MODULE I
A bank is a financial institution which deals with money and credit. It accepts deposits
from the public, makes the funds available to those who need them, and helps in the remittance
of money from one place to another.
According to Crowther, a bank “collects money from those who have it to spare or who
are saving it out of their incomes, and it lends this money to those who require it”.
Features of bank:
i.
ii.
iii.
iv.
It deals with money; it accepts deposits and advances loans.
It also deals with credit; it has the ability to create credit.
It is commercial institution; it aims at earning profit.
It is a unique institution that creates demand deposits which serves as a medium of
exchange and, as a result, the banks manage the payment system of the country.
Organizational structure of Indian banking system
RBI
Commercial
Banks
Cooperative Banks
Development Banks
SIDBI
Public sector
Banks
SBI
Group
Nationalized
banks
Private sector
banks
RRBs
Urban
Rural
IFCI
NABARD
Indian banking system
Reserve bank of India (RBI) - The RBI is the supreme monetary and banking authority in the
country and has the responsibility to control the banking system in the country. It keeps the
reserves of all scheduled banks and hence is known as the ‘Reserve bank of India’.
Commercial Banks- Commercial banks are established with a purpose to help businessmen.
Commercial banks collect money from general public and give short term loans to businessmen
by way of cash credits, overdrafts etc.


Public sector banks: -The public sector bank is a government undertaking. Public sector
banks consist of:I.
State Bank of India and its associates:- This consist of the State Bank of India and
associate banks of SBI.
E.g. SBT
RBI owns majority share of SBI and some associate banks of SBI. The SBI acts
as an agent of RBI.
II.
Nationalized banks:- Nationalized banks are wholly owned by Govt, although
some of them have made public issues(shares).
E.g. Corporation Bank, Bank of Baroda, etc.
III.
Regional Rural Banks:- The Govt. of India set up Regional Rural Banks(RRBs)
on Oct. 2, 1975. Regional Rural Banks provide credit to the weaker sections of
the rural areas, particularly the small and marginal farmers, agricultural workers
and small entrepreneurs.
Private Sector banks:- A Private sector bank owned by shareholders.
E.g. City Union Bank Ltd, Dhanalakshmi Bank Ltd (old generation banks), ICICI,
HDFC, Kotak Mahindra, Axis Bank etc.
Co-operative sector banks:- Co-operative banks are co-operative credit instiyutions that are
registered under the Co-operative Societies Act and work according to the cooperatyive
principles of mutual assistance.
E.g. State co-operative banks, Central co-operative banks, Primary Agricultural credit ocieties,
Land Development banks etc.
Development banks:- Development banks are specialized financial institutions that provide short
term and long term finance to industries.
E.g. Industrial Finance Co-operation of India(IFCI), Industrial Development Bank of ndia(IDBI),
Small Industries Development Bank of India(SIDBI),National Bank for Agriculture and Rural
Development(NABARD), Export Import Bank(EXIM Bank) etc.
I.
Types of Banks
Banks are classified into various types on the basis of their functions, ownership,
domicile, etc.
1. On the basis of functions
On the basis of functions, banks are classified into:1) Commercial Banks:-
Banks which perform all kinds of banking business and generally finance trade and
commerce are known as commercial banks. Commercial banks provide short term, medium term
and long term loans to trade and commerce. Commercial banks provide various services like
collecting cheques, bill of exchange, and remittance of money from one place to another place
etc. In India, commercial banks are established under Companies Act, 1956.
E.g. SBI and Associates.
2) Industrial Banks / Development banks:Industrial banks, also known as investment banks, mainly meet the medium term and
long term financial needs of the industries. The main functions of Industrial banks are: 1) they
grant long term loans to the industrialists to enable them to purchase land, construct factory
building, purchase heavy machinery etc. 2) they help selling or even underwrite the debentures
and shares of industrial firms. 3) They can also provide information regarding general economic
conditions of the economy.
E.g. IDBI, IFCI etc.
3) Agricultural banks:Agricultural credits are different from those of industry and trade. Industrial and commerce
banks normally do not deal with agricultural finance. The agriculturists require 1) a short term
credit to buy seeds, fertilizers and other inputs, and,2) long term credit to purchase land, to make
permanent improvements on land, to purchase agricultural machinery and equipments etc. n
India, agricultural credit facilities are generally provide by co-operative institutions. They
provide short term loans and Land Development Banks provide the long term credit to the
agriculturists.
E.g. NABARD, Co-operative societies etc.
4) Exchange Banks:Exchange banks deals with foreign exchange and specialize in financing foreign trade.
They facilitate international payments through the sale and purchase of bills of exchange and
thus play an important role in promoting foreign trade. These banks facilitates for the conversion
of Indian currency into foreign currency to make payments to foreign exporters.
E.g. Hong Kong Bank, Bank of Tokyo, Bank of America
5) Savings Banks:The main purpose of saving banks is to promote saving habits among the general
public and mobilize their small savings. The deposits collected from public are deposited in
mutual funds and stocks.
E.g. Post Office savings
6) Central bank:Every country of the world has a central bank. In India, it is Reserve Bank of India.
Central bank is the apex monitory institution which controls, regulates and supervises the
monitory and credit system of the country. They provide specialized functions i.e., issue of paper
currency, working as bankers bank, banker to the government, supervising and controlling of
foreign exchange etc. A central bank is a non-profit making institution.
2. On the basis of ownership.
On the basis of ownership, banks can be classified into 3 categories:
7) Public sector banks:
These are owned and controlled by the government. In India, the nationalized banks
and regional rural banks come under this category. The commercial Banks which had been
nationalized by Government of India, through an ordinance in the year 1969 and 1980 are known
as Nationalized Banks. In a Nationalized Bank, more than 50% of the shares will be held by
central Government
E.g. SBI and its associates Banks, Canara Bank, Allahabad Bank, Punjab National Bank etc.
8) Private sector banks:
These banks are owned by private individuals or corporations and not by the
government or co-operative societies.
9) Co-operative banks:
Co-operative banks are operated on the co-operative lines. In India, cooperative
credit institutions are organized under co-operative society law and play an important role in
meeting financial needs in the rural areas.
3. On the basis of Domicile:
On the basis of domicile, banks are divided into:10) Domestic Banks:These are registered and incorporated within the country.
11) Foreign banks:These are foreign in origin and have their head offices in the country of origin.
4. Scheduled and Non-scheduled banks
In India, banks are broadly classified into scheduled and non- scheduled banks. A
scheduled bank is that which has been included in the Second schedule of the RBI Act, 1934.
The banks which are not included in the Second schedule of the RBI Act are non-scheduled
banks.
II.
Commercial Banks
Commercial banks finance generally trade and industry by giving short term loans.
They raise funds by pooling together the scattered savings of the public.
Functions of commercial banks:Primary functions:1) Acceptance of deposits:The foremost function of commercial bank is to accept the deposit from the public,
who possesses the ability to save, but are unable to utilize their savings properly. Basically there
are 3 types of deposits:a) Fixed deposit account:- The fixed deposits are also named as time deposits. The money
in such account is accepted for a fixed period viz. 1 year, 2 year, 5 year or more. Money
can also be accepted for 90 days. The accepted money cannot be withdrawn before the
expiry of the fixed period. The rate of interest on such deposits will be higher than that of
other savings.
b) Current Account:- Current accounts are also known as demand deposits. These accounts
are for traders or businessmen to meet their day to day requirements. The businessman
can withdraw money from these accounts as many times as they desire. Normally such
accounts carry no interest rate rather; the bank levies certain incidental charges on the
customers for the service rendered by it.
c) Savings bank account:- The main objective of this account is to attract small savings of
the public. Under this account, various restrictions are imposed on the depositors viz.
they can withdraw only a specific sum of money in a week or a month , the amount
withdrawn is to be deposited in a given time period etc. The rate of interest is generally
lower than fixed deposit.
2) Advancing of loans:The second important function performed by the bank is the advancing of loans.
After keeping a certain percentage of cash reserves, the balance deposits are lent out by
the bank to the needy borrowers in the form of loans and advances. The various types of
loans are:a) Discounting of Bill of Exchange: - Through this method, the holder of an exchange bill
can get it discounted by the banks. The banks, after deducting its commission, pay the
present price to the holder of the bill. When the exchange bill matures, the bank can
accept the payment from the party who has accepted the bill.
b) Overdraft: - Sometimes, the bank provides overdraft facility to their customers. In this
case, the depositor in a current account is allowed to draw over and above his account up
to a previously agreed limit. Suppose, a business man has only RS. 30000/- in his current
account in a bank but requires Rs. 60000/- to meet his expenses. He may approach his
bank and borrow the additional amount of Rs. 30000/-. The bank allows the customer to
overdraw his account through cheques. The bank however charges interest only on the
amount withdrawn from the account.
c) Term loans: - Apart from providing other loans, the banks provide medium as well as
long term loans to the public. These loans are for more than 1 year. The banks either pays
or credits the entire amount of the loan sanctioned to the borrower’s account. The interest
is charged on the entire amount of the loan.
d) Ordinary Loans:- These loans are of very short period. The bank can recall it at its own
option.
3) Credit creation:-
4) Remittance of funds:Commercial banks, on account of their network of branches throughout the country,
also provides facilities to remit funds from one place to another for their customers by issuing
bank drafts, mail transfers or telegraphic transfers on nominal commission charges. As compared
to postal money orders, or other instruments, bank drafts have proved to be a much cheaper
mode of transferring the money.
Secondary functions:1) Promotion of cheque system:The commercial banks render a very useful service of cheques. People find it more
convenient to settle their debts than through the use of cash. In fact, it is the most developed
credit instrument in the money market.
2) Financing internal and external trade:The bank finances internal and external trade through discounting of exchange bills. Sometimes,
the bank gives short-term loans to traders on the security of commercial papers. The discounting
business greatly facilitates the movement of internal and external trade.
3) Agency services:Banks also perform certain agency functions on behalf of their customers.
a) Sale and purchase of securities:- The commercial banks helps its customers to buy and
sell stocks and shares of the private companies as well as government securities. In this
regard, the banks neither give any advice for these investments nor levy any charges for
the services performed. The bank simply acts as a broker.
b) Income tax consultant:- The commercial banks advice its customers in the matter of
income tax. The income tax experts of the bank help its customers to prepare their
income tax returns.
c) Acts as Trustee and the Executor:- Banks preserve the wills of the customers and execute
them after death.
d) Collection of dividends on the shares of the customers:- The bank collects dividends as
well as interest on the shares and debentures of its customers and credits them to their
respective accounts.
e) Acts as Correspondent:- the bank may acts as a correspondent, agent, or representative of
its customers. They may also procure tickets and passports for their customers.
f) Banks collects and pays various credit instruments like cheques, bill of exchange etc, on
behalf of their customers.
g) Banks execute the standing instructions to pay insurance premium, rents etc of their
customers.
4) Purchase and sale of foreign exchange:The commercial banks sell and purchase foreign currencies. Generally, the purchase
and sale of foreign currency is done by the Foreign Exchange Banks, while in our country, some
commercial banks also do business in foreign exchange.
5) Miscellaneous functions:In addition to the above functions, banks perform the following miscellaneous
functions also:a) Locker facility: - Banks provide locker facility to their customers. The customers can
keep their valuables, such as gold and silver ornaments, important documents etc in this
locker for safe custody.
b) Traveler’s cheques and credit cards:- Banks issue traveler’s cheques to help their
customers to travel without fear of theft or loss of money. With this facility, the
customers need not take the risk of carrying cash with them during their travels.
c) Letter of credit: - Letters of credit are issued by the banks to their customers certifying
their credit worthiness. Letters of credit are very useful in foreign trade.
d) Collection of statistics: - Banks collects statistics giving important information relating to
trade, commerce, industries, money and banking. They also publish valuable journals
and bulletins containing articles on economic and financial matters.
e) Acting referee: - Banks may acts as referees with respect to the financial standing,
business reputation and respectability of customers.
f) Gift cheques: - Some banks issue cheques of various denominations to be used on
auspicious occasions.
g) Accepting bills of exchange on behalf of customers: - Sometimes, banks accept bill of
exchange, internal as well as foreign, on behalf of their customers. It enables customers
to import goods.
III.
Role of Commercial Banks in a developing economy or in India.
A well developed banking system is necessary pre-condition for economic
development in a modern economy. Commercial banks can contribute to a country’s economic
development in the following way:1) Capital formation:Capital formation is the most important determinant of economic development and
banks promote capital formation in the following ways. (A) They stimulate savings by providing
a number of incentives to savers, such as interest on deposits, free and cheap remittance of funds,
safe custody of valuables, etc. (B) By expanding their branches in different areas, they succeed in
mobilizing the savings generated. (C) They make the mobilized resources available to those who
have the opportunity of productive investment.
2) Encouragement to Entrepreneurial innovations:In UDCs/ India, entrepreneurs generally hesitate to invest in new ventures and
undertake innovations largely due to lack of funds. Facilities of bank loans enable the
entrepreneurs to step up their investment and innovational activities, adopt new methods of
production and increase productive capacity of the economy.
3) Influencing economic activity:Banks can directly influence economic activity, and hence, the pace of economic
development through its influence on the rate of interest and the availability of credit.
A reduction in interest rate makes the investments more profitable and stimulates
economic activity. An increase in interest rate, on the other hand discourages investment and
economic activity. Banks can influence economic activity by the availability of credit. Through
their credit creation activity, the banks increase the supply of purchasing power and hence the
aggregate demand. Thus, in turn, increase investment, production and trade in the economy.
4) Implementation of monetary policy:Control and regulation of credit by the monetary authority is not possible without the
active co-operation of banking system in the country.
5) Promotion of trade and industry:The use of bank cheques, the bank drafts, bill of exchange has revolutionized the
internal and international trade, which in turn, has encouraged specialization and accelerated the
pace of industrialization.
6) Encouragement of right type of industries:-
In a planned economy, it is necessary that, the banks should formulate their loan
policies in accordance with the broad objectives and strategy of industrialization as adopted in
the plan. This will promote right type of industrialization in the economy.
7) Regional development:Banks can transfer surplus capital from the developed regions to the less developed regions
where it is scarce and most needed. This reallocation of funds between regions will promote
economic development in underdeveloped areas of the economy.
8) Development of agriculture and other neglected sectors:Banks promote agriculture and allied activities by providing short, medium and long
term loans. In India, there are SIDBI and NABARD as industrial and agricultural banks, which
are devoted for the purpose.
IV.
