Introduction

Parts of the UPSC syllabus

1. Indian economy
2. Indian society and social justice
3. Geo+Environment and ecology
4. Polity and governance
5. Science and tech
6. History + Art and culture
7. Ethics
8. International relations
9. Internal security
10. Disaster management
11. Current affairs
Prelims is a recognition test. There’s a difference between writing the correct answer and recognising the
correct answer.
Sources must be limited and reading unlimited.
Syllabus tells what UPSC expects from you and PYQs tell what you can expect from UPSC
For optimum benefit of the class, presence in the class and continuous revision of notes is required
How to read PYQs:
1. Read PYQs and mention topics next to them
2. After the subject is completed attempt the PYQs → Identify the grey areas
3. Work on the grey areas
Pre and main exam questions will be given after the chapter completion. Get it checked on the app
Main exam answer writing
Take off and landing analogy for the Main exam answers. Both start and end of the answer must be soft
and smooth.
Three aspects of an answer
1. Content
Kitchen masala analogy for knowledge and contents in a question.
2. Structure
3. Presentation
 underline and put keywords in box
 Draw diagrams
Tailwords can be divided primarily into two categories— descriptive and analytical

Division of newspaper notes

1. General news
2. Market and economy
3. Science and tech
4. Places in news
5. People in news
6. Awards
7. Books and authors

Page | 1
 8. Sports

Root word and origin

 Oikonomia = Oikos(Household) + Nomos(Management)
The word economics is derived from a Greek word ‘Oikonomia’. The word is a combination of two other
Greek words oikos and nomos. Oikos means household or family. Whereas nomos means management
hence Oikonomia means household management. It refers to how a family manages its expenditure using
its limited resources.
As economics is derived from the word Oikonomia it can be defined as a discipline or a subject which deals
with the study of the process of household management. However, it is the simplest definition of economics
which is possible. The scope of Economics is much wider than that. In other words, economics can be
defined as a systematic discipline which deals with the study of the process of production, distribution and
consumption of goods and services.
The process of production distribution and consumption of goods and services can be termed as the
economic activities which constitute an economy. Hence, these economic activities or the economy is the
subject matter whereas economics is the subject which deals with study of this subject matter.

Shorts
 Economics from Greek 'Oikonomia': 'oikos' (household) + 'nomos' (management) = household
management
 Economics: At simplest level, study of household management; broader scope includes economic
activities such as production, distribution, and consumption
 Economy: Collective economic activities
 Economics: Study of economic activities/economy

Classification of economics
As a discipline economics can be broadly classified into following two parts—
1. Micro economics
2. Macro economics
This classification of economics into micro and macro was given by a Norwegian economist Ragnar Frisch.
Along with Jan Tinbergen of Holland, Ragnar Frisch was the first recipient of Nobel Prize in economics in
1969. Nobel Prize in economics is its popular name, officially it is termed as Sveriges Riksbank Pirze in
Economic Sciences. Sveriges Riksbank is the central bank of Sweden which is the oldest central bank in
the entire world. When this bank completed three hundred years of its existence on this occasion this award
was announced.
Micro economics and macro economics are different from each other but they are very closely associated
with each other. They both influence each other. Micro is a Greek word which means small and hence
micro economics deals with study of the smaller aspects of the economy. It deals with the study of those
individual units with which the economy is constituted. In other words, micro economics deals with the study
of the economic activities at the level of a family and at the level of a firm. It deals with the study of demand
and supply which are the basic units of economic activities. It also deals with the study of the market where
goods and services are bought and sold.
Macro is another Greek word which means large hence it can be said that macroeconomics deals with the
study of larger aspects of the economy. In other words, macroeconomics deals with the study of economic

Page | 2
activities at the level of the entire society/country/state etc. It includes study of gross domestic product,
national income, economic growth, economic development, economic policies, inflation, unemployment and
so on.
GDP refers to the total value of finally marketable goods and services produced within the boundary of a
country in one financial year.
Shorts
 Classification of economics: Micro and macro by Ragnar Frisch
 Frisch: Recipient of the First Nobel Prize in economics in 1969, along with Jan Tinbergen
 Nobel Prize in economics officially termed as Sveriges Riksbank Prize in Economic Sciences
 Sveriges Riksbank: Oldest central bank, Sweden
 Microeconomics:
 Study of smaller aspects of economy
 Focus: individual units (families, firms)
 Topics: demand, supply, market dynamics
 Macroeconomics:
 Study of larger aspects of economy
 Focus: entire society, country, state
 Topics: GDP, national income, economic growth, development, policies, inflation, unemployment

Economic Growth and Development

Economic growth is a quantitative concept whereas economic development is a qualitative concept.
Quantitative concept means it is related to quantity and change in production whereas qualitative means
something that brings about qualitative change in one’s life.
Economic growth can be defined as increase in GDP over a period of time. For instance, when the
production in any economy increases over a period of time then it’s economic growth.
On the other hand, growth with equity is economic development. Along with increase in production when
equitable redistribution of resources takes place leading to improvement in the standard of living then it is
economic development. When the benefits of increase in production or economic growth reach the common
people then it is economic development. Because of increase in production employment is generated, the
people are made capable enough to procure the necessities of life such as food, shelter, clothes, education
and healthcare then it is termed as economic development.
It can be concluded that economic growth is essential for economic development but only growth cannot be
sufficient in order to ensure development. Development also requires proper redistribution of the resources.
For example, Green Revolution enhanced food grain production in India. It made India food sufficient.
However, even after that starvation continues to exist. It means that India is yet to become food secure. It
can be concluded that because of green revolution economic growth took place but economic development
still lags behind. In terms of GDP India is the fifth largest economy in the world but it is still categorised as a
developing country.
Key economic reforms must focus on increasing productivity, fostering innovation, enhancing infrastructure,
and e suring fiscal discipline. As a FM 1 would priaritise those reforms that promote sustainable growth,
improve lose of doing business and attract investments across sectors.
Taxation & Fiscal Reforms Agritech Integration
1. Simplify GST Agricultural
2. Direct Tax Code Market Reforms
3. Fiscal discipline Reforms
Agri Exports

Page | 3
 Banking Sector
Infrastructure Development Financial Sector
Reforms Financial Inclusion
1. PPP
2. National Infrastructure Pipeline Capital Market deepening
3. Smart cities & digital infrastructure
Manufacturing and industry Boost
1. Make in India 2.0 Skill Development
Human Capital
2. Ease of doing B. Development
3. PLI Scheme expansion Health and Education

Green Economy
Energy &
Evnironmen Climate Action

Energy Efficiency

Trade & Foreign FTA negotiations

Investment
Attracting FDI

Export led growth

Sustainable growth supported by innovations, skilled and GG.

Economic Growth and development
 Economic growth: Quantitative concept, related to increase in GDP over time
 Example: Production increase in economy signifies economic growth
 Economic development: Qualitative concept, brings qualitative change in life
 Growth with equity: Equitable redistribution of resources, leading to improved standard of living
 Benefits reaching common people signify economic development
 Employment generation, access to necessities (food, shelter, clothes, education, healthcare)
denote economic development
 Relationship: Economic growth essential for development, but not sufficient. Development requires
proper redistribution of resources
 Example: Green Revolution in India
 Increased food grain production, made India food-sufficient
 Starvation still exists, indicating lack of food security
 GDP-wise, India ranks fifth globally, but classified as a developing country
Inclusive development
Development is a value laden concept. It means when the term development is used it can be concluded
that something positive is taking place. Development refers to gradual unfolding of the society in a positive
direction. Inclusive development is a combination of two important aspects — development of all and
development in all the aspects.
Development of all means that every single member in the society should be made a party to the process of
development. It means the benefits of development reach every single individual. It is based on the concept
of ‘Antyodaya’ to ‘Sarvodaya’. ‘Antyodaya’ refers to development of those/upliftment of those who are at the
bottom of the rank order. If it is done continuously the goal of ‘Sarvodaya’ can be achieved which means
upliftment of all.

Page | 4
It is said that no chain is stronger than its weakest link. Similarly, no society is stronger than its weakest
member. Hence, for social empowerment the empowerment of the weakest has to be ensured. This is
development of all.
Development in all the aspects means economic development, socio-cultural development and political
development. Economic development refers to making people capable enough to procure the basic
necessities of life. On the other hand, socio-cultural development refers to elimination of discrimination
based on gender, caste, race, religion, region etc. Political development refers to democratisation of the
society. It refers to people being provided opportunities for political participation which includes the right to
contest elections and the right to choose our representatives. When all such forms of development take
place then it is development in all the aspects.
Development of all along with development in all the aspects leads to inclusive development.
Inclusive development
 Development in general is a Value-laden concept, signifies positive progress and gradual societal
improvement
 Inclusive development: Development for all, in all aspects
 Development for all: Benefits reach every individual, from 'Antyodaya' to 'Sarvodaya'
 'Antyodaya': Upliftment of the weakest
 'Sarvodaya': Upliftment of all
 Development in all aspects: Economic, socio-cultural, political
 Economic: Access to basic necessities
 Socio-cultural: Elimination of discrimination
 Political: Democratization, political participation
Sustainable development
Development is a positive concept however the consequences of development may not be always positive.
It may have a number of side effects. Development always comes at a cost. This cost of development is not
only monetary but may even be social and environmental.
In the process of development such as construction of dams, thermal power plants, airports etc. the local
people are displaced. They are the one who pay the cost of development but the benefits are taken away
by the others. This may lead to a feeling of relative deprivation(when we compare our condition with
someone else and in comparison when we feel deprived then it is termed as relative deprivation). This
relative deprivation may become a cause behind conflict in society.
In the process of development even the exhaustible resources are extracted in a reckless manner. Because
of this it becomes obvious that these resources maybe exhausted completely and they may no longer
remain available to the next generations. In the process of development land under cultivation is used for
different economic activities affecting production of food. In the process of development even deforestation
takes place. We also cause environmental pollution in different ways.
If this is how development takes place, this process of development may not be continued for long. That
process of development which can be continued generation after generation is termed as sustainable
development. In the process of development if the resources are used in a judicious manner they can be
preserved even for future. In the process of development if we take care of the environment it will benefit
not only the present generation but even the generations to come. Development should take place with a
human face. It means that those who are displaced are compensated adequately and they are rehabilitated
properly. This process of development can be termed as sustainable development.
Sometimes, even the objective of inclusive development may lead to rapid process of development which
may compromise the objective of sustainable development. The idea of sustainable development is based
on the belief that this earth and its resources have not been inherited by us from our ancestors but they are
something that we owe to our next generations.

Page | 5
Sustainable development
 Cost of development can be monetary, social, environmental
 Development projects (dams, power plants, airports) displace local people, leading to relative
deprivation and societal conflict
 Reckless extraction of exhaustible resources threatens future availability
 Land use changes affect food production, deforestation, environmental pollution
 Sustainable development: Continuable across generations
 Judicious resource use preserves for the future
 Environmentally conscious development benefits present and future generations
 Development with a human face: Adequate compensation and rehabilitation for displaced
 Conflict: sometimes inclusive development may compromise sustainability
Types of Economies
Based on the fact that how exactly an economy functions and who exactly owns and controls the forces of
production the economies can be classified into different types:
1. Capitalist economy : Capitalism is an ideology which propounds a particular type of economic
arrangement known as the capitalist economy. In this type of economy the forces of production are
owned and controlled by individuals who are the capitalists. The capitalists are those who have
resources. Investment and re-investment are the means whereas maximisation of profit is the
objective.
In a capitalistic economy the government has a limited role. It acts as a facilitator and provides a
conducive environment for investment and business. The interference of the government is
minimum. Since the government keeps it’s hands away from the economy it is also known as ‘hands
off economy’. In French it is termed as ‘laissezfaire’. A capitalist economy is driven by market forces
that is demand and supply. Hence, it is also known as ‘free market’ economy.
2. Socialist economy : In socialist economy the role of the government is maximum. In this type of
economy the forces of production are owned and controlled by the state and it is the responsibility of
the state to ensure equitable redistribution of resources.
3. Mixed economy : It refers to that type of economy which has co-existence of public as well as
private investment. Here public investment means the investment done by the government and
private investment means the investment done by the individuals.
India is an example of mixed economy. It has public as well as private investment. Post-
independence during the first five-year plan India adopted Harrod-Domar model of development.
Harrod and Domar were two different economists who suggested that for a developing country
labour and capital are the most important factors for development. Such countries have sufficient
labour but in absence of the investors capital is not sufficient. Therefore, the government must play
the role of an investor. Based on this model the government in India started investing in business
along with the private investors. Hence, indian economy became a mixed economy. However,
gradually even the Indian economy is moving towards capitalistic arrangement.
Shorts
 Capitalist economy:
 Forces of production owned and controlled by capitalists (individuals with resources)
 Objective: Profit maximization through investment and reinvestmen
 Government: Limited role, acts as facilitator, minimal interference
 Driven by market forces (demand and supply), known as 'free market' economy or 'laissez-faire'
 Socialist economy:
 Government plays maximum role, owns and controls forces of production
 Responsibility: Ensure equitable redistribution of resources
 Mixed economy

Page | 6
  Coexistence of public (government) and private(individuals’) investment
 Example: India
 Initially followed Harrod-Domar model, emphasizing labor and capital for development
 Government started investing alongside private investors, leading to mixed economy
 Gradual shift towards capitalist arrangement observed in Indian economy
Model questions
1. Explain the concept of economic growth and economic development. Critically analyse the fact that
economic growth alone may not lead to economic development.
2. Explain the concept of inflation and its impact over the economy. Mention the drawbacks of WPI
because of which it was replaced by CPI as the main index.

***

Page | 7
 Introduction
Date created @May 13, 2024 12:42 PM

Revisions 8

Start date @May 13, 2024 * May 15, 2024

Status Complete

Parts of the UPSC syllabus

Main exam answer writing
Division of newspaper notes
Indian economy lesson plan
Root word and origin
Classification of economics
Economic Growth and Development
Economic Growth and development

Introduction 1
 Inclusive development
Inclusive development
Sustainable development
Sustainable development
Types of Economies
Model questions
Next chapter 💸 Inflation(म¸5ा T K)

Parts of the UPSC syllabus

1. Indian economy 7. Ethics

2. Indian society and social justice 8. International relations

3. Geo+Environment and ecology 9. Internal security

4. Polity and governance 10. Disaster management

5. Science and tech 11. Current affairs

6. History + Art and culture

Prelims is a recognition test. Thereʼs a difference between writing the correct answer and
recognising the correct answer.

Sources must be limited and reading unlimited.

Syllabus tells what UPSC expects from you and PYQs tell what you can expect from UPSC

For optimum benefit of the class, presence in the class and continuous revision of notes is
required

How to read PYQs:

1. Read PYQs and mention topics next to them

2. After the subject is completed attempt the PYQs * Identify the grey areas

3. Work on the grey areas

📌 Pre and main exam questions will be given after the chapter completion. Get it checked on the app.

Main exam answer writing

Take off and landing analogy for the Main exam answers. Both start and end of the answer must
be soft and smooth.

Three aspects of an answer

1. Content

Kitchen masala analogy for knowledge and contents in a question.

2. Structure

3. Presentation

underline and put keywords in box

Draw diagrams

Introduction 2
 Tailwords can be divided primarily into two categories— descriptive and analytical

Division of newspaper notes

1. General news 5. People in news

2. Market and economy 6. Awards

3. Science and tech 7. Books and authors

4. Places in news 8. Sports

Indian economy lesson plan

Introduction* Foreign investment and trade **
Inflation ** Balance of payments **

Monetary policies ** Agriculture **

Banking system in India — one of the longest part of Industry **

the syllabus **
International organisations
Money market *
WTO** , WB* , IMF*
Capital market **
Investment models *
National income **

Fiscal system **

Taxation **

*Main questions only

**Pre+Main questions

Root word and origin

Oikonomia Oikos(Household) + Nomos(Management)

The word economics is derived from a Greek word ‘Oikonomiaʼ. The word is a combination of two other Greek words oikos
and nomos. Oikos means household or family. Whereas nomos means management hence Oikonomia means household
management. It refers to how a family manages its expenditure using its limited resources.

As economics is derived from the word Oikonomia it can be defined as a discipline or a subject which deals with the study
of the process of household management. However, it is the simplest definition of economics which is possible. The scope
of Economics is much wider than that. In other words, economics can be defined as a systematic discipline which deals
with the study of the process of production, distribution and consumption of goods and services.

The process of production distribution and consumption of goods and services can be termed as the economic activities
which constitute an economy. Hence, these economic activities or the economy is the subject matter whereas economics
is the subject which deals with study of this subject matter.

Introduction 3
 🩳

Classification of economics
As a discipline economics can be broadly classified into following two parts—

1. Micro economics

2. Macro economics

This classification of economics into micro and macro was given by a Norwegian economist Ragnar Frisch. Along with Jan
Tinbergen of Holland, Ragnar Frisch was the first recipient of Nobel Prize in economics in 1969. Nobel Prize in economics
is its popular name, officially it is termed as Sveriges Riksbank Pirze in Economic Sciences. Sveriges Riksbank is the
central bank of Sweden which is the oldest central bank in the entire world. When this bank completed three hundred years
of its existence on this occasion this award was announced.

Micro economics and macro economics are different from each other but they are very closely associated with each other.
They both influence each other. Micro is a Greek word which means small and hence micro economics deals with study of
the smaller aspects of the economy. It deals with the study of those individual units with which the economy is constituted.
In other words, micro economics deals with the study of the economic activities at the level of a family and at the level of a
firm. It deals with the study of demand and supply which are the basic units of economic activities. It also deals with the
study of the market where goods and services are bought and sold.

Macro is another Greek word which means large hence it can be said that macroeconomics deals with the study of larger
aspects of the economy. In other words, macroeconomics deals with the study of economic activities at the level of the
entire society/country/state etc. It includes study of gross domestic product, national income, economic growth, economic
development, economic policies, inflation, unemployment and so on.

📎 GDP refers to the total value of finally marketable goods and services produced within the boundary of a country

Ragnar Frisch is known for his contributions to econometrics and mathematical economic modelling, including the first mathematical model to
describe fluctuations in the business cycle.

Introduction 4
 🩳

Topics: demand, supply, market dynamics

Macroeconomics:

Topics: GDP, national income, economic growth, development, policies, inflation, unemployment

Economic Growth and Development

Economic growth is a quantitative concept whereas economic development is a qualitative concept. Quantitative concept
means it is related to quantity and change in production whereas qualitative means something that brings about qualitative
change in oneʼs life.

Economic growth can be defined as increase in GDP over a period of time. For instance, when the production in any
economy increases over a period of time then itʼs economic growth.

On the other hand, growth with equity is economic development. Along with increase in production when equitable
redistribution of resources takes place leading to improvement in the standard of living then it is economic development.
When the benefits of increase in production or economic growth reach the common people then it is economic
development. Because of increase in production employment is generated, the people are made capable enough to
procure the necessities of life such as food, shelter, clothes, education and healthcare then it is termed as economic
development.

It can be concluded that economic growth is essential for economic development but only growth cannot be sufficient in
order to ensure development. Development also requires proper redistribution of the resources. For example, Green
Revolution enhanced food grain production in India. It made India food sufficient. However, even after that starvation
continues to exist. It means that India is yet to become food secure. It can be concluded that because of green revolution
economic growth took place but economic development still lags behind. In terms of GDP India is the fifth largest economy
in the world but it is still categorised as a developing country.

Introduction 5
Introduction 6
 🩳
Economic Growth and development
Economic growth: Quantitative concept, related to increase in GDP over time

Example: Production increase in economy signifies economic growth

Economic development: Qualitative concept, brings qualitative change in life

Growth with equity: Equitable redistribution of resources, leading to improved standard of living

Benefits reaching common people signify economic development

Employment generation, access to necessities (food, shelter, clothes, education, healthcare) denote
economic development

Relationship: Economic growth essential for development, but not sufficient. Development requires proper
redistribution of resources

GDP-wise, India ranks fifth globally, but classified as a developing country

Inclusive development
Development is a value laden concept. It means when the term development is used it can be concluded that something
positive is taking place. Development refers to gradual unfolding of the society in a positive direction. Inclusive
development is a combination of two important aspects — development of all and development in all the aspects.

Development of all means that every single member in the society should be made a party to the process of development.
It means the benefits of development reach every single individual. It is based on the concept of ‘Antyodayaʼ to
‘Sarvodayaʼ. ‘Antyodayaʼ refers to development of those/upliftment of those who are at the bottom of the rank order. If it is
done continuously the goal of ‘Sarvodayaʼ can be achieved which means upliftment of all.

It is said that no chain is stronger than its weakest link. Similarly, no society is stronger than its weakest member. Hence,
for social empowerment the empowerment of the weakest has to be ensured. This is development of all.
Development in all the aspects means economic development, socio-cultural development and political development.
Economic development refers to making people capable enough to procure the basic necessities of life. On the other hand,
socio-cultural development refers to elimination of discrimination based on gender, caste, race, religion, region etc.
Political development refers to democratisation of the society. It refers to people being provided opportunities for political
participation which includes the right to contest elections and the right to choose our representatives. When all such forms
of development take place then it is development in all the aspects.

Development of all along with development in all the aspects leads to inclusive development.

Introduction 7
 🩳
development

Inclusive development: Development for all, in all aspects

'Sarvodaya': Upliftment of all

Socio-cultural: Elimination of discrimination

Political: Democratization, political participation

Sustainable development
Development is a positive concept however the consequences of development may not be always positive. It may have a
number of side effects. Development always comes at a cost. This cost of development is not only monetary but may even
be social and environmental.

In the process of development such as construction of dams, thermal power plants, airports etc. the local people are
displaced. They are the one who pay the cost of development but the benefits are taken away by the others. This may lead
to a feeling of relative deprivation(when we compare our condition with someone else and in comparison when we feel
deprived then it is termed as relative deprivation). This relative deprivation may become a cause behind conflict in society.

In the process of development even the exhaustible resources are extracted in a reckless manner. Because of this it
becomes obvious that these resources maybe exhausted completely and they may no longer remain available to the next
generations. In the process of development land under cultivation is used for different economic activities affecting
production of food. In the process of development even deforestation takes place. We also cause environmental pollution
in different ways.

If this is how development takes place, this process of development may not be continued for long. That process of
development which can be continued generation after generation is termed as sustainable development. In the process of
development if the resources are used in a judicious manner they can be preserved even for future. In the process of
development if we take care of the environment it will benefit not only the present generation but even the generations to
come. Development should take place with a human face. It means that those who are displaced are compensated
adequately and they are rehabilitated properly. This process of development can be termed as sustainable development.

Sometimes, even the objective of inclusive development may lead to rapid process of development which may compromise
the objective of sustainable development. The idea of sustainable development is based on the belief that this earth and its
resources have not been inherited by us from our ancestors but they are something that we owe to our next generations.

Introduction 8
 🩳
Sustainable development
Cost of development can be monetary, social, environmental

Development projects (dams, power plants, airports) displace local people, leading to relative deprivation
and societal conflict

Reckless extraction of exhaustible resources threatens future availability

Land use changes affect food production, deforestation, environmental pollution

Sustainable development: Continuable across generations

Environmentally conscious development benefits present and future generations

Development with a human face: Adequate compensation and rehabilitation for displaced

Conflict: sometimes inclusive development may compromise sustainability

🎯 SDGs and Millennium Goals

Types of Economies
Based on the fact that how exactly an economy functions and who exactly owns and controls the forces of production the
economies can be classified into different types:

1. Capitalist economy

Capitalism is an ideology which propounds a particular type of economic arrangement known as the capitalist
economy. In this type of economy the forces of production are owned and controlled by individuals who are the
capitalists. The capitalists are those who have resources. Investment and re-investment are the means whereas
maximisation of profit is the objective.

In a capitalistic economy the government has a limited role. It acts as a facilitator and provides a conducive
environment for investment and business. The interference of the government is minimum. Since the government
keeps itʼs hands away from the economy it is also known as ‘hands off economyʼ. In French it is termed as ‘laissez-
faireʼ. A capitalist economy is driven by market forces that is demand and supply. Hence, it is also known as ‘free
marketʼ economy.

2. Socialist economy

In socialist economy the role of the government is maximum. In this type of economy the forces of production are
owned and controlled by the state and it is the responsibility of the state to ensure equitable redistribution of resources.

3. Mixed economy

It refers to that type of economy which has co-existence of public as well as private investment. Here public
investment means the investment done by the government and private investment means the investment done by the
individuals.

India is an example of mixed economy. It has public as well as private investment. Post-independence during the first
five-year plan India adopted Harrod-Domar model of development. Harrod and Domar were two different economists
who suggested that for a developing country labour and capital are the most important factors for development. Such
countries have sufficient labour but in absence of the investors capital is not sufficient. Therefore, the government
must play the role of an investor. Based on this model the government in India started investing in business along with
the private investors. Hence, indian economy became a mixed economy. However, gradually even the Indian economy
is moving towards capitalistic arrangement.

Introduction 9
 🩳
Capitalist economy:

Government: Limited role, acts as facilitator, minimal interference

Driven by market forces (demand and supply), known as 'free market' economy or 'laissez-faire'

Socialist economy:

Government plays maximum role, owns and controls forces of production

Mixed economy:

Coexistence of public(government) and private(individualsʼ) investment

Initially followed Harrod-Domar model, emphasizing labor and capital for development

Government started investing alongside private investors, leading to mixed economy

Model questions
1. Explain the concept of economic growth and economic development. Critically analyse the fact that economic growth
alone may not lead to economic development.

2. Explain the concept of inflation and its impact over the economy. Mention the drawbacks of WPI because of which it
was replaced by CPI as the main index.

Next chapter Inflation( )

Introduction 10
 💸
Inflation( )
Date created May 15, 2024 1 16 PM

Revisions 9

Start date May 16, 2024 May 25, 2024

Status Complete

Inflation
Types of Inflation
Demand Pull inflation
Cost Push Inflation
Structural inflation
Inflation in India
Types of inflation based on rate
Some Key terms related to Inflation
Deflation
Disinflation
Reflation
Shrinkflation And Skimpflation
Inflation spiral / wage price spiral 🌀
Inflation Tax
Stagflation
Phillips curve

Inflation(मु�ा �Tfत) 1
 Calculation of Inflation
Producer Price Index
Wholesale Price Index
Limitations of WPI
Consumer Price Index(CPI)
Core inflation
Next chapter 🏦 Monetary policies

Inflation
It refers to continuous rise in prices of goods and services leading to decline in the purchasing capacity of the currency of
that country. That is the reason why with passage of time as inflation increases continuously it is a possibility that the
purchasing capacity of a currency note or coin may become negligible. In such a situation that currency note or coin will be
withdrawn from circulation.

It is also seen that with passages of time due to inflation the size and thickness of a coin is reduced. Metals are used for
minting the coins. Metals have their own intrinsic value. Due to inflation even the value of metal increases. In such a
situation if the value of the metal used in the coin exceeds the market value of that coin then instead of using that coin in
the form of a coin, people will start using it as metal. Hence, as the price of metal increases, the size and thickness of the
coin is reduced and when it no longer is possible to reduce the size further, that coin will be withdrawn from circulation.
According to the guidelines of RBI, at present the lowest denomination coin which is a legal tender(currency or coin which
is a valid medium of exchange) is fifty paise coin. However, it can only be used in order to make a payment of upto ₹10.
Inflation affects our savings adversely. If the price of goods and services increases our consumption will get costlier. If the
income does not increase accordingly then due to increase in the cost of consumption, savings will be affected.

Inflation affects the poor the most. The poor has limited income and hence he doesnʼt have surplus. If the goods and
services become costlier but his income does not increase accordingly, he will have to compromise with his consumption.
On the other hand, the rich has surplus which can be invested by him in different assets such as land, gold, shares etc.
Along with increase in inflation his cost of consumption will increase but at the same time even the value of the assets will
increase. This increase in the value of the assets will counterbalance the increase in the cost of consumption.

If inflation increases at a rapid pace, but the banks continue to provide low rate of interest on deposit then the depositors
will be at loss. Hence, in such a situation the depositors may start withdrawing their deposits in order to invest it in different
assets. It will affect the business of the banks. Hence, in order to prevent such withdrawals and to attract the depositors
the banks will increase the rate of interest on deposit. As the rate of interest on deposit increases the banks will be
compelled to increase the rate of interest even on lending. Hence, it can be concluded that along with increase in inflation,
interest rates are bound to increase. Due to increase in interest rates, borrowing becomes costlier, affecting consumption
adversely. Hence, even this can be concluded that if inflation remains very high it will affect economic growth. Even the law
of demand says that if the price increases the, demand may fall down.

Whenever inflation increases at a rapid pace, the lender will be at loss whereas the borrowers will benefit. This is the
reason why when the banks provide long-term loans, the interest rate charged by them is floating rather than fixed. Hence,
as inflation increases the banks increase the rate of interest not only for the new borrowers but also for the existing
borrowers

Inflation(मु�ा �Tfत) 2
 Shorts

Inflation
Continuous rise in prices, decreasing purchasing power of currency

Could lead to withdrawal of currency notes/coins

Affects savings adversely, particularly for those with fixed incomes

Impact on Poor Limited income, compromise in consumption

Impact on Rich Assets' value increase counterbalances raised cost of consumption

Impact on Depositors:

Low bank interest rates during rapid inflation lead to losses

Depositors withdraw funds, affecting bank business

Interest Rates Banks increase interest rates to attract depositors, affecting borrowing and consumption

Interest on deposits⬆ Interest on lending⬆ Borrowing⬇ Consumption⬇

Economic Growth High inflation affects growth, as borrowing becomes costlier, demand falls⬇

Veblen Goods:

Demand increases with price due to exclusivity and status symbol appeal

Contrary to typical demand patterns

Lending and Borrowing:

Lenders/debtors lose during inflation, borrowers benefit

Banks adjust interest rates accordingly, especially for long-term loans

Types of Inflation

Demand Pull inflation

In other words, when the money supply in the economy is high the consumers will be left with more amount of money in
their hand. This will lead to increase in consumption that is demand. If this increase in demand is not adequately met with
supply on time then the prices will increase leading to demand pull inflation. Increase in employment, increase in income,
increase in public(government) expenditure in the form of welfare schemes and developmental activities, increase in black
money, availability of loan at a lower rate of interest, they all will lead to increase in money supply. This increase in money
supply will lead to increase in demand resulting in demand pull inflation.

It takes place in any economy because of increase in demand. When the aggregate demand exceeds the aggregate supply
leading to increase in the price then it is demand pull inflation.

Inflation(मु�ा �Tfत) 3
 India is a developing country where people are getting employment and gradually even the standard of living is improving.
The population is also high and therefore the demand always remains high. In such developing economies demand pull
inflation is a common phenomenon.

Inflation is not always bad. In fact, demand pull inflation if remains within control it is a good sign for any economy. It shows
that people have surplus, they are consuming and hence the demand is in tact. In such economies new investments take
place in order to ensure increase in production. It also creates new employment opportunities. Hence, it can be said that
demand pull inflation is associated with economic growth. Demand pull inflation also benefits the producers for the same
goods and services they get a higher price. Even the law of supply says that when the price increases the producer
produces more.

Virtuous cycle of inflation. Controlled and moderate inflation is a positive sign in an economy.

With increase in employment inflation increases. Hence, when employment increases at a rapid pace even inflation
increases at a rapid pace. That is the reason why different countries follow the concept Non Accelerating Inflation Rate of
Unemployment(NAIRU . It means that unemployment has to be reduced but only at a rate which does not accelerate
inflation beyond control. More and more employment should be provided in productive sectors so that along with increase
in consumption even the production is enhanced.

Inflation(मु�ा �Tfत) 4
 Demand Pull Inflation:

Positive Aspects of Inflation:

Concept:

Cost Push Inflation

It takes place in an economy because of increase in the cost of production. If the raw material cost or the cost of any other
input such as labour, transportation, fuel, etc increases then the cost of the final product and services will automatically
increase leading to cost push inflation. For example, because of conflict between Russia and Ukraine the price of crude oil
increased in the international market. Crude oil is a source of production of diesel and petrol which are an important source
of fuel in the process of production. Increase in their price lead to cost push inflation throughout the world.

Structural inflation
It takes place in an economy because of structural problems that exist in the economy. For example, if the transportation
system is inadequate and different places are not well-connected then it becomes difficult to carry even essential
commodities to such distant places. It also becomes difficult to provide essential services in such places. It may lead to
increase in the price of goods and services leading to structural inflation.

In an economy even the storage facilities maybe inadequate. For example, India lacks sufficient cold storage facilities
because of which out of the total fruits and vegetables produced in India a large part is wasted. Hence, it fails to reach the
market leading to increase in the prices.

Structural inflation may also take place because of cartelisation, hoarding and even black-marketing.

Inflation(मु�ा �Tfत) 5
 📎

Cost Push Inflation:

Structural Inflation:

Cartelisation Producers collude to raise prices, reducing competition; illegal

Inflation in India
In India demand pull inflation, cost push inflation and structural inflation all coexist. Because of this inflation remains
relatively high. India is a developing economy. Even the population is high, people are getting employment, they are
continuously procuring the basic necessities of life. Because of this the consumption/demand remains high. Even the flow
of black money in Indian economy is relatively high leading to additional demand. All such factors together give rise to
demand pull inflation.

With respect to a number of raw materials India is dependent on import. For example, even crude oil, due to different
international issues such raw material become costlier leading to cost push inflation. With passage of time even the
standard of living and cost of living are increasing in India. Because of this labour is becoming costlier leading to cost push
inflation.

India has all the structural problems, the transportation system and the storage facilities are inadequate. The economy
faces problems such as cartelisation, hoarding, black marketing, etc. They all lead to high structural inflation in the country.

In india, inflation targeting is done by the government of India in consultation with the RBI. We have adopted a flexible
target in which inflation should not fall down below 2% and it should not go beyond 6%. However, it is the responsibility of
RBI to control inflation and to keep it within the target range.

Although the RBI is responsible for controlling inflation it has very limited tools to control it. The RBI has no role in
controlling structural inflation and it has negligible role in controlling cost push inflation. The RBI mainly controls demand
pull inflation that too in a limited manner. Through its monetary policies the RBI may suck surplus money from the banking
system and it may enhance the rate of interest on lending. This will make borrowing difficult and costlier, bringing down
demand and inflation. However, the RBI has limited control over black money and over expenditure of the government. The
RBI may not take away employment and it may not curtail our income. Hence, with respect to even demand pull inflation

Inflation(मु�ा �Tfत) 6
 the RBI has limited role. Inflation in India cannot be controlled without proper coordination among the RBI, the state
governments and the central government.

India

Targeting:

Government of India in consultation with RBI target a flexible inflation rate 2% 6% RBI

is responsible for controlling inflation within this range

RBI's Role and Limitations:

Types of inflation based on rate

Based on the rate at which inflation increases it can be classified into the following types:

When inflation increases at a rate of upto 3% and continues to move at a very slow pace then it is termed as creeping
inflation. Normally, it is seen in developed economies where structural inflation is almost absent and inflation is only due to

Inflation(मु�ा �Tfत) 7
 limited demand pull and limited cost push. In such economies, the demand remains limited mainly because they have
reached their saturation. The people have almost everything that they desire in life.

When the rate of inflation remains above 3% and upto 10% then it is termed as walking or trotting inflation. In developing
economies like India walking inflation is a common phenomenon. In such economies demand pull, cost push and structural
factors exist simultaneously. Hence, inflation remains relatively high.
When the rate of inflation remains above 10% and upto 20%(in some books upto 30% then it is termed as runaway
inflation. It is a kind of warning to the authorities that inflation is going out of control and hence it should be brought under
control.

When inflation increases at a rate of more than 20%(or 30% then it is galloping inflation which is a serious concern.
When inflation goes completely beyond control then it is termed as hyperinflation which is a sign of economic failure. In
this situation the purchasing capacity of currency falls down to almost zero and hence people resort to barter system(व�तु-
व नमय ण ली).

Types of inflation based on rate and their rate ranges

Creeping Inflation:

Inflation:

Runaway Inflation:

Galloping Inflation:

Inflation above 20% (or 30%

Hyperinflation:

Inflation(मु�ा �Tfत) 8
 Some Key terms related to Inflation
Deflation
It is just the opposite of inflation. Deflation refers to continuous decline in the prices of goods and services. Deflation is not
always good and at the same time it is not always bad. If the price of goods and services have already gone upwards and
thereafter due to deflation they start coming down to normal then it is not bad for the economy. Similarly, if the demand in
the economy is normal and the supply exceeds the demand leading to decline in the price causing deflation, then it is also
not a serious concern in the economy.

However, if the supply remains normal but the demand starts falling down leading to deflation then it is a bad sign for the
economy. This decline in demand may be because of the following reasons:

If the consumers do not have sufficient money to consume

If the unemployment rate in the economy increases

If the banks are not in a position to provide sufficient loan

If a country has aging population

If an economy has already reached its saturation and the people have almost everything that they desire in life

If demand declines in the economy leading to deflation, new investments in the economy maybe affected adversely. This
will lead to increase in unemployment and it will also affect the GDP adversely. It is also a possibility that the producers
may start shifting their base to other countries.

Shorts

Deflation, the opposite of inflation, refers to a continuous decline in the prices of goods and services. It can
have mixed effects on the economy:

Potentially Positive Effects:

Correction of Overinflation If prices have previously risen significantly, deflation can bring them back
to a normal level.

Excess Supply If supply exceeds demand while demand remains stable, deflation is not a serious
concern.

Causes behind deflation— problematic for the economy:

Reduced Consumer Money Indicative of the fact that consumers may not have sufficient money to
spend.

Rising Unemployment An increase in unemployment rates can lead to decreased demand.

Inadequate Bank Lending If banks cannot provide sufficient loans, it can reduce consumer spending.

Aging Population An aging population may reduce overall demand. Like Japan.

Economic Saturation In economies where consumers already have most of what they desire, demand
may decline.

Economic Consequences:

Reduced Investment Falling demand can lead to a decrease in new investments.

Increased Unemployment Less investment can lead to higher unemployment rates.

GDP Impact Lower demand and investment can negatively affect GDP.

Relocation of Producers Producers might move their operations to other countries.

Disinflation

Inflation(मु�ा �Tfत) 9
 Disinflation is different from deflation. It refers to decline in the rate at which inflation increases. In other words disinflation
is decline in inflation. It is a situation of price rise but in this situation the rate at which the price is increasing witnesses a
continuous decline. Hence, every case of disinflation is also a case of inflation. However, every case of inflation is not a
case of disinflation. If disinflation continues for a very long period of time, it is a possibility that it may turn into deflation.

Reflation
If the demand in the economy declines, even the price of goods and services may come down leading to deflation. This is
not a good sign for the economy. Hence, in order to revive the economy the government as well as the central bank may
become active.

In order to create demand in the economy the government may reduce income tax so that the consumers are left with more
amount of money in their hands. This maybe used by them for the purpose of consumption leading to increase in demand.
The government may also reduce the indirect taxes such as GST because of which consumption of goods and services will
become even more attractive. It will also create demand in the economy. The government may even increase public
expenditure in order to infuse more amount of money in the economy. Even this may enhance demand. These measures
adopted by the government can be termed as fiscal stimulus.

In order to revive the economy the central bank may infuse surplus money in the banking system. It may also reduce rate
of interest through its monetary policies. This will enhance liquidity/flow of money in the economy leading to increase in
demand. Such policies adopted by the central bank are termed as cheap money policy and even expansionary policies.

Because of the efforts made by the central bank, and the government, the demand will revive but along with that even
inflation may start rising. This entire process of decline in demand leading to deflation and thereafter increase in demand
leading to inflation is termed as reflation.

Shrinkflation And Skimpflation

Both are forms of inflation. In case of shrinkflation the manufacturer or the seller keeps the price of a commodity
unchanged. However, the quantity of the commodity is reduced. It creates a psychological impact over the consumer that
he is spending the same amount of money but in reality the consumer is paying the price for a reduced quantity of that
product. Hence, it is inflation. For example, a packet of Parle-G was available for ₹5 and it is still available for ₹5. But the
quantity has been reduced.

In case of skimpflation the price and the quantity remains the same but the producer or the seller compromises with
quality. If the quality of the product is compromised with then it is a possibility that the sale of the product may decline.
Therefore, the quality of any other related factor maybe compromised with. For example, the packaging.

Inflation spiral / wage price spiral 🌀

Wages/income and inflation are very closely associated with each other, one stimulates the other. If the income increases
due to increase in demand even the prices will increase. This increase in the prices will lead to increase in income/wages.
This becomes a continuous process in which the wages/income and inflation increase simultaneously. If the income of the
employees or the workers engaged in productive sector increases, it will not only lead to demand-pull but also cost push
inflation.

Inflation(मु�ा �Tfत) 10
 Inflation spiral or wage price spiral

Inflation(मु�ा �Tfत) 11
 Shorts

Disinflation is the decline in the rate at which inflation increases. It signifies a slowing down of the rate of
price rise, although prices are still increasing.

Difference from Deflation Unlike deflation, which involves a decrease in the overall price level,
disinflation involves a decrease in the inflation rate.

Implication Every case of disinflation is also a case of inflation, but not every case of inflation is
disinflation.

Potential Outcome Prolonged disinflation can potentially lead to deflation.

Reflation occurs when government and central bank measures are implemented to revive demand and
combat deflation.

Government Actions Fiscal Stimulus):

Reduce Income Tax Increases disposable income for consumers, leading to higher consumption
and demand.

Reduce Indirect Taxes (e.g., GST Makes goods and services more affordable, boosting demand.

Increase Public Expenditure Infuses more money into the economy, enhancing demand.

Central Bank Actions Monetary Policies):

Infuse Surplus Money Increases liquidity in the banking system.

Reduce Interest Rates Lowers borrowing costs, stimulating spending and investment.

Outcome These measures revive demand, potentially leading to increased inflation. This process,
from deflation to increased demand and inflation, is termed reflation.

Shrinkflation Price remains unchanged, but the quantity of the product is reduced.

Impact Consumers pay the same price for less quantity, effectively experiencing inflation.

Example A packet of Parle-G biscuits costs ₹5, but the quantity has been reduced.

Skimpflation Price and quantity remain the same, but the quality of the product is reduced.

Impact Consumers receive lower quality for the same price, effectively experiencing inflation.

Example Compromised packaging quality while maintaining the same price and quantity.

Inflation Spiral / Wage-Price Spiral A cycle where increases in wages lead to higher prices, which in turn
lead to further wage increases.

Increased wages/income boost demand, leading to higher prices.

Higher prices result in demands for higher wages.

This cycle of rising wages and inflation continues.

Impact: Wage increases in the productive sector can cause both demand-pull and cost-push inflation,
creating a continuous cycle of rising wages and prices.

Inflation Tax
Inflation tax is not exactly a tax collected by the government. However, the impact of inflation and the impact of tax can be
similar. Taxes affect our savings adversely. Similarly, even inflation affects our savings adversely. Taxes make our
consumption costly. Similarly, even inflation increases the cost of consumption.

Inflation and tax also have some other relations. Along with increase in inflation even our income increases but because of
increase in income we have to pay a higher tax. At the same time even consumption becomes costlier. Hence, the increase
in income hardly benefits the consumers.

Stagflation
The term stagflation is made up of a combination of two words—stagnant and inflation. However, the meaning of the word
cannot be derived by combining both the words. Here the word stagnant is used for the economy. Stagflation is an

Inflation(मु�ा �Tfत) 12
 abnormal contradictory situation in which the economy remains stagnant without any growth but inflation increases
continuously. Here the reason behind inflation is not demand pull but cost-push and structural factors.

Normally, when thereʼs demand in the economy inflation increases and along with that even production increases leading
to economic growth. Hence, inflation along with economic growth is a normal condition but in case of stagflation inflation
exists without economic growth. Here, even unemployment rate remains high.
Thereʼs another definition associated with stagflation. According to this definition when inflation is too high and the price
goes beyond the reach of the consumers the demand automatically falls down leading to decline in economic growth.
Hence, it is decline in economic growth due to price rise.

Phillips curve
There is a normal relation ship between unemployment and inflation. As unemployment rate increases, inflation falls down.
However, this relationship is not followed in case of stagflation. In case of stagflation unemployment rate and inflation both
increase simultaneously.

The normal relationship between unemployment and inflation was shown with the help of a curve by economist Alban
Phillips. This curve is termed as Phillips curve.

Inflation(मु�ा �Tfत) 13
 Shorts

Inflation Tax
Not a literal tax but the erosion of savings' value due to inflation.

Relation to Taxes Higher inflation can push incomes up, leading to higher taxes but not benefiting
consumers due to increased prices.

Impact on:

Savings Decreases real value.

Consumption Increases costs.

Stagflation
Economic stagnation with high inflation.

Characteristics No growth, Rising prices, High unemployment.

Causes Cost-push inflation, structural issues.

Impact Inflation without growth, unlike typical economic conditions.

Phillips Curve
Illustrates inverse relationship between unemployment and inflation.

Normal Relationship Lower unemployment = higher inflation; higher unemployment = lower inflation.

Stagflation Exception Both unemployment and inflation rise, defying the curve. Managing both
simultaneously is challenging during stagflation.

Calculation of Inflation
In most of the economies inflation is calculated by different authorities in order to find out that in which direction and at
which rate the prices are changing. For this purpose three different indices are used:

Producer Price Index

When the change in the price is measured at the point of production then PPI is used as an index. It measures the change
in the cost of production. Hence, it is the most of effective index for calculating cost-push inflation. However, in India PPI is
not calculated yet. In India for the purpose of calculation of inflation WPI and CPI are published. A committee has been
setup under the chairmanship of Ramesh Chandra, a member of NITI Aayog to suggest how PPI can be calculated and

Inflation(मु�ा �Tfत) 14
 published in future even in India. The committee will also suggest modifications in calculations of WPI. Hence, it is a
possibility that in near future even PPI will be published in India.

Wholesale Price Index

WPI in India is calculated and published by the office of Economic Adviser, Ministry of Commerce. WPI is calculated at
wholesale level that is the reason why it is also known as wholesale inflation. For calculation of WPI price data is collected
from wholesale markets and the change in the price is tracked at the level of wholesale market only. Since wholesale
markets are less in number and at wholesale level thereʼs price uniformity, collecting data for WPI was relatively
convenient. That is the reason why prior to April 2014 WPI was considered as the most important index in India based on
which the RBI used to formulate its monetary policies. Therefore, WPI was also termed as Headline Inflation. However,
since April 2014 CPI(combined) is considered as the headline inflation in India.

For the purpose of calculation of WPI a basket is maintained. This basket is modified from time to time. According to the
convention followed, this basket is modified only after five years but not later than ten years. Last time the basket was
modified in the year 2017. At present the basket consists of 697 items. The basket for WPI includes only goods, and
services are not at all included. Whenever the basket is modified those goods which we do not use anymore are removed
from the basket and those goods that we have started consuming are added to the basket.

This basket of WPI is divided into three different segments. One segment is of primary goods which consists of 117 items
such as fruits, vegetables, food grains, egg, fish, chicken, mutton, milk, minerals, tea, coffee, etc.

The other segment is of manufactured goods which includes 564 items. They are those goods which are produced in the
factories using machines and tools. It includes consumer durable goods, fast moving consumer goods(FMCG), cement,
metals, chemicals, etc.

The third segment is of fuel, power, lubricants. This segment includes petroleum products, electricity, LPG, etc.

In WPI, change in the price of only these items is taken into consideration. WPI is calculated once in a month. Change in
the price for any month is calculated over the same month of the previous year. In this basket every single commodity may
not become costlier simultaneously or they may not become cheaper simultaneously. Some of the items become costlier
and they pull the index upwards. Some of the items become cheaper and they pull the index downwards whereas the price
of some of the items remains unchanged. This upward and downward pull is termed as skewflation. At present, the base

Inflation(मु�ा �Tfत) 15
 year for calculation of WPI is 2011 12. At present while collecting price data for calculation of WPI indirect taxes such as
GST will not be taken into consideration.

Limitations of WPI
Whether it is WPI or CPI for calculation of inflation, whenever a basket is used it will have certain limitations. The basket
may not include every single item that we consume at the same time it is also a possibility that number of items that are
there in the basket may not be consumed by us. Hence, such baskets may never give a clear picture of what the consumer
is spending.

There are some limitations exclusively associated with WPI

In WPI the price movement is tracked at wholesale level whereas the consumers consume at retail level. Hence, WPI
cannot give a clear picture of what the consumer is spending.

WPI basket consists of only goods. It does not include services. However, services are an important part of our
consumption.

In WPI basket maximum weightage is given to manufactured goods. They are maximum in number. Hence, they
influence the basket the most. However, the manufactured goods are not bought by the consumers on a regular basis.

Because of these limitations associated with WPI, the Urjit Patel committee suggested, that WPI should not be taken as the
most important index for the purpose of policy formulation. In place of WPI the RBI should take CPI as the Headline
Inflation. Based on this recommendation, CPI(combined) became the headline inflation in India from April 2014.

During that period retail inflation in India was increasing at an annual average rate of 10%. The Urjit Patel committee
suggested that since 2014 during next 12 months the RBI should try to bring down retail inflation to 8% with the help of its
monetary policies. Again in the next 12 months it should be brought down to 6%. Again, in the next 12 months it should be
brought down to 4%. Over this 4% a range of +/ 2% should be imposed. The RBI should formulate policies in such a
manner that retail inflation in India should not fall down below 2% and it should not go beyond 6%.

Based on this recommendation, flexible inflation targeting started in India from the year 2016. For this purpose, the RBI act
was amended. The government of India in consultation with RBI sets target for five years. However, it is the responsibility
of RBI to keep inflation within this target. For the first time the target was set from 2016 to 2021. The target was from 2% to
6%. Again, the targets were renewed from 2021 to 2026. Even for this period the target remains the same ie retail inflation
in India should not come down below 2% and should not go beyond 6%.

Inflation(मु�ा �Tfत) 16
 Shorts

Producer Price Index (PPI)

Purpose Measures change in production costs.

Relevance Effective for calculating cost-push inflation.

Current Status in India Not yet calculated; WPI and CPI are used.

Future Plans A committee led by Ramesh Chandra NITI Aayog) will suggest how to calculate and publish PPI
and update WPI calculations.

Wholesale Price Index (WPI)

Calculation Published by the Office of Economic Adviser, Ministry of Commerce.

Focus Measures price changes at the wholesale level (wholesale inflation).

Data Collection From wholesale markets, making it convenient due to fewer markets and price uniformity.
GST will not be taken into consideration.

Historical Importance Prior to April 2014, WPI was the primary index (headline inflation) for RBI's monetary
policies. Now, CPI(combined) is used.

WPI Basket
Modification Updated every 5 10 years; last modified in 2017.

Contents 697 items, only goods (no services).

Segments:

Primary Goods 117 items (fruits, vegetables, food grains, etc.).

Manufactured Goods 564 items (consumer durables, FMCG, cement, metals, etc.).

Fuel, Power, Lubricants 16 items( Petroleum products, electricity, LPG .

Calculation Details
Frequency Monthly.

Comparison Price change for any month is compared to the same month of the previous year.

Skewflation Some items' prices rise, pulling the index up, while others fall, pulling it down, creating a mixed
effect.

Base Year 2011 12.

Limitations of WPI
Wholesale vs Retail:

Tracks price movements at the wholesale level.

Consumers spend at the retail level, causing discrepancies.

Exclusion of Services:

WPI basket only includes goods.

Services, a significant part of consumption, are excluded.

Weightage to Manufactured Goods:

Manufactured goods have maximum weightage.

These goods are not regularly purchased by consumers.

Basket Limitations:

May not include all items consumed and may include items not consumed by everyone.

Recommendations and Changes

Inflation(मु�ा �Tfत) 17
 Urjit Patel Committee Recommendations: Suggested

CPI over WPI for policy formulation.

Implementation:

Targets set in consultation with the government for five-year periods 2016 2021, 2021 2026 . Target

range: 2% to 6%.

Consumer Price Index(CPI)

When change in the price is tracked at retail level then CPI is used as an index. For calculation of CPI, price data is
collected at retail level. Since, the retail outlets are millions in number it becomes difficult to collect price data. At retail level
price variation is also widespread. Hence, it becomes difficult to decide that which price should be taken into
consideration.

Initially, four CPI indices were published based on consumption patterns of different societal groups:

CPI for Industrial Workers IW

CPI for Rural Labourers

CPI for Agricultural Labourers

CPI for Urban Non-Manual Employees UNME

The Labour Bureau, under the Ministry of Labour, published the first three indices. However, they now only publish CPI for
Industrial Workers, as CPI for Rural Labourers and Agricultural Labourers are no longer issued. The Central Statistics Office
CSO , under the Ministry of Statistics and Programme Implementation MoSPI , was responsible for publishing CPI UNME .

Initially for calculation of CPI(urban) and CPI(rural) price data was collected by National Sample Survey Office(NSSO).
Based on this data the index was calculated and published by Central Statistics Office(CSO). They both functioned under
MoSPI. However, in the year 2019 NSSO and CSO were merged with each other and National Statistical Office(NSO) was
created. Publishing these indices is now the responsibility of NSO. Now following four indices are published:

CPI IW CPI(rural) CPI(urban) CPI Combined

Data from 88 industrial areas 1181 rural areas 310 urban areas —

Basket items 463 448 460 —

Base year 2016 2012 2012 —

Labour Bureau
Current Publishing
under Ministry of NSO under MoSPI NSO under MoSPI NSO under MoSPI
organisation
Labour

Used for
calculating
Dearness Measuring inflation in Measuring inflation in Average of CPI(rural) and CPI(urban).
Purpose
Allowance DA for rural areas urban areas Considered headline inflation in India
government
employees.

Inflation(मु�ा �Tfत) 18
 The basket for calculating CPI consists of goods as well as services. At present, the basket is divided into the following six
segments:

Consumer Price Index (CPI)

Challenges:

CPI for Industrial Workers IW CPI

for Rural Labourers

First three published by Labour Bureau Ministry of Labour).

CPI UNME published by Central Statistics Office CSO, under MoSPI .

Initially by National Sample Survey Office NSSO and Central Statistics Office(CSO) —both under
MoSPI.

In 2019, NSSO and CSO merged to form National Statistical Office NSO .

Inflation(मु�ा �Tfत) 19
 Core inflation
For calculation of inflation, the basket which is used consists of those items which are highly volatile with respect to the
price and even those items whose price is relatively stable. From the basket when the volatile items are removed and
change in the price of only the stable items is calculated then we derive core inflation.

Core inflation basket = CPI basket items − V olatile items

Next chapter 🏦 Monetary policies

Economy Timeline

Year Economic Event/significance Chapter

2011 Arab spring Inflation

2014 April CPI(combined) replaced WPI as headline inflation in India Inflation

Inflation(मु�ा �Tfत) 20
 Banking system in India
Date created @June 7, 2024 12:11 PM

Revisions 6

Start date @June 7, 2024

Status Complete

Banking system in India

The responsibilities of RBI
Different mechanism for printing fresh currency
Minimum reserve system
Proportional reserve system
Responsibilities of RBI
Currency Printing Mechanisms:
History of banks in India
Currency Printing in India
History of nationalisation of Banks
Classification of Banks in India
Regional rural banks(RRBs)
Cooperative banks
Narasimham Committee on banking sector reform

Banking system in India 1

 Rules related to foreign investment— Indian banking sector
For foreign banks
For public sector banks
For private sector banks
Guidelines related to establishment of commercial banks in India
Priority Sector Lending
Priority Sector Lending Certificate(PSLC)
Priority Sector Lending (PSL) Guidelines:
Penalties for Non-Compliance:
Priority Sector Lending Certificate (PSLC):
Non-performing Asset(NPA)
Deposit Insurance and Credit Guarantee Corporation(DICGC)
Twin balance sheet problem
CIBIL(Credit Information Bureau(India) Ltd.) and Public Credit Registry(PCR)
Wilful defaulter
Asset Reconstruction Company(ARC)
Prompt Corrective Action(PCA)
Mission Indradhanush 2.0
Financial Services Institution Bureau(FSIB)
Non-Banking Financial Companies(NBFCs)
Financial assets Vs Non-financial assets
Islamic Bank
Digital Banking Units
Self Help Groups(SHGs) and Micro Finance Institutions(MFIs)
Financial Inclusion
Measures adopted to achieve the goal of financial inclusion
MUDRA-Micro Units Development and Refinance Agency
@July 2, 2024
Micro, Small and Medium Enterprises(MSMEs)
Pradhan Mantri Jan Dhan Yojana(PMJDY)
@July 3, 2024
Nachiket Mor Committee
Payments banks
Small finance banks
@July 4, 2024
Export Import Bank of India
Sovereign Gold Bond Scheme
Gold Monetization Scheme
80:20 Scheme
@July 5, 2024
5:20 Scheme
Domestic systemically Important Banks and NBFCs
RBI Banking Ombudsman
@July 6, 2024
Core Banking Solution(CBS)
Merchant Discount Rate(MDR)
Real Time Gross Settlement(RTGS) & National Electronic Fund Transfer(NEFT)
Immediate Payment Service(IMPS)
Unified Payments Interface(UPI)/Bharat Interface for Money(BHIM)
@July 8, 2024
National Payments Corporation of India(NPCI)
Types of ATMs 🏧
National Bank for Agriculture and Rural Development(NABARD)
Kisan Credit Card(KCC)
@July 9, 2024
Society for Worldwide Interbank Financial Telecommunication(SWIFT)
Nostro and Vostro account
Basel norms
@July 10, 2024
e-Rupi
National Automated Clearing House(NACH)
Neo Bank

Banking system in India 2

 Narasimham Committee 2
Loan at fixed rate, floating rate and Teaser loan
@July 11, 2024
Line of Credit and Syndicated lending
Model questions

Banking system in India

In India, in the banking system, RBI is the apex authority. The RBI was setup by the RBI Act 1934 on April 1st 1935. Hence,
the RBI is a statutory body setup by an act of parliament. In case of any statutory body the structure and function is well
defined by the provisions of the act. Hence, in order to modify the structure and functions of the body, the act must be
modified by the parliament. (Constitutional bodies are different from statutory bodies. In order to modify the structure and
functions of a constitutional body, the constitution must be amended by the parliament. The RBI is not a constitutional
body.)

When the RBI was setup its headquarter was located in Calcutta. However, in 1937 its headquarter was permanently shifted
to Mumbai. Post independence in the year 1948 RBI(Transfer to Public Ownership) Act was passed and under this act on
January 1st, 1949 the RBI was brought under the control of the Government of India .

The RBI is headed by a Governor and also has four Deputy Governors. The first governor of RBI was Sir Osborne Smith.
The first Indian governor of RBI was CD Deshmukh. At present, Sanjay Malhotra is the governor of RBI. The governor of the
RBI is appointed by the government. Initially, the term period of the governor was of five years which has been revised to
three years. However, the governor is eligible for reappointments. He maybe removed or he may resign even before the
completion of the term period.

🩳
Reserve Bank of India (RBI):

A statutory body, meaning its structure and functions are defined by an act of Parliament, which must be

Post-Independence:

Leadership:

First Governor: Sir Osborne Smith.

First Indian Governor: CD Deshmukh.

Deputy Governors: Four in total.

Appointment and Term:

Governor appointed by the government.

The responsibilities of RBI

Banking system in India 3

 The structure and function of RBI are governed by provisions of the RBI Act 1934. This act has been amended a number of
times and it can be amended even in the future. Hence, the functions and responsibilities of RBI have kept on changing
with changing circumstances. Some of the important functions of RBI are as follows:

RBI is the banker to the government. It means that RBI provides banking services to the central government as well as to
the state governments. For the centre, it is mandatory to avail banking services from RBI. However, the states sign a mutual
contract with RBI to avail banking services. At present, RBI provides banking services to all the states and union territories,
except Sikkim(Sikkim avails banking services from the State Bank of Sikkim).

1. Under the banking services provided to the governments, the governments deposit their surplus with RBI and when
they are in need they may borrow through RBI or directly from RBI. The Consolidated Fund, the Contingency Fund and
the Public Account of the government are with RBI.

2. RBI is banker to the banks. It means that the banks regulated by RBI may maintain their surplus with RBI and whenever
they are in need they may borrow from RBI. RBI may also provide financial consultancy to the banks. If a bank is in a
condition of financial crisis and it is not able to borrow from anywhere, the RBI may come to the rescue of the bank.
Hence, the RBI is also often termed as ‘the lender of last resortʼ.

3. RBI also regulates some of the Non-Banking Financial Companies(NBFCs). However, insurance companies are
regulated by IRDAI, mutual fund companies are regulated by SEBI.

4. RBI regulates the entire banking system in India. It may formulate rules for the banks. It may issue new banking licences
and it may also cancel the licence of an existing bank.

5. RBI also plays an important role in regulation of the Fintech companies(however, the fintech companies in India are also
regulated by IRDAI and SEBI).

6. RBI plays an important role in formulating the monetary policies. With the help of these policies, RBI manages liquidity
in the economy, it tries to control inflation, it tries to manage economic growth and it also tries to maintain a stable
exchange rate of domestic currency.

7. RBI plays an important role in foreign investment, external borrowings of the corporates and the government and even
with respect to remittances.

8. RBI also regulates the payment and settlement system in India.

9. RBI is the custodian of foreign exchange reserve in India. As a part of its foreign exchange reserve, India maintains
gold, USD, pound, euro, yen and Special Drawing Rights(SDRs).

Gold is a liquid asset which is accepted by the entire world and which can be easily converted into cash. USD, Euro,
Pound and Yen are hard currencies which are accepted by the entire world. SDR is the accounting unit of International
Monetary Fund(IMF). It is also accepted by the entire world.

10. RBI issues currency notes above the denomination of ₹1(₹1 note and all the coins are issued by the /Government of
India. However, even the ₹1 note and the coins are circulated in the economy by RBI only.

Different mechanism for printing fresh currency

Banking system in India 4

 In different countries in order to print fresh currency two different mechanisms are used—

1. Minimum reserve system

2. Proportional reserve system

Minimum reserve system

This mechanism is used in India and in a number of other developing countries. In India it is being followed since 1956.
Under this mechanism, in any FY the RBI maintains a minimum reserve of worth ₹200 crore. This reserve of ₹200 crore is
fixed but is in the form of gold and other hard currencies. In this reserve, gold worth ₹115 crore is maintained and hard
currency worth ₹85 crore is maintained. Against this reserve the RBI may print any amount of fresh currency in that
financial year. No external agency has the authority to regulate RBI in this regard. However, by printing fresh currency, RBI
will keep in mind the economic interest of the country such as the desirable economic growth, the rate of inflation and even
the exchange rate(fresh currency that is printed is maximum inflationary in nature).

In modern economies money is the medium of exchange. Since they are the valid medium of exchange they are termed as
legal tender. However, in modern economies the currency notes which are in use are just a piece of paper. They do not
have any intrinsic value of their own. They have a value only because of the guarantee of the government and the promise
made by the central bank. Because of this such currency notes are also termed as fiat money.

Because of the promise made by the governor, a currency note becomes the liability of the central bank. It serves as claim
over the central bank. It means that if a bearer has no faith in the currency note, it can be given back to RBI. In return RBI
will give the currency notes of different denomination. If the different denomination is also not acceptable to the bearer,
then this reserve can be used which consists of those assets which are internationally accepted. However, such condition
may not arise in India because the economy is relatively stable and even the Indian currency is relatively stable.

Proportional reserve system

Even this mechanism is used by a number of countries throughout the world, especially, the developed countries. In this
mechanism the reserve which is maintained in order to print currency is not fixed. It keeps on changing along with the
change in the amount to be printed. It means that as the amount which is to be printed increases, the reserve will also
increase in the same proportion.

Banking system in India 5

 Short

Responsibilities of RBI
Governing Act: RBI Act 1934; amended multiple times. Functions and responsibilities evolve with amendments.

1. Banker to the Government:

Provides banking services to central and state governments (all except Sikkim).

Manages the Consolidated Fund, Contingency Fund, and Public Account.

2. Banker to Banks:

Banks can maintain surplus with RBI and borrow when needed.

Acts as 'lender of last resort' during financial crises.

Provides financial consultancy.

3. Regulator:

Regulates banks and some Non-Banking Financial Companies (NBFCs).

Issues and cancels banking licenses.

Regulates Fintech companies (alongside IRDAI and SEBI).

4. Monetary Policy: Formulates policies to manage liquidity, control inflation, promote economic growth, and
stabilize exchange rates.

5. Foreign Exchange and Investment: Manages foreign investments, external borrowings, and remittances.

6. Payment and Settlements Systems: Oversees the regulation of these systems in India.

7. Custodian of Foreign Exchange Reserves: Maintains reserves in gold, USD, pound, euro, yen, and Special
Drawing Rights (SDRs).

8. Currency Issuance: Issues notes above ₹1; ₹1 notes and coins issued by the Government of India, but
circulated by RBI.

Currency Printing Mechanisms:

1. Minimum Reserve System:

Followed in India since 1956. Maintains a reserve of total ₹200 crore in the form of gold (₹115 crore) and
hard currencies (₹85 crore).

Prints currency based on economic needs, mindful of growth, inflation, and exchange rates.

2. Proportional Reserve System:

Used by many developed countries. Reserve varies proportionally with the amount of currency printed.

Fiat Money:

Modern economies use currency notes with no intrinsic value, termed as fiat money.

Currency notes are a liability of the central bank due to the promise made by the governor.

Stability:

Indian economy and currency are relatively stable, ensuring faith in the currency notes.

Banking system in India 6

 📎
India but they were demonetised in 1978. In India currency notes are printed only at four different places—

Salboni in West Bengal

Since the ₹1 note is issued by the Government of India, on it RBI is nowhere mentioned. On ₹1 note no promise is
printed and it is signed by the finance secretary rather than the governor of RBI.

History of banks in India

The first bank to be setup in India was the Bank of
Hindustan. It was setup in 1770 by Alexander and
company. However, this bank didnʼt continue
🗓 Timeline
1770: First Bank - Bank of Hindustan
operation for long. The East India Company(EIC)
established three important banks one after the
other. In 1806 Bank of Calcutta was setup which
was renamed as Bank of Bengal in 1809. In 1840
1840: Bank of Bombay
Bank of Bombay was established. In 1843 Bank of
Madras was established. All these three banks 1843: Bank of Madras
were merged with each other in the year 1921 and
Imperial Bank of India was created. Post
independence, in the year 1955 the Imperial Bank
of India was brought under the control of
Government of India and renamed as the State 1894: Punjab National Bank (only Indian investors)
Bank of India(SBI). In subsequent years, few more
large banks were converted into the associates of
SBI. Finally, SBI had seven associates—

1. State Bank of Travancore

2. State Bank of Hyderabad

3. State bank of Saurashtra

4. State Bank of Patiala

5. State Bank of Bikaner and Jaipur

6. State Bank of Mysore

7. State Bank of Indore

Out of these associates, State Bank of Saurashtra was merged with SBI in 2008. State Bank of Indore was merged with SBI
in 2010. The remaining associates were merged with SBI in 2017. Hence, the associates do not exist anymore. The merger
of the associates was done with the SBI in order to enhance the size of SBI. This also brought down competition and
operational cost.

In 2013, the Government of India had established a bank named as Bhartiya Mahila Bank. Even this bank was merged with
SBI on April 1st 2017. Hence, it also does not exist anymore.

Banking system in India 7

 In between 1843 and 1921 few more banks were setup in India which are historically important. In the year 1865, Allahabad
bank with its HQ in Calcutta was setup. It has been merged with Indian bank in 2020 and doesnʼt exist anymore. In the year
1881, Oudh Commercial Bank was setup. It was Indiaʼs first joint stock bank which also had shareholders. In 1894 Punjab
National Bank(PNB) was setup in which only the Indians had invested.

📎 Since the origin of SBI is traced back to Bank of Calcutta which came into existence in 1806, it is regarded as the
oldest serving bank in India.

🩳
Currency Printing in India
Paper: 100% cotton.

Maximum Denomination: ₹10,000 (demonetised in 1978).

Printing Locations:

Press location Owned by

Dewas, Madhya Pradesh Government of India

Nashik, Maharashtra Government of India

Salboni, West Bengal RBI

Mysuru, Karnataka RBI

History of nationalisation of Banks

Nationalisation as a process is just the opposite of
Privatisation. When a public sector company is sold by the
government to a private investor in which the ownership as
well as the management both get transferred to the private
investor then it is termed as privatisation. On the other
hand when a private company is brought under the control
of the government, ownership as well as the management
both come to the government, then it is termed as
nationalisation. Post independence a phase of
12 public sector commercial banks in India
nationalisation started in India. It was decided that all the
strategic sectors will be brought completely under the
Under this process of nationalisation, in the year 1969,
control of the government. Hence, with this objective even
fourteen large banks with a minimum deposit of ₹50 crore
the nationalisation of banks in India was started.
each were nationalised. Again in the year 1980, six large
During independence all the banks operating in India banks with a minimum deposit of ₹200 crore each were
belonged to private sector. The banking sector suffered nationalised. With this nationalisation excluding SBI and
from fraudulent activities. The banks were present only in associates the number of nationalised commercial banks
urban areas and they hardly in the rural areas. Only the went upto 20. However, in the year 1993, out of these 20
middle class and the upper class of the society had access banks, the New Bank of India went bankrupt and was
to banking. Hence, in order to safeguard the deposit of the merged with PNB. Thereafter, the number came down to
depositors, to expand the banking sector in rural areas and 19.
to provide access to banking to the people even at

Banking system in India 8

 grassroots level, the process of nationalisation of banks During the American recession of 2008 it was realised that
was undertaken. during a situation of severe economic crisis it becomes
difficult for the smaller banks to survive. Hence, it was
decided that gradually the smaller and the weaker banks
will be merged with the larger public sector banks. Under
the same process of merger, Allahabad bank was merged
with the Indian bank.

Dena bank and Vijaya bank were merged with the Bank of Baroda and finally the number of these nationalised commercial
banks has been reduced to 11 excluding SBI. At present including SBI there are 12 public sector commercial banks
operating in India. Out of these the smaller banks such as UCO bank, Indian Overseas Bank, Bank of Maharashtra and
Punjab and Sind bank will be privatised in subsequent years.

Once a private banks is nationalised it also becomes a public sector bank. Hence, every nationalised bank is also a public
sector bank. However, the banks which are setup by the government itself will be a public sector bank but they will not be
a nationalised bank. Hence, every public sector bank is not necessarily a nationalised bank. For example, Bhartiya Mahila
Bank which was public sector bank since its inception and was later merged with SBI.

Initially, IDBI bank was also a public sector bank. However, it was sold by the government to LIC and thereafter it was
declared a private sector bank by the RBI.

Classification of Banks in India

The banks operating in India are mainly classified into the following two types:

1. Scheduled banks

2. Non-scheduled banks

Scheduled banks are those banks which are regulated by the RBI and are listed in the second schedule of RBI act 1934.
This list is dynamic and is not fixed forever. Whenever a new bank is setup in India, after seeking permission from the RBI,
it is listed in the second schedule of the act. Whenever a bank winds up its business in India, it is eliminated from this list.
These banks must follow certain guidelines issued by the RBI—

1. It is the RBI which decides the paid up capital of these banks. Initially for a commercial bank it used to be ₹5 lakh but
gradually it has been increased by the RBI.

2. None of their activities should adversely affect the interest of their customers.

3. They must follow the monetary policies formulated by the RBI.

In return whenever these banks are in need they may borrow from the RBI. The scheduled banks are as follows:

Banking system in India 9

 The commercial banks are those banks which operate with an objective of making profit. They can be public sector(like
SBI, PNB, Canara, BoB etc.) or private sector banks. The private sector banks can be of Indian or foreign origin. Banks like
ICICI, HDFC, Axis, Yes bank etc. are some of the Indian private sector banks. Out of the foreign banks operational in India
few notable ones are HSBC bank(British), Barclays bank(British), Standard Chartered bank(British). Deutsche bank, which
is the largest German bank, BNP Paribas which is the largest French bank, Industrial and Commercial Bank of China are
some other important foreign banks operating in India. Out of all the foreign banks which operate in India Standard
Chartered Bank has maximum number of branches in India. Citi bank which is one of the largest banks of the world is an
American bank which was operational in India but its Indian banking operation has been sold to Axis bank. Based on
market capitalisation/market value JP Morgan Chase, an American bank is the worldʼs largest bank. However, it doesnʼt
provide banking services in India. Based on market capitalisation, HDFC bank is Indiaʼs largest bank. Based on asset, total
deposit and number of branches SBI is the largest bank in India.

In banking, the profit is partial but the loss is complete.

Banking system in India 10

 Shorts

History of Nationalisation of Banks

Nationalisation vs. Privatisation:

Privatisation: Public sector company sold to private investor, transferring ownership and management.

Nationalisation: Private company brought under government control, transferring ownership and
management to the government.

Post-Independence Nationalisation:

Aim: Control strategic sectors, including banking.

Reasons

Address fraudulent activities in private banks.

Expand banking in rural areas.

Provide banking access to all social classes.

Nationalisation Milestones:

1969: Fourteen large banks with minimum ₹50 crore deposits nationalised.

1980: Six more large banks with minimum ₹200 crore deposits nationalised.

Total nationalised banks (excluding SBI and associates): 20.

1993: New Bank of India after bankruptcy merged with PNB, reducing number to 19.

Post-2008: Merging of smaller banks with larger ones to enhance stability.

Examples:

Allahabad Bank with Indian Bank.

Dena Bank and Vijaya Bank with Bank of Baroda.

Current count of nationalised commercial banks: 11 (excluding SBI).

Public Sector Banks:

Current Total: 12 (including SBI).

Future plans: Privatisation of smaller banks (UCO Bank, Indian Overseas Bank, Bank of Maharashtra,
Punjab and Sind Bank).

Public Sector vs. Nationalised Banks:

Nationalised Bank: Once private, now government-controlled.

Public Sector Bank: Set up by government, not necessarily nationalised.

Example: Bhartiya Mahila Bank (public sector since inception, merged with SBI).

IDBI Bank: Initially a public sector bank, sold to LIC, now a private sector bank.

Classification of Banks in India

Two Main Types:

1. Scheduled Banks

2. Non-Scheduled Banks

Scheduled Banks:

Regulated by RBI, listed in the second schedule of the RBI Act 1934.

Dynamic list, updated with new bank entries and removals.

RBI Guidelines for Scheduled Banks:

1. Paid-up Capital: Decided by RBI (initially ₹5 lakh, increased over time).

2. Customer Interest: Activities should not adversely affect customers.

Banking system in India 11

 Regional rural banks(RRBs)
RRBs are classified as a scheduled bank regulated by the RBI. They are established in a particular region in a particular
state and they setup branches only in the rural areas of that region. Hence, they are termed as Regional Rural Banks. They
cannot setup branches in urban areas. The main objective of the RRBs is to connect the rural population with the banking
system. The goal is to encourage the rural population to deposit their surplus in the banks and to avail institutionalised
credit from the banks.

Whenever a RRB is setup, 50% of the total capital investment is done by the Government of India. 35% of the investment is
done by a public sector bank and the remaining 15% is done by the state government. The public sector bank which acts
as an investor is termed as the sponsor bank. On 2nd October 1975 in four different states of India the first set of five RRBs
came into existence. However, the RRB act was passed in 1976. Gradually, their number increased to 196 and these RRBs
established thousands of branches throughout the country. When a regional rural bank is setup it operates with a different
name and it has its own management.
Banking in rural areas is a difficult task. The rural population hardly has surplus and those who have surplus they
themselves become moneylenders. The rural population borrows mainly for the purpose of agriculture in which the
uncertainty remains high and hence even the rate of defaulting remains high. Because of this most of the RRBs were
operating with loses. Hence, the government decided to consolidate by merging them with each other. Gradually, through
their merger the number has been reduced from 196 to 43. At present in India new RRBs are not setup. Their number will
be brought down further. However, except Goa and Sikkim every state in India has RRBs.

📎 Just like a commercial bank even RRBs must maintain CRR and SLR. However, the RRBs have to maintain their
SLR completely in the form of government securities.

Cooperative banks
Cooperative banks in India are also classified as scheduled banks. They operate on the basis of mutual cooperation with
the objective of no profit, no loss. The cooperative banks have a number of members who contribute in the form of
deposit and whenever they are in need they may borrow from the banks.

The cooperative banks are broadly classified into two different types:

1. State cooperative banks

2. Urban cooperative banks

The state cooperative banks are mainly registered under State Cooperative Societies act. They remain confined to one
single state and they cannot have branches outside that particular state. The state cooperative banks are known as Central
Cooperative banks at district level. At village level they are termed as Primary Agricultural Credit Societies(PACS). PACS are
also provided assistance by the Central Cooperative banks.

The Urban Cooperative banks are mainly registered under Multi-State Cooperative Societies act. They can operate in
different states. Initially, they were not allowed to provide loan for agriculture but now the restriction has been lifted.

Initially, the RBI had no role in regulation of the cooperative banks. The registered Cooperative Banks were regulated only
by the state government. In the year 1966 the Cooperative Banks were partially under the regulation of the RBI. Thereafter,
dual regulation was applied over the cooperative. The banking services are regulated by the RBI but the management is
regulated by the state governments. Because of the role of the state government, politicisation of the cooperative banks
has been a common problem in India.

Few years back, because of the scam related Punjab and Maharashtra Cooperative bank in the year 2020 banking
regulation act was amended. With this amendment, regulation of the RBI over Cooperative Banks was further enhanced.
Now the RBI can even intervene in their management. However, the PACS are still outside regulation of the RBI. They are
mainly regulate by NABARD.

Banking system in India 12

 Shorts

Regional Rural Banks (RRBs)

Classification: Scheduled banks regulated by RBI.

Operations: Established in specific regions within states, with branches only in rural areas.

Objective: Connect rural population with banking, encourage deposits, and provide institutional credit.

Capital Investment:

Government of India 50% + Public sector bank (Sponsor Bank) 35% +

State government 15%

History:

First set of five RRBs established on 2nd October 1975 in four states. RRB Act passed in 1976.

Initially increased to 196 RRBs. Merged to reduce number to 43 due to operational losses.

Current Status:

No new RRBs being set up. Existing RRBs expected to decrease further.

Present in all states except Goa and Sikkim(owing to their small size and mostly urban population).

Regulatory Requirements:

Maintain CRR and SLR like commercial banks.

SLR must be entirely in the form of government securities.

Merge RRBs with sponsor banks, say 2 bank unions

Cooperative Banks
Classification: Scheduled banks based on mutual cooperation, aiming for no profit, no loss.

Membership: Members contribute deposits and can borrow as needed.

Types:

1. State Cooperative Banks:

Registered under State Cooperative Societies Act.

Operate within one state, known as Central Cooperative Banks at district level and Primary
Agricultural Credit Societies(PACS) at village level.

2. Urban Cooperative Banks:

Registered under Multi-State Cooperative Societies Act.

Can operate in multiple states.

Initially restricted from disbursing agricultural loans, now allowed.

Regulation:

Initially regulated only by state governments.

Partial RBI regulation since 1966, leading to dual regulation. RBI regulates banking services, state
governments manage operations.

Politicisation is a common issue due to involvement of the state government.

Recent Developments:

2020 amendment to Banking Regulation Act enhanced RBI's regulatory powers over cooperative
banks.

RBI can now intervene in management decisions as well. Although PACS remain regulated by NABARD,
not RBI.

Banking system in India 13

 Narasimham Committee on banking sector reform
The process of nationalisation of the banks had several objectives. These objectives were also fulfilled to a great extent.
However, it also had a number of negative consequences. Since, most of the major banks had come under complete
control of the government the competition in the banking sector declined which affected the services adversely. Even the
profit of the public sector banks was not upto the expectations. The banking sector remained almost stagnant. Hence, in
order to improve the health of the banking sector a committee was constituted under the chairmanship of M. Narasimham,
a former RBI governor. Narasimham committee was constituted twice. Once, in 1991 and again in 1998. The
recommendations of the first Narasimham committee constituted in 1991 were as follows:

1. There should be no more nationalisation of banks so that private investment in the banking sector can be encouraged.

2. Complete computerisation of all the branches of all the banks in order to ensure better services.

3. With respect to rules there should be no discrimination in between the public sector banks and the private sector
banks. They both should be treated at par.

