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  Basic Economy Theory 

Chapter 1: STATE OF THE INDIAN ECONOMY PRE - INDEPENDENCE

Introduction

The British rule lasted for two centuries before India won its independence in 1947. The sole purpose of the British economic policy was to reduce India into a feeder economy for expansion of Britain’s own modern industrial base. Pre independence India had a flourishing economy based on agriculture and handicrafts. The quality of workmanship in field on textiles and precious stones was high leading to a worldwide base for Indian products. The British policy was to turn India into an exporter of raw materials and consumer of finished goods. This led to disruption of Indian economy. The British never made any attempt to calculate the national or per capita income. Amongst Indian economists V.K.R.V Rao was first to do so.

Indian Economy

                                                                                

                                                                                                Fig 1: GDP

Agriculture

The Indian economy was highly agrarian as 85% of Indians depended on it. But the sector remained stagnant as the British focused on extracting maximum revenue from it without any capital development. The revenue collection system further aggravated woes. The poor productivity, lack of irrigation and other factors led to ruin of this sector. Although a few areas that grew cash crops were seen to prosper but here to rural indebtedness increased as food crops were neglected. Finally after partition the fertile and irrigated jute growing areas went to Pakistan and India lost its monopoly.

Industry

The Indian industry which was mainly handicraft based was destroyed by British. The reason being to support the industrial base of Britain. The export of finished machine made goods flooded India and the artisans couldn’t compete with them. The second half of the 19th century saw jute industry dominated by foreigner in east India and cotton mills dominated by Indians in western India. Iron and steel plants were started around the beginning of 20th century and after the Second World War the cement, sugar, paper industry started. But the contribution of these to GDP remained small. Moreover these remained confined to railways, ports, communications and other departmental undertakings.

Foreign trade

The foreign trade was an export surplus but the trade surplus went mostly in fuelling the expenses of the colonial administration in India. The common people never got the benefit of this trade. The trade also led to acute shortage of commodity for domestic demands. The British capital investment in railways was to benefit its own industrial base as the markets expanded. The communication facilities too were for the purpose of law and order and the Indians never derived any benefit out of it.


                                                                                                                           

                                                                                                                                          

                                                                                                                                                 Fig 2: Economy of the world

In all the British domination was seen in all aspects of the Indian economy and was the main reason it remained stagnant for two centuries.

Chapter 2: INDIAN ECONOMY 1950 - 1990

Introduction

Usually the economy of the country is based on who shall answer the questions like what to produce? How to produce? How to distribute what is produced? These questions when answered by the market forces mean a capitalist economy, when answered by government then a socialist economy and a mixed economy is where jointly these questions are answered.

Post Independence Dilemma

Indian planners after independence were attracted to the socialist scheme as it gave an opportunity for all to grow. But they were not inclined towards the extreme form of socialismthat was seen in USSR where no private property is allowed and state control over all industries is seen. They wanted a mixed economy where the state shall control industry which isn’t attractive to private sector and the market shall work on things it can do profitably.

Five Year Plans

The idea of five year plans was taken from USSR but the Indian innovation to it was that the private sector too was included in it. The focus of each plan was self reliance, equity, growth or modernization. The planning commission setup in 1950 with the PM as chairman set the planning era in motion. The planning set pace during the second five year under the guidance of renowned statistician P. C. Mahanobolis. He established the Indian statistical institute and was known as the architect of Indian planning.

                                                                        


                                                                                Fig 1: Five year plans

With the growth of Indian economy the structural change was seen in the Indian system. The agriculture sector which dominated India Pre independence had declined in its contribution to GDP. The share of services increased as is seen in modern economies and this was accelerated post – 1991 when the era of globalization began.


                                                                                                      

The planner wanted domination of public sector in the growth of the economy. The private sector would play a complimentary role. This thinking dominated the planning process from 1950-90. This thinking had several positives and negatives too. 

The focus on self reliance in agriculture led to green revolution being adopted. The green revolution made India from an importer of food crops to an exporter. The industrial policy too focused on domination of state. The sectors of industry were divided into three: total state control, private control and joint control but with the state taking the lead in establishing new units. Though the private sector was allowed to start industrialization it was controlled by the state indirectly through a system of licenses.

Trade Policy

The trade policy too complemented the industrial policy and the first 7 plans wanted import substitution. The planner however never seriously considered any impetus to the exports. This policy had good results as in 40 years the share of industry to GDP doubled. This meant development of the country. The Indian industry too saw diversification and expansion of its market. This was due to protection of competition from foreign industries and the policy favoring small scale industries. However now the economists are critical of the state of the economy and favor privatization of non strategic P.S.U and fully opening economy to private and foreign industries.

The negatives seen were that the Indian industry had a captive market and were insulated from competing with other industries of foreign countries and hence they had no incentive to improve their working. The monopoly of state owned industry in certain sector where private parties could have provided good service to hampered the economy. The industrialists were busy in permit License Raj and could focus on starting new industry or expanding production. It was seen that this system also led to also was misused by some industrialist to prevent others from opening new industries by capturing the licenses.

Owning to this it was felt that there is a need for a new economic policy and this was started in 1991.

Chapter 3: NEW ECONOMIC POLICY - 1991

 

Introduction

The year 1991 saw a financial crisis on the government that acted as a catalyst for economic reforms. The crisis was due to several factors like the gulf war that pushed up oil prices and lower remittances from gulf, foreign reserves at all time low, hyperinflation occurring at the same time.

This forced the government to launch a new set of economic policy measures was needed to combat these. The government approached the International Bank of Reconstruction and Development [I.B.R.D] aka World Bank and the International Monetary Fund [ I.M.F ] to give a loan. The financial assistance came with a rider to open up the economy and remove restrictions on the private sector. This set of measures was announced in 1991 as the New Economic Policy.


                                                                    

                                                  Fig 1: New Economic Policy

The policy had measures which came under two heads: Stabilization measures [short term measures to control inflation and correct balance of payments] and Structural reform measures [improve efficiency of economy and increase international competitiveness by removing rigidity in various economic segments]. The policy focused on liberalization, privatization and its outcome was globalization.

Liberalization measures:

  1. Deregulation of industrial sector – removal of licenses, deregulation of sectors for private entry, removal of price controls, De - reservation commodities meant for small scale industries.
  2. Financial sector reforms – reduced role of RBI from regulator to facilitator, removal on foreign borrowing limits, foreign investment was allowed, private banks were allowed.
  3. Tax reforms – rates were lowered for direct and indirect taxes to improve voluntary disclosure and compliance and procedures were simplified.
  4. Foreign exchange reforms: devaluation of rupee, market determined exchange rates.
  5. Trade and investment policy reforms: with the aim to increase international competitiveness of Indian economy and infuse foreign capital and technology the liberalization of trade and investment regime was done. Import licenses and export duties were removed also quota on imports were abolished.

 

Privatization measures:

  1. Government ownership of private companies was removed by outright sale of P.S.U or removal of government from managements of these companies.
  2. Disinvestment which meant selling a part of the equity to private sector was started as private capital and managerial capabilities could be effectively utilized to improve working of P.S.Us.
  3. P.S.Us were granted status of Navratnas and Maharatnas to grant operational autonomy to them.

