INTRODUCTION

Concepts and significance of economic environment

“Business is an enterprise engaged in the production and distribution of goods for sale in a market
or rendering of services for a price”.

“Business is a form of activity pursued primarily with the object of earning profits for the benefit
of those on whose behalf the activity is conducted”.

“Business is any enterprise which makes, distributes or provides any article or service which other
members of the community need and are willing to pay for”

“Business may be defined as human activity directed towards producing or acquiring wealth
through buying and selling of goods”.

BUSINESS

Business may be understood as the organized efforts of enterprises to supply consumers with
goods and services for a profit

BUSINESS GOALS IN GENERAL

• Profit (Bottom-line)

• Survival

• Growth

• Efficiency

• Market Leadership

• Customer satisfaction

• Employee satisfaction

• Quality Products & Services

• Service to Society

Characteristics of Business

• Change / Risks

• Exchange of goods or services for income

• Diversification

• Globalization

• Information & Technology

• Profit Motive

• Competition

CLASSIFICATION OF BUSINESS

Business which …

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 • PRODUCE GOODS Commodities (goods produced by primary sector eg. agriculture)
(wheat) / Products (goods produced by secondary sector) (wheat flour)

• PRODUCE SERVICES (service sector in GDP) (transportation, telephone, hotels, IT…)

• DISTRIBUTE GOODS (wholesalers, retailers…..)

• FACILITATE DISTRIBUTION OF GOODS (warehouse, storage, auction houses….)

• FINANCE AND FINANCIAL SERVICES (banks, merchant bankers, insurance, stock

exchange….)

On the basis of NATURE OF ACTIVITY

• Extractive Industries - which extract goods from nature (eg fishing, mining, lumbering, oil
extraction….)

• Genetic Industries - related to genetics or breeding (eg. BT seeds, poultry, aquaculture)

• Manufacturing Industries - converting raw materials into processed goods

• Construction Industries (eg. Roads, bridges, dams…..)

• Service Industries (eg. Doctors, lawyers, advertising,…..)

• IT Industries `

On the basis of COMPETITIVE STRUCTURE

• Monopoly

- single firm industry

• Duopoly (discussion point no. 11)

- only two firms

• Oligopoly

- few firms holds major market share

- perfect oligopoly (product is homogeneous)

- imperfect oligopoly (some degree of differentiation exists between the products)

• Monopolistic competition

- large number of firms selling products that are close but not perfect substitutes

- Product differentiation is the key

• perfect competition

On the basis of USE

• Basic industries

(which provide essential input for development of other industry) (eg. Iron and steel industry)

• capital goods industries

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(which produces machinery) (do not serve any consumption requirement)

• intermediate goods

(which have already undergon some process but still requires further processing)

• consumer goods industries

(whose output serve final consumption requirements)

BUSINESS ENVIRONMENT

Business Environment consists of all those factors that have a bearing on the business,

such as

• the strengths, weaknesses, internal power relationships and orientations of the

organization;

• government policies and regulations;

• nature of the economy and economic conditions;

• socio-cultural factors;

• demographic trends;

• natural factors; and,

• global trends and cross-border developments

• Modern business is dynamic.

• If there is any single word that can best describe today’s business, it is change.

• This change makes the companies spend substantially on Research and development
(R&D) to survive in the market.

Today’s business is characterized by diversification,

which may be:

• Concentric Diversification – It refers to the process of adding new, but related products or
services.

• Horizontal Diversification – Adding new, unrelated products or services for present

customers is called horizontal Diversification.

• Conglomerate Diversification – It refers to adding new and unrelated products or services.

Going international is yet another trend followed by modern business houses.

A business firm is an open system.

It gets resources from the environment and supplies its goods and services to the environment.

There are different levels of environmental forces.

Some are close and internal forces whereas others are external forces.

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External forces may be related to national level, regional level or international level.

COMPONENTS OF BUSINESS ENVIRONMENT

Firm may not sometimes have complete control over all the internal factors.

Also, it is some times possible to change certain external factors.

Some of the external factors have a direct and intimate impact on the firm (like the suppliers and
distributors of the firm).

These factors are classified as micro environment, also known as task environment and operating
environment.

There are other external factors which affect an industry very generally (such as industrial policy
demographic factors etc).

They constitute what is called macro environment, general environment or remote environment.

INTERNAL ENVIRONMENT

• Value System

o Tata Sons

o After the EID Parry group was taken over by the Murugappa group,
one of the most profitable businesses (liquor) of the ailing Parry group was
sold off as the liquor business did not fit into the value system of the
Murugappa group.

• Vision, Mission and objectives

Infosys

o Ranbaxy's thrust in to the foreign markets and development has

beendriven by its mission "to become a research based international
pharmaceutical company.

• Management structure and nature

o Wipro vs Tata group

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 The share-holding pattern could have important managerial implications. There are very large
companies where majority of the share is held by the promoters (like Wipro) and there are large
firms where the promoters' position is very vulnerable (like the Tata group of companies)

• Internal power relationship

• relationship between the members of Board of Directors and between

the chief executive and the Board

• Human resources

• Infosys

• Rover Group, observes that a Japanese company of 30,000 employees is

30,000 process improvers. In a Western company, it is 2,000 process
improvers and 28,000 workers.

• Company image and brand equity

• image of the company matters while raising finance, forming joint

ventures or other alliances, soliciting marketing intermediaries, entering
purchase or sale contracts, launching new, products etc.

• Miscellaneous Factors

• Physical assets

• R&D Technological capabilities

• Marketing resources

• Financial factors

• EXTERNAL ENVIRONMENT

Micro Environment Macro Environment

It consists of the factors in the It comprises general trends and forces
company’s immediate environment that may not immediately affect the
that affect the performance of the organization but sooner or later will
company alter the way organization operates.
• Suppliers • Technological environment
• Customers • Economic environment
• Competitors • Political environment
• Marketing intermediaries • Natural environment
• Financers • Global or international
• Public environment
• Social and cultural environment

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 MACRO ENVIRONMENT

Economic Environment

The economic environment constitutes to economic conditions, economic policies, and the
economic system that is important to external factors of business.

