Summary of Indian Economy-Part-I

7/25/2019 Summary of Indian Economy-Part-I

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CONTENTS

INDIA UNDER THE BRITISH RULE

INFLATION IN INDIA

MONETARY POLICY OF INDIA

MONEY MARKET

ROLE OF RBI

NATIONALISATION OF BANKS, JULY 1969

NARSIMHAN COMMITTEE (1991)

FISCAL POLICY OF INDIA

FISCAL RESPONSIBILITY AND BUDGETARY MANAGEMENT ACT, 2003

ROLE OF RBI

GENERAL ROLES

INDIA REFORMS EXPERIENCE

EXTERNAL SECTOR REFORMS

FINANCIAL SECTOR REFORMS

FINANCIAL INCLUSION AND CUSTOMER SERVICES

PROSPECTS, CHALLENGES AND STRENGTHS OF THE ECONOMY NOW

INDIAN PUBLIC FINANCE

VALUE ADDED TAX

GOODS AND SERVICE TAX

STATE FINANCES

PUBLIC DEBT


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India under the British Rule

The economic consequences of the British rule can be studied under three heads:

Decline of Indian Handicrafts and progressive ruralisation of the Indian economy

Growth of the new land system and the commercialisation of Indian agriculture

Process of industrial transition of India

Decline of Handicrafts

While India was an exporter of Handicrafts before the Industrial Revolution, the revolution

reversed the character of Indias foreigntrade

o Increase in demand for raw material for British industries

o Hence, steps were made to crush Indian handcrafts as well as commercialise

agriculture to meet the interests of the British industries

Principle causes for the decline of Indian handicrafts

o Disappearance of Princely courts

o Hostile policy of the East India Company and the British Parliament

o

Competition of machine-made goods

o The development of new forms and patterns of demand as a result of foreign

influence

Economic consequences of the decline of handicrafts

o Increased unemployment

o Back-to-the-land movement: handicrafts were forced to take up agriculture or

become landless labourers. This increased the pressure on land. This trend of

growing proportion of the working force on agriculture is described asprogressive

ruralisation or deindustrialisation of India. Thus, the crisis in handicraftsand

industries seriously crippled Indian agriculture.

Land System during 1793-1850

1793: permanent settlement

Zamindari, Ryotwari, Mahalwari systems

Absentee landlordism emerged

The result of the whole change in the land system led to the emergence of subsistence

agriculture

It helped the concentration of economic power in the hand of absentee landlords and

moneylenders in rural India.

Commercialisation of Agriculture (1850-1947)

Define: Production of crop for sale rather than for family consumption

What distinguished commercial agriculture from normal sales of marketable surplus was

that it was a deliberate policy worked up under the pressure from British industries. It was

thus forced upon the Indian peasantry.

Resistance: Indigo revolution etc

Why CA? Industrial Revolution

Impact of railways and road transport: Railways and road transport made possible a huge

expansion in cash cropping, for national and international markets, and production regimes

across the subcontinent were placed in a new context of opportunity Impact of CA

o Mass movement to commercial agriculture caused decline in food production,


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increase in prices and famines.

o Halted the process of industrialisation in India

Industrial Transition in India

The process of industrial transition divided into: industrial growth during the 19 th century

and industrial progress during the 20th

century

Industrial growth during the 19

th

centuryo Decline of indigenous industries and the rise of large scale modern industries

o 1850-55: first cotton mill, first jute mill and the first coal mine established.

Railway also introduced.

o Despite some industrialisation, India was becoming an agricultural colony

o The thrust to industrialisation came from the British because

They had capital

They had experience in setting up industries in Britain

They had state support

o British industrialists were interested in making profits rather than economic growth

of India

o

Parsis, Jews and Americans were also setting industries

o No Indian industrialists because

Neither the merchants nor the craftsmen took the lead in setting industries

While the craftsmen didnt possess capital, the merchants were happywith

trading and money lending activity which was also growing at that time.

o However, some Parsis, Gujaratis, Marwaris, Jains and Chettiars joined the ranks

of industrialists

Industrial Growth in the first half of the 20th century

o Imp events that stimulated industrial growth

1905: Swadeshi Movement

First WW

Second WW

o Great stimulus was given to the production of iron and steel, cotton and woollen

textiles, leather products, jute.

o Tariff protection was given to Indian industries between 1924 and 1939. This led

to growth and Indian industrialists were able to capture the market and eliminate

foreign completion altogether in important fields

o The increase in industrial output between 1939 and 1945 was about 20 percent

o After the WW I, the share of the foreign enterprises in Indiasmajor industries began

to decline.