Globalization:

Integrating economy of the country with the world.

  1. Outsourcing became an outcome of Indian policies. The foreign companies hired cheap Indian talent. The growth of IT industry further fueled this. The low wage rates and availability of degree of skill and accuracy also influenced this phenomenon.
  1. World Trade Organization [W.T.O] was founded as a successor to General Agreement on Trade and Tariff [G.A.T.T] in the Uruguay convention. India was a founder member and has been instrumental in deciding policies. W.T.O aims to reduce tariff and non tariff barriers amongst nations and ensure all countries take advantage of world’s trade.

Critics have pointed out that market driven globalization has increased trade disparity between developed and developing countries. The opening of trade has benefited the developed countries more as they have been able to access the developing markets. On the other hand the developing countries haven’t been able to compete in the markets of developed countries due to inferior goods.

Chapter 4: ECONOMICS OF POVERTY

Introduction

Dadabhai Nauroji was the first to come up with a concept of the poverty line. Post independence India saw the planning commission come up with the mechanism to make a poverty line. The poor are categorized as always poor, non poor, chronic poor [usually poor but may get money occasionally], churning poor [they move in and out of poverty] occasional poor / transient poor [rich who may become poor due to bad luck]. 

Multi dimensional poverty index: U.N.D.P 

It calculates intensity * incidence. It has replaced the Human poverty index.

Incidence: Health, Education and standard of living

Intensity: How many indicators do households lack


                                                                                          

                                        Fig 1: Multidimensional poverty index

G.I.N.I Coefficient:

It varies from 0 - 1. 0 is good and 1 is bad. It is published by World Bank. India has G.I.N.I coefficient of 0.33 which is higher than USA, B.R.I.C.S but less than Germany, Japan.


                                                                                

                                                                                                                                                            Fig 2: G.I.N.I Coefficient

Concepts of macroeconomics:

Consumption goods: these are consumed by their final purchasers like food and drinks or services like recreation.

Capital goods: these are of durable character which is used in the production process. These goods form a part of the capital and they continue to enable the production process to go on for continuous cycles of production.

Consumer durables: these are consumer goods but which have a longer durability as they are not extinguished by short or intermediate use.

All the above are final goods as they don’t undergo any transformation in the economic process. Intermediate goods are those that used as raw materials or inputs for production of other commodities.

Depreciation is the deletion from the value of gross investments in order to accommodate regular wear and tear of capital.

Net investment = gross investment – depreciation

Circular flow of income: the consumption and production process are linked. The process of production generates factor payment for those involved in the production process and generates goods and services as an outcome. These are then consumed by those who receive the income from factor payments.

Consider in the economy a single household and a single factory. If the household works for the factory then the factory pays it and this income is used by the household to buy the goods of the factory and thus the cycle continues. It the income in this cycle has to be calculated then there are multiple ways.

The income of the economy can be calculated by the total spending it has done on the goods. This method is the expenditure method. If we calculate the income by measuring the total value of goods produced then it is the product method. And if calculated by the total value of payments made by the factory then it’s the income method.

Product method:

GDP = sum total of gross value added for all firms in the economy.

                                              GDP = total value of sale – cost of intermediate inputs

                                              NDP = GDP - depreciation

Expenditure method:

GDP = sum total of final expenditures received by all firms in the economy

       GDP = consumption + investment + government purchase + net trade balance

Income method:

GDP = sum total of factor payments made by firms in the economy

Central statistics organization [C.S.O]:

It is calculating GDP since 1955. There are three sectors in Indian economy primary, secondary and tertiary.

CSO utilizes data from the following sources:

  1. Annual survey of industries, NSSO surveys, economic census, IIP
  2. Central board of direst taxes, CBEC, CPI– indexes.

 

The GDP was being calculated based on income or factor cost method but from 2015 onwards the reforms were put in it.

  1. The salary or wages component now contains EPFO contribution by employer
  2. The workers would earn wage and the entrepreneurs would earn profit but for informal, family owned unorganized agro cottage industry the concept of mixed income / operating surplus was developed.
  3. From above sources we add production taxes and subtract production subsidies to get gross value added at basic prices.

                        GVA [market price] = GVA [basic prices] + product taxes – product subsidies

  1. The GVA [market price] adjusted for inflation becomes our official GDP.

                                          

Universal Basic Income

The poverty alleviation schemes are of two types i.e. In kind income transfers and cash transfers.

 

The in kind income transfers allow for poverty reduction by provision of resources to the needy, that are required for their sustenance. Two major such schemes are [National Rural Employment Guarenteee Act] MNREGA and the FSA [National Food security Act].

 

However, Study after study have revealed that out of the subsidised food around 15% reaches the beneficiaries and around 50% is siphoned off by the liquor mafia, corrupt officials, food mills etc. Even in MNREGA jobs and income are alleged to be allocated to ghost workers and panchayat leaders. These two schemes contribute black money in quantity of 1% of the GDP.

 

A solution to the problem of elimination of leakages is the system of Universal Basic Income - A guarenteed minimum income to all population. This has become possible due to growth in technology and implementation of Aadhar Enabled Payments Systems.

 

The Tendulkar poverty line estimates have become obsolete as the Per capital consumption of a person per month has exceeded that estimated by the poverty line. This poverty gap i.e. Difference between the average consumption level and the relevant poverty line can be reduced by an implementation of Universal basic income.

 

Due to significant increase in collections of direct taxes, the scheme could cost the government Rs. 1 lakh crore annually far less than the Rs. 1.75 lakh crore cost of the MNREGA + FSA. The impact of such a scheme on the poor shall be greater than the effect of the in-kind income transfer schemes.

Chapter 5: MACROECONOMICS

Introduction

Deficits and their Definitions

Budget deficit [BD] = government expenditure - government income

Trade deficit = import expenditure – export revenue

Effective revenue deficit [ERD] = revenue deficit – grants given to state for building capital assets

Revenue deficit [RD]: refers to the revenue expenditure being in excess of revenue deficit.

Revenue deficit = revenue expenditure – revenue income

Fiscal deficit [FD]: difference between the government’s total expenditure and its total receipts including borrowing.

Gross fiscal deficit = net borrowing from home + borrowing from RBI + borrowing from abroad.

Primary deficit [PD]: gross fiscal deficit – net interest payments.

The Fiscal Responsibility and Budget Management Act want to reduce fiscal deficit to 3% of GDP by 31-3-2017 and E.R.D to 0% of GDP by 31st march 2015.

F.D > R.D > E.R.D > P.D > B.D

Non plan expenditure > plan expenditure

Revenue receipt > capital receipt

National Income and Gross Domestic Product

The macroeconomic variable that considers the addition when the Indian worker earns in foreign countries and subtractions of income earned by foreigners in India is called gross national product.

GNP = GDP + factor income earned by domestic factors of production employed in foreign – factor income earned by foreign factors of production employed in India.

NNP = GNP – depreciation.

When the indirect taxes and subsidies are adjusted from the N.N.P we get N.N.P at factor cost or national income.

NI = N.N.P at market prices – indirect taxes + subsidies

Net disposable income = N.N.P [market price] + current transfers [salaries, pensions, fees transferred abroad]

Real GDP is the GDP is the GDP that is evaluated by considering the goods and services at a constant rate.