Reserve Bank of India (RBI)
The Reserve Bank of India (RBI) is India’s Central bank. It is the apex monetary
institution which supervises, regulates controls and develops the monetary and financial system
of the country. The RBI was established on April 1, 1935 under the Reserve Bank of India Act,
1934. It was nationalized on Jan. 1, 1949.
Present Governor of RBI - Dr. Raghuram Rajan.
Various Departments of RBI:a)
b)
c)
d)
e)
f)
g)
h)
V.
Human Resource Management Department.
Department of Banking Supervision.
Issue Department.
Cash Department.
Department of Non Banking Supervision.
Department of Information Technology.
Central Establishment Section.
Banking Department.
Functions of RBI
The main functions of RBI are discussed below.
1) Note Issue:The Reserve Bank has the monopoly of note issue in the country. It has the sole right
to issue currency notes of all denominations except 1 rupee notes and coins. One rupee notes and
other coins are issued by Govt. of India.
RBI follows the Principle of Minimum Reserve System for note issue. According to
this system, the bank keeps a minimum reserve of Rs. 200 crores worth gold and foreign
securities, out of which, gold alone must be of the value of Rs. 115 crores. RBI has powers not
only to issue but also to withdraw but, even to exchange these currency notes for other
denominations.
2) Banker to the Government:The RBI acts as the banker, agent, and adviser to the Govt. of India in the following ways:a)
b)
c)
d)
e)
f)
g)
It maintains and operates govt. deposits.
It collects and makes payments on behalf of the govt.
It helps govt. to float new loans and manage public debt.
It gives short term advances to Central and State govt.
It provides development finances to govt. for carrying out 5 year plans.
It undertakes foreign exchange transactions on behalf of the Central govt.
It acts as the agent of Govt. of India in the latter’s dealings with IMF, World Bank, and
other international financial institutions.
h) It advices govt. on all financial matters such as loan operations, investments, agricultural
and industrial finance, banking, planning, economic development etc.
3) Banker’s Bank:The RBI acts as the Banker’s bank in the following aspects:a) The RBI provides financial assistance to the scheduled commercial banks by discounting
their eligible bills and through loans and advances against approved securities.
b) In every country, the commercial banks are required to keep a certain percentage of
liabilities with the central bank. The sole aim of these reserves is to enable central bank to
provide the financial assistance to the scheduled banks in the time of emergency.
c) Under the Banking Regulation Act of 1949, the RBI has been empowered the right to
supervise, and control the various activities of commercial banks. These powers are
related to give licensing, for branch expansion, liquidity of assets, management and
methods of working of the bank, and the inspection of banks etc.
d) The RBI acts as the lender of last resort. It means when the commercial banks find that,
they are not able to meet their financial resources from other sources, they can approach
the central bank for financial accommodation. The RBI studies the financial conditions of
the concerned banks, and offers suggestions for its improvement.
4) Control of credit:In order to ensure internal price stability and economic growth, the central bank
undertakes the responsibility of controlling credit. The central bank ensures price stability and
avoids inflationary and deflationary tendencies by raising or lowering bank rate and by
purchasing and selling of securities in the open market.
5) Custodian of Exchange Reserves:Custodian of exchange reserves is another function of RBI. It controls both reserves
as well as payment of foreign exchange. In case of fluctuations in the foreign exchange rates, the
Central bank may buy or sell foreign currencies in the market to minimize the fluctuations which
in turn helps to reduce the price of the currency in the market. On the other hand, if the price of
the foreign currency declines, the Central Bank purchases foreign currency from the market.
During the period of emergency, the RBI may impose restrictions on the buying and selling of
foreign currencies in the market. In this way, RBI performs the role of custodian of foreign
reserves.
6) Research and Statistics:The RBI maintains a department of research and statistics. The department collects
data on the operations of commercial banks, Govt. finances etc. Analysis based on them
periodically published in the bank’s publications. RBI is the principal source of certain financial
statistics and banking data.
7) Developmental and promotional functions:The RBI provides facilities for agricultural and industrial finance. RBI does not
provide finance directly to agriculturists, but through agencies like co-operative banks; land
development banks, commercial banks etc. RBI has also helped in the establishment of financial
institutions like SIDBI, IDBI, UTI, etc. These institutions were set up by RBI to promote saving
habits and provide to industrial finance. For the promotion of foreign trade, RBI has established
the Export Import Bank of India.
8) General functions:RBI has powers of supervision and control over commercial and co-operative banks
relating to licensing, branch expansion, liquidity of their assets, management and methods of
working and liquidation. RBI is authorized to carry out periodical inspections. RBI receives
deposits from central and state govt., local bodies and banks without interest. It is empowered to
purchase and sell gold and Govt. securities.
VI.
Credit Control Measures of RBI/ Monetary measures of RBI
Monetary policy refers to those3 policy measures which the monetary authority of the
country (Central Bank) adopts to control and regulate the volume of currency and credit in the
country. Following are the Credit control measures of RBI:1) Quantitative credit control measures:a) Bank rate policy or discount rate policy:
The bank rate or discount rate is the rate at which central bank rediscounts first
class bills and eligible securities from the member banks. A rise or fall in the bank rate is
normally followed by a greater rise of fall in lending rates of commercial banks. During
inflation, RBI increase bank rate. When bank rate increases all other interest rates in the
economy also go up. As a result, the commercial banks also raise their interest rate. As a result
bank loans become dearer (Cost of credit increases). This discourages borrowings in the
economy. On the other hand, at time of deflation, RBI decreases bank rate, and the rate of
interest also decreases as a result bank loans become cheaper. This will encourage business
activity in the economy.
Current Bank rate is 8.5%
b) Open market operations (OMO):Open market operation means, purchase and sale of securities in the open market, to
control the volume of credit. In order to control the excessive expansion of credit, the central
bank sells securities in the open market. When the commercial bank purchases them, the cash
reserves with the commercial banks decreases. Reduction of cash reserves would leads to
reduction of lending capacities of banks, resulting in a contraction of the volume of credit and
thus a fall in price level and vice versa.
c) Variable reserve ratio (VRR):Every commercial bank is required either by law or by custom the capacity of the
commercial bank to create credit. Consequently, the inflation can be arrested. Conversely, when
there is deflation, the central bank will lower the reserve ratio. As a result, they have to keep a
certain percentage of their deposits in the form of cash with the RBI. These reserves are known
as Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). At time of inflation, RBI will
raise the reserve ratio; as such they have to keep more with RBI and this will reduce will be an
expansion in the volume of credit which encourage economic activities and rise in the level of
prices. Ultimately depression is arrested.
CRR =4% and SLR= 21.5%
2) Qualitative credit control measures:a) Selective Credit control:The central bank ensures that the credit money is going into the deserving hands.
b) Credit Squeeze policy:Credit squeeze policy or dear money policy is an anti-inflationary measure. This
policy aims at curbing overall loanable resources of banks and also increasing the cost of
credit of borrowers from banks.
c) Variations in margin requirements:
The term margin refers to the difference between market value of the securities and
the loan sanctioned. By fixing the margin rate, RBI does not permits the commercial banks to
lend their customers the full value of securities offered by them, but only a part of their market
value. A higher margin will reduce the amount of loans given by commercial banks. As a result,
the bank credit will be diverted from the field of speculative transactions to the productive
activities.
d) Moral suasion:This method implies persuasion and request made by the central bank to
commercial banks to cooperate with general monitory policy of the central bank. Since this
method is a physiological means of credit control, it success largely depend on strength and
prestige of the central bank.
e) Control through directives:
Directives may be in the form of written or oral statements, appeals of warning to
restrain credit. The bank that fails to obey directive of the central bank is punished generally.
f) Publicity:RBI informs all the scheduled banks about the nation’s economic needs and the
procedures to be followed in order to cater them. It may issue warning to the people and
commercial banks, substantiating its views by facts, figures and statements, through the media of
publicity.
g) Control of bank advances:The RBI has fixed from time to time maximum limits for some kinds of loans and
advances.
VII. Small Scale Industries in India- Role.
A significant feature of the Indian economy since independence is, the rapid growth of
the Small Scale Industrial (SSI) sector. SSI can be defined as, “Industrial undertaking having
fixed investments plants and machinery , whether held on ownership basis or on lease basis or
hire purchase basis is not exceeding rupees one crore”. SSI has played an important role in the
economic growth of India. The same is explained below:
1) Creating employment opportunity :
This argument is based on the assumption that, small industries are labour intensive in
nature. Thus, they utilize more labour and less capital. It has been estimated that, rupees one lakh
of investment in fixed assets in the Small Scale sector generates employment for four person.
2) Small Scale Industries helps to wipe out inequality of Income :
The income generated in a large number of small enterprises is dispersed more widely
in the community than income generated in a few large enterprises. In this way, small enterprises
bring about greater equality of income distribution.
3) Small Scale Industries increase production of goods and services :
The small scale industrial sector contributes almost 40% of the gross industrial value
added in the Indian economy. It has been estimated that, Rs.100,000 of investment in fixed asset
in small scale sector produces Rs.4,62,000 worth of goods and services with an approximate
value addition of 10% points.
4) Small Scale Industries utilizes latent resources:
The Small enterprises are able to tap latent resources like hoarded wealth,
entrepreneurial ship ability etc. thereby, optimum utilization of these resources are happening.
5) The Decentralization of industrial Sector:
Industrialization of the country becomes complete only if, it penetrates into remote
areas of the country. The smaller towns and the countryside, in order to benefit from modern
industrialization, must encourage small enterprises. Decentralization of industrial enterprises also
help to tap local resources such as a raw material, idle saving , local talents etc. and also
improves the standard of living of people.
6) Provides opportunities for development of technologies :
Small Scale Industries have tremendous capacity to generate or absorb innovations.
They provide ample opportunities for the development of technology. The Small Scale
enterprises commercialize new inventions and products. It also transfers technology from one to
another. As a result, the economy reaps the benefits of improved technology.
7) Indigenization :
Small Scale Industries make better use of indigenous organizational and management
capabilities by pooling the entrepreneurial talents. They provide productive outlets for the
enterprising of independent people.
8) Promotes exports:
Small Scale Industries have registered a phenomenal growth in export over the years.
About 45% to 50% of Indian exports is contributed by small scale industrial sector. It has been
mostly fuelled by the garments, leather and, gems and jewelry units of this sector.
9) Support the growth of large industries:
Small scale industries assist bigger industries and projects, so that, the planned activity
of developmental work is timely attended. They support large industries by providing
components, accessories, and semi finished goods required by them.
10) Better industrial relation:
There are hardly any strikes and lockouts in these industries due to good employee –
employer relation.
The above explained are the important role played by Small Scale Industries in our
country. Small industrial sector has performed exceedingly well and enabled our country to
achieve a wide measure of industrial growth and diversification.
VIII.
Small Industries Development Bank of India (SIDBI)
Small Industries Development Bank of India (SIDBI) was set as wholly owned
subsidiary of Industrial Development Bank of India (IDBI) under the Small Industries
Development of India Act, 1989. SIDBI started its functioning in 1990.It coordinates the
functions of institutions engaged in similar activities.
Objectives of SIDBI:
a) To Develop Small Scale Industries (SSI):-
Initiate steps for technological up gradation and modernization of existing SSIs.
b) Promotion:Promotion of employment oriented industries, especially in semi- urban areas to create
more employment opportunities.
c) Expanding the channels for marketing the products of SSIs.
d) Co-ordination of the functions of other institutions engaged in similar activities.
Functions of SIDBI:SIDBI provides financial assistance to small scale industries through the existing
banking and other financial institutions in the country such as, State Financial Corporation
(SFC), State Industrial Development Corporation, commercial banks, co-operative banks, RRBs
etc. The major functions of SIDBI are as follows:a) It refinances loans and advances provided by the existing lending institutions to the small
scale units.
b) It discounts and re-discounts the bills arising from the sale of machinery to and
manufactured by small industrial units.
c) It extends seed capital/ soft loan assistance under National Equity Fund, Mahila Udyan
Nidhi and Mahila Vikas Nidhi and seed capital schemes.
d) It grants direct assistance and refinances loans extended by primary lending institutions
for financing exports of products manufactured by small scale units.
e) It provides services like factoring, leasing etc. to small units.
f) It provides financial support to State Small Industries Corporations for providing scarce
raw materials to and marketing the products of the small scale units.
g) It provides financial support to National Small Industries Corporation for providing;
leasing, hire purchasing and marketing help to the small scale units.
IX.
National Bank for Agriculture and Rural Development (NABARD)
The establishment of NABARD was a land mark in the history of economic
development of the country. The NABARD has been established on 12th July 1982. It has been
taken over the entire undertaking of Agricultural Refinance Development Corporation (ARDC)
and RBI’s functions in the field of credit.
Objectives of NABARD:a) To provide credit for the promotion of agriculture, small scale and village industries,
handicrafts, and other rural crafts in the rural areas with a view to promote integrated
rural development.
b) To provide refinances for the institutional credits such as long-term, short-term for the
promotion of activities in the rural areas.
c) To provide direct lending to any institution approved by the Central Govt.
d) To have an organic link with the RBI and maintain a close link within.
Functions of NABARD:a) Apex institution for Rural finance:NABARD performs all the functions which were previously performed by RBI. It
directs the policy, planning and operations in the field of credit for agriculture and other
economic activities in rural areas.
b) Refinance institution:It serves as an apex refinancing agency for the institutions providing production and
investment credit for promoting various developmental activities in rural areas. Thea\se activities
are related to agriculture, small scale industries, village and cottage industries, handicrafts, small
artisans etc. NABARD has taken over the function of refinancing from the Agriculture
Refinancing Developmental Corporation.
c) Contributing to share capital:NABARD contributes to the share capital of any institution concerned with agriculture
and rural development.
d) Investment in securities:NABARD can invest in securities of any institution concerned with agriculture and
rural development. For promoting innovative investments, NABARD has started venture capital
fund.
e) Conversion and rescheduling facilities:NABARD provides refinance to eligible institutions for conversion and rescheduling
of loans, under conditions of drought, famine or other natural calamities, military operations etc.
f) Financial help to non-agricultural sector:NABARD provides help to non-agricultural sector with an aim to promote integrated
rural development. It provides financial assistance to SSIs and industrial co-operative socities for
meeting their working capital and fixed capital needs.
g) Co-ordination of activities:-
NABARD co-ordinates the activities of central and state govt., planning commission,
and other institutions concerned with the development of rural areas.
h) Regulatory function:NABARD has the responsibility to inspect rural banks and central and state co-operative banks.
i) Maintenance of R&D fund:NABARD maintains R&D fund to promote research in agriculture and rural
development, to formulate programmes to suite the requirements of different areas , and to cover
special activities.
j) Training programmes:NABARD has to provide training programmes to its own as well as to the staffs of
central and state co-operative banks, RRBs etc. It is to upgrade the technical skill and
competence of staffs.
k) Evaluation of projects:NABARD undertakes monitoring and evaluation of projects refinanced by it. It is
responsible for the development, policy, planning operational matters, co-ordination, monitoring,
training, consultancy, etc., relating to rural credit
NABARD is playing a vital role in the reduction of regional imbalances and providing
assistance to small farmers, marginal farmers and weaker sections.
