Economic environment – factors
The economic environment consists of microeconomic and macroeconomic factors.
Microeconomic factors
The microeconomic environment refers to things that happen at the individual company or consumer level.
Microeconomic factors do not affect the whole economy. Below are some microeconomic factors that may influence a business:
• Competitors.
• Demand.
• Market size.
• Suppliers.
• Supply.
• How you supply your goods, i.e., the distribution chain. For example, through retail stores, distributors, the Internet, etc.
Macroeconomic factors
The macroeconomic environment, on the other hand, refers to things that affect the entire economy. Macroeconomics is concerned with general or large-scale economic factors, such as:
• Unemployment
• Inflation.
• Interest rates.
• GDP growth. GDP stands for Gross Domestic Product. In other words, is the economy in recession, is it booming, etc.
• Taxes.
• Exchange rates, i.e., how much currencies are worth in relation to one another.
• How much discretionary income consumers have, i.e., income after paying tax, social security, etc.
• Levels of consumer confidence.
• Savings rates.
Business people cannot control their economic environment. However, they can evaluate conditions in the marketplace before deciding whether to proceed with a plan or project.
In this context, the term ‘marketplace ‘means the same as ‘market‘ in its abstract sense.
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Economic environment vs. environmental economics
Do not confuse the term ‘economic environment’ with ‘environmental economics.’ Although they sound similar, their meanings are quite different.
Environmental economics, a sub-field of economics, is all about environmental issues. Since the second half of the last century, environmental economics has become an increasingly popular topic.
Environmental economics looks at the economic effects of local or national environmental policies across the globe. Particular issues include the costs and benefits of alternative environmental policies that deal with water quality, air pollution, and global warming.
Components of Economic Environment
Role of Private and Public sector matters a lot in order to get investment. Because when the investors invest money, they see industry growth and the role of private sectors in the economy.
Rate of growth of GDP, GNP, and Per Capita Income, When the gross domestic product of the economy increases, it brings investment in the economy and show the growth of the economy to the investors.
Transport and Communication System helps to increase the growth of the economy. When the transport system will be good, it will increase the finished goods. When the communication system will effective, it will connect more people and will give them opportunities to do more business.
International Debt also matters in the growth of the economy. if the economy has more international debt, then the investors afraid to invest in the economy and vice-versa
2. Economic Environment refers to those economic factors which have impact on the
working of business. Economic environment is very complex in nature. It is very
dynamic.
ELEMENTS OF ECONOMIC ENVIRONMENT
Economic Conditions - includes income level, distribution of income, demand and
supply trends etc. If the economy is in boom conditions, it positively affect demand
and market share. On the other hand if the economy is in depression, it will have
negative effect on the business.
Economic Policies - Economic policies are framed by government. These policies
establish relationship between business and government. The effect of these policies
may be favourable or Unfavourable
Economic System - Different economic system prevail in different countries. These
system affect the business. The economic system includes capitalism, socialism and
mixed economy
3. SILENT FEATURES OF ECONOMIC ENVIRONMENT.
Dynamic
Factors go on changing, according to country,
time period and circumstances
Effect of various factors
Mutually interrelated human factors are
controllable, but nature is not
Related with economic activities Banking, business, transport, communications,...
Affected with non economic factors also
Infrastructure Availability of communication, transport....
Role of government Government policies
Economic disparities
Inequal distribution leads to corruption, robbery,
black marketing.....
Public morality Ethical values, high moral standards
Effect of economic system Capitalism, socialist, mixed
Availability of capital
Availability of sufficient capital leads to optimum
use of human and natural resources
4. Economic growth –
increase over time in a country’s real output of goods and services – or more
appropriately product per capita
Economic development –
progressive changes in the socio-economic structure of a country. Development is
measured from the perspective of progressive reduction in unemployment, poverty and
inequalities
Economic underdevelopment –
it is characterised by a low level of per capita income. It is the coexistence of unutilized
or underutilized manpower and of unexploited natural resources.
5. COMMON CHARACTERISTICS OF UNDERDEVELOPED ECONOMIES:
• Low GNP per capita
• Scarcity of capital
• Rapid population growth and high dependency burden
• Low levels of productivity
• Technological backwardness
• High levels of unemployment and under employment
• Lower level of human well-being
• Wide income inequalities
• High incidence of poverty
• Agrarian economy
• Lower participation in foreign trade
• Dependence
7. Economics – the social science that analyzes the production, distribution, and
consumption of goods and services
Economic system - a social organism through which people make their living.
It is constituted of all those individuals, households, farms, firms, factories, banks and
government, which act and interact to produce and consume goods and services.
Economic system defined:
The structure that guides production, allocation of economic inputs, distribution
of economic outputs, and consumption of goods and services in an economy.
8. Malawi's financial system is small even by regional standards and bank
dominated but with a variety of institutions and markets. The Malawian
financial system consists of nine banks, two discount houses, one leasing
company, eight insurance companies, four development finance institutions
(DFIs), a young-but growing-microfinance industry, and a nascent capital
market.
Only 10 percent of Malawi's population has access to formal financial services,
reflecting the high incidence of poverty, high degree of informality, and a high
proportion of the population in rural areas. Malawi's financial system offers a
variety of conventional financial services, concentrated on the short-term end of
the yield curve, but with an increasing focus on down-market products.
Significant ownership linkages within the financial system and with non-
financial corporations pose challenges for governance and related party
transactions.
9. TYPES OF ECONOMIC SYSTEM:
• CAPITALISM
• SOCIALISM
• COMMUNISM
• MIXED ECONOMIC SYSTEM
10. • One of the modern economic system, that appeared after world war II
• An economic system in which factories, equipment, or other means of
production are privately owned rather than controlled by the government.
• Example – United State of America
Laissez-Faire (French for “Leave Alone”)
• The idea that the free market, through supply and demand, will regulate itself if
government does not interfere
• Government should be “hands off” with big business
• Highest form of capitalism
• Ex. Rise of Industry in America in 19th Century
CAPITALISM
11. Advantages:
• Private ownership
• Free enterprise
• Free market
• Competitive market
• Innovation and creativity
• Unlimited earning wealth
Disadvantages:
• Unequal distribution of wealth
• Monopoly
• Oligarchy
Relationship between capitalist political system and business:
The capitalist political system is pro-private businesses. Efficiency is rewarded in the market.
Businesses flourish through efficiency, innovation and serving, the consumers. Businesses are
directed by market mechanism, least influenced by governmental factors.
12. Welfare capitalism:
Capitalism has certain limitations such as neglect of certain business not yielding good
profits or those involving greater risk individual ‘good’.
So, some state role is needed.
Here in the government intervenes and fills up the gaps to ensure maximum social
advantage.
Government supplements and does not substitute private entrepreneurships.
The characters of capitalism are applicable to this system in total, subject to the above
referred to variation.
Government relationship with the business takes the same pattern as in the same
capitalism, except the government intervenes in a small way to ensure social welfare of
people at large.
13. Karl Marx – “workers of the world unite”
A political and economic theory that advocates ownership of the means of
production, such as factories and farms, by the people rather than by capitalists
and land owners.
Power belongs to the working class
This system imposes the duty of work on everyone, because ‘who does not work
does not eat’
Ex – China, Yugoslavia (parts of U.S.S.R.)
Note: In socialist system, production is done according to plans developed and
supervised by the state, and the output is distributed according to individual
contribution
SOCIALISM
14. • An economic or political system in which the state or the community owns all
property and the means of production, and all citizens share the wealth.
• Creates a classless society (theoretically)
• Ex – Vietnam, Cuba, U.S.S.R.
Advantages:
• Abolition of class divisions in the society
• Abolition of exploitation of man by man
Disadvantages:
• Individual will not be allowed to have more than they barely need
• The system will deny people the initiative, responsibility and the imaginative
power and self interest.