Nominal GDP is the GDP that is evaluated at the current prevailing price.

GDP deflator = nominal GDP / real GDP

In the absence of indirect taxes or subsidies the GDP is equal to the national income.

Consumer and Wholesale Price Index

Consumer price index and wholesale price index are ways to measure change of prices in an economy. We calculate the prices of commodities in two years – base year and current year. The latter is expressed as a percentage of the former. This gives us the CPI / WPI of that year.

GDP is taken as a measure of welfare of a country but it isn’t one as:

  1. Distribution of GDP isn’t uniform and it may indicate an increase but this can be concentrated in a handful of people and the majority might be worse off. This means that the GDP isn’t an indicator of the well being of the people.
  2. Non monetary exchanges: many activities aren’t evaluated in non monetary terms. Barter exchanges are not in monetary terms and hence don’t get registered in the GDP. This is a case of underestimation of GDP. Hence the GDP of a country doesn’t give an indication of productive activity or well being of a country.
  3. Externalities are the benefits or harm an entity causes to another for which it doesn’t pay. Example, if a factory producing goods disposes wastes in the river then the pollutant can kill the fishes and harm the livelihoods of fishermen. The factory doesn’t pay and hence such negative externality isn’t counted in the GDP. There could be positive externality too. Hence GDP might not indicate the actual welfare of the people.

Note: National income [Rs. 84 lac Cr.] and the Per capita income [Rs. 74000] have been rising every year. Share of services in the Gross Value Added at basic price [current] is 60% (including construction) and in that highest share is of “Financial and real estate service”.

Money Supply

Velocity of circulation of money: the number of times a unit of money changes hands during a unit period of time.

When the interest rate is high people expect it to fall and so convert their money into bonds. Thus speculative demand for money is low. When people feels the rates are too low they convert bonds to money anticipating an increase in the interest rates. Thus speculative demand for money is higher.

Speculative demand for money is inversely proportional to rate of interest.

External Trade

Balance of payments [BOP]: it is a record of transactions of goods, services and assets of residents of a country with the rest of the world.

BOP has two components – current account and capital account.

                                             

                                                Fig 1: Balance of Payments components 

Current account records exports and imports in goods and services and transfer payments. Trade in services is called as invisible trade as they aren’t seen to cross national borders. This includes factor income and non factor income.

Transfer payments are receipts which a country’s citizens receive for free i.e. Remittances, gifts, grants. India is number 1 in receiving remittances [approx $70 billion].

India has a current account deficit as the import of goods is higher than the income received from remittances and services. But India has a capital account surplus due to large FDI, FII and external borrowings. The overall BOP is positive for India.

Balance of trade [BoT]: balance of exports and imports of goods.

A country is said to be in Balance of Payments equilibrium when the sum of current account and capital account is zero.

When a country has negative balance of payments its monetary authority sells foreign exchange to finance deficit. When the country has positive balance of payments its monetary authority buys foreign exchange.

BOP being positive is usually bad for exporters as the rupee appreciates and BOP negative isusually bad for importers as rupee weakens.
                                               

                                                            

                                                                                                                                                             Fig 2: Balance of trade

Chapter 6: FINANCIAL FACTS

Introduction 

Foreign direct investment vs. Foreign Institutional Investment

  1. Any investment in unlisted companies i.e. Companies not on stock exchanges is considered as F.D.I. But investment > 10% in listed companies is F.D.I and <10% is F.I.I / F.P.I [foreign portfolio investment].
  2. F.D.I is long term relation with the company and F.I.I is short term and anonymous.
  3. F.D.I is investment in equity instruments not debt instruments. F.I.I can’t invest in T-Bills; they can buy G-Secs of Rs.30 billion and corporate bonds Rs. 50 billion. Their investment can be in debt or equity.

Foreign exchange reserves:

The country foreign exchange reserves are the foreign exchange with the R.B.I, gold reserves with R.B.I, special drawing rights with I.M.F and reserve tranche with the I.M.F.

Exchange rates – the price of foreign currency in terms of domestic currency. This is also called the bilateral nominal exchange rate.

Real exchange rate – ratio of foreign to domestic prices measured in the same currency.

RER = e * Pf /P

E.g. A pen cost $4 in USA [Pf] and nominal exchange rate is Rs. 50 per dollar [e]. And the RER is 1. Then the pen should cost Rs. 200 [p] in India. If the RER is more than 1 it means price of goods abroad have become more expensive than at home. RER is taken as the measure of international competitiveness.

Nominal effective interest rate NEER and real effective exchange rate REER – it gives the movement of domestic currency relative to other currencies. It is a multilateral exchange rate representing price of a representative basket of foreign currency each weighted by its importance to India as a trade partner.

REER > 100 means overvalued currency and

Floating exchange rates:

The exchange rate is determined by market forces of demand and supply.

Exchange rate of a country depreciates with respect to other if its inflation is higher than other. Similarly the demand for imports increase than exports its currency depreciates. When interest rates rise the currency at home appreciates.

However due to volatility countries prefer to have a “managed” floating exchange rate. Hence RBI buys or sells dollars from its reserve to prevent high volatility.

Fixed exchange rates or pegged exchange rate:

Bretton woods system of 1944 succeeded the gold standard system that was being followed from 19th century to the outbreak of the WWI. All currencies were valued in terms of the gold they could purchase. Example, if 1 unit of currency A was worth 1 gram of gold and 1 unit of currency B was worth 2 grams then currency A was valued at half of currency B.

The Bretton woods system was established in 1944 along with the World Bank and the IMF. A two tier system of currency was established at the center of which was the dollar. The USA monetary authorities pegged the exchange rate at $35 per ounce of gold. The second tier of the system was the guarantee of each member of the IMF to convert their regional currency to the dollar at a fixed rate.

E.g.: the Indian rupee could be converted to dollar for Rs. 50 per dollar [fixed rate]. The dollar would be converted to one ounce of gold at $35 for 1 ounce. Thus Rs. 35*50 would be the price of 1 ounce of gold. USA was chosen as it had 70% of the worlds gold reserves.

Pros and cons of fixed rate system:

  1. Good for trade as it promotes flexibility and predictability in exchange rates.
  2. Since dollar was pegged to gold the USA wars in Vietnam, Korea reduced the value of dollar but gold price increased in the open market.
  3. Gold could now be purchased at lower price from us and sold in market for higher price.

                                                                                                                                                      Fig 1: Exchange rates

Chapter 7: STATISTICAL CONCEPTS

Introduction 

Inflation

Inflation is ratio of price rise in current year to price rise in base year.

Inflation indices:

  1. Wholesale price index – calculated by economic advisor, ministry of commerce [base year – 2004]
  2. Consumer price index – calculated by CSO [base year – 2012]
  3. Index of industrial production – CSO [base yr – 2004]
  4. GDP – CSO [base year – 2011]

Index of industrial production

It has 682 items which are grouped into three categories like Manufacturing, Mining and Electricity. Total weight of three is 1000.