X.
Stock Exchange/ Stock Market
The stock exchange is a market where, stocks, shares and other securities are bought
and sold. The owners may sell their securities, stocks or shares as and when they like. It serves as
a forum for trading in stocks, shares and bonds. Stock exchanges are organized and regulated
markets.
An investor, who puts his money in a company by buying its shares, cannot get the
amount back until he sells the shares through the stock market. There are many stock exchanges
in India at present. The oldest stock exchange is Bombay Stock exchange (BSE), which was
established in 1875, as a voluntary nonprofit making association at Mumbai. The management of
BSE consists of a governing board including executive director, government nominee, RBI
nominee, public nominee etc.
National Stock Exchange (NSE), was established in Nov 1992 with an equity of Rs.25
crore. NSE is a professionally managed national market for shares, PSU bonds, debentures and
Government securities with all the necessary infrastructure and trading facilities. NSE is an
electronic screen based system where, members have equal access and equal opportunity of
trading, irrespective of their location in different part of the country as they are connected
through a satellite network.
Role / Functions of Stock Exchange (SE):1) Raising capital for business:SE provides companies with the facility to raise capital for expansion through selling
shares to the investing public. The surplus funds of the public are mobilized for investment in
company securities.
2) Facilitate company growth:A takeover bid or merger or a merger agreement through the stock market ios one of the
simplest and most common ways for a company to grow by acquisition or fusion.
3) Creates investment opportunities for small investors:As opposed to other businesses that require huge capital outlay, investing in shares is
open to both the large and small stock investors, because, a person buys the number of shares
they can afford. Therefore, the SE provides the opportunity for small investors to own shares of
the same companies as large investors.
4) Corporate governance:By having a varied scope of owners, companies generally tend to improve on their and
efficiency in order to satisfy the demands of these shareholders. Consequently, public companies
(companies that are owned by shareholders who are members of the general public and trade
shares on public exchanges) tend to have better management records than privately held
companies (those companies where shares are not publically traded).
5) Government capital:Governments at various levels decide to borrow money in order to finance
infrastructure projects such as sewage and water treatment works or housing estates by selling
bonds. These bonds can be raised through the SE whereby members of public buy them, thus
loaning money to the Govt. Also the govt. can go for equity disinvestment in the PSU companies
to raise money and subsequently the SE provides liquidity options to the buyer, who buys the
share of such companies in the primary market.
6) Redistribution of wealth:Both casual and professional stock investors, through dividends and stock price share
the wealth of profitable business.
7) Barometer of the economy:At the stock exchange, share prices rise and fall depending, largely on market forces.
Share prices tend to rise or remain constant when companies and the economy in general show
signs of stability and growth. An economic recession or financial crisis could eventually lead to a
stock market crash. Therefore, the movement of share prices and in general of the stock indexes
can be an indicator of the general trend in the economy.
8) Mobilizing savings for investment:-
When people draw their savings, and invest in shares, it lead to a more rational allocation
of resources because funds, which could have been consumed, or kept in idle deposits with
banks, are mobilized and redirected to promote business activity.
Types of transactions:1) Investment transactions:-Investment transactions involve the actual delivery of the
security and payment of full price. But this will not provide necessary volume of
business.
2) Speculative transactions:- In speculative transactions, delivery of securities or payment
of full price is rare, but the difference is paid.
Problems/ Weaknesses faced by Stock Exchanges:The stock exchanges in India plays vital role in capital mobilization and capitalization. ,
However, it also has certain problems. The major problems faced by the Indian stock exchanges
are given below:
1) Lack of Integration :
There is large number of stock exchanges in the country, though BSE dominates
them with over 70% of all transactions in the country, there is no proper integration between all
the stock exchanges .This results to too much variation in the prices of share in different market.
2) Specified and Non Specified Shares:
Indian stock exchanges follows a peculiar practice of classifying listed shares into
“Specified” groups and “Unspecified” groups. The shares in the specified group are provided
certain special facilities like settlement period, carrying forward and clearing to promote
speculation. At present, market liquidity is limited to these speculative shares only, whereas
investor would prefer liquidity for all the shares across a broad front.
3) Margins:
The margin levied by Indian stock exchanges on speculative transactions is wholly of
discretionary character varying from share to share and from day to day, ranging from 0% to 40
%.
4) The system of settlement and carry forward(Badla):
The carry forward system is responsible for high price fluctuations and high risk
exposure to market participants. It is often responsible for excessive speculation.
5) Weakness of Stock Exchange management:The management organization and structure of Indian Stock Exchanges in general, is
weak and deficient. The governing body of a stock exchange does not have either the concern or
the will to introduce necessary reforms in trading.
6) Lack of professionalism:The foremost weakness of stock exchange is the lack of professionalism. They lack
of proper education, business skills, infrastructural facilities etc.
7) Domination of financial institutions:
Indian stock exchanges are dominated by a few financial institutions like UTI, LIC,
and GIC etc.
8) Poor liquidity:
The Indian stock exchanges suffer from poor liquidity. A small number of scrip is
regularly traded in stock exchanges. Out of over 3000 scrips, less than 500 scrips are generally
traded and even out of these, 90% volume of trade confines to between 200-250 scrip. This
means other scrip have very low liquidity.
9) Speculative trading:
At BSE upto5% and at other exchanges, up to 10% transactions are genuine
investment deals. The brokers try to create a sentiment in the market which will be beneficial to
them.
The above mentioned are the major problems faced by Indian stock exchanges. Dr L.C
Gupta had put forward many practical suggestions to overcome this problem. They includes
introduction of uniform one week settlement, marking the market system, abolition of Badla
system, management of information system etc. Most of them have been accepted and
implemented.
Suggestions for Betterment:1) Uniform settlement system throughout the country.
2) Financing of the trading in SE’s by commercial banks.
3) One week settlement system in all stock exchanges.
4) Make the trading transparent.
5) Changes in governing body.
6) Executive director should be appointed by the govt. or SEBI.
7) The composition of the General Body should be changed to 50 to 50 between broker,
directors, and non broker directors.
Benefits/ Advantages of Stock Exchange
A well organized SE is of great benefit to the company, community and the investor. These
benefits are summarized below under 3 heads.
Benefits to the community:1) Stock exchanges generate economic growth of the community and the nation. The
investors are encouraged to invest their savings in productive enterprises.
2) They uphold the position of efficiently run companies by encouraging marketability of
securities.
3) SE encourages encourage capital formation through the investment of savings in
securities.
4) They provide funds to the Govt. for undertaking important project by borrowing from the
public.
Benefits to the company:-
1) A company enjoys greater reputation in the credit market when its shares are dealt in
share market.
2) The SEs provides a wide market for the company’s securities.
3) A company gets a better bargaining power in case of its amalgamation or merger because
the market value of shares will be higher.
4) If the shares are highly marketable, a good will be established and the company can
easily raise further funds.
Benefits to the Investor:1)
2)
3)
4)
5)
6)
The stock exchanges increase the liquidity of the investor’s investment.
It gives security and safety to his investments.
The investor can know the true worth of his investment at any time.
It instills confidence in the mind of the investor as regards safety of his investments.
The security that is dealt in a stock exchange provides him a ‘good cover’ for loans.
Finally, since the securities are highly marketable, it is an incentive to the people for
investing their savings.
Some people consider a stock exchange as ‘Ali Baba’s’ treasure or a place to ‘get rich
quick’. There are some who consider it as a place for gambling. However, a stock exchange is
known as “the market of the world”. SEs also acts as barometers of the industrial atmosphere.
They play a substantial role in the industrial and economic development of a nation.
XI.
Mutual Funds
An investment instrument that is made up of a pool of funds collected from many
investors for the purpose of investing in securities such as stocks, bonds, money market
instruments, and similar assets. The income earned through these investments and the capital
appreciation realized is shared by its unit holders in proportion to the number of units owned by
them. Mutual funds are operated by money managers, who actively manage a fund's assets in an
attempt to produce positive returns for the fund's investors. A mutual fund's portfolio strategy is
structured and maintained to match the investment objectives stated in its prospectus.
Types of Mutual Funds (MFs):1) By Objective:Investment goals vary from person t person. While somebody wants security, others
give importance to returns, somebody want to plan for his child’s education while others might
be saving for their retirement etc. So, MFs can be classified based on objectives as under.
a) Equity fund:- Equity funds invest a major portion of their corpus in equity shares issued
by companies. NAV of equity funds are fluctuated by fluctuation in price of shares that it
holds. So, there is a high risk as well as high return in equity fund. Eg:- ICICI
b)
c)
d)
e)
2)
a)
b)
c)
3)
Prudential Growth Plan, Tata Pure Equity Fund, Reliance Vision, Franklin India
Prima Fund etc.
Debt fund:- Debt funds invest n debt instruments issued by governments, private
companies, banks and financial institutions. By investing in debt, these funds target low
risk and stable income to investors. Eg:- Birla Income Plus, Principal Income Fund,
HDFC Income Fund, UTI Bond fund etc.Balanced fund:- A balanced fund comprises of equity and debt funds. The idea is to
reduce volatility of funds, while providing some upside for capital appreciation. They are
best suitable for people looking for a combination of capital appreciation and regular
income.E.g.:- ICICI Prudential Balanced fund, Birla Balance fund, Franklin India
Balance Fund, Sundaram Balance Fund etc.
Money Market fund:- Money market funds invest in securities of a short term nature,
such as Treasury bills of Govt. Certificates of deposit issued by banks and Commercial
papers issued by companies etc. They are highly liquid and safe. E.g. ICICI Prudential
Liquid Plan, Templeton India Liquid Fund, Grindlays ash fund etc.
Gilt Fund: - Gilt Funds are mutual funds that invest only in government securities. They
are preferred by risk averse and conservative investors who wish to invest in the shadow
of secure government bonds.Since gilt funds invest only in government bonds, investors
are protected from credit risk. The instruments where these funds invest have sovereign
guarantee. Hence no default risk is associated with these instruments. These funds are best
suited for regular income and long term investment objectives. E.g. ICICI Prudential
Gilt fund, Tata Gilt securities fund, Templeton India Govt. Securities fund etc.
By Duration:Open ended fund: - An open-end fund is one that is available for subscription all through
the year. The majority of mutual funds are open-end funds. Investors have the flexibility
to buy or sell any part of their investment at any time at a price linked to the fund's Net
Asset Value. These funds do not have a fixed maturity period. The key feature is
liquidity.
Close ended funds: - A closed-end fund has a fixed number of shares outstanding and
operates for a fixed duration (generally ranging from 3 to 15 years). The fund would be
open for subscription only during a specified period and there is an even balance of
buyers and sellers, so someone would have to be selling in order for you to be able to buy
it. Closed-end funds are also listed on the stock exchange so it is traded just like other
stocks on an exchange or over the counter.
Interval funds: - Interval funds combine the feature of both open ended and close ended
schemes. They are open for sale and redemption during pre determined intervals at NAV
related prices.
Tax saving fund:-
These schemes offer tax rebates to the investors under specific provisions of the
Income Tax Act, 1961 as the Govt. offers tax incentives for investment in specified avenues
like, Equity Linked Saving Scheme (ELSS). Pension schemes also offer tax benefits.
E.g.ICICI Prudential Tax Plan, Templeton India Pension Plan, Franklin India Tax
shield etc.
4) Sector funds:These are the funds which invest in the securities of only those sector or industries as
specified in the offer documents like Pharmaceuticals, software, petroleum etc. These types of
funds are more risky compared to diversified funds. E.g. Biral IT fund,ICICI Prudential FCG
fund, Franklin India Pharma fund etc.
Advantages of MFs
1) Simplicity:-MFs can be easily bought and companies have flexible plans whereby
amounts can be invested on a monthly basis ( E.g. SIP)
2) Diversification:- The MF investments can be in a number of companies across a broad
section of industries and sectors. This diversification reduces risk because all stock
cannot go through a downtrend at the same time and in the same proportion.
3) Portfolio investment:- Each investor in a fund is a part owner of all the fund’s assets,
thus enabling investor to hold a diversified investment portfolio even with a small
amount of investment, which would other wise require a huge capital.
4) Professional management:- MFs provides services of experienced and skilled
professionals, backed by a dedicated research team that analyze the performance and
prospect of companies and select suitable investments to achieve the objectives of the
scheme.
5) Economies of scale:- The MFs buys and sells large amounts of securities at a time. So,
its transaction costs are lower than what an individual has to pay for securities
transactions.
6) Liquidity:- By investing in MFs the investors can cash their investment by selling their
units any time.
7) Convenience and flexibility:- MF companies offer investor to transfer their holding
from one scheme to other.
8) Tax benefits: - The investors are totally exempted from paying any tax on the income
they receive from the MFs.
9) Regulatory: - MFs are subject to many Govt. regulations that protect investors from
fraud.
10) Convenience: - One can easily buy MF shares by mail, phone or over internet.
Disadvantages of MFs
1) Costs: - All funds charge administrative fees to cover their day- to- day expenses. The
investor pays inv3estment management fees as long as he remains with the fund, even
while the value of his investments are declining.
2) Mutual fund investments are subjected to market risk: - MFs do not give guarantee for
the returns for the investments made in the various schemes of the mutual fund. There is
always a possibility of depreciation of value of MFs.
3) Diversification doest maximize returns: - Although diversification reduces the amount of
risk involved in investing in MFs, it can also be a disadvantage. Because, funds have
small holdings across different companies, high return from a few investments often
doesn’t make much difference on the overall return.
4) Taxes: - If the MFs makes a profit on its sales, taxes have to be paid on the amount
receive even if reinvestment is made.
5) No insurance: - MFs, although regulated by Govt., are not insured against losses.
6) Loss of control: - The managers of MFs make all of the decisions about, which securities
to buy and sell and when to do so.
Self Review Questions
1) Elaborate the functions of RBI.
2) Explain the policy of credit control of RBI.
3) Define bank. What are the different types of banks?
4) Explain the credit creation function of commercial banks.
5) Commercial banks are the manufacturers of money. Explain.
6) Discuss the role of commercial banks in India.
7) What are the functions of commercial banks?
8) Describe in detail SIDBI.
9) What are the objectives and functions of SIDBI?
