2.

2 Services
Chapter 1: Introduction
to Economics Unlike goods, services are intangible activities
provided by businesses or individuals.

1. Definition of Economics  Examples: Healthcare, education,

banking, transportation.
Economics is a social science that studies how  Key Features:
societies allocate scarce resources to satisfy o Cannot be stored (produced
unlimited human wants. The fundamental and consumed simultaneously).
economic problem arises due to scarcity, as o Labor-intensive (requires
resources (land, labor, capital) are limited, but human skills and expertise).
human needs and desires are infinite.
3. Utility & Consumer Behavior
Economists analyze how individuals, businesses,
and governments make decisions regarding the 3.1 Utility
production, distribution, and consumption of
goods and services. Utility refers to the satisfaction a person derives
from consuming a good or service.
2. Basic Economic Concepts
1. Total Utility (TU) – The total
2.1 Goods satisfaction from consuming all units of
a good.
Goods are tangible products used for 2. Marginal Utility (MU) – The additional
consumption or production. satisfaction from consuming one more
unit of a good.
A. Classification Based on Use
Law of Diminishing Marginal Utility
1. Consumer Goods – Directly consumed
by individuals.  As more units of a good are consumed,
o Examples: Food, clothing, the additional satisfaction (MU) from
smartphones. each extra unit declines.
2. Capital Goods – Used to produce  Example: The first slice of pizza gives
other goods. high satisfaction, but the fifth slice may
o Examples: Machinery, factory give little or no additional pleasure.
equipment, buildings.
4. Cost Concepts
B. Classification Based on Durability
4.1 Types of Costs
1. Durable Goods – Last more than three
years. 1. Fixed Costs (FC) – Do not change with
o Examples: Cars, refrigerators, production (e.g., rent, salaries).
furniture. 2. Variable Costs (VC) – Change with
2. Non-Durable Goods – Consumed production (e.g., raw materials).
quickly. 3. Total Cost (TC) = Fixed Cost +
o Examples: Food, beverages, Variable Cost.
newspapers. 4. Average Cost (AC) = Total Cost ÷
Quantity Produced.
C. Classification Based on Rivalry &
Excludability 4.2 Opportunity Cost

Type of  The next best alternative foregone

Rivalrous? Excludable? Example
Good when making a choice.
Clothes,  Example: Choosing to start a business
Private instead of taking a high-paying job
✅ Yes ✅ Yes personal
Goods means the salary foregone is the
vehicles
National opportunity cost.
Public defense,
❌ No ❌ No 5. Price and Market Mechanism
Goods street
lighting
Common Fisheries, 5.1 Price
✅ Yes ❌ No
Goods forests
Netflix,  The monetary value assigned to a good
Club
❌ No ✅ Yes private golf or service.
Goods courses  Determined by:
1. Supply & Demand
 2. Production Costs  Direct relationship between price and
3. Market Competition quantity supplied.
4. Government Policies  Represented by an upward-sloping
supply curve.
6. Demand & Supply Analysis
Elasticity of Supply
6.1 Demand
1. Elastic Supply (Es > 1) – Quick
Definition: The quantity of a good or service production response to price changes
that consumers are willing and able to buy at (e.g., manufactured goods).
different prices. 2. Inelastic Supply (Es < 1) – Difficult to
change production (e.g., agriculture, rare
Determinants of Demand minerals).

1. Price of the Good – Inverse 7. Market Equilibrium

relationship (Price ↑ → Demand ↓).
2. Consumer Income – Higher income →  Equilibrium Price – Where demand =
Higher demand. supply.
3. Price of Related Goods  Surplus (Excess Supply) – Price is too
o Substitutes: Tea & coffee (if high, quantity supplied > quantity
tea price ↑, coffee demand ↑). demanded.
o Complements: Car & fuel (if  Shortage (Excess Demand) – Price is
car price ↓, fuel demand ↑). too low, quantity demanded > quantity
4. Consumer Preferences – Popular supplied.
trends increase demand.
5. Population Size – Larger population → 8. Market Structures & Competition
Higher demand.
8.1 Perfect Competition
Law of Demand
 Many buyers & sellers, identical
 Inverse relationship between price and products, no price control.
quantity demanded.  Example: Agricultural markets.
 Represented by a downward-sloping
demand curve. 8.2 Monopolistic Competition

Elasticity of Demand  Many sellers, differentiated products,

some price control.
1. Elastic Demand (Ed > 1) – Large  Example: Fast food chains (McDonald's,
change in demand for a small price KFC).
change.
o Example: Luxury cars, branded 8.3 Oligopoly
clothing.
2. Inelastic Demand (Ed < 1) – Small  Few dominant firms, interdependent
change in demand despite a price pricing.
change.  Example: Smartphone industry (Apple,
o Example: Medicine, salt. Samsung).

6.2 Supply 8.4 Monopoly

Definition: The quantity of goods/services that  Single seller, complete price control.
producers are willing to sell at different prices.  Example: Railways, public utilities.

Determinants of Supply 8.5 Monopsony

1. Production Costs – Higher costs reduce  Single buyer, many sellers.

supply.  Example: A factory being the only
2. Technology – Advanced technology employer in a town
increases supply.
3. Government Policies – Taxes reduce
supply, subsidies increase it.
4. Number of Sellers – More firms
increase supply.

Law of Supply
 3.1 Components of GDP
Chapter 2: National
Income Accounting Component Explanation
Total spending by households
Consumption (C)
on goods & services.
1. Introduction to National Income Accounting Business spending on capital
Investment (I) goods like machinery &
1.1 Definition infrastructure.
Total expenditure by the
 National Income Accounting (NIA) Government
government on public services,
refers to the systematic recording and Spending (G)
defense, etc.
analysis of a country’s economic Net Exports (X - Difference between exports (X)
activities to measure economic M) and imports (M).
performance over a specific period
(typically a financial year). 3.2 Types of GDP
 It provides a quantitative assessment of
the country’s total income, output, and
expenditure. GDP
Definition Calculation Usefulness
Type
1.2 Importance of National Income Accounting GDP at Reflects
Nominal
current current
GDP = P ×
Nominal market economic size
 Economic Planning: Helps governments Q (Current
GDP prices, but may
design economic policies based on current Year Prices
includes overstate
performance. × Quantity)
inflation. growth.
 Comparative Analysis: Enables
comparison of economic growth over GDP
adjusted for Real GDP =
different periods or between countries. Better for
Real inflation, Base Year
 Standard of Living: Provides a basis for comparisons
GDP measures Price ×
measuring the average income per over time.
person (Per Capita Income). true Quantity
 Sectoral Performance: Evaluates growth.
contributions from agriculture, industry,
and services to national income.

2. Major Measures of National Income

Measure Definition Formula

What it 3.3 GDP Deflator
Represents
Total value of all
A measure of a  Measures inflation rate in the economy.
Gross final goods &
country's
Domestic services produced GDP = C + I +
economic  Formula:
Product within a country’s G + (X - M)
activity &
(GDP) domestic territory
growth.
in a financial year.
Total value of final Economic
Gross goods & services output by
National produced by a GNP = GDP + nationals,
Product country’s citizens, NFIA both inside
(GNP) regardless of and outside
location. the country.
GDP after Measures
Net
deducting actual
Domestic NDP = GDP -
depreciation productive
Product Depreciation
(capital capacity of the
(NDP)
consumption). economy.
Measures total
Net National GNP after
NNP = GNP - income
Product deducting
Depreciation available to
(NNP) depreciation.
the nation.
Total income 4. Gross National Product (GNP) & Net Factor
Measures total
earned by a
National
country’s citizens
NI = NNP at earnings of Income from Abroad (NFIA)
Income (NI) Factor Cost citizens from
from productive
production.
activities.
4.1 GNP vs. GDP
PI = NI +
Transfer
Total income Payments - Aspect GDP GNP
Personal Income before
actually received Corporate
Income (PI) paying taxes. Output produced Output produced by
by individuals. Taxes -
Retained Measures within domestic nationals
Earnings territory. worldwide.
Personal Money
Disposable
Income left after
PDI = PI - available for Goods & services
paying personal Goods & services by
Income Personal Taxes spending or Includes within national
(PDI)
taxes.
saving. nationals abroad.
borders.
Income of foreigners
Income of citizens
Excludes working in the
3. Gross Domestic Product (GDP) working abroad.
country.
4.2 Net Factor Income from Abroad (NFIA) o Shift from Factor Cost to
Market Price (Includes taxes &
 NFIA = Income earned by residents subsidies).
abroad - Income earned by foreigners o Sector-wise GDP based on
domestically. Gross Value Added (GVA).
 Effect on GNP:
o If NFIA > 0, GNP > GDP 8. Organizations Involved in National Income
(citizens earn more abroad). Estimation
o If NFIA < 0, GNP < GDP
(foreigners earn more  Central Statistics Office (CSO) –
domestically). Responsible for GDP calculation in
India.
5. National Income Calculation Methods  Uses three methods (Production,
Income, Expenditure) for estimation.
5.1 Value-Added (Production) Method

 Formula:
GDP=∑(Value Added by Each Industry)
 Steps:
1. Identify all sectors (agriculture,
industry, services).
2. Compute value added = Output –
Intermediate Goods.
3. Sum across all sectors.

5.2 Income Method

 Formula:
 GDP=Wages+Rent+Interest+Profits
 Steps:
1. Calculate factor incomes (wages,
rent, interest, profits).
2. Sum all incomes earned in
production.

5.3 Expenditure Method

 Formula: GDP=C+I+G+(X−M)
 Steps:
1. C – Household consumption.
2. I – Business investments.
3. G – Government spending.
4. (X - M) – Net exports.

6. Potential GDP & Factors Affecting Growth

6.1 Potential GDP

 Maximum GDP an economy can achieve

with full employment & efficiency.

6.2 Challenges Affecting India’s GDP

Factor Explanation
Infrastructure Poor roads, power supply
Deficiency constraints.
Skill gaps & insufficient
Low Human Capital
education.
Regulatory Burden
Bureaucracy & complex
policies.
Chapter 3: Growth and
Agricultural Small landholdings & Development
Inefficiency outdated techniques.
1. Introduction to Economic Growth and
Development
7. New GDP Series (2011-12 Base Year)
1.1 Economic Growth
 Changes:
  Definition: Economic growth refers to an 2. Rising Income Inequality
increase in the production of goods and o Growth benefits corporate and
services within a country over a specific industrial sectors more than the
period, usually measured by the Gross working class.
Domestic Product (GDP) growth rate. o Example: India’s IT and financial
 Key Features of Economic Growth: sector growth benefits urban
o Quantitative in nature (measures populations more than rural
increase in GDP, GNP, and Per communities.
Capita Income). 3. Neglect of Social Welfare
o Indicates a rise in total economic o Education, healthcare, and
output but does not necessarily infrastructure are underfunded
improve quality of life. while the economy grows.
o Can result from increased o Example: Sub-Saharan Africa has
production, better technology, resource-rich economies but lacks
capital accumulation, or adequate healthcare and
workforce expansion. education systems.
4. Production and Consumption of Harmful
1.2 Economic Development Goods
o Industries focused on alcohol,
 Definition: Economic development is a tobacco, gambling boost GDP but
broader concept than economic growth, create social problems.
encompassing social, political, and
institutional improvements in addition to 3. Measuring Economic Growth
an increase in GDP.
 Key Features of Economic Development: Indicator Definition
o Qualitative and quantitative Total value of goods and services
improvements in standard of living. Gross Domestic
produced within a country in a
o Measured using Human Product (GDP)
given year.
Development Index (HDI), GDP + Income earned by residents
literacy rate, life expectancy, and Gross National
from abroad – Income earned by
poverty reduction. Product (GNP)
foreigners domestically.
o Focuses on reducing poverty,
Net Domestic GDP minus depreciation (wear and
improving healthcare, education, Product (NDP) tear of capital goods).
and infrastructure.
Net National
o Takes into account income GNP minus depreciation.
Product (NNP)
distribution and employment
opportunities. National income divided by total
Per Capita
population (indicator of standard of
Income (PCI)
living).
2. Relationship Between Economic Growth and
Development
4. Key Factors Contributing to Economic Growth
2.1 Economic Growth ≠ Economic Development
4.1 Investment
 A country can have high economic growth
but still low economic development if:
o Income inequality is high (only a  Spending on capital goods (factories,
small section of the population machines, infrastructure).
benefits).  Example: Government funding for road
o Poor healthcare and education construction boosts economic activity.
systems exist despite increasing
GDP. 4.2 Savings
o Environmental degradation
occurs due to industrial expansion.  Higher savings lead to more funds
 Example: available for investments.
o Country A: High GDP growth but  Example: Countries with high savings
widespread poverty and lack of rates (like China) can invest more in
education. infrastructure and industries.
o Country B: Moderate GDP growth
but investments in healthcare, 4.3 Human Capital Development
education, and social welfare lead
to a better quality of life.  Education and skill development improve
worker productivity.
2.2 When Economic Growth Goes Against  Example: South Korea’s investment in
Development education led to its rapid
industrialization.
1. Environmental Degradation
o Rapid industrialization leads to 4.4 Technological Progress
pollution, deforestation, and
climate change.  Enhances efficiency and reduces
o Example: China’s economic boom production costs.
led to severe air and water
pollution.
  Example: India’s IT sector growth due to o Falling consumer spending.
advancements in software and
telecommunications. 6.2 Government Measures to Overcome Recession