Economic system Import and export policy

Nature of the country economy Tax rates, Interest rates
The monetary and fiscal policies Government budget deficit & Consumption pattern
Autonomy of the economy Price fluctuations
Functions of economics Global movement of labour and capital
Factors of productions Stock market trends
Economic trends and structures Availability of credits
Economic policy statements and structure Inflation trends in country
Economic legislation
Cultural Environment
Unemployment trends
Economic problems Foreign country economic conditions……
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 • Social Customs & Rituals and practices

• Lifestyle patterns

• Family structure

• Role & position of men, women, children and aged in family & society

Demographic Environment

• Growth of population

• Age Composition

• Life Expectancy

• Sex Ratio

• Fertility and Mortality rates

• Inter-state migration

Technological Environment

• Sources of technology

• Technological development

• Impact of technology

Political Environment

• Political parties in power

• Political Philosophy

Regulatory Environment

• Constitutional framework

• Policies relating to pricing and foreign investment

• Policies related to the public sector, SSIs, development of backward areas

• control of environmental pollution

International environment

• Growth of world economy

• Distribution of world GDP

• International institutions IMF,WTO ILO

• Economic relations between nations

• Global human resource-nature and quality of skills, mobility of labor

• Global technology and quality standards

• Global demographic patterns

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CHARACTERISTICS OF BUSINESS ENVIRONMENT

• Environment is Complex

• Environment is Multi–faceted

• Environment is Dynamic

• Environment has a far reaching impact

ENVIRONMENTAL ANALYSIS

• Environment analysis is to analysis changes pattern and impact of business for decision
making.

• It will considers to an opportunity to use and time to anticipated the corporate objectives
through proper planning and make optional utilization of available resource in the company.

• These things helps to strategist to form and develop and give warning early system to
prevent threats or to develop strategies which can be turn threat into advantages

• Environmental analysis is a strategic tool.

• It is a process to identify all the external and internal elements, which can affect the
organization’s performance.

ENVIRONMENTAL ANALYSIS HAS THREE BASIC GOALS AS OUTLINED .

• Environmental analysis must be provided the current and potential changes

• Environment analysis basically provide strategic inputs for strategic decision making. (It is
not mere collection of data)

• Environment analysis is the basic tool and it should make facilitate and foster strategic thinking in
the organisation.

IDENTIFICATION OF STRATEGIC FACTORS

1. Functional approach

2. The value chain approach

i. Functional approach

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Functional approach refers to organisation basic capabilities; characteristics, swot analysis and
limitation are the key strategic factors.

Functional approach key strategic factors are as follows:

• Marketing

• Finance and accounting

• Production /operation/ technical

• Human resource development

• Organisation of general management

ii. THE VALUE CHAIN APPROACH

A value chain approach is a systematic way of viewing the serious activities of the organisation that
performs to provide a product to its customers. An organisation gains competitive advantage by
performing primary and support activities, these activities are more important strategically.

• Primary activities

• Support activities

EVALUATION OF STRATEGIC INTERNAL FACTORS

• Comparison with organisation’s past performance

• Stages of product/market evolution

• Comparison with the competitors

• Comparison with key success factors in the organisation’s industry

ENVIRONMENTAL ANALYSIS

STAGES:

• scanning – to identify the factors that impact the organization

• monitoring – in-depth analysis of relevant environmental trends

• forecasting – identifying future opportunities and threat

• assessment – assess the impact of the environmental factors on the organization

APPROACHES:

• Outside IN (macro) approach (broader view)

• Inside OUT (micro) approach (narrow view)

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 SWOT ANALYSIS

• The internal factors are generally – regarded as controllable factors because the company
has control over these factors;

• it can alter or modify such factors as its personnel, physical facilities, organization and
functional means, such as marketing mix, to suit the environment.

• Strength weakness

• The external factors, on the other hand, are, by and large, - beyond the control of a
company.

• The external or environmental factors such as the economic "factors, socio-cultural factors,
government and legal factors, demographic factors, geo-physical factors etc; are, therefore,
generally regarded as uncontrollable factors.

• Opportunity threat

FIVE FORCES MODEL

According to Michael Porter’s well known model of structural analysis of industries, the
state of competition in an industry depends on five basic competitive forces, viz.

1. Rivalry among existing firms

2. Threat of new entrants

3. Threat of substitutes

4. Bargaining power of suppliers

5. Bargaining power of buyers.

Entry barriers:
Rivalry among existing customers
• government policy
• number of firms and their relative
• economies of scale
market share
• cost disadvantages independent
• state of growth of industry
of scale
• fixed or storage costs
• product differentiation
• indivisibility of capital augmentation
• monopoly elements
• product standardization and switching
• capital requirements
costs
• strategic stake
• exit barrier
Threat of substitutes
Bargaining power of buyers
• diverse competitors
Bargaining power of suppliers • switching costs
10 • expected retaliation
COPMETITOR ANALYSIS

1. Who are the competitors of the firm?

2. What are the current strategies of the competitors?

3. What are their future goals and likely strategies?

4. What drives the competitor?

5. Where is the competitor vulnerable?

6. How are the competitors likely to respond to the strategies of others?

Future goals

Analysis of future goals would be helpful to identify the attitude and behavior of the

competitor and likely strategies.

Current strategy

Assumptions

1. The competitor's assumptions about itself.

2. The competitor's assumptions about the industry and the other companies in it.

Capabilities (SWOT)

Tools for Analyzing the Environment

PEST Analysis

PESTEL Analysis

STEEPLE Analysis

S - Social

T - Technological

E - Economic

E - Environmental

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P - Political

L - Legal

E - Ethical

TYPES OF FORECASTING

• Economic forecast

• social forecast

• political forecast

• technological forecast

STEPS IN ENVIRONMENTAL FORECASTING

• Identification of relevant environmental variables

• collection of information

• selection of forecasting techniques

• Monitoring

TECHNIQUES OF ENVIRONMENTAL FORECASTING

• ECONOMETRIC TECHNIQUES

involves casual models to predict major economic indicators

Can be used when there is well established relationship between two or more variables

Eg. If demand is a function of consumer income, the impact of increase in consumer income on
demand can be predicted using the equation between these two variables

Multiple regression analysis and time series regression models

• TREND EXTRAPOLATION (time series)

Assumes that past is prologue to the future and extrapolate the historical data to the future

• SCENARIO DEVELOPMENT (development of alternative scenario)

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A scenario is a detailed description of how certain events may occur in the future and their
consequences for the organisation

• Premising method (drawing premises based on certain assumptions)

• system diagram method ( based on the present system of organisation)

• critical site method (critical decisions)

• newspaper headline method (using hypothetical headline in newspaper)

• logical possibilities method ( alternative supplement to other models)

• Judgement Models (opinion of people with intimate knowledge of relevant factors)

• BRAINSTORMING

Creative method of generating ideas and forecasts.