COMMUNISM
15.
16. MIXED ECONOMY:
“Mixed economy is that economy in which both government and private individuals
exercise economic control.” –Murad.
“Mixed economy is that economy in which both public and private sectors
cooperate.” - Prof. Samuelson
It is a golden mixture of capitalism and socialism.
Under this system there is freedom of economic activities and government
interferences for the social welfare.
Hence it is a blend of both the economies.
The concept of mixed economy is of recent origin.
17. FEATURES OF MIXED ECONOMY:
• Co-existence of Private and Public Sector
• Personal Freedom
• Private Property is allowed
• Economic Planning
• Price Mechanism and Controlled Price
• Profit Motive and Social Welfare
• Check on Economic Inequalities
• Control of Monopoly Power
18. TYPES OF MIXED ECONOMY:
CAPITALISTIC MIXED ECONOMY:
ownership of various factors of production remains under private control.
Government does not interfere in any manner.
The main responsibility of the government in this system is to ensure rapid
economic growth without allowing concentration of economic power in the few
hands.
19. SOCIALISTIC MIXED ECONOMY:
means of production are in the hands of state.
The forces of demand and supply are used for basic economic decisions.
However, whenever and wherever demand is necessary, government takes actions so
that basic idea of economic growth is not hampered
• Liberal Socialistic Mixed Economy
the government interferes to bring about timely changes in market forces so that
the pace of rapid economic growth remains uninterrupted.
• Centralised Socialistic Mixed Economy
major decisions are taken by central agency according to the needs of the economy.
20. Merits of Mixed Economy
• Encouragement to Private Sector
• Freedom
• Optimum Use of Resources
• Advantages of Economic Planning
• Lesser Economic Inequalities
• Competition and Efficient Production
• Social Welfare
• Economic Development
Demerits of Mixed Economy
• Un-stability
• Ineffectiveness of Sectors
• Inefficient Planning
• Lack of Efficiency
• Delay in Economic Decisions
• More Wastages
• Corruption and Black Marketing
• Threat of Nationalism
21. MIXED ECONOMY:
In India we adopt the ‘golden mean’ of capitalism and socialism.
Side by side, public and private ownership exist.
This system is known as mixed economy.
The features of capitalism and socialism are jointly present in this system.
Private initiative freedom of enterprise, consumer sovereignty, individual savings
and investment profit orientation and market mechanism are all there. But not
entirely free of government control. State initiative, state enterprise, state
investment, social objective like equal distribution, balanced development of a
regions, concessions and privileges for the less privileged reservations for the
benefit of weaker sections, etc. are found
22. Industrial Policy Trade Policy
Foreign Exchange Policy Foreign Investment and
technology Policy
Fiscal Policy Monetary Policy
ECONOMIC
POLICY
• Low Income Economies
• High Income Economies
• Middle Income Economies
• Developed Economies / countries
• Under - Developed Economies / countries
• Developing Economies / countries
23. Economic reforms or new economic policy refers to various policy measures and
changes introduced since 1991.
The common objective of all these measures is to improve productivity and efficiency
of the economy by creating a more competitive environment therein.
The reforms can be classified into two broad categories:
• Liberalisation, privatisation and globalisation measures.
• Macroeconomic reforms and structural adjustments.
24. Need for Economic Reforms or New Economic Policy
• Increase in Fiscal Deficit
• Increase in Adverse Balance of Payments:
• Gulf Crisis
• Fall in Foreign Exchange Reserves
• Rise in prices
• Poor Performance of Public Sector Undertakings (PSU)
25. LIBERALISATION
Liberalisation of the economy means to free it from direct or physical controls imposed by the
government
Prior to 1991, government had imposed several types of controls on Indian economy,
e.g.,
industrial licensing system;
price control or financial control on goods,
Import license,
foreign exchange control,
restrictions on investment by big business houses, etc.
These had dampened the enthusiasm of the entrepreneurs to establish new industries giving
rise to corruption, undue delays and inefficiency.
Economic reforms were based on the assumption that market forces could guide the economy in a
more effective manner than government control.
26. MEASURES TAKEN FOR LIBERALISATION
• Abolition of Industrial Licensing and Registration
(implementation of New Industrial Policy) (de-licensing)
• Concession from Monopolies Act (abolishing MRTP Act)
• Freedom for Expansion and Production to Industries
• Increase in the Investment Limit of the Small Industries
• Freedom to import Capital Goods
27. PRIVATISATION
Transfer of ownership and/or management of an enterprise from the public sector to the
private sector.
It also means the withdrawal of the state from an industry or sector, partially or fully.
Another dimension of privatization is opening up of an industry that has been reserved for the public
sector to the private sector.
• Privatization may be defined as the transfer of the public sector activities and functions to the
private sector.
• This applies to the commercial and industrial enterprises which are often owned, managed and
implemented by the public sector which could otherwise be operated by the private sector.
• Privatization is premised on the assumption of the superiority of market forces over administrative
directives in governing economic activity to achieve efficiency
28. OBJECTIVES:
• To improve the performance of PSUs (Public Sector Undertakings) so as to lessen the financial
burden on taxpayers.
• To increase the size and dynamism of the private sector, distributing ownership more widely
in the population at large.
• To encourage and to facilitate private sector investments, from both domestic and foreign
sources.
• To generate revenues for the state.
• To reduce the administrative burden on the state.
• Launching and sustaining the transformation of the economy from a command to a market
model.
29. IMPORTANT WAYS OF PRIVATIZATION ARE:
• Divestiture or privatization of ownership, through the sales of equity.
• Denationalization or reprivatisation.
• Contracting - under which government contracts out services to other organizations that
produce and deliver them.
• Franchising- authorizing the delivery of certain services in designated geographical areas- is
common in utilities and urban transport.
• Government withdrawing from the provision of certain goods and services leaving then wholly
or partly to the private sector.
• Privatization of management, using leases and management contracts
• Liquidation, which can be either formal or informal. Formal liquidation involves the closure of an
enterprise and the sale of its assets. Under informal liquidation, a firm retains its legal status even
though some or all of its operations may be suspended.
30. BENEFITS OF PRIVATIZATION
• It reduces the fiscal burden of the state by relieving it of the losses of the SOEs
(State owned Enterprise) and reducing the size of the bureaucracy.
• Privatization of SOEs enables the government to mop up funds.
• Privatization helps the state to trim the size of the administrative machinery.
• It enables the government to concentrate more on the essential state functions.
• Privatization helps accelerate the pace of economic developments as it attracts more
resources from the private sector for development.
• It may result in better management of the enterprises.
• Privatization may also encourage entrepreneurship.
31. ARGUMENT AGAINST PRIVATIZATION IS AS FOLLOWS:
• The public sector has been developed with certain noble objectives and privatization means
discarding them in one stroke.
• Privatization will encourage concentration of economic power to the common detriment.
• If privatization results in the substitution of the monopoly power of the public enterprises by the
monopoly power of private enterprises it will be very dangerous.
• Privatization many a time results in the acquisition of national firms by foreign firms.
• Privatization of profitable enterprises, including potentially profitable, means foregoing future
streams of income for the government.
• Privatization of strategic and vital sectors is against national interests.
32. • There are well managed and ill-managed firms both in the public and private sectors. It is not
sector that matters, but the quality and commitment of the management.
• The capital markets of developing countries are not developed enough for efficiently carrying
out privatization.
• Privatization in many instances is a half-hearted measure and therefore it is not properly
carried out. As a result that the expected results may not be achieved.
• In many instance, there are vested interested behind privatization and it amounts deceiving
the nation. In many countries privatization often has been a “garage sale” to favored individuals
and groups.
33. TYPES OF PRIVATIZATION:
1. By section – namely government sectors which are service based that had been transferred to
the private sector.