4.5 Infrastructure Development Measure Explanation

Increased government spending
 Better roads, ports, energy supply, and Fiscal Stimulus
on infrastructure.
internet connectivity enhance productivity. Reducing interest rates to
 Example: Bharatmala Project in India Monetary Policy
encourage borrowing.
improves highway networks, boosting
Lowering taxes to boost
logistics and trade. Tax Cuts
disposable income.
Support for Small Providing low-interest loans
4.6 Natural Resources
Businesses and grants.

 Oil, minerals, fertile land, and forests

contribute to economic output.
7. Measuring Economic Development
 Example: Middle Eastern countries rely
on oil exports for economic growth.
7.1 Human Development Index (HDI)
4.7 Stable Institutions and Governance
 Measures economic and social well-being
based on three factors:
 Strong legal and financial systems attract
1. Life expectancy (health).
investment and encourage
2. Education levels (mean and
entrepreneurship.
expected years of schooling).
 Example: Singapore’s transparent
3. GNI per capita (income).
governance makes it a business-friendly
hub.
7.2 Gender Inequality Index (GII)
4.8 Trade and Global Integration
 Measures gender disparity in education,
political participation, and labor market.
 Exports lead to higher economic output
and job creation.
 Example: China’s export-led growth 7.3 Inequality-Adjusted HDI (IHDI)
strategy has transformed its economy.
 Adjusts HDI by considering income
5. Jobless Growth inequality.

5.1 Definition 8. Government Initiatives for Economic

Development
 Economic growth without a proportional
increase in employment opportunities. Sector Initiative Objective
Direct income
Agriculture PM-KISAN
5.2 Causes of Jobless Growth support for farmers.
Sarva Shiksha Universal primary
Education
1. Automation and AI – Machines replace Abhiyan education.
human labor. Ayushman Free healthcare for
Health
2. Skill Mismatch – Job seekers lack skills Bharat poor families.
demanded by industries. Bharatmala Highway
Infrastructure
3. Shift from Labor-Intensive to Capital- Project development.
Intensive Industries. Promote domestic
Manufacturing Make in India
industry
5.3 Solutions to Jobless Growth

1. Skill Development Programs (Skill India

Mission).
2. Encouraging Startups (Startup India
Initiative).
3. Investing in Infrastructure to create
labor-intensive jobs.

6. Economic Recession
Chapter 4: Inclusive
6.1 Definition Growth
 A recession is a significant decline in
economic activity lasting more than two 1. Introduction to Inclusive Growth
quarters.
 Indicators: 1.1 Definition
o Declining GDP.
o Rising unemployment.
  Inclusive growth refers to economic growth Feature Explanation Example
that is broad-based, equitable, and sectors.
benefits all sections of society, including Bridging gaps
marginalized and disadvantaged groups. Reservation
3. Reduction of between rich and
 Ensures that the benefits of growth are not policies for SCs,
Inequality poor, urban and
concentrated among a few but are shared STs, and OBCs.
rural areas.
widely.
Growth that does
4. Sustainable Promoting
not harm the
1.2 Key Characteristics Development renewable energy.
environment.
Improving National Health
 Reduction in poverty and income 5. Human education, Mission (NHM)
inequality. Development healthcare, and for better
 Creation of employment opportunities quality of life. healthcare access.
across all sectors.
 Access to education, healthcare, and
social services for all.
4. India’s Progress Towards Inclusive Growth
 Sustainable development without
environmental degradation.
 Social and economic empowerment of 4.1 Measuring Inclusive Growth
marginalized communities.
India's progress can be assessed through various
2. Importance of Inclusive Growth in India indices:

2.1 Large and Diverse Population 1. Multidimensional Poverty Index (MPI)

 India has a high population with economic  Measures poverty based on health,
disparities. education, and standard of living.
 A significant portion of the population lives  India’s MPI declined from 54.7% (2019) to
below the poverty line. 49.9% (2021).
 Economic policies must benefit all sections  Progress: Better access to education,
of society, especially the poor. healthcare, and sanitation.

2.2 Reducing Inequality and Promoting Social 2. Human Development Index (HDI)
Justice
 Composite measure of health, education,
 Income and wealth disparities are and income.
widespread.  India’s HDI increased from 0.580 (2000)
 Unequal access to education, healthcare, to 0.645 (2019).
and employment opportunities.  Challenge: India ranks 131 out of 189
 Inclusive growth can bridge these gaps countries, indicating slow progress.
through targeted policies.
3. Gender Inequality Index (GII)
2.3 Sustainable Development
 Measures gender-based disparities in
 India faces environmental challenges such reproductive health, education, and
as deforestation, pollution, and climate economic participation.
change.  India’s GII declined from 0.707 (2015) to
 Sustainable economic policies ensure 0.501 (2020).
growth without harming the environment.  Challenge: India still ranks 140 out of 162
countries, highlighting gender disparities.
2.4 Examples
4. Other Indicators
 Coal mining vs. Renewable Energy
o Coal-based growth benefits a few Indicator Progress
while causing pollution. Decreased, but still 20% of the
o Renewable energy projects (solar, Poverty Rate population lives in extreme
wind) provide widespread poverty.
employment and ensure Increased to 77.7% (as per National
Literacy Rate
sustainability. Statistical Office, 2021).
Improved due to schemes like Jal
Access to Basic
Jeevan Mission (clean water
Services
access).
3. Salient Features of Inclusive Growth

5. Challenges in Achieving Inclusive Growth in

Feature Explanation Example
India
Economic policies MGNREGA
1. Reduction of
should uplift the provides rural
Poverty Challenge Explanation
poor. employment.
2. Creating jobs, MSME sector The top 10% own 57% of
Employment especially in generates 1. Income Inequality India’s wealth, while the
Generation labor-intensive employment. bottom 50% own only 2%.
 Challenge Explanation 9. Measures to Address Inclusive Growth
States like Bihar, Uttar Challenges
2. Regional Pradesh lag behind
Disparities Maharashtra, Gujarat in Measure Explanation
growth. Implement progressive
Despite growth, youth 1. Pro-Poor
taxation, subsidies, and welfare
3. Unemployment unemployment remains high Policies
programs.
(8-9%). 2. Investment in Improve education and
4. Limited Access to Rural areas have poor Human Capital vocational training.
Education & education and medical Promote microfinance and
Healthcare facilities. 3. Access to
credit facilities for small
Caste, gender, and religious Finance
5. Social businesses.
discrimination limit Provide tax incentives and
Discrimination 4. Support for
opportunities. financial assistance to small
SMEs
enterprises.
Enhance rural connectivity,
5. Infrastructure
6. Investment in Infrastructure for Inclusive healthcare, and sanitation
Development
Growth facilities.
Expand social security, health
6.1 Physical Infrastructure 6. Social Protection insurance, and unemployment
benefits.
 Better roads, ports, electricity, and water Private sector, civil society,
7. Stakeholder
supply boost connectivity. and government collaboration
Engagement
 Example: Pradhan Mantri Gram Sadak for inclusive growth.
Yojana (PMGSY) improves rural
connectivity.
10. Inclusive Growth in a Market Economy
6.2 Digital Infrastructure
Policy Explanation
 Expanding internet access, mobile Ensure economic benefits reach
banking, and e-governance. Pro-Poor Policies
low-income groups.
 Example: Digital India initiative enables Promote financial inclusion
rural digital inclusion. Access to Finance through affordable banking
services.
7. Intra-Generational and Inter-Generational Investment in Strengthen education and job
Equity in Inclusive Growth Human Capital training programs.
Improve transportation,
7.1 Intra-Generational Equity Infrastructure
electricity, and digital
Development
connectivity.
 Fair distribution of resources within a Provide low-interest loans and
Support for SMEs
single generation. technical assistance.
 Example: Ensuring urban and rural
populations have equal access to
healthcare and education.

7.2 Inter-Generational Equity

 Sustainable resource use for future

generations.
 Example: Preserving forests, water, and
minerals for future use.

8. Relationship Between Inclusiveness and

Sustainability

 Inclusive Growth → Sustainable

Development
o Reducing inequality and poverty
stabilizes society and prevents
conflicts. Chapter 5: Inequality
o Investments in renewable energy
and green technologies create jobs and Poverty
without harming the
environment.
 Sustainability Supports Inclusiveness 1. Introduction
o Resource conservation ensures
future generations have economic Despite being one of the fastest-growing
opportunities. economies in the world, India faces high levels
o Example: Green jobs in of inequality and widespread poverty. This
renewable energy benefit all has significant implications for:
sections of society.
  Economic growth and stability.  Higher Palma Ratio means higher
 Social justice and equality. inequality.
 The overall well-being of citizens.
4.3 Lorenz Curve and Gini Coefficient
Section 1: Inequality
Lorenz Curve
2. Definition of Inequality
 Graphical representation of income
 Inequality refers to the unequal distribution.
distribution of resources,  Perfect equality → A 45-degree line
opportunities, and wealth among (every segment of the population earns
individuals or groups within a society. an equal share).
 It affects access to education,  Actual income distribution → A
healthcare, jobs, and income levels. curved line below the perfect equality
line.
3. Types of Inequality  Greater deviation from the 45-degree
line → greater inequality.
Type Definition Example
Unequal social Gini Coefficient
Caste-based
status, power,
discrimination in  Numerical measure of income
and prestige
Social India limiting inequality, ranging from 0 to 1.
among
Inequality access to  Formula:
individuals based
education and
on caste, gender,
jobs.
religion, or race.
Unequal
Top 1% of Where:
distribution of
India’s
Economic wealth, income,
population owns
Inequality and access to o A = Area between Lorenz
over 40% of the
economic Curve and the line of equality.
total wealth.
resources. o B = Total area under the line
of equality.
 Interpretation:
4. Methods and Indicators to Measure o G = 0 → Perfect equality
Inequality (everyone has equal income).
o G = 1 → Perfect inequality
4.1 Quintile Ratio (one person owns all the
income).
 Measures income inequality by  India’s Gini Coefficient (2021): 0.48,
comparing the top 20% of income indicating high inequality.
earners with the bottom 20%.
 Formula

