013 National Food Security
Act (NFSA) was enacted. These acts helped in increasing farmer incomes
and guaranteeing nutritional security by regulating food prices.

The agriculture sector has been well protected by the Essential Commodities
Act , 1955 according to which government controls the production, supply,
distribution, and pricing of these commodities to ensure that they are made
available to the consumers at fair prices along with the APMC Act regulated
by states. In 2020, new farm reforms were enacted and now farmers are
permitted to sell their produce outside the APMC regulated mandis but it
does not abolish them. It aims to provide lucrative prices to farmers via
alternative trade channels. A national framework for contract farming has
also been introduced. The Essential Commodities Act was also amended in
151
Overview of 2020 and it states that certain commodities will be listed as essential and
Indian Economy
government will regulate their supply and prices only in cases of war, famine,
extraordinary price rises, or natural calamities. Several commodities
including cereals, pulses, potato, onion, edible oilseeds, and oils have been
deregulated.

To increase production of agricultural commodities, a number of

players/middlemen have emerged over the years. Only enhancing production
will not be of any help, hence agricultural marketing as a concept has picked
up pace. These intermediaries are primarily Merchant middlemen acting as
wholesalers, retailers, Village merchants and Mashakakhores. Then there are
agent middlemen who cater to activities like negotiations between buyer and
seller for commissions. Speculative middlemen buy products at a low price
when arrivals are sizable usually in off-season when prices are high.
Processors are the ones who employ agents to buy for them from areas where
production is high either and carry on their businesses either on their own or
on custom basis. Facilitative middlemen facilitate buying and selling while
assisting in the marketing process. Transporters who assist in movement of
the produce from one market to another and communication agencies
including advertising agencies which majorly help in decision making about
the purchase of goods are a part of this group.

Agricultural marketing has a vital role as it helps in Optimization of Resource

use and Output Management, Increase in Farm Income, Widening of
Markets, Growth of Agro-based Industries, Price Signals, Adoption and
Spread of New Technology, Employment Creation, Addition to National
Income and Improved Living.

7.8 KEY WORDS

Gross Value Added (GVA): It is an economic productivity metric that
measures the contribution of a corporate subsidiary, company, or
municipality to an economy, producer, sector, or region. GVA thus adjusts
gross domestic product (GDP) by the impact of subsidies and taxes (tariffs)
on products.

Foreign Direct Investment (FDI): FDI is an investment made by a firm or

individual in one country into business interests located in another country.
Generally, FDI takes place when an investor establishes foreign business
operations or acquires foreign business assets in a foreign company.

Minimum Support Price (MSP): It is an agricultural product price, set by

the Government of India to purchase directly from the farmer. This is not
enforceable by law. By definition, this rate is to safeguard the farmer to a
minimum profit for the harvest, if the open market has lesser price than the
cost incurred.

152
Legislative Power: It is exercised for giving exemption from licensing Agri-Business
Environment
requirements.

Green Revolution: It is the Third Agricultural Revolution, is the set of

research technology transfer initiatives occurring between 1950 and the late
1960s that increased agricultural production worldwide, beginning most
markedly in the late 1960s.

Commission: Getting paid for an activity.

Liberalisation: Removal or reduction of restrictions or barriers on the free

exchange of goods between nations.

7.9 SELF-ASSESSMENT QUESTIONS

1) Critically compare the pre and post 2020 Agricultural Reforms in India.

2) Give a roadmap for modifying the existing farm laws and also state their
shortcomings.

3) Suggest changes in the present Agricultural Policy of India to ensure

adequate growth of the country.

4) How will contract farming change the agriculture landscape in India?

Discuss in detail.

7.10 REFERENCES/ FURTHER READINGS

• Mishra, Srijit and D. Narasimha Reddy (2011): Persistence of Crisis in
Agriculture: Need for Technological and Institutional Alternatives (in
India Development Report, 2011, edited by D.M. Nachane, Oxford
University Press, New Delhi).

• Deshpande R S and Shah Khalil (2007), Agrarian Distress and

Agricultural Labour, The Indian Journal of Agricultural Labour, Vol.
50(2), July.

• India Brand Equity Foundation, www.ibef.org.

153
Overview of
Indian Economy

154
 Agri-Business
Environment

BLOCK 3
STRUCTURAL REFORMS

155
Overview of
Indian Economy BLOCK 3: STRUCTURAL REFORMS
Economic Reforms through Liberalisation, Privatisation, Globalisation
brought in a wide range of changes in different sectors of the economy which
has major implications on businesses. This block concentrates on reforms in
key sectors of the economy and has following two units:

Unit 8: New Economic Policy

Unit 9: Financial Sector and Fiscal Sector Reforms

156
UNIT 8 NEW ECONOMIC POLICY New Economic Policy

Objectives

After reading this unit you should be able to:

• understand the history of economic reforms introduced in 1991;

• discuss the meaning and measures related to Liberalisation. Privatisation
and Globalisation; and
• discuss the latest economic policies of the Government like Pradhan
Mantri Jan Dhan Yojana, Mudra Scheme, Swach Bharat Mission,
Atmanirbhar Bharat and others.

Structure

8.1 Introduction
8.2 New Economic Policy (1991)
8.3 New Economic Policy (2014)
8.4 New Economic Policy (2020)
8.5 Other Initiatives
8.6 Summary
8.7 Key Words
8.8 Self-Assessment Questions
8.9 References/ Further Readings

8.1 INTRODUCTION
The year 1991 is one of the landmark years in India’s economic history as
Economic Reforms or New Economic Policy (NEP) or policy of
Liberalisation, Privatisation and Globalisation (LPG) were initiated in this
year. Indian economy witnessed a paradigm shift from the policy of licence
raj to liberalisation and nationalisation to privatisation.

The introduction of economic reforms was not merely a coincidence but the
consequence of a multitude of problems that were brewing in the system for
many years. Factors that led to the introduction of these policy changes can
be classified into two factors namely i) international, ii) domestic.
International factors like the disintegration of the Union of Soviet Socialist
Republics (USSR) and the Gulf wars. These factors led to a decline in Indian
exports on one hand and a rise in crude oil prices along with a fall in
international remittances on the other. This was translated into the Balance of
Payments (BoP) crisis, fall in foreign exchange earnings and widening of the
trade deficit. Domestic factors like burgeoning fiscal deficit and inflation
further fuelled the problem. The fiscal deficit reached a height of 8.4 % in
1990-91and the inflation rate was in double digits. India’s foreign exchange 157
Structural reserves were fast depleting and they were sufficient for only three weeks of
Reforms
imports. India was in a precarious situation of default and debt.

To overcome these crises, India approached International Monetary Fund

(IMF) for grants and assistance. IMF provided assistance with certain terms
and conditions which necessitated certain changes in the economic system.
Further, the policymakers also thought that it was a ripe time to learn from
the growth experiences of other countries like East Asian Economies and to
bring about a reorientation in the working of the economic system. This led
to the introduction of economic reforms in India. These reforms have two
main aspects namely macroeconomic stabilization measures and structural
adjustment measures. Macroeconomic stabilization measures included tax
reforms, the balance of payment reforms, monetary policy reforms and
inflation control. Structural adjustment reforms included new industrial
policy, banking sector reforms, phasing out subsidies, disinvestment and
others. Both these policy changes led to liberalisation processes in the form
of de-licencing, de-reservation and de-regulation. Increasing the role of
private sectors in the functioning of the economy and disinvestment connotes
privatisation. Further, changes in trade policies like reducing the rates of
duties and tariffs made trade attractive, the flow of FDI and integration with
world economy or globalisation. Our orientation shifted from ‘Inward
looking policy’ to ‘Outward looking policy’.

The combination of liberalisation, privatisation and globalisation ushered a

new era in the economic history of India, GDP numbers increased, industrial
activities gained momentum, services sector bloomed and the presence of
India on the global platform was being recognised. However, the story of
economic reforms is not without criticism like jobless growth, neglect of the
agriculture sector and unskilled labour, the rise in income and wealth
inequalities and many others.

8.2 NEW ECONOMIC POLICY (1991)

Liberalisation, Privatisation and Globalisation (LPG) form the main
component of New Economic Policy, 1991. In the following section, you
shall read about the meaning of liberalisation, privatisation and globalisation
and the various measures undertaken to achieve the objectives of these policy
measures.

Liberalisation

Liberalisation refers to curtailing or lessening of the excessive state/

government regulations and restrictions as to enhance the participation of
private entities/ sectors in the functioning of the economy. Prior to the policy
of LPG, the Indian economy was entangled in beaurocracy, excessive state
control, red-tapism and licence raj. These factors not only inhibited the
efficiency of the public sector but the overall competitiveness of the economy
was hampered. Post-1991, Liberalisation measures include new industrial
158
policy, financial sector reforms, tax reforms, FOREX reforms and others. In New Economic Policy
the Industrial policy of 1991, several measures were undertaken to liberalise
the economy.

First, the list of projects requiring industrial licensing was pruned and only
18 industries related to security concerns, environment, hazardous chemicals,
white or luxury goods, etc were kept under the purview of compulsory
licencing. Second, Industries reserved for the public sector were reduced to
only two industries i.e. one related to atomic energy and second, railways.
Third, the requirement of licensing for setting up of industries within 25
Kms of the periphery of cities having a population of more than 10 lakh for a
certain class of industries was removed. Fourth, to boost and invite Foreign
Direct Investment (FDI) in high priority industries which requires heavy,
lumpsum investment and advanced technology, it was decided to provide
approval for FDI up to 51% foreign equity in 33 industries like electrical
equipment, metallurgical industries, etc. Similarly, to inject technological
dynamism in Indian industries, the government provided automatic approval
for technology agreements related to high priority industries with specific
parameters. Fifth, the Monopolies and Restrictive Trade Practices Act
(MRTP) 1969 was repealed. Sixth, the sick industries were referred to Board
for Industrial and Financial Reconstruction (BIFR) for the formulation of
revival/ rehabilitation schemes.

Privatisation

Privatisation in a broader sense means a change of ownership from the public

sector to the private sector and the induction of private management and
control in the public sector. Three broad measures of privatisation are i)
ownership ii) organisation and iii) operational.

Under ownership measures, the ownership of public enterprises, fully or

partially, is transferred to the private sector. Ownership measures include
total denationalisation, joint venture, liquidation and worker’s cooperative.
Total denationalisation means 100% transfer of ownership of public
enterprise to the private sector. A joint venture implies partial transfer ( 25%,
51% and 74%) of public enterprise to a private entity. Liquidation is the sale
of assets to a person who may use them for the same purpose or some other
purpose. Worker’s cooperative is a special form of decentralisation whereby
the ownership of the enterprise is transferred to workers who may form a
cooperative to run the enterprise.

Organisational measures are imposed to limit state control. These measures

include the formation of a holding company structure in which the
government provided a sufficient degree of autonomy in the decision making
of the company. Big companies are split into smaller units without loss of
economies of scale. The smaller units become independent in certain product
lines or regional operations. Leasing is another measure whereby government
agrees to transfer the use of assets of a public enterprise to a private bidder
159
Structural for a specified period for example 5 years. The tenderers have to give an
Reforms
undertaking of the profit that would be passed over to the government. The
government enjoys the right of obtaining profits as per agreement. In case,
the bidder fails to meet the expectations of the government, the latter has the
right to replace the bidder with a more promising bidder. Further,
restructuring intends to bring public sector enterprise under market discipline.
Restructuring is of two types namely financial and basic. In financial
restructuring accumulated losses are written off and capital composition is
rationalised in respect of debt-equity ratio. In basic restructuring, the public
sector shed some of its activities which are taken up by ancillaries or small
scale units.

Operational measures aim to improve the overall functioning of the economy,

even if fully denationalisation has not been undertaken. Operational measures
include granting autonomy to public enterprises, provision of incentives to
the employees, freedom to buy inputs from the market, development of
proper investment criteria, permission to raise resources from capital markets
for expansion or diversification.

Various measures in the Industrial policy like dereservation of industries

under the public sector, increasing the limit of the FDI in industries,
disinvestment policy, the opening of private sector banks, restructuring of
nationalised banks are some of the steps undertaken towards privatisation. In
the 1991 Budget, the government announced the intention of partial
disinvestment in selected PSUs in order to raise resources, encourage wider
public participation and promote greater accountability. Up to 20 of the
Government equity in 31 selected enterprises were offered to Mutual Funds,
Financial Investment Institutions, workers and the general public. From 1991
to 1999 through the disinvestment method of market sale of shares Rs 18,638
crore were realised.

Globalisation

It refers to the integration of the domestic economy with the rest of the world.
Globalisation connotes the reduction of the trade barriers to permit free trade,
free flow of capital, technology and labour. The important measures
undertaken to pursue the objectives of globalisation are:

i) Reduction of Import Duties: Reduction in import duties have been

important measures for improvement of the tax system. During 1990,
import duties were 300 % or more for several items and above 200 for
many items. Peak rates were trimmed progressively during the 1990s to
reach 35% in 2001-02. The median tariff rate was brought down to 25%
in 2003-04. Besides reducing import duties, the government attempted to
dismantle the quantitative restrictions on imports and exports. In the
Import -Export policy of 1990, the list of Open General Licence (OGL)
was expanded to facilitate easy access to the import of items. The
number of capital goods was expanded from 1261 to 1343 under OGL.
160
 A scheme of Star Trading Houses was introduced for exporters with an New Economic Policy
average annual net foreign exchange earning of Rs. 75 crores in the
preceding three licensing years.

ii) Encouragement of Foreign Investment: As we have seen in the

industrial policy of 1991, automatic approval would be given for FDI up
to 51% in high priority industries. Further, in 1996, a new list of
industries was approved whereby joint ventures with up to 74% foreign
equity would be cleared automatically. As present in 2021, 100% FDI
through automatic route is permitted in major subsectors of Mining,
Broadcasting, Airports, Industrial Parks, Telecom Services,
Pharmaceuticals, Single Brand Retail Trading, Textiles & Garments,
Thermal Power, Tourism & Hospitality, White Label ATM Operations
and Insurance & Insurance Intermediaries, etc.

Now having a glimpse about the NEP of 1991, we understand that nearly
three decades have passed since the introduction of economic reforms
and over time the results of these reforms have faded. So the need is felt
for looking at recent policies and changes introduced in the economy and
try to see how these policies and programmes are shaping the economic
landscape of the country. In the following section, we shall study the
major changes and new policies which have been introduced over the
past decades.

8.3 NEW ECONOMIC POLICY (2014)

Foreign Trade Policy (FTP) 2015-2020

One of the important policies which affects the external sector is the foreign
trade policy in India and each FTP brings new changes in the economic
policy of the country. FTP is formulated every five years and currently,
Foreign Trade Policy for the year 2015-2020 is in force. The major features
and highlights of the FTP 2015-2020 are as follows:

Export from India Scheme

• Merchandise Export from India Scheme (MEIS)

Under this scheme, the scrips which will be issued will have no
conditionality attached to them. The notified goods which are exported to
notified markets would be rewarded on realised Free on Board (FOB) value
of exports. Under this scheme, countries of exports have been grouped into
three categories namely country A, B and C. Country A or traditional market
includes, USA, Canada, EU and others. Country B or emerging and focus
markets include Africa, Latin America and Mexico, Turkey and West Asian
countries, ASEAN countries, Japan, China and others. Country C contains
the list of 70 countries like Bangladesh, Bhutan, Nepal, etc. Further different
types of supports like global support are extended under MEIS. Global
support has been granted to fruits, flowers, vegetables, tea, coffee, spices,
161
Structural processed foods, marine products, handicrafts, furniture, etc. New 852 Tariff
Reforms
lines that fit in the product criteria but were not receiving support in earlier
Foreign Trade Policy have been extended this support and these include lines
from fruits, vegetables, Ayush and herbal products, paper products, etc.

Service Exports from India Scheme (SEIS)

Service exports from the India scheme have replaced the old Served From
India Scheme (SFIS). This scheme aims at promoting exports of services
from India, to make services more competitive in the global market and to
provide incentives to exports. Under this scheme incentives ranging from 3
percent to 5 percent are provided to the exporters of services who are
providing services from India to the various organisations situated outside
India, The rate of incentive under SEIS is computed on the net foreign
exchange earned. Business services, communication services, construction
and related engineering services, educational services, environmental, health-
related services, recreational services are covered under a 5 percent rate.
Services like hotels, restaurants and other services attract 3 percent rate. The
rewards earned in this scheme in the form of duty credit scrips are freely
transferable and can be used for all types of goods and service tax debits on
procurement of services or goods.

• The benefits of MEIS and SEIS are also extended to Special Economic
Zones (SEZ).

• All duty scrips issued under MEIS and SEIS scheme and the goods
imported against these scrips are fully transferable and scrips issued
under Exports from India can be used for payment of customs duty,
excise duty and payment of service tax.

• A new concept of Status Holders has been introduced in Foreign Trade

Policy 2015-2020. Business leaders who are prominent in the arena of
foreign trade and have successfully contributed to the country’s foreign
trade would be termed/ recognized as Status Holders. These holders
would be given special treatment and privileges to facilitate their trade
transactions.

• Boost to “Make in India”: In view of encouraging domestic

manufacturing and promoting brand India several measures has been
introduced under FTP. Under MEIS schemes higher rewards will be
provided for those export items which has high domestic content and
value addition.

• Under the Export Promotion Capital Goods (EPCG) scheme, the specific
export obligation has been reduced to 75 percent in case capital goods
are procured from indigenous manufacturers.

• Ease of Doing Business: For trade facilitation and Ease of Doing

Business provision for online filling of documents or applications has
162 been made whereby various applications by exporters/importers can be
 filled online. Further, there is no need for hard copies of applications and New Economic Policy
specified documents. Landing documents of export consignment as
proofs for the notified market can be digitally uploaded.

Goods and Service Tax (GST)

• One of the major initiatives/reforms in the Indian tax sector was the
introduction of GST. GST Act was passed in 2017 by the parliament and
came into effect from 1st July 2017. It is a comprehensive, multi-stage,
destination-based tax that is levied on every value addition. Prior to the
introduction of GST, there were a plethora of taxes levied by the Central
and State Governments which lead to cascading effects of the taxes. GST
has subsumed a large number of taxes and intended to simplify the
structure of the indirect taxes. At present, there are four GST types
namely Integrated Goods and Service Tax (IGST), State Goods and
Services Tax (SGST), Central Goods and Services Tax (CGST) and
Union Territory Goods and Services Tax (UTGST).

• The major benefits accruing from GST are the creation of a unified
common national market for India, giving a boost to foreign investment
and the Make in India programme. Other benefits include mitigation of
cascading of taxes, harmonization of tax laws and procedures, simpler
tax regime, increase in ease of doing business, reduction in compliance
costs. For consumers, benefits are in the form of reduction of prices of
goods and transparency in the fixation of final prices of the goods. More
detailed information about GST is given in Unit 9.

Pradhan Mantri Jan Dhan Yojana

To widen the scope of financial inclusion in the country is the ultimate goal
of inclusive growth. To bring the backward and marginalised citizens of the
country under the umbrella of institutional sources of finance is the goal of
the financial inclusion programme. The Government of India launched one of
the biggest initiatives for financial inclusion on 15th August 2014 namely
“Pradhan Mantri Jan Dhan Yojana”. The mission was launched with the
objective of making financial products and services approachable to the
common citizens of the country at the least cost possible with the extensive
use of technology to expand the coverage of financial inclusion.

The basic tenets of the scheme are to provide basic banking services to
unbanked citizens in the form of opening a basic bank saving account in any
bank branch or business correspondent with zero balance and zero charges.
Providing debit cards with free accident insurance coverage of Rs 2 Lakh.
The six main pillars of this scheme are universal access to banking services,
overdraft facility of Rs.10,000 with every basic saving bank account.
Expediting the programme of financial literacy in the form of spreading
information about the usage of ATMs, promotions of savings, use of banking
services for insurance and pension. Creation of credit guarantee fund to save
the banks from defaults. To provide insurance cover with both accident 163
Structural insurance upto Rs 1,00,000 ((enhanced to Rs. 2 lakh to new PMJDY accounts
Reforms
opened after 28.8.2018) and life insurance of Rs 30,000 and to provide a
safety net to the workers working in the unorganised sector through a pension
scheme.

PMJDY account can be used for Direct Benefit Transfers (DBT) for the
social security schemes namely Pradhan Mantri Mudra Yojana (PMMY),
Atal Pension Yojana (APY), Pradhan Mantri Jeevan Jyoti Bima Yojana
(PMJJBY) and Pradhan Mantri Suraksha Bima Yojana (PMSBY). Post-2018,
the focus of PMJDY has shifted from “ Every Household” to “Every
Unbanked Adult”. The overdraft facility has increased to Rs 10,000 from Rs
5000 and the age limit for the overdraft facility has been increased to 65
years. As of April 2021, the total number of PMJDY account stood at 42.25
Crore and in these accounts, Rs 145408.07 crore was deposited and 30.93
crore Rupay cards were issued. Further, Jan Dhan Darshak App was also
launched to provide necessary information related to banking services like
locating ATMs, Bank Branches, etc.

Mudra Scheme for MSME

To revitalise and meet the credit need of non-corporate, non-farm micro and
small enterprises Prime Minister Mudra Yojana (PMMY) was launched in
2015. These micro-enterprises plays an important role in labour surplus
country like India. These enterprises are labour intensive, need less credit,
caters to local economy needs and plays a supplementary role to the medium
and large Industries. However, they reel under the problem of deficiency of
finance and depend upon non-institutional sources of finance like money
lenders. So to expand the ambit of the institutional sources of finance to this
sector PMMY was launched. MUDRA stands for Micro Units Development
and Refinance Agency and provided loans upto Rs 10 Lakhs to eligible
enterprises.

MUDRA is a wholly-owned subsidiary of Small Industries Development

Bank of India (SIDBI) with an authorised capital of Rs 1000 crores and 750
crores of paid-up capital. Micro enterprises can borrow term loans or
overdraft facility without any need for collateral, processing fee and this
scheme does not prescribe any minimum amount of loan, small to small loans
can be taken. MUDRA schemes have three categories namely Sishu, Kishor
and Tarun.

Under the Sishu scheme, a maximum loan of Rs 50000 is sanctioned for

start-up micro-enterprises. Kishor categories cater to the need of
entrepreneurs who are looking for a fresh fund for the expansion of business
and they can avail of the loan ranging between Rs 50001- Rs 5 Lakh. If the
entrepreneurs are looking for diversification of their operation then they avail
the loan facility in the Kishor category. Under this category, the loan amount
sanctioned is Rs 5,00,000 to Rs 10,00,000. Entrepreneurs can take a loan for
the commercial vehicle, plant and machinery, business loans and working
164
capital. In the financial year 2020-21, Rs. 43370003 PMMY loans were New Economic Policy
sanctioned.

Swachh Bharat Mission (SBM)

On 2nd October 2014, Prime Minister Sh. Narendra Modi launched a multi-
pronged programme to augment the sanitation drive in the country namely
Swachh Bharat Mission (SBM) or Clean India. This programme was
launched at the backdrop that in 2014 more than half of the population (55
crore people) practised open defecation. The situation was not only grim in a
country like India alone nearly 2.3 billion people globally lacked basic
sanitation services. Under SBM, beneficiaries were provided with an
incentive of Rs 12000 for the construction of Individual household latrines.
The financial burden was shared in the 60:40 ratio between the central
government and state government. However, in the case of special categories
states ( like J&K, HP, North Eastern states) this participatory role increased
to 90:10. Further, permission was also granted to create avenues for
additional contributions from other sources also. SBM is not about providing
financial incentives also rather it is about capacity building and aims at
instilling behavioural change among communities and individuals. Since its
inception, the percentage of fund utilization under this scheme has been more
than 95 percent. Nearly 10 crore toilets have been built since 2014 and 711
districts declared as free from open defecation.

Make in India

With the idea and desire of transforming India into a global design and
manufacturing hub and to boost domestic manufacturing PM in September
2014 launched a much-hyped initiative of ‘Make in India’. The intuition was
to create a conducive environment that encourages investment not only
domestic but foreign also and built a network of modern and efficient
infrastructure. This programme has three objectives. First, to boost the
manufacturing sector and increase the growth rate of this sector to 12-14
percent per annum. Second, to make the manufacturing sector one of the
largest employment provider sectors and to create 100 million additional
manufacturing jobs by 2022. Third, to increase the share of manufacturing
upto 25 percent by 2025. This scheme focuses on 25 sectors namely
automobiles, aviation, chemicals, construction, defence manufacturing,
electronic system, food processing, leather, mining, pharma, railways,
tourism, renewable energy, etc.

Major Initiatives under Make in India

• Ministry of defence reserved 26 items that will be only procured from

local suppliers.

• NLC India announced to set up a 500 MW Solar Power Plant in Odisha

with the cost of Rs 3,000 crore.

165
Structural • FDI in the defence sector increased to 74 percent under the automatic
Reforms
route.

• 100 percent FDI under automatic route for construction and specified rail
infrastructure projects.

Stand Up India

To promote entrepreneurial skills among women and to bring the

marginalised section of the society i.e Schedule Caste (SC) and Scheduled
Tribe (ST) individuals into the net of financial inclusion a scheme called
Stand-Up India for financing SC/ST and/or Women Entrepreneurs was
launched in 2016. Under this scheme, a composite bank loan of Rs 10 lakh
and Rs 100 lakh (1 crore) is provided for setting up greenfield enterprises to
be advanced to at least one SC/ST borrower and at least one women borrower
per bank branch. The enterprise may be in the manufacturing, services,
trading sector or activities allied to agriculture like pisciculture, beekeeping,
poultry, etc. To provide collateral-free coverage, Government of India has set
up the Credit Guarantee Fund for Stand-Up India (CGFSI). The loan needs to
paid back in 7 years with 18 months of the maximum moratorium period.
Nearly Rs 26000 crore has been sanctioned till 2021.

PM Ujjwala Yojana

To provide clean and efficient Liquified Petroleum Gas (LPG) to rural India,
PM Modi launched PM Ujjwala Yojana in 2016. This scheme aimed at
providing 5 crore LPG connections to women below the poverty line across
India. The scheme provides financial support of Rs 1600 for each LPG
connection which includes cylinder, stove, pressure regulator and the
financial burden is borne by the government.

Skill India

Skill India or Pradhan Mantri Kaushal Vikas Yojana (PMKVY) is the

flagship scheme of the Ministry of Skill Development and Entrepreneurship
(MSDE). This scheme was launched in 2015 with the target of providing
industry-relevant skill training and financial and placement assistance to over
10 million youth between 2016-2020. MSDE has set up different agencies
and institutions to focus on different areas and activities. Three agencies are
playing a prominent role in achieving the target of PMKVY, namely,
National Skill Development Authority (NSDA), National Skill Development
Corporation (NSDC) and Directorate General of Training (DGT). NSDA is
tasked with the implementation of the National Skills Qualification
Framework (NSQF) and strengthen State Skill Development Missions
(SSDMs). NSDC is entrusted with the implementation of PMKVY and
Pradhan Mantri Kaushal Vikas Kendra (PMKK) while DGT is tasked with
the establishment and monitoring of Industrial Training Institutes (ITIs).

166
Activity 1 New Economic Policy

1) Visit the website of Pradhan Mantri Jan Dhan Yojana and check the
progress of this scheme in your state and district.