Group of knowledgeable people are encouraged to generate ideas, discuss them and to make
forecast.

• DELPHI METHOD (uses panel of experts on subject)

Opinion are gathered from the experts using a semi structured questionnaire or / and interview

• STRATEGIC ISSUES ANALYSIS (qualitative technique )

Systematic monitoring of social, regulatory and political changes that can affect corporate
performance and identify the impact on the company

BENEFITS / IMPORTANCE OF ENVIRONMENTAL ANALYSIS

• awareness of the environment – organization linkage

• helps an organization to identify the present / future threats and opportunities

• provides an insight on factors which influence the business

• helps to understand the transformation of the industry

• identification of risks

• prerequisite for formulation of right strategies

• helps making suitable modifications of strategies when needed

• keeps managers informed, alert and often dynamic

LIMITATION OF ENVIRONMENTAL FORECASTING

Limitations of forecasting arise from the limitation of the methods used and errors affecting the
reliability of the forecasts

Internal Business External

Environment Decision Environment
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METHODS OF ASSESSING ENVIRONMENT RISK

Expert opinion

Rating and ranking systems

Economic methods

Checklist

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 Module 1 Concepts and significance of economic environment

Economic Environment refers to those economic factors which have impact on the working of
business.

ELEMENTS OF ECONOMIC ENVIRONMENT

• Economic Conditions - includes income level, distribution of income, demand and supply
trends etc. If the economy is in boom conditions, it positively affect demand and market
share. On the other hand if the economy is in depression, it will have negative effect on the
business.

• Economic Policies - Economic policies are framed by government. These policies establish
relationship between business and government. The effect of these policies may be
favourable or Unfavourable

• Economic System - Different economic system prevail in different countries. These system
affect the business. The economic system includes capitalism, socialism and mixed economy

FEATURES OF ECONOMIC ENVIRONMENT.

• Economic indicators

• Market conditions

• Business cycles

• Economic policies

• Globalization

• Technological advancements.

FEATURES OF ECONOMIC ENVIRONMENT

Factors go on changing, according to country, time

Dynamic
period and circumstances

Mutually interrelated human factors are

Effect of various factors
controllable, but nature is not

Related with economic activities Banking, business, transport, communications,...

Affected with non economic factors also

Infrastructure Availability of communication, transport....

Role of government Government policies

Inequal distribution leads to corruption, robbery,

Economic disparities
black marketing.....

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 Public morality Ethical values, high moral standards

Effect of economic system Capitalism, socialist, mixed

Availability of sufficient capital leads to optimum use

Availability of capital
of human and natural resources

Conceptual terms:

• Economic growth –

• Increase over time in a country’s real output of goods and services – or more
appropriately product per capita

• Economic development –

• progressive changes in the socio-economic structure of a country.

• Development is measured from the perspective of progressive reduction in

unemployment, poverty and inequalities

• Economic underdevelopment –

• it is characterised by a low level of per capita income.

• It is the coexistence of unutilized or underutilized manpower and of unexploited

natural resources.

CHARACTERISTICS OF UNDERDEVELOPED ECONOMIES:

• Low GNP per capita

• Scarcity of capital

• Rapid population growth and high dependency burden

• Low levels of productivity

• Technological backwardness

• High levels of unemployment and under employment

• Lower level of human well-being

• Wide income inequalities

• High incidence of poverty

• Agrarian economy

• Lower participation in foreign trade

• Dependence

BRIEF OVERVIEW OF INDIAN ECONOMY

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 • economy of India is a developing mixed economy

BASIC FEATURES OF INDIAN ECONOMY

• Low National Income

• Low per capita Income

• Predominance of Agriculture

• Population Explosion

• Underemployment and Unemployment

• Unbalanced Foreign Trade

• Planned and Mixed Economy

• Poverty in Plenty

• Unbalanced Industrial Growth

• Dependence on Monsoon

• Deficit Financing

• Lack of transportation

• Obsolete Technology

• Vicious cycle of Poverty

INFLATION AND ECONOMY

ECONOMIC SYSTEM

Economics :

is the social science that analyzes the production, distribution, and consumption of goods and
services

Economic system

• a social organism through which people make their living.

• It is constituted of all those individuals, households, farms, firms, factories, banks

and government, which act and interact to produce and consume goods and
services.

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Economic system defined:

The structure that guides production, allocation of economic inputs, distribution of economic
outputs, and consumption of goods and services in an economy.

TYPES OF ECONOMIC SYSTEM:

• CAPITALISM

• SOCIALISM

• COMMUNISM

MIXED ECONOMIC SYSTEM

CAPITALISM

• One of the modern economic system, that appeared after world war II

• An economic system in which factories, equipment, or other means of production are

privately owned rather than controlled by the government.

• Example – United State of America

Laissez-Faire (French for “Leave Alone”)

• The idea that the free market, through supply and demand, will regulate itself if
government does not interfere

• Government should be “hands off” with big business

• Highest form of capitalism

• Ex. Rise of Industry in America in 19th Century

Advantages:
Disadvantages:
• Private ownership
• Unequal distribution of wealth
• Free enterprise
• Monopoly
• Free market
• Oligarchy
• Competitive market

• Innovation and creativity

• Unlimited earning wealth

Relationship between capitalist political system and business:

• The capitalist political system is pro-private businesses. Efficiency is rewarded in the market.
Businesses flourish through efficiency, innovation and serving, the consumers. Businesses
are directed by market mechanism, least influenced by governmental factors.

Welfare capitalism:

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 • Capitalism has certain limitations such as neglect of certain business not yielding good
profits or those involving greater risk individual ‘good’.

• So, some state role is needed.

• Here in the government intervenes and fills up the gaps to ensure maximum social
advantage.

• Government supplements and does not substitute private entrepreneurships.

• The characters of capitalism are applicable to this system in total, subject to the above
referred to variation.

• Government relationship with the business takes the same pattern as in the same
capitalism, except the government intervenes in a small way to ensure social welfare of
people at large.

SOCIALISM

• Karl Marx – “workers of the world unite”

• A political and economic theory that advocates ownership of the means of production, such
as factories and farms, by the people rather than by capitalists and land owners.

• Power belongs to the working class

• This system imposes the duty of work on everyone, because ‘who does not work does not
eat’

• Ex – China, Yugoslavia (parts of U.S.S.R.)