Manufacturing [755] + mining [141] + electricity [103] = 1000

There are 8 core sectors of I.I.P which have 38% weight [coal, fertilizer, electricity, crude oil, natural gas, steel, cement, refinery products]. Electricity is highest weight and fertilizer is lowest weight. I.I.P is released monthly.

Maximum data of items comes from D.I.P.P, followed by Indian bureau of mines remaining items are from ministries, commodity boards and government dept.

I.I.P data is also presented goods category wise and their weights:

  1. Basic goods - 456
  2. Consumer non durables - 213
  3. Intermediate goods - 156
  4. Capital goods - 88
  5. Consumer non durables – 84
  6. Total - 1000

Wholesale price index:

There are three categories of articles in W.P.I: manufactured products = 65, primary articles = 20 and fuel and power = 15. Total weight is 100. It is released weekly and monthly. Total = 676 items. Data is collected from leading manufacturing units, P.S.Us, government departments and state governments.

Core inflation means inflation of non – food and non fuel part.

Consumer price index:

C.P.I has 6 sectors and three types of C.P.I: rural, urban and consolidated. The sectors and weights are given below. C.P.I covers service sector too which is not a part of W.P.I or I.I.P.



Rural C.P.I has no housing component. C.P.I is released monthly. C.P.I urban is calculated after data from N.S.S.O and rural is from data collected by N.S.S.O + post office.

Annual survey of industries:

It is conducted by C.S.O and covers all registered units under Factories Act. Also includes electricity companies, movie companies. Services are excluded. 2.17 lakh units covered. It provides information to understand the growth, composition of organized manufacturing sector.

Chapter 8: BANKING CONCEPTS

Introduction 

Type of Deposits

  1. Demand deposits: they are payable by the bank on demand from the account holder. E.g. Savings in bank accounts, current account, demand draft.
  1. Time deposits: they have a fixed period of maturity. E.g. fixed deposits, recurring deposits, cash certificates, staff security certificates.

Note:

Time deposits are more than demand deposits in banks.

N.T.D.L = net time and demand liabilities = time deposits + demand deposits.

Money supply:

Total stock of money in circulation with the public at any point of time is called Money Supply.

Measures of money supply:

  1. M1 = currency in circulation with public [CU] + demand deposits in commercial banks [DD]
  2. M2 = M1 + saving deposits held by post office banks
  3. M3 = M1 + net time deposits held in commercial banks.
  4. M4 = M3 + total deposits with post office banks[except national savings certificate]

M1, M2 are narrow money and M3, M4 are broad money. Liquidity increases from M4 to M1. M3 is the most popular measure of money supply known as aggregate monetary resource.

                                       Fig 1: Money supply

Factors affecting money supply:

  1. Currency deposit ratio: ratio of money held by public in currency to that they hold as deposits in banks.

                                   C.D.R = CU / DD.

  1. Reserve deposit ratio: proportion of total deposits banks keep in reserves.
  2. Cash reserve ratio: fraction of the deposits banks must keep with RBI
  3. Statutory liquidity ratio: fraction of the total demand and time deposits banks must keep in liquid assets.
  4. High powered money or monetary base or reserved money [M0]: total liability of the monetary authority of the country. It consists of currency in circulation with public and vault cash with banks and deposits of commercial banks and government of India with RBI.

Money multiplier = ratio of stock of money to the high powered money. i.e. M3 / M0

When all depositors of the bank want their money withdrawn the bank will default. Hence in such situations the RBI acts as banker to banks / lender of the last resort and extends loans to ensure solvency of the latter.

RBI also acts as banker to the government. When governments can’t meet their expense with their income, they print currency to meet the budget deficit. In reality it involves selling of bonds to the RBI which issues currency to the government in return. The money then ultimately comes in the hands of the public and becomes a part of money supply. Financing of budgets in this manner is called “deficit financing from central bank borrowing”.

Open market operations: RBI purchases or sells government securities to the general public in the attempt to increase or decrease liquidity or stock of high powered money in the economy.

Marginal propensity to save is the proportion of the total additional income of the economy people wish to save as a whole. Marginal propensity to consume is the fraction of the total additional income people wish to consume. It the people of the economy increase the total proportion of income they save then the total value of savings in the economy will either decrease or remain same – paradox of thrift.

Debt: the government deficits have to be financed by either borrowing, taxation or financing. The government prefers to borrow thus creating government debt.

Open economy: a country that trades with other nations in goods and services and also in financial assets. The degree of openness of an economy is the ratio of total foreign trade [exports+ imports] to the country’s GDP.

Rates of RBI:

  1. Bank rate: long term loan from RBI. No collateral needed.
  2. Marginal standing facility: commercial banks can borrow from RBI at this rate [Repo+1]% and can use SLR securities as collateral. Limit is 0.75% of N.T.DL
  3. Repo rate: all clients can borrow from RBI for short period at this rate but can’t use SLR securities as collateral. No limit to borrowing.
  4. Reverse Repo rate: RBI pays this to its clients for short term loans [Repo – 1]%.
  5. Statutory liquidity ratio: banks have to keep this much in gold, securities, cash etc. It is decided by RBI.
  6. Cash reserve ratio: have to deposit this much cash with RBI but no interest earned.

Note: both S.L.R, C.R.R are counted on net time and demand liabilities [N.T.D.L = net time and demand liabilities = time deposits + demand deposits].

Inflation:

To reduce inflation: tight monetary policy, reduce money supply

To fight deflation: increase money supply, easy monetary policy.

Monetary policy instruments with the RBI:

      

  1. Quantitative
  2. Reserve ratio: CRR, SLR
  3. Open market operations [OMO]
  4. Rates: reverse repo, repo, marginal standing facility, bank rate
  5. Qualitative
  6. Rationing – ceiling of loans to specific sectors
  7. Moral suasion
  8. Direct action
  9. Consumer credit control
  10. Margin / loan to value – if customer wants to keep collateral of 1 kg gold worth 1 lakh and the LTV is 60% then bank can loan him only 60% of 1 lac= 60,000.

Qualitative instruments are selective and direct. Quantitative instruments are general and indirect.

During high inflation RBI increases CRR, SLR and the rates and sells government securities through open market operations [OMO] to reduce money supply. During deflation RBI decreases CRR, SLR, rates and buys G-Secs from public via OMO.

Monetary policy:

Monetary policy is currently decided solely by RBI governor but to fix responsibility a monetary policy committee needed with RBI governor [chairman] + deputy governor [vice chairman] + executive director and 2 outsiders.

Priority sector lending [PSL]:

Indian banks, foreign banks with more than 20 branches have to lend 40% of net loans given to priority lending sector in that year.

Foreign banks with less than 20 branches must give 32% of their net loans given to PSL in a year.

PSL consists of agriculture [18% out of 40% should go here], weaker sections [10% out of 40%] and remaining to housing, education, micro & small enterprises, retail trade, renewable energy, export credit. For foreign banks with less than 20 branches no sector specific targets but should reach 32%.

In case the Indian banks or foreign banks with 20+ branches don’t meet their target the amount of shortfall must be given to rural infrastructure development fund managed by NABARD. This is used to give loans to states and bank earns interest on it decided by RBI.

For foreign banks with

PSL applies only to commercial banks both public and private. It doesn’t apply to cooperative banks, regional rural banks, NBFC.