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

2) Visit the website of Make in India and choose any one sector of your
choice like agriculture, health, digital awareness and list out the changes
or reforms introduced in this sector under the ambit of the Make in India
scheme.

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

8.4 NEW ECONOMIC POLICY (2020)

Atmanirbhar Bharat

COVID pandemic had a devastating effect on all the economies of the world
be it either big or small, developed or underdeveloped. It had a deep impact
on the economic growth and the income and employment nosedived. It made
the policymakers rethink the way the economic system works. It was at this
juncture that Prime Minister of India, Shri Narendra Modi while announcing
an economic package related to pandemic echoed the slogan of Atmanirbhar
Bharat in May 2020. This was followed by a clamour that whether India is
regressing towards an old socialist pattern of a closed economy and we are
going to fly against the wind of globalisation. Though the different versions
of Atmanirbhar Bharat were already part and parcel of the Indian planning
process since 1976. And even some mention can be found in the Tenth Five-
Year plan also. In 2020, Atmanirbhar Bharat was declared as Oxford Hindi
word of the year.

This should not be only understood as self-reliant only as it is frowned upon

by global economics. It connotes policies that aim towards promoting
resilience, efficiency and equity. PM again in 2021, emphasised that the core
of this slogan is about the creations of values, wealth and ethos not only for
167
Structural India but for the larger humanity. Till now three packages have been given
Reforms
under this scheme (Appendix-I).

The main constituents of Atmanirbhar Bharat are:

i) Demand
ii) Demography
iii) Economy
iv) Infrastructure
v) System

The Government of India via this package has tried to extend a helping hand
to almost every sector of the economy i.e. Micro, Small and Medium
Enterprises (MSMEs), farmers, rural labourers, migrants or the
empowerment of the poor. We will discuss some of the financial and policy
highlights which were initiated under the various economic packages given
under this scheme.

Micro, Small and Medium Enterprises (MSMEs)

• Revision of Definition: One of the prominent reforms in this sector was

to redefine MSMEs and this was done through amending the MSMEs
Development Act, 2006. Earlier there was a different definition of the
enterprises in the manufacturing sector and enterprises engaged in the
service sector. But now this distinction is abolished and one common
definition given in terms of investment in plant and machinery and
annual turnover. The new definition is given below.

The new definition of MSMEs

Micro Small Medium

Investment Not more than Not more than Not more than Rs
in plant and Rs 1 crore Rs 10 crore 50 crore
machinery

Annual Turnover Not more than Not more than Not more than Rs
Rs 5 crore Rs 50 crore 250 crore

• Collateral free loan of upto three lakh crore rupees to MSMEs which
aims to provide benefit to nearly 45 Lakh units.

• Rs 10,000 crore fund created to help these enterprises.

• To expand the government procurement from MSMS it was decided not

to float global tenders of up to Rs 200 crore in various procurement
undertaken by the government.

• A subordinate debt of Rs 20,000 crore for equity support for the stressed
168 MSMEs.
The Agriculture and Allied sectors New Economic Policy

The following are some of the measures undertaken to strengthen agriculture

and allied sectors.

• To develop infrastructure in the agriculture sector a corpus amounting to

One lakh crore to be set up at aggregation points and farm-gate.
Farmgate is the place where both farmers and buyers can interact directly
with one another.

• For crop loan requirements an additional fund of Rs 30,000 crore is

allocated and it will be disbursed via the National Bank of Agriculture
and Rural Development (NABARD) to Rural Cooperative Banks and
Regional Rural Banks (RRBs).

• To support the fishermen and fisheries Pradhan Mantri Matsya Sampada

Yojana (PMMSY) was launched. Under this scheme total of Rs 20,000
crores has been allotted for aquaculture inland fisheries and marine along
with the development of Infrastructures like cold chains and fishing
harbours.

• To help the dairy industry an Animal Husbandry Infrastructure

Development Fund of Rs 15000 crore was set up.

• To control the foot and mouth disease and Brucellosis a National Animal
Disease Control programme was launched with an outlay of Rs 13,343
crore for achieving universal vaccination of cattle, buffalo, goat, pigs and
sheep.

• Rs 500 crore has been extended for beekeeping initiatives.

• The government has decided to amend The Essential Commodities Act,

1955 to deregulate food items like edible oil, onions, pulses, potatoes and
oilseeds to attract investment in the sector.

Migrant Workers

• One Nation One Card scheme had been launched whereby migrants
can access the Public Distribution System (PDS) from anywhere.

• 5 Kg of grain per person and 1 kg of chana per family per month for two
months will be given to all those migrant workers who are not
beneficiaries under the National Food Security Act ration card or state
card. It is estimated that it will benefit eight crore migrants.

• Pradhan Mantri Awas Yojana envisages providing living facilities at an

affordable price to migrant labourers/urban poor.

• Rs 5000 crore credit facility to street vendors which are the most affected
segment of the population due to ongoing pandemic. Under this facility,
the bank credit facility for initial working capital upto Rs 10,000 for each
enterprise will be extended. 169
Structural Civil Aviation and Defence
Reforms
• Airports with world-class infrastructure to be built through Public-
Private Partnership (PPP). The Airport Authority of India has initially
awarded three airports of Ahmedabad, Lucknow and Mangaluru for
operation and maintenance on a PPP basis.

• Foreign Direct Investment (FDI) limit in defence manufacturing

increased to 74 % from 49 % under automatic route.

• Reservation for Indian vendors in some categories like production

agency in Design and Development, etc. and further FDI of more than 40
percent is not allowed.

• The Ministry of defence will bring out the list of items on which the ban
of the import of certain items shall be announced.

• Mission Raksha Gyan Shakti launched to promote innovation and

technology development.

Energy

• To improve the functioning and efficiency of the power sector it was

decided to privatise power department/utilities in Union Territories.

• To ensure a progressive reduction in cross-subsidies in the sector it was

decided to amend the Electricity Act, 2003.

• Rs 118,273 crore worth of loans have been sanctioned to 17 states/UTs

for liquidity injection for DISCOMs.

Social Sector

• MGNREGS has been given an additional allocation of Rs 40,000 crore

to provide impetus to rural demand and employment.

• To further strengthen and enhance technology in the education sector PM

eVidya will be launched for digital/online education.

8.5 OTHER INITIATIVES

Other measures / initiatives include the following:

• Festival advance scheme to government employees under SBI Utsav

cards.

• New Leave Travel Concession (LTC) voucher scheme launched.

• A new scheme Atmanirbhar Bharat Rozgar Yojana launched to create

new job avenues during the COVID recovery phase.

• Rs 1.46 lakh crore boost has been given to 10 champion sectors like
advanced, electronic /technology products, pharmaceutical drugs, cell
170
 chemistry battery, telecom and networking products, food products, New Economic Policy
high-efficiency solar PV modules, automobiles and auto components,
White goods and speciality steel, textile products.

• Rs 18,000 crore additional outlay for PM Awaas Yojana-Urban.

• Rs 900 crore provided for Covid Suraksha Mission for R&D of Indian
Covid vaccine.

Further, under this slogan, various sub slogans like Vocal For Local, Local
for Global, etc. were echoed.

National Food Security Mission

This mission was launched in 2007 as a centrally sponsored scheme which

aimed to increase the annual production of rice, wheat and pluses by 10
million tonnes, 8 million tonnes and 2 million tonnes respectively by the end
of 2011-12. This increase in production was intended to achieve by restoring
soil fertility, improving farm level economy, expanding the area under
cultivation and fostering new employment avenues. Subsequently, from
2014-15, coarse cereals and commercial crops like sugarcane, cotton and jute
were also included under this mission. Further, it was decided to extend this
mission to 2019-2020 and new targets of achieving production of 13 million
tonnes of additional foodgrain production are fixed. At present this mission is
being implemented in selected districts of 29 states of the country.

National Food Security Act (NFSA) 2013

A paradigm shift in the country’s food security occurred in 2013 when the
government enacted NFSA, 2013 which made provision to distribute
subsidized foodgrains under the Targeted Public Distribution System (TPDS)
to nearly 75 % of the rural population and 50 % of the urban population.
Under this act, identified households are provided 5 Kg foodgrains per
person at the highly subsidised price of Rs 3 for rice, Rs 2 for wheat and Rs 1
for coarse grains. Households covered under Antyodaya Anna Yojana (AAY)
to receive 35 kg per family per month. This act also includes Mid Day Meal
(MDM) and Integrated Child Development Services (ICDS). Pregnant
women and lactating mothers and children in the age group of 6 months to 14
years are entitled to nutritious meals. Maternity benefits of not less than Rs
6,000 are given to pregnant women and lactating mothers. The ration cards
are in the name of the eldest woman of the household of age 18 years or
above. This act also provides for a grievance redressal mechanism at the
district and state levels apart from social audits to ensure transparency and
accountability. If the states are not able to supply the entitled foodgrains to
the beneficiaries the act makes the provision for food security allowance. At
present this act is being implemented in all States/UTs, covering nearly 80.5
crore persons.

171
Structural Smart Cities Mission
Reforms
Smart Cities Mission was launched in 2015 for rejuvenating urban
development. It aims to enhance economic growth along with improving the
quality of life of people living in cities through comprehensive work on
physical, economic, social and institutional pillars of the city. The focus is on
inclusive and sustainable development. To promote and provide the core
infrastructure like adequate water supply, sanitation, assured electricity
supply, solid waste management, affordable housing, digitalization, e-
governance, sustainable environment, the safety of women, children and
elderly, health and education. 100 cities were to be selected based on two-
step criteria. This is a centrally sponsored scheme and at the time of
inception, Rs 48,000 crore were sanctioned over five years. Smart Command
and Control Centres have been completed in 16 cities. Smart water, Smart
Roads, Smart Solars have been completed in 24 cities, 23 cities and 15 cities
respectively.

Bharat Net or National Optical Fibre Network (NOFN)

In the mission of connecting rural India with internet services, National

Optical Fibre Network was launched in 2011 and was renamed Bharat Net in
2015. This mission envisages connecting all 2,50,000 Gram panchayats with
the minimum 100 Mbps bandwidth covering nearly 625,000 villages. Bharat
Broadband Network Limited (BBNL) is the special purpose vehicle created
as Public Sector Undertaking (PSU) for the execution of NOFN. The project
aims to provide e-services and e-applications like e-health, e-education, etc.

Activity 2

1) Choose one of the cities from your state that is covered under the Smart
Cities mission and prepare a note about the various facilities, financial
resources, etc. which are granted to the city. Try to analyse whether the
city has turned smart or not?

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

8.6 SUMMARY
In this unit, we started with the history of economic reforms and the rationale
behind introducing the same in the country. The year of 1991 is remembered
as a year of economic reforms wherein NEP was introduced which liberalised
India from the clutches of licence raj, excessive government controls, permit
172 raj, red-tapism and state-created monopolies. India adopted a positive outlook
for globalisation and policies were initiated to integrate the Indian economy New Economic Policy
with the rest of the world. However, more than 30 years have passed since
this policy so the need was felt to look into recent changes in the economic
field. More specifically to look into some of the economic changes which
were undertaken in the last decade or so.

To provide basic financial and insurance services to the financially excluded

section of the society and to curb the ongoing leakages in various welfare
schemes the trinity of JAM was introduced and Jan Dhan Yojana is one of
the steps in this right direction.

Similarly, the Mudra scheme is intended to benefit budding entrepreneurs

and MSMEs. Following the proverb of cleanliness is next to godliness,
Swachh Bharat Mission was initiated to clean the neighbourhoods and
prevent the spread of infectious disease along with improving the living
conditions of the citizens. Finally, to strengthen domestic manufacturing and
improve the process of industrialisation the ambitious project of Atmanirbhar
Bharat is being implemented. This scheme is impacting every sector of the
economy and one of the visible impacts in the recent pandemic is the
manufacturing of homemade vaccine, Covaxin.

8.7 KEY WORDS

Cess: It is a tax on tax. It is levied by the government for a specific purpose
like health, education etc.
Financial Inclusion: Initiative by the government to bring the financially
excluded sections like marginalised sections, women, tribals, etc under the
umbrella of formal credit facilities.
Fiscal deficit: It is the difference between the total income of the
government i.e. total tax receipts and non-debt capital receipts and total
expenditure.
Foreign Direct Investment: It is an investment made by a firm or individual
in one country but its headquarter/control is in another country.
PDS: Public Distribution System is a system of providing subsidised ration
including foodgrains, edible oil, sugar, pulses etc to the targeted proportion
of the population.
Tax: Tax is a compulsory payment made by individuals or corporations to
the Government
Trade deficit: It is a situation wherein the country’s imports and higher than
exports.

8.8 SELF-ASSESSMENT QUESTIONS

1) Discuss the rationale behind economic reforms introduced in India in
1991.
173
Structural 2) What are the eligibility conditions and benefits received by PMJDY
Reforms
beneficiaries?

3) What are the facilities offered under Swach Bharat Mission to

individuals?

4) Distinguish between financial and basic restructuring.

8.9 REFERENCES/ FURTHER READINGS

• Ahluwalia, I J (Eds.) (1998), India’s Economic Reforms &
Development (Essays in Honour of Manmohan Singh), Oxford
University Press, New Delhi

• Dhingra, I. C. (2001), The Indian Economy: Environment and Policy,

Sultan Chand & Sons, New Delhi.

• Jalan B (1992), The Indian Economy-Problems and Prospects, Viking,

New Delhi Publication, Calcutta.

• Ministry of Finance. (2017). Economic Survey 2016-17. Government

of India. New Delhi.

• Ministry of Finance. (2018). Economic Survey 2017-18. Government

of India. New Delhi.

• Ministry of Finance. (2019). Economic Survey 2018-19. Government

of India. New Delhi.

• Ministry of Finance. (2020). Economic Survey 2019-20. Government

of India. New Delhi.

• Misra S.K. & V.K.Puri.(2020). Indian Economy (38th edition)–

Himalaya Publication House, Mumbai.

• Dutt, Rudar. & K.P.M. Sundram (2009), Indian Economy, S. Chand,

New Delhi.

174
 Appendix-I New Economic Policy

Atmanirbhar Bharat Abhiyan

The Hon’ble Prime Minister, Shri. Narendra Modi announced a special

economic package on 12 May 2020 of Rs.20 lakh crore (equivalent to 10% of
India’s GDP) under the ‘Atmanirbhar Bharat Abhiyan’. This special
economic package was announced to make India independent against the
tough global supply chain competition and help empower the labourers, poor
and migrants who had been severely affected by the COVID-19 pandemic.

Accordingly, the Finance Minister, Smt. Nirmala Sitharaman announced the

details of the measures provided under the Atmanirbhar Bharat Abhiyan
through five press conferences. These measures are provided to different
sectors and areas to cover and help everyone affected by the pandemic. The
measures were announced keeping in mind the five pillars of Atmanirbhar
Bharat Abhiyan. These five pillars are the pillars for making India self-
reliant.

Five Pillars of Atmanirbhar Bharat Abhiyan

The five pillars of Atmanirbhar Bharat Abhiyan are:

• Economy – That brings quantum jump rather than incremental change.

• Infrastructure – To become the identity of modern India.

• System – That is driven by technology and a system not based on the

past policy.

• Demography – India’s strength is its demography, and it is the source of

energy for self-reliant India.

• Demand – The demand and supply chain in the economy is the strength
that must be harnessed to its rightful potential.

Measures Provided Under Atmanirbhar Bharat Abhiyan

The various measures are undertaken by the government under the

Atmanirbhar Bharat Abhiyan in different sectors are as follows:

Reforms for MSME

• The Emergency Credit Line Guarantee Scheme (ECLGS) to Businesses

or MSMEs from Banks and Non-Banking Financial Companies
(NBFCs) up to 20% of the entire outstanding credit as of 29.2.2020.

• Rs.20,000 crore for Subordinate Debt for Stressed MSMEs.

• Rs.50,000 crore equity infusion for MSMEs through ‘Fund of Funds’,

which are doing viable business but need hand holding due to the
pandemic situation.

175
Structural • Revision of MSME definition by increasing the upper limits of turnover
Reforms
and investments in plant machinery and equipment for MSME. The new
definition differentiates MSME under the criteria of investment and
annual turnover, which is the same for both the manufacturing and
service sector.
• For protecting MSMEs from foreign company competition, global
tenders of up to Rs.200 crore will be disallowed in government
procurement tenders.
Reforms for Agriculture, Fisheries and Food Processing Sectors
• Rs.1 lakh crore for Agri Infrastructure Fund to farmers for farm-gate
infrastructure.
• Rs.10,000 crore scheme for Formalisation of Micro Food Enterprises
(MFE).
• Rs.20,000 crore for fishermen through Pradhan Mantri Matsya Sampada
Yojana (PMMSY).
• Animal Husbandry Infrastructure Development Fund set up for
Rs.15,000 crore to support private investment in Dairy Processing, cattle
feed infrastructure and value addition.
• Promotion of Herbal Cultivation with an outlay of Rs.4,000 crore.
Reforms for Employment and Ease of Doing Business
• Additional allotment of Rs.40,000 crore for MGNREGS for boosting
employment.
• Decriminalisation of the Companies Act, 2013 for ease of doing
business.
• Permission for direct listing of securities by Indian public companies in
foreign jurisdictions.
• Private companies that list Non-convertible debentures (NCDs) on stock
exchanges will not be regarded as listed companies.
• Including the provisions of Producer Companies (Part IXA) of
Companies Act, 1956 in Companies Act, 2013.
• Power to the National Company Law Appellate Tribunal (NCLAT) for
creating additional or specialised benches.
• Lowering of penalties for all defaults for One-person Companies, Small
Companies, Producer Companies and Startups.

176
Reforms for Poor, Farmers and Migrant Workers New Economic Policy

• Introduction of One Nation One Card. The migrant workers can access
the Public Distribution System, i.e. Ration from the Fair Price Shop
situated anywhere in India under the scheme of One Nation One Card.
• Provided living facilities to the migrant labours and urban poor at
affordable rent under the PMAY (Pradhan Mantri Awas Yojana).
• PM Svanidhi scheme launched to facilitate easy access to credit for
urban street vendors.
• NABARD extended Rs.30,000 crore additional re-finance support for
meeting crop loan requirements of Regional Rural Banks and Rural
Cooperative Banks.
• A special drive to give concessional credit to PM-KISAN beneficiaries
through the Kisan Credit Cards. Animal Husbandry Farmers and
Fishermen are also included in this drive.
Atmanirbhar Bharat Abhiyan 2.0
After the announcement of Atmanirbhar Bharat Abhiyan by the Prime
Minister on 12 May 2020, announcements were made on 12 October 2020
under Atmanirbhar Bharat Abhiyan 2.0. Under Atmanirbhar Bharat Abhiyan
2.0:
• SBI Utsav Cards were distributed.
• 11 States were sanctioned Rs.3,621 crore towards the capital expenditure
as an interest-free loan.
• LTC voucher schemes were launched.
• Additional capital expenditure of Rs.25,000 crore was provided to the
Ministry of Road Transport and the Ministry of Defence.
Atmanirbhar Bharat Abhiyan 3.0
On 12 November 2020, the Finance Minister, Smt. Nirmala Sitharaman,
along with the Minister of State for Finance and Corporate Affairs, Shri.
Anurag Thakur launched the Atmanirbhar Bharat 3.0 for boosting the Covid-
hit economy.
Twelve announcements were made by Finance Minister Nirmala under the
Atmanirbhar Bharat 3.0, which focused on job creation and tax relief in the
housing sector. The twelve announcements are as follows:
• Launch of Atmanirbhar Bharat Rozgar Yojana for the creation of new
employment opportunities.
• Launch of ECLGS 2.0 for supporting stressed sectors with a tenure of 5
years, including a moratorium of 1 year.
• Rs.1.46 lakh crore for Atmanirbhar Manufacturing Production Linked
Incentives (PLI) for 10 champion sectors.
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Structural • An additional outlay of Rs.18,000 crore provided for the PMAY-Urban.
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• The performance security on contracts was reduced to 3% instead of 5-
10% to ongoing contracts free of disputes and Public Sector Enterprises
to support infrastructure and construction.
• Demand booster for the Residential Real Estate Income Tax relief for the
Home Buyers and Developers from 10% to 20% (under section 43CA)
for only primary sale of residential units valuing up to Rs.2 crore.
• Rs.6,000 crore Equity infusion in NIIF Debt Platform and Rs.1.10 lakh
crore Platform for Infra Debt Financing.
• Rs.65,000 crore for subsidised fertilisers for helping 140 million farmers.
• An additional outlay of Rs.10,000 crore provided for Pradhan Mantri
Garib Kalyan Rozgar Yojana.
• Rs.3,000 crore released to EXIM Bank for promoting the export projects
through lines of credit under the IDEAS scheme.
• An additional outlay of Rs.10,200 crore towards Capital and Industrial
expenditure.
• Rs.900 crore provided for the COVID Suraksha Mission for Research
and Development of Indian COVID-19 Vaccine to the Department of
Biotechnology.

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UNIT 9 FINANCIAL SECTOR AND FISCAL Financial Sector and
Fiscal Sector Reforms
SECTOR REFORMS

Objectives

After reading this unit you should be able to:

• review the major reforms introduced in the financial and fiscal sector
during and after 1991;
• discuss reforms in the banking and insurance sector; and
• discuss tax reforms introduced in India in recent times.

Structure

9.1 Introduction
9.2 Banking Sector Reforms 1991
9.3 Reforms in Financial Sector
9.4 Reforms in the Insurance Sector
9.5 Tax Reforms 1991
9.6 Fiscal Sector Reforms
9.7 Summary
9.8 Key Words
9.9 Self-Assessment Questions
9.10 References/ Further Readings

9.1 INTRODUCTION
You have studied the circular flow of income, output and employment and
learnt how various sectors of the economy interact with one another. In
circular flow, the financial sector plays a pivotal role in channelising savings
and investment. The banking and insurance sector is an important constituent
of the financial sector. You must have noted that even after so many decades
of India’s Independence large chunk of the population is not covered by
formal banking and insurance services. Due to the dearth of these services,
the social security of the citizens is threatened and they have to be dependent
on non-institutional sources of credit/finance which is exploitative. The
financial sector is itself marred with problems like Non-Performing Assets
(NPA), inefficiencies, lack of capital and many more. In this unit we will
examine the major banking sector reforms introduced as part of New
Economic Policy (NEP) 1991 and then move to recent reforms introduced in
the financial sector especially post 2010.

Fiscal policy is related to taxation, expenditure and public debt. Tax is

mainly of two types direct and indirect. An efficient tax system is necessary
179
Structural for collecting tax revenue in the country. In unit 8, you have learnt about
Reforms
economic reforms of 1991 and during the process of liberalisation,
privatisation and globalisation a series of measures were introduced in the
fiscal sector in the form of direct and indirect tax reforms.

In recent years, the economic policies of the country have taken a new
direction and dimension whereby emphasis is placed on domestic
manufacturing, bringing more investment both from the private and foreign
sectors, reducing foreign dependence. Make in India and Ease of Doing
Business are the buzz word. To achieve these objectives lot of reforms have
been introduced in the banking sector, insurance sector, labour market, direct
and indirect taxes and similarly in many other sectors. In this unit, you will
study major reforms and policies undertaken in these sectors.

9.2 BANKING SECTOR REFORMS 1991

In continuation to NEP and to bring structural reforms in the working of the
economy, a series of measures were introduced in the financial sector
especially in the banking sector. In 1991, the Government of India set up the
Narasimham Committee to examine all aspects relating to the structure,
functioning, organization and procedure of the financial system to remodel
these institutions for raising the overall efficiency.

Narasimham Committee, 1991

Narasimham Committee was set up in 1991 to analyse the falling efficiency

of the India banking sector and then recommended certain reforms to revive
the banking sector.

Major recommendations of the Narasimham Committee, 1991 are:

i) The committee felt that the present structure was too rigid and inflexible
so it proposed the deregulation of the interest rate structure and said that
the interest rate should be determined by market forces.

ii) Re-examination of direct credit programme and to include small and

marginal farmers, tiny industrial sector and weaker sections. The
aggregate credit to the redefined priority sector to be fixed at 10%.

iii) Reduction of Statutory liquidity ratio (SLR) to 25% over a period of 5

years from 38.5% in 1991. Further, the cash reserve ratio (CRR) to be
reduced in a phased manner from the existing rate of 15%.

iv) Establishment of 4 tier hierarchy for the banking structure which should
be as follows:

a) 3-4 banks (including SBI) at the top of the banking structure and
they could become international in character.

b) 8-10 banks engaged in general or universal banking and they would

180 have a network of branches throughout the country.
 c) Local banks whose operation would be confined to a specific region. Financial Sector and
Fiscal Sector Reforms
d) Regional banks including Reginal Rural Banks (RRBs) would be
confined to rural areas and they would be engaged in financing
agriculture and allied activities.

v) Introduction of prudential norms and regulation:

a) Definition of Non-Performing Assets: An asset would be considered

non-performing if the interest on such assets remains past due for a
period exceeding 180 days at the balance sheet date. Banks and
financial institutions to be given a period of 3 years to move towards
these norms.

b) For the purpose of provisioning, the committee recommended

classifying assets into 4 categories, namely, standard, sub-standard,
doubtful and loss assets. Regarding the substandard, a general
provision should be created equal to 10 percent of the total
outstanding under this category. In case of doubtful assets provision
should be created to the extent of 100 percent of security shortfall. In
respect of the secured portion of some doubtful debts, further
provision should be created ranging from 20-50 percent depending on
the period for which such assets remain in the doubtful category. With
respect to loss assets, it is suggested that either fully they be written
off or provision be created to the extent of 100 percent. The
committee also suggested that a period of 4 years should be given to
the banks and financial institutions to conform to those provision
requirements.

c) Banks and financial institutions should achieve a minimum of 4 %

capital adequacy ratio by March 1993 of which Tier-1 capital should
not be less than 2%.

vi) An Asset Reconstruction Fund (ARF) to be established for the recovery

of loans. This fund would take a portion of the bad and doubtful debts of
the banks at a discount.

vii) To end the duality of control and RBI should be the primary agency for
the regulation of the banking system.

viii) To provide autonomy to the banks the chief executive of the bank should
be appointed based on professionalism and integrity and not on political
consideration.

ix) Banks can access the capital market and issue of fresh capital to the
public through the capital market.The Banking Companies (Acquisition
and Transfer of Undertaking) Act was amended so that banks can raise
capital through public issues but to the condition that the holding of
Central Government would not fall below 51% of paid-up capital.

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Structural x) Setting up of new private sector banks if they conform to the requirement
Reforms
of minimum start-up capital and other requirements. Further, there
should not be any differential treatment between public and private
sector banks.

xi) Opening of foreign banks to open offices in India either as branches or as

subsidiaries.