4. Some of the indian banks should be promoted as global banks

5. Two or more stronger banks can be merged with each other in order to create a much stronger larger bank. However,
weaker banks must not be merged with stronger banks otherwise it will also affect the health of the stronger bank.

6. CRR and SLR should be reduced so that the banks are left with more amount of money to conduct their business.

7. Asset Reconstruction Companies(ARCs) should be setup in order to recover the NPAs of the banks.

8. Those public sector banks which are healthy and in profit should be allowed to be listed on the stock exchange in order
to raise capital from the capital market.

9. The interest given by the banks on saving accounts deposits should not be regulated by the RBI and or should be left to
the banks to decide that how much interest they wish to pay.

10. Priority sector lending should be rationalised and it should be left to the banks to decide. The mandatory clause of 40%
must be reduced to 10%(this recommendation was rejected by the RBI).

Rules related to foreign investment— Indian banking sector

In order to understand the rules related to foreign investment in the banking sector in India the commercial banks can be
broadly classified into— Foreign bank operating in India, Public sector banks and Private sector Indian banks.

For foreign banks

In case of a foreign bank operating in India, the parent bank may invest 100% and may continue to hold full stake in its
Indian subsidiary. Hence, it maybe concluded that in the Indian banking sector foreign investment of upto 100% is allowed.

For public sector banks

Banking system in India 14

 In case of a public sector bank, the government may hold 100% stake. However, if the government decides to sell some of
its stake, it may bring down its holding upto 51%. The remaining 49% can be sold to the other interested investors.
However, no single investor can have more than 10% stake. Insurance companies are an exception and an insurance
company may hold upto 15%. Total foreign investment in a public sector bank cannot exceed 20%.

For private sector banks

When a private investor is given banking licence by the RBI, the promoter may hold complete 100% stake. During the first
five years of establishment the promoter may bring down his holding in the bank upto 40%. It means that the remaining
60% can be sold. No single investor can have more than 10% stake in the bank. Insurance companies are an exception and
they can hold upto 15%. During these first 5 years, foreign investment in the bank cannot exceed 49%.
After the fifth year and by the end of fifteenth year, the promoter will have to bring down his holding essentially to 26%. It
means that the remaining 74% stake can be sold. No single investor can have more than 10%, the insurance
companies(15%) being an exception. During these years—by the end of fifteenth year—foreign investment in the bank may
go upto 74%. After these fifteen years foreign investment in such banks may even go upto 100% but it is possible only
when the promoter is will to sell even the remaining 26%.

Banking system in India 15

 Shorts

Narasimham Committee on Banking Sector Reforms

Nationalisation of banks aimed to enhance service reach and safeguard deposits.

However, it led to decreased competition and stagnation in the banking sector.

Narasimham Committee (1991) Recommendations:

1. No More Nationalisation: To encourage private investment.

2. Complete Computerisation: For better service delivery.

3. Equal Treatment: Public and private sector banks to be treated equally.

4. Promote Global Banks: Some Indian banks should aim to become global players.

5. Mergers: Stronger banks may merge; avoid merging weaker banks with stronger ones.

6. Reduce CRR and SLR: Free up funds for banking business.

7. Asset Reconstruction Companies (ARCs): Recover Non-Performing Assets (NPAs).

8. Stock Exchange Listing: Profitable public sector banks should raise capital via stock markets.

9. Interest Rates on Savings: Should be deregulated.

10. Priority Sector Lending: Rationalisation, reduction of mandatory 40% to 10% (RBI rejected this).

Rules on Foreign Investment in Indian Banking Sector

Foreign Banks:

Parent banks may hold 100% stake in their Indian subsidiaries.

Public Sector Banks:

Government can hold 100% stake but may reduce it to 51%.

Other investors can hold up to 49%, with a cap of 10% per single investor (15% for insurance companies).

Total foreign investment capped at 20%.

Private Sector Banks:

Initial Phase:

Promoter can hold 100% stake, but must reduce to 40% within 5 years.

Foreign investment capped at 49% in the first 5 years.

After 5 to 15 Years:
Promoterʼs stake must reduce to 26%.

Foreign investment may increase upto 74%.

Beyond 15 Years:

Foreign investment can go up to 100% if the promoter sells the remaining 26%.

Guidelines related to establishment of commercial banks in India

In order to setup a universal commercial bank of Indian origin the RBI issues guidelines based on which the licence is
granted. From time to time the guidelines are also modified by the RBI. Based on the existing guidelines in the year 2024,
Yes bank and Kotak Mahindra Bank were given licence. Again in the year 2014, two more banks—Bandhan bank and IDFC
First bank—were given licences. Since then the rules have been modified and till date no new universal bank of Indian
origin has been given licence by the RBI. During this period several foreign banks have started operation in India and even
the Payments banks and the Small Finance banks have come into existence. Initially, the RBI used to issue notification and
the interested investors had to apply for a banking licence only during the notified period. However, at present the entire
process has been made ‘On Tapʼ. It means that now the interested parties may apply for a banking licence any time. The

Banking system in India 16

 RBI does not issue any notification for that. Under this ‘on tapʼ process the applications which are filed can be accepted or
rejected by the RBI. In order to provide banking licence the modified guidelines are as follows:

1. An individual investor or a NBFC and even Indian company may apply for a banking licence. They must be resident
Indian and must have a neat and clean history of at least 10 years of operation in India.

2. A group company like the Tatas, the Ambanis, the Adanis etc. are not eligible for a banking licence. However, they can
have upto 10% stake in existing commercial banks.

3. If the licence is given it will remain valid only for 18 months during which the bank must start its operation

4. Minimum capital investment of ₹1000 crore will be required.

5. During the first five years of establishment the promoter may bring down his holding in the bank to 40%. During this
period 60% stake can be sold to the other investors but foreign investment cannot exceed 49%. No single investor can
have more than 10% stake. Insurance companies are an exception, which may hold upto 15% stake.

6. After five years and by the end of the 15th year the promoter will have to bring down his holding essentially to 26%.
The remaining 74% stake has to be sold. No single investor except the insurance companies can have more than 10%
stake. During this period foreign investment may go upto 74%.

7. At least 1/4th of the total branches must be setup in unbanked rural areas with a population not less than 9999 as per
2011 census.

8. The bank will have to be listed on the stock exchange within a period of six years.

Shorts

Guidelines for Establishing Commercial Banks in India (2024)

RBI issues and periodically updates guidelines for granting banking licenses.

The process was revised to 'On Tap,' allowing applications at any time without RBI notifications.

1. Eligibility:

Individual investors, NBFCs, and Indian companies with a minimum of 10 years of clean operation
history in India.

Large group companies (e.g., Tatas, Ambanis, Adanis) are ineligible but can hold up to 10% stake in
existing banks.

2. Licence Validity: License remains valid for 18 months, within which the bank must commence operations.

3. Capital Requirement: Minimum capital investment required is ₹1000 crore.

4. Promoter's Stake:

First 5 years: Promoter may reduce holding to 40%, with 60% sold to other investors. Foreign
investment capped at 49%, single investor stake at 10% (15% for insurance companies).

By end of 15th year: Promoterʼs holding must be reduced to 26%, with foreign investment potentially
increasing to 74%.

5. Branch Requirement: At least 1/4th of branches must be in unbanked rural areas with populations below
9999 (as per 2011 census).

6. Stock Exchange Listing: Bank must be listed on the stock exchange within 6 years of establishment.

Priority Sector Lending

Some of the sectors in India are given high priority by the RBI and even by the government. It is a belief that for overall
development of the country the development of these sectors is extremely important. These sectors include the following:

1. Agriculture and related activities Later on this list was amended and The amended list was once again
four more sectors were added to the amended and three more sectors
2. Infrastructure
list. These are: have been added to it—
3. Education

Banking system in India 17

 4. Export 9. Social infrastructure such as 13. Loan given to the FPOs(Farmer,
construction of schools, Producer Organisations)
5. Weaker sections of the society
hospitals, toilets, etc.
such as the SC, ST, members of
SHGs etc.

6. Microfinance institutions

7. Low cost housing 12. Overdraft facility provided under

Pradhan Mantri Jan Dhan Yojana
8. Micro and small enterprises.

Under priority sector lending it is compulsory for a bank to provide a fix part of their Adjusted Net Bank Credit(ANBC) to
the priority sector in the form of loan(ANBC of a bank refers to the total loan given by a bank excluding the investment in
G-secs which constitute a part of their SLR. It means investment in G-secs over and above the SLR will be counted as a
part of their ANBC).

The rules regarding PSL are as follows:

1. For an Indian commercial bank it is necessary that at least 40% of its ANBC should go to priority sector in the form of
loan. 18% of its ANBC should alone go to agriculture. Even this 18% will be counted as a part of that 40% which is to be
given to the priority sector.

2. For the foreign banks operating in India having 20 or more branches it is necessary that 40% of its ANBC must go to
priority sector in the form of loan. 18% of its ANBC which will be counted as a part of this 40% should go to agriculture
essentially. It means that for the foreign banks with 20 or more branches in India these rules are similar to the rules
followed by the Indian commercial banks.

3. For the foreign banks operating in India with less than 20 branches the rules are different. For such banks it is essential
that 40% of their ANBC should go to priority sector in the form of loan but the rules related to agriculture is not
applicable. These banks may provide upto 32% of their ANBC in the form of loan to export sector. This will be counted
as a part of this total loan of 40%

4. For RRBs and for small finance banks it is essential that 75% of ANBC must go to priority sector in the form of loan.
18% of their ANBC should go to agriculture which will be counted as a part of that total loan of 75%.

If in a FY a bank fails to achieve the target related to Priority Sector then the shortfall amount must be deposited by the
bank in Rural Infrastructure Development Fund or any other similar fund maintained by NABARD. This deposit will be for a
long term purpose over which the bank will be given a nominal interest.

On 21st June 2024, through a notification the RBI has modified the rules related to PSL. The RBI will issue the list of those
districts in which the per capita priority sector loan is even below ₹9000. The banks operating in India will have to give
priority to such districts while providing loan to the priority sector. This list will remain valid till 2026-27. This change will be
applied from the year 2024-25.

Priority Sector Lending Certificate(PSLC)

PSLC was introduced in India in the year 2016 on the recommendations of Raghuram Rajan committee. Under this
mechanism, it is ensured that the banks which exceed the PSL target are given an option to derive some benefit. Under this
mechanism, the such banks are allowed to issue PSLC with a value equal to the value by which the target is exceeded.
This PSLC is issued in the electronic form can be auctioned by the issuing bank on E-Kuber. Those banks which have failed
to achieved the target, have an option to buy these certificates. The certificate is issued with a face value but is auctioned
at a price which is higher than the face value. During the audit conducted by the RBI, the banks failing to achieve the PSL
target may show these certificates as a part of their priority sector lending and escape penalty. This certificate remains
valid till the last day of a financial year and expires on the first day of the next financial year. It means this certificate is
issued and sold on 31st March and on the next day i.e. 1st April it expires. The moment it expires the issuing bank will return
the amount equal to the face value to the bank which had bought the certificate. The amount which was over and above
the face value will remain with the issuing bank which will be its profit.

Banking system in India 18

 Shorts

Priority Sector Lending (PSL) Guidelines:

1. Indian Commercial Banks:

At least 40% of Adjusted Net Bank Credit(ANBC) should be for priority sectors.

18% of ANBC should be specifically for agriculture, included within the 40%.

2. Foreign Banks with 20+ Branches:

Same rules as Indian banks: 40% of ANBC to priority sectors, including 18% to agriculture.

3. Foreign Banks with 20 Branches:

40% of ANBC to priority sectors.

No specific agriculture requirement.

Up to 32% of ANBC can be for the export sector, counted within the 40%.

4. Regional Rural Banks (RRBs) and Small Finance Banks:

75% of ANBC to priority sectors.

18% of ANBC to agriculture, included within the 75%.

Penalties for Non-Compliance:

Shortfalls in PSL targets must be deposited in the Rural Infrastructure Development Fund (RIDF) or similar
NABARD funds.

Deposits in such funds are long-term with nominal interest.

Priority Sector Lending Certificate (PSLC):

Introduced in 2016, based on Raghuram Rajan committee recommendations.

Mechanism for banks exceeding PSL targets to gain benefits.

PSLCs are issued electronically and auctioned on E-Kuber.

Banks failing PSL targets can buy PSLCs to avoid penalties.

Certificates expire on 31st March and the issuing bank returns the face value to the buyer.

Profit for the issuing bank is the amount above the face value from the auction.

Banking system in India 19

 Non-performing Asset(NPA)
The loan given by a bank or a NBFC can be termed as an asset of that bank or the NBFC. When the borrower continues to
pay principal as well as the interest, it is said that the asset is performing. However, if the borrower defaults and
discontinues the repayment of principal as well as interest then it can be said that the asset is not performing. Hence,
technically NPA refers to that account of a borrower in which he fails to repay principal as well as interest consecutively for
90 days.

For the NBFCs initially this time period was of 180 days i.e. in order to classify a loan as NPA they had to wait for 180 days.
However, at present even the NBFCs have to classify a loan as NPA after 90 days.

For agricultural loan the rules are relatively different. For this purpose the crops are classified into two different types—
short term crops(mature within a period of 6 months) and long term crops(mature within a period of one year). In case of
loan given for short term crop the banks wait for two complete seasons i.e. six months + six months before classifying the
loan as NPA. On the other hand for the long term crops, the banks wait for one complete season i.e. one year.

The moment a loan becomes NPA it is classified into three different types—

1. The moment a loan becomes NPA, it will be classified as a sub-standard asset.

2. Continuously for 12 months the loan remains in the category of sub-standard asset. The moment this NPA becomes
older 12 months it is placed under the category of doubtful asset.

3. Till the end of 36 months that NPA will remain in the category of doubtful asset but the moment this NPA becomes
older than 36 months it will be placed under the category of loss asset.

Hence, it can be said that the NPAs are basically classified as substandard asset, doubtful asset and loss asset. NPAs are
also termed as bad loan/bad debt/sticky loan. Older the NPA, lower are the chances of recovery. However, at any point of
time if the repayment starts again, the loan will be classified as standard asset and it will not be termed as a NPA.

The loan which is defaulted and which is to be recovered is termed as the Net NPA of the bank. In order to express it in % it
is compared with the total loan given by the bank. For example, if a bank has given a total loan of ₹100, out of which a loan
of ₹1 is defaulted then it can be said that the Net NPA of the bank is 1%.

Normally, the banks use the deposit of the depositors in order to provide loan to the borrowers. Hence, the moment a loan
becomes NPA it is the depositor who is at risk. Therefore, under the guidelines of the RBI it is the duty of the bank to
safeguard the deposit of the depositors. With this objective gradually the bank will set aside a part of its profit until this
amount becomes equal to 100% of the Net NPA. This amount which is set aside by the bank is termed as provision. If the
bank is not able to make profit, the promoter will have to infuse additional capital in the bank so that the bank is able to
maintain sufficient provision. The provision which is maintained is also an asset of the bank. But the bank cannot use this
amount for other purposes. Hence, even this amount is termed as NPA. When the amount maintained as provision is added
to the Net NPA of the bank then we derive the gross NPA of the bank.

Gross NPA = Net NPA + Provision

Balance sheet of company is its financial report card. It shows the financial condition of a company including its asset and
liability. Even the banks maintain their balance sheet which also reflect the Net NPA and the Gross NPA of the banks. From
time to time, as a regular procedure, even the banks clean their balance sheets. With this objective the NPAs which are
relatively old are shown as a loss by the bank in that financial year and it will be eliminated from the balance sheet. This
elimination of a NPA from the balance sheet is termed as write-off. Even if an NPA is written-off from the balance sheet, the
recovery continues. Hence, loan write-off is completely different from waive-off. In case of a loan waive-off, which is
mainly done in case of agricultural loan, the borrower is freed from the liability to repay and the recovery is discontinued. In
case of farm loan waive-off, the banks are compensated by the government. The moment an NPA is written-off, the
provision which was maintained against it, is set free which can be used by the banks for providing fresh loan to the
borrowers.

Deposit Insurance and Credit Guarantee Corporation(DICGC)

DIGC is a 100% owned subsidiary of the RBI. It provides insurance cover to the deposit of the depositors. DICGC covers all
the scheduled banks operating in India—Indian and foreign commercial banks, RRBs, cooperative banks, payments banks,
small finance baks, etc. PACS and NBFCs are not covered under DICGC.

Banking system in India 20

 According to the present rule, if a bank goes bankrupt, the deposit of upto ₹5 lakh including the interest will have an
insurance cover. It means a depositor will get an amount of upto ₹5 lakh. This amount is not directly paid by DICGC to the
depositors. This amount is paid by DICGC to the entity which was given the responsibility of liquidation of the bank and it
will compensate the depositors. The amount is to be paid by DICGC within a period of sixty days.

In order to avail the insurance cover, for every ₹100 deposit a premium of 12 paise is to be paid to DICGC. The burden of
the premium payment falls upon the bank and not upon the depositors.

Bank deposits are showing growth, but are they protected?

Banking system in India 21

 Shorts

Non-performing Asset (NPA)

An NPA is a loan or advance for which the principal or interest payment remains overdue for a period of 90
days.

For agricultural loans, the classification as NPA depends on crop type:

Short-term crops: Defaults for two crop seasons (roughly 12 months).

Long-term crops: Defaults for one crop season (one year).

Classification of NPAs:

1. Sub-standard Asset: Loans that are NPAs for less than or equal to 12 months.

2. Doubtful Asset: Loans that remain NPAs for more than 12 months but less than 36 months.

3. Loss Asset: Loans that are NPAs for more than 36 months and are considered uncollectible.

Provisioning:

Banks are required to set aside a portion of their profit as a provision to cover potential losses from NPAs,
ensuring depositor safety.

This provisioning is an asset but is restricted and cannot be used for other banking operations.

Impact on Balance Sheet:

Net NPA: The amount of defaulted loans after deducting provisions. Expressed as a percentage of total
loans.

Gross NPA: The sum of Net NPAs and the provisions made against NPAs.

Gross NPA = Net NPA + Provision

Write-offs and Waive-offs:

Write-off: Removal of bad loans from the balance sheet while continuing recovery efforts. This frees up
the provision amount for new loans.

Waive-off: Complete forgiveness of the loan, ending all recovery efforts. Typically applied to agricultural
loans, with the government compensating banks.

Deposit Insurance and Credit Guarantee Corporation (DICGC)

Role and Coverage:

A wholly owned subsidiary of the RBI, providing insurance cover for bank deposits.

Covers all scheduled banks (Indian and foreign commercial banks, RRBs, cooperative banks, payments
banks, small finance banks). PACS and NBFCs are excluded.

Insurance Details:

Insurance cover is up to ₹5 lakh per depositor, including interest.

In case of bank bankruptcy, DICGC compensates depositors through the appointed liquidator within 60
days.

Banks pay a premium of 12 paise per ₹100 deposit to DICGC for this insurance.

The DICGC provides a safety net for depositors, ensuring confidence in the banking system.

Twin balance sheet problem

Balance sheet of a company is a financial statement which reflects the asset and the liability of that company. It is a kind of
financial report card of the company which shows that how healthy the company is financially.

Banking system in India 22

 When the financial condition of a company declines it affects the balance sheet of that company. When the balance sheet
of a company affects the balance sheet of another company then it is termed as Twin Balance Sheet problem. This problem
is very common in the banking sector. Normally, the corporates borrow from the banks and invest in businesses. If the
business is affected adversely, their balance sheet will be affected. Because of this adverse economic condition, if they
default then the NPAs of the bank will increase affecting bankʼs balance sheet. This is twin balance sheet problem.

Normally, an economy moves in a cyclic manner. After economic boom economic bust can be seen. This is termed as
business cycle/trade cycle . The phase of economic boom is a phase of rapid economic growth. In this phase the
demand remains high and hence in order to meet the demand, even the producers try to produce more. For this purpose
they borrow from the banks, setup new machines and expand their production base. Since it is phase of high demand they
are able to sell more and more, they make more profit and continue repay the loans easily. However, it cannot be predicted
exactly when the phase of economic boom will end and bust will start. It is a phase of economic slowdown in which the
demand declines affecting even the production. In such situations even the profit of such companies will decline affecting
their balance sheet. It is a possibility that the companies may default, affecting the balance sheet of banks. It will be a
situation of twin balance sheet problem.

Prior to 2008 the world economy was growing at a rapid pace. However, the US recession which took place in 2008
affected the economies throughout the world. This lead to twin balance sheet problem even in India. Gradually all the
economies began reviving. But in 2016 the demonetisation done in India caused decline in money supply which again
resulted in twin balance sheet problem. Again because of Covid pandemic , twin balance sheet problem became a
common problem throughout the world.

Twin balance sheet problem can be resolved through the following measures:

1. The corporate loans can be restructured during adverse economic conditions. In this restructuring the EMI can be
reduced, the term period of the loan can be increased, the rate of interest can be brought down and even loan
moratorium can be given(moratorium refers legal suspension of the repayment for a particular time period).

2. The NPAs can be sold to ARCs

3. In order to clean the balance sheet, the banks may write-off the NPAs but the recovery may continue.

4. Insolvency and Bankruptcy Code can be used in order to declare a company bankrupt and the asset of the company
can be liquidated.

CIBIL(Credit Information Bureau(India) Ltd.) and Public Credit Registry(PCR)

Whenever a borrower borrows from a bank or a financial institution, his credit history is activated. There are different
companies in India which maintain the credit history of the borrowers. CIBIL is one such company. It was setup in India in
the year 2000 by an American company called TransUnion. Now the full form doesnʼt exist and it is only known as
TransUnion CIBIL. Other similar companies which maintain the database of the borrowers in India are Equifax, Experian,
High Mark, etc.

The moment a borrower borrows, the bank or the NBFC provide his complete personal details as well as the complete
detail of the loan to these companies which maintain the credit history. Based on the pattern of repayment and the nature
of loan, the borrower is given a credit score out of total 900. If the score falls down below 700, it becomes extremely
difficult for the borrower to borrow again in future.

Based on the same mechanism, a committee headed by YM Deoasthalee suggested the RBI that it should constitute its
own credit score platform. Based on the recommendation, Public Credit Registry(PCR) came into existence. This PCR also
connects the tax department hence it will also include the details of the tax defaulted by a taxpayer.

Banking system in India 23

 Shorts

Twin Balance Sheet Problem

The twin balance sheet problem arises when the financial stress of corporations (their balance sheets)
impacts the financial health of banks.

Balance Sheet of a Company: Reflects assets and liabilities, essentially a financial report card.

Impact of Decline: When a companyʼs financial health deteriorates, its balance sheet shows increased
liabilities or reduced assets.

Mechanism of the Twin Balance Sheet Problem:

Corporate Borrowing: Corporates borrow from banks to invest in businesses.

Adverse Business Impact: If businesses face downturns, their financial conditions worsen, leading to
defaults on bank loans.

Bank NPAs: Defaults by corporates result in increased NPAs for banks, thus affecting the banks' balance
sheets.

Economic Cycles:

Economic Boom: Characterized by high demand and rapid economic growth. Corporates borrow heavily
to expand production, profiting and repaying loans easily.

Economic Bust: A phase of economic slowdown where demand declines, affecting production and profits,
leading to possible corporate defaults and bank NPAs.

Historical Context:

Pre-2008: Rapid global economic growth.

2008 Recession: Triggered by the US financial crisis, causing a global economic downturn and twin
balance sheet problems in India.

2016 Demonetisation: Led to a decline in money supply and subsequent twin balance sheet issues.

COVID-19 Pandemic: Widespread economic disruption, exacerbating twin balance sheet problems
globally.

Resolution Measures:

1. Loan Restructuring: Modify loan terms to reduce EMIs, extend loan periods, lower interest rates, or
provide moratoriums.

2. Selling NPAs to ARCs: Offload NPAs to Asset Reconstruction Companies to clean bank balance sheets.

3. Write-offs: Banks can write-off NPAs, continuing recovery efforts, to clear balance sheets.

4. Insolvency and Bankruptcy Code (IBC): Utilize IBC to declare bankruptcies and liquidate assets for
recovery.

CIBIL and Public Credit Registry (PCR)

Credit Information Bureau (India) Ltd. - CIBIL:

Establishment: Set up in 2000 by TransUnion, now known as TransUnion CIBIL.

Function: Maintains credit histories of borrowers. Other similar entities include Equifax, Experian, and High
Mark.

Credit Score: Borrowers are assigned a score out of 900 based on repayment history. Scores below 700
make future borrowing difficult.

Public Credit Registry (PCR):

Recommendation: Based on suggestions by a committee led by YM Deoasthalee.

Purpose: A centralised platform by the RBI to maintain credit scores, integrating data from tax
departments and detailing tax defaults.

Benefits: Provides comprehensive credit information, aiding in better risk assessment for lenders.

Banking system in India 24

 The twin balance sheet problem highlights the interconnectedness of corporate health and banking stability.

Effective management of NPAs and robust credit information systems like CIBIL and PCR are crucial for
maintaining financial stability and promoting healthy lending practices.

Wilful defaulter
When a borrower borrows and defaults willingly or deliberately he can be declared as a wilful defaulter. In such situation,
case maybe filed by the banks against the defaulting customers. A borrower can be classified as a wilful defaulter under
following circumstances:

1. If a borrower has resource and even after that he fails to repay

2. If a borrower diverts the available fund or resources and defaults thereafter.

3. If a borrower borrows using forged documents and defaults thereafter

4. If a borrower has borrowed for a particular purpose but uses the money for any other purpose and thereafter he fails to
repay.

5. If a borrower borrows by pledging assets as collateral but the assets are disposed of without informing the bank and
thereafter he fails to repay

6. In all such situations when a borrower is classified as a wilful defaulter the banks can take legal action. With respect to
wilful defaulters, from time to time different rules have been framed and modified.

In order to prevent such borrowers from leaving the country the Indian passport act was amended. According to
the amendment, if the borrowed amount is of ₹50 crore or more and the borrower is classified as wilful defaulter,
his passport will be taken away. In the year 2018, Fugitive Economic Offenders act was passed to ensure that if a
wilful defaulter leaves the country and doesnʼt come back, all his assets in India can be foreclosed and auctioned.

In September 2023, the RBI introduced some more terms and conditions related to the wilful defaulters. According
to the modified rules, just like the banks, now even the NBFCs can declare a borrower as wilful defaulter. In order to
declare a borrower as a wilful defaulter, the amount borrowed should not be less than ₹25 lakh.

Even before classifying a borrower as wilful defaulter, the banks will wait for at least six months. If a borrower is
declared as a wilful defaulter, he will be given a time of 15 days to present his arguments.

Asset Reconstruction Company(ARC)

The most important responsibilities of a bank are to accept deposit from the depositors and to provide loan to borrowers.
Hence, when a loan is defaulted it becomes very difficult for the banks to recover the NPAs. The problem of recovery is
more grave with respect to unsecured loans. On the recommendations of the Narsimham committee,
SARFAESI(Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) act 2002 was
passed. The SARFAESI act legally empowered the banks to foreclose an asset in case of secured loan being defaulted and
to auction that asset in order to recover the borrowed amount. The SARFAESI act also paved the way for establishment of
ARCs which may make it easier to recover even the unsecured loans. Based on this act the first ARC that was setup in India
was ARCIL(Asset Reconstruction India Private Limited). It was setup by three banks together SBI, ICICI and IDBI.

The ARCs are setup as a company under companies act. They are registered under SARFAESI act and are regulated by the
RBI. They can be setup by individual investors and even through collaboration between different banks. The ARCs buy the
NPAs of the bank at a discounted price and try to recover it with the help of their trained employees.

Because of the recession that was witnessed in the US in the year 2008, even the other countries including India began
suffering from the Twin Balance Sheet problem in the subsequent years. The NPAs of the banks in India began increasing.
Some of the NPAs were even politically complex because of political interference. Hence, the government decided to setup
a bad bank which will have the backing of the government. Bad bank is just a name given to the ARC which the
government was planning to setup. It was decided that this bad bank will buy the bad debt of the banks and will recover
even those loans which are politically complex. However, this idea was opposed by the then governor of RBI, Raghuram
Rajan. He argued that the bad bank will not be a solution. Its establishment will only shift the problem of the banks to the
bad bank. He also doubted that how this bad bank will be able to raise capital in order to buy the NPAs at a discounted
price. Because of the opposition the idea of setting up the bad bank was temporarily suspended by the government.
When Urjit Patel replaced Raghuram Rajan as the governor of RBI, the idea of setting up the bad bank was revived.
However, it was given a different name—Public Sector Asset Rehabilitation Agency(PARA). In the year 2016, Insolvency And

Banking system in India 25

 Bankruptcy Code was passed. This newly enacted code helped in recovery of the NPAs at a rapid pace. Due to its instant
success, the establishment idea of even PARA was suspended. However, again because of the Covid crisis the NPAs of the
banks began increasing and the government again decided to revive the establishment of the bad banks which was finally
announced in the year 2021-22.

Based on the Union Budget 2021 proposal, bad bank has been setup in India. It has been setup in two different parts, with
two different names and registered as two different companies—National Asset Reconstruction Company Limited(NARCL)
and Indian Debt Resolution Company Limited(IDRCL). In NARCL, 51% investment has been done by the public sector banks
and the remaining 49% has been done by the private sector banks. On the other hand, in IDRCL 51% investment has been
done by the private sector banks and the remaining 49% of the investment has been done by the public sector banks.

NARCL as an asset reconstruction company will buy only those NPAs which are not less than ₹500 crore. It will negotiate
with the banks and buy the NPAs at a discounted price. In order to buy the NPA, only 15% of the negotiated price will be
paid to the bank in cash for the remaining 85% of the amount, the bank will be given Security Receipt. This Security
Receipt is secured by the Government of India for which in the first phase Government of India has set aside ₹30,600
crore. This Security Receipt has a maturity period of five years.

Once the NPA is bought it will be handed over to IDRCL. As a debt resolution company it will be the responsibility of IDRCL
to recover the NPA. Once the NPA is recovered, the bank will be paid the remaining 85% and the Security Receipt will be
surrendered by the bank. If NARCL fails to pay the bank, the bank will be compensated by the Government of India since
the security receipt is guaranteed by the government.

Banking system in India 26

 Shorts

Wilful Defaulter
A wilful defaulter is a borrower who deliberately defaults on a loan despite having the means to repay.
Conditions for declaring a borrower wilful defaulter can include one or more of the below:

1. Adequate Resources but Non-repayment: Borrower has resources but fails to repay.

2. Diversion of Funds: Loan amount or resources diverted and defaulted.

3. Forged Documents: Borrowed using false documents and defaulted.

4. Misuse of Loan: Loan used for unapproved purposes and defaulted.

5. Disposal of Collateral: Collateral assets disposed off without informing the bank and defaulted.

Legal Actions:

Indian Passport Act Amendment: Passport can be confiscated for defaults of ₹50 crore or more.

Fugitive Economic Offenders Act, 2018: Assets of defaulters who flee can be seized.

RBI's 2023 Rules: NBFCs can declare defaults of ₹25 lakh or more as wilful; banks must wait six months
and provide 15 days for borrower arguments.

Recovery Mechanisms for NPAs

SARFAESI Act, 2002:

SARFAESI(Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest)

Empowers Banks: Allows foreclosure and auction of defaulting assets.

ARCs: Asset Reconstruction Companies buy NPAs at a discount and recover loans.

Bad Bank Concept:

Initial Opposition: Raghuram Rajan opposed, fearing problem-shifting.

PARA: Proposed Public Sector Asset Rehabilitation Agency, later suspended after IBC success.

Insolvency and Bankruptcy Code (IBC), 2016:

Purpose: Time-bound insolvency resolution process.

Impact: Rapid NPA recovery, reducing initial bad bank need.

COVID-19 Impact:

NPA Increase: Pandemic led to rising NPAs.

Bad Bank Announcement: Officially revived in 2021-22.

Conclusion
Wilful defaulters and NPA recovery are managed through legal measures and regulatory frameworks like
SARFAESI, ARCs, the IBC, and with the bad bank concept to address persistent issues.

Bad Bank Setup in India

Based on the Union Budget 2021 proposal, India has established a "bad bank" structured into two entities:

1. National Asset Reconstruction Company Limited (NARCL)

2. Indian Debt Resolution Company Limited (IDRCL)

Investment Structure:
NARCL: 51% by public sector banks + 49% by private sector banks

IDRCL: 51% by private sector banks + 49% by public sector banks

Roles and Responsibilities:

Banking system in India 27

 NARCL (Asset Reconstruction Company):

Focus: Acquires NPAs of ₹500 crore and above. Buys NPAs at a negotiated discount from banks

Payment Structure:

Pays 15% of the price in cash.

Security Receipts have a five-year maturity period.

Function: Manages and recovers NPAs handed over by NARCL.

Government Guarantee:

Prompt Corrective Action(PCA)

PCA is an action taken by the RBI in order to improve the health of the banks operating in India. As a banking regulator, the
RBI keeps a close watch over the functioning of the banks. The financial health of the banks is continuously evaluated. If
the RBI feels that the health of a bank is declining it will be placed in category 1 of PCA.

The moment a bank is placed in category 1 of PCA, the RBI will impose certain restrictions over that bank. The bank will be
prevented from distributing dividend to the promoter and the other share holders. If it is a foreign bank, the RBI will ask the
promoter to infuse additional capital. With these measures if the health starts improving the bank will be taken out of this
prompt corrective action. If the health continues to decline, the bank will be placed is category 2 of PCA.

The moment a bank is placed in category 2 of PCA, the RBI will instruct the bank to shut down those branches which are
running in losses. The RBI will restrict the bank from opening new branches. Along with these restrictions even the initial
restrictions will continue. Through these measures if the health of the bank starts improving it will be taken out of PCA.
However, if the health continued to decline the bank will be placed in category 3 of PCA.

The moment a bank is placed in category 3 of PCA, the initial restrictions will continue and some more restrictions will be
imposed. The RBI may ask the bank to reduce the remuneration of the top officials of the bank. The RBI may prevent the
bank from accepting large deposits. It may prevent the bank from providing loan to the riskier sectors. If even these
measures do not work then only merger/acquisition or closure of the bank may take place.

When Urjit Patel was the governor of RBI, he placed 11 PSBs in PCA and restricted them from distributing dividend even to
the government. This became a bone of contention between the government and the governor. However, when
Shaktikanta Das became the governor these banks were taken out of PCA.

Banking system in India 28

 Shorts

Prompt Corrective Action (PCA)

Prompt Corrective Action (PCA) is a framework implemented by the Reserve Bank of India (RBI) to improve
the financial health of banks operating in India.

The PCA framework involves monitoring key financial metrics and imposing restrictions when necessary to
prevent further decline in a bankʼs health.

PCA Categories and Measures:

1. Category 1: Initial Restrictions

Triggers: When the RBI detects early signs of financial stress.

Measures:

Restriction on distributing dividends to promoters and shareholders.

Requirement for foreign banks to infuse additional capital.

2. Category 2: Increased Restrictions

Triggers: Continued decline in financial health after Category 1 measures.

Measures:

Closing loss-making branches.

Restrictions on opening new branches.

Continuation of Category 1 restrictions.

3. Category 3: Severe Restrictions

Triggers: Further deterioration after Category 2 measures.

Measures:

Reduction in top officialsʼ remuneration.

Restrictions on accepting large deposits.

Restrictions on lending to high-risk sectors.

Continuation of Category 1 and 2 restrictions.

Potential for merger, acquisition, or closure of the bank if conditions do not improve.

Urjit Patel Era: Placed 11 public sector banks (PSBs) under PCA, restricting dividend distribution even to
the government. This led to tension between the RBI and the government.

Shaktikanta Das Era:Many of these banks were removed from PCA restrictions, reflecting a change in
regulatory approach.

Mission Indradhanush 2.0

It is an initiative of the finance ministry. It was launched in 2015 on the basis of the recommendations of PJ Nayak
committee. There is another mission indradhanush which is an initiative of ministry of health which aims at complete
vaccination of children and is unrelated to this one. This MI 2.0 aims to improve the health of public sector banks. Since it
has seven provisions it is known as Indradhanush . The provisions start with A and end with G because of which it is also
known as A to G of banking sector reforms. These seven provisions are as follows:

Banking system in India 29

 Under Mission Indradhanush reforms related to appointments at the top most positions of the PSBs was suggested. The
public sector banks were headed by a Chairman and Managing Director(CMD). It used to be one single position held by
one single official. It was suggested that this post should be divided into two parts and two different officials should be
appointed as chairman and MD. It was suggested that even a third position of a non-executive chairman must be created at
the top most level. It was suggested that efficient people even from outside the PSBs through lateral entry should be
appointed.

Banks Board Bureau(BBB) should be constituted in order to recommend the names of eligible candidates who can be
appointed at the top most position of the PSBs by the government. BBB will also suggest the banks to raise capital from the
market efficiently. Based on this recommendation in 2016 BBB came into existence. Vinod Rai was appointed as the first
chairman of BBB. He was former Comptroller and Auditor General(CAG) of India. The position is honorary with financial
reward. The term period is of two years with option of reappointments. In 2018, Vinod Rai was replaced by Bhanu Pratap
Sharma. Due to Covid he was reappointed as chairman in 2020. However, in 2022 BBB was replaced by Financial Services
Institution Bureau(FSIB). Bhanu Pratap Sharma has been made the new chairman of this newly constituted FSIB.

Capitalisation means infusing additional amount of capital in the PSBs by the government. So that the PSBs are able to
maintain sufficient provision and they are able to adopt the BASEL-III norms.

Destressing refers to reducing the stress of the banks. Because of increasing NPA the banks were under stress. It affected
the credit flow in the economy. Hence, it was suggested that the NPAs should be written off and they should be sold to the
ARCs for the purpose of recovery. It may help in cleaning the balance sheet of the public sector banks.

Empowerment refers to providing more autonomy to the public sector banks my minimising the interference of the
government in their functioning it was suggested that with respect to the recruitment of employees at the middle level and
even at the lower level the banks should be set free.

Framework of accountability means that somebody has to be made accountable/answerable. It means that the employees
with a particular responsibility will be held answerable for any kind of breach.
Governance reform means that those changes should be adopted in the management of the public sector banks which
may prevent any kind of crisis in the future.

Banking system in India 30

 For this purpose from time to time Gyaan Sangam is organised. In which the PM, the finance minister, the governor of RBI
and the CMD of different public sector banks participate.

It can be concluded that Mission Indradhanush 2.0 aims at restoring the financial health of the public sector banks. It aims
at making them stronger and competent.

Shorts

Mission Indradhanush 2.0

Mission Indradhanush 2.0, launched in 2015 by the Ministry of Finance, aims to reform public sector banks
(PSBs) based on PJ Nayak Committee recommendations. It includes seven key provisions, each named after a
letter from A to G:

1. Appointments

Separate the roles of Chairman and Managing Director (CMD).

Introduce a non-executive chairman position.

Allow lateral entry of qualified individuals from outside PSBs.

2. Banks Board Bureau (BBB)

Recommends candidates for top PSB positions.

Advises on raising capital.

Vinod Rai was the first chairman, replaced by Bhanu Pratap Sharma in 2018.

In 2022, BBB was replaced by the Financial Services Institution Bureau (FSIB), chaired by Bhanu
Pratap Sharma.

3. Capitalisation

Infuse additional capital into PSBs to maintain sufficient provisions and adopt BASEL-III norms.

4. Destressing: Address stressed assets and NPAs.

5. Empowerment: Provide greater operational autonomy to PSBs.

6. Framework of Accountability: Establish clear accountability mechanisms.

7. Governance: Improve governance standards and practices.

Financial Services Institution Bureau(FSIB)

In the year 2022 BBB was discontinued and was replaced by FSIB. When the BBB was constituted, it was given the
responsibility to recommend the names of those eligible candidates who can be appointed by the government at the
topmost position of the PSBs. However, the government instructed BBB to recommend even the names of those eligible
candidates who can be appointed at the topmost position of the public sector insurance companies. However, this decision
was challenged in the court by higher officials of these public sector insurance companies who were superseded in this
process of appointment.

The court decided against the decision of the government and the officials who were appointed had to resign. Hence, FSIB
was constituted by replacing BBB with an additional responsibility to recommend even the names of those eligible
candidates who can be appointed at the top most position of pubic sector insurance companies. The first chairman of FSIB
is Bhanu Pratap Sharma who also the last chairman of BBB.

FSIB recommends C.S. Setty for SBI Chairmanʼs post

Non-Banking Financial Companies(NBFCs)

NBFCs are just like banks but they are not exactly a bank. Hence, they are also termed as shadow banks. NBFCs are
financial institutions which are engaged in financial transactions but they cannot provide all the financial services provided
by the bank.

Banking system in India 31

 NBFCs are registered as company under companies act. However, a company to be registered as NBFC it must fulfil the
following two conditions:

1. Not less than 50% of the asset of that company should be in the form of financial asset such as cash, shares,
government securities, debentures, etc.

2. Not less than 50% of the total income of such companies should come from its financial asset.

Even if a company is registered as an NBFC it is not necessary that all the NBFCs will be regulated by the RBI. For example,
the housing finance companies of India are regulated by National Housing Bank which is a 100% owned subsidiary of
Government of India. Similarly, the insurance companies in India are regulated by Insurance Regulatory and Development
Authority of India(IRDAI). The Mutual fund companies are regulated by Securities and Exchange Board of India(SEBI).

The NBFCs which are regulated by the RBI can be broadly classified into the following two types:

1. Non-deposit taking

2. Deposit taking

Non-deposit taking NBFCs cannot accept deposit from the depositors in any form. Since they cannot accept deposit it
becomes obvious that they cannot issue debit card and even chequebooks. However, even such NBFCs can provide loan.
Hence, after seeking permission from the RBI they can issue credit card . In order to provide loan, such NBFCs use their
own money or they may borrow from the market including the banks.

The deposit taking NBFCs can accept deposit from the depositors but not in the form of demand deposit. They can accept
deposit only in the form of term deposit with a maturity of not less than 12 months and not more than sixty months. Since
they cannot accept demand deposits, they cannot issue debit cards and chequebooks. However, they can provide loans
and hence they can issue credit card. Such NBFCs can use deposits, their own funds and borrow from the market in order
to provide loans. In any case it can be concluded that NBFCs are not a part of Payment and Settlement Systems. Even the
deposits accepted by the NBFCs are not covered by DICGC and not insured. The NBFCs are not required to maintain CRR
and SLR but must maintain Capital Adequacy Ratio(CAR).

Interbank deposits—deposit of a bank in any other bank.

Deposit of land development banks with a state cooperative bank.

Banking system in India 32

 Shorts

Financial Services Institution Bureau (FSIB)

In 2022, FSIB replaced the Banks Board Bureau (BBB). FSIB recommends candidates for top positions in
both public sector banks (PSBs) and public sector insurance companies.

This change followed a court ruling against BBB's involvement in insurance appointments. Bhanu Pratap
Sharma, former BBB chairman, is the first FSIB chairman.

Non-Banking Financial Companies (NBFCs)

NBFCs, known as shadow banks, are financial institutions that provide services similar to banks but with
certain restrictions. They must:

1. Have at least 50% of assets as financial assets.

2. Derive at least 50% of their income from financial assets.

Types of NBFCs:

1. Non-Deposit Taking NBFCs:

Cannot accept deposits.

Cannot issue debit cards or chequebooks.

Can issue credit cards and provide loans with their own or borrowed funds.

2. Deposit Taking NBFCs:

Accept term deposits (12 to 60 months).

Cannot issue demand deposits, debit cards, or chequebooks.

Can issue credit cards and provide loans using deposits, own funds, and borrowed funds.

Regulation:

Not part of Payment and Settlements Systems.

Deposits not insured by DICGC.

Must maintain a Capital Adequacy Ratio (CAR) but not CRR or SLR.

Regulatory Authorities:

Housing Finance: National Housing Bank

Insurance: Insurance Regulatory and Development Authority of India (IRDAI)

Mutual Funds: Securities and Exchange Board of India (SEBI)

Deposits Not Covered by DICGC:

1. Foreign government deposits.

2. Central and state government deposits.

3. Interbank deposits.

4. Deposits of land development banks with state cooperative banks.

5. Deposits of Primary Agricultural Credit Societies (PACS).

Financial assets Vs Non-financial assets

Financial Assets Non-Financial Assets

1. Nature: Financial assets represent claims on 1. Nature: Non-financial assets are tangible or intangible assets
the income or wealth of another entity. They are that are not financial in nature.
typically intangible.
2. Examples: Real estate, equipment, machinery, intellectual
property (patents, trademarks), and natural resources.

Banking system in India 33

 2. Examples: Stocks, bonds, bank deposits, 3. Liquidity: Typically less liquid, as they cannot be quickly sold
mutual funds, and derivatives. without a substantial loss of value.

3. Liquidity: Generally more liquid, as they can be 4. Valuation: Their value is often based on physical attributes,
quickly bought or sold in financial markets. usage, and market conditions specific to the asset.

4. Valuation: Their value is often determined by 5. Income Generation: Generate income through their use or
market prices and can fluctuate based on rental. For example, real estate generates rental income, and
economic conditions and market sentiment. machinery generates operational revenue.

5. Income Generation: Financial assets generate 6. Risk: Subject to operational risk, market risk (specific to the
income through interest, dividends, or capital type of asset), and depreciation or obsolescence.
gains.

6. Risk: Subject to market risk, credit risk, and

interest rate risk.

Islamic Bank
The concept of Islamic bank is relatively new in India. However, it has existed in the Islamic countries since long. Religion is
an important aspect of human society hence religious beliefs also have huge influence over our day to day lives.
Sometimes the religious beliefs may also go against the economic practices and because of this the religious beliefs may
become a hurdle in economic development of a religious community.

In Islam paying interest and receiving interest both are against the Islamic belief. Since the traditional banking is completely
based on payment and receipt of interest, the entire banking system becomes illegitimate under Islamic belief. Hence, a
number of hardcore believers remain away from the traditional banking system. This affects their financial inclusion. In
order to resolve this problem and to connect even such hardcore believers to the financial system Islamic bank can be
used as tool. Since Islamic banks function according to the Islamic beliefs it does not go against the religious sentiments of
even the hardcore believers.

In India the first licence for establishment of an Islamic bank was given by the RBI in the year 2013. However, the licence
was given as an NBFC. The name of this Islamic bank is Cheraman Financial Services Limited which has been setup in
Kerala. The RBI decided that in order to setup an Islamic bank a minimum capital investment of ₹1000 crore will be
required. In this Islamic bank with 11% stake, Kerala State Industrial Development Corporation is the single largest stake
holder. No other investor can hold a stake of more than 9% in this NBFC. Since it is an Islamic bank, it will function
according to the Islamic rules. Few years back, the Islamic development bank from Jeddah(Saudi Arabia) came to india in
order to setup its business in Gujarat in collaboration with EXIM bank of India. It became the first foreign Islamic bank to
start business in India.

An Islamic bank will not take interest and will not receive interest. Those who park their fund with an Islamic bank will not
receive any interest. With the help of these funds the Islamic bank will create a pool of amount which will not be given in
the form of loan. This amount will be invested by the Islamic bank in different businesses. These businesses can be related
to manufacturing, mining, services, construction, etc. However, the Islamic bank will not invest in any business which is
against islam. For example, it will not invest in businesses related to gambling or betting, a business related to alcohol or
insurance. A business related to pork or non-halal products etc. It is mainly because such business activities are against
the Islamic beliefs.

In any business in which the Islamic bank invests, the fund will be provided an investment and not as loan. Hence, Islamic
bank will not receive interest. It will be entitled to receive a part of the profit generated in that business. Hence, even those
who park their funds with an Islamic bank, will be entitled to receive a part of profit rather than interest.

Digital Banking Units

On the occasion of 75 years of Indiaʼs independence in union budget 2022-23 the finance minister announced that in
different districts of the country(75 districts) 75 digital banking units will be setup. They will be setup by domestic
commercial banks and small finance banks. The cooperative banks, RRBs and the Payments banks will not setup these
units. The Digital Banking Units are outlets through which the banks will provide all the banking services to the customers
in digital form using automated machines. They will be just like the branch of a bank but the services will not be provided
by the employees manually. Through such automated machines the customer may avail self-service. They may remain

Banking system in India 34

 open 24/7. Through these outlets the customer may deposit cash, may deposit cheque, may apply for loan, credit card,
debit card, change of address in a bank account etc.

Shorts

Islamic Bank
Islamic banks operate according to Islamic beliefs, which prohibit paying or receiving interest. This ensures
financial inclusion for devout Muslims who avoid traditional banks.
Key Points:

First Islamic Bank in India: Cheraman Financial Services Limited, established in Kerala in 2013 as an NBFC.

Investment: Requires a minimum capital of ₹1000 crore.

Stakeholders: Kerala State Industrial Development Corporation holds 11%; no other investor can hold more
than 9%.

Operations: Invests funds in businesses (excluding those against Islamic beliefs like gambling, alcohol,
etc.) and shares profits instead of charging interest.

Digital Banking Units

Announced in the 2022-23 Union Budget, 75 digital banking units are to be set up in 75 districts by domestic
commercial and small finance banks.

Key Points:

Services: Provide banking services through automated machines.

Accessibility: Open 24/7 for self-service.

Exclusions: Cooperative banks, RRBs, and payment banks are not involved.

Self Help Groups(SHGs) and Micro Finance Institutions(MFIs)

SHGs do not have any universal nature and objective. However, they have a universal nature. This universal nature is that
they function on the basis of mutual cooperation. It has no universal structure means it may be large in size or relatively
small. It may have female members or it may have male members. SHGs are voluntary associations whose members come
together, associate with each other and try to fulfill a common interest through mutual cooperation. However, the most
common type of SHG is the group of 5 to 15 women, active in rural areas. They associate with each other in order to set up
a Micro Enterprise to earn their livelihood. Since such women do not have a credit history it becomes difficult for them to
borrow from the banks. The banks may also not have presence in every rural part of India. Hence, the Micro Finance
Institutions(MFIs) become important.

MFIs initially were not regulated by the RBI. Since they provided small amount of loan to the member of SHGs, they are
termed as Micro Finance Institutions. Although, the loan is given to the individual, the responsibility of repayment lies with
the entire group. Hence, under social pressure the repayment is ensured. The members of SHG borrow from the MFIs and
create a pool of entire amount. They invest and set up a micro enterprise. The objective is to earn their livelihood. However,
for a SHG it is extremely difficult to transform itself in a micro enterprise.

The MFIs do not have enough resources so they borrow from the banks and provide future loans. Because of this, the rate
of interest remains high. In rural areas due to lack of infrastructures, transportation and communication facilities, it
becomes difficult to set up a successful enterprise. Indian society especially the rural areas are strictly male - dominated.
Hence, the women hardly get support from the male members. Under family pressure, the money which is borrowed for
the purpose of investment is consumed sometimes. Since the amount of loan provided is less, the members of a single
SHG borrow from a number of MFIs. Because of all such reasons, repayment becomes difficult. Therefore the MFIs started
a forceful recovery of loans. It brought down their popularity and this entire arrangement failed miserably.

In 1992, NABARD took the initiative to connect the SHGs with the banks. It was termed as SHG-Bank Linkage Program. It
was a pilot project in which initially only 500 SHGs were connected with the banking sector. Gradually, it was expanded. In
1998, for the same purpose, NABARD created Micro Credit Innovation Department. NABARD claims that more than 100
million families have benefited from this initiative. Micro Credit Innovation Department initiated a project known as e-Shakti.

Banking system in India 35

 Initially it was created only in 2 districts but gradually expanded in 100 districts. e-Shakti aims at computerization of the
accounting system of the SHGs.

In order to strengthen the SHGs and the MFIs, the RBI constituted a committee headed by Y.H. Malegam. RBI in March
2022 announced new guidelines for MFIs. The main recommendations of the Malegam committee are as follows:

1. It was suggested that a new category of NBFCs known as NBFC-MFI should be created
and the Micro Finance Institutions should be brought under the regulation of the RBI.

2. A single individual should be allowed to become a member of any one SHG.

3. An individual living in rural areas should be allowed to borrow from MFIs only if in case his annual family income does
not exceed Rs. 3 Lakhs. Earlier it was 50 thousand which was raised to 1.25 lakhs for rural areas and 2 lakh for other
areas. The new limit has been announced in March 2022.

4. Any member of SHG should be allowed to borrow only from two MFIs. Including both the MFIs an individual cannot
borrow an amount more than Rs. 1.25 Lakhs.
Earlier even this limit was also 50 thousand.

5. RBI has also put a limit on the maximum repayment value to 50% of the monthly household income to curtail over-
lending to customers. Thus, if the household income is Rs. 3 lakh, the maximum loan instalment that a borrower needs
to pay cannot exceed Rs. 1.5 lakh per year.

6. Recently the RBI has removed the cap of interest rate to be charged by MFIs. Earlier the maximum Interest charged by
MFI were capped at 26%. For a large MFI which had provided a total loan of not less than 100 crore rupees, the profit
margin was capped at 10%. For smaller MFIs the profit margin was capped at 12%. Although RBI mentioned that MFIs
should have an interest rate of either cost of funds plus margin of 10% (for MFIs with loan portfolio not less than 100
crore rupees) and 12% for others or 2.75 times of the average base rate of the 5 largest commercial banks of India on
the basis of asset, whichever is less.
The average base rate of the five largest commercial banks is announced by RBI at the end of each quarter which
determines the interest rate for the ensuing quarter.

7. In case of any forceful recovery, the company (MFI) will be held liable.

8. There cannot be any hidden charges other than the interest and the processing fee.

9. The loan given to the members of self-help group by MFIs cannot be consumed. It has to be invested in order to setup
a micro enterprise.

10. Micro finance institutions (MFIs) will remain a part of priority sector lending for the banks.

Earlier 85% of the total loan given by MFIs were to be based on these guidelines. The remaining 15% could have been
given in any manner to any borrower at any rate of interest. RBI in March 2022 liberalised this ratio to 75:25.

Banking system in India 36

 Shorts

Self Help Groups (SHGs):

Voluntary associations of 5-15 members, often women in rural areas.

Aim: Mutual cooperation to set up micro enterprises for livelihood.

Lack credit history, making it hard to borrow from traditional banks.

Micro Finance Institutions (MFIs):

Provide small loans to SHG members, focusing on social pressure for repayment.

Initially unregulated by RBI, now regulated following Malegam Committee recommendations.

High-interest rates due to limited resources; borrow from banks to fund loans.

Challenges:

High interest rates.

Difficulties in transforming SHGs into successful micro enterprises.

Male-dominated rural society limiting women's support.

Danger of borrowed money being used for consumption and not investment.

Forceful loan recovery damaging MFI reputation.

NABARD Initiatives:

1992: SHG-Bank Linkage Program to connect SHGs with banks.

1998: Creation of Micro Credit Innovation Department.

e-Shakti Project: Computerization of SHG accounting, expanded to 100 districts.

Malegam Committee Recommendations:

1. Create NBFC-MFI category for regulation by RBI.

2. One individual per SHG membership.

3. Income cap for rural borrowers: ₹3 Lakhs annual family income.

4. Limit borrowing to two MFIs; maximum combined loan: ₹1.25 Lakhs.

5. Repayment limit: 50% of monthly household income.

6. Removed interest rate cap; previous cap was 26%.

7. Liability on MFIs for forceful recovery.

8. No hidden charges beyond interest and processing fees.

9. Loans must be invested, not consumed.

10. MFIs to remain part of priority sector lending.

RBI Guidelines (March 2022):

Adjusted ratio for loan guidelines compliance from 85:15 to 75:25.

Financial Inclusion
The finance sector is the most important sector in any economy. It is mainly because without finance no developmental
activity can happen. Financial inclusion refers to connecting each and every citizen of the country with the banking
system. Although the process of financial inclusion started right after the independence, it gained momentum very late.
The term "Financial Inclusion" was used for the first time by H.R. Khan Committee.
Mangalam village in Tamil Nadu became the first village in which every household was provided with at least one bank
account. It became possible due to the efforts of K.C. Chakrabarty who was then the Chairman of Indian bank. Kerala
became the first state in India where every household was provided with at least one bank account. The process of
financial inclusion has following objective:

Banking system in India 37

 1. To provide access to institutionalized banking so that a habit of saving can be developed.

2. To provide Access to institutionalized credit, so that dependency on money lenders can be reduced.

3. To provide face-to-face and no cost financial consultancy.

4. To provide financial literacy.

5. To promote cashless transactions.

6. To ensure direct benefit transfer in account of the beneficiaries.

7. To ensure social security by providing insurance cover, etc.

Measures adopted to achieve the goal of financial inclusion

1. Post-independence in order to expand the banking system even in rural areas and to connect the people at the bottom
of the society with the banking system, the process of Nationalisation of Banks was initiated.

2. In 1969, the concept of Lead Bank was introduced. It is also known as Service Area Approach. Under this, a bank with
maximum number of branches in a district has to adopt that district for the purpose of financial inclusion.

3. In 1975, RRBs were set up in order to connect the rural population with the banking system.

4. In 1982, NABARD was set up for the purpose of rural development.

5. In 1998, Kisan Credit Card (KCC) was introduced on the recommendation of R.V.
Gupta committee report. Based on KCC a farmer may avail subsidized loan for agriculture. KCC also provides insurance
cover to the farmer which is upto 50,000 at an annual premium of Rs. 15. It can be issued by commercial banks, RRBs
or cooperative banks. Gradually this KCC which was in the form of paper is being converted into plastic credit card.

6. Even the concept of Priority Sector Lending has been made mandatory for the banks. it was also aimed at achieving
the goal of financial inclusion.

7. The concept of No-Frills Account or Basic Saving Account with zero balance was also introduced.

8. The concept of Islamic Bank to connect even the Muslim population(hardcore believers) with the banking system is
also aimed at achieving the goal of financial inclusion.

9. In order to provide door to door Banking services the Concept of Bank Correspondence(BC) was introduced.

10. MUDRA Yojana was introduced to provide loan for setting up small businesses.

11. Expansion of NBFCs.

12. Micro finance institutions and the idea of Self-help groups also aim at achieving the goal of financial inclusion.

13. Committee headed by Nachiket Mor was constituted, which suggested establishment of Payments Banks and Small
Finance Banks.

14. Pradhan Mantri Jan Dhan Yojna was initiated in 2014.

15. Stand-Up India Scheme: Facilitates bank loans between ₹10 lakh and ₹1 crore to at least one Scheduled Caste (SC) or
Scheduled Tribe (ST) borrower and at least one woman borrower per bank branch for setting up greenfield enterprises.

16. RBI Initiatives— Simplified KYC Norms: Eased the Know Your Customer (KYC) requirements to make it easier for people
to open bank accounts.

MUDRA-Micro Units Development and Refinance Agency

Banking system in India 38

 MUDRA scheme was initiated by the Government of India on 8th April 2015. Under this scheme Mudra bank has been setup
under SIDBI. MUDRA bank was setup with a total capital investment of ₹20,000 crore and with an additional credit
guarantee corpus of ₹3000 crore.
MUDRA bank is not exactly a bank. It is a refinance agency. It is funded by the government and it provides funds to the
banks, NBFCs and Micro-finance Institutions. These banks, NBFCs and Micro-finance Institutions provide loan without any
collateral to those who are interested in setting up a micro enterprise. The loans given are classified into three categories—

1. Shishu — an amount upto ₹50,000

2. Kishore — ₹50K to ₹5 lakh

3. Tarun — more than ₹5 lakh and upto ₹10 lakh

MUDRA Yojana becomes important because it ensures livelihood. Because of increasing population and lack of sufficient
opportunities in the organised sector self-employment remains the only option. Even in order to setup a micro enterprise
capital investment is the biggest hurdle. MUDRA Yojana tries to eliminate this hurdle. However, in MUDRA scheme the
defaults are relatively high and hence it is adding to the NPAs of the bank.

Banking system in India 39

 Shorts

Financial Inclusion
Financial Inclusion:

Ensuring all citizens have access to financial services.

Key to development as it promotes savings, credit access, and financial literacy.

Historical Milestones:

First Use: Term "Financial Inclusion" by H.R. Khan Committee.

Mangalam Village: First village with universal bank accounts.

Kerala: First state with at least one bank account per household.

Objectives:

1. Develop saving habits through institutionalized banking.

2. Reduce reliance on money lenders via institutional credit.

3. Provide free financial consultancy.

4. Enhance financial literacy.

5. Promote cashless transactions.

6. Ensure direct benefit transfers.

7. Offer social security through insurance.

Measures for Financial Inclusion:

1. Bank Nationalization: Expanded banking to rural areas post-independence.

2. Lead Bank Scheme (1969): Banks adopt districts to promote inclusion.

3. RRBs (1975): Connect rural populations to banking.

4. NABARD (1982): Focus on rural development.

5. Kisan Credit Card (1998): Subsidized loans and insurance for farmers.

6. Priority Sector Lending: Mandatory lending to under-served sectors.

7. No-Frills Accounts: Zero-balance accounts.

8. Islamic Banking: Inclusion of Muslim population.

9. Bank Correspondents: Door-to-door banking services.

10. MUDRA Yojana(2015): Loans for small businesses.

11. Expansion of NBFCs: Broaden access to financial services.

12. SHGs and MFIs: Promote financial inclusion in rural areas.

13. Nachiket Mor Committee: Establishment of Payments Banks and Small Finance Banks.

14. Pradhan Mantri Jan Dhan Yojana (2014): Mass financial inclusion initiative.

MUDRA (Micro Units Development and Refinance Agency)

Initiation: Launched on 8th April 2015 under SIDBI.

Structure:

Capital: ₹20,000 crore

Credit Guarantee Corpus: ₹3,000 crore

Not a bank, but a refinance agency providing funds to banks, NBFCs, and MFIs.

Loan Categories:

1. Shishu: Up to ₹50,000

Banking system in India 40

 Tarun: ₹5 lakh to ₹10 lakh

Importance: Promotes self-employment and micro enterprises. Addresses capital investment hurdles.

@July 2, 2024

Micro, Small and Medium Enterprises(MSMEs)

Based on size the business entities or the enterprises can be classified into different types. They can be micro enterpries,
small enterprises and medium enterprises. In short they are termed as MSMEs. All those enterprises which are relatively
larger and which do not fall under the category of MSME can be termed as a large enterprise.

The MSMEs constitute approximately 99% of the total enterprises which are operational in India and the remaining 1% fall
under the category of large enterprises. In India, approximately more than 7 crore MSMEs are functional. They are not only
an important source of self-employment but also an important means of employment generations. They not only contribute
to the GDP of India but also contribute in external trade. They contribute in increasing Indiaʼs share in world trade. They are
also a means through which the country earns foreign exchange.

Although the MSMEs are important for the Indian economy it is very difficult for them to remain profitable and to remain in
business due to high competition faced from large enterprises. Hence, from time to time the RBI and even the government
may come out with different policies with the help of which the MSMEs can be given some or the other benefits. In order to
provide these benefits it becomes essential to identify the real beneficiaries. Hence, in order to identify and define the
MSME act was passed in 2006. This act has been amended from time to time.

Initially, under this act the definition for the enterprises engaged in manufacturing and the enterprises engaged in services
were different. However, according to the modified definition both— enterprises engaged in manufacturing or the
enterprises engaged in services—have a common definition. In order to define them only two important factors are taken
into consideration—

1. Capital investment in machines and tools (it does not include investment in land or building for the purpose
of defining MSMEs)

2. Annual revenue or the turnover of the company

However, for the purpose of defining the MSMEs, the revenue generated through exports will not be counted as a part of
its annual revenue. According to the present definition the MSMEs are defined in the following manner:

Machine and tools investment Annual turnover

Micro enterprises Upto ₹1 crore Upto ₹5 crore

Small Upto ₹10 crore Upto ₹50 crore

Medium Upto ₹50 crore Upto ₹250 crore

Large Above ₹50 crore Above ₹250 crore

Banking system in India 41

 Shorts

Micro, Small, and Medium Enterprises (MSMEs)

Micro Enterprises: Smallest businesses in terms of size and investment.

Small Enterprises: Slightly larger than micro, with higher investment and turnover.

Medium Enterprises: Larger than small, but still not classified as large enterprises.

Large Enterprises: All businesses that do not qualify as MSMEs.

Significance:

Constitute 99% of operational enterprises in India.

Over 7 crore MSMEs are functional.

Major source of self-employment and employment generation.

Contribute significantly to GDP and external trade.

Help increase India's share in world trade and earn foreign exchange.

Challenges:

High competition from large enterprises.

Difficulty in maintaining profitability and business continuity.

Support Policies:

RBI and government periodically introduce policies to support MSMEs.

Essential to identify genuine beneficiaries for effective support.

Criteria for Definition: Unified definition post amendment applies to both manufacturing and service
enterprises.

1. Capital Investment: In machines and tools (excluding land and buildings).

2. Annual Revenue/Turnover: Revenue generated from exports is excluded from this calculation.

Legislation:

MSME Act 2006: Defines MSMEs and provides a framework for their identification and support.

Amendments: The act has been amended to adapt to changing economic conditions and business
environments.

Pradhan Mantri Jan Dhan Yojana(PMJDY)

Pradhan Mantri Jan Dhan Yojana can be considered as the most important scheme initiated by the government in order to
achieve the goal of financial inclusion. Under this scheme, the public sector as well as the private sector banks, both have
to provide a bank account to every single individual at the age of 18 or above. Even those who are at the age of 10 years to
17 years can be provided a bank account, but it will require the supervision of a guardian. The scheme was initiated on
28th August 2014.

On the first day itself, 7 thousand camps were set up throughout the country and 1.5 crore bank accounts were opened. It
was a World Record. More than 50 crore bank accounts have been opened under this scheme in more than 9 years. Out of
these, approximately 55.5% of accounts have been provided to women. More than 67% of accounts have been provided in
rural areas. Jan Dhan Accounts have a deposit of over 2 lakh crore rupees.

In order to ensure that every individual is provided with a bank account, Know Your Customer (KYC) norms were eased.
Along with the traditional identity proofs and address proof, even the job cards provided under the 'Mahatma Gandhi
National Rural Employment Guarantee Act' are considered a valid proof. If even the MGNREGA job card is not available, a
written proof from the Gram Panchayat is also considered a valid proof.

In order to ensure that even the people at the bottom of the rank order are given a bank account, under Pradhan Mantri Jan
Dhan Yojana, Basic Savings Accounts are provided. It is a bank account in which no minimum balance is to be maintained.
The account holder will be provided with a Debit card issued by RuPay. RuPay is an Indian payment gateway service

Banking system in India 42

 provider set up by the National Payments Corporation of India (NPCI). Since it is an Indian payment gateway service
provider, the annual charges will be less as compared to what is charged by 'Visa' or 'MasterCard'. In order to make the
scheme more attractive, certain provisions have been included.

The account holder will be given accidental insurance of Rs. 1 lakh. Now it is increased to Rs. 2 Lakh. The insurance cover
is being provided by HDFC. If the account has been opened before 26th January 2015, an additional insurance cover of
Rs.30,000 will be provided. This insurance of Rs. 30,000 is being provided by LIC. Since the benefit of insurance always
involves payment of premium, under this scheme the premium will be paid by RuPay from the amount deducted by it as an
annual debit card charge.

If the account remains active continuously for six months and it is connected with Aadhaar, then an overdraft facility of up
to Rs. 5,000 will be provided. It has also been increased to Rs. 10,000. Overdraft is a kind of loan which is provided by the
bank to the customer.

Pradhan Mantri Jan Dhan Yojana is a part of the JAM Trinity of the government. Here 'J' stands for Jan Dhan, 'A' stands for
Aadhaar and 'M' stands for Mobile. It is to ensure that every individual is provided with a bank account, which is connected
with an Aadhaar as well as a mobile number. All the benefits in future provided by the government will be transferred
directly to the account of the beneficiary. Jan Dhan Yojana in this manner is preventing the diversion of funds. It also
promotes a habit of saving in the banks which would ensure that the money lying at home goes into the economy in the
form of loans. It also promotes cashless transactions since the account holders are provided with debit card, cheque book,
and online banking facility. It also ensures social security in the form of insurance cover. Even the overdraft will serve as an
institutionalized credit facility.

However, this scheme also has some negative consequences. Out of the total bank accounts opened, a large number of
bank accounts have remained dormant. It has led to a financial burden over the banks, and even the debit card and the
passbook issued to such customers proved to be a wastage of resources. Although the number of depositors increased
suddenly, the number of branches of banks, ATMs, and even employees did not increase in the same manner. Hence, it is
leading to a burden over the banking system.

Banking system in India 43

 Shorts

Pradhan Mantri Jan Dhan Yojana (PMJDY)

Overview:

Launch Date: 28th August 2014

Objective: Achieve comprehensive financial inclusion by providing a bank account to every individual
aged 18 or above.

Eligibility: Individuals aged 10 to 17 can also open accounts with guardian supervision.

Achievements:

Initial Launch: 7,000 camps set up; 1.5 crore accounts opened on the first day, setting a world record.

Total Accounts: Over 50 crore accounts opened in more than 9 years.

Women Account Holders: Approximately 55.5% of accounts.

Rural Accounts: Over 67% of accounts.

Deposits: Total deposits exceeding 2 lakh crore rupees.

Key Features:

Eased KYC Norms: Accepted traditional ID proofs, MGNREGA job cards, and Gram Panchayat certificates.

Basic Savings Accounts: No minimum balance requirement.

RuPay Debit Card: Lower annual charges compared to Visa or MasterCard.

Additional Benefits:

Accidental Insurance: Rs. 1 lakh (increased to Rs. 2 lakh), provided by HDFC.

Additional Insurance: Rs. 30,000 for accounts opened before 26th January 2015, provided by LIC.

Premium Payment: Covered by RuPay through annual debit card charges.

Overdraft Facility: Up to Rs. 5,000 (increased to Rs. 10,000) for active accounts connected with Aadhaar
for six months.

JAM Trinity:

J: Jan Dhan (bank accounts)

A: Aadhaar (unique identification number)

M: Mobile (mobile phone connectivity)

Purpose: Ensure direct benefit transfer, prevent fund diversion, promote savings, facilitate cashless
transactions, and provide social security.

Benefits:

1. Savings Habit: Encourages people to save money in banks.

2. Direct Benefit Transfer (DBT): Ensures government benefits reach beneficiaries directly.

3. Cashless Transactions: Debit card, cheque book, and online banking facilities provided.

4. Social Security: Insurance cover for account holders.

5. Institutional Credit: Overdraft facility acts as a form of credit.

Challenges:

1. Dormant Accounts: Many accounts remain inactive, causing financial strain on banks.

2. Resource Wastage: Unused debit cards and passbooks.

3. Banking System Burden: Increased number of depositors without a proportional increase in bank
branches, ATMs, and employees, leading to operational challenges.

Banking system in India 44

 @July 3, 2024

Nachiket Mor Committee

With an objective of achieving the goal of financial inclusion, in 2013 a committee was constituted by the RBI under the
chairmanship of Nachiket Mor. He was associated with the ICICI foundation. The responsibility of the committee was to
suggest measures through which the goal of financial inclusion can be achieved.

The committee suggested that achieving the goal of financial inclusion is important but it should not be done at the cost of
financial stability of the country. Ensuring access to institutionalised credit to everyone may increase the risk of the
banking sector. Even for access to institutionalised banking, Aadhaar should be treated as the most important document. It
suggested that since the beginning of 2014 during the next 12 months at least 50% of the population at the age of 18 and
above should be provided with a bank account. In the next 12 months the remaining 50% should be provided with a bank
account. In rural areas at a walking distance of 15 minutes banking facilities should be made available. According to the
committee the main objective of the universal commercial banks is to make profit and hence they may not be committed
towards achieving the goal of financial inclusion. Hence, dedicated differentiated banks in the form of payments banks and
in the form of small finance banks should be setup to achieve the goal of financial inclusion. Based on the
recommendations of the Nachiket Mor committee, in November 2014 the RBI came out with guidelines for setting payments
banks and small finance banks

Payments banks
Guidelines issued by the RBI for establishment of payments banks—

1. A minimum capital investment of ₹100 crore is required.

2. During first five years of its establishment the promoter may bring down his holding to 40% and the remaining 60% can
be sold.

3. By the end of 12th year the promoter must bring down his holding essentially to 26%

4. Payments banks can setup branches only in rural areas and cannot setup branches in the urban areas.

5. Payments banks may accept deposits but only in the form of demand deposits i.e. CASA deposits. Payments banks
cannot accept term deposits

6. In any account with a payments bank, a deposit of not more than ₹2 lakhs can be maintained(initially it was only ₹1 lakh.

7. Since payments banks can accept demand deposits they can issue debit cards as well as chequebooks.

8. The payments banks cannot provide loan to the public. Hence, they cannot issue credit cards

9. Payments banks must maintain CRR just like a commercial bank which is at present 4.5%

10. Payments bank will maintain a SLR of 75%. However, this SLR can be maintained only in the form of G-secs with a
maturity of upto 1 year(the interest earned from investment in G-secs will be the main source of income for the
Payments banks).

11. After maintaining CRR and SLR the remaining part of the deposit with a payments banks is to be deposited in
commercial banks in the form of fixed deposit(FD) in Current accounts(interest earned through this FD will be another
source of its income).

12. Payments banks may serve as agents to insurance companies, mutual fund companies and even the commercial
banks.

13. The payments banks are suggested to use more and more technology to keep their operational costs low.

The first payments bank to begin business in India was Airtel Payments bank. Even India Post was given licence and India
Post payments bank is in operation. Recently, the RBI cancelled the licence of Paytm payments bank because of non-
compliance and supervisory concerns. Breach of KYC norms while providing the bank accounts was the most serious
concern. Other payments bank which are in operation is Jio payments bank and Fino payments bank.

The idea of Payments bank has not been very successful. In fact, a number of payments bank have shut down their
businesses and some even surrendered the licence before beginning operation. Those which are functioning are incurring
losses. In order to attract the depositors the payments bank offer high rate of interest on saving account deposits. Since
they are not allowed to provide loan to the public they hardly have any concrete source of income. Even the interest earned
through government securities is relatively low. The idea of payments bank had lead to dispute between the then RBI

Banking system in India 45

 governor Raghuram Rajan and deputy governor KC Chakrabarty. This tension became the primary cause behind Mr
Chakrabarty resignation.

Small finance banks

Guidelines are as follows:

1. Minimum capital investment required is ₹300 crore(at the outset it was ₹100 crore, then raised to ₹200 crore)

2. During the first five years the promoter may bring down his holdings to 40% and the remaining 60% can be sold.

3. By the end of 12th year the promoter must bring down her holding essentially to 26% and by the end of 15th year she
will have to bring it down to 15%

4. The rules related to foreign investment will be similar to that of private sector commercial banks of Indian origin.

5. They can setup branches in rural as well as in urban areas.

6. 25% of their total branches should be in rural areas.

7. They can accept deposit in any form.

8. They can issue debit cards as well as chequebooks.

9. They are allowed to provide loan and hence they can even issue credit cards.

10. They had to maintain CRR just like a commercial bank which is at present 4.5%

11. They have to maintain SLR just like a commercial bank which is at present 18%

12. Out of the total loan given by them, 75% has to be given in priority sector.

13. Out of the total loan given by them 50% is to be given in such a manner that from this 50% no single borrower is able
to borrow an amount which is more than ₹25 lakh

14. Within a period of eight years they have to be listed on the stock exchange

Small finance banks are highly successful in fact some of them are giving tough competition to the commercial banks.
Some important small finance banks are AU small finance bank, Utkarsh small finance bank, Ujjivan small finance bank,
Equitas small finance bank, etc. Even the payments banks have been given an option of transforming into a small finance
banks by complying with the above guidelines.

Banking system in India 46

 Shorts

Nachiket Mor Committee

Objective: Achieve financial inclusion in India without compromising financial stability.
Key Recommendations:

1. Balanced Financial Inclusion: Financial inclusion should not undermine the financial stability of the
country. Expanding access to credit must be managed to avoid excessive risk in the banking sector.

2. Aadhaar as Essential Document: Aadhaar should be the primary document for accessing institutional
banking services.

3. Universal Bank Accounts:

Within the first 12 months (starting 2014), 50% of the population aged 18 and above should have bank
accounts.

In the following 12 months, the remaining 50% should be provided with bank accounts.

4. Accessibility in Rural Areas: Banking facilities should be available within a 15-minute walking distance in
rural areas.

5. Differentiated Banks:

Universal commercial banks, focused on profit, may not prioritize financial inclusion.

Establish payments banks and small finance banks dedicated to financial inclusion.

Implementation:

In November 2014, the RBI issued guidelines for setting up payments banks and small finance banks
based on the committee's recommendations

Payments Banks
Guidelines Issued by RBI for Establishment of Payments Banks:

1. Capital Investment: Minimum required: ₹100 crore.

2. Promoter Holdings:

First 5 years: Promoter may reduce holding to 40%.

By end of 12th year: Promoter must reduce holding to 26%.

3. Branch Locations: Allowed only in rural areas; not permitted in urban areas.

4. Deposit Acceptance:

Only demand deposits (CASA deposits) are accepted.

Maximum deposit per account: ₹2 lakhs (initially ₹1 lakh).

5. Banking Services:

Can issue debit cards and chequebooks.

Cannot provide loans or issue credit cards.

6. Regulatory Requirements:

Must maintain Cash Reserve Ratio (CRR) similar to commercial banks (currently 4.5%).

Statutory Liquidity Ratio (SLR): 75%, maintained in G-secs with maturity up to 1 year.

Remaining deposits must be placed as fixed deposits in commercial banks.

7. Income Sources:

Interest from G-secs.

Interest from fixed deposits in commercial banks.

8. Additional Services: Can serve as agents for insurance companies, mutual funds, and commercial banks.

9. Technology Use: Emphasis on leveraging technology to reduce operational costs.

Banking system in India 47

 Current Scenario:

First Operational Payments Bank: Airtel Payments Bank.

Other Notable Payments Banks: India Post Payments Bank, Jio Payments Bank, Fino Payments Bank.

Challenges: High operational costs, limited income sources, compliance issues (e.g., Paytm Payments
Bank license cancellation).

Small Finance Banks

Guidelines Issued by RBI for Establishment of Small Finance Banks:

1. Capital Investment: Minimum required: ₹300 crore (initially ₹100 crore, then raised to ₹200 crore).

2. Promoter Holdings:

First 5 years: Promoter may reduce holding to 40%.

By end of 12th year: Promoter must reduce holding to 26%.

By end of 15th year: Promoter must reduce holding to 15%.

3. Branch Locations:

Allowed in both rural and urban areas.

25% of total branches must be in rural areas.

4. Deposit Acceptance: Can accept deposits in any form.

5. Banking Services: Cards, chequebooks, and credit cards.

6. Regulatory Requirements:

Must maintain CRR similar to commercial banks (currently 4.5%).

SLR: 18%, similar to commercial banks.

7. Lending Requirements:

75% of total loans must be in the priority sector.

50% of total loans should ensure no single borrower exceeds ₹25 lakh.

8. Stock Exchange Listing: Must be listed on the stock exchange within eight years.

Current Scenario:

Successful Small Finance Banks: AU Small Finance Bank, Utkarsh Small Finance Bank, Ujjivan Small
Finance Bank, Equitas Small Finance Bank, etc.

Payments Banks Conversion: Payments banks have the option to convert into small finance banks by
complying with the guidelines.

Comparison and Current Status

Payments Banks:

Focus on providing basic banking services in rural areas.

Face limitations due to inability to offer loans.

High operational costs and regulatory constraints have led to limited success and some closures.

Small Finance Banks:

More comprehensive banking services including loans and credit cards.

Operate in both rural and urban areas, with a mandate to support rural branches.

Generally successful and competitive with commercial banks, contributing significantly to financial
inclusion.

Conclusion:
While payments banks aim to provide basic financial services and facilitate financial inclusion, they face

Banking system in India 48

 @July 4, 2024

Export Import Bank of India

In order to setup the EXIM bank of India, the act was passed in 1981. Through this act the EXIM bank came into existence in
1982. Its headquarter is located in Mumbai. It is completely owned by the Government of India and just like NABARD, NHB,
SIDBI, even EXIM bank falls under the category of all india financial institutions. Although they are owned by the
Government of India, the RBI continues to play an important role in their regulation.