Financial inclusion:

It has four pillars:

  1. Banking: savings, payments through branches, ATM, cheques
  2. Credit: loans at affordable rates
  3. Investment: mutual funds, pension plans
  4. Insurance: life and non life insurance

Note: RBI mandates that banks should have 25% branches in rural areas. To open branches in urban areas [metro / tier 1-3 cities] RBI permission needed but no permission needed for tier 4-6 areas or north east states and Sikkim.

PM Jan Dhan Yojana:

Phase 1: to divide country into sub service areas with 1000-1500 families within 5 km distance. Each family gets 1 account, 1 RuPay debit card, Rs. 1 lac worth accident insurance. Rs. 5000 overdraft if good credit history.

Phase 2: direct benefit transfer, sell micro insurance and credit guarantee fund to cover losses.

Types of Banks:

Small banks:

  1. 100 cr. Minimum capital. Large business houses and industrial houses can’t apply. FDI and voting rights same as commercial banks.
  2. Focus on a small area for deposit and loans. 50% loans to MSME, 25% rural branches.
  3. NBFC can convert to it; even individuals with 10 yrs experience in banking field can apply.
  4. Can appoint business correspondents but can’t become BC for other banks.
  5. Can’t have subsidiaries, NRI can apply, cooperative banks can’t. PSL target must be met in 3 yrs.

Payment banks:

  1. Can have current and savings account but no time deposits.
  2. Can’t give loans, must put entire investment in G-Secs. Must give interest on deposits.
  3. Can’t have more than 1 lac in account per customer.

Cooperative banks:

  1. CRR, SLR mandatory but no PSL.
  2. 1 person in board has 1 vote. No profit no loss is motive.
  3. Registered with the state registrar as a cooperative society. Regulator is NABARD.
  4. Can be urban or rural. In rural it could be state cooperative, district or village cooperative.

Regional rural bank:

  1. Present in only a few districts.
  2. Union government owns 50% + state 15% and sponsor bank 35%.
    Regulator is NABARD.

Wholesale bank:

  1. Need to get registered under banking regulation act.
  2. Can’t accept deposits less than Rs. 5 cr.
  3. Can give loans to only large corporate and infrastructure
  4. SARFAESI powers + CRR, SLR and PSL targets.
  5. Wholesale investment bank have less than 20 branches and for them no need for 25% rural branches. They can’t act as bank saathi for other banks
  6. Wholesale consumer banks have 20+ branches and they must have 25% rural branches. They can act as bank saathi for other banks.

 

All India financial institutions: 

  1. EXIM bank: export import bank. Loans, credit, finance to exporters and importers. Promotes cross border trade and investment. It is wholly owned by central government.
  2. NABARD: national bank for agriculture and rural development. Owned by government 99.3% and RBI 0.7%. Regulatory authority for cooperatives bank and regional rural banks. Helps state cooperative banks and farmers, cottage industry.
  3. National housing bank: apex institution for housing finance. 100% owned by RBI. Finance to banks and NBFCs for housing projects. Publishes RESIDEX [housing sector inflation]
  4. SIDBI: owned by public sector banks and public sector insurance companies. Finance to state industrial development corporations, state finance corporations and banks.

 



Non banking finance corporation:

They are of two types: non banking and financial company. They get license under company act. Not all NBFC are regulated by RBI. Insurance NBFCs are controlled by IRDA and merchant banks by SEBI. Deposit taking NBFCs are allowed to take time deposit but not demand deposits.

No CRR but for deposit taking NBFC SLR is 15%. No PSL and entry capital is 5 cr. They take collateral as gold, bonds or shares. Only housing finance NBFC have SARFAESI powers i.e. to auction land of borrowers who can’t repay.

Types of NBFC:

  1. Asset finance, infrastructure finance , infrastructure debt fund, investment companies, core investment companies, chit fund, loan company, factoring company – regulated by RBI
  2. Insurance companies – regulated by IRDA
  3. Housing finance companies – regulated by NHB
  4. Stock broker, mutual fund, venture capital fund, merchant bank, investment banks – regulated by SEBI

Microfinance companies:

  1. Regulated by dept. Of corporate affairs.
  2. Entry capital 5 cr., can’t lend more than 50000 per person, loans without collateral, borrower fixes EMI, installments.

Focus on women, poor.

Miscellaneous 

Business correspondents or bank saathi:

Banks can’t open branches in all villages due to financial infeasibility. This creates hardship to the villagers as they have to travel long distances for accessing banking facilities.  Thus to act as a link between villagers and banks in rural areas we have business correspondents.

BCA help villagers open account, help them in performing transactions; they have an electronic device which is used to process transactions. They also help villagers with loan applications, access insurance and micro credit.

A National asset reconstruction company is being considered to take over the bad assets of banks.The private ARC’s demand that bad assets be sold to them at a discount. However banks don’t sell assets to ARC’s as they fear prosecution from government agencies. Thus in this situation a National ARC may be a good option.

Chapter 9: CONCEPT OF BUDGETING

Introduction

The financial year of India runs from 1 April to 31 march. The budget or Annual Financial Statement should separate revenue expenditure from the rest. Therefore the budget comprises of revenue budget and capital budget.

                                                   Fig 1: Budget 2016 theme – “Transform India”.

 

Revenue account:

This shows the current receipts of the government and the expense that can be met from these.

Revenue receipts:

  1. Tax revenues – taxes and duties.
  2. Non tax revenues – interest on loans, grants in aid from foreign bodies, payment for services, dividends from investment.

Taxes are direct taxes like income tax, corporation, estate duty, wealth tax [abolished], and security transaction tax. All these are imposed directly on individuals.

Indirect taxes are excise duty, customs duty, service tax that is paid by consumers indirectly to the government.  India follows a progressive taxation regime on income of individuals which means higher the income higher the tax. 

But for corporate its charges a proportional tax which is a fixed proportion of its profit.

Revenue expenditure:

It is all the expenditure incurred by the government which doesn’t result in physical or financial asset creation.

E.g.: interest on borrowing, subsidies, pensions, salaries, grants to other entities.

The budget may classify revenue expenditure into plan and non plan. Plan expenditure is incurred on central five year plans and state and UT five year plans. Non plan component is more that the plan component and includes interest payment, defense, salaries, subsidies and pensions.

Capital accounts:

This is an account of assets and liabilities of the central government that takes into account change in capital. This shows capital requirements of the government and their pattern of financing.

Capital receipts:

  1. Loans raised by government from public, banks, RBI, selling of treasury bonds, foreign entities via external commercial borrowings.
  2. Money received by selling shares of P.S.U.
  3. Recoveries of loans given by central government
  4. Small savings, post office credit, provident fund.

Capital expenditure:

  1. Loans to states and UT’s.
  2. Expenditure on acquisition of land, machinery, building, shares.

Capital budget also has plan and non plan components. Plan component means the expenditure is on five year plan of centre and states. Non plan component means the expenditure is on general, social, economic services of the government.