5. Reasons for Inequality in India

Factor Explanation
The caste system and
 Example: If the top 20% earn 40% of colonial rule created long-
1. Historical
the total income while the bottom 20% lasting disparities in
Factors
earn 10%, the ratio is: 40/10=440/10 = education, land ownership,
440/10=4 Higher the ratio → greater and social status.
the inequality. Access to healthcare,
2. Unequal education, and financial
4.2 Palma Ratio Resource resources remains
Distribution concentrated among the
 Compares the income share of the wealthy.
richest 10% with the poorest 40%. Gender and caste-based
 Formula: 3. Labor Market wage gaps limit income
 Discrimination opportunities for women and
 marginalized communities.
 Large landowners
 Example: If the top 10% earn 30% of 4. Unequal Land dominate agriculture, while
the total income while the bottom 40% Ownership small farmers struggle due to
earn 10%, the Palma ratio is: lack of resources.
30/10=330/10 = 330/10=3
6. Solutions to Combat Inequality Committee Year Poverty Line Criteria
Lakdawala Rural: 2400 kcal/day,
1993
Solution Explanation Committee Urban: 2100 kcal/day
Investing in vocational Rural: ₹27/day, Urban:
Education and Tendulkar
training and higher 2009 ₹33/day, includes food +
Skill Committee
education to improve job non-food items
Development
opportunities. Rural: ₹32/day, Urban:
Higher income groups pay Rangarajan ₹47/day, considers more
Progressive 2015
higher tax rates, generating Committee comprehensive
Taxation
funds for welfare programs. consumption
Government subsidies for
Employment companies hiring women,
Incentives minorities, and disabled 10. Solutions to Reduce Poverty
individuals.
Welfare programs like food Solution Explanation
Social Safety
subsidies, free healthcare, Promoting MSMEs, skill
Nets
and unemployment benefits. Job Creation development, and rural
employment schemes.
Free primary education and
Section 2: Poverty Education
scholarships for poor
Reforms
students.
7. Definition of Poverty Expanding Ayushman
Healthcare Access Bharat to provide free
 Poverty refers to the lack of sufficient medical care.
resources to meet basic human needs Increasing microfinance and
such as food, shelter, healthcare, and Financial
credit facilities for small
education. Inclusion
businesses.
Improving roads, electricity,
8. Types of Poverty Infrastructure
and internet connectivity in
Development
villages.
Type Definition Example
Lack of basic A homeless
necessities person with
Absolute Poverty
like food and no access to
shelter. food.
A worker
Income below
who earns
average
Relative Poverty less than half
societal
the average
standards.
salary.
Poverty in
cities due to Slum
Urban Poverty high costs and dwellers in
lack of Mumbai.
services.
Poverty in
Small farmers
villages due to
Rural Poverty in drought-
lack of jobs
prone areas.
and resources.
Poverty
passed from A child from
Intergenerational
parents to a poor family Chapter 6: Money
children due unable to
Poverty
to lack of break the 1. Introduction to Money
education and poverty cycle.
resources. Money plays a fundamental role in the functioning
Temporary of modern economies. It is essential for the
Families exchange of goods and services and provides a
poverty due to
Situational affected by convenient way to conduct economic transactions.
job loss,
Poverty COVID-19 Without money, trade would revert to the barter
illness, or
lockdowns. system, making transactions much more complicated
disasters. and inefficient.

2. Evolution of Money
9. Committees on Poverty Estimation in India
Money has evolved over centuries, from a simple  Example: The cost of a carton of eggs is
barter system to modern digital money. Below are ₹50, making it easier to compare to other
key stages in the evolution of money: goods.

2.1 Barter System 3.3 Store of Value

 Earliest form of trade; goods and services  Money can be saved for future use,
exchanged directly. maintaining purchasing power over time.
 Challenges: Required double coincidence  Example: Savings in a bank account
of wants, meaning both parties must want represent the value of one’s labor for future
what the other offers. use.

2.2 Commodity Money 3.4 Standard of Deferred Payment

 Items such as gold, silver, or salt used for  Money is used to settle debts that will be
trade. paid in the future.
 The value of these commodities was widely  Example: Taking a loan to buy a car, to be
accepted and recognized. repaid in installments over time.

2.3 Coinage 4. Types of Money

 Coins made of precious metals like gold or 4.1 Full-bodied Money

silver introduced for efficiency in trade.
 They were portable, easy to count, and  Intrinsic value: Made from precious
easy to store. metals like gold or silver.
 Example: Roman Empire introduced coins  Examples: Gold coins, Silver coins.
like the denarius.
4.2 Token Money
2.4 Paper Money
 Has no intrinsic value, used as a substitute
 China, Tang Dynasty (618-907 AD) first for full-bodied money.
introduced paper money.  Examples: Copper coins, Paper money.
 Initially used for large purchases such as
land or buildings. 4.3 Representative Money

2.5 Banknotes  Represents a claim on a commodity like

gold or silver.
 Introduced by Bank of England in the 17th  Examples: Gold certificates, Silver
century as paper money backed by gold or certificates.
silver.
 Allowed for carrying large sums of money 4.4 Fiat Money
without risk.
 Currency that has no physical backing but
2.6 Digital Money derives value from government trust.
 Examples: Indian Rupee.
 With the rise of the internet and digital o Advantage: Allows the
technology, digital money has gained government greater flexibility in
popularity. managing monetary policy.
 Examples include cryptocurrencies like o Risk: Excessive printing can lead
Bitcoin and Ethereum. to inflation.
 Advantages: Secure, easy to transfer, and
used in online and physical stores.
4.5 Legal Tender Money
3. Functions of Money
 Officially recognized by the government
for payment of debts and taxes.
Money fulfills four primary functions in an  Example: Indian Rupee notes and coins
economy: issued by the Reserve Bank of India (RBI).

3.1 Medium of Exchange 4.6 Non-legal Tender Money

 Facilitates buying and selling of goods and  Currency or payment methods not
services. recognized by the government for tax
 Example: Buying a smartphone without payments.
needing to barter, using either cash or  Examples: Gift cards, Loyalty points,
digital payment. Cryptocurrencies like Bitcoin.
o Advantages: Offer flexibility, but
3.2 Unit of Account also come with risks like volatility.

 Provides a standard measure of value for 4.7 Bank Money

comparing prices of goods and services.
  Created through bank lending and deposits. 6. Money Supply Measures
 Example: Money in checking and savings
accounts. In India, the Reserve Bank of India (RBI) tracks
o Banks create money by adding loan various measures of the money supply:
amounts to accounts, making funds
available for spending.  M1: Narrow measure: Currency in
circulation + demand deposits.
4.8 Near Money  M2: Includes M1 + savings deposits with
the Post Office.
 Financial assets that are easily convertible  M3: Includes M2 + net time deposits of
into cash. commercial banks.
 Examples: Savings accounts, Money  M4: Broadest measure: Includes M3 + all
market accounts, Short-term government post office deposits and deposits with
securities. NBFCs (Non-Banking Financial
o Used for short-term savings or Companies).
emergency funds.
6.1 Reserve Money (High-Powered Money)
4.9 Cryptocurrency
 The base money controlled by the central
 Digital money secured by cryptography; bank (RBI).
operates on a decentralized blockchain.  Formula:
 Examples: Bitcoin, Ethereum. 
o Features: Decentralized, secure, 
and peer-to-peer transactions.  Reserve Money=Currency in Circulation+B
o Risks: Price volatility, fraud, ankers’ Deposits with RBI+Other Liabilities
regulatory uncertainty. of RBI
 Influences money supply through central
bank policies.
5. Money Supply and Economic Impact
7. Credit Creation and Money Multiplier
5.1 Money Supply
The Money Multiplier indicates how much bank
 The total amount of money circulating in
money is created through the lending process.
the economy, including physical currency
and bank deposits.
 Affects economic activity, consumer  Formula:
spending, and inflation.
Money Multiplier (m)=
5.2 Velocity of Money Circulation

 Measures how quickly money changes

hands within the economy. For example, if Reserve Money increases
 Formula: Velocity of Money= by Rs. 1,000 crore and the Money
Multiplier is 2, the money supply could
increase by Rs. 2,000 crore.

 High velocity suggests active spending and  Credit Creation: When banks lend out
higher economic activity. deposits, they create new money in the
 Low velocity indicates a slow economy. economy, contributing to economic activity
 o Increased consumer spending (due
Chapter 7: Inflation to higher wages or government
stimulus).
o Increased business investments.
1. Definition of Inflation
o Economic expansion leading to
higher demand.
 Inflation refers to the sustained increase in the  Example: With higher disposable income,
general price level of goods and services over people buy more cars and homes, pushing up
time, leading to a decrease in the purchasing prices.
power of money. Essentially, the same amount
of money will buy fewer goods and services as
inflation increases. 3.2 Cost-Push Inflation
 Moderate inflation can stimulate economic
activity, while excessive inflation can disrupt  Caused by rising production costs (e.g.,
economic stability and people's lives. wages, raw material costs, taxes).
 Example: A rise in oil prices increases costs
2. Types of Inflation for many industries, pushing up prices for
goods like transportation and manufacturing.
2.1 Creeping Inflation
4. Market Equilibrium and Inflation
 Rate: Typically up to 3% annually.
 Characteristics: Gradual price increases; for  Market Equilibrium occurs when demand
example, a pack of bread rising from Rs 50 to equals supply, resulting in a stable price.
Rs 51 in a year.  Price Adjustments:
 Positive Effects: o If demand is high and supply is low,
o Encourages spending and prices rise.
investment, stimulating economic o If supply exceeds demand, prices fall.
growth. o An imbalance between supply and
o Reduces real value of debt for demand can result in inflation.
borrowers.
5. Reasons Behind Inflation
2.2 Trotting Inflation
5.1 Demand-Pull Inflation
 Rate: Ranges from 3-10% annually.
 Example: Price of rice rising from ₹50 to ₹55  Increased demand for goods/services.
in a year.  Expansionary fiscal policies (government
 Potential Impact: Not drastic, but if spending).
sustained, can lead to significant price  Easy credit and low interest rates.
increases over time.  Population growth and higher consumer
spending.
2.3 Running Inflation
5.2 Cost-Push Inflation
 Rate: 10-20% annually.
 Example: Price of rice increasing from ₹50 to  Rising production costs (e.g., wages, raw
₹65 in a year. materials).
 Impact: Faster price increases, putting  Energy price hikes (e.g., oil).
pressure on household budgets.  New taxes or regulations increasing
production costs.
2.4 Galloping Inflation  Supply chain disruptions.
 Currency devaluation, increasing import
prices.
 Rate: 20-100% annually.
 Example: Rice prices increase from ₹50 to
₹150. 6. Measures of Inflation
 Impact: Prices surge rapidly, causing
difficulty in affording essential goods. 6.1 Producer Price Index (PPI)

2.5 Hyperinflation  Measures the average change in the prices

producers receive for their goods/services at
 Rate: Over 1000% annually. wholesale levels.
 Example: Historical event in Germany in the  Formula: PPI=
1920s, where bread prices soared from 250
marks to over 200 billion marks.
 Impact: Economy breaks down, savings
become worthless, and society struggles.  Example: If revenue rises from Rs. 1000 to Rs.
1200, the PPI would be 120, indicating a 20%
3. Types of Inflation Based on Causes price increase.

3.1 Demand-Pull Inflation 6.2 Wholesale Price Index (WPI)

 Occurs when demand exceeds supply for  Measures price changes at the wholesale
goods/services. market level.
 Factors include:  Basket includes primary articles, fuel, power,
and manufactured goods.
  Published by Office of the Economic Adviser  Inflation distorts relative prices, making it
in India. difficult to discern if price changes reflect true
supply and demand changes.
6.3 Consumer Price Index (CPI)
8.7 Wage-Price Spiral
 Measures the average change in prices paid by
consumers for goods and services.  Rising prices lead to demands for higher
 Formula: CPI wages, which may further fuel inflation if
wages outpace productivity.