The EXIM bank was setup with an objective of increasing Indiaʼs share in world trade especially by enhancing export.
Hence, EXIM bank provides loan even in the form of line of credit for the purpose of export and import. It may also provide
loan for the development of those infrastructure which help in export and import. For this purpose EXIM bank may provide
loan even to different countries.

Sovereign Gold Bond Scheme

In the year 2015, the government introduced Sovereign Gold Bond scheme as well as Gold Monetization Scheme. These
were aimed at bringing down the import of gold in physical form so that the outflow of foreign currencies can be
prevented.

Sovereign Gold Bond scheme was introduced in order to bring down investment in gold in physical form. Investment in gold
in physical form suffers from some basic risks. First of all, the risk is related to the purity of gold in physical form. Secondly
the risk is related to its safety. If it is kept in a locker, it will incur cost. If it is kept at home the risk involved will be high.
Hence, investment in gold which is in the form of bond is always beneficial.

This scheme has following provisions -

1. The bond is issued in the form of paper and even in digital form by the RBI with permission from the Government of
India.

2. It is issued with the face value of minimum 1 gram of gold and thereafter in multiple of that.

3. The bond will be considered as 99.99% pure gold.

4. The bond can be sold through the post offices and through commercial banks and even through the stock exchanges.
After the launch of RBI Retail Direct portal now these bonds can be bought directly from RBI.

5. While buying the bond the applicable price will be the average price of physical gold during the last three working days
of the previous week.

6. If the bond is bought in cash, then maximum amount will be of 20,000 rupees or
else in order to buy it with an amount which is more than that, online payment or payment in the form of cheque etc.
must be done.

7. If online payment is done, on every gram of bond a discount of rupees 50 will be given.

8. An individual or an undivided family can buy a minimum of 1gram of gold bond and maximum of 4 kg gold bond in one
financial year. A university or a trust can buy bond of minimum 1 gram of gold and maximum 20 kg of gold in one
financial year.

9. The value of the bond will fluctuate along with the value of gold in physical form.

10. The bond will have a maturity period of 8 years, but it can be surrendered at any time after 5 years. In digital form the
bond can be sold on stock exchanges any time after 15 days of being bought.

11. An interest of 2.5 % will be paid to the investor on the initial value of investment. Although it is annual rate of interest
which will be divided into two parts and paid semi-annually.

12. The bond can be pledged by the buyer and he may borrow against it.

13. When the bond is surrendered or sold, capital gain tax will not be applicable on the profit. However, the interest
received is taxable. When it is surrendered the price applicable will be equal to the average price of gold in the physical

Banking system in India 49

 form during the last three working days of the previous week.

14. Even the banks can show the sovereign gold bond as the part of their SLR.

15. The post offices and the banks which sell this bond will get a commission which is 1% of the value of the bond.

16. If the post offices or the banks use an agent in order to sell the bond, then
50% of that 1% will go to the agent in the form of commission. However in India investment in gold is done mainly using
Black Money in cash. Hence this scheme could not succeed as per expectations.

Gold Monetization Scheme

Gold Monetization scheme was aimed at ensuring that the requirement of gold in physical form is fulfilled through domestic
sources. In Indian households and temples more than 20,000 tons of surplus gold is lying without any use. Even after that
India remains the largest importer of gold in the entire world. Hence, Gold Monetization Scheme was aimed at ensuring
availability of gold
in the market through domestic sources. Although the value of gold lying at home as well as in temples fluctuates along
with the price of gold in the market but there are no additional benefits associated with it. Gold Monetization Scheme not
only provides safety to the gold of the depositors but it also ensures additional benefit in the form of interest. Under this
scheme an interested individual or a temple will have to open a gold monetization account with commercial banks. Gold
can be deposited in any form, but it will be melted and converted into bars. A minimum of 10 gram of pure gold has to be
deposited (initially it was 30gm). There is no ceiling over the maximum quantity of gold deposited. Under this scheme three
different types of accounts can be opened—

1. With a maturity period of 1 year to 3 years

2. With a maturity period of 5 years to 7 years

3. With a maturity period of 12 years to 15 years

Under the first account, deposits will be considered as the liability of the bank or in other words it will be considered as
deposits of the bank. Hence the bank will have to maintain CRR and SLR over it. While depositing the gold, the depositors
have to give it in written form that on maturity, he wants back gold or cash. Once it is given in written it cannot be changed.
The gold will be valued at current price of the gold. Once the bank receives the gold it can be sold to the jewellers and the
money received can be used by the bank in order to provide loan to the borrowers. The depositors of gold will receive
interest of approximately 2% annually. Even the interest can be received in the form of gold or cash. This also has to be
given by the depositor in written form.

The gold deposited in the second and third account will not be considered as a liability of the bank. Hence the bank need
not maintain CRR and SLR against it. In these two accounts the banks act only as mediator. The gold deposited is
considered as the liability of the government. Hence the gold received by the banks under these two accounts will go to
MMTC. It will be sold to the jewellers and the money wil go to the government in the form of loan. In the account with the
maturity period of 5 to 7 years the annual interest paid by the government to the depositors will be 2.25%. In the account
with the maturity period of 12 to 15 years the annual interest paid by the government will be 2.50%. Even in the case of
second and third account it will be taken in written from the depositor that on maturity whether he wants gold or money.
This money which the government receives by the sale of gold ensure availability of loan to the government at extremely
low interest rate and the gold sold in the market ensure availability of gold in physical form without being imported.

📎 In February 2021 Revamped Gold Monetization Scheme was started. Under this the minimum deposit limit of gold
was reduced from earlier 30 grams to 10 grams. At least one third of public sector bank branches in all towns will
have to provide revamped gold deposit scheme on demand with special designated officers.

80:20 Scheme
This scheme was introduced in 2013 by RBI with respect to import of gold by the Indian importers. Under this scheme, out
of the total gold imported by an importer only 80% can be sold in the domestic market. The remaining 20% was to be
modified into jewellery and exported after value addition. If an importer fails to adhere to the guideline, he will not be
allowed to import gold next time. Because of this scheme small importers were eliminated from the market and only the
large importers, who were able to export, survived in the business. However, in 2014 this scheme was discontinued.

Banking system in India 50

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Export Import Bank of India (EXIM Bank)

Establishment and Objective:

Established in 1982 through an act passed in 1981.

Headquarters in Mumbai.

Fully owned by the Government of India; regulated by the RBI.

Objective: Increase Indiaʼs share in world trade by enhancing exports.

Functions:

Provides loans for export and import activities.

Extends lines of credit to facilitate international trade.

Funds infrastructure development supporting export and import.

Can extend loans to other countries.

Sovereign Gold Bond Scheme

Introduction and Purpose: Introduced in 2015 to reduce physical gold imports and prevent foreign currency
outflow.

Provisions:

Issued by RBI with Government of India approval, in paper and digital form.

Represents 99.99% pure gold; sold through post offices, banks, stock exchanges, and RBI Retail Direct
portal.

Price based on the average of the last three working daysʼ physical gold prices.

Maximum cash purchase limit: ₹20,000; discount of ₹50 per gram for online payments.

Investment limits: Individuals/HUFs (1 gram minimum, 4 kg maximum per financial year);

Universities/Trusts (1 gram minimum, 20 kg maximum).

Value fluctuates with gold prices; 8-year maturity with early redemption after 5 years.

Interest rate: 2.5% annually, paid semi-annually; interest is taxable, but capital gains tax is exempt.

Bonds can be pledged for loans and count towards banks' SLR requirements.

Banks/post offices earn a 1% commission; agents receive 0.5% of this commission.

Challenges: Investment in gold often involves black money, limiting the scheme's success.

Gold Monetization Scheme

Introduction and Purpose: Introduced in 2015 to utilize surplus gold in households and temples, reducing
physical gold imports.

Provisions:

Minimum deposit: 10 grams of pure gold; no maximum limit.

Three account types: Short-term (1-3 years), Medium-term (5-7 years), Long-term (12-15 years).

Option to receive gold or cash upon maturity; interest rate: 2% for short-term, 2.25% for medium-term,
2.5% for long-term.

Deposited gold is melted into bars; banks can sell gold to jewelers, and use proceeds for loans.

Medium and long-term deposits go to MMTC and are sold, with proceeds loaned to the government.

Revamped in 2021: Minimum deposit limit reduced to 10 grams; public sector banks required to offer
revamped scheme on demand.

80:20 Scheme
Introduction and Purpose:

Banking system in India 51

 Provisions:

80% of imported gold can be sold domestically; 20% must be exported as value-added jewelry.

Favored large importers capable of exporting, eliminating small importers; discontinued in 2014.

@July 5, 2024

5:20 Scheme
This scheme was there in civil aviation sector. According to this rule a company related to civil aviation which is given
licence can provide only domestic services initially. The company will be able to provide international services only if the
following two conditions are met:

1. The company should be at least five years old.

2. The company should have at least 20 aircrafts.

This 5:20 scheme was scrapped in 2016 and now in its place 0:20 scheme is applicable.

Domestic systemically Important Banks and NBFCs

The BASEL committee on banking supervision maintains a list of those global banks which are extremely important for the
world economy. These banks are two big to fall. It is a belief that if these banks collapse it will have huge impact over the
world economy. In this list the American bank JP Morgan Chase is at the top most position. Just below it there are two
other American banks— Bank of America and Citi Bank. HSBC is another bank which is in the top four.

In this list of global systemically important banks no Indian banks are present so far. However, the RBI maintains another list
which is the list of domestic systemically important banks. They are those banks which are extremely important in Indian
economy. It is a belief that if they collapse it will have huge impact over the domestic economy. They are those banks
which have given a total loan of not less than 2% of the Indian GDP. At present this list includes only three banks in India—
SBI, ICICI and HDFC Bank. Since these banks are important, the RBI keeps a strict watch over their functioning.

Initially, the definition for systemically important NBFCs was different. All those NBFCs which had an asset size of not less
than ₹500 crore were termed as systemically important NBFCs.

Now the NBFCs operating in India will be classified into four different layers—

1. Top layer(NBFC-TL) 3. Middle layer(NBFC-ML)

2. Upper Layer(NBFC-UL) 4. Base layer(NBFC-BL)

The top layer is kept empty. However, in due course of time it will be filled gradually by the RBI. In the upper layer the top
ten NBFCs plus those selected by the RBI have been placed. At present, the list of NBFCs includes 15 companies. In the
base layer only those non-deposit taking NBFCs with an asset size of upto ₹1000 crore are added. All the deposit taking
NBFCs which are not the part of upper layer and all the non-deposit taking NBFCs with asset size of more than ₹1000 crore
and which are not the part of the upper layer will remain in the middle layer. Higher the layer of NBFC, more will be the
regulation. Gradually the NBFCs from lower layers may move to subsequent higher layers as the asset size increases.

Banking system in India 52

 RBI Banking Ombudsman
Banking ombudsman is a higher official in the RBI who is appointed by the governor of the RBI. The job of the ombudsman
is to resolve any dispute between the customer and a financial institution. Initially, the banks, the NBFCs and only the digital
payment platforms were kept under the purview of the banking ombudsman. In case of dispute with a bank or an NBFC
and even with a digital payment platform three different ombudsman were appointed by the RBI. The companies which
provide credit score to the borrowers were not included under the purview of banking ombudsman.

Whenever a dispute used to emerge it was essential that complain must only be filed with that ombudsman under whom
that particular financial institution falls. However, on November 12th 2021 the RBI introduced integrated banking
ombudsman scheme. Under this scheme even the credit score providers have been brought under the purview of the
ombudsman. In case of any dispute now there will be only one ombudsman with whom the complain can be filed. However,
whenever thereʼs a dispute the complaint cannot be directly filed with the Integrated ombudsman. The customer must first
approach the financial institution in order to get the issue resolved. If the customer is not satisfied with the solution or if he
doesnʼt get any reply within 30 days, then only a complaint can be filed with the Integrated Ombudsman. The complaint
must be filed within the period of 12 months of the dispute origin. In case of mental harassment the customer may even
demand a penalty of upto ₹1 lakh. The customer may file complaint through online portal of RBI integrated ombudsman or
the complain can be filed in written through post. Telephonic customer care is available but complaints cannot be filed
through it. If the solution provided by the integrated ombudsman is not acceptable then appeal can be filed.

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5:20 Scheme
Introduction and Purpose:

Implemented in the civil aviation sector.

Required new airlines to operate domestically for at least five years and have a minimum of 20 aircraft to
qualify for international operations.

Changes:

Scrapped in 2016 and replaced by the 0:20 scheme.

Under the new rule, airlines need a minimum of 20 aircraft to operate international flights, regardless of
their operational age.

Domestic Systemically Important Banks and NBFCs

Global Context:

The BASEL Committee on Banking Supervision lists global systemically important banks (G-SIBs) crucial to
the world economy.

Prominent banks include JP Morgan Chase, Bank of America, Citi Bank, and HSBC.

No Indian banks are currently in the G-SIB list.

Domestic Systemically Important Banks (D-SIBs):

Maintained by RBI, crucial to the Indian economy.

Banks with total loans exceeding 2% of India's GDP.

Current D-SIBs: State Bank of India (SBI), ICICI Bank, and HDFC Bank.

RBI closely monitors these banks due to their significance to the domestic economy.

Systemically Important NBFCs:

Previously defined as NBFCs with an asset size of at least ₹500 crore.

Now classified into four layers by RBI:

1. Top Layer (NBFC-TL): Currently empty, to be filled gradually.

2. Upper Layer (NBFC-UL): Includes top ten NBFCs and others selected by RBI, currently listing 15
companies.

3. Middle Layer (NBFC-ML): Includes deposit-taking NBFCs not in the upper layer and non-deposit-
taking NBFCs with assets over ₹1000 crore.

4. Base Layer (NBFC-BL): Includes non-deposit-taking NBFCs with assets up to ₹1000 crore.

Regulation intensity increases with the NBFC layer, ensuring that NBFCs with larger asset sizes and more
significant market roles are safe and protected.

RBI Banking Ombudsman

Role and Appointment:

A senior official in the RBI, appointed by the Governor.

Resolves disputes between customers and financial institutions.

Jurisdiction:

Initially covered banks, NBFCs, and digital payment platforms.

Separate ombudsmen were appointed for banks, NBFCs, and digital payment platforms.

Credit score providers were not included initially.

Integrated Banking Ombudsman Scheme (Introduced on November 12, 2021):

Unified the separate ombudsmen into a single Integrated Ombudsman.

Banking system in India 54

 Complaint Process:

Filing a Complaint:

If the solution provided by the Integrated Ombudsman is unsatisfactory, an appeal can be filed.

@July 6, 2024

Core Banking Solution(CBS)

Prior to computerisation of the banking sector and prior to expansion of internet as well as intranet, the banks used to
provide services to a customer only from the branch where the account was opened. However, CBS as a mechanism
ensures anywhere banking facility. Under CBS all the branches of a bank are connected with each other through a
centralised server because of this a bank is able to provide services to a customer from any of the branches. It has made
banking even more convenient for the customers.
The RBI has made it mandatory even for the NBFCs to connect all its branches to a centralised server. It will ensure that a
customer of any NBFC will be able to avail financial services from any of the branches of that NBFC. This is termed as Core
Financial Services Solution(CFSS).

The platform known as e-Kuber which connects the RBI with different banks and financial institutions is also termed as the
Core Banking Solution of the RBI.

Merchant Discount Rate(MDR)

Whenever a payment is done by a consumer to a seller using a debit card or a credit card, the seller will not receive the
entire amount in his account. A part of the payment and GST over this part will be deducted from the total amount and only
the remaining amount will be credited to the account of the seller.

Depending upon the type of card the MDR may vary. For example, if payment is done using debit card then the MDR will be
lower as compared to credit card. If the card is Visa international or it is provided by American Express, the MDR will be
even higher. To promote RuPay debit card the MDR charged on payments done through RuPay debit card has been
reduced to zero. However, MDR is applicable on payment done through RuPay credit card. The MDR charged is shared
among the banks involved in the payment service provider group and even the PoS provider.

Real Time Gross Settlement(RTGS) & National Electronic Fund

Transfer(NEFT)
Both these services are provided by the RBI for the purpose of online transfer of fund from one account to another. These
facilities can be used through internet banking by the user on his own or these facilities can be availed by the
user/customer from the branch of his bank. If these facilities are availed through internet banking then they remain
available 24 7. However, if they are availed from the branch they may remain open on working day within the working
hours.
Initially, they were chargeable and have been made free of cost now.

Banking system in India 55

 RTGS is real-time service in which the payment is transferred to the account of beneficiaries. RTGS is gross settlement
meaning thereʼs a limit on the money that can be transferred. Less than ₹2 lakh money cannot be transferred. With respect
to maximum amount thereʼs no limit. However a customer may instruct his bank to impose a limit over RTGS transfers in his
account.

Different from RTGS, NEFT is not real time. When fund is transferred through NEFT, the settlement will always take
sometime. In NEFT thereʼs no limit to the amount that can be transferred, neither maximum nor minimum. However, a
customer may instruct his bank to impose a limit over NEFT transfers in his account.

Immediate Payment Service(IMPS)

IMPS is a service through which online payment can be transferred from one account to another. This service has been
developed by National Payments Corporation of India(NPCI). IMPS is real time. It means the payment done through IMPS is
received by the beneficiary immediately. This service is available 24 7 but is normally a paid service. A bank may make it
free for its customers. In IMPS thereʼs no limit over minimum amount but it has a limit of ₹5 lakh per payment. It means
since thereʼs an upper limit, IMPS is an instrument of retail payment.

Unified Payments Interface(UPI)/Bharat Interface for

Money(BHIM)
UPI is the most famous payment service in India. It has been developed by NPCI. On an experimental basis it was launched
in 2016. Initially only 19 banks were connected to it but gradually almost all the banks in India got connected. UPI is a real
time retail payment service. It means using UPI, payment is transferred from one account to another immediately but it has
a maximum limit of ₹1 lakh in 24 hours. UPI is a free service unlike RTGS, NEFT, IMPS. In order to transfer funds through
UPI we need not add the beneficiary to our account. Using UPI payment can be done using mobile number, UPI id and even
through Quick Response(QR) code. UPI services are even available in foreign countries such as Bhutan, Nepal, UAE,
Singapore, etc.

In order to avail UPI services a platform is required. One such platform has been developed even by NPCI which is known
as BHIM. Some other platforms are Phone Pe, GPay, Paytm, Amazon pay, Bharat Pe, etc. Out of these, Phone Pe is the
market leader which accounts for more than 50% of the UPI transactions in India. It is owned by Walmart.

📎 In terms of value of online transactions in India RTGS contributes maximum. But in terms of volume UPI is the
leader. Just because of large usage of UPI, India accounts for maximum number of online transactions in the

Banking system in India 56

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Core Banking Solution (CBS)

Prior to CBS, banking services were restricted to the branch where the account was opened.

CBS enables anywhere banking by connecting all branches through a centralized server.

The RBI mandates NBFCs to connect all branches to a centralized server, termed as Core Financial
Services Solution (CFSS).

The RBI's e-Kuber platform, connecting RBI with various banks and financial institutions, is also a Core
Banking Solution.

Merchant Discount Rate (MDR)

When a consumer makes a payment using a debit or credit card, the seller does not receive the entire
amount.

MDR varies by card type: lower for debit cards, higher for credit cards, and highest for international cards
like Visa and American Express.

MDR for RuPay debit cards has been reduced to zero to promote their use.

The MDR is shared among banks, payment service providers, and PoS providers.

Real Time Gross Settlement (RTGS) & National Electronic Fund Transfer (NEFT)
RTGS and NEFT are online fund transfer services provided by the RBI.

Available 24 7 through internet banking; during working hours if availed from a bank branch.

Previously chargeable, now free of cost.

RTGS:

Real-time and gross settlement service.

Transfers more than ₹2 lakh, with no upper limit.

Customers can instruct banks to impose transfer limits.

NEFT:

Not real-time; settlement takes some time.

No limits on the amount transferred.

Customers can instruct banks to impose transfer limits.

Immediate Payment Service (IMPS)

Developed by NPCI for real-time online payments.

Available 24 7, often a paid service (can be free depending on the bank).

No minimum amount; maximum limit of ₹5 lakh per transaction.

Unified Payments Interface (UPI)/Bharat Interface for Money (BHIM)

Developed by NPCI, launched in 2016.

Connects almost all Indian banks.

Real-time retail payment service with a maximum limit of ₹1 lakh per 24 hours.

Free service; does not require adding beneficiaries for fund transfers.

Payment can be made using mobile number, UPI ID, or QR code.

UPI services are available in several foreign countries—Bhutan, Nepal, Singapore, Dubai, etc.

BHIM, PhonePe, GPay, Paytm, Amazon Pay, and Bharat Pe are platforms providing UPI services.

PhonePe, owned by Walmart, is the market leader in UPI transactions.

Banking system in India 57

 Additional Information:
RTGS contributes the maximum in terms of value of online transactions in India.

@July 8, 2024

National Payments Corporation of India(NPCI)

NPCI is an umbrella entity which came into existence for the purpose of retail payment and settlement in electronic form.
As an umbrella entity, NPCI has created a number of products/platforms for the purpose of retail payment and settlements.
For example, RuPay, e-Rupi, UPI/BHIM, FasTag/NETC, NACH, etc. all have been developed by NPCI. It also connects all the
ATMs belonging to different banks in India with each other. For this purpose it initially acquired National Financial
Switch(NFS) and thereafter further expanded it.

NPCI came into existence under payment and settlements systems act 2007 and it started functioning from 2008. It is
registered as a company under the Companies Act with an objective of no-profit no-loss. As per instructions of the RBI 10
large banks including SBI, PNB, ICICI, HDFC, HSBC, Citi bank etc. developed NPCI. Gradually, the stake-holding banks in
NPCI have increased in number. As an umbrella entity the innovative products which have been launched by NPCI are
playing an important role in the process of financial inclusion.

Since online transactions in India are continuously increasing, the pressure over NPCI is also increasing. Hence, few years
back RBI came out with a notification, that new licences will be issued under new umbrella entities(NUE). For this purpose,
the RBI invited proposals from the interested parties. However, the RBI felt that none of the proposals was innovative
enough and all the applications were rejected.

Types of ATMs
Based on the purpose and the fact that who exactly has established an ATM(Automatic Teller Machine), they maybe
classified into different types—

1. Brown label ATMs : They operate with a name of a bank. It is a possibility that the machine is setup by the bank itself
or it is setup by a third party on behalf of the bank. These brown label ATMs are again classified into on site and off-
site. On-site ATMs are located within the branch of the bank or next to the branch. On the other hand, off site ATMs are
located away from the branch of the bank.

2. White label : Such ATMs are setup by NBFCs. Although they do not issue debit cards they can setup ATMs after
seeking permission from the RBI. These machines can be used by the customers belonging to different banks which is
a source of generating income. The NBFCs can issue credit card and hence these machines can be used even by their
own customers holding credit card.

3. Pink Label ATMs: Such ATMs are setup by the banks. Hence, they can be termed as a type of Brown label ATMs.
However, they are a symbol of women empowerment and are meant for women.

4. Green Label ATMs: Even these ATMs are setup by the banks. They are meant for agricultural transactions.

5. Yellow label ATMs: They are meant for e-commerce transactions

6. Orange label ATMs: Such ATMs are meant for share market transactions

Banking system in India 58

 National Bank for Agriculture and Rural Development(NABARD)
NABARD is not exactly a bank. It can be termed as a developmental bank and even as a Refinance agency. It falls under the
category of All India Financial Institutions(AIFI).

NABARD was setup under the recommendations of Siveraman committee. For this purpose NABARD act 1981 was passed
and in 1982 NABARD came into existence. Its HQ is located in Mumbai and regional offices mainly in state capitals. It was
setup with a total capital investment of ₹100 crore as a 50:50 joint venture between the Government of India and RBI.
However, gradually the RBI shifted all its stake in NABARD to the Government of India. Hence, at present the Government of
India holds 100% stake in NABARD. Government may infuse funds in NABARD or NABARD may even raise funds from the
market. NABARD loans the funds to the banks and banks lend it to the farmers for agriculture and rural development.

NABARD does not provide loan directly to the farmers but it may provide loan to cooperative societies directly. It also
provides loan to the states for the purpose of rural development. It may also provide loan to the corporate for setting up
industry related to agriculture such as food processing industry. Sometimes different funds are created for the purpose of
agriculture and rural development and NABARD is made the custodian of such funds. It also regulates PACS. It has also
formulated the minute details for Kisan Credit Card(KCC).

Although NABARD is owned by Government of India the RBI plays an important role in its regulation. NABARD has also
played an important role in the process of financial inclusion. For example, it initiated the SHG-Bank linkage programme
which became an overwhelming success as claimed NABARD.

Kisan Credit Card(KCC)

KCC as an instrument was introduced for the purpose for financial inclusion. They were introduced in 1998 under the
recommendations of RV Gupta committee. Initially they were issued in the form of paper and they used to serve as a
document based on which a farmer may borrow from the banks using single window facility. Now these cards are being
converted into plastic credit cards.

Kisan credit cards can be issued by commercial banks, Regional Rural Banks, Cooperative banks and small finance banks.
Out of all these banks, the biggest loan for agriculture is given by commercial banks. The minute details of KCC were
prepared by NABARD. Using KCC a farmer or a tenant may borrow at a subsidised rate of interest for following purposes—

1. For the purpose of cultivation of crop.

2. For the purpose of harvesting and post harvesting expenses.

3. For the purpose of transportation and marketing.

4. To meet any household requirement.

5. To have sufficient working capital. Even for the purpose of maintenance of agriculture machines and tool.

Banking system in India 59

 6. For the purpose of investing in allied industries such as animal husbandry.

If a farmer borrows using KCC, with a payment of ₹15 he may avail insurance of upto ₹50,000.

Banking system in India 60

 Shorts

National Payments Corporation of India (NPCI)

Purpose: Umbrella entity for retail payment and settlement in electronic form.

Products: Includes RuPay, e-Rupi, UPI/BHIM, FasTag/NETC, NACH, etc.

ATM Connectivity: Connects all ATMs across India through National Financial Switch (NFS).

Establishment: Formed under the Payment and Settlement Systems Act 2007; operational since 2008.

Structure: Registered as a no-profit no-loss company, initially developed by 10 large banks. Gradually,
more banks have become stakeholders.

Financial Inclusion: NPCI's products play a crucial role in financial inclusion.

New Umbrella Entities (NUE): RBI plans to issue new licenses to manage the growing online transaction
load, though initial proposals were rejected for lack of innovation.

Types of ATMs
1. Brown Label ATMs: Operate under a bank's name; setup by the bank or a third party. Classified as on-site
(within/next to a bank branch) or off-site (away from the bank branch).

2. White Label ATMs: Setup by NBFCs, allowing use by customers of different banks. They can issue credit
cards.

3. Pink Label ATMs: Setup by banks, meant for women, symbolizing women empowerment.

4. Green Label ATMs: Setup by banks, meant for agricultural transactions.

5. Yellow Label ATMs: Meant for e-commerce transactions.

6. Orange Label ATMs: Meant for share market transactions.

National Bank for Agriculture and Rural Development (NABARD)

Nature: Developmental bank and refinance agency; falls under All India Financial Institutions (AIFI).

Establishment: Formed under NABARD Act 1981, operational since 1982 based on Siveraman Committee's
recommendations.

Structure: Initially a 50:50 joint venture between Government of India and RBI. Currently, Government of
India holds 100% stake.

Funding: Government infusion or market raising.

Function: Loans funds to banks for agriculture and rural development. Provides direct loans to cooperative
societies and state governments, and corporate loans for agriculture-related industries.

Custodian: Manages various funds for agriculture and rural development.

Regulation: Regulates PACS and formulates details for Kisan Credit Card (KCC).

Financial Inclusion: Initiated SHG-Bank linkage program, contributing significantly to financial inclusion.

Kisan Credit Card (KCC)

Purpose: Instrument for financial inclusion; introduced in 1998 based on RV Gupta Committee's
recommendations.

Evolution: Initially paper-based, now converted to plastic credit cards.

Issuers: Commercial banks, Regional Rural Banks, Cooperative banks, and small finance banks.

Usage: Allows borrowing for various purposes at subsidized interest rates:

1. Cultivation of crops.

2. Harvesting and post-harvesting expenses.

3. Transportation and marketing.

4. Household requirements.

Banking system in India 61

 Working capital for agriculture machines and tools maintenance.

Insurance: Borrowers can avail insurance of up to ₹50,000 for a premium of ₹15.

@July 9, 2024

Society for Worldwide Interbank Financial

Telecommunication(SWIFT)
SWIFT is an information technology platform developed by seven banks in the year 1973. Continuously for four long years
testing was conducted and finally in the year 1977 this platform was made live. After SWIFTʼs emergence it replaced an
already existing platform known as Telex. Through Swift the banks and the financial institutions throughout the world
communicate with each other. They send financial instructions to each other in an encrypted manner. The server for Swift
is located in Brussels, Belgium .

Throughout the world more than 11,000 banks and financial institutions are connected to Swift. Its service is available in
more than 200 countries and regions. All the banks and financial institutions which are connected to Swift are given a Swift
code which is 8 - 11 digit alphanumeric code. This Swift code becomes the international identity of that bank or financial
institution. Whenever fund is to be transferred or any other financial instruction is to be sent by a bank or financial
institution to any other bank or financial institution in some other country then the message or instruction is sent through
Swift. Since the messages are end to end encrypted it is extremely difficult to hack or intercept them. The banks or
financial institutions which receive such messages follow the given instructions. Through Swift, fund does not reach from
one bank to another. It is only a medium of communication.

When Nirav Modi had borrowed from a foreign bank in which the guarantee was provided by PNB. The Letter of
Undertaking(LoU) was sent by PNB to the lending bank through Swift.
When Russia invaded Ukraine a number of sanctions were imposed on Russia by USA and other European countries. As a
part of these sanctions in order to prevent international transactions all the Russian banks and other banks operating in
Russia were detached by Swift platform.

Nostro and Vostro account

Nostro and Vostro they both are Latin/Italian words. Nostro means ‘oursʼ whereas Vostro means ‘yoursʼ. If a bank which
exists in India has no branch in a particular country then in order to provide banking services to its clients in that country
that Indian bank may open an account with any existing bank in that country. This account will belong to that Indian bank
which will be termed as Nostro account by the India bank. The same account will be termed as Vostro account by the bank
with whom the account has been opened. In this account the bank will deposit money in local currency which can be used
in order to provide banking services to its clients in that country.

Basel norms
The Basel committee on banking supervision has its HQ located in Basel, Switzerland. It came into existence in 1974. It was
setup through an initiative of 10 different countries. However, at present it has 45 members. Even India is a member of
Basel Committee.

From time to time the Basel committee comes out with suggestions to reduce the risk involved in banking. The suggestions
given by the Basel committee are only advisory in nature. They can be implemented by the central bank of a country in that
particular country. The suggestions maybe fully implemented, partially implemented and can even be modified by the
central bank before implementing.

Banking system in India 62

 Whenever the Basel committee comes out with a set of suggestions they are termed as Basel I, Basel II and Basel III and so
on. So far the Basel committee come out with suggestions three times—

1. Basel I : Published in 1988

2. Basel II : Published in 2004

3. Basel III : Published in 2010

This risk involved in banking can be broadly classified into three different types—

1. Credit risk: It is the most common risk related to banking which refers to loan defaults

2. Market risk: It is rooted in market forces. For example, if a bank invests in gold, shares, etc. and their value declines

3. Operational risk: It is related to issues associated with operation. For example, it may include internal scams, issues
related to non-compliance, theft, cyber threat, penalties imposed by the central bank and so on.

Under Basel I, the Basel committee was mainly concerned with credit risk. Hence, it came out with suggestions only to
reduce the credit risk. The loans given by the banks were classified into riskier and non-riskier. For example, the loan given
to the government was considered as non-riskier whereas the loans given to the public including the industry were
considered as riskier. The Basel committee suggested that the banks should maintain a CAR(Capital Adequacy Ratio) of 8%
against the riskier loans given by them. It is also known as Capital to Risk Weighted Ratio(CRAR). CAR is asset worth a
certain percentage of the total riskier loan given by a bank. It is different from provision which is to be maintained only
when a loan becomes NPA. CAR is to be maintained against the loan given. This asset maybe in the form of cash, foreign
exchange, bullion, shares, other securities, land, building, etc. This asset maybe used by a bank in order to meet any
emergency.

During Basel II, the Basel committee came out with three important suggestions which came to be known as the three
pillars of Basel II—

1. It was decided that the Basel committee will come out with suggestions even for reducing the market risk and
operational risk along with credit risk.

2. The banks should maintain more transparency while disclosing their asset quality.

3. The central bank should increase regulation of the banks.

After the American recession of 2008 in the year 2010, the Basel III norms were published. It was realised that even the
loan given to the government is not free from risk. Hence, the banks should maintain CAR against the total loan given by
them. It was also suggested that additional asset worth 2.5% of the loan should be maintained which will be termed as

Banking system in India 63

 capital conservation buffer. In those financial years when the credit flow is exceptionally high the central bank should
instruct the banks to maintain 2.5% asset as Counter Cyclic Buffer.

Since, it was not possible for the member countries to implement these changes overnight, it was decided to implement the
norms in a phased manner. India began implementing these norms from 2013. It was to be implemented by March 31st,
2019 but the deadline was gradually shifted to March 31st, 2023.

📎 Initially the cooperative banks and the RRBs were not allowed to participate in LAF. However, they were allowed to
maintain sufficient CAR

Shorts

Society for Worldwide Interbank Financial Telecommunication (SWIFT)

Establishment: Developed in 1973 by seven banks, operational since 1977 after rigorous testing of 4
years.

Purpose: Facilitates encrypted communication of financial instructions between banks and financial
institutions globally.

Reach: Connects over 11,000 institutions in more than 200 countries.

SWIFT Code: An 8-11 digit alphanumeric code identifying each connected institution.

Location: Headquartered in Brussels, Belgium.

Function: SWIFT is a communication platform, not a fund transfer mechanism.

Nostro and Vostro Accounts

Nostro Account: An account held by an Indian bank in a foreign country to provide services to its clients
there. Termed "ours" by the Indian bank.

Vostro Account: The same account, referred to as "yours" by the foreign bank where the account is held.

Basel Norms
The Basel Committee on Banking Supervision, headquartered in Basel, Switzerland, issues guidelines to
mitigate banking risks. These guidelines, known as Basel norms, are advisory and can be adopted by central
banks worldwide. The key Basel norms are:

1. Basel I (1988): Focused on reducing credit risk by requiring banks to maintain a Capital Adequacy Ratio
(CAR) of 8% against riskier loans.

2. Basel II (2004): Introduced three pillars:

Addressed credit risk, market risk, and operational risk.

Advocated for greater transparency in asset quality disclosure.

Recommended increased regulation by central banks.

3. Basel III (2010): In response to the 2008 financial crisis, suggested maintaining CAR against all loans,
including government loans. Introduced additional buffers like the Capital Conservation Buffer and Counter
Cyclic Buffer, to be implemented gradually, with deadlines extended to 2023.

@July 10, 2024

e- Rupi

Banking system in India 64

 The concept of e-Rupi is different from the concept of e-Rupee. E-Rupi as an instrument was launched in 2021. It has been
developed by NPCI in collaboration with Department of Financial Services, Ministry of Finance and National Health
Authority, Ministry of Health.

From time to time, the Government of India comes out with several welfare schemes. Under such schemes benefits maybe
given in the form of cash to the beneficiaries. This cash is given with particular objective/purpose but thereʼs a possibility
that the cash may be misused. In such a situation the purpose of the welfare scheme is defeated. Hence, the concept of e-
Rupi has been developed in order to get rid of this problem related to misuse.
E-Rupi is in the form of voucher code which is sent to the beneficiary through sms. This voucher can have a value of upto
₹1 Lakh, which can be used only on those outlets which are associated with this entire arrangement. Out of the total value
of the entire amount, a payment of desirable value can be done through OTP and the remaining value will be left in the
voucher. For example, if e-Rupi in the form of voucher is sent to a beneficiary it can be used only in the hospital and health
care clinics which are a part of this entire arrangement. Hence, payment cannot be done anywhere else.

National Automated Clearing House(NACH)

NACH as a mechanism has been developed by NPCI. It is a platform which facilitates electronic clearance. Through this
mechanism standing instructions can be given to the banks for payment of a certain amount from one account to another
at a regular interval. Through NACH payment can be done in a number accounts simultaneously in automated manner. It
can be used by an individual for payment of EMI on loan or for investing in SIPs, etc. This facility can be used by an
employee including the government in order to make payment to the employees, it can be used by the corporates in order
to distribute dividend simultaneously in different accounts.

Neo Bank
Neo means new. These banks are not exactly a bank. They are fintech companies which develop an app and collaborate
with one or more banks. They connect different customers with the partner bank in order to facilitate different types of
banking services and in order to provide different banking products. Since they do not have a banking licence, the banking
services will always be provided through the banks they collaborate with. For example, Jupiter money, Niyo global, Fi
money, etc.

Narasimham Committee 2
The second Narasimham committee was constituted in 1998. Even this committee was related to banking sector reforms.
The major recommendations of the second Narasimham committee were as follows:

Banking system in India 65

 1. The committee introduced the concept of narrow banking which is just the opposite of universal banking. Under the
concept of universal banking a bank can provide all the financial services which a bank is eligible to provide. However,
in case of narrow banking a bank will be instructed to provide loan only to less riskier sectors. The Narasimham
committee suggested that in order to improve the health of the weaker bank, the bank should be restricted by the RBI
and instructed to provide short term loans and only those long terms loans which are relatively secure.

2. The committee suggested that the RBI should remain only as a regulator and it should not own a bank or any other
financial institution.

3. With respect to the ownership of the government in the PSBs, the committee suggested that the government should
review its ownership. Ownership of the banks by the governments affects the autonomy of the banks due to frequent
interference. Even for the RBI, it becomes difficult to interfere in a public sector bank

4. The NPAs of the banks should be reduced to 3% by the year 2002. For this purpose, it again suggested that ARCs
should be setup.

5. It suggested the RBI to increase CAR in India.

6. It was suggested that for a foreign bank in order to setup its business in India the minimum capital investment should
be increased from $10 Million to $25 million(at present it is ₹5 billion which is equal to ₹500 crore.)

Loan at fixed rate, floating rate and Teaser loan

If a borrower borrows at fixed rate of interest then throughout the term period the rate of interest will remain the same. It
will not change even due to change in the monetary policies.

On the other hand in case of loan at floating rate the interest rate is not fixed. Even for the existing customers/borrowers
the rate of interest will keep on changing according to the change in the monetary policies/repo rate. If the central bank
follows cheap money policy the rate of interest for the existing borrower will decline automatically. On the other hand if the
central bank follows dear money policy the rate of interest for the existing customer will increase.

Banking system in India 66

 Teaser loans in case of home loans had become common in India. However, it lead to increase in default. Hence, the RBI
prohibited teaser loans. In teaser loan the banks offer a lower rate of interest through advertisements. This just in order to
attract the borrower. This lower rate of interest remains applicable only during first few years and thereafter it changes into
market rate.

@July 11, 2024

Line of Credit and Syndicated lending

Line of credit is an arrangement between a borrower and a lender in which a particular amount is set aside by the lender
for the borrower. The borrower will be able to borrow an amount upto the set limit under line of credit. However, it is not
necessary that he will borrow the entire amount at once. From this entire amount he may borrow in a phased manner
whenever required. The borrower will have to pay interest only on the amount that he has actually borrowed.

Syndicated lending or syndicated loan is a mechanism in which two or more banks collectively provide loan to a borrower.
Here the amount of loan is large and hence when the banks collectively provide the loan. It not only becomes easier for
them but even the risk gets distributed. This huge amount of loan can be given at once or it can be provided in the form of
line of credit.

Banking system in India 67

 Shorts

e- Rupi
Launch: 2021 by NPCI, Department of Financial Services, Ministry of Finance, and National Health
Authority, Ministry of Health.

Purpose: Ensure welfare benefits are used for intended purposes, preventing misuse.

Format: Digital voucher sent via SMS.

Value: Up to ₹1 lakh.

Usage: Redeemable only at designated outlets, partial payments via OTP.

National Automated Clearing House (NACH)

Developed by: NPCI.

Function: Facilitates electronic clearance and automated regular payments between accounts.

Applications: EMI payments, SIP investments, salary disbursements, corporate dividend distributions.

National Electronic Toll Collection (NETC)

Function: Facilitates electronic toll collection.

Technology: FASTag stickers with Radio Frequency Identification (RFID).

Developed by: NPCI.

Neo Bank
Definition: Fintech companies offering banking services through apps in collaboration with traditional
banks.

Function: Provide banking products and services without a banking license.

Examples: Jupiter Money, Niyo Global, Fi Money.

Narasimham Committee 2
Established: 1998.

Purpose: Recommend banking sector reforms.

Key Recommendations:

1. Introduce narrow banking for weaker banks.

2. RBI should act only as a regulator.

3. Government should review its ownership in PSBs.

4. Reduce NPAs to 3% by 2002.

5. Increase CAR.

6. Increase minimum capital investment for foreign banks.

Loan Types
Fixed Rate Loan: Interest rate remains constant throughout the term.

Floating Rate Loan: Interest rate varies with monetary policy changes.

Teaser Loan: Initially low-interest rate, which later shifts to market rate; prohibited by RBI due to increased
defaults.

Line of Credit
Definition: A flexible borrowing arrangement between a borrower and a lender.

Key Features:

1. Credit Limit: A specific amount set aside by the lender for the borrower.

Banking system in India 68

 Syndicated Lending

Key Features:

Large Loan Amounts: Ideal for borrowers requiring substantial funding.

Flexibility: The loan can be disbursed either as a lump sum or as a line of credit.

Model questions
1. What are the objectives of financial inclusion? List the measures adopted by the RBI and the Government of India in
order to achieve the goal of financial inclusion. What are the major challenges associated with it?

a. Define financial inclusion

b. Objective—

i. Reduce dependency on moneylenders

ii. Avoid investment in Ponzi schemes

iii. Ensure DBT

iv. Promoting cashless transactions

v. Distribution of social security measures

c. Measures—

i. Nationalisation of banks

ii. Concept of lead bank

d. Challenges—

i. Penetration of banking infrastructure

ii. Lack of awareness

iii. Misconceptions rooted in religion

iv. Behaviour of banking officials

v. Income disparity

vi. Cyber threats

vii. Gender disparity

viii. Cost of financial services

ix. Fear of high risk

x. Lack of financial awareness

xi. Liquidity trap

xii. Improper implementation of government policies

xiii. Lack of technical knowledge

xiv. Profitability of banks

e. Conclusion— sum up and way forward. FI as a mechanism has numerous Nobel objective. Many measures taken
thus far— some successful some not very successful. Challenges evolving but measures are also being added and
modified in the right direction.

Banking system in India 69

 2. Explain the concept of SHGs and MFI and list the measures adopted by the RBI to reform the entire arrangement based
on the suggestions given by the Malegam committee.

a. What are SHGs and MFIs

i. One of teh most important measure in India to achieve the goal of FI. Then define both. Whatʼs their relation

b. Malegam committee suggestion— they are good concepts but failed to yield satisfactory results. Hence the
committee.

c. SHGs and MFIs are very closely associated with other and complement each other. The RBI has tried to make this
bonding stronger with the committee— more transparency added to achieve the goal of FI.

Banking system in India 70

 Money Market
Date created July 11, 2024 1 36 PM

Revisions 4

Start date July 11, 2024

Status Complete

Introduction
Participants of Money Market
Government Securities in the form of bills
July 13, 2024
Certificate of Deposit
Commercial paper
Velocity of Money 💸
Money Multiplier
Near Money
Calculation of liquidity

Introduction
Money market refers to lending and borrowing of short term fund with a maturity of upto 365 days. Money market can be
unorganised or informal and it can also be organised or formal.

In unorganised money market thereʼs no codified rule and thereʼs no regulator. Also, the participants are not well defined.
Even the instruments which are used are not well-defined. For example, the lending and borrowing at local level among the
people.

Money Market 1
 On the other hand organised money market has codified rules and regulators. It has well defined participants and
instruments. Our concern in this chapter is only organised money market.

Organised money market in India is regulated by the RBI. In money market if the borrowing takes place only for one day it
will be termed as ‘overnight call moneyʼ or ‘call moneyʼ. If the borrowing takes place for more than one day and upto 14
days then it will be termed as ‘short term notice moneyʼ or ‘notice moneyʼ. If the borrowing takes place for more than 14
days and upto 365 days then it is referred to as ‘term moneyʼ.

Normally, in money market the lending and borrowing takes place on the basis of goodwill. If the goodwill is high borrowing
will be easier. If it is low, borrowing will be difficult. Hence, we can conclude that on the basis of goodwill no collateral in
physical form will be needed for pledging. However, if the participation of a participant is restricted or if the goodwill is not
as expected then Collateralised Borrowing and Lending Obligation(CBLO) can be used as an instrument in money market. It
was introduced in 2003 in India.

In money market if the rate of interest is not fixed then it is based on demand and supply of money and the goodwill of the
borrower. If the money supply is high, the rate of interest will remain low. If the money supply is low, the rate of interest will
remain high. If the goodwill is high, the rate of interest will remain low. If the goodwill is low, the rate of interest will remain
high.

Participants of Money Market

Even the participants of organised money market are well defined. Since the RBI regulates the money market in India it
automatically becomes a participant in the money market. It participates in the money market on behalf of the government
of India. The other participants of the money market are as follows:

The banks operating in India including the commercial banks, small finance banks, cooperative banks and the RRBs(the
RRBs were allowed to participate in money market only in 2020 and thereafter even they have become eligible to
borrow and lend in money market)

All India Financial Institutions such as NABARD, EXIM bank, National Housing Bank and SIDBI

The primary dealers act as a broker and who are registered as an NBFC.

Top-rated corporates

Individual investors

Intangible assets which are not counted while calculating net worth of a company are not present in physical form

In money market there are several instruments which can be used in order to raise short term fund. These instruments can
be termed as the instruments of money market are as follows—

Government securities- in the form of bills

Certificate of deposit.

Commercial paper

Government Securities in the form of bills

Money Market 2
 G-secs in the form of bills are short term money market instruments with the help of which the government may borrow for
short term period with the maturity of upto 365 days. These securities are promissory notes which can also be termed as a
short term debt instrument. In order to borrow on behalf of the government these securities are issued and are sold by RBI
to the other participants. G-secs in the form of bills can be issued only by the Central government. They canʼt by issued by
the states.

These securities issued in the form of bills have maturity period of 91 days, 182 days or 364 days. If the government wants
to borrow for a period of less than 90 day then Cash Management Bills are issued. They were introduced in India in the
year 2010. The government securities in the form of bills are of mainly following two types:

Normal securities

Treasury bills

In case of normal securities, they are issued at face value and the buyer is entitled to receive interest.

On the other hand, in case of treasury bills interest is not paid. T-bills are issued at a discounted price but redeemed at par.
It means they are sold to the buyer at a discount over face value but on maturity the buyer is entitled to an amount which is
equal to the face value. Hence, the benefit is given to the buyer in the form of discount. The banks in India prefer T-bills in
order to maintain their SLR.

Initially, the retail investors like us were not allowed to buy the government securities directly from the RBI. Hence,
investment in G-secs by such investors was done through a broker/a primary dealer/ a bank. However, in 2021 the RBI
introduced RBI retail direct scheme to facilitate. Investment in G-secs directly by the retail investors. It can be done
through RBIʼs retail direct portal/PRAVAAH portal. Recently, for this purpose even PRAVAAH app has been developed.
Platform for Regulatory Application, VAlidation and AutHorisation(PRAVAAH .

Negotiated Dealing System-Order Matching system(NDS OM is the mechanism which works behind RBI retail direct
scheme and it also works behind the transactions that take place on e-Kuber. It is a screen-based anonymous trade that
takes place between the seller and the buyer but the trade will be executed only when the order matches. It is there in India
since 2005.

Money Market 3
 Shorts

Introduction to Money Market

Definition Involves lending and borrowing short-term funds (up to 365 days).

Types:

Unorganised/Informal No codified rules, no regulator, undefined participants and instruments.

Organised/Formal Codified rules, regulated, well-defined participants and instruments.

Organised Money Market in India

Regulator Reserve Bank of India RBI .

Lending Basis Primarily based on goodwill, no physical collateral needed unless using Collateralised
Borrowing and Lending Obligation CBLO .

Variable Rates Based on demand and supply of money and the goodwill of the borrower.

Participants of Money Market

RBI On behalf of the Government of India.

Banks Including commercial banks, small finance banks, cooperative banks, and regional rural banks
RRBs).

All India Financial Institutions NABARD, EXIM Bank, National Housing Bank, SIDBI.

Primary Dealers Registered as NBFCs.

Top-Rated Corporates Corporates with a net worth of not less than ₹4 crore.

Individual Investors Retail investors through the RBI retail direct scheme.

Instruments of Money Market

Government Securities G-secs) in the form of Bills:

Definition Short-term debt instruments issued by the central government.

Maturity 91 days, 182 days, or 364 days. Cash Management Bills for less than 90 days.

Types:

Normal Securities Issued at face value with interest payment.

Treasury Bills T-bills) Issued at a discount, redeemed at face value, no interest.

Investment channels Initially through brokers, now directly via RBI retail direct scheme PRAVAAH
portal/app). Platform for Regulatory Application, VAlidation and AutHorisation(PRAVAAH .

Certificate of Deposit Negotiable money market instrument issued by banks.

Commercial Paper Unsecured, short-term promissory notes issued by companies.

Technology and Systems in Money Market

NDS OM Negotiated Dealing System-Order Matching system, screen-based anonymous trade for G-secs
transactions.

Money Market 4
 e-Kuber and PRAVAAH Platform for government securities trading. Both powered by NDS OM.

@July 13, 2024

Certificate of Deposit
It is another important instrument of money market. Certificate of deposit as an instrument was introduced in India in 1989.
They are unsecured short term debt instruments issued as a promissory note. If a bank is in need of short term fund to
meet its short term expenditure then the bank may issue certificate of deposit. These certificates of deposits can be sold
to the other participants such as banks, corporates, individual investors and even primary dealers. The fund raised is in the
form of short term borrowing. The certificate of deposit has a maturity period of not less than seven days and not more
than 365 days. They are issued with a minimum value of ₹5 lakh and in a multiple of that. They can be issued at a
discounted price or with interest.

📎
year and more than 3 years.

Till the time Liquidity Adjustment Facility(LAF) of the RBI remains available, the banks may borrow from RBI. However,
once the LAF is over the banks normally transact with each other. That rate of interest is driven by demand and supply of
money and the goodwill of the borrower. If a bank is suffering from adverse financial condition, it will not only get difficult
for it to borrow from the money market but it will also become costlier for the bank to borrow. When the depositors rush to
the bank in order to withdraw their deposit due to the increased feeling of insecurity then it is termed as bank run.

Initially, in normal circumstances when the banks in England EB used to borrow from each other for short term purposes
then the rate of interest was termed as Lodon Interbank Offer Rate(LIBOR . It served as a kind of benchmark. India
borrowed this concept and adopted Mumbai Interbank Offer Rate(MIBOR . It became the rate of interest at which the banks
in India lend to each other for short term period. In Japan it was termed as TIBOR and in Eurozone it was termed as
EURIBOR. However, at present almost all the countries have set aside these concepts and now itʼs Secured Overnight
Financing Rate(SOFR) which serves as a benchmark.
SOFR is a benchmark which is based on such borrowings in which government securities are pledged as collateral. In India
the concept of fixed reverse repo rate is no longer used but the RBI still uses Variable Reverse Repo Rate(VRRR)
mechanism to adjust liquidity in the banking system. In variable reverse repo rate, the term period as well as the rate both
are variable. Different banks interested in lending to RBI, offer different rate of interest through online bidding and
thereafter based on all such biddings the RBI decides the rate.

Commercial paper
It is also a short term money market instrument which was introduced in India in 1980. It is a debt instrument issued in the
form of unsecured promissory note. If a top rated corporate including NBFCs are interested in raising funds from the
money market to meet their short term expenditure then they may issue commercial papers. Commercial papers have a
maturity period of not less than 7 days and not more than 365 days. They are issued with a minimum value of ₹5 lakhs and
thereafter in multiples of that. They can be issued at a discounted price or issued with interest.

Although all the financial instruments are to be rated by credit rating agencies, if a company issues commercial papers to
raise more than ₹1000 crore in one FY, then the commercial paper is to be rated by at least two credit rating agencies. Out
of these two ratings the lower rating will be applied. The lower the rating of a financial instrument the higher will be risk and

Money Market 5
 hence higher will be the interest offered. On the other hand, higher will be the rating, lower will be the risk and hence
interest offered will also be lower.

Velocity of Money 💸
It refers to the frequency with which money changes hands. If currency notes are not used and are hoarded at home it may
not create a positive impact over the economy. However, if people consume and spend more, money will move from one
hand to another frequently. This frequent movement of money will create demand in the economy. Leading to economic
growth. One single currency note may create an impact worth lakhs of rupees. If the velocity of money remains low the
economic growth may remain slow.

Money Multiplier
When a deposit comes to a bank it maybe used again and again to provide loan to the borrowers. For example, if a
depositor deposits certain amount of money the bank will set aside the reserve ratios and the remaining amount can be
used in order to provide loan. The borrower will use the money either in the form of consumption or in the form of
investments. Whatever maybe the form, when the money goes to someone else, he may again deposit that amount to a
bank. From this deposit the bank will again set aside the reserve ratios and the remaining amount maybe given in the form
of loan. This process continues and is termed as Money Multiplier.

The Reserve Ratios CRR SLR will adversely affect money multiplier. Higher the reserve ratios, lower will be the money
multiplier.

It also depends upon the banking habits of the people and access to banking to the people.

Near Money
Those financial instruments which can be easily converted into cash can be termed as near money. It may include bills of
exchange such as G-secs in the form of bill, certificate of deposit, commercial papers, even those bonds which are about
to get matured. Sometimes even current account and savings account are termed as near money. Cheque, DD, etc. are
also type of near money.

Calculation of liquidity
In India the RBI issues currency notes above the denomination of ₹1. The ₹1 note and all the coins are issued by the
Government of India and are circulated by the RBI. However, in order to calculate how much money is present where in the
economy, the concept of M0, M1, M2, M3, M4, etc. is used. The calculation varies from country to country and even within
a country it may change with passage of time. In India at present they are calculated in the following manner:

Money Market 6
 Shorts

Certificate of Deposit
Introduced in India in 1989.

Unsecured short-term debt instruments, issued as promissory notes by banks.

Used to meet short-term funding needs.

Maturity:

7 to 365 days for banks.

1 to 3 years for All India Financial Institutions AIFIs).

Denomination Minimum value of ₹5 lakh and multiples of that.

Issuance Can be issued at a discount or with interest.

Liquidity Part of bank deposits, subject to CRR and SLR requirements.

Liquidity Adjustment Facility (LAF)

Availability Banks can borrow from the RBI while the LAF is available.

Post-LAF Banks transact with each other at rates driven by money demand, supply, and borrower
goodwill.

Adverse Conditions:

Difficult and costlier for financially troubled banks to borrow.

A rush by depositors to withdraw funds due to insecurity is termed a "bank run."

Historical and Current Benchmark Rates

LIBOR London Interbank Offer Rate, used as a benchmark for short-term interbank borrowing in England.

MIBOR Mumbai Interbank Offer Rate, India's equivalent to LIBOR for short-term interbank lending.

TIBOR Tokyo Interbank Offer Rate, Japan's equivalent.

EURIBOR Euro Interbank Offered Rate, used in the Eurozone.

Current Benchmark:

SOFR Secured Overnight Financing Rate, based on collateralized borrowings (government securities
as collateral).

Reverse Repo Rate Mechanism in India

Fixed Reverse Repo Rate No longer used.

Variable Reverse Repo Rate VRRR :

Adjustable term period and rate.

Banks offer different rates through online bidding.

RBI decides the rate based on these bids to manage banking system liquidity.

Commercial Paper
Introduction:

Introduced in India in 1980.

Unsecured short-term debt instruments issued by top-rated corporates and NBFCs.

Maturity 7 to 365 days.

Denomination Minimum value of ₹5 lakh and multiples of that.

Issuance Can be issued at a discount or with interest.

Money Market 7
 Credit Rating Required if issuance exceeds ₹1000 crore in a financial year, rated by at least two agencies.
Lower rating implies higher risk and interest.

Velocity of Money
Definition Frequency of money changing hands.

Impact: Higher velocity indicates more economic activity and growth. Low velocity can slow economic
growth.

Money Multiplier
Definition Process by which deposited money is reused for lending, increasing money supply.

Influence of reserve ratios Higher reserve ratios CRR SLR reduce the money multiplier. Dependent on
banking habits and access to banking.

Near Money
Financial instruments easily convertible to cash.

Bills of exchange, G-secs, certificates of deposit, commercial papers, maturing bonds.

Current and savings accounts, cheques, demand drafts.

Calculation of Liquidity
Currency Issuance Notes above ₹1 issued by RBI. ₹1 notes and coins issued by Government of India,
circulated by RBI.

Liquidity Measures M0, M1, M2, M3, M4 etc., vary by country and over time to measure money supply.

Money Market 8
 Capital market
it
Date created July 13, 2024 725 PM

Am
r
Revisions 1

Start date July 13, 2024

ma
Status Complete

K u
b y
i cs
o m
o n
E c
Contents

July 15, 2024

Introduction
Government securities in the form of bonds
Bond price and Bond yield
July 16, 2024
Industrial securities in the form of Debentures and shares
Stock Exchange(SE)
July 17, 2024
NIFTY50 and SENSEX
Classification of stock/share market
Primary market
Initial Public Offering(IPO)
July 18, 2024
Follow-on Public Offer
Rights Issue
Secondary market
Application Supported By Blocked Amount(ASBA)
Some Important terminologies
Market Capitalisation

Capital market 1
 Classification of companies based on market cap
Bluechip companies
July 19, 2024
Bulls and Bears
Stag
Insider Trading
Circular trading
Front running
Hostile bidding
IPO Financing
July 20, 2024
Rolling settlement
Beta value
Alpha value
Employees Stock Ownership Plans(ESOPs)
Sweat Equity
Angel investors and venture capitalists
Startup: As defined by the Government of India
July 22, 2024
Anchor investors
Arbitrage
Equity shares and preferential shares
Mutual fund

t
July 23, 2024
Exchange Traded Fund(ETF)
Real Estate Investment Trust(REIT) & Infrastructure Investment Trust(InvITs)
m i
Foreign Portfolio Investors(FPI)
July 24, 2024
r A
Participatory Notes(PNotes)
Some important indices of the world
m a
ADR and GDR
Indian Depository Receipt(IDR)
K u
Factors affecting share market

b y
s
Debentures
Bharat bond ETF

i c
m
Perpetual bond

o
July 26, 2024
Additional Tier(AT)1 Bond

o n
c
Sovereign Green Bonds(SGBs)

E
Blue Bond
Muni bond
Inflation Indexed Bond
Masala Bond
July 27, 2024
Insurance sector
Controversy between SEBI and IRDAI w.r.t. ULIPs
Commodity trading
July 29, 2024
Social Stock Exchange
Universal Exchange
Derivatives
Bitcoin/Cryptocurrency
Reasons behind the popularity of Crypto Currencies
Concerns associated with Crypto Currencies
Non-Fungible Token NFT
Central Bank Digital Currency CBDC
July 30, 2024
Peer-to-Peer Lending(P2P)
Depository
Credit Rating Agency
July 31, 2024
Insolvency and Bankruptcy Code(IBC)
Core Investment Company
Financial Debt

Capital market 2
 Non-financial debt
Model questions

@July 15, 2024

Introduction
Capital market refers to raising long term fund with a maturity of more than one year. In capital market, role of the RBI is limited
and capital market in India is mainly regulated by Securities and Exchange Board of India(SEBI). SEBI even regulates the stock
exchange, the brokers and the depository. SEBI was setup in 1988 but SEBI act was passed in 1992. With this act SEBI was
made a statutory body. The HQ of SEBI is located in Mumbai. Normally, SEBI was headed by a bureaucrat but for the first time
SEBI is being headed by somebody who is not related to bureaucracy. At present the chairperson of SEBI is Madhabi Puri
Buch. Prior to her appointment she was associated with ICICI bank. She is first woman to head SEBI. SEBI not only formulates
rules for the capital market but is also responsible for preventing fraudulent activities in the market.
There are several participants who are active in capital market—

 The RBI participates on behalf of the Government of  Primary dealers

India
 Brokers
 The banks operating in India
 Stock exchange
 Top-rated corporates

t
 Depository
 All India Financial Institutions

m i
 Individual investors etc.

A
 NBFCs

a r
The main instruments used in capital market in order to raise funds are the following:

 G-secs in the form of bonds

u m
 Industrial securities in the form of shares and debentures

y K
s
Government securities in the formb of bonds
i c
Bonds are long term capital market instruments which have a maturity period of more than 365 days. They also are

o m
promissory notes and a debt instrument. Just like bills even bonds can be termed as a negotiable instrument(a signed

n
document or financial instrument which is issued with a guarantee of payment of specified amount when it is presented or

o
E c
when it gets matured. Eg. Bills, bonds, cheques, etc.)

Government securities in the form of bond can be issued by

the centre and can even be issued by the states. If the states
issue government securities in the form of bonds then they
are termed as State Development Loan(SDL). When the
government is in need of long term fund to meet its long
term expenditure it may issue long-term securities in the
form of bonds. These bonds are mainly sold by the RBI to the
interested investors. After introduction of RBI Retail Direct
scheme even the retail investors like us can buy these
securities directly from the RBI.

Image: Gilt-edged securities issued earlier in the British era. The

border(edge) was golden coloured as a convention. Hence, the name
Gilt-edged.

Capital market 3
 The bonds are also termed as Gilt edged securities.
Although, the securities are now issued in electronic form
but were earlier issued in paper. Since the British period,
when these highly secured bonds were issued in the form of
paper they used to have a golden colour border around
them. Hence, they were termed as Gilt-edged securities. The
G-secs in the form of bonds can be broadly classified as →

Dated securities are normal securities which are issued at face value. The buyer is entitled to receive interest on such
securities. When the bonds are simple bonds, without any additional features they are also referred to as Plain Vanilla Bond.

On the other hand, coupon in economics means interest. Hence, zero coupon means zero interest. Zero coupon bonds are
just like treasury bills, the only difference is of maturity period. Zero coupon bonds are issued at a discounted price but
redeemed at par. It means they are sold at a discount over face value but on maturity the investor is entitled to receive an
amount equal to the face value.

Bond price and Bond yield

t
Bond price refers to the price at which the bond is sold. On the other hand, bond yield refers to the benefit that an investor

m i
derives through investment in bonds when the bond price declines, the bond yield increases. On the other hand, when the
bond price increases, the bond yield declines. Hence, it can be concluded that bond price and bond yield are inversely
proportional.
r A
Bond yield α
1
m a
u
Bond P rice

K
y
If the liquidity in the economy is low and the government is willing to borrow from the market to meet its expenditure then the

s b
RBI will offer more discount on the securities. It will lead to decline in the price but the yield will increase. On the other hand, if
the liquidity is high, the discount offered will be less and therefore the bond price will be high leading to decline in of bond
yield.
i c
o m
The bond issuer is the borrower. Whereas the bond holder is the lender. When inflation increases at a rapid pace but the rate

n
of interest is fixed, the creditor is at loss. In other words, the bond holder will be at loss.

o
E c

Capital market 4
 Shorts

Introduction
Capital market refers to raising long-term funds with a maturity of more than one year.

Regulation:

Primarily regulated by the Securities and Exchange Board of India SEBI.

SEBI regulates the stock exchange, brokers, and depositories.

SEBI established in 1988; became a statutory body in 1992.

Headquarters in Mumbai.

Current chairperson: Madhabi Puri Buch (first non-bureaucrat and first woman to head SEBI.

it
A m
Main Instruments of Capital Market
a r
m
 Government securities in the form of bonds

 Industrial securities in the form of shares and debentures

K u
Government Securities in the Form of Bonds
b y
notes and debt instruments.
i cs
Definition Long-term capital market instruments with a maturity of more than 365 days. They are promissory

Types:
o m
o n
Issued by both central and state governments.

E c
Although state-issued bonds are termed as State Development Loans SDLs).

Purpose:

Used to meet long-term expenditure needs.

Sold by the RBI to interested investors; available to retail investors via the RBI Retail Direct scheme.

Terminology:

Gilt-edged securities (historically had a golden border; now issued electronically).

Classification:

Dated Securities Issued at face value with interest payments. Simple bonds are known as Plain Vanilla
Bonds.

Zero Coupon Bonds Issued at a discount and redeemed at face value, similar to treasury bills but with a
longer maturity.

Bond Price and Bond Yield

Bond Price The price at which a bond is sold.

Bond Yield The benefit an investor derives from the bond investment.

Relationship Inversely proportional. When bond price declines, bond yield increases and vice versa.

1
Bond yiel d α
Bond P rice

Capital market 5
 Market Dynamics:

When liquidity is low, government borrows at increased discounts, lowering bond prices as a result raising
yields.

High liquidity reduces discounts, raising bond prices and hence lowering yields.

Impact of Inflation
Bond Issuer = The borrower. Benefits from higher inflation

Bond Holder = The lender. Loses when inflation is high.

Inflation Impact Rapid inflation with fixed interest rates disadvantages the creditor (bond holder).

@July 16, 2024

Industrial securities in the form of Debentures and shares

If a company is interested in raising long term fund to meet its long term expenditure then it may issue shares or debentures.
Debentures are long term debt instruments which are issued in the form of bonds. By issuing debenture a company may
borrow for long term period. However, if a company does not want to borrow and wants to raise fund without borrowing then
the company may issue shares. Shares are also instruments of capital market. By issuing shares, long term fund can be

it
raised. Shares are a part of the company. Based on the authorised capital, the shares of a company can be derived. The

A m
company may sell the shares to the interested investors and capital will come to the company in the form of investment. Since
the amount received by the company is not in the form of loan it is not be repaid. Those who buy the shares, become partial

a r
owners in the company and are termed as share holders. The shareholders own the company in the ratio in which they hold

m
the shares of the company. They are not entitled to receive interest. They receive a part of the profit of the company which
can be termed as dividend.

K u
Now the shares are issued in electronic form. Hence, they are to be bought, sold and held in electronic form only. In order to

b y
buy, sell and hold the shares in electronic form, a demat(dematerialised) account is required. It is an electronic account which

i cs
can be provided to the investors by a broker. Zerodha, Groww, India Infoline, etc are some of the popular brokers in India. Even
the banks may provide brokerage service. The brokers are regulated by SEBI.

Stock Exchange(SE) o m
o n
E c
It is a platform or a market which facilitates buying and selling of shares. Stock exchange serve as a link between the buyers
and the sellers. When a company sells its shares to the interested investors, the company gets listed over the SE. The shares
of that company can be traded over the SE only after its listing.

The oldest SE in the world is Amsterdam SE which was setup in 1602. In the year 2000 Amsterdam SE was merged with Paris
SE and Brussels SE. After this merger the name was modified to Euronext Amsterdam. The largest SE in the world is NYSE.
In India, the most important SEs are National Stock Exchange(NSE) and Bombay Stock Exchange(BSE). The newest SE in India
is India International Exchange(IINX). It is located in GIFT city, Gandhinagar, Gujarat.

BSE was setup in 1875. It is Asiaʼs oldest SE. Based on the total volume and the total value of shares traded per day, BSE is
Indiaʼs second largest SE. However, based on the total number of companies listed, BSE is the largest SE. BSE was setup by
brokers and is located in Mumbai.

NSE was established in Mumbai in 1992 and began functioning in 1994. It was setup not by the government but because of the
efforts made by the government. Some prominent stakeholders in NSE are LIC, SBI, India infoline, etc. It was Indiaʼs first fully
computerised SE which came into existence mainly in order to challenge the dominance of BSE. Based on the total value and
volume of shares traded per day it is Indiaʼs largest SE. Based on the total number of companies listed it is Indiaʼs second
largest stock exchange.

At present, more than 5300 companies are listed on BSE. More than 2200 companies are listed on NSE. The most important
index of NSE is Nifty-50 and that of BSE in SENSEX.

Capital market 6
 Shorts

Industrial Securities: Debentures and Shares

Raising Long-Term Funds:

Debentures:

Long-term debt instruments issued as bonds.

Companies borrow long-term funds through debentures.

Shares:

Instruments of capital market for raising long-term funds without borrowing.

Represent partial ownership in the company.

Issued based on authorized capital.

Capital raised from shares is not repaid; shareholders receive dividends.

Electronic Form and Demat Accounts:

Shares are issued, bought, sold, and held electronically.

Requires a dematerialized (demat) account provided by brokers (e.g., Zerodha, Groww, India Infoline) or
banks.

Brokers are regulated by SEBI.

it
Stock Exchange (SE)
A m
Platform for buying and selling shares.

a r
m
Links buyers and sellers.

Companies get listed on SE to trade shares.

K u
Historical and Major Stock Exchanges:

b y
s
Oldest SE Amsterdam Stock Exchange 1602, now Euronext Amsterdam.

Largest SE New York Stock Exchange NYSE.

i c
Indian Stock Exchanges:
o m
o
Bombay Stock Exchange BSE:
n
E c
Established in 1875, Asiaʼs oldest SE.

Indiaʼs second-largest by daily trade volume and value.

Largest by the number of listed companies (over 5300.

Key index  SENSEX

National Stock Exchange NSE:

Established in 1992, began operations in 1994.

First fully computerized SE in India.

Indiaʼs largest by daily trade volume and value.

Second largest by the number of listed companies (over 2200.

Key index  NIFTY50

Newest SE in India: India International Exchange IINXLocated in GIFT city, Gandhinagar, Gujarat.

@July 17, 2024

NIFTY-50 and SENSEX

NIFTY50 is the most important index of NSE whereas SENSEX is the most important index of BSE. These indices are used in
order to track the movement of the share market. Out of all the companies listed on NSE, the top 50 companies belonging to

Capital market 7
 different sectors are included in NIFTY50. These sectors can be oil and gas, banking and finance, metal, telecommunication,
pharma, etc. NIFTY tracks only the average movement of the share price of these 50 companies. If overall NIFTY moves
upwards, it is said that the share market is moving upwards. Similarly, if NIFTY goes downwards, it is said that the share
market is going downwards. Hence, it cannot be said that if NIFTY is going upwards, each and every stock will also go
upwards, and vice versa, it cannot be concluded that if NIFTY goes downwards, each and every stock will go downwards.
Just like NIFTY50 even SENSEX is an index. However, out of all the companies listed on BSE, only top 30 companies
belonging to different sectors are included in SENSEX. It tracks only the average movement of these 30 companies based on
which it is said that whether the market is moving upwards or downwards.

Other than NIFTY50 and SENSEX, NSE and BSE both have a number of different indices.

Classification of stock/share market

The stock market or the share market can be broadly classified into following two types—

 Primary market

 Secondary market

Primary market
When a financial instrument is directly sold by the issuer to the interested investors without any role played by the stock
exchange then it is termed as primary market. Once the shares or the financial instruments start trading over the stock
exchange then it is termed as secondary market. The shares of a company can even be sold by the company through private

it
placement. Unlike public placement, in private placement the company transfers its shares to a few known investors. Even in

m
this case stock exchange has no role. But through private placement a company cannot be listed.

A
r
Some major instruments which are used in primary market are as follows:

 Initial Public Offering(IPO)

m a
 Follow on Public Offer(FPO)

 Rights Issue
K u
b y
Initial Public Offering(IPO)

i cs
If a closely held company i.e. a company whose shares are only with promoter(s) is interested in raising funds from the capital

o m
market by sale of its shares for the first time to the public then the company will come out with its IPO. In order to manage the
IPO, the company will hire one or more investment banking company/merchant banking company(those companies which help

o n
other companies in raising funds from the market). These investment banking companies will manage the entire IPO. They will

E c
evaluate the company and suggest that the shares can be sold through IPO with how much premium over the face value.

Thereafter an application will be filed with SEBI in order to seek permission. This application is termed as Draft Red Herring
Prospectus. The cover page of the prospectus is printed in Red. Once the permission is granted, the company shall advertise
the IPO. A company with a minimum net worth of ₹25 crore can come out with its IPO. In case of IPO of small and medium
enterprises it is termed as SMEIPO. The IPOs of large companies are termed as main board IPOs.

The IPO of a company normally remains open for three working days during which an investor can invest. For investing an
investor must have a Demat account. Fund can be transferred to the company directly from the bank account of the investor.
The shares will be directly transferred to the investorʼs Demat account. In an IPO, the price has a band—upper and lower.
Investor may invest and buy at least one lot of the shares. Lot size is decided by the company, the value of which generally
comes around ₹15,000. An investor can buy one lot or in a multiple of that. Those individual investors who invest upto ₹2 lakh
in an IPO are termed as retail investors(35% shares reserved for them) and investors investing more than that are termed as
High Net-worth Individual(HNI) investors(15% reserved for them). The financial institutions which invest in IPOs are termed as
institutional investors and for them 50% of IPO is reserved.

If the demand for the shares in the IPO is too high then the IPO will be oversubscribed. In case of oversubscription those who
had applied for the IPO at lower price band will be taken out of the applicants list. For the remaining investors, the number of
lots will be reduced. Even after that if oversubscription remains then lucky draw is conducted.

If the demand of an IPO is low, it will remain undersubscribed. In such a situation one of the Investment/merchant Banking
companies hired for managing the IPO, will have to buy the unsubscribed shares. This will be termed as underwriting of
shares in an IPO. That investment banking company will be the Lead Manager for that IPO.

Once the shares are allotted to the investors through IPO, a date is decided on which the company shall be listed on Stock
Exchange(SE). Thereafter, the investors can trade the shares of the company over the SE.

Capital market 8
 Those shares of the company which go to the public and can be freely traded over the SE are termed as free float shares of
the company. So far the largest IPO in the world was of Saudi Aramco, the largest oil company in the world. In India, the
largest IPO was of LIC.

it
A m
a r
u m
y K
s b
i c
o m
o n
E c

Capital market 9
 Shorts

NIFTY50

The most important index of NSE.

Comprises the top 50 companies across various sectors (e.g., oil and gas, banking and finance, metal,
telecom, pharma).

Tracks the average movement of share prices of these companies.

Movement in NIFTY indicates overall market trend but not individual stock performance.

SENSEX

The most important index of BSE.

Comprises the top 30 companies across various sectors.

Tracks the average movement of share prices of these companies.

Like NIFTY, SENSEX indicates overall market trend but not individual stock performance.

Other Indices:

NSE and BSE have multiple indices beyond NIFTY50 and SENSEX to track different segments of the market.

Classification of Stock/Share Market

Primary Market:
it
A
Includes private placement where shares are sold to a few known investors.
m
Financial instruments are sold directly by the issuer to investors without stock exchange involvement.

Secondary Market:
a r
u m
Shares and other financial instruments are traded after being listed on the stock exchange.

Major Instruments in Primary Market y K

s b
Initial Public Offering (IPO): ic

o m
When a company sells its shares to the public for the first time.

o n
Managed by investment/merchant banking companies.

E c
Requires SEBI approval through a Draft Red Herring Prospectus.

Companies need a minimum net worth of ₹25 crore for an IPO (for SME IPOs, lower requirements apply).

Remains open for three working days.

Requires investors to have a Demat account.

IPO price has a band (upper and lower); investors buy at least one lot.

Different categories of investors:

Retail Investors (up to ₹2 lakh, 35% reserved).

High Net-worth Individuals HNIs, above ₹2 lakh, 15% reserved).

Institutional Investors 50% reserved).

Oversubscription Demand exceeds supply; applicants at lower price band are excluded, lots are reduced,
and a lucky draw may be conducted.

Undersubscription Demand is low; one investment banking company Lead Manager) buys unsubscribed
shares (underwriting).

Post-IPO:

Shares are allotted and the company gets listed on SE.

Shares can then be traded in the secondary market.

Free float shares: Shares that can be freely traded on SE.

Capital market 10
 Notable IPOs

Largest IPO in the world: Saudi Aramco.

Largest IPO in India: LIC.

Follow-on Public Offer (FPO):

Companies raise additional funds by selling new shares at a discount.

Can fail if shareholders sell existing shares to buy at the discount, lowering the market price.

Rights Issue:
Companies offer additional shares at a discount to existing shareholders.

Shareholders can sell their rights if they do not wish to buy more shares.

@July 18, 2024

Follow-on Public Offer

If an already listed company is interested in raising additional fund by selling additional shares to the investors then the
company may come out with its FPO or Rights Issue.

it
In FPO, a company sells its additional shares to the interested investors at a discounted price over the market price. The
investors will buy the shares from the company just in order to get the benefit of the discount. However, in a number of cases

A m
the FPOs fail and the company has to withdraw the FPO. It is mainly because when the investors come to know that the

r
company is offering the same shares at a discounted price the existing share holders start selling the shares over the stock

m a
exchange thinking that the same shares can be bought back from the company at a discounted price through FPO. However,
this leads to increase in supply of these shares on the stock exchange and the price may fall down even below the discounted

u
price. In order to prevent this from happening Rights Issue is seen as a better option.

K
Rights Issue
b y
i cs
It is also an instrument of the Primary Market. If an already listed company is interested in raising additional funds from the
capital market by selling some additional shares then the company may come out with its rights issue. In Rights Issue the

o m
company sells its additional shares at a discounted price to the existing shareholders. Hence, the benefit of the discount can
be availed only if the investor continues to hold the shares. If he sells the shares his rights will be gone. If in case the existing

o n
shareholder is not interested in buying more shares through rights issue, she may sell her rights to other interested investors
over the SE.

E c
Secondary market
When the buying and selling of the shares and other such financial instruments takes place over the stock exchange then it is
termed as secondary market.

Application Supported By Blocked Amount(ASBA)

When the investors apply for IPO, FPO, etc. through their bank accounts the money which is used does not go to the company
instantly. It remains in the accounts of investors only but it is blocked till the time of allotment of the shares. If the shares are
allotted this blocked money will go to the company and if the shares are not allotted the money will be unblocked and it can be
used by the account holder.

Some Important terminologies

Market Capitalisation
Refers to the total market value of a company. It is calculated by multiplying the total number of shares of a company with the
market price of one share of that company. Since the share price keeps on fluctuating every second when the market remains
open, even the market capitalisation of a company keeps on fluctuating during that period.
Based on market capitalisation, Reliance Industries Limited is Indiaʼs largest company. It has become the first Indian company
to surpass a market capitalisation of ₹20 lakh crore. Based on market capitalisation, HDFC bank is the Indiaʼs largest bank.

Capital market 11
 Based on market capitalisation Apple and Microsoft both are worldʼs largest companies. They have a market capitalisation of
more than $3 trillion.
Even the list of the richest individuals is based on market capitalisation. It is based on the total value of the shares held by that
person in his own company and even in other companies.

Classification of companies based on market cap

Based on market capitalisation, in India the listed companies are classified into three types— Large, Mid and Small.

According to the earlier definition, all the companies listed in India which have a market cap of —

i ₹20,000 crore or more were termed as large cap.

ii ₹5,000 crore or more were termed as mid cap.

iii Less than ₹5,000 crore were termed as small cap.

SEBI came out with another definition according to which among the listed companies based on market cap the—

i Top 100 companies will termed as large cap

ii Between 101 and 250 will be termed as mid cap

iii Beyond 250 will be termed as small cap

Bluechip companies
They are large companies with a long history of growth, profit and dividend payout. Investment in the shares of such

it
companies is relatively less riskier mainly because of their stability. All the companies in the main index— NIFTY50 or SENSEX

companies.
A m
— are bluechip companies. However, there are companies outside the index which can also be termed as bluechip

a r
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s b
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Capital market 12
 Shorts

Secondary Market
Secondary Market:

Where shares and financial instruments are traded on the stock exchange.

Key Terms

Market Capitalization:
Total market value of a company (number of shares x share price).