Fiscal responsibility and budget management act, 2003 mandates that along with the budget the following documents should also be presented:

  1. Medium term fiscal policy statement
  2. Fiscal policy strategy statement
  3. Macroeconomic framework statement

Indicators of government deficit:

  1. Revenue deficit: refers to the revenue expenditure being in excess of revenue deficit.

Revenue deficit = revenue expenditure – revenue income

  1. Fiscal deficit: difference between the government’s total expenditure and its total receipts including borrowing.

Gross fiscal deficit = net borrowing from home + borrowing from RBI + borrowing from abroad.

  1. Primary deficit: gross fiscal deficit – net interest payments.

Budget 2017-18

Key features :

  1. Plan and non plan distinction to be removed
  2. Railway budget and general budget to be merged.
  3. Post demonetization strategy to boost spending to be unveiled.
  4. GST shall be implemented.

The railway budget has been of a size less than the defence budget and so a need to separate presentation was not felt. The merger of budget shall ensure freedom from payment of dividend to the government. This can be utilized by railways for capital investment.

Plan expenditure was the expense of creating productive assets and non plan was on routine expenses like salaries, pensions, subsidies. This shall be replaced by a better indicator of productivity like capital and revenue expenditure.

Advancing the budget date shall ensure that the ministries have funds to spend right from the start of the fiscal year.

Chapter 10: FINANCIAL MARKETS

Introduction

Businesses can raise funds through various ways and many sources through the financial markets. A financial market helps mobilize funds between savers [households] and investors [business]. The work of allocation is done by two intermediaries which can be banks or financial markets. The banks can deposit money of the savers and lend to the businesses or the alternative is buying of shares or debentures of companies using the financial markets.

Functions of financial markets:

  1. Mobilization of savings and channeling them into the most productive use:
  2. Price discovery of a financial asset.
  3. Provide liquidity to financial assets
  4. Provide a platform for buyer and sellers and reduce cost of transaction.

Classification of financial markets:

  1. Money markets -      Financial instruments traded in them mature in less than a year
  2. Capital markets -    Financial instruments traded in them mature in more than a year.

Money market instruments:

  1. Treasury bills: instrument of short term borrowing by the government with maturity of less than a year. They are also called zero coupon bonds.
  2.  Commercial paper: these are unsecured promissory notes issued by companies to secure short term loans at rates lower than market rates.
  3. Call money: short term borrowing by banks from each other to maintain cash reserve ratio.
  4. Certificate of deposit: issued by commercial banks to secure money for short periods when liquidity is low and demand for cash is high.

Capital market:

It refers to institutional arrangements through which long term funds both debt and equity are raised and invested.

      

Primary markets: 

    

        It is a platform where new securities are issued for the first time. The securities are for opening a new venture or expansion of an existing venture. The investors can be institutional or retail investors.  E.g. IPOs, offer for sale, offer through prospectus.

     

Secondary markets:

It is stock market or stock exchange where existing securities are traded.



Promissory notes or offshore derivative instruments:

 

  1. An offshore investor needs a pan card and KYC for purchasing securities in India. But if he doesn’t want to follow procedures he can take the p-note route.
  2. A registered FII like HSBC can purchase the securities and then give a p-note to the offshore investor. The p-note is an anonymous instrument which doesn’t have the name of the person to which it’s sold.
  3. It derives its value from the underlying securities. The owner of p-note can sell it to anyone without any paper trail or paying capital gains tax to country.
  4. Hence p-notes have been flagged as security risk due to misuse by terrorists or hawala operators.

S.E.B.I has taken precaution and to prevent misuse it has restricted people who can issue p-notes.

Category -I: government of foreign countries, foreign PSUs

Category -II: mutual funds, pension funds, university endowment funds

Category III-: not in above e.g. Hedge funds

Only Category -I, II can issue P-notes.

Note: bonds are issued by the government and are secured by underlying assets which can be sold to repay the bond holders. Debentures are issued by private company and are unsecured so holder is at high risk.

Bond yield and interest are inversely proportional to bond price.

S.E.B.I – Securities and Exchange board of India


Established in 1988 as a body for promoting orderly and healthy growth of securities market and for investor protection.  It was given a statutory status in 1992.

Reasons for establishment of SEBI:

  1. The expanding investor population and the market capitalization led to malpractices by the companies, traders, brokers, consultants.
  2. These malpractices included self styled merchant bankers, price rigging, unofficial private placements, insider trading, non adherence to provisions of companies act, violation of rules and regulations of stock exchange, delay in delivery of shares.
  3. The investor confidence was eroded and investor grievance was multiplied. To counter this government set up a regulatory body.

Objectives of the SEBI:

  1. Regulate stock exchange and securities industry to promote their orderly functioning.
  2. Protect rights and interests of investors
  3. Prevent malpractices and promote balance between self regulation by the industry and statutory regulations
  4. To make the intermediaries more professional and competitive by making a code of conduct and fair practices.

Functions of SEBI:

  1. Registration of brokers, sub brokers
  2. Registration of investment schemes and mutual funds
  3. Prohibiting unfair and prohibitory practices.
  4. Enforcing the act and penalizing defaulters.
  5. Levying charges and fees for enforcing the act
  6. Exercising functions as delegated to it by the central government under the securities contracts act.
  7. Investor education, training of intermediaries, conducting research and promoting code of conduct.       

    Chapter 11: INTERNATIONAL BODIES

    Introduction

    IMF structure:

    1   Managing director

                      5 yr term and by convention a European citizen and HQ in Washington.

           2  Executive board

                   Daily work and 24 members with 5 positions reserved for UK, USA, France, Japan and Germany.

            3  Board of Governors

  1.     All nations are represented by finance ministers or central bank governors
  2.       Annual meeting

 

https://www.imf.org/external/about/images/govstruct.gif



 

 

Functions:  

  1. Help countries overcome BOP crisis
  2.  Surveillance of global, national and regional economy
  3.  Technical assistance, advisory role.

Special drawing right [S.D.R] also known as paper gold. Up to 1970 1 S.D.R = $1 = 0.88 gram of gold. But now it’s a basket of 5 currencies [euro, yen, dollar, renminbi and pound] with weight assigned to them based on their importance in international trade. S.D.R can be converted to member currency. Renminbi was added in 2016.

IMF quota:

The size of quota of a country depends on its openness to world trade, size of economy and G.D.P. The emerging economies have negligible quota. Hence there is a need to change the quota assigned to them. However the change needs 70% quota votes which isn’t going to happen. Thus I.M.F reforms have been slow.

Multilateral Development Banks

Due to the slow pace of reforms in agencies like IMF, World bank and Asian development banknew multilateral finance agencies are emerging in developing countries like New Development Bank [B.R.I.C.S bank] and Asian Infrastructure Investment Bank.

New development bank, Shanghai

AIIB, Beijing

Established in the 6th BRICS summit atFortaleza. Operations to start from 2016.

MoU signed between china and 21 members in 2014 and work to start in 2015.

Five members with equal voting power

China and 21 members. S. Korea and Australia didn’t join

Capital; 50 billion

100 billion capital with shareholding based on GDP and voting rights based on shareholding. China and India have 1st, 2nd highest shareholding

Loans for infrastructure development, sustainable development and overcome BOP crisis

Infrastructure investment projects

A separate fund for BOP crisis with 100 billion

Structure: President – directors – board of governors

 
  

 

  KV kamath has become the first president of the N.D.B.