2. By Choice- mainly government sectors that are partly privatized.
3. Trade Oriented- whereby the government still holds the company but the capital concepts are
privatized.
4. By Contract- whereby the private sector would prepare the services for the government.
5. By Mortgage- where by the facilities provided by the government would by rent by the private
sector.
34. GLOBALISATION
process by which local, regional or national phenomena become integrated on a global scale.
India’s economic integration with the rest of the world was very limited because of the
restrictive economic policies followed until 1991.
Globalization may be defined as
“ the growing economic interdependence of countries worldwide through increasing volume and
variety of cross border transactions in goods and services and of international capital flows, and
also through the more rapid and widespread diffusion of technology”.
35. Globalization may be considered at two levels:
• at the macro level (i.e., globalization of the world economy) and
• at the micro level (i.e., globalization of the business and the firm).
Globalization of the world economy is achieved, quite obviously, by globalizing the
national economies. Globalization of the economies and globalization of business are
very much interdependent.
36. REASONS FOR GLOBALISATION
• The rapid shrinking of time and distance across the globe due to faster communication, speedier
transportation, growing financial flows and rapid technological changes.
• The domestic markets are no longer adequate rich. It is necessary to search of international
markets and to set up overseas production facilities.
• Companies may choose for going international to find political stability, which is relatively good in
other countries.
• To get technology and managerial know-how.
• Companies often set up overseas plants to reduce high transportation costs.
• Some companies set up plants overseas so as to be close to their raw materials supply and to the
markets for their finished products.
• Other developments also contribute to the increasing international of business.
• The creation of the World Trade Organization (WTO) is stimulating increased cross-border trade.
37. Fiscal reforms mean increasing the revenue receipts and reducing the public expenditure of the
government in a manner that production and economic welfare are not adversely affected.
Its main objective was to reduce fiscal deficit
• control over public expenditure,
• increase in taxes (direct taxes refroms),
• sale of share of public sector enterprise and
• increased price of public sector products
Banking Sector Reforms :The recommendations of the Narasimham Committee formed the basis
of the banking sector reforms.
The government carried out a phased reduction of Statutory Liquidity Ratio (SLR) and permitted
a measure of freedom and flexibility to the banks in their operations.
The government also went in for partial disinvestment of its equity in the nationalised banks.
It also cleared the way for the setting up of a new private sector banks I the country.
38. Capital Market Reforms
• Setting up of Securities and Exchange Board of India (SEBI)
• Abolition of the office of the Controller of Capital Issues (CCI) in 1992, which means that the
pricing of new issues on the capital market will not be bureaucratically dictated
• Launching of Over the Counter Exchange Of India (OTCEI)
• Introduction of Screen-based System
• introduction of electronic delivery of securities facilitated by depositories
• Shifting to rolling settlement
Insurance Sector Reforms
The Insurance Regulatory and Development Authority (IRDA) Act was passed by parliament in
1999
entry of private sector, including foreign private sector, into the insurance business, which had
been a government monopoly for decades
39. MAIN OBJECTIVES
• To maintain a sustained growth in productivity
• To enhance gainful employment
• To prevent undue concentration of economic power
• To achieve optimal utilization of human resources
• To attain international competitiveness and
• To transform India into a major partner and player in the global arena
40. Pre vs. Post 1991 Policy
Distinctive Objectives of New Industrial Policy (NIP), 1991: NIP had two distinctive objectives
compared to the earlier industrial policies:
i) Redefinition of Concept of Self-Reliance:
Since 1956 till 1991, India had always emphasized on Import Substitution Industrialization
(ISI) strategy to achieve economic-self reliance.
Economic self-reliance meant indigenous development of production capabilities and
producing indigenously all industrial goods, which the country would demand rather
than importing from outside.
ii) International Competitiveness:
NIP emphasized the need to develop indigenous capabilities in technology and manufacturing to
world standards.
For the first time, NIP explicitly underlined the need for domestic industry to achieve
international competitiveness.
41. The important elements of NIP can be classified as follows:
1. Public sector de-reservation and privatization of public sector through disinvestment
2. Industrial Delicensing;
3. Amendments of Monopolies and Restrictive Trade Practices (MRTP) Act, 1969;
4. Liberalised Foreign Investment Policy;
5. Foreign Technology Agreements (FTA);
6. Dilution of protection to SSI and emphasis on competitiveness enhancement
42. 1. Public Sector De-Reservation and Privatization through Dis-Investment:
Till 1991, Public Sector was assigned a pre-eminent position in Indian Industry to enable it to
achieve “commanding heights of the economy” under the Industrial Policy Resolution (IPR),
1956.
Accordingly, areas of strategic importance and core sectors were exclusively reserved for
public sector enterprises.
Public enterprises were accorded preference even in areas where private investments were
possible.
Since 1991, the public sector policy consists of:
(i) Reduction in the number of industries reserved for public sector:
(ii) Implementation of Memorandum of Understanding (MOU )
(iii) Referral to BIFR (Board for Industrial and Financial Reconstruction) (sick PSU)
(iv) Manpower Rationalization (VRS scheme for surplus manpower)
(v) Private Equity Participation
(vi) Disinvestment and Privatization:
43. 2. Industrial Delicensing:
The removal of licensing requirements for industries, domestic as well as foreign, commonly
known as “de-licensing of industries” is another important feature of NIP.
Till the 1990s, licensing was compulsory for almost every industry, which was not reserved for the
public sector.
This licensing system was applicable to all industrial enterprises having investment in fixed assets
(which include land, buildings, plant & machinery) above a certain limit.
With progressive liberalization and deregulation of the economy, industrial license is required in
very few cases.
Industrial licenses are regulated under the Industries (Development and Regulation) Act 1951.
44. 3. Amendment of Monopolies and Restrictive Trade Practices (MRTP) Act, 1969:
An MRTP firm was mainly defined in terms of asset size.
An MRTP company had to obtain prior approval of the government for setting up a new enterprise
as well as for expansion. However, MRTP Act was applicable only to private sector companies.
The asset restriction and market share for defining an MRTP firm has been done away with.
MRTP Act is now applicable to both private and public sector enterprises and financial
institutions.
Today only restrictive trade practices of companies are monitored and controlled.
The MRTP act has been replaced by the Competition Act, 2002.
This law aims at upholding competition in the Indian market.
The competition commission has been established in 2003 which mainly control the practice that
have an adverse impact on competition
45. 4. Liberalized Foreign Investment Policy:
India’s earlier industrial policies welcomed FDI but emphasized that ownership and control of all
enterprises involving foreign equity should be in Indian hands.
The Balance of Payments (BoP) difficulties in the mid 1960s forced the country to adopt a more
restrictive approach towards FDI through the setting up of a Foreign Investment Board, which
classified industries into two groups: banned and favored for foreign technical collaboration and
FDI.
The number of industries for foreign investment was steadily narrowed down and by 1973 there
were only 19 industries where FDI was permitted (Kucchal, 1983).
The enactment of FERA, 1973 marked the beginning of the most restrictive phase of India’s foreign
investment policy. The NIP radically reformed foreign investment policy to attract foreign
investment. The important foreign investment policy measures are as follows:
46. 5. Foreign Technology Agreement
The automatic approvals for technology agreement are allowed to industries within specified
parameters.
Indian companies are free to negotiate the terms of technology transfer with their foreign
counterparts according to their own commercial judgment.
47. 6. Dilution of Protection to Small Scale Industries (SSI) and Emphasis on Competitiveness:
SSIs enjoyed a unique status in Indian economy due to its diversified presence across the country
and thereby utilizing resources and skills, which would have otherwise remained unutilized.
Due to their potential to generate large-scale employment, produce consumer goods of mass
consumption, alleviate regional disparities, etc., industrial policies protected the sector for its
growth.