Reliance Industries is India's largest by market cap, over ₹20 lakh crore.

Apple and Microsoft lead globally, each with over $3 trillion.

Company Classification by Market Cap

 Large Cap:

Market cap of ₹20,000 crore+.

Top 100 companies.

 Mid Cap:

Market cap ₹5,000 crore to ₹20,000 crore.

it
Companies ranked 101250.
A m
 Small Cap:
a r
Market cap below ₹5,000 crore.

u m
Companies ranked 251.

y K
Bluechip Companies

s b
c
Stable, established companies with a strong history of growth and dividends.
i
m
Include all NIFTY50 and SENSEX companies, plus others.

o
o n
@July 19, 2024
E c
Bulls and Bears
Both are speculators. They speculate the movement of the market and invest accordingly for long term period. The bulls are
optimistic and they speculate that the market is going to move upwards. Hence, they indulge in buying of shares. That is
the reason when the market moves upwards it is said that the market is bullish.

On the other hand, bears are pessimist and speculate that the market is going to move downwards. Hence, they indulge in
selling of shares. That is the reason whenever the market moves downwards it is said that the market is bearish.

Stag
The literal meaning of stag is deer. They are also speculators but they invest for extremely short term period. They try to make
instant profit. For example, they may indulge in intraday buying and selling which means they will buy the shares and sell them
on the same day or they may invest in the IPO and exit on the day of listing.

Insider Trading
Insider trading is an illegal act and a punishable offence in the share market. If an individual is an insider of a company and
because of that he has access to crucial information of the company even before they are made public then insider trading is
possible. Based on such confidential informations, if the person trades in the shares of that company then it is termed as
insider trading. https://en.wikipedia.org/wiki/Rajat_Gupta

Capital market 13
 Insider trading | How Rajat Gupta fell from the pinnacle of power to the ignominy of incarceration
For Rajat Gupta, the reputational damage was huge. McKinsey, the firm he led for nine years, removed his
name from the company's alumni directory.
https://www.moneycontrol.com/news/business/how-rajat-gupta-fell-from-the-pinnacle-of-power-to-the-
ignominy-of-incarceration-12432171.html

Circular trading
Itʼs another illegal act and punishable offence in the share market. In circular trading some traders who are known to each
other manipulate the price of the shares of a company by buying and selling the shares among themselves. Gradually when
the share prices reach a certain height, even the other investors get attracted towards the same shares. These investors will
now sell these shares to the other investors at a higher price and will exit from the share making huge profit.

Front running
It is another illegal act which is a punishable offence. It is mainly done by the brokers. It is also known as Tailgating. A broker
may have a number of large clients. It is a possibility that large client of a broker may instruct the broker to buy the shares of a
company in huge quantity. The quantity is so huge that the order may pull the price of the shares upwards. In such a situation
even before placing the order of the client the broker will himself buy the shares of the same company. Thereafter, the
moment the order of the client is placed, the share price may jump and the broker will be able to make instant profit. This is
referred to as front running.

Hostile bidding
it
A m
In stock market, hostile bidding is considered as unethical but is not illegal. Hostile bidding is possible only when the promoter
of a company does not hold majority stake in his own company. In this case any investor who is cash rich may buy the shares

example, acquisition of NDTV by the Adani Group or acquisition of Arcelor Steel by Mittal Steel.
a r
of a company from the market and may acquire majority stake in that company even against the wish of the promoter. For

IPO Financing u m
y K
b
Investment in IPOs has become highly attractive. It is mainly because a number of IPOs were oversubscribed several times

s
due to high demand and because of that on the day of listing itself such IPOs have given excellent return to the investors. This

i c
resulted in a trend in which the HNI investors started borrowing from the banks in order to invest in IPOs. When the banks give

m
loan to an investor for the purpose of investing in an IPO then it is termed as IPO financing. Here the investor sells the shares

o
on the day of listing and the amount is repaid to the bank along with interest.

n
co
Some times back a controversy between Ashneer Grover, the co-founder of BharatPe and Kotak Mahindra Bank emerged.
This controversy was related to IPO financing for the purpose of investment in the IPO of Nykaa. When this controversy came

E
into limelight the RBI and SEBI modified the rules related to IPO financing.

According to the rules modified by the RBI, an HNI investor can borrow an amount of upto ₹1 crore in order to invest in an IPO.
According to the rules modified by SEBI, in any IPO out of the 15% reserved for HNI investors 1/3rd will remain reserved for
those HNI investors who invest more than ₹2 lakh and upto ₹10 lakh in the IPO. The remaining 2/3rd of the 15% will remain
reserved for those HNI investors who invest more than ₹10 lakh in the IPO.

Capital market 14
 Shorts

Bulls and Bears

Bulls:

Optimistic investors who believe the market will rise.

Buy shares expecting to profit from an upward market movement.

Bears:

Pessimistic investors who believe the market will fall.

Sell shares expecting to profit from a downward market movement.

Stags
Short-term investors looking for quick profits.

Engage in activities like intraday trading or investing in IPOs and selling on the listing day.

Insider Trading
Illegal and punishable offense.

Involves trading based on non-public, confidential information by company insiders.

Circular Trading
it
Illegal and punishable practice.

A m
other investors and sell at higher prices.
a r
Involves a group of traders manipulating share prices by buying and selling among themselves to attract

Front Running
u m
y K
Illegal and punishable act by brokers, also known as tailgating.

s b
Brokers trade ahead of large client orders to benefit from the anticipated price movement.

Hostile Bidding i c
Unethical but not illegal.
o m
o n
Occurs when an investor acquires a majority stake in a company against the promoter's wishes, typically

E c
when the promoter doesnʼt hold a majority stake.

IPO Financing
Borrowing funds from banks to invest in IPOs.

Controversy Ashneer Grover vs. Kotak Mahindra Bank over Nykaa IPO financing.

Regulations:

RBI HNI investors can borrow up to ₹1 crore for IPO investment.

SEBI For IPOs, 15% reserved for HNIs is split into:

1/3rd for investments between ₹2 lakh and ₹10 lakh.

2/3rd for investments above ₹10 lakh.

@July 20, 2024

Rolling settlement
In the Indian share/stock market, the settlement of the trades used to take place on T2 basis. This is a form of rolling
settlement in which the settlement of the trade does not take place instantly. It is done on a subsequent date. Here, T refers to
the day of trade and 2 refers to two additional days. It means that the final settlement takes place only on the third day. For
example, if the shares are sold today, the money will actually come in the trading account only on the third day. Thereafter it

Capital market 15
 can be withdrawn. Similarly, if a share is bought today, it will be the day of trade and actually the shares will come to the
demat account only on the third day. This is rolling settlements. However, this rolling settlement in India has been reduced to
T1 basis. Here, T is the day of trade and 1 is one additional day. In a phased manner, it is being reduced to T0, settlement
on the same day. However, for the same day settlement, the trade has to be executed before 130 pm.

Beta value
In the stock market, the shares that are traded maybe highly volatile, stable or less volatile. Those stocks which are highly
volatile and their average movement is even faster than the movement of the index such as NIFTY50 will be termed as high
Beta stocks. On the other hand, those stocks which are less volatile and which move at a slower pace as compared to the
index will be termed as low beta stocks. Those stocks which move along with the index will have a beta value equal to 1. The
high beta stocks will have a beta value of more than 1 and low beta stocks will have a beta value of less than 1.

Alpha value
Investment in share market can be done even through mutual fund companies. The mutual fund companies collect money
from a number of investors and invest it in a diversified manner in the shares of different companies. The investment can be
done in an active manner or it can be done in a passive manner. In passive investment the fund is invested in the shares of
those companies which constitute the index. Hence, they normally give a return which is similar to the return given by the
index. On the other hand, in active funds, the fund manager conducts research and analysis over the shares of different
companies belonging to different sectors. Based on the analysis, the investment is done. Such investments may give a return
which maybe lower or higher as compared to the return given by the index. If the return is higher as compared to the index
then the difference is termed as the alpha value.

it
Employees Stock Ownership Plans(ESOPs)
A m
r
Through ESOPs, a company tries to retain its productive and efficient employees. For this purpose the employees maybe

m a
rewarded by the company. If this reward is given in the form of shares of the company then it is termed as ESOPs. It is not a
kind of reward but the employee gets ownership in the same ratio by becoming a share holder. It results in a kind of

K u
belongingness and the commitment of the employee towards the company may increase. The shares in the form of ESOP
maybe given free of cost or it may be given to the employee at a discounted price. However, in case of ESOP, the companies

b y
normally impose a lock-in period during which the shares cannot be sold by the employee. During this lock-in period if the

i cs
employee leaves the company the reward will be taken away i.e. the ESOP will be gone.

Sweat Equity
o m
n
It can be defined in two different ways. In a startup company or in a company which does not have sufficient cash, if a

o
c
professional or an employee provides unpaid labour to revive the company or to restructure the company and at the end she is

E
rewarded with a stake in the company then it will be termed as sweat equity.

Thereʼs another way in which sweat equity can be defined. It may refer to the value addition done by an individual in his own
company through his hard work.

Angel investors and venture capitalists

They both are big investors who invest for long-term period and have high risk appetite. They invest in mainly newly setup
startup companies which are engaged in innovative business. The stake is sold to them by the startup companies through
private placement. They hold the stake for long-term period expecting that the company will succeed. Because of their
investment the valuation of a startup company may increase or it may fall down.

Angel investors invest their own money, whereas, venture capitalists collect money from a number from investors and invest in
different startups. They are the main source of funding for the startup companies.

Startup: As defined by the Government of India

From time to time, even the government comes out with certain schemes to provide certain benefits to the startup companies.
It is done in order to promote the startup culture as well as the startup companies. For example, for a startup company in India,
a loan of upto ₹50 crore is counted as a part of priority sector lending. Similarly, in its first ten years of establishment it may
choose any three consecutive years during which the corporate tax applicable will be zero. However, in order to provide such
benefits the startups are defined by the government differently. The definition is as follows:

 It should be registered as a company under companies act

 It should not be older than 10 years

Capital market 16
  In these ten years, the annual turnover(total sale) must not exceed ₹100 crore in any year.

 It should be engaged in non-traditional innovative business such as e-commerce, biotech, IT and software, etc.

If the market value of a startup company exceeds—

$1 Billion it is referred to as a Unicorn .

$10 Bn it is called a Decacorn.

$100 then it is called Hectocorn.

Shorts

Rolling Settlement
T1 Basis Trade settlement takes place one day after the trade date. If shares are sold today, funds are
available on the next day.

Transition to T0 Future aim to settle trades on the same day, if executed before 130 pm.

Beta Value
Measures volatility of a stock compared to the market.

High Beta 1 More volatile than the market.

it
Low Beta 1 Less volatile than the market.

A m
Beta  1 Moves with the market.

a r
Alpha Value
u m
K
Active vs. Passive Funds:

y
Active Funds Managed based on research, potentially yielding returns higher or lower than the market.
b
Passive Funds Track market index returns.

i cs
Alpha The excess return of a fund compared to the market index.

o m
n
Employees Stock Ownership Plans (ESOPs)

o
E c
Employee Retention Shares given to employees to foster loyalty and ownership.

Lock-in Period Restricts selling shares for a set period; forfeited if the employee leaves the company during
this time.

Sweat Equity
Startup Context Unpaid labor rewarded with company stake.

Value Addition Contribution of an individual to their own company through hard work.

Angel Investors and Venture Capitalists

Angel Investors Invest their own money in startups, expecting long-term gains.

Venture Capitalists Pool money from various investors to fund startups, primary funding source for startups.

Government of India's Definition of a Startup

Criteria:

 Registered under the Companies Act.

 It should not be older than 10 years

 In these ten years, the annual turnover(total sale) must not exceed ₹100 crore in any year.

 It should be engaged in non-traditional innovative business such as e-commerce, biotech, IT and

software, etc.

Capital market 17
 @July 22, 2024

Anchor investors
They are large institutional investors. It means that they are financial institutions which invest in IPOs of different companies.
As a large institutional investor, they help in making an IPO successful. In other words, they take an IPO to its destination or
they help the IPO in getting full subscription.

In any IPO 50% is reserved for institutional investors. Out of this 30% of the total IPO is reserved for anchor investors. This
30% is a part of the overall 50% reserved for the institutional investors. The anchor investors are allocated shares by the
company one day prior to opening of the IPO for other investors. The investment done by the anchor investors is made public
by the company. This helps in gaining the trust of the other investors which encourages the investors to invest in the IPO.

In case of IPO of SMEs, an anchor investor will invest at least ₹1 crore. In case of main board IPOs an anchor investor will
invest at least ₹10 crore. If the company is raising an amount of upto ₹250 crore through the IPO then at least two anchor
investors will be needed. If the amount being raised is of more than ₹250 crore then at least 5 anchor investors will be needed.
The anchor investors cannot sell their share instantly on the day of listing or within a period of one month of the listing. They
can sell 50% of their holding after 30 days of listing and the reaming 50 % can only be sold after 90 days.

Arbitrage
It is a mechanism of trading in share market. It is even practised in trade related to crypto currency. For a company which is
listed on NSE and BSE, its shares can be traded on both the stock exchanges. It is a possibility that the price of its shares may

it
vary on both the exchanges. The traders try to derive profit from this variation. The shares can be bought over the exchange

m
where the price is low and can be instantly sold over the exchange where the price is high. The difference in the price will be

A
the profit of the investor. However, this difference in the price may not last for long. Within a few seconds, the price may

a r
become equal on both the exchanges. It is a continuous process till the market remains open. The trading happens at a rapid
pace. Earlier it was done manually but now done using pre-programmed softwares which are much faster. Such software

m
based trading in the share market is termed as algorithmic trading or algo-trading or Blackbox trading.

u
Equity shares and preferential shares
y K
b
The shares of a company can be broadly classified into two different types—

s
 Equity shares
i c
 Preferential shares
o m
n
Equity shares are normal shares of a company which are bought and sold at market price. Normally, the investors and even

o
E c
the promoters of a company have equity shares of the company. Since, equity shares are equal, the equity share holders have
equal voting rights . The equity shareholders also have right to receive dividend. However, they will receive dividend only
when the company in its annual general meeting.

1 equity share = 1 vote

On the other hand, preferential shares are issued by the company to some selected investors. These shares are normally sold
at a price higher than the market price. They are not traded over the stock exchange. Preferential share holders have a fix
right over the dividend distributed by the company but they do not have voting rights in the decisions of the company.

In case of bankruptcy, when assets of the company are liquidated and the liabilities are cleared the equity shareholders are at
the bottom of the sequence whereas the preferential shareholders are just above the equity holders.

Mutual fund
Investment in share market is relatively riskier. In order to invest the investors should have proper knowledge of the market
and must how the sectors and the shares can be analysed. At the same time investment in share market should always be
diversified. But diversification may not always be possible if the capital which is to be invested is less. Hence, investment in
share market through mutual fund is considered better and is relatively safe.

Mutual fund companies are aka Asset Management Companies(AMCs) and are regulated by SEBI. They collect money from
a number of interested investors. Create a pool of that entire amount and invest it in a diversified manner in the shares of
different companies. They have expert fund managers who analyse not only the companies but also different sectors and
invest the money of the investors in an efficient manner. They continue to charge fund management charges and the profit or
the loss will belong to the investors. Mutual fund companies also invest in debt instruments(like G-secs, debentures, etc.)

Capital market 18
 @July 23, 2024
The mutual fund companies come out with different schemes from time to time, in which the investors may invest. Such new
schemes are termed as New Fund Offer(NFO). This NFO remains open for a certain period of time. During this time period the
investors can invest in the scheme. The mutual fund companies disclose that how and where the money of the investors will
be invested. If it is to be invested only—

in equity/shares, it will be termed as Equity Fund.

in debt instruments, it will be termed as debt fund.

in equity debt instruments and other financial assets or non-financial assets such as gold then it will be termed as hybrid
fund.

in the shares of the large cap companies, it will be termed as large cap fund.

in the shares of only mid-cap companies, it will be termed a mid cap fund.

in the shares of only small cap companies, it will be termed as small cap fund.

in large cap, mid cap and small cap simultaneously, it will be termed as multi-cap or flexi-cap fund.

in sector specific, like, if the fund is to be invested only in pharma companies or it is to be invested only in banking
companies then it is termed as sectoral or thematic fund.

In any NFO, the total fund collected by an AMC is termed as Asset Under Management(AUM). If the fund collected is to be
invested only in the shares of those companies which constitute the index then the fund manager is not required to conduct

research and based on that research it

any research. Such Mutual Fund(MF) schemes can be termed as passive funds. If the fund manager actively conducts
she actively invests the fund in the shares of different companies then it is called
as active fund.
A m
a r
In an NFO the total fund collected is divided into units of ₹10 each. Based on the amount invested by an investor she is
allocated number of units. For example, if an investor has invested ₹1000, she will be given 100 units of ₹10 each. The value of

m
one unit is termed as Net Asset Value(NAV). The total amount collected by the mutual fund company in any NFO is invested in
u
K
the shares of different companies in a diversified manner. Gradually, as the value of the investment increases or decreases,

y
even the value of the units(NAV) will change accordingly. A mutual fund scheme may or may not have a lock-in period. If it has

s b
a lock-in period, then the investor will have to remain invested till the lock-in period expires. After the expiry of lock-in period,
if an investor is in need of fund, she may surrender her units to the MF company and will be able to get her investment back

i c
according to the current value of the units. For this purpose, the mutual fund company will sell shares from the same scheme

m
equal to the value of the units which have been surrendered. This is called redemption of the units.

o
Mutual fund schemes can be—

o n
 Close-ended

 Open-ended E c
In close-ended MF schemes investment can be done only till the time the NFO remains open. Once the NFO closes, new
investments in the same scheme will not be allowed. Hence, in future the total number of units in such schemes will not
increase. But due to continuous redemption the total number of units may decline.

In case of open-ended mutual funds, investment can be done when an NFO remains open and new investments can be done
even after the closure of the NFO. However, when new investment is done. When an NFO is close, the investors may buy new
units at current prevailing rate(NAV).

In MF schemes, investment can be done in two different ways—

 Lump-sum investment

 Systematic Investment Plan(SIP)

In case of lump-sum investment, a fixed amount of money is invested in a particular mutual fund scheme at once.

On the other hand, in SIP a fixed amount of money is invested in the same mutual fund scheme every month. Hence, it can be
concluded that in close ended MF schemes only lump-sum investment is possible. But in open-ended mutual fund schemes
lump-sum investment and SIP both are possible.

There are some MF schemes in which the invested amount of upto ₹1.5 lakh remains tax-free. Such schemes are termed as
Equity Linked Saving Scheme(ELSS).

Capital market 19
 The Association of Mutual Funds in India(AMFI) is an association of mutual fund companies operating in India.

Brand ambassadors of AMFI

it
A m
a r
u m
y K
s b
i c
o m
o n
E c

Capital market 20
 Shorts

Anchor Investors
Definition Large institutional investors who invest in IPOs to help ensure their success.

Key Features:

 Role They help achieve full subscription for IPOs by investing substantial amounts.

 Allocation In any IPO, 50% is reserved for institutional investors, out of which 30% is for anchor investors.

 Timing Allocated shares one day before the IPO opens to other investors, boosting confidence and trust
among potential investors.

 Investment Thresholds:

SMEs: Minimum ₹1 crore.

Main board IPOs: Minimum ₹10 crore.

For IPOs raising up to ₹250 crore: At least two anchor investors.

For IPOs raising more than ₹250 crore: At least five anchor investors.

 Lock-In Period Cannot sell shares instantly; 50% can be sold after 30 days, and the remaining 50% after 90
days.

Arbitrage
it
m
Definition A trading strategy that exploits price differences of the same asset on different exchanges.

A
Key Features:

a r
 Mechanism Buy low on one exchange (e.g., NSE and sell high on another (e.g., BSE.

u m
 Rapid Trading Differences in prices usually last for a few seconds.

y K
 Algorithmic Trading Often done using pre-programmed software for speed, also known as algo-trading or
Blackbox trading.

s b
Equity Shares and Preferential Shares
i c
Equity Shares:
o m
n
 Definition Common shares bought and sold at market price.
o
E c
 Rights Equal voting rights 1 share  1 vote) and rights over dividends.

 Trading Freely traded on stock exchanges.

 Bankruptcy Last in line to receive proceeds after liabilities are cleared.

Preferential Shares:

 Definition Issued to selected investors at a price higher than market value.

 Rights Fixed dividends but no voting rights.

 Trading Not traded on stock exchanges.

 Bankruptcy Priority over equity shareholders in receiving proceeds.

Mutual Funds
Definition Investment vehicles that pool money from many investors to invest in diversified portfolios managed
by professionals.

Key Features:

 Managed by AMCs Asset Management Companies regulated by SEBI.

 Diversification Invests in various sectors and companies to spread risk.

 Fund Managers Experts who analyze markets and make investment decisions.

 Charges Investors pay fund management fees.

Capital market 21
  Types Invest in both equity (shares) and debt instruments (like G-secs, debentures).

New Fund Offer (NFO)

Definition A new scheme launched by mutual fund companies for a limited period, during which investors can
invest.

Types of Funds in NFO

 Equity Fund Invests only in shares.

 Debt Fund Invests only in debt instruments.

 Hybrid Fund Invests in equity, debt instruments, and other assets like gold.

 Large Cap Fund Invests in shares of large-cap companies.

 Mid Cap Fund Invests in shares of mid-cap companies.

 Small Cap Fund Invests in shares of small-cap companies.

 Multi-Cap/Flexi-Cap Fund Invests in large, mid, and small-cap companies.

 Sectoral/Thematic Fund Invests in specific sectors, like pharma or banking.

Fund Management Styles

 Active Fund Fund manager actively conducts research and selects investments.

it
 Passive Fund Invests in shares that constitute an index, requiring no active research.

Key Terms
A m
Asset Under Management AUM Total fund collected in an NFO.
a r
m
Net Asset Value NAV Value of one unit of the fund. Initially ₹10 in an NFO.

u
Investment and Redemption

y K
b
Lock-In Period Period during which investors cannot redeem their units.

s
c
Redemption Investors can sell their units back to the mutual fund company to get their investment based on
current NAV.

m i
Types of Mutual Fund Schemes
n o
co
 Close-Ended Investment is only allowed during the NFO period. No new investments post-NFO.

E
 Open-Ended Investment is allowed during and after the NFO. New units can be purchased at current NAV.

Investment Methods
 Lump-Sum Investment One-time investment in a mutual fund scheme.

 Systematic Investment Plan SIP Regular monthly investments in a mutual fund scheme.

Tax Benefits
Equity Linked Saving Scheme ELSS Investment up to ₹1.5 lakh is tax-free.

Exchange Traded Fund(ETF)

Those financial instruments which can be traded over the SE. For example, if a MF scheme is in the form of ETF then it is not
necessary for the investor to surrender the units for the purpose of redemption. The units can be sold over the SE at market
price to any other interested investor. The SE provides different platforms to facilitate buying and selling of different types of
financial instruments.

Real Estate Investment Trust(REIT) & Infrastructure Investment Trust(InvITs)

Even if an investor has limited amount of money it is possible for her to invest in the shares of large and good companies in a
diversified manner through mutual funds. However, it was not possible for the investors to invest in real estate sector or in
infrastructural projects. However, with the introduction of REIT and InvITS it has become possible to invest in real estate

Capital market 22
 projects and infrastructural projects even with limited amount of money. REITs function as the mutual fund of real estate sector
and InvITs as those of infrastructure sectors. They both are regulated by SEBI. Both are registered as trusts. The minimum
investment can be of ₹10K15K whereas maximum has no limit. They collect money from the interested investors, create a pool
of money and invest in an under construction or completely contracted project.

Similarly, the money pool of INVITs is invested in infrastructural projects. 10% of the profit generated will be taken away by
them and the remaining will be distributed among the investors. The profit of the investors, is taxable.

Foreign Portfolio Investors(FPI)

They are foreign investors belonging to other countries who invest in the Indian stock market. They may invest in equity and
even in debt instruments including government securities. When they invest in the shares of a company they will always hold
stake of less than 10%. If they buy stake of 10% or more in one single company it will not longer be counted as FPI but will be
treated as Foreign Direct Investment(FDI).

The FPI are interested in making immediate profit and the moment the share market goes upwards they sell their investment
and move out of the country. Since the money brought in by them doesnʼt remain stable it is termed as ‘hot-moneyʼ .
Because of the out flow of this hot money, the domestic currency may feel the heat and decline. Hence the domestic currency
is termed as the ‘heated moneyʼ .

@July 24, 2024

FPIs can be broadly classified into the following two types—

 Foreign Institutional Investment/Investors(FIIs)

it
 Qualified Foreign Investment/Investors(QFIs)

A m
FIIs are foreign financial institutions such as mutual fund companies, insurance companies, core investment companies, etc.

a r
They collect money from a number of investors, may create a pool of that entire amount of money and invest in Indian stock

m
market. They invest in equity as well as debt instruments including government securities.

K u
On the other hand QFI are individual investors who belong to other countries but they are allowed to invest in the Indian stock
market. They are citizens of those countries who are members of the Financial Action Task Force(FATF).

b y
FATF is an international organisation which keeps a check on money laundering and terror financing. It has its HQ in Paris,

cs
including India it has 40 members. Out of these 40 members, 38 members are individual countries and two are organisations
—European Union(EU) and Gulf Cooperation Council(GCC).
i
o m
o n
E c

Capital market 23
 Shorts

Exchange Traded Fund (ETF)

Definition ETFs are financial instruments that can be traded on stock exchanges SE like shares. Investors can
buy and sell ETF units at market prices without needing to surrender them for redemption.

Real Estate Investment Trust (REIT) & Infrastructure Investment Trust (InvIT)
Function Both REITs and InvITs enable investors to pool money to invest in real estate or infrastructure projects.

REIT Functions like mutual funds for the real estate sector.

InvIT Functions like mutual funds for infrastructure projects.

Key Features:

Regulated by SEBI.

Registered as trusts.

Minimum investment: ₹10,000  ₹15,000.

Maximum investment: No limit.

Distributes 90% of profits to investors; 10% taken as management fees.

Profits distributed to investors are taxable.

Foreign Portfolio Investors (FPI) it

A m
Definition FPIs are foreign investors who invest in Indian stock markets, including equities and debt instruments
such as government securities.

Key Characteristics: a r
Hold less than 10% stake in a single company.
u m
y K
Investments of 10% or more are treated as Foreign Direct Investment FDI.

b
Primarily interested in immediate profits, often resulting in quick market exits when share prices rise.
s
i c
Known as "hot money" due to their tendency to move funds quickly, impacting domestic currency stability.

Types of FPIs:
o m
o n
 Foreign Institutional Investors FIIs):

companies. E c
FIIs include foreign financial institutions like mutual funds, insurance companies, and core investment

They collect money from multiple investors, create a pooled fund, and invest in the Indian stock market.

Investments can be in equity, debt instruments, or government securities.

 Qualified Foreign Investors QFIs):

QFIs are individual investors from countries that are members of the Financial Action Task Force FATF.

FATF is an international organization headquartered in Paris, with 40 members, including India. The
members include 38 individual countries and two organizations (the European Union and the Gulf
Cooperation Council).

Participatory Notes(P-Notes)
PNotes are financial instrument which were introduced in India by SEBI in the year 2000. Prior to its introduction only those
FIIs which were registered with SEBI were allowed to invest in the Indian stock market. However, in order to encourage foreign
investment in the Indian stock market and enable inflow of foreign exchange, P-notes were introduced.

Although P-notes were introduced by SEBI, they are issued by those FIIs which are registered with SEBI. Using these P-notes
even the unregistered FIIs may invest in the Indian stock market through the registered FIIs. In order to make such investments
even more attractive, it was decided that the profit made by such investments which have come to India through P-note will
not be taxed. Secondly, it was also decided that the Indian authorities will not seek information regarding the source of fund of
these unregistered FIIs.

Capital market 24
 Both the provisions lead to different problems in India. The main objective behind the introduction of P-note was to attract
foreign exchange in the form of investment. However, we were not prepared for the negative consequences. Because of
relaxation related to tax, even those FIIs which were capable of registering themselves in India, started investing in the country
through P-note. It lead to loss of revenue for the government. There came a time when more than 50% of the foreign
investment in the Indian stock market had come through P-note. Because of the introduction of P-notes, the foreign currency
such as dollar began depreciating and Indian currency appreciated. This compelled the RBI to buy dollar from the market
which lead to the infusion of Indian currency in the market. In order to resolve the issue, Market Stabilisation Scheme(MSS)
was introduced.

Since the Indian authorities were not authorised to seek information regarding the source of fund brought by the unregistered
FIIs, India witnessed inflow of black money from different parts of the world in form of investment in the share market. Also
black money from India was sent out of the country and again reinvested in the Indian share market in the form of foreign
investment through P-notes. When black money of a country goes out of the country and comes back to the same country in
the form of foreign investment then it is termed as round tripping.

Some important indices of the world

In USA the two most important stock exchanges are New York Stock Exchange(NYSE) and National Association of Securities
Dealers Automated Quotation(NASDAQ. The full form of NASDAQ does not exist anymore. NYSE is the worldʼs largest stock
exchange based on the total value of trade. NASDAQ was worldʼs fully computerised stock exchange. Its most important index
is NASDAQ Composite. On the other hand, the most important index of NYSE is Dow Jones Industrial Average. Dow Jones is
the most popular index in the entire world. It includes top thirty companies out of all the companies listed on NYSE. Another
important index of NYSE is S&P 500. Some other important indices of the world are as follows—

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ADR and GDR

If a non-American company is interested in raising fund by listing itself on any
American stock exchange, it can be listed in the form of American Depository
Receipt(ADR). A company may merge two or more shares in order to create one ADR
or even one share of the company maybe equal to one ADR. These ADRs are
transferred to an investment banking company operating in the US which will be
responsible for selling these ADRs to the interested investors in order to raise fund
On NASDAQ
from the American capital market. Once these ADRs are sold, they will be listed on
an American stock exchange. Thereafter these ADRs can be traded on that stock
exchange. The ADR holders are entitled to receive dividend but they do not have
voting rights. The first Indian company to be listed on any American stock exchange
in the form of ADR was Infosys. It was listed on NASDAQ. The second such Indian
company was ICICI bank. It was listed on NYSE.

On London SE

Capital market 25
 On NYSE

If a non-European company is interested in raising fund from any European capital market by listing itself on a European stock
exchange, it can be done through Global Depository Receipt(GDR). The rules are same as ADR. The first Indian company to be
listed in the form of GDR was Reliance Industries Limited(RIL). It was listed on London Stock Exchange. By listing in the form
of ADR or GDR a company is not only able to raise fund in hard currency but it also gains popularity.

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Capital market 26
 Shorts

Participatory Notes (P-Notes)

Introduced by SEBI in 2000 to encourage foreign investment and inflow of foreign exchange.

Issued by SEBI-registered FIIs, allowing unregistered FIIs to invest in the Indian stock market through these
notes.

Profits from P-note investments are not taxed, and Indian authorities do not seek information about the source
of funds for these unregistered FIIs.

Problems with PNotes:

Loss of government revenue due to tax relaxations.

Over 50% of foreign investment came through P-notes, leading to the depreciation of foreign currencies like
the dollar and appreciation of the Indian currency.

Black money inflow and round-tripping: Black money from abroad and within India was invested in the Indian
market through P-notes.

As foreign currency inflows increased, the Indian rupee appreciated. To stabilize the domestic currency, the
RBI bought dollars, increasing market liquidity by releasing rupees. The Market Stabilisation Scheme MSS
was later introduced to absorb this excess liquidity.

Important Global Indices and Stock Exchanges

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USA

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New York Stock Exchange NYSE World's largest stock exchange by total trade value.

a r
Important Indices: Dow Jones Industrial Average (most popular index globally, includes top 30
companies on NYSE and S&P 500.

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NASDAQ Worldʼs first fully computerized stock exchange.

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Important Index: NASDAQ Composite.

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American Depository Receipts (ADRs) and Global Depository Receipts (GDRs)

ADRs:

Used by non-American companies to raise funds in the American market.

Represents a specified number of shares of the foreign company, sold by US investment banks to US
investors.

Traded on American stock exchanges.

ADR holders receive dividends but do not have voting rights.

First Indian company listed as ADR Infosys NASDAQ, followed by ICICI Bank NYSE.

Capital market 27
 GDRs:

Used by non-European companies to raise funds in European markets.

Similar to ADRs in terms of structure and rules.

First Indian company listed as GDR Reliance Industries Limited London Stock Exchange).

Indian Depository Receipt(IDR)

India borrowed the concept of ADR and GDR and implemented the concept of IDR. If a non-Indian company is interested in
raising fund by listing its global business on any Indian stock exchange then the company may list itself in the form of IDR. The
IDR holders are entitled to receive dividend but they do not have the right to vote. The company has to provide dividend from
its global profit. Only one single company i.e. Standard Chartered bank had listed itself in the form of IDR. However, even that
has been delisted. There are other foreign companies which are listed on the indian stock exchange but they have listed their
Indian units. Hence, the listing is in the form of shares. For example, Abbott India Ltd., Nestle India Ltd., etc. The shareholders
of these companies have voting rights and they receive dividend from the Indian profit of these companies.

When the promoters of a listed company buy back all the free float shares for their own company then the company
gets delisted from the stock exchange.

Factors affecting share market

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in direction.
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The following factors may influence the share market to a great extent. This influence maybe positive in direction or negative

The economic fundamentals

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If the economy is performing well i.e. if the economy is growing due to continuous demand and supply then even the share
market will perform well. On the other hand, if the fundamentals are weak and the demand is low affecting the supply then

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the impact will be seen even over the share market. Similarly, if an individual company is fundamentally strong, the impact

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can be seen over its share price. If the company is fundamentally weak, the share price will come down.

s
Liquidity in the domestic and as well as global market

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Also play an important role. If the liquidity remains high, investment in share market will also increase. This will pull the

o
market upwards in direction. On the other hand, if the liquidity remains low even the share market will remain low.

n
The sentiments

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Also, play an important role in influencing the share market. These sentiments can be economic, political and can even be
military. The positive sentiments will pull the market upwards whereas the negative sentiments will pull the market
downwards.

Debentures
Are industrial securities issued by the corporates in order to raise long-term fund. Debentures are promissory notes issued in
the form of bond. As a debt instrument they are part of capital market with a maturity of more than one year. By issuing
debenture a company borrows for long-term period. The debenture holder is the lender and is entitled to receive benefit in the
form of interest or discount.

The debentures are rated by credit rating agencies. Higher the rating, lower will be the risk and hence, lower the interest
offered. Lower the rating, higher will be the risk and hence, higher the interest offered. Debentures can be secured and
unsecured.

Secured debentures Unsecured debentures

The issuer will set aside the asset worth equal to the value of Are issued on the basis of goodwill.
the debentures being issued.
The risk involved is high and hence the
The risk involved in secured debenture is low and hence and interest offered will be high.
the interest offered is low.

Whether debentures are secured or unsecured, they can be issued in three major forms.

Non-convertible debentures

Capital market 28
 Remain in the form of debenture only all throughout their term period.

Cannot be converted into the shares of the company

Less flexible

Semi-convertible debentures

Can be partially converted into the shares of the company and partially remain in the form of debenture only

Fully convertible debentures

Can be converted into the shares of the company after a particular time period.

Once the debenture is converted into the shares of the company, the debenture holder becomes a shareholder.

As a share holder she will be entitled to receive dividend rather than interest

Since these are highly flexible and can be converted into shares of the company they also provide protection to some
extent against inflation.

Bharat bond ETF

ETFs are the financial instruments that can be traded over the stock exchange. Bharat Bond ETF is such an instrument and is
managed by Edelweiss mutual fund company. It is just like a debt mutual fund but the units can be traded over the stock
exchange. In Bharat Bond ETF some of the top public sector companies(PSCs) have participated which have a credit rating of
AAA. In this arrangement, these PSCs have issued bonds worth equal to the amount they needed to raise. These bonds were

it
handed over to Edelweiss creating a basket of bonds. The entire value has been divided into units of ₹1000 each. These units

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have been sold to the interested investors and the fund raised has been given to these PSCs in the form of loan after

A
deducting fund management charges which is as low as 0.0005%. Since these units can be traded over the stock exchange it

a r
is termed as ETF. The investors need not surrender the units in order to get their investment back. They need not wait for
maturity period as these units can be sold to any other interested investor over the stock exchange.

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Perpetual bond
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The bonds which do not have a maturity period are termed as perpetual bond. However, the issuer and the buyer may
negotiate after the lock-in period. Since, they do not have a maturity period they offer a higher rate of interest. The buyer will

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continue to hold them all throughout and the issuer will continue to pay interest.

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Capital market 29
 Shorts

Indian Depository Receipt (IDR)

Concept and Implementation:

India adopted the idea of ADR American Depository Receipt) and GDR Global Depository Receipt) to
introduce IDR.

Non-Indian companies can raise funds by listing their global businesses on Indian stock exchanges
through IDRs.

IDR holders receive dividends but do not have voting rights. Dividends come from the company's global
profits.

Example: Standard Chartered Bank was the only company listed as an IDR but has since been delisted.

Other foreign companies like Abbott India Ltd. and Nestle India Ltd. are listed via their Indian units, offering
shareholders voting rights and dividends from Indian profits.

Factors Affecting the Share Market

Economic Fundamentals:

Strong economic performance boosts the share market, while weak fundamentals depress it.

Individual companies' fundamentals also influence their share prices.

Liquidity:
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High liquidity in domestic and global markets encourages investment in the share market, raising prices.

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Low liquidity has the opposite effect, pulling the market down.
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Sentiments:

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Economic, political, and military sentiments significantly influence the share market.

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Positive sentiments drive the market up, while negative sentiments drag it down.

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Debentures
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Definition and Purpose:

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Debentures are long-term debt instruments issued by corporates to raise funds.

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They are promissory notes in the form of bonds, offering interest or discounts to the holders.

Credit Rating:
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Debentures are rated by credit rating agencies, affecting the interest rates based on risk levels.

Types of Debentures:

Secured Debentures:

Backed by assets equivalent to the debenture's value.

Lower risk and interest rates.

Unsecured Debentures:

Issued based on the company's goodwill.

Higher risk and interest rates.

Forms of Debentures:

Non-convertible Debentures:

Remain debentures throughout their term.

Not convertible to company shares.

Semi-convertible Debentures:

Partially convertible into shares, partially remain debentures.

Fully Convertible Debentures:

Capital market 30
 Can be converted into company shares after a specific period.

Once converted, holders receive dividends instead of interest.

Bharat Bond ETF

Concept:

Managed by Edelweiss Mutual Fund, it operates like a debt mutual fund but can be traded on the stock
exchange.

Top public sector companies PSCs) with AAA credit ratings issue bonds pooled into a basket and divided
into units of ₹1,000 each.

Investment Mechanism:

Investors buy units, and the funds raised are lent to the PSCs after minimal fund management charges
0.0005%.

Units can be traded on the stock exchange, providing liquidity without waiting for maturity.

Perpetual Bonds
Definition:

Bonds without a maturity period.

Issuers and buyers can negotiate terms after the lock-in period.

Interest Rates:
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Offer higher interest rates due to the lack of maturity.
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Buyers hold them indefinitely, receiving ongoing interest payments from the issuer.

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These financial instruments and mechanisms illustrate the complexity and diversity of investment options

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available in the Indian market, catering to various investor needs and risk profiles.

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@July 26, 2024
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Additional Tier(AT)-1 Bond Sovereign Green

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They were introduced under Basel-III norms. They are perpetual
bonds without any fixed maturity period. Since they are highly risky,
Bonds(SGBs)
They are other important financial instruments
they offer a higher rate of interest. If in case the issuer faces a
through which a government may raise long term
situation of insolvency, these bonds can be unilaterally written off by
fund in order to invest in such projects which are
the issuer without consulting the lenders. This is done under the
environmentally friendly and may reduce carbon
instruction of the central bank. The lenders will not be able to make
emission/intensity. For example, the fund maybe
any claim.
used in order to promote the production of wind
The AT1 bonds were in news few years back in 2020 when under energy, solar energy or in order to construct green
the instruction of RBI, Yes bank had written off AT1 bonds worth buildings. Since, by issuing green bonds the fund
more than ₹8,400 crore. Against this decision the Bombay high court raised is used for a noble cause, the interest offered
had imposed a stay. However, the RBI and Yes bank approached the may remain low. The concept of Sovereign Green
Supreme Court and it imposed a stay against the decision of the Bond came into lime light when the finance minister
Bombay HC. Hence, the matter is still subjudice. in budget 202223 announced that the Government
of India will be issuing SGBs.

Blue Bond Muni bond

Blue economy refer to those resources which are we derive They are also termed as Municipal bond. There are a number
mainly from the ocean. Hence, it also termed as ocean of developmental activities which are carried out by the
economy. Hence, it becomes that even the blue bonds are municipal corporations/councils. In order to fulfil such
related to the resources that are derived from the ocean. The developmental activities for example, construction of roads,

Capital market 31
 fund raised by issuing blue bonds are used in order in to parks, drainage system, etc. even the municipal corporation
preserve those resources that we derive from the ocean. may raise long term fund by issuing bonds. These bonds
issued by them are termed as Muni bonds.

Inflation Indexed Bond

Normally, when a bond is issued at a fixed rate of interest but inflation increases at a rapid pace then the lender/investor will
be at loss. Hence, in order to provide protection against rapid inflation to the lenders, the government may issue Inflation
Indexed bonds. Although the rate of interest offered in such bonds is relatively low, the principal continue to increase along
with inflation and the interest is calculated over the modified principal.

For example, if the principal/face value is of ₹100, interest offered is 4% and in a particular year inflation has increased at a
rate of 10% then over the principal, this 10% of inflation will be calculated which comes out to be ₹10. This ₹10 will be added to
the principal and the interest of 4% will be calculated over the new principal(₹110). Therefore, the principal will keep on
changing along with inflation and interest will be calculated over the modified principal. However, the profit of the investor is
taxable.

Masala Bond
The concept of masala bond was introduced and popularised by International Finance Corporation(IFC) which is the
investment wing of the World Bank. Imitating IFC, the Indian corporates have started issuing masala bonds. Masala bonds are
given this name just in order to show that they are related to India. Hence, such bonds will always have a name which will

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make it obvious that the bond is related to which particular country. For example, even Maharaja bond is related to India
whereas Samurai bond was related to Japan .

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As the investment wing of world bank, IFC encourages private investment in the member countries and in such investments

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IFC will also hold stake. With this objective IFC will borrow and for the purpose of borrowing Masala bond can be issued.

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Masala bonds are used for borrowing from external sources. But they are different from normal dollar denomination bonds. In
case of normal dollar denomination bonds the face value of the bond will be in dollar and the risk related to exchange rate will

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fall upon the borrower. Different from this, masala bonds are rupee denomination bonds which means that the face value is

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printed in the form of rupee and the risk related to exchange rate will fall upon the lender.

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For example, if an Indian company X wants to borrow from a foreign financial institution Y then X will issue masala bond which
will be a rupee denomination bond. If $1  ₹50 and the face value of the bond is ₹50, by selling this bond X will get $1 which

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will be converted into ₹50. At the time of repayment if the exchange rate changes and now $1  ₹100, when Y returns this

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bond having face value of ₹50, X will only pay $0.5 dollar. On the hand if $1 ₹25, X will pay $2 which is worth ₹50. This is
how these bonds function.

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Capital market 32
 Shorts

Additional Tier-1 (AT-1) Bonds

Introduction and Nature:

Introduced under Basel-III norms.

Perpetual bonds without a fixed maturity period, making them highly risky but offering higher interest
rates.

Risk and Write-off Clause:

Can be unilaterally written off by the issuer during insolvency, under the central bank's instruction,
without consulting lenders.

Example: In 2020, Yes Bank wrote off AT1 bonds worth over ₹8,400 crore under RBI's instruction. The
Bombay High Court initially stayed this decision, but the Supreme Court stayed the Bombay HC's
decision, leaving the matter subjudice.

Sovereign Green Bonds (SGBs)

Purpose:

Issued by governments to raise long-term funds for environmentally friendly projects aimed at reducing
carbon emissions.

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Examples: Promoting wind energy, solar energy, or constructing green buildings.

Interest Rates:

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Announced in India's 202223 budget by the Finance Minister. a r
Typically lower interest rates due to the noble cause of environmental protection.

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Blue Bonds
Definition and Purpose:
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Related to the blue economy, which involves resources derived from the ocean.

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Funds raised are used to preserve and sustainably manage ocean resources.

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Municipal Bonds (Muni Bonds)

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Purpose:

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Issued by municipal corporations/councils to fund developmental activities like road construction, parks,
and drainage systems.

Long-term funding mechanism for local government projects.

Inflation Indexed Bonds

Protection Against Inflation:

Designed to protect investors against rapid inflation.

Interest rates are relatively low, but the principal amount adjusts with inflation.

Example:

If a bond has a principal of ₹100 and an interest rate of 4%, with a 10% inflation rate, the new principal
becomes ₹110. The interest is then calculated on the new principal.

Masala Bonds
Introduction and Purpose:

Introduced by the International Finance Corporation IFC to encourage private investment in member
countries.

Also, being used by Indian corporates to borrow from external sources.

Currency Denomination and Exchange Rate Risk:

Capital market 33
 Rupee-denominated bonds, unlike dollar-denominated bonds.

The exchange rate risk falls on the lender, not the borrower.

Example:

If an Indian company issues a masala bond with a face value of ₹50 when $1  ₹50, the company receives
$1. If the exchange rate changes to $1  ₹100, the company repays $0.5, and if it changes to $1  ₹25, the
company repays $2, both equivalent to ₹50.

@July 27, 2024

Insurance sector
In India, insurance sector is regulated by Insurance Regulatory and Development Authority of India(IRDAI. IRDAI was setup
under IRDAI act 1999. At present the chairman of IRDAI is Debashish Panda . The head office of IRDAI is located in
Hyderabad. In the Indian insurance sector, foreign investment of upto 74% is allowed. Hence, if a foreign insurance company
comes to India, it needs to have an Indian partner. However, if a foreign company is engaged only in brokerage business then
foreign investment of upto 100% is allowed.
Insurance can broadly be classified into two different types—

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 Life insurance

 General insurance
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assured sum as benefits.
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In life insurance, life cover is provided. In such insurances, after death of the insured, the nominee/dependents are given the

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All other insurance which do not provide life cover, for example, travel insurance, health insurance, motor insurance, fire

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insurance, theft insurance, etc. are types of general insurance. Since life insurance and general insurance both are different
from each other they both are provided by different companies. For example,Life Insurance Corporation of India(LIC India) is a

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life insurance company, whereas National Insurance Company, Oriental Insurance Company, New India Insurance company

b
s
are those public sector insurance companies which only provide general insurance. Similarly, ICICI Prudential is a life

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insurance company whereas ICICI Lombard is a general insurance company.

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Life insurance can again be classified into two different types—

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 Life insurance

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a Traditional

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b Unit Linked-Insurance Plans(ULIPs)

In traditional insurance plans the premium that is paid by the insured is mainly invested in debt instruments like G-secs(T-bills
and bonds) or commercial papers, certificate of deposits and debentures. Hence, through this the money goes to the
government and industry in the form of loan. In such insurance, the company can easily calculate that how much return will be
there on investment. Hence, the insurance holder is assured of a fixed maturity benefit. These insurance plans are considered
relatively safe.

Different from the traditional insurance plans in case of ULIPs, the premium paid by the insured is mainly invested by the
insurance company in share market. Hence, ULIPs are similar to mutual funds. The only difference is that ULIPs provide
insurance cover whereas mutual funds do not provide insurance cover. However, just like the mutual fund, the ULIPsʼ maturity
return is market-driven i.e. it is based on the movement of the share market. Hence, as compared to the traditional plans they
are riskier.

Controversy between SEBI and IRDAI w.r.t. ULIPs

In the year 2010, SEBI was headed by C.B. Bhave and IRDAI was headed by J. Hari Narayana. SEBI prohibited the insurance
companies from selling ULIPS. It instructed to return the investment of the investors and not to invest the remaining corpus
in the share market. SEBI argued that ULIPS are just like mutual funds and hence they must be regulated by SEBI.

The insurance companies argued that they have already taken permission from IRDAI and ULIPS are completely legitimate.
They approached IRDAI and requested to intervene. IRDAI argued that although the fund raised through ULIPs is invested in
the share market, they also provide insurance cover and hence different from mutual funds. Since they provide insurance
cover, they must be regulated only by IRDAI.

Capital market 34
 The conflict between SEBI and IRDAI was affecting the image of the government. Both these regulators function under the
Ministry of Finance. Since the parliament was not in session the government was not able to do anything. Finally,
presidential ordinance was issued and the decision was taken in the favour of IRDAI. When the parliament came back in
session IRDAI act was amended and ULIPs were brought under its regulation. However, the Government of India realised
that due to overlapping authorities, such conflicts among the regulators maybe possible even in the future. In order to
prevent such conflicts from emerging, Financial Sector Legislative Reform Commission(FSLRC was constituted in 2011.

Commodity trading
Just like shares, commodities can also be traded over commodity exchange. The exchange serves as a platform over which
different commodities like gold, silver, crude oil, natural gas, soyabean, cotton, jeera, dhaniya, etc. can be traded virtually. The
largest commodity exchange in the world is the New York Mercantile Exchange(NYMEX. The largest commodity exchange in
India is Multi Commodity Exchange(MCX). The second largest commodity exchange in India is National Commodity and
Derivatives Exchange(NCDEX. Initially, in India commodity trading was regulated by Forward Market Commission(FMC).
However, it was merged with SEBI in 2015. Hence, commodity trading and exchange is regulated by SEBI in India.
Commodity trading is a future contract between a buyer and a seller. They both are speculators who speculate whether the
price of a commodity is going to move upwards or downwards. Based on that they trade in a commodity. It is a virtual trade
which takes place over commodity exchange which means that the commodities are not traded in physical form. Based on this
speculative trade, the price changes which influences the price of that commodity in the physical market. Hence, it can be
said that commodity trading is a mechanism of price determination.

@July 29, 2024

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Even crude oil is traded over commodity exchange. Crude oil is of different types. For
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example, Brent Crude aka Light Sweet Crude Oil. It is light because it has low density due to

m a
low sulphur content. This oil is produced in North Sea(Europe). Since the oil wells in the
North Sea are named after the name of different birds, light sweet crude oil is aka Brent

Hence the name, Brent crude.

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Crude. One of the largest oil wells in the North Sea is named after the bird Brent goose.

b y
The crude oil produced by Organisation of the Petroleum Exporting Countries(OPEC), is
termed as OPEC basket.

i cs
In USA, the most popular type of crude oil is West Texas Intermediate(WTI). During Covid

o m
crisis due to lockdown the demand for crude oil had fallen suddenly. Because of this even

n
the speculation in the commodity market started increasing. The virtual sale of crude oil over

o
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the commodity exchange increased so much that the price of WTI came down to

E
approximately $40 per barrel. However, practically this was not possible. Therefore, the
trade that was witnessed during that period when the price went down in negative was
cancelled and was eliminated even from the historical price chart. It had happened on 20th
April 2020. It highlighted the risk involved in commodity trading.

Brent goose

Capital market 35
 Shorts

Insurance Sector in India

Regulation:

Regulated by the Insurance Regulatory and Development Authority of India IRDAI.

Established under the IRDAI Act, 1999.

Current Chairman: Debashish Panda.

Head Office: Hyderabad.

Foreign investment allowed up to 74%, except in brokerage firms like PolicyBazaar(100% allowed).

Types of Insurance:

 Life Insurance:

Traditional Plans Invest in debt instruments; assured fixed maturity benefits.

Unit Linked-Insurance Plans ULIPs) Invest in the share market; market-driven returns, riskier.

Both provide life cover; beneficiaries receive the assured sum after the insured's death. Examples: Life
Insurance Corporation of India LIC, ICICI Prudential.

 General Insurance:

Covers non-life events: travel, health, motor, fire, theft, etc.

it
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Examples: National Insurance Company, Oriental Insurance Company, ICICI Lombard.

A
r
SEBI vs. IRDAI on ULIPs:

a
Conflict SEBI, under C.B. Bhave, banned ULIPs, arguing they are akin to mutual funds.

m
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IRDAI's Stand ULIPs provide insurance cover, thus should be regulated by IRDAI.

Resolution Presidential ordinance favored IRDAI; later, IRDAI Act amended to include ULIPs.

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Additional outcome Formation of the Financial Sector Legislative Reform Commission FSLRC in 2011 to
prevent future regulatory conflicts.

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Commodity Trading
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Overview:

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Commodities (e.g., gold, silver, crude oil, agricultural products) traded over commodity exchanges.

Largest global exchange: New York Mercantile Exchange NYMEX.

Largest in India: Multi Commodity Exchange MCX; second largest: National Commodity and Derivatives
Exchange NCDEX.

Initially regulated by Forward Market Commission FMC; merged with SEBI in 2015.

Mechanism:

Future Contracts Agreements between buyers and sellers speculating on commodity prices.

Virtual Trade No physical exchange of commodities; price speculation impacts physical market prices.

Purpose Acts as a mechanism for price determination.

Crude Oil Trading on Commodity Exchange

Types of Crude Oil:

 Brent Crude Light Sweet Crude Oil):

Low density and low sulfur content.

Produced in the North Sea Europe).

Named after Brent goose; oil wells in North Sea are named after birds.

 OPEC Basket:

Crude oil produced by the Organization of the Petroleum Exporting Countries OPEC.

Capital market 36
  West Texas Intermediate WTI:

Popular in the USA.

Impact of COVID19 on Crude Oil Trading:

Lockdown led to a drastic fall in crude oil demand.

Speculation in the commodity market surged.

On April 20, 2020, the price of WTI dropped to approximately $40 per barrel due to excessive virtual sales.

This negative pricing event was unprecedented and was subsequently nullified from historical price charts.

Highlighted the inherent risks in commodity trading.

Social Stock Exchange

Few years back in the Union budget speech, the finance minister has announced the establishment of Social Stock Exchange.
In India, it is a new concept but is already existent in different countries. Social Stock Exchange have been setup by NSE and
BSE and are regulated by SEBI. They are just another platform provided by NSE and BSE. Over this platform the Not-for-Profit
Organisations engaged in charitable works or works related to social welfare can list different financial instruments in order to
raise funds. However, religious organisations and political organisations will not be allowed to list themselves. In 2023, Unnati
Foundation became the first Not for Profit Organisation to list itself on Social Stock Exchange.

Universal Exchange it
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In 2018, SEBI allowed the existing exchanges to convert themselves in universal exchanges. Based on this even the stock

a r
exchanges were allowed to facilitate commodity trading and even the commodity exchange were allowed to facilitate trading
in other financial instruments such as equity, bills and bonds, currency, etc. An exchange provides different platforms over
which such instruments can be traded.
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Derivatives y K
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These are financial instruments which are traded over the exchange. Derivatives do not have a value of their own. Their value
is derived from some underlying asset. Once they are traded as future contract their value continues to fluctuate. For example,

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in the stock market option trading such as call and put. Even currency trading, commodity trading, etc. all fall under
derivatives trading.

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Capital market 37
 Shorts

Social Stock Exchange (SSE)

Announced in the Union Budget speech a few years ago. New in India but existing in other countries.

Set up by NSE and BSE. Regulated by SEBI.

A platform for Not-for-Profit Organisations NPOs) engaged in charitable or social welfare work to list financial
instruments and raise funds.

Religious and political organizations are not allowed to list.

First Listing In 2023, Unnati Foundation became the first NPO to list on the Social Stock Exchange.

Universal Exchange
Introduced by SEBI in 2018.

Allows existing exchanges to convert to universal exchanges.

Functionality:

Stock exchanges can now facilitate commodity trading.

Commodity exchanges can now trade in other financial instruments such as equity, bills, bonds, and
currency.

Derivatives
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Financial instruments traded on the exchange. Derivatives derive their value from an underlying asset.

Types and Trading:

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Examples include options (call and put), currency trading, and commodity trading.

Traded as future contracts, with values fluctuating based on the underlying asset.

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Bitcoin/Cryptocurrency
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Bitcoin is a virtual currency or coin which is issued in an electronic/digital form. It

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came into existence in 2008, and it is believed to be invented by a Japanese

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Software Engineer Satoshi Nakamoto. But it is not clear whether it is the name of a
person or a group. Another Australian software engineer Craig Wright is also
associated with it. E
It is a type of Crypto Currency mainly because Bitcoins are mined through a
technology called Cryptography. Crypto currency is based on Blockchain
Technology. This Blockchain technology also tracks the movement of Bitcoins from
one account to another. The entire system has mathematical puzzles, the moment a
puzzle is solved a Bitcoin is created.

Faceless Santoshi Nakamoto Budapest)

For this purpose hardware and software are needed and anybody can connect to this Blockchain system via the Internet.
Since only 21 million such mathematical puzzles are there, a maximum of 21 million Bitcoins can be mined, out of which more
than 19 million Bitcoins have already been mined. Since the difficulty level of the mathematical puzzles is continuously
increasing, mining of Bitcoin is becoming more and more difficult.

These Bitcoins can be either created by a user or they can be bought from other holders. This virtual buying and selling
results into fluctuation of the price of Bitcoins. Since the number is fixed but the demand can be unlimited it is expected that
the price of Bitcoins will continuously rise. But it is mere a speculation. The moment the internet users stop accepting the

Capital market 38
 Bitcoins, the value is bound to fall. It may even fall down to zero. There are countries such as Japan, USA etc. where Bitcoins
can be used as a mode of payment but only if the other party is willing to accept it. But it is not a legal tender in these
countries. El-Slavador and Central African Republic are two countries which have adopted bitcoin as legal tender. In China,
Saudi Arabia, Bangladesh etc. Crypto Currency is completely banned. In India buying and selling of Crypto Currency is
allowed. It can be held as a virtual asset and it can be even given as a gift. But in India Crypto Currency cannot be used as a
medium of payment.
Government of India brought Crypto currencies under the tax bracket, terming them as Virtual Digital Asset in the budget
202223. The profit by buying and selling Crypto Currency and other such virtual assets such as NFT is taxed at a rate of
30%. The government also proposed issuing a virtual digital currency backed by RBI.

LIBRA is a Crypto currency backed by Facebook. In 2020 it has been renamed as DIEM. Other popular Crypto currencies are
Ethereum, Litecoin, Dogecoin, Shiba, Solana, Matic, Cardano etc.

Reasons behind the popularity of Crypto Currencies

 Some times back the price of gold remained stagnant due to which investment in Crypto currency became lucrative.

 Share markets around the world have reached their all-time high due to which the investment in the share market is seen
as riskier.

 Increase in the internet penetration in the developing countries.

 Presence of a significant amount of liquidity in the major economies of the world.

 For a long time there was no tax in any country on the profits made by investment in the Crypto currencies.

 Absence of any centralized regulator.

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 Privacy Protection: The use of pseudonyms conceals the identities, information and details of the parties to the
transaction.

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 Cost-effectiveness: They have single valuation globally, and the transaction fee is extremely low, being as low as 1% of

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the transaction amount. Crypto currencies eliminate third party clearing houses or gateways, cutting down the costs and

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time delay. All the transactions over crypto currency platforms, whether domestic or international, are equal.

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 Lower Entry Barriers: Crypto currencies lowers entry barriers, they are free to join, high on usability and the users do not

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require any disclosure or proof for income, address or identity.

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 Alternative to Banking Systems and Fiat Currencies: Crypto currencies offer the user a reliable and secure means of

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exchange of money outside the direct control of national or private banking systems.

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 Fast and efficient: Fund transfer is easier and faster with Crypto currencies as compared to conventional methods.

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 Open Source Methodology and Public Participation: Majority of the Crypto currencies are based on open source
methodology, their software source code is publicly available for review, further development, enhancement, and scrutiny.

 Immunity to Government-led Financial Retribution: Governments have the authority and means to freeze or seize a bank
account, but it is infeasible to do so in the case of Crypto currencies. For citizens in repressive countries, where
governments can easily freeze or seize the bank accounts, Crypto currencies are immune to any such seizure by the
state.

 Counterfeiting: It is created by Cryptography and uses Blockchain technology and hence is much harder to counterfeit
than paper currency.

Concerns associated with Crypto Currencies

Despite these numerous advantages and user-friendly processes, Crypto currencies have their own set of associated risks in
the form of volatility in valuation, lack of liquidity, security and many more.

 Crypto currencies have seen very high fluctuation in their values because it depends on supply and demand. This results
in fluctuation in the wealth of cryptocurrency holders.

 Crypto currencies are being denounced in many countries because of their use in grey and black markets.

 They also have the potential to be used for Illicit Trade and Criminal Activities and can be used for Terror Financing.

 They also have the potential for Tax Evasion.

 With an increase in mining of Crypto currencies, there has been an increase in energy consumption as well. It was
reported that in November 2017, the power consumed by the entire Bitcoin network was higher than that of Ireland. This
will have an impact on power production, consumption, power prices, global warming, etc.

Capital market 39
 Non-Fungible Token (NFT)
Non-Fungible Token NFT is a digital asset that represents objects like art, music, videos, in-game products etc. It is like you
buy a suit or weapon for your in-game character in PUBG, Freefire, or even earlier in GTA Vice City. But an NFT is different
only in one aspect that, it is Non-Fungible. It means that the digital asset is unique and no other person can have the same
asset in the world.
A 100 rupees note or a bitcoin can be exchanged for other 100 rupees note or another bitcoin respectively. But no two NFTs
can be exchanged, as they are not equal. So they cannot be used as a medium of transaction. Like in the real-world the bat
used by M.S.Dhoni to hit the winning six in 2011 world Cup is Non-Fungible. If that bat of M.S.D. is represented in digital form
as a unique cryptographic token then it will be NFT of the winning bat.

NFTs are traded online using cryptocurrency and are generally encoded with some underlying software created on
blockchain. They contain built-in authentication, which serves as proof of ownership. You might be able to see them,
screenshot them or even download them for free, but to have that right of ownership you will have to buy them by negotiating
with the owner.

Central Bank Digital Currency (CBDC)

The RBI had issued a concept note on Central Bank Digital Currency CBDC on October 7, 2022. The RBI has launched pilot
projects of CBDC in both the Wholesale and Retail segments. The pilot in the wholesale segment, known as the Digital Rupee -
Wholesale (e₹W. It was launched on November 1, 2022, being limited to the settlement of secondary market transactions in
government securities.

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The use of e₹W, is expected to make the inter-bank market more efficient. Settlement in central bank money would reduce
transaction costs.

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The pilot project in the retail segment, known as digital Rupee-Retail (e₹R, was launched on December 01, 2022, within a

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closed user group comprising participating customers and merchants. The e₹R exists as a digital token that represents legal

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tender. It is being issued in the same denominations as paper currency and coins. It is being distributed through financial

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intermediaries like banks. Users will be able to transact with e₹ R through a digital wallet offered by the participating banks.

Transactions can be both Person to Person P2P and Person to Merchant P2M. The e₹R offers features of physical cash

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like trust, safety, and settlement finality. Like cash, the CBDC will not earn any interest and can be converted to other forms of
money, like deposits with banks.

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Eight banks have been chosen by the RBI to participate in the retail pilot project in stages. Four banks namely the SBI, ICICI

m
Bank, Yes Bank, and IDFC First Bank are included in the first phase. Following that, the Bank of Baroda, Union Bank of India,

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HDFC Bank, and Kotak Mahindra Bank will also join in the retail project.

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Unlike crypto currencies the value of CBDC will not fluctuate. It will be just like normal currency but in digital form. Its usage

E
will also save the cost of printing and transportation. Since it can be transferred instantly, even the transportation time will be
saved.

Capital market 40
 Shorts

Bitcoin/Cryptocurrency
Bitcoin A virtual currency created in 2008, attributed to Satoshi Nakamoto (identity uncertain). Craig Wright
is also associated with its creation.

Cryptocurrency Based on Blockchain Technology, utilizing cryptography for mining and transactions.

Mining:

Bitcoins are mined by solving mathematical puzzles, with a maximum cap of 21 million Bitcoins. Over 19
million have already been mined, and the difficulty of puzzles increases over time, making mining
progressively harder.

Trading and Value:

Bitcoins can be created by users or bought from others, leading to price fluctuations driven by supply and
demand. Its price is speculative and can potentially drop to zero if not accepted by users.

Global Acceptance:

Used as a payment method in some countries like Japan and the USA, but not legal tender. El Salvador and
Central African Republic have adopted Bitcoin as legal tender.

Banned in countries like China, Saudi Arabia, and Bangladesh.

t
In India, it can be bought, sold, held as a virtual asset, and given as a gift but cannot be used for payments.
i
Regulation and Taxation in India:

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Categorized as a Virtual Digital Asset and taxed at 30% on profits from transactions.

Government proposed issuing a digital currency backed by the RBI.

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Other Cryptocurrencies:
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Popular ones include Ethereum, Litecoin, Dogecoin, Shiba, Solana, Matic, and Cardano.

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Facebook's cryptocurrency LIBRA, renamed DIEM in 2020.

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Concerns:

 High volatility.

Capital market 41
  Usage in grey and black markets.

 Potential for illicit trade and terror financing.

 Potential for tax evasion.

 High energy consumption for mining.

Non-Fungible Token (NFT)

Definition:

A digital asset representing unique objects like art, music, and in-game items.

NFTs are non-fungible, meaning they cannot be exchanged for something of equal value like regular
currencies or Bitcoin.

Usage:

Traded online using cryptocurrency.

Provide proof of ownership through built-in authentication.

Central Bank Digital Currency (CBDC)

Introduction:

Concept note issued by RBI on October 7, 2022.

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Pilot projects launched in Wholesale and Retail segments.

Wholesale Segment (e₹W:

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Launched on November 1, 2022.

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a
Used for settling secondary market transactions in government securities, aiming to reduce transaction costs.

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Retail Segment (e₹R:

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Launched on December 1, 2022, within a closed user group of participating customers and merchants.

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Issued in the same denominations as paper currency and coins, distributed through banks.

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Transactions can be Person to Person P2P and Person to Merchant P2M.

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Offers features of physical cash without earning interest.

Participating Banks:
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Eight banks chosen: SBI, ICICI Bank, Yes Bank, IDFC First Bank, Bank of Baroda, Union Bank of India, HDFC

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Bank, and Kotak Mahindra Bank.

Advantages:

Value does not fluctuate like cryptocurrencies.

Saves printing and transportation costs.

Enables instant transfer of funds. Although hacking is a challenge.

Cryptography
Cryptography is the science of securing information by transforming it into a format that can only be read by
authorized parties. It involves various techniques and principles to protect data from unauthorized access,
ensuring confidentiality, integrity, and authenticity. Key concepts in cryptography include:

Encryption Converting plaintext into ciphertext using an algorithm and a key.

Decryption Converting ciphertext back into plaintext using the appropriate key.

Hashing Creating a fixed-size string (hash) from input data, which is unique to the input data.

Digital Signatures Ensuring the authenticity and integrity of a message using cryptographic techniques.

Public and Private Keys Utilized in asymmetric cryptography, where a public key encrypts data and a
corresponding private key decrypts it.

Blockchain Technology

Capital market 42
 Blockchain technology is a decentralized digital ledger that records transactions across multiple computers
so that the records cannot be altered retroactively without the alteration of all subsequent blocks and the
consensus of the network. Key components include:

Blocks Each block contains a list of transactions and a reference to the previous block.

Chain Blocks are linked together in a chronological order, forming a chain.

Decentralization No central authority controls the blockchain; instead, it is maintained by a distributed

network of nodes.

Consensus Mechanisms Methods like Proof of Work PoW or Proof of Stake PoS ensure that all nodes
agree on the state of the blockchain.

Cryptocurrencies
Cryptocurrencies are digital or virtual currencies that use cryptography for security and operate on
blockchain technology. Hereʼs how cryptography and blockchain are used in cryptocurrencies:

 Transaction Security Cryptographic techniques ensure that transactions are secure and cannot be
tampered with. Public and private keys are used to encrypt and decrypt transaction information, ensuring
that only the intended recipient can access the funds.

 Identity Verification Digital signatures, created using cryptographic algorithms, verify the identity of the
sender and ensure that the transaction has not been altered.

 Decentralization and Consensus Blockchain technology enables a decentralized network where no

it
single entity has control. Consensus mechanisms, such as PoW and PoS, ensure that all participants agree
on the validity of transactions.

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 Immutability Once a transaction is recorded in a block and added to the blockchain, it cannot be altered

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or deleted. This immutability is enforced by cryptographic hashing, which links each block to the previous
one.

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 Transparency and Anonymity While blockchain transactions are transparent and publicly visible, the use
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of cryptographic addresses ensures a level of anonymity, as these addresses do not directly reveal
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personal information.

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By combining cryptography and blockchain technology, cryptocurrencies provide a secure, transparent, and
decentralized way of conducting digital transactions.

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@July 30, 2024
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Peer-to-Peer Lending(P2P)
P2P lending is similar to crowdfunding. However, crowdfunding is not in the form of loan whereas P2P lending is in the form of
loan which is to be repaid. There are several online platforms in India such LenDen Club, Faircent, Lend Box etc. which serve
as a link between the lenders and the borrowers. These lenders are not a bank or a financial institution. Through such
platforms they provide online loan to the individual borrowers. In order to borrow documents are required but nothing is to be
pledged as collateral. Because of this such lending becomes highly risky.
In order to regulate such lending the RBI came out with certain guidelines. Under these guidelines such platforms must be
registered as NBFC. The following guidelines have to be followed by the lenders and the borrowers—

 Including all the platforms and all the borrowers, one single lender cannot lend more than ₹50 lakh.

 Including all the platforms and and all the lenders one single borrower cannot borrow an amount more than ₹10 lakh

 One single borrower cannot borrow an amount more than ₹50,000 from one single lender including all the platforms.

 The maturity period of the loan cannot exceed three years.

Depository
In financial sector depository is a custodian with whom our financial assets in digital form are kept safe. The two depositories
in India are—

Capital market 43
  National Securities Depository Limited(NSDL) in which IDBI, UTI and NSE have been the major promoters.

 The other depository is Central Depository Services Limited(CDSL). Promoter is BSE and other major stake holders are
HDFC, LIC, Standard Chartered bank, etc.

When we buy shares, ETFs, etc. they are reflected in our demat account but they are actually held with the depository. Even if
the broker runs away these financial assets will remain safe.

Credit Rating Agency

These are private companies regulated by SEBI in India. These companies evaluate the financial health of a company and a
country and based on that provide them a rating. If a company is rated, it is termed as industrial rating but if a country is rated
it is termed as a sovereign rating. The rating ranges from AAA to D. Where AAA is the highest rating and D is the lowest rating.
For example, just below AAA, there will be AAA, then AA and AA and so on. Higher the rating is, better is the financial health.
Lower the rating is, adverse is the financial health. BBB is considered as the lowest investment grade rating. The ratings
below BBB are termed as junk ratings.
There are more than 70 credit rating agencies throughout but more than 90% of the ratings are done by the three largest
agencies— S&P, Moodyʼs and Fitch. Some other important credit rating agencies active in India are Care, CRISIL, ICRA, Brick
Work(promoted by Canara bank), etc.

Along with the rating, these agencies also provide outlook which can be positive, stable and negative. For a company and for
its financial instruments credit rating is essential. But for a country it is voluntary. By most of the credit rating agencies, India is
given a rating of BBB which is not at all justified and which does not reflect the fundamentals. Even in case of the companies,

it
the credit rating agencies are paid by them in order to avail their services. Hence, it is difficult for the credit rating agencies to
offend their client. In a number of case it has been seen that a company is given highest rating and it goes bankrupt. This has
affected the credit worthiness of these agencies. However, they still remain important.
A m
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With the help of these ratings the investors are able to realise that how much risk is involved in a particular investment. The
rating also serves as a motivation for the company and even for the country. If the rating is high for them, the borrowing cost

m
will decline. A country with higher rating attracts more foreign investments.
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Capital market 44
 Shorts

Peer-to-Peer Lending (P2P)

Definition and Overview:

P2P lending is a form of loan-based crowdfunding where individuals lend to borrowers via online platforms.

Unlike crowdfunding, P2P involves loans that must be repaid.

Examples of P2P platforms in India include LenDen Club, Faircent, and Lend Box.

Lenders are not banks or financial institutions but individuals.

Loans are provided without collateral, making them risky.

Regulations by RBI:

Platforms must register as Non-Banking Financial Companies NBFCs).

Guidelines for lenders and borrowers:

 A single lender cannot lend more than ₹50 lakh across all platforms and borrowers.

 A single borrower cannot borrow more than ₹10 lakh across all platforms and lenders.

 A single borrower cannot borrow more than ₹50,000 from a single lender across all platforms.

 Loan maturity cannot exceed three years.

Depository it
A depository is a custodian for financial assets in digital form.
A m
Depositories in India:
a r
 National Securities Depository Limited NSDL:

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Promoters: IDBI, UTI, and NSE.

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 Central Depository Services Limited CDSL:

Promoter: BSE.

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Major stakeholders: HDFC, LIC, Standard Chartered Bank, etc.

Function:
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Financial assets like shares and ETFs are reflected in demat accounts but are held with the depository.

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Assets remain safe even if the broker fails.

Credit Rating Agency

Definition:

Private companies regulated by SEBI in India.

They evaluate and rate the financial health of companies (industrial rating) and countries (sovereign rating).

Rating Scale:

Ratings range from AAA (highest) to D (lowest).

Example: AAA, AAA, AA, AA, etc.

BBB is the lowest investment grade rating; ratings below BBB are termed junk ratings.

Major Agencies:

Globally: S&P, Moodyʼs, and Fitch (conduct over 90% of ratings).

In India: CARE, CRISIL, ICRA, Brickwork (promoted by Canara Bank), etc.

Outlook Ratings also come with outlooks: positive, stable, or negative.

Importance:

Helps investors assess risk in investments.

Motivates companies and countries to maintain or improve ratings.

Capital market 45
 High ratings reduce borrowing costs and attract foreign investments.

Criticism:

India's rating BBB by many agencies is considered unjustified and not reflective of its fundamentals.

Potential conflict of interest as agencies are paid by the companies they rate.

Incidents where companies with high ratings went bankrupt, impacting agency credibility.

@July 31, 2024

Insolvency and Bankruptcy Code(IBC)

IBC was enacted on the 1 of June 2016. It is being considered an economic reform that will enhance the ease of doing
business in India. It replaces the existing laws related to Insolvency and Bankruptcy in the country. The code makes the entire
process more uniform and effective making it easier to exit a business in India. Because of the complex laws, getting into a
business has always been difficult in the country but because of the same complexities getting out of the business has been
even more difficult.

Earlier only the borrower was authorized to seek bankruptcy but under the new code, even the creditors can approach the
designated authority to declare a borrower to be bankrupt. The new code provides for the settlement of the entire matter in a

t
time-bound manner preventing delays and ensuring reconstruction or liquidation as early as possible. The process of appeal

cleared has been modified.

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has been streamlined and designated authorities have been established. Even the sequence in which the liability has to be

r
Insolvency refers to a financial condition in which an individual or a corporate is not A
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able to meet his or its financial obligations (liability). In other words, they are not able to clear their liabilities. When a court or a
designated agency is approached by the borrower in order to legally declare her or it insolvent then, it is termed as

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bankruptcy. Hence, every bankruptcy is a result of insolvency but every insolvency may not necessarily lead to bankruptcy.
Insolvency is involuntary because such financial conditions may occur automatically due to economic failures. However,
bankruptcy is always voluntary.
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Prior to this code, bankruptcy cases of a company were allowed to be filed with Company Law Board CLB, Board for
Industrial and Financial Reconstruction BIFR and even with the High courts. However, this entire process has been made

m
uniform. For this purpose, National Company Law Tribunal NCLT has been constituted which came into force on 1st June

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n
2016. It can be approached by the borrower as well as the creditor.

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NCLT is a quasi-judicial body that has been created under Companies Act 2013. It has 16 benches throughout the country

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including a principal bench in Delhi. The NCLT has replaced the Company Law Board and all the cases pending with CLB, BIFR
or in different courts are gradually being transferred to NCLT.

Once the case is filed, the bankruptcy process will not start immediately. The NCLT will initiate an Insolvency Resolution
Process IRP. It is a process of evaluation to decide whether the company can be revived, restructured or not. For this
purpose, insolvency professionals are hired, whether they are working ethically or not, it is supervised by Insolvency and
Bankruptcy Board of India. Once the resolution fails then only the process of bankruptcy will be initiated. In the case of a large
company the matter must be completed within a period of 180 days, with a maximum extension 90 days more. In the case of
MSMEs the matter has to be completed within 90 days with an additional extension of not more than 45 days. In case the
bankruptcy is completed then only the liquidation will take place. It refers to the sale of the asset of the company.
The liabilities will be cleared according to the following sequence under the new code:

 Workmen/Employees dues of the last 24 months and secured lenders (debentureholders).

 Unsecured lenders such as commercial paper holders or unsecured debentureholders. .

 The dues of states and central government

 Preferential shareholders.

 Equity shareholders.

Any decision taken by the NCLT can be challenged only in National Company Law Appellate Tribunal NCLAT. A decision
taken by NCLAT can only be challenged in the Supreme Court.
In case of liquidation of a company, the promoter of the company is not allowed to bid. Even an individual related to the
promoter is not allowed to bid. If the promoter of a company is willing to bid in the insolvency process of another company,
then there should not be any such loan on his company or the promoter himself that he is not able to repay. In case of

Capital market 46
 bankruptcy of a real estate company, the home buyers will be treated as financial creditors and they will be placed at the
topmost position along with the employees of the company and the debenture holders.

It was also seen that many creditors were criticising the decisions taken under IBC which resulted in unnecessary delay in the
process. Hence, Inter Creditors Agreement has been signed. This is an agreement between creditors, under which if between
those creditors who account for at least 66% of the total loan, sign an agreement, then the same agreement will be applicable
on all the creditors.

With the success of this code, RBI had decided to end the restructuring of the corporate loans by issuing a notification on 12th
February 2018. Time period of 180 days was given to banks and corporate. It was decided that if such corporates were able to
pay at least 20% of the total due amount then, such corporates won't be declared bankrupt. Otherwise the process of
bankruptcy would begin against such corporates.
Special Provisions for MSME Now the promoters of MSMEs are allowed to bid for their companies as long as they are not
wilful defaulters and don't attract any other related disqualification.
Provisions for individuals: In the case related to bankruptcy of individuals the Debt Recovery Tribunal DRT can be
approached. The decision of DRT can be challenged only in Debt Recovery Appellate Tribunal DRAT. The decision of the
DRAT can be challenged only in the Supreme Court.

All these provisions have made the insolvency process easier, but they have many challenges. The establishment of these
tribunals have affected the authority of High courts in India. Along with this even those cases which were being heard in front
of other authorities, are again brought under NCLT. It will lead to delay in these cases. As now the creditor can also apply for
bankruptcy, the misuse of these provisions is bound to increase. Still this code will help in reducing the NPAs of the banks in
India. Finance Minister in her budget speech of 202223 proposed that the government will bring necessary amendments in

it
the Insolvency and Bankruptcy Code to enhance corporate resolution. She also announced to facilitate cross-border

m
insolvency process as well under the present IBC regime.

r A
Earlier during pandemic, in order to provide relief to the firms facing grave financial stress, the government had suspended
the initiation of the corporate insolvency process under IBC for one year starting from 25 March 2020 to 24 March 2021. It

a
also increased the minimum threshold for insolvency initiation from 1 lakh to 1 crore.

m
K u
The Economic Survey 202122 noted that the IBC has brought behavioural changes among corporate debtors as thousands of
them opting to resolve the distress at early stages as they feel default is imminent. The survey pointed that 421 cases of

y
corporate debtors were resolved under the IBC by September 2021. It helped recover ₹2.55 lakh crore against the total debt of

b
s
₹7.94 lakh crore, reflecting a success rate of over 32%. The survey has also advocated for the simplification of the voluntary

i c
liquidation process as well as to create a single window for the entire process.