10) Write a note on NABARD.
11) Explain the role of NABARD in the development of Indian economy.
12) What is a SE?
13) State various functions performed by Indian stock exchanges.
14) Write a note on NSE and BSE.
15) What are the major problems faced by
16) Indian stock exchanges? How they can overcome?
17) Define MF. What are the various types?
18) List out the advantages and disadvantages of MFs.
Module II
With the introduction of New Economic Policy (NEP) in 1991 by the Govt. of India,
through the implementation of Liberalization, Privatization and Globalization (LPG), drastic
changes are experiencing in the economic scenario. The intrusion of Multinational Companies
and advancement made in the realm of Information Technology culminated a sweeping change
in the Indian economy.
I. Multinational Companies (MNCs)
MNC is one which is registered as a company in one country but carries on business in a number
of other countries by setting up factories, branches or subsidiaries. Such a company may produce
goods or arrange services in one or more countries and sell these in the same or other countries.
The Multinational corporations may be known as a group of companies operating simultaneously
in different countries under the effective control of the corporation. They are huge industrial
organizations which extend their industrial and marketing operations through a network of their
branches.
Examples of MNCs: - Hindustan Unilever, Johnson and Johnson, Philips, Sony, Colgate, CEAT,
MRF, Coca-Cola, Pepsi, LG, Nestle, Thompson, Timex etc.
Features of MNCs: 1) Giant size: - MNCs are giant in size. Their assets and sales run into billions of dollars and
they make supernormal profits.
2) International operations: - MNCs operate all over the world. The corporation has a
group of subsidiary companies with their branch network operating in various countries
under its effective control and supervision.
3) Branches in multiple countries.
4) Oligopolistic structure: - They have the oligopolistic structure (few sellers) coupled with
their giant size.
5) Collective transfer of resources: - An MNC facilitate a multilateral transfer of resources.
Usually, this transfer takes place in the form of a ‘package’ which includes technical
know-how, equipment and machinery, raw materials, finished products, managerial
services and so on. This transfer is from parent company to the subsidiaries.
6) Multinational ownership: - Citizens of many companies have share in the capital of
MNCs. Shares of MNCs are bought and sold at the international level.
7) Varied activities: - MNCs are engaged in various types opf activities. These corporations
are engaged in basic industries, consumer goods industries, service sector, export oriented
industries etc.
8) Multinational management: - MNCs are managed at multinational level. Their
managing board is comprised of experts of several countries.
9) Huge financial resources: - MNCs have huge financial resources. Their capital base is
very large. Their capital runs in millions and billions.
10) Use of advanced technology: - MNCs use modern and advanced technology. R&D
activities of MNCs are very strong.
11) Marketing Security: - Generally, MNCs enjoy marketing superiority because of well
reputed brands and international image of launching new products in different countries.
Objectives of MNCs: 1) TO expand the business beyond boundaries of the home country where they were
originally established.
2) To minimize the cost f production, especially labor cot.
3) To capture the foreign market against international competitors.
4) To avail the competitive advantage internationally.
5) To achieve greater efficiency by producing in local market and then exporting the
product.
6) To make the diversification intentionally effective so that a steady growth of business
could be achieved.
7) To safeguard the company’s interest in order to get behind the tariff walls.
8) To make the best use of technological advantages by setting up production facilities
abroad.
9) To establish an international image.
10) To counter the regulatory measures in the parent company.
Reasons for the growth for MNCs in the world: The various reasons for the growth of MNCs are as follows:
1) International image:- Due to international image of MNCs, their products are
acceptable worldwide. They can easily collaborate with big industrial houses or govt. of
the nation where they want to start their operations. Moreover these MNCs are welcomed
in all over the world.
2) Financial superiority:- MNCs enjoy much financial supremacy when compared to
other business organizations functioning in domestic economy. Itis because of large scale
financial resources and east accessibility to foreign markets that’s the MNCs thrive in
attaining financial supremacy.
3) Marketing supremacy: - MNCs enjoy better marketing superiorities over the national
firms. They are:a) International image
b) Good quality products on account of technological supremacy.
c) Well reputed brands.
d) Effective advertising and sales promotion methods.
e) Efficient warehousing facilities.
f) Experience in launching of new products.
4) Technological supremacy: - Most f the MNCs implement most advanced and
sophisticated technological appliances. This will enable to produce the best quality
products which are appreciated and highly demanded all over the world.
5) High level of R&D facilities: - Innovative methods with modern technology are
implemented in MNCs. This will facilitate up gradation of technology and best form of
research and development facilities.
Reasons for the growth for MNCs in India:
There are a number of reasons why the MNCs are coming down to India. Few
important reasons are discussed below:1) Market potential: - India has a huge market for goods and services due to its vast
population and consumer power. It has also got one of the fastest growing economies in
the world. India has wide market for different and new goods and services due to the ever
increasing population and varying consumer taste.
2) Availability of labour: - MNCs have started running their operations in India due to less
labour cost and availability of talented labour. India has large pool of qualified and
experienced manpower and has developed strong industrial and technological capabilities
in some sectors.
3) Policy of the Govt.: - For quite a long time, India has a restrictive policy in terms of FDI.
As a result, there was lesser number of companies that showed interest in investing in
Indian market. However, the scenario changed during the financial liberalization of the
country, especially after 1991. Nowadays, Govt. makes continues efforts to attract
foreign investments by relaxing many of its policies. As a result, a number of MNCs have
shown interest in Indian market.
Impact of MNCs in India
A. Positive Impact
1) Increase in FDI: - The contribution of manufacturing sector to industrial development
increased considerably which made significant increase in FDI.
2) Increase in Export: - By utilizing cheap domestic lobour and capital resources by the
MNCs, it is easy to convert raw materials into finished products. By adopting modern
technology, better quality products could be produced. Besides, selling in the domestic
market, large quantity could be sold out in the foreign market leading to an increase in
exports and foreign exchange earnings.
3) Economic growth: - Factors such as, taxes paid by MNCs, FDI, production, employment
etc aid in the growth of host country. MNCs help in globalization of Indian market.
4) Globalization of products: - By the effect on capital movement, production and
distribution of goods and services has been globalizes during the last few decades.
5) Technology transfer: - MNCs provide technology transfer of tremendous amount of
managerial and technological know-how facilitating international exposure.
6) Provision of capital and technology: - Adequate supply of capital and technology is an
important advantage. Petroleum, chemicals and minerals are some of the areas where,
sophisticated capital intensive technology had to be employed.
7) Creation of large scale employment: - MNCs help in creation of large scale employment
opportunities by setting up their branch and subsidiaries in the host country. In this way,
MNCs have largely helped in the countries like India, in solving the problem of
unemployment.
8) Better marketing facilities: - Besides technology and production, another important
aspect is the marketing services that MNCs make available for export of manufactured
goods.
9) Increase in competition: - Presence of MNCs improves competition in domestic market.
Competition results in lower prices, which is beneficial for the consumers.
10) Rapid industrialization: - The MNCs could make a congenial atmosphere for the
development of industries thereby leading to rapid industrialization in our country.
11) Foreign capital: - MNCs helped India to secure foreign capital from the developed
countries. Thus, they assist in transfer of capital from the countries where it is in
abundance to countries where it is scarce.
12) Human resource development in developing countries: - The MNCs were able to
provide ‘a knowledge base’ so as to make the development of human resources. This
served the development of knowledge, expertise, training, education and research.
13) Integration of national economies: - MNCs provide an efficient means of integrating
national economies.
B. Negative Impact.
1) Target of profit maximization: - MNC’s technology is designed for attaining the
objective of profit maximization due to transfer pricing and not the development needs of
the country.
2) Suppression of domestic industries: - Through their power and flexibility, MNCs inflict
heavy damage on the host countries through suppression of domestic enterprises by
restricting their marketing facilities.
3) Formulation of oligopolies: - MNCs cause distraction of competition, extension of
oligopoly practices and acquire monopoly power in the long run. It ultimately results in
concentration of economic powers at the world level.
4) Adverse effect on Balance of Payment (BOP) position: - MNCs have an unfavorable
effect on the BOP position of the country through the outflow of large sums of money in
the form of dividends and profits. This results in the drainage of foreign exchange
earnings.
5) Absence of business ethics: - MNCs adopt bad business ethics and interfere directly and
indirectly in the internal political and other affairs of the country.
6) Inappropriate technology: -It causes faulty technology transfer affecting the employment
position in the country. MNCs do not implement an appropriate technology suitable for
the developing countries.
7) Conspicuous consumption pattern: - MNCs care only the elite group and the upper
middle class by creating new consumption culture producing highly sophisticated
products.
8) Widening income disparity: - The income levels of rich and poor widens due to the over
influence of MNCs. The rich becoming richer and poor becoming poorer.
9) Reduce employment: - MNCs may change labour intensive technology to capital
intensive technology. It may reduce employment opportunities in the developing country.
10) Exploitation of labour force: - MNCs working in India can exploit the cheap labour
force available in the country by providing comparatively less wages than developed
countries or home countries.
11) Unbalanced regional development: - MNCs will set up their factories or outlets, where
there is better infrastructure facilities are available and ignore the rural and
underdeveloped areas.
12) Tax evasion: - In order to avoid corporation taxes, MNCs reduce the amount of their
profit by adopting transfer pricing methods. According to this method, MNCs buy raw
materials or goods from their subsidiaries abroad at high prices to show lower profit.
Similarly, they export their products to their subsidiaries abroad at lower prices, so as to
undervalue the exports to shoe lower profits. Thus, MNCs over invoice the imports and
under invoice the exports so as to show less profit. So, through manipulation of bills,
MNCs evade tax.
II. Liberalization, Privatization and Globalization(LPG)
LPG model of development which was introduced in 1991, by the then finance
minister Dr. Manmohan Sigh with a big bang, was intended to charter a new strategy, with
emphasis on Liberalization, Privatization, and Globalization.
A. Liberalization:
Liberalization refers to, a relaxation of previous government restrictions, usually in such
areas of social, political and economic policy. Liberalization measures undertaken by the
Government of India are:
1). Exemption of industries from licensing: - The government exempted all industries (except
for alcohol, cigarettes, hazardous chemicals, explosives, electronic aerospace and drugs) from
any kind of industrial licensing.
2). Expansion of Industries:- Industries are free to expand themselves according to the needs of
market. Even government approval is not required. Ceiling for capital has also been abolished.
3). Freedom of Production:- According to the new economic policy, producers are free to
produce goods of their choice
4). Going away with the concept of MRTP:- Now, there are no 'MRTP’ companies. These
companies can take their own investment decision and expansion plans.
5). Extending Investment Limit of Small Industries:- According to the new policy, investment
limit of small scale industries have been increased to one crore, so that, they may modernize
these industries.
6). Inviting Direct Foreign Investment (FDI): - The Indian companies can invite the foreign
investors to invest in their industries which has further enlarged and expanded many Indian
industries.
B. Globalization
Globalization is the term which has recently come into existence along with
liberalization and privatization. Globalization means, the process of integration of the world into
one huge market. It is the process of increasing economic integration and growing economic
interdependence among the world economies. It is made through the closer integration of
countries and people of the world by removing all trade barriers. There is cross country flows of
information, ideas, technology, goods, services, capital and people.
Globalization refers to “all those processes, by which the people of the world are
incorporated into a single world society/ global society”.
-Albrow (1990)
Essential conditions for Globalization: There should not be unnecessary govt. restrictions which come in the way of
globalization, like import restrictions or other factors for foreign investments etc.
1) Facilities:- The extent to which an enterprise can develop globally from home country
base depends on the facilities available like the infrastructural facilities.
2) Govt. support: - Even though Govt. interference is a hindrance to FDI, the support of
govt. is necessary. It may be in the form of infrastructure, relaxation in policies of trade,
R&D facilities etc.
3) Resources: - Resource is one of the important factor which often decides the ability of a
firm to globalize. Resourceful companies may find it easier to develop in the global
market.
4) Competitiveness: - A firm may derive competitive advantage from any one or more of
the factors such as low cost and price, product quality, product differentiation,
technological superiority, after sale services, marketing strength etc.
Measures adopted for globalization in India: 1) Increase in foreign investment: Under economic reforms, limit of foreign capital investment has been raised. In
many industries, FDI to the extent of 100% will be allowed without restriction.
Telecom - 100%, Single brand retail – 100%, Courier service – 100%, civil aviation- 49%,
Defense production-26%, Insurance- 49%, Petroleum refinery- 49%
2) Partial convertibility of Indian Rupee: To achieve the objective of globalization, partial convertibility of Indian rupee was allowed.
Partial convertibility means to buy or sell foreign currency like dollar or pound sterling, for
foreign transactions at a price determined by the market.
3) Foreign trade policy: The foreign trade policy became more liberalized. All restrictions and controls on foreign trade
have been removed. Open competition has been encouraged and all facilities are provided t this
end. Administrative controls have been minimized.
4) Reduction in tariffs:-
In order to render Indian economy benefited internationally, custom duties and tariffs
imposed on imports and exports are being reduced gradually.
5) Export promotion:Exports have been promoted. Special facilities have been provided to the exporters in
order to increase the share of Indian exports in world trade.
6) Freedom to repatriate: Before New Economic Policy (NEP), foreign investment were allowed in India on a
non-repatriation basis ie; the foreign investors could not take their income on foreign investment
back to their country without the prior approval of RBI. RBI would allow this repatriation on a
restrictive basis. This provision was a great hindrance in inflow of foreign investment. But now,
foreign investors are free to repatriate the investment as well as income on investment. It has
attracted more foreign investors to invest in India.
7) Devaluation: The first step of globalization was taken with the announcement of the devaluation of
Indian currency by 18-19% against major currencies in the international foreign exchange
market.
8) Dismantling the industrial licensing regime:At present, only few companies are under compulsory licensing mainly on account
of environmental safety and strategic considerations. The major industries that come under
compulsory licensing policy are:Coal & lignite, Petroleum and its distillation products, Distillery, Sugar, Animal fat& oil, Cigar
& cigarettes, Asbestos and asbestos products, Explosives etc.
Impacts or Effects of Globalization on Indian economy:A. Positive effects:1) Increase in foreign trade:- As a result of liberalized foreign trade policies adopted in the
wake of the process of globalization, India’s share in the world trade has gone up.
(India’s share in the world trade is 2.07%)
2) Increase I foreign investment: - As a consequence of globalization, there has been a
considerable increase in the FDI as well as foreign portfolio investment (FPI).
a) FDI :-
FDI is made up by the foreign companies in order to establish wholly owned
companies in another country and to manage them or to purchase shares of
companies in another country for the purpose of managing such companies.
b) FPI:Under this type of investment, foreign companies buy shares or debentures of
native companies; however management and control remain vested with the
native / domestic companies themselves.