48. IMPACT OF INDUSTRIAL POLICY, 1991
• The all-round changes introduced in the industrial policy framework have given a new
direction to the future industrialization of the country.
• There are encouraging trends on diverse fronts.
• The industrial structure is much more balanced.
• The impact of industrial reforms is reflected in multiple increases in investment envisaged,
both domestic and foreign.
• There has been dramatic increase in FDI since 1991.
• The capital goods have grown at an accelerated pace, over a high base attained in the
previous years, which augurs well for the required industrial capacity addition.
50. Some definitions of monetary policy
Johnson : “Monetary policy is the policy employing central bank’s control of the supply of money as
an instrument for achieving the objectives of general economic policy.”
G.K. Shaw : “Any conscious action undertaken by the monetary authorities to change the quantity,
availability or cost of money is monetary policy.”
Monetary policy refers to the use of monetary instruments under the control of the central bank
to regulate magnitudes such as interest rates, money supply and availability of credit with a
view to achieving the ultimate objective of economic policy.
• Monetary policy refers to the policy of the central bank with regard to the use of monetary
instruments under its control to achieve the goals specified in the Act.
• The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy.
This responsibility is explicitly mandated under the Reserve Bank of India Act, 1934.
51. The Monetary and Credit Policy is the policy statement, traditionally announced twice a year,
through which the Reserve Bank of India seeks to ensure price stability for the economy.
These factors include - money supply, interest rates and the inflation. In banking and economic
terms money supply is referred to as M3 - which indicates the level (stock) of legal currency in the
economy.
Besides, the RBI also announces norms for the banking and financial sector and the institutions
which are governed by it.
52. OBJECTIVES OF THE MONETARY POLICY
• Price Stability
• Controlled Expansion Of Bank Credit
• Promotion of Fixed Investment
• Restriction of Inventories and stocks
• To Promote Efficiency
• Reducing the Rigidity
• Economic growth
• Exchange rate stability
53. INSTRUMENTS OF MONETARY POLICY
Bank Rate of Interest
Cash Reserve Ratio
Statutory Liquidity Ratio
Open market Operations
Margin Requirements
Deficit Financing
Issue of New Currency
Credit Control
54. BANK RATE OF INTEREST
It is the interest rate which is fixed by the RBI to control the lending capacity of Commercial
banks.
During Inflation, RBI increases the bank rate of interest due to which borrowing power of
commercial banks reduces which thereby reduces the supply of money or credit in the economy.
When the prices are declining bank rate is reduced and the borrowers can avail funds at low
interest rates. The bank rate is reduced when there is depression in the prices. Central bank
lowers the lending rates and the commercial banks can borrow at cheap rates.
Ultimately borrowers and businessmen are motivated to borrow more. This leads to increase
in investment
55. CASH RESERVE RATIO
CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which banks have to
keep/maintain with the RBI.
During Inflation RBI increases the CRR due to which commercial banks have to keep a greater
portion of their deposits with the RBI . This serves two purposes.
• It ensures that a portion of bank deposits is totally risk-free and
• secondly it enables that RBI control liquidity in the system, and thereby, inflation.
STATUTORY LIQUIDITY RATIO
Banks are required to invest a portion of their deposits in government securities as a part of their
statutory liquidity ratio (SLR) requirements .
If SLR increases the lending capacity of commercial banks decreases thereby regulating the supply of
money in the economy.
56. OPEN MARKET OPERATIONS
It refers to the buying and selling of Govt. securities in the open market.
During inflation RBI sells securities in the open market which leads to transfer of money to RBI.
The purchase and sale of securities by the central bank in the money market is known as open
market operations. The securities are sold by the central bank, when there is an increase in the
prices and a control is required. The commercial banks are not in a position to lend more to
borrowers and business community because their reserves are reduced. As a result price
rise is checked due to discouraged investment.
In the same way when recession starts in the economy, the securities are purchased by the
central bank and there is a rise in the reserves of commercial banks. Price fall is checked,
because commercial banks lend more, which leads to increase in investments, output,
employment, income and demand rise.
Thus money supply is controlled in the economy.
57. MARGIN REQUIREMENTS
During Inflation RBI fixes a high rate of margin on the securities kept by the public for loans.
If the margin increases the commercial banks will give less amount of credit on the
securities kept by the public thereby controlling inflation.
58. RESTRICTIVE VS ACCOMODATING MONETARY POLICY
Restrictive monetary policy:
Seeks to raise the rate of interest, reduce money supply growth rate and restrict the flow of
credit
Generally aimed at fighting inflation
Accommodating monetary policy (liberal)
Meant to fight recession and stimulate demand through credit liberalisation, monetary
expansion and fall in the rate of interest.
59. LIMITATIONS OF MONETARY POLICY
• Huge Budgetary Deficits
• Only Commercial Banks are covered
• Problems in management of Financial Institutions and Banks
• Money Market is unorganised
• Black Money
• Exchange Rate Stability
• Inflation control or price stability
The monetary policy must move in parity with fiscal policy to accelerate on the path of growth and
achieve other objectives of the economy.
61. FISCAL POLICY
Otto Eskstein : “changes in taxes and expenditure which aim at short run goals of full employment
price level and stability”.
Harvey and Johnson : “changes in government expenditure and taxation designed to influence the
pattern and level of activity”.
Fiscal policy is a part of the government that is concerned with raising revenue through taxation
and other means and deciding on the level and pattern of expenditure
It operates though budgets
62. Fiscal policy plays an important role in economic and social setup of a country.
Concerned with the determination of state income and expenditure policy
Fiscal policy consists of policy decisions relating to the entire financial structure of the
government including tax revenue, public expenditure, loans, transfers, debt
management, budgetary deficit……
Attempts to achieve a proper balance among these factors to achieve best possible
results in terms of economic growth
If the revenue exceeds expenditure, then this situation is known as fiscal surplus, whereas if
the expenditure is greater than the revenue, it is known as the fiscal deficit.
63. The main objective of the fiscal policy is to bring stability, reduce unemployment and growth of
the economy.
The instruments used in the Fiscal Policy are the level of taxation & its composition and
expenditure on various projects.
There are two types of fiscal policy, they are:
• Expansionary Fiscal Policy: The policy in which the government minimises taxes and
increase public spending.
• Contractionary Fiscal Policy: The policy in which the government increases taxes and
reduce public expenditure.
64. OBJECTIVES OF FISCAL POLICY
• to mobilize adequate resources for financing various programs and projects adopted for
economic development
• to raise the rate of savings and investment for increasing the rate of capital formation.
• to promote necessary development in the private sector
• to arrange an optimum utilization of resources
• to control the inflationary pressures in economy
• to remove poverty and unemployment
• to attain the growth of public sector for attaining the objective of a socialistic pattern of
society
• to reduce regional disparities
• to reduce the degree of inequality in the distribution of income and wealth
65. ASPECTS OF FISCAL POLICY
• Taxation policy
• Public expenditure policy
• Public debt policy
• Deficit financing policy
66. TAXATION POLICY
Tax revenue = important source of income for the government
Direct taxes & indirect taxes
Objectives:
• mobilization of resources for financing economic developments
• formation of capital by promoting saving and investment through time deposits, investment in
government bonds, insurance ….
• attainment of quality in distribution of income and wealth through progressive direct taxes
• attainment of price stability by adopting an anti-inflationary taxation policy.
67. PUBLIC EXPENDITURE POLICY
Public expenditure :
• Developmental expenditure &
• Non Developmental expenditure
Developmental expenditure : mostly related to development activities i.e. development of
infrastructure, industry, health facilities, educational institutions,….
Non Developmental expenditure : related to maintenance type expenditure including, law and
order and others……
Some of the important features:
• development of infrastructure
• development of public enterprises
• support to private sector
• social welfare and employment programmes
68. DEFICIT FINANCING
Deficit financing is the budgetary situation where expenditure is higher than the revenue.