Causes for the slow growth of private enterprise in Indiasindustrialisationo Inadequacy of entrepreneurial ability

Indian industrialists were short-sighted and cared very little for replacement

and renovation of machinery

Nepotism dictated choice of personnel

High profits by high prices rather than high profits by low margins and

larger sales

o Problem of capital and private enterprise

Scarce capital

Few avenues for the investment of surplus

No government loans Absence of financial institutions

Banking was not highly developed and was more concerned with commerce


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rather than industry

o Private enterprises and the role of government

Lack of support from the government

Discriminatory tariff policy: one way free-trade

Restrictions transfer of capital equipments and machinery from Britain

Almost all machinery was imported

Despite these difficulties, the Indian indigenous business communities continued to grow,

albeit at a slow pace.

Forms and Consequences of Colonial Exploitation

Main forms of colonial exploitation

o Exploitation through trade policies

o Exploitation through export of British Capital to India

o Exploitation through finance capital via the Managing agency system

o Exploitation through the payments for the costs of the British administration

Exploitation through trade policies

o Exp of cultivators to boost indigo export: forced

o

Exp of artisans by compulsory procurement by the Company at low prices: gomastaswere the agents of the Company who used to do this

o Exp through manipulation of export and import duties:

Imports of Indian printed cotton fabrics in England were banned

Heavy import duties on Indian manufactures and very nominal duties on

British manufactures.

Discriminating protection was given (to industries that had to face

competition from some country other than Britain). This was whittled down,

however, by the clause of Imperial Preference under which imports from GB

and exports to GB should enjoy the MFN status.

Exploitation through export of British Capital to Indiao There were three purposes of these investment (in transport and communication)

To build better access systems for exploited Indias naturalresources

To provide a quick means of communication for maintaining law and order

To provide for quicker disbursal of British manufactures throughout the

country and that raw materials could be easily procured

o Fields of FDI

Economic overhead and infrastructure like railways, shippings, port, roads,

communication

For promoting mining of resources

Commercial agriculture Investment in consumer goods industries

Investments made in machine building, engineering industries and chemicals

o Forms of investment

Direct private foreign investment

Sterling loans given to the British Government in India

o Estimates show that foreign capital increased from 365 mn sterling in 1911 to 1000 mn

sterling in 1933.

o British multinationals were the chief instruments of exploitation and it were they

who drained out the wealth of India.

o These investments show that

British were interested in creating economic infrastructure to aid

exploitation and resource drain


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They invested in consumer goods and not in basic and heavy industries to

prevent the development of Indian industries

Ownership and management of these companies lay in British hands

Exploitation through finance capital via the Managing agency system

o Managing agency system: The British merchants who had earlier set up firms acted as

pioneers and promoters in several industries like jute, tea and coal. These persons were

called managing agents

o

It may be described as partnerships of companies formed by a group of individuals

with strong financial resources and business experience

o Functions of managing agents

To float new concerns

Arrange for finance

Act as agents for purchase of raw materials

Act as agents to market the produce

Manage the affairs of the business

o They were important because they supplied finance to India when it was starved of

capital

o

In due course, they started dictating the terms of the industry and business andbecame exploitative and inefficient

o They demanded high percentage of profits. When refused they threatened to

withdraw their finance

Exploitation through payments for the costs of British administration

o British officers occupied high positions and were paid fabulous remunerations.

o These expenditures were paid by India

o They transferred their savings to Britain

o India had to pay interest on Sterling Loans

o India has to pay for the war expedition of the Company and later the Crown

Consequences of the exploitation

India remained primarily an agricultural economy

Handcrafts and industries were ruined

Trade disadvantage developed due to the policy of the British

Economic infrastructure was developed only to meet the colonial interests

Drain of Wealth

The net result of the British policies was poverty and stagnation of the Indian economy

Drain Theory

Dadabhai Naoroji: Poverty in India(1876) He claimed that the drain of wealth and capital from the country which started after 1757

was responsible for absence of development in India.

Drain was done through trade, industry and finance

Two elements of the drain

o That arising from the remittances by European officials of their savings, and fro their

expenditure in England

o Arising from remittance by non-official Europeans

India has to export much more than she imported to meet the requirements of the

economic drain

In 1880 it amounted to 4.14% of Indias nationalincome Consequences of the Drain

o Prevented the process of capital formation in India


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o Through the drained wealth, the British established industrial concerns in India

owned by British nationals

o It acted as a drag on economic development

Inflation in India

this question is very likely to be asked given the present inflationary

trend.