World trade organization

WTO structure:

  1.      Ministerial council

    1. Appoints Director General
    2. Meets every 2 years and 160 members are present
    3. Signs trade agreements
  2.    General council

    1. Day to day working
    2. HQ at Geneva
    3. Bodies: Trade Policy Review and Dispute Settlement
  3.     Director General and Secretariat

    1. Term 4 years and can be reappointed

http://mytclworld.com/soi2/images/283.jpg

WTO functions:

  1. Lower tariff and non tariff barriers to trade
  2. Ensure less developed countries get benefit of world trade
  3. Make agreements to ensure above points
  4. Dispute settlement if agreement are violated
  5. Cooperation with others to ensure sustainable development and environment protection.

Miscellaneous

Tariff barriers are import duties and export subsidies. Non tariff barriers are delay in customs clearance, quota for imports, subsidies, public procurement norms and quality controls.

Quality control Norms:

  1. A.  Technical barriers to trade
  2. B.   Sanitary and Phytosanitary measures [SPS].

SPS agreement means countries can ban imports to protect local plants, animals and human lives. QC norms should be scientific and developing countries should be given time to comply.

 


 

Chapter 12: FOURTEENTH FINANCE COMMISSION

Introduction

Chairman is YV Reddy and four members. Report delivered on Dec 2014 and implementation of it shall be done from 2015-2020.

Functions:

  1. Tax devolution to states and between center and states
  2. Grants in aid
  3. Augment resources of Panchayati raj institutions.
  4. Other functions as decided by the president

Report:

  • Vertical tax devolution between center and states should be 42%. Taxes of art. 268 and art. 269, cess and surcharge on goods shouldn’t be shared with states. Also service tax shouldn’t be shared with J&K. Income tax, corporation tax, excise, customs, security transaction tax, service tax should be shared.
  • Horizontal tax devolution between states should be based on following factors:
  •         Area [weight-age – 15%]
  •        Forest cover [8%]
  •       Population of 1971 and 2011 census [17%]
  •       Demographic change [10%]
  •        Income distance [50%]

Difference with respect to 13th FC: fiscal discipline removed as criteria, population -2011 and forest cover added as criteria. No additional benefits for special category states. Also sector specific grants stopped.

Art. 268: levied by union and collected and kept by states. E.g. Stamp duty on cheque, promissory notes, insurance policy, and share transfer. Excise on medicinal, toiletry preparation using alcohol and narcotics.

Art. 269: levied and collected union but fully assigned to states. E.g.: central sales tax [belongs to exporter state]


                                                              

Report on PRI:

  1. Local bodies are unable to mobilize resources and depend on state government grants. The state finance commissions are created rarely and their reports are implemented but not within timeframe. They are constituted in a manner that their work isn’t in sync with the central finance commissions.
  2. Recommended to disburse 2lac crore to rural bodies and 87000 cr. to urban bodies. Out of which in case of rural bodies 90% must be disbursed and 10% additional based on performance. Similarly for urban bodies 80% must be disbursed and remaining 20% based on performance.
  3. States should share its own taxes with the local bodies like entertainment, professional tax, mining royalty, advertisement tax.
  4. Since union properties can’t be taxed by state or local bodies the union should compensate them.

Chapter 12: FOURTEENTH FINANCE COMMISSION

Introduction

Chairman is YV Reddy and four members. Report delivered on Dec 2014 and implementation of it shall be done from 2015-2020.

Functions:

  1. Tax devolution to states and between center and states
  2. Grants in aid
  3. Augment resources of Panchayati raj institutions.
  4. Other functions as decided by the president

Report:

  1. Vertical tax devolution between center and states should be 42%. Taxes of art. 268 and art. 269, cess and surcharge on goods shouldn’t be shared with states. Also service tax shouldn’t be shared with J&K. Income tax, corporation tax, excise, customs, security transaction tax, service tax should be shared.
  2. Horizontal tax devolution between states should be based on following factors:
  3. Area [weight-age – 15%]
  4. Forest cover [8%]
  5. Population of 1971 and 2011 census [17%]
  6. Demographic change [10%]
  7. Income distance [50%]

Difference with respect to 13th FC: fiscal discipline removed as criteria, population -2011 and forest cover added as criteria. No additional benefits for special category states. Also sector specific grants stopped.

Art. 268: levied by union and collected and kept by states. E.g. Stamp duty on cheque, promissory notes, insurance policy, and share transfer. Excise on medicinal, toiletry preparation using alcohol and narcotics.

Art. 269: levied and collected union but fully assigned to states. E.g.: central sales tax [belongs to exporter state]


                                                              

Report on PRI:

  1. Local bodies are unable to mobilize resources and depend on state government grants. The state finance commissions are created rarely and their reports are implemented but not within timeframe. They are constituted in a manner that their work isn’t in sync with the central finance commissions.
  2. Recommended to disburse 2lac crore to rural bodies and 87000 cr. to urban bodies. Out of which in case of rural bodies 90% must be disbursed and 10% additional based on performance. Similarly for urban bodies 80% must be disbursed and remaining 20% based on performance.
  3. States should share its own taxes with the local bodies like entertainment, professional tax, mining royalty, advertisement tax.
  4. Since union properties can’t be taxed by state or local bodies the union should compensate them.

    Chapter 13: GOODS AND SERVICE TAX

    Introduction

    Sales tax system is bad as it has a cascading effect on the price. It is a tax on tax. If the merchant sells without bill there is no record and hence no liability. Due to the opaque system it leads to increase in corruption and also the tax revenue is lost.

    Sales tax system works as follows: suppose a mobile of Rs 10000 is sold buy the company to retailer, the retailer pays 1000 which is 10% as sales tax to government. Now the tax has to be recovered from the user so the price of the mobile increases to 11000. The retailer makes an addition of Rs. 500 to the price of the mobile which is his value added charge or profit. Now the value of the mobile is 10000+1000+500.  While selling this to the consumer he has to pay tax of Rs. 1150 to the government. This charge has to be borne by the consumer and so the price of the mobile increases to 11500+1150 = Rs. 12650.


                                                              

                                                                                                                           Fig 1: Cascading effect of taxes

    To counter this system we move to Value Added Tax. VAT is also borne by the final consumer but the burden is less as it isn’t a tax on tax. The working of the VAT system is as follows: suppose a mobile of Rs 10000 is sold buy the company to retailer, the retailer pays Rs. 1000 which is 10% as VAT to government. The retailer makes an addition of Rs. 500 to the price of the mobile which is profit. Now the value of the mobile is 10000+1000+500.  While selling this to the consumer he has to pay tax of Rs. 50 to the government. This Rs. 50 is the 10% tax on the value added by him which was Rs.500. This charge has to be borne by the consumer and so the price of the mobile increases to 11500+50 = Rs. 11550.


                                                  

    Hence VAT isn’t a tax on tax. Also for VAT the dealer has to maintain a tax invoice and tin number due to which the tax can’t be avoided. This increases the tax collection.