• Note: In socialist system, production is done according to plans developed and supervised
by the state, and the output is distributed according to individual contribution

COMMUNISM

• An economic or political system in which the state or the community owns all property and
the means of production, and all citizens share the wealth.

• Creates a classless society (theoretically)

• Ex – Vietnam, Cuba, U.S.S.R.

Advantages:

• Abolition of class divisions in the society

• Abolition of exploitation of man by man

Disadvantages:

• Individual will not be allowed to have more than they barely need

• The system will deny people the initiative, responsibility and the imaginative power and self
interest.

MIXED ECONOMY:

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 • “Mixed economy is that economy in which both government and private individuals exercise
economic control.” –Murad.

• “Mixed economy is that economy in which both public and private sectors cooperate.” -
Prof. Samuelson

• It is a golden mixture of capitalism and socialism.

• Under this system there is freedom of economic activities and government interferences for
the social welfare.

• Hence it is a blend of both the economies.

• The concept of mixed economy is of recent origin.

FEATURES OF MIXED ECONOMY:

• Co-existence of Private and Public Sector

• Personal Freedom

• Private Property is allowed

• Economic Planning

• Price Mechanism and Controlled Price

• Profit Motive and Social Welfare

• Check on Economic Inequalities

• Control of Monopoly Power

TYPES OF MIXED ECONOMY:

i. CAPITALISTIC MIXED ECONOMY:

• ownership of various factors of production remains under private control.

• Government does not interfere in any manner.

• The main responsibility of the government in this system is to ensure rapid economic
growth without allowing concentration of economic power in the few hands.

ii. SOCIALISTIC MIXED ECONOMY:

means of production are in the hands of state.

The forces of demand and supply are used for basic economic decisions.

However, whenever and wherever demand is necessary, government takes actions so that basic idea
of economic growth is not hampered

Liberal Socialistic Mixed Economy

the government interferes to bring about timely changes in market forces so that the pace of rapid
economic growth remains uninterrupted.

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Centralised Socialistic Mixed Economy

major decisions are taken by central agency according to the needs of the economy.

Merits of Mixed Economy Demerits of Mixed Economy

• Encouragement to Private Sector • Un-stability
• Ineffectiveness of Sectors
• Freedom • Inefficient Planning
• Optimum Use of Resources • Lack of Efficiency
• Delay in Economic Decisions
• Advantages of Economic Planning • More Wastages
• Corruption and Black Marketing
• Lesser Economic Inequalities
• Threat of Nationalism
• Competition and Efficient Production

• Social Welfare

• Economic Development

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Parameters Capitalist economy Socialist economy Mixed economy

Ownership of property Private ownership Public ownership Both public and private
ownerships

Price determination Prices are determined by the Prices are determined by the Prices are determined by the
market forces of demand and central planning authority. central planning authority, and
supply. demand and supply.

Motive of production Profit motive Social welfare Profit motive in the private
sector and welfare motive in
the public sector

Role of government No role Complete role Full role in the public sector
and limited role in the private
sector

Competition Exists No competition Exists only in the private sector

Distribution of income Very unequal Quite equal Considerable inequalities exist

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ECONOMIC REFORMS IN INDIA

Economic reforms refer to the policies and measures undertaken by a government to improve the
functioning of its economy.

These reforms may involve changes to fiscal and monetary policies, trade regulations, and market
structures to promote economic growth and development.

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FUNCTIONS OF STATE

(ADOPTED FROM WORLD BANK, WORLD DEVELOPMENT REPORT)

ADDRESSING MARKET FAILURE IMPROVING EQUITY

Providing Pure public goods

• Defense Protecting the poor

MINIMAL • Law and order • Antipoverty

FUNCTIONS • Property rights programmes

• Macroeconomic management • Disaster relief

• public health

Overcoming
• Providing social
Addressing Regulating imperfect
insurance
externalities monopoly information
• Redistributive
INTERMEDIATE • Basic • Utility • Insurance
pensions
FUNCTIONS education regulation • Financial
• Family allowances
• Environment • Antitrust regulation
protection policy • Unemployment
• Consumer
insurance
protection

Coordinating private activity Redistribution

ACTIVIST
• Fostering markets • Asset
FUNCTIONS
• Cluster initiatives redistribution

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The common objective of all these measures is to improve productivity and efficiency of the
economy by creating a more competitive environment therein.

The reforms can be classified into two broad categories:

• Liberalisation, privatisation and globalisation measures.

• Macroeconomic reforms and structural adjustments.

ECONOMIC ERA – INDEPENDENT INDIA

The Early Years

- started out with the independence

- high degree of uncertainty

- Socialist model of development

- Planning Commission was set up

- process of generating five-year Plans was initiated.

- first plan focused on Agriculture and the second on Industries

- Navratna’s had their roots in this period

- large amount of investment in the infrastructure sector

- Planning estimates often went awry and delays became commonplace

- Chinese War of 1962

- depend on aid of food from the US and other countries

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ECONOMIC ERA – INDEPENDENT INDIA

• The Nationalist Era

- period after Nehru was politically fluid and notable reforms did not happen immediately.

- Indira Gandhi became the Prime Minister

- the state became the planner and the executor of macroeconomic policies.

- success of the Green Revolution

- nationalization was done in the Banking and the Refining Sector

- During the seventies, India moved closer to the Socialist bloc (SOVIET)

- this period was characterized by the near total withdrawal of Western companies from
India.

- Rajiv Gandhi became the Prime Minister

- opening up of the telecom sector and the focus on high technology

- Investment stagnated and to fund government investment, tax rates were very high

- savings rate was also poor & government had to rely on internal and external debt

- First Gulf War saw high oil prices

- This period saw India pledging its gold to boost up reserves

• The Post-Reform Era

- India undertook short-term stabilization measures and long term economic reform in the
wake of this crisis primarily included, pledging of gold to meet short term payment, a de-
valuation of the rupee, tightening of imports, change in monetary policy and some
international loans Once the short term was dealt with India embarked on structural reform
of the economy.

Need for Economic Reforms or New Economic Policy

• Increase in Fiscal Deficit

• Increase in Adverse Balance of Payments:

• Gulf Crisis

• Fall in Foreign Exchange Reserves

• Rise in prices

• Poor Performance of Public Sector Undertakings (PSU)

In India, major economic reforms have been implemented since its independence in 1947.