8.8 International Competitiveness

 Four types of CPI in India:
o CPI-U: Urban areas.  High inflation can reduce a country's
o CPI-R: Rural areas. competitiveness in international trade, as
o CPI-C: Combined urban and rural. domestic prices rise faster than those of
o CPI-IW: Industrial workers, CPI- competitors
AL: Agricultural laborers.
1. Measures to Control Inflation
6.4 Comparison of WPI and CPI
Monetary Measures (Central Bank Actions):
 WPI measures wholesale goods prices; CPI
measures consumer goods and services. 1. Increasing the Interest Rate: Raising interest
 CPI is more relevant for understanding the rates makes borrowing more expensive, which
cost of living. reduces demand for loans and credit. This, in
turn, slows down spending by businesses and
7. GDP Deflator consumers, helping to reduce inflation.
2. Reducing Money Supply: Central banks can
reduce the money supply by selling
 Measures the price level of all goods and government securities or increasing the reserve
services produced within a country. requirement for banks. This makes money
 Formula: GDP Deflator scarcer, reduces lending, and curbs inflation.

Fiscal Measures (Government Actions):

 A higher GDP deflator indicates that prices 1. Increasing Taxes: Higher taxes reduce
have increased, signaling inflation. disposable income for consumers and
businesses, lowering demand for goods and
8. Effects of Inflation services, which helps in controlling inflation.
2. Reducing Government Spending: Cutting
8.1 Reduced Purchasing Power back on government spending can help reduce
the overall demand in the economy, thereby
helping to control inflation.
 As prices rise, money buys fewer goods and
services, leading to a reduction in real
income. 2. Inflation-related Concepts

8.2 Increased Production Costs Deflation:

 Rising input costs (e.g., raw materials, wages)  Definition: A decrease in the overall price
make it harder for businesses to maintain level of goods and services.
profitability.  Example: Price of rice dropping from ₹50 to
₹40.
 Causes: Can result from a decrease in demand
8.3 Redistribution of Wealth
or oversupply of goods.
 Effects: While lower prices may benefit
 Fixed-income individuals (e.g., pensioners, consumers in the short term, deflation can lead
low-wage earners) face difficulty in coping to economic problems like reduced investment,
with rising prices. unemployment, and lower economic growth
 Wealthier individuals or those with assets that due to a decline in demand.
appreciate in value may see their wealth grow.
Disinflation:
8.4 Uncertainty & Reduced Investment
 Definition: A decrease in the rate of inflation,
 Businesses may hesitate to invest due to the where prices are still rising but at a slower rate.
uncertainty about future costs and prices,  Example: Inflation drops from 6% to 3%.
affecting economic growth.  Impact: Disinflation is seen as positive
because it reduces the cost of living without
8.5 Impact on Savings and Investments causing deflation.

 Inflation erodes the value of savings and Stagflation:

fixed-rate investments, leading to potential
losses in real value.  Definition: A situation where inflation and
unemployment are both high.
8.6 Distortion of Price Signals  Example: Rising oil prices increase costs for
companies, leading to inflation, but the same
 causes reduce demand for labor, raising  Definition: When actual output exceeds
unemployment. potential output, leading to increased prices.
 Challenges: Policies aimed at reducing  Example: Consumer spending during festive
inflation may worsen unemployment, and vice seasons can push demand beyond the
versa. economy’s capacity, leading to higher prices.

Reflation: Deflationary Gap:

 Definition: The deliberate attempt to stimulate  Definition: Occurs when total spending in an
the economy and raise prices after a period of economy is insufficient to purchase all the
deflation or economic contraction. goods and services it can produce, leading to a
 Example: The New Deal during the Great decrease in prices and economic activity.
Depression, or quantitative easing (QE) to  Example: If an economy can produce 1000
increase the money supply and encourage units, but demand only allows the purchase of
spending. 900 units, resulting in deflationary pressures.

Open Inflation: 4. Phillips Curve and Business Cycle

 Definition: Inflation caused by external factors Phillips Curve:

like global oil price increases or natural
disasters, which affect supply and demand.  Definition: A graphical representation of the
 Example: Oil price hikes leading to higher inverse relationship between inflation and
production costs and subsequently higher unemployment.
prices for goods.  Observation: When unemployment is low,
inflation tends to be higher due to increased
Headline Inflation: demand for labor, leading to higher wages and
prices.
 Definition: The overall inflation rate as
reported in the media, typically measured by Business Cycle:
the Consumer Price Index (CPI).
 Example: If the CPI shows a 2% increase, it  Phases:
means that the general price level of goods and o Expansion: Economic growth with
services has risen by 2%. rising GDP, employment, and
income.
Core Inflation: o Peak: The highest point before the
economy slows down, possibly with
 Definition: Inflation excluding volatile items inflation.
like food and fuel to reflect underlying o Contraction: Economic slowdown
inflation trends. with reduced GDP and employment.
 Purpose: Helps policymakers assess long-term o Trough: The lowest point, where the
inflation trends without short-term volatility. economy experiences a recession and
high unemployment.
Bottleneck Inflation:
Economic Recovery:
 Definition: Inflation caused by supply
shortages or bottlenecks in the supply chain,  V-shaped: Quick decline and rapid recovery,
which drive up prices. as seen in some industries post-COVID-19
 Example: A shortage of microchips increasing lockdowns.
smartphone prices.  U-shaped: Prolonged downturn followed by
gradual recovery, like after the 2008 financial
Base Effect: crisis.
 Swoosh-shaped: Gradual recovery with a
prolonged upward slope.
 Definition: A distortion in percentage changes
 Z-shaped: Multiple fluctuations before
due to a significant change in the base year.
stabilizing.
 Example: A large price hike in one year can
 W-shaped: Double-dip recession, where the
make percentage changes in subsequent years
economy recovers then dips again before
seem more dramatic than they really are.
stabilizing.
 L-shaped: Long-term stagnation, typical of
3. Inflation Gaps economies facing structural issues.

Inflationary Gap:
 reduced spending and
Chapter 8: Monetary investment.
Policy  Reducing money
supply: The RBI may
sell government bonds
Monetary Policy Overview or raise the reserve
requirements for
Monetary policy refers to the actions taken by commercial banks,
the Reserve Bank of India (RBI) to control the limiting the amount of
supply of money, influence interest rates, and money available in the
ensure liquidity in the economy. The key economy.
objectives are to stabilize prices, promote o Example: When inflation
economic growth, and maintain financial exceeds the target range, the
stability. Through monetary policy, the RBI RBI may raise interest rates to
affects various economic indicators such as slow borrowing, spending, and
inflation, employment, interest rates, and investment, thereby reducing
economic growth. By adjusting interest rates inflationary pressures.
and regulating the money supply, monetary
policy can steer the economy in a desired Goals of Monetary Policy
direction.
The RBI formulates monetary policy with
Types of Monetary Policy several key goals in mind, primarily aimed at
fostering long-term economic stability and
1. Expansionary Monetary Policy: growth.
o Objective: To stimulate
economic growth during periods 1. Controlling Inflation:
of economic downturns, o Targeting Inflation: The RBI
recessions, or low inflation. sets inflation targets through the
o Methods: Monetary Policy Framework
 Lowering interest Agreement (MPFA). The
rates: This reduces the current target is to keep inflation
cost of borrowing for within the range of 2% to 6%
businesses and based on the Consumer Price
consumers, encouraging Index (CPI).
investment and o Impact: Inflation control is
spending. crucial to preserve the
 Increasing money purchasing power of money.
supply: The central Uncontrolled inflation can lead
bank may buy to higher prices, reduce real
government bonds or incomes, and cause economic
reduce the reserve instability.
requirements for o Example: If inflation exceeds
commercial banks, the target, the RBI raises
which increases the interest rates to reduce spending
money available for and borrowing, thus curbing
lending and inflation.
consumption. 2. Promoting Economic Growth:
o Example: During the COVID- o Objective: Foster economic
19 pandemic, the RBI growth by maintaining a
implemented expansionary balance between economic
monetary policies, lowering expansion and inflation.
interest rates and introducing o Methods: Lowering interest
liquidity measures to stimulate rates and ensuring sufficient
economic activity and provide liquidity in the market
relief to businesses and encourages borrowing and
individuals. investment, stimulating
2. Contractionary Monetary Policy: economic activity.
o Objective: To control inflation, o Example: By lowering interest
cool down an overheating rates during an economic
economy, or reduce excessive downturn, the RBI helps
demand for credit. encourage businesses to expand,
o Methods: invest in infrastructure, and
 Raising interest rates: create jobs.
Increases the cost of 3. Maintaining Financial Stability:
borrowing, leading to
 o Objective: Ensure the health Quantitative Tools (Affect the quantity of
and stability of the banking and money and credit)
financial systems.
o Methods: The RBI ensures that 1. Cash Reserve Ratio (CRR):
banks have sufficient liquidity o Definition: The percentage of a
to meet their obligations. It also bank's deposits that must be
acts as a lender of last resort to kept with the RBI as a reserve.
ensure the financial system o Impact: Increasing the CRR
doesn’t collapse. limits the amount of money
o Example: During crises like the available for lending, reducing
2008 global financial credit supply and controlling
meltdown, the RBI injected inflation. Conversely, lowering
liquidity into the banking the CRR increases liquidity in
system, providing emergency the economy.
funds to stabilize banks and o Example: If CRR is raised to
prevent financial panic. 6%, banks must hold 6% of
their deposits as reserve and can
Monetary Policy Framework in India lend out only 94%.
2. Statutory Liquidity Ratio (SLR):
The Monetary Policy Framework Agreement o Definition: The proportion of a
(MPFA) guides the RBI’s monetary policy. The bank's net demand and time
framework establishes the following: liabilities (NDTL) that must be
held in liquid assets such as
 Inflation Targeting: The RBI’s cash, gold, or government
inflation target is 4% with a +/- 2% bonds.
tolerance band, meaning inflation o Impact: An increase in the SLR
should remain within the range of 2% to reduces the amount of money
6%. banks can lend out, thus limiting
 Support for Growth: While inflation credit growth and reducing
control is the priority, the RBI also aims inflationary pressures.
to support economic growth by ensuring o Example: If a bank has Rs.
credit availability and managing interest 1000 crore in deposits and the
rates. SLR requirement is 18%, it
 Decision-Making: The RBI's Monetary must hold Rs. 180 crore in
Policy Committee (MPC) is liquid assets, leaving Rs. 820
responsible for setting the monetary crore available for lending.
policy stance based on inflation trends 3. Liquidity Adjustment Facility (LAF):
and other macroeconomic factors. o Repo Rate: The interest rate at
which the RBI lends short-term
Monetary Policy Committee (MPC) funds to banks against
government securities.
 Composition: The MPC consists of 6 o Reverse Repo Rate: The
members: interest rate at which the RBI
o RBI Governor (Chairperson) borrows funds from banks, thus
o RBI Deputy Governor in reducing excess liquidity in the
charge of monetary policy market.
o One official nominated by the o Impact: Adjusting the repo and
RBI Board reverse repo rates directly
o Three external members influences the availability of
appointed by the government credit and short-term borrowing
 Meeting Frequency: The MPC meets at costs in the economy.
least every two months to review the o Example: Lowering the repo
economic situation and make decisions rate makes borrowing cheaper
on monetary policy. for banks, while raising the
 Voting Mechanism: Decisions are reverse repo rate absorbs
made by majority vote. In case of a tie, excess liquidity from the
the RBI Governor has the casting vote. market.
 Key Role: The MPC sets the repo rate, 4. Open Market Operations (OMOs):
which influences short-term interest o Definition: The buying and
rates in the economy and is a key tool in selling of government securities
inflation control and economic in the open market.
management. o Impact: Buying securities
injects money into the economy,
Instruments of Monetary Policy while selling securities absorbs
liquidity, thus regulating the
The RBI employs both quantitative and money supply.
qualitative tools to regulate the economy:
 o Example: If the RBI wants to o Example: Raising the LTV
increase money supply, it will ratio to 90% means a borrower
buy government securities from can take a loan for 90% of the
banks, increasing their reserves property value, while the
and lending capacity. remaining 10% must be paid
upfront.
Qualitative Tools (Focus on the structure of
credit) Limitations of Monetary Policy in India