Narasimham Committee II -1998

This committee was given the mandate to review the progress of banking
sector reforms, and design a programme to further strengthen the financial
structure, technological up-gradation, human resource development, capital
adequacy norms and bank mergers. The major recommendations include:

i) A stronger banking system in the context of Current Account

Convertibility (CAC). Indian banks must be made capable of handling
problems pertaining to domestic liquidity and exchange rate
management. So strong banks need to be merged which will have a
multiplier effect on the industry.

ii) Revival of Narrow Banking Concept whereby weak banks should place
their funds only in short term and risk-free assets like government
securities.

iii) Setting up of small, local banks which would cater to needs of states or
cluster of the districts to serve local trade, small industry and
agriculture.

iv) Banks should aim to reduce gross NPAs to 3 % by 2002.

v) To improve the strength of the Indian banking system the government

should raise capital adequacy norms of 9 % by 2000, 10 % by 2002.

vi) Banks to give more autonomy and freedom in the recruitment of

skilled, specialized manpower from the market.

vii) Rapid introduction of computerization and technology.

viii) Amendments in the Banking Regulation Act, Nationalisation Act and

State Bank of India Act, RBI Act, Bank Nationalisation Act, etc. to
allow greater autonomy, higher private-sector shareholdings, and so on.

9.3 REFORMS IN FINANCIAL SECTOR

The Government of India from time to time have been making certain
reforms to strengthen and stabilize the financial sector.

i) Financial Stability and Development Council (FSDC)

The government of India, in 2010 created an apex body (non-statutory) to

promote financial sector development and strengthen the mechanism for
182
maintaining financial stability. The regulator is entrusted with the Financial Sector and
Fiscal Sector Reforms
responsibility to maintain macro-prudential supervision in the country, inter-
regulatory coordination and financial development issues. The Union Finance
Minister is the chairperson of the FSDC and other members include the
governor of RBI, chairman of SEBI, IRDA and others.

ii) Merger of Forward Markets Commission (FMC) with the Securities

and Exchange Board of India (SEBI)

You must be familiar with forward trading in the context of shares in which
buyers and sellers agree to trade a financial asset at a future date at a
specified price. Similarly, forward contracts are agreements in the
commodity market concerning the future delivery of a commodity at the pre-
negotiated prices. The Forward Market Commission (FMC) established in
1953 acted as the regulatory body for the commodity futures market in India.
However, as part of Financial Sectors Reforms, FMC was merged with the
Securities and Exchange Board of India (SEBI) in 2015. The merger aimed at
realising the benefits of economies of scope and scale for exchange and to
harmonize the regulation of commodity derivatives and the securities market.

iii) Insolvency and Bankruptcy Code, 2016

Before the Insolvency and Bankruptcy Code, 2016, there were several laws
and procedures mostly overlapping and adjudicating forums that dealt with
insolvency and financial failure of individuals and companies in India. The
institutional and legal framework imposed a heavy strain on the Indian credit
system as there was no time limit on the effective and time recovery or
restructuring of defaulted assets. Reforms in the bankruptcy and insolvency
regime were critical not only for credit markets which were under a lot of
stress but for the ease of doing business in the country. The new code aims at
consolidating and amending laws relating to reorganization and resolution of
corporate persons, individuals and partnership firms in a time-bound manner
i.e. 180 days in case of companies. However, a subsequent amendment in this
code in 2019 (The Insolvency and Bankruptcy Code (Amendment) Act,
2019) has enhanced the mandatory upper time limit to 330 days which
includes time spent in the various legal processes to complete the resolution
process.

To promote entrepreneurship and availability of credit and balance the

interests of all the stakeholders, under the new Code, the National Company
Law Tribunal (NCLT) will now adjudicate insolvency resolution for
companies and the Debt Recovery Tribunal (DRT) will adjudicate insolvency
resolution for individuals. Establishment of the Insolvency and Bankruptcy
Board of India will oversee the insolvency proceedings in the country and
regulation of all entities registered under it.

To speed up the implementation of this Code, Government of India

established the Tribunals, National Company Law Tribunal (NCLT) and
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Structural National Company Appellate Tribunal (NCLAT) and Insolvency and
Reforms
Bankruptcy Board of India (IBBI) in 2016.
Box 9.1: Insolvency and Bankruptcy Code (Amendment)
Ordinance, 2021

The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021

was promulgated in 2021. The Ordinance targeted the corporate
persons classified as MSMEs to provide them with an efficient
alternative insolvency resolution framework and to provide cost
effective, faster and value maximising outcomes for all the
stakeholders . This is to be done in such a manner which is least
disruptive and preserve jobs. The incorporation of Pre-packed
insolvency resolution process for MSMEs in the code is expected to
provide some reflief to Covid hit sector. The timely and cost effective
resolution of distress can ensure positiveness to debt market,
employment preservation and ease of doing business.

Source: The Insolvency and Bankruptcy Code (Amendment) Ordinanace, 2021.

iv) Banking Regulation (Amendment) Ordinance, 2017

One of the biggest problems in the Indian banking system pertains to Non-
Performing Assets (NPA). Over the years they have accumulated and have
reached trillion of crore rupees. To deal with the problem of stressed assets,
Banking Regulation (Amendment) Ordinance, 2017 was promulgated in
2017. The bill has amended the Banking Regulation Act, 1949 and has
inserted two new sections namely 35AA and 35AB after Section 35A.
Accordingly, RBI is now authorized to direct banking companies to resolve
specific stressed assets by initiating an insolvency resolution process
wherever required. The RBI is also empowered to issue other directions for
the resolution of the stressed assets. RBI can also form committees to advise
banks on the resolution of stressed assets and the members of such
committees will be appointed by the RBI. The Ordinance enabled RBI to deal
with NPAs quickly. Accordingly, now the Oversight Committee can bypass
three major factors/hurdles which slowed the resolution process. These are:
1) stop ‘free riding’ by lenders who did not participate in the resolution
process. 2) compliance after an agreement has been sealed. 3) certify the
process to alleviate fears of future investigations.

v) The Banking Regulation (Amendment) Act, 2020

To find a solution to the deteriorating condition of cooperative banks in the

country, the government amended the Banking Regulation Act, 1949 and
promulgated Banking Regulation Amendment Bill, 2020. The major
objective is to bring cooperative banks under the supervision of the RBI.

After placing the bank under a moratorium RBI can prepare a scheme for
reconstruction or amalgamation of the bank. This is done once the RBI is
satisfied that such an order is necessary to protect the interest of the
184
depositors, public of the banking system. However, the act also allows RBI to Financial Sector and
Fiscal Sector Reforms
initiate such a scheme without imposing a moratorium.

The cooperative bank can now issue equity shares, preference shares or
special shares to its members or to any other person residing within its area
of operation, They can also issue unsecured debentures or bonds with a
maturity of 10 years or more to such person with the prior approval of RBI.
No person can demand payment towards the surrender of shares that are
issued by a cooperative bank.

The RBI may exempt a cooperative bank or a class of cooperative banks

from a certain provision of the Act through notification. The cooperative
banks cannot employ someone who is insolvent or has been convicted of a
crime. The RBI has the power to remove the chairman if he/she is not fit for
the position and can appoint another person as chairman.

Cooperative banks cannot make loans or advances on the security of their

own shares. They cannot grant unsecured loans or advances to their directors
or to private companies where the bank’s director or chairman is an interested
party. The Act has specified certain conditions under which unsecured loans
or advances may be granted and it specifies how these loans may be reported
to RBI.

The cooperative banks without prior approval of RBI, cannot open a new
place of business or change their location outside the city, town or village in
which it is currently located. This Act does not apply to Primary Agricultural
Credit Societies (PACS) and cooperative land mortgage banks.

9.4 REFORMS IN THE INSURANCE SECTOR

To provide a universal social security system especially to the
underprivileged and the poor population of the country, the three major
schemes were launched in 2015 namely, Pradhan Mantri Suraksha Bima
Yojana, Atal Pension Yojana and Pradhan Mantri Jeevan Jyoti Bima Yojana.
We shall study some details about these schemes in the following sections.

i) Pradhan Mantri Suraksha Bima Yojana (PMSBY)

The scheme provides for coverage of Rs 2 Lakh for accidental death and
permanent total disability and Rs 1 lakh for partial disability. The renewal of
one-year accidental-death-cum-disability cover is available to account
holders in the age group of 18-70 years. The premium of Rs 12 per annum is
deducted from the bank account through the ‘auto debit’ facility in one
instalment. As of April 2021, cumulative gross enrollment by banks in
PMSBY stood at 23.36 crores. Over 45,600 claims were disbursed under this
scheme.

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Structural ii) Pradhan Mantri Jeevan Jyoti Bima Yojana (PMJJBY)
Reforms
This scheme offers a renewable one-year term life cover of Rs 2 lakh to all
subscribing bank account holders. The subscribers can be in the age group of
18-50 years.. PMJJBY is offered by Life Insurance Corporation (LIC) and all
other life insurers. A premium of Rs 330 per annum is auto-debited in one
instalment from the subscriber's bank account.As of April 2021, cumulative
gross enrollment by banks in PMJJBY stood at 10.32 crores. Over 2,39,000
claims were disbursed under this scheme.

iii) Atal Pension Yojana (APY)

In 2015, the Government introduced Atal Pension Yojana (APY) to provide

pension especially to people engaged in the unorganised sector like
gardeners, maids, etc,. APY replaces the previous Swavalamban Yojana. This
scheme provides a defined pension depending upon the contribution and its
period. The subscribers are subject to the minimum pension of Rs 1000,
2000, 3000, 4000 or 5000 per month, from the age of 60 years contingent
upon the contribution by the subscribers and the age at the time of joining the
scheme. The spouse of the contributor in the case of death and nominee in
case of death of both the contributor and spouse can claim pension /paid the
accumulated corpus. The central government co-contributes 50% of the total
contribution subject to a maximum of Rs 1000 per annum, to each
subscriber’s account, for a period of five years, i.e. from FY 2015-16 to
2019-20. To avail the benefit of this scheme the subscriber should not be part
of other social security schemes like EPF or be paying income taxes. As of
April 2021, a total number of 304.33 lakh people have enrolled, under APY.

Ayushman Bharat

This Scheme was launched on the recommendation of the National Health

Policy, 2017 to achieve the Universal Health Coverage (UHC). Ayushman
Bharat scheme is launched to meet Sustainable Development Goals (SDGs)
and its commitment of “Leave no one behind”. This scheme has two inter-
related components namely Health and Wellness Centres (HWCs) and
Pradhan Mantri Jan Arogya Yojana (PM-JAY).

Health and Wellness Centres (HWCs): These centres were developed to

cater to the primary health care need of the citizens in their respective areas.
A large number of services related to reproductive, maternal, newborn,
communicable diseases, ENT, Ophthalmology and others are to be provided
in these centres, so that people need not run to nearby towns or cities
ultimately leading to saving of both time, energy and money.

Pradhan Mantri Jan Arogya Yojana (PM-JAY): It was launched in 2018

in Jharkhand by Hon’ble PM. It is the largest public health insurance scheme
in the world aiming to provide Swasthya Suraksha to nearly 10.74 crore poor
and vulnerable families as per the Socio-Economic Caste Census, 2011 and
the beneficiaries of Rashtriya Swasthya Bima Yojana. The Scheme provides
186
a cover of Rs 5 Lakh per family per year for medical and hospitalization Financial Sector and
Fiscal Sector Reforms
expenses in most of the secondary and tertiary hospitals. 3 days of pre-
hospitalisation and 15 days post-hospitalization expenses are covered under
this and all pre-existing diseases are covered from day one onwards. In 2020,
according to National Health Authority, cashless treatments of nearly Rs
15,500 crore was provided under Ayushman Bharat PMJAY.

Activity 1

1) Choose any bank of your preference (public, private or foreign) and from
its website look into its growth over a period of time like branch
expansion, credit-deposit ratio, etc. Also, look for data on the NPA of
that bank.

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

9.5 TAX REFORMS 1991

The government of India has appointed many committees to suggest
measures in both the direct and indirect taxation system of the country.

Chelliah Committee 1991

To examine the structure of both direct and indirect taxes, a Tax Reform
Committee under the chairmanship of Dr Raja J. Chelliah was constituted in
1991. The main task of the committee was to give suggestions on ways to
improve the elasticity of direct and indirect taxes, making the taxation system
broad-based and fair. Rationalisation of the direct taxes and improving
equity, to identify new areas for taxation and methods of improving tax
compliance and strengthening enforcement. The committee made the
following recommendations and most of these suggestions were incorporated
in the budget of 1993-94 (Appendix -I).

Kelkar Committee

In 2002, a task force under the chairmanship of Dr Vijay Kelkar was

constituted to recommend measures for simplification and rationalisation of
direct and indirect taxes. The committee recommended formulating a simple,
effective and better tax system. For direct tax, the recommendations were
related to raising the exemption limit of personal income tax, abolition of
wealth tax, long term capital gain tax, etc. Further, widening of the tax base,
expansion in the coverage of service tax, etc. were the recommendations for
indirect taxes (Appendix-II).
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Structural Kelkar Committee on Fiscal Consolidation
Reforms
In August 2012 a Committee was constituted under the chairmanship of Dr.
Vijay Kelkar to outline a roadmap for fiscal consolidation. The main reason
behind constituting the Committee was that in 2012-13, the fiscal deficit was
soaring high and it was estimated to reach 6.1% of GDP and a higher fiscal
deficit is a cause of worry for the economy which could led to higher
inflation, the external balance could widen, investment, growth and
employment tend to weaken and the overall confidence of investor is shaken.
The recommendations of the Committee are given in (Appendix- III).

Direct Tax Reforms

Direct Taxes are those taxes in which the impact and incidence of the tax fall
on the same person. Examples like Income Tax, Corporation Tax, etc. A
series of reforms have been introduced in the direct taxes which are given in
(Appendix-IV).

Changes in Direct and Indirect Tax in Union Budget 2021-22

In Union budget 2021-22, the Finance minister has proposed the major
changes/reforms in the direct and indirect taxes (Appendix-V).

9.6 FISCAL SECTOR REFORMS

Goods and Service Tax (GST)

In India, the constitution of India gives the power both to the state and central
government to levy taxes. Central government levies tax like custom duty,
central sales tax, etc. and state government levies taxes like Value Added Tax
(VAT). There was a large number of multiple taxes at various levels of the
supply chain levied by both Centre and State government that led to a
complex structure of the indirect taxes. The cascading of taxes which is due
to the ‘tax on tax’ ultimately inflate the price of the goods and services
artificially and the ultimate burden of these indirect taxes fall on consumers.
This set of multiple taxes with different tax bases and tax rates are also costly
to administer and comply with. So it was decided to have one comprehensive
indirect tax or consumption base tax namely Goods and Service Tax (GST).
The concept of GST was introduced in the year 2000. A task force on Fiscal
Responsibility and Budget Management was formed in 2003 and it
recommended the introduction of GST in 2004. However, it came into effect
by 101st Amendment to the Constitution of India from 1st July 2017. The
motto of GST is ‘One Tax, One Market and One Nation’. With the
implementation of GST large number of indirect taxes were subsumed into it.
GST replaced the taxes levied and collected by the Centre namely service
tax, central excise duty, duties of excise on medicinal and toilet preparations,
additional duties of Excise (Goods of special importance and textiles and
textile products), additional duties of customs, special additional duty of
customs and cesses and surcharges related to supply of goods and services.
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State taxes like state value-added tax (vat), central states tax, purchase tax, Financial Sector and
Fiscal Sector Reforms
luxury tax, entry tax, taxes on advertisements, entertainment tax and
amusement tax ( except those levied by the local bodies), state cesses and
surcharges on supply of goods and services.

Salient Features of GST

GST is applicable on ‘supply of goods’ or services as against manufacture of

goods or on sale of goods or provision of services. It is a destination-based
consumption tax. It is a dual GST namely Central GST (CGST) and State
GST( SGST). CGST is levied by Central Government and SGST is levied by
State Government. An Integrated GST or IGST is levied on the inter-state
supply of goods or services. IGST is levied and collected by Central
Government and is divided among the Union and the States on the
recommendation of the GST Council. At present there are 4 rates of GST
namely 5%, 12%, 18% and 28%. Some of the items which are exempted
from GST are alcohol for human consumption. Similarly, petrol, high-speed
diesel, supply of petroleum crude, natural gas and aviation turbine fuel and
electricity are kept outside GST.

GST Council

GST council act has a provision for the GST council which is an apex
committee on GST matters. The composition of the members includes the
chairman of the council (which is the Union Finance Minister), The Union
minister of state in charge of revenue or finance, one member from each state
who is the minister in charge of finance or taxation or any other member. The
Vice-chairman is elected among these members of the state. The secretary of
the revenue department is the Ex-Officio secretary and the chairperson of the
Central Board of Excise and Customs is the permanent invitee in the GST but
has no voting right. GST council recommends the Union Government of
India and States on subsuming various taxes, cess and surcharges in GST.
Deciding on the threshold limit below which services and goods will be
exempted from GST. Details of services and goods that will be subjected to
GST or will be exempted. Making special provisions to special category
states namely Jammu and Kashmir, Himachal Pradesh, Arunachal Pradesh,
Assam, Mizoram, Nagaland, Manipur, Meghalaya, Sikkim, Tripura, and
Uttarakhand. Model IGST laws, principles of levy, apportionment of IGST
and the principles that govern the place of supply. Any special rate of rates
for a specified period to raise additional resources during a disaster or natural
calamity and any other matter relating to GST.

Input Tax Credit

Input tax credit refers to the tax which was already paid by the
seller/manufacturer at the time of purchase of goods or service and which is
available as a deduction from the tax payable or the seller can reduce/deduct
the tax which they already paid on inputs at the time of paying tax on output.
For example, seller A bought the goods of amount Rs 18,000 and these goods 189
Structural attract GST @ 18% so the GST amount is Rs 3240. Now, seller, A sold these
Reforms
goods for Rs 22,000 and this attracts GST @18% or Rs 3960. In this case, the
net GST payable will be (Rs 3960 -Rs 3240 = Rs 720) and the input tax
credit is Rs 3240.

GST Network (GSTN)

GSTN is a non-profit, non-government organisation and manages the entire

information and technology system of the GST portal. Taxpayers file their
tax returns through this portal and the government can track every financial
transaction through GSTN.

Advantages of GST

Some of the benefits which can accrue due to GST are the creation of a
unified common national market for India and boosting the “Make in India”
campaign.

• Elimination of multiple taxes and mitigating the cascading of taxes,

harmonization of laws and rates of taxes.

• Evolution of simple tax regime, increase in ease of doing business,

reduction in the prices of goods in the long run benefiting the customers.

• According to Economic Survey 2020-21, the Government received GST

revenue worth Rs 1.15 lakh crore in December 2020 along with the
ongoing pandemic of COVID-19.

Activity 2

Study the latest budget and economic survey and read about any new changes
introduced in fiscal measures like change in income tax rate or new changes
in direct or indirect taxes and list them.

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

9.7 SUMMARY
In this unit, we studied the financial and fiscal sector reforms which were
introduced as part of NEP. Within the financial sector, banking sector
reforms initiated on the recommendation of the Narasimham committee were
of much importance. These reforms overhauled the financial sector in general
and the banking sector in particular. Post-1991 reform period, reforms in the
banking and insurance sector have focused on expediting the insolvency
resolution process and a maximum time limit has been imposed to finalise
these processes. RBI can now have more supervision on the functioning of
190
cooperative banks. The cooperative banks can now float shares and Financial Sector and
Fiscal Sector Reforms
debentures and work more efficiently. Schemes like PMSBY, PMJJBY and
APY seek to cover the unbanked proportion of the population and aims to
bring them under the ambit of formal basic banking and insurance services.
These schemes aim at extending the net of social security to the vulnerable
workers and sections of society along with the provision of health facility in
the nearby Primary Health Centres.

The taxation reforms 1991 attempted to make taxation broad-based and

increasing the compliance mechanism. Recently the introduction of GST
attempted to overhaul the existing indirect tax regime in the country which
was plagued with multiple taxes and that led to an artificial increase in the
prices. GST has opened up entire India as a single market with easing the
movement of goods across states. Since its introduction, this system has
shown many encouraging results in the form of an increase in tax collection
and revenue.

9.8 KEY WORDS

Insolvency: It is the state in which a person or company is unable to pay the
debt at maturity.

Fiscal Year: It is one year period that is used for financial reporting and
budgeting by companies and governments.

Non-Performing Assets (NPAs): It is a loan or advance that are in default or

arrears. The principal or interest payment is due for 90 days.

Incidence of Tax: It is the final burden of the tax. Incidence is one person
who ultimately bears the real burden of the tax.

Direct Tax: Taxes which are imposed on individuals or corporation. The

impact and incidence of these taxes are on the same persons. Income tax,
corporation tax, wealth tax, are some of the examples.

Indirect Tax: It a tax in which impact and incidence are on different entities.
These taxes can be passed on to another individual. They are generally
imposed on manufacturer or suppliers who ultimately pass on the burden to
the final consumer. Some of the examples of indirect tax are GST, VAT,
customs duty, etc.

9.9 SELF- ASSESSMENT QUESTIONS

1) Discuss the major advantages and features of GST.
2) What are the major facilities offered under the Ayushman Bharat
Scheme?
3) Discuss the Service exports from the India Scheme under Foreign Trade
Policy 2015-2020.
191
Structural 4) Critically examine the recommendations of the Narasimham Committee.
Reforms
5) Critically examine the recommendations of the Kelkar Committee.

9.10 REFERENCES/ FURTHER READINGS

• Misra S.K. &V.K.Puri.(2020). Indian Economy (38th edition)- Himalaya
Publication House, Mumbai.
• Datt,Gaurav. & Ashwani Mahajan. (2019). Indian Economy. S.Chand
Publication
• Ministry of Finance. (2015). Economic Survey 2014-15. Government of
India. New Delhi.
• Ministry of Finance. (2016). Economic Survey 2015-16. Government of
India. New Delhi.
• Ministry of Finance. (2017). Economic Survey 2016-17. Government of
India. New Delhi.
• Ministry of Finance. (2018). Economic Survey 2017-18. Government of
India. New Delhi.
• Ministry of Finance. (2019). Economic Survey 2018-19. Government of
India. New Delhi.
• Ministry of Finance. (2020). Economic Survey 2019-20. Government of
India. New Delhi.
• Ministry of Finance. (2021). Economic Survey 2020-21. Government of
India. New Delhi.

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 Appendix-I Financial Sector and
Fiscal Sector Reforms
i) Reduction in rate of corporate tax from 51.75 % to 45 % and further
reduction to 40 % from 1994-95.

ii) Abolition of surcharge on corporate tax.

iii) Abolition of Interest tax

iv) To continue gift tax (however, exemption limit ehnaced to Rs 30,000

from 20,000)

v) Tax on agricultural income of non-farmers if it exceeds Rs 25,000.

vi) To extend Value Added Tax (VAT) tax system upto the manufacturing
level.

vii) To start TIN (Taxpayer Identification Number) in place of Permanent

Account Number (PAN) for the identification of taxpayers.

viii) To reduce the import duty ceiling to 50 % from the existing 110 %.

ix) To minimise the tax slabs.

x) Import duty to have five slabs, lowest 5 % and highest 30 %.

xi) 50 % import duty on non-essential consumer items.

xii) Duty-free import of wheat and rice, but oilseeds, pulses and other
agricultural products to have 10 % ad valorem import duty.

xiii) Duty-free imported items should be charged 5 % duty under the

‘Protection’ head.

xiv) 5 % import duty on inputs of fertiliser and newsprints production.

xv) 20 % import duty on medical equipment

xvi) To continue the advanced licencing system for exporters.

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Structural Appendix-II
Reforms
Tax Administration

i) To expand taxpayer services both quantitatively and qualitatively.

ii) Extension of PAN to cover all economic agents/citizens.

iii) The time limit of 4 months for the processing of tax returns and refunds.

iv) Transparency and objectivity in the process of selection of cases.

v) Establishment of a Tax Information Network on a build, operate and

transfer basis to speed up the process of modernisation and consequent
simplification and rationalisation of the scheme of tax deduction at
source.

vi) Enhancing the accountability of officers and staff.

vii) To provide more administrative and financial powers to the Central

Board of Direct Taxes (CBDT).

Direct Tax

i) Generalised exemption limit raised to Rs 1 lakh from Rs 50,000.

ii) Exemption limit of Rs 1,50,000 for widows and senior citizens

iii) 3 tier income tax structure replaced with 2 tier structure.

Taxable Income tax rate(%)

Upto 1 lakh nil

1-4 lakh 10

Above 4 lakh 20

iv) Standard deduction and surcharge abolished.

v) Tax incentives for saving needs to be withdrawn.

vi) To encourage investment in an annuity-oriented pension scheme

proposal to double the exemption under 80 C to Rs 2 Lakh from 1 lakh.

vii) Deduction under Section 80CCC for contribution to pension funds to be

increased from Rs.10,000 to Rs.20,000

viii) Abolition of dividend and long term capital gain tax.

ix) Tax rebate on housing interest reduced to Rs 50,000 from Rs 1.5 lakh
and 2 % interest subsidy on housing loans upto 5 lakh.

x) Income tax on agriculture income should be left to states.

xi) Tax rebate schemes under section 88, 88 B and 88 C withdrawn.

194
 xii) The deduction for handicapped under 80 DD and 80 U to continue. Financial Sector and
Fiscal Sector Reforms
xiii) 5 % surcharge on income tax to be withdrawn.

xiv) For domestic companies, corporate tax reduced to 30 % from 36.75 %.

xv) For foreign companies, tax on income reduced to 35 % from 40 %.

xvi) No tax on the distribution of dividends by a company.

xvii) The general rate of depreciation for plants and machinery reduced to 15
%.

xviii) Minimum alternative tax under section 1157 B abolished.

xix) Elimination of tax incentives under Section 88, 80L and interest income
under section 10.

Indirect Taxes

i) The multiplicity of levies to be reduced to three, viz., basic customs duty,

additional duty of customs and anti-dumping duties

ii) For raw materials, inputs and intermediate goods customs duty reduced to
10 % and for consumer durables it was reduced to 20 % by 2004-05.

iii) Removal of exemption under Section 33AB, 33AC, 33B, 35, 35AC,
35CCA .

iv) By 2006-07, customs duty for coal, ores and other raw materials to be
reduced to 5 % and for capital goods, basic chemicals to 8 %.

v) Higher duty of 150 % for specified agri-products and demerits goods.

vi) Complete exemption of customs duty on life-saving drugs and defence-

related equipment.

vii) Central excise duty on kerosene raised by Rs 1 per litre.

viii) Duty exemption for Small Scale Industries (SSIs) with turnover upto Rs
50 lakh.

ix) By 2003, the nationwide introduction of VAT and service tax.

x) Removal of exemption under Section 33AB, 33AC, 33B, 35, 35AC,

35CCA etc.

xi) Income of mutual funds derived from short-term capital gains and interest
to be taxed at a flat rate in the hands of the mutual funds.

xii) The merger of tax on expenditure in hotels with service tax.

xiii) A duty of 8 percent on crude oil and 15 percent on petroleum products

from 2003-04. A duty of 5 percent on crude oil and 10 percent on
petroleum products from 2004-05.
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Structural xiv) All levies to be reviewed and to be replaced by only one levy, i.e., the
Reforms
CENVAT.

xv) A uniform rate of 16 percent on all fibres and yarns, by raising duty on
cotton yarn from 8 percent to 14 percent and bringing down duty on
polyester filament yarn to 14 percent in four instalments.

xvi) All exemptions to be removed on the textile sector except for fabrics
woven handlooms, handloom fabric certified as khadi, etc.