3) Increase in foreign collaboration: - Globalization has promoted collaboration of foreign
companies with many Indian companies. These collaboration agreements can be
technical, financial or both. In financial collaboration, foreign companies provide
financial resources, while in technical collaboration; modern technology is provided by
foreign companies.
4) Increase in foreign exchange reserves: - As a result of globalization of Indian economy,
foreign exchange reserves have also increased substantially.
5) Expansion of market: - Globalization has expanded the size of market. It has permitted
Indian business units to expand their business in the whole world. Now, MNCs has no
nation boundaries. Indian companies like Infosys, TCS, Wipro, Tata Steel etc are doing
their business in many countries.
6) Technological development: - Globalization has enabled the inflow of foreign
technology, which is very superior and advanced. Now, Indian business units use this
modern technology.
7) Brand development: - Globalization has promoted the use of branded goods. Now, not
only durable goods are branded but, products like garments, juices, snacks, foodgrains
etc are also branded. Foreign brands are very popular among Indian consumers. Brand
development has led to quality improvement.
8) Development of capital market: - Globalization has helped in the development of Indian
capital market. Now, many foreign investors invest in Indian capital market. Recently,
there has been substantial increase in inflow of FDI and FPI.
9) Development of service sector: - Globalization has helped in the growth of service sector.
With the entry of foreign companies, tremendous improvement has been witnessed in
various services like telecommunication, insurance, banking, etc.
10) Increase in employment: - Globalization has promoted employment opportunities.
Foreign companies are establishing their production and trading units in India. It has
increased employment opportunities for Indians. E.g. many Indians are presently
employed in foreign insurance companies, mobile companies etc.
11) Reduction in brain drain: - As a result of globalization, many MNCs have set up their
business units in India. They provide attractive salary package and good working
conditions to efficient, skilled Indian engineers, managers, professionals etc. Now,
Indians get good employment opportunities in India. It has resulted in reduction of brain
drain.
12) Improvement in standard of living: - As a result of globalization, the standard of living
of Indian population has improved. Now, Indians get better quality products at low
prices. Globalization has resulted in reduction of prices of many products particularly
electronic items like TV, Air Conditioner, Mobile phones, refrigerator etc. Now middle
income group also uses luxury products, which were earlier used only by rich class.
B. Negative effects: 1) Loss to domestic industries: - As a consequence of globalization, foreign competition
has increased in India. Now Indian industrial units have to compete with foreign
industrial units. Because of better quality and low cost of foreign goods, many Indian
units have failed to face competition and have been closed. Small and cottage industries
arte worst hit by this increased competition.
2) Unemployment: - Foreign companies operate in India use capital intensive technology.
Even some Indian companies use imported capital intensive technology. With the
increased use of computers and automatic machines, employment opportunities are
reduced.
3) Exploitation of labour: - Globalization exploits unskilled workers by giving lower
wages, less job security, long working hours etc. Labourers have to work even in these
conditions because of bad job and less wages are better than no job.
4) Demonstration effects: - With the easy availability of foreign goods, demonstration
effects has increased among Indians. Now, many consumers are using luxury products
by imitating others. It has promoted tendency of wasteful consumption in India. This
increasing wasteful expenditure has in turn reduced saving and capital formation.
5) Increase in inequalities: - Globalization has increased inequalities in our economy.
Globalization has benefited MNCs and big industrial units but small and cottage
industries are adversely hit by it. It has increased income inequalities in India.
6) Dominance of foreign institutions: - With globalization, dominance of foreign
institutions has increased in India. Globalization has helped foreign companies in
enlarging their market shares. For example, in Indian cold drink market, a large share is
controlled by Pepsi and Coca-Cola, which are foreign companies.
C. Privatization
Privatization is an act of reducing the role of government or increasing the role of the
private sector in an activity in the ownership of assets. It implies the introduction of private
ownership and management in publically owned enterprises.
Definition:-
“Privatization is the general process of involving the private sector in the ownership and
operation of a state owned enterprise. Thus, the term refers to private purchase of all or part of a
company.”
- Barbara Lee
Objectives of privatization:
a) Ideological objectives: - To strengthen liberalization and globalization which provides
greater choice as well as freedom to consumers.
b) Economic objectives: - Privatization aims at enhancing efficiency through competition
and making maximum profit.
c) Fiscal objectives: - Another objective of privatization is to curtail the revenue deficits
through various fiscal measures in an economy.
d) Administrative objectives: - Administrative expediency of reducing costs of bureaucracy
is still another objective.
e) Socio- political objectives: - Privatization also aims at changing power balances, say
adverse to organize unions and bring socio- political balances.
Measures taken for privatization:
1) Disinvestment:Disinvestment means reducing of investment in public sector. The process of
disinvestment or selling of Government’s equity in public sector units began during 1992-93 in
the wake of new industrial policy of 1991.
Methods of Disinvestment: a) Initially, equity was offered to retail investors through domestic public issues.
b) Introducing Global Depository Receipts (GDR) to attract overseas investors.
c) Cross holding i.e.; sale of shares of PSUs to other PSUs.
d) Warehousing – means purchase of shares of PSUs by the country’s financial institutions
itself.
e) ‘Retaining the Golden Share’ i.e.; holding the government’s share as only 26%.
2) Contraction of public sector: The number of industries which were kept reserved for the public sector has been
reduced from 17 to 3 only. These 3 industries are atomic energy, atomic minerals and railways.
3) Sale of share of public sector to the private sector: Up to 74% of shares of public sector have been sold to foreign investors, mutual
funds, public and work.
4) Introducing Board of Industrial and Financial Reconstruction (BIFR): To take decisions about the sick industries, BIFR had been introduced.
5) Memorandum of Understanding (MoU): -
To improve the working of PSUs, a system of MoU has been introduced. Under it,
management of PSUs will be given more freedom and they will be accountable for better results.
6) National Renewal Fund: This fund was set up for protecting the interest of employees on account of
privatization. The employees were offered Voluntary Retirement Scheme (VRS) under this
scheme.
Arguments in favour of Privatization: 1) Clarity of objectives: There exists a high degree of confusion among the managers of PSUs regarding the
profit objectives as well as social responsibility. Many PSUs failed on both fronts. Thus, after
privatization, profit becomes the foremost social responsibility.
2) Reduction in budgetary deficits: There would be no question of budgetary deficit; if the PSUs yielded a 1% return on
investment. But in reality, it is not so. Therefore the govt. can control its staggering budgetary
deficit by using sale proceeds on the shares in PSUs.
3) Reduction in public debt: Privatization helps in reducing public debt of the govt.
4) Creation of more jobs: New capital and profits are considered to be the main source of new jobs. Thus, if the
PSUs start earning rich profits, several new projects will come up which in turn will help to
generate more employment opportunities in the country.
5) Promotion of capital market: The transfer of PSUs to the private sector such as SAIL, BHEL, IPCL etc encouraged
capital market.
6) Possibility of immediate decision: The PSUs can speed up their mechanism and operations in a business manner.
7) Less political intervention: The PSUs can perform their functions in a more precise manner without much
interference of political groups.
8) Increase accountability: Once the PSUs are privatized and the shares are listed on the stock exchange, market
forces would compel these units to become accountable.
Arguments against Privatization:
1) Social unrest: Social unrest may prevail through gheraos, dharnas, fasts, and bandhs and so on.
2) Formation of cartels: After privatization, there is every possibility of the formation of cartels. Therefore, a
little bit carelessness will replace the state monopolies by the private monopolies.
3) Entry of multinationals: Another argument against privatization is the creation of multinational corporations.
4) Political instability:Privatization leads t political instability. From ruling to opposition party no one is
happy with privatization as they will have to lose their political clout.
5) No safety for weaker section: After privatization, weaker sections of the society may have to protest as they will not
find much safety net.
6) Decreased social welfare: The objective of profit maximization is against social welfare objective.
7) Increased inequality: There is a chance for increased inequality and results in concentration of economic
power in few hands.
8) Ignore weaker section: The profit maximization objective ignores the weaker sections in the society.
9) Increase in regional imbalances: Because of the lack of infrastructure, the private sector hesitates to start their business
in rural areas. It may create regional imbalances.
III. Public sector in India.
In India, Public Sector Undertakings (PSUs) is the term used for the govt. owned corporation.
The term is used to refer to companies in which the govt. owned a majority (51% or more) of the
company equity. Public enterprises are controlled and operated by the govt. or in association
with private enterprises. There are about 253 PSUs all over India.
E.g. Hindustan Aeronautical Ltd (HAL), Indian Oil Corporation Ltd (IOCL), Oil and Natural
Gas Corporation (ONGC), Bharat Heavy Electrical Ltd (BHEL), Steel Authority of India Ltd
(SAIL).
Objectives of PSUs: 1) To develop infrastructure: The primary condition of economic development in every under developed country is
the infrastructure.
E.g. Transportation facilities, irrigation facilities, power, road, water supply etc.
The PSUs enable the economy to develop a strong infrastructure for the future of
economic growth.
2) Strong industrial base:Only if govt. invest in heavy and basic industries such as iron and steel, heavy
engineering, coal, heavy electrical machinery, petroleum and natural gas etc, the consumer goods
industries (both in private and public sector) can progress at a sufficiently rapid pace.
3) Removal of regional disparities: The PSUs set up in backward areas cause economic development in those areas.
E.g. the major steel plants- Bhilai Steel Plant, Rourkela Steel Plant, Durgapur Steel Plant and
Bokaro Steel Plant were set up in the backward states to cause economic development.
4) To check over concentration of economic power: Expansion of public sector will help in putting a brake on the tendency towards
concentration of wealth and economic power in the private sector.
4) To create employment opportunities in large scale: PSUs consider people impartially and recruit and promote staff on merit.
5) To look after welfare of public: PSUs are engaged in not-for-profit business. PSUs place the public interest over
personal interest.
Forms of public organizations:A) Departmental organizations: They are run by govt. department with a minister on the top who is responsible to the
parliament for its operations. E.g: Railways, post & telegraph services.
These are managed in 2 ways:
1) Management through concerned ministry. E.g: Post & telegraph, Railways etc.
2) Management through Inter- department Committee or Board. E.g: Coir board, All India
Handloom Board etc.
Advantages: a) Because of the govt. control, it is easy to achieve its economical, political and social
objectives.
b) Such organizations are suitable for public utility services and defense industries.
c) Because of the govt. control, complete security is possible.
Disadvantages: a) Delayed decisions
b) Lack of initiative, as promotions are seniority based than merit based.
c) Red tapism.
B) Public corporations: It is a corporate body created by the Legislator or Parliament under the special acts
which sets out powers and duties.
E.g. LIC is set up under LIC Act 1956, RBI under RBI Act 1934.
It is managed by board of directors nominated by the govt.
Advantages: -
a) These are better managed and provide better working conditions to the employees and
provide better and cheaper products to consumers.
b) Quick decisions are possible because of absence of redtapism.
c) More flexible as compared to departmental organizations.
d) Management is in capable hands.
Disadvantages: a) The autonomy in the power and constitution require an amendment (change) in the
particular Act which is difficult and time consuming.
b) The autonomy of the corporations is only in papers but in reality, there will be
interference of political leader and govt. officers.
C) Govt. Companies: A govt. company is any company in which, not less than 51% of share capital is held
by the Central Govt. or any State Govt. or partly by the Central and partly by one or more state
govt.
E.g. FACT, TCC (Travancore Cochin Chemicals), BHEL, BEML, HAL, ONGC, Air India etc
Advantages: a) Easy to form.
b) The directors are free to take decisions and are not bound by certain rigid rules and
regulations.
c) More efficient.
d) They satisfy their consumers because otherwise they might lose to their competitors.
Disadvantages: a) Misuse of excessive freedom.
Merits of Public Sector:1) Helps to provide infrastructure facilities for the growth of economy.
2) Promotes rapid economic growth.
3) Prevents economic concentration in few hands.
4) Creates employment opportunities in large scale.
5) Look after welfare of public.
6) Minimizes exploitation of workers and consumers.
7) GDP of our country increases.
8) Development of key sectors of the economy (Irrigation, railway, iron, steel etc.)
9) Helped for a strong industrial base in our country.
10) Safeguarding key industries (Atomic energy, armaments & ammunition, aircrafts)
11) Development of key industries (Coal, iron & steel, aircraft, ship building)
12) Increased contribution to the govt. exchequer through payment of corporate taxes, excise
duties, customs duty etc.
Demerits of Public sector: 1) Less efficient.
2) Administrative expenses are high.
3) Political interferences.
4) Delay in decision making.
5) Increasing losses.
6) Inefficient price policy ( Mainly non- profit maximization profit)
7) Use of man power resources in excess of actual requirements.
8) Faulty controls.
9) Inefficient management.
IV. Information technology and its Future
The term Information technology includes computers and communication technology along with
associated software. IT industry referred to the entire gamut of media and devices used to
transmit and process information for use y various target groups in the society.
Use of IT Industry ( Categories of IT industry)
1) Infrastructure and services: The present level of IT Infrastructure in the country is nowhere close to a common man being
able to take advantage of internet and IT services. For benefit of IT to reach a common man,
there is an urgent need to take steps to facilitate reach of internet and IT services at mass scale in
the country.
2) Electronic Governance:In order to have a visible impact of the benefit of IT on people, govt. must select major services
at different levels such as, Ministries/ departments of Central govt. and state govt., district
administration, municipal services related to local governance at block/ panchayath level, and reengineer them through excessive use of IT.
3) Education: The use of IT for education and literacy provides a major opportunity to address the age- old
problem in this area. There is a major imbalance in the facilities for IT education particularly,
engineering education in different regions of the country. The facilities for IT education at the
levels of schools and poly- techniques are confined to only small part of the country. There is an
urgent need to spread IT education facilities on mass scale in all parts of the country.
4) Mass campaign for IT awareness: A common man in the country continuous to be largely unaware of potentials of IT in day - to day life. This slows down adoption of IT tools and services by people in the country. There is a
need to initiate a mass campaign for creating awareness with regard to benefit of IT in the
country.
Reasons for the growth of IT in India: 1) Technically skilled professionals: India has a huge reservoir of technically sound manpower. This has proved to be one of
the most critical success factors of Indian IT sector.
2) English speaking population: Because of India’s colonial past, the medium of education in India primarily is
English. This is proved to be boon to the industry. India is the second largest nation in the world
in terms English speaking population, first being USA.