Monetary Policy of India

Topics

1. MP background

2. Evolution of monetary policy in India: Different phases

3. Transmission Mechanism

4. Goals of MP

5. Instruments of MP

6. Determinants of MP

7.Role of RBI: Pre and post-reforms8. MP: pre and post reforms

9. Committees on Monetary Management in India

10.MP and Money Market

11.MP and Fiscal Policy

12.MP and the external sector

13.MP and the banking sector

14.MP and Economic growth

15.MP and Inflation

16.Financial Stability: New Challenge

17.Challenges before monetary policy

18.Criticisms of IndiasMP

Some background information

An important factor that determines the effectiveness of MP is its transmissiona process

through which changes in the policy achieve the objectives of controlling inflation and

achieving growth

MP transmission mechanism describes how MP action affects output and inflation, the final

objectives of MP

Various MP transmission channels

o

Quantum Channel relating to money supply and credito Interest Rate Channelthis has become important in the post reform period

o Exchange Rate Channel

o Asset Price Channel

How these channels function in an economy depends on its stage of development and its

underlying financial structure.

These channels, however, are not mutually exclusive. There could be considerable feedback

and interaction among them.


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Evolution of MP

1935: Proportional Reserve System

1954: Minimum Reserve System

1973-76: Minimum and maximum lending rates for bank loans prescribed

1985: Flexible monetary targeting with feedback

1998: Multiple indicator approach adopted

Functions of RBI

Monetary functions

o

Conduct of monetary policy

o Bank of issue

o Banker to the government

o Bankers Bank and Lender of the LastResort

o Controller of credit

o Custodian of foreign exchange reserves

o Foreign exchange managementcurrent and capital account management

o Oversight of the payment and settlement systems

Non-monetary functions

o Regulation and supervision of the banking and non-banking financial institutions,

including credit information companieso Regulation of money, forex and government securities markets as also certain

financial derivatives


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o Promotional functions: promotion of IFCI, SFC etc

o Developmental role

o Research and statistics

Objective of MP

To catalyse economic growth: by ensuring adequate flow of credit to productive sectors

Price stability

After the financial crisis, achieving Financial Stability has emerged as an important objective.

Exchange rate management can be yet another objective

Tools of MP

General Credit Control (Quantitative Control)

o Bank Rate

o Open Market Operations

o Cash Reserve Ratio

Specific and direct credit control (Qualitative Control)

o Lending margins

o Purpose specific credit ceiling

o Discriminatory interest rates

o Eg: Credit Authorisation Scheme, Credit Monitoring Arrangement.

MP pre-reforms

MP in India was conducted under the monetary targeting framework till 1997-98 with M3 as

an intermediate target. This amounted to regulating money supply consistent with the

expected growth in real income and a projected level of inflation.

During the monetary targeting phase (1985-1998), while M3 growth provided the nominal

anchor, reserve money was used as the operating target and cash reserve ratio (CRR) was used

as the principal operating instrument. Besides CRR, in the pre-reform period prior to 1991,

given the command and control nature of the economy, the Reserve Bank had to resort to

direct instruments like interest rate regulations and selective credit control. These instruments

were used intermittently to neutralize the expansionary impact of large fiscal deficits which

were partly monetised. The administered interest rate regime kept the yield rate of the

government securities artificially low. The demand for them was created through periodic

hikes in the Statutory Liquidity Ratio (SLR) for banks. The task before the Reserve Bank was,

therefore, to develop the financial markets to prepare the ground for indirect operations.

MP post-reform

In the wake of the financial reforms, questions were raised about the appropriateness of this

framework.

Working Group on Money Supply (1998)

o Highlighted that the interest rate channel of transmission mechanism was gaining

importance

On the recommendation of this working group, RBI shifted over to a multiple-indicator

approach from 1998-9

Multiple Indicator Approach: Interest rates or rates of return in different markets (money,

capital and g-sec), along with such data as on currency, credit extended by banks and

financial institutions, fiscal position, trade, capital flows, inflation rate, exchange rate,


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refinancing and transactions in foreign exchange available on high-frequency basis, are

juxtaposed with output data for drawing policy perspectives.

LAF: Another important feature post reform is the increased use of LAF. It has enabled RBI

to modulate short-term liquidity under varied financial market conditions, including large

capital inflows from abroad.

CRR: Reduced 1992-93: market borrowing programme of the government was put through the auction

process

SLR was brought down to its statutory minimum of 25 pc by Oct 1997 and 24 pc in 2010

CRR was brought down from 15 pc of NDTL of banks to 9.5 pc in Nov 1997 which

has stabilised at 6 pc for a long time. Not bound by its statutory limit (lower) of 3 pc

now.