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 Appendix- III Financial Sector and
Fiscal Sector Reforms
i) To bring the tax to GDP ratio to the high levels of 2007-08 i.e. 11.9 %

ii) Establishment of data warehousing and data mining infrastructure,

modernise outdated investigation processes.

iii) Revision of Direct Taxes code bill.

iv) Implementation of GST.

v) Revision of the negative list of services that are exempted from tax.

vi) Proposal of ‘call option model’ to accelerate the disinvestment process.

vii) Establishment of Exchange Traded Fund to provide investors with the

benefits of diversification, low-cost access and flexibility.

viii) Selling of minority holdings in largely private entities.

ix) To mitigate the financial burden of subsidies, the committee suggested

increasing the price of diesel by Rs 4/liter, Rs 2/litre in kerosene and Rs
50 per LPG cylinder. The committee also recommends phasing out the
subsidy on diesel and LPG by 2014-15.

x) Increase the price of urea by 10 %.

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Structural Appendix- IV
Reforms
• The Taxation Laws (Amendment) Ordinance,2019 provides a
concessional tax regime of 22 % for all domestic companies from the
Fiscal Year 2019-2010 provided they do not avail any
exemption/incentive. If surcharges and cess is also included then the
effective tax rate is 25.17 %. Such companies have been given
exemption from paying Minimum Alternate Tax (MAT).

• To give a boost to the ‘Make in India’ initiative a new provision is

introduced in Income Tax Act, which allows that any new domestic
company to pay income tax at a 15 % tax rate if it is incorporated on or
after 1st October 2019. Such companies should not avail any
exemption/incentive and commence production on or before 31st March
2023. Further, these companies are given exemption from paying
Minimum Alternate Tax (MAT).

• The rate of MAT has been reduced to 15 % from 18.5 %.

• In accordance with the Finance Act, 2019, exemption of income tax to

individuals earning income up to Rs 5 Lakh and the standard deduction
is increased from Rs.40,000 to Rs. 50,000.

• The Finance Act, 2020, provides an option of paying income tax at

concessional rates to individuals and corporation, if they do not avail
exemption/incentive.

• Dividend Distribution Tax (DDT) stands abolished.

• Direct Tax Vivad se Vishwas Scheme, 2020 to reduce the litigations and
settle the cases which are long pending before various appellate forums.

• Faceless E-assessment Scheme and Faceless Appeals: To eliminate

the interface between the assessing officer and the assesses and
optimising the use of resources these schemes/option was launched.

• Unique Document Number: To bring efficiency and transparency to

every communication.

• Encouragement to digital transactions to reduce unaccounted

transactions.

• Provision of hassle-free tax environment to Startups like simplification

of the assessment procedure, exemption from Angel-tax, etc.

• A transaction like huge cash withdrawal, purchase of a luxury car, sale of

goods, etc. would be under the ambit of Tax Deduction at Source (TDS)
and Tax Collection at Source (TCS). These steps are undertaken to
widen the tax base and ultimate increase in tax revenue.

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 Appendix-V Financial Sector and
Fiscal Sector Reforms
Changes in Direct and Indirect Tax in Union Budget 2021-22

Direct Taxes

i) No change in the income tax rates for individuals and corporations

Income range tax rate
Upto 2,50,000 Nil
2.5 lakh to 5 lakh 5
5 lakh to 10 lakh 20
Above 10 lakh 30
ii) Faceless Assessment and Faceless Appeal introduced.
iii) Senior citizens over 75 years of age having only pension and interest
income exempted from filing tax returns.
iv) The time limit for reopening of cases reduced to 3 years from 6 years.
v) Dispute resolution committee to be set up for taxpayers with taxable
income upto Rs 50 lakh and disputed income upto Rs 10 lakh.
vi) Rules to be notified for NRIs regarding their foreign retirement
accounts.
vii) For entities that carry out 95 % transaction digitally the limit for such
entities for tax audit increased to Rs. 10 crore from the existing Rs. 5
crore.
viii) Dividend payment to REIT/ InvIT exempt from TDS.
ix) Infrastructure Debt Funds cab raise funds by issuing Zero Coupons
Bonds.
x) Additional deduction of interest, up to Rs. 1.5 lakh, for the loan taken
to buy an affordable house extended for loans taken till March 2022.
xi) Tax holiday for Affordable Housing projects extended till March 2022.
xii) Tax exemption allowed for notified Affordable Rental Housing
Projects.
xiii) Tax holiday for capital gains from incomes of aircraft leasing
companies.
xiv) Tax exemptions for aircraft lease rentals paid to foreign lessors.
xv) Tax incentive for relocating foreign funds in the IFSC.
xvi) Tax exemption to investment division of foreign banks located in IFSC.
xvii) Capital gains exemption for investment in start-ups extended till 31st
March, 2022.

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Structural
Indirect Taxes
Reforms

i) Major measures were undertaken under GST. Nil return through SMS,
Quarterly return and monthly payment for small taxpayers, Electronic
invoice system, Validated input tax statement, Pre-filled editable GST
return, Staggering of returns filing, Enhancement of capacity of GSTN
system, Use of deep analytics and AI to identify tax evaders.
ii) Revised, distortion-free customs duty structure to be put in place from
1st October 2021 by reviewing more than 400 old exemptions.
iii) New customs duty exemptions to have validity up to the 31st March
following two years from its issue date.
iv) Customs duty reduced uniformly to 7.5% on semis, flat, and long
products of non-alloy, alloy, and stainless steels.
v) Duty on steel scrap exempted up to 31st March 2022.
vi) Anti-Dumping Duty (ADD) and Counter-Veiling Duty (CVD) revoked
on certain steel products.
vii) Duty on copper scrap reduced from 5% to 2.5%.
viii) Duty on solar invertors raised from 5% to 20%, and on solar lanterns
from 5% to 15% to encourage domestic production.
ix) Exemption on import of duty-free items rationalized to incentivize
exporters of garments, leather, and handicraft items.
x) Exemption on imports of certain kind of leathers withdrawn.
xi) Customs duty on cotton increased from nil to 10% and on raw silk and
silk yarn from 10% to 15%.
xii) Agriculture Infrastructure and Development Cess (AIDC) on a small
number of items.

200
 Financial Sector and
Fiscal Sector Reforms

BLOCK 4
INTERNATIONAL BUSINESS ENVIRONEMENT

201
Structural
Reforms
BLOCK 4 INTERNATIONAL BUSINESS
ENVIRONEMENT
The process of globalisation has impact on the country’s economy, society
and culture resulting in new structures, new technologies thereby resulting in
increase in economic opportunities. This block focuses on international
business environment and has following five units:

Unit 10: International Financial System

Unit 11: Balance of Payments (BoP)

Unit 12: Foreign Trade

Unit 13: Sources of Global Financing

Unit 14: Technological Environment

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UNIT 10 INTERNATIONAL FINANCIAL International
Financial System
SYSTEM

Objectives

After reading this unit you should be able to:

• explain how the international financial system works;

• identify the institutions responsible to stabilise and reconstruct the
countries in need of such assistance;
• describe the roles and functions of Bretton Woods Institutions; and
• distinguish between International Monetary Fund (IMF) and World
Bank.

Structure

10.1 Introduction
10.2 International Monetary Fund (IMF)
10.3 The World Bank
10.4 World Bank Group Institutions
10.5 Difference between IMF and the World Bank
10.6 International Monetary System
10.7 Summary
10.8 Key Words
10.9 Self-Assessment Questions
10.10 References/ Further Readings

10.1 INTRODUCTION
The international financial system is an arrangement through which the
financial flows are governed. This is a combination of financial systems of
individual countries and monetary arrangements (like European Monetary
Union), the operation of organisations like the World Bank and the IMF,
exchange rate systems followed by individual countries and the role of USA
as an anchor country. The present-day financial architecture of the world is
complex given the level of global integration achieved between countries.
Hence, policies of individual countries can cause problems for their trade
partners. The major role of the international financial system is to maintain
stability. Countries may run into difficulty due to paucity of foreign exchange
and default on their payment obligations. This may affect the lenders and
cause a ripple effect throughout the globe. Hence a mechanism needs to be
put in place to prevent such fluctuations through a system of providing the

203
Structural finances with the conditionality that appropriate policies would be persued to
Reforms
correct the imbalances.

The two World Wars caused a lot of disruptions and one of the major impacts
was on the countries severely damaged by them. These countries had to
depend on countries like USA for funds to reconstruct their economies. USA
did help those countries but need was felt for institutions which could
supplement this and take the responsibility for problems which could be
faced in the future. In 1944 the Bretton Woods Conference agreed to form the
World Bank and IMF. Political conflicts led to economic conflicts during and
after the wars. Protectionism led to reduction in World trade and also caused
a slowdown of the world GDP. Exchange rates were floated or being pegged
at will causing a lot of disruptions. Hence a need was felt for a coordinated
arrangement where the member countries can only deviate when they faced a
“fundamental disequilibrium”. Though the IMF has not given any definition
of what they mean by “fundamental disequilibrium” it can be construed as a
situation where the outward payments continuously deviate from inward
payments.

To understand the international financial system thus we need to start from

the Institutions entrusted with task of maintaining its stability. The IMF and
the World Bank will be discussed in the next two sections.

10.2 INTERNATIONAL MONETARY FUND (IMF)

The IMF is an autonomous international organisation of around 190
countries. Members subscribe to its quota and in turn IMF provides
assistance during the crisis of balance of payments (BoP). Further, technical
assistance to help countries better manage their economy and training and
policy advice is also part of IMF’s responsibilities. The IMF came into
existence on December 27, 1945 after the articles of agreement was adopted
by the members during the Bretton Woods Conference in 1944. The mandate
of IMF according to the articles of agreement establishing it are as follows:

• To promote cooperation among the members in monetary matters and

provide a forum for discussions to maintain cordial relationships;

• To smoothen the process so that international trade is fostered,

employment levels increase, real incomes grow and productive resources
accumulate for the member countries;

• To incentivise orderly exchange rate arrangements and its stability and

see to it that the members don’t indulge in competitive devaluation;

• To help the member countries develop a system of payments to facilitate

multilateral transactions and to remove restrictions on foreign exchange
which hampers trade;

204
• To become a vehicle through which members can get over difficult times International
Financial System
in terms of payments problems by accessing its resources so that they
don’t have to resort to policies which are further damaging; and

• To lessen the trauma of the member countries by shortening the time and
degree of disequilibrium in BoP.

Functions

The IMF performs the following functions which range from surveillance of
member countries to advisory for mobilising of external finance.

1) IMF has the mandate and legal backing to monitor the economies of the
member countries to check whether they conform to its objectives.

2) Major function of IMF is direct lending to member countries to get over

temporary BoP difficulties and to see to it that they take corrective
measures so that the disequilibrium adjusts smoothly.

3) Low-income countries are helped by IMF through linking them to

external donor agencies and sources of funds. Along with World Bank,
IMF helps such countries in their payments and development spheres.
IMF is also involved with debt relief and high indebtedness of these
countries.

4) IMF’s constant monitoring of the members’ economic wellbeing helps

donors and financial markets to properly gauge the economies. This
helps them get external funding.

5) The institution also serves as a forum for consultations and international

coordination among member countries to prevent disorderly movements
in exchange rates.

6) Supply additional international liquidity through issuing of Special

Drawing Rights (SDRs) if need is felt. SDRs are the unit of account in
which the Fund transacts with its members but they are not a claim on
the institution. SDRs can be exchanged for convertible currencies.

7) IMF also engages in training and capacity building of especially

developing country members in areas of its expertise. This helps the
members to avoid costly mistakes while formulating economic policies.

8) In order to serve its members in a better way the Fund undertakes

research in areas where it normally advices. The research is disseminated
through Reports, Working Papers, Journal articles through electronic
modes. It is also a major source of cross-country data on financial,
monetary and economic variables useful to its member governments,
researchers and business people.

IMF’s Policies over the Years

205
Structural IMF’s bailout role starts with the country in crisis approaching it. Mostly this
Reforms
happens when the countries are on the verge of defaulting on external
obligations like imports or external debt servicing. IMF decides on the
modalities of help which majorly are soft loans proportional to the country’s
quota. The repayment schedule is decided on the basis of the liquidity
condition of the country so that they don’t face any problems. In lieu of the
help the countries need to follow IMF conditionalities. Such conditionalities
are mainly targeted towards bringing the country back to the growth path.
Typically, they are policies to improve budgets, reduce inflation,
privatisation, liberalisation which are basically market-oriented policies. IMF
cannot force the countries to follow the conditionalities but can withhold
further assistance or delay subsequent sanction of loans. One of the major
criticisms against such policies has been that it ignored the ground realities in
the crisis-hit countries. In many cases including some countries in Latin
America and Africa, such policies led to reduction in GDP growth due to
inability of such countries to compete with now liberal imports. Further, the
austerity measures to curtail government expenditure to improve budgets
along with increased taxes added to the problems of recipient countries. A
one-size-fit-all strategy was criticised by many experts.

Many commentators claim that IMF policies not only caused economic
malaise but led to major health disasters like Ebola outbreak in Africa where
debt repayment was emphasised over resulting lack of resources to fight such
a health disaster. Most often the recipient countries refused to follow the
prescribed policies leading IMF to threaten to cut them off from future aid.
However, studies found that conditionalities had little impact on effectiveness
of IMF programmes. From a structuralist point of view when one looks at
IMF’s dealings with recipient countries interesting facts emerge. Countries
close to US are less stringently dealt with. Countries receiving debt from
other international organisations get preferential treatments while disbursing
loans. Countries favourably looked at by UN agencies are especially the
temporary members of Security Council. In many cases the conditionalities
were more severe in case of the highly affected country. Even when well
meant conditionalities sometimes led to adverse international reserve position
and higher interest rates for the recipient countries. Many feel it is not the
problem with conditionality alone but lack of mechanisms to properly
enforce them was also a problem area. IMF rarely succeeded in punishing the
countries for not following its dictates. The change in IMF’s assistance
programme has been dramatic in case of geographic coverage. For the first
time IMF was involved in bailing out European countries following the
Sovereign Debt Crisis. The major initiative was in Greece where the bailout
was to the tune of $375 billion over eight years. The amount was larger than
the normal proportion of bailout (relative to membership subscription).

The jury on IMF’s effectiveness is still tilted towards negative. Some experts
argue that to be fair no one knows without these policies what would have
happened. Role of IMF’s policies in helping East Asian countries to quickly
206
recover from the crisis in 1997-98 was lauded. Further, the assistance International
Financial System
provided to Brazil in 2002 was another IMF success story where the country
could repay the debt before scheduled date. But austerity programmes in
Greece and Spain have led to 30% youth unemployment. Some cite Ireland
as a success story for the bailout programmes.

IMF have added more strategies like ‘flexible credit line’ and a
‘precautionary and liquidity line’ to help countries in difficulties but who
otherwise don’t qualify for assistance. Further, in order to tackle the
criticisms levelled by developing countries IMF have been proactive in
helping them in achieving the Millennium Development Goals (MDGs). In
view of some of the troubled countries seeking relief from other countries
and not IMF, the Fund has tried to improve on transparency and timeliness of
the assistance. On leadership part though it has still a lot to achieve as the
MD has most of the times been from some European country and the other
members especially developing countries are bitter about it.

During the recent Covid Crisis IMF doubled the funds available for
assistance through Rapid Financing Instrument and Rapid Credit Facility. A
demand of almost $100 billion was construed. More than 100 countries have
asked for relief. Till August, 2020 almost 70 countries have been touched
through $30 billion loans. Chile and Peru have been given assistance through
Flexible credit line. Poorest countries have been given grants to cover their
payments in the interim period. The Fund has also requested wealthy
countries including China to resist from asking the poorest countries to pay
their debt obligations in this difficult year. Thus, the Fund has come a long
way from stringent conditionalities to a more flexible approach. Further, now
it is trying to cater to the development needs of the poorest countries.

Activity 1

1) Find out from internet or other sources at least two countries which have
got assistance from IMF.

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

2) Did policies suggested by IMF benefit these countries? Write detailed

note.

……………………………………………………………………………

…………………………………………………………………………… 207
Structural ……………………………………………………………………………
Reforms
……………………………………………………………………………

10.3 THE WORLD BANK

This institution also came into being after the Bretton Woods Conference.
The major role perceived for the institution was to re-build the countries
severely impacted by World War II. It functions like a development financial
institution and an investment bank at the same time. After its operations in
the war-ravaged countries their conditions improved. The Bank then shifted
focus to the development needs of the poor countries. The funding source for
the Bank’s operation is mainly capital markets. Issuing bonds and grants
received from its members are its other sources of funding. Direct selling of
bonds and notes to its member countries are also sometimes resorted to raise
funds.

Roles of World Bank

• Assist countries to come out of indebtedness: Due to the two oil price
shocks in 1980s many developing countries were on the brink. The Bank
resorted to adjustment lending to restore economic growth in such
countries. Later focus shifted to poverty reduction and re-tuning the
adjustment lending to achieve this objective.

• Poverty reduction: This has become a thrust area for the Bank and has
led to major loans to poverty afflicted countries over the years. The areas
through which this was done is mentioned in the following box.

Box 10.1: Thrust Areas

Agricultural and Rural Development, Aids, Anti-Corruption, Debt

Relief: Heavily Indebted Poor Countries, Education and Training,
Energy, Environment, Evaluation Monitoring, Financial Sector,
Gender, Globalization, Global Monitoring, Governance and Public
Sector Reform, Health, Nutrition and Population, Information and
Communication Technologies, Infrastructure, Knowledge Sharing,
Law and Justice, Macroeconomics and Growth, Mining,
Participation, Policies, Poverty, Private Sector Development, Social
Development, Social Protection and Labour, Sustainable
Development, Trade, Transport, Urban Development.

Source: World Bank Website

• Country Assistance: The mandate of the Bank was to lend to clearly

identified projects for intervention. It was soon realised that the countries
targeted were not capable of identifying projects. Thus, the Bank had to
involve itself into policy reviews, advising on policy making,
formulating projects to ask for assistance, etc. The country assistance has
the following steps as mentioned in the box below.
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 Box 10.2: Stages of Assistance International
Financial System
1) Country Assistance Strategy
The Bank prepares lending and advisory services, based on the
selectivity framework and areas of comparative advantage, targeted to
country poverty reduction efforts.
2) Identification
Projects are identified that support strategies and that are financially,
economically, socially, and environmentally sound. Development
Strategies are analyzed.
3) Preparation
The Bank provides policy and project advice along with financial
assistance. Clients conduct studies and prepare final project
documentation.
4) Appraisal
The Bank assesses the economic, technical, institutional, financial,
environmental, and social aspects of the project. The project appraisal
document and draft legal documents are prepared.
5) Negotiations and Board Approval
The Bank and borrower agree on loan or credit agreement and the project
is presented to the Board for approval.
6) Implementation and Supervision
The borrower implements the project. The Bank ensures that the loan
proceeds are used for the loan purposes with due regard for economy,
efficiency, and effectiveness.
7) Implementation and Completion
The Implementation Completion Report is prepared to evaluate the
performance of both the Bank and the borrower.
8) Evaluation
The Bank's independent Operations Evaluation Department prepares an
audit report and evaluates the project. Analysis is used for future
projects.

• Provider of International Public Goods: The Bank is looked upon to

provide necessary advice regarding economic policy and risks involved
in general in investing in certain countries. The public goods provided by
the Bank are strengthening the democratic processes, promoting
partnership with the private sector, providing knowledge about and
relevant to development, global environment, correcting market failures,
rectification of information failures, elimination of drug trafficking,

209
Structural management of global capital flows along with overcoming market
Reforms
imperfections and policy intervention in poor countries.

• Knowledge Bank: Given its expertise in a wide-ranging area the Bank is

a repository of information which spans across countries and sectors.
The Bank needs research to decide its intervention strategy and to
monitor the countries to identify early warning signs. Based on research
the Bank can provide relevant advice to its member countries. The
databases hosted by the Bank can be used by academicians, policy
makers, corporates, etc. for their relevant work. Doing Business Reports,
World Integrated Trade Solutions are some of the very useful Reports
and databases used widely across the world.

Activity 2

1) Search for World Bank projects especially in the area of infrastructure in

India. What are the features of the projects and what is the role of World
Bank in facilitating such projects?

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

2) In the area of poverty-alleviation what are the World Bank projects being
implemented in India? Find out and write about their social impact.

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

10.4 WORLD BANK GROUP INSTITUTIONS

International Development Association (IDA)

This arm of the Bank looks after the poverty alleviation and debt relief of
majorly the 74 poorest countries of the World. They lend money on
concessional or near zero interest rate terms. The loans are made for long
term 30-40 years with interim 5-10 years grace periods. The debt relief is
done through two initiatives called Heavily Indebted Poor Countries and
Multilateral Debt Relief Initiative. The institution provides a range of
assistance to promote economic growth, equality, employment opportunities,
210
higher income and enhanced living standards. Major areas covered under the International
Financial System
institute’s initiatives are, primary education, basic health services, clean
water and sanitation, agriculture, business climate improvements,
infrastructure, and institutional reforms.

International Finance Corporation (IFC)

This arm of the Bank is involved in private sector development in member

countries especially those projects which have welfare implications. The
institution can help private sector entities by giving loans, taking equity
stakes, stock options or by sharing profits. It may also provide venture capital
and stimulate investments by other private entities and overall try to develop
the capital market in developing countries. This is meant to foster private
investment flows both within and across borders. The funds for these
programmes are sourced from the institution’s net worth, retained earnings,
public and private placements of bonds and from the Bank. The major thrust
has been to increase efficiency of public utilities through push towards
privatisation of such services. Services like power, water, transportation, and
communications have been targeted for this purpose. In terms of technical
assistance, the institution tries to help private sector entities to get select
technology partners, find markets for their products and sources of low-cost
finance for their expansion.

Multilateral Investment Guarantee Agency (MIGA)

Foreign investments are an important source of funds for fuelling economic

growth and reducing poverty in developing countries. Observed foreign
flows shows appetite for only a handful of such countries severely limiting
the prospects of growth and development in countries facing internal or
external problems related to the political atmosphere. MIGA comes in here
and tries to channelise foreign investment in disturbed and poor countries
through its initiatives. The most important of them is the political risk
insurance products which can be bought by the investing companies to guard
them against any problems which makes their investment bad in host
countries. The Agency also provides services like technical assistance to
promote investment climate, settle investment disputes and promote foreign
capital flows in disturbed countries who need them the most. The
Independent Evaluation Group (IEG-MIGA) was established in the year 2002
to assess MIGA’s operational and developmental effectiveness. Activities to
be evaluated include guaranteeing projects, technical assistance, advisory and
legal services, as well as the evaluation of MIGA’s institutional efficiency,
efficacy and strategy.

International Centre for Settlement of Investment Disputes (ICSID)

ICSID gives a platform for the investors to settle their disputes with the host
states. A need was felt for tackling the non-commercial risks of foreign
investments. The members involved in the dispute can voluntarily resort to
the mechanisms available with ICSID to settle their disputes. But once 211
Structural sought they cannot withdraw from the proceedings. Additionally, over the
Reforms
years given the requests by the members ICSID may also involve itself with
fact finding missions related to the disputes. It now also allows cases if one
of the countries involved in the dispute are not its member. Additionally, it
may also involve in transactions which cannot be categorised as foreign
investment but is distinct from a ordinary commercial transaction. An
example can be fact finding proceedings. Further, the Secretary General of
ICSID is available for appointing arbitrators or disqualifying them for
disputes covered under their conventions. ICSID provides well equipped
hearing rooms for the proceedings related to disputes.

Activity 3

Try to make a case study on operations of each of the arms of the World
Bank. It can be a country case study, disputes between countries, insurance
for foreign investments in risky countries, etc.

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

10.5 DIFFERENCE BETWEEN IMF AND THE

WORLD BANK
The major differences between the World Bank and the IMF can be
understood through the following table.

Table 10.1: The International Monetary Fund and the

World Bank at a Glance
International Monetary Fund World Bank
• oversees the international • seeks to promote the economic
monetary system development of the world's poorer
countries
• promotes exchange stability and • assists developing countries
orderly exchange relations among through long-term financing of
its member countries development projects and
programs

• assists all members-both • provides to the poorest

industrial and developing developing countries whose per
countries--that find themselves in capita GNP is less than $865 a
temporary balance of payments year special financial assistance
difficulties by providing short- to through the International
medium-term credits Development Association (IDA)
212
 International
• supplements the currency • encourages private enterprises in Financial System
reserves of its members through developing countries through its
the allocation of Special Drawing affiliate, the International Finance
Rights (SDRs); to date SDR 21.4 Corporation (IFC)
billion has been issued to member
countries in proportion to their
quotas
• draws its financial resources • acquires most of its financial
principally from the quota resources by borrowing on the
subscriptions of its member international bond market
countries
• has at its disposal fully paid-in • has an authorized capital of $184
quotas now totalling SDRs 145 billion, of which members pay in
billion (about $215 billion) about 10 percent
• has a staff of 2,300 drawn from • has a staff of 7,000 drawn from
182 member countries 180 member countries

Source: https://www.imf.org/external/pubs/ft/exrp/differ/differ.htm

Activity 4

Which of these two institutions (IMF and World Bank) are more beneficial
for poor countries? Explain with the help of appropriate case studies.

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

10.6 INTERNATIONAL MONETARY SYSTEM

The nations transact with each other mainly through trade and capital flows.
Net transactions have to be settled at regular intervals. While engaging in
such transactions some of the countries may face situations where the
payment obligations are more than their receipts. In that case such
disequilibrium in Balance of Payments (BoP) is either met through foreign
exchange reserves or through borrowed funds. Hence, there is a requirement
for countries and institutions to act as supplier of such reserves. Amount of
such reserves that would be demanded depends on the speed of adjustment of
BoP and the institutional framework of the world economy.

Exchange rate system followed by the countries also impacts the amount of
reserves that can be demanded. In a completely market determined exchange
rate system the movement in exchange rate brings the BoP back to
213
Structural equilibrium reducing the requirement for international reserves. In case of a
Reforms
fixed or pegged exchange rate system in order to maintain a certain level of
exchange rate the requirement for foreign exchange reserves increases. The
other function of international reserves is to facilitate government
intervention in foreign exchange rate markets. Higher the volume of such
activities higher is the requirement of international reserves.

The other major factors impacting the demand for international reserves are
the speed of automatic adjustment, policies aimed at restoring BoP
equilibrium and international coordination of economic policies. If the
automatic adjustment mechanism takes time, then the demand for
international reserves goes up. For example, a BoP deficit triggers a
depreciation of home currency which enhances exports and reduces imports
and automatically moving the country towards equilibrium. But if rigidities
cause the adjustment to be slow then the country has to resort to international
reserves either owned by them or borrowed from others. Similarly, if the
economic policies geared towards restoring equilibrium takes time to achieve
the desired outcomes again the demand for international reserves go up. The
coordination of economic policies across countries has been the objective of
institutions like IMF. Groups like Organisation of Economic Cooperation and
Development (OECD) and monetary unions like European Union (EU) are
efforts towards this direction. More the coordinated are the economic policies
across countries lesser would be the need for international reserves.