1. Credit Rationing: 1. Limited Scope: The RBI controls

o Definition: Setting limits on the money supply and interest rates but does
amount of credit banks can not have control over the demand for
extend to certain sectors of the money, which is influenced by
economy. consumer behavior.
o Impact: Credit rationing allows 2. Time Lags: Changes in interest rates or
the RBI to control credit flow to money supply take time to show effects
specific sectors, such as real on the economy, making it challenging
estate or infrastructure, which to implement timely responses.
may be prone to overheating. 3. Structural Constraints: The informal
o Example: During an overheated sector, which is outside the reach of
housing market, the RBI may monetary policy tools, limits the overall
restrict banks from providing effectiveness of monetary policy in
excessive loans for property India.
purchases. 4. Dependence on Fiscal Policy:
2. Moral Suasion: Government spending and taxation
o Definition: Using persuasive (fiscal policy) have a significant impact
tactics to encourage banks and on economic growth, and monetary
financial institutions to align policy may not be fully effective
their lending policies with the without fiscal support.
RBI’s objectives. 5. External Factors: Global conditions,
o Impact: By exercising moral such as oil prices, international trade
suasion, the RBI can influence dynamics, and foreign exchange
banks' behavior without using fluctuations, can impact inflation and
formal regulations. growth, reducing the effectiveness of
o Example: During the global domestic monetary policy.
financial crisis, the RBI used
moral suasion to encourage Transmission of Monetary Policy
banks to lend to small and
medium enterprises (SMEs), Transmission refers to how changes in the RBI’s
which were facing liquidity policy rates, such as the repo rate, affect
issues. lending rates in the economy. The RBI expects
3. Margin Requirements and Loan-to- commercial banks to adjust their lending rates
Value (LTV) Ratio: in response to changes in the policy rates.
o Definition: Setting minimum However, there are challenges in this
down payment requirements transmission process:
(margin) for loans and
restricting the maximum loan  MCLR System: The introduction of
amount compared to asset value MCLR (Marginal Cost of Funds Based
(LTV ratio). Lending Rate) aimed to improve the
o Impact: Lowering the LTV transmission of RBI’s policy changes by
ratio restricts borrowing linking banks’ lending rates more
capacity, thereby controlling closely to the cost of funds, allowing
excessive credit growth in quicker adjustments in lending rates
sectors like real estate.
 Fees and Charges: For services like
Chapter 9: Public Finance o
licensing, user charges, fines, etc.
o Fines and Penalties: Collected for
1. Introduction to Public Finance
violations or legal infractions.
o Income from Government Assets:
Public finance involves the management of a Rent or lease income from
country’s revenue, expenditures, and debt load to
government-owned land,
achieve economic objectives. It primarily focuses on
buildings, etc.
how governments raise and allocate funds, ensuring
their economic goals are met, which include:
2.3 Capital Receipts
 Promoting Economic Growth: Efficient
financial management can boost economic Capital receipts come from one-time or non-recurring
performance. sources:
 Ensuring Social Equity and Justice: Proper
fiscal policies aim to reduce inequality and  Debt Capital Receipts: These are
ensure fair distribution of resources. borrowings that the government raises
 Stabilizing the Economy: Governments through:
manage public finances to prevent o Domestic Borrowings: Loans from
economic instability during crises. local banks and financial
institutions, including Treasury
Governments use various financial tools, such as Bills and Government Bonds.
taxation, public spending, borrowing, and fiscal o External Borrowings: Loans from
policies. The annual financial statement, or budget, foreign governments or
summarizes this entire process. The budget outlines international agencies such as the
anticipated receipts (revenues) and expenditures for World Bank or the International
a given fiscal year and serves as a reflection of the Monetary Fund (IMF).
government's economic priorities.
 Non-Debt Capital Receipts: These do not
2. Components of the Budget involve borrowing and include:
o Sale of Government Assets:
The Budget consists of two primary components: Revenue from selling assets like
Receipts and Expenditures. land, buildings, or public sector
enterprises.
Receipts refer to the total amount of money the o Recovery of Loans: Money
government expects to collect during the fiscal year. recovered from loans previously
Expenditures represent how the government plans to granted by the government.
spend that money to achieve its policy goals.
2.4 Expenditure
2.1 Receipts
Expenditure refers to the money spent by the
Budget receipts can be classified into two categories: government. It can be classified into:

 Revenue Receipts: Regular and recurring  Revenue Expenditure: Recurring

income generated from taxes, duties, fees, expenditures necessary for the day-to-day
and other government services. functioning of the government and provision
 Capital Receipts: Non-recurring income of public services. This includes:
sources like borrowings and sales of o Salaries of Government
government assets. Employees
o Maintenance Costs: Running costs
2.2 Revenue Receipts for government offices,
infrastructure, etc.
o Welfare Schemes: Government
Revenue receipts are the core of the government's
annual income, typically recurring and based on spending on programs like
taxes and fees. These can be further divided into: healthcare, education, subsidies,
etc.
 Tax Revenue: Money collected from
individuals, corporations, and businesses.  Capital Expenditure: Long-term
Taxes are categorized into: investment in infrastructure and
o Direct Taxes: Taxes levied on development programs. These expenditures
income or wealth, such as Income are meant to create assets for the future,
Tax, Wealth Tax, Corporate Tax. such as:
o Indirect Taxes: Taxes levied on o Infrastructure Projects: Roads,
goods and services, such as Sales bridges, public buildings, etc.
Tax, Value Added Tax (VAT), and o Public Investment: Spending on
Customs Duties. public enterprises, development
schemes, etc.
 Non-Tax Revenue: Income generated by
the government from non-tax sources like: 3. Types of Budget
Based on the balance between government receipts 4.1 Consolidated Fund of India (Article 266)
and expenditures, the budget can be classified into
several types: This is the main fund of the Indian government used
for regular governmental expenses, except for
3.1 Balance Budget exceptional items. Sources include tax revenue,
borrowings, and sale of assets. Expenditure from
A balanced budget occurs when the government's this fund requires Parliament approval, except for
estimated receipts equal its estimated expenditure. "charged" expenses like salaries of constitutional
This means the government does not plan to borrow authorities.
money.
4.2 Public Account of India (Article 266(2))
3.2 Surplus Budget
Funds in this account do not belong to the
In a surplus budget, the government's estimated government but are held on behalf of others, such as
receipts exceed its expenditures, allowing it to save provident funds or small savings. These funds must
or pay off debts. This typically indicates a financially be returned to their rightful owners. Expenditure
healthy government. from this fund does not require Parliament
approval.
3.3 Deficit Budget
4.3 Contingency Fund of India (Article 267(1))
A deficit budget occurs when the government's
estimated expenditures exceed its receipts, The Contingency Fund is used for unforeseen
necessitating borrowing to cover the shortfall. This is expenditures that cannot wait for Parliament
common during times of economic distress or when approval. The fund is at the disposal of the President,
large investments are needed. with a limit of INR 30,000 crore. Expenditures are
later replenished by Parliament approval.
3.4 Performance Budget
5. Budget Deficits and Their Types
A performance budget allocates funds based on
specific outcomes and the effectiveness of Deficits are important indicators of a government’s
government programs. It focuses on achieving financial health.
measurable results.
5.1 Revenue Deficit
3.5 Zero-Based Budget
Revenue Deficit is the difference between Revenue
A zero-based budget starts from zero every year, Expenditure and Revenue Receipts:
requiring each department to justify its budget
allocation based on its needs, rather than using the  Formula: Revenue Deficit = Revenue
previous year’s budget as a base. Expenditure - Revenue Receipts.

3.6 Incremental Budget 5.2 Fiscal Deficit

An incremental budget builds on the previous year's Fiscal Deficit is the total borrowing required by the
budget, adjusting for inflation, new programs, or government, calculated as the difference between
policy changes. This method often leads to total expenditure and total receipts (excluding
inefficiencies as past spending is taken as a given. borrowings).

3.7 Gender Budget  Formula: Fiscal Deficit = Total Expenditure -

Total Receipts (excluding borrowings).
A gender budget assesses how different government
policies and expenditure plans impact men and 5.3 Primary Deficit
women. It aims to ensure that both genders are
considered in policy formulation, with a focus on The Primary Deficit excludes interest payments on
empowering women and addressing gender-based past borrowing. It’s an indicator of how much the
inequalities. government needs to borrow to meet its current
obligations.
3.8 Outcome Budget
 Formula: Primary Deficit = Fiscal Deficit -
An outcome budget focuses on the impact of Interest Payments.
government programs on the population. Unlike
traditional budgets that emphasize inputs (money 5.4 Effective Revenue Deficit
allocated), outcome budgets track the results
achieved from those investments.
This is a refined measure of Revenue Deficit,
focusing only on unproductive expenditure.
4. Types of Funds
 Formula: Effective Revenue Deficit =
Funds in public finance are classified based on their
Revenue Deficit - Grants for Capital Assets.
purpose and nature.
5.5 Budget Deficit  External Commercial Borrowings (ECBs):
Loans from international banks (15-18%).
The Budget Deficit reflects the difference between  Sovereign Bonds: Bonds issued in
total government expenditure and total receipts. It international markets (22-25%).
indicates how much the government needs to borrow.
8. Debt-to-GDP Ratio
 Formula: Budget Deficit = Total Expenditure
- Total Receipts. This ratio compares a country's total debt to its GDP,
providing an indicator of economic health. A higher
6. Public Debt ratio signals potential instability and may lead to
inflation and reduced spending on public welfare.
Public debt refers to the borrowing done by the
government to finance its deficits. It can be classified 9. Public Expenditure Management
into:
Public Expenditure Management (PEM) ensures
6.1 Internal Debt efficient and responsible use of government funds,
aiming to:
 Borrowed from domestic sources, such as
 Maintain Fiscal Discipline: Aligning
commercial banks, individuals, non-
expenditures with revenues.
banking financial institutions, and the
 Ensure Allocative Efficiency: Allocating
Reserve Bank of India (RBI).
resources based on strategic goals.
 Achieve Operational Efficiency: Providing
6.2 External Debt services effectively and economically.

 Borrowed from foreign governments or 10. Challenges in Public Expenditure

international agencies like the World Bank, Management
IMF, or foreign commercial banks.
1. Fiscal Deficit: Managing increasing
7. Managing Public Debt expenditure demands while adhering to
fiscal discipline.
Government borrows money to fund deficits but 2. Subsidy Burden: Managing the rising costs
needs to manage its public debt carefully to avoid of subsidies like those on fuel, food, and
inflation and reduce interest payments. Excessive fertilizers.
borrowing may have adverse effects on economic 3. Public Sector Enterprises (PSEs): Addressing
stability. inefficiencies in loss-making PSEs.
4. Tax Base: Expanding the tax base and
Components of Domestic Debt improving collection efficiency.
5. Operational Inefficiencies: Overcoming
 Government Securities: Long-term bonds bureaucratic delays and inefficiencies.
(70% of domestic debt).
 Treasury Bills: Short-term debt (5%). 11. The FRBM Act (2003)
 State Development Loans: Loans raised by
state governments (10%). The FRBM Act aims to bring fiscal discipline by
 Small Savings Schemes: Savings schemes setting targets for key fiscal indicators, including the
like PPF (15%). Fiscal Deficit, Revenue Deficit, and Debt-to-GDP
ratio. The act mandates:
Components of External Debt
 Medium-Term Fiscal Policy: Annually
 Multilateral Loans: From institutions like outlining targets for fiscal consolidation.
the World Bank (9-12%).  Fiscal Responsibility: Bringing deficits to
 Bilateral Loans: From foreign governments sustainable levels and promoting inter-
(5-7%). generational equity
 o Example: Excise duties and
Chapter 10: Taxation - service tax are indirect taxes
collected by manufacturers or
Detailed Summary service providers.