Narsimhan Committee (1998) recommended reforms in the money market

o RBI introduced LAF in 2000 to manage market liquidity on a daily basis and also to

transmit interest rate signals to the market. In the post-reform period, LAF, with

OMO, has emerged as the dominant instrument of MP, though CRR continued to beused as an additional instrument of policy.

o Call money market was transformed into a pure inter-bank market by 2005.

o With the introduction of prudential limits on borrowing and lending by banks in the

call money market, the collateralized money market segments developed rapidly

To absorb the capital inflows in excess of the absorptive capacity of the economy MSS was

introduced in 2004. Interestingly, in the face of reversal of capital flows during the recent

crisis, unwinding of the sterilised liquidity under the MSS helped to ease liquidity conditions.

Increased Micro-finance: To strengthen rural finance RBI has focused on SHGs.

Fiscal Monetary Separation: Automatic monetization of deficit faced out since 1994. Thus

it has separated the monetary policy from the fiscal policy. Changed interest rate structure: Phased deregulation of lending rates in the credit market.

Minimum lending rates had been abolished and lending rates above Rs. 2 lakh were freed. In

2010, the base rate mechanism was adopted. Savings rate was deregulated in 2011

Higher market orientation for banking: the banking sector got more autonomy

and operational flexibility.

Challenges in the post-reform period

A major challenge is the conduct of monetary policy in surplus liquidity conditions.

Increased capital inflows

o

To deal with this, RBI initiated the Market Stabilization Scheme (MSS) in 2004o Under the scheme RBI issues Treasury Bills and dated government securities. The

money generated from sale of these bills is kept in a different account held by the

government and maintained and operated by RBI. This money is not available for

governments expenditure. Thus, liquidity in the market ismopped.

o The operationalisation of the MSS to absorb liquidity of more enduring nature has

considerably reduced the burden of sterilization on the LAF window.

Financial stability is an emerging concern

The ongoing modernisation of the payments system with the introduction of RTGS would

have a significant impact on MP.

The transmission of policy signals tobankslending rates has been rather slow.

Central bank independence


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Criticisms/Limitations

In case of high fiscal deficit, monetary expansion has continued to happen

Limited coverage: The MP covers only commercial banking system and leaves out the non-

bank institutions. This limits the effectiveness of MP

Unorganised money market: Its pretty large and does not come under the control of the RBI.Hence, MP does not affect them.

Predominance of cash transcation (?): In India, still there is

huge dominance of cash in total money supply. It is one of the main obstables in the effective

implementation of MP. Because MP operates on the bank credit rather than cash.

Increase volatility: As MP has adoptged changes in accordance to the changes in the external

sector as well, it could lead to a high amount of volatility.

Evaluation of the changes in MP and Money Market

In response to the reforms, over the years the turnover in various market segments

increased significantly The reforms have also led to improvement in liquidity management operations by the RBI as

is evident from the stability in call money rates, which also helped improve integration of

various money market segments and thereby effective transmission of policy signals

The rule based fiscal policy pursued under the FRBM Act, by easing fiscal

dominance, contributed to overall improvement in monetary management.

With the changing framework of monetary policy in India from monetary targeting to an

augmented multiple indictors approach, the operating targets and processes have also undergone

a change. There has been a shift from quantitative intermediate targets to interest rates, as the

development of financial markets enabled transmission of policy signals through the interest rate

channel. At the same time, availability of multiple instruments such as CRR, OMO includingLAF and MSS has provided necessary flexibility to monetary operations. While monetary policy

formulation is a technical process, it has become more consultative and participative with the

involvement of market participant, academics and experts. The internal process has also been re-

engineered with more technical analysis and market orientation. In order to enhance

transparency in communication the focus has been on dissemination of information and analysis

to the public through the Governorsmonetary policy statements and also through regular

sharing of policy research and macroeconomic and financial information.

The availability of multiple instruments and their flexible use in the implementation of

monetary policy have enabled the RBI to successfully influence the liquidity and interest

rate conditions in the economy.

Changes in MP

Pre-reform Post-reform

Operating Target Reserve Money was used as theoperating target in the monetary

targeting framework until mid-1990s

Multiple Indicator Approach


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MonetaryPolicyInstruments

CRR and SLR was heavily used Reliance on direct instrumentshas been reduced and liquiditymanagement in the system iscarried out through OMOs in the

form of outright purchases of g-secs and daily repo and reverse

repo operations under LAF.MSS also introduced.

Large capital inflows witnessedin recent years have posed amajor challenge in the conductof monetary and exchange ratemanagement.