It is a practice adopted for financing the excess expenditure with outside resources.
The expenditure-revenue gap is financed by either printing of currency or through borrowing.
Thus, it is a method of meeting government deficits through the creation of new money.
The deficit is the gap caused by the excess of government expenditure over its receipts.
According to Indian Planning Commission “The term deficit financing is used to denote the direct
addition to gross national expenditure through budget deficits, whether the deficits are on
current revenue or of capital accounts.”
69. Deficit financing is the budgetary situation where expenditure is higher than the revenue.
It is a practice adopted for financing the excess expenditure with outside resources.
The expenditure revenue gap is financed by either printing of currency or through borrowing
Various indicators of deficit in the budget are:
Budget deficit = total expenditure – total receipts
Revenue deficit = revenue expenditure – revenue receipts
Fiscal Deficit = total expenditure – total receipts except borrowings
Primary Deficit = Fiscal deficit- interest payments
Effective revenue Deficit-= Revenue Deficit – grants for the creation of capital assets
Monetized Fiscal Deficit = that part of the fiscal deficit covered by borrowing from the RBI.
70. METHODS OF DEFICIT FINANCING
• Borrowing from the Central Bank- Raising funds from the RBI in the form of new
currency is one of the important instruments for the government in this regard.
• Issue of New Currency- The government may either borrow from the Central Bank in the
form of new currency or issue new currency itself to increase the money circulation in the
economy.
• Withdrawal of its accumulated cash balances from the RBI
71. OBJECTIVES OF DEFICIT FINANCING
• To finance war- Deficit financing has generally being used as a method of financing war
expenditure. During the time of war, it becomes difficult to mobilize adequate resources; hence,
deficit financing is used as a means of raising funds.
Remedy for depression - In developed countries deficit financing is used as an instrument of
economic policy for removing the conditions of depression. Prof. Keynes has also advocated for
deficit financing as a remedy for depression and unemployment.
• Economic development- The main objective of deficit financing in an under developed country like
India is to promote economic development. The use of deficit financing in fact becomes essential for
financing the development plans.
• For payment of interest - Loan which are taken by the govt. are supposed to be repaid with their
interest for that government needs money deficit financing is an important tool to get the income for
the repayment of loan along with the interest.
• To overcome low tax receipts.
• To overcome the losses of public sector enterprises
• For implementing anti-poverty programmes.
72. ECONOMIC EFFECTS OF DEFICIT FINANCING
Deficit financing has several economic effects which are interrelated in many ways:
• Deficit financing and inflation
• Deficit financing and capital formation and economic development
• Deficit financing and income distribution.
73. INSTRUMENTS OF FISCAL POLICY
1. Reduction of Govt. Expenditure
2. Increase in Taxation
3. Imposition of new Taxes
4. Wage Control
5.Rationing
6. Public Debt
7. Increase in savings
8. Maintaining Surplus Budget
74. HOW IS THE MONETARY POLICY DIFFERENT FROM THE FISCAL POLICY?
• The Monetary Policy regulates the supply of money and the cost and availability of credit in the
economy. It deals with both the lending and borrowing rates of interest for commercial banks.
• The Monetary Policy aims to maintain price stability, full employment and economic growth.
• The Monetary Policy is different from Fiscal Policy as the former brings about a change in the
economy by changing money supply and interest rate, whereas fiscal policy is a broader tool with
the government.
• The Fiscal Policy can be used to overcome recession and control inflation. It may be defined as a
deliberate change in government revenue and expenditure to influence the level of national
output and prices.
75. BASIS FOR
COMPARISON
FISCAL POLICY MONETARY POLICY
Meaning
The tool used by the government in which
it uses its tax revenue and expenditure
policies to affect the economy is known as
Fiscal Policy.
The tool used by the central bank to regulate
the money supply in the economy is known
as Monetary Policy.
Administered by Ministry of Finance Central Bank
Nature The fiscal policy changes every year.
The change in monetary policy depends on
the economic status of the nation.
Related to Government Revenue & Expenditure Banks & Credit Control
Focuses on Economic Growth Economic Stability
Policy instruments Tax rates and government spending Interest rates and credit ratios
Political influence Yes No
76. • Foreign Exchange Reserves
it constitutes foreign currency assets, central bank's holdings and special drawing rights.
It is an important indicator of macroeconomic environment as it indicates country's ability to pay
for imports, discharge its external debt liabilities and stabilizes the exchange rate.
Absence of adequate foreign exchange reserves decreases a country's international credibility and
can destabilize the economy by devaluating the country's currency as wide fluctuations in
exchange rate create uncertainty in foreign trade, encourage speculation and discourage
investment by foreign companies
77. • Foreign Trade
Foreign trade (export and import) indicates the degree of a country's openness or globalization.
The composition of foreign trade reflects the nature of an economy like a high level of foreign trade
indicates economic liberalization, degree of international competitiveness and globalization.
On the other hand its low level indicates a country's inward orientation and poor international
economic relations
78. Consumer Protection Act 2003
This Act provides for the protection of (rights of) consumers and
establishes for this and other purposes the Consumer Protection
Council. The Council, which shall be a body corporate, shall,
among other things: coordinate, monitor and promote the
activities of consumer organizations; create or facilitate the
establishment of conflict resolution mechanisms on consumer
issues; investigate any complaint received regarding consumer
protection, and where appropriate, refer the complaint to a
compete
79. Foundation and history of competition policy
The Malawi competition policy was adopted in 1997, with a focus on business
behaviour that eliminated or reduced competition, including price fixing,
collusive tendering, customer allocation and tied sales, that is, market structures
that lead to the abuse of market power. Where there are economies of scale,
there may be economic benefits arising from a monopoly or oligopoly situation.
2.
The current supporting policy is provided in Malawi Growth and Development
Strategy III 2017–2022, the successor to Strategy I 2006–2010 and Strategy II
2011–2016. During the implementation of the earlier strategies, Malawi recorded
commendable growth rates, but these were neither sustained nor inclusive.
Phase III provides for the development of new competition policies and
legislation and was linked with Malawi National Export Strategy 2013–2018.
Notably, the latter recognized competition policy as one of the essential areas
necessary to allow the cluster on import substitution, among others, to meet its
potential and guideline targets, as outlined in the strategy document.
80. OVERVIEW OF THE NATIONAL PAYMENT SYSTEM IN
MALAWI
The development of the payment system in Malawi has been
influenced to a great extent by the structural reforms that have
been implemented in the financial sector since the early 1980s.
These reforms were initiated by the Malawi Government as part of
the overall structural adjustment programmes the country has
implemented since 1981 with the help of the International
Monetary Fund and the World Bank.
They are aimed at making the whole financial system more
responsive and efficient so that it can adequately support the
development requirements of the country by providing the
required financial resources.
81. The importance of cash in payments processes is reflected in the share
of (M1) in the aggregate money supply which averaged 53% between
1992 and 1996.A number of factors have a limiting effect on the
process of modernisation in Malawi.
Some of these factors are:
– lack of commitment by the individual commercial banks to the
modernisation programmedue to high cost implications;
– low level of computerisation in the banking sector;
– legal and technological shortfalls; and
– differences in corporate strategies among banks.
82. General legal aspects
There is no specific legislation that currently governs the payment
systems in Malawi,but the following legislation is relevant to the payment and
clearing system in the country:
– Reserve Bank of Malawi Act 1989;
– Banking Act 1989;
– Bills of Exchange Act 1967;
– Bank Supervision Act 1989;
– Building Societies Act 1964;
– Capital Markets Development Act 1990.