Core Investment Company o m

o n
E c
Core investment companies are special type of NBFCs. In order to be registered with the RBI under this category their asset
size should not be less than ₹100 crore. Not less than 90% of their assets should be in the form of shares and other securities.
For example, equity shares, preferential shares and debt instruments. That shares and the other financial instruments held by
them should not be for the purpose of trading. They should only be for the purpose of holding.
Tata sons is a core investment company which holds majority stake in most of the Tata group companies. Dividend from these
companies is the main source of income of this NBFC. Recently, the RBI placed Tata sons in the category of upper layer NBFC
which makes it mandatory for Tata sons to get listed within a period of three years. Based on this Tata sons will have to be
listed on the stock exchange by September 2025. However, it has requested RBI to exempt it from the mandatory listing.

Financial Debt Non-financial debt

If a bank, NBFC, etc. which fall under the If borrowing is done by those entities which do not fall under the category
category of financial institutions borrow then it of financial institutions then it is non-financial debt. For example, the
will be termed as financial debt. Even the government, the households, the companies other than financial
instruments issued by them, such as institutions. Even the financial instruments issued by them fall under this
Certificate of Deposit will fall under this category. Eg.- treasury bills , G-secs in the form of bonds, debenture
category. issued by a manufacturing company, etc.

Capital market 47
 Shorts

Insolvency and Bankruptcy Code (IBC)

Insolvency refers to a financial condition in which an individual or a corporate is not
able to meet his or its financial obligations (liability).

When a court or a designated agency is approached by the borrower in order to legally declare her or it
insolvent then, it is termed as bankruptcy.

Every bankruptcy is a result of insolvency but every insolvency may not necessarily lead to bankruptcy.

Insolvency is involuntary because such financial conditions may occur automatically due to economic
failures.

Bankruptcy is always voluntary.

Enacted on June 1, 2016, as a major economic reform to improve the ease of doing business in India.

Replaces previous insolvency and bankruptcy laws to create a more uniform and effective exit strategy for
businesses.

Key Features:

 Authorization Both borrowers and creditors can initiate bankruptcy proceedings.

 Time-bound Process Ensures quick resolution, reconstruction, or liquidation to avoid delays.

it
 Designated Authorities Establishment of the National Company Law Tribunal NCLT for handling cases.

and a principal bench in Delhi.

A m
NCLT is a quasi-judicial body that has been created under Companies Act 2013 with 16 benches across India,

a r
 Uniformity Replaces the Company Law Board CLB, Board for Industrial and Financial Reconstruction BIFR,

m
and High Courts for bankruptcy cases.

bankruptcy.
K u
 Insolvency Resolution Process IRP Evaluates if a company can be revived or restructured before

Process and Timeline:

b y
i cs
For large companies: Must be completed within 180 days, extendable by 90 days.

m
For MSMEs: The process must be completed within 90 days, extendable by 45 days.

o
n
If IRP fails, bankruptcy and liquidation follow.

o
E c
Sequence of Liability Clearance:

 Workmen/employees' dues of the last 24 months and secured lenders.

 Unsecured lenders.

 State and central government dues.

 Preferential shareholders.

 Equity shareholders.

Appeals:

Decisions by NCLT can be appealed in the National Company Law Appellate Tribunal NCLAT, and further in
the Supreme Court.

Restrictions on Bidding:

Promoters of a bankrupt company cannot bid for their company.

Related individuals are also restricted.

Promoters can bid for other companies if they are not wilful defaulters and meet certain conditions.

Special Provisions for MSMEs:

Promoters can bid for their companies if they are not wilful defaulters.

Provisions for Individuals:

Capital market 48
 Debt Recovery Tribunal DRT handles individual bankruptcy cases, with appeals going to the Debt Recovery
Appellate Tribunal DRAT and then the Supreme Court.

Inter-Creditors Agreement:

To reduce delays, creditors with 66% of total loan agreement can enforce the agreement on all creditors.

Impact and Success:

The IBC has led to early resolution of distress among corporate debtors.

By September 2021, 421 corporate debtors were resolved, recovering ₹2.55 lakh crore from ₹7.94 lakh crore
of debt, reflecting a 32% success rate.

Challenges and Amendments:

Establishment of NCLT affected High Courts' authority and caused delays in ongoing debt resolution cases.

Potential misuse by creditors since they can also apply for bankruptcy.

The government proposed amendments to enhance corporate resolution and facilitate cross-border
insolvency processes.

During the pandemic, the initiation of the corporate insolvency process was suspended from March 25, 2020,
to March 24, 2021, and the minimum threshold for insolvency initiation was increased from ₹1 lakh to ₹1 crore.

Core Investment Company

Definition A type of NBFC with an asset size of at least ₹100 crore, 90% of which should be in shares and
securities.
it
m
Examples Tata Sons— Holds a majority stake in Tata Group companies, primarily earning income from
A
r
dividends.

three years (by September 2025.

m a
Regulations RBI categorized Tata Sons as an upper-layer NBFC, requiring listing on stock exchanges within

Financial Debt K u
b y
Borrowing by financial institutions like banks and NBFCs.

i cs
Includes instruments like Certificates of Deposit.

Non-Financial Debt
o m
o n
Borrowing by non-financial entities such as the government, households, and manufacturing companies.

E c
Includes instruments like treasury bills, government securities, and debentures.

Model questions
 Critically evaluate IBC as an economic reform.

Probable solution outline

 Insolvency kya hai and bankruptcy kya hai?

 Comment on the Ease of Doing Business.

 Bringing down NPAs and Ease of exiting a business

 Drawbacks of previous era. Changes in new regime. Examples

 Drawbacks

 Although it has some drawback, and scope of improvement is there, it helps to catch wilful defaulters and help the
banks and business goes to functioning buyers.

 How capital market maybe helpful in industrial growth and development in India?

Probable solution outline

 Capital markets refers to raising long term funds.

Capital market 49
  Capex of a company is for expansion. It is always long term. Hence, capital market is the tool. Funds need not be
repaid. SEBI regulates and brings about transparency. Corporate governance improves.

 Promotes foreign investments.

 Negatives

a Fraudulent activities

b Exit of angel investor

c Fraud with retail investors

it
A m
a r
u m
y K
s b
i c
o m
o n
E c

Capital market 50
 National Income
Date created @August 1, 2024 12:35 PM

Revisions 1

Start date @August 1, 2024

Status Complete

Gross Domestic Product(GDP)

Types of GDP
Nominal GDP
Real GDP
@August 2, 2024
GDP at Factor Cost
Hindu rate of growth
Technical recession
Gross National Product(GNP)
Net National Product(NNP)
National Income(NI)
Purchasing Power Parity(PPP)
@August 5, 2024
Green GDP

National Income 1
 Gross National Happiness
Per Capita GDP and Per Capita Income
GDP Deflator
Potential GDP and Actual GDP
New method of GDP Calculation
@August 6, 2024
Nominal Effective Exchange Rate & Real Effective Exchange Rate

Gross Domestic Product(GDP)

The most common method for calculation of national income is the production method. In order to calculat e national
income through production method, Gross Domestic Product (GDP) is a key concept or factor. GDP can be defined as the
total value of finally marketable goods and services produced within the territory of a country in a financial year(FY). Here
territory also includes Exclusive Economic Zones(EEZ) of that country. EEZs refer to the oceanic area or that sea adjacent
to the land area of a country extending upto 200 nautical miles(230 miles). Even the resources extracted from the EEZ are
counted as the part of the GDP of that country. Based on the definition it can be concluded that when we add the total
value of the finally market able goods and services produced in a country in a given FY, we get the GDP of that country.
Based on GDP, the size of the economy of a country is derived. Based on this we can say that more the GDP, larger will be
the economy.
According to the data published by IMF, with a GDP of more than $28 trillion USA is the worldʼs largest economy. It alone
produces approximately 25% of the goods and services produced in the world(GDP of the entire world is more than
$100 trillion). With a GDP of more than $18 trillion, China is the second largest economy. With a GDP of approximately
$4.5 trillion, Germany has surpassed Japan to become the third largest economy. With a GDP of approximat ely $4.1
trillion, Japan is at the fourth position. With the GDP of approximat ely $3.9 trillion, India is at the fifth position. With the
GDP of approximat ely $66 million only, Tuvalu is the worldʼs smallest economy.

Increase in the GDP of a country over a period time is termed as economic growth. Since, economic growth is related to
increase in production it is termed as a quantitative concept.

In calculation of GDP only the finally marketable goods and services are taken into account . It means that the value of the
raw mat erials or the inputs will not be added separately. It is mainly because the final price of the goods and services will
also include the price of the raw material and the inputs.

In calculation of GDP it hardly matters who exactly is the producer. It only matters that where exactly the pr oduction is
taking place. Hence, within the territory of India even if a foreign company is producing, it will be added to the GDP of
India.

The High Commission of different countries or the Embassy of different countries located in India will be considered as
foreign territory. Hence, the services sold within those high commission and embassy will be added to their GDP and not in
Indian GDP. The airline companies and the shipping companies registered in India but their services sold in the entire world
will be added to the GDP of India.

In calculation of GDP the resale value of a product will not be added. Similarly, in calculation of GDP, transfer
payments(payments made without any service; like pension, scholarship, etc.) cannot be added.

In the GDP, even Care Economy cannot be added. It refers to services without payment. Such services are provided out of
love and affection or as a goodwill gesture. For example, the domestic services provided by mother, sister, wife, etc. Such
services are not paid for and hence they cannot have a monetary value and cannot be added to the GDP. The economists
have remained divided w.r.t. this matter. According to some either such services should be given a monetary reward or
they should be given a monetary value and be added to the GDP. On the other hand some economists argue that such
services are provided out of love and care and hence cannot be monetised. Even if economic reward is given, it cannot be
monitored. Hence, the care economy should not be added to the GDP.

Prior to the establishment of National Statistical Office(NSO), GDP in India was calculated by Central Statistics Office(CSO).
However, at present it is calculat ed by NSO. Calculation of GDP is difficult. Data from the organised sector can be collected
easily but collecting data from the unorganised sector is difficult. Hence, a large part of the GDP that is derived from the
unorganised sector is estimat ed. Approximat ely, half of the GDP comes from this sector.

Types of GDP
Based on how the GDP is calculat ed it can be classified into the following three types—

1. Nominal GDP / GDP at market price / GDP at current price

National Income 2
 2. Real GDP / GDP at constant price / GDP at base price

3. GDP at factor cost

Nominal GDP
In calculation of nominal GDP the current market price of the goods and services will be taken into account. It means it will
also include the impact of inflation, deflation and the indirect taxes. Hence, it can be concluded that nominal GDP may
change due to change in price even if the production does not change. In the FY 2023-24, nominal GDP in India has
witnessed a growth rate of 9.6%

Real GDP
In calculation of real GDP, the price remains constant. It means that the impact of inflation, deflation, and even change in
the indirect taxes are set aside. For this purpose a base year is taken into consideration. At present, this base year is 2011-
12. The price in the base year will be taken into account again and again even in the subsequent years for the calculation of
real GDP. Hence, it can be concluded that real GDP will change only with change in production. In the FY 2023-24 the real
GDP in India increased at a rate of 8.2%. Based on the growth rate of nominal GDP and real GDP out of all the major
economies, India is the fastest growing economy.

National Income 3
 Shorts

Gross Domestic Product (GDP)

Definition:
GDP is the total value of all final goods and services produced within a country's borders, including its
Exclusive Economic Zones (EEZs), in a financial year (FY).

Key Points:

Territory Includes: Land and EEZ (up to 200 nautical miles).

Production Method: Measures GDP by adding up the value of final goods and services.

Economic Size: Higher GDP indicates a larger economy.

Exclusions:

Care Economy: Services provided out of love and affection without monetary payment (e.g., domestic
services by family members). These services are not included in GDP as they lack a market value.

Transfer Payments: Payments made without any exchange of goods or services, such as pensions and
scholarships. These do not contribut e to GDP as they are not payment s for production.

Resale Values: The value of resold products is not counted to avoid double counting.

Global Rankings:

1. USA: $28+ trillion

2. China: $18+ trillion

3. Germany: $4.5 trillion

4. Japan: $4.1 trillion

5. India : $3.9 trillion

Types of GDP:

1. Nominal GDP: Measured at current market prices, includes inflation/deflation.

2. Real GDP: Adjusted for inflation/deflation, based on constant base year prices.

3. GDP at Factor Cost: Excludes indirect taxes, includes subsidies.

Current Data (FY 2023-24):

Nominal GDP Growth: 9.6%

Real GDP Growth: 8.2%

India is currently the fastest-growing major economy based on GDP growth rates.

@August 2, 2024

GDP at Factor Cost

Subsidies and indirect taxes are two types of important factors which influence the nominal GDP of a country. Subsidies
are given by the government and the indirect taxes are levied by the government over the goods and services. Subsidies
are financial assistance given by the government to the producer or the seller so that a particular commodity or a service is
made available to the consumers at a lower price. Hence, the subsidies bring down the nominal GDP. On the other hand
indirect taxes such as excise, GST, etc. make the goods and services costlier and hence they enhance nominal GDP.

In order to calculat e GDP at factor cost the impact of the indirect taxes and the subsidies is to be eliminat ed from the
nominal GDP. Hence, in order to calculate GDP at factor cost the indirect taxes will be subtracted from the nominal GDP
and subsidies will be added to it.

GDP factor cost = Nominal GDP − Indirect taxes + Subsidies

National Income 4
 Hindu rate of growth
Since independence till the beginning of 1990s the Indian economy witnessed a slow rate of growth averaging from 3.5%
to 4%. For t his slow rat e of growt h, a Marxist economist Rajkrishna coined the t erm ‘hindu rate of growthʼ. He blamed the
beliefs of Hinduism as the main reason behind this slow growth rate. According to him, the religion is self satisfied and
complacent which affects t he economic growt h. However, the ot her economists reject ed t his view and said t hat t his slow
rate of growth was mainly because of the ineffective policies of the government and religion is not to be blamed.

📎 When we compare the GDP of different states in India(GSDP), Maharashtra and Tamil Nadu occupy the first and

Technical recession
When the GDP of a country declines consecutively for two or more quarters then the country is said to be in recession.
However, if the GDP declines only for two quarters and it recovers from the third quart er then it is termed as technical
recession. In case of recession the GDP of a particular quarter is compared with the GDP of the same quarter in the
previous year.

Due to Covid crisis when the lockdown was imposed, in the first quarter of FY 2020-21, the GDP of India witnessed a
decline of approximately 24% as compared to the same quarter of the previous year. It was the sharpest ever decline
witnessed in India since we started the calculation of GDP. Out of all the major economies, India experienced the sharpest
decline. Even in the next quarter the GDP witnessed a decline as compared to the previous year. Hence, India witnessed
technical recession because in the next quarter the economy recovered. In FY2021 the overall GDP remained low as
compared to the previous FY. Agriculture was the only sector which witnessed a positive growth that year.

Gross National Product(GNP)

It refers to the total value of goods and services produced by the nationals of a country anywhere in the world. Based on
the definition it can be said that in calculation of GNP it hardly matters that where the production is taking place. It only
matters that who exactly is producing. It means that if an Indian company is producing in Britain it will be added to the GDP
of Britain but it will be added to the GNP of India. However, in reality the calculation in such a manner is not possible. The
Indians working abroad or the Indian companies producing some where else may send a part of their income back to India.
It will be termed as net inflow. Similarly, the foreigners or the foreign companies working in India may send a part of their
income to their own country. This maybe termed as the net outflow. In the GDP of a country when the net inflow is added
and the net outflow is subtracted then the GNP of that country is derived.

GNP = GDP + Net inflow − Net outflow

Net National Product(NNP)

In the process of production of goods and while providing services machines and tools are used. With usage these
machines and tools wear and tear. Hence, in order to replace them a company will set aside a part of its revenue every
year. This amount which is set aside is termed as depreciation. When this depreciation is subtract ed from the GNP we
derive Net National Product(NNP).

NNP = GNP − Depreciation

📎 When depreciation is subtracted from GDP we derive the NDP.

National Income(NI)
When NNP is calculat ed at factor cost, we derive National Income(NI).

NI = NNP − Indirect taxes + Subsidies

National Income 5
 Purchasing Power Parity(PPP)
Every country calculat es its GDP in its own currency. However, in order to compare the GDP of different countries with
each other, they are converted into a common currency i.e. USD. When the GDP of India is converted into dollar based on
exchange rate then the GDP comes out to be $3.9 trillion and India becomes the fifth largest economy.

However, there is another mechanism through which the GDP can be converted into dollar. This mechanism is PPP. In this
mechanism, the purchasing power of a domestic currency is compared with the PPP of USD. For this purpose two baskets
are maintained in which the same amount of same essential commodities and services are placed. One basket will be
purchased in India using Indian currency and the other will be purchased in the US using USD. Since the cost of living in
India is low the same basket can be purchased by spending less. For example, in the US if the baskets costs $1, in India the
same basket will cost approximately ₹22. In this case it can be said that the purchasing power of ₹$1 and ₹22 is equal.
Based on this PPP when the GDP of India in converted into USD, it goes beyond $10 trillion making India the worldʼs third
largest economy. Similarly, China becomes the largest economy and USA becomes the second largest.

National Income 6
 Shorts

GDP at Factor Cost

Subsidies and Indirect Taxes:

Subsidies lower nominal GDP by making goods and services cheaper.

Indirect taxes (e.g., excise, GST) increase nominal GDP by raising prices.

GDP factor cost = Nominal GDP − Indirect taxes + Subsidies

Hindu Rate of Growth

Definition: Slow economic growth rate (3.5%-4%) in India from independence until early 1990s.

Coined By: Marxist economist Rajkrishna.

Blame: Attributed to Hinduism's self-satisfied nature.

Counterpoint: Other economists blamed ineffective government policies.

GSDP Comparison: Maharashtra and Tamil Nadu rank first and second among Indian states in GDP,
followed closely by UP, Gujarat, and Karnat aka.

Technical Recession
Definition: GDP declines for two consecutive quarters.

Technical Recession: GDP declines for two quarters but recovers in the third.

Example:

FY 2020-21: India's GDP declined by 24% in the first quarter due to COVID-19 lockdowns.

Recovery: Agricult ure was the only sector with positive growth that year.

Gross National Product (GNP)

Definition: Total value of goods and services produced by nationals worldwide.

Components:

Includes net inflow from citizens and companies abroad.

Subtract s net outflow to foreign entities.

GNP = GDP + Net inflow − Net outflow

Net National Product (NNP)

Definition: GNP minus depreciation (accounting for wear and tear of machinery and tools).

NNP = GNP − Depreciation

NDP Calculation: Subtracting depreciation from GDP gives Net Domestic Product (NDP).

National Income (NI)

Definition: NNP calculated at factor cost.

NI = NNP − Indirect taxes + Subsidies

Purchasing Power Parity (PPP)

Purpose: Compare GDP of different countries in a common currency (USD).

Mechanism:

Compares purchasing power of domestic currency with USD.

Uses a basket of essential commodities and services.

National Income 7
 Impact:

@August 5, 2024

Green GDP
The concept of green GDP was introduced by China. However, since it was impossible to calculat e Green GDP even China
discontinued its calculation. GDP is based on the total production that takes place within a country. However, in this
process of production, environment al consequences can be seen. For example, deforestation as well as different forms of
pollution. This negative consequence over the environment is given a monetary value and when it is subtract ed from the
GDP then the remaining GDP is termed as Green GDP.

Green GDP = GDP − Cost of Negative consequence over environment

Gross National Happiness

The concept was introduced by the fourth king of Bhutan for the first time. In Gross National Happiness it is evaluat ed
that how happy the people are in the country. It has nothing to do with increase or decrease in GDP. Based on different
aspect s of life, questionnaire can be prepared with different options. Based on the answers collected it is concluded that
how happy the people are.

Per Capita GDP and Per Capita Income

Per capita GDP and Per capita Income are seen as benchmark for economic development. However, they can never give a
clear picture of the economic well being of a country. When the GDP of a country is divided by the population of the
country then it is termed as per capita GDP. Similarly, when the national income is divided by the total population then the
outcome is termed as per capita income. However, neither per capita GDP can show what exactly an individual is
producing nor per capita income can exactly show the income of an individual.

In India, based on per capita GDP income, Goa and Sikkim are the two top states. Based on these factors, India is at the
130th(136) position. Even the position of China is not within the top 50 countries.

GDP of the country

Per capita GDP =
Population of the country

National income of the country

Per capita income =
Population of the country

GDP Deflator
It is also a mechanism through which inflation can be measured. However, it is different from the indices such as WPI and
CPI.

For calculating GDP deflator in any financial year the Nominal GDP is divided by the Real GDP of that financial year and the
outcome is multiplied with 100. When the GDP deflator of a financial year is compared with the GDP deflator of the previous
year then the inflation for that year can be derived.

GDP deflator is a comprehensive way of calculating inflation. Unlike WPI and CPI which have baskets containing certain
goods and services, in case of GDP deflator all the goods and services produced within the territory are taken into
consideration.

However, GDP deflator as a mechanism of calculation of inflation has two major drawbacks—

1. Since in calculation of GDP the goods which are imported are not taken into consideration. In GDP deflator their impact
will not be reflect ed.

National Income 8
 2. We calculate inflation on a monthly basis and based on it the monetary policies are formulated. However, the data
related to GDP are available only on a quarterly basis

Nominal GDP
GDP deflator = × 100
Real GDP

Potential GDP and Actual GDP

Potential GDP refers to the GDP that can be achieved whereas actual GDP refers to the GDP that exists in reality. In any
economy when land, labour, capital and the natural resources are used in optimum manner the potential GDP can be
achieved. However, in almost every economy it is extremely difficult to achieve the potential GDP. Hence, the actual GDP
remains relatively low as compared to the potential GDP.

India is a large country with huge resources and even its maximum population is in the productive age group. Hence, the
potential GDP that can be achieved has higher possibilities but because of some external and internal problems the actual
GDP remains low. Lack of political will, bureaucratic will and high levels of indifference among the workforce affect s the
economic activities. Corruption also plays an important role in affecting the economy adversely. Low levels of eduction and
skill also have negative consequenc es over GDP. Due to gender disparity, women in India are mostly confined to domestic
activities. They fail to become a part of the workforce. Since women fail to contribut e economically the GDP is affect ed
adversely. According to Okunʼs law with every 1% of unemployment the GDP is roughly affected by 2%. It is mainly
because unemployment affects production as well as consumption. Even reckless use of resources may affect the GDP.

Normally, the potential GDP is higher than the actual GDP of an economy. This gap between Potential GDP and Actual GDP
is termed as deflationary gap. It shows that the economy is not moving at its full capacity. And the economic growth is
slow.

On the other hand if the actual GDP surpasses even the potential GDP then the gap is termed as inflationary gap. It is a sign
that the demand is too high in the economy.

National Income 9
 Shorts

Green GDP
Introduced by China, but discontinued due to calculation difficulties.

Subtracts the monetary value of environmental negative consequences (e.g., deforestation, pollution) from
GDP.

Gross National Happiness

Introduced by the fourth king of Bhutan.

Measures the happiness of people, independent of GDP changes.

Uses questionnaires based on various life aspect s to assess happiness.

Per Capita GDP and Per Capita Income

Benchmarks for economic development but not accurate indicators of individual economic well-being.

Per Capita GDP: GDP divided by the country's population.

Per Capita Income: National income divided by the country's population.

GDP of the country

Per Capita GDP =
Population of the country
National Income of the country
Per Capita Income =
Population of the country

Goa and Sikkim top states in India based on these metrics; India ranks around 130th globally.

GDP Deflator
Measures inflation by comparing nominal GDP to real GDP and multiplying by 100.

More comprehensive than WPI and CPI, as it considers all goods and services produced.

Two major drawbacks:

1. Excludes impact of imported goods.

2. Data is available quarterly, not monthly.

Nominal GDP
GDP Deflator = × 100
Real GDP

Potential GDP and Actual GDP

Potential GDP: Maximum achievable GDP using optimal resource utilization.

Actual GDP: The real GDP achieved, usually lower than potential GDP.

Factors affecting actual GDP in India: political/bureaucratic will, corruption, education, skill levels, gender
disparity.

Deflationary Gap: When actual GDP is lower than potential GDP, indicating underperformance.

Inflationary Gap: When actual GDP exceeds potential GDP, indicating excessive demand.

Okunʼs Law: 1% unemployment roughly reduces GDP by 2%.

New method of GDP Calculation

@August 6, 2024

National Income 10
 In the year 2015, the mechanism of calculation of GDP in India was modified. In this process of modification even the base
year was modified to 2011-12. However, the most important modification was related to data collection from the organised
and the unorganised sectors.
Prior to the modification from the organised sector the data was collected by the authorities individually from the registered
companies. However, after the modification all the registered companies are given a 21 digit code known as MCA-
21(Ministry of Corporate Affairs-21). Using this code the registered companies upload their data on the portal from where it
is collect ed by the authorities for the purpose of calculation of GDP. However, different survey reveal that out of these
registered companies 36-38% companies vanish every three years. Some of the companies shutdown due to loss while
most vanish because they are shell corporations. It means in this process of data collection even the data of such fake
companies are collect ed which contribut e to the GDP of the country.

Wit h respect to collection of dat a from t he unorganised sect or a survey is conduct ed aft er a gap of every five years. During
the next five years until the next survey is conduct ed we assume t hat even the GDP of t he unorganised sector has grown at
the same rate at which the organised sector has grown. The unorganised sector is prone to economic shock such as
demonetisation, Covid crisis, etc. However, because of this assumption that the unorganised sector would have grown at
the same rate at which the organised sector has grown such economic shock are ignored. Which is not justified. Hence,
the calculation of GDP under the new mechanism has been controversial.

Nominal Effective Exchange Rate & Real Effective Exchange Rate

Exchange rate refers to the value of a domestic currency against any other international currency. For example, if $1 ₹83
then it can be said that the exchange rate of dollar as compared to Indian currency is ₹83. It shows that in order to buy $1
we will have to spend ₹83. This is nominal exchange rate. However, when the exchange of the domestic currency is
compared with a basket of different currencies then it is termed as Nominal Effective Exchange Rate(NEER).

When the Exchange rate is derived on the basis of purchasing power parity then itʼs also termed as inflation adjust ed
exchange rate. It is also known as real exchange rate. When this inflation adjusted exchange rate is calculated against a
basket of different currencies rather than a single currency then it is termed as Real Effective Exchange Rate(REER).

If a statement is given that the exchange rate is increasing then it means that our domestic currency is becoming
costlier/stronger. If this happens our trade competitiveness i.e. export will suffer adversely. But the risk related to external

debt will decline( Monetary policies).

National Income 11
 🧾
Fiscal System
Date created @August 6, 2024 1:17 PM

Revisions 1

Start date @August 6, 2024

Status Complete

Introduction
@August 6, 2024
@August 7, 2024
Fiscal System and Fiscal Policies in India
Reforms Introduced in Budget 2017-18
Receipts and Expenditure
@August 8, 2024

Fiscal System 1
 Deficits of the government
Fiscal deficit
Revenue deficit
Primary deficit
@August 9, 2024
Effective Revenue Deficit
Effective capital expenditure
Monetised Deficit
Deficit financing
Ways and Means Advances(WMA)
@August 10, 2024
Fiscal Responsibility and Budget Management(FRBM) Act 2003
Fiscal Activism and Pump Priming
@August 12, 2024
15th Finance Commission
Important terms of reference
Recommendations of 15th Finance Commission
Income distance
Off/Extra budget borrowing
Fiscal Consolidation
16th Finance Commission
@August 13, 2024
Financial Sector Legislative Reform Commission(FSLRC)
Public Debt Management Cell(PD MC)
Status Paper on Government Debt(12th edition)
@August 16, 2024
Types of Budgeting
Line Item Budget
Performance Budget and Outcome Budget
Zero Base Budget
Gender Budget
The merger of Rail Budget and General Budget
Model questions

Introduction
@August 6, 2024
Fiscal system refers to the receipt and expendit ure of the government. In order to enhance the receipt and manage the
expendit ure the policies which are formulat ed are termed as fiscal policies. The fiscal policies are the responsibilit y of the
finance ministry. The complete detail of the actual receipt and expenditure and even the estimated detail of the receipt and
expendit ure are present ed in the parliament in the form of budget. The budget is technically known as annual financial
statement. It is laid down in the parliament in the name of the President of India. Once the budget is passed in the
parliament, the government is authorised to withdraw funds from the Consolidated Fund of India(CFI) in order to meet its
expenditure in the upcoming financial year(FY). This is the reason why a budget is always for the FY which is about to
start. For example, if budget is presented on February 1st, 2025 it will termed as Budget 2025-26. Just one day prior to the
budget , the Economic Survey(ES) is present ed in the parliament. However, it will be associat ed with the FY which is about
to get over. Hence, the ES that will be present ed on January 31st, 2025 will be termed as Economic Survey 2024-25.
The year in which the general election is to be conducted, the outgoing government is constitutionally restricted to get the
full year budget passed. Only the new government which is formed after the election will have the authority to get the full
year budget passed. Hence the outgoing government will come out with interim budget. This interim budget is only for the
period till the new lok sabha is constitut ed.

On February 1st 2024, interim budget was presented and once the new lok sabha(new government) is formed, the full year
budget is passed. In a budget, data related to three different FYs are mentioned. The FY which is about to start for that we
will have budget estimat e. The FY which is about to get over, for that we will have revised estimat e and the FY which is
already over for that we will have actuals(act ual numbers).

Budget estimate for 2024-25 Revised estimate for 2023-24 Actuals for 2022-23

Fiscal System 2
 @August 7, 2024
In the budget 2017-18 three important reforms were introduced—

1. The date on which the budget is presented in the Parliament was changed from last working day of February to the first
working day of February. It was a much needed change introduced with respect to the budget. Earlier when the budget
was present ed on the last working day, a recess was declared. After going through the provision of the budget , the
parliamentarian would assemble on resumption of the session and a healthy debate on the budget was expected. Aft er
the debate, the budget was passed in the parliament. However it used to be a long process and finally the government
was able to get the budget passed only by the month of May. Therefore, till the time budget was passed, in order to
meet the expenditure of the government, vote on account was presented in the parliament. To seek permission from
the parliament to withdraw fund from the consolidat ed fund of India(CFI). However, after change of the date of
presenting the budget now the government is able to get the budget passed even before the FY starts. Hence, even
vote on account is not required.

2. In the budget 2017-18 it was decided that calculation of planned expenditure and non-planned expenditure will also be
discontinued. Planned expenditure used to be that expenditure of the government which was already mentioned in the
five year plans. Since the planning commission was discontinued and the recommendations of the 12th five year plan
were to expire on March 31st 2017 it was not possible to calculat e planned expendit ure any more.

3. After 92 years rail budget was merged with general budget.

Fiscal System 3
 Shorts

Fiscal System and Fiscal Policies in India

Fiscal System: Government receipts and expenditures.

Fiscal Policies: Formulated by the finance ministry.

Budget: Annual financial statement presented in parliament.

Lays out actual and estimated receipts and expenditures.

Presented in the name of the President of India.

Authorizes fund withdrawal from the Consolidated Fund of India (CFI).

Example:

Budget presented on February 1, 2025, termed Budget 2025-26.

Economic Survey on January 31, 2025, termed Economic Survey 2024-25.

Interim Budget:

Presented in election years.

Covers period until the new government is formed.

New government passes the full-year budget .

Budget Data:

Budget Estimate: FY about to start (e.g., 2024-25).

Revised Estimate: FY about to end (e.g., 2023-24).

Actuals: FY already over (e.g., 2022-23).

Reforms Introduced in Budget 2017-18

1. Presentation Date Change:

From last working day of February to the first working day.

Eliminated need for vote on account.

2. Discontinuation of Planned and Non-Planned Expenditure:

Due to the end of the Planning Commission and five-year plans.

3. Merger of Rail Budget with General Budget:

After 92 years, rail budget merged with the general budget.

Receipts and Expenditure

Receipts refer to what the government is earning. On the other hand expenditure of the government refers to what the
government is spending.

The receipts of the government are broadly classified into the following two types— Revenue receipt and Capital receipt.

Revenue receipts are all such receipt s which neither lead to liability over the government nor they reduce the asset of the
government. In other simple words such receipts are neither in the form of borrowings of the government nor they are not
made by sale of any government asset. Revenue receipts can again be classified into tax receipt and non-tax receipt. The
sources/forms revenue receipt are the following —

1. Direct and indirect taxes(tax receipt) 6. User service charges such as on electricit y supply, water
supply, transport ation, etc.
2. Penalty imposed by the government
7. Grants
3. Dividend received from the public sector
companies (Other than the taxes all the above mentioned receipts are a
part of non-tax receipt)
4. Income from rent or lease

Fiscal System 4
 5. Receipt in the form of interest over the loan given
by the government.

Different from revenue receipt, the government 's capital receipt can be defined as those receipts which are either in the
form of liability or which reduce the asset of the government. In other simple words, those receipts which are in the form of
borrowings or those receipts which come through sale of asset will be termed as capital receipt. It may include the
following—

1. Receipt through privatisation and disinvestment 3. Receipt through sale of land, building, etc.

2. Receipt through domestic as well as external 4. Recovery of the principal of the loan given to any other
borrowings entity.

For the centre, revenue receipt is always higher than the capital receipt. In the budget 2024 -25, for the same FY, total
revenue receipt is estimated to be more than ₹31 lakh crore whereas capital receipt is estimated to be just below ₹17 lakh
crore.

In the budget 2024-25, it has been revealed that direct and indirect taxes combined together are still the largest source of
receipt. The direct taxes continue to contribute more as compared to the indirect taxes. Out of all the taxes individually,
income tax has become the single largest source of tax receipt surpassing GST. If all the different types of taxes are
counted individually, then borrowings become the largest source of receipt for the centre.

Out of the total receipt the contribution of all the taxes together is 63% in Income tax cont ributes the maximum(19%). GST
is the second largest contributor(18%). However, different from the taxes, the borrowings alone contribute 27% in the total
receipt of the government.

Just like the receipts even the expendit ure of the government can be classified into the following two types— Revenue
expenditure and Capital expenditure
Revenue expenditures include those expenditure which are meant for consumption and they do not create any asset. It
may include the following—

1. The grants given to the state Including state devolution 6. Maintenance cost of different assets

2. Payment of salary and pension to the government employees 7. Maintenance of law and order

3. Scholarships given to the student 8. Defence

4. Interest interest payments over the borrowings 9. Welfare schemes

5. Subsidies 10. Expenditure to meet natural calamities

Different from the revenue expenditure, the governmentʼs capital expenditure include those expenditures which create an
asset and may include the following—

1. Infrastructure development

2. Social infrastruct ure such as construction of schools and hospitals

3. Cultural infrastructure such as theatre, library, museum, etc.

4. Industrialisation

5. Loan given to any other entity

6. In expenditure such as Defence, welfare schemes, etc. some part maybe spent for capital formation/asset creation. For
example, procurement of fighter planes, warships, etc. Such expenditure are counted under capital expenditure in the
process of calculation.

The revenue expenditure of the Centre is always higher as compare to the capital expenditure. In the budget 2024 -25, it is
estimated that the revenue expenditure of the Centre will be more than 37 lakh crore. For the same financial year, it is
estimated that the capital expenditure Will be more than 11 lakh crore.

In the total expenditure of the centre, the grants given to the states, including state devolution is the single largest
expenditure. They contribute, 9+21 30% of the total expenditure. The second largest expenditure is interest payment,
which is 19% of the total expenditure.

@August 8, 2024

Fiscal System 5
 In the budget 2024-25, it has been mentioned that out of the total expendit ure of the government 8% is spent over
centrally sponsored schemes and 16% is spent over central sector schemes. Centrally sponsored schemes are those
welfare schemes in which the centre as well as the states both contribute in the same or in different ratios. On the other
hand central sector schemes are those schemes which are completely funded by the centre. Out of the total expendit ure
8% goes to defence whereas 6% goes to subsidies.

Fiscal System 6
Fiscal System 7
 Shorts

Revenue Receipt Details (2024-25)

Taxes (63% of total receipts):

Income tax: 19% (largest individual source).

GST: 18%.

Borrowings: 27%.

Budget 2024-25: Revenue receipts estimated at ₹31+ lakh crore, capital receipts below ₹17 lakh crore.

Expenditure Details (2024-25)

Grants to states and state devolution: 30% of total expenditure.

Interest payments: 19% of total expenditure.

Budget 2024-25: Revenue expenditure estimated at ₹37+ lakh crore, capital expenditure over ₹11 lakh
crore.

Budget 2024-25: Allocation of Government Expenditure

Central Sector Schemes (CS): Schemes fully funded by the Centre.

Expenditure Share: 16% of the total government expenditure.

Centrally Sponsored Schemes (CSS): Welfare schemes jointly funded by the Centre and states (same or
different ratios).

Expenditure Share: 8% of the total government expenditure.

Defence: 8% of the total government expenditure.

Subsidies: 6% of the total government expenditure.

Deficits of the government

When the receipt of the government is more than its expenditure then the government is said to be in surplus. On the other
hand, when the receipt is less than the expendit ure the government is in a deficit. The deficits of the government can be
classified into different types—

1. Fiscal deficit

2. Revenue deficit

3. Primary deficit

4. Effective revenue deficit

5. Monetised deficit(no longer calculated)

Fiscal deficit
It refers to the difference between the total receipt(excluding the borrowings) and the total expenditure of the government.
If the receipt is less than the expendit ure then fiscal deficit will exist. Here total receipt includes revenue receipt as well as
capital receipt and total expendit ure includes revenue expendit ure as well as capital expendit ure. The borrowing of the
government in that FY will be equal to the fiscal deficit. If the borrowing is counted as the part of the receipt then deficit
will not be reflect ed(will appear zero). The government borrows in order to bridge this deficit.
When fiscal deficit is to be expressed in %, then it is compared with the GDP. Hence, in order to bring down fiscal deficit
either the income should be enhanced or the expenditure can be brought down or they both can be done simultaneously. If
the GDP increases, and deficit remains the same in terms of % the deficit will automatically decline.

In the budget 2024-25 the budget estimate for FY 2024-25, w.r.t. fiscal deficit is 4.9% of the GDP. The revised estimate for
2023-24 is 5.8% of the GDP. The actual fiscal deficit in 2022-23 was 6.4% of the. GDP.

Fiscal System 8
 Revenue deficit
In calculation of revenue deficit, capital receipt and capital expenditure do not play any role. In its calculation only revenue
receipt and revenue expenditure are taken in to consideration. If the revenue receipt is less than revenue expenditure then
the government is in revenue deficit. Revenue deficit is a serious concern. It shows that the revenue receipt of the
government is not enough to cover even the consumption expenditure and the government is borrowing even in order to
meet its consumption expenditure.
Just like fiscal deficit even in case of revenue deficit in order to express in percentage it is compared with the GDP. In order
to bridge this deficit will have to enhance its revenue receipt and will have to its revenue expenditure.

In the budget 2024-25 it is estimated that the revenue deficit for the FY 2024-25 will be 1.8% of the GDP. For the FY 2023-
24 the revised estimate is 2.8% of the GDP. For FY 2022-23 the actual revenue deficit was 4% of the GDP.

Primary deficit
In the total expenditure of the government, interest payment is an important part. This interest payment is for the
accumulated debt of the previous years. When the government tries to find out that if the burden of interest payments was
not there, what would be the deficit then for this purpose the interest payments is subtracted from the fiscal deficit and we
derive the primary deficit.

Primary deficit = Fiscal deficit − Interest payments

In the budget 2024-25 it is estimated that the primary deficit for the FY 2024-25 will be 1.4% of the GDP. For the FY 2023-
24 the revised estimate is 2.3% of the GDP. For FY 2022-23 the actual revenue deficit was 3% of the GDP.

@August 9, 2024
Effective Revenue Deficit
The calculation of effective revenue deficit was introduced in India by amending FRBM Act in the year 2011-12. Prior to that
effective revenue deficit was not calculat ed. The grants given to the states by the centre is a part of its revenue
expenditure and a part of their revenue receipt for the states. Since, the grants given is a part of the revenue expenditure of
the centre they contribut e in the revenue deficit of the centre. However, this entire grant received by states may not be
completely used for the purpose of consumption. It is a possibility that some part of the grant maybe used by the states in
order to create asset. Hence, this part of the grant is ultimat ely being used for the purpose of asset creation.

This part of the grant which is used by the states for the purpose of asset creation is subtract ed from the revenue deficit of
the centre and the remaining revenue deficit is termed as effective revenue deficit. Its calculation was initiated on the
recommendations of the 13th Finance Commission. However, the 14th Finance Commission was against its calculation.
In the budget 2024-25 it is estimated that in FY 2024-25 the effective revenue deficit will be 0.6% of the GDP. For the FY
2023-24 the revised estimate is 1.8% of the GDP. For FY 2022-23 the actual revenue deficit was 2.8% of the GDP.

Effective capital expenditure

The grants given to the state by the centre is a part of centreʼs revenue expenditure. However, some part of the grant is
used by the states for the purpose of asset creation. When this part which has been used by the states for the purpose of
asset creation is added to the capital expendit ure of the centre then the total is termed as effective capital expendit ure of
the centre.

Monetised Deficit
The concept of monetised deficit existed in India till 31st March 1997 and was discontinued on 1st April 1997. Prior to this, in
order to bridge its deficit, the government used to borrow from the banking system and other financial institutions. It also
borrowed from the public and external sources as well. Even after these borrowings, if the deficit existed, it was bridged by
printing fresh currency. In this entire process the RBI was compelled to print fresh currency, and in return the government
would issue ad-hoc treasury bills. Fresh currency was given to the government in the form of loans by the RBI. This part of
deficit which was reached by printing fresh currency was termed as monetised deficit.

Since printing of currency is highly inflationary in nature and it also led to the depreciation of the Indian currency, the
mechanism was criticised. Through this mechanism, the government was able to borrow easily which affect ed the fiscal
discipline in the country. Hence this mechanism was discontinued. During the Covid crisis, the government had to borrow

Fiscal System 9
 more. There was a shortage of funds in the banking system and even the public was not in a position to lend. The liquidity
condition in the international market was also not conducive. Hence different economists advised the government to revive
the mechanism of monetised deficit.

Deficit financing
The process of financing the deficit is termed as deficit financing. If the government is in deficit it will have to bridge the
deficit. For this purpose it borrows from the banking system and from the financial institutions. However, the government
does not borrow from the banking system beyond a certain limit. It is mainly because if the government borrows
continuously, the banks may not be left with sufficient funds to lend to the private sector. It may throw the private sector
out of the economy. This phenomenon is termed as crowding out.

In the process of deficit financing the government also borrows from the public through small savings schemes such as by
sale of national savings certificate and other such instruments. The government also borrows from the external sources
but external borrowings are highly risky. Since, the exchange rate of foreign currency keeps on fluctuating, if rupee
depreciates the external debt will automatically increase. At the same time external debt is to be repaid with interest in hard
currency. Hence, in this process of deficit financing the remaining deficit was bridged by printing fresh
currency(monetised deficit).

This entire process was termed as the process of deficit financing. However, printing of fresh currency was highly
inflationary and at the same time it also affected the fiscal discipline in the country. Therefore, this mechanism is modified
and Ways and Means Advances(WMA) was introduced.

Ways and Means Advances(WMA)

For the centre WMA as a facility was introduced on 1st April 1997. This facility was available to the states even before that.
Except Sikkim all the states in India avail this facility from the RBI. It is a facility through which temporary mismatch
between income and expendit ure can be bridged. To avail t his facilit y, t he st at es have to open a current account with t he
RBI. The minimum balance which is to be maintained is decided on the basis of the size of the stateʼs GDP. The states will
have to maintain their surplus in this current account.

In order to avail this facility even the centre had to open a current account with the RBI. In this current account o n every
Friday and on the last day of the FY of the centre(Government of India) and the last day of the FY of the RBI at least ₹100
crore is to be maintained as minimum balance. On any other day it has to be at least ₹10 crore.

(The FY of the government starts on 1st April and it ends on 31st March. However, initially the FY of RBI used to start on
July 1st and ended on June 30th. It was decided that the FY of the RBI will be modified as the FY of the government.
Hence, in 2020 the FY of the RBI start ed on 1st July but ended on March 31st 2021. This was done in order to ensure that
from the next FY the st arting dat e and the closing date for the government as well as the RBI will be the same. Hence, the
FY 2020-21 of RBI had only 9 months).
Under WMA it was decided t hat fresh currency will not be issued in order to bridge t he deficit of t he government. It was
also decided that from April 1st 1997 ad-hoc treasury bills will be discontinued. Under this mechanism in the beginning of
the FY itself, the Government of India and the RBI mutually decide that when all the sources are exhausted w.r.t. borrowing
then the maximum amount that the RBI can provide in the form of short term loans. This short term loan under WMA has a
maturit y period is 90 days. The rate of interest is equal to repo rate. If this amount decided in the beginning of the FY is
exhaust ed and the government is sill in need of funds then the additional amount provided by the RBI will be termed as
overdraft. This overdraft is to be repaid within twelve working days. If the overdraft is upto 100% of the initially decided
amount then the rate of interest will be repo rate +2%. If it exceeds 100% of the initially decided amount then over the
exceeded amount the rate of interest will be repo rate + 5%. It shows that if the government fails to manage its borrowings
the rate of interest will continue to increase.

Fiscal System 10
 Shorts

Deficits of the Government

Surplus vs. Deficit:

Surplus: When the government's receipts exceed its expenditure.

Deficit: When the government's receipts are less than its expenditure.

Types of Deficits:

1. Fiscal Deficit:

Definition: The difference between total receipts (excluding borrowings) and total expenditure.

Relation to Borrowing: Government borrowing equals the fiscal deficit.

Budget 2024-25:

Estimated Fiscal Deficit for FY 2024-25: 4.9% of GDP.

Revised Estimate for FY 2023-24: 5.8% of GDP.

Actual Fiscal Deficit for FY 2022-23: 6.4% of GDP.

2. Revenue Deficit:

Definition: The difference between revenue receipts and revenue expenditure.

Concern: Indicates borrowing to meet consumption expenditure.

Budget 2024-25:

Estimated Revenue Deficit for FY 2024-25: 1.8% of GDP.

Revised Estimate for FY 2023-24: 2.8% of GDP.

Actual Revenue Deficit for FY 2022-23: 4% of GDP.

3. Primary Deficit:

Definition: Fiscal deficit minus interest payments.

Budget 2024-25:

Estimated Primary Deficit for FY 2024-25: 1.4% of GDP.

Revised Estimate for FY 2023-24: 2.3% of GDP.

Actual Primary Deficit for FY 2022-23: 3% of GDP.

4. Effective Revenue Deficit:

Definition: Revenue deficit minus grants used by states for asset creation.

Introduced: In 2011-12 via the FRBM Act amendment.

Budget 2024-25:

Estimated Effective Revenue Deficit for FY 2024-25: 0.6% of GDP.

Revised Estimate for FY 2023-24: 1.8% of GDP.

Actual Effective Revenue Deficit for FY 2022-23: 2.8% of GDP.

5. Monetised Deficit (No longer calculated):

Definition: The deficit bridged by printing fresh currency.

Discontinued: 1st April 1997 due to its inflationary nature and impact on fiscal discipline.

Effective Capital Expenditure:

Definition: Capital expenditure plus the part of grants to states used for asset creation.

Deficit Financing:

Definition: The process of financing the government deficit.

Fiscal System 11
 Sources: Borrowing from banks, financial institutions, public (e.g., small savings schemes), and external
sources.

Crowding Out: Excessive government borrowing from banks may reduce funds available for the private
sector.

Ways and Means Advances (WMA)

Introduction:

Introduced for the Centre on April 1, 1997.

Available to states earlier; except Sikkim, all Indian states use this facility.

Purpose:

Temporary solution for mismatches between income and expenditure.

State Requirements:

States must open a current account with the RBI.

Minimum balance based on the st ateʼs GDP size.

States must maintain their surplus in this account.

Centre Requirements:

Centre also required to open a current account with RBI.

Minimum balance:

₹100 crore on Fridays and last day of FY (for both Centre and RBI).

₹10 crore on any other day.

Fiscal Year Alignment:

FY for Govt: April 1 - March 31.

RBIʼs FY aligned to the Govtʼs FY from 2021 (previously July 1 - June 30).

FY 2020-21 for RBI: 9 months (July 2020 - March 2021).

Mechanism:

Fresh currency issuance for government deficit is prohibited.

Ad-hoc treasury bills discontinued from April 1, 1997.

Govt and RBI mutually decide the maximum short-term loan limit at FY start.

Loan maturity: 90 days.

Interest rate: Equal to repo rate.

Overdraft Facility:

Additional funds provided beyond the agreed WMA amount.

Repayment period: 12 working days.

Interest rates:

Up to 100% of WMA limit: Repo rate + 2%.

Over 100% of WMA limit: Repo rate + 5%.

Implication:

Failure to manage borrowings results in escalating interest rates.

@August 10, 2024

Fiscal System 12
 Fiscal Responsibility and Budget Management(FRBM) Act 2003
Since the Fiscal health of the country was continuously declining, a committ ee was constitut ed under the chairmanship of
Vijay Kelkar. This committee was also known as the Kelkar task force. It suggested that the deficits of the government must
be brought down in a targeted manner. The targets recommended were enacted in the form of an act by the parliament
known as the FRBM act 2003. It became effective in 2004. The major provisions of the act were the following—

1. From FY 2004-05, every year fiscal deficit should be reduced by 0.3% of the GDP

2. By 31st Match 2009 it should be brought down to 3% of the GDP.

3. From 2004-05 every year revenue deficit should be reduced by 0.5% of the GDP.

4. By 31st March 2009 revenue deficit should be drought down to zero.

5. As compared to the previous FY the borrowing of the government in the current FY should not exceed 9%.

6. The complete detail of the fiscal health of every quarter should be presented in the parliament to maintain
transparency.

7. In case of unforeseen circumstances the targets can be modified.

Till the beginning of 2008 the fiscal health of the government was completely on track as suggested by the FRBM act.
However, the American recession compelled the government to increase its expenditure in order to pump additional money
in the economy. At the same time due to elections in 2009 the government came out with several welfare schemes tinged
with populism. Even this affected the fiscal health of the government. Since, the government was not able to meet the
targets, the act was amended again and again. In the year 2011-12, amending the act effective revenue deficit was
introduced. It was decided that if the government is unable to bring down the revenue deficit to zero then at least effective
revenue deficit must be brought down to zero by 31st March 2015. However, the government failed to achieve even this
objective.

Since the government was failing to achieve the targets of the FRBM act y-o-y, and the targets were being modified again
and again a debate around it emerged. People against the FRBM act argued that it has no relevance now. If the targets are
not being achieved and they are being amended again and again the act becomes meaningless. Because of these targets
the government remains under pressure and in order to reduce its expenditure it even fails to fulfil its social responsibilities.

The other side of the debate argued that the act has its own relevance even if the government is failing to achieve the
targets these targets compel the government to maintain fiscal discipline. They prevent the government from spending
recklessly. The targets make the government answerable and account able. Hence, it should continue.

In order to resolve the debate, the government constituted a committee under the chairmanship of N.K. Singh.

The FRBM review committee headed by NK Singh came out with the following recommendations:

1. It suggested that FRBM act should continue to exist. Even if the government is not able to meet the targets. it
pressurises the government to maintain fiscal discipline. However, there should be an escape clause of 0.5% over the
target and even if the deficit is within 0.5% of the set target then it is alright.

2. In order to formulate fiscal policies, a fiscal council must be constituted.

3. This review committee was constituted in 2016 and it came with its recommendations in 2017. The committee
suggested that 2017-23 the policies should be formulated in such a manner that fiscal deficit of the government comes
down to 2.5% of the GDP.

4. From 2017 to 2023 revenue deficit should be brought down to 0.8% of the GDP.

5. The combined accumulated outstanding debt of the centre and the states was 70% of the GDP. In this the contribution
of the centre was 49% and 21% of the states. The committee suggested that the total outstanding debt should be
brought down to 60% of the GDP in which centres contribution must not exceed 40% and the contribution of the states
should not exceed 20%. However, due to Covid crisis the income of the centre as well as the states came down at a
rapid pace but the expenditure remained extremely high. Hence, the government failed to meet even these targets.

Fiscal Activism and Pump Priming

In a situation of economic slowdown or recession when the government tries to revive the economy using the fiscal
policies actively then it is termed as fiscal activism. In this fiscal activism the government may reduce direct taxes in the
form of income tax so that surplus money is left with the consumers to consume. Indirect taxes such as GST maybe
reduced so that the goods and services become cheaper which will make consumption even more attractive. The

Fiscal System 13
 government may increase public expenditure(done by the government) in the form of welfare schemes and developmental
activities. This infusion of additional funds in the economy is aka pump priming. All these measures are a part of fiscal
activism which helps in reviving the demand in the economy leading to economic growth. However, this adversely affects
the fiscal health of the government.

Fiscal System 14
 Shorts

Fiscal Responsibility and Budget Management (FRBM) Act 2003

Background:

Reason for Enactment: Declining fiscal health of the country.

Committee: Chaired by Vijay Kelkar (Kelkar Task Force).

Objective: To reduce government deficits in a targeted manner.

Key Provisions:

1. Fiscal Deficit Reduction: Start: FY 2004-05. Annual Reduction: 0.3% of GDP. Target: Reduce to 3% of
GDP by 31st March 2009.

2. Revenue Deficit Reduction:

Start: FY 2004-05.

Annual Reduction: 0.5% of GDP.

Target: Reduce to zero by 31st March 2009.

3. Borrowing Limit: Government borrowing in the current FY should not exceed 9% of the previous FY.

4. Transparency: Quarterly fiscal health reports to be presented in Parliament.

5. Flexibility: Targets can be modified in unforeseen circumstances.

Challenges and Amendments:

2008 Recession: Increased government expenditure to stimulate the economy.

Elections in 2009: Introduction of populist welfare schemes.

2011-12 Amendment: Introduction of Effective Revenue Deficit, aiming to reduce it to zero by 31st March
2015, but the target was not achieved.

Debate on FRBM Act:

Against FRBM Act:

Argument: Act is irrelevant if targets are not met and constantly amended.

Impact: Pressure on the government, leading to reduced social expenditure.

For FRBM Act:

Argument: Ensures fiscal discipline and prevents reckless spending.

Accountability: Makes the government answerable.

NK Singh FRBM Review Committee Recommendations (2017):

Fiscal System 15
 Fiscal Deficit Target: Reduce to 2.5% of GDP by 2023.

Revenue Deficit Target: Reduce to 0.8% of GDP by 2023.

Outstanding Debt:

States' contribution: Should not exceed 20%.

Fiscal Activism and Pump Priming

Fiscal Activism:

Tax Reductions:

Direct Taxes (e.g., Income Tax): Leaves consumers with more disposable income.

Increased Public Expenditure:

Welfare Schemes and Developmental Activities: Government spending boosts economic activity.

Pump Priming:

Impact: Revives demand but can adversely affect the government's fiscal health.

@August 12, 2024

15th Finance Commission

Article 280 of the constitution provides for a Finance Commission. The finance commission plays an important role in the
centre-state financial relationship. The first finance commission was constituted in 1951. The 15th Finance Commission had
been constitut ed under the chairmanship of N.K.Singh.

Important terms of reference

1. It had to review the receipt/revenue of the government.

2. It had to review the expenditure of the government.

3. By reviewing the receipt and expendit ure a road map for fiscal consolidation was to
be prepared.

Fiscal System 16
 4. The outstanding debt of the states, as well as the centre as compared to the GDP, was to be reviewed and a road map
was to be prepared to bring them down.

5. The state devolution of 42% of the total tax receipt of the centre was to be reviewed.

6. Some of the states are also given a revenue deficit grant by the centre. Even this was to be reviewed whether it should
be there or not.

7. The impact of GST was to be reviewed and even the mechanism of compensating the states for any revenue loss due
to GST was to be reviewed.

8. Art 293 (3) of the constitution says that if a state has borrowed from the centre and is yet to repay, then to borrow fresh
loan, the state must seek permission from the centre. Even this provision was to be reviewed. The article and clause is
still there.

9. In the case of Disaster Management, the share of the centre and states was to be reviewed.

10. The commission was required to examine whether a separate funding mechanism for defence and internal security
should be set up and if so, how it can be operationalised.

11. While deciding that out of the total tax receipt of the centre how much amount will go to which state. The census data
of 2011 will be taken into consideration. The data of 1971 wil no longer be considered. (It was the most controversial
provision which was being opposed by the South Indian States. They believed that it is a kind of incentive being given
by the centre to states which have failed to control population growth.)

Recommendations of 15th Finance Commission

The 15th Finance Commission was required to submit two
reports. The first report consist ed of recommendations for
the financial year 2020-21. The second report had the
recommendations for the 2021-26 period. The 15th Finance
Commission used the following criteria while determining
the share of states:-

1. 45% for the income distance

2. 15% for the population in 2011

3. 15% for the area

4. 10% for forest and ecology

5. 12.5% for demographic performance

6. 2.5% for tax effort

Based on this Uttar Pradesh and Bihar received the largest devolutions for 2020- 21, receiving ₹1,53,342 crore, and
₹86,039 crore respectively. Karnataka and Kerala saw the largest decline in the share of the divisible pool with a fall of
0.49% and 0.25% respectively.

The recommendations of the 15th Finance Commission are as follows:-

1. The share of states in the centre's taxes is recommended to be decreased from 42% to 41% for period 2020-21 and
2021-26. The 1% which is set aside is for the allocation to the newly formed union territories of Jammu &Kashmir and
Ladakh from the resources of the central government.

2. The commission noted that recommending a credible fiscal and debt trajectory roadmap remains problematic due to
uncert aint y around the economy. It recommended that both central and state government s should focus on debt
consolidation and comply with their respective targets of fiscal deficit and debt levels as per Fiscal Responsibilit y and
Budget Management (FRBM) Acts.

3. The Commission observed that financing capital expendit ure through Off-Budget Borrowings deviates from the
compliance of the FRBM Act. It recommended that both the central and state governments should make full disclosure
of Extra Budget ary Borrowings.

4. In 2018-19, the tax revenue of state governments and central government together stood at around 17.5% of the GDP.
The commission noted that tax revenue is far below the estimat ed tax capacit y of the country. Further, India's tax

Fiscal System 17
 capacity has largely remained unchanged since the early 1990s. In contrast, tax revenue has been rising in other
emerging market s. The commission recommended of:-

a. Broadening the tax base.

b. Streamlining tax rates.

c. Increasing capacity and expertise of tax administration in all tiers of the government.

5. The Commission highlighted some challenges with the implementation of the GST—

a. Large shortfall in collections as compared to the original forecast.

b. High volatility in collections.

c. Accumulation of large integrated GST credit.

d. Glitches in invoice and input tax matching.

e. Delay in refunds.

6. The commission observed that the continuing dependence of states on compensation from the central government is a
concern. In its second report for the period 2021-26 the commission has recommended post-devolution revenue deficit
grants amounting to about ₹3 trillion over the five- year period. According to the commission, the number of states
qualifying for the revenue deficit grants will decrease from 17 in Fiscal Year 2022 (the first year of the award period) to
6 in Fiscal Year 2026(the last year)

7. The arrangement for disaster management should remain the same.

8. Regarding separate funding mechanism for defence and internal security, the commission suggests to constitute an
expert group comprising represent atives of the Ministries of Defence, Home Affairs, and Finance. The commission
noted that the Ministry of Defence proposed the following measures for this purpose:

a. Setting up of a non-lapsable fund.

b. Levy a cess.

c. The monetisation of surplus land and other assets.

d. Tax-free defence bonds.

e. Utilising proceeds of disinvest ment of defence public sector undert akings.

The expert group is expected to examine these proposals or suggest alternative funding mechanisms.

Income distance
In deciding the horizontal devolution given to the states by the centre from its total tax receipt income plays a very
important role. Income distance shows that economically where exactly a particular state stands. More the distance, poorer
the state. Lesser the distance, better the state economically. For the purpose of measuring the income distance, the per
capita income/GDP of a state is compared with the per capita income/GDP of the state which is at the top most position.
Since, in terms of per capita GDP and per capita income, Goa and Sikkim are the top two states but they are extremely
small in size the 15th finance commission measured the income distance in comparison to Haryana which was at the third
position.

Off/Extra budget borrowing

There are a number of government agencies which have several responsibilities. But they do not have sufficient source of
income. For example, Food Corporation of India(FCI). Such government agencies depend upon the government to meet
their expendit ure. If the government borrows to provide to such agencies, the loan will be reflect ed in the books of the
government . However, if these agencies are asked to borrow directly from the market the loan will be reflect ed in the
books of such agencies but ultimately the responsibility to repay will lie with the government. This will have consequences
over the fiscal health of the government. But since they are not in the books of the government, they will not appear in the
budget. This is termed as extra/off budget borrowing. The 15th Finance Commission suggested that the government must
avoid such extra budget borrowings and if such borrowings are done they must be revealed in a transparent manner.

Fiscal System 18
 📎
contribute 10%. In case of any other state the centre contributes 75% and the states contribute 25%.

Fiscal Consolidation
It refers to a process through which the government reduces its deficits. In a country, fiscal consolidation becomes
essential mainly because the high deficit will lead to high borrowings, which will increase the burden of interest payment
by the government. If the burden of interest payment remains high the government will be left with lesser resources for
development al activities. High borrowings also affect the credit ratings of a country which has an adverse impact on
foreign investment and at the same time the cost of borrowing for the government from international sources increases.
Hence deficits may not be good for a country.

In a country like India, the capital and revenue expenditure both have remained high for the government. Post
Independence due to the lack of private investors the government had to play the role of an investor. Industrialization and
infrastructure development have been other important responsibilities of the government.

In the case of revenue expendit ure, education and health-care remained the responsibility of the government. Because of
economic disparity in India, in order to ensure social justice the government had to initiate several welfare schemes. At the
same time since poverty remained high, to ensure the availability of essential commodities and services, subsidies were
used as an instrument.

Along with it due to lack of awareness and prevalence of corrupt practices, the tax compliance remained low in the
country. Out of the total voters only 7% file income tax return which means that out of the total population in the country
not even 2% file income tax return. Apart from this, to achieve certain policy objective the Tax Expenditure of the
government remained high. Tax Expenditures refers to the tax exemptions given by the government.

The deficits in the country are not always bad. However, the revenue deficit overall is not good for the economy. The
'Golden Rule of Fiscal Consolidation' states that revenue deficit should be brought down to zero and borrowing should only
take place for capital formation. To
reduce the deficit, the income and expendit ure both should be taken care of. Under fiscal consolidation following measures
can be adopted-

1. Downsizing of the Ministries

2. Downsizing of the Bureaucracy.

3. Discontinuing those welfare schemes which are socially and economically no more beneficial.

4. Rationalizing the subsidies i.e. either discontinuing them or by preventing diversion through DBT (Direct Benefit
Transfer).

5. By simplifying the taxes and the procedure of filing the taxes.

6. By making the tax laws stringent.

7. By creating awareness among the taxpayers with respect to their duties.

8. By gradually shifting towards a less-cash economy and promoting online transactions.

9. By making demonetization a frequent process.

10. By enhancing the tax base rather than increasing the tax rate.

11. The receipt of the government can be enhanced even by disinvestment. Even different government resources can be
monetised in order to ensure additional receipt. For example, railway land and defence land can be monetised,
highways can be used for advertisement through billboards, railways platforms and even the trains can be used for
publicity or campaigning in order to generat e additional income.

Even the process of Budgeting has to be made more effective and for the same purpose, the government adopted Zero-
Based Budgeting, Performance Budget , and even Outcome Budget .

Fiscal System 19
 Shorts

15th Finance Commission

Constitutional Provision:

Article 280: Provides for the constitution of a Finance Commission to oversee the financial relationship
between the Centre and States.

First Commission: Constituted in 1951.

15th Finance Commission: Chaired by N.K. Singh.

Terms of Reference:
1. Review Receipts/Revenue: Examine the government's revenue generation.

2. Review Expenditure: Analyze government spending.

3. Fiscal Consolidation: Develop a roadmap for reducing fiscal deficits.

4. Outstanding Debt: Review the debt of the Centre and States relative to GDP and create a plan to reduce it.

5. State Devolution: Re-examine the 42% tax devolution to states from central tax receipts.

6. Revenue Deficit Grants: Assess the necessity of these grants to states.

7. GST Impact: Review the impact of GST and the compensation mechanism for states.

8. Article 293(3): Review the provision requiring states with outstanding loans from the Centre to seek
permission for fresh borrowing. The article and clause is still there.

9. Disaster Management: Review the financial contributions of the Centre and States.

10. Defence and Internal Security: Consider setting up a separate funding mechanism for these sectors.

11. Census Data for Allocation: Use 2011 Census data instead of 1971 data for determining state shares, a
controversial point for South Indian states.

Recommendations of the 15th Finance Commission:

Reports Submitted:

First Report: Financial Year 2020-21.

Second Report: Recommendations for 2021-26.

Criteria for State Share Determination:

1. Income Distance: 45%.

2. Population (2011): 15%.

3. Area: 15%.

4. Demographic Performance: 12.5%.

5. Forest and Ecology: 10%.

6. Tax Effort: 2.5%.

Key Outcomes:

Largest Devolutions: Uttar Pradesh (₹1,53,342 crore) and Bihar (₹86,039 crore).

Decline in Shares: Karnataka and Kerala.

Major Recommendations:
1. State's Share in Central Taxes: Decrease from 42% to 41% for 2020-21 and 2021-26. The 1% reduction is
allocated to Jammu & Kashmir and Ladakh.

2. Fiscal and Debt Roadmap: Focus on debt consolidation and adhere to FRBM targets.

3. Off-Budget Borrowings: Both Central and State governments should disclose all Extra Budgetary
Borrowings.

Fiscal System 20
 4. Tax Revenue:

Current Level: 17.5% of GDP (2018-19).

Recommendations: Broaden the tax base, streamline tax rates, and improve tax administration.

5. GST Challenges:

Issues: Shortfall in collections, volatility, IGST credit accumulation, glitches in input tax matching, and
refund delays.

Concern: Continued state dependence on central compensation.

6. Revenue Deficit Grants: Recommended ₹3 trillion over 2021-26, with a decreasing number of states
qualifying for these grants.

7. Disaster Management: Maintain the existing funding arrangement.

Centre-State Contribution:

In hilly states, including the North Eastern states, the Centre contributes 90% for disaster
management, while the states contribute 10%.

In other states, the Centre contributes 75%, and the states contribute 25%.

8. Defence and Internal Security Funding:

Proposals: Non-lapsable fund, cess, asset monetization, tax-free defence bonds, and disinvestment
proceeds.

Expert Group: To review these proposals or suggest alternatives.

Income Distance:
Definition: Measures how far a state's income is from the highest income state.

Benchmark: 15th Finance Commission used Haryana, considering it a better representative than the
smaller states of Goa and Sikkim.

Off/Extra Budget Borrowing:

Definition: Borrowing by government agencies, which ultimately is the government's responsibility but
doesn't appear in its budget .

Recommendation: Avoid such borrowings or ensure full transparency if they occur.

Fiscal Consolidation:
Purpose: Reduce government deficits to avoid high debt and interest burdens, improve credit ratings, and
ensure more resources for development.

Challenges in India:

High capital and revenue expenditure due to infrastructure development and social responsibilities.

Low tax compliance and high tax expendit ure.

Golden Rule: Revenue deficit should be zero; borrowing should be only for capital formation.

Fiscal System 21
 Budgeting: Adopt Zero-Based Budgeting, Performance Budget, and Outcome Budget to enhance
effectiveness.

16th Finance Commission

Constitut ed on December 31st 2023

Recommendation expected by October 31st 2025

Arvind Panagariya, first vice-chairperson of the NITI Aayog, is heading the

commission

Recommendations will be implemented from April 1st 2026

Arvind Panagar iy a, chairman 16th finance

commission

@August 13, 2024

Financial Sector Legislative Reform Commission(FSLRC)

In the year 2010, the conflict between SEBI and IRDAI compelled the government to constitute FSLRC. This FSLRC was
headed by Justice BN Shrikrishan. It was constituted by the finance ministry in the year 2011 and the recommendations
were given in the year 2013. The commission was setup in order to suggest measures to prevent disputes among the
regulat ors. The disputes were mainly because of overlapping authorities. The commission studied the entire financial
system in the country and presented its report in two parts. In the first part it explained that how exactly the financial
system in India functions. What all are the responsibilities of the different regulators. In the second part the
recommendations were given and it was termed as India Financial Code. The recommendations of the FSLRC were as
follows—

1. The RBI should function only as a regulator and hence its responsibility to borrow on behalf of the government should
be taken away. The responsibilit y to sell government securities and to buy them back should be shifted to a new
agency specialising in that.

2. This new agency should be termed as Public Debt Management Agency(PDMA). This agency should be given the
responsibilit y to borrow on behalf of the government by sale of government securities.

3. There are different regulators in the country such as SEBI, FMC, IRDAI, Pension Fund Regulatory and Development
Authority(PFRDA). They all should be merged with each other and a super regulator should be created which should be
named as Unified Financial Agency(UFA). This agency should be divided into departments to regulate different sectors.
This will prevent clash of interest and authority.

4. In order to resolve any dispute, Financial Sector Appellate tribunal should be constituted.

5. The regulator must ensure that the financial institutions do not resort to anything which may harm the interests of the
customers.

6. The regulator must ensure that the financial institutions do not go bankrupt.

The government had decided that the responsibility to borrow on its behalf should be taken away from the RBI and was
supposed to be assigned to PDMA which was to be created. However, RBI under ex-governor Raghuram Rajan was
completely against it. He argued that buying and selling G-secs are also an integral part of its monetary policies.
Therefore, the responsibility must remain with the RBI. Because of this resistance the plan to setup PDMA was dropped by
the government. However, in its place Public Debt Management Cell(PDMC) was constitut ed in 2016. FMC was merged
with SEBI in 2015 but the other regulat ors continue to exist even today.

Fiscal System 22
 Public Debt Management Cell(PDMC)
PDMC is not an independent body. It was constituted under the RBI in place of PDMA. It was decided that this PDMC will
pave the way for establishment of PDMA. The role of PDMC is advisory. It gives suggestions to the government with
respect to borrowings. It suggests that whether the borrowings should be domestic or it should be external. It suggests
that whether the borrowing should be short-term or long-term. It also suggests that what should be the source of
borrowing. Its responsibilit y is to suggest measures that how the bond market can be developed further. It plays an
important role in publishing the status paper on government debt.

Status Paper on Government Debt(12th edition)

Since 2010, the government is continuously publishing status paper on its borrowings. It is in order to reveal the condition
of debt publicly. After the establishment of PDMC, it also plays an important role in preparing the status paper. The 12th
edition of this status paper was published in 2023 and it consists of information till March 31st 2022.

It shows that the combined outstanding debt of the centre and the states is 83.3% of the GDP. In this the centre
contributes 59.1% and the states contribute 24.2%. However, out of the total borrowings of the central government, 95.3%
is from domestic sources and only 4.7% is from external sources. It shows that the risk related to borrowing is relatively
low.

Fiscal System 23
 Shorts

Financial Sector Legislative Reforms Commission (FSLRC) Overview

Background and Purpose:

Constituted in 2011 by the Finance Ministry due to conflicts between SEBI and IRDAI over overlapping
regulatory authorities.

Headed by Justice B.N. Srikrishna, with recommendations submitted in 2013.

Aimed to prevent disputes among regulators and streamline the financial regulatory framework.

Key Recommendations:

1. RBI's Role:

RBI should only act as a regulator.

Transfer the responsibility of borrowing on behalf of the government to a specialized new agency.

2. Public Debt Management Agency (PDMA):

Proposed agency to manage government borrowing by selling and buying back government
securities.

3. Unified Financial Agency (UFA):

Merge various regulators (SEBI, FMC, IRDAI, PFRDA) into a super-regulator with specialized
departments to prevent clashes in authority.

4. Financial Sector Appellate Tribunal:

Establish a tribunal to resolve disputes among regulators.

5. Customer Protection:

Regulators must ensure financial institutions do not harm customer interests or become insolvent.

Implementation Challenges:

The government initially planned to shift the borrowing responsibility from RBI to PDMA, but this was
opposed by RBI under Governor Raghuram Rajan.

As a compromise, Public Debt Management Cell (PDMC) was established in 2016 under RBI instead of
creating PDMA.

FMC was merged with SEBI in 2015, but other regulators like IRDAI and PFRDA continue to operate
independently.

Public Debt Management Cell (PDMC)

Function and Role:

Not an independent body, PDMC operates under RBI as an advisory unit.

Advises the government on borrowing strategies, such as domestic vs. external, short-term vs. long-
term borrowings, and source selection.

Plays a role in developing the bond market and preparing the Status Paper on Government Debt.

Status Paper on Government Debt (12th Edition, 2023)

Key Highlights:

Published annually since 2010, the 12th edition covers data up to March 31, 2022.

Combined Outstanding Debt: 83.3% of GDP, with the Centre at 59.1% and states at 24.2%.

Borrowing Sources: 95.3% of the central government's borrowing is domestic, reducing risk related to
external debt(4.7%).

@August 16, 2024

Fiscal System 24
 Types of Budgeting
Budgeting is an important aspect of financial governance and is important not only for the government but also for a
household or an individual. Budgeting helps in managing the finances in an effective manner. Through proper budgeting it
becomes possible to meet the expenditure with the help of available resources. Hence, from time to time even the
government has kept on modifying the process of budgeting in order to make it more effective so that it may improve its
fiscal health.

Initially, the process of budgeting that was in practice was termed as line item budget. On the recommendations of the
Administrative Reform Commission(ARC), in the year 1969, performance budget was introduced which replaced line item
budget . In FY 2005-06 performance budget was modified to outcome budget. In the year 1983 zero base budget was
introduced and again in 2001 the concept of gender budgeting was adopted.

Line Item Budget

It was an initial form of budgeting adopted by the government in India. It is also known as historical budgeting and it is also
known as increment al budget. It used to be rigid and less effective. In this type of budgeting all the areas of expendit ure
were placed in a sequence one below the other. Next to them was mentioned the fund allocated for that particular purpose.
The fund allocated for one purpose cannot be used for any other purpose. Hence the rigidity. At the same time the
government was mainly concerned about the amount allocat ed rather than how effectively the amount has been utilised.
Hence, in this type of budgeting wastage of resourc es was also seen. Year-on-year in all these areas of expendit ure some
increment was done and an increased amount was allocated. That is the reason why this process of budgeting was also
termed as increment al budget.

Performance Budget and Outcome Budget

In order to make the process of budgeting more effective, performance budget was adopted. Effective budgeting system
also helps in the process of fiscal consolidation. Performanc e budget was also termed as Planning Programming Based
Budgeting System. This process of budgeting was borrowed by India from USA. Through five-year plans long-term socio-
economic goals were setup. In order to achieve these goals different programs were initiated. In order to run these
programs fund was allocat ed through budget. In case of performance budget , after the end of the FY, quantit ative
evaluation was done that how much amount has been spent where. Every single rupee spent must be justified.

Outcome budget was a modification of performance budget. It is still in place and is even more effective. In outcome
budget even before the fund is allocated a blueprint is to be prepared by different departments explaining how much
amount is needed for which particular purpose. After evaluation of the blueprint, the fund is allocated. After the end of FY
quantitative and qualitative evaluation will be done in order to conclude whether the expendit ure was justified or not and
whether it has been done according to the blueprint or not.

Zero Base Budget

Even zero base budgeting was borrowed by India from USA. Initially, it was implemented only in the department of science
and tech in the year 1983. Later on, in 1986, zero base budget was introduced in all the departments under different
ministries.
Under zero base budgeting all the programs or projects which are partially or fully funded by the government are evaluated
every year afresh. It is seen that whether the program or the project is socially and economically beneficial anymore or not.
If it is no longer beneficial then it will be discontinued immediately. No new fund will be allocated for the program or the
project from there onwards even if a large part of the fund has already been spent. It is in order to prevent misuse of
resources and it helps the government in bringing down its unwant ed expendit ure and attain fiscal consolidation.

Gender Budget
Gender is a neutral term. It means that the term can be used for men, women and even for transgenders . Gender
Budgeting refers to evaluating the provisions of the budget to analyze its impact on a particular gender.

Indian society has been a patriarchal, patrilineal society in which the authority lies with the male members and traditionally,
property and title both are transferred from father to son. Hence, women in India are not only subjected to male dominance
but also deprived economically. The gender based norms have traditionally confined women to domestic responsibilities. It
has led to economic dependency of women. Their health care as well as education, is hardly taken care of. Hence, the
incidence of poverty is maximum among women in India. This can also be termed as the Feminization of Poverty.

Fiscal System 25
 Because of the socio-economic deprivation of women, Gender Budgeting in India becomes an instrument of social justice.
The term Gender Budgeting was used for the first time by the Ministry of Finance in the year 2001. The Budget 2001-02
was evaluated to analyze its impact on women in the country. The responsibility of this Gender Budgeting was given to the
National Institute of Public Finance and Policy. In the financial year, 2002-03 a similar evaluation of the budget was done
by a number of states. In 2003 the cabinet secret ary ordered that all the
departments under all the ministries should publish a separate chapter in their annual report to specify the measures
adopted by the particular department for women's upliftment. In the year 2004, the ministry of finance instructed that all
the ministries should have a gender budgeting cell by January 1st, 2005. This gender budgeting cell is responsible for
evaluating those welfare schemes which are 100% dedicated to women empowerment and those welfare schemes in
which at least 30% of the provisions are for women upliftment. Hence from there onwards, this gender budgeting has
become an instrument in the country for ensuring social justice.

The merger of Rail Budget and General Budget

Before 1924 the rail budget and the general budget both were presented together. However, at that time in the general
budget, the share of railways was much higher as compared to the receipts and expenditure of the government in all the
other sectors of the economy. Hence, during this period the contribution of the railways prevent ed the failure of the
government from being exposed. Therefore, in order to bring transparency, East Indian Railway Committee under the
chairmanship of Sir William Acworth was constituted. This committee was constituted in 1920 and on its recommendation,
the rail budget and the general budget were separated in 1924. Post-Independence the condition was reviewed again.
However, even during that period, the Rail Budget was 6% higher than the general budget. Therefore, it was decided to
continue the same mechanism.
This mechanism of presenting the rail budget as well as the general budget separately continued for 92 years and finally, in
the Budget 2017-18, they both were merged again. The merger of the rail budget and the general budget had become
obvious and inevitable. The railways in India were not able to change themselves according to the changing
circumst ances. The market share of railways in the transport ation sector used to be as high as 89%. However, because of
competition from the roadways and civil aviation its market share has fallen to 30%. The market share of the roadways has
gone up to 65% and the market share of civil aviation is 5%. The roadways have much wider penetration as compared to
the railways. At the same time, the roadways provide door to door services that cannot be provided by railways. Even with
respect to the transportation of oil and gas the market share of railways was more than 90%, which has come down to 10%
because of the tough competition from the pipeline sector.

The railways have also witnessed lack of political will. Since the rail budget was present ed separat ely it was considered to
be a matter of pride to have railway ministry as a portfolio. Hence in the era of coalition politics, the railways became an
instrument of political blackmailing. Prior to 2014, for a very long period of time, the railway ministry was hardly with the
mainstream political parties. The regional political parties used railways as an instrument of appeasement. Hence more and
more services were introduced without improving the infrastructure. Reckless recruitments resulted in an increase in the
workforce even beyond the desirable limit. The burden of salary payment as well as pension remained high. Even the cost
due to wear and tear has always been high. Several routes are yet to be electrified which made operation in these routes
costlier. The railways make profit on freight services. But with respect to the passenger services, out of every Rs. 100
spent the railways recover only Rs. 57 by sale of tickets. Hence, the profit from freight services is used as a cross-subsidy
for providing passenger services. The railways in India had to depend on budget ary allocation for capital formation.
Because of this it had to pay an amount of approx. ₹9000 crore to the Finance Ministry from its revenue every year. It
affect ed the financial health of the railways further.

At the time of merger of rail budget and general budget, the rail budget was not even 6% of the general budget. It was
even smaller than the budget for agriculture and defence. Since we do not have a separate budget for defence, agriculture,
etc, there was no point in having a separate budget for railways. At the same time if the rail budget and general budget are
combined, the railways need not repay the Ministry of Finance for the budgetary allocation done for capital formation.
Hence on the recommendation of the Bibek Debroy Committee the rail budget and the general budget have been merged.