Overview of Taxation Cess and Surcharge

Taxation is a critical mechanism through which the 1. Cess:

government generates revenue to fund public goods o Definition: A cess is an additional
and services such as education, healthcare, defense, tax imposed on top of existing
and infrastructure. Taxes are compulsory payments taxes, meant for specific purposes.
levied on individuals, businesses, and organizations, o Examples:
and they play a crucial role in shaping economic  Swachh Bharat Cess (for
policies. cleanliness drive),
 Krishi Kalyan Cess (for
Classification of Taxes agricultural initiatives),
 Health and Education
Cess (for health and
Taxes can be classified in different ways based on
education initiatives).
various criteria like fairness, tax incidence, and
o Impact: Revenue collected from
collection methods:
cesses is typically earmarked for
the specified purpose, such as
1. Based on Fairness (Equity) education or healthcare.
2. Surcharge:
1. Progressive Taxes: o Definition: A surcharge is an
o Definition: These taxes increase as additional tax imposed on
income increases. Higher earners individuals or entities with higher
pay a higher percentage of their income, applied on top of the
income in taxes. regular tax.
o Example: Income tax in India, o Purpose: Aimed at higher earners
where individuals with higher to make the tax system more
incomes are taxed at higher rates. equitable.
2. Regressive Taxes: o Example: A surcharge on income
o Definition: These taxes decrease as tax is applied for individuals with
income increases. Lower-income income above certain thresholds.
earners pay a larger percentage of o Income Range & Surcharge:
their income in taxes compared to  Up to ₹50 lakh: No
higher-income earners. surcharge,
o Example: GST on essential goods  ₹50 lakh to ₹1 crore:
like food and clothing, which 10% surcharge,
consumes a larger portion of the  ₹1 crore to ₹2 crore:
income of low-income individuals. 15% surcharge,
3. Proportional Taxes:  ₹2 crore to ₹5 crore:
o Definition: These taxes remain the 25% surcharge,
same percentage regardless of  Above ₹5 crore: 37%
income, so everyone pays the same surcharge.
proportion of their income in taxes.
o Example: Property tax in India, Taxation in India
where property owners pay the
same percentage of their property’s
The Indian Constitution provides the framework for
value in taxes.
the country’s taxation system, dividing tax powers
between central and state governments.
2. Based on Who Pays the Tax
Key Constitutional Articles Related to Taxation:
1. Direct Taxes:
o Definition: These taxes are directly
 Article 265: No taxation without
levied on individuals or entities and authority. Taxes can only be levied if
cannot be passed on to others. authorized by law.
o Examples: Income tax, corporate  Article 246 (Schedule VII): Distribution of
tax, and capital gains tax. legislative powers between central and state
o Example: An individual earning a governments regarding taxation.
salary must directly pay income  Article 277: Grants from the Union to
tax. certain states for revenue deficiencies.
2. Indirect Taxes:  Article 279A: Goods and Services Tax
o Definition: These taxes are levied (GST). Establishes the GST Council.
on goods and services, collected by  Article 243G and 243W: Grants local
intermediaries (businesses) and bodies such as Panchayats and
passed on to the final consumer. Municipalities the power to levy taxes,
o Example: GST, which businesses duties, tolls, and fees.
collect from consumers when they
sell goods and services. Direct Taxes in India
Direct taxes are levied on income, wealth, and capital  Description: A comprehensive indirect tax
gains. These taxes are directly paid by the taxpayer to levied on the supply of goods and services.
the government. It replaced several indirect taxes like VAT,
service tax, and excise duty.
1. Personal Income Tax:  Levy: Levied jointly by the central
government and state governments.
 Description: Levied on the income earned
by individuals, including salary, rental 2. Excise Duty:
income, business income, and capital gains.
 Progressive System: The tax rate increases  Description: A tax on the manufacture or
with income. production of goods. Levied by the central
 Example: government.
o Income Range:  Example: Excise duty is imposed on the
 Up to ₹3 lakh: Nil, production of goods like alcohol and
 ₹3 lakh to ₹6 lakh: 5%, tobacco.
 ₹6 lakh to ₹9 lakh: 10%,
 ₹9 lakh to ₹12 lakh: 3. Customs Duty:
15%,
 ₹12 lakh to ₹15 lakh:  Description: A tax on the import and export
20%, of goods.
 Above ₹15 lakh: 30%.  Levy: Levied by the central government.
 Example Calculation: If an individual’s
taxable income is ₹8 lakh, they would pay
4. Service Tax:
₹35,000 in income tax.

 Description: A tax on the provision of

2. Corporate Tax:
specific services.
 Levy: Levied by the central government.
 Description: Tax levied on the profits of
companies and corporations.
5. Value Added Tax (VAT):
 Rates:
o For turnover up to ₹400 crore:
25%,  Description: Tax on the value added at each
o For turnover above ₹400 crore: stage of the supply chain, levied by state
30%. governments.
 Example: A company with a ₹50 crore  Example: VAT is applicable to products
profit would pay ₹12.5 crore in corporate sold within states.
tax at a 25% rate.
6. Other State Levies:
3. Minimum Alternate Tax (MAT):
 Entertainment Tax: Levied by states on
 Description: MAT ensures that companies entertainment services like cinema tickets.
which are exempt from taxes or pay very  Luxury Tax: Levied by states on luxury
low tax due to exemptions pay a minimum goods like high-end hotel stays.
amount of tax.
 Rate: MAT is levied at 15% of the book Other Taxes in India
profits.
 Example: If a company has ₹1 crore in 1. Wealth Tax: Tax on an individual’s net
book profit but ₹50 lakh taxable income, wealth. Abolished in 2016.
they will pay ₹15 lakh MAT if it’s higher 2. Fringe Benefits Tax: Tax on non-monetary
than the regular tax liability. benefits provided by employers. Abolished
in 2009.
4. Capital Gains Tax: 3. Gift Tax: Tax on gifts received. Abolished
in 1998.
 Description: Tax on profits from the sale of 4. Estate Duty: Tax on the assets left by a
capital assets like land, stocks, and bonds. deceased person. Abolished in 1985.
 Types: 5. Property Tax: Levied by state governments
o Short-Term Capital Gains on real estate.
(STCG): Levied on assets held for 6. Profession Tax: Levied by state
less than 36 months. governments on professionals’ income.
o Long-Term Capital Gains
(LTCG): Levied on assets held for Goods and Services Tax (GST):
more than 36 months.
 Example: A ₹20 lakh profit from selling  Introduction:
land bought for ₹50 lakh will be taxed as o GST was introduced in India on
capital gains. July 1, 2017, to streamline the
taxation process by replacing
Indirect Taxes in India various indirect taxes (such as
VAT, excise duty, and service tax)
Indirect taxes are collected by intermediaries (such as with a single unified tax. GST is
businesses) and passed on to the final consumer. applied to the value added at
each stage of the supply chain,
1. Goods and Services Tax (GST):
 and the ultimate tax burden is  Rationalization of Tax Rates:
borne by the consumer. o GST aims to standardize tax rates
across the country, simplifying
 Types of GST: the process for businesses and
o CGST (Central Goods and consumers, and reducing the
Services Tax): Levied by the compliance burden.
central government on intra-
state supply of goods and  Increase in Tax Revenue:
services. o GST increases transparency,
o SGST (State Goods and Services improves the tax base, and leads
Tax): Levied by state to better compliance, thus
governments on intra-state boosting government tax
supply of goods and services. revenue.
o IGST (Integrated Goods and
Services Tax): Levied by the Compensation to States:
central government on inter-
state supply of goods and  GST Compensation Mechanism:
services. o To protect state governments
o UTGST (Union Territory Goods from revenue losses due to the
and Services Tax): Levied by shift to GST, a compensation
Union Territory governments on mechanism was put in place.
intra-state supply of goods and States are compensated for any
services in Union Territories. revenue shortfall compared to
projected growth rates for the
 GST Council: first five years of GST
o A constitutional body that implementation (until 2022).
oversees the implementation and o The compensation is funded
administration of GST. It is through the GST Compensation
headed by the Union Finance Cess, which is a levy on specific
Minister and includes Finance goods and services falling under
Ministers from all the states and the highest tax slabs.
Union Territories. The GST
Council is responsible for making Challenges with GST:
recommendations on the tax
rates, exemptions, and other key
 Technical Glitches in GST Network:
matters related to GST.
o The GST Network (GSTN), the IT
infrastructure supporting GST,
Benefits of GST: has faced technical issues since
its inception, causing delays in
 Simplification of Tax Administration: filing returns and compliance-
o GST simplifies the tax process by related challenges.
consolidating multiple indirect  Compliance Burden for Small
taxes into one single tax, Businesses:
reducing confusion and o Small businesses with limited
administrative burdens. resources face difficulties in
complying with GST's complex
 Reduction in Tax Evasion: regulations, adding to their
o The unified nature of GST makes operational costs and time
it harder for businesses to evade investment.
taxes, as it is closely monitored  Revenue Loss for Some States:
by both central and state o Some states, particularly those
governments, and is fully that relied heavily on taxes like
integrated into the formal Sales Tax or VAT, have faced
economy. revenue losses under the new
GST regime, which has created
 Boost to Economic Growth: fiscal challenges for these states.
o GST facilitates a more
competitive business Recent Tax Reforms:
environment by reducing
transaction costs and enabling 1. Long-Term Capital Gains (LTCG) Tax:
easier cross-border trade, which o Reintroduction in Budget
leads to overall economic growth. 2018: A 10% tax is levied on
long-term capital gains (above
 Reduction in Cascading Tax Effect: Rs. 1 lakh) from the sale of listed
o Under the previous tax regime, securities or equity mutual funds
businesses had to pay taxes on held for more than one year.
taxes (cascading effect). With o Example: If an individual invests
GST, businesses can claim input Rs. 100,000 in shares, and after
tax credit for taxes paid on one year the shares rise to Rs.
purchases, reducing the 150,000, the capital gain of Rs.
cascading effect. 50,000 will be taxed at 10%.
 2. Dividend Distribution Tax (DDT) o Tax breaks for businesses
Abolished: investing in renewable energy.
o Budget 2020: The government o Tax deductions for research and
abolished DDT, which was development activities.
previously levied on companies
distributing dividends. Now, the  Benefits:
tax liability for dividends falls on o Stimulates economic activity and
the recipient, based on their incentivizes behavior that aligns
individual income tax slab. with government policy
o Example: A shareholder who objectives (e.g., renewable
receives a dividend of Rs. 10,000 energy investment).
will pay tax based on their tax o Reduces the tax burden for
bracket, instead of the company individuals and businesses,
paying DDT. promoting higher spending and
investment.
3. Equalization Levy (Google Tax):
o This tax is imposed on digital  Criticisms:
services provided by foreign o Selective Benefits: Tax
companies (like online expenditure can
advertising or digital content disproportionately benefit
streaming) to Indian businesses certain sectors or individuals,
or consumers. It ensures foreign creating inequality.
companies contribute to India's o Revenue Loss: Excessive tax
tax revenue. breaks can result in a significant
loss of government revenue.
Tax-GDP Ratio: o Complexity: The presence of
numerous exemptions and
 Definition: The Tax-GDP ratio measures deductions can create loopholes,
the total tax revenue collected by the enabling tax avoidance.
government as a percentage of the
country's Gross Domestic Product (GDP). Tax Evasion vs. Tax Avoidance:
 India’s Tax-GDP Ratio:
o India's tax-GDP ratio has been
 Tax Evasion:
relatively low. For 2020-21, it o Illegal methods of avoiding tax
stood at 9.9%, significantly lower
(e.g., underreporting income,
than developed nations like the
hiding assets, claiming false
US (25-30%).
deductions).
o Example: A business declaring
 Reasons for Low Tax-GDP Ratio: Rs. 30 lakh in revenue while
o Large Informal Sector: A large actually earning Rs. 50 lakh.
portion of the Indian economy  Tax Avoidance:
remains unregistered and doesn't o Legal methods to reduce tax
contribute to tax revenue. liability through deductions,
o Tax Evasion: Many individuals exemptions, or investments in
and businesses underreport tax-saving schemes.
income or fail to file taxes. o Example: Investing in a tax-
o Low Compliance: The saving instrument (like PPF) to
complexity of the tax system and reduce taxable income.
bureaucratic hurdles discourage  Key Difference: Tax evasion is illegal and
tax compliance. punishable by law, while tax avoidance is
legal, though controversial at times.
 Government Initiatives to Improve
Tax-GDP Ratio: Black Money:
o Simplifying tax systems (e.g.,
GST).  Definition: Black money refers to income
o Using technology to improve tax or assets that are earned through illegal
administration. means and are not reported to the
o Expanding the tax base and government for tax purposes.
reducing evasion through  Sources of Black Money:
voluntary disclosure schemes o Underreporting of income.
and crackdowns on tax fraud. o Bribery and corruption.
o Money laundering and hawala
Tax Expenditure: transactions.