3) Robust Telecom industries: The telecom industry in India is well established. The telecommunications network in
India is the third largest network in the world and the second largest among the emerging nations
in Asia. The availability of reliable telecom connectivity has added to the success of the whole
industry in India.
4) Lower cost of offshore outsourcing: The initial driver for off shoring to India was cost. But, India has proved to deliver
quality services at affordable costs.
5) Encouraging govt. policies: Policies adopted by the govt. of India have led to substantial domestic investment and
foreign capital.
6) Public investment in human capital: The govt. has undertaken huge investment for skill formation in computer technology.
Many institutions are established to train and educate people in software technology.
7) Special Economic Zones (SEZ): India has given special concessions to software companies set up in Special Economic
Zones (SEZ).
The growth of IT industry is essential for India. Reasons.
Information Technology is the industry, which through the use of computer and other
supporting equipments, help in the spread of knowledge. Information technology is the industry
that has given a face to India on global level. The success of Indian software industries has had a
wide ranging effect across the Indian economy. Policy changes to enhance exports are
facilitating rapid development of domestic IT market, offering efficiency gains through, adopting
of information technology. Today the country has developed great relationship with various
other western countries on the basis of its remarkable IT service. The following are some
applications of IT in various fields.
1) The foremost application of computers is found in business activities. Computers are
ideally suited to handle primary business functions like accounting, inventory payroll
and personnel etc. and have become integral part of modern society. Office people use
them to write letters, create budget, communicate with co workers, find information, and
manage projects and so on.
2) Computers can be used scientifically to develop hypothesis, collect and analysis test data,
exchange information electronically with colleagues throughout the world. Scientist can
also use computers to stimulate complex events like predicting what damage will an
earthquake is going to do etc. Satellite and space probes have brought a wealth of
information about our planet, solar system.
3) Computers have made their permanent place in class rooms and libraries where they have
become essential to the learning process such as for analyzing, interpreting, searching
and scanning the books, journals and magazines.
4) Without information technology, many medical facilities and corporations would find it
difficult to keep information stored squarely
IT is essential for India. The reason can be discussed under the heading merits of IT
industries in India.
Merits of IT in India
1) Increase in revenue and GDP: IT Industries earns revenue from software, hardware, maintenance, networking etc.
These revenues are earned either in domestic market or in the export market.
2) Higher share in export: The share of IT software in total export increases at a tremendous rate. Reviewing the
progress of IT industries, the 10th plan states, “IT industries achieved a compound annual growth
rate of 25% in production and 46.5% in exports”.
3) Employment generation: This sector has also lead to higher level of employment generation through BPO. BPO
occurs when a producer in the host country take up a job from the producer in as foreign country.
The IT industry provides employment directly and indirectly. Bangalore, Chennai, Hyderabad,
Mumbai, Pune, Delhi and Kolkata dominate the IT – ITES industry and constitute about 77% of
total industrial revenue.
4) Elimination of Intermediaries and reduction in cost: Electronic market could eliminate the role of intermediaries for conducting transaction
.The direct contact between manufacturer and customer enable speedy transaction by bringing
down transaction cost and cost of production. Internet has the potential to evolve into an
electronic market place bring buyers and seller together to facilitate commercial exchange.
5) Revolutionary changes in the international business: -
Advance in IT has revolutionized the mode of operation of marketing the global business
system. The business horizon become so vast and wide with buzzwords like internet , WWW,
cyberspace, information superhighway etc which totally changed the way of contacting
customers, as well as networking and integrating business systems. It is now possible for
customers and suppliers to transact business at any time in any part of the globe without having
to come together physically due to the development video conferencing, optical fiber technology,
e-mail etc.
6) Effective communication in big enterprises: Effective use of IT helps a company to identify and profile customers by reaching
them quickly and more effectively. These will enable inventory management and distribution
systems more efficient.
7) Development of E-Business and Growth of E-Commerce:From telemarketing, development is made to e-business in most of the countries due
to the advancement of IT. IT is becoming efficient in networking the business system, marketing
a shift from e-commerce to e-business. E-commerce become E-business, when a company
connect its business system directly to its critical constituent – customers, employees, vendors,
and suppliers through internet. Now global business is increasingly becoming e-business.
Future scope of IT industry in India: Globally, India’s IT growth is mainly dominated by IT software and services including
system integration, application development and maintenance, application management, software
testing, IT consulting, Web solutions and services and service oriented architecture. The high
rate of IT outstanding services ensures the spectacular future of IT in India. India, compared to
its competitors, ranks high on several parameters, including level of govt. support, quality and
delivery, quality of labour pool, English language skills, project management skills, and a
favorable time zone difference with the US that permits 24/7 operations. Some of the weaknesses
that persist are slow growth in the domestic market and lack of innovation. Infrastructure needs
improvement in many areas such as roads, electricity, capital and airports. However, a
comparison of India with competitors in software exports suggests that India’s current position is
quite sustainable in the near future.
Self Review Questions
1)
2)
3)
4)
5)
6)
7)
What do you mean by MNC? List out 10 MNCs in India.
Describe the characteristics of MNCs.
What are reasons for the growth of MNCs?
Discuss the effects of MNCs in the Indian economy.
Define globalization. What are its features?
What are the causes of expansion of globalization?
Discuss the effects of globalization in Indian economy.
8) Discuss the effects of globalization in Indian trade.
9) Discuss the effects of privatization.
10) What are the measures followed by Indian govt. in case of LPG?
11) Do you feel that privatization possessed more evil than good? If so, suggest conditions
for its success.
12) Comment on LPG.
13) Describe the growth, development of IT industry in India.
14) The growth of IT industry is essential for India. Explain the reasons.
15) Explain the main categories of IT industry.
Module III
Taxation
Taxation is the biggest source of public revenue of the modern govt. In a democratic
political set p, taxation is responsible for shaping the political activities of the govt. Tax is a
kind of money of which, it is the legal duty of every citizen of a country to pay honestly. It
may be levied on income, property or even at the time of purchasing a commodity.
“A tax is a compulsory payment from a person to the govt. to defray the expenses
incurred in the common interest of all without reference to special benefits conferred”
-Seligman.
I. Nature of tax: 1) Compulsory contribution: - Though paying taxes to the govt. is painful and pinching
matter for a tax payer, yet no person can deny its payment on this account. Non- payment
of it is followed by legal action and punishment by the state authority.
2) Tax revenue for general welfare: - Tax paid by the individual is collected and spent by the
state authority for the general welfare of the citizens. There is no question of getting equal
return or satisfaction and welfare for the amount of taxes paid.
3) No Quid Pro Quo (No Proportionate Return): - The essence of a tax as distinguished from
other charges by govt. is the absence of a direct quid pro quo (Proportionate return) to the
tax payer from public authority. A rich person, who pays Rs. 2 lakhs as income tax n a
year, cannot claim from the govt. economic welfare worth the same amount. Such quid pro
quo cannot be expected.
II.
Objectives / functions of Taxation: -
1) To raise revenue: In order to meet the state expenditure for carrying out its functions, the govt. levies
taxes of different types so that is revenues may increase.
2) To regulate: We know that taxation is an important component of fiscal policy. Therefore, it
regulates the economy of a country. Taxation policy regulates consumption; production is special
and economic activities in general.
3) Equal distribution: In recent years, the taxes have been levied on the income of the rich community
because; their taxable capacity is more than that of the poor and middle class. Thus, taxes
collected from the rich, are spent on the welfare of the poor people through social services.
Taxation policy of the govt. helps in decreasing the disparities of income in the country.
4) Anti inflationary: -
The direct tax can help to control inflation. During inflation periods, the govt. may
increase the tax rate. With an increase in tax rate, the consumption demand may decline, which
in turn may reduce inflation.
Characteristics of a good taxation system: 1) A good tax system would cause minimum aggregate sacrifice.
2) It should ensure maximum social advantage.
3) Taxes are universally applicable with the same ability to pay without any discrimination.
4) A good tax must follow most of the cannons of taxation. I.e. taxes should be justifiable,
equitable, convenient to pay, economical certainty, productive and elastic.
5) Simple.
6) Acceptable to the public.
7) A good tax does not hamper the growth of trade and industry.
8) The cost should be least to the govt. and citizens.
III. Canons / Principles of Taxations: 1) Canon of equality: - The govt. should impose taxes in such a way that people have to pay
according to their ability. If a poor man bears a greater tax burden than a rich man, it will
go against these cannon. Equality does not mean equal amount of tax. It means that, the
burden of a tax must be fair and justice.
2) Canon of certainty: - Certainty creates confidence in the tax payers. It also reduces the
cost of collection of taxes and increases economic welfare, because it tends to avoid all
economic waste. Absence of certainty is likely to make the tax system arbitrary and
unfair to the tax payer. These cannon are important for the individual and the state.
3) Canon of convenience: - The taxes should be levied and collected in such a manner that
it provides the maximum of convenience to the tax payers.
4) Canon of economy: - It implies that minimum possible money should be spent in the
collection of taxes. The maximum part of the collected amount should be deposited in the
govt. treasury. Thus, all unnecessary expenditure in the collection should be avoided at
all costs.
5) Canon of productivity: - This canon implies that, it is better to impose a few productive
taxes rather than to go in for a large number of unproductive taxes. These unproductive
taxes create so many complications both for the people and the govt.
6) Canon of elasticity: - This canon signifies that, the taxes should be imposed in such a
way that, the amount to be procured by them can be increased or decreased with the least
inconvenience. Modern age is full of so many fluctuations. Hence, it must have the
capacity to meet the adverse circumstances. For instance, during an emergency, govt. is
forced to collect more and more revenue.
7) Canon of diversity: - The burden of the tax should be scattered among different kinds of
the people. The burden of paying tax should not centralize on ne group of people but it
should be diversified so that every tax payer must pay to the exchequer according to his
ability to pay.
8) Canon of simplicity: - Every tax should be simple, easy and understandable to a common
man. Its procedure must be simple in nature so that, the tax payer is able to understand
and calculate it.
9) Canon of expediency: - According to this canon, a tax should be such that, it requires no
justification and it should not be a subject of any criticism. Thus, it should not be
baseless. In other words, tax payers should have no doubt about its desirability.
10) Canon of co-ordination: - This canon refers that, there must be co-ordination between
different taxes that are imposed by various taxation authorities i. e. by central, state and
local bodies in democratic countries like India. So, it is absolutely worthwhile that, there
must be close co- ordination between the various taxes imposed by public authorities.
Otherwise, there will be overlapping and unnecessary inconvenience to all tax payers.
11) Canon of neutrality: - It means that, a tax should avoid interference with the attainment
of optimum allocation and getting of maximum satisfaction. In short, it must not have any
inflationary or deflationary effect on the economy.
12) Canon of flexibility: - The tax should be flexible in nature.
IV.
Classification of Taxes: Taxes have been classified into various forms.
A. On the basis of tax burden: 1) Direct taxes: Direct tax is one that is collected directly from the people. In the case of direct tax, the man who
pays it also intended to bear the burden of it. I.e. impact and incidence are on the same person.
The person from whom it is collected cannot shift its burden to anybody else.
E.g. Income tax, wealth tax, property tax, corporate/company tax etc. In case of direct tax,
relationship between the tax payer and the authorities are direct and personal.
Merits of direct tax: a) Economy: - Direct taxes are economical as the cost of collecting these taxes are relatively
low. These taxes are usually collected at source. Moreover, the tax payer makes the
payment of these taxes directly to the state.
b) Equity: - Direct taxes can be thoughtfully chosen and determined according to the ability
to pay. It is based on justice and equity. In direct taxes, we can find the degree of
progression and consequently, it is easy to achieve the sufficient level of social and
economic justice through direct taxation.
c) Civic consciousness among tax payers: - It is admitted that, direct tax creates civic
consciousness among common masses. Besides, a direct tax like the income tax pinches
the people who pay the tax and in turn the tax payer becomes conscious about their
d)
e)
f)
g)
h)
i)
j)
rights. A direct tax creates keen interest in the affairs of the state i.e. develops
responsibility among the tax payers.
Reduction in inequality: - As direct taxes are progressive in nature, therefore, the person
belonging to higher income groups are imposed higher rate of taxation. On the other
hand, the lower income groups are exempted from some taxes. In this manner, it is
responsible for removing the disparities among sections of the society to a greater extend.
Certainty: - Direct taxes satisfy the canon of certainty because of its certain effects on the
tax payer. So, he makes adequate provision for payment of taxation in advance. The govt.
collects certain amount through direct taxes. Thus, it enables the public authority to
calculate the yield of taxation and hence, plan outlay should be well prepared with great
certainty.
Elasticity: - The income from these taxes can be raised by increasing the rate of taxation
in an appropriate way in the hour of crisis. Moreover, the income from direct taxes will
also increase with raising income of the people.
Educative value: - Direct taxes have the educative value among the common masses.
People are aware about the amount collected from them and can check the wastage in
public expenditure.
Easily understandable: - Direct tax is claimed to be easily understandable even the
layman of the society. Moreover, it does not cause any distortion in the resource
allocation of the economy.
Public spirit: - Direct tax promotes civil and political consciousness because, tax payers
take keen interest to observe and criticize the way in which their contributions are paid by
the govt.
Anti inflationary: - The direct tax can help to control inflation. During inflation periods,
the govt. may increase the tax rate. With an increase in tax rate, the consumption demand
may decline, which in turn may reduce inflation.
Demerits of direct tax: a) Inconvenience: - Direct taxes are inconvenient in the sense that, they involve several
procedures and formalities in filling of returns.
b) Unpopular: - These taxes are not popular because burden of direct tax is felt by the tax
payer.
c) Uneconomical: - The cost of collection of such tax is quite high particularly when the
numbers of tax payers are infinite and the amount of tax collected is in small quantity.
d) Possibility of evasion: - The tax payers evade these taxes by making understatement of
their income or try to give a wrong statement.
e) Against the equity principle: - Sometimes, poor people are exempted from the direct tax
and rich people are supposed to pay heavy tax which is against the principle of justice.
Thus, it is not based on justice.
f) Narrow in scope: - Generally, direct tax is levied only on certain group of persons which
restricts to raise the civic consciousness among all the people of the society.
g) Hindrance to capital formation: - If the rate of these taxes is very high, it affects saving
adversely, reducing the rate of capital formation.
h) Only political decisions: - Some critics of direct tax are of the view that, it is a political
decision which hinders the economic development of the country.
2) Indirect tax: Taxes imposed upon goods and services are labeled under indirect taxes. Here,
the buyer has to the tax indirectly to the govt. through shop keeper.
E.g. customs duty, excise duty, sales tax, VAT, service tax etc.