Fiscal System 26
 Shorts

Types of Budgeting
1. Line Item Budget(initial phase)

Description:

Initial budgeting method in India, also known as historical or incremental budgeting.

Budget items listed sequentially with specific fund allocations.

Funds allocated for one purpose cannot be used for another, leading to rigidity.

Issues:

Focus on allocation amount rather than effectiveness.

Resource wastage due to lack of performance evaluation.

2. Performance Budget(1969)

Introduction:

Introduced in 1969, replacing Line Item Budget, based on the Administrative Reform Commission's
recommendations.

Also known as Planning Programming Based Budgeting System (PPBS), borrowed from the USA.

Features:

Focus on achieving long-term socio-economic goals set by Five-Year Plans.

Evaluat es how funds are spent at the end of the fiscal year.

Every rupee spent must be justified to ensure efficient use of resources.

3. Zero Base Budget(1983)

Introduction:

Adopted in India in 1983, initially in the Department of Science and Technology, later extended to
all departments in 1986.

Borrowed from the USA.

Features:

Annual fresh evaluation of government-funded programs/project s.

Continuation of funding is based on current social and economic benefits.

Programs found no longer beneficial are discontinued, regardless of previous funding, preventing
resource misuse and aiding fiscal consolidation.

4. Gender Budget(2001)

Introduction:

Introduced in 2001, first used in the Budget 2001-02.

Purpose:

Evaluat es budget provisions to assess their impact on different genders, with a focus on women
due to socio-economic disparities.

Implementation:

In 2003, all departments were instructed to include measures for women's upliftment in their
annual reports.

By 2005, Gender Budgeting Cells were established in all ministries to monitor schemes dedicat ed
to or benefiting women.

5. Outcome Budget(2005-06)

Introduction:

Fiscal System 27
 Introduced in FY 2005-06 as a modification of the Performance Budget.

Features:

Departments must prepare a blueprint before fund allocation, detailing required funds for specific
purposes.

Post-FY evaluation includes both quantitative and qualitative assessments to ensure expenditure
aligns with the blueprint.

The Merger of Rail Budget and General Budget

Historical Context:

Rail Budget separated from General Budget in 1924 based on the East Indian Railway Committee's
recommendation due to the railways' significant share in the general budget.

Separation continued for 92 years, largely due to the railways' importance in the economy.

Challenges:

Railways lost market share in transportation to roadways and civil aviation, leading to financial strain.

Railways became a tool for political leverage in coalition governments, resulting in excessive
recruit ment and service expansion without infrastruct ure upgrades.

The reliance on budgetary allocations for capital formation led to significant repayments to the Finance
Ministry, further deteriorating the railways' financial health.

Merger Rationale:

By the time of the merger in Budget 2017-18, the Rail Budget was less than 6% of the general budget,
smaller than other sectors like agricult ure and defence.

Combined budget eliminated the need for the railways to repay capital allocations to the Finance
Ministry, improving financial efficiency.

The merger was recommended by the Bibek Debroy Committee to streamline budgeting and reflect
the reduced economic importanc e of railways relative to other sectors.

Model questions
What is fiscal consolidation? Which all measures can be adopted in order to achieve the goal of fiscal consolidation.

1. Define fiscal consolidation—

a. How can it be done?

b. Golden rule of fiscal consolidation— revenue deficit zero and borrowing takes place only for capital formation

2. Increase receipt

3. Reduce expendit ure

4. Burden of Interest payments

5. Conclude

Why the process of budgeting is important? Highlight the evolution of the process of budgeting in India?

1. What is budget and budgeting? Income and receipt of an entity— family, individual, government.

2. Economy is a dynamic reality. Ever changing. Hence, the process of budgeting has to be evolving in nature.

Fiscal System 28
 👛
Taxation
Date created @August 17, 2024 12:00 PM

Revisions 1

Start date @August 17, 2024

Status Complete

Introduction
Classification of taxes
Tax v. Duty
Ad-valorem and specific duty
Cess and Surcharge
@August 20, 2024
Tax Deducted at Source(TDS) or Tax Withholding
Tax Planning
Tax avoidance

Taxation 1
 Tax evasion
Direct taxes
@August 21, 2024
Personal Income Tax
Old tax regime
New tax regime
Fiscal drag
@August 22, 2024
Corporate tax
Minimum Alternate Tax(MAT)
Capital gain tax
@August 23, 2024
Securities Transaction Tax(STT)
Dividend Distribution Tax(DDT)
Vivad se Vishwas Scheme
Double Taxation Avoidance Agreement(DTAA)
8/24/24
Tax Administration Reform Commission(TARC)
Transfer Pricing, Base Erosion and Profit Shifting
Direct Tax Code(D TC)
Google Tax/Equalisation levy
Global Minimum Corporate Tax
Proposed two pillar solution:-
@August 27, 2024
Transparent Taxation— ‘Honouring the Honestʼ Platform and
Taxpayersʼ Charter
Tax on Virtual Digital Asset
Windfall tax
Tax buoyancy
Laffer Curve
Indirect taxes
Custom duty
@August 28, 2024
Service tax
Excise duty
@August 29, 2024
State Sales Tax(SST)
Value Added Tax(VAT)
Goods and Services Tax(GST)
Composition scheme
E-way bill
Sabka Vishwas Scheme
Pigouvian tax
Tobin tax
Sin tax
Angel tax
Tax expenditure
Regressive taxation
Demonetisation

Introduction
Tax is a compulsory collection done by the government over our income and over our consumption. Taxes are the most
important source of receipt for any government. Even in India taxes are the most important source of income for the
government. It is not only the centre but even the states and local bodies which collect taxes. Which tax will be collected
by which authority is clearly defined by the constitution.

Constitutional Provisions Regarding Taxation in India

Thereʼs an unwritten agreement between the government and the citizens which define the responsibilities and the rights
of both the entities. It is the responsibility of the citizens to pay taxes and it is the right of the government to collect taxes. It

Taxation 2
 is the responsibility of the government to provide basic amenities to the people, to provide internal security and to ensure
defence of the country. And at the same time to avail all these facilities is the right of the citizens.

Classification of taxes
Taxes can be broadly classified into two different types—

1. Direct taxes: Direct taxes are those taxes in which the real burden of the tax falls upon the same entity from whom it is
collected. For example, income tax and corporate tax.

2. Indirect taxes: The real burden of the tax falls upon the consumer but the tax is collected from either the seller or the
producer. For example, GST.

For the central government direct taxes contribute more as compared to the indirect taxes in its total tax receipt. Whereas
in case of the states the indirect taxes contribute more as compared to the direct taxes in their total tax receipt.

When the total tax receipt is compared with the GDP, then tax to GDP ratio is derived. It is expressed in percentage. In the
budget 2024-25, it is estimated that the gross tax receipt of the centre will be 11.8% of the GDP. In which the contribution
of the direct taxes is estimated to be 6.8% whereas the contribution of indirect taxes is estimated to be 5%. For FY 2023 -
24 the revised estimate of gross tax receipt is 11.6%. In this the contribution of direct taxes is estimated to be 6.6%,
whereas the contribution of indirect taxes is estimated to be 5%. For the FY2022-23, the actual gross tax receipt of the
centre was 11.3%. In this the contribution of direct taxes is estimated to be 6.2%, whereas the contribution of indirect taxes
is estimated to be 5.1%.

Tax v. Duty
Both the t erms t ax and duty are synonymously used but have some basic differences. Tax
is a much larger concept wit hin which duties fall. Hence, it can be said t hat every duty is a
tax but not every tax is a duty.

Tax can be direct or indirect. If indirect, it can be imposed both on the goods as well as
the services. On the other hand, duty is always indirect and is always imposed on goods
only. For example, excise duty, custom, stamp duty(goes to the state government).

Duty as subset of Tax

Ad-valorem and specific duty

Ad-Valorem is a Latin term which means according to the value. Hence, if a duty is imposed according to the value then it
is termed as ad-valorem duty. It has nothing to do with the volume or quantity. For example, if on import of gold, import
duty is 6% then whatever maybe the quantity, over the value of the import, duty at the rate of 6% will be collected.

When a duty is imposed and collected not over the value but over the volume or the quantity then it is termed as specific
duty. For example, if the government says that on import of every gram of gold import duty of ₹100 will be collected
irrespective of the value, then the duty will be collected according to the volume/quantity.

Cess and Surcharge

They both are tax over tax. They are imposed by the government in order to generate additional income. For example, on
income tax or on corporate tax, health and education cess is collected at a rate of 4% by the central government. Similarly,
over the corporate tax of a foreign company, surcharge of 2% or 5% is collected. Over the corporate tax of an Indian
company, surcharge of 7% or 12% is collected by the centre. If over a tax cess and surcharge both are to be calculated,
surcharge will be calculat ed first, it will be added to the t ax amount and t hen t he cess will be calculat ed over t he revised
total.

Although the nature of cess and surcharge is similar, they have some basic difference. Cess is collected for a specific
purpose and hence it is always given a particular name. The money collected can be used by the government for the
purpose specified only. For example, health and education cess, krishi kalyan cess, swacch Bharat cess, etc. On the other
hand surcharge has no specific purpose. Money collected through surcharge can be used by the government for any

Taxation 3
 purpose. Unlike taxes, from the total receipt through cess and surcharge the government need not share any part
essentially with the states.

Taxation 4
 Shorts

Introduction
Tax: A compulsory collection by the government on income and consumption. It is a primary revenue
source for the government, including central, state, and local bodies in India. The authority to collect
specific taxes is defined by the Constitution.

Government-Citizen Agreement: An unwritten understanding where citizens are responsible for paying
taxes, and the government is responsible for providing basic amenities, securit y, and defense.

Classification of Taxes
1. Direct Taxes:

The tax burden falls directly on the entity from whom it is collected.

Examples: Income tax, corporate tax.

2. Indirect Taxes:

The tax burden is ultimately borne by consumers, though collected from sellers or producers.

Examples: GST.

Central vs. State Receipts:

Central Government: Direct taxes contribute more to total tax receipts.

State Governments: Indirect taxes contribute more to total tax receipts.

Tax-to-GDP Ratio:

2024-25 (Estimated): 11.8% of GDP; Direct taxes: 6.8%, Indirect taxes: 5%.

2023-24 (Revised Estimate): 11.6% of GDP; Direct taxes: 6.6%, Indirect taxes: 5%.

2022-23 (Actual): 11.3% of GDP; Direct taxes: 6.2%, Indirect taxes: 5.1%.

Tax vs. Duty

Tax: A broader concept that includes duties.

Can be direct or indirect, imposed on goods and services.

Duty: Always an indirect tax, imposed specifically on goods.

Examples: Excise duty, customs, stamp duty.

Ad-Valorem vs. Specific Duty

Ad-Valorem Duty: Imposed according to the value of goods.

Example: 6% import duty on the value of gold.

Specific Duty: Imposed based on quantity or volume, regardless of value.

Example: ₹100 import duty per gram of gold.

Cess and Surcharge

Similarities:

Both are additional taxes imposed over existing taxes to generate extra revenue.

Differences:

Cess:

Collected for a specific purpose and named accordingly.

Example: Health and education cess.

Surcharge:

No specific purpose; can be used for any government expendit ure.

Taxation 5
 Calculation:

Sharing with States: Revenue from cess and surcharge does not necessarily need to be shared with the
states.

@August 20, 2024

Tax Deducted at Source(TDS) or Tax Withholding
Whenever a payment is done to an employee by an employer or a payment is done to a professional or a service provider,
etc. then a part of the payment is deducted at the source of payment and deposited to the income tax department account
of the beneficiary. This amount which is deducted is termed as TDS. Through TDS the government ensures that it
continues to get some amount of money from time to time in order to meet its expenditure. It is also ensured that the
beneficiary may not be able to hide her income and at the same time it can be shown as a part of the expenditure by the
entity who is making the payment.

Tax Planning
There are different investment instruments made available to the taxpayers by the government under different provisions of
the IT Act. By investing in such financial instruments a tax payer may bring down his tax liability. This is called tax planning.
For example, under provision 80C an investment of upto ₹1.5 lakh in financial instrument s such as National Savings
Certificat e(NSC) or Life Insurance or Provident Fund or Equity Linked Saving Schemes(ELSS) will remain exempt ed from
income tax. It also includes fixed deposit in banks with a maturit y of 5 years. Similarly, under provision 80D an invest ment
of upto ₹25K in health insurance will remain exempted. Under provision 80CCD(1B) an investment of upto ₹50K in National
Pension System(NPS) will remain exempt ed from tax. Similarly, under provision 24B and 80EE the interest paid on home
loan which upto ₹2 lakh will remain exempted from income tax. This is tax planning.

Tax avoidance
Most of the cases of tax avoidance are legally possible but some cases are also termed as illegal. If there are loopholes in
the tax laws and using those loopholes if a taxpayer brings down her tax liability then it is termed as tax avoidance. For
example, if on import of fully furnished comput er, import duty is of 20% but on import of spare parts the duty is only 5%
then by importing spare parts a comput er can be assembled and the tax liability can be reduced. This is tax avoidance.

Tax evasion
Is an illegal act and is a punishable offence. If an individual or any entity earns through legitimate or illegitimate sources, in
both the cases if tax is not paid then it will be termed as tax evasion. Giving a wrong account of income or hiding oneʼs
income in order to prevent payment of taxes falls under the category of tax evasion.

That income over which tax is evaded is termed as black money. Even this black money drives a large part of the economy
i.e. it creates demand in the economy. In a number of businesses black money is an important source of funding. That part
of the economy which is driven by black money is termed as parallel economy.

When black money is convert ed into white money then it is termed as money laundering. There are several ways in which
money laundering is done. For example such income can be shown as agricultural income and since in India on agricultural
income tax is not applicable, black money can be convert ed into white without paying taxes. Even trusts are used for the
purpose of laundering. It is also seen that people setup shell corporations in order to convert black money into white. Shell
corporations are fake companies which are mainly on paper and which are not engaged in any business. The money
earned through illegitimate sources is shown as an income through such shell corporations and taxes are paid making the
income legitimat e. This is how black money can be convert ed into white.

It is also a possibility that the black money can be sent out of the country. It maybe deposited in a bank account belonging
to a country which is a tax haven. Thereaft er, the money can be withdrawn, handed over to an unregist ered FII and
invested into the Indian share market through P-not e. It will be considered an example of round-tripping. When the black
money of a country goes out of the country and comes back to the same country in the form of foreign investments, it is
termed as round-tripping.

Taxation 6
 Direct taxes
They are those taxes in which the real burden of the tax falls upon the same entity from whom it is collected. Taxes such as
personal income tax, corporat e tax, minimum alternat e tax, capital gains tax, securities transaction tax, etc. fall under the
category of direct taxes.

@August 21, 2024

Personal Income Tax
Personal income tax is a tax which is paid by an individual or an Undivided family over their income. It is a direct tax
collected by the central government. Only on agricultural income the income tax can be imposed by the state government
but in none of the states income tax is applied on agricult ural income.
Personal income tax in India is a progressive tax which means as the income increases the burden of tax will also increase.
It means that those who earn less are either exempt ed from income tax or they have to pay tax at a lower rate.

In order to calculat e income tax two different regimes or methodology are used— Old tax regime & New tax regime. Both
the methodology or regime are optional for the tax payers. It means the taxpayer can choose any of the regime in order to
file income tax return. However, the default setting on the website of the income tax department is the new tax regime. The
Government of India is promoting the new tax regime by making it more attractive. It is a possibility that in due course of
time the new tax regime will complet ely replace the old tax regime.

Old tax regime

Using tax planning a taxpayer may bring down her tax
liability.
Old tax regime
For the salaried employees a standard deduction of
₹0–2.5 lakh Nil
₹50k is also applicable which is not taxable.
₹2.5–5 lakh 5%
Annual income of upto ₹5 lakh is exempted from tax.
₹5–10 lakh 20%
Income is of more than ₹5 lakh, is taxes as per ₹10 lakh + 30%
prescribed tax slabs →

New tax regime

Tax planning is not allowed.

For the salaried people standard deduction is allowed which has been increased to ₹75K in the budget 2024-25.

W.R.T. tax rate and slabs the new tax regime is more attractive.

After the standard deduction the tax is calculate as per the slabs mentioned below—

Tax slabs FY 2023-24 Tax Rate Tax slabs FY 2024-25 Tax rate

Upto ₹3 lakh Nil Upto ₹3 lakh Nil

₹3-6 lakh 5% ₹3–7 lakh 5%

₹6-9 lakh 10% ₹7-10 lakh 10%

₹9-12 lakh 15% ₹10–12 lakh 15%

₹12-15 lakh 20% ₹12–15 lakh 20%

₹15 lakh+ 30% ₹15 lakh+ 30%

📎 Health and education cess of 4% is applicable on the calculated tax in both the regimes.

In the interim budget of 2019-20, the Government of India announced that people earning upto ₹5 lakh will be exempted
from income tax. At that point the new tax regime did not exist. The new tax regime was introduced only in the budget of
2020-21.

Taxation 7
 Because of this relaxation given it was obvious that the
Surcharge rates
government would incur losses. Hence, in order to
₹0–50 lakh Nil
compensate itself, in the full year budget 2019-20
Government of India announced a surcharge on income ₹50 lakh–1 Crore 10%

tax. This surcharge has been modified from time to time. ₹1 crore–2 Crore 15%
The surcharge applicable on income tax is as per the slab ₹2 crore+ 25%
→

Fiscal drag
With increase in inflation it is a possibility that even the income of an individual will increase. However, with increase in
income the taxpayer may go into a higher tax slab. Hence, the burden of tax payment will automatically increase leading to
the increase in the income of the government. This is fiscal drag. However, it is also a possibility that the taxpayer may not
have any benefit because of increase in his income. When the increased tax burden and the increase in the cost of
consumption both are combined it maybe higher as compared to increase in the income.

Taxation 8
 Shorts

Tax Deducted at Source (TDS) or Tax Withholding

Definition: A portion of payment deducted at the source by the payer (e.g., employer, service provider)
and deposited to the Income Tax Department on behalf of the payee (beneficiary).

Purpose:

Ensures the government receives periodic revenue to meet its expenditures.

Helps prevent income concealment by the beneficiary.

Allows the payer to show the deduction as an expenditure.

Tax Planning
Definition: The process by which taxpayers reduce their tax liability through investments in specific
instruments allowed under various provisions of the Income Tax (IT) Act.

Examples of Tax Planning Instruments:

Section 80C: Investment up to ₹1.5 lakh in instruments like NSC, Life Insurance, Provident Fund, ELSS,
or a 5-year fixed deposit is tax-exempt.

Section 80D: Investment up to ₹25K in health insurance is tax-exempt.

Section 80CCD(1B): Investment up to ₹50K in the National Pension System (NPS) is tax-exempt.

Sections 24B & 80EE: Interest paid on a home loan up to ₹2 lakh is tax-exempt.

Tax Avoidance
Definition: Reducing tax liability by exploiting loopholes in tax laws, which may be legal but is sometimes
deemed unethical or illegal.

Example: Importing computer parts instead of fully assembled computers to take advantage of lower
import duties (5% on parts vs. 20% on fully furnished computers).

Tax Evasion
Definition: An illegal activity where an individual or entity intentionally avoids paying taxes on earned
income, either by underreporting income or concealing it.

Black Money:

Income on which taxes are evaded.

Drives a significant part of the economy (parallel economy).

Money Laundering:

The process of converting black money into white money.

Methods:

Showing black money as agricultural income (which is tax-exempt in India).

Using trusts or shell corporations to legitimize income.

Round-Tripping: Black money is sent abroad and then reinvested in the country through foreign
investments like P-notes.

Direct Taxes
Definition: Taxes where the burden is directly on the entity from whom it is collected.

Examples: Personal income tax, corporate tax, minimum alternate tax, capital gains tax, securities
transaction tax.

Personal Income Tax

Definition: A tax on the income of individuals or undivided families, collected by the central government.
Agricult ural income is exempt from this tax.

Taxation 9
 Progressive Tax:

Tax Regimes:

New Tax Regime: Simpler, with lower tax rates but fewer deductions.

Fiscal Drag

Impact: The combined effect of higher taxes and rising living costs may offset any income gains for the
taxpayer.

@August 22, 2024

Corporate tax
It is also known as corporation tax or corporate income tax. It is a direct tax collected only by the central government over
the profit made by a company or a firm. From the revenue, the companies subtract their expenditure and the remaining part
is their profit. Over this profit the tax that is collected by the centre is corporate tax. Corporate tax in India is a propo rtional
tax. It means that whatever maybe the profit, the companies are taxed at a fixed rate. The rate does not increase wit h
increase in profit. Prior to 2019, corporate tax used to be the single largest source of tax receipt for the centre. However, at
present personal income tax has become the single largest source of tax receipt for the centre.

On the profit of the Indian companies, corporat e tax is calculat ed at a rate of 30%. However, over the corporat e tax,
surcharge and cess are also applicable. If the profit is less than ₹1 crore, surcharge is not applicable. However, if the profit
is ₹1 - 10 crore a surcharge at a rate of 7% will be applicable in case of indian companies. If the profit is ₹10 crore+, the rate
of surcharge will be 12%. Health and education cess of 4% is also applicable.

In the year 2019, the rate of corporate tax for the Indian companies was reduced to 22% from 30% + surcharge + cess.
However, the benefit of this reduced rate can be availed by an Indian company only if it is not availing any other tax
benefits from the government.

For the foreign companies, corporat e tax is applicable at a rate of 40%. However, in the budget 2024-25 it has been
reduced to 35%. Surcharge and cess are applicable even over them. If the profit is less than ₹1 crore, surcharge is not
applicable. If the profit is from ₹1-10 crore over the corporate tax surcharge of 2% will be applicable. If the profit is of more
than ₹10 crore, the rate of surcharge will be 5%. Even the foreign companies need to pay health and education cess of 4%.

In order to promote manufact uring activities in India, in the year 2019 itself a proposal was given by the government that if
a new manufact uring company is setup on or after October 1st, 2019 and starts production by March 31st, 2024 then the
company will have to pay corporate tax at a rate of only 15% all throughout its existence. However, the company will have
to pay surcharge and cess over the corporate tax.

To encourage startup culture, it was proposed that if a startup company is setup on or before March 31st, 2024 then during
the first 10 years of its existence, the company may choose any three consecutive years and may not pay any tax in those
years.

Minimum Alternate Tax(MAT)

The corporates in India pay corporate tax under the provisions of the Income Tax act. It is to be paid only over the realised
profit of the company. That profit which has been made but is yet to be realised is termed as book profit. There are a
number of companies in India which used to show zero profit or even losses under the provisions of the income tax act but
the same companies used to show book profit under the provisions of the companies act. Since, the realised profit was

Taxation 10
 shown as zero they did not pay corporat e tax. Such companies were termed as zero tax companies. Over the book profit of
such companies an alternat e tax is imposed by the centre which is termed as MAT. At present, the rate of MAT is 15% +
surcharge + cess. However, when the company realises the profit, it must pay corporat e tax after adjusting the MAT
already.

Capital gain tax

Capital gain refers to the profit that is made by sale of an asset such as shares, land, house, gold, silver, etc. Over this
capital gain, the central government collects tax which is termed as capital gain tax. Capital gain tax is a direct tax.
Capital gain can be classified into two different types— Short term capital gain and Long term capital gain.

It is applied in the following manner—

1. If shares, including mutual funds, are bought and sold within a period of one year, then the profit is termed as short
term capital gain. On the other hand, if such assets are sold after a period of one year then the profit made is termed as
longterm capital gain.

2. If land or house is bought and sold within a period of two years then the profit made is termed as short term capital
gain. If they are sold after two years, the profit made is termed as longterm capital gain.

3. In case of assets such as gold and silver, the rules related to time period have been modified in the budget 2024-25.
Prior to this, if gold and silver were bought and sold within a period of three years, the profit made was termed short
term capital gain. If they were sold after three years. The profit made was termed as long term capital gain. However, in
this budget, this time period of three years has been modified to 2 years.

Over the short term capital gain, the tax that is collected is termed as short term capital gain tax and longterm capital gain
tax in case of short term capital gain. These taxes are calculat ed in the following manner—

i. In case of shares short term capital gain tax was applicable at the rate of 15%. However, in the budget 2024-25 it has
been increased to 20%.

ii. In order to make investment in the share market more attractive and make it more stable, in 2004-05 longterm capital
gain tax was removed on the profit made from sale of shares. In order to compensate itself. In the same year Securities
Transaction Tax(STT) was introduced. In the budget 2018-19 longterm capital gain tax was reintroduced on the sale of
shares including mutual funds. It was proposed that if in one FY longterm capital gain by sale of shares is upto ₹1 lakh,
no tax will be applicable. However, if the profit exceeds ₹1 lakh then over the exceeded profit longterm capital gain tax
at a rate of 10% will be applicable. No indexation was allowed.

📎 Even after reintroduction of longterm capital gain tax on sale of shares, STT continues to exist.

iii. In budget 2024-25 the rules related to longterm capital gain tax have been modified again in case of sale of shares
including mutual fund. Now the longterm gain tax is applicable at a rate of 12.5%. However, the profit that is exempted
has been increased from ₹1 lakh to ₹1.25 lakh. No indexation is allowed.

iv. In case of other assets like gold, silver, land, house, etc. long term capital gain tax was applicable at a rate of 20%.
However, the tax was not calculated over the entire profit. Before calculating the tax, indexation was done. It means
that from the profit the impact of inflation was subtracted and only on the remaining profit was taxed at a rate of 20%.

v. In the budget 2024-25, the provisions related to long-term capital gains tax were modified. The rate of tax has been
reduced from 20% to 12.5%. However, the provision of indexation has been dicontinued. Because of this the
government had to face critcism, hence, another modification has been done. Only on sale of property bought and
registered before 23rd July 2024, indexation is allowed while calculating the capital gain tax. The taxpayer will
calculate tax at the rate of 20% after indexation or at a rate of 12.5% without indexation. In both the calculations
whichever is lower, is to be paid as tax. However, in case of property bought later than the above cut off date,
indexation will not be allowed but the rate will be 12.5%.

@August 23, 2024

Taxation 11
 Securities Transaction Tax(STT)
It is direct tax collected by the centre. It was introduced in the FY 2004-05. It was introduced by the government in order to
compensate itself from the loss that it would have incurred by eliminating long term capital gain tax on sale of shares. STT
is collected by the government at different rate in different types of trade. It has nothing to do with the profit or loss of the
trader/investor. It is collected over the total value of trade. For example, if shares worth ₹100 are sold and bought, on the
same value the seller as well as the buyer, both will pay STT.

Dividend Distribution Tax(DDT)

Prior to 2020, the rules related to dividend distribution tax were different. However, in the Union budget 2021, the rules
were modified.

According to the older provision, if a company distributes dividend then the beneficiary was not taxed. However, the
company had to pay dividend distribution tax at a rate of 15% over the amount which was to be distributed in the form of
dividend.

According to the modified provision now the company need now pay DDT. The dividend received by the beneficiary will be
added to his annual income and it will be taxed according to the slabs of the income tax act. Hence, those with lower
income, receiving lesser amount of dividend not falling in the tax bracket will not pay any tax over the dividend received
but the taxpayer with higher income will end up paying tax at the highest rate.

Vivad se Vishwas Scheme

This scheme was introduced for the first time in 2020. It has again been reintroduced in the budget 2024-25. The scheme
is related to resolving the disputes w.r.t. direct taxes. The objective is to bring down the number of litigations by resolving
the matter out of court under this scheme the tax payers were given an option. If they are confident that the dispute will be
settled in their favour they may continue the litigation. However, if they are not confident they may pay only the disputed
tax amount. The government will renounce the demand of penalty and interest and shall withdraw the case.

Double Taxation Avoidance Agreement(DTAA)

When the same income is taxed more than once then it is termed as double taxation. In order to avoid this when two
countries sign an agreement then it is termed as DTAA. Even India has signed such agreements with a number of countries.
Under such agreement s the corporat e tax is normally collect ed by the country from where the invest ment has come.
Whereas the country where the investment has taken place renounces this tax. The provisions in all such agreements vary
from country to country. This is called limitation of benefit clause.

Such agreements are signed in order to attract foreign investments, enhance production and employment and in order to
improve political and economic relationship with other countries.
Although such agreements are aimed at different benefits, they may also cause harm. Even in case of India, the companies
belonging to other countries with whom India has not signed DTAA started investing in India through countries like
Mauritius and Singapore with whom India has signed DTAA. This is called Treaty Shopping. That is the reason
why maximum foreign investment in India comes from these two tiny nations. It leads to loss of revenue because India is
not able to tax the profit.

Although DTAA leads to loss to the government in terms of revenue, it became a serious matter of concern only after the
transaction that took place between Hutch and Vodafone in which two foreign companies conduct ed a transaction in a
foreign country but the physical asset that was transferred belonged to India. Such transfers are termed as indirect
transfer. Due to this deal the Indian government incurrred huge losses. As a result it was decided that General Anti
Avoidance Rule(GAAR) will be implemented in India.

8/24/24
As a tax law GAAR was implement ed for the first time by Germany and thereaft er it has been adopted by a number of
countries including India. GAAR is a tax law which impowers the tax authorities. Under this law any financial transaction
which is done deliberat ely in order to taxes and to cause loss to Government of India can be classified as a case of evasion
and penalty can be imposed after investigation. It was decided that GAAR will be implement ed and will be made effective
retrospectively so that even the transaction between Hutch and Vodafone can be brought under the purview of gaar. In
case of disputes, a three member GAAR council will be formed, headed by the chairman of CBDT. It was decided that in
case of any conflict between the provisions of DTAA and GAAR, priority will be given to GAAR.

Taxation 12
 However, the TARC headed by Parthasarathi Shome suggested that GAAR should not be implemented retrospectively. Even
before it is made effective, the DTAA signed with different countries must be amended and it should be added that in case
of conflict GAAR will preferred.

GAAR was implemented in India in 2017 on 1st April. It was made effective from the same date hence no retrospective
implementation. Even before implementation of GAAR, most of the DTAA singed with different countries were amended. It
was decided that only those companies will be given the benefit which have their HQ located in such countries. Even in
case of Mauritius, the company has to be at least one year old to get the benefit of the DTAA. Companies ho perated by
NRIs will not be given benefit. It was decided that in any transaction if capital gain is made it will be taxed by India. Even
after that Mauritius and Singapore remain the top contributors of foreign investment in India.

Tax Administration Reform Commission(TARC)

TARC was constituted in 2013. It was headed by Parthasarathi Shome. It was the first commission setup by the Government
of India related to taxation whose objective was not to suggest that how tax receipt of the Government of India sho uld be
enhanced. Its objective was to suggest that how the administrative structure of the taxation system should be improved.
How the administration should be made more conducive for the taxpayers. The commission gave following suggestions—

1. Under the MoF we have depart ment of revenue, headed by the revenue secret ary. Just below the depart ment of
revenue we have Central Board of Direct Taxes(CBDT) and we have Central Board of Indirect Taxes and Custom(CBIC).
Both are headed by chairmen belonging to the IRS. The direct taxes come under CBDT and indirect taxes under CBIC.
The commission suggest ed that the depart ment of revenue should be discontinued and even the post of revenue
secret ary should be discontinued. CBDT and CBIC should be merged in order to create one entity which should be
headed by one chairman. It was suggested in order to ensure proper coordination in between direct taxes and indirect
taxes.

2. Required modifications should be done in the training of the tax officials so that they can be made more sensitive
towards the travails of taxpayers.

3. Out of the total expenditure done by the Government of India for the purpose of tax collection at least 10% should be
spent to provide facilities to the taxpayers.

4. At all the ports and international airports 24X7 custom clearance should be provided.

5. GAAR should be implemented but not should not be made effective retrospectively.

6. Before implement ation of GAAR, DTAAs should be amended adding the fact that in case of conflict between GAAR and
DTAA, GAAR will be prioritised.

Transfer Pricing, Base Erosion and Profit Shifting

If a company has its units in different countries then these units will be termed as its foreign subsidiaries. The price at
which such companies sell spare parts, inputs, technology, etc. to their foreign subsidiaries is termed as transfer pricing.
It is not necessary that a company will sell the inputs, spare parts or technology etc to their subsidiaries at a lower price. It
depends that in which country the rate of tax is low and in which country it is high. The price will be set in such a manner

Taxation 13
 that higher profit will be shown in the country where the tax rate is low and lower profit will be shown where the tax rate is
high. This is termed as profit shifting.

Because of profit shifting, the country where less profit is shown will suffer from loss of revenue. Hence, in order to
prevent this loss the country may impose arms length rule. According to this rule, the company will have to maintain the
same distance from its subsidiaries and from any other company to whom it supplies inputs, spare parts or technology, etc.
In other words, in a transaction with its own subsidiaries and with any other company the profit margin must remain the
same.
It is a possibility that a company may supply inputs, spare parts, technology, etc. only to its own subsidiary and such thing s
are not supplied by that company to any other company. In such a situation arms length rule cannot be applied. Hence, in
such situations, advance pricing agreement s must be signed. Such agreements are signed between a company and
countries. In such agreements it is decided in advance that while supplying such things to its subsi diary what would be the
price. However, by relaxing the rule related to profit shifting and transfer printing, a country may attract foreign investme nt.

It is also seen that the multinational companies, just in order to avoid taxes, relocate their HQs to t hose countries which are
tax havens. In such countries the tax laws are lenient, tax rate is low and they have signed DTAA with a number of different
countries. This relocation is termed as Base Erosion. Even this a cause behind loss of revenue for the governments. All
such issues were raised for the first time in the Organisation for Economic Cooperation and Development(OECD) which has
its HQ in Paris.

Taxation 14
 Shorts

Corporate Tax
Definition: Also known as corporation tax or corporate income tax, it is a direct tax collected by the central
government on the profit made by a company or firm.

Tax Calculation: Companies subtract their expenditures from revenue to determine profit, which is then
taxed.

Proportional Tax: The corporate tax rate is fixed, regardless of profit size.

Corporate Tax Rates in India:

Indian Companies:

Before 2019: 30% + surcharge + cess.

After 2019: Reduced to 22% (if no other tax benefits are availed).

Surcharge:

Profit ₹1 crore: No surcharge.

Profit ₹1-10 crore: 7% surcharge.

Profit ₹10 crore: 12% surcharge.

Health and Education Cess: 4%.

Foreign Companies:

Before 2024-25: 40% + surcharge + cess.

After 2024-25: Reduced to 35%.

Surcharge:

Profit ₹1 crore: No surcharge.

Profit ₹1-10 crore: 2% surcharge.

Profit ₹10 crore: 5% surcharge.

Health and Education Cess: 4%.

Special Corporate Tax Rates:

New Manufacturing Companies (Post-October 1, 2019): 15% corporate tax (plus surcharge and cess) if
production starts by March 31, 2024.

Startups (Before March 31, 2024): Option to not pay tax for any three consecutive years during the first 10
years.

Minimum Alternate Tax (MAT)

Definition: A tax on book profit (profit made but not realized) to ensure that zero-tax companies (those
showing zero profit for tax purposes) pay some tax.

Rate: 15% + surcharge + cess.

Adjustment: When realized profit is taxed, MAT already paid is adjusted.

Capital Gains Tax

Definition: A tax on profit from the sale of assets like shares, land, houses, gold, silver, etc.

Types of Capital Gains:

Short-Term Capital Gain: Profit from assets held for a short period (e.g., shares sold within 1 year,
property sold within 2 years).

Long-Term Capital Gain: Profit from assets held for a longer period (e.g., shares held for more than 1
year, property held for more than 2 years).

Taxation 15
 Capital Gains Tax Rates:
Short-Term Capital Gains:

Shares: Increased from 15% to 20% in 2024-25.

Long-Term Capital Gains:

Shares (Post-2018): 10% on gains exceeding ₹1 lakh; increased to 12.5% with an exemption limit
raised to ₹1.25 lakh in 2024-25.

Other Assets (Property, Gold, Silver): Reduced from 20% (with indexation) to 12.5% (without
indexation) in 2024-25.

Special Provision (Property bought before July 23, 2024): Choose between 20% with indexation or
12.5% without indexation; pay the lower amount.

Securities Transaction Tax (STT)

Definition: A direct tax collected on the total value of trade in securities (e.g., shares), regardless of profit
or loss.

Purpose: Introduced in 2004-05 to compensate for the removal of long-term capital gains tax on shares
(later reintroduced in 2018-19).

Dividend Distribution Tax (DDT)

Before 2021: Companies paid a 15% tax on dividends distributed; the beneficiary was not taxed.

After 2021: DDT was abolished; dividends are added to the beneficiary's income and taxed according to
their income tax slab.

Vivad se Vishwas Scheme

Introduced: In 2020, reintroduced in 2024-25.

Objective: Resolve direct tax disputes by allowing taxpayers to settle disputes by paying the disputed tax
amount, with the government waiving penalties and interest.

Double Taxation Avoidance Agreement (DTAA)

Definition: An agreement between two countries to prevent the same income from being taxed more than
once.

Objective: Attract foreign investments, enhance production and employment, and improve political and
economic relations.

Challenge: Treaty shopping, where companies from non-DTAA countries route investments through DTAA
countries (e.g., Mauritius, Singapore) to avoid taxes, leading to revenue loss.

General Anti-Avoidance Rules (GAAR)

Introduction: GAAR is a tax law initially implemented by Germany and later adopted by various countries,
including India.

Purpose: Empowers tax authorities to classify financial transactions designed to avoid taxes and cause
financial loss to the government as tax evasion, leading to penalties after investi gation.

GAAR Implementation in India:

Retrospective Application: Initially proposed to apply retrospectively, specifically targeting transactions
like the Hutch-Vodafone deal.

GAAR Council: A three-member council headed by the Chairman of the Central Board of Direct Taxes
(CBDT) is formed to resolve disput es under GAAR.

Priority Over DTAA: In case of conflict between GAAR and Double Taxation Avoidance Agreements
(DTAA), GAAR takes precedence.

TARC Recommendations:

Taxation 16
 Retrospective Implementation: The Tax Administration Reform Commission (TARC), led by Parthasarathi
Shome, recommended against retrospective implementation of GAAR.

DTAA Amendments: Suggested amending DTAAs before GAAR's implementation to clarify that GAAR
would have precedence in conflicts.

Final Implementation in India:

Effective Date: GAAR was implemented on April 1, 2017, with no retrospective effect.

DTAA Amendments: Before GAAR's implementation, most DTAAs were amended to reflect GAAR's
precedence.

Conditions for DTAA Benefits:

Company HQ: Benefits under DTAA are available only to companies with headquart ers in DTAA
countries.

Mauritius Example: To benefit from the India-Mauritius DTAA, companies must be at least one year
old.

NRI Companies: Companies operated by Non-Resident Indians (NRIs) are excluded from these
benefits.

Taxation of Capital Gains: India reserves the right to tax capital gains made from transactions, even if the
investing entity is from a DTAA country.

Despite GAAR and the amended DTAAs, Mauritius and Singapore continue to be the top sources of foreign
investment in India.

Tax Administration Reform Commission (TARC)

Constitution and Purpose:

Established in 2013 and headed by Parthasarathi Shome.

First commission in India focused not on increasing tax revenue but on improving the administrative
structure of the tax system.

Aimed to make tax administration more taxpayer-friendly.

Key Recommendations:

1. Reorganization of Tax Departments:

Suggested discontinuing the Department of Revenue and the post of Revenue Secretary.

Proposed merging the Central Board of Direct Taxes (CBDT) and the Central Board of Indirect
Taxes and Customs (CBIC) into a single entity, headed by one chairman, to ensure better
coordination between direct and indirect taxes.

2. Training for Tax Officials:

Recommended modifications in training to make tax officials more sensitive to taxpayer issues.

3. Expenditure on Taxpayer Services:

Advised that at least 10% of the government's tax collection expenditure should be spent on
facilities for taxpayers.

4. 24 7 Customs Clearance:

Suggested providing round-the-clock customs clearance at all ports and international airports.

5. General Anti-Avoidance Rule (GAAR):

Recommended implementing GAAR but not applying it retrospectively.

Suggest ed amending Double Taxation Avoidance Agreements (DTAAs) to prioritize GAAR in case
of conflicts.

Transfer Pricing, Base Erosion, and Profit Shifting

Transfer Pricing:

Taxation 17
 Profit Shifting:

Causes revenue loss for countries where lower profits are reported due to high tax rates.

Base Erosion:

These issues were highlighted by the Organisation for Economic Cooperation and Development
(OECD).

Direct Tax Code(DTC)

It was a proposed tax reform in the field of Direct Taxes. Once implemented it was supposed to replace the existing Income
Tax Act. However, since several provisions proposed under DTC were not very popular, the government decided that the
major provisions will be implemented by amending the Income Tax act gradually rather than by replacing the entire Income
Tax Act.
The major recommendations under DTC were as follows-

1. Most of the under tax planning financial instruments in India, through which a taxpayer m ay bring down his tax liability,
function on EEE (Exempt, Exempt, Exempt) mechanism. Under this mechanism, the amount invested remains exempted
from tax in the year of investment.
It remains
exempted from tax throughout the term period of investment. Even on maturity on withdrawal the principal as well as
the profit which may be even in the form of interest remains exempted. However, under DTC it was proposed that this
EEE mechanism will be replaced with EET (Exempt Exempt Tax) Mechanism. Under this, t he investment will remain
exempted in the year of investment. It will remain exempted throughout the term period of investment. However on
maturity when the investment is withdrawn at least the profit part will be taxed.

2. It was proposed that if the EET mechanism is introduced the income exempted from the tax
will be raised.

3. It was also proposed that if the EET mechanism is introduced the investment limit for exemption under provision 80C
will be raised.

4. Corporate Tax for Indian companies will be brought down to 25%.

5. MAT will be made applicable to all companies. It will not be collected on book profit. It will be collected on the total
value of the asset of a company. For all the companies the rate of MAT
will be 2% and for banking companies, it will be 0.25%.

6. It was proposed that the distinction between short-term and long-term capital gain will be discontinued and all the
capital gains will be taxed at one single rate.

Google Tax/Equalisation levy

It is also known as Amazon tax. It is a type of withholding tax. It also falls under the control of CBDT and is a direct tax. This
tax was proposed by OECD while discussing the issue related to
base erosion and profit shifting. In India, it is officially known as Equalisation Levy and was introduced in the Budget 2016-
17.

The internet companies such as Google, Facebook, etc are located in the USA but
through the internet, their presence is even in India. Several Indian companies pay huge amounts of the sum to such
companies for publishing their advertisements on these websites. Since these internet giants are located outside India, the

Taxation 18
 Indian authorities cannot tax their income. Therefore under equalization levy, it has been decided that if in a financial year a
company located in India pays an amount of more than Rs 1 Lakh for such advertisements then 6% of the amount will be
deducted from that payment by the company and it will be paid to Indian authorities in the form of tax.

Global Minimum Corporate Tax

The countries involved in this agreement have been asked
to give it the form of domestic legislation in the year 2022,
so that this global minimum tax agreement can be
implemented from 2023.

There are mainly 3 objectives of this global agreement:-

1. Stopping the payment of low tax or zero tax by

multinational companies. The multinational companies
do this by booking the profits of their global business in
tax haven countries.

2. Forcing these multinational companies to pay taxes in

countries where these companies earn profit by doing
business but do not have physical presence in that
country.

3. To end decades of tax competition between

government s to attract foreign invest ment.

Proposed two pillar solution:-

Pillar One is to ensure the distribution of tax levying rights for fair distribution of profits among different countries regarding
the largest multinational companies who have been taking the most advant age of globalization.

The right to levy tax on 25% of profits of the largest and most profitable multinational enterprises above a set profit margin
(residual profits) be reallocat ed to the countries where the customers and users of that company are located.

Tax certainty is a key aspect of the new rules. For this a mandatory and binding dispute resolution process has been
included. But for developing countries an alternative mechanism will be made available in some cases.

In recent years, countries that have imposed taxes, such as the National Digital Services Tax, will have to repeal all those
taxes. For example - Google tax or equalization levy levied in India.

Second Pillar sets a limit on tax competition related to corporation tax

through a global corporation tax rate of 15% that countries can use to protect their tax bases.

Governments can still set their own local corporate tax rate. But if the company pays lower rates in a particular country, the
domestic government of that company can increase its taxes on that company by a minimum of 15% thereby eliminating
the benefit of transferring profits.
After the Covid-19 crisis, almost all the governments of the world are facing the problems related to finance. In such
situation, most government s want to discourage the tendency of MNCs to shift their profits. Income from intangible
sources such as royalties on drug patents, softwares and intellectual properties are increasingly shifting to tax havens. Due
to which these companies are avoiding paying taxes in their home countries.

@August 27, 2024

Taxation 19
 Transparent Taxation— ‘Honouring the Honestʼ Platform and
Taxpayersʼ Charter
This platform was launched by the PM in 2020. In taxation system in India widespread corruption continues to exist. At the
same time the tax officials behave in an arrogant manner and they are also insensitive to the problems of the taxpayers.
This platform was launched in order to rectify these problems. Gradually it is expected that the taxation system in India will
become more and more transparent and the taxpayers will also get their due respect. Even taxpayers charter has been
released stating that what can be expected from the tax department by the taxpayers and what the department expects
from the taxpayers.

In order to maintain transparency in the taxation system, faceless filing of tax return, faceless appeal, etc. are being
promoted. It means gradually all the services are being made online so that minimum contact between the officials and the
taxpayers may exist.

Tax on Virtual Digital Asset

Here virtual digital asset includes crypto currency and even Non-fungible Token(NFT). Any profit which is made through
investment in these virtual digital assets, is now taxable in India. This tax was imposed in the budget 2022 -23. The profit is
taxed at a rate of 30%. Over the tax, health and education cess is also applicable at a rate of 4%.

In order to track the sale of crypto or NFT, the exchanges operating in India have been instructed to set aside TDS of 1%
over the entire value of sale. This TDS will be adjust ed while filing ITR.

Windfall tax
Windfall tax is that tax which is imposed and collect ed over the windfall gain of a company. Windfall gain or profit is that
profit of a company which is sudden and unexpect ed. On this sudden and unexpected profit additional tax is imposed by
the government which is termed as windfall tax. If this sudden gain is temporary even the windfall tax will be temporary.
For example, when Russia attacked Ukraine , crude oil prices began rising sharply. Because of this increase the
companies engaged in extracting oil in India began making sudden profit. Hence, the government imposed windfall tax
over them. Over the additional profit. As the oil prices began coming down, even the windfall tax was withdrawn.

Tax buoyancy
It refers to a situation in which the tax collection in a country increases at a rapid pace. It is a situation in which the rate at
which tax receipt increases is higher as compared to the rate at which the GDP increases. It shows improvement in tax
compliance and it also shows that more and more people are being brought under the purview of taxation. It means that
even the tax base is expanding. Tax buoyancy may improve tax to GDP ratio.

Laffer Curve
This curve was given by an American economist Arthur Laffer. With the
help of this curve he tried to show the relationship between the rate of tax
and the revenue from tax. According to him, if the tax rate remains low the
tax receipt will also remain low. As the rate increases, the tax receipt also
increases. However, if the rate goes beyond a certain limit, the tax receipt
will start declining. It shows that the tax collection will be maximum only
when the tax rete is moderat e. When the tax rate goes beyond a certain
limit, payment of tax is seen as a burden which leads to tax evasion.

Laffer curve depictin g maximu m tax collection at an

optimum rate

Hence, people begin evading tax by hiding their income. It can be concluded that tax receipt can be maximised when the
tax rate is moderat e and the tax base is enhanced continuously by bringing in new taxes imposed on different
entities(which not paying taxes earlier) or bringing in more and more people under the tax blanket.

Taxation 20
 Shorts

1. Direct Tax Code (DTC)

The Direct Tax Code (DTC) was a proposed reform in India's direct tax system intended to replace the existing
Income Tax Act. However, due to some unpopular provisions, the government opted to implement major
changes gradually by amending the existing law rather than overhauling it complet ely. Key recommendations
under the DTC included:

Change from EEE to EET Mechanism:

Most tax-saving financial instruments in India follow the EEE (Exempt, Exempt, Exempt) model, where
investments are exempt from tax at all stages: investment, accumulation, and withdrawal.

DTC proposed to replace this with the EET (Exempt, Exempt, Tax) model. In EET, the initial investment
and accumulation remain exempt, but withdrawals, especially the profit portion, would be taxed.

Raising Income and Investment Exemption Limits:

With the introduction of the EET model, the DTC proposed raising the income exemption limits and the
investment limit for exemptions under Section 80C.

Reduction in Corporate Tax Rate:

A proposed reduction of the corporate tax rate for Indian companies to 25%.

Minimum Alternate Tax (MAT):

DTC suggest ed applying MAT to all companies based on the total value of assets rather than book
profits. The rate proposed was 2% for most companies and 0.25% for banking companies.

Uniform Tax on Capital Gains:

The distinction between short-term and long-term capital gains was to be eliminated, with all gains
taxed at a single rate.

2. Google Tax/Equalisation Levy

Also known as the Amazon tax, the Equalisation Levy is a type of withholding tax aimed at taxing digital
transactions. Proposed by the OECD to address base erosion and profit shifting (BEPS), this tax was
introduced in India in the 2016-17 budget. It targets foreign internet companies like Google and Facebook,
which earn substantial revenues from Indian clients without a physical presence in India.

Mechanism:

If an Indian company pays over Rs. 1 lakh annually for digital advertising to a foreign entity, it must
deduct 6% of the payment as a tax and remit it to the Indian authorities.

3. Global Minimum Corporate Tax

A global initiative to curb tax avoidance by multinational corporations by establishing a minimum corporate tax
rate.

Objectives:

1. Preventing multinationals from paying low or no taxes by booking profits in tax havens.

2. Ensuring companies pay taxes in countries where they earn profits, even without a physical presence.

3. Ending competitive tax reductions among governments to attract foreign investment.

Two-Pillar Solution:

Pillar One: Redistributes tax rights on a portion of profits of the largest multinationals to countries
where their customers are located.

Pillar Two: Imposes a global minimum corporate tax rate of 15%, ensuring that companies pay at least
this rate wherever they operat e.

4. Transparent Taxation— 'Honouring the Honest' Platform and Taxpayersʼ Charter

Launched in 2020 to enhance transparency and fairness in India's tax system.

Taxation 21
 Features:

Promotes faceless filing of tax returns and appeals to minimize direct interaction between taxpayers
and officials, reducing corruption and harassment.

Includes a Taxpayers' Charter outlining the rights and expectations of taxpayers and the tax
department.

5. Tax on Virtual Digital Assets

Introduced in the 2022-23 budget, this tax targets profits from investments in cryptocurrencies and NFTs
(Non-Fungible Tokens).

Tax Rate:

Profits from these assets are taxed at 30%. Additionally, a health and education cess of 4% is
applicable.

Exchanges must deduct a TDS (Tax Deducted at Source) of 1% on the sale value, adjustable during
Income Tax Returns (ITR) filing.

6. Windfall Tax
A tax imposed on companies that make unexpected or excessive profits due to external circumstances.

Example:

During the Russia-Ukraine conflict, rising crude oil prices led to unexpect ed profits for oil companies in
India, prompting the government to impose a windfall tax. As oil prices stabilized, the tax was
withdrawn.

7. Tax Buoyancy
Refers to the rapid increase in tax collection relative to GDP growth. Indicates improved tax compliance and a
broader tax base, leading to a higher tax-to-GDP ratio.

8. Laffer Curve
A concept introduced by economist Arthur Laffer that illustrates the relationship between tax rates and tax
revenue.

Explanation:

At low tax rates, tax revenue is low. As tax rates increase, revenue rises until it reaches an optimal
point. Beyond this point, further tax rate increases lead to a decline in revenue due to increased tax
evasion and reduced economic activity.

Indirect taxes
They are those taxes in which the real burden of the tax falls upon the consumer but it is collected by the government from
the seller or the producer in case of central government the revenue from indirect taxes is relatively low as compared to
the revenue from direct taxes. However, in case of states, the revenue from indirect taxes is higher as compared to the
direct taxes. Some major indirect taxes are the following:

Custom duty
It is an indirect tax collected by the centre on import and export of goods. It cannot be collected on services. It is classi fied
into import duty and export duty. Import duty is collected on import of goods whereas export duty is collected on export of
goods. It is not only a source of tax receipt but also an instrument through the inflow and outflow of essential and non -
essential can be regulated. For example, in order to prevent of a commodity, export duty can be enhanced over that
commodity. In order to prevent inflow of a commodity import duty can be enhanced. Similarly, in order to enhance outflow
of a commodity export duty can be reduced and in order to enhance the inflow import duty can be reduced.

Custom duty can also be used in order to encourage foreign investment. For example, on import of fully furnished
automobiles India imposes more than 100% import duty. It compels the manufact urers to setup their production unit in
India.

Taxation 22
 @August 28, 2024
Service tax
It used to be an indirect which was collected by the central government on sale of services. Although it was collected from
the seller the burden used to fall upon the consumer. Hence, it has been an indirect tax. After the introduction of GST
service tax was subsumed in GST and it does not exist anymore independently. At present on sale of services GST is
applicable which is an indirect tax shared between the centre and the states.

Excise duty
With the introduction of GST, the relevance of excise has fallen down. In fact excise has been subsumed in GST. Hence,
those products which are under the purview of GST are free from excise duty.

In any case excise duty can only be collected on manufact ured goods which are produced in the factories using machines
and tools. They cannot be collected over services and even over those product s that we derive directly from plants and
animals.

Excise duty is broadly classified into two parts— state excise and central excise on alcohol for human consumption and on
opium product s state excise is applicable. Since, they are outside GST, state excise is still collect ed. On every other
manufactured commodity the central government had the right to collect excise duty. Since petroleum products are still
outside GST the centre continues to collect excise duty on petroleum products. Excise duty is an indirect tax which finally
burdens the consumer.

The Organization for Economic Cooperation and Development (OECD) in October 2021 reported that 136 countries have
jointly agreed to ensure that large multi national companies have to pay a minimum tax rat e of 15%. These 136 countries
included in the agreement, contribute more than 90% to the global economy. India is also among these 136 countries.

@August 29, 2024

State Sales Tax(SST)
It was an indirect tax collected by the states on sale of goods. It used to be the most important source of tax receipt for the
states. It had numerous issues. The states were free to impose sales tax at any rate on a particular commodit y in their
state. Because of this there was widespread price variation from state to state. Secondly, in SST the problem of double
taxation existed in all the stages of production and sale. Thirdly, it suffered from cascading effect of tax over tax.

Because of these issues state sales tax was replaced by Value Added Tax(VAT).

Value Added Tax(VAT)

VAT is another indirect tax which was introduced in India over the sale of goods. For this purpose VAT Act 2005 was
passed but even before the act was passed by the parliament Haryana had become the first state to implement VAT. UP
became the last state to implement VAT. VAT was collected on sale of goods by the states. It was considered as a reform
over state sales tax. In VAT, during the process of production the tax is to be collected only on the value added part. The
objective was eliminate double taxation and to eliminate the cascading effect of tax over tax. However, even after
introduction of VAT we failed to eliminate double taxation and cascading effect completely. Even after implementation of
VAT due to numerous indirect taxes in India, the system of taxation in India remained complex. Hence, finally GST(pure
value added tax) was introduced in 2017.

Goods and Services Tax(GST)

GST can be seen as a comprehensive tax reform in the field of indirect taxes in India. France was the 1st country to
implement GST thereafter approximat ely 150 countries have adopted GST. In India, GST came into the limelight in the year
2003. The 'Kelkar task force'() constit uted under the chairmanship of Vijay Kelkar recommended for the 1st time that GST
should be implemented by the year 2009-10. For this purpose, an empowered committee of state finance ministers was
constituted to study the process of implementation of GST. Earlier 115th constitutional Amendment Bill was presented to
implement GST. However, the Bill did not pass. Since GST should have affected even the revenue of states, in order to
implement it, a Constitutional amendment was to be done with a special majority along with ratification by at least half of
the states, which was not an easy task. Again 122nd Amendment Bil was presented, which was passed in both the houses
and became the 101st Amendment Act.

Taxation 23
 GST is a comprehensive indirect tax that subsumes several existing indirect taxes
which were imposed and collected by the states as well as the centre on production and sale of goods and service. As an
indirect tax, GST came into force on 1st July 2017. It has the following objectives—

1. To eliminate multiple indirect taxes and to ensure one single indirect tax only at the point of
consumption.

2. It simplifies the entire mechanism of indirect taxes.

3. To eliminate the cascading effect of tax-over-tax with the mechanism of input tax credit under which the tax paid by
the manufact urer or the service providers over the purchase of inputs is refunded.

4. To bring all the goods and services under a few tax slabs and gradually under one single slab to ensure "One Nation
One tax".

5. To bring down the price of goods to ensure an increase in consumption, investment, and
production. In other words to boost the economy and enhance the ease of doing business in India.

6. To make the filing of indirect tax completely digital i.e. online through the GST-N portal for
convenienc e and corruption prevention.

7. To develop a chain/mechanism which will prevent tax evasion in the process of manufact uring and sale of goods as
well as supply of services.

Prior to the implementation of GST, several indirect taxes were in place in the country. Some of these taxes were collected
by the centre whereas some by the states. Under GST some of the indirect taxes collected by the centre such as central
excise, service tax, etc have been subsumed. Customs duty has been kept out of GST. Some of the indirect taxes such as
VAT, central sales tax, entry tax, Octroi (Collected by local bodies) entertainment tax, etc, collected by the states have al so
been subsumed. GST is a tax that is applicable only at the point of consumption. Hence most of the taxes paid in the form
of GST over the purchase of input have to be credited. This is termed as Input Tax Credit(ITC).

Under GST there are slabs of 5%, 12%, 18%, and 28%. Some goods and services are kept out of the purview of GST eg.
Fruits, vegetables, food grains, etc. Gold and diamond jewellery is an exception over which GST of 3% has been imposed.
Since the states were apprehensive about the loss of revenue because of the implementation of GST, they demanded a
revenue-neutral rate. It refers to that rate of GST which would ensure that from the 1st day itself neither the states nor the
center would suffer any loss of revenue. However the demand was rejected. In order to set aside this apprehension, it was
decided that the state wil be compensated 100% for 5 years for any loss. To mobilise funds for this purpose, over luxurious
goods and sin goods such as cold drink, cigarett e, etc an additional cess is applicable. It has also been decided that some
of the items which have been the main source of income for the state will be kept out of the purview
of GST for the first few years. The states will be free to collect tax over these items as they have been collecting. These
items include petroleum product s, electricit y, liquor, opium product s, etc.

Since GST subsumes the indirect taxes collected by the centre as well as states, it has to be divided into two parts. One
part will be paid to the central government which is termed as CGST and the other part will be paid to the state where
consumption takes place and is termed as SGST. If consumption takes place in a union territory then the tax will be divided
into two parts CGST and UTGST. In the case of Inter-state where the production takes place in one state and consumption
in another state, then it will cause loss to the producer state and will benefit the consumer state. Hence to prevent this, on
inter-state trade IGST is collected by the centre.

On most of the items, the taxes are bound to come down and it is to be ensured that the benefit is entirely passed on to the
consumers, for this purpose Anti-profiteering clause has been introduced.

To protect the federal structure of the country GST Council has been created which is headed by the Union Finance
Minister. The other members are the Minister of State for Finance at the centre and the Finance Ministers of all the states
and UT's (which have assemblies). Any modification in GST or its slabs is done by the GST Council. However, the proposal
is passed only if in case 75% of the votes are in favour of the proposal. The weightage of the votes of the 2 represent atives
of the centre will be 1/3rd of the total weightage, whereas the combined weightage of the votes of the states and UT's will
be 2/3rd of the total weightage, which means neither the centre nor the states can unilaterally take any decision.

Although GST has several positive objectives and consequences it also has certain challenges as well as few negative
consequences—

GST prevents evasion of indirect t axes and the e-filing makes the entire process more convenient. However, since t he
increase in consumption was not accompanied by an increase in production it led to demand-pull inflation in t he initial
months.

Taxation 24
 Since petroleum products and electricity have been kept out of GST, higher rate of tax imposed by the states on these
items would keep the cost of production high.

Even after a reduction in the taxes, it is a possibility that instead of shifting the benefit to the consumers the producer
may jack up the prices to maximize their profits.

Due to a reduction in the taxes, the products produced by the organised sector became cheaper, the local products
produced by the unorganised sector are not able to compet e, and hence they are adversely affect ed.

Although GST seems to be a simplified tax, the compliance is highly complex; hence it has to be support ed by the GST-
N portal which initially had several complexities and glitches.

In the quarter prior to implementation of GST and in few subsequent quarters due to lack of clarity, the GDP growth
suffered. It was mainly because the companies were aware that after the implementation of GST, benefit in the form of
the input tax credit is to be made available by the government, in the quarter prior to its implementation, instead of
producing more and more they tried to clear their inventory. Even in the subsequent quarters, the tax
rate was modified frequently because of which the producers kept the production low.

15th finance commission also pointed out many drawbacks in proper implementation of GST. There is a huge
fluctuation in tax collection under GST. Tax collection under GST has been below the expectation. Delay in refund in the
form of input tax credit is another major issue. The mismatch in invoice and input tax has been another problem. The
15th finance commission pointed that the dependency of states over centre for compensation is a matter of concern.

In GST it can be said that by subsuming indirect taxes the taxation was simplified but the compliance became complex.
Due to provision of Input Tax Credit(ITC) a buyer will always prefer buying from a GST registered seller. It affects the
business of unregistered small sellers with a lower turnover. In hilly states if a seller is selling services worth ₹10 lakh or
more annually or sheʼs selling goods worth ₹20 lakh or more annually, it will be mandat ory for her to get GST
registration. In other states for services the minimum turnover is ₹20 lakh and for goods it is ₹ 40 lakh.

On GST portal the content is only in English which makes it difficult for the less sellers educat ed in the vernacular
medium to use the portal on their own. Since, everything is online the user has to be tech savvy.

The benefit of the reduced tax was to be passed on to the consumers. However, the benefit was taken away by the
producer or the seller by jacking up the prices and imposing the GST over the increased price.

Due to Covid crisis in the year 2020-21 a huge drop in GST collection was seen. So providing the compensation to the
states became a concern for the centre. In order to meet the gap of States due to short release of compensation and
shortfall in cess collection, the Centre has borrowed and released 1.1 lakh crore in 2020-21 and 1.59 lakh crore in 2021-22.
Many states demanded to extend the GST Compensation Cess deadline by 5 years. However the demand was rejected by
the centre. But the central government in 2022, extended the time for levy of GST compensation cess. The GST Council,
decided to extend it till March 2026 to repay the loans taken in the last two fiscal years impacted due to Covid to make up
for the shortfall in their revenue collection.

Composition scheme
Although GST is a tax reform, the complianc e in GST is highly complex. Hence, it becomes difficult for the sellers with
lower turnover to bear the cost of compliance. Hence, as a relief to such sellers composition scheme was introduced.
Composition scheme was initially available only to the sellers of the goods and the restaurant. In hilly states, the scheme
can only be availed by the sellers who have an annual turnover of not more than ₹70 lakh. In other sates, the annual
turnover must not exceed ₹1.5 crore. Such sellers need not follow the compliance but they will have to pay 1% of the total
turnover in the form of tax to the government. Half of the tax will go to the centre whereas the remaining half will go to th e
state where the seller is located. Those restaurant which do not sell liquor can avail the facility but they will have to pay 5%
of their annual turnover in the form of tax. Half of this will go to the centre and half will go to the state.

Later on, composition scheme was extended even to the sellers of the services. This facility can be availed by those
service providers who have an annual turnover of not more than ₹50 lakh. They need to pay 6% of the total turnover in the
form of tax. Half of this will go to the centre and the remaining half will go to the state of consumption. However, the sellers
who avail composition scheme will have to follow the following guidelines:

1. They cannot claim ITC

2. They cannot engage in interstate trade

3. They cannot collect GST from the buyers separat ely by issuing GST invoice

E-way bill

Taxation 25
 In the cost of commodity, even the cost of transportation plays an important role. In India, prior to the introduction of E-way
bill system the documents were to be verified at the check posts manually. It lead to traffic congestion, wastage of time
and even consumption of extra fuel . In India, because of such reasons in the final price of a product the cost of
transportation used to be as high as 14%. Because of this in the logistics performance index, Indiaʼs ranking remained low.
In order to get rid of these problems E-way bill was introduced under GST. It became effective in 2018.

If a commodity worth more than ₹50K is to be transported within a state or from one state to another then e-way bill will be
mandatory. E-way bill can be generat ed in electronic form by the seller or the transport er or even by the buyer. The check
post system has been discontinued and the vehicles can be intercept ed anywhere on the route by the tax officials and the
e-way bill number can be demanded. They carry a hand held device with the help of which the e-way bill number can be
cross-examined. If tax is evaded then a penalty of ₹10K or the amount evaded whichever is higher will be collect ed. After
its introduction, the issues pertaining to transportation have been brought down and in the logistics performance index
2023, Indiaʼs ranking was rose to the 38th position among 139 countries.

The validity of e-way bill is 1 day per 100 km for normal vehicles. For over-dimensional vehicles, the validity is one day per
20 km.

Sabka Vishwas Scheme

Indirect taxes such as excise, service tax, etc. after the introduction of GST became irrelevant to some extent. Hence, in
order to get rid of the disputes pertaining to such taxes, in 2019 centre came up with this scheme. Under this scheme it
was proposed that in case of dispute pertaining to indirect taxes, if the taxpayer agrees to pay the tax amount, the
Government will renounce the penalty as well as the interest and withdraw the case.

Pigouvian tax
This tax was proposed by Arthur Pigou. Based on his name even the tax is termed as Pigouvian tax. Pigou suggested that
any positive act having some negative externalities should be taxed. In other simple words, a positive act having negative
consequences should be taxed. For example, in the process of production of steel, power, etc. even pollution is caused
due to emission. Hence, such activities can be taxed. The additional fund that is raised can be used in order to rectify the
harm to some extent. For example, carbon tax.

Tobin tax
This tax was proposed by James Tobin of Nobel prize fame. The tax is named after him. James Tobin proposed that in
order to prevent sudden inflow of foreign exchange and sudden outflow of foreign exchange, conversion of foreign
currency into foreign currency and foreign currency into domestic currency should be taxed by the government . This tax
will cause additional burden and hence may prevent sudden inflow or outflow. Tobin tax is mainly in the form of direct tax.

Sin tax
There are a number of products which are harmful for health. Consumption of liquor, cigarettes, other tobacco products,
soft drinks, etc. may have negative consequence over health. On such product s additional tax can be imposed by the
government in the form of sin tax. It is an indirect tax. The government believes that such taxes increase the price of the
product and may discourage its consumption. At the same time the additional funds received can be used to improve
healthcare facilities.

Angel tax
For the startup companies, funding from angel investors and the venture capitalist s is the most important source of funds.
However, the fund received was taxable. The fair market value of the stake sold was calculated by the Government of India
and the amount raised which is over and above the fair market value was taxed at a rate of 30.9% including cess. In the
budget 2024-25, this tax has been discontinued.

Tax expenditure
The central government continuously remains in deficit. It is mainly because the income remains low whereas the
expenditure remains high. The two most important reasons behind the low receipt of the government are — tax evasion

Taxation 26
 and tax expenditure. Tax evasion refers to non-payment of taxes on taxable income by hiding the income or by providing
the wrong account of the income. Hence, it is an illegal act. However, tax expenditure is different.

Tax expenditure is deliberately done by the government. It refers to those taxes which were supposed to come to the
government but the government renounces them. In other simple words it refers to the tax exemptions given by the
government. Although tax expenditure leads to loss of revenue, it helps the government in achieving a number of policy
objectives.

Numerous exemptions are given to the low income group of the society so that they are left with more amount of money in
their hands which can be used for the purpose of consumption. This leads to economic growth.

The taxpayers are provided with a number of financial instruments by investing in which they may bring down their tax
liability. Such invest ment s remain free from tax and it promotes small savings.

For the purpose of industrialisation of a given region tax exemptions can be announced for several years. In order to
promote startup culture, in the first ten years for their establishment they may choose any three consecutive years during
which they need not pay corporat e tax.

In order to promote low cost housing, GST can be eliminated, principal as well as interest payment on home loans can be
exempted from tax.

In order to promote export and investment, the concept of SEZ was introduced with a number of tax exemptions. Hence, it
can be concluded that tax expenditure helps the government in achieving a number of objectives.

Regressive taxation
A taxation system in which the rate of tax decreases with increase in income. Such taxation system is not justified.

Taxation 27
 Shorts

Indirect Taxes Overview

Indirect taxes are those where the burden of the tax ultimately falls on the consumer, even though the
government collects the tax from the seller or producer. Indirect taxes can significantly differ between the
central government and state governments in India, with states typically earning more from these taxes than
from direct taxes.

1. Major Types of Indirect Taxes

Custom Duty:

This is an indirect tax imposed by the central government on the import and export of goods, not
services.

It includes two types: import duty (on imports) and export duty (on exports). Custom duty helps
regulate the inflow and outflow of goods and encourages foreign investment by imposing high taxes
on fully imported product s, encouraging production within India.

Service Tax:

Before the introduction of the Goods and Services Tax (GST), the central government collected service
tax on services.

With GST's implementation, service tax was merged into GST, making GST the applicable indirect tax
on services today.

Excise Duty:

Excise duty was historically imposed on manufactured goods produced in factories.

Post-GST, excise duty has been largely subsumed into GST, except for petroleum products and
alcohol for human consumption, which are still taxed under state or central excise.

State Sales Tax (SST):

SST was a major source of revenue for states on the sale of goods but faced issues like double
taxation, price variations, and cascading effects.

It has been replaced by Value Added Tax (VAT), which aimed to eliminate these issues by taxing only
the value added at each stage of production.

Value Added Tax (VAT):

Introduced as a reform over SST, VAT was collected by states on the sale of goods, focusing on taxing
the value addition only.

Despite its introduction, VAT failed to fully resolve issues of double taxation and tax cascading, leading
to the adoption of GST.

Goods and Services Tax (GST):

Implemented on July 1, 2017, GST is a comprehensive indirect tax that subsumes various central and
state taxes into a single tax applied at the point of consumption.

GST aims to simplify the indirect tax system, prevent tax evasion, eliminate cascading effects, and
encourage economic growth by lowering overall tax burdens.

It is divided into CGST (central share), SGST (state share), UTGST (union territory share), and IGST (for
interstate transactions).

2. Specific Indirect Taxes and Concepts

E-way Bill:

Introduced in 2018, this is a digital document required for the transportation of goods worth more than
₹50,000. It helps streamline logistics and reduce transportation costs by replacing manual checks at
state borders.

Sabka Vishwas Scheme:

Taxation 28
 Launched in 2019 to settle disputes related to pre-GST indirect taxes. It allowed taxpayers to settle
their dues by paying only the tax amount, with penalties and interest being waived off.

Sin Tax:

A tax imposed on goods considered harmful to health, such as tobacco and alcohol, to discourage
their consumption and generat e revenue for health services.

Pigouvian Tax:

Named after economist Arthur Pigou, this tax is levied on activities that produce negative externalities,
like pollution, to fund corrective measures.

Tobin Tax:

Proposed by economist James Tobin, it is a tax on currency conversions to curb excessive volatility in
foreign exchange market s.

Angel Tax:

Previously imposed on funds raised by startups over the fair market value, it was discontinued in the
2024-25 budget.

3. Taxation Policies and Effects

Tax Expenditure:

Refers to revenue losses due to tax exemptions granted by the government to achieve various policy
objectives, like encouraging savings or invest ments in specific sectors.

Regressive Taxation:

A tax system where the tax rate decreases as the taxpayer's income increases, considered unjust as it
places a higher relative burden on lower-income individuals.

Demonetisation
Money is a medium of exchange. Currency or coin which is legally accept ed as a medium of exchange is known as Legal
Tender Money. If the central bank of a country or the central government withdraws this legal support or legitimacy
associated with a particular denomination of currency note or coin then it is termed as demonetisation. Demonetisation by
the central bank of a country is a common phenomenon but demonetisation done by the government of a country has
been seen in India only thrice. Once in 1946, again in 1978, and recently on 8 November 2016. However, the nature and
purpose of the process of demonetisation done in 2016 were different from the earlier ones. Clause 26(2) of RBI Act 1934
authorises even the central government to withdraw its guarantee from any denomination note.
The RBI mentioned that the soil rate of higher denomination currencies were higher. It is that rate at which notes are
considered to be too damaged to be used and returned to the central bank. According to data from the RBI, the soil rate for
smaller denomination notes in India is 33% annually. The soil rate for the Rs. 1000 note was only 11%, whereas it was 22%
for the Rs. 500 note. Assuming that all of these notes would degrade at the same pace if they were actually being used for
transactions is one method of estimating black money.

The officially declared objectives of demonetisation were as follows-

1. To curb Black money

2. To curb corruption

3. To eliminate fake/ counterfeit currency notes

4. To prevent terror financing

Other than the officially declared objectives of demonetization, this process of demonetization may fulfill some additional
objectives. If a certain part of the currency notes lying in the economy in the form of 500 rupee notes and 1000 rupee
notes fail to come back to the RBI then the liability of RBI would come down to the same extent.

However, out of 15.41 lakh crore rupees, 15.31 lakh crore came back to the RBI. Hence, this objective was not fulfilled
according to the expectations. Even after that once the process of demonetisation is complete, it is for sure that the fresh
currency note will not be issued in the same proportion. Hence, in any case, the liability of the RBI will come down. This
becomes an important basis for the improvement in the sovereign rating of India. Demonetization also encouraged cash -

Taxation 29
 less transactions ensuring that the Indian economy gradually moves towards a 'less-cashʼ economy. When transactions are
conducted in a cashless form, it becomes easier to track the movement of money from one hand to another. The money
lying at home or being hoarded doesn't contribute to the economic activities. However, after demonetization, the liquidity in
the banking system increased making the availability of loans cheaper. In the long run, this would enhance consumption
and investment.

A number of the hoarders used several loopholes to launder their black money. A huge amount of money being deposit ed
in Bank Accounts doesn't certify that it is not black money. Any amount of money deposited in accounts will always leave
behind its footprints, making it easier for authorities to track it. Even in case black money is invested in some asset and
finally, it comes to the account of the entity which sold the asset, somebody in this entire chain will have to bear the burd en
of the tax. That is the reason why in the Fiscal Year that ended on 31st March 2017, the tax receipt of the government
increased by 38%. The collection of Central Excise went up by 33.9%. At the same time, the Service tax collection
increased by 20.2%. A sharp jump in the filing of IT-ret urn was witnessed. Advance personal income tax collection
increased by 41.7%. 1.8 million bank account s have been identified in which the cash deposit was not in line with the
income shown by them in previous years. Thousands of shell corporations have been identified which were set up just to
launder black money. Out of these 1.8 million accounts, half of the accounts have together witnessed a total deposit of 2.9
lakh crore rupees.

However, demonetization also had its negative consequences. In India, more than 86% of the total employment is in the
unorganized sector. It is mainly a cash-driven sector. The sudden outflow of cash from the economy adversely affected
employment in this sector. It had an immediate impact on the GDP of a country. Demonetizat ion also resulted in the sudden
increase in burden over the banking system. A large section of the society is still not connected with the banking system
which made it difficult for them to deposit the old currency notes. The RBI failed to ensure the avail ability of sufficient cash
(new currency) in the rural and interior parts leading to an extreme decline in liquidity. It means that the implementation o f
demonetization could have been smoother. However, all these problems were temporary.

The introduction of the currency note with the denomination of Rupees 2000 encouraged its
hoarding. As a result, the RBI declared in May 2023 that it will withdraw banknot es with denomination of Rs 2000 from
circulation.The notes can be deposit ed or exchanged until 30 September 2023, according to a deadline set by the RBI.
According to the RBI, the removal of the Rs. 2000 notes is a component of its Currency Management Operation. The
elimination of the Rs. 500 and Rs. 1000 notes during the demonetization operation necessitated the introduction of the Rs.
2000 banknot es in order to satisfy the need of quick remonetisation. The printing of Rs 2000 notes was discontinued way
back in 2018-19 since there was a sufficient supply of other
denominations and the intended goal of remonetisation was achieved.

Taxation 30
 Shorts

Demonetisation
Definition: Demonetisation is the withdrawal of a currency's legal tender status by the central bank or
government.

Occurrences in India: 1946 * 1978 * 2016 (notable for its different nature and objectives)

Legal Basis: Clause 26(2) of the RBI Act, 1934 allows the government to demonetise currency.

Reasons for 2016 Demonetisation

Official Objectives:

1. Curb black money

2. Curb corruption

3. Eliminate counterfeit currency

4. Prevent terror financing

Additional Objectives:

Reduce RBI's liability if currency doesnʼt return

Promote cashless transactions and a less-cash economy

Improve sovereign rating by reducing currency in circulation

Outcomes of 2016 Demonetisation

Positive Outcomes:

Increase in tax revenue and compliance

Surge in cashless transactions

Identification of suspicious accounts and shell companies

Negative Consequences:

Disruption to the unorganised sector

Temporary GDP decline

Initial shortage of new currency, especially in rural areas

Encouragement of hoarding due to the introduction of the Rs. 2000 note

Recent Developments
Rs. 2000 Note Withdrawal:

Announc ed in May 2023 as part of currency management

Notes to be exchanged or deposit ed by 30 September 2023

Rs. 2000 note printing stopped in 2018-19 due to sufficient other denominations

Budget 2024 key figures

https://prod-files-secure.s3.us-west-2.amazonaws.com/d987ee5c-daee-4c49-b53c-3e66ea17aa63/1ed17bdb-f023
-4f19-89a7-17b69ec96ce8/Budget_2024-25_key _figures.pdf

Taxation 31
 Foreign Investment and Trade
Date created @September 2, 2024 11:54 AM

Revisions 1

Start date @September 2, 2024

Status Complete

Contents
Introduction
Foreign Direct Investment(FDI)
Pros and cons of FDI
@September 3, 2024
FDI in Multi-brand Retail Sector
FDI in E-commerce sector
Foreign Portfolio Investment(FPI)
@September 4, 2024
Balance of Payment
American Recession

Foreign Investment and Trade 1

 Euro Zone Crisis and Brexit
BREXITʼs impact on European Union
BREXITʼs impact on Britain
BREXITʼs Global Consequence
@September 6, 2024
Sri Lankan Crisis
Late convergenc e trap
Decoupling of the economy
Special Economic Zones(SEZ)
@September 7, 2024
Regional Comprehensive Economic Partnership(RCEP)
Why has India not signed it-

Introduction
Foreign investment refers to that investment which comes to India from outside. On the other hand foreign trade refers to
import and export of goods and services. Foreign investment can be classified into —

1. Foreign Direct Investment(FDI)

2. Foreign Portfolio Investment(FPI)

Foreign Direct Investment(FDI)

FDI is that form of foreign investment which comes to a country from outside with long term objectives. They either aim at
setting up a new business or they aim at investing in an existing business along with some role in the management of the
company/business. Hence, FDI is stable source of inflow of foreign funds. The investors aim at making profit through
business and not through change in the price of shares.

FDI can again be classified into two different types—

1. Greenfield FDI

2. Brownfield FDI

When FDI comes to India and a new business is setup then it is termed as greenfield FDI. On the other hand when foreign
investment in the form of FDI comes into an already existing company then it is termed as brownfield FDI.

Whether it is greenfield FDI or brownfield FDI, they may come to India through either of the two routes—

1. Automatic route or Mumbai route

2. Government route or Delhi route

Those sectors of the economy which are not strategically important which may not impact the internal and external
security and int egrity of the country fall under aut omatic rout e. In such sectors, invest ments can be made without seeking
permission from the Government of India. The invest ment maybe done automatically. However, the RBI has to be informed
within a period of 30 days.