The supply of international reserves can be owned or borrowed. They are

majorly in the form of gold, acceptable foreign currencies and Special
Drawing Rights (SDRs). Gold has always been a major form in which
international reserves were kept. During the years of the Gold Standard
System (1880-1914), gold served as a means of payment, unit of account and
store of value. The national currencies were denominated in terms of gold
and since its supply was not that flexible it disciplined the Central Banks in
the sense that excessive money growth was not possible. Countries stood
committed to exchange gold for their currencies freely. The importance of
gold in money supply however drastically came down before WWI and the
importance of paper money and demand deposits in banks increased
manifold. At the end of WWI when inflationary tendencies were high there
was a demand to return back to the gold standard. US was one of the first
countries to announce the return to gold standard. But it turned out to be an
uphill task and due to the onset of Great Depression it was no longer possible
to maintain the system and countries one by one abandoned the gold
standard.

After the WWII when IMF came into being the world moved on to what is
known as the Gold Exchange Standard. Gold was considered as a unit of
account. US took the responsibility of being the international banker. Dollar
was denominated in terms of gold. All other currencies were denominated in
terms of gold or gold content of dollars. US agreed to freely convert dollar to
214
gold whenever presented with the currency by the other countries. Dollar thus International
Financial System
served as a reserve currency. This system was perfect till the time US gold
reserves were higher than outstanding dollar liabilities. But as gold reserves
fell short of such liabilities fear creeped in to the minds of the countries
holding dollars that the US might devalue the dollar leading to losses for
them. On 1st January 1975 gold was abolished as a unit of account and could
be freely traded by countries like other commodities. Use of gold was
discontinued by IMF. Recent data shows that the percentage of international
reserves kept in terms of gold is less than 1%.

Given the expansion of international trade and capital flows, dollars and gold
was found to be inadequate to serve as international reserves. The need was
thus felt for an additional international reserve currency. SDRs were
contemplated as a unit to decide the contributions of the members to IMF.
The value of SDRs was determined by the basket of acceptable currencies
like dollars, yen, pound and euro. The proportion is decided on the basis of
trade in these currencies in the last five years. SDRs are not claims on IMF
but on the countries, which issue the acceptable currencies on the basis of
which value of the SDRs is determined. Countries holding SDRs can freely
convert them into these currencies.

The nations can access international reserves from two special windows of
IMF. One is the IMF Drawings. In this the nations in need of international
reserves can buy foreign currency by pledging their home currency and agree
to buy them back at some future date. This is normally extended till 50% of
the quota for that country is reached. Additional amounts can be accessed
through special permissions. The second option is to access credit through
IMF’s General Arrangements to Borrow. G10 countries agreed to give
additional funds to IMF to finance this facility. This is over and above the
amount accessed through IMF Drawings when the latter is found to be
inadequate to finance BoP deficits.

Activity 5

1) Try to find out the various exchange rate systems followed by countries
across the world.

…………………………………………………………………………

…………………………………………………………………………

…………………………………………………………………………

…………………………………………………………………………

…………………………………………………………………………

2) Does a flexible or fixed exchange rate result in a more stable financial

system? Read materials on internet and find out the answer to this
question.
215
Structural …………………………………………………………………………
Reforms
…………………………………………………………………………

…………………………………………………………………………

…………………………………………………………………………

…………………………………………………………………………

…………………………………………………………………………

3) India faced a severe BoP Crisis in 1990. Discuss the causes and
consequences of the Crisis and the impact of IMF conditionalities on
India. Were the policies beneficial for India? Explain.

…………………………………………………………………………

…………………………………………………………………………

…………………………………………………………………………

…………………………………………………………………………

…………………………………………………………………………

10.7 SUMMARY
Process of globalization gave rise to the need for an orderly financial system.
The IMF and the World Bank can be seen as institutions which were created
for maintaining a stable international financial system. Specifically, IMF was
entrusted with the job of assisting nations in payment problems. In return for
such assistance the countries were supposed to follow prescribed policies.
Such policies while successful in some countries created further problems in
others. The World Bank majorly looked at assisting countries in reducing
poverty. Private enterprises in such countries were also encouraged through
assistance from IFC an important arm of the Bank. The current role of IMF is
more flexible than in the past and is seen as more conducive for the
developing countries. The World Bank on the other hand is engaged in
poverty reduction and helps build smart infrastructure in developing
countries. Countries thus have means to stabilize their financial system and
address poverty related problems which may be beyond their capacities to
tackle.

10.8 KEY WORDS

Protectionism: Tendencies of the countries to create barriers to flow of
goods, services and people.

Bretton Woods Conference: A Conference of 44 allied countries held at

Bretton Woods in USA to discuss the course of the future world order after
the World War II.
216
Special Drawing Rights (SDRs): is an international reserve currency created International
Financial System
by IMF whose value is determined by a basket of currencies comprising of
US dollars, Euro, Renminbi, Yen and GBP.

Structuralists: The proponents of this view feel that the result of the world
financial order is higher inequality and distorted development across
countries.

Flexible Credit Line: This facility is given by IMF to countries to prevent

crisis but having good track record and past economic performance.

Precautionary and Liquidity Line: Funding under this facility is for those
countries facing difficulties but having sound fundamentals but ineligible for
Flexible Credit Line.

Public Goods: Goods which cannot be exclusively made available to a

person or persons. It is difficult to prevent someone from using it once it is
made available to some person or persons, for example, road.

Gold Standard: In this system the currencies of countries were directly

linked to the value of gold.

Gold Exchange Standard: The reserve currency (US dollar) was

denominated in terms of gold. All other currencies had a fixed exchange rate
with dollars. The country issuing the reserve currency stood ready to
exchange that currency for gold with central banks of other currencies.

10.9 SELF - ASSESSMENT QUESTIONS

1) Explain why it was felt that unilateral assistance by countries like USA
was not enough? Do you think the world needed institutions like IMF
and World Bank? Discuss.

2) Explain how during Gold Standard system the international financial

system operated.

3) What was the Bretton Woods system of exchange rate arrangement?

Why did it come to an end?

4) Which are the most important functions of IMF according to you?

Explain.

5) Distinguish the role of the World Bank from that of IMF. To tackle
poverty which one of these Institutions would be more effective?
Explain.

6) Given the criticisms of IMF’s policies what new initiatives have been
taken by the Institution? Do you think they would be effective? Explain.

7) How is Gold Exchange Standard different from Gold Standard?

217
Structural 8) What are the various arms of the World Bank? How do they facilitate
Reforms
international business? Explain.

10.10 REFERENCES/ FURTHER READINGS

• https://www.piie.com/commentary/speeches-papers/globalization-and-
international-financial-system

• https://www.brookings.edu/research/the-international-monetary-and-
financial-system-how-to-fit-it-for-purpose/

• Douglas D Evanoff (Federal Reserve Bank of Chicago, USA), Andrew G

Haldane (Bank of England, UK) and George G Kaufman (Loyola
University Chicago, USA), Edited,. The New International Financial
System Analyzing the Cumulative Impact of Regulatory Reform,
December 2015.

• Sukumar Nandi, Economics of the International Financial System,

Routledge India, 2014.

218
UNIT 11 BALANCE OF PAYMENTS (BoP) Balance of Payments
(BoP)

Objectives

After reading this unit you should be able to:

• explain the concept of Balance of Payments (BoP) of a country and its

major components;
• highlight the importance of Balance of Payments (BoP) for an
economy; and
• analyse the trends in India’s Balance of Payments (BoP).

Structure

11.1 Introduction
11.2 Importance of Balance of Payments (BoP)
11.3 Components of Balance of Payments (BoP)
11.4 Basic BoP Accounting Rule
11.5 Equilibrium in Balance of Payments (BoP)
11.6 Balance of Trade (BoT) and Balance of Payments (BoP)
11.7 Factors Affecting the Balance of Payments (BoP)
11.8 Balance of Payments (BoP) and the Central Bank
11.9 Trends in India’s Balance of Payments (BoP)
11.10 Summary
11.11 Key Words
11.12 Self-Assessment Questions
11.13 References/ Further Readings

11.1 INTRODUCTION
The Balance of Payments (BoP) for a country can be defined as a systematic
record of all the transactions between the economic units of one country
(such as households, firms and the government) and the rest of the world in
any given period of time. This includes all the transaction records made
among the individuals, corporates and the government and helps in keeping
the flow of funds in track, to develop the economy as a whole. Balance of
Payments (BoP) is the sole integral determinant of the health of an economy
as well as its relations globally. It portrays the overall transactions of an
economy with the other global economies during a given time period in a
systematic and prudent manner.

219
Structural
Reforms
11.2 IMPORTANCE OF BALANCE OF
PAYMENTS (BoP)
The Balance of Payments (BoP) of a country is important because:

• The BoP reflects the financial and economic status of a country;

• The BoP may act as an indicator to determine whether a country’s value

of currency is appreciating or depreciating;

• The BoP statement helps the government in making decisions on fiscal

and trade policies;

• The BoP statement provides vital insights into the economic dealings of
a country with the rest of the world.

A close study of the BoP statement and its components would help in
identifying the trends which might be beneficial or harmful for an economy
and thus, helps in taking appropriate economic measures.

11.3 COMPONENTS OF BALANCE OF

PAYMENTS (BoP)
There are two main components of Balance of Payments (BoP):

 Current Account

 Capital Account

Balance of Payments

Current Account Capital Account

• Merchandise • Loans & Borrowings
• Services • Investments
• Transfers • Foreign Exchange
• Earnings Reserves

Figure 11.1: Components of Balance of Payments (BoP)

Current Account

The current account in the BoP, comprises of the transactions in goods and
services, alongside transfers during the current time period.

Current Account = (value of exports – value of imports) + net transfers from

abroad
= net exports + net transfers from abroad…… (i)

220
The net exports are also termed as the trade balance, which is the net sum of Balance of Payments
(BoP)
a country’s exports and imports in goods as well as in services. Trade in
services is often said to be invisible as they cannot be seen to cross national
borders. For instance, when a foreign country pays for the maintenance of its
factory in the domestic home (or domestic) country or for the services by a
home resident who is working in that foreign country, then the home country
is said to be exporting a service. Tourism, is one major service export.

The trade balance reflects a surplus (positive) if the value of exports of a

country exceeds its imports while it is said to reflect a deficit (negative) if the
value of imports of a country is higher than its exports.

Transfers to and from abroad may be in the form of gifts or remittances that
residents of one country might send (receive) to (from) another country. If
the net transfers from abroad is positive, it means that transfers from
residents in abroad are greater than that sent by domestic residents to abroad.
Similarly, the net transfers from abroad is negative, if transfers from foreign
countries are lesser than the transfers to abroad. Net foreign aid received by a
country during a particular period is also a part of transfers.

If the right-hand side of the equation (i) is positive (negative), then the
current account is in surplus (deficit). It must be noted that large transfers
from abroad may put the current account in surplus, even if the net exports is
negative. However, to keep things simple, the term “net transfers” will be
ignored in the subsequent analysis and hence, the current account will
comprise of net exports or trade balance only.

Capital Account

The capital account records all transactions in assets. An asset may include
any one of the type in which wealth can be held, for instance, stocks, bonds,
government debt, etc. Purchase of an asset records a deduction in the capital
account. If an Indian is purchasing a US Car company, then it is recorded as
debit in the capital account of India (as the Indian has to pay in dollars which
means that the foreign exchange is going out of India). The sale of assets, for
instance, the sale of share of an Indian company to a US customer is recorded
as a surplus in India’s capital account (as sale of assets to foreign country will
bring foreign exchange into the country).

Taking the two accounts together, the BoP can be summed up as:

Balance of Payments = current account + capital account…… (ii)

BoP is in surplus (deficit) if both the current and the capital account
(combined) has a surplus (deficit). Thus, a deficit in current (capital) account
doesn’t alone lead to a BoP deficit. It has to be outweighed by a large surplus
in the capital (current) account.

Thus, it is very important to keep the basic rule of BoP accounting in mind.

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Structural Activity 1
Reforms
Can you deduce which of the following belong to the capital or current
account of India’s BoP?

a) Purchase of a share in Indian company by an American mutual fund.

b) Export of automobile parts by an Indian manufacturing company to

London.

c) A French investor making a deposit in an Indian bank.

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

11.4 BASIC BoP ACCOUNTING RULE

All transactions leading to a net receipt of foreign exchange creates a credit
(surplus) in the corresponding account, whereas all transactions leading to
net payment to foreign countries create a debit (deficit) in the corresponding
account.

When the value of exports for a country exceeds its imports, it accumulates
more of foreign exchange, leading to a current account surplus for the
country. Similarly, if the sale of domestic bonds to foreign countries
(borrowing from a foreign country) exceeds the purchase of foreign bonds
(lending to a foreign country), then there is a capital account surplus for the
domestic country. A foreign loan repayment, however is recorded as a debit
in the capital account as it involves outflow of payments in foreign
currencies. A deficit (surplus) in the capital account is termed as net capital
outflow (inflow) from the country. A current account deficit in a country is
necessarily being offset by the capital account surplus in the economy.

222
 Double-entry Book keeping Balance of Payments
(BoP)
The BoP accounting follows the system of double-entry bookkeeping in
which all the transactions are recorded twice, one as a credit and the other as
debit. Any transaction which leads to payment from (to) abroad is a credit
(debit). The payments are recorded as an offsetting entry to the transactions
which are its cause.
Suppose a country (say, India) exports automobile parts to a foreign country
(say, US). The US will have to pay for the purchase, which will be a current
account surplus for India. The payment can be made in any form, either
through granting of credit or bank drafts by the Indian exporter to the US
recipient. In both the instances, India’s foreign reserves increase and an
offsetting deficit is recorded in India’s capital account.
According to the system of double-entry bookkeeping, the BoP always
balances in principle, where the total value of credit records will be equal to
that of the debit records. However, this does not ever happen in practice due
to proper unavailability or recording of data. Thus, a record for errors and
omissions are included to make the overall balance in payments zero.

11.5 EQUILIBRIUM IN BALANCE OF

PAYMENTS (BoP)
The Balance of Payments of a country depends on the records of transactions
both in the current as well as in the capital account. A surplus in the capital
(or current) account records an inflow of foreign exchange into the country
(supply of foreign exchange exceeds its demand) whereas, a deficit in the
current (or capital) account leads to an outflow of foreign exchange (demand
of foreign exchange is higher than its supply) from the country.

Now that we know what Balance of Payments (BoP) means and how it
works, let us try to understand what it means to have the Balance of
Payments of a country in equilibrium. A country can have its BoP in
equilibrium only when the demand for its foreign exchange reserves equals
the supply of foreign exchange i.e. when both the inflow and outflow of
foreign exchanges from the country are equal.

If a country’s inflow of foreign exchange exceeds its outflow, it is said to

have a favourable Balance of Payments or BoP surplus. Similarly, if the
country’s inflow of foreign exchange is exceeded by its outflow, it is said to
be having an unfavourable BoP or BoP deficit.

If the BoP moves against the country, necessary adjustments must be made to
improve the same by encouraging more of exports (both in goods and
services) and less of imports. Again, a favourable Balance of Payments of an
economy may lead to encouraging of imports (for both goods and services),
purchase of foreign assets or granting of foreign aid to other countries in
need. A country can never have a permanent favourable or unfavourable
223
Structural Balance of Payments. What needs to be maintained is that, the total liabilities
Reforms
and total assets, as of individual countries, must balance out in the long-term.

An equilibrium in the Balance of Payments, thus is an indicator of a sound

economy. Disequilibrium in the BoP is a short-term phenomenon and is
balanced out by the supply and demand for foreign reserves possessed by the
economy.

11.6 BALANCE OF TRADE (BoT) AND BALANCE

OF PAYMENTS (BoP)
One might have a question as how is the Balance of Trade different from that
of the Balance of Payments. Are they related or are two different concepts?
The answer to this is as follows:

The Balance of Trade (BoT) is a major part of the transactions in the current
account of the Balance of Payments. It is nothing but the net exports
(difference between value of exports and the value of imports). The BoT can
either be positive, negative or zero and determines if the country has incurred
a net profit or loss from the net exports. It depends only on the export and
import of goods and services and doesn’t take into account the transfers and
financial asset transactions. A positive BoT may result in surplus of foreign
reserves in the country, which can be a major determinant of a sound
economy. A negative BoT can lead to outflow of foreign reserves and can
lead to disequilibrium in the economy’s BoP. The ideal situation turns out
when the BoT equals zero (Net exports = 0), which may not necessarily be
true in all cases.

The Balance of Payments (BoP) is a broader concept and includes transaction

records from trade balance, net transfers, and transactions in financial assets
(capital account transactions). The BoP is an indicator of whether a country is
having surplus or deficit of foreign reserves. Any receipt of payments, in the
form of export payments, gifts or remittances or selling of bonds leads to a
surplus in the BoP whereas any payment such as payment for imports,
transfers to abroad or purchase of foreign bonds leads to deficit in the BoP.
The BoP is a crucial indicator of whether the country is having a stable
economy or not.

11.7 FACTORS AFFECTING THE BALANCE OF

PAYMENTS (BoP)
The factors which affect the Balance of Payments (BoP) are divided into two
groups:

• The factors affecting the current account

• The factors affecting the capital account

224
The factors affecting the Current Account Balance of Payments
(BoP)
The current account may be affected by the following factors:

1) Rate of Inflation in the Resident (domestic) Country: A higher rate of

inflation in the domestic economy, compared to its trading partners, lead
to:

• cheaper imports which lead to increase in purchase of foreign goods.

Imports therefore, tend to rise with rise in the inflation rate; and

• rise in cost of the exports in the foreign market, as a result of which

the foreign nationals will less likely be purchasing the domestic
country’s goods. Exports, therefore tend to decline.

Thus, rise in imports and fall in exports will lead to a current account deficit.

2) National Income: According to most of the empirical studies, an increase

in national income of a country, in comparison with its trading partners,
may lead to:

• higher tendency among domestic residents to purchase more of

foreign products which will generate a significant rise in imports and
thus, more outflow of foreign reserves from the country leading to
current account deficit; and

• in some exceptional cases, a rise in national income may also lead to

improvement in the current account as it may be associated with
increase in production capacity in the economy and surplus
generation of exports.

3) Import Restrictions by Government: Imposition of taxes (such as tariffs)

by the government on the goods imported, leads to a rise in its prices in
the domestic economy. As a result, domestic residents will reduce their
purchase of foreign products, thereby improving the current account.

Sometimes, the government also imposes quota restrictions on its

imports which again, lead to decline in the imports and generates a
current account surplus.

4) Exchange Rate: The Exchange rates measure the prices of the domestic
currencies in terms of the foreign currencies. The current account is a
function of Real Exchange Rate (RER). A higher RER is associated with
lowering of exports and increase in imports whereas a lower RER is
associated with higher number of exports and decline in imports. Thus, it
can be interpreted that lowering of RER (which might happen through
devaluation of currency) might lead to improvement of current account.

The factors affecting the Capital Account

Capital movement across borders is affected by the following factors:

225
Structural 1) Imposition of tax by the government on the income accumulated by the
Reforms
domestic investors, who have invested in the foreign markets. This will
lead to lower outflow of capital.

2) Economic liberalization might have an impact on the capital account.

3) An expected change in the exchange rates may affect the flow of capital
as it tends to have an impact on the expected rate of return in the foreign
investment.

4) Changes in the interest rates, in comparison to other countries, may tend

to affect capital flows across borders. A higher domestic interest rate
may lead to lower capital flows into the country whereas a reduction in
domestic interest rates may tend to have greater capital flows into the
country.

Activity 2

India faced a severe BoP Crisis in 1990s. Look at the balance of payments
account (you can get it from Economic Survey of 1989-90 and 1990-91) and
try to find the figures which reveal the crisis. Write down a brief note on
what led to such a crisis and how was it addressed.

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

11.8 BALANCE OF PAYMENTS (BoP) AND THE

CENTRAL BANK
The Central Bank of all countries holds reserves of foreign currencies, which
they can use to finance the deficit in the current account. For instance, a
country, say India, has a deficit in current account worth Rs. 200 bn and a
surplus in the capital account worth Rs. 180 bn. Then, there is an overall BoP
deficit of Rs. 20 bn. If the Central Bank (in this case, RBI) intervenes, then it
can meet the deficit by selling equivalent amount of foreign exchange to its
importers for payments to foreign countries. However, in case of a capital
account deficit, sale of foreign exchange by RBI may be required for foreign
lending or repayment of foreign loans by the Indian residents. Such purchase
and sale of Foreign Exchange Reserves by the Central bank are termed as
official reserve transactions.

An overall surplus in the BoP leads to purchase of foreign exchange assets

by the Central Bank, which expands its stock of foreign reserves and hence
increases the money supply in the economy. An overall BoP deficit, on the
226
other hand leads to sale of foreign exchange reserves by the Central Bank Balance of Payments
(BoP)
which leads to depletion of its foreign exchange reserves, thereby lowering
the money supply in the economy.

Let us consider an example to understand. Suppose US has a current account

surplus of $60 million and a capital account deficit of $40 million. This
implies that:

i) there is an overall BoP surplus of $20 million;

ii) if the Federal Reserve intervenes, then it will purchase foreign exchange
reserves, equivalent to $20 million and add to its stock of foreign
reserves; and

iii) there is an increase in the net foreign reserves of the Federal Reserve.

In case, the Federal Reserve doesn’t want to intervene in buying and selling
of foreign exchange reserves, then the exchange rate (the value of home
currency relative to foreign currencies) will automatically adjust to eliminate
the deficits or surpluses in the BoP. Such a system, where the Central Bank
of a country doesn’t intervene in the foreign exchange market is called as
fully flexible system of exchange or a clean float of the currency.

Activity 3

Suppose that India records a current account deficit of US$ 20 million and a
capital account surplus of US$ 36 million. What can you conclude from this
information?

• Is India’s overall BoP in deficit or surplus?

• If RBI tries to intervene, will it buy or sell India’s Foreign Exchange

assets? What will happen to overall money supply in the economy?

• If RBI doesn’t intervene, how will it impact India’s exchange rate

system?

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

Should a Current Account Deficit (CAD) always be a situation of alarm?

In an open economy, we know that

Y = C + I+ G + X – M
or
M – X = CAD = (C + I + G) – Y 227
Structural Where,
Reforms
Y = Income of the economy
C = Expenditure incurred on consumption
I = Expenditure on investments
G = Expenditure incurred by the Government
X = Value of exports
I = Value of imports
X– M = Net exports (or trade balance).

Here, (C + I + G) is the aggregate demand or planned expenditure of an

economy and Y is the income of an economy. In case of a current account
deficit (CAD), a country is spending more than its income (on accumulating
imports) and builds up debts in the outside world. Whether a CAD is a cause
of alarm or not, depends on the nature of expenditure involved in the
economy. A CAD will not be an alarming cause as it might be offset with the
help of some productive I or G in the economy. The debts plus interest (that
accumulates as result of deficit) will automatically be repaid through the
growth dividends generated out of those productive investment or
government expenditures. In such a scenario, a CAD will be a sign of health
of a robust economy. If the CAD is triggered by more of consumption or
unproductive investment or government spending, then the CAD will indeed
turn out to be a severe cause for alarm in the economy.

How to Finance a Current Account Deficit (CAD)?

As discussed earlier, CAD may or may not be necessarily harmful for an

economy. However, CAD can be financed through various capital inflows
such as:

• Portfolio investments
• External commercial borrowings
• Foreign Direct Investments
• NRI deposits

11.9 TRENDS IN INDIA’S BALANCE OF

PAYMENTS (BoP)
During the first quarter of the FY 2020-21, India witnessed a sharp decline in
both its exports and imports in line with the contraction in global trade. The
decline in imports exceeded that of exports, which led to a smaller trade
deficit of US$ 9.8 billion compared to US$ 49.2 billion in Q1 of FY 2019-20.
India recorded a trade surplus only in the month of June, 2020 after a period
of 18 long years. A gradual improvement in India’s merchandise trade was
witnessed post unlocking of the economy due to Covid-19 pandemic, from
228 June, 2020 onwards. The trade-deficit during April-December, 2020-21 was
US$ 57.5 billion compared to US$ 125.9 billion in April-December, 2019- Balance of Payments
(BoP)
20. Figure 11.2 illustrates India’s merchandise trade during the FY 2018-19,
2019-20 and Q1 of 2020-21.

Source: Economic Survey 2020-21.

Figure 11.2: Merchandise Trade Balance, Exports and Imports

Net service receipts remained stable, amounting to US$ 41.7 billion, during
April- September, 2020 compared to US$ 40.5 billion in the corresponding
period in 2019. This is because of the international mobility restrictions and
falling remittances on the onset of the covid 19 pandemic. The quicker
recovery of the service sector was mainly driven by the software services
which amounted to 49% of the total service exports in 2020.

India recorded a current account surplus (which is 0.1 per cent of GDP) in Q4
of FY 2019-20, after a gap of 13 years after Q4 of 2006-07. This has been
possible on account of a lower trade deficit and a steep rise in the net
invisible receipts. The surplus continued successively in the Q1 and Q2 of
FY 2020-21. A sharp fall in the merchandise exports and a lower outgo for
travel services led to a sharper decline in current payments, by 30.8 per cent,
than current receipts (by 15.1 per cent)- which led to current account surplus
of US$ 34.7 billion (which is 3.1 per cent of GDP). It is expected that India
will tend to end with a current account surplus of at least 2 per cent of GDP,
given the trends in its imports of goods and services, after a period a gap of
17 of GDP trends in its goods and a period a years.

Net capital flows witnessed a decline in the first half of FY 2020-21 at US$
16.5 billion, as against US$ 40.0 billion in the first half of FY 2019-20, due
to the net repayments of the External Commercial Borrowings and decline in
the banking capital. However, net foreign investments saw an increase at
US$ 31.4 billion in the first half of FY 2020-21 as against US$ 28.7 billion in
the corresponding period in 2019-20. Foreign Direct Investments (FDI)
recorded an inflow of US$ 27.5 billion, during April-October, 2020, which is
229
Structural 14.8 per cent higher than the second half of FY 2019-20. Computer hardware
Reforms
and software accounted for the highest FDI inflows amounting to US$ 17.6
billion in April- September, 2020 compared to US$ 4.0 billion in April-
September, 2019. Addition of Indian stocks to the Morgan Stanley Capital
International (MSCI) also played a major role in attracting foreign capital
inflows.

Foreign Portfolio Investments (FPI) too, recorded a net inflow of US$ 28.5
billion during April-December, 2020 as compared to US$ 12.3 billion in the
corresponding period in 2019. This increase in the net FPI resulted on the
grounds of immense support provided to the Indian equities by the abundant
global liquidity, better corporate earnings in the successive quarters and
better management of the Covid-19 economic recovery prospects.

India’s external debt stood at US$ 556.2 billion, in end-September, 2020,

which recorded a decline by US$ 2.0 billion over that in end-March, 2020.
External Commercial Borrowings (ECBs), which is the largest component of
India’s external debt, recorded an amount of US$ 207 billion at the end-
September, 2020, which is 5.8 per cent lower than that in end-March, 2020.
The stocks of NRI deposits, the second largest component of India’s external
debt, rose to US$ 137.3 billion (by 5.1 per cent) compared to that in end-
March, 2020. The (import-financing) trade deficit, the third largest
component, shrank by 2.0 percent to US$ 99.4 billion compared to that in
end-March, 2020. Government debt, on the other hand, increased from US$
100.9 billion in the end-March, 2020 to US$ 103.6 billion in the end-
September, 2020.