Editor's Notes
Abolition of Industrial Licensing and Registration: The New Industrial Policy (NIP) is the
first part of the liberalisation measures. Under the NIP, industrial licensing has been greatly
liberalised. All industries, except a few specified ones, have been de-licensed under the NIP
and liberated from the clutches of control in a bid to eliminate the obstacles to industrial
growth. De-licensing of passenger car industry, bulk drugs industry, consumer electronics
industry, etc. became landmarks and several new players entered these industries. Industries
for which licenses are still necessary are: Liquor, b) Cigarette, c) Defence equipment’s, d)
Industrial Explosives, e) Dangerous Chemicals, f) Drugs. Small Scale Industry (SSI) de-
reservation, however, has not made much progress.
Concession from Monopolies Act: according to the provisions of Monopolies and
Restrictive Trade Practices Act (MRTP Act) all those companies having assets worth more
than 100 crore used to be declared MRTP firms and were subjected to several restrictions.
Now the concept of MRTP has been done away with. These firms are now no longer required
to obtain prior approval of the government, at the time of taking investment decisions.
Freedom for Expansion and Production to Industries: as a result of liberalisation policy,
industries have been given the following freedom:
a) Prior to liberalisation under the provisions of old policy at the time of granting license
government used to fix maximum limit of production capacity. No industry could produce
beyond this limit. Now this limit has been removed.
b) Producers are now free to produce any thing on the basis of demand in the market.
Previously, only those goods could be produced which were mentioned in the licence.
Increase in the Investment Limit of the Small Industries: Investment limit of the small
industries has been raised to Rs. 1 crore so as to enable them to introduce modernisation.
Investment limit of tiny industries has also been increased to Rs. 25 lakh.
Freedom to import Capital Goods: under the policy of liberalisation. Indian industries will
be free to buy machines and raw materials from abroad in order to expand and modernise
themselves.
Conditions for Success
• Privatization cannot be sustained unless the political leadership is committed to it,
and unless it reflects a shift in the preferences of the public arising out of
dissatisfaction with the performance of other alternatives.
• Replacement of a government monopoly by a private monopoly may not increase
public welfare-there must a multiplicity of private suppliers. Freedom of entry to
provide goods and services.
• Public services to be provided by the private sector must be specific or have
measurable outcome.
• Lack of specificity makes it more difficult to control services provided by the
private sector. Service delivery by non-governmental organizational or local
governments may be more appropriate under these conditions.
• Consumers should be able to link the benefits they receive from a service to the
costs they pay for it, since they will then shop more wisely for difficult services.
• The importance of educating consumers and disseminating information to the
public is necessary.
• Privately provided services should be less susceptible to fraud than government
services if they are to be effective.
• Equity is an important consideration in the delivery of public services. Broadly
speaking, the benefits of privatization can accrue to the capital owner to the
consumer and to public at large.
STAGES OF GLOBALISATION
First stage
The first stage is the arm’s length service activity of essentially domestic company, which moves into new markets overseas by linking up with local dealers and distributors.
Second stage
In the stage two, the company takes over these activities on its own.
Third stage
In the next stage, the domestic based company begins to carry out its own manufacturing, marketing and sales in the key foreign markets.
Four stage
In the stage four, the company moves to a full insider position in these markets, supported by a complete business system including R & D and engineering. This stage
calls on the managers to replicate in a new environment the hardware, systems and operational approaches that have worked so well at home.
Fifth stage
In the fifth stage, the company moves toward a genuinely global mode of operation.
GLOBALIZATION STRATEGIES
Exporting
Licensing and Franchising
Contract manufacturing
Management contracting
Turnkey contracts
Wholly Owned Manufacturing Facilities
Joint Ventures
Third country location
Mergers and acquisitions
Strategic alliance
Counter trade
It covers rules, regulations, principles, policies, & procedures laid down by government for regulating & controlling industrial undertakings in the country.
prescribes the respective roles of the public, private, joint, cooperative large, medium & small scale sectors for the development of industries.
It incorporates fiscal & monetary policies, tariff policy, labor policy.
It shows the government attitude not only towards external assistance but also toward public & private sectors.
key objective of the economic policy is to achieve self-reliance in all sectors of the economy and to develop socialistic pattern of society.
Pre vs. Post 1991 Policy
1. Distinctive Objectives of New Industrial Policy (NIP), 1991: NIP had two distinctive objectives compared to the earlier industrial policies:
i) Redefinition of Concept of Self-Reliance: NIP redefined the concept of economic self-reliance. Since 1956 till 1991, India had always emphasized on Import Substitution Industrialization (ISI) strategy to achieve economic-self reliance. Economic self-reliance meant indigenous development of production capabilities and producing indigenously all industrial goods, which the country would demand rather than importing from outside. The goal of economic self-reliance necessitated the promotion of ISI strategy. It helped to built up the vast base of capital goods, intermediate goods and basic goods industries over a period of time. NIP redefined economic self-reliance to mean the ability to pay for imports through foreign exchange earnings through exports and not necessarily depending upon the domestic industries.
ii) International Competitiveness: NIP emphasized the need to develop indigenous capabilities in technology and manufacturing to world standards. None of the earlier industrial policies, either explicitly or implicitly, had made reference to international technology and manufacturing capabilities in the context of domestic industrial development (Ministry of Commerce and Industry, 2001). For the first time, NIP explicitly underlined the need for domestic industry to achieve international competitiveness.
1. Public Sector De-Reservation and Privatization through Dis-Investment:
Till 1991, Public Sector was assigned a pre-eminent position in Indian Industry to enable it to achieve “commanding heights of the economy” under the Industrial Policy Resolution (IPR), 1956. Accordingly, areas of strategic importance and core sectors were exclusively reserved for public sector enterprises. Public enterprises were accorded preference even in areas where private investments were possible.
Since 1991, the public sector policy consists of:
(i) Reduction in the number of industries reserved for public sector: Now only two industries (atomic energy and railway transport) are reserved for the Public Sector. They are known as “Annexure I” industries (Ministry of Commerce and Industry, 2001). The essence of government’s Public Sector Undertakings (PSUs) policy since 1991 has been that government should not operate any commercial enterprises. The policy emphasized to bring down government equity in all non-strategic PSUs to 26 percent or lower, restructure or revive potentially viable PSUs, close down PSUs, which cannot be revived and fully protect the interests of workers. Government’s withdrawal from non-core sectors is indicated on considerations of long-term efficient use of capital, growing financial un-viability and the compulsions for these PSUs to operate in an increasingly competitive and market oriented environment (Disinvestment Commission, 1997).
(ii) Implementation of Memorandum of Understanding (MOU): As a part of the measures to improve the performance of public enterprises, more and more of public sector units have been brought under the purview of Memorandum of Understanding (MoU) system. A memorandum of understanding is a performance contract, a freely negotiated document between the Government and a specific public enterprise.
(iii) Referral to BIFR: Many sick public sector units have been referred to the Board for Industrial and Financial Reconstruction (BIFR) for rehabilitation or, where necessary, for winding up.
(iv) Manpower Rationalization: In order to make manpower rationalization Voluntary Retirement Scheme (VRS) has been introduced in a number of PSUs to shed the surplus manpower.
(v) Private Equity Participation: PSUs have been allowed to raise equity finance from the capital market. This has provided market pressure on PSUs to improve their performance.
(vi) Disinvestment and Privatization: Disinvestment and privatization of existing PSUs has been adopted to improve corporate efficiency, financial performance and competition amongst PSUs. It involves transfer of Government holding in PSUs to the private shareholders.
2. Industrial Delicensing:
The removal of licensing requirements for industries, domestic as well as foreign, commonly known as “de-licensing of industries” is another important feature of NIP. Till the 1990s, licensing was compulsory for almost every industry, which was not reserved for the public sector. This licensing system was applicable to all industrial enterprises having investment in fixed assets (which include land, buildings, plant & machinery) above a certain limit. With progressive liberalization and deregulation of the economy, industrial license is required in very few cases. Industrial licenses are regulated under the Industries (Development and Regulation) Act 1951. At present, industrial license is required only for the following:
(i) Industries retained under compulsory licensing (five industries are reserved under this category).