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These reforms have been aimed at liberalizing the Indian economy and reducing the government's
control over it.

Some of the major economic reforms in India since independence:

INDUSTRIAL POLICY REFORMS

(promoted import substitution and protected domestic industries from foreign competition)

FISCAL AND MONETARY REFORMS

(aimed at reducing inflation and improving the efficiency of the financial sector)

TRADE POLICY REFORMS

(to liberalize trade and reduce barriers to international trade)

FINANCIAL SECTOR REFORMS

(aimed at improving the efficiency of the banking system and increasing access to credit.)

INFRASTRUCTURE DEVELOPMENT

(to promote economic growth and development)

A, INDUSTRIAL POLICY REFORMS IN 1950’s

Some of the Major features were:

• LICENSE RAJ (to ensure that industrial development was controlled and regulated by
the government.)

• PUBLIC SECTOR DOMINANCE (government set up public sector enterprises in key

sectors )

• IMPORT SUBSTITUTION (government imposed high tariffs on imported goods and

provided incentives for domestic production)

• SMALL SCALE INDUSTRIES (government provided subsidies and other incentives to

small-scale industries)

• PROTECTIONISM (government imposed strict regulations on foreign investment and

limited the participation of foreign companies in the Indian market)

• Indian economy had experienced major policy changes in early 1990s.

• The new economic reform, popularly known as, Liberalization, Privatization and
Globalization (LPG model) aimed at making the Indian economy as fastest growing economy
and globally competitive.

• The series of reforms undertaken with respect to industrial sector, trade as well as financial
sector aimed at making the economy more efficient.

Liberalisation

Liberalisation of the economy means to free it from direct or physical controls imposed by the
government

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Prior to 1991, government had imposed several types of controls on Indian economy,

e.g.,

• industrial licensing system;

• price control or financial control on goods,

• Import license,

• foreign exchange control,

• restrictions on investment by big business houses, etc.

MEASURES TAKEN FOR LIBERALISATION

• Abolition of Industrial Licensing and Registration (de-licensing)

• Concession from Monopolies Act (abolishing MRTP Act)

• Freedom for Expansion and Production to Industries

• Increase in the Investment Limit of the Small Industries

• Freedom to import Capital Goods

PRIVATISATION

• Transfer of ownership and/or management of an enterprise from the public sector to the
private sector.

• Another dimension of privatization is opening up of an industry that has been reserved for
the public sector to the private sector.

• Privatization may be defined as the TRANSFER of the public sector activities and functions to
the private sector.

• Privatization is premised on the assumption of the SUPERIORITY OF MARKET FORCES over

administrative directives in governing economic activity to achieve efficiency

• This applies to the commercial and industrial enterprises which are often owned, managed
and implemented by the public sector which could otherwise be operated by the private
sector.

OBJECTIVES:

• To improve the performance of PSUs (Public Sector Undertakings) so as to lessen the

financial burden on taxpayers.

• To increase the size and dynamism of the private sector, distributing ownership more
widely in the population at large.

• To encourage and to facilitate private sector investments, from both domestic and foreign
sources.

• To generate revenues for the state.

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 • To reduce the administrative burden on the state.

• Launching and sustaining the transformation of the economy from a command to a market
model.

IMPORTANT WAYS OF PRIVATIZATION ARE:

• Divestiture or privatization of ownership, through the sales of equity.

• Denationalization or reprivatisation.

• Contracting -under which government

• Franchising-. authorizing the delivery of certain services in designated geographical areas-

is common in utilities and urban transport.

• contracts out services to other orgnisation

• Government withdrawing from the provision of certain goods and services leaving then
wholly or partly to the private sector.

• Privatization of management, using leases and management contracts

• Liquidation, which can be either formal or informal. Formal liquidation involves the closure
of an enterprise and the sale of its assets. Under informal liquidation, a firm retains its legal
status even though some or all of its operations may be suspended.anizations that produce
and deliver them

BENEFITS OF PRIVATIZATION

• It reduces the fiscal burden of the state by relieving it of the losses of the SOEs

(State owned Enterprise) and reducing the size of the bureaucracy.

• Privatization of SOEs enables the government to mop up funds.

• Privatization helps the state to trim the size of the administrative machinery.

• It enables the government to concentrate more on the essential state functions.

• Privatization helps accelerate the pace of economic developments as it attracts more resources
from the private sector for development.

• It may result in better management of the enterprises.

• Privatization may also encourage entrepreneurship.

ARGUMENT AGAINST PRIVATIZATION IS AS FOLLOWS:

• The public sector has been developed with certain noble objectives and privatization means
discarding them in one stroke.

• Privatization will encourage concentration of economic power to the common detriment.

• If privatization results in the substitution of the monopoly power of the public enterprises by the
monopoly power of private enterprises it will be very dangerous.

• Privatization many a time results in the acquisition of national firms by foreign firms.

29
• Privatization of profitable enterprises, including potentially profitable, means foregoing future
streams of income for the government.

• Privatization of strategic and vital sectors is against national interests.

• There are well managed and ill-managed firms both in the public and private sectors. It is not
sector that matters, but the quality and commitment of the management.

• The capital markets of developing countries are not developed enough for efficiently carrying out
privatization.

• Privatization in many instances is a half-hearted measure and therefore it is not properly carried
out. As a result that the expected results may not be achieved.

• In many instance, there are vested interested behind privatization and it amounts deceiving the
nation. In many countries privatization often has been a “garage sale” to favored individuals and
groups.

TYPES OF PRIVATIZATION:

1. By section – namely government sectors which are service based that had been transferred to
the private sector.

2. By Choice- mainly government sectors that are partly privatized.

3. Trade Oriented- whereby the government still holds the company but the capital concepts are
privatized.

4. By Contract- whereby the private sector would prepare the services for the government.

5. By Mortgage- where by the facilities provided by the government would by rent by the private
sector.

GLOBALISATION

the growing economic interdependence of countries worldwide through increasing volume and
variety of cross border transactions in goods and services and of international capital flows, and also
through the more rapid and widespread diffusion of technology”.

Globalization may be considered at two levels:

• at the macro level (i.e., globalization of the world economy) and

• at the micro level (i.e., globalization of the business and the firm).

REASONS FOR GLOBALISATION

• The rapid shrinking of time and distance across the globe due to faster communication,
speedier transportation, growing financial flows and rapid technological changes.

• The domestic markets are no longer adequate rich. It is necessary to search of international
markets and to set up overseas production facilities.