To sum up, India, being an emerging market economy, typically runs a

deficit in the current account which is being offset by a corresponding capital
account surplus. However, India has been witnessing a current account
surplus since Q4 of FY 2019-20 along with increased capital inflows which
have led to an overall BoP surplus.

Activity 4

1) List the major countries with which India’s merchandise trade balance is
positive during the financial years 2019-20 and 2020-21.

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

2) List the top 10 export commodities of India during the FY 2019-20. Also
find out the top 10 export destinations of India during the FY 2019-20.
230
 ……………………………………………………………………………. Balance of Payments
(BoP)
…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

…………………………………………………………………………….

11.10 SUMMARY
The Balance of Payments (BoP) of a country summarizes all payment
transactions and receipts by individuals, firms and the government in a given
time period. It has two major components – the current account and the
capital account. The current account transactions mainly include the net value
of imports and exports of a country alongside net transfers from abroad. The
current account transactions mainly include the transactions involved in
purchase and sale of assets across the geographical boundary. An inflow of
funds (in the form of foreign exchange reserves) leads to a BoP surplus in a
country whereas an outflow of funds result in a BoP Deficit. A surplus in
BoP leads to purchase of foreign exchange reserves by the Central Bank,
thereby increasing its stock of foreign reserves and money supply in the
economy. A BoP deficit, on the other hand is characterized by sale of foreign
exchange reserves by the Central Bank, thereby reducing the money supply
in the economy. The balance of payments can be in equilibrium, only if the
demand and supply of foreign exchange reserves are equal i.e., when the
inflow and outflow of foreign exchange reserves from the country are equal.

11.11 KEY WORDS

Quota Restrictions: Quota restrictions are usually a form of tariff, imposed
by the Government of a country, on the quantity of the imported goods.

Tariffs : A tax or a duty imposed on the imports or exports.

Real Exchange Rate (RER): Rate of valuation of home country currency in

terms of the foreign country currency, given the relative prices of both the
countries. It is the rate at which goods or services are exchanged between two
countries.

Portfolio Investments: Financial flows targeted towards stocks, bonds and

other assets in order to gain from returns or growth in value of such items.
They are generally of short-term nature without intension to control.

External Commercial Borrowings: Loans made to entities in a country by

non-residents in foreign currency.

Foreign Direct Investment (FDI): These are financial flows which target
control of the entity in which investments are made.
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Structural NRI Deposits: These are foreign currency deposits made in banks in India by
Reforms
non-resident Indians.

11.12 SELF - ASSESSMENT QUESTIONS

1) Define Balance of Payments (BoP)?
2) Why is Balance of Payments (BoP) important for a country?
3) What are the components of Balance of Payments (BoP)? Briefly
explain.
4) When is the Balance of Payments (BoP) said to be in equilibrium?
5) What is the difference between the Balance of Trade and Balance of
Payments?
6) How does the Central Bank of a country play a role in influencing the
Balance of Payments (BoP)?
7) Do you think that a current account deficit is always a cause of alarm?
How can it be financed?
8) Can you elaborate on India’s overall Balance of Payments (BoP)
situation during the FY 2017-18 and 2018-19?

11.13 REFERENCES/ FURTHER READINGS

• International Monetary Fund. (1996). Balance of Payments Textbook
(5th edition).

• Vaish, M.C. & Singh, S. (2018). International Economics (9th

Edition). Oxford.

• Salvatore, D. (2014). International Economics (11th Edition). Wiley.

• Rornbush, R., Fischer, S., & Startz, R. (2012). Macroeconomics (10th

Edition). Tala McGrawHill.

• Stern, R.M. (2007). Balance of Payments: Theory & Economic Policy

(1st Edition). Routledge.

232
UNIT 12 FOREIGN TRADE Foreign Trade

Objectives

After reading this unit you should be able to:

• define the concept of foreign trade and the need for it;
• state the advantages and disadvantages of foreign trade;
• identify the types of trade barriers and the initiatives taken to remove
these barriers; and
• analyse recent trends in India’s foreign trade.

Structure

12.1 Introduction
12.2 Brief Historical Overview
12.3 Need for Foreign Trade
12.4 Advantages and Disadvantages of Foreign Trade
12.5 Theory of Absolute and Comparative Advantage
12.6 Intra- Industry Trade among Similar Economies
12.7 Types of Barriers to Foreign Trade
12.8 Measures to Reduce Barriers to Foreign Trade
12.9 India’s Foreign Trade: Recent Trends
12.10 Summary
12.11 Key Words
12.12 Self- Assessment Questions
12.13 References/ Further Readings

12.1 INTRODUCTION
We all exist in a global marketplace. The clothes up in your wardrobe might
be designed and made in Italy or China. The car that you own might be from
Japan or Korea. The fancy and latest smart phone that you possess might be
made in Korea or China or Japan. The toy that you have gifted your child on
her 5th birthday, might be made in China. The laptop that you are working on,
might be developed in UK. As an employee, your job might be related to
airplanes, cars, computers, farming, machinery or other technology related
industries, such that the major proportion of the sales of your company and
your salary, in turn, gets generated from the exports of such products. In
short, we all are connected through foreign trade, which has shown an
immense growth in the last few decades.

233
International Foreign trade refers to the exchange of goods and services between the
Business
Environement countries. In other words, Foreign Trade simply means imports and exports
of goods and services. Export refers to the selling of goods and services out
of the country while import refers to flow of goods and services into the
country. From time immemorial trade has taken place through land and sea
routes. Trade helps countries to boost their productivity by concentrating on
producing goods in which they are competitive. Trade also helps to increase
efficiency of world production under certain conditions. Given the
advancement in transport and communication the dimensions have changed
over time. Costs have come down significantly and thus countries trade more
today than they used to even 50 years ago. The progress of trade however has
been bumpy with occasional protectionism halting its flow. Currently the
world is going through such a crisis. But history has shown that trade is one
of the vehicles through which world GDP growth can be influenced in the
positive direction.

12.2 BRIEF HISTORICAL OVERVIEW

The exchange of goods and services among people (more commonly the
Barter system of exchange) is an age-old practice. Several political ideologies
evolved since the late Renaissance period and has continued up to World War
II and have defined the world trading pattern according to their own beliefs.

According to the mercantilists, who dominated during the 16-18th century:

• Acquisition of wealth, in the form of gold, by a nation is of utmost

importance.

• A nation can increase as well as benefit from trade only at the cost of
other nations’ welfare. This led to imposition of price and wage controls,
promoting of domestic industries, exports of finalised goods and imports
of raw materials while limiting the exports of raw materials and imports
of finalised goods.

A strong opposition against the mercantilists came up towards the latter half
of the eighteenth century, in the form of Physiocrats (some French economic
thinkers called themselves so as they supported Liberalism) who demanded
liberty in both production and trade. This led to strong opposition against
excessively high and often prohibitive custom duties and tariffs, and
negotiations of trade agreements with the more powerful foreign countries. A
major success of this ideology came in the form of the Anglo-French trade
agreement of 1860, according to which the French protective duties were
lowered to a maximum of 25 per cent within 5 years along with free entry of
all French products except wine in Britain.

In the middle of the nineteenth century, there was an emergence of

protectionist measures of trade. The protective customs policies shielded
many economies from the foreign competition. The French Tariff of 1860,
234
for example, charged extremely high rates on British products, more Foreign Trade
precisely, 60 percent on pig iron, 40-50 percent on machinery and near about
600-800 percent on woollen blankets. Transport costs between the two
countries were an additional layer of protection imposed.

The latter half of the nineteenth century witnessed Germany to follow

systematically protectionist policy followed by the US raising its duty rates
sharply based on the McKinley Tariff Act of 1890.

The protectionism in the last quarter of the nineteenth century weren’t much
stringent. Quantitative restrictions were null and void, custom duties were
low and stable, currencies were freely convertible into gold, lesser issues
with Balance of Payments and free factor mobility was allowed across
borders.

Post the World War I, in the first half of the twentieth century, trading
conditions were dead. World trade disrupted to such an extent from where
recovery was almost impossible. It was further followed by the Great
Depression of 1930s, that witnessed mass unemployment levels, giving rise
to the mercantilists’ system of trade, through imposition of protective
measures. Most of the countries attempted to improve their Balance of
Payments by raising their custom duties, introducing a wide range of import
quotas and imposition of exchange controls (government restrictions on the
transactions related to foreign exchange, where purchases involving foreign
exchange transactions cannot exceed receipts in foreign exchange). The
resurgence of this ideology continued till the end of World War II, post
which several trade agreements and newer trading systems emerged to
promote free flow of Foreign Trade.

12.3 NEED FOR FOREIGN TRADE

Countries engage in trading internationally, when there are not sufficient
resources or capacity to satisfy all needs and wants of consumers
domestically. By developing and utilising its own domestic resources, a
country can produce goods it is capable of, create surplus and then trade
internationally to buy goods and services from abroad which it is not capable
of producing.

The concept of foreign trade goes back to almost 10,000 years ago, when
there were not much defined modern states and national border concepts. It
goes back to the time when ships and pack animals were the only mode of
trading among people.

The countries today, globally, would not be able to survive without trading
internationally. With greater size and increasing population, there is an
increase in needs and wants of nations domestically, which a country may not
be able to produce, given its resource base. Hence, import and export
relations worldwide are an integral part of survival for every economy.
235
International Now, we know the reason behind exporting of goods by a country. But why
Business
Environement does a country go for importing of some goods and services? This question
can be answered based on the reasons below:

• Price: A country may produce something at a relatively lower price than

another country, which may produce it at a higher cost.

• Quality: Every country has its own set of resource base which might
differ from other countries, and hence can produce goods it is capable of
making by using its own resource base. So, if country A can produce
product 1 using its own resources and country B produces product 2 in a
similar line, they can import goods from each other which will be of
much superior quality than had they produced both domestically, without
trading.

• Availability: Nations are not well equipped to produce all goods and
services domestically. Hence, trading is a source of availability of all
goods domestically.

• Demand: With increasing population, demand for goods and services

increase. Hence, importing of goods become necessary.

12.4 ADVANTAGES AND DISADVANTAGES OF

FOREIGN TRADE
Trading internationally has the following advantages:

1) Economies of Scale: When a country produces goods and services, it

produces them in surplus. This surplus is being traded internationally.
Since, higher volumes of goods are being produced, the cost of
producing each good is reduced i.e., the country attains economies of
scale.

2) Comparative Advantage: Trading allows countries to specialize in

production of goods and services, it is capable of producing, using its
resource base.

3) Competition: Selling goods and services internationally boosts both the

foreign and domestic markets. Domestic suppliers and consumers are
aware about the foreign competition in terms of prices and quality of
goods and suppliers would ensure the quality and price of their goods in
order to meet the global competition.

4) Transfer of Technology: Foreign trade enables transfer of technology

among countries, especially from a developed to a developing nation.
Foreign companies are also approached by the developing nations to set
up local manufacturing units and help in infusion of such technologies in
the production of local goods.

236
5) More Job Creating Opportunities: Increase in international trading Foreign Trade
also leads to creation of more job opportunities in both domestic and
foreign countries, thereby reducing unemployment rates.

However, there are certain disadvantages associated with Foreign Trade

such as:

1) Over-dependence adversely affects Demand: One of the major cons of

trading internationally is exposed to both favourable and unfavourable
events globally. Any unfavourable event in the global front may affect
the demand for domestic goods and can even lead to higher risks of
unemployment and reduced economies of scale.

2) Unfair for Start-ups: New start-ups or companies may not be able to

flourish or may not be able to expand both its resources and experience
to compete against the bigger foreign firms.

3) National Security Threats: If a country is highly dependent on imports

for strategic industries (such as food, energy or military equipment), the
country may be forced to take up a decision which might be
unfavourable to national interests.

4) Burden on Natural Resources: Every economy has a limited resource

base, but if it decides to welcome the entry of more foreign companies,
the natural resource base may tend to drain faster.

12.5 THEORY OF ABSOLUTE AND

COMPARATIVE ADVANTAGE
Foreign trade is now a global necessity. No country can better off without
trading internationally. David Ricardo, an economist and a member of the
British Parliament, in the year 1817, argued in his paper “On the Principles of
Political Economy and Taxation” stating that, free trade and specialization
can benefit all trading partners, including a country which happens to be
relatively inefficient. To understand this, we need to dive into the concepts of
Absolute and Comparative Advantages of trade.

Let us take for example, that there are two countries, Home and Foreign,
producing two goods-cheese and wine. To keep things simple, we assume
that each country has only one factor of production- Labour. The unit labour
requirements (labour hours required to produce a unit of a good) to produce
cheese and wine in Home country is given by aLC and aLW while that in
Foreign is denoted by a*LC and a*LW.

One might think that to determine which country will produce cheese and
which country will produce wine, all that is need to be done is to compare
their unit labour requirements in production of cheese and wine. If aLC<a*LC
(case I), we can say that the Home labour is more efficient in producing
cheese than Foreign. Similarly, if aLC>a*LC (case II), we say that the Foreign
237
International labour is more efficient in production of cheese than Home. The Theory of
Business
Environement Absolute Advantage states that when one country can produce a good with
lesser units of a factor of production compared to another country, then the
former country is said to have an absolute advantage in the production of
that good. In case I, Home country is said to have an absolute advantage in
the production of cheese whereas in case II, the foreign country is said to
have an absolute advantage in the production of cheese. However, in a global
scenario, where there are more than two countries engaging in trade, absolute
advantage alone is not sufficient in explaining the pattern of trade.

The Theory of Comparative Advantage, however, brings in the concept of

opportunity cost, to determine the gains from trade. A country has a
comparative advantage in producing a good if the opportunity cost of
producing the good, in terms of other goods, is lower in that country
compared to other countries. The term opportunity cost refers to the amount
of one good that is to be forgiven to produce one extra unit of another good.
From our example, if we want to derive that Home is more productive in
cheese and less productive in wine than Foreign, we can assume a relative
comparison of the unit labour requirements for both goods, in both the
countries, in the form,

aLC/aLW< a*LC/a*LW……. (i)

or, to be precise, we can write it as,

aLC/a*LC < aLW/a*LW……. (ii)

This states that the ratio of the labour required to produce a pound of cheese
to that of a gallon of wine is lesser in the Home country than that in the
Foreign. This ratio of labour requirements is nothing but the opportunity
costs of producing cheese in terms of wine and the comparative advantage
theory is defined in terms of opportunity costs. So, from (i) and (ii), we can
say that Home has a comparative advantage in the production of cheese than
the Foreign. Foreign, on the other hand, will have comparative advantage in
the production of wine than Home and both the countries will gain from trade
by exporting the goods in which they are having comparative advantage.

Does a country benefit from having Absolute Advantage in all goods?

One can only imagine that a country with higher-income levels, higher
number of skilled workers, technologically advanced equipment and the
latest advanced production processes can have an absolute advantage in all
goods. US, for example, have the ability to produce both computers and
roses. As roses usually can be grown in the warm temperatures, how hard it
might be, for US, to supply roses in winter, especially in the month of
February and on the eve of Valentines Day? The flowers have to be grown in
heated greenhouses which involve great expenses in terms of capital
investment and other scarce resources that are required to grow roses. Those
resources could have been put to produce computers.
238
Suppose, US grows 1 million roses for sale on Valentine’s Day. The Foreign Trade
resources required to grow those roses could have produced 100,000
computers. Then the opportunity cost of 1 million roses is 100,000
computers. Now, if those 1 million roses could instead be grown in South
America, it would be extremely likely that the opportunity cost of those roses
in terms of computers would be lesser than that in United States. This is
because, growing roses in South America is easier as it is summer in
February rather than winter. On the other hand, South American workers are
less productive than their US counterparts in the production of computers and
thus computer production in South America will yield lower computers (say
30,000 computers) than it would have been in US. So, the opportunity cost of
30000 computers is 1 million roses.

These differences in opportunity costs raise the possibility of mutually

beneficial trade agreements between US and South America. Let US stop
growing roses completely and produce only computers while South America
shifts its resource base completely in the production of roses than computers.
The resulting changes in production are given in the Table 12.1.

Table 12.1: Changes in Production pattern of Roses and Computers

(Hypothetical)

Country Roses (in millions) Computers (in

thousands)
United States -01 +100
South America +01 -30
Total 0 +70

From Table 12.1, it is clear that the world is producing just as many roses as
before, but the global production of computers saw a rise. So, with increase
in production of computers by US and that of roses by South America, there
is an increase in the world’s economic pie, which in turn, also leads to
increase in standards of living.

Thus, it can be concluded that even if a country has the ability to produce all
goods, it can still benefit from trading with other countries, as a result of
comparative advantage.

Activity 1

Look at India’s exports in 2019-20. Top 5 export commodities should be

considered in terms of value (say Rs. Crores). Now try to see whether the
trade theories you have learnt can explain why India exports these products.
(You can look at Economic Survey 2019-20 where top 100 principal
commodities exported are published).

…………………………………………………………………………………
239
International …………………………………………………………………………………
Business
Environement
…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

12.6 INTRA-INDUSTRY TRADE AMONG

SIMILAR ECONOMIES
According to the theory of Comparative Advantage, a country can produce
goods in which it specialises to a certain degree and then trade them off
globally. However, a significant proportion of trade is intra-industry trade –
trading of goods within the same industry, among fairly similar economies
like US, Japan, China, Mexico, and the European Union. But why do similar
economies engage in intra- industry trade? Well, this has three reasons:

• Gains from Specialization and Learning: Intra- industry trade between

similar economies produces economic gains as it allows both the firms
and the workers to learn and innovate on particular products and often on
some very particular parts of the Value chain- production of goods in
different stages. For example- An Apple Macbook may be designed and
engineered in the US, parts might be supplied from Korea, assembled in
China and advertised and marketed by Japan. A large part of contribution
in this splitting up of the value chain goes to newer up-gradations in
communication technology, information-sharing services and
transportation services. Instead of production of an entire product in a
single large factory, all the above steps can be done operating in different
places and different economies, thereby involving greater involvement of
learning, innovation and gathering of skills.

• Economies of Scale, Competition and Variety: The concept of

economies of scale means that as the scale of production of an output
increases, the average cost of production declines. Intra-industry trade
among fairly high-income economies involves a lot of competition
among products and consumer choices globally, if they go for trading
internationally. Had there been no trade, and only one or two large plants
were supplying products within a country, the consumers would have
been left with little option to choose their products from. Also, little or
no level of competition would have existed among the manufacturers
globally.

• Dynamic Comparative Advantage: In an intra–industry trade, the

comparative advantage is dynamic – in the sense that the level of labour
productivity does not only depend on climate, geography, education or
acquiring of new skill sets. It instead, depends on how a firm engages its
workers in specific and specialized learning about different products or
240 product parts, which has been made possible with the splitting up of the
 value chain. Newer ways of acquiring unique set of skills are evolving Foreign Trade
with time which keeps on changing the line of comparative advantage
for the economies.

12.7 TYPES OF BARRIERS TO FOREIGN TRADE

The most common barriers to foreign trade are:

- Tariffs,

- Quotas and

- Non-tariff barriers.

Tariffs are taxes imposed by governments on the imported goods. Quotas,

on the other hand, are trade restrictions imposed on the quantitative number
of goods that can be imported or exported during a particular period.

The effects of both tariffs and quotas are same i.e., both aim at lowering of
imports and protecting the domestic producers from the foreign competition.
A tariff raises the price of the imported good in the tariff imposing country,
which in turn, reduces the demand for, and eventually the supply of the good
in the tariff imposing country. Quotas, on the other hand, put restrictions on
the amount of goods to be supplied to the quota imposing country, which in
turn, raises the price of the product within the quota imposing country,
thereby reducing its demand among the consumers of that country.

Non-tariff barriers include regulations imposed on product content or

quality, product standards, packaging and shipping regulations, harbour and
airport permits, heavy customs procedures, etc.

Activity 2

Find out the principal barriers to India’s products exported to countries like
USA, EU and Japan. Do you see any similarity? (Look at WTO I-TIP portal)

…………………………………………………………………………………

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12.8 MEASURES TO REDUCE BARRIERS TO
FOREIGN TRADE
Free trade refers to elimination of all barriers to Foreign Trade. Several
numbers of organizations and trade agreements are working out to ease the
barriers to trade, thereby promoting more of trade and mutual economic gains
from it. Some of the important initiatives taken to remove those barriers are
discussed below:

1) General Agreement on Tariffs and Trade (GATT): Post the Great

Depression and World War II, Foreign Trade faced stringent cross-
border restrictions. To eliminate those, twenty-three nations came
forward and united in 1947 to sign the General Agreement on Tariffs and
Trade (GATT). GATT encouraged free trade through proper regulation
and reduction in tariffs and also provided a forum for resolving trade
related disputes among its signatories.

2) World Trade Organization (WTO) and Regional Trading

Agreements (RTAs): Founded in 1995 by the members of GATT,
located in Geneva, Switzerland and with approximately 159 member
countries at present, WTO encourages global trade through lowering of
trade barriers, introducing multilateral trading systems through Regional
Trading Agreements (RTAs), enforcement of Foreign Trade rules and
providing a forum for resolving trade disputes. It is also empowered to
monitor a country’s trade policy and can guide the “guilty” members in
eliminating all disputed trade restrictions imposed, if any.

Non-discrimination is the core principle of WTO, and its members have

committed not to favour any one trading partner over others. An
exception to these is the Regional Trade Agreements (RTAs), which are
discriminatory by nature – in the sense that only its member signatories
can enjoy more favourable market-access conditions. The RTAs aim at
facilitating trade between its signatories but do not raise trade barriers
with the other trading countries.

WTO member countries can enter into the RTAs under specific
conditions which will cover: i) formation and operations of customs
unions and free trade areas covering trade in goods, ii) regional or global
arrangements for trade in goods between developing member countries
and iii) agreements covering trade in services. In general, RTAs must
cover all trade in goods and services and help in promoting more of free
trade among the countries under RTA.

As of June 2016, all WTO member countries now have an RTA in force.

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 Foreign Trade

3) The World Bank and the IMF: The primary determinant in helping the
poorer nations or the less developing economies to involve as active
members in the global trading system is by providing financial
assistance. This has been a major shared goal of two international
organizations – The International Monetary Fund (IMF) and the
World Bank.

The IMF lends financial assistance to the needy economies, with

conditions imposed, which might include some of the tender financial or
economic reforms.

The World Bank, on the other hand, provides economic assistance to the
poor and the least developing economies so as to ameliorate the lives of
the people through community-support programs which are mainly
designed to ensure the provision of better health, education, nutrition,
infrastructure and other social services.

4) Trading Blocs: In some parts of the world, a group of countries have

integrated to allow free flow of commodities and services among their
mutual boundaries. Such groups of countries are known as Trading
Blocs.

The North American Free Trade Association (NAFTA) – (agreement

signed for mutual flow of trade among the US, Mexico and Canada) and
the European Union ( EU) (signed by 27 countries of Europe to open
their borders for free trade) are the two most powerful trading blocs at
present.

Activity 3

Find out the major Regional Trading Blocs in the world and try to write a
brief note on each of them. (Go to commerce.gov.in)

…………………………………………………………………………………

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12.9 INDIA’S FOREIGN TRADE: RECENT

TRENDS
India’s Gross Domestic Product (GDP) reached to US$ 2.88 trillion (Rs.
203.39 trillion) in 2019-20 through tremendous acceleration in the twin
channels of trade and capital flows into the country over the last two decades.
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International India generated a trade surplus of US$ 13.59 billion between April and
Business
Environement November, 2020, with exports (of both goods and services) amounting to
US$ 304.25 billion and imports totalling to US$ 290.66 billion (as per data
from the Ministry of Commerce and Industry). The Government of India is
looking forward to grow exports, thereby creating a pool of more jobs for the
educated and talented youth, as well as, for the semi and un-skilled workers
of India.

As per sources of RBI, its foreign exchange reserves now stand at US$
583.13 billion (Rs. 42.75 trillion) as of December, 2020.

India’s external sector, during 2020-21, witnessed a series of MOUs

(Memorandum of Understanding) signed for:

i) Strengthening the cross-border cooperation in the electricity sector with

the United States

ii) Strengthening the cross-border cooperation in the area of securities, with

Luxembourg

iii) Technology cooperation in the road infrastructure sector, with the

Republic of Austria

iv) Cooperation in the fields of Health and Medicine, with Cambodia (valid
for a period of 5 years)

v) Making education materials accessible to children with hearing

disabilities, in cooperation with NCERT, and

vi) Strengthening the bilateral trade between India and Mexico through
cooperation in the sectors like pharmaceuticals, medical equipment,
health care, agro-products, fisheries, food processing and aerospace.

India’s foreign trade is sooner going to witness a new Foreign Trade Policy
(2021-26) with major focus on outlining policies and steps to accelerate
domestic production and exports. It has emerged as one of the most sought-
after destination for foreign investments due to its trade policies, government
reforms and inherent economic strengths, alongside recent technological and
infrastructural developments across the country. It is expected to raise its
exports (of both goods and services) to Australia by US$ 15 billion in 2025
and US$ 35 billion by 2035.

Activity 4

i) Find out the largest and significant trading partners of India.

……………………………………………………………………………

……………………………………………………………………………

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244 ……………………………………………………………………………
 …………………………………………………………………………… Foreign Trade

……………………………………………………………………………

ii) Write a short note, using internet resources, on the initiatives taken by
the Indian government to boost its exports under the Foreign Trade
Policy, 2015-20.

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……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

12.10 SUMMARY
Foreign trade allows countries to engage in buying and selling of goods
across their geographical boundaries, and can ensure productivity efficiency
of the trading economies at the same time. Despite bearing a few
disadvantages like exposure to national security threats, depletion of
domestic natural resource base, creation of highly competitive forums for the
newer start-ups to flourish and adverse effects on the domestic demand on
account of any unfavourable global scenario, foreign trade ensures that a
country attains economies of scale, can specialise in production of goods and
services given its natural resource base, regulates the prices and quality of the
commodities traded globally, facilitates the transfer of technologies among
the trading countries and helps in creation of employment opportunities
globally.

A country cannot benefit from trade if it has absolute advantage in the

production of all goods and services as it eliminates the scope of specialising
in the production of goods and services as well as trading with other
countries. It can benefit from trade only if it has comparative advantage in the
production of goods and services, which accelerates the productive efficiency
of that country. However, trading globally also involves some barriers in the
form of tariff and non-tariff measures that are being imposed by the
government, and which may have an impact on the prices, quality and
quantity of the goods traded. To curb those barriers, several international
organizations (such as the World Bank, the IMF, GATT, WTO) and
agreement bodies (such as the RTAs and the trading blocs) have come into
being, which work towards encouragement of free trade, reduction as well as
regulation of the tariff barriers, solving of trade disputes among the global
trading partners and ensuring improvement in living standards and
employment rates worldwide.

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12.11 KEY WORDS
Economies of Scale: Economies of scale refer to the cost advantages
experienced by a firm when it increases its production of output. These cost
advantages arise because of the inverse relationship that exists between the
per-unit fixed costs and the quantity of the units produced. The greater the
production of output, the lower is the per-unit fixed cost. It also ensures a fall
in the average variable costs due to the operational efficiencies that arise with
the increase in the scale of production.