 Definition: Tax expenditure refers to  Impact on the Economy:

revenue losses incurred by the o Loss of Tax Revenue: Reduces
government due to provisions in the tax government revenue, leading to
code that provide exemptions, budget deficits.
deductions, credits, or deferrals to o Distortion of Economic Data:
taxpayers. Black money is not recorded in
 Examples: official economic statistics,
 leading to inaccuracies in GDP money laundering and exchange
calculations. financial information.
o Unfair Competition: Legal
businesses suffer as tax-evading Tax Haven:
businesses can operate at lower
costs.  Definition: Tax havens are jurisdictions
with low or zero tax rates used by
 Government Initiatives: individuals or corporations to avoid
o Demonetization (2016): Aimed higher taxes in their home countries.
to eliminate unaccounted cash  Countermeasures:
and force the deposit of black o Tax Treaties: Countries sign
money into the banking system. agreements to exchange tax-
o Voluntary Disclosure Schemes: related information and prevent
Allowed individuals and tax evasion.
businesses to declare unreported o Taxation of Controlled Foreign
income without fear of Corporations (CFCs):
prosecution. Companies controlled by
o Benami Transactions residents of another country but
(Prohibition) Act: Targets based in a tax haven are taxed.
properties held in others' names o Blacklisting: Countries that
to conceal ownership and evade don't cooperate with tax
taxes. regulations may be blacklisted
o GST Implementation: Expanded and face sanctions.
the formal tax base and reduced
evasion. Indirect Transfers:

Money Laundering:  Definition: Transactions where

ownership of a company’s shares is
 Definition: Money laundering is the transferred, but the value comes from
process of disguising illicitly gained underlying assets located in a different
money as legitimate, to avoid detection by country, potentially evading tax liabilities.
authorities.  Example: Vodafone’s acquisition of
 Stages of Money Laundering: Hutchison Essar in 2007, where the real
1. Placement: Introducing illicit value of assets lay in India, but the
funds into the financial system transaction involved shares of a Hong
(e.g., depositing cash in banks). Kong-based company. Indian authorities
2. Layering: Concealing the source argued that the transfer of Indian assets
through complex transactions should be taxed.
(e.g., transferring money
between accounts). Global Taxation Agreements:
3. Integration: Reintroducing the
laundered money into the
 Double Taxation Avoidance Agreement
legitimate economy (e.g., buying
(DTAA):
assets or starting businesses).
o A treaty between two countries
that prevents the same income
 Modern Methods: from being taxed twice.

o Cryptocurrency: Digital  Base Erosion and Profit Shifting

currencies like Bitcoin provide (BEPS):
anonymity and facilitate cross- o A set of guidelines developed by
border transactions. the OECD to prevent
o Online Payment Systems: multinational companies from
Payment platforms can be exploiting tax loopholes.
exploited for moving illicit funds.
o Offshore Accounts: Using tax
 Global Minimum Tax:
havens to disguise ownership of o A proposed tax to ensure that
funds.
multinational companies pay a
minimum level of tax on their
 Government Measures: profits, regardless of where they
o Prevention of Money are located.
Laundering Act (PMLA):
Provides a legal framework to  Advance Pricing Agreement (APA):
combat money laundering. o A pre-agreed pricing structure
o KYC (Know Your Customer)
between tax authorities and a
Norms: Financial institutions taxpayer to prevent disputes
must verify customer identities over transfer pricing.
to prevent illegal transactions.
o International Cooperation:
 General Anti-Avoidance Rule (GAAR):
India cooperates with global
o A provision in Indian law that
bodies like FATF to combat
allows tax authorities to
recharacterize transactions
designed primarily for tax avoidance.
Chapter 11: Banking
Introduction to Banking:  Financial Inclusion: Initiatives like the
Pradhan Mantri Jan Dhan Yojana
 Definition: A bank is a financial institution (PMJDY) were launched to ensure financial
that accepts deposits from individuals and inclusion, promoting access to banking
organizations and provides loans, credit, and services for all households in India,
other financial services to its customers. especially in rural areas.
Banks are intermediaries in the financial
system that promote economic growth by Primary Functions of Banks:
facilitating financial transactions. They
ensure the smooth functioning of the 1. Accepting Deposits:
economy by managing money flow, offering
credit, and supporting the payment system.  Banks offer various types of deposit
accounts such as:
Evolution of Banking in India: o Savings Accounts: Allow
customers to save money and earn
Pre-independence: interest.
o Current Accounts: Primarily for
 First Bank: The first bank in India, the business use, without interest, but
Bank of Hindustan, was established in allows for frequent transactions.
1770 by European merchants. This marked o Fixed Deposits (FDs): Customers
the beginning of the organized banking deposit money for a fixed tenure at
system in India. an interest rate.
 Foreign Banks: The British Empire  Importance: These deposits provide banks
controlled banking in India, and several with the capital needed for lending and
foreign banks established branches in India, investments, forming the basis for their
including the Bank of Bengal, Bank of operations.
Bombay, and Bank of Madras, which were
later merged into the Imperial Bank of 2. Providing Loans:
India (now State Bank of India).
 Indian Entrepreneurs: In the late 19th  Banks lend money to individuals,
century, Indian entrepreneurs like Lala businesses, and governments for various
Lajpat Rai and Baba Khem Singh Bedi purposes, such as:
began establishing banks to cater to the o Personal Loans: Unsecured loans
needs of the Indian population. Notable
to individuals.
examples include the Punjab National
o Home Loans: Financing for
Bank (founded in 1894) and the Bank of
purchasing homes.
India.
o Business Loans: For small and
medium-sized enterprises (SMEs).
Post-independence (1947-1991): o Car Loans: Loans for buying
vehicles.
 Nationalization of Banks: After  Importance: Loans provide credit to the
independence, the Indian government economy, fueling consumption and business
nationalized several foreign-owned banks to investment.
promote Indian control over the banking
sector. For example, the Imperial Bank of
Secondary Functions of Banks:
India became the State Bank of India in
1955.
 Developmental Banks: The government 1. Providing Financial Advice:
established banks such as the Industrial
Development Bank of India (IDBI) and  Banks offer expert advice on investments,
NABARD (National Bank for Agriculture tax planning, retirement planning, and
and Rural Development) to support insurance.
industrial and agricultural development.  They may recommend products like mutual
 Regulation and Control: The banking funds, bonds, or life insurance.
system was highly regulated, with interest
rates and lending practices controlled by the 2. Issuing Credit and Debit Cards:
government, which limited innovation and
access to credit.  Banks provide customers with credit and
debit cards, enabling cashless transactions.
Post-1991 Liberalization:  Credit cards allow individuals to borrow
money for purchases, while debit cards
 Economic Reforms: Starting in the 1990s, deduct funds directly from a customer's
economic liberalization led to significant bank account.
reforms in the banking sector. Private sector
banks were allowed to operate, and foreign 3. Safe Deposit Boxes:
banks were permitted to expand their
operations.
  Banks offer safe deposit boxes where  Role: These banks play a crucial role in
customers can store valuables like financial inclusion, offering services to rural
documents, jewelry, or other important and low-income groups.
items securely.
Private Sector Banks:
4. Foreign Exchange Services:
 Ownership: Owned by private shareholders
 Banks provide currency exchange services and entities.
for customers traveling abroad or for  Examples: HDFC Bank, ICICI Bank,
businesses dealing in international trade. Axis Bank, Kotak Mahindra Bank.
 They facilitate buying and selling of foreign  Role: These banks focus on profit-driven
currencies and manage remittances. strategies while also adhering to regulatory
oversight from the RBI.
Bank's Balance Sheet:
Foreign Banks:
 Assets:
o Cash: Physical currency the bank  Definition: Banks that are headquartered
holds. outside India but operate branches in India.
o Loans: The amount loaned out to  Examples: HSBC, Citibank, Standard
individuals, businesses, or Chartered Bank.
governments.  Regulation: These banks must comply with
o Investments: Banks invest in the regulations of the RBI just like Indian
government bonds, equities, and banks.
other financial instruments.
o Other Assets: Includes buildings, Regional Rural Banks (RRBs):
equipment, etc.
 Liabilities:  Purpose: These banks cater to rural areas by
o Deposits: Money deposited by providing loans for agriculture and rural
customers in savings, current, and development.
fixed accounts.  Ownership: Jointly owned by the central
o Borrowings: Loans and credit government (50%), state governments
received from other banks or (15%), and sponsor banks (35%).
financial institutions.  Examples: Baroda Uttar Pradesh Gramin
o Bank's Capital: Equity capital Bank, Bihar Gramin Bank.
invested by shareholders.
o Other Liabilities: Includes bills, Small Finance Banks:
short-term borrowings, etc.
 Purpose: These banks focus on providing
Classification of Banks in India: financial services like loans and deposits to
underserved sectors such as small farmers,
1. Scheduled Banks: micro-enterprises, and the unorganized
sector.
 Definition: Banks listed in the 2nd  Capital Adequacy: Minimum 15% capital
Schedule of the RBI Act, 1934. adequacy ratio, and 75% of loans must be
 Regulation: They are required to follow directed toward priority sectors.
RBI’s guidelines, including maintaining a  Examples: AU Small Finance Bank,
specified Cash Reserve Ratio (CRR). Capital Small Finance Bank.
 Examples: State Bank of India, HDFC
Bank, ICICI Bank, Axis Bank. Payment Banks:

2. Non-Scheduled Banks:  Purpose: These banks offer payment

services without the ability to lend or issue
 Definition: Banks not listed in the 2nd credit cards.
Schedule of the RBI Act.  Focus: Providing services to low-income
 Regulation: They must adhere to basic RBI customers, especially in rural areas, through
norms but are not subject to the same mobile and digital banking.
regulatory framework as scheduled banks.  Examples: Airtel Payments Bank, Fino
 Examples: Ujjivan Small Finance Bank, Payments Bank, Paytm Payments Bank.
Janalakshmi Financial Services.
Co-operative Banks:
Types of Banks in India:
 Ownership: Owned by their members who
Public Sector Banks: pool resources for mutual benefit.
 Types: Urban Cooperative Banks
(operating in cities) and Rural Cooperative
 Ownership: Majority (over 50%) of the
Banks (operating in rural areas).
shares are owned by the government.
 Examples: Various regional cooperative
 Examples: State Bank of India, Punjab
banks.
National Bank, Bank of India, Canara
Bank.
Non-Banking Financial Companies (NBFCs):
  Definition: Financial institutions that Feature Bank NBFC
provide various services such as loans, may not have
credit, and investment advice without Lending priority sectors.
such obligations
holding a banking license.
 Key Difference: Unlike banks, NBFCs
All India Financial Institutions (AIFIs):
cannot accept demand deposits but rely on
time deposits, borrowings, and issuing
bonds for funding. AIFIs are institutions created by the Indian
 Regulation: While NBFCs are regulated by government to provide long-term funding to key
the RBI, their guidelines are different from sectors of the economy, particularly infrastructure,
those of traditional banks. agriculture, housing, and small-scale industries.
These institutions are government-owned and operate
at the national level to support critical areas of
Types of NBFCs:
economic growth.