• Companies may choose for going international to find political stability, which is relatively
good in other countries.

• To get technology and managerial know-how.

30
 • Companies often set up overseas plants to reduce high transportation costs.

• Some companies set up plants overseas so as to be close to their raw materials supply and
to the markets for their finished products.

• Other developments also contribute to the increasing international of business.

• The creation of the World Trade Organization (WTO) is stimulating increased cross-border
trade.

STAGES OF GLOBALISATION

First stage

The first stage is the arm’s length service activity of essentially domestic company, which moves into
new markets overseas by linking up with local dealers and distributors.

Second stage

In the stage two, the company takes over these activities on its own.

Third stage

In the next stage, the domestic based company begins to carry out its own manufacturing, marketing
and sales in the key foreign markets.

Four stage

In the stage four, the company moves to a full insider position in these markets, supported by a
complete business system including R & D and engineering. This stage

calls on the managers to replicate in a new environment the hardware, systems and operational
approaches that have worked so well at home.

Fifth stage

In the fifth stage, the company moves toward a genuinely global mode of operation.

GLOBALIZATION STRATEGIES

• Exporting

• Licensing and Franchising

• Contract manufacturing

• Management contracting

• Turnkey contracts

• Wholly Owned Manufacturing Facilities

• Joint Ventures

• Third country location

• Mergers and acquisitions

• Strategic alliance

31
 • Counter trade

MAIN COMPONENTS OF GLOBALISATION OF INDIAN ECONOMY

• Increase in Foreign Investment

• Devaluation

• Reduction in tariffs

• Export Promotion

• Rupee made Convertible

• ARGUMENTS IN FAVOUR OF GLOBALIZATION ARE:

• • Productivity grows more quickly when countries produce goods and services in which they
have comparative advantage.

• • Living standards can go up faster.

• • Global competition and imports keep a lid on prices, so inflation is less likely to derail
economic growth.

• • An open economy spurs innovation with fresh ideas from abroad.

• • Export jobs often pay more than other jobs.

• • Unfettered capital flows give access to foreign investment and keep interest rates low.

• ARGUMENTS AGAINST GLOBALIZATION

• • Millions have lost jobs due to imports or production shifts abroad. Most find new jobs that
pay less.

• • Millions of others fear losing their jobs, especially at those companies operating under
competitive pressure.

• • Workers face pay cut demands from employers, which often threaten to export jobs.

• • Services and white-collar jobs are increasingly vulnerable to operations moving offshore.

• • Employees can lose their comparative advantage when companies build advanced
factories in low-wage countries, making them as productive as those at home.

• MACROECONOMIC REFORMS AND STRUCTURAL ADJUSTMENTS

• • Fiscal reforms

• • Banking Reforms

• • Capital market reforms

• • Containment of inflation and public debt

• • Phasing out of subsidies, dismantling of price controls and introduction of market-

• driven price environment.

• • Public sector restructuring

32
 • • Exit policy

• MAIN OBJECTIVES

• To maintain a sustained growth in productivity

• To enhance gainful employment

• To prevent undue concentration of economic power

• To achieve optimal utilization of human resources

• To attain international competitiveness and

• To transform India into a major partner and player in the global arena

Pre vs. Post 1991 Policy

Distinctive Objectives of New Industrial Policy (NIP), 1991: NIP had two distinctive objectives
compared to the earlier industrial policies:

i) Redefinition of Concept of Self-Reliance:

Since 1956 till 1991, India had always emphasized on Import Substitution Industrialization (ISI)
strategy to achieve economic-self reliance.

Economic self-reliance meant indigenous development of production capabilities and producing

indigenously all industrial goods, which the country would demand rather than importing from
outside.

ii) International Competitiveness:

NIP emphasized the need to develop indigenous capabilities in technology and manufacturing to
world standards.

For the first time, NIP explicitly underlined the need for domestic industry to achieve international
competitiveness.

The important elements of NIP can be classified as follows:

1. Public sector de-reservation and privatization of public sector through disinvestment

2. Industrial Delicensing;

3. Amendments of Monopolies and Restrictive Trade Practices (MRTP) Act, 1969;

4. Liberalised Foreign Investment Policy;

5. Foreign Technology Agreements (FTA);

6. Dilution of protection to SSI and emphasis on competitiveness enhancement

33
MONETARY AND FISCAL POLICY
Definitions

Johnson : “Monetary policy is the policy employing central bank’s control of the supply of money as
an instrument for achieving the objectives of general economic policy.”

G.K. Shaw : “Any conscious action undertaken by the monetary authorities to change the quantity,
availability or cost of money is monetary policy.”

Monetary policy refers to

the use of monetary instruments under the control of the central bank to regulate magnitudes such
as interest rates, money supply and availability of credit with a view to achieving the ultimate
objective of economic policy.

Monetary policy refers to the policy of the central bank with regard to the use of monetary
instruments under its control to achieve the goals specified in the Act.

The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy. This
responsibility is explicitly mandated under the Reserve Bank of India Act, 1934.

Monetary policy refers to the actions taken by a country's central bank to manage the supply of
money and credit in the economy.

The central bank uses monetary policy tools such as interest rates, reserve requirements, and open
market operations to influence the amount of money available in the economy and the cost of
borrowing.

The goal of monetary policy is to achieve price stability, sustainable economic growth, and full
employment.

The Monetary and Credit Policy is the policy statement, traditionally announced twice a year,
through which the Reserve Bank of India seeks to ensure price stability for the economy.

These factors include - money supply, interest rates and the inflation.

In banking and economic terms money supply is referred to as M3 - which indicates the level (stock)
of legal currency in the economy.

Besides, the RBI also announces norms for the banking and financial sector and the institutions
which are governed by it.

OBJECTIVES OF THE MONETARY POLICY

• Price Stability

• Controlled Expansion Of Bank Credit

• Promotion of Fixed Investment

• Restriction of Inventories and stocks

• To Promote Efficiency

34
 • Reducing the Rigidity

• Economic growth

• Exchange rate stability

INSTRUMENTS OF MONETARY POLICY

• Bank Rate of Interest - Bank Rate Policy The bank rate, also known as the discount
rate, is the rate of interest charged by the RBI for providing funds or loans to the
banking system.

• Cash Reserve Ratio - CRR, or cash reserve ratio, refers to a portion of deposits (as
cash) which banks have to keep/maintain with the RBI.