Phased deregulation of theinterest rates

High SLR and CRR Low SLR and CRR

Money Market

RBI operationalises its monetary policy through its operations in government

securities, foreign exchange and money markets

1985: Money Market reforms begin

1992: Introduction of auction system for government securities

1996: Primary Dealer System initiated

2002: Electronic trading and guaranteed settlement through CCIL for G-Sec starts

2006: RBI expressly empowered to regulate money, forex, G-sec and gold related

securities markets

Role of RBI

Pre-reform Post-reform

Developmental Role: thedevelopmental role hasincreased in view of thechanging structure of theeconomy with a focus onSMEs and financial inclusion

Priority Sector Lending:Introduced from 1974 withpublic sector banks. Extendedto all commercial banks by1992

In the revised guidelines forPSL the thrust is on ensuringadequate flow of bank credit tothose sectors that impact largesegments of the population andweaker sections, and to thesectors which are employmentintensive such as agricultureand small enterprises

Lead Bank Scheme Special Agricultural CreditPlan introduced.

Kisan Credit Card

scheme (1998-99)

Focus on credit flow to micro,

small and medium enterprisesdevelopment

Financial Inclusion


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Monetary Policy: the role ofRBI has changed fromregulating credit and moneyflow directly to using market

mechanisms for achievingpolicy targets. MP framework

has changed to promotefinancial deregulations andmarket development. Role as a

facilitator rather than asprincipal actor.

M3 as an intermediary target Multiple Indicator Approach

Regulation of foreign exchange Management of foreign

exchange

Direct credit control Open Market Operations, MSS,LAF

Rupee convertabilityhighly managed

Full current ac convertabilityand some capital account

convertability

Banker to the government Monetary policy was linked tothe fiscal policy due to

automatic monetisation of thedeficit

Delinking of monetary policyfrom the fiscal policy. From

2006, under FRBM, RBIceased to participate in theprimary market auctions of thecentral governmentssecurities.

As regulator of financial

sector: As regulator of thefinancial sector, RBI has facedthe challenge of regulating theincreasing financial sector inIndia. Credit flows haveincreased. RBI had to makesure that financial institutions

Reduction in SLR

are regulated in a way to protectthe consumers while notimpeding economic growth.

Custodian of FOREX reserves Forex reserves have increaseddrastically. Need to manage it

adequately and avoidinflationary impact

Inflation Direct instruments were used Multiple indicators

Financial Stability Closed economy Increased FDI and FII hasmade financial stability one of

the policy objectives.

Money Market Narsimhan Committee (1998)recommended reforms in themoney market

Refer to the 2006 report on Currency and Finance for further details. Reforms and the banking sector


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Nationalisation of Banks, July 1969

Why? Also, elaborate on the situation in 1969

To extend the reach of banks geographically

To extend reach of banks functionally to priority sectors.

Narsimhan Committee (1991)

Problems with the banking system:Revenue Side

High reserve requirements in form of CRR and SLR

Directed credit programme

o The banks were told to shift from security-oriented credit to purpose-

oriented credit.

Political and Administrative Interference. This led to lower income for banks,

inadequate provisioning for bad debt, locking of credit from more productive uses and

erosion of profitability Subsidizing of credit: Low rate of interest.

Expenditure Side

Phenomenal increase in branch banking led to increased expenditure of the banks.

Rapid increase in the number of staff.

Trade unions contributed to the restrictive practices regarding promotions, transfers,

discipline, work culture etc.

Extension of the coverage of bank credit to priority sectors with higher administrative and

functional costs.

Fiscal Responsibility and Budgetary Management Act, 2003What is the FRBM Act?

The FRBM Act was enacted by Parliament in 2003 to bring in fiscal discipline. It received the

Presidentsassent in August the same year. The United Progressive Alliance (UPA) government had

notified the FRBM Rules in July 2004.

As Parliament is the supreme legislative body, these will bind the present finance minister P

Chidambaram, and also future finance ministers and governments.

How will it help in redeeming the fiscal situation?

The FRBM Rules impose limits on fiscal and revenue deficit. Hence, it will be the duty of the Uniongovernment to stick to the deficit targets.

As per the target, revenue deficit, which is revenue expenditure minus revenue receipts, have to be

reduced to nil in five years beginning 2004-05. Each year, the government is required to reduce the

revenue deficit by 0.5% of the GDP.

The fiscal deficit is required to be reduced to 3% of the GDP by 2008-09.It would mean reduction of

fiscal deficit by 0.3 % of GDP every year.

How are these targets monitored?

The Rules have mid-year targets for fiscal and revenue deficits. The Rules required the government torestrict fiscal and revenue deficit to 45% of budget estimates at the end of September (first half of the

financial year).