On the other hand, there are sectors which are strategically important for the country. In such sectors FDI only through
government route is allowed. Since, the Government of India conducts its business in Delhi it is also termed as Delhi rout e
of investment. For such investments, prior permission is required. Initially, for such investments of upto ₹5000 crore we
had Foreign Investment Promotion Board(FIPB). For investments of more than ₹5000 crore the application was to be sent to
cabinet committee on economic affairs. However, at present this entire arrangement has been modified.

FIPB doesnʼt exist anymore. For FDI through government route, Foreign Investment Facilitation Portal(FIFP) has been
created. It functions under Department for Promotion of Industry and Internal Trade(DPIIT), Ministry of Commerce and
Industry. The proposals are to be posted by the investors on the portal and it is sent to the related ministry. After evaluating
the proposal, the ministry may accept or reject it. Any such proposal coming from Pakistan and Bangladesh will be sent to
the Ministry of Home Affairs for its permission. Even if in case the related ministry is in favour of the proposal the final
decision will be taken only by the Ministry of Home Affairs.

During Covid pandemic , the share market had fallen down throughout the world. The share price of even the large
companies in India had fallen to their multi-year low. Taking benefit of this opportunity, the central bank of China bought
more than 1% stake in HDFC. It was seen as a risk by the Government of India and hence, without naming China some
modification was done w.r.t. the rules related to FDI. According to the new rule, whether a sector falls in the list of

Foreign Investment and Trade 2

 automatic route or in the list of government route, if foreign investment is coming from any country which shares land
border with India it will not be allowed without seeking permission.

In some sectors in India, FDI is still not allowed. For example, in inventory based e-commerce companies, in any business
related to lottery, in any business related to gambling, etc. There are sectors in which FDI of upto 100% is allowed and
there are sectors in which FDI of upto 26% or 49% or 51% or 74% is allowed.

Pros and cons of FDI

Positive consequences—

1. It leads to inflow of foreign exchange adding to foreign exchange reserve

2. It is a relatively stable source of inflow

3. It leads to production and sale of services adding to the GDP of the country.

4. Whatever surplus is produced is exported leading to increase in Indiaʼs share in world trade.

5. It creates employment opportunities.

6. It changes work culture.

7. It may lead to technology transfer.

8. It enhances competition which improves quality and brings down the price.

Negative consequences—

1. Since MNCs have huge resources, they may kill competition and the domestic companies maybe thrown out of
business or they maybe acquired.

2. Once the competition is set aside, the foreign companies may increase the price.

3. The foreign companies pressurise the government to formulate policies in their favour.

4. The foreign companies create dependencies w.r.t. consumption which can be termed as Neo-imperialism.

5. They may bring foreign exchange once but the dividend flows forever to their HQ leading to outflow.

Foreign Investment and Trade 3

 Shorts

Introduction
Foreign Investment: Capital inflow from external sources into a country, contributing to economic growth
and development.

Types of Foreign Investment:

1. Foreign Direct Investment (FDI):

Definition: Long-term investments by foreign entities aiming to establish new businesses or invest
in existing ones with managerial involvement.

2. Foreign Portfolio Investment (FPI):

Definition: Short-term investments in financial assets like stocks and bonds without managerial
control.

Foreign Direct Investment (FDI)

Types of FDI
1. Greenfield FDI:

Description: Investment where a foreign entity establishes a new business or facility from scratch.

Impact: Leads to job creation, infrastructure development, and technology transfer.

2. Brownfield FDI:

Description: Investment where a foreign entity acquires or invests in an existing company or facility.

Impact: Infuses capital, enhances efficiency, and may bring in new management practices.

Routes for FDI Inflow

FDI can enter the country through two primary routes:

1. Automatic Route (Mumbai Route):

Description:

Applicable to sectors not strategically sensitive.

Investments do not require prior approval from the Government of India.

Investors must inform the Reserve Bank of India (RBI) within 30 days of investment.

Examples of Sectors: Information Technology, Manufact uring, Services (non-strategic).

2. Government Route (Delhi Route):

Description:

Applicable to strategically important sectors affecting national security and integrity.

Prior approval from the Government of India is mandatory.

Approval Process:

Foreign Investment Facilitation Portal (FIFP):

Managed by the Department for Promotion of Industry and Internal Trade (DPIIT) under the
Ministry of Commerce and Industry.

Investors submit proposals online, which are then forwarded to the relevant ministries for
evaluation.

Special Cases:

Investments from countries sharing land borders with India (e.g., China, Pakistan, Bangladesh)
require mandat ory clearance from the Ministry of Home Affairs, regardless of sector.

Historical Context:

Foreign Investment and Trade 4

 Former Mechanism: Foreign Investment Promotion Board (FIPB) handled approvals up to ₹5000
crore; abolished and replaced by FIFP.

Amendments Post-2020:

In response to opportunistic takeovers during the COVID-19 pandemic (e.g., China's central
bank acquiring over 1% stake in HDFC), regulations were tightened to scrutinize investments
from neighboring countries.

Sectoral Caps and Restrictions

100% FDI Allowed: In sectors like automobile, green energy, and some areas of the service sector.

Partial FDI Allowed:

74% FDI: Certain defense and insurance sectors.

51% FDI: Multi-brand retail.

26% or 49% FDI: Print media, broadcasting, and other sensitive sectors.

FDI Prohibited Sectors:

Inventory-based E-commerce: Direct selling to consumers without intermediaries.

Gambling and Betting: Includes casinos and online gambling platforms.

Lottery Business: Including government and private lotteries.

Real Estate Business: Excluding construction development projects.

Tobacco and Tobacco Products Manufacturing.

Pros and Cons of FDI

Positive Consequences
1. Inflow of Foreign Exchange:

Enhances the country's foreign exchange reserves, strengthening economic stability.

2. Stable Capital Source:

Provides long-term and reliable funding compared to volatile portfolio investments.

3. Economic Growth:

Boosts GDP through increased production and service delivery.

4. Trade Expansion:

Surplus production leads to increased exports, improving the trade balance and global trade share.

5. Employment Generation:

Creates direct and indirect job opportunities across various sectors.

6. Technological Advancement:

Introduces advanced technologies and innovative practices enhancing productivity.

7. Improved Work Culture:

Brings in international standards, better management practices, and corporate governance.

8. Enhanced Competition:

Drives domestic companies to improve quality and efficiency, leading to better products and services
at competitive prices.

Negative Consequences
1. Threat to Domestic Industries:

Large multinational corporations (MNCs) with vast resources may outcompete and displace local
businesses.

Foreign Investment and Trade 5

 Potential for Monopolies:

After eliminating competition, foreign entities may dominate markets and increase prices.

Policy Influence:

Powerful foreign investors might exert undue influence on government policies to favor their interests.

Economic Dependency:

Overreliance on foreign companies can lead to neocolonialism, where local consumption patterns and
economic policies are heavily influenced by external entities.

Profit Repatriation:

Summary

@September 3, 2024
FDI in Multi-brand Retail Sector
When goods are sold at wholesale level, it is termed as whole selling. When the goods are sold at retail level then it is
termed as retailing. If from an outlet products belonging to one single brand are sold at wholesale level, then it is termed as
single-brand whole selling. On the other hand if at product s belonging to different brands are sold from the same outlet at
wholesale level then it is termed as multi-brand whole selling. W.R.T. single brand whole selling and multi-brand whole
selling upto 100% FDI is allowed.

If from an outlet, products belonging to one single brand are sold at retail level then it is termed as single brand retailing.
Even in case of single brand retailing, upto 100% FDI is allowed.

If form an outlet, products belonging to multiple brands are sold at retail level, then it is termed as multi-brand retailing. The
Manmohan Singh government tried to introduce FDI of upto 51% in multibrand retailing. However, due to resistance from
the small retailers, it never became effective. Retailing in India is the second largest source of livelihood after agriculture.
The retailers were apprehensive that if the multinational companies enter into the retail business, the small retailers will be
thrown out of business. Hence, due to excessive resistance the provisions never became effective.

The provisions related to this FDI were as follows— The benefits of FDI in multi-brand retailing where as
follows—
1. FDI of only 51% was allowed, hence the remaining
stake must be held by an Indian investor. 1. Inflow of foreign exchange

2. A minimum investment of $100 million was required. 2. Retailing would have become an organised sector in
India upto a greater extent
3. At least half of the invest ment was to be done in
infrastruct ural development such as constructing cold 3. Employment generation with all the employees benefits
storage, godowns, procurement centres in rural areas
4. Increase in competition and quality of goods and
and so on.
services
4. The investment was allowed only in those cities which
5. Infrastructure creation
had a population of not less than one million according
to the census of 2011(during that period such cities 6. Since they were to be set up only in large cities with a
were 53 in number). million plus population their existence would not have
affected the retailers in rural areas and in small cities.
5. These retailers had to procure at least 30% of the
goods sold by them from the small scale industries. 7. There procurement from the small scale industries
would have benefited such industries which are a large
6. While procuring anything from the farmers, they cannot
source of employment in India.
use middlemen.

Foreign Investment and Trade 6

 7. In case of procurement of essential commodities, the 8. In the absence of middlemen the benefits can be
government will have the first right to procure. passed on to the farmers and to the consumers.

9. Organised retail will prevent tax evasion

10. Organised retail will help in collecting data for the

calculation of inflation at retail level.

FDI in E-commerce sector

E-commerce refers to electronic commerce. It refers to selling of goods and services online through app and websites. It is
a growing sector in India but it is facing a number of challenges. E-commerce sector has become a threat for the retailers
selling from the brick and mortar outlets because their operational cost remains low and they functio n 24 7. They may sell
products at a lower price all throughout the day and night. Since they are present online, their app or website can reach the
entire country. However, it has been seen that the e-commerce companies are resorting to predatory pricing. It means that
some times they keep the price even below the cost in order to eliminate competition.

In India, even without clear guidelines FDI in E-commerce sector had started coming. Hence, the brick and mortar retailers
filed case against such FDI in the Delhi High court. On the instructions of the court, the government had to frame guidelines
for FDI in e-commerce sector. For this purpose the e-commerce companies are classified into the following two types—

1. Inventory based E-commerce companies 2. Marketplace based E-commerce companies

If a an E-commerce company is set up and only the If an E-commerce company is acting as a market or as
company it self is selling t he product s using its own a platform for various sellers to sell their products then
platform then it is termed as inventory based E- it is termed as a market place based E-commerce
commerce company. In such E-commerce companies, company.
FDI is not allowed.

Flipkart, Amazon in India are all examples of marketplace based E-commerce companies. In such E-commerce companies,
FDI of upto 100% is allowed. W.R.T. such E-commerce companies, the rules related to FDI have been modified from time to
time. At present the rules are the following—

1. Such E-commerce companies will act only as a platform over which they cannot sell products themselves.

2. Different sellers may use the platform in order to sell different products but the E-commerce company cannot hold
stake in these sellers. However, the sellers will pay commission to the company.

3. The E-commerce company cannot compel a seller to sell exclusively using its platform. It means a seller is free to sell
product s on different platforms.

4. The E-commerce company cannot compel a seller to give discount.

5. Predatory pricing is not allowed.

Foreign Investment and Trade 7

 Shorts

FDI in Multi-brand Retail Sector

Retailing Types:

Wholesale Level:

Single-brand wholesaling: Selling products of one brand from an outlet

Multi-brand wholesaling: Selling products of multiple brands from the same outlet

Retail Level:

Single-brand retailing: Selling products of one brand at retail level

Multi-brand retailing: Selling products of multiple brands at retail level

FDI Policy:

Single-brand wholesaling/retailing: Up to 100% FDI allowed

Multi-brand wholesaling: Up to 100% FDI allowed

Multi-brand retailing: Proposed 51% FDI by the Manmohan Singh government, but not implemented
due to resistance from small retailers

Proposed FDI Provisions in Multi-brand Retail:

1. FDI Limit: 51%, with remaining stake by Indian investor

2. Minimum Investment: $100 million

3. Investment Allocation: At least 50% in infrastructure (e.g., cold storage, procurement centers)

4. Location Restriction: Allowed only in cities with a population of 1 million or more (53 cities as per 2011
Census)

5. Procurement Requirements: 30% of goods from small-scale industries

6. Farmer Procurement: Direct procurement, without middlemen

7. Essential Commodities: Government has first right to procure

FDI in E-commerce Sector

E-commerce Definition: Selling goods and services online through apps and websites

Challenges in E-commerce:

Threat to brick-and-mortar retailers due to lower operational costs and 24 7 availability

Predatory Pricing: Selling products below cost to eliminate competition

FDI Guidelines in E-commerce:

Inventory-based E-commerce:

Company sells its own product s on its platform

Foreign Investment and Trade 8

 FDI: Not allowed

Marketplace-based E-commerce:

Platform for various sellers to sell their products (e.g., Flipkart, Amazon)

FDI: Up to 100% allowed

Current FDI Rules for Marketplace-based E-commerce:

Stake Limitation: E-commerce company cannot hold a stake in sellers using its platform

Exclusive Selling: Sellers are not compelled to sell exclusively on one platform

Discounting: E-commerce company cannot force sellers to offer discounts

Predatory Pricing: Not allowed

Foreign Portfolio Investment(FPI)

FPI includes FII and QFI. They come to India form outside in the form of investment in the stock market with an objective of
making instant profit. For more details refer to →

@September 4, 2024

Balance of Payment
Balance of payment refers to the total financial transaction of a country with the entire world. Hence, it includes the total
inflow and total outflow of foreign currency in one financial year. If the inflow is more than the outflow, then it is termed as
Balance of Payment Surplus. On the other hand, if the outflow is more than the inflow then it is termed as Balance of
Payment Deficit. If in case a country has sufficient foreign exchange reserve to bridge this deficit then it is not a problem
for the country. However, if the country does not have sufficient foreign exchange reserve to bridge this deficit then it may
become a Balance of Payment Crisis. This is the only situation in which a member country may borrow from the IMF.

The inflow and outflow of foreign currency is calculated in a country under 2 different accounts—

Inflow and outflow of— 1. Short term lending and borrowing

1. Export and import 2. Long term lending and borrowing.

2. Invisibles 3. Medium-term lending and borrowing (Even the NRI

deposits in India will be counted as a part of our
a. Services
external debt/borrowing).
b. Income (dividend from companies operating
4. Financial Account- FDI and FPI.
abroad and interest payments

c. Transfers i.e. remittances

When the inflow and the outflow only in the current account of a country is calculated and the inflow is more than the
outflow then the country is said to be in current account surplus. On the other hand, if the outflow is more than the inflow in
the current account then it is termed as current account deficit. If a country suffers from a fiscal deficit as well as a current
account deficit then it is term as Twin Deficit. India is the largest recipient of remittance in the entire world, hence, the
current account deficit in India is mainly because of the outflow of foreign exchange due to import being more than our
export.

If only inflow and outflow with respect to export and import is calculated then it is termed as Balance of Trade. If the inflow
because of export is more than the outflow of foreign currency because of import, then it is termed as Balance of Trade
Surplus. On the other hand, if the outflow is more than the inflow then it is termed as Balance of Trade Deficit. The balance
of trade of a country is calculat ed with the entire world and also with every single country. With the entire world, India has
been in balance of trade deficit for last two decades. Itʼs mainly because of the import of gold and crude oil.

With countries like the USA, India is in the balance of trade surplus, but with china, India has always been in balance of
trade deficit. In terms of export, the USA is India's largest trading partner and in terms of imports, China is India's largest

Foreign Investment and Trade 9

 trading partner. According to Economic Survey 2022-23, USA remained the top export destination for India between April-
November, 2022. USA was followed by UAE and the Netherlands. On the other hand, after China, UAE, USA and Russia are
respectively the nations from where we import the most. A country always tries to maintain sufficient foreign exchange
reserves to meet its import requirement for at least 3 months. This is termed as Import Cover.

To fulfil any of the objectives under the current account or capital account foreign currency must be converted into
domestic currency or domestic currency must be converted into foreign currency. The ease with which a domestic
currency can be converted into foreign currency and foreign currency into domestic currency is termed as Convertibility of
Currency. If it is for the current account it will be termed as current account convertibility. In India, current account
convertibility is completely allowed with certain ceilings. However, capital account convertibility is not complet ely allowed
and it has numerous restrictions.

Fiscal deficit should be under control 3.5% or less

The exchange rate of domestic currency remains stable

American Recession
When the GDP of a country declines continuously for two or more quarters then the country is said to be in Recession. In
America, the recession which was witnessed in 2008 was also termed as "Sub-prime crisis" and "Housing crisis". Since
the entire crisis took place because of home loans given to the sub-prime customers the term sub-prime crisis was used.
Sub-prime customers are those customers who do not have a very good credit history. They are those customers who
have default ed in past. Since a home loan is considered to be a secured loan, the banks in the USA started providing home
loans even to the sub-prime customers at a higher rate of interest. Because of this, the demand for property increased, and
so did the prices.
Another instrument was created by the banks to maximize their profit. It was in the form of mortgage loan i.e., the same
property was mortgaged/pledged again and an additional loan was provided. It increased the burden of repayment. Hence,
the subprime customers started defaulting. The banks foreclosed such properties. However, such defaults were in millions,
and when the banks tried to auction these properties to recover their money, they failed to find suitable buyers. Hence the
supply increased but the demand for properties was low. Therefore the price of such properties started coming down and
the banks went into losses. The credit flow in the economy was affect ed. Because of this, the demand in the economy
declined which affected production. This continuous decline in the GDP pushed USA into recession. To maintain their profit
or reduce their losses, the companies started reducing the workforce. This led to increase in unemployment which further
brought down the demand and the recession became even more severe.

Whenever a country suffers from recession, the government of the country as well as the Central Bank both become
active. The government reduces direct taxes (income tax) leaving surplus in the hands of the consumers. Even the indirect
taxes (GST) are reduced making goods and services cheaper. The government also increases public expendit ure. They all
result in increased consumption. This external support provided by the government to the economy is termed as "Fiscal
Activism" aka "Fiscal Stimulus". The central bank reduces the interest rates so that the banks may borrow at a lower rate of
interest and may provide loans to the consumers at a lower rate. It will further enhance demand. This support provided by
the central bank is termed as "Quantit ative Easing".

Foreign Investment and Trade 10

 However, if the income of the government comes down
and expendit ure increases, due to the shortage of liquidity
in its own economy the government borrows from external
sources. If it borrows continuously, there may be a
situation when the government itself may not be in a
position to repay. It can be termed as a situation of Balance
of Payment crisis or more precisely, Sovereign Debt Crisis.
Because of this government may be compelled to withdraw
its support given to the economy. If it is done and as a
result, the economy falls again then it will be termed a
"Double-dip Recession". However, this situation was not
witnessed in the USA.

Courtesy: Business Insider

The recession did not affect India severely. It was mainly because the Indian economy is a domestically driven economy
with a huge domestic market where the demand never came down. However, the sectors which were export-orient ed
suffered adversely. Foreign investment was affected and a sudden flight of capital from the share market was witnessed.
Because of this, the share market went down sharply. This sharp and sudden decline in the share market is termed as
Financial Meltdown. However, the impact of the American recession was extremely severe in the European economies,
especially the smaller ones such as Portugal, Italy, Ireland, Greece, and Spain (PIGS).

Euro Zone Crisis and Brexit

The American recession had a widespread impact on the European economies, especially
the smaller ones including Portugal, Ireland, Italy, Greece, and Spain (PIGS). However, the main reason behind their
problem was not the American recession but the establishment of the European Union as well as the Euro Zone itself. The
smaller European economies were already weak. The American recession exposed their weakness even more. Including
Britain, the European Union had 28 members. This European Union has been a 'Free Trade Area' which ensures restriction-
free trade in goods as well as services. Hence the barriers on the export of goods and services remained low. Even the
movement of human resource was encouraged without any restriction. Because of this, the trade among the member
countries remained high. But the maximum benefit was derived by the larger economies such as Germany, Britain, and
France. To further strengthen trade relations common currency "Euro" was introduced. However, including Germany and
France, only 20 countries out of 28 countries had accept ed this common currency "Euro". These 20 countries constitut e
the "Euro Zone". Croatia on 1st Jan 2023 became the 20th member of Euro Zone. Britain was never a part of this Euro
zone. This common
currency Euro has been seen as a substit ut e or alternative to the 'US Dollar'. Prior to the use of this common currency, the
smaller economies of the European Union, as well as the larger economies, used their respective currencies. Hence, due to
the weak domestic currency of the smaller economies, these countries had some edge over the other larger economies
with respect to export. However, with the introduction of the Euro as a common currency, this edge was lost. It benefit ed
France and Germany the most. But this benefit was at the cost of the smaller economies. Secondly, after the constitution of
the 'Eurozone,' a common ECB (European Central Bank) was creat ed. Its main responsibility is to formulat e Monetary
Policies for the entire Euro Zone. However, the fiscal policies were formulat ed by the government s of the respective
countries. Because of this mismat ch between the monet ary policies and the fiscal policies was seen which affect ed the
fiscal health of smaller economies. The larger economies also enjoyed the benefits of "economy of scale". With the
American recession the demand in the American economy declined and the export of the PIGS countries declined further.
It made them even more vulnerable and they went into recession. Some of the countries also suffered from a situation of
"Sovereign debt crisis". To help them a TROIKA was constitut ed which included the European Commission, European
Central Bank (ECB), and the IMF.

To rescue these economies even Britain had to contribute, which became a political issue in Britain.

Even the economic opportunities which were being created in countries like Britain were being taken away by the
migrant s from the smaller economies.

Being a member of the European Union, Britain was not able to restrict the inflow of migrants. Even this was an
important issue.

Foreign Investment and Trade 11

 Whenever IMF provides a loan to a member country, it imposes certain restrictions on the borrower to reduce its wasteful
expenditure. However, even after borrowing, Greece failed to adopt such restrictions and defaulted on repayment in 2015
becoming the first developed economy to do so. It was realized even in Britain that the problems are not going to end soon.
Hence to decide whether Britain should remain a part of the European Union or not, a referendum was conducted in which
Britain finally decided on existing European Union. This exit finally took place on 31st January 2020.

The consequences of BREXIT can be felt at 3 different levels- over European Union, over Britain, and over the entire world
—

BREXITʼs impact on European Union

1. It lost a large trading partner in the form of Britain.

2. Britain's exit will make the EU weaker and relatively less important in the world economy.

3. With Britain's exit even among the other dissatisfied member countries, the demand for exit will increase making the EU
unstable.

4. EU was also a symbol of common European culture. The exit of Britain can be seen as the beginning of the end of this
common culture.

BREXITʼs impact on Britain

1. It is a protectionist policy adopted by Britain. Hence, the employment opportunities created
within the country will mainly remain with the British people.

2. Because of BREXIT, the pound has started weakening which will enhance Britain's export to other parts of the world.

3. However, no more being a members of the European Union. Britain will not be able to export goods and services to
these 27 countries without restrictions. Hence, Britain's export to other members of the European Union will take a hit.

4. Several companies from other parts of the world had invested in Britain to get the benefits of its membership to the
European Union, now these companies will start relocating to other parts of the EU.

5. Even to export to the EU, Britain will have to compete with companies from countries like India and China.

6. In the referendum, Scotland wanted to remain within European Union. But because of the overall majority voting in
favor of exit, discontentment among the people of Scotland increased. Now even Scotland is demanding a referendum
to exit from Great Britain. So that it may separately acquire membership in the European Union. It may lead to the
disintegration of Britain.

According to experts, earlier the negative effects of Brexit were hidden by COVID-19. But now the negative effects of Brexit
are more obvious as Britain's economic problem stems from rising inflation, a high cost of living and low productivity. The
domestic currency Pound Sterling has witnessed decline and the country is profusely bleeding foreign exchange.

BREXITʼs Global Consequence

1. It is a protectionist policy adopted by Britain which is being followed by other developed countries like the USA. It will
affect investments in the emerging economies like India. It will also affect trade in goods and services globally.

2. It is also being termed as the beginning of the process of de-globalization making multilateral organizations like WTO
meaningless.

3. It may also create an opportunity for countries like India and China to enhance their trade with the EU and Britain
separately.

Foreign Investment and Trade 12

 Shorts

Balance of Payment (BOP)

Definition: Total financial transactions of a country with the world, including foreign currency inflow and
outflow in a financial year.

Surplus/Deficit:

BOP Surplus: Inflow Outflow.

BOP Deficit: Outflow Inflow.

BOP Crisis: If foreign exchange reserves are insufficient to bridge the deficit.

IMF borrowing allowed only during a BOP crisis.

Accounts in BOP
1. Current Account:

Export & Import

Invisibles:

Services

Income (dividends, interest)

Transfers (remittances)

Current Account Deficit/Surplus: Based on inflow and outflow in the current account.

2. Capital Account:

Short, Medium, and Long-term lending/borrowing.

Financial Account: FDI and FPI.

Other Key Terms:

Balance of Trade:

Focuses on export and import.

Surplus: Export Import.

Deficit: Import Export.

India has a trade deficit for two decades due to gold and crude oil imports.

Import Cover: Sufficient foreign exchange reserves for 3 months of imports.

Convertibility of Currency:
Current Account Convertibility: Fully allowed with limits.

Capital Account Convertibility: Restricted to prevent sudden capital flight.

SS Tarapore Committeeʼs conditions for full capital convertibility:

1. Fiscal deficit control ( 3.5%)

2. Inflation control (3%–5%)

3. NPA reduction

4. Adequate forex reserves

5. Stable exchange rate.

American Recession (2008 Sub-prime Crisis)

Cause: Loans to sub-prime customers led to housing market collapse.

Effects:

Foreign Investment and Trade 13

 Property foreclosures increased.

Credit flow reduced, impacting demand and GDP.

Companies cut jobs, worsening the recession.

Responses:
Fiscal Activism: Government reduces taxes and increases public expenditure.

Quantitative Easing: Central Bank lowers interest rates to boost credit.

Double-dip Recession: Possible when government support is withdrawn, but not witnessed in the USA.

Impact on India:
Minimal Impact: Indiaʼs economy is domestically driven.

Sectors Affected: Export-oriented sectors, foreign investment flight, and financial meltdown in the stock
market.

Eurozone Crisis and Brexit

Eurozone Crisis (PIGS Countries)

Affected Nations: Portugal, Ireland, Italy, Greece, Spain.

Key Factors:

Weak economies worsened by the American recession.

Eurozone Problems: Smaller economies lost export advantages due to the common currency (Euro).

Mismat ch between monetary (ECB) and fiscal policies.

Troikaʼs Role: European Commission, ECB, and IMF helped debt-ridden countries.

Brexit
Reasons:

Britainʼs economic burden to support weaker EU countries.

Unrestrict ed migration affecting job opportunities.

Consequences:

For the EU:

1. Loss of a major trading partner (Britain).

2. Weakens EUʼs global standing.

3. Potential exits by other dissatisfied countries.

For Britain:

1. Reduced access to the EU market.

2. Declining pound boosts exports, but affects global competitiveness.

3. Companies relocating from Britain to EU nations.

4. Potential disintegration due to Scotlandʼs demand for an EU referendum.

Global Impact:

1. Shift towards protectionism.

2. Beginning of de-globalization.

3. Trade opportunities for India and China with both the EU and Britain.

@September 6, 2024

Foreign Investment and Trade 14

 Sri Lankan Crisis
When the inflow of foreign exchange in a country is less than the outflow leading to BOP deficit and the country does not
have sufficient foreign exchange reserve to bridge the deficit then it is t ermed as BOP crisis. Even Sri Lanka was facing t he
same crisis in 2022 because of which it had t o seek a bailout package of $3 billion from t he IMF. Sri Lanka had t o face t his
crisis because of several reasons—

1. Tourism is an important contributor in the economy of Sri Lanka. It is a large contributor in its foreign exchange reserve.
However, in the year 2019 on Easter Sunday because of serial terror attacks more than 250 people died in different
churches and luxury hotels. It affected tourism adversely which came down by more than 70%. This affected forex
inflow in the country.

2. In the year 2020, the Covid crisis further affected tourism in Sri Lanka which came down to almost zero. The forex
reserve was further depleted.

3. Sri Lanka tried to transform its agriculture to 100% organic. This suddenly brought down its agricultural production.
It not only affected export of agricultural products but also compelled Sri Lanka to import essential agri cultural
products. This lead to price rise and further depleted the forex reserve.

4. Due to the populist policies adopted by the government, the borrowings of the government increased continuously
which surpassed 100% of the GDP.

5. In the year 2022, the conflict between Russia and Ukraine lead to increase in crude oil prices in the international
market. Because of this the import cost increased and Sri Lanka had to borrow heavily from the external sources.

6. The borrowings done from China for developmental projects resulted in increase of the burden of repayment.

All such factors compelled Sri Lanka to default on its external borrowings and the country had to face BOP crisis.

Late convergence trap

On the basis of per capita income, the countries throughout the world are classified into three major categories—

When the per capita income of a low income country increases and it becomes almost equal to the per capita income of
the middle income countries then itʼs termed as convergence. Similarly, when the per capita income of a middle income
country increases and it becomes almost equal to the per capita income of high income countries then it is termed as
convergence.

Based on this classification, India falls in the category of low middle income countries. India is finding the process of
convergence highly difficult. It is mainly because India started the process of economic reform very late and since the
environment is not conducive the country is stuck in a trap and convergence remains a distant dream.

It has happened because of policy paralysis. It is a situation when the policies remain stagnant and they fail to change with
changing circumst ances. Post independence India failed to derive the benefits of globalisation whereas at the same time
the other neighbouring countries such as South Korea , Taiwan , Singapore , etc. continued to derive the benefit s of
globalisation to its maximum extent. Hence, for them convergence became easier. However, India continued to restrict
foreign investment s and economy grew at a low annual average rate of 3.5-4%.

Foreign Investment and Trade 15

 Due to adverse economic conditions India also had to face BOP crisis in 1990 -91. Thereaft er the country adopt ed the
process of economic liberalisation. However, the global condition and the domestic condition did not remain conducive.
India witnessed a phase of political inst ability and when t he economy began recovering, t he American recession of 2008
affected the world economy. Gradually, the world economy recovered from the crisis but demonetisation was done in the
country. Even the initial impact of GST over the economy was negative to some extent. When again the economy started
recovering, the world witnessed Covid crisis. As the world economy started recovering from the impact of Covid crisis, the
conflict between Russia and Ukraine lead to the increase in crude oil prices because of which inflation went up to its multi-
year high. Britainʼs exit from the EU is being seen as beginning of de-globalisation. The collective effect of all these
problems was that the process of convergence for India became difficult. This situation is also termed as Late
Convergence Trap.

Decoupling of the economy

Coupling of economy refers to a situation in which a domestic economy moves along with the world economy at almost the
same pace and in the same direction. Different from this when a domestic economy fails to move with the world economy
in the same fashion then it is termed as decoupling of the economy. In this situation it is a possibility that the world
economy is moving at a faster pace but the domestic economy remains slow or vice versa. It is also a possibility that the
world economy and the domestic economy may move in two different directions. Since last several years, the Indian
economy is witnessing decoupling. Sometimes the economy performs better and sometimes worse in comparison to the
world economy.

Foreign Investment and Trade 16

 Shorts

Sri Lankan Crisis (2022)

BOP Crisis: Occurs when foreign exchange outflow exceeds inflow, leading to a Balance of Payment
deficit.

Sri Lankaʼs Crisis: Faced a BOP crisis in 2022 and sought a $3 billion IMF bailout.

Causes:
1. Tourism Decline (2019):

2019 Easter terror attacks killed 250+ people, reducing tourism by 70%.

Significant reduction in foreign exchange earnings.

2. COVID-19 Impact (2020):

Tourism fell to almost zero, further depleting foreign exchange reserves.

3. Agricultural Reforms (2021):

Shift to 100% organic farming reduced agricultural production.

Resulted in lower agricultural exports and increased imports, causing price hikes.

4. Populist Policies:

Government borrowings exceeded 100% of GDP.

5. Russia-Ukraine Conflict (2022):

Led to a rise in crude oil prices, increasing import costs.

6. Chinese Debt:

Heavy borrowings for development projects increased repayment burden.

Outcome: Sri Lanka defaulted on external borrowings, leading to a BOP crisis.

Late Convergence Trap

Convergence: Process where low-income countries' per capita income rises to match middle-income
countries, and middle-income countries converge with high-income countries.

Indiaʼs Situation:

India, a low-middle-income country, struggles with convergence due to delayed economic reforms and
policy paralysis.

Reasons for Late Convergence:

1. Policy Paralysis:

India's restrictive policies post-independence limited growth.

Neighboring countries (South Korea, Taiwan, Singapore) benefited from globalization.

2. Low Economic Growth (Post-Independence):

Economy grew at a slow pace of 3.5-4%.

3. BOP Crisis (1990-91):

Led to economic liberalization, but global and domestic conditions remained challenging.

4. Political Instability:

Recession in 2008, demonetization, GST, COVID-19 crisis, and Russia-Ukraine conflict hindered
growth.

5. De-globalization:

Brexit signaled the beginning of de-globalization, further complicating convergence for India.

Foreign Investment and Trade 17

 Decoupling of the Economy
Coupling of Economy: Domestic economy moves at the same pace and direction as the global economy.

Decoupling: Domestic economy moves independently of the global economy, either faster, slower, or in a
different direction.

Indiaʼs economy has been witnessing decoupling, performing better or worse than the global economy at
different times.

Special Economic Zones(SEZ)

SEZs are specially demarcated areas within which the tax laws of the land i.e. country may not b e applicable in the same
form. It means that for SEZs, different tax laws are formulated. In India, SEZ Act was passed in 2005 but it became
effective in 2006. India borrowed this concept from China. SEZs aim at enhancing India's export. The applicable tax laws
have been formulated in such a manner that they will automatically provide an edge to Indian exporters.

In this entire arrangement, a developer will be there. It can be a private party, the government, or even a public-privat e
partnership. The developer has to acquire the land and develops the entire zone with all the basic facilities such as water
supply, electricity supply, transportation, communications, etc. The developer has to operate the zone at least for 15 years.
During the first 10 years, the developer need not pay any corporat e tax on its earnings from the SEZ. Once the zone is
developed space will be given on lease to the units which are interested in operating from the zone.
The units set up within the zone can be from the service sector and can even be from the manufact uring sector. All the
units may be associat ed with the same type of business or they may be associat ed with different types of businesses.
These units need not pay any duty on the procurement of capital goods as well as raw materials. Supplies to SEZs are
zero-rat ed under
IGST Act, 2017. Single window clearance for Central and State level approvals. Even while exporting, they need not pay
export duty. For the first five years, they will remain 100% exempted from corporate tax. During the next 5 years, they need
to pay corporate tax at half of the rate. During the next 5 years, they need to pay corporate tax at normal rate but on the
ploughed back profit (that part of the profit which is invested in the same business) corporate tax rate would be half.

These units have to follow some restrictions. Whatever they produce can only be exported and cannot be sold in the
domestic market. Secondly, they have to become net foreign exchange earners within a time period of 3 years. If they sell
their product s in the domestic market , all the benefit s will be taken away. India has more than 350 SEZs at present .

The objectives are-

To enhance India's export and increase its share in world trade. With respect to the import and export of goods, India
share is just about 3%. However, Indiaʼs import of goods is more than its export. On the other hand with respect to
trade and services, Indiaʼs share is more than 6%, with India exporting is more services itʼs importing.

To add to the GDP of the country and to create employment opportunities.

To attract domestic as well as foreign investment.

However, the biggest challenge is land acquisition. In order to set up SEZs, the minimum land required was 1000 hectare
when the units are engaged in different activities and 100 hectare when the units are engaged in similar activities. This was
revised to 550 hectare and 50 hectare respectively. According to the modified provisions, the unoccupied can be de-
notified and used for normal business. Hence, it is a possibility, that an SEZ may function in an area less than the minimum
prescribed area.

In the Budget 2022-23, the government has announced that the Special Economic Zones Act will be replaced by a new law
that will enable states to be partners in the development of enterprise and service hubs. This will cover all major existing
and new industrial enclaves to make better use of the available infrastructure and enhance the competitiveness of exports.

Exports from SEZs fell from $112.3 billion(FY20) to $102.3 billion in FY21. Percent age decline of 8.9%.

The Act has been reconsidered after the government last year adopted a sunset clause regarding the SEZs, declaring that
only those units which have started production on or before June 30, 2020, will be given a phased tax holiday for 5 years.

The Baba Kalyani committee set up in 2019 suggested that SEZ should be converted into Employment and Economic
Enclaves - 3Es by providing basic infrastructure like efficient transport, uninterrupted water, power supply, etc.

Foreign Investment and Trade 18

 The committ ee also favoured the speedy resolution of disput es through arbitration. It support ed flexibility in dual-use
norms for non-processing sectors, an extension of sunset clauses, simplification of procedures, tax benefit s to the service
sector, and expansion of MSME schemes in these areas.

Foreign Investment and Trade 19

 Shorts

Special Economic Zones (SEZs)

Definition: SEZs are specially demarcat ed areas with different tax laws, aimed at boosting exports by
providing tax and operational benefits to businesses.

Key Features:
SEZ Act (2005): Became effective in 2006. India adopted the SEZ concept from China.

Developer Role: Can be private, government, or PPP. The developer acquires land, sets up infrastructure,
and operates the zone for at least 15 years.

Tax Exemption: No corporate tax for the first 10 years.

Benefits for Units in SEZs:

Tax Benefits:

No duty on capital goods/raw materials.

Zero-rated supplies under the IGST Act, 2017.

100% corporate tax exemption for the first 5 years.

50% corporate tax for the next 5 years.

After 10 years, normal corporate tax applies, but half the rate on ploughed-back profits.

Export-Oriented: Units must export all their production and cannot sell in the domestic market.

Net Forex Earning: Units must become net foreign exchange earners within 3 years.

Single Window Clearance: Central and State level approvals are streamlined.

Objectives:
1. Increase India's Export Share: Currently, 3% in goods, and over 6% in services.

2. Boost GDP and Employment: Attract domestic and foreign investment.

Challenges:
Land Acquisition: Minimum land requirement reduced from 1000 hectares to 550 hectares for diverse
activities.

De-notification of Unused Land: Allows underutilized land to be repurposed for other businesses.

Recent Developments:
Budget 2022-23: SEZ Act will be replaced to involve states in developing enterprise and service hubs.

Goal: Better infrastructure utilization and enhanced export competitiveness.

Export Decline: SEZ exports fell by 8.9%, from $112.3 billion in FY20 to $102.3 billion in FY21.

Sunset Clause: Units starting production before June 30, 2020, will receive phased tax benefits for 5
years.

Baba Kalyani Committee (2019):

Recommendation: Convert SEZs into Employment and Economic Enclaves (3Es).

Emphasis on infrastructure (transport, power, water).

Dispute resolution via arbitration.

Flexibility in dual-use norms for non-processing sectors.

Extension of sunset clauses and simplification of procedures.

Expansion of MSME schemes and service sector tax benefits.

Foreign Investment and Trade 20

 @September 7, 2024

Regional Comprehensive Economic Partnership(RCEP)

The Regional Comprehensive Economic Partnership (RCEP) is a proposed agreement between the member states of the
Association of Southeast Asian Nations (ASEAN) and its Free Trade Agreement (FTA) partners. The pact aims to cover
trade in goods and services, intellectual property, etc. The Regional Comprehensive Economic Partnership was introduced
during the 19th ASEAN meet held in November 2011. The RCEP negotiations were kick-started during the 21st ASEAN
Summit in Cambodia in November 2012.

RCEP aims to create an integrated market with 15 countries, making it easier for products and services of each of these
countries to be available across this region. The negotiations were focused on the following:

Trade in goods and services investment

e-commerce, intellectual property

small and medium enterprises dispute settlement,

economic cooperation.

Why has India not signed it-

1. India wants all RCEP countries to have the right to protect data and prohibit cross-border data flow in the national
interest.

2. India already has over a $100 billion trade deficit with RCEP countries. Out of this, China alone account s for a $54
billion trade deficit ($101 B at present). So, India had apprehensions about signing this agreement. Moreover, RCEP
would have result ed in the increased flow of (Cheap) Chinese manufact ured and electronic goods into the Indian
market, and Indian MSMEs automobile, and steel industries had not been able to compete. So, India wanted separate
levels of customs duty against Chinese imports, which was rejected.

3. India is among the largest producers of milk but its specialty is mostly in liquid products whereas New Zealand is
renowned for its solid products (milk powder, butter, cheese, etc.) These solid dairy products have a longer shelf-life
and easier to transport over long distances. So, if trade barriers were removed, the Indian market would have been
flooded with cheap dairy products which might have led to the suffering of Indian farmers and dairy entrepreneurs.

4. Southern India's plantation farmers were afraid of cheaper tea, coffee, rubber, cardamom, and pepper from Malaysia
, Indonesia and other RCEP nations.

5. India wanted an Automatic Trigger Safeguard Mechanism (ATSM) to protect itself from the surge in imports.

6. Ratchet Obligation: It means a nation cannot go back/undo its commitments under the RCEP
agreement. India wanted certain exemptions on it.

7. India wanted the base year for tax cuts fixed at 2019 instead of 2014. Because since 2014, India has raised custom
duties on over 3,500 product s.

Foreign Investment and Trade 21

 Regional Comprehensive Economic Partnership (RCEP)
Introduction:

Proposed trade agreement between ASEAN countries and their FTA partners.

Aims to create an integrated market among 15 countries for goods, services, investment, and
intellectual property.

Key Focus Areas:

Trade in goods and services

E-commerce

Small and medium enterprises

Economic cooperation

Investment and intellectual property

Dispute settlement

Why India Didn't Join RCEP:

1. Data Protection Concerns:

India wanted rights for countries to protect data and restrict cross-border data flow in the national
interest.

2. Trade Deficit:

India already has a significant trade deficit of over $100 billion with RCEP countries, particularly with
China ($54 billion).

Concerns that RCEP would flood the Indian market with cheap Chinese goods, impacting Indian
MSMEs, automobile, and steel industries.

3. Dairy Sector Concerns:

India, a large milk producer, feared competition from New Zealand's solid dairy products (milk powder,
butter, cheese) with a longer shelf life, which could harm Indian farmers.

4. Agriculture Sector Concerns:

Plantation farmers in southern India were worried about cheaper imports of tea, coffee, rubber,
cardamom, and pepper from Malaysia, Indonesia, and other RCEP countries.

5. Safeguard Mechanism:

India demanded an Automatic Trigger Safeguard Mechanism (ATSM) to protect against import surges.

6. Ratchet Obligation:

India wanted flexibility to withdraw certain commitments under RCEP, which was rejected.

7. Tax Cut Base Year:

India wanted 2019 as the base year for tax cuts, instead of 2014, as it had increased customs duties on
over 3,500 product s since 2014.

Foreign Investment and Trade 22

 Multilateral organisations
@October 24, 2024 1:20 PM

Introduction
Tariff and Non-tariff barriers
Most Favoured Nation(MFN) status
Anti-dumping duty and countervailing duty
Agreement on agriculture
World Bank and International Monetary Fund
World Bank
International Bank for Reconstruction and Development (IBRD)
International Development Association (IDA)
International Finance Corporation (IFC)
Multilateral Investment Guarantee Agency (MIGA)
International Centre for Settlement of Investment Disputes (ICSID)
International Monetary Fund (IMF)

Introduction
Multilateral organizations such as the WTO, IMF, and World Bank can be seen as
product s of globalization. As international bodies, they further enhance the
process of globalization worldwide. The World Trade Organization (WTO) is a
multilat eral organization that aims to promote trade in goods and services with
minimal restrictions. It came into existence in 1995 as a successor to the General
Agreement on Tariffs and Trade (GATT). GATT was an agreement signed in 1947,
and India was a party to it as well as a founding member of the WTO.

The WTO headquarters is located in Geneva and is headed by a Director-General.

Peter Sutherland, who was also the last Director-General of GATT, became the
first Director-General of the WTO. Currently, the Director-General is Ngozi Okonjo-
Iweala from Nigeria, the first woman and African to lead the organization.

Multilateral organisations 1
 The highest conference of the WTO is called the Ministerial Conference. India is
represent ed at this conference by its Commerce Minister (currently Piyush Goyal).
The first Ministerial Conference was held in Singapore in 1996. The 13th Ministerial
Conference, the most recent, took place in Abu Dhabi in February 2024. During
this conference, Comoros (an African country) became the 165th member of the
WTO, and Timor-Lest e (East Timor) became the 166th member.

The WTO is an egalitarian organization where each country, regardless of its size
or economy, has one vote. This structure ensures equal representation for all 166
members in the decision-making process.

Tariff and Non-tariff barriers

WT O aims at bringing down t ariff and non-t ariff barriers which affect trade. Tariff
barriers are in t he form of export and import dut ies. By increasing such duties t he
outflow and inflow of goods can be restrict ed. However, the non-t ariff barriers are
different. They maybe broadly classified into the following types—

1. Quota restriction

2. Social clause

3. Environmental clause

Quota restrictions is also known as quantitative restriction. The developed

countries impose such restrictions on imports from the developing countries or
underdeveloped countries. It can also be imposed on movement of people
through visa restrictions. Under quota restrictions a maximum ceiling can be
imposed w.r.t. import of a particular commodity.

Social clause is in the from of social issues based on which import of a particular
commodity maybe restricted. For example, if child labour is used in the process if
production or if the workers are not even paid minimum wages, the importing
country may impose restrictions using such bases.

Under environmental clause environmental issues are taken as a base. For

example, if pesticide cont ent in an agricult ural product is high or if in t he process
of manufact uring of a commodit y carbon emissions are high then rest rictions on
import of such product s can be imposed.

Multilateral organisations 2
 Most Favoured Nation(MFN) status
Under WTO norms the member countries provide MFN status to each other. It
means that the member counties cannot discriminate against any other country
w.r.t. trade. Positive discrimination in the form of FTAs is possible but negative
discrimination should not be there.

Anti-dumping duty and countervailing duty

Although the WTO aims to reduce tariff and non-tariff barriers, certain
circumst ances allow for the imposition of barriers to protect domestic producers
from unfair trade practices. These barriers may take the form of anti-dumping
duties and count ervailing duties.
Dumping occurs when a country produces a product in quantities that exceed
both its domestic consumption and international market demand. Producers may
then export these product s to other countries at prices below the cost of
production or fair market value. This trade-manipulative practice adversely affects
domestic producers in the importing country. To protect them, the government of
the destination country may impose an additional duty on such imports, known as
an anti-dumping duty.

Similarly, government subsidies to producers or exporters can manipulate

international trade by keeping production costs and export prices artificially low.
This also affects domestic producers in importing countries. To count erbalanc e
the benefits of such subsidies, the government of the importing country may
impose additional import duties, called countervailing duties.

Agreement on agriculture
Agricultural subsidies and export of agricultural products have been an important
issue in WTO. The subsidies given in agricult ure to the farmers maybe trade
manipulative. Hence, WTO classify such subsidies into different type and impose
certain restrictions over such subsidies. The agricult ural subsidies are classified
into three different colours of boxes.

Multilateral organisations 3
 1. Blue box subsidy—These subsidies are given by the government to farmers to
keep production low. Farmers are asked to leave part of their land fallow,
ostensibly to restore soil fertility. Since production is kept low, farmers incur
losses. The government compensat es for these losses through subsidies.
Although this subsidy is trade-manipulative, it is considered less so than other
types.
2. Amber box subsidy— These subsidies are highly frade manipulative. They
maybe in the form of subsidised seed, fertilisers, subsidised electricit y, even
cash compensation, etc. These subsidies have to be brought down under
WTO norms. The developed countries to bring down then subsidies to five
percent of the total value of their production. On the other hand, the
developing countries have to reduce them to 10%

3. Green box subsidy— These are least trade manipulative and given for R&D in
agricultural sector. It hs to be continued without any restrictions.

value of the buffer created in a particular year cannot exceed 10% of the
total production in that year. This norms is in conflict with the interests

World Bank and International Monetary

Fund
The World Bank and IMF, known as the Bretton Woods Twins, were conceived
during the Bretton Woods Agreement in 1944. Named after a location in New
Hampshire, USA, these institutions were established to reconstruct the world after
World War II. Initially signed by 44 countries, the agreement brought both

Multilateral organisations 4
 organizations into existence in 1945. The World Bank began operations in 1946,
followed by the IMF in 1947.

While sharing similarities, the World Bank and IMF also have distinct differences.
Both headquart ered in Washington DC, they operate on a principle where IMF
membership automatically grants World Bank membership. As of 2024, the IMF
has 190 members, with Andorra being the newest addition—a small country
nestled between France and Spain. Andorra is expected to join the World Bank in
due course.

By convention, the World Bank president is always American, while the IMF
managing director is European. Currently, Ajay Banga serves as the 14th president
of the World Bank, appointed in June 2023 for a five-year term. Kristalina
Georgieva of Bulgaria holds the position of IMF Managing Director.

World Bank
The World Bank, initially known as the International Bank for Reconstruction and
Development (IBRD), was established to rebuild the world after World War II. Upon
fulfilling this responsibility, it was officially renamed the World Bank, with IBRD
becoming a component.

In 1960, the International Development Association (IDA) was created and

incorporated into the World Bank. Thus, the World Bank now comprises IBRD and
IDA. Subsequently, three more organizations were brought under its purview:

1. International Finance Corporation (IFC)

2. Multilateral Investment Guarantee Agency (MIGA)

3. International Centre for Settlement of Investment Disputes (ICSID)

These organizations, combined with the World Bank, form the World Bank Group
(IBRD + IDA + IFC + MIGA + ICSID).

International Bank for Reconstruction and

Development (IBRD)
Jointly owned by all member countries, IBRD provides long-term loans to middle-
and high-income countries for development al projects in areas such as poverty
alleviation, health, education, environment al conservation, and infrastruct ure.

Multilateral organisations 5
 Since 1959, IBRD has maintained the highest credit rating, enabling it to borrow
from other markets at lower interest rates.

International Development Association (IDA)

IDA offers long-term loans for similar developmental purposes but focuses on the
poorest countries, providing loans at extremely low interest rates. Funded
primarily by IBRD profits and member countries, IDA loans typically have a 25-30
year maturity with an additional 5-10 year extension. India graduated from IDA
assistance in November 2014.

International Finance Corporation (IFC)

As the investment arm of the World Bank Group, IFC encourages member
countries and private investors to invest in other member nations. It also takes
stakes in these investments, sharing in the profits.

Multilateral Investment Guarantee Agency (MIGA)

MIGA serves as the insurance wing of the World Bank Group. It provides
insurance coverage to companies investing in different countries based on IFC
recommendations. However, this coverage is limited to non-commercial risks,
such as forced nationalization.

International Centre for Settlement of Investment

Disputes (ICSID)
ICSID resolves investment-related disputes between member countries when the
World Bank is involved. Its decisions are binding on member countries.

Note: While India is a member of the World Bank and World Bank Group, it is not a
member of ICSID.

International Monetary Fund (IMF)

The IMF, often called the World Bank's twin sister, serves a distinct function. Its
primary responsibility is providing short-term loans to member countries facing
balance of payment s crises. Additional responsibilities include promoting a unified

Multilateral organisations 6
 international accounting system, ensuring financial cooperation among members,
maintaining stable exchange rates for various currencies, and encouraging private
investment in member countries.

The IMF's highest decision-making body is the Board of Governors (BoG),

comprising finance ministers from all member countries. Each country also has an
alternat e governor, typically the central bank governor. Decisions require at least
85% of the total votes in favor.
Unlike the World Bank, the IMF is not egalitarian; member countries have different
voting weights based primarily on their GDP and contributions to the IMF.
Currently, the USA holds 16.7% of the votes, while India has 2.6%. This structure
allows the USA to veto any proposal unilaterally, prompting calls for IMF reform.

For lending to member countries during balance of payments crises, the IMF uses
Special Drawing Rights (SDR) as its accounting unit. Accept ed by all member
countries, SDR is also known as "paper gold." It represent s a claim on member
countries rather than the IMF itself, allowing loans taken in any currency to be
repaid in SDR.

The SDR's exchange rate is determined against a basket of currencies. Prior to

October 1, 2016, this basket included the USD, Yen, Pound, and Euro. On that date,
the Chinese Yuan/Renminbi was added. Factors considered for including a
currency in this basket are:

1. Foreign exchange reserves of the country

2. The country's share in world trade

3. Stability of the currency's exchange rate

4. GDP of the country/size of the economy

SDR was introduced in 1969, initially priced at 0.888g of gold (equivalent to 1

USD). This gold-based pricing, known as the Bretton Woods System, was
discontinued in 1973. The IMF then adopted the currency basket for SDR
valuation. As of 2024, 1 USD equals 0.75 SDR.

When providing loans, the IMF imposes conditions to prevent future crises. These
typically include:

Instructing the government to downsize the bureaucracy

Multilateral organisations 7
 Downsizing ministries

Adopting austerity measures in public expenditures

Discontinuing irrelevant welfare schemes

Eliminating subsidies

Encouraging Liberalization, Privatization, and Globalization (LPG) model

Multilateral organisations 8
 Agriculture
Date created @September 7, 2024 12:45 PM

Revisions 1

Start date @September 7, 2024

Status Complete

Introduction
@September 7, 2024
Factors behind initial positive trends in Indian agriculture
@September 9, 2024
Law of diminishing return
Classification of farm households
@September 10, 2024
Measures adopted in order to improve health of agriculture in India
Land Reform in India
Negative consequences of Green Revolution in India
@September 11, 2024
Failure of Green Revolution in Eastern States
Minimum support price
@September 12, 2024
Public Distribution System (PDS)
Electronic - Point of Sale (E-POS) and One Nation One Ration Card
Model Agricultural Produce Market Committee(APMC) Act 2003
and the amendments done in 2013
@September 13, 2024
PM Kisan Samman Nidhi Scheme
Pradhan Mantri Fasal Bima Yojana 2.0
Food Processing in India
@September 14, 2024
Kisan rail and Krishi Udan scheme
Subsidies in agriculture

Agriculture 1
 Economics of animal husbandry
Seed technology in Indian agriculture
Why is Seed Technology Important for Indian Agriculture?
What are Some Examples of Seed Technologies in Use or Development in
India?
Policies and Regulations that Support Agriculture in India
Seed Technology
Challenges of Indian Agriculture
Way Forward
E-technology in Indian agriculture
Role of e-Technology in Transforming the Agricultural Sector:
Government E-Initiatives to Empower Farmers:

Introduction
@September 7, 2024
In GDP the contribution of all these three segments is important.
However, with the passage of time the contribution of industry and
services surpass the contribution of agricult ure and allied
activities. Even after that, the importance of agriculture may not
decline because it provides food which is the most essential
necessit y for sustaining life. Though the contribution of agricult ure
in GDP remains less than 20%. The contribution of industry
remains 25-30%. Whereas services contribute more than 50% and
are the single largest contribut or in the GDP.

The economic activity in any society evolve with the passage of

time. Initially we were engaged in hunting and gathering food
material. Thereafter, the economy switched over to herding i.e.
animal husbandry and then to horticulture(production of fruits and
vegetables). Then began agriculture but in this initial form the
sources of irrigation were natural and later manmade sources of
irrigation were used. From this the economy switches over to
industry and from there to services.

During independence the contribution of agriculture in our GDP

was 50% and about 2/3 of the population depended upon
agriculture and allied activities. Gradually, the contribution of
agriculture has fallen down even below 20% but still 50%+
population remains dependent on agriculture. Agriculture is the
single largest source of livelihood in India today. It shows that the
share of agriculture in GDP has fallen at a rapid pace but the
dependency has not come down at the same pace. It is a sign of
impoverishment. A sector contributing least in the GDP of a
country is sustaining maximum of its population. The dependency
still remains high because we failed to provide skill to the people
and make them employable in other sectors. At the same time we
also failed to create sufficient employment opportunities in other
sectors of the economy. In agriculture in India the surplus
workforce engaged i.e. more than what is required. That is the
reason why agricult ure suffers from disguised
unemployment(hidden unemployment).

It means that the surplus workforce which is engaged has zero productivity. The work can be completed on time with
complete efficiency even without them. In other words marginal productivity in agriculture in India is nil. Marginal
productivity refers to the additional production that can be ensured with one additional labour. Agriculture in India also
suffers from seasonal unemployment. It means that during the cultivation and harvesting season agriculture provides
employment but in rest of the seasons it fails to provide employment. Since dependency on agriculture in India remains
extremely high , Indian society is termed as an Agrarian Society. India is one of the largest producers of food grains, fruit s

Agriculture 2
 and vegetables. According to the economic survey 2023-24, the total food grains production in India was expected to be
328.9 million tonnes.

Factors behind initial positive trends in Indian agriculture

Just after independence for some time Indian agriculture witnessed an increase in production. However, gradually the
Indian agricult ure began suffering for stagnancy. The reasons behind the initial trend were as follows—

After initial increase in production, agricultural sector in India gradually started witnessing a decline. After initial incr ease in
production, agricultural sector in India gradually started witnessing a decline. There were factors which led to stagnancy in
agricultural sector. These factors were the following-

1. After initial expansion in the net sown area the country is gradually witnessing a decline. Agricultural land is being
acquired for other developmental activities, such as industrialisation, housing, infrastructure etc.

2. The government failed to create asset(capital formation) in agricultural sector. For example, we lagged behind in the
process of construction of dams, canals cold storages, mandis, godowns, etc. Such assets would have benefit ed the
farmers in longer run.

3. In any agricultural land there must be three types of nutrients—NPK(Nitrogen, Phosphorus and Potassium). They have
to be present in a particular ration that is 4:2:1. However, since the farmers in India are less aware even without
knowing the proper ratio they excessively use the subsidised fertilisers. This has made agricult ural land in most of the
areas toxic.

4. Although green revolution had a number of positive impact on agriculture it also had some negative consequences.
Excessive use of chemical pesticides and chemical fertilisers had made the soil toxic and had also lead to water
pollution. Excessive use of ground water for the purpose of irrigation has affect ed the water table.

5. Because of the concept of the MSP, the farmers prefer producing only those agricult ural products which are covered
under MSP. Hence, the other items are ignored, mainly the perishable items like fruits and vegetables.

6. Since agriculture is hardly profitable the educated youth in India remains away from agriculture and as a result the level
of literacy in agricultural sector in India remains low. Hence, innovation in Indian agriculture remains absent.

7. Migration towards the urban areas has increased continuously due to industrialisation. This resulted in disintegration of
joint families and fragmentation of land. Agriculture no longer remains profitable due to such decreasing average land
holding.

8. Agriculture in India suffers from diminishing returns. Even the farmers now are renouncing agriculture because of this
and gradually engaging themselves in other economic activities.

9. Even today a large part of agriculural land in India depends on monsoon for the purpose of irrigation. Uncertain
Monsoon also affect s the agricult ure in India.

Agriculture 3
 Introduction to Economic Segments:
Economic activities are divided into three segments:

1. Agriculture & Allied Activities

2. Industry

3. Services

Contribution to GDP:

Agriculture: Less than 20%

Industry: 25-30%

Services: Over 50% (largest contributor)

Evolution of Economic Activity:

Transition phases:

1. Hunting & Gathering

2. Herding (Animal husbandry)

3. Horticulture (Fruits & Vegetables)

4. Agriculture (Natural to man-made irrigation)

5. Industry

6. Services

Agriculture and the Indian Economy:

At independence:

Agriculture contributed 50% to GDP

2/3 of population depended on agriculture

Current scenario:

Agriculture now contributes less than 20% to GDP

Still sustains 50%+ of the population

Largest source of livelihood in India

Sign of impoverishment:

Agriculture's share in GDP fell, but dependency on it remained high

Lack of skills and employment opportunities in other sectors led to high agricultural dependency

Employment Issues in Agriculture:

Disguised Unemployment: Surplus workforce with zero productivity, leading to nil marginal productivity.

Seasonal Unemployment: Employment is available only during cultivation and harvest seasons.

Agrarian Society: India remains highly dependent on agriculture, producing a significant amount of food
grains, fruits, and vegetables.

Food Grain Production: Expected to reach 328.9 million tonnes in 2023-24 (Economic Survey).

Factors Behind Initial Positive Trends in Indian Agriculture:

1. Expansion in net sown area

2. Land reform measures

3. Financial inclusion

4. Government subsidies for farmers

Agriculture 4
 Minimum Support Price (MSP) mechanism

@September 9, 2024

Law of diminishing return

In any economic activity, if the profit declines then it can be said that the business suffers from diminishing return.
Agriculture suffers from the same problem of diminishing return. In agricultural sector the area under cultivation is
continuously declining. Hence, agricultural production cannot be enhanced. With the passage of time due to inflation the
cost of agriculture increases continuously. Although the price of the final product also increases but not in the same
proportion. Hence, agriculture no longer remains profitable. Such economic activities cannot create new employment
opportunities. At the same time even the farmers are gradually renouncing agriculture as an economic activity.

Classification of farm households

Since 1970-71 at a gap of every five years, agriculture census is conducted in India by the Ministry of Agriculture. The
latest census was conducted for the year 2015-16 and the data was published in 2020. The agriculture census presents a
clear picture of the agricultural sector in the country. It has details related to the total area under cultivation, total number of
farm households, average landholding and data w.r.t. percentage of farm households falling in different categories. This
census also presents the trend of migration towards the urban areas of people engaged in agricultural sector .

According to the latest census, the area under cultivation has declined in size. But the total number of farm households has
increased continuously. It is mainly because of fragmentation of land due to disintegration of family. The data shows that
total area under cultivation is 158 million hectares(ha). The total land holdings is 146 million in number. Hence, the averag e
land holding comes down to 1.08 ha. This average land holding is too low because of which agriculture does not remain
profitable. A farm household does not have enough resources to invest in machines and tools.

In India, based on the size of landholdings farm households are classified in the following categories—

Size of land holding(ha) Category of farm household % of total land holding families

Below 1 ha Marginal 68.5%

1 — 2 ha Small 17.6 %

2 — 4 ha Semi-medium 9.6%

4 — 10 ha Medium 3.8%

More than 10 ha Large 0.57%

Data shows that when the marginal and small farm households are combined they become 86.1% of the total land holding
families in the Indian agricultural sector. It is sign of impoverishment. In agricultural sector the landless labourers heavi ly
suffer from seasonal unemployment. Migration is a direct result of this. Since large farmers have resources, their children
migrate to urban areas for education and employment.

@September 10, 2024

Measures adopted in order to improve health of agriculture in

India
1. In India since independence the policies formulated by the government have always been Production Centric. However,
the recent policies, formulat ed by the government are also Income Centric.

2. Under these incomes centric policies, it has been decided by the government that the Minimum Support Price (MSP)
will be 50% higher than cost of agricult ure. Even MSP has been gradually extended to 22 different agricult ural
products.

3. Under the same income centric policies and government introduced Pradhan Mantri Fasal Bima Yojana in 2016 to
eliminate uncertainties related to agriculture and provide financial security to the farmers. This scheme has been
revamped again in 2020 to remove some issues related to it.

Agriculture 5
 4. In the interim budget of 2019-20 Pradhan Mantri Kisan Samman Nidhi Yojana was introduced. It ensures a cash transfer
of ₹6000 per year to every farm households.

5. The government is committed to double the income of farmers.

6. After Green Revolution the country is concentrating on Evergreen Revolution. It will be based on biotechnology.

7. In order to increase the net sown area satellite-based mapping is being done.

8. Animal husbandry is being promoted as a complimentary economic activity.

9. Food processing industry is being promoted in order to support agriculture. For this purpose, Pradhan Mantri Kisan
Sampada Yojana was introduced in 2016.

10. In order to reduce the volatility with respect to price of Tomato, Onion and Potato, Operation Green was introduced with
a total expenditure of ₹500 crore. It will enhance production, storage as well as transportation of these three
vegetables. In Budget 2021-22 it has been announced that Operation Green will be expanded by adding 22 perishable
agricultural items to it.

11. Bamboo which is known as Green Gold has been categorised as a grass, if it is grown outside the forest areas. It can be
cultivat ed and sold by the farmers in order to enhance their income.

12. In India in 2007 Food Security Mission was introduced. It was aimed at enhancing the production of Rice, Wheat and
Pulses. During the 12th five-year plan, food security mission was modified and even the coarse grains were added to it.

13. In 2004, National Commission on Farmers was constituted under the chairmanship of M.S. Swaminathan. The main
objective of this commission was to suggest measures to enhance income of farmers to make agricult ure more
profitable and to encourage the educat ed youth to join agricult ural activities.

14. The process of Financial Inclusion is gaining moment um continuously. The Kisan Credit Card Scheme was introduced
in 1998 and now it is being convert ed into plastic credit card.

15. In order to ensure irrigation facilities in those areas which depend upon the monsoon, National Rainfed Area Authority
was constituted in 2006. Under this the coordination was established among five different ministries - Ministry of
Agriculture, Ministry of Rural Development, Ministry of Jal Shakti, Ministry of Panchayati Raj and Ministry of
Environment and Forest. In this direction with the objective of 'Per Drop More Crop' Pradhan Mantri Krishi Sinchai
Yojana was started in the year 2015.

16. In order to set up Mandis, Model APMC Act was passed by the parliament. It has been again modified in 2017. In the
budget 2018-19 the concept of GrAMs (Grameen Agricult ural Market s) has been introduced. Under this with the
expenditure of ₹2000 crore, 22,000 grameen haats are to be converted into Grameen Agricultural Markets. In the year
2016 the concept of e-NAM (electronic- National Agricult ural Market ) was introduced.

17. In order to provide information to the farmers, dedicated Radio, TV channels and even call centres have been
established.

18. To provide information regarding the health of their soil a scheme known as Soil Health Card was introduced.

19. In order to ensure the reach of farm products to international market, Agriculture Export Policy was introduced. Along
with supply chain management, initiatives such as Kisan Rail and Krishi Udan were also announced in budget 2020-21.

20. In 2008 Land Record Modernisation Programme was initiated by Ministry of Rural Development. It can reduce court
cases related to sale and purchase of land. Swamitva Yojana was launched to give Record of Rights to rural population
in the form of Property Cards. In budget 2021-22 it was proposed to expand it in the whole country.

21. In the budget 2022-23, the government also announced to work towards making digital technology and hi-tech
services accessible to the farmers. In this context, schemes will be brought under public-private partnership model.

22. The government announced that the use of 'Kisan Drones' for assessment of crops, digitization of land leases,
spraying of pesticides and nutrients will be promoted.

23. According to budget 2022-23, states will be encouraged to revise the syllabi of agricult ural universities as per the
needs like modern agricult ure, zero budget natural farming, supply chain management, organic
farming, etc.

24. Govt has proposed a plan to encourage chemical free natural farming in the country. In the first phase chemical free
natural farming in 5 km wide corridor along the river Ganga in farmers' land wili be initiated.

25. The budget stated that the government will bring in policies and necessary legal changes to
promote agro- forestry and private forestry. Financial assistance will be provided to those farmers belonging to

Agriculture 6
 Scheduled Castes and Scheduled Tribes who wish to adopt agro-forestry.

Land Reform in India

In any agrarian society agriculture becomes most important economic activity and land becomes the most important asset.
Even economic disparity is based on the ownership and non-ownership of land. Hence, redistribution of land is considered
as the most important tool to reduce this disparity. Therefore, in order to reduce this disparity all major political parties in
India had started claiming even before independence that post-independence, surplus land will be identified and will be
redistribut ed among the tillers. With this objective land reform measures were adopted. Land Reform had the following
objectives:-

1. To abolish Zamindari

2. To impose land ceiling

3. To introduce land consolidation.

4. To modify the tenancy laws.

5. To prepare proper land ownership record throughout the country.

Under the tenancy laws it was decided that if a piece of land is rented out, the landlord can only take 1/4th of the total
produce and remaining will go to the tillers.

Land consolidation and land ceiling were the most important provisions. Under land consolidation, scattered pieces of land
were to be brought together in order to make cultivation easier, cost-effective and more profitable. Under this, if a family or
an individual owns different pieces of land lying in different directions they were to be brought together. However, this can
be done only by taking away someone else's land adjacent to the land of that individual or the family. In a rural area it was a
very difficult task mainly because land is associat ed with the family's honour and prestige. It is also connect ed with
emotion. At the same time all the pieces of land may not be equally fertile. Hence, land consolidation succeeded only in few
regions such as Punjab, Haryana, Western UP and Coastal Andhra Pradesh. It failed in other parts of the country. In Punjab
and Haryana land consolidation was made compulsory. Whereas in other states it was optional.

Under land ceiling, limit was to be imposed with respect to land holding. This limit was different in different areas based on
the fertility of the soil. Any piece of land held by a family beyond that limit was identified as surplus. It was to be declared
public land, acquired by the government and redistributed among the tillers.

In order to prevent frequent interference of the judiciary in the entire process the constitution was amended and ninth
schedule was added. Right to property no longer remained a fundament al right and was converted to a legal right.
However, land ceiling also succeeded only in few states such as West Bengal and Kerala. It failed in other parts of the
country. The reasons behind failure were as follows:-

1. The entire process lacked bureaucratic as well as political will. It was mainly because the Political Elite of the country
which were responsible for formulating these laws and the Bureaucratic Elite of the country which were responsible for
implementing these laws belonged to the same land owning section of the society.

2. Even the concept of Benami Property came into existence. Under this, in order to bring down the land holding within
the prescribed limit, surplus land was registered in the name of such people who did not even exist.

3. Sometimes the landlords used to allocate some part of their land to the landless labourers but the effective control over
the land remained with the landlords only.

4. The part of land given to the authorities, by the landlords were mainly barren lands. Hence, even if such pieces of land
were distributed to the tillers they were of no use.

The failure of the land reform measures in India resulted in agrarian unrest. It became a cause behind conflict between the
landlords and the landless labourers. All the agrarian movement s witnessed in India post-independence can be seen as a
result of the failure of land reform measures.

Negative consequences of Green Revolution in India

In India M.S. Swaminathan is regarded as the father of Green Revolution. All over the world it was Norman Borlaug, an
American Agronomist who is regarded as father of Green Revolution.
Green revolution in India brought about revolutionary change in agricultural sector. The term revolution has been used in a
symbolic manner. Under green revolution technology was introduced in Indian agriculture and with the use of chemical

Agriculture 7
 fertilizers, pesticides, man made sources of irrigation, machines and tools etc. agricultural production was enhanced. It
made India a food sufficient country. India became net exporter of food grains.

However, green revolution also had serious negative consequences. These negative consequences were as follows:-

1. It resulted in capitalistic transformation of Indian agriculture. The cost of investment increased due to use of
technology. The large farmers were able to bear the cost easily. However, the small and marginal farmers had to borrow
from the money lenders which resulted in their debt and finally land alienati on was witnessed. It can be said that green
revolution resulted in economic disparity in the areas where it succeeded. The large farmers were able to maximize the
profit whereas the small and marginal farmers were completely ruined.

2. Green revolution succeeded only in few areas such as Punjab, Haryana, Western UP and Coastal Andhra Pradesh. It
failed in other parts of the country. Hence, it became reason behind regional disparity in rural India.

3. The areas where green revolution succeeded became overwhelmingly agrarian. Hence, they lagged behind in the
process of industrialisation. Agriculture suffers from the law of diminishing return, hence it can never provide sufficient
employment opportunities. Due to low industrialisation, the rate of unemployment increased in these areas. It led to
youth unrest which was one of the most important reasons behind drug addiction in Punjab and even the Khalistan
movement.

4. Because of green revolution in these area agriculture became the most important activity. Hence, land became the
most important asset. In order to prevent fragmentation of land, joint families were given preference. Indian society has
been a patrilineal society under which property is transferred from father to son. (Only the Amended Hindu Succession
Act has ensured the daughter's right over father's property.) Hence in joint families land was to be transferred from
father to son. The preference for male child increased and the importance of daughters declined. The daughter
became an economic burden because of which female
infanticide increased in these areas. These areas still have adversely skewed sex ratio.

5. Green revolution encouraged production of rice and wheat. Due to which other food grains were ignored.

6. Excessive use of chemic al fertilizers, pesticides affect ed the fertility of the soil and it also resulted in water and soil
pollution.

7. Excessive use of groundwater for the purpose of irrigation affected the water table.

8. Accumulation of water on the surface of land for cultivation of rice leads to emission of methane, which is a leading
cause behind global warming.

@September 11, 2024

Failure of Green Revolution in Eastern States

Green revolution didnʼt succeed in every part of the country. It succeeded in Punjab, Haryana, Western UP, coastal Andhra
Pradesh. However, even after the land being fertile in a number of eastern states like eastern UP, Bihar, Jharkhand, Assam,
Odisha, West Bengal, etc. green revolution didnʼt succeed. The failure had the following reasons—

1. Lack of political and bureaucratic will

2. The average of landholding being even below the national average of 1.08 ha makes agriculture difficult. This also
made the investment in agricult ural made cost ineffective.

3. The farmers in these states are relatively poorer because of which it was difficult for them to adopt technology.

4. The level of literacy among the farmers in these states have remained low. Even because of this they failed to innovate.

5. Most of these states and regions suffered from natural calamities which adversely affected agriculture.

6. The problems related to terrorism/naxalism/insurgency affected agriculture adversely.

7. Even the mindset of the people played an important role in the failure of green revolution.

Agriculture 8
 Law of Diminishing Returns

Definition: Economic principle where increasing input results in lower profit or output after a certain point.

Application in Agriculture:

Declining land under cultivation.

Rising inflation and cost of agriculture.

Final product prices increase but not proportionally, making agriculture less profitable.

Limited job creation and farmers renouncing agriculture.

Classification of Farm Households

Agriculture Census: Conducted every five years by the Ministry of Agriculture (latest 2015-16, data
published in 2020).

Key Data:

Total cultivation area: 158 million ha.

Total landholdings: 146 million (average landholding 1.08 ha).

Landholding Categories:

Marginal ( 1 ha): 68.5%

Small (1-2 ha): 17.6%

Semi-medium (2-4 ha): 9.6%

Medium (4-10 ha): 3.8%

Large ( 10 ha): 0.57%

Implication: 86.1% of farm households are marginal and small, showing economic disparity and
encouraging migration.

Measures to Improve Agriculture

1. Income-Centric Policies:

MSP 50% higher than production cost.

Pradhan Mantri Fasal Bima Yojana (2016) for financial security.

Pradhan Mantri Kisan Samman Nidhi Yojana (₹6000 cash transfer/year).

Goal: Double farmers' income.

2. Promoting Agricultural Activities:

Evergreen Revolution based on biotechnology.

Animal husbandry and food processing (Pradhan Mantri Kisan Sampada Yojana).

Operation Green (price stabilization for vegetables).

Bamboo cultivation ("Green Gold") for income enhancement.

3. Technology & Support:

e-NAM and GrAMs for better market access.

Kisan Credit Card for financial inclusion.

Pradhan Mantri Krishi Sinchai Yojana for irrigation ("Per Drop More Crop").

Kisan Drones for monitoring crops.

Soil Health Card Scheme and Agriculture Export Policy.

Land Reform in India

Key Objectives:

Abolish Zamindari, impose land ceilings, consolidate land, modify tenancy laws.

Agriculture 9
 Redistribute surplus land among tillers.

Challenges:

Lack of political/bureaucratic will.

Emergence of Benami property.

Barren land given to authorities.

Outcome: Partial success in some states (West Bengal, Kerala) but overall failure led to agrarian unrest.

Negative Consequences of Green Revolution

1. Economic Disparity: Large farmers benefited, small farmers faced debt and land alienation.

2. Regional Disparity: Success in Punjab, Haryana, Western UP, but failure in other regions.

3. Unemployment & Youth Unrest: Focus on agriculture limited industrialization, leading to unemployment
and social unrest.

4. Skewed Sex Ratio: Male preference in joint families due to land inheritance, leading to female infanticide.

5. Environmental Damage:

Excessive use of fertilizers and pesticides reduced soil fertility and caused pollution.

Overuse of groundwat er affect ed water tables.

Rice cultivation contributed to methane emissions (global warming).

Failure of Green Revolution in Eastern States

Lack of political and bureaucratic will hindered implementation.

Small landholdings below the national average made agriculture less viable.

Poverty among farmers restricted adoption of new technologies.

Low literacy levels limited innovation and modern practices.

Natural calamities like floods and droughts disrupted agriculture.

Terrorism, naxalism, and insurgency affected agricultural activities.

Traditional mindset and resistance to change also contributed to the failure.

Minimum support price

The concept of MSP was introduced by the centre in 1965. For this purpose, Agricult ural Prices Commission was set up in
the same year. It was later renamed as Commission for Agricult ural Costs and Prices (CACP) in the year 1985.

Under MSP, the minimum price at which a particular agricult ural product will be procured is decided even before the
sowing season. This minimum price has to be paid by the government agencies as well as the private agencies while
procuring that particular agricult ural product. The cost at which the product has to be procured can be equal to the MSP or
can be higher than the MSP but it cannot be lower than the MSP. It is the CACP which recommends MSP, but it is
implemented by the Cabinet Committee on Economic Affairs (CCEA).

MSP serves as a kind of financial security for the farmers. Even if production is high the price may not fall below the MSP. It
encourages the farmers to produce more and more. In the budget 2018-19 it was declared by the government that the MSP
over agricultural products will be 50% higher than the cost of production. At the same time, it was also decided that the
cost of production will be calculat ed on the basis of A2 + FL. There are three different ways in which cost of production
can be calculat ed. It can be A2, A2 + FL or C2. A2 includes all the direct expenses such as cost of seeds, fertilisers,
pesticides, labour, fuel, transportation etc. However, it is a possibility that the marginal and the small farmers may not be
able to hire labour and may use their family labour. Amonetary value of family labour is derived and is termed as FL. Hence
A2 +FL also includes the cost of family labour. C2 is known as comprehensive cost. It includes A2, FL and even the burden
of interest payment over the farmers, rent and interest on capital goods. Out of the three at present A2 + FL is taken as the
basis.

Agriculture 10
 However, MSP also has a certain drawbacks. Even if the production remains high the price may not come down. Due to
continuous increase in MSP the inflation will remain high as well. It affects the consumers. At the same time government
agencies buy the agricultural products at an increased MSP to distribute them at a subsidised price through Public
Distribution System. Because of this the financial health of the government gets affected. It increases the fiscal deficit. The
benefit of MSP is generally taken by big farmers of sates like Punjab, Haryana, Western UP. So, it leads to economic and
regional disparity. Political influence is also witnessed in estimation and declaration of MSP.

MSP also has other negative consequences. The government implements MSP over 22 agricultural products. It comprises
7 cereals (paddy, wheat, maize, sorghum, pearl millet, barley and ragi), 5 pulses (gram, tur, moong, urad, lentil), 7 oilseeds
(groundnut, rapeseed-must ard, soyabean, sesame, sunflower, safflower, nigerseed), and 3 commercial crops (copra,
cotton and raw jute). The perishable items such as fruits and vegetables are not included in it. So, the farmers resort to
production of only those agricultural products over which MSP is
applicable. The other agricultural products are completely ignored due to this.

Over sugarcane MSP is not applicable. In case of sugarcane State Advised Price- SAP is applicable. It is decided by the
states where sugarcane is produced. This price has to be paid to the farmers by this Sugar Mills while procuring
sugarcane. However, during election season in order to please the farmers SAP is increased continuously. This affects the
financial health of sugar producers. Hence in 2009, the central government introduced the concept of Fair and
Remunerative Price- FRP. If the SAP is higher than FRP, the sugar mills had to pay FRP to the farmers, whereas the
difference between SAP and FRP was to be paid to the farmers by the state government. However,it was protested by the
state governments and the centre made it optional. Now the FRP is announced but its implementation is optional for the
states. They may or may not implement it. Maharashtra implemented FRP while some states like UP still follow the SAP
system.

Agriculture 11
 Minimum Support Price (MSP) - Short Notes
Introduction

Introduced in 1965, with the Agricultural Prices Commission (later renamed CACP in 1985).

MSP is set before the sowing season, ensuring minimum price for farmers' produce.

Both government and private agencies must procure products at or above MSP.

Purpose

Provides financial security for farmers, prevents price drops even in high production years.

Encourages more agricult ural production.

Calculation Methods

A2: Direct expenses like seeds, labor, and transportation.

A2 + FL: Adds family labor costs to A2.

C2: Comprehensive, includes A2 + FL, interest, and capital costs.

Currently, A2 + FL is used as the basis for MSP.