• Statutory Liquidity Ratio - Banks are required to invest a portion of their deposits in
government securities as a part of their statutory liquidity ratio (SLR) requirements .

• If SLR increases the lending capacity of commercial banks decreases thereby

regulating the supply of money in the economy.

• Open market Operations - It refers to the buying and selling of Govt. securities in
the open market.

• Margin Requirements - During Inflation RBI fixes a high rate of margin on the
securities kept by the public for loans.

• If the margin increases the commercial banks will give less amount of credit on the
securities kept by the public thereby controlling inflation.

• REPO RATE AND REVERSE REPO - Repo rate is the rate at which RBI lends to its
clients generally against government securities.

• Reverse Repo rate is the rate at which RBI borrows money from the commercial
banks.

• This increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the
policy.

• Deficit Financing - It means printing of new currency notes by Reserve Bank of India
.If more new notes are printed it will increase the supply of money thereby
increasing demand and prices.

• Thus during Inflation, RBI will stop printing new currency notes thereby controlling
inflation.

• During Inflation the RBI will issue new currency notes replacing many old notes.

• This will reduce the supply of money in the economy.

• Issue of New Currency

• LIMITATIONS OF MONETARY POLICY

• Huge Budgetary Deficits

• Only Commercial Banks are covered

35
 • Problems in management of Financial Institutions and Banks

• Money Market is unorganised

• Black Money

• Exchange Rate Stability

• Inflation control or price stability

• 8.1 Huge Budgetary Deficits

• To control inflation and balance the money supply in the market best efforts are made by
Reserve Bank of India but monetary policy has been unproductive due to budgetary deficits
Of the central government.

• 8.2 Only Commercial Banks are covered

• RBI can control the inflationary pressure caused by banking finance only because it has
control on commercial banks and have no control on other factors which can cause inflation
like goods scarcity and deficit financing.

• 8.3 Problems in management of Financial Institutions and Banks

• Inflation can be controlled by monetary policy and overall development can be achieved
only when there is dedicated and efficient management of banks and financial institutions.

• 8.4 Money Market is unorganised

• There is an unorganized money market present in the Indian financial system over which RBI
has no control .Hence monetary policy turn out to be less effectual

• 8.5 Black Money

• Black money generation is a bigger problem of the Indian economy which is not controllable
by RBI.

• Hence total money supply in the economy is beyond the sphere of RBI and monetary policy.

• Making credit availability to be adequate and lowering cost of credit. Economic

growth quickens

• when credit is available at low interest rate which ultimately stimulates investment.

• 8.6 Exchange Rate Stability

• Fixed exchange rate system is followed by India till 1991 and with permission of IMF, India
devalued the rupee rarely. Since 1991 there is volatility in the exchange rate of rupee due to
globalization and floating exchange rate.

• Fluctuations in rupee exchange rate are due to capital outflows and inflows and
alterations in foreign exchange demand and supply which crop up due to imports and
exports. So as to ensure stability in the foreign exchange rate Reserve Bank have to

36
 take suitable monetary measures to prevent large appreciation and depreciation of foreign
exchange rate.

• 8.7 Inflation control or price stability

• Monetary policy has the major objective to control inflation or maintenance of price
stability.

• However price stability does not mean totally no changes in the prices. In a developing
country like

• India certain price level changes or inflation is quiet expected. Although there may be an
adverse effect of the high degree of inflation on the economy. Firstly the cost of living of the
people is raised by inflation. Secondly, exports are discouraged because inflation makes
them costly and people are forced to import goods because of high prices in domestic
markets. Hence there is an adverse effect on balance of payments due to inflation. Thirdly
due to high inflation money value quickly falls and people have less motivation to save
.Ultimately investments are reduced which leads to lower economic growth. Fourthly people
are encouraged to invest in other assets like real estate, jewellery and gold etc.

FISCAL POLICY

Fiscal policy is a part of the government policy that is concerned with raising revenue through
taxation and other means and deciding on the level and pattern of expenditure

Fiscal Policy deals with the revenue and expenditure policy of the Govt.

Definitions :-

Otto Eskstein :

“changes in taxes and expenditure which aim at short run goals of full employment price level and
stability”.

Harvey and Johnson :

“changes in government expenditure and taxation designed to influence the pattern and level of
activity”.

• Fiscal policy consists of policy decisions relating to the entire financial structure of the
government including tax revenue, public expenditure, loans, transfers, debt management,
budgetary deficit……

• The main objective of the fiscal policy is to bring stability, reduce unemployment and
growth of the economy.

• Attempts to achieve a proper balance among these factors to achieve best possible results
in terms of economic growth

• If the revenue exceeds expenditure, then this situation is known as fiscal surplus, whereas if
the expenditure is greater than the revenue, it is known as the fiscal deficit.

There are two types of fiscal policy, they are:

37
Expansionary Fiscal Policy:

The policy in which the government minimises taxes and increase public spending.

Contractionary Fiscal Policy:

The policy in which the government increases taxes and reduce public expenditure.

The following are the objectives of the Fiscal Policy:

• Higher Economic Growth

• Price Stability

• Reduction in Inequality

The above objectives are met in the following ways:

• Consumption Control – This way, the ratio of savings to income is raised.

• Raising the rate of investment.

• Taxation, infrastructure development.

• Imposition of progressive taxes.

• Exemption from the taxes provided to the vulnerable classes.

• Heavy taxation on luxury goods.

• Discouraging unearned income.

OBJECTIVES OF FISCAL POLICY

• to mobilize adequate resources for financing various programs and projects

adopted for economic development

• to raise the rate of savings and investment for increasing the rate of capital
formation.

• to promote necessary development in the private sector

• to arrange an optimum utilization of resources

• to control the inflationary pressures in economy

• to remove poverty and unemployment

• to attain the growth of public sector for attaining the objective of a socialistic
pattern of society

• to reduce regional disparities

• to reduce the degree of inequality in the distribution of income and wealth

ASPECTS OF FISCAL POLICY

• Taxation policy

• Public expenditure policy

38
 • Public debt policy

• Deficit financing policy

GOVERNMENT RECEIPTS

The categorisation of the government receipts is given below:

Revenue Receipt

• Tax Revenue

o Direct Tax

o Indirect Tax

• Non Tax Revenue

o Fees

o License and Permits

o Fines and Penalties, etc

Capital Receipt

• Loans Recovery

• Disinvestments

• Borrowing and other liabilities

Debt Trap – Situation where the borrower has to borrow again for the payment of an instalment on
the previous debt. A borrower unable to meet debt service obligations without borrowing is known
to be in a debt trap.