In case of indirect tax, the impact and incidence are on different persons and hence,
there is the possibility of shifting the tax burden. So, the tax payer is not the tax bearer.
“Indirect taxes are these taxes which are shifted and incidence of which is on other
than the original payers.”
- Anatol Murad
Merits: a) Convenience: - Compared to direct taxes, it is very convenient to pay indirect tax.
Indirect taxes are paid in small installments instead of lump sum. They are generally
included in the price of the commodity and the burden is not felt by the consumer. People
pay taxes without any obligation because of their necessities. Therefore, indirect taxes are
quite convenient.
b) Elastic: - It is elastic in nature as, according to the needs of the state, wide variety of
goods and services can be taxed so as to raise revenue.
c) No possibility of evasion: - It is impossible for an individual to evade the payment of
indirect taxes because they are already included in the price of the commodity. Thus,
there is very little possibility for the evasion of such taxes.
d) Equity: - Indirect taxes are made equitable, by imposing higher rate on goods consumed
by the rich and low rate for necessities.
e) Higher production and investment: - Indirect tax serves as a powerful tool in molding
the production and investment activities in an economy.
f) Beneficial social effect: - Apart from the economic objective of raising revenue, indirect
taxes have a beneficial social effect. By imposing high taxes on harmful drugs, liquor and
intoxicants which are injurious to health, its consumption can be reduced.
g) Progressive in nature: - Indirect taxes can be said to be more progressive in nature if the
luxurious commodities are heavily taxed and the essential commodities are exempted
from tax.
h) Wider coverage: - Indirect taxes are broad based and paid by all people as it is imposed
upon almost all items of consumption. As the tax net is very wide, the majoriy of the
public contribute t the public exchequer.
i) Productive: - Since the indirect taxes are of a wide coverage, they can be very
productive. In India, union excise duties and sales tax yield are very substantial revenue
for the govt.
j) Easy to collect: - As the taxes are hidden in the price of the product, whenever an
individual purchases the good, he gives the tax also. So, there is no collection cost.
Demerits: a) Regressive in nature: - A serious criticism leveled against indirect tax is that, it is highly
regressive in nature. Every consumer of the commodity, rich or poor, pays the same rate
of tax and so, it affects the poor more heavily.
b) Uncertainty: - It is not easy for an individual to estimate the exact amount of tax paid and
hence, it is uncertain. For the govt. also, estimation of the total yield from different taxes
are difficult.
c) No civic consciousness: - As indirect taxes are levied on the commodity, the consumer
does not feel the burden of tax which makes him less conscious about the public
expenditure system.
d) Discourage savings: - Indirect taxes discourage savings because these taxes are included
in the price and, therefore, people have spent more on the purchase of the goods.
e) Inflationary: - The indirect tax levied on commodity raises the prices and there by leads
to inflation.
f) Uneconomical: - The taxed commodity passed through a number of middlemen and the
final consumer pays much more than what the state receives. In case of custom duties,
there is large number of highly paid officials. So, the administrative cost is usually
higher.
g) Tax evasion: - Some of the indirect taxes are easily evaded. Excise duty is an example.
h) No direct link with the govt.: - Indirect tax being invisible loses direct link between the
tax payers and the public authority.
Distinction between Direct and Indirect Tax: The distinction between direct and indirect tax is the common and popular one.
Prof. Dalton made a distinction between direct and indirect taxes as that, “ a direct tax is really
paid by a person on whom it is legally imposed, while an indirect tax is imposed on one person,
but paid partly or wholly by another.” Thus, an indirect tax is conceived as one which can be
shifted or passed on while a direct is one which cannot be shifted to others. The main differences
are as follows: Direct tax
Indirect tax
Tax burden cannot be shifted by the tax
Tax burden can be easily shifted to another
payer.
person.
Direct tax is imposed on personal income
Indirect taxes are imposed on various
and corporate income.
goods and services (excise duty and service
tax)
Direct tax is imposed at progressive rates
which help to reduce inequalities of income
among different people of the society.
Direct tax has no inflationary pressure.
The impact and incidence are the same in case
of direct tax.
Direct tax is less elastic.
Indirect tax is imposed by the govt. on various
commodities to raise the revenue.
Indirect tax has inflationary pressure.
The impact and incidence differ in case of
indirect tax.
Indirect tax is more elastic.
B. On the basis of tax rate:Taxes are grouped into 4 such as proportional, progressive, regressive and digressive taxes.
1) Proportional taxation: In the proportional taxation, all incomes are taxed at a uniform rate of taxation. It
is not linked with the income of the tax payer. In other words, a proportional tax is one in which
the rate of tax remains the same.
For example, the same 10% taxes are levied on the person earning Rs 5000/- and
the person earning Rs 500/-.
The following table shows the proportional tax:
Proportional tax:
Income (y)
1000
2000
3000
Percentage (rate)
10
10
10
Amount (Rs)
100
200
300
Y
0
X
The figure shows that, on the Y axis, Rate of interest is measured, and on the X axis income. The
tax rate is same irrespective of the income of people. In this tax, the tax revenue increases in
proportion to increase in income.
Merits of Proportional Tax: 1) Simple and uniform: - Proportional tax system is simple and uniformly applicable. The
tax can be enforced relatively easily. Since everyone pays the same proportion of their
income (Y), the system has a popular appeal and the revenue can be raised with minimum
opposition from the tax payer.
2) Free from Harmful effects: - It is free from the harmful effects like discouragement to
save and produce that are associated with progressive taxation imposed steeply.
3) Easy to calculate: - Proportional taxes are levied at certain proportion of the income and
the rate of tax does not vary. Therefore, they are easy to calculate.
4) Equality of sacrifice: - Proportional taxes are justified on the ground that the real burden
of taxes must be equal to the money burden. If this principle is accepted, then the
proportional taxes can be justified.
5) Certain: - Such taxes enjoy the benefit of certainty. Both the tax payer and the state can
know the amount of tax.
Demerits of Proportional Tax: 1) Not equitable: - They are unjust, as the burden is heavier on poor sections. They have
been justified on the wrong notion that the real burden of tax is equal to its money
burden. The fact is that, the real burden is heavier on small income groups.
2) Less elastic: - Proportional taxes are somewhat less elastic as compared to progressive
taxes. The taxes cannot increase beyond a certain limit because of low taxable capacity of
the poor people. Thus, it is not easy for the state to increase its income through such
taxes.
3) Adverse effects on distribution of wealth: - Revenue is not the only motive of tax. The
idea that taxes are for revenue only has long been discarded. The weapon of taxation is
increasingly used to promote social justice. It is in this field that, proportional taxes
miserably fail. They fail to narrow down the inequalities in the distribution of wealth.
4) Inelastic: - This tax system is not elastic as the financial needs of the state may change
from time to time and it is often required to collect more funds. As the rich and poor
sections of the society are taxed equally, so there is little scope of increasing rate of
taxation because it will cause more miseries to poor people.
5) Not according to ability to pay: - It is not according to the ability to pay of the individual.
Low income groups feel heavy burden of taxation. The marginal utility of money
decreases rapidly with the increase in income. So, the rich income group have negligible
burden.
2) Progressive taxation: A progressive tax is that, in which the rate of tax depends on change in the
income (Y) of the individual. It implies that the rate of taxation should increase with the
increase in Y i.e. the higher the Y, the higher should be the rate of taxation.
The progressive taxes attempt to decrease the tax of people with a lower ability to
pay. All countries have adopted progressive method, as it is more reasonable.
Progressive tax
Income (y)
1000
2000
3000
Percentage (rate)
10
15
25
Amount (Rs)
100
300
750
Y
25
15
10
0
X
1000
2000
3000
From the table and figure, it is clear that, as the income (Y) increases, the tax rate also increases.
Merits of progressive taxation: 1) Based on the principle of equity: - This kind of tax increases along with thwe increase in
income. So, it is equitable and just.
2) Powerful tool for decreasing inequality: - It is a powerful tool for decreasing inequality
of income and wealth because; the rich people are bound to pay more taxes.
3) More elastic: - The state can change the rate of taxation for any particular time like war,
famine, drought etc. for collection of more funds and a minor change in the rate of
taxation in the higher income group can bring substantial increase in the income.
4) Economical: - Progressive tax can be justified on the ground that they are more
economical as the cost of collection does not rise with the rate of taxes.
5) Based on social justice: - It is a powerful instrument for narrowing down the gap
between rich and poor sections of the society. Actually, they are based on the ability to
pay principle. It helps to promote social progress.
6) More productive: - It is more suitable because the govt. revenue increases automatically
with the increase in economic activities.
7) Anti inflationary: - Progressive taxation may be helpful in curbing the inflationary trends
as it decreases consumption demand. The resource mobilization can be directed towards
productive investments which may increases the supply of commodities.
Demerits of progressive taxation: 1) Difficult to understand.
2) There is no definite principle in fixing the rate of taxation.
3) This system adversely affects the community’s power to save, will to save, and capital
formation.
4) It makes entrepreneurs disappointed. It adversely affects total volume of production and
employment.
5) Progressive taxation beyond a limit leads to evasion of taxes.
3) Regressive tax: A tax is said to be regressive, when its burden falls heavily on poor than rich.
No civilizes govt. imposes a tax in which as income (Y) increases, rate of tax decreases.
Regressive tax
Income (y)
1000
2000
3000
Percentage (rate)
10
8
6
Amount (Rs)
100
160
180
Y
10
8
6
0
1000
2000
3000
X
The table and figure shows that as the income (Y) increase, the rate of tax decreases. Here, there
is a negative relationship between Y and rate of tax. So, this tax is impractical and inappropriate
in poor countries.
4) Digressive tax:The digressive tax is a mixture of proportional as well as progressive taxes. Up to a certain limit,
the tax rate increases and after that, the rate of taxation is constant with the change in income. In
it, higher income group people have to make little sacrifice in comparison with the lower income
group.
5) Single tax: A single tax refers to a system in which the taxes are levied only on one item or head tax. It is
only one kind of tax. It serves as the government’s only source of income. In most cases, it takes
the form of a tax on land.
6) Multiple tax: It implies that, there should be all types of taxes so that, every citizen can contribute to the state
revenue. It may include single tax system, direct taxes, indirect taxes, progressive taxes etc. This
tax system is most suitable to get sufficient resources to meet the requirements of the economy.
7) Specific and Ad Valorem Taxation: a) Specific tax: - Taxes which are based on specific qualities or attributes of goods are
called specific taxes. This tax is imposed on the commodity according to its weight, size
or volume. E.g. specific excise duty may be levied on the cloth in the length units and tax
on the sugar is based according to the units of weight. The tax on TV picture tube is
based on the size.
b) Ad Valorem Tax: - As the tax imposed on a commodity according to its value, it is called
Ad valorem tax. This kind of tax is received after assessing the value of the taxable
possession of a person. Several imported articles are taxed in terms of value and they
have nothing to do with the size, length and weight of the commodity.
For instance, the import duty in many cases is levied on the value of goods
imported like 20% of the value of goods imported.
8) VAT: Basically, VAT belongs to the family of sales tax. As the name indicates, VAT
is a tax on the value added to a commodity or service (except export and govt. services). VAT is
not a tax on the total value f the commodity being sold, but on the value added t goods and
services by entrepreneurs at each stage of production and distribution up to the last trader. It
means, value is added at each stage, from the stage of production to the point f last sale to the
consumer. Hence, the trader is not liable to pay a tax on gross value but on the net value i.e. the
gross value minus the value of the commodity purchased from the other firms. In this way, VAT
implies a tax which is to be paid by all sellers of goods and services.
V. Impact, Incidence and Shifting of Taxation: Impact of taxation refers to the immediate burden of tax. The impact of a tax,
therefore, is the immediate result of the imposition of a tax on the person who pays it in first
instance. However, it is not essential that the person who pays it will also bear the ultimate or
final money burden of a tax. To be more specific, the impact and incidence of a tax may not fall
on the same person. The impact of taxation is on the producer while incidence of taxation is on
the consumer. The impact does not decrease the income of the producer, though it puts pressure
on him for a short period where as, incidence is durable and it ends in diminishing the monetary
income of the tax payers.
The incidence of tax refers to the final money burden on a person who ultimately
bears it. Whenever the money burden of a tax finally settles to rest on an ultimate tax payer s
called the incidence of a tax. The incidence of tax is classified into 2: -
Incidence of tax
Money burden
Direct
Real burden
Indirect
(Decrease in disposable (The conveyance
Y of tax payer)
Direct
Indirect
(Sacrifice of welfare)
charge incurred for
(The ultimate
unemployment and
The payment of tax)
decrease in production)
Distinction between Impact and Incidence: Impact
Incidence
It is felt by the tax payer at the point of
imposition of a tax
It is felt by the tax payer at the point of
settlement of a tax.
It refers to the initial burden of the tax
It refers to the ultimate burden of the tax
It can be easily shifted
It can be shifted
Evasion of tax is illegal
Avoidance of tax is not illegal
It is felt by the person from whom the tax
the collected
It is felt by the person who actually bears
the burden of the tax
Monetary payment of tax is included in it
Direct monetary burden is included in it
Impact can be on a person who cannot shift
it
Burden of tax can be easily shifted on
others
Shifting of taxation is the process by which the money burden of a tax is transferred
from one person to another. Thus, when a person wants to save himself from the burden of tax
and it falls on him as an incidence and places the duty of someone else to pay the tax is known as
shifting of the tax burden. The incidence of a tax is on that person who cannot shift it further.
Generally, shifting of tax will always be with an increase in price.
E.g. A salesman who pays the tax to the govt. will recollect it from the consumer in the form of
increased price for the good. It will be inclusive of the tax he paid and his profit.
Types of tax shifting: Forward Shifting: - In this shifting, the tax is shifted forward from the seller to the purchaser. In
forward shifting, the prices of goods are increased. For example, a sugar producer pays the
excise duty on sugar. He can shift the whole or a part of it to the consumers, through the
wholesalers or the retailers, by increasing the price. Thus, in the forward shifting, the monetary
burden of taxation can be shifted fully or partially by the sellers to the consumers by raising the
price.
Backward shifting: - Backward shifting occurs when the burden of tax is transferred from the
consumer to the manufacturer. In the backward shifting, the seller, instead of collecting the
amount of tax from the buyer, collects it by paying lesser price to the factors of production such
as reducing the wages of workers. In backward shifting, the prices of goods are decreased.
Factors related to shifting of tax: 1) Nature of tax: - i.e. whether the tax is treated as a part of the fixed cost or that of a
variable cost.
2) Elasticity of demand: - If the demand is elastic, most of the burden of taxation will have
to be borne by the seller or producer, and there will be less shifting of the tax and vice
versa.