(ii) Manufacture of items reserved for small scale sector by larger units: An industrial undertaking is defined as small scale unit if the capital investment does not exceed Rs. 10 million (approximately $ 222,222). The Government has reserved certain items for exclusive manufacture in the small-scale sector. Non small-scale units can manufacture items reserved for the small-scale sector if they undertake an obligation to export 50 percent of the production after obtaining an industrial license.
(iii) When the proposed location attracts locational restriction: Industrial undertakings to be located within 25 kms of the standard urban area limit of 23 cities having a population of 1 million as per 1991 census require an industrial license.
Thus, excluding these, investors are free to set up a new industrial enterprise, expand an industrial enterprise substantially, change the location of an existing industrial enterprise and manufacture a new product through an already established industrial enterprise. The objective of industrial delicencing would be to enable business enterprises to respond to the fast changing external conditions. Entrepreneurs will be free to make investment decisions on the basis of their own commercial judgment. This will facilitate the technological dynamism and international competitiveness. Further industries will have freedom to take advantage of ‘economies of scale’ as well as ‘economies of scope’ in the current industrial policy environment.
Since 1991 MRTP Act has been restructured and pre-entry restrictions have been removed with regard to prior approval of the government for the establishment of a new undertaking, expansion, amalgamation, merger, take over, and appointment of directors of companies.
3. Amendment of Monopolies and Restrictive Trade Practices (MRTP) Act, 1969: An important objective of India’s earlier industrial policies was to prevent emergence of private monopolies and concentration of economic power in a few individuals. Accordingly, Monopolies and Restrictive Trade Practices (MRTP) Act, 1969 was enacted and MRTP Commission was set up as a permanent body to periodically review industrial ownership, advice the government to prevent concentration of economic power, investigate monopolistic trade practices and inquire into restrictive trade practices, which are prejudicial to public interest. An MRTP firm was mainly defined in terms of asset size. An MRTP company had to obtain prior approval of the government for setting up a new enterprise as well as for expansion. However, MRTP Act was applicable only to private sector companies.
Since 1991 MRTP Act has been restructured and pre-entry restrictions have been removed with regard to prior approval of the government for the establishment of a new undertaking, expansion, amalgamation, merger, take over, and appointment of directors of companies. The asset restriction and market share for defining an MRTP firm has been done away with. MRTP Act is now applicable to both private and public sector enterprises and financial institutions. Today only restrictive trade practices of companies are monitored and controlled. The MRTP act has been replaced by the Competition Act, 2002. This law aims at upholding competition in the Indian market. The competition commission has been established in 2003 which mainly control the practice that have an adverse impact on competition
4. Liberalized Foreign Investment Policy:
India’s earlier industrial policies welcomed FDI but emphasized that ownership and control of all enterprises involving foreign equity should be in Indian hands. The Balance of Payments (BoP) difficulties in the mid 1960s forced the country to adopt a more restrictive approach towards FDI through the setting up of a Foreign Investment Board, which classified industries into two groups: banned and favored for foreign technical collaboration and FDI. The number of industries for foreign investment was steadily narrowed down and by 1973 there were only 19 industries where FDI was permitted (Kucchal, 1983).The enactment of FERA, 1973 marked the beginning of the most restrictive phase of India’s foreign investment policy. The NIP radically reformed foreign investment policy to attract foreign investment. The important foreign investment policy measures are as follows:
i) Repeal of FERA, 1973: FERA, 1973 has been repealed and Foreign Exchange Management Act (FEMA) has come into force with effect from June 2000 (RBI, 2003). Investment and returns can be freely repatriated except where the approval is subject to specific conditions such as lock-in period on original investment, dividend cap, foreign exchange neutrality, etc. as specified in the sector specific policies. The condition of ‘dividend balancing’ was withdrawn for dividends declared. A foreign investor can freely enter, invest and operate industrial enterprises in India,
ii) Dilution of Restrictions on Foreign Direct Investment (FDI): FDI is allowed in all sectors including the services sector except atomic energy and railway transport. FDI in small scale industries is allowed up to 24 percent equity. Use of brand names/trade marks is allowed. Further, FDI up to 100 percent is allowed under the automatic route in all activities/sectors except the following which require prior approval of the Government:-
- Sectors prohibited for FDI; - Activities/items that require an industrial license; - Proposals in which the foreign collaborator has an existing financial/technical
collaboration in India in the same field;- Proposals for acquisitions of shares in an existing Indian company in financial
service sector and where Securities and Exchange Board of India (substantial
acquisition of shares and takeovers) regulations, 1997 is attracted;- All proposals falling outside notified sectoral policy/CAPS under sectors in
which FDI is not permitted.
Thus most of the sectors fall under the automatic route for FDI.
The principal protective measures for SSI comprised:
Demarcating SSI from the rest of industry through a definition under the IDR Act, 1951,
Concessional credit from the banking system,
Fiscal concessions,
Exemption from industrial licensing and labor legislations,
Preferential access to scarce raw materials, both domestic and imported,
Market support from the government through reservation of products for government purchase and price preferences, and
Reservation of products for exclusive manufacturing in SSIs and restrictions on the growth of output and capacity in the large-scale sector for products reserved for SSI manufacturing. These policy measures protected SSIs from both internal and external competition.
Price Stability Price Stability implies promoting economic development with considerable emphasis on price stability. The centre of focus is to facilitate the environment which is favourable to the architecture that enables the developmental projects to run swiftly while also maintaining reasonable price stability.
Controlled Expansion Of Bank Credit One of the important functions of RBI is the controlled expansion of bank credit and money supply with special attention to seasonal requirement for credit without affecting the output.
Promotion of Fixed Investment The aim here is to increase the productivity of investment by restraining non essential fixed investment.
Restriction of Inventories and stocks Overfilling of stocks and products becoming outdated due to excess of stock often results in sickness of the unit. To avoid this problem the central monetary authority carries out this essential function of restricting the inventories. The main objective of this policy is to avoid over-stocking and idle money in the organization.
To Promote Efficiency It is another essential aspect where the central banks pay a lot of attention. It tries to increase the efficiency in the financial system and tries to incorporate structural changes such as deregulating interest rates, ease operational constraints in the credit delivery system, to introduce new money market instruments etc.
Reducing the Rigidity RBI tries to bring about the flexibilities in the operations which provide a considerable autonomy. It encourages more competitive environment and diversification. It maintains its control over financial system whenever and wherever necessary to maintain the discipline and prudence in operations of the financial system.
Economic Growth : - Monetary policy has another important objective i.e. economic growth. The economic growth can be
achieved by making credit availability to be adequate and lowering cost of credit. Economic growth
quickens when credit is available at low interest rate which ultimately stimulates investment.
Exchange Rate Stability - Fixed exchange rate system is followed by India till 1991 and with permission of IMF, India devalued
the rupee rarely. Since 1991 there is volatility in the exchange rate of rupee due to globalization and
floating exchange rate. Fluctuations in rupee exchange rate are due to capital outflows and inflows
and alterations in foreign exchange demand and supply which crop up due to imports and exports. So
as to ensure stability in the foreign exchange rate Reserve Bank have to take suitable monetary
measures to prevent large appreciation and depreciation of foreign exchange rate.
The objectives are to maintain price stability and ensure adequate flow of credit to the productive sectors of the economy.
Stability for the national currency (after looking at prevailing economic conditions), growth in employment and income are also looked into.
The monetary policy affects the real sector through long and variable periods while the financial markets are also impacted through short-term implications.