Key Agricultural Products

MSP applies to 22 product s: 7 cereals, 5 pulses, 7 oilseeds, 3 commercial crops.

Perishable items like fruits and vegetables are excluded.

Drawbacks

Can lead to inflation and higher fiscal deficit due to government procurement at MSP.

Primarily benefits large farmers in certain states (Punjab, Haryana, Western UP), creating regional and
economic disparity.

Encourages monocult ure—farmers focus on MSP-covered crops, ignoring others.

MSP for Sugarcane

Sugarcane is governed by State Advised Price (SAP), not MSP.

Fair and Remunerative Price (FRP) was introduced in 2009 as an alternative, but its implementation is
optional for states.

@September 12, 2024

Public Distribution System (PDS)

PDS was introduced in India for the first time by the British government in 1939. However, it was named as rationing
system. It was a period of Second World War, because of which the price of wheat and rice was continuously increasing.
Hence in order to make these two commodities available to the general public at an affordable, price rationing system was
introduced. However, once the Second World War was over the rationing system was discontinued.
Post-independence the same system was introduced by the government with the name of Public Distribution System(PDS).
During the first five-year plan, only rice and wheat were made available at a subsidised price under this system. Gradually
other essential commodities like sugar, kerosene oil, coal etc. were added to the list of items.

In India even after independence the socio-economic conditions remained adverse. Income disparity was high. People
were suffering from poverty and starvation. Hence in order to
reduce the impact of poverty, PDS was used as an instrument. It ensured the availability of essential commodities at a
subsidised price.

However, these subsidies make the people dependent upon the government. It also affects the financial health of the
government. In India under PDS three different entities are involved -

1. The central government

Agriculture 12
 2. State governments

3. The PDS stores

It is the responsibility of the centre to make these essential commodities available at a subsidised price. The cost of
transportation, storage within the state and the margin of the PDS store has to be borne by the states.

It is the Food Corporation of India- FCI, which is responsible for procuring rice and wheat from the farmers. When the
production is high, wheat and rice are procured by the FCI at the MSP. Through this the FCI increases its buffer stock in
those years when the production remains high. The buffer stock is created with two objectives. First, in order to ensure
availabilit y of wheat and rice through PDS at a subsidised price and secondly to ensure availability of wheat and rice in
adequat e quantit y in open market when the production remains low. The cost of procurement is borne by the centre.

Kerosene oil through PDS is made available at a subsidized price by the oil marketing companies. For this, they are again
compensated by the centre. In order to compensate the downstream(involved in distribution and sale of oil) oil companies,
some part of profit of upstream(involved in oil extraction) and middle stream(involved in refining of oil) oil companies is
taken away by the central government.

Coal India limited is responsible for distributing coal at a subsidised price. Coal India limited is also a central public sector
undertaking. Hence even this cost is ultimately borne by the centre. In order to distribute sugar at a subsidised price the
sugar producers in India have to set aside 10% of their total produce. It is termed as levy sugar. It is procured by the centre
at a price lower than the market price. Although through this process, the centre is able to save some money. But it causes
loss to the sugar producers.

Pulses and edible oil are not regularly supplied through PDS. Only in those times when the price of these two commodities
starts going beyond the reach of consumers their import is increased
and they are supplied through PDS at a price at which government incurs no profit no loss.

PDS can be of two different types -

1. Targeted PDS (TPDS)

2. Universal PDS (UPDS).

In case of Targeted PDS, the benefit has to be provided only to a particular category of people. In this the beneficiaries are
identified on the basis of socio-economic conditions and the benefit of PDS is provided only to them. On the other hand,
Universal PDS is that PDS under which every member of the society is covered irrespective of their socio-economic
condition. Both these systems have their own advant ages and disadvant ages. In case of TPDS it becomes difficult to set a
benchmark based on which the beneficiaries can be identified. In such situation it is a possibility that some actual
beneficiaries may be left outside the safety net of PDS. However, it does save resources. On the other hand, UPDS ensures
that not even a single beneficiary is left behind. However, under this even those may derive the benefit s, who do not
actually need it. It leads to wastage of resources.

India is a food sufficient country but it is yet to become food secure. Hence in order to ensure food security, Food Security
Act was passed in 2013. Under this 50% of the urban population and 75% of the rural population has been given the
benefits. It is a form of TPDS. It means that it is not available to all. However, the scheme is not confined only to the peo ple
below poverty line. Under this scheme 5 kg food grains are made available to each member per month. It is up to the
individual and the family, whether they want rice, wheat or coarse grain. Rice is made available at a rate of 3 rupees per kg ,
wheat at 2 rupees per kg and the coarse grains at 1 rupee per kg. The Antyodaya Anna Yojana which provid es 35 kg of
food grains per family per month to the poorest of poor family has been merged with the food security act. Keeping in mind
women empowerment, ration card under this scheme is issued in the name of the eldest female member of the family, who
should be at least 18 years in age.

PDS in India has not been a great success. It suffers from a number of drawbacks. First of all, proper coordination between
the centre-states and the states-PDS stores remains missing. FCI which is responsible for procurement, storage and
distribution of rice and wheat has been inefficient. Sometimes inferior food grains are procured. The quantity supplied to
the transporters may be less than what is mentioned. Huge part of the foodgrains is wasted due to lack of a proper storage
facility. A large part is damaged by rodents. Even in the process of transportation, theft and diversion is a common
problem.The problem of fake ration cards and black marketing of these essential commodities are serious issues. Because
of these issues a number of solutions are being adopted.

Widespread use of technology can be seen. For example- end to end comput erisation, installation of CCTV cameras for
surveillance, GPS fitted vehicles for the purpose of transportation are being used. PDS is being gradually transformed into
e-PDS in which biometric ration cards and impressions are being used. Ensuring participation of local people may be
useful. Direct benefit transfer may also be of great help. Regarding PDS Chhattisgarh model has been commendable.

Agriculture 13
 In the year 2020, the finance minister announced 1.7 lakh crore worth of relief package under Pradhan Mantri Gareeb
Kalyan Yojana. During the fight against Covid pandemic Pradhan Mantri Gareeb Kalyan Anna Yojana was launched under
this package. Under this, extra 5 kg of free food grains and 1 kg of pulses were given to the 80 crore ration card holders.
The timeline of this scheme was expanded many times. In January 2023, this PMGKAY has been merged with PDS. Budget
2023-24 announced that 5 kg food grains will be given free of cost to all Antyodya and PDS family till 31 Dec 2023. It h as
been further extended.

Electronic - Point of Sale (E-POS) and One Nation One Ration Card
Under PDS, machines with biometric identification are being provided to all fair price shops. Along with this, the Aadhaar
cards of the beneficiaries are being linked with their ration cards. This ensures that only the actual beneficiaries are getting
the benefit and no one else is taking their share. This will make PDS more effective and transparent.

The concept of 'One Nation One Ration Card' is related to the concept of E-POS. Both these platforms are based on
Integrated Management-PDS(IMPDS). This will ensure inter state portability or usage of ration card. If a beneficiary
migrates to another state, still she will be able to use the same ration card in that state too. This will mainly help the migrant
labourers and their families. A migrant can get food grains up to 50% of the approved quota for her family through this.
Under this, a person can get only subsidised food grains supported by the central
government. It has been implemented across the country since July 2020.

Many reforms have been introduced from time to time to make the PDS and Food Security Act more effective. For example,
during the COVID-19 pandemic, the Center directed al states to include all persons with disabilities in the Food Securit y
Act. Section 38 of this Act empowers the Center to give such directions to the States and Union Territories.

Model Agricultural Produce Market Committee(APMC) Act 2003

and the amendments done in 2013
In agricultural sector in India construction of Mandis and formation of rules regarding it have been the responsibilities of the
states. Hence the parliament can only pass a model act in this regard. Based on this model act the states can pass their
own act.
Model Agricult ural Produce and Market Committ ee Act 2003 was passed by the centre. A number of states followed it and
passed their separat e laws based on the model act. More than 6000 Mandis were established throughout the country.
The Model APMC Act provided for establishment of such mandis, through which the farmers can sell their agricult ural
product s directly to the buyers. According to the model act, middlemen should not be used in the entire process. The
mandi was to be setup by the state government but it was to be managed and maintained by the farmers. For this purpose,
office bearers were to be elected directly by the farmers. In the election, only those farmers were allowed to participat e
who were associated with that mandi. The farmers belonging to an area which comes under the purview of a particular
mandi can only sell their product through that mandi. A farmer may sell his agricultural products even without using mandi,
but after that she will not be able to participate in the election of the mandi.

Mandi should have all the facilities i.e., it should have godowns, cold storages, post offices, police stations, auction hall,
weighing machines, toilets etc. All these facilities can be availed by the farmers.

Although the concept was good but the APMC act passed by the states was not same as the model act. Many states
appointed commission agents officially. In a number of states Mandi tax
was imposed. In order to use any facility including godowns, cold storages, weighing machine etc. the farmers had to pay.
Because of these charges ultimately the farmers were not even able to recover an amount equal to the MSP. Hence in 2017
the model APMC act was amended again. Now the act is named as Agricult ural Produce and Livestock Market Committee
Act. It means that along with agricult ural product s now even livestocks can be bought and sold through these mandis.
Private invest ment was allowed in the process of construction of these mandis. The mandi tax has been fixed. In case of
sale of fruits and vegetables the mandi tax will be applicable at a rate of 2%, whereas in case of food grains it will be
applicable at the rate of 1%. The commission of the commission agents has also been fixed at a rate of 2%. A farmer can
use any mandi located in that state to sell his produce. If a state allows, even the farmers from other states may sell their
produce using the mandis located in that state.

Agriculture 14
 Public Distribution System (PDS)
Introduction

Introduced as a rationing system in 1939 by the British government during WWII.

Reintroduced post-independence as PDS to provide essential commodities at subsidized prices.

Initially covered rice and wheat; later included sugar, kerosene, coal, etc.

Purpose

Address poverty and starvation, ensuring availability of essentials.

Provides subsidized food to low-income groups, impacting the financial health of the government.

Entities Involved

1. Central Government – provides essential commodities.

2. State Governments – manage transportation, storage, and PDS store margins.

3. PDS Stores – distribute to beneficiaries.

Role of FCI

Food Corporation of India (FCI) procures rice and wheat from farmers.

Builds buffer stock for distribution through PDS or for release into the open market during shortages.

Subsidized Products

Kerosene: Distributed via oil marketing companies, compensat ed by the central government.

Coal: Distributed by Coal India Limited at subsidized rates.

Sugar: Sugar producers must reserve 10% of their produce for government procurement at lower rates
(levy sugar).

Types of PDS

1. Targeted PDS (TPDS) – Benefits specific socio-economic groups.

2. Universal PDS (UPDS) – Open to all citizens regardless of socio-economic status.

TPDS is resource-saving but may exclude some actual beneficiaries.

UPDS prevents exclusion but may lead to resource wastage.

Food Security Act, 2013

Covers 50% of urban and 75% of rural populations (TPDS).

Provides 5 kg of food grains per person per month at subsidized prices.

Antyodaya Anna Yojana merged, offering 35 kg of grains to the poorest families.

Challenges in PDS

Lack of coordination between the center, states, and PDS stores.

Inefficient procurement and storage by FCI.

Fake ration cards, theft, black marketing, and poor storage leading to wastage.

Reforms and Technological Integration

e-PDS: Biometric ration cards, CCTV surveillance, GPS for transportation.

Direct Benefit Transfer (DBT) to prevent leakages.

Chhattisgarh model praised for PDS reform.

Recent Initiatives

Pradhan Mantri Gareeb Kalyan Yojana (PMGKY): Provided free food grains during COVID-19.

Merged with PDS in January 2023, extending benefits of 5 kg of free food grains.

Electronic Point of Sale (E-POS): Ensures transparency and eliminates fake beneficiaries.

Agriculture 15
 One Nation One Ration Card: Allows interstate portability of ration cards, aiding migrant workers.

Conclusion

PDS continues to evolve, with ongoing efforts to improve transparency and reach through
technological reforms and inclusive measures like the One Nation One Ration Card system.

Model Agricultural Produce Market Committee (APMC) Act 2003 and 2013 Amendments
Introduction

Agriculture-related regulations and mandi construction are state responsibilities.

The Model APMC Act 2003 was passed by the central government as a guideline for states.

States enacted their own versions, leading to the creation of over 6000 mandis.

APMC Act 2003 Highlights

Mandis: Established for direct sale of agricultural products by farmers to buyers.

No Middlemen: Farmers were to sell directly to buyers, avoiding intermediaries.

Farmer-Managed Mandis: Farmers elected officials to manage the mandis.

Mandi Facilities: Mandis were to have essential infrastructure like godowns, cold storage, auction
halls, etc.

Election Eligibility: Farmers had to sell through the mandi to participate in its elections.

Local Restrictions: Farmers could only sell in mandis within their area.

Challenges in Implementation

State Variations: States altered the model act, leading to variations in implementation.

Appointment of Commission Agents: In several states, agents were officially appointed.

Mandi Taxes: States imposed taxes for using mandi facilities like storage and weighing machines.

Farmersʼ Earnings: These taxes and charges often reduced farmers' earnings, sometimes below the
Minimum Support Price (MSP).

Amendments in 2013

Renamed the act as Agricultural Produce and Livestock Market Committee Act.

Expanded to include the sale of livestock in addition to agricultural products.

Private Investment: Encouraged private investments in mandi infrastructure.

Tax Rates: Fixed mandi tax rates:

2% for fruits and vegetables.

1% for food grains.

Commission Cap: Fixed the agent's commission at 2%.

Statewide Access: Farmers could sell their produce in any mandi within the state.

Interstate Trade: If allowed by the state, farmers from other states could sell their products in its
mandis.

Conclusion

The Model APMC Act 2003 and its 2013 amendments aimed to empower farmers by giving them
better access to markets.

Despite these reforms, challenges related to state-level variations, taxes, and commission agents
remain, which continue to affect farmer incomes.

@September 13, 2024

Agriculture 16
 PM Kisan Samman Nidhi Scheme
This scheme was introduced in the interim budget 2019-20. Under this scheme, it was announced that the marginal and
small farmers will be given ₹6000 every year by the Center in cash in their bank account. This benefit is given in the form
of direct benefit transfer(DBT). It is given in three instalments of ₹2000 each at a gap of four months each. Although the
scheme was announced on 1 February 2019, it was made effective retrospectively from December 2018. At present, the
benefit of the scheme has been extended to other farmers. Hence, it is no longer confined only to the marginal farmers and
small farmers. However, this benefit is not available to the landless labourers.

Pradhan Mantri Fasal Bima Yojana 2.0

Whenever a new policy is implement ed, its success depends on its popularit y. Popularit y can be achieved by making
people aware. Only when a policy is implement ed, its shortcomings are exposed over a period of time. These shortcomings
have to be rectified from time to time for the policy to be successful. Although the Pradhan Mantri Fasal Bima Yojana, which
was launched in 2016 has been a successful scheme, Pradhan Mantri Fasal Bima Yojana 2.0, announced in February 2020
tries to overcome the shortcomings of the earlier scheme.

In this revised scheme, the Pradhan Mantri Fasal Bima Yojana has been made completely voluntary. This means whether a
farmer takes a loan under Kisan Credit Card (KCC) or not, crop insurance has been made optional for him. This has been
done on the demand of the farmers. Due to the availability of adequate irrigation facilities in areas like Punjab and Haryana,
the challenges related to agriculture are less. Hence crop insurance is not required in these areas. But under the previous
scheme, if these farmers used Kisan Credit Card (KCC) to take a loan, then it was mandatory for them to take the crop
insurance. The insurance scheme was automatically activated. In many cases, farmers who used KCC were not even aware
that they would have to pay the insurance premium in the process of loan repayment. This premium was automatically
added to the principal amount. Therefore, now this insurance in the scheme has been made optional.

Under this restructured Pradhan Mantri Fasal Bima Yojana, 6-7 districts are being linked to make a cluster. For the selection
of insuranc e providers by the government, a tender for 3 years is floated. Therefore, to increase their business, insuranc e
companies wil have to spread awareness among the farmers.

Here too, the farmers will participat e in the premium payment like in the earlier scheme. This share will be 2% for Kharif
crops, 1.5% for Rabi crops, and 5% for Horticulture and Commercial crops. The remaining premium amount wil be paid by
the Central Government and the State Government. Both of them will pay 50-50% of the remaining premium. In hilly states
mainly the north-eastern states the centre contributes 90% and the states contribute 10%. If a state does not give its share
on time, then that state wil not be given the benefit of the scheme in the next season. Therefore, it becomes obligatory for
the states to make timely payments. Insurance companies will now have to compulsorily spend 0.5% of the total premiums
deposited in information, education and communication activities.

The insurance scheme covers:

1. Standing crops.

2. Crops harvested

3. but damaged within 14 days.If sowing does not take place due to adverse weather conditions. (25% of the insured
amount will be given.

In high risk regions insurance premium cannot exceed 30% of the insured amount and in low risk regions it cannot exceed
25%.

Food Processing in India

Agriculture 17
 Food processing refers to modifying a raw
food into a new form with an objective of
value addition.
For example, corn can be modified into
popcorn, milk into ice cream and so on.

With respect to production of processed food India is at the 5th place in the world. Even with respect to consumption and
export of processed food, India is at the 5th position only. However, the scope with respect to food processing industry
remains very high in the country. This sector has a share of 11.6% in the total employment of India. The sector is the
thirteenth largest recipient of FDI in India. At 2011-12 prices, this sector contributes 9.87% in the Gross Value Added (GVA)
of manufact uring sector and 11.38% in agricultural sectorʼs GVA. According to CII, in the next 10 years India is expecting an
investment of approx $33 billion in this sector. Out of all the raw food processed in India maximum processing is done with
respect to milk and meat. Out of the total milk produced in India only 30% is processed.

The government in India is serious about the possibilities associated with food processing in the country. This is why there
is a separat e ministry for food processing industry. The scope in this regard remains high mainly because of following
reasons—

1. India is an overwhelmingly agrarian society. The dependence on agriculture remains high. Food processing industry
will become complement agriculture in India. Agriculture may ensure availability of raw material as input to these
industries. It will help in industrialisation of rural parts of the country.

2. India has sufficient human resources, which can be trained in order to

fulfil the need of food processing sector. It will reduce the disguised unemployment in agriculture sector.

3. With respect to climatic conditions India is highly diversified. Therefore, almost every type of flora and fauna can be
seen in India.

4. With respect to livestocks, India is at the top most position in the world.

5. With respect to production of milk, India is again at the 1st position.

6. With respect to production of food grains the country is among the top three producers of the world.

7. With respect to production of fruits and vegetables India is at the second position.

8. With respect to production of a spices India is again at the top.

Agriculture 18
 Despite conducive conditions, food processing in India suffers from the problems related to Backward-Forward Linkages. It
can also be termed as problems associated with Upstream-Downstream management or Supply Chain Management.
Upstream-Downstream management refers to connecting the point of production of raw material to the point of processing
and consumption. It not only includes production and consumption of raw materials butt also includes its preservation,
transportation, processing, packaging and marketing.
Even the Multinational Companies which invest in this sector in India remain apprehensive because of these problems.
Hence most of the times, instead of investing in processing, they confine themselves only to marketing(Varun beverages
produces for Coca Cola). These products are produced by local producers. After quality assessment, branding is done and
finally marketed by the MNCs. However, such foreign investment may not be stable.

In order to get rid of these problems the government came out with a scheme known as Pradhan Mantri Kisan Sampada
Yojana. Here SAMPADA stands for Scheme for Agro Marine Processing And the Development of Agro processing clusters.
The scheme was introduced in 2016.

PM Kisan SAMPADA Yojana is a comprehensive package which will result in creation of modern infrastruct ure with efficient
supply chain management from farm gate to retail outlet. It will not only provide a big boost to the growth of food
processing sector in the country but also help in providing better returns to farmers and is a big step towards doubling of
farmers' income, creating huge employment opportunities especially in the rural areas, reducing wastage of agricult ural
produce, increasing the processing level and enhancing the export of the processed foods. It has 7 important objectives—

1. Establishment of Mega Food Parks.

2. Integrated Cold Chain and Value Addition Infrastructure.

3. Creation and Expansion of Food Processing and Preservation Capacities.

4. Infrastructure for Agro Processing Clusters.

5. Creation of Backward-Forward Linkages.

6. Food safety and quality assurance infrastruct ure.

7. Human Resources and Institutions.

Since raw materials which are used in food processing industry are perishable, their preservation becomes a major
challenge. Even the processed food may not last for very long. Hence the supply chain management has to be made
effective. In this regard the Mega Food Parks and the Supermarket s play an important role. Mega Food Parks are food
processing centres with all the facilities needed for food processing activities. Even the government contributes in their
establishment. In order to set up a Mega Food Park, minimum 50 acres of land is required. In plain areas, setting aside the
value of land, out of total investment the government contributes 50 crore rupees or 50% of the total investment whichever
is lower. In case of a hilly area setting aside the value of land the government's contribution is either 50 crore rupees or
75% of the total investment whichever is lower. The Supermarket s help in connecting the Mega Food Parks with the
consumers. Mega food parks setup procurement centres in a radius of 10 km to procure directly from the farmers.

Agriculture 19
 PM Kisan Samman Nidhi Scheme
Introduction:

Launched in Interim Budget 2019-20 to support marginal and small farmers.

Provides ₹6,000/year in Direct Benefit Transfer (DBT) directly to farmers' bank accounts.

Key Features:

Eligibility: Initially for small and marginal farmers, now extended to all farmers except landless
laborers.

Payment Structure: ₹6,000 paid in three installments of ₹2,000, every four months.

Effective Date: Announced on 1 February 2019, applied retrospectively from December 2018.

Pradhan Mantri Fasal Bima Yojana (PMFBY) 2.0

Introduction:

Introduced in February 2020 to address shortcomings of PMFBY 2016.

Made crop insurance voluntary for farmers.

Key Features:

Optional Insurance: Farmers with Kisan Credit Card (KCC) can choose crop insurance.

Premium Structure:

2% for Kharif, 1.5% for Rabi, and 5% for Horticulture and Commercial Crops.

Central and state governments split the remaining premium 50:50.

Cluster Model: 6-7 districts form clusters, and insurance companies are selected via 3-year tenders.

Coverage:

1. Standing crops.

2. Harvested crops damaged within 14 days.

3. 25% of insured amount paid if sowing is not possible due to adverse weather.

Food Processing in India

Introduction:

Food processing: Modifying raw food for value addition (e.g., milk into ice cream).

India ranks 5th globally in food processing, consumption, and export.

Importance:

Employs 11.6% of India's total workforce.

Contributes 9.87% to the manufact uring sector's GVA and 11.38% to the agriculture sector's GVA.

Opportunities:

1. Agrarian Society: Complements India's agricultural base.

2. Human Resources: Adequate manpower can be trained for food processing.

3. Diverse Climate: India produces a variety of crops and livestock.

Challenges:

Supply Chain Management: Issues in linking production, processing, and consumption due to weak
backward-forward linkages.

MNC Hesitation: Foreign investors often avoid investing in processing due to these challenges.

Pradhan Mantri Kisan Sampada Yojana

Introduction:

Agriculture 20
 Launched in 2016 to develop agro-processing clusters and boost food processing.

Objectives:

Mega Food Parks establishment.

Integrated Cold Chain and value addition infrastructure.

Expansion of Food Processing Capacities.

Creation of Agro Processing Clusters.

Development of Backward-Forward Linkages.

Food Safety and Quality Assurance infrastructure.

Investment in Human Resources and Institutions.

Mega Food Parks:

Require 50 acres of land.

@September 14, 2024

Kisan rail and Krishi Udan scheme

Both these schemes were introduced in the year 2020. Kisan rail has been initiated in collaboration with the railways
ministry and Krishi Udan in collaboration with civil aviation ministry. Both these schemes aim at connecting the food
deficient areas with the food sufficient areas. It will ensure proper supply of food items and prevent wastage of perishable
agricultural products. It will keep food inflation under control and add to the income of the farmers.

Those places which are connect ed through the railways will benefit from Kisan rail scheme. For this purpose dedicat ed
trains are being operated with refrigerated and normal bogies. The refrigerated bogies are for perishable items. The first
Kisan rail was started from Deolali in Nashik to Danapur in Bihar. For places not well-connected with railways like the NE
states, Krishi Udan Yojana is in place. Krishi Udan Yojana will also improve the export of agricult ural goods.

Subsidies in agriculture
Subsidies are financial assistance provided by the government so that the price of a commodity or service can be kept low.
Just like any other country in the world, even in India subsidies are provided to the farmers. The objective is to keep the
cost of agricult ure low so that the farmers can make more and more profit. These subsidies can be provided by the centre
as well as the states.

Subsidies can be broadly classified into the following two types—

1. Direct subsidies

2. Indirect subsidies

Direct subsidies are those in which the payment is done by the government to the beneficiaries directly in their own
account in the form of Direct Benefit Transfer(DBT).

On the other hand, in case of indirect subsidies the beneficiary is benefited and the payment is done to some other entity.

In indirect subsidies the diversion and misuse of funds is more. Hence, DBT is comparatively better. In agriculture in India,
the subsidies are mainly indirect. The farmers are provided subsidised crop insurance, seeds, fertilisers, loans, etc.

Although, the subsidies are meant to benefit the farmers they make the farmers more and dependent over the government.
Since the subsidies are for consumption they are needed y-o-y continuously. Subsidies also create a habit and are
gradually considered to be a right. They also lead to misuse of resourc es.

The government in India kept on spending more and more in the process of providing subsidies to the farmers. It was left
with lesser resources to spend for the purpose of capital formation in agricult ural sector. That is the reason why
construction of dams and canals for the purpose of irrigation, construction of mandis for the sale of agricult ure product,
construction of cold storages and godowns for storage all lagged behind. Excessive expendit ure on subsidies also affects

Agriculture 21
 the fiscal health of the government. The taxpayers money is used for subsidising the farmers instead of using it for the
purpose of development. Subsidies are also trade manipulative in nature.

However, 86% of the farmers in India fall under the category of small and marginal farmers. They are economically weak to
afford high cost of agricult ure. Agricult ure in India suffers from the problem of diminishing returns and hence is no longer
profitable. Therefore, subsidising the farmers is not only an economic imperative but also a social responsibilit y of the
government. Most of the farmers in India cannot subsist without subsidies given by the government. Even agriculture as an
economic activity may collapse without these subsidies.

Economics of animal husbandry

Animal husbandry is considered to be a part of the allied activities associated with agriculture. It is an economic activity
which can be conducted along with agriculture. Agriculture and animal husbandry do not require separate infrastructure
and can be done simultaneously without affecting each other. Agriculture suffers from a number of uncertainties. Failure of
Monsoon, slight climatic change may affect agricult ure instantly. Hence in such situation animal husbandry serves as an
alternative and becomes a source of additional income for the farmers. That is the reason why it is considered to be
complementary to agricultural activities. In fact through agriculture, availability of fodder can be ensured for animal
husbandry and through animal husbandry availability of natural fertilisers can be ensured for agriculture. Therefore, they
both complement each other in a circular way.

In order to strengthen animal husbandry as an important economic activity, in 2014 National Livestock Mission was
introduced. This mission had four important objectives:

1. How to make agriculture and animal husbandry more and more complementary to each other. To ensure the availability
of fodder and natural fertilisers.

2. To protect livestock by enhancing their procreation.

3. To promote rearing of pigs in North Eastern state.

4. To maximise use of technology in every possible way for the benefit of animal
husbandry.

This mission has also yielded positive result and in terms of livestock India has achieved the top most position surpassing
Brazil. In terms of climatic conditions India is a highly diversified country. It can support breeding and rearing of different
type of livestock.

According to the Economic Survey 2021-22, the animal husbandry sector in the last five years, has grown at an annual rate
of 8.15%. As per the latest Situation Assessment Survey (SAS), this sector has emerged as a stable source of income for
the agricult ural households. The animal husbandry sector contribut es an average of 15% to the monthly income of the
farmers.

In the budget 2020-21, the concept of Sagar Mitras and Fish FPOs were introduced and it was decided to promote these
concepts. These Sagar Mitras are the rural youth living in coastal areas of the country. Fish FPOs are just like the Farmer
Producer Organisations related to agriculture. The government had decided that with the help of 3,477 Sagar Mitra and 500
Fish FPOs, production and export of sea food will be promoted. It will not only add to the GDP of country but also create
new employment opportunities. Budget 2023-24 focus on launching a new sub scheme of PM Matsya Sampada Yojana.

Agriculture 22
 Kisan Rail and Krishi Udan Scheme
Overview:

Both introduced in 2020.

Kisan Rail: Collaboration with the Railways Ministry.

Krishi Udan: Collaboration with the Civil Aviation Ministry.

Aim: Connect food-deficient areas with food-sufficient areas, prevent wastage of perishable products,
control food inflation, and increase farmer income.

Kisan Rail:

Operates dedicated trains with refrigerated and normal bogies.

First train: Deolali (Nashik) to Danapur (Bihar).

Focuses on areas connect ed by railways.

Krishi Udan:

Targets regions poorly connected by rail (e.g., NE states).

Aims to improve agricultural exports.

Subsidies in Agriculture
Financial assistance from the government to keep commodit y prices low.

Objective: Reduce agricult ural costs and increase farmer profits.

Types of Subsidies:

1. Direct Subsidies:

Payments made directly to beneficiaries (e.g., Direct Benefit Transfer - DBT).

2. Indirect Subsidies:

Payments made to another entity on behalf of beneficiaries.

Issues with Subsidies:

Predominantly indirect in agricult ure, leading to misuse of funds.

Dependency on government assistance; subsidies viewed as entitlements.

High subsidy expenditure limits capital investment in agricultural infrastructure (dams, mandis, cold
storage).

Strains fiscal health of the government.

Social Responsibility:

86% of Indian farmers are small/marginal and depend on subsidies.

Necessary for the survival of many farmers and the agricultural sector.

Economics of Animal Husbandry

Integration with Agriculture:

Complementary activity; requires no separate infrastructure.

Serves as an alternative income source amid agricultural uncertainties.

National Livestock Mission (2014):

Objectives:

1. Strengthen the link between agriculture and animal husbandry.

2. Enhance livestock protection and procreation.

3. Promote pig rearing in NE states.

Agriculture 23
 Impact:

Recent Initiatives:

Fish FPOs: Similar to Farmer Producer Organizations for fish.

Budget 2023-24: Launch of a new sub-scheme under PM Matsya Sampada Yojana to enhance fisheries.

Seed technology in Indian agriculture

Agriculture and allied sectors are central to the Indian economy. Keeping this and a sustainable future in mind, the Indian
government, quite rightly, is promoting technology-enabled sustainable farming, including natural, regenerative and
organic systems, during its G20 presidency. However, India still faces many challenges and opportunities in its agricultural
sector, such as meeting the demand and affordability of some crops, improving the producti vity, quality and nutrition of its
agricultural produce, reducing the cost of production and the environmental impact of farming, and coping with climate
change and its effects on agriculture. This can be done by adopting seed technology.

India has a rich history and tradition of seed technology, dating back to the 1960s when the National Seeds Corporation
was established. Since then, India has made significant progress in developing and adopting various seed technologies,
such as hybridization, tissue culture, molecular markers, transgenics, etc. Seed technology refers to the science and art of
improving the genetic and physiological quality of seeds to enhanc e their performance under different cultivation
conditions. Seed technology can offer significant advantages for sustainable agricult ure at little additional cost. The size of
the Indian seed market has reached an estimat ed $4–6 billion with untapped potential to be the seed hub for G20
countries.

Why is Seed Technology Important for Indian Agriculture?

Higher Productivity:

Seed technology can increase the yield potential of crops by developing improved
varieties that have desirable traits, such as high grain or fruit quality, resistance to
pests and diseases, tolerance to drought or salinity, etc.

Seed technology can also improve the germination rate, seedling vigour, and plant
establishment of seeds by using priming or physiologic al advancement protocols.

Higher Input Use Efficiency:

Seed technology can reduce the amount and cost of inputs such as fertilisers,
pesticides, and water by using film coating, pelleting, or seed treatments that can
deliver these inputs directly to the seeds or plants in optimal doses.

Seed technology can also enhance the nutrient uptake and utilisation of plants by
using bio-stimulants and nutrients that can stimulate plant growth and metabolism.

Higher Resilience:

Seed technology can improve the adaptabilit y and stability of crops under changing and unpredict able climatic
conditions by using genetic manipulation, speed breeding, gene-editing tools, or Al-responsive sensors or substances
that can modulat e
plant response and external stimuli.

Seed technology can also improve the diversity and health of crops by using
biologicals or microbial inoculum that can enhance plant immunity and soil fertility.

What are Some Examples of Seed Technologies in Use or Development in

India?

Agriculture 24
 Millet Seeds:

Millets are nutrient-rich, hardy and short-cycle crops that are well-suited
for sustainable agricult ure.

India is the global leader in millet production and has the potential to capture the
global seed market by producing quality-assured seeds of improved varieties of
millets, especially minor millets.

India has developed several high-yielding and climate-resilient varieties of millets

using conventional breeding and molecular techniques.

India has also introduced priming and film coating technologies for millet seeds to improve their germination,
emergence, uniformity, and protection.

Cotton seeds:

Cotton is one of the most important cash crops in India and a major source of income for
millions of farmers.

India has achieved remarkable success in cotton production by introducing Bt

cotton hybrids in 2002.

Bt cotton is a transgenic crop that expresses a gene from a soil bacterium called
Bacillus thuringiensis (Bt) that produces a protein which kills certain insect pests.

Bt cotton has increased cotton yield by reducing pest damage and pesticide use.

India has also developed several new varieties of cotton using molecular breeding and
gene-editing tools that have improved traits such as fibre quality, drought tolerance,
herbicide resistance, etc.

Vegetable Seeds:

India has a diverse range of vegetable crops that require different types of seeds.

India has developed many improved varieties and hybrids of vegetables using conventional
breeding and biotechnology methods.

India has also introduced various seed enhancement technologies for vegetable seeds such
as film coating, pelleting, priming, bio-stimulants, nutrients, biologicals, etc., to improve their quality and performance.

Policies and Regulations that Support Agriculture in India

Agriculture 25
 Seed Technology
Protection of Plant Varieties & Farmers' Rights Act (PPV&FR Act), 2001:

Provides intellectual property rights protection to plant breeders and farmers for their varieties and innovations.

Encourages the conservation on and sustainable use of plant genetic resources.

Seeds Act, 1966 and Seeds Rules, 1968:

Regulates quality control and certification of seeds in India.

Prescribes standards and procedures for seed testing, labeling, and marketing.

Fertiliser (Inorganic, Organic or Mixed) (Control) Amendment Order, 2021:

Amends the Fertiliser (Inorganic, Organic or Mixed) (Control) Order, 1985 to include bio-stimulants as a category of
fertilizers.

Bio-stimulants enhance plant growth and development.

Facilitates the registration and use of bio-stimulants in India.

Challenges of Indian Agriculture

Uncertainty in Water Supply:

Largely dependent on monsoon rains, which are often erratic and insufficient.

Production of food grains and other crops fluct uat es year after year.

Only one-third of the cropped area is under irrigation, with inadequate and poorly maintained infrastructure.

Water scarcity and drought are major threats, especially in semi-arid and arid regions.

Lack of Remunerative Income:

Majority of farmers practice subsist ence farming, growing crops mainly for their own consumption.

Low and volatile prices often do not cover production costs.

Farmers face exploitation from middlemen and have limited access to formal credit and insurance, making them
vulnerable to debt.

Fragmentation of Land Holdings:

Continuous subdivision of agricult ural land due to population growth and breakdown of joint family systems.

Average size of land holdings is less than 2 hectares.

Reduces efficiency, productivity, and scope for mechanization.

Lack of Access to Quality Seeds and Inputs:

Many farmers lack access to quality seeds with desirable traits (high yield, pest resistance).

The seed replacement rate (SRR) is low for many crops (e.g., rice: 39.8%, wheat: 40.3%). SRR is the area sown
using the quality seeds.

Limited access to fertilizers, pesticides, and nutrients that enhance seed performance.

Lack of Mechanization and Modernization:

Minimal use of machinery in farming operations increases labor costs and reduces efficiency.

Many farmers are unaware of or lack training in modern technologies that can improve agricultural productivity.

Lack of Allied Infrastructure:

Insufficient market access, storage facilities, and transport networks hinder farmers from maximizing income.

Farmers often sell produce at low prices due to lack of market information and competition.

Post-harvest losses occur due to inadequat e storage facilities.

Way Forward

Agriculture 26
 Maximizing Income, Minimizing Risk:

Empower farmers to make informed choices regarding crops, markets, and technologies.

Strengthen institutions like Minimum Support Price (MSP) and crop insurance.

Create new mechanisms like contract farming and farmer producer organizations.

Liberalized Farming:

Farmers should have the freedom to determine resource use and access competitive markets.

Remove barriers that hinder the free flow of agricult ural goods and services.

Create an enabling environment for private sector investment and innovation in agriculture.

Sustainable Farming:

Encourage sustainable practices that conserve resources, enhance soil health, and improve biodiversity.

Promote agro-ecological approaches (e.g., organic farming, integrated pest management ).

Raise awareness and demand for sustainable agricultural products among consumers.

E-technology in Indian agriculture

In a nation where the agrarian sector employs over half the workforce and contributes around 15 -17% to the GDP,
harnessing e-technology has become an imperative to unlock the sector's true potential. By leveraging digital technologies
(ICTs), the government is driving several e-initiatives aimed at enhancing agricultural productivity, improving market
access, and enriching farmer livelihoods.

Role of e-Technology in Transforming the Agricultural Sector:

Precision Farming: E-technology enables precision farming techniques, such as remote sensing, GPS-based soil
mapping, and variable rate technology, optimizing resource utilization, reducing waste, and increasing yields. Reports
suggest using Agricult ure-Int ernet of Things (Ag-IoT) can reduce water usage by 30% with precision farming.

Real-time Weather and Climate Information: Farmers can access real-time weather forecasts, climate data, and early
warning systems through digital platforms, enabling better planning and decision-making. Apps like AccuWeather and
MAUSAM (developed by IMD) provide seamless and user-friendly access to weather information, including observed
weather, forecasts, radar images, and alerts for impending weather events.

Market Intelligence: E-platforms provide farmers with up-to-date information on market prices, demand trends, and
supply chains, empowering them to make informed decisions and fetch better prices for their produce.

Access to Agricultural Expertise: E-technology facilitates the dissemination of agricultural knowledge and best
practices through online forums, video tutorials, and virtual advisory services, bridging the gap between farmers and
experts. Portals/apps such as mKisan and Kisan Suvidha provide information on topics like fertilizers, subsidies,
weather, and market prices, helping farmers manage operations in their local language.

Supply Chain Management: Digital solutions streamline the agricultural supply chain, enabling efficient tracking,
traceability, and logistics management, reducing waste and ensuring timely delivery of produce. IIT Ropar has
developed an IoT device called AmbiTag, which records real-time ambient temperature during the transportation of
perishable products, body organs, and blood. The AmbiTag temperature data log advises users on whether the
transported item is usable or if the cold chain has been compromised.

Financial Inclusion: E-technologies like mobile banking and digital payment systems have facilitated financial inclusion
for farmers, providing easier access to credit, insurance, and government subsidies. Some non-banking financial
companies (NBFCs) like Clix Capital offer customized loan products through their digital platform, onboarding farmers
and ag-tech startups.

Government E-Initiatives to Empower Farmers:

Digital India Land Records Modernization Programme (DILRMP): Aims to digitize and modernize land records,
ensuring transparent and efficient land management for farmers.

Soil Health Card Scheme: Provides farmers with soil health cards containing nutrient status and recommended
fertilizer doses, enabling better soil management and productivity.

Agriculture 27
 e-National Agriculture Market (e-NAM): An online trading platform that connects farmers with buyers across the
country, enabling better price discovery and reducing intermediaries.

Kisan Suvidha Mobile App: Offers information on weather, market prices, plant protection, and government schemes.

Agri-Udaan: An initiative to nurture startup growth in the agricultural sector by connecting promising innovators with
institutional investors.

National e-Governance Plan in Agriculture (NeGP-A): Provides end-to-end digitized services to farmers, including
information dissemination, input management, and market linkages.

While the government has undertaken various e-initiatives to empower farmers, there is still a need for continued efforts to
bridge the digital divide, improve digital literacy, and ensure last-mile connectivity to maximize the benefits of e-technology
in the agricultural sector. Public-private partnerships and collaboration with agri-tech startups can further accelerate the
adoption of e-technology and drive the transformation of Indian agriculture.

Agriculture 28
 Seed Technology in Indian

Agriculture Introduction
Agriculture is vital to the Indian economy.

India promotes technology-enabled sustainable farming, but still faces challenges like low productivity,
high costs, and climat e change impacts.

Seed technology plays a crucial role in addressing these challenges.

Importance of Seed Technology

Higher Productivity:

Improves yield with enhanced varieties resistant to pests, diseases, drought, etc.

Improves seedling vigor and germination.

Higher Input Use Efficiency:

Reduces costs through seed treatments, pelleting, and film coating.

Enhances nutrient uptake using bio-stimulant s.

Higher Resilience:

Adapts crops to changing climates via genetic tools and microbial inoculants.

Strengthens plant immunit y and soil fertility.

Key Seed Technologies in India

Millet Seeds:

High-yield, climate-resilient varieties developed.

India leads in millet production globally, using priming and film-coating techniques.

Cotton Seeds:

Introduction of Bt cotton in 2002 improved yields and reduced pesticide use.

New varieties developed with traits like herbicide resistance, fiber quality, and drought tolerance.

Vegetable Seeds:

Development of improved hybrids with seed enhancement technologies like film coating and bio-
stimulant s.

Policies Supporting Seed Technology

Protection of Plant Varieties & Farmers' Rights Act (PPV&FR Act), 2001: IP rights for breeders,
encourages genetic resource conservation.

Seeds Act, 1966 and Seeds Rules, 1968: Quality control and certification standards for seeds.

Fertiliser (Control) Amendment Order, 2021: Inclusion of bio-stimulants in fertilizers.

Challenges in Indian Agriculture

Uncertainty in Water Supply: Dependent on erratic monsoons, with only 33% of the land irrigated.

Lack of Remunerative Income: Farmers face price volatility and lack access to credit and insurance.

Fragmented Land Holdings: Small land sizes reduce efficiency and mechanization.

Lack of Access to Quality Seeds and Inputs: Low seed replacement rates for crops like rice and wheat.

Lack of Mechanization: Low mechanization increases labor costs.

Insufficient Infrastructure: Poor market access, storage, and transport.

Way Forward

Agriculture 29
 Maximizing Income, Minimizing Risk: Strengthen institutions like MSP, crop insurance, and promote

Sustainable Farming: Promote sustainable practices like organic farming and agro-ecology.

Conclusion

Agriculture 30
 Industry
Date created @September 17, 2024 6:27 AM

Start date @September 14, 2024

Status Complete

Introduction
Factors leading to shift towards service sector
@September 17, 2024
Planning in India and related issues
Factors which affected industrial development in India
Measures adopted in order to improve the health of industry in India
The concept of Maharatna, Navratna and Miniratna
@September 18, 2024
Disinvestment and Privatization
Strategic Disinvestment
Strategic Disinvestment Policy
National Investment and Manufacturing zone- NIMZ
New Economic Policy / Industrial Policy / LPG Model
The main objectives of the new policy
Low Income and Middle-Income Trap
Gross Capital Formation

Industry 1
 Ease of Doing Business
Investment Models
@September 20, 2024
Aatma Nirbhar Bharat Abhiyan
Criticism of the Campaign
GVA (Gross Value Added)
@September 20, 2024
Gig economy
Index of Industrial Production(IIP)
FERA and FEMA
Trade-Related Aspects of Intellectual Property Rights (TRIPs)
Patent
Copyright
Trademark
Trade Secret
Geographical Indication

Introduction
The economic activities can be classified into three major groups— agriculture and allied activities, industry and services.
In Indian economy agriculture and allied activities contribute less than 20% in the GDP. Industry contribute 25 -30% in the
GDP and services contribute more than 50%. Out of all these three sectors, industry is highly labour intensive and hence it
may provide maximum employment opportunity.

Industry can again be classified into three important parts— manufact uring, mining and construction. The contribution of
manufact uring in the GDP of India remains 15-20%, mining 2.5% and construction approx. 8%. Out of these three, the
importance of manufact uring in employment generation is maximum. It is mainly because it is a continuous process and
heavily dependent on labour.

In India, the contribution of industry is less than what is required. In a thickly populated country like India, industry mus t
contribut e not less than 40%. Even the contribution of manufact uring must not be less than 25%. Since the contribution
remains low, the rate of unemployment in India remains high.

Services may contribute to the GDP but they cannot create employment at the pace that of industry. That is the reason why
services sector kept on contributing to the Indian GDP but it failed to create sufficient employment opportunity and India
witnessed a phase of jobless growth. Excessive dependency on agriculture, low skill development, high rate of illiteracy,
low rate of industrialisation and sudden shift of the economy towards the service sector without reaching the peak of
industrial activities, all have lead to high rate of unemployment.

Factors leading to shift towards service sector

1. Land required in service sector is less as compared to industry.

2. Service sector is mainly footloose and can be setup anywhere.

3. Capital investment in industry is more as compared to services.

4. Service sector is less dependent on labour.

5. Profit margin in service sector is more as compared to industry.

6. Huge English speaking population has encouraged Business Process Outsourcing.

7. Rapid expansion of IT and software sector.

Industry 2
 Secondary sector— it includes manufacturing as well as construction 🦺

@September 17, 2024

Planning in India and related issues

During the British period, the Indian economy was affected adversely. Hence, post-independence the country was in a
state of dilemma that in which direction should the country move. Hence, in order to provide a proper direction to the
process of change, planning was adopted as an instrument. Planning is an instrument of directed social change. In this
process of change long term socio-economic goals are set and in order to achieve those goals even the means are
prescribed.

Even before independence the country had started talking about the process of planning. With this objective the Bombay
Plan was proposed by industrialists such as JRD Tata, GD Birla, etc. This Bombay plan was based on the Japanese model.
It suggest ed that India should not try to become self-sufficient /self-dependent rather it should concentrat e on production
of only those goods in which it has an edge over its competitors(comparative advant age). The country should export such
goods to the entire world and the foreign exchange earned can be used in order to import the other essential commodities.
However, post-independenc e the Bombay plan was not adopted.

Post-independence in order to implement the process of planning, Planning Commission was setup in 1950. The first five
year plan was implement ed in 1951. The first five year plan was based on Harrod-Domar model made by two different
economists who suggested that in a developing economy for the purpose of development, labour and capital are essential.
In such economies labour is sufficient but capital is not. Hence, in such economies in absence of the capitalist class the
government should play the role of an investor. This is how the government started investing in infrastructure and in
industrialisation.

The second five-year plan was based on Nehru-M ahalanobis approach. P.C. Mahalanobis was a statistician who founded
the Indian Statistical Institute(ISI), Calcutta. The Nehru-Mahalanobis approach is also termed as trickle down approach. In
trickle down approach, the development is done at higher level and it is expected that the benefits will trickle down even to
the grassroots level. The Nehru-M ahalanobis approach suggest ed that India should try to become self-dependent as soon
as possible. It also suggest ed that the county should concentrat e in heavy industry, the small scale industries will
automatically flourish. It also suggested that India should not allow foreign investment and the Indian investors should not
be allowed to invest abroad. The approach suggested that all the strategic sectors should remain under complete control of
the Government of India. Hence, based on the suggestions India witnessed a phase of forceful nationalisation. Indian
economy became a mixed economy which means coexistence of private as well as public investment.

The Government of India had to invest because of the following reasons—

1. Dearth of private investors

2. Trust deficit towards the private investors

3. Profiteering being the main objective of the private investors

4. Unwillingness of the private investors to invest in the sectors where profit is low

The private investors continued to exist and were not completely sidelined because—

1. The government lacked resources

2. The government lacked expertise

3. The Indian capitalists had played an important role in Indiaʼs struggle for independence.

Hence, their complet e elimination would have amount ed to injustice.

Industry 3
 Since India did not allow foreign investment, the foreign exchange reserve remained low. Since our export remained low as
compared to import, the outflow of foreign exchange was more as compared to the inflow. Hence, in order to meet the
expenditure of import, India had to borrow from the external sources. In order to repay the debt as well as the interest, the
country had to borrow again. It was a situation of debt trap which finally culminated into the balance of payment crisis.

The process of planning may not be very effective. It is mainly because the economy suffers from uncertainties. It is
extremely difficult to predict that what would happen next in the economy. Hence, setting up long term targets and
achieving them is a challenge. In 2015, the planning commission was replaced by NITI Aayog and the five year plans were
discontinued. NITI Aayog is a think tank which is headed by the PM. It presents a vision of the future and prepares a
roadmap. However, the approach is more flexible as compared to the process of planning.

Factors which affected industrial development in India

Since the industrial sector was dominat ed by public sector companies, the problems
associat ed with the public sector companies affected the entire industrial sector. The
problems were as follows:-

1. Continuous interference of ministries affected the autonomy of the public sector companies.

2. Inefficient leadership of the bureaucracy also affected the public sector companies.

3. The monopoly of the government in a number of sectors affected competition. It also reduced efficiency.

4. The public sector companies also suffered from locational disadvant ages. In order to develop a region, industries were
set up even without thinking that whether such industries will be able to survive in that region or not.

5. In order to fulfil its social responsibility, the government resorted to price regulation. This price regulation also affected
the profit of public sector companies.

6. The workforce of the public sector companies was also more than what was required. Unwanted workforce was added
in order to remain politically popular. Hence even the burden of salaries affect ed the profit of the public sector
companies.

7. Since the public sector companies were not able to upgrade themselves with new machines
and tools their Increment al Capit al Output Ratio (ICOR) remained adverse. Increment al Capital Output Ratio refers to
that extra capital invest ment which is required in order to increase the production by 1 unit. The less is the ICOR of a
company the more
efficient it is. As compared to privat e sect or companies, the ICOR of t he public sector companies always remained high
which affect ed their economic health.

8. Even the adverse mentality of public sector employees affected the health of a public sector companies.

9. Due to fear of Nationalisation, private investment remained low.

Measures adopted in order to improve the health of industry in

India
Since the public sector and the private sector in India were not performing well, several measures were adopted in order to
improve their condition. Some of the important measures are as follows:-

1. In 1987 Board for Industrial and Financial Reconstruction (BIFR) was constituted. The main responsibility was to
suggest that how a public sector company running in loss can be reconstruct ed.

2. In 1991 India adopted LPG Model of development(aka Rao-Manmohan model). LPG stands for Liberalisation,
Privatisation and Globalisation. It was to ease rules related to business in India, encourage private investment in India
and open up the Indian economy for the entire world.

3. National Disinvestment Commission was set up under the chairmanship of G.V. Ramkrishna in 1996 to ensure
privatisation and disinvest ment in public sector companies.

4. In order to provide financial autonomy to public sector companies in the year 1997 the
concept of Navratna and Miniratna was introduced. In the year 2009 the concept of Maharatna was also brought.

5. In 1999 a separate Department of Disinvestment was set up. In the year 2016 it was renamed as Department of
Investment and Public Asset Management (DIPAM).

Industry 4
 6. In order to prevent frequent interference of the government in the day to day working
of public sector companies the concept of Memorandum of Underst anding(MoU) was introduced. Under this
arrangement in the beginning of the financial year itself
the public sector company and respective ministry both set a target. If the company is able to meet the target then on
the basis of performance, the company is categorised into excellent, very good and good. If the company is able to
achieve the target, the government will not intervene. The government will intervene only if in case the company fails to
achieve the target.

7. In order to give preference to the public sector companies in the process of procurement, Purchase Preference Policy
(PPP) was introduced. Under this policy, public sector companies are preferred over private sector companies in the
process of procurement. If a department of government or any other government entity is interested in procuring
something from a company and in the bidding process along with private sector companies if public sector companies
are also involved then even if the public sector company quotes a price which is higher but is within a range of 10% of
the lowest bid then the public sector company will be preferred over the private sector companies.

8. In order to reduce the workforce of public sector companies, Voluntary Retirement Scheme (VRS) was introduced.

9. In order to enhance the percentage of manufacturing in Indian GDP, in 2011 under National
Manufact uring Policy
the concept of National Investment and Manufacturing Zone(NIMZ) was introduced. As a complementary scheme, in
the year 2014 the concept of Make in India was launched.

10. In order to encourage investment in India and to promote export from India, Special Economic Zone Act was passed.

11. Micro Small and Medium Enterprises are labour intensive and can create sufficient employment opportunities. At the
same time it is easier to set such enterprises, so MSMEs are being promoted in India.

12. The Aatma Nirbhar Bharat Abhiyan aims at boosting investment.

13. In the Budget 2021-22, the government declared National Disinvestment Policy.

14. In the Budget 2022-23, the government has announced the PM Gati Shakti National Master Plan. Its objective is to
promote infrastructure development in the country.

15. Budget 2023-24 announced an increase in capital expenditure on infrastructure investment by 33 %. The ₹10 lakh
crore capital expendit ure on infrastruct ure is 3.3 percent of GDP.

The concept of Maharatna, Navratna and Miniratna

In order to provide financial autonomy to the public sector companies, the concept of Navratna and Miniratna was
introduced in 1997. The concept of Maharat na was introduced later in 2009. In order to categorise a company as
Maharat na Company the following conditions have to be fulfilled—

It should be a public sector company.

It should be listed on the stock exchange.

It should have a global presence.

It should be an existing Navratna company.

In last 3 years average annual revenue of the company should not be less than
₹25,000 crore.

In last 3 years average annual net worth of the company should not be less than ₹15,000 crore.

In the last three years average annual profit of the company should not be less
than ₹5,000 crore.

Maharatna company may do a capital investment of upto ₹5,000 crore or up to 15% of

its net worth (whichever is less), in one financial year without seeking permission from the related ministry. At present there
are 14 Maharat na companies, they are as follows:-

1. CIL-Coal India Limited.

2. ONGC - Oil and Natural Gas Corporation Limited.

3. NTPC - National Thermal Power Corporation Limited.

4. BHEL - Bharat Heavy Electricals Limited

Industry 5
 5. GAIL - Gas Authority of India Limited.

6. SAIL - Steel Authority of India Limited.

7. BPCL - Bharat Petroleum Corporation Limited.

8. IOCL - Indian Oil Corporation Limited.

9. PGC - Power Grid Corporation of India Limited.

10. HPCL - Hindustan Petroleum Corporation Limited.

11. PFC - Power Finance Corporation.

12. REC - Rural Electrification Corporation

13. OIL- Oil India Ltd

14. HAL- Hindustan Aeronautics Limited

In order to classify a company in the category of Navratna, following conditions have to be fulfilled—

It should be a public sector company.

Out of the last five years, in any three years the company should be in the category of excellent, very good based on
the concept of MOU.

Based on six different factors like profit, income per share etc. a report card of public
sector companies is prepared. Company should be able to score at least 60% out of the
total score.

At present there are 24 Navratna companies. Navratna company may do a capital investment of up to ₹1,000 crore in one
financial year or up to 15% of its net worth (whichever is less, without seeking permission from the related ministry.

For a company to be categorised as Miniratna company it should be—

A public sector company

In the last three years the company should be in profit and during this period in none of the years the company's net
worth should be negative.

It should not be financially dependent on government.

Should not have defaulted in the loan borrowed from the banks.

Miniratna companies are again classified into two types:

Miniratna Category 1 companies can invest an amount upto ₹500 crore or up to 15% of their net worth (whichever is
less) in one financial year, without seeking permission from
the related ministry. In last 3 years, if in any of the years the profit is ₹30 crore or more, the company will be
categorised as Miniratna category 1. At present they are 51 in number.

Miniratna Category 2 companies can invest an amount upto ₹300 crore or up to 15% of their net worth (whichever
is less) in one financial year without seeking permission from the related ministry. At present they are 11 in number.

Industry 6
 Planning in India and Related Issues
Post-independence, India adopted planning to provide a direction for socio-economic change.

Planning involves setting long-term socio-economic goals and means to achieve them.

Pre-Independence Planning
Bombay Plan: Proposed by industrialists like JRD Tata and GD Birla; based on the Japanese model.

Focused on comparative advantage and foreign exchange for essential imports.

Post-independence, this plan was not adopted.

Post-Independence Planning
Planning Commission (1950): Implemented to direct the economy.

First Five-Year Plan (1951): Based on Harrod-Domar model, focusing on labor and capital investment by
the government.

Second Five-Year Plan: Nehru-Mahalanobis approach aimed at self-reliance, heavy industry

development, and public sector dominance.

Introduced mixed economy and strategic sectors under government control.

Reasons for Public Sector Dominance

Dearth of private investors.

Trust deficit in private investors.

Focus of private investors on profit-making sectors.

Balance of Payment Crisis

Low exports, high imports, and restricted foreign investments led to debt traps and balance of payment
crises.

Criticism of Planning
Long-term predictions in a dynamic economy are challenging.

In 2015, NITI Aayog replaced the Planning Commission, offering a more flexible, think-tank approach to
economic strategy.

Industrial Development in India

Factors Affecting Industrial Growth

1. Public sector company challenges:

Government interference, inefficient bureaucracy, and monopoly.

Locational disadvant ages, price regulations, and overstaffing.

High Incremental Capital Output Ratio (ICOR) and low efficiency.

2. Private sector issues:

Fear of nationalization led to low private investments.

Measures to Improve Industrial Health

1. BIFR (1987): Reconstructing loss-making public sector units.

2. LPG Model (1991): Liberalization, Privatization, and Globalization reforms.

3. Disinvestment Commissions (1996) and DIPAM (2016): Focused on privatization and disinvestment.

4. Navratna, Miniratna, and Maharatna (1997/2009): Provided financial autonomy to public companies.

5. MoU Concept: Performance-based government intervention in public companies.

Industry 7
 6. Make in India (2014): Promoted manufacturing and industrialization.

7. PM Gati Shakti (2023): Infrastructure development initiative.

Maharatna, Navratna, and Miniratna Companies

Maharatna
Requirements: Listed public sector company with global presence.

Revenue, net worth, and profit thresholds (₹25,000 crore, ₹15,000 crore, ₹5,000 crore respectively).

Capital investment limit: ₹5,000 crore or 15% of net worth.

Navratna
Requires a public sector company with excellent MoU ratings and a minimum performance score of 60%.

Capital investment limit: ₹1,000 crore or 15% of net worth.

Miniratna
Requirements:

Public sector company

Must be in profit during last three years and during this period in none of the years the company's net
worth should be negative.

It should not be financially dependent on government.

Should not have defaulted in the loan borrowed from the banks.

Divided into:

Category 1: Investment limit of ₹500 crore without permission of the related ministry.

Category 2: Investment limit of ₹300 crore without permission of the related ministry.

@September 18, 2024

Disinvestment and Privatization

In a public sector company when the government retains the majority stake ownership as well as management and sells
only minority stake, then it is termed as Disinvestment. In disinvestment government retains 51% or more shares of a
company. On the other hand when the government sells majority stakes (more than 51%) in a public company to a private
company/investor, transferring not only the management but also the ownership of the company, then it is termed as
Privatisation.

Both these tools are not only used to increase the revenue of the government or reduce the fiscal deficit, but also used to
fulfil some important policy based objectives. Through disinvestment the government is not only able to raise funds but it
also creates shareholders which lead to transparency in the functioning of the company. Normally when the government
fails to run a company and a company continues to remain in loss then privatisation is used as a tool. If the government
lacks expertise and the future prospect s of a company are not bright, then also privatization is used as a tool.

Disinvestment and privatization are a part of the LPG model of development. For this purpose Disinvestment Commission
was constituted in 1996 under the chairmanship of G.V. Ramkrishna. A separate Department of Disinvestment was set up in
1999. In the year 2005, National Investment Fund (NIF) was constituted.

The capital raised through disinvest ment and privatisation is maintained by the government in NIF. The fund can be used
only for specified purposes. The entire amount is divided into two parts of 75% and 25%. The 75% part can be used by the
government only for welfare schemes, the remaining 25% can be used for following purposes:

For the purpose of expansion of public sector company.

In order to buy back the sold shares of the public sector companies.

For the purpose of expansion of Indian railway.

Industry 8
 For setting up metro rail services in different cities.

For the purpose of providing fund to NABARD as well as EXIM Bank.

To refinanc e the public sector banks.

To provide fund to Uranium Corporation of India limited and Nuclear Power Corporation of
India.

In financial year 2008-09 because of the American recession, even the Indian economy was affected to some extent.
Hence it was decided that from 1st April 2009 till 31st March 2013, the entire amount i.e., 100% of NIF will be used for
welfare schemes. Again from 1st April 2013 the same old arrangement has been adopted. The National Investment Fund
has been made a part of Public Account and hence in order to withdraw fund from it the government need not seek
permission from the parliament.

Strategic Disinvestment
Disinvest ment is a process in which the government sells its stake in Public Sector Undertakings. When the government
transfers ownership or control of a government undert aking to another entity, this process is called Strategic
Disinvestment. The entity to which the ownership or control is transferred can be another government entity or a private
entity, but most often this transfer takes place only to private entities. It can be considered as a form of privatization, unlike
normal disinvestment. The Department of Investment and Public Asset Management (DIPAM), functioning under the
Ministry of Finance, has defined strategic disinvest ment . According to DIPAM, transfer of 50% or more stakes (as decided
by the appropriate authority) and management control in a government or central public sector enterprise comes under the
purview of strategic disinvestment. DIPAM is the nodal department for strategic disinvestment in India. However, NITI
Aayog also support s in identifying PSUs for this process.

Strategic Disinvestment Policy

The government has announced a strategic disinvestment policy in the budget 2021-22. The Finance Minister said that the
objective of this strategic disinvest ment is to use the funds to finance social sector and development programs and to
introduce private capital, technology and best management practices in public sector enterprises. It was announced in the
budget that this policy will lead a clear roadmap for disinvest ment in all non-strat egic and strategic sectors. Fulfilling the
commitments of the government under the Atmanirbhar package, the Finance Minister talked about the disinvestment of
the current central public sector undertakings, public banks and public insurance companies. In the non-strategic sector,
the government will get out of all the businesses. The government will have its presence in only 4 major strategic areas,
these areas are:-

Nuclear energy, Space and Defence.

Transport and Telecommunications.

Energy, Petroleum, Coal and Other Minerals.

Banks, Insurance and Financial Services.

Apart from this, the central government will also encourage the states for disinvest ment . Rationalisation of public sector
undert akings will be possible with this disinvest ment policy. Also, the government 's exit from the non-strat egic sector will
enhance competitiveness and quality. The financial burden on the government will also be reduced by the disinvestment of
non-profit making companies.
Critics, on the other hand, contend that bridging the budget gap through disinvestment would encourage a malpractice.
Withdrawal of government will increase the private sector's arbitrariness in several sectors. At the same time, the
disinvest ment process gets trapped in administ rative delays, indicating a lack of objectivity. Disinvest ment of good
enterprises will reduce the government's long-term revenue. Furthermore, investment in loss-making businesses is less
appealing. As a result, appropriat e pricing is unavailable.

National Investment and Manufacturing zone- NIMZ

The idea of NIMZ was conceived under National Manufact uring Policy- 2011. It was aimed at promoting manufact uring
activities in India. NIMZ will be dedicated townships in which manufact uring activities will be promoted. Along with
manufact uring units, even colonies will be set up for the people to live. Hence the services will automatically flourish there.
It was decided that for setting up a NIMZ, minimum 5000 hectare of land will be required. NIMZ will be green field projects.
It means that NIMZ will be set up in such pieces of land where nothing is in existence. Different from Greenfield project, a
Brownfield project refers to modifying or dismantling an existing structure in order to set up a new structure.

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 It was decided that through NIMZ in next 10 years the contribution of manufact uring in Indian GDP will be increased to 25%
which was just 15 - 16% at that time. It was also perceived that through NIMZ approx. 100 million job opportunities will be
created in 10 years.

The government had decided that in order to set up an NIMZ world class infrastructure will be provided to interested
investors and single window clearance will be ensured in order to ease investment. However, tax benefits will not be given.
Initially it was decided that NIMZ will be set up around a dedicated freight corridor (Dadri to Jawahar Lal Nehru Port).
However, the first allotment of land for NIMZ was done in 2015 in Prakasam district of Andhra Pradesh.

The most serious challenge in case of setting up NIMZ is land acquisition. The second most serious challenge is to
encourage invest ment from domestic as well as foreign investors.
The banks in India are suffering from losses and even the corporates are facing adverse financial situation. Hence foreign
investment remains the only option.

In order to promote foreign investment and domestic investment in manufact uring sector Make in India Programme
initiative was adopted. It was started to complement the concept of NIMZ. Make in India was also introduced to promote
manufact uring sector.

Under this initiative India is being projected as a destination for investment in manufact uring activities. In order to promo te
NIMZ as well as Make in India initiative, the country is trying to improve its ranking in Ease of Doing Business Index
published by the World Bank. The announcement of Atmanirbhar Bharat Abhiyan can also be linked to promotion of
manufact uring sector in India. There are some similarities and differences between SEZ and NIMZ.

Similarities-

1. Both are established as clusters of industrial entities.

2. Both are dedicated areas.

3. Both have the objective of increasing investment, trade and commerce.

4. Rules have been liberalised in order to promote both of them.

Differences-

1. SEZs are clusters in which infrastruct ure is developed for the purpose of setting up businesses. On the other hand
NIMZ are dedicat ed townships.

2. SEZs maybe Brownfield projects or Greenfield projects. Whereas an NIMZ will only be Greenfield projects.

3. In a SEZ units related to service sector as well as manufact uring sectors can be set up. Whereas NIMZ is dedicated for
manufact uring only.

4. The units operating in SEZs are given tax benefits. Whereas the units operating in an NIMZ does not get any tax
benefits. The units operating in NIMZ are given relaxations related to rules for investment.

5. Whatever is produced in SEZs, can only be exported and cannot be sold in domestic market. Whereas whatever is
produced in NIMZ can be sold in domestic market and can also be exported.

New Economic Policy / Industrial Policy / LPG Model

In 1956, the economic policies which were formulat ed continued for long. Although the country and economic conditions
were changing, the policies remained the same. The existing policies failed to fulfil the need for changing global and
domestic conditions. Foreign investment in the country remained restricted under the Nehru-Mahalanobis approach. Since
India was not self-sufficient , its imports remained higher as compared to exports. For this, India had to borrow from
external sources to bridge the gap. In order to repay the loan, the country had to borrow again. It became a situation of a
debt trap. Since the country did not have enough foreign exchange, India had to face a Balance of Payment Crisis in 1990-
91. This situation compelled India to borrow from the IMF.

However, when the IMF lends to a member country, it imposes a number of conditions. These conditions are imposed so
that the country does not face the same problem in the future again. Under these conditions, Liberalisation, Privatisation,
and Globalisation are the most important instruments. Hence, based on this, India adopted the New Industrial Policy in 1991.
It was a compulsion as well as a necessity for India. These policies were termed as the LPG model of development. It was
also termed as the Rao-Manmohan model of development.

The main objectives of the new policy

1. To prevent Balance of Payment Crisis situations in the future.

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 2. To ensure inflow of foreign investment so that the foreign exchange reserve remains healthy.

3. To ensure Ease of Doing Business.

4. To make sure that India's GDP grows.

5. To enhance India's share in world trade.

6. To create more employment opportunities.

7. To make the country as self-dependent as possible.

8. To ensure restriction-free flow of goods and services as well as human resources.

Liberalisation refers to easing the rules related to investment and business. It also refers to getting rid of the Licence Permit
Raj and bringing down Inspector Raj. Under this, gradually the provision of compulsory licensing was eliminat ed
concerning several businesses. At present, only some sectors such as the production of hazardous chemicals, explosives,
and tobacco product s require compulsory licensing. In order to reduce Inspector Raj, the arbitrary powers given to
government officials have been gradually taken away.

Privatisation refers to opening up even those sectors for private investment in which the government had its monopoly. At
present , only in two sectors, Atomic Minerals and Atomic Energy, does complet e monopoly of the government exist.
Privatisation also refers to the selling of those public sector companies to private parties that are running in losses or wh ich
may not be managed by the government. Disinvestment can also be termed as a part of privatisation. It ensures private
investment leading to competition, which enhances the quality of goods and services.

Globalisation refers to the opening of the domestic economy for the entire world. It not only ensures free flow of
investment but also includes the free flow of goods, services, technology, and human resources.

But due to economic liberalisation, domestic producers were adversely affected in the initial stages. They were complet ely
thrown out of competition. The process of globalisation gives birth to Neo-Imperialism. Under this, the Multi-National
Companies of developed countries make t he consumers of developing countries dependent on t hem. As globalisation
made t he exchange of t echnology easier, domestic companies in the organised sect or that had resources were able to
acquire these technologies easily. This led to automation, reducing employment opportunities in the country. When
employment opport unities in the organised sector st art declining, the dependency on the unorganised sector increases. I n
this process, the economy transforms from organised to unorganised.

Low Income and Middle-Income Trap

Based on per capita income, countries are classified into high income, middle income, and low-income countries. In order
to bridge the gap with high-income countries, it is essential for a low-income or middle-income country to grow at a higher
pace compared to high-income countries. The process of decline in the income gap between a high-income country and a
low or middle-income country is known as Convergence.

If a low-income country keeps growing at a rate equal to or lower than the growth rate of high-income countries, then it will
continue to remain a low-income country. This is known as a Low-Income Trap. Similarly, in the case of a middle-income
country, if its growth rate remains equal to or less than that of high-income countries, then they are considered to have
fallen into the Middle-Income Trap. Some middle-income countries grew at a rate higher than that of high-income
countries, and now they have per capita incomes higher than those of high-income countries. India is also a middle-
income country. Since the process of convergence is very slow, it has remained in the Middle-Income Trap for a long time.

Gross Capital Formation

In an economy, in any financial year, the sum total of all new assets created through investment is termed as Gross Capital
Formation. It may include the construction of new buildings, roads, dams, bridges, etc. However, the price of land is not
included in its calculation. Gross Capital Formation also includes the procurement of new machines. However, in the
calculation of Gross Capital Formation, the cost of maintenance, repair, etc. is not included.

Ease of Doing Business

Ease of Doing Business refers to the ease with which businessmen can do business in a country. This annual report,
released by the World Bank, evaluat es how conducive a country is to starting and running a business.

This report is prepared based on the following parameters:

1. Starting a Business

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 2. Permit for Construction

3. Power Supply

4. Registration of Property

5. Availability of Credit

6. Protection of Minority Investors

7. Paying Taxes

8. Doing Business Across Borders

9. Enforcement of Contracts

10. Resolution of Bankruptcy

In addition to these ten standards, the 11th standard is the Appointment of Workers, and the 12th standard is the Contract
with the Government. But these are not included while calculating the marks.

India was ranked 63rd out of 190 countries in the Ease of Doing Business Report 2020. It was an improvement of 79 places
in the last five years. In 2014, India was placed at 142nd rank in this report.

In August 2020, the World Bank halted the publication of the Ease of Doing Business Report. The World Bank said in a
press release that data provided by some countries revealed irregularities. Therefore, in December 2020, the World Bank,
after evaluating and reviewing the Ease of Doing Business report of the last five years, presented a new report.

The World Bank said in this revised report that China should have been seven places down in the report released in 2018.
Apart from this, the World Bank has also improved the ranking of Saudi Arabia, the United Arab Emirat es, and Azerbaijan.
India's position remained unchanged in these reports.

In September 2021, the World Bank announced that after data irregularities in Doing Business Reports 2018 and 2020
reported internally in June 2020, the World Bank paused the next Doing Business Report. The World Bank initiated a series
of reviews and audits of the report and its methodology. The internal reports raised ethical matters, including the conduct
of former Board officials as well as current and former Bank staff, management reported the allegations to the Bank's
appropriat e internal account abilit y mechanisms.

After reviewing all the information available on the Doing Business Report, including the reviews, audits, and reports, the
management of the World Bank has taken the decision to discontinue the Doing Business report.

Although India has made significant progress in this report, critics believe that there is a lack of development at the ground
level. Despite the improvement in India's position in this report, foreign investment inflows have been relatively low.

Based on this report, the Department for Promotion of Industry and Internal Trade (DPIIT), working under the Ministry of
Trade and Commerce, in collaboration with the World Bank, has started the publication of the Ease of Doing Business
Report for the states to encourage healthy competitive development among the states. The report, based on the Business
Reform Action Plan (BRAP), was launched in 2015.

Investment Models
In India, since independence, investment in infrastructure has mainly remained the responsibility of the government.
However, gradually it was seen that the government not only lacks resources but also lacks expertise. Hence, the
involvement of private parties became important. It came to be known as Public-Private Partnership (PPP). In 2014, in
place of the concept of PPP, the concept of PPPP was introduced. It refers to People Public Private Partnership. It shows
that participation of people is also important.

Public-Private Partnership models of investment are mainly used in the infrastructure sector. Under this, the most common
models are as follows:

BOT Model: Build Operate Transfer Model

In this model, which is mainly used for the purpose of construction of roads and bridges, land is provided by the
government and the responsibility of construction lies with the private party. Depending on the length of the road or
the bridge, its time period is decided. During this time period, it is the responsibilit y of the private company to
complete the project. Even the maintenance is the responsibility of the private party. Once the time period is over,
the project is transferred to the government and the private party exits. Since a deadline is there and the
maintenance is also the responsibility of the private party, the project will be completed on time and with better
quality.

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 BOT model is again classified into two types:

1. Build Operate Transfer Annuity Model

2. Build Operate Transfer Toll Model

In the Annuity Model, a private party complet es the project but it is not allowed to collect toll. The company is paid
an annual amount by the government directly. With the money received, it can pay back the loan taken for the
construction of the project. In the Toll Model, the private company is allowed to collect tolls for the use of the road
or bridge.

EPC Model: Engineering Procurement Construction Model

Under this model, the private party handles engineering, procurement, and construction work. However, all
specifications are given by the government. This model is adopted for construction projects in which the
government requires strict adherence to specifications.

Swiss Challenge Model: Under this model, the lowest bid is disclosed to others who may come forward to present a
bid against it. The lowest bidder has to provide a justification as to why it was the lowest. If the justification is
satisfactory, the lowest bidder is awarded the contract.

Hybrid Annuity Model: This model includes both public and private funding. In this model, the government bears 40%
of the project cost. The remaining cost is borne by the private party. However, the private party is not allowed to take
tolls until the project is complet ed. After completion, the private party can collect tolls.

BOO Model: Build Own Operate Model

Under this model, a private party builds, owns, and operates the project. The ownership of the project remains with
the private party even after the project is complet ed.

BLOT Model: Build Lease Operate Transfer Model

In this model, the project is constructed by a private party. However, the operation of the project is done by another
private party, which is known as a leaseholder.

@September 20, 2024

Aatma Nirbhar Bharat Abhiyan

During the COVID-19 pandemic, the government of India launched the Aatma Nirbhar Bharat Abhiyan. A ₹20 lakh crore
economic package was announced to help the economy recover. This campaign focuses on making the country self-
reliant, highlighting the need for self-sufficiency, and aims to transform the Indian economy. The main objective of the
Aatma Nirbhar Bharat Abhiyan is to make the country self-reliant by promoting local industries, businesses, and products.
The campaign emphasizes five pillars:

1. Economy: Aiming for quantum jumps.

2. Infrastructure: Modern and efficient infrastructure.

3. Technology: Emphasizing technology innovations in the 21st century.

4. Vibrant Demography: Leveraging population for economic growth.

5. Demand: Maximizing the potential of the supply chain.

Criticism of the Campaign

Critics have stated that the economic package was exaggerated and did not address the demand-side recovery
adequately. They believe it is a remodelling of the Make in India initiative, which has also received criticism for failing to
attract adequat e foreign invest ment.

GVA (Gross Value Added)

GVA is an indicator of economic growth. It calculat es the value added by different sectors in the economy by subtracting
intermediat e consumption from total value. Despite the RBI moving away from using GVA as a metric, the government
continues to utilize it in assessments of economic performance.

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 @September 20, 2024

Gig economy
It is anew form of economic arrangement which is becoming popular continuously. The workers which are associated with
gig economy are termed as gig workers. The workers who are engaged are not permanent employees of a company or
organisation. They are contract ual in nature or they are freelancers. Hence, gig economy is associat ed with on demand
service. it means that the workers provide their services only when it is required by the company. It means that the
payment will only be done when service is provided and if the work is not there, no payment will be done. Gig economy is
also associat ed with part time jobs.
Taxi drivers, delivery agents, etc. are also a part of the gig economy. Gig economy provides flexibility to the workers.
Those associat ed with gig economy may provide their services only till the time they are interested in providing services.
Even the company will continue to hire them only till the time the company requires their services. Hence, it even becomes
cost effective for the company. This is also giving a fillip to rising women workforce as it provides flexibility to balance job
and domestic responsibilities.

However, gig economy may also be exploitative. It suffers from job insecurity. The workers engaged may not have regular
income. They do not enjoy any employment benefits like provident funds, etc. Excessive work due to flexibility may also
affect the health of those who are engaged in such economic activities.

Index of Industrial Production(IIP)

IIP measures industrial growth in India. This index is published once in a month by NSO. The data of any month is
compared with the same month of the previous year. This index shows the performance of the industrial sector in the
economy. Since GDP is calculat ed on a quarterly basis and this index is calculat ed on a monthly basis, the performance of
this index gives a rough idea of how the GDP is going to perform.

In this index only three major sectors are included—

1. Manufact uring

2. Mining

3. Electricity generation

These major sectors are further divided. Out of these sectors, the eight most important sectors constitute the core sector
of the IIP. In this entire index the core sector has a total weightage of 40.27%. These eight sectors which constitut e the
core sector or the core industries.

Within this core sector these eight have different weightage.

FERA and FEMA

Foreign Exchange Regulation Act and Foreign Exchange Management Act. In order to regulat e transactions related to
foreign exchange, FERA was passed in 1973. However, the objective of FERA was to prevent the outflow of forex and hence
was rigid. Any offence related to such transactions was categorised as criminal offence and the punishment was rigorous.
With the process of liberalisation a need to liberalise even this law was felt. Hence, in 1999 FERA was replaced by FEMA.
Under FEMA, such offences are categorised as civil offence.

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 Trade-Related Aspects of Intellectual Property Rights (TRIPs)
TRIPs rights are granted under WTO norms to protect intellectual properties, which are products of the human mind that
are new, novel, non-obvious, and have commercial utility. The TRIPs laws cover the following:

1. Patent

2. Copyright

3. Trademark

4. Trade Secret

5. Geographical Indication

Patent
A patent is a right provided to the inventor of a technology, chemical, medicine, or any other product that is non-
obvious, complet ely new, and has commercial utility (e.g., microchips).

Patent rights are granted for 20 years, during which no other individual or company can produce or sell the same
product without prior permission from the patent holder.

Prior to 2005, India only provided process patents, meaning only the method of producing a product was patented.
This allowed others to produce the same product using different processes.

After 2005, under WTO norms, all member countries, including India, had to provide product patents. However, Indian
laws do not allow evergreening, where a slightly modified patented product can be renewed after expiry.

Developed countries argue that patent rights promote R&D, enabling patent holders to recover their costs, while
developing and underdeveloped countries view patents as instrument s for creating monopolies.

Copyright
Copyright rights are granted under the TRIPs agreement for written and published materials such as books, poems, and
lyrics.

Copyright-protected material cannot be republished by others without permission from the copyright holder.

Rights are granted for the lifetime of the creator and extend for an additional 60 years after their death.

Trademark
A trademark is a logo or symbol that identifies a company and can only be commercially used by that company.

Trademarks are granted for a lifetime but must be renewed every 10 years.

Trade Secret
A business can protect certain secrets or private methods that enhance its operations, provided they are not obvious.

Geographical Indication
Geographical indications identify products with distinct qualities due to local factors (e.g., soil, climate, or local skills)
rather than innovation.

Patent rights cannot be granted for these products, which are marked with a Geographical Indication tag along with the
place name. Examples include Basmati Rice, French Wine, Darjeeling Tea, Tirupati Ladoo, and Kolhapuri Chappals.

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