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In case of a breach of either of the two limits, the FM will be required to explain to Parliament the

reasons for the breach, the corrective steps, as well as the proposals for funding the additional

deficit.

What is fiscal deficit?

Every government raises resources for funding its expenditure. The major sources for funds are taxesand borrowings. Borrowings could be from the Reserve Bank of India (RBI), from the public by

floating bonds, financial institutions, banks and even foreign institutions. These borrowings

constitute public debt and fiscal deficit is a measure of borrowings by the government in a financial

year.

In budgetary arithmetic, it is total expenditure minus the sum of revenue receipts, recoveries of

loans and other receipts such as proceeds from disinvestment.


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Do economies need a fiscal deficit?

Many economists, including Lord Keynes, had advocated the need for small fiscal deficits to

boost an economy, especially in times of crises. What it means is that government should

raise public investment by investing borrowed funds. This exercise is also called pump-

priming. The basic purpose of the whole exercise is to accelerate the growth of an economy bypublic intervention.

Hence, there is nothing fundamentally wrong with a fiscal deficit, provided the cost of

intervention does not exceed the emanating benefits.

The darker side of the story is that the borrowed funds, which always remain on tap,

have to be repayed. And pending repayment, these loans have to be serviced.

Ideally, the yield on investment on borrowed funds must be higher than the cost of borrowing.

For example, if the government borrows Rs 100 at 10%, it must earn more than 10% on

investment of Rs 100. In that situation, fiscal deficit will not pose any problem.

However, the government spends money on all kinds of projects, including social sector

schemes, where it is impossible to calculate the rate of return at least in monetary terms. So,

one will never know whether the borrowed funds are being invested wisely.

And how grave is the problem of fiscal deficit?

Over the years, public debt has continued to mount and so have interest payments.

According to budget figures (revised estimates for 2003-04) the government borrowed Rs

1,32,103 crore. The interest payment during the year was Rs 1,24,555 crore.

What is alarming is that except for a comparatively small sum of about Rs 7,500 crore, more

than 94% of borrowed funds are being used to pay interest for past loans. This is what is called

the debt trap, where one is compelled to borrow to service past loans.

The other way of looking at the fiscal problem is that more than 66% of government taxes,

totalling Rs 1,87,539 crore in 2003-04 were used to pay interest on past borrowings.

Servicing of loans also erodes the governmentsability to spend money on critical areas

such as health and education and on essential sovereign functions like policing, judiciary

and defence.

The following points are worth notable of FRBM Act.

1)The FRBM Rules impose limits on fiscal and revenue deficit. Hence, it will be the duty of

the Union government to stick to the deficit targets.

2)As per the target, revenue deficit, which is revenue expenditure minus revenue receipts,

have to be reduced to nil in five years beginning 2004-05.

3)The target reduction annually is in Deficits, Government borrowings and debt.

4)A cap on the level of guarantee and total liabilities of the government.

5)Prohibits Government to borrow from RBI(major step)


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6)Placing an assessment of trends in receipts and expenditure before both house of the

parliament on a quarterly basis

7)

Annual presentation in the Parliament , the Frame work Statement, Medium Term FiscalPolicy Statement and Fiscal policy strategy statement.

8) Under exceptional circumstances, Government may be compelled to fall short of the

targets. In case of deviations, the Government would not only be required to take corrective

measures, but the Finance Minister shall also make a statement in both the House of

Parliament.

9) Borrowing from RBI is permitted in exceptional situations like natural calamities.

10)

The need for fiscal discipline , Increase plan expenditure, Reduce the amount ofborrowings is clear, Particularly in the era of Globalization when penalty for

irresponsibility is high.

11)The government can engage in capital expenditure without violating the FRBM Act.

Cons

The act would, in effect, force the government to undertake market borrowings at

relatively higher rates of interest that, in turn, would increase revenue expenditures

The governments may reduce even productive expenditure in order to meet the fiscal

deficit targets. There are a series of substantial programmes like Bharat Nirman, SSA, MNREGA

etc that need high government spending. FRBM should not be used as an excuse to

cut spending on the social sector.

The Parliamentary Standing Committee on the FRBM bill had cautioned in 2000

that the rigidities such as ban on government borrowing from RBI (except for

ways and means advances) serve as a binding constraint on capital expenditures

and development programmes and not on revenue expenditures.

Some economists argue that fiscal discipline and prudence are better achieved by

concerted reforms on the administrative front, including effective decentralisation

rather than by controlling single measures like the fiscal and revenue deficits. Chelliah: Reducing the growth of expenditure and/or raising the rate of growth of

revenue in a mechanical way irrespective of prevalent and emerging economic

conditions might adversely affect the growth rate. Policies need to be calibrated

according to economic trends.