GOVERNMENT EXPENDITURE

There are two classifications of public expenditure:

Revenue Expenditure – It is a recurring expenditure:

• Interest Payments

• Defence Expenses

• Salaries to Central Government employees, etc are examples of revenue

expenditure

Capital Expenditure – It is a non-recurring expenditure

• Loans repayments

• Loans to public enterprises, etc.

• FISCAL DEFICIT

• The fiscal deficit is the difference between the government’s total expenditure and its total
receipts (excluding borrowing).

39
 • A fiscal deficit occurs when this expenditure exceeds the revenue generated.

• Fiscal deficit is when a government’s total expenditures exceed the revenue that it
generates (excluding money from borrowings).

• The deficit does not mean debt, which is an addition of annual deficits.

Fiscal deficit = Total Expenditure – Total Revenue (excluding the borrowings)

Fiscal Deficit Financed

There are two sources to finance the fiscal deficit.

Borrowings: internally from a commercial bank, or from external sources like the IMF, other
governments, etc.

Deficit financing (that is, printing new currency): borrowing funds from RBI against its securities (so,
RBI prints new currency).

INSTRUMENTS OF FISCAL POLICY

1. Reduction of Govt. Expenditure

2. Increase in Taxation

3. Imposition of new Taxes

4. Wage Control

5.Rationing

6. Public Debt

7. Increase in savings

8. Maintaining Surplus Budget

Suggestions for necessary reforms in FISCAL POLICY OF INDIA

• progressive tax

• agricultural taxation

• broad based tax net

• checking tax evasion

• increasing reliance on direct taxes

• simplified tax structure

• reduction of non development expenditure

• checking black money

• raising profitability of PSU’s

HOW IS THE MONETARY POLICY DIFFERENT FROM THE FISCAL POLICY?

40
 • The Monetary Policy regulates the supply of money and the cost and availability of credit in
the economy. It deals with both the lending and borrowing rates of interest for commercial
banks.

• The Monetary Policy aims to maintain price stability, full employment and economic growth.

• The Monetary Policy is different from Fiscal Policy as the former brings about a change in the
economy by changing money supply and interest rate, whereas fiscal policy is a broader tool
with the government.

• The Fiscal Policy can be used to overcome recession and control inflation. It may be defined
as a deliberate change in government revenue and expenditure to influence the level of
national output and prices.

BASIS FOR
FISCAL POLICY MONETARY POLICY
COMPARISON

The tool used by the government in

The tool used by the central bank to
which it uses its tax revenue and
Meaning regulate the money supply in the economy
expenditure policies to affect the
is known as Monetary Policy.
economy is known as Fiscal Policy.

Administered by Ministry of Finance Central Bank

The change in monetary policy depends on

Nature The fiscal policy changes every year.
the economic status of the nation.

Related to Government Revenue & Expenditure Banks & Credit Control

Focuses on Economic Growth Economic Stability

Policy instruments Tax rates and government spending Interest rates and credit ratios

Political influence Yes No

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TAXATION POLICY
Tax revenue = important source of income for the government

Direct taxes & indirect taxes

Objectives:

• mobilization of resources for financing economic developments

• formation of capital by promoting saving and investment through time deposits,

investment in government bonds, insurance ….

• attainment of quality in distribution of income and wealth through progressive

direct taxes

• attainment of price stability by adopting an anti-inflationary taxation policy.

PUBLIC EXPENDITURE POLICY

Public expenditure :

• Developmental expenditure &

• Non Developmental expenditure

Developmental expenditure : mostly related to development activities i.e. development of

infrastructure, industry, health facilities, educational institutions,….

Non Developmental expenditure : related to maintenance type expenditure including, law and
order and others……

Some of the important features:

• development of infrastructure

• development of public enterprises

• support to private sector

• social welfare and employment programs

DEFICIT FINANCING

According to Indian Planning Commission

“The term deficit financing is used to denote the direct addition to gross national expenditure
through budget deficits, whether the deficits are on current revenue or of capital accounts.”

• Deficit financing is the budgetary situation where expenditure is higher than the revenue.

• It is a practice adopted for financing the excess expenditure with outside resources.

• The expenditure revenue gap is financed by either printing of currency or through

borrowing

Various indicators of deficit in the budget are:

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Budget deficit = total expenditure – total receipts

Revenue deficit = revenue expenditure – revenue receipts

Fiscal Deficit = total expenditure – total receipts except borrowings

Primary Deficit = Fiscal deficit- interest payments

Effective revenue Deficit-= Revenue Deficit – grants for the creation of capital assets

Monetized Fiscal Deficit = that part of the fiscal deficit covered by borrowing from the RBI

Deficit financing has several economic effects which are interrelated in many ways:

i… Deficit financing and inflation

It is said that deficit financing is inherently inflationary. Since deficit financing raises aggregate
expenditure and, hence, increases aggregate demand, the danger of inflation looms large. This is
particularly true when deficit financing is made for the persecution of war. This method of financing
during wartime is totally unproductive since it neither adds to society’s stock of wealth nor enables
a society to enlarge its production capacity. The end result is hyperinflation. On the contrary,
resources mobilized through deficit financing get diverted from civil to military production, thereby
leading to a shortage of consumer goods. Anyway, additional money thus created fuels the
inflationary fire. Deficit financing and capital formation and economic development

ii… Deficit financing and income distribution.

deficit financing is inflationary or not depends on the nature of deficit financing. Being unproductive
in character, war expenditure made through deficit financing is definitely inflationary. But if a
developmental expenditure is made, deficit financing may not be inflationary although it results in
an increase in money supply. To quote an expert view: “Deficit financing, undertaken for the
purpose of building up useful capital during a short period of time, is likely to improve productivity
and ultimately increase the elasticity of supply curves.” And the increase in productivity can act as an
antidote against price inflation. In other words, inflation arising out of inflation is temporary in
nature.

Deficit Financing and Capital Formation and Economic

Development: The technique of deficit financing may be used to promote economic development in
several ways. Nobody denies the role of deficit financing in garnering resources required for
economic development, though the method is an inflationary one. Economic development largely
depends on capital formation. The basic source of capital formation is savings. But, LDCs are
characterized by low saving-income ratio. In these low-saving countries, deficit finance- led inflation
becomes an important source of capital accumulation. During inflation; producers are largely