Bank Rate Policy The bank rate, also known as the discount rate, is the rate of interest charged by the RBI for providing funds or loans to the banking system. This banking system involves commercial and co-operative banks, Industrial Development Bank of India, IFC, EXIM Bank, and other approved financial institutes. Funds are provided either through lending directly or discounting or buying money market instruments like commercial bills and treasury bills. Increase in Bank Rate increases the cost of borrowing by commercial banks which results in the reduction in credit volume to the banks and hence declines the supply of money. Increase in the bank rate is the symbol of tightening of RBI monetary policy.
Cash Reserve RatioCash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves or balances. Higher the CRR with the RBI lower will be the liquidity in the system and vice versa. RBI is empowered to vary CRR between 15 percent and 3 percent. But as per the suggestion by the Narsimham committee Report the CRR was reduced from 15% in the 1990 to 5 percent in 2002.
Statutory Liquidity RatioEvery financial institution has to maintain a certain quantity of liquid assets with themselves at any point of time of their total time and demand liabilities. These assets have to be kept in non cash form such as G-secs precious metals, approved securities like bonds etc. The ratio of the liquid assets to time and demand assets is termed as the Statutory liquidity ratio.There was a reduction of SLR from 38.5% to 25% because of the suggestion by Narsimham Committee.
Open Market OperationsAn open market operation is an instrument of monetary policy which involves buying or selling of government securities from or to the public and banks. This mechanism influences the reserve position of the banks, yield on government securities and cost of bank credit. The RBI sells government securities to control the flow of credit and buys government securities to increase credit flow. Open market operation makes bank rate policy effective and maintains stability in government securities market.
Credit CeilingIn this operation RBI issues prior information or direction that loans to the commercial banks will be given up to a certain limit. In this case commercial bank will be tight in advancing loans to the public. They will allocate loans to limited sectors. Few examples of ceiling are agriculture sector advances, priority sector lending.
LIMITATIONS OF MONETARY POLICY
8.1 Huge Budgetary Deficits
To control inflation and balance the money supply in the market best efforts are made by Reserve
Bank of India but monetary policy has been unproductive due to budgetary deficits Of the central
government.
8.2 Only Commercial Banks are covered
RBI can control the inflationary pressure caused by banking finance only because it has control on
commercial banks and have no control on other factors which can cause inflation like goods scarcity
and deficit financing.
8.3 Problems in management of Financial Institutions and Banks
Inflation can be controlled by monetary policy and overall development can be achieved only when
there is dedicated and efficient management of banks and financial institutions.
8.4 Money Market is unorganised
There is an unorganized money market present in the Indian financial system over which RBI has no
control .Hence monetary policy turn out to be less effectual
8.5 Black Money
Black money generation is a bigger problem of the Indian economy which is not controllable by RBI.
Hence total money supply in the economy is beyond the sphere of RBI and monetary policy.
Making credit availability to be adequate and lowering cost of credit. Economic growth quickens
when credit is available at low interest rate which ultimately stimulates investment.
8.6 Exchange Rate Stability
Fixed exchange rate system is followed by India till 1991 and with permission of IMF, India devalued
the rupee rarely. Since 1991 there is volatility in the exchange rate of rupee due to globalization and
floating exchange rate. Fluctuations in rupee exchange rate are due to capital outflows and inflows
and alterations in foreign exchange demand and supply which crop up due to imports and exports. So
as to ensure stability in the foreign exchange rate Reserve Bank have to take suitable monetary
measures to prevent large appreciation and depreciation of foreign exchange rate.
8.7 Inflation control or price stability
Monetary policy has the major objective to control inflation or maintenance of price stability.
However price stability does not mean totally no changes in the prices. In a developing country like
India certain price level changes or inflation is quiet expected. Although there may be an adverse
effect of the high degree of inflation on the economy. Firstly the cost of living of the people is raised
by inflation. Secondly, exports are discouraged because inflation makes them costly and people are
forced to import goods because of high prices in domestic markets. Hence there is an adverse effect
on balance of payments due to inflation. Thirdly due to high inflation money value quickly falls and
people have less motivation to save .Ultimately investments are reduced which leads to lower
economic growth. Fourthly people are encouraged to invest in other assets like real estate, jewellery
and gold etc.
Deficit Financing and Inflation: It is said that deficit financing is
inherently inflationary. Since deficit financing raises aggregate
expenditure and, hence, increases aggregate demand, the danger of
inflation looms large. This is particularly true when deficit financing is
made for the persecution of war. This method of financing during wartime
is totally unproductive since it neither adds to society’s stock of wealth
nor enables a society to enlarge its production capacity. The end result is
hyperinflation. On the contrary, resources mobilized through deficit
financing get diverted from civil to military production, thereby leading to
a shortage of consumer goods. Anyway, additional money thus created
fuels the inflationary fire.
However, whether deficit financing is inflationary or not depends on
the nature of deficit financing. Being unproductive in character, war
expenditure made through deficit financing is definitely inflationary. But
if a developmental expenditure is made, deficit financing may not be
inflationary although it results in an increase in money supply. To quote
an expert view: “Deficit financing, undertaken for the purpose of building
up useful capital during a short period of time, is likely to improve
productivity and ultimately increase the elasticity of supply curves.” And
the increase in productivity can act as an antidote against price inflation.
In other words, inflation arising out of inflation is temporary in nature.
o Deficit Financing and Capital Formation and Economic
Development: The technique of deficit financing may be used to promote
economic development in several ways. Nobody denies the role of deficit
financing in garnering resources required for economic development,
though the method is an inflationary one. Economic development largely
depends on capital formation. The basic source of capital formation is
savings. But, LDCs are characterized by low saving-income ratio. In these
low-saving countries, deficit finance- led inflation becomes an important
source of capital accumulation. During inflation; producers are largely
benefited compared to the poor fixed-income earners. Saving propensities
of the former are considerably higher. As a result, aggregate savings of the
community becomes larger which can be used for capital formation to
accelerate the level of economic development. Further, deficit-led
inflation tends to reduce consumption propensities of the public. Such is
called ‘forced savings’ which can be utilized for the production of capital
goods. Consequently, a rapid economic development will take place in
these countries.
o Deficit Financing and Income Distribution: It is said that deficit
financing tends to widen income inequality. This is because of the fact
that it creates excess purchasing power. But due to inelasticity in the
supply of essential goods, excess purchasing power of the general public
acts as an incentive to price rise. During inflation, it is said that rich
becomes richer and the poor becomes poorer. Thus, social injustice
becomes prominent. However, all types of deficit expenditure, not necessarily tend to disturb existing social justice. If money collected
through deficit financing is spent on public good or in public welfare
programmes, some sort of favourable distribution of income and wealth
may be made. Ultimately, excess dose of deficit financing leading to
inflationary rise in prices will exacerbate income inequality. Anyway,
much depends on the volume of deficit financing.
Key Differences Between Fiscal Policy and Monetary Policy
The following are the major differences between fiscal policy and monetary policy.
The policy of the government in which it utilises its tax revenue and expenditure policy to influence the aggregate demand and supply for products and services the economy is known as Fiscal Policy. The policy through which the central bank controls and regulates the supply of money in the economy is known as Monetary Policy.
Fiscal Policy is carried out by the Ministry of Finance whereas the Monetary Policy is administered by the Central Bank of the country.
Fiscal Policy is made for a short duration, normally one year, while the Monetary Policy lasts longer.
Fiscal Policy gives direction to the economy. On the other hand, Monetary Policy brings price stability.
Fiscal Policy is concerned with government revenue and expenditure, but Monetary Policy is concerned with borrowing and financial arrangement.
The major instrument of fiscal policy is tax rates and government spending. Conversely, interest rates and credit ratios are the tools of Monetary Policy.
Political influence is there in fiscal policy. However, this is not in the case of monetary policy.