1. Asset Finance Companies (AFCs): Provide

Key AIFIs in India:
financing for purchasing physical assets like
vehicles or machinery.
o Example: Shriram Transport 1. Small Industries Development Bank of India
Finance. (SIDBI):
2. Investment Companies (ICs): Primarily
focus on securities like stocks and bonds.  Establishment: SIDBI was established in
o Example: Bajaj Capital. 1990 by an Act of Parliament to support and
3. Loan Companies (LCs): Specialize in promote the Micro, Small, and Medium
providing loans to individuals and Enterprises (MSME) sector in India.
businesses.  Objective: SIDBI's primary role is to
o Example: Bajaj Finserv. provide financial and non-financial
4. Infrastructure Finance Companies assistance to MSMEs, which are pivotal to
(IFCs): Focus on financing infrastructure India's economic growth by generating
projects like roads, bridges, and power employment and contributing to the GDP.
plants.
o Example: L&T Infrastructure Services Offered by SIDBI:
Finance.
5. Microfinance Companies (MFIs): Provide 1. Direct Financing:
small loans to low-income individuals and o Loans and Credit Facilities:
businesses. SIDBI offers working capital loans,
o Example: Bandhan Bank. term loans, project financing, and
6. Systemically Important Core Investment equipment financing. These are
Companies (CICs): Large, interconnected tailored to the needs of MSMEs at
NBFCs with stricter regulations. various stages of their lifecycle.
o Example: Aditya Birla Financial 2. Refinancing:
Services. o Refinancing of Banks and
Financial Institutions: SIDBI
Difference Between Banks and NBFCs: provides refinancing services to
banks and other financial
institutions that lend to MSMEs,
Feature Bank NBFC
increasing the availability of credit
Licensed to accept Provides financial and reducing borrowing costs for
Definition deposits and make services without a MSMEs.
loans. banking license. 3. Developmental Services:
Regulated by the Regulated by the o Non-financial Support: SIDBI
RBI with RBI with also offers services like training,
Regulation
comprehensive different capacity-building, technology
guidelines. guidelines. upgradation, market development
Deposit Can accept Cannot accept assistance, and support for export
Acceptance demand deposits. demand deposits. promotion.
Deposits are 4. Venture Capital:
Deposit Deposits are not
usually insured by o SIDBI Venture Capital Limited
Insurance insured.
DICGC. (SVCL): SIDBI has a subsidiary
Part of the Cannot issue for providing venture capital and
Payment and
payment system cheques and is private equity financing to
Settlement
and can issue not part of the innovative and high-growth
System
cheques. payment system. MSMEs.
Branching Subject to stricter
More lenient 5. Microfinance:
Norms branching norms. branching norms. o Promotion of Microfinance
Lower capital Institutions (MFIs): SIDBI has
Capital Higher capital requirements worked towards the growth of
Requirement requirements. compared to MFIs that provide credit and other
banks. financial services to low-income
May have More lenient households and small businesses,
Foreign restrictions on foreign especially in rural and semi-urban
Investment foreign investment areas.
investment. norms.
Priority Sector Banks must lend to NBFCs may or
2. National Bank for Agriculture and Rural 5. Advisory Services:
Development (NABARD): o Exim Bank offers services like
market intelligence, export
 Establishment: NABARD was established counseling, and trade information
in 1982 by the Government of India as an to help Indian businesses expand
apex development bank focused on internationally.
agriculture and rural development.
 Objective: NABARD supports financial and 4. National Housing Bank (NHB):
developmental initiatives in agriculture,
rural entrepreneurship, and the rural  Establishment: NHB was created in 1988
livelihood sector. under the National Housing Bank Act to
promote and support the housing finance
Key Areas of NABARD's Focus: sector in India.

1. Agriculture Credit: Key Functions of NHB:

o NABARD provides credit facilities
to farmers and rural entrepreneurs 1. Refinancing:
through commercial banks, o NHB provides refinancing services
regional rural banks, and co- to banks and housing finance
operative banks, enabling them to companies (HFCs) to increase their
meet their financial needs. capacity to provide housing loans
2. Rural Infrastructure Development: to individuals and businesses.
o Funding for Infrastructure: 2. Regulation of Housing Finance
NABARD supports the Companies:
construction of rural infrastructure o NHB sets standards for the
like roads, irrigation systems, operations of HFCs, including
bridges, and other essential minimum capital requirements and
facilities. prudential lending norms.
3. Microfinance: 3. Technical Assistance:
o NABARD finances microfinance o NHB offers technical support to
institutions (MFIs) that provide housing finance companies and
financial services to small-scale conducts research on housing
businesses and low-income development.
individuals in rural areas.
4. Sustainable Livelihoods:
5. Micro Units Development and Refinance
o NABARD supports sustainable
Agency (MUDRA):
rural livelihoods by promoting
agricultural projects, fisheries, and
other rural businesses, helping  Establishment: Launched in 2015,
improve productivity and income MUDRA aims to provide financial support
for rural households. to small and micro-businesses, which often
struggle to access loans from traditional
banks.
3. Export-Import Bank of India (Exim Bank):
Loan Categories:
 Establishment: Exim Bank was set up in
1982 by the Government of India to
facilitate international trade by providing 1. Shishu Loans:
financial assistance and advisory services to o Loans up to Rs. 50,000 for
Indian exporters and importers. businesses in the initial stages.
2. Kishor Loans:
o Loans ranging from Rs. 50,000 to
Services Provided by Exim Bank:
Rs. 5 lakh for established
businesses needing additional
1. Pre-shipment and Post-shipment Finance: capital.
o Exim Bank provides funding for 3. Tarun Loans:
exporters before and after shipment o Loans ranging from Rs. 5 lakh to
to ensure that they have the Rs. 10 lakh for well-established
necessary capital to carry out trade businesses aiming for significant
operations. growth.
2. Export Credit Guarantees:
o The bank offers export credit
 Unique Feature: MUDRA loans do not
guarantees to protect Indian
require collateral or a guarantor, making it
exporters from the risk of non-
easier for small entrepreneurs to access
payment by foreign buyers.
finance.
3. Overseas Investment Finance:
o Exim Bank offers finance for
Indian companies looking to invest Understanding the Financial Position of a Bank:
in foreign markets.
4. Lines of Credit: Bank Run:
o The bank provides lines of credit to
foreign governments and entities,  A bank run occurs when a large number of
supporting India's trade and depositors withdraw their money due to
investment interests. fears that the bank may not be able to fulfill
 its obligations. If not handled properly, it  India, through the RBI, has adopted Basel I,
can lead to a bank failure and a financial II, and III norms, ensuring higher capital
crisis. adequacy ratios (12% for public sector
banks, 9% for scheduled commercial banks),
Capital Adequacy Ratio (CAR): better risk management, and more stringent
liquidity requirements.
 CAR is a measure of a bank's financial  The RBI has also implemented the
strength. It is the ratio of a bank’s capital to Liquidity Coverage Ratio (LCR) and Net
its risk-weighted assets and ensures that Stable Funding Ratio (NSFR) for Indian
banks have enough capital to absorb losses. banks.

CAR Formula: Non-Performing Assets (NPAs):

CAR=Tier I Capital+Tier II CapitalRisk-Weighted A  NPAs are loans where the borrower fails to
ssets\text{CAR} = \frac{\text{Tier I Capital} + \ repay for 90 days or more, and the loan
text{Tier II Capital}}{\text{Risk-Weighted stops generating income for the bank.
Assets}}CAR=Risk-Weighted AssetsTier I Capital+
Tier II Capital Categories of NPAs:

 Tier I Capital: Core capital like equity and 1. Sub-Standard Assets: NPAs for less than
reserves. 12 months.
 Tier II Capital: Secondary sources like 2. Doubtful Assets: NPAs for more than 12
subordinated debt and general provisions. months.
3. Loss Assets: Assets deemed uncollectable
Example: If a bank has Tier I Capital of Rs. 100 by the bank.
crore, Tier II Capital of Rs. 50 crore, and Risk-
Weighted Assets of Rs. 1000 crore, the CAR would  NPA Ratio is used to measure the level of
be 15%. NPAs in banks:
NPA Ratio=Gross NPAsGross Advances\
Basel Norms: text{NPA Ratio} = \frac{\text{Gross
NPAs}}{\text{Gross
Advances}}NPA Ratio=Gross AdvancesGro
 Basel Norms are international banking ss NPAs
regulations that ensure financial stability by
setting requirements for capital, risk
management, and liquidity. NPA Crisis in India:

Basel I (1988):  Causes:

o Economic slowdown, fraud,
inadequate risk management, and
 Introduced minimum capital lack of credit discipline contributed
requirements, where banks must hold to the rise in NPAs.
capital equal to 8% of their risk-weighted  Adverse Effects:
assets. o Reduced profits for banks, hindered
credit growth, and compromised
Basel II (2004): public trust in the banking sector.

 Introduced three pillars of risk Initiatives to Tackle NPAs:

management:
1. Minimum Capital Requirements
1. Debt Recovery Tribunals (DRTs): Set up
2. Supervisory Review: Assessing
in 1993 to expedite recovery processes.
risk management and internal
2. Lok Adalats: Informal dispute resolution
controls.
through mediation.
3. Market Discipline: Disclosures to
3. SARFAESI Act (2002): Allows banks to
the public about banks' risk
seize and sell assets of defaulters without
profiles.
going to court.
4. Asset Reconstruction Companies (ARCs):
Basel III (2010): Help banks clean up their balance sheets by
buying bad loans at a discount.
 Strengthened Capital Requirements: 5. Mission Indradhanush (2015): A
Banks must hold higher-quality capital. comprehensive plan to reduce NPAs in
 Liquidity Coverage Ratio (LCR): Ensures public sector banks.
banks can meet short-term obligations. 6. Insolvency and Bankruptcy Code (2016):
 Net Stable Funding Ratio (NSFR): Provides a structured process for bankruptcy
Ensures banks have stable funding for long- resolution.
term obligations. 7. Bad Bank (2020): A platform for
 Leverage Ratio: Measures a bank’s capital purchasing bad loans from banks at a
against its total exposure, providing a discounted price.
backstop to risk-weighted measures.
Committees on Banking Sector Reforms:
India and Basel Norms:
1. Narasimham Committee I (1991):
Recommended liberalization of the banking
 sector, reduction in SLR and CRR, and 4. Khan Committee (2012): Addressed
establishment of ARCs. governance issues in public sector banks.
2. Narasimham Committee II (1998): 5. Nayak Committee (2014): Proposed
Focused on reducing government ownership restructuring the governance of public sector
in banks and improving recovery methods. banks with an autonomous body overseeing
3. Rangarajan Committee (1998): Focused appointments and performance evaluations.
on enhancing priority sector lending.