Intra-Industry Trade: Foreign Trade that occurs within similar industries

rather than between any two or more different industries. Intra-industry trade
is highly beneficial as it stimulates the innovation, ensures significant
production efficacy and exploits economies of scale.

Non-tariff Barriers: Barriers other than tariff which restrict trade. Major
ones are sanitary and phyto-sanitary measures, labelling requirements,
technical barriers to trade, inspection etc. Developed countries are skilled in
applying these measures to restrict trade in products of interest from
developing countries.

Quotas: These are quantitative restrictions on trade. Such barriers are more
restrictive than tariffs since it outrightly prevents the flow of goods. In case
of tariffs the change in flows also depends on elasticity.

12.12 SELF-ASSESSMENT QUESTIONS

1) Define Foreign Trade. Why is Foreign Trade beneficial for a country?
Discuss.

2) What has been the world trade pattern during historical times?

3) State two advantages and disadvantages each of Foreign Trade?

4) Briefly explain the concepts of Absolute Advantage and Comparative

Advantage Theory of Foreign Trade? Give suitable examples to illustrate
the concepts.

5) Do you think that a country can benefit from trade if it has Absolute
Advantage in all goods? Explain.

6) What types of barriers affect Foreign Trade? How can they be managed?

7) What are Trading Blocs? State an example of one such trading bloc.

8) How does India’s external sector look like in the upcoming years? Will it
be an engine of growth? Discuss.

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12.13 REFERENCES/ FURTHER READINGS Foreign Trade

• Krugman, P.R., Obstfeld, M., & Meletz, M.J. (2018). Foreign Trade:
Theory and Policy (11th Edition). Pearson.

• Vaish, M.C., & Singh, S. (2018). International Economics (9th Edition).

Oxford.

• Gandolfo, G. (2014). Foreign Trade Theory and Policy (2nd Edition).

Springer.

• Salvatore, D. (2014). International Economics (11th Edition). Wiley.

• Reserve Bank of India. (2021). Handbook of Statistics on Indian

Economy, 202-21.

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International
Business UNIT 13 SOURCES OF GLOBAL
Environement
FINANCING

Objectives

After reading this unit you should be able to:

• identify various sources of global financing that a country can opt for;
• define Foreign Direct Investment (FDI) and Foreign Portfolio Investment
(FPI);
• explain how international money markets function; and
• analyse the trends in India’s global sources of financing.

Structure

13.1 Introduction
13.2 Foreign Direct Investment (FDI)
13.3 Foreign Portfolio Investment (FPI)
13.4 External Commercial Borrowings (ECBs)
13.5 International Money Markets
13.6 Foreign Aid
13.7 Trade Financing
13.8 American Depository Receipts (ADRs)
13.9 Global Depository Receipts (GDRs)
13.10 Trends in India’s Global Sources of Financing
13.11 Summary
13.12 Key Words
13.13 Self-Assessment Questions
13.14 References/ Further Readings

13.1 INTRODUCTION
Foreign Trade has now become an integral factor to determine a country’s
economic growth prospects. However, trading across national borders does
involve costs which are to be incurred by the domestic exporters (or
importers) such as costs associated with the shipment of merchandise, import
payments, costs associated with selling goods to authorised third parties of
sale, etc.

A country with a financial robustness can be able to incur all its expenses
related to foreign trade. However, in due course of time and with
strengthening of cross-border relations among trading partners, various
248 sources of trade financing have come up, which may ensure complete safety
to both the importers and exporters of a country, the most important among Sources of Global
Financing
them being the strengthening of global financial market operations. This unit
will make you familiar with various sources of global financing that a
country can opt for, while engaging in cross-border trading.

Countries are involved in cross-border transactions given the flow of goods,

services and capital. This requires dealing in a number of currencies. Further,
the financing of transactions through various means also assumes a lot of
importance. Transactions may be settled in advance or at a later date. This
requires a well functioning global financial system. Countries may be capital
surplus or deficient. The movement of capital across countries follows certain
rules. In this unit we are going to look at some of the popular means of global
financing.

13.2 FOREIGN DIRECT INVESTMENT (FDI)

Foreign Direct Investment (FDI) can be defined as an investment made by an
individual or a firm of one country into the business interests of another
country. In general, FDI occurs when an investor set up business operations
or purchases assets in a foreign company. If an American multinational
company, for example, intends to set up its operations in India or New
Zealand, either by partnering with a local firm or by opening up its own
branch, it is considered as an FDI.

FDI is actively operational in open economies that are capable of offering a

trained labour force and remarkable economic growth prospects for an
investor to invest. It involves both capital investment as well as provisions of
management or technology.

FDI can be done in multiple ways which may include entering into a merger
or joint venture with a foreign enterprise or opening of a subsidiary or an
associate firm in a foreign land.

The threshold for a FDI to establish a controlling interest in the business

making decisions of the foreign company is set as per the guidelines of the
Organization of Economic Cooperation and Development (OECD) which is a
minimum 10% stake in a foreign based stake.

Types of Foreign Direct Investment (FDI)

FDI is commonly categorised as:

• Horizontal FDI: It refers to the investor establishing a business

operation in a foreign country, similar to that operating in the home
country. For example, a cell phone service provider in US opening its
stores in India.

• Vertical FDI: It refers to setting up of different business-related

activities, from the investor’s main business, in the foreign land. For
example, a manufacturing company in US may wish to set up a company
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International supplying raw materials or parts, or may wish to merge with a local
Business
Environement company supplying materials, in the foreign country.

• Conglomerate FDI: A type of FDI in which a company wishes to make

an investment in a business, in a foreign country, which is not related to
its current business in the domestic country. Such an investment, by an
investor doesn’t involve any prior experience, they usually opt for a joint
venture in a business already operating in that foreign country.

Activity 1

India recorded the highest ever FDI inflows in the Financial Year 2020-21.
Identify the sectors that attracted the highest FDI during 2020-21. Also,
identify the top investors that invested during FY 2020-21. (You may consult
the DIPP’s website)

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13.3 FOREIGN PORTFOLIO INVESTMENT (FPI)

Foreign Portfolio Investment (FPI) refers to investments by residents of one
country in a foreign country’s securities which include shares, bonds
(government or corporate), convertible securities, infrastructure securities,
etc. Those investing in these securities are termed as the Foreign Portfolio
Investors.

FPI is one of the major components of the capital account for a country and is
reflected in the Balance of Payments (BoP). It consists of passive ownership,
unlike FDI, where investors do not have any control over ventures or direct
ownership of property or stake in a company.

FPI is mainly encouraged by the differences in equity price scenario, bond

yield, prospects of growth, rate of interests, dividends and rate of return on
capital in the foreign country’s financial assets.

In case of India, Securities and Exchange Board of India (SEBI) has

stipulated the criteria for FPI to be less than or equal to 10% of capital in a
company in the year 2016, while above 10% will be considered as FDI.

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13.4 EXTERNAL COMMERCIAL BORROWINGS Sources of Global
Financing
(ECBs)
External Commercial Borrowings (ECBs) can usually be defined as the
commercial loans (debt-based funding arrangement between a business and a
financial institution such as bank, to finance major capital expenditures or
operational costs of a company) which can be in the form of bank loans,
securitized instruments such as floating or fixed rate bonds, partially,
optionally or non -convertible preference shares, buyer’s credit or supplier’s
credit availed from the non-resident lenders with a minimum average
maturity period of 3 years.

Following are the main advantages of ECBs:

a) ECBs are allowed by the Government of India, as a source of financing

existing as well as new investment projects, at a much cheaper rate.

b) ECBs are mainly encouraged in the infrastructural areas such as telecom,

railways, power, urban infrastructures as well as Small and Medium
Enterprises (SMEs).

c) ECBs can be accessed both under Automatic and Approval route. Those
accessed under the Automatic route do not require any approval from the
Government of India or the Reserve Bank of India (RBI). Such ECBs are
usually applied for investments in industrial sector, infrastructural sector
or some specified service sector in India. The ECBs which come through
approval from the RBI/Government of India falls under the Approval
route.

d) ECBs have other advantages such as diversification of the investor’s

base and providing international recognition to the companies.

ECBs have some disadvantages too. To mention among them,

a) ECBs tend to increase a country’s external debt and as a result increase

the borrower’s foreign exchange rate risk.

b) Such foreign currency fluctuations may lead to a loss which may succeed
the savings in interest costs.

To avoid these, there is a capping set on the ECBs in a financial year and an
overall cap on the ECBs in different sectors, which are subject to change by
the RBI/Government of India.

Activity 2

ECBs, the largest component of India’s external debt declined by 5.8 per cent
at end-September, 2020. This may be due to India opting for ease of doing
business policy measures during the pandemic. It may also be due to
reduction in economic activities due to the pandemic. Write a brief note on
the same. (You may consult the Economic Survey, 2021) 251
International …………………………………………………………………………………
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13.5 INTERNATIONAL MONEY MARKETS

The Foreign Trade and foreign direct investments have, by far, witnessed a
large significance across the globe, when it comes to expanding its base for
trading goods and services across national borders, as well as, as a source of
global financing. The purpose of international money markets hereby comes
into action, which makes this financing much easier, through facilitation of
borrowing of foreign currencies for financing its imports or debts.

The international money markets usually comprise of the following:

i) The Eurocurrency Markets: Any freely convertible currency, which is

deposited in a bank, outside the country of its origin, is termed as a
Eurocurrency. The US dollars, for example, if deposited in a bank in
London or Singapore are termed as Eurodollars. US dollar deposits in
Hong Kong or Malaysia is termed as Eurodollar deposits. Such kinds of
deposits are being maintained in a foreign bank or a foreign branch of a
domestic bank. Such banks, which accept deposits and facilitate loans in
foreign currency, are termed as Euro banks.

ii) The Eurobond Markets: Eurobonds are bonds traded in any freely
convertible currency outside the country of its origin. Eurobonds are
either frequently grouped together by the currency in which they will be
denominated such as Eurodollars or Euro-yen bonds. The significance of
the Eurobonds is that they help organizations or countries raise capital
with the flexibility of issuing them another currency.

The issuance of the Eurobonds is usually handled by a depository bank

or an international financial organization, on behalf of the borrower,
which underwrites the bond and takes the guarantee of purchasing the
entire issue. The Eurobond markets have seen enormous growth since
the 1980s and a much wider range of credits are being issued at present,
which includes emerging market corporates and sovereigns and
structured notes (asset and mortgage-backed securities).

iii) Euro Notes and Euro-Commercial Papers: The Euro banks issue
short-term note issuance facilities (SNIFs) or simply note issuance
facilities (NIFs), as a low-cost alternative of Eurobonds, which permits
the borrowers to issue their own short-term Euro notes, that are
distributed by those Eurobanks to other foreign countries or companies
252
 apart from the borrowing country or company. These are short-term Sources of Global
Financing
debts issued by large corporate houses with excellent credit ratings.

NIFs usually include:

1) Various contract features offered by Multiple Pricing Components which

include a market-based rate of interest and quite a few more fees known
as participation, facility and underwriting fees.

2) Other fees that are charged annually or based on full size of the NIF.

Under the NIFs, the notes that are being issued are also at times referred
to as the Euro Commercial Paper (CP), if they are not underwritten.

Following are the differences between the US and Euro CP:

1) The maturity period of a Euro CP, on an average, is twice as long as that

of an US CP.

2) The Euro CP is significantly traded in the secondary market whereas the

US CP is traded by its actual investors.

3) Central and commercial banks as well as corporations are also an

essential part of the investor’s base in case of Euro CP whereas US CP
holders are mainly confined to the money market funds.

13.6 FOREIGN AID

Any kind of an assistance that a country voluntarily transfers to another
country in the form of a gift, grant or loan is known as a Foreign Aid. It is
usually offered by the developed nations to the developing or least developed
nations during the times of a natural calamity, economic crisis or during
political instability. According to the United Nations, the developed countries
are required to have an expenditure share of at least 0.7% of their gross
national income on foreign aid.

Types of Foreign Aid

An international aid can be granted as follows:

• Foreign Direct Investment (FDI): Private FDI by multinational

companies is a primary type of foreign aid in the form of foreign
development assistance. They are usually in the form of equity holdings
of foreign assets by non-residents of the recipient country. US
companies, for example, may engage in FDI by purchasing shares of an
Indian company.

• Foreign aid can be in the form of several development tools which are
being funded by the government agencies or foreign non-profit
organizations to tackle problems associated with poverty. This usually
comes in the form of humanitarian assistance from the wealthier
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International countries which are the member countries of the Organization for
Business
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• Engaging in foreign trade is a third primary type of foreign aid, where

a country’s openness to foreign trade may lead to development process,
especially among the least developed (or poorer) countries, along with
political stability and economic freedom.

• Bilateral Aid: This kind of foreign aid is prevalent, where the

government of one country transfers money or other kind of assets,
directly to the recipient country. An example of a bilateral aid is the
American bilateral aid programs which aim at spreading economic
growth, development and democracy.

• Military Aid: It is also a form of bilateral aid in which a nation involves

in purchasing of arms or signs direct defence contracts with the US. The
federal government, in some instances, procures the arms, and transport
them to the recipient country. Israel receives major military aid from the
US.

• Multilateral Aid: Similar to bilateral aid, multilateral aid is provided by

many governments, instead of one, to the recipient country. In this case,
a single international organization (such as the World Bank) collects
funds as donated by governments of different countries and transfers the
same to the recipient country. Multilateral aid comprises a very small
part of the US agency for international development foreign aid
programs.

• Humanitarian Assistance: It is a form of aid which is usually provided

in times of natural disasters, political instability or a severe economic
crisis. Such kind of efforts gets a higher amount of private funding than
other types of aid.

South Asia received more funds from the advanced economies during an
earthquake, which recorded a magnitude of 9.1, and was triggered by a
tsunami, killing around 2 lac people.

13.7 TRADE FINANCING

Financing is an important part of trading goods and services abroad. The
exporters may require financing while buying or manufacturing of goods
whereas importers may require the same for the purpose of inventory
investment or procuring goods and services from foreign land.

There are five principal means of trade financing, which are being ranked in
terms of its increasing risk to its exporters:

i) Cash in Advance: This offers the greatest protection to the exporter as

the transactions are done mostly in cash, either before or after the arrival
of the goods. An exporter usually prefers cash terms, in situations like a
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 political instability in the importing country or when the buyer’s credit Sources of Global
Financing
seems to be risky or doubtful, as these may cause delays in payments or
even completely stop the fund transfers. Cash in advance, in such cases,
enables the exporters to both finance its production and reduce marketing
risks.

ii) Documentary Credit (D/C): A documentary credit (or documentary

letter of credit) is a form of letter which is addressed to the seller (or
exporter), written and signed by a bank acting on behalf of the buyer (or
importer). In the letter, the bank promises to honour the drafts drawn on
itself if the seller conforms to the specific conditions as mentioned in the
documentary credit.

The major types of a Documentary Credit that are prevalent include:

a) Revocable D/C: Means of arranging payments, which doesn’t carry a

guarantee.

b) Irrevocable D/C: Refers to the means of arranging payments under

specific permissions of all parties concerned, including the exporter.

c) Confirmed D/C: A Confirmed D/C is the one which is issued by one

bank and confirmed by another, obligating both the banks to honour any
drafts drawn in compliance.

d) Unconfirmed D/C: Under an unconfirmed D/C, it is the obligation of

only the issuing bank, without being confirmed by another bank.

e) Transferable D/C: This type of D/C issues the right to the beneficiary to
instruct the paying bank for making the credit available to one or more
secondary beneficiaries. A D/C is non-transferable if not authorized in
the credit.

iii) Draft: Drafts are commonly used means of financing in Foreign Trade.
It is an unconditional order in writing, usually signed by the seller (or
exporter) and addressed to the buyer (or importer) or the importer’s
agent – ordering the buyer to pay on demand or at a fixed future date, the
amount mentioned on its face. It is also known as a bill of exchange.

A draft serves three most important functions, which include:

a) Provision of written evidence, in clear and simple terms, of a financial

obligation.

b) Enabling both the parties (importer and exporter) to potentially reduce

their costs of financing.

c) Provision of a negotiable and unconditional instrument (i.e. the payment

must be made to any holder despite any disputes over the principal
commercial transaction).

Drafts can be negotiable under the following conditions: 255

International • It must be in a written format
Business
Environement • Must be signed by the issuer (drawer)
• Must be an unconditional order to pay
• Must be a certain sum of money
• Must be payable on demand or at a fixed future time
• Must be payable to order of bearer

Drafts can be:

a) Sight Drafts: Drafts paid on presentation or else dishonoured.

b) Time Drafts: Drafts payable at some specified future date. A matured

time draft is termed as its usance or tenor. A time draft is said to become
an acceptance, if it is being accepted by the drawee by authorizing with a
signature and date. A draft, which is accepted by a bank is termed as
banker’s acceptance and that drawn on and accepted by a commercial
enterprise is termed as a trade acceptance.

c) Clean Draft: This kind of draft is not accompanied by any other official
papers and is usually required for non-trade payment settlements only. It
is primarily focused on pressurizing any non-complaint debtor to pay or
accept the draft, failing which may lead to damage to its credit
reputation.

d) Documentary Draft: Such a kind of draft can either be Sight or Time

Drafts and are usually accompanied by other official documents which
are to be delivered to the drawee on payment or on acceptance of the
draft. The official documents include mainly the bill of lading in
negotiable form, the commercial invoice (of trading), the consular
invoice (document certifying the shipment of goods and shows
information such as the consignor, the consignee and value of the
shipment) and an insurance certificate.

iv) Consignment: Under a Consignment, goods sent are only shipped but
are not sold to the importer. In this kind of an arrangement, the goods are
left in possession of an authorized third party to sell. The exporter
(consignor), on selling goods in consignment, draws a portion of the
profits, either as a flat rate fee or commission. Goods and services sold in
the consignment arrangement mode can be of low-commission and low
time- investment way of selling.

This mode of financing usually involves large risks. The exporter need to
carefully verify the credit risks involved along with the availability of
foreign exchange in the importer’s country. If the buyer defaults, it
becomes difficult for the exporter to collect the payments for his
shipment.

256
v) Open Account: Open account selling involves shipping of goods first Sources of Global
Financing
and then billing the importer later. The credit terms are arranged between
the importer and the exporter and in these kinds of arrangement, the
exporter doesn’t have much information about the importer’s obligation
to pay. Open account selling is usually preferable with the foreign
affiliates or with a customer with whom the exporter has long history of
favourable business dealings.

Open account selling has seen a vast expansion with increase in the
volume of Foreign Trade as it has witnessed an improvement in credit
information about the importers and a greater acquaintance with the
exporting in general.

The benefits of an open account selling include greater flexibility of

trading and payments (no specific dates of payment set), lower costs and
fewer bank charges.

Banks and Trade Financing

Banks are usually involved for providing loans or a documentary credit,

when it comes to financing Foreign Trade. However, as financing became a
fundamental aspect of trading, the banks – especially the international banks
have started evolving as well. The banks now provide financing of discrete
trade deals, and assist with comprehensive solutions to trade needs such as
facilitation of combined lending by banks with subsidized funds from the
government export agencies, international leasing, other non-bank financing
resources, along with other associated political and economic risk insurance.

Activity 3

With the help of internet sources, find out the predominant method of
payments opted for by Indian firms to finance trade.

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

13.8 AMERICAN DEPOSITORY RECEIPTS

(ADRs)
A negotiable certificate which is being issued by a US Bank and represents a
specified number of shares of a non-US company which is being traded on a
US Exchange is termed as an American Depository Receipt. They are
measured in US Dollars and are transacted in the US stock market similar to
stocks of any other US company, and are issued in US by an US bank.

257
International The ADRs are listed in either New York Stock Exchange (NYSE) or the
Business
Environement American Stock Exchange (AMEX) or the National Association for
Securities Dealers Automated Quotation (NASDAQ).

ADRs offer the US investors, an opportunity to purchase stocks of foreign

companies, in the US market in US dollars. On the other hand, it also benefits
the foreign companies by enabling them to attract American investors and
trade its share in the US market without the hassle and expense of listing in
the US stock exchanges.

ADRs can be:

Sponsored ADRs: When a foreign company enters directly into an

agreement with the depository bank of US for maintaining records,
communicating with the ADR holders, payment of dividends and other
shares.

Non-sponsored ADRs: When there is no involvement of any US depository

bank and the foreign company wishes to establish itself in the US trading
market with the help of a broker-dealer.

There are three types of ADRs:

Level 1 ADRs: These ADRs does not intend to raise capital. They are listed
in the exchange and traded only over-the-counter market. No information
about the issuer company in the US Securities Exchange Commission (SEC).

Level 2 ADRs: These ADRs are either listed on an exchange or quoted on

NASDAQ. They too, like the level 1 ADRs, do not wish to raise capital but
are required to file annual reports in the US Securities Exchange Commission
(SEC).

Level 3 ADRs: The most important category of ADRs which are issued to
raise money and trade in the US exchange market. They are also required to
file annual reports to SEC.

In case of the sponsored ADRs, a fee is charged by the US depository bank,

while making an agreement with the foreign company for rendering its
services to the ADR holders. Such a fee is called the Custody fee and is often
deducted from the gross dividend, by the foreign company, and the net
dividend is paid to the ADR holders.

13.9 GLOBAL DEPOSITORY RECEIPTS (GDRs)

A bank certificate which is issued in more than one country for shares in a
foreign company is termed as a Global Depository Receipt. They are listed in
two or more markets – mainly the US and the Euro markets are denominated
in a freely convertible foreign currency.

A foreign company issues shares to the depository bank of the share trading
258 country. The Depository bank then issues GDRs against these shares to the
investors of the other foreign countries. In case of GDRs, the GDR holders Sources of Global
Financing
are not the shareholders of the share issuing company. The depository bank
becomes the main shareholder of the issuing company and also has the voting
rights.

13.10 TRENDS IN INDIA’S GLOBAL SOURCES OF

FINANCING
Indian domestic markets have been sluggish when it comes to raising of
funds for their business needs. As a result, Indian companies have shifted
their focus towards international fundraising sources through several
traditional and non-traditional channels available, some of which are
mentioned as follows:

1) Equity based channels are open for the Indian business environment as
a source of financing. They may be in the form of:

a) Foreign Direct Investment policy, which is a liberal and balanced

policy, where global investors can invest in almost all sectors.
Saving in a few sensitive sectors like retail and insurance is quite
easy, as 100% foreign equity participation is available.

b) Investment funds, in the form of pure financial funds, sovereign

funds, social impact funds or other related institutions have at least
two main attractions for investments – investing in the industry or
sector of the target business customers, and having an appetite to
invest in India.

c) Partnership with foreign companies through Joint Ventures

works best if the partnering companies belong to a technology and
capital rich country. Joint venturing allows access to the capital
markets of the foreign partnering companies for additional equity
and low-cost debt. Some European economies have the foresight to
invest in emerging market economies in order to overcome the
saturation in their own investment sectors.

d) Listing of Indian companies in stock markets and other

alternative investment exchanges is available in most of the
advanced economies. This can be available through organic listing
by means of an Initial Public Offering (IPO) or with the help of a
reverse merger with an already existing company followed by stock
offerings. Canada, US and Singapore stock markets are best suited
for such kind of transactions.

e) Equity guaranteed debt rely on the reputation of a Joint Venturing

partner or a significant partner shareholder that floats a loan for the
Indian companies and guarantees it locally, thereby making
fundraising by Indian businesses easier and more economical.
259
International 2) Debt based instruments include major banks and other financial
Business
Environement institutions as primary choices of raising debt funds from foreign
sources. Quite a handful of commercial banks in major economies like
US, Japan, China, UK, Switzerland, Canada and Taiwan provide funds
to Indian businesses for financing their business needs. Debts from banks
and large financial institutions such as the World Bank, the International
Monetary Fund, the US International Development Finance Corporation
and the Asian Development Bank are mostly suited to finance Indian
projects of economic importance.

Smaller banks and debt funds are mostly accessible to the MSME
Sectors for providing loans and funds with an interest rate higher than
the larger institutions but lower than the domestic funders. Partner
companies through joint ventures provide channels for funding through
their own banking relationships, by leveraging low-cost debt themselves
followed by a low-cost debt as another alternative lender to its own
business under the current Indian external commercial banking policy.

Besides business development funding, there are certain European banks

that are willing to finance global businesses of their clients by providing
debts at economical rates in emerging economies like India as long as the
foreign partner company is a part of the business.

Alongside these financing options, Indian business firms are now open to
trade factoring in businesses with reputable importers of their products.
Export finance is greatly beneficial when buying capital goods from
advanced economies like US, Canada, China and Japan. Extreme low-
cost financing options are also available for the right customers in India.

Setting up of a subsidiary of an Indian company in a foreign capital

rich economy is another option of securing low-cost finance, as many
schemes and opportunities for growth can be availed using this method
for the reputable business firms in India.

Foreign capital markets are thus, a valuable source of financing for the
Indian businesses and it is a perfect opportunity for them to access such
global capital markets and accrue more of capital reserves in the near
future.

Activity 4

1) Identify any top 5 Indian companies (using internet resources) and their
sources of global funding.

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………
260
 …………………………………………………………………………… Sources of Global
Financing
2) Can you list world’s top 5 private equity companies that have invested in
India. (Use Internet sources like GlobalEdgeTM)

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

……………………………………………………………………………

13.11 SUMMARY
Global trading is an essential factor for determining a country’s economic
growth prospect. But it also comes with some costs involved during purchase
and sale of merchandise across geographical boundaries, such as costs
associated with the shipment of goods, payments to exporters, etc. A country
with a strong financial backbone can bear all its financing of trade expenses.
However, with the passage of time, cross-border trading relations
strengthened and several sources of trade financing have emerged for the
trading countries in the form of Foreign Direct and Foreign Portfolio
investments, External Commercial borrowings, Foreign Aid, American
Depository and Global Depository Receipts and International money markets
(which includes Eurocurrencies, Eurobonds, Euro notes, etc.). As far as the
payment terms between the exporter and the importer is concerned, five
additional means of financing trade have been identified and ranked as per
the associated risks for the exporters. Such means include payments through
Cash in Advance, Drafts, Documentary Credits, Consignments and Open
Account Selling, and banking operations.

Countries can now opt for their sources of funding, as required, without
involving much of the depletion of its foreign stock of reserves.

13.12 KEY WORDS

Credit Rating: A quantitative assessment of a borrower’s credit worthiness
in terms of a particular debt or financial obligation. It can be assigned to any
entity, be it an individual, a company or a sovereign government.

Small and Medium-sized Enterprises (SMEs): SMEs are non-subsidiary,

independent firms (or business operations) which employ fewer than a certain
limit of employees. Small and medium enterprises generally have 50 or less
than 50 employees while micro firms operate with at most 10, or in some
cases, 5 employees.

Organization for Economic Co-operation and Development (OECD):

OECD Founded in 1961 and headquartered in Paris, France, is a 38-member 261
International intergovernmental economic organization which aims towards encouraging
Business
Environement economic progress and trade worldwide. It also provides a forum for its
member countries who are committed to democracy and market economy to
compare their policy experiences, identifying problems and seeking answers
to them, and identifying good practices and coordinating domestic and
international policies of its members.