                                              

    MODVAT: Modified VAT

    In the manufacturing process, the excise duty has to be borne on individual items of the manufactured product. For example, in manufacturing of car the excise duty has to be placed on wheels, tires, seats, screws as well as the entire assembly of car. This too is a tax on tax and has a cascading effect. To avoid this, the excises paid on the individual items are credited and excise is levied on final item only.

    Central VAT: CENVAT

    In the manufacturing process, the service tax paid on any services used or the excise paid on raw materials and components both is credited back when the final good is made. The tax is imposed only on the final goods.

    Even though the CENVAT and MODVAT have improved the tax collection, the problems of VAT system are there due to which there is a need for a GST.

    Problems of VAT :
    1. Taxes on commodities are multiple and imposed at state as well as central level. These include electricity tax, advertisement tax, central sales tax, tax on fuels, service tax and excise duty. Though some as credit due to CENVAT but not all.
    2. No standard VAT rate across states. States demand share in Cess and surcharges.
    3. Retailers have formed cartels to create false invoices to reduce VAT liability.

                                              

    Benefits of GST over VAT:

    1. Services are covered. Uniform tax rates. Most Cess and surcharge will be removed. Covers most union and state direct and indirect taxes. Minimum exceptions to it.
    2. Cooperative federalism as a GST council will be formed with finance minister [chairman] + minister of state for finance + FM of states. The union shall have 1/3rd voting power and states 2/3rd voting power.
    3. GST council shall decide which  Cess , taxes, surcharges to subsume and too exempt.
    4. GST system of India shall have three components central GST, state GST and integrated GST [not a tax but system].
    1. Currently customs duty, customs Cess, excise duty + GST on tobacco products, petroleum products kept outside GST till council decide date.

    Advantages of GST:

    1. GST expands tax base, eliminate tax barriers and creates a national economy. Most of the taxes, Cess and surcharge shall be subsumed. The tax rate shall be lowered and tax base can be increased.
    2. The central sales tax was an origin based tax and the exporter state would get the credit. The high cost of transportation and other liabilities while transporting goods increased the price of it. To offset this, the MNCs would build warehouses in all states to reduce tax liability. This was unfavorable to MSMEs as they couldn’t compete with MNCs.
    3. To combat this we have IGST which is made of CGST and SGST. The CGST shall be transferred to union and the SGST is transferred to importing state not exporting state. The IGST has been levied by union.
    4. Due to the presence of central and state indirect taxes company do in-house production of everything to reduce tax liability. But now after GST these shall be subsumed by a single tax. All tax on inputs shall be credited and hence there is no advantage for in-house production of everything.
    5. Thus GST shall create MSMEs, jobs, subcontracting, outsourcing and increase tax base.
    6. GST shall benefits that exports shall be zero rated as all input taxes shall be credited. But for credit bills and tin have to be saved. This would mean that the system will be transparent and no evasion or bribery possible.
    7. The GST shall be computed on the same base and won’t be a tax on tax so no cascading effect e.g. For a mobile of Rs. 10000 the CGST and SGST shall both be say 10% of Rs 10000 and so consumer finally has to pay less.

    Challenges of GST:

    1. High revenue neutral rate will lead to evasion, smuggling and low compliance. But solution is increasing tax base and no exemptions.
    2. Destination based tax not good for industrialized states. Solution anonymous GST fund with tapering effect.
    3. Union to make a robust ICT infrastructure, he would have to coordinate with 30 states for credit; state it officials need to be trained as they are inept. It infrastructure missing at state level.

    Dual Control over Tax Assessees


    GST shall have dual control by the states and center over small assessees i.e. upto Rs. 1.5 crore turnover. The assessees shall be divided randomly in a 90:10 ratio for the purpose of audit and scrutiny between the center and the states. No assessee shall have to face dual audit. Also assessees above the threshold of Rs. 1.5 crore shall be divided in 50:50 ratio and face scrutiny either from the states or the center.


    The states have also been given the power to tax economic activity within 12 nautical miles of the territorial waters. The Center has shown great flexibility by allowing such concessions. GST shall make a major impact on the Nation’s economy and this is possible only by taking the states together in this endeavor.

     
    The cashless payment methods that have become popular after demonetization are:

    1. Credit / Debit cards based payments using point of sales machines
    2. Electronic wallets
    3. Unified payment interface
    4. Unstructured supplementary service data
    5. Aadhar enabled payment system

    There are 75 crore debit cards [2016] out of which 72 crore are debit and rest are credit. Most of the debit cards are used for withdrawing money from ATM's. The POS terminals are needed to transact from these cards. The merchants or shopkeepers get these POS terminals for free from banks where they have an account.

    However banks have different eligibility criteria to decide whether they can give the POS to the merchant. Each POS would cost the bank about Rs. 15000 but now mobile POS are present that have a cost of Rs. 3000.For transactions using POS banks charge around 1% commission also called Merchant discount rate. MDR is capped by RBI and usually MDR is passed on to the customers.

    PayTM, MobiKwik are different electronic wallet providers. These days even banks are developing their own e-wallets. The user of the wallet has to download an application from trusted source and install on his smart phone. The application takes the basic details like mobile number and email id of the user. The wallet can be filled with money using debit card, credit card or internet banking. Wallets by banks also can be connected to accounts making operating and transfer easier.

    Money in the wallet is taken out of the banking system and continues to circulate in the wallet operator's system.There is a nominal charge if you want to transfer money from the wallet to the bank. Wallets are used for payment of various utilities but now even local stores are keen to accept payment from them. No physical infrastructure is needed at any side and so it makes wallets ideal for shopping.

    However one limitation is use of smart phones and internet. Feature phones are more and internet penetration is poor so wallets don't have universal application today.

    In India inter-operability between wallets isn't allowed so PayTM account holder cant send money to MobiKwib etc. However National Payments Corporation of India has created Unified Payment Interface to use Immediate Mobile Payment System to transfer money from any account to any account.

    A UPI based application has to be downloaded from Google play store and installed. The payee will get to create a virtual payment account like yourname@icici etc. Then he shall need to generate a MMID which is a seven digit random number generated by the bank. The recipient MMID and virtual address can be used to transfer money to him.

    Here too the process of generating MMID and payment transfer is complicated. Again this medium is only limited to smart phones with internet connection.

    This too is a universal application for transferring money but unique in the sense that even feature phone without any internet connection can use it.

    The mobile user has to get his phone linked to his bank account to use this facility. The user then can dial a special code *99# and connect to the National USSD Platform. Options like transferring to other account, checking balance etc are available on dialing different codes.

    The USSD service is available in all banks and in 11 Indian languages.However like UPI this too relies on generation of MMID for transferring from one account to another.

    The number of Aadhar card linked to bank accounts are 36 crore [2016]. This number shall only increase and so Aadhar shall become a powerful medium for promoting financial inclusion.

    The AEPS aims to make aadhar card a virtual debit card. This can be used to transfer funds from any bank to any bank. All it needs is for the merchant to have a device to read the Aadhar number and scan the bio-metrics of the user. Once this is done the User can transfer money from his account to any other account. 118 banks are on board with this system.

    This system is useful in areas where debit / credit cards are not present widely. The advantage is also that the machine is to be installed by the merchant and it costs around rs. 2000-4000 only. The payee needs only his Aadhar number linked to a bank account.