How was it decided that 3% FD is optimal? No economic rule suggests that.

There should be more dynamic sources of resource mobilisation

The focus deserves to be shift in favour of not the size of gross fiscal

deficit but the productive purposes for which government deficits are

incurred.

Increasing social expenditure will call for some pressure on the revenuedeficit of the government which will have to be tolerated.

Fiscal rules could not have been adhered to in the 2009-10 budget in the milieu of


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the global meltdown.

For fiscal responsibility (Rangarajan and Subbarao: 2007)

o There needs to be fiscal correction not just at the centre but also in thestates

o

For sustaining and accelerating growth, achieving the FRBM targets isnecessary, but not sufficient. It must, however, be borne in mind that

sustained growth is an essential prerequisite for meeting the fiscal caps.

o We need to pay attention to achieving the targets not only in quantitative

terms but also with respect to the quality of adjustment.

Plug the inadequacies that have become evident in the Act since it was passed in2003.

Update

Amendment to FRBM Act is being proposed by the finmin

The idea is to have some leeway for counter-cyclical adjustments in case of

economic or political shocks This will mean the Centre will have the leeway to increase its spending and deviate

from deficit targets in times of economic crisis. But in good times, when the

revenues are buoyant, it would have to perform better

The 13th

Finance Commission had also suggested such a cushion and said it can be

used in times of an agrarian crisis, asset price bubble or a global recession

Role of RBI

General Roles

Role in the fiscal system: As the banker and the debt manager of both Central and

State Governments. It also provides temporary support to tide over mismatches intheir receipts and payments in the form of Ways and Means Advances (WMA).

India Reforms Experience

External Sector Reforms

Reforms

o Exchange rate of rupee became market determined from 1993

o 1994: India became current account convertible

o FEMA was enacted in 2000. With this, the objectives of regulation have

been redefined as facilitating trade and payments as well as orderly

development and functioning of foreign exchange market in India.

Effects

o Indias external sector has become moreresilient

o Exports growth rate: -- pc

o Current account deficit an issue

o Strengthening of the capital account

o Accretion of the foreign exchange reserves

o Capital outflows: the current regime of outflows in India is characterized by

liberal but not incentivised framework for corporates to invest in the real

economic outside India, including through the acquisition route.

Financial Sector Reforms

Situation before reforms


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o Financial markets were marked by administered interest rates, quantitative

ceilings, statutory pre-emptions, captive market for government securities,

excessive reliance on central bank financing of fiscal deficit, pegged exchange

rate and current and capital account restrictions.

Reformso Phased reductions in statutory pre-emption like CRR and SLR

o Deregulation of interest rates on deposits and lending, except for a select

segment.

o Diversification of ownership of banking institutions: private shareholding

in public sector banks

o Financial Markets: removal of structural bottlenecks,

introduction/diversification of new players/instruments, free pricing of

financial assets, relaxation of quantitative restrictions, better regulatory

systems, introduction of new technology, improvement in trading

infrastructure, clearing and settlement practices and greater transparency.

Effects

o The banking sector reform combines a comprehensive reorientation of

competition, regulation and ownership in a non-disruptive and cost-effective

manner.

o FDI in the private sector banks is now allowed upto 74 pc

o 100 pc FDI is allowed under the automatic route in NBFCs

o Urban Cooperative Banks suffer from various problems. Several structural,

legislative and regulatory measures have been initiated in recent years for

UCBs with

a view to evolving a policy framework oriented towards revival and healthy

growth of the sector.o Fin mkt: the price discovery in the primary market is more credible than

before and secondary markets have acquired greater depth and liquidity.

o Number of steps (like RTGS) for making the payment systems safe,

secure and efficient.

Financial Inclusion and Customer ServicesA. Initiation of no-frills account These accounts provide basic facilities of deposit and

withdrawal to accountholders makes banking affordable by cutting down on extra frills that areno use for the lower section of the society. These accounts are expected to provide a low-cost

mode to access bank accounts. RBI also eased KYC (Know Your customer) norms for opening

of such accounts.

B. Banking service reaches homes through business correspondents The banking systems havestarted to adopt the business correspondent mechanism to facilitate banking services in those

areas where banks are unable to open brick and mortar branches for cost considerations.Business Correspondents provide affordability and easy accessibility to this unbanked

population. Armed with suitable technology, the business correspondents help in taking thebanks to the doorsteps of rural households.