National Association of Securities Dealers Automated Quotations

(NASDAQ): Founded in 1971, NASDAQ is an American stock exchange
market based in New York City and ranked second in the list of stock
exchanges after the New York Stock Exchange. It is owned by NASDAQ
Inc. which also owns the NASDAQ Nordic stock market network and
various US Stock and Option exchanges. NASDAQ allows its investors to
buy and sell stocks in an automated, transparent and a faster computing
network.

Morgan Stanley Capital International (MSCI): Founded in 1969 the

MSCI is an American financial company which is based in New York City
and serves as a global provider of fixed income, equities, hedge fund stock
market indexes, multi-asset portfolio analysis tools and Environmental,
Social and Governance (ESG) factors products.

Joint Venture (JV): A type of business entity created by two or more

parties, generally characterised by shared ownership, shared returns and risks,
and shared governance. Companies usually engage into a Joint Venture to
access to a new market (especially emerging markets), gaining efficiencies of
scale, sharing risks for major investments or projects and for accessing newer
skills and potentialities.

Initial Public Offering (IPO): An IPO (also referred to as Stock Launch) is

a public offering in which shares of a company are sold to institutional
investors and retail investors. An IPO is usually underwritten by one or more
investment banks, who arranges for the shares to be listed in one or more
stock exchanges.

13.13 SELF-ASSESSMENT QUESTIONS

1) State the differences between Foreign Direct Investment (FDI) and
Foreign Portfolio Investment (FPI).

2) What are the advantages and disadvantages of External Commercial

Borrowings (ECBs)?

3) What are the components of International Money Markets? Explain in

detail.

4) What is Foreign Aid? State the types of Foreign Aid.

5) What are American Depository Receipts (ADRs) and Global Depository

Receipts (GDRs)? Explain.
262
6) State and explain the five principal means of trade financing. Sources of Global
Financing
7) What are the various types of Documentary Credits? Explain their
purposes.

8) What are the five major trends that India’s financial account is
witnessing in the recent times? Elaborate.

13.14 REFERENCES/ FURTHER READINGS

• Salvatore, D. (2014). International Economics (11th Edition), Wiley.

• Krugman, P.R., Obstfeld, M., & Meletz, M.J. (2018). Foreign Trade:
Theory and Policy (11th Edition), Pearson.

• Buckley, R.P. (2008). International Financial System: Policy and

Regulation. Kluwer Law International.

• Levi, M.D. (2010). International Finance (5th Edition), Taylor &

Francis.

263
International
Business UNIT 14 TECHNOLOGICAL
Environement
ENVIRONMENT

Objectives

After reading this unit you should be able to:

• discuss the important aspects of technological environment in

international business;
• analyse recent trends in technological environment;
• describe the impact of technological environment on international
business; and
• highlight the recent trends in technological advancements adopted by
Indian businesses.

Structure

14.1 Introduction
14.2 Trends in Technological Environment
14.3 Impact of Technological Environment on International Business
14.4 Trends in Technological Advancements
14.5 Summary
14.6 Key Words
14.7 Self-Assessment Questions
14.8 References/ Further Readings

14.1 INTRODUCTION
The technological environment portrays a country’s potential in terms of the
availability of raw materials and machinery which is required for the
manufacturing of goods. No company can possibly control the global
environment and hence adaption of technologies may seem to be quite
essential for the businesses to ensure a competitive advantage. This unit will
essentially focus on making one understand why technological environment
is important for a business to flourish both nationally and internationally,
what are the advancements in technology that can help a business expand and
finally what are its impacts in the global market.

Technology is crucial for the entire global business world. Even though
lowering of trade barriers have theoretically helped expand markets and
production potential worldwide, the advent of technological innovations has
added a practical reality to it. In today’s world, almost every business
operation and transaction involve a significant use of technology.

264
Let us look at some of the important aspects of technological environment in Technological
Environment
the international business.

1) Business Necessity- In the earlier days, everything in business was

performed manually. Introduction of technology has helped revolutionize
the business concepts and models, thereby bringing tremendous growth
in trade and commerce. It has provided a faster, more convenient and
more efficient way of performing business transactions.

Some of the technological uses in an international business environment

include accounting systems, management information systems, logistics
tracking systems, customer relationship services, point of sales systems,
etc. These have enabled businesses to expand globally as well.

2) Communication with Customers- In today’s world, technology has a

great importance in building relationships with customers. In a global
business environment, quick and clear interaction with the clients
(globally) is a necessity as websites take hours to respond to customer
queries. Alongside, technological innovations in the transportation
services have enabled fast shipment disbursal in a shorter span of time
across national borders. Language translation systems have enabled
employees of a business/organization to interact with customers
worldwide, understand their concerns and resolve their issues. This is
how a global business environment benefits from a stronger
communication system globally.

3) Efficient Business Operations- Technological advancements in a global

business environment have helped organisations understand their cash
flow needs, needs for free flow of shipment, needs for proper inventory
management, need for proper tracking and monitoring of shipment and
need for proper communication with clients in a much more efficient and
faster processes, thereby saving time and physical space. Low-cost
internet services and world wide web have also enabled businesses to
grow internationally and cater to global needs easily.

4) Impact on Business Culture and Relations- With the advent of

technology, stronger communications are being facilitated among
employees of a business, customers, shipment coordinators and all those
who are associated with a global business environment, directly or
indirectly. This has helped to keep aside all social tensions, distrust and
formation of cliques which might have a negative impact on the business
to a large extent. Instead, it has helped develop a strong bond between
the employees and customers of a business.

5) Business Security- Businesses are often subject to threats. In order to

expand globally, businesses have started expanding online through
internet services. This gets them exposed to cyber-crime threats. With
the technological innovations in line, especially in the form of Artificial
Intelligence (AI) and Machine Learning (ML), businesses can now 265
International monitor and secure financial transaction, client related data, various
Business
Environement confidential reports and other proprietary information. With the help of
cloud computing, employees can now access to all business and client
related data along with communicating with their clients and other
employees, while travelling or working remotely, even without direct
active management of data.

6) Research Capacity- All businesses need to expand – both the line of

production capacity and client base. Technology helps meet the business
with newer opportunities by facilitating enough Research and
Development (R&D). This enables a business realise newer dimensions
to expand both domestically and internationally, along with facing
competition in the world market. Internet has enabled businesses to
access data on global markets without facing the costs of travelling or
risks of creating separate production plant abroad.

Activity1

Give an example of a business where technology is playing a special role.

What aspects of technology are being used in your chosen business?

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

…………………………………………………………………………………

14.2 TRENDS IN TECHNOLOGICAL

ENVIRONMENT
A global business environment cannot function without a technological
environment. The more the technology evolves, the greater the benefits
obtained by a business from it. Following are some of the important ways in
which technology has helped a business environment globally:

Biotechnology

Biotechnology can be defined as an amalgamation of technology and science,

more specifically, the creation of agricultural or medical products with the
help of industrial usage and manipulation of living organisms. With the rise
of digital innovations such as cellular phones, computers and wireless
technologies, advancements have not only evolved in efficient
communication and productivity, but has also extended its effect towards
medical and agricultural use.

Following biotechnological advancements have been witnessed worldwide:

266
i) The fusion of science and technology have bred a common bionic man Technological
Environment
immune to diseases through advanced technologies in prosthetics, cell
regeneration through stem cell research and laboratory-engineered drugs
which helps in preventing or curing of diseases like HIV or cancer.

ii) Pharmaceutical advancements are widespread through the raw material

reserves of China, arrival of biotech companies such as Genentech and
New Merck (which is acquired by Swiss biotech company Serono) and
India’s emergence as a major supplier of effective and affordable drugs
of the largest and most generic pharmaceutical company Ranbaxy.

iii) Biotech companies have made attempts to discover genetic

abnormalities, and therefore medical solutions through exploration of
organisms at the molecular level or formulation of compounds from
inorganic materials that reflect organic substances. Manipulation of
DNA in the laboratories also extended beyond common human research.

iv) The demand for corn-derived Ethanol as a fuel alternative saw a rise in
US due to uncertain future oil supplies. However, usage of corn as a bio
fuel not only increased the price of fuel but also created an imbalance
between the corn that is used as a bio fuel and the corn consumed.
Hence, many global companies are working in collaboration, towards
creation of genetically modified seeds like drought-tolerant corn and
herbicide tolerant soybeans. These technological advancements have not
only led to nutritionally advanced crops but also helped fight hunger
worldwide.

v) Biotechnological advancements have also benefitted the meat industry

worldwide. The collaborative work of researchers in US and Japan, in
eliminating the gene which might be responsible for certain ailments in
animals, has engineered a solution to the outbreak of certain diseases
arising from meat consumption. Furthermore, animal cloning has rose to
high demand, where a copy of pre-existing animal DNA, can speed up
the food production with the increase in production of meat or dairy-
producing animals. US, South Korea, Japan, Australia, Italy, New
Zealand and China are among the most active animal-cloning countries.

vi) Technological advancements have also been witnessed in laser surgeries

in correcting eyesight, creation of vaccine to fight against emerging
viruses or production of more nutrient-content food products.

In all, biotechnological advancements are actively emerging up to cope with

the worldwide issues of hunger and poor healthcare.

E-Commerce

Availability of internet and the growing demand of the world wide web has
brought a drastic change in the marketing of goods and services. It has
enabled firms ranging from small enterprises to large industrial houses realise
the potential of online global marketing along with facilitating online buying 267
International and selling of goods and services globally. The low entry costs of internet
Business
Environement have, by far, permitted the small and medium enterprises (SMEs) having low
capital investments to emerge as significant global online marketers at a rapid
pace. On the other hand, internet has also enabled the customers to get an
explosive range of information about varied products and services online,
alongside providing the potential to obtain products from the low-priced
suppliers in the world. This has helped in increasing the standardization of
prices across national borders, thereby narrowing the differences in prices, as
consumers are now more aware of prices globally and purchase products
online accordingly.

Telecommunications

An important dimension of the technological environment in the international

businesses is telecommunications. From hardwiring a city/locality to provide
its residents with a telephone service, to wireless telecommunication services
through usage of cellular phones, pagers and other such services,
technological leapfrogging is quick across the globe. Additionally,
technology has also merged the cellular phone and the computer, due to
which growing number of people is now getting access to web services,
through their cellular phones. This growth is warmly acceptable as
businesses, domestic or global, will not be able to prosper without an
efficient telecommunication system. Telecom advancements in the form of
4G and 5G services have fostered closely knit global businesses.

Transportation

Technology, apart from bringing innovations in the telecommunications and

computers, has also brought in some major developments in the
transportation sector, ever since the period of World War II. The most
important developments came in the form of introduction of commercial jet
aircrafts, super freighters and containerization (system of intermodal freight
transport using intermodal (or shipping/ISO) containers of standardized
dimensions), which has simplified the transhipment from one mode of
transport to another. While the containerization led to reduction in the cost of
shipments to longer distances, commercial jet aircrafts helped in the
reduction of the travel time for businessmen.

Globalisation of Production Processes

A network of strong worldwide communications has become essential to

facilitate globalisation of production for any multinational firm. Texas
Instruments (TI), an US based electronics firm, for example, have
approximately 50 plants across 19 countries. A system on satellite-based
communication allows the firm to coordinate and monitor its production
systems in all those 50 plants located globally, that include the planning of
production processes, accounting and financial planning, marketing of
products, facilitation of customer services and human resource management.
268
Globalisation of Markets Technological
Environment
The globalisation of production and innovations in the transportation sector
has facilitated the globalization of markets too. The advent of
containerization has led to faster and reliable transhipment of goods within
and across national boundaries, thereby leading to creation of global markets.
Commercial jet aircrafts have facilitated low-cost movement of people
around the world. Low-cost global communication networks, such as the
world wide web have led to global exposure of goods and services from
around the world, through online marketing. Global communications and
global media together help in reducing cultural distances among countries
and encouraging a convergence of tastes and preferences of consumers
worldwide, thereby creating a world market for consumer goods. For
instance, one can find a McDonald’s restaurant in India, as it is in New York,
buy a Sony Walkman in Delhi, as it is in Berlin or grab a Levi’s jeans in
Paris as it is in US.

Technology Transfer

It is a process that permits the flow of technology from a source to a receiver.

Both the source and the recipient of such technological transfers can be an
individual, company or a country. The source, in this case, is the owner or
holder of the technological knowledge, while the receiver is the beneficiary
of such knowledge. With the advancements in the technological environment,
the transfer of such technological innovations is spreading rapidly across
world markets, especially benefitting the less developed and the emerging
economies. The source of such technological knowledge usually happens to
be the advanced economies.

Block Chain

Block Chain is a system of recording information that completely prohibits to

change, hack or cheat the system. It is essentially a digital ledger of
transactions that is duplicated and distributed across the entire network of
computer systems in the Block Chain.

Block Chain and Block Chain-based distributed ledger technologies are

creating a tremendous impact both in the global trade supply chain as well as
in the global trade financially. It not only makes the shipment of goods more
convenient, but also simplifies the long and tedious process of obtaining a
Letter of Credit (LoC), a payment mechanism that is used in global trade.

Several trade organizations such as the Dubai Chamber of Commerce and

Industry have launched an initiative to implement Block Chain technology
for addressing world trade issues like high costs and lack of transparency and
security. Deloitte, have assisted an Indian private sector bank in redesigning
its LoC issuance service, using a Block Chain based solution that reduced the
issuance time from 20-30 days to hours. Companies such as Skuchain are by-
passing the LoC altogether and is providing real-time tracking of goods and
269
International inventory financing that reduces the risks associated with transactions, and
Business
Environement allows the trade financers to provide working capital relief to all the supply
chain partners at the lowest cost of capital in that supply chain.

Artificial Intelligence (AI) and Machine Learning (ML)

Artificial Intelligence (AI) refers to the simulation of human intelligence in

machines or computer systems that are programmed to think and act like
humans. This term is also applied to any machine that functions like a human
– mind such as learning and problem – solving.

Machine Learning (ML), on the other hand, is a part of Artificial Intelligence

(AI). It is a study of computer algorithms that can be improved automatically
through everyday experience and with the use of data.

Both AI and ML can be used to optimise trade shipping routes, manage

vessel and truck traffic at ports and translate e-commerce search queries from
one language to another and respond with the translated inventory. It also
works more towards making global trade sustainable, rather than focusing
only on efficiency gains and better customer services. An example of this is
the launching of Global Fishing Watch by Google in 2016, a real-time tool
based on Machine Learning which is used to curb the illegal means of fishing
through provision of a global view of commercial fishing activities based on
satellite data and ship movements. Governments and other organizations can
also use this to track suspicious behaviours and work on developing
sustainable policies accordingly.

Trading Services through Digital Platforms

Trading services have now become much more convenient online. With the
help of several online digital platforms such as ‘Upwork’, users can now look
for service providers worldwide for a vast range of services, and can be able
to find anything from an accountant in US, to a web developer in Japan, or a
virtual assistant in India. Certain start-ups have come up with an online
learning digital platform that enables pairing up educators with children
across the globe to provide online education on a wide range of courses. An
example of such an online digital learning platform is VIPKID which
connects American educational instructors with Chinese children for teaching
English online. Many online digital platforms have also come up to connect
customers with various professional service providers in just few clicks.

3D-Printing Services

3D-Printing (also known as Additive manufacturing) is a process of creating

a three-dimensional solid object from a digital file. This is done using an
additive process in which an object is created with successive layers of
material until the object is created.

3D-Printing has the potential to make the production of goods, from food to
medical supplies and to great coral reefs, accessible to everyone. In future, it
270
may also lead its way into the businesses, disaster sites, outer space, etc. The Technological
Environment
significance of 3D- printing on a global business environment is still a
debatable topic. Some studies predict that with the mass-adoption of high-
speed 3D-printing and lower associated costs, global trade might see a
decline by approx. 25 per cent, as 3D- printing involves lesser manpower and
reduces the need for importing goods. Others argue on the account of
complexities and reality associated with mass-manufacturing using 3D-
printing. Regardless of being positive or negative, the impact of 3D-printing
seems to have a real impact on global trade, with the efficient and low-priced
availability of 3D-printing methods.

Mobile Payment Services

With the advent of M-Pesa, Mobikwik, Google Pay, Phone Pe and other UPI
(Unified Payments Interface) methods, mobile payments seem to transform
the lives of people and help in linking more people to global market
opportunities. As per the World Bank Global Inclusion Database, mobile
money payments were a major drive for financial inclusion during 2011-14,
especially in the emerging economies, as the number of people who gained
access to bank accounts increased by 20 per cent during the same period.
This has made people to participate in global trade in a much easier and faster
method, either as consumers or businessmen.

Customer Relationship Management (CRM) Software Services

With the expansion of a business across national borders, one needs to

essentially look into the customer services and therefore maintaining healthy
customer relationships. However, global expansion of business can really
make it difficult to keep a proper track on all client records. This is where the
CRM software services come into play.

The CRM software helps in creation of a database for all your customer
contacts that can easily be accessed by any member of one’s team, related to
business. This software is very much essential while running businesses on a
global scale. It helps to create a database for maintaining the product order
histories, concerns raised by consumers, and personal as well as business
related information of each individual consumer along with their contact
details (phone calls, emails and chats). This information enables a company
or a business to track their customer’s location, along with the languages that
they speak and the local customs that the company may require to be aware
of, alongside any applicable trade rules or restrictions.

Cloud Computing Services

Cloud computing refers to an on-demand availability of all computer system

resources, especially data storage and computing power, even without direct
active management by the user. It is generally used to describe the data
centres over the internet.

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International This technology is especially beneficial for companies working on a global
Business
Environement front and where employees need to travel quite frequently or work remotely.
With the help of cloud computing, an employee can get access to files and
essential information regarding their organization from anywhere and can
remain connected to its customers as well as office, on filing of reports,
sharing of data or communicating uninterruptedly around the globe.

Logistics Tracking Technology

Logistics is an essential part of doing business, especially during buying and

selling goods internationally. Execution, receipt and tracking of shipment
require a lot of planning, consideration and careful handling as a wrong
shipment can have an adverse impact on time, money and customers.

In order to help the companies deal with this task efficiently, an innovative
technology in the form of Logistics Management Systems have come up.
This system helps in planning of trade routes, monitoring of any trade
restrictions or problem areas, if any, and track movements of goods and
services. It also helps in modifying disrupted trade routes to get the deliveries
back on track. Electronic Shipment Tracking is nowadays evolving to help
in meeting business needs. Cost effective Radio Frequency Identification
(RFID) devices have evolved to be more affordable and attainable for
companies, followed by Bluetooth Beacons which emerged as another
alternative option for electronically tracking shipments.

The emergence of RFID and Bluetooth Beacons has therefore, helped the
businesses in taking advantage of Automatic Identification and Data
Capture (AIDC) in their supply chains, making it more reliable to manage
and track their shipments.

Translation and Language Learning Software and Services

Language barriers can appear to be a real challenge for a global company,

especially when it comes to communicating effectively with its customers or
business clients. Web-based translation companies have evolved themselves
and are still in the process of upgrading their functions every day. Though
they sophistically translate and check the communications, it is still
suggested to have a professional translator or a fluent speaker to check the
communications and avoid inaccuracies, if any.

In order to continue a business with its partner or customer in the long-run,

learning of the foreign languages can help reducing expenses or translation
costs and can help provide better customer services. In such a case, a plenty
of online reputable programmes and software courses can help one learn and
improve their foreign language skills.

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Activity 2 Technological
Environment
Can you name the latest technologies (taking help from the internet sources)
that are shaping up the following:

a) Education Sector

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b) Banking Sector

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c) Healthcare Sector

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14.3 IMPACT OF TECHNOLOGICAL

ENVIRONMENT ON INTERNATIONAL
BUSINESS
Every businessman or marketer around the globe is now well aware of how
important technology is for the businesses and what are its effects on a
business environment? There are both negative and positive effects of
technology for a business.

Initially, the businesses were dependent on a labour force. But with the rise in
technology, businesses do not want to lag behind. They have already started

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International implementing newer technologies to flourish worldwide. Here are some of
Business
Environement the ways in which the technology affects the global business environment.

1) Technology helps in diminishing business security risks by hiring best of

security specialists for preventing sudden cyber-attacks and with the use
of AI and ML, such threats are being minimized.

2) Technology ensures business growth by enabling almost all business

actions to be automated, thereby reducing involvement of human labour.
This has helped in increasing the sales, revenue and profit for the
businesses and the usage of internet have enabled them to grow online
and expand worldwide.

3) Online presence through social media channels is one of the business-

oriented targets that the enterprises are trying to fulfil to grow along with
the broadening of its client base. Technological tools that help businesses
identify their preferred content, optimum time of posting their service
contents, automated posting and location- specific targeting to expand
their business, are actually helping to establish the business better in the
online world. Tools like Google analytics are playing a major role in this.

4) Technology helps in increasing employee productivity for a business

through various computer programming and software such as AI, ML,
and cloud computing that helps businesses to process more information,
sitting anywhere in the world, than manual methods, thereby reducing
much of human involvement in such tasks. Organizations are also using
fundamental business technologies for employee performance appraisal
information in the online framework to supervise the performance of its
employees and create measurable goals for their employees to achieve
and thereby sustain the business objectives.

5) Business technologies are now allowing companies to outsource certain

business functions to other businesses in the national and global business
framework. Technical support and customer service are the two most
common outsourced functions. Outsourcing therefore helps companies
lower their business costs and focus on completing their business
functions, which they are best at. With the help of several technological
innovations, businesses can also outsource their functions to the least
expensive areas possible, including those in foreign countries as well.

Activity 3

Explain with an appropriate example, how technology has enabled

international business. What would be the progress of the sector chosen if
technology had not progressed to the level it has?

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………………………………………………………………………………… Technological
Environment
…………………………………………………………………………………

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14.4 TRENDS IN TECHNOLOGICAL

ADVANCEMENTS
Several new technological creations have been developed for the Indian
businesses to improve their business performances using more advanced
technologies such as Robotic Process Automation (RPA), Artificial
Intelligence (AI) and Analytics. The top five trends in technological
innovation with respect to Indian business environment, during the period
2019-20 are as follows:

1) Emergence of Hyper-automation – An infusion of the RPA, AI and

Analytics creates a new technology called Hyper-automation which
enables optimisation and modernisation of processes. Hyper-automation
uses a mix of rising technologies such as Machine Learning, RPA,
Intelligent business management software and AI, to take the automation
of organizational processes to a higher level. A mix of devices supports
this process to function exactly as human workforce, post which the
solution can even carry out the decision-making process independently.
This process results in increasing rates of productivity, broader access to
data and helping decision makers to carry out better decisions for their
customer leveraging analytics.

2) Increase in Artificial Intelligence (AI) Usage – AI is now blending into

the daily routine of human workforce with more reliable and advanced
AI engines. High-speed optical fibre internet is now available at every
home in India, enabling the data to develop devices that are more human
friendly and easily handled. AI will also help in streamlining the non-
value-added tasks to be performed, therefore freeing up humans to invest
their time in more meaningful and other important business-related
activities. More and more, Indian companies have now started investing
in data analytics, AI and ML to train and enrich their workforce with
various analytical skills, thereby enabling them to take advantage of
advanced technologies. Some of the uses of data analysis include
algorithms for analysing fingerprint data systems, finding of errors and
giving insights, and also suggesting new data that should be analysed
along with.

3) Conversational AI and Natural Language Processing (NLP) – NLP

has earned a great popularity through the use of voice search and voice
assistants, thereby creating a paradigm shift in AI, in many Indian
companies. The NLP helps in increasing visualised dashboards and
reports within their Business Intelligence systems. A number of Q&A or
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International chat mediums are being used to gain real-time answers and useful
Business
Environement visualizations from data-specific queries. Computational linguistics is
still a major area of ongoing research using NLP, considering its ability
to improve efficiency and insights, according to which NLP will turn out
to be beneficial in the process of optimizing data exploration and
improving communications in the upcoming future.

4) Autonomous Things (AT) – One of the most revolutionary innovations

in technology in the Indian business environment is the Autonomous
Things (AT). AT allows multiple devices to work in collaboration using
limited or no human dependency input. It has the ability to surpass
process automation to integrate advanced AI for delivering
communications and behaviours with more natural interactions with
humans and the business environment.

5) Data Storage Technology Innovations – With the increased amount of

data, the concept of Software Defined Storage (SDS) system has
evolved, which combines the software and hardware from different
manufacturers for operating together resulting in an enormous efficient
data handling performance, making it more secure and easier to perform.

Alongside, another popular trend in technology has been witnessed

through hyper scale data centre construction, which is prevalent in the
data centre industry since 2019, allowing Indian business sectors to
adopt Data Centre Infrastructure Management (DCIM) solutions, in
order to cater the demands of modern business environment. The year
2020 saw an increase in the enterprises who have been designing and
implementing smart data centres for operators to integrate proactive
sustainability and efficiency measures.

Activity 4

Given the recent changes in technological environment worldwide how far,

do you think, India has progressed on these fronts? Give some views about
the present state in India in the areas mentioned in this section.

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14.5 SUMMARY
Technology has its own significance when it comes to connecting businesses
worldwide and expands a global market. Not only does it limit its efficacy to
276 improving the global business relations, but also has an impact on day-to-day
business activities including customer relationship management, production Technological
Environment
planning, logistics tracking, ensuring proper shipment and delivery of goods,
financial planning, cost management, database management etc. Up-
gradations in the technological environment in the form of Artificial
Intelligence, Machine Learning, Cloud Computing, Block Chains, Natural
Language Processing and several others have helped businesses to move
from more of manual and less of technology base to more of technological
base and less of manual labour involvement in its day-to-day activities. It
also assists in tracking suspicious behaviours and ensures security to data
hacking threats. Connecting customers worldwide and addressing their
concerns in just a few clicks have also been improvised with the help of
several technological inventions. In short, technology has now become the
soul of a global business environment.

14.6 KEY WORDS

Genetically modified seeds: Seeds designed to make the plants/crops more
resistant to rain, drought, pests, diseases, etc.

Globalization: A process by which businesses or enterprises develop

international influence or start operating on a global scale.

Algorithm: Set of rules that are followed in calculations or other problem-

solving operations, by a computer.

Analytics: A systematic computational analysis and the resultant information

obtained using data or statistics.

14.7 SELF-ASSESSMENT QUESTIONS

1) What is the importance of technology in international business
environment?

2) How has biotechnology brought about advancements in international

business environment?

3) How has internet services and telecommunications revolutionised

international business environment?

4) What is Technology Transfer? Give an example.

5) Define Block Chain, Artificial Intelligence (AI) and Machine Learning

(ML). Mention some areas where they are frequently used.

6) How does Customer Relationship Management (CRM) software changed

the way business is done?

7) What is Cloud Computing? What is its contribution?

8) How has Logistics Tracking Technology helped in improving the

international business environment?
277
International 9) How does technological advancement impact international business?
Business
Environement Discuss.

10) State any two technological advancements that India is witnessing to

have impacted her international business pattern.

14.8 REFERNCES/ FURTHER READINGS

• Pablos, P.O. (2014) International Business Strategy and
Entrepreneurship: An Information Technology Respective. IGI Global.

• Hill, C.W.L., hult, G.t.M., ?& Mehtani, R. (2018). International Business

(11th Edition). McGraw Hill Education.

• Joshi, R.M. (2009). International Business. Oxford University.

• Cavusgil, S.M., Knights., & Riesenberger, J. (2017). International

Business (4th Edition). Pearson.

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