3) Customary prices: - Some commodities of general consumption have the prices of which
are constant. Under these situations, the shifting of taxation is difficult.
4) Amount of tax: - If the amount of tax is very small, the seller himself bears it instead of
shifting it on to the buyer by increasing prices.
5) Nature of commodity: - If tax is levied on sugar, cloth etc., it can be easily shifted to the
consumers. But the tax imposed on a house cannot be easily shifted to the tenants.
6) Substitutes: - Shifting of tax s difficult in those commodities which have their substitutes,
for example, tea and coffee. It is so because, the amount of tax will increase the price of
the commodity concerned and its demand will decrease, as the people choose its
substitutes.
7) Area of tax: - The shifting of excess amount of local tax is not possible. If the producers
will try to shift this tax to the consumers, the consumers will buy the commodity from
some other market where no such tax exists.
VI. Tax Evasion: Tax evasion is the efforts that are made by trusts, individuals, firms and various other
entities to avoid paying taxes by illegal and unfair means. The evasion of tax usually takes place
when tax payers intentionally hide their income from the tax authorities in order to reduce their
liability of tax. The level of evasion of tax also depends on the chartered accountants and tax
lawyers who help companies, firms, and individuals evade paying taxes. Tax evasion is a
punishable crime.
Tax evasion is different from Tax Avoidance, which is making use of legal methods to
minimize the tax burden. If a person is able to manage for tax exemption within the framework
of law by taking all possible advantages of exemption limits and other privileges, it is a method
of ‘tax planning’. Through this procedure, there exists tax avoidance.
A person can avoid tax by utilizing the following methods: a) Housing loans.
b) Tax saving MFs, comes under Equity Linked Saving Scheme (ELSS). E.g. Franklin India
Tax Shield, HDFC Long Term Advantage Fund, ICICI Prudential Tax Plan.
c) Tax saving fixed deposits with five year locking period.
d) Public Provident Fund.
e) National Saving Certificate.
f) Medical Insurance.
g) Govt. bonds.
Methods of Tax Evasion: 1) Smuggling: - People resorts to illegal methods of transporting goods to avoid paying to
official chargeable customs duties.
2) Custom duty evasion: The imports evade paying customs but, by false declaration or
description of the product and its quantity.
3) Vat Evasion: The producer of goods who collect VAT from the consumer evades
paying tax to government by furnishing false information by lessening the amount of
sales.
4) Black Money Or unaccounted money: Some people resorts to illegal methods such as
theft, gambling, drug trafficking, hawala transaction etc and huge amount of
unaccounted money for which they do not pay any tax.
5) Income Tax evasion: The income tax payers deliberately declare a lower income to
the tax authorities so as to pay a lesser amount tax.
6) Black market: - People deliberately create artificial scarcity in the market by hoarding
goods so as to sell at a high price n future. This will create black money resulting in tax
evasion.
7) Fake currency: - An extensive amount of fake currency is pumped into the economy
causing wide circulation.
Reasons for Tax Evasion in India: The problem of tax evasion is an economic malady facing the Indian tax structure today.
Wanchoo Committee pointed out the following factors as reasons for tax evasion in India.
a) High rate of taxation: - Tax payers always consider tax rates as very high which had a
negative impact upon their tax paying decisions. A moderate rate of taxation will
definitely reduce the intensity of tax evasion.
b) Weak tax administration: - The extent of tax evasion depends on the efficiency of tax
administration. If there is much inefficiency and corruption on the part of tax evasion will
be automatically higher.
c) No trust in govt.: - The public may feel that, there no need of paying taxes because govt.
only takes away their money without providing any benefit directly for them. They
consider that, the govt. wastes money instead of producing public goods and services.
d) Corrupted ax officials: - Corruption by the tax officials often renders control of evasion
difficult. Corrupted tax officials help the tax payers by adopting foul practices and
misutilize their power.
e) Ineffective enforcement of tax laws: - The govt. has a variety of tax laws relating to
income tax, sales tax, stamp duties, excise duty etc. Due to wide spread corruption in all
these departments, their enforcement is very weak and ineffective.
f) Complexity and rigidity of tax laws: - It is difficult for common people to understand the
various procedures and technical formalities involved in the tax system. Hence, everyone
seeks different methods to escape taxation.
g) Donation to charities and contribution to political parties by very rich people lead to tax
evasion.
h) Lack of publicity: - Lack of publicity regarding the intensity of punishment for this crime
leads to tax evasion.
i) Deterioration of the moral standard of people is a main reason for adopting malpractices
by showing false accounts.
j) Prevalence of high level of controls and licenses cause violation of tax laws.
Consequences of Tax Evasion: 1) The country’s economic growth: - The biggest impact of tax evasion is that, it halts the
country’s growth due to lack of funds from the govt. Govt. earning depends on tax
2)
3)
4)
5)
6)
7)
8)
revenue. If the public stops paying the tax to the govt., it cannot fund to public sector
which needs the funds for their better operation.
Increase the inflation: - increasing tax evasion and avoidance results in building up of
black income and wealth on a large scale. High amount of cash in limited hands increases
the purchasing power of that limited people and hence results in growth of prices of
goods with scarcity of goods; which is inflation.
Higher taxation: - If collection of tax does not improve to meet the costs necessary to
meet the necessary functions, the govt. will be forced to increase the tax rate.
Reduces the rate of investment in India: - Since the black money of Indian is mostly
deposited outside India, result in reducing rate of investment in India.
Increase in price of land and houses: - A higher percentage of tax evasion involved in real
estate dealings. Hence the person having tax evaded money finds it the best to invest his
black money in property. This has resulted in the increase of prices of the property.
Effects on income distribution system: - The person who is paying his tax regularly, his
income didn’t match with other person who is not paying tax. So, it widens the income
gap in the society.
Demonstration effect: - The unaccounted money will be spend on the construction of
posh houses and for marriage functions. It may create demonstration effect in our
economy which is harmful to it.
Creation of black market and black money.
Control of tax evasion: 1) Reducing the tax rate: - Govt. by reducing the tax rate on an individual and income
earned after investment will encourage them to avoid tax evasion and invest in various
investment instruments.
2) Strong surveillance system: - Govt. should bring strong surveillance system in place
which will check suspicious trade and transaction taking place.
3) Bringing strong corruption laws: - Corruption is the root cause of tax evasion. If
corruption is reduced, there will be considerable decrease in tax evasion.
4) Simplified tax laws and filling mechanism: - Present tax laws and tax filing mechanism
is very complex for a common man to understand it and claim for various deductions
available in various sections. Simplified tax law will make things easy for everyone to
pay taxes.
VII.
Black Money: -.
Black money is tax-evaded income. It can be earned both through legal and illegal
means. Its legitimate source is that the income-earners do not reveal their whole income for tax
purposes. For example, government doctors earning money by private practice even when they
get non-practicing allowance; advocates charging much higher fee than shown in their account
books, and so forth.
Its illegitimate source is bribe, smuggling, black-marketing, selling commodities at prices higher
than the controlled prices etc., selling house at a high premium price but showing it at much
lower price in the account books, and so on.
Causes of black money:1) High Rate of Tax: An unrealistic and disproportionate increase in taxes and duties compel some people to
evade tax and accumulate black money. Many experts says that India is the most highly taxed
nation. People usually expect higher income than legally permitted. But the high rate of taxation
prevents this and invites tax evasion.
2) Different Rates of Excise Duty:
The Government has fixed different rates of excise duty. On the basis of the quality, the
products [such as paints, pipes, textiles, electric wires, etc.] are classified into different grades,
and tax duties are levied on the basis of the classification made by the manufacturer.
Manufacturers, sometimes downgrade a product to pay lower rates of excise, which will help
generate black money.
3) Price-control Policy of Government:
The Government often regulates the prices of some commodities [such as sugar, cement,
steel, paper, vanaspati, automobile tires, fertilizers, etc.] by following what is known as “pricecontrol policy”. Since this policy is comparatively rigid it does not take into account the ups and
downs in the market due to the interplay of demand and supply. The private manufacturer and
merchants take undue advantage of this policy and resort to hoarding, fraud, artificial scarcity,
etc., which will result in black money.
4) Inflation:
Inflationary situation is said to be one of the causes of black money. In this situation, the
prices of certain commodities [like petrol] go up and moneyed people start spending their
unaccounted money. They may also divert resources from production to speculation. This will
cause inflation.
5) Quota System and Scarcity:
The Government has fixed quota for import, export and foreign exchange. This quota
system is misused to make black money.
When there arises a scarcity of essential goods people are complied to pay more for them than
the controlled prices. This gives scope for black money. For example, people are paying now
more money than what is fixed as its price for kerosene oil due to its scarcity. The extra payment
made by the customer will add to the black money.
6) Elections in a Democratic System:
Elections are a part of the democratic process. Electioneering has become a costly affair
today. Hence the candidates contesting for elections are bound to spend more than what is legally
permissible for them. These elections are generally financed by the black money holders.
There is an unholy alliance between the political parties and the business tycoons. These
business oriented black money holders expect political patronage and economic concessions.
They obtain such concessions from the political leaders by paying them heavy donations through
black money. The concessions will help them to generate more and more black money.
7) Real Estate Transactions:
People amass black money through real estate transactions. Purchasing a house and/or
land at a cheaper rate and selling it at a higher rate by manipulating to pay very less stamp duty
has become a profitable business in all major towns and cities. This is also an important source
of black money.
8) Large public expenditure: Huge amounts were allotted for welfare schemes, removal of poverty and subsidies. A
good part of this leak into black money flow since govt. funds are easily available.
Effects of Black Economy:
The effects of black money in a country are discussed under the following heads:
1) False Information about the Economy:
The most important effect of black money is providing false information about the
actual economy because it remains outside the purview of the economic policies. The presence
of a sizeable black money casts doubts on the validity of the data on national income estimates,
per capita income, and distribution of income, consumption, savings and investment. The
economic planning losses it’s worth, because they are based on macro-economic parameters
which completely ignore the black money.
2) Impact on Fiscal System:
Government is fully based on tax revenue. Evasion of taxes has serious consequences for
the economy’s fiscal system. In long-run, consequence of such revenue loss is to reduce the
built-in elasticity of the tax system. To raise a given target of revenue, the Government is obliged
to depend increasingly on discretionary hikes in tax rates or to expand the array of taxes.
Direct Taxes Enquiry Committee in this connection mentioned “Black money and tax
evasion, which go hand in hand, have also the effect of seriously undermining the equity concept
of taxation and warping its progressiveness. Together, they throw a greater burden to the
economy.”
3) Create Inequalities:
The black money creates inequalities among people. The excess of money leads to
purchase non- essential articles, which gives demonstration effect. The overall consumption
pattern is titled in favour of rich and elite classes.
A rise in the overall consumption on non-essential products leaves less resource for
investment in priority areas. These distortions in the product-mix in favour of non-essential
consumption have adverse effects on production and thus they distort the objectives of planning.
4) Misguiding on Resource Allocation:
Block money distorts resource allocation in the economy and often leads to wasteful use
of money. It leads to conspicuous consumption and in turn results in the diversion of large funds
to unproductive channels which ultimately put the economy out of order.
5) Implications for Monetary Policy:
The black money related to the stock of ‘black liquidity’. The stock of ‘black liquidity’ is
defined as the accumulation of black savings (from black incomes) in the form of cash and other
readily convertible assets such as gold and silver.
It is the ‘black liquidity’ which creates a lot of problems for monetary authorities to
regulate the economy. The existence of sizable ‘black liquidity’ in our country misguides the
Government to diverting credit from more urgent to the less urgent.
Measures to control Black money:1) Checking tax evasion: - Evasion of tax has been the root cause of generation of black
money. Thus, the govt. has taken various steps to check evasion of both direct and
indirect taxes. Govt. has taken the following steps to control tax evasion.
a) Tax raids: - Income tax authorities have been given wide power to conduct raids
on person suspected to have black money.
b) Allotting Permanent Account Number (PAN): - Income tax law made it
mandatory for all the income tax payable citizens to obtain PAN from Income
Tax (IT) Office. The income tax payable citizens have to file IT returns regularly,
mention PAN at the time of buying and selling real estates, purchasing
automobiles, opening a new bank account etc.
c) Strengthening the norms of Tax Deductions at Source (TDS): - To check tax
evasions, govt. strengthened the tax system and scope of TDS. Now various types
of incomes are covered under TDS, like income from salary, interest, dividend,
lottery income etc. Under this system, tax is to deducted at source by the person
who is making such payment and is to be deposited with govt.
2) Special bearer bond scheme: - Under special bearer bond scheme, any person holding
black money could purchase such bonds and the person purchasing such bonds would
not be questioned about his sources of income and his identity would be kept secret.
3) Voluntary disclosure schemes: - Under VDS, any person holding black money can
declare his income by paying tax at the highest slab rates, without paying any penalty.
Moreover, the person declaring such incomes will not be questioned about his source of
income and his identity will not be disclosed.
4) Non – resident investment scheme: - Under this scheme, the non- resident can send
their money to India. This scheme attracted black money held abroad by NRIs.
5) Deposit in national housing bank: - The person making deposits under this scheme will
not be questioned about his source of income.
6) Controlling election expenses: - Election commission of India has put a ceiling on
election expenses to be incurred by a candidate for canvassing. Earlier a huge amount
of black money was spent on election. The step was taken to curb wasteful expenses on
canvassing and thus to reduce the use of black money.
7) Improving tax system: - For checking black money, tax system should be
strengthened by further reduction in tax rates, more income tax surveys, having more
tax raids and by having more efforts to collect indirect taxes.
8) Removal of unnecessary controls, permits, licenses make grounds for black.
Unnecessary controls restrict productivity and hence unnecessary controls should be
withdrawn.
9) Strengthening of audit: - For checking the black money audit work should be
strengthened, so that, the auditors do not merely check entries and sign the balance
sheets, but they also detect the concealment of income and wealth.
VIII. Deficit Financing: Deficit financing is a measure to meet the deficit of the government’s budget. When
the government’s total expenditure exceeds its total revenue, it suffers a deficit. This deficit is
made steady by adopting steps such as borrowing from within the country, borrowing loan from
foreign countries or by printing additional money. Thus, deficit financing refers to means of
financing the deliberate excess of expenditure over income through printing of currency notes or
through borrowings. The term is also generally used to refer to the financing of a planned deficit
whether operated by a government in its domestic affairs or with reference to balance of payment
deficit.
“Deficit financing is the financing of deliberately created gap between public revenue
and public expenditure or a budgetary deficit, the method of financing being of a type that results
in the quantity of money in a country.”
-Dr. V.K.R.V Rao