C. EBT Electronic Benefits Transfer To plug the leakages that are present in transfer ofpayments through the various levels of bureaucracy, government has begun the procedure of

transferring payment directly to accounts of the beneficiaries. This human-less transfer of

payment is expected to provide better benefits and relief to the beneficiaries while reducinggovernments cost of transfer and monitoring. Oncethe benefits starts to accrue to the masses,those who remain unbanked shall start looking to enter the formal financial sector.


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Why Financial Inclusion?

It mobilizes savings that promote economic growth through productive investment.

It promotes financial literacy of the rural population and hence guides them to avoid the

expensive and unreliable financial services.

This helps the weaker sections to channelize their incomes into buying productive resources or

assets.

In the situations of economic crisis, the rural economy can be a support system to stabilize the

financial system. Hence, it helps in ensuring a sustainable financial system.

Prospects, Challenges and Strengths of the economy now

Prospects

o High growth rate

o

Macroeconomic stabilityo Service Sector

Challenges

o While over 60 pc of the workforce is dependent on agriculture, the sector

accounts for 20 pc of the GDP

o Slow pace of poverty reduction

o Volatility in agricultural growth

o Inadequate availability of modern infrastructure

o Regulatory framework and overall investment climate

o For fiscal consolidation the subsidies need to be reduced while making the

existing ones more effective

o

The delivery of essential public services such as education and health to

a large section of the population is a major challenge

o Governance reforms: they are essential to strengthen state capacity and enable

it to perform its core functions

o Good governance can co-exist only when public sector functions

fairly and efficiently, which is achievable by improving and not

undermining it.

Strength

o Increasing human resource. English speakers.

o Demographics: Young country

Indian Public Finance

Value Added Tax

Under the constitution the States have the exclusive power to tax sales and

purchases of goods other than newspapers

There are however defects of sales tax

o It is regressive in nature. Families with low income a larger proportion

of their income as sales tax.

o Has a cascading effecttax is collected at all stages and every time a

commodity is bought or sold

o

Sales tax is easily evaded by the consumers by not asking for receipts. VAT is the tax on the value added to goods in the process of production and

distribution.


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With the implementation of VAT, the origin based Central Sales Tax is phased out.

Introduced from April 1, 2005

Advantages

o Is a neutral tax. Does not have a distortionary effect

o

Imposed on a large number of firms instead of at the final stageo Easier to enforce as tax paid by one firm is reported as a deduction by a

subsequent firm

o Difficult to evade as collection is done at different stages

o Incentive to produce and invest more as producer goods can be easily

excluded under VAT

o Encourages exports since VAT is identifiable and fully rebated on exports

Difficulties in implementing

o For collection of VAT all producers, distributers, traders and everyone in the

chain of production should keep proper account of all their transactions

o Bribing of sales tax officials to escape taxes

o

The government has to simplify VAT procedures for small traders andartisans

Goods and Services Tax The Goods and Service Tax Bill or GST Bill, officially known as The Constitution

(122nd Amendment) Bill, 2014, would be aValue added Tax (VAT) to be implemented

inIndia,from April 2016. GST stands for Goods and Services Tax, and is proposed tobe a comprehensive indirect tax levy on manufacture, sale and consumption of goods aswell as services at the national level. It will replace allindirect taxes levied on goods andservices by the IndianCentral andStategovernments. It is aimed at being comprehensivefor most goods and services

State Finances Borrowing by the State governments is subordinated to prior approval by the

national government

Furthermore, State Governments are not permitted to borrow externally unlike the

centre.

Public Debt

The aggregate stock of public debt of the Centre and States as a percentage of GDP

is high (around 75 pc)

Unique features of public debt in India

o States have no direct exposure to external debt

o

Almost the whole of PD is local currency denominated and held almost

wholly by residents

o The PD of both center and states is actively managed by the RBI ensuring comfort

the financial markets without any undue volatility.

o The g-sec market has developed significantly in recent years

o Contractual savings supplement marketable debt in financing deficits

o Direct monetary financing of primary issues of debt has been discontinued since

April 2006.
http://en.wikipedia.org/wiki/Value_added_Taxhttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Indirect_taxhttp://en.wikipedia.org/wiki/Govt_of_Indiahttp://en.wikipedia.org/wiki/States_of_Indiahttp://en.wikipedia.org/wiki/States_of_Indiahttp://en.wikipedia.org/wiki/Govt_of_Indiahttp://en.wikipedia.org/wiki/Indirect_taxhttp://en.wikipedia.org/wiki/Indiahttp://en.wikipedia.org/wiki/Value_added_Tax

Summary of Indian Economy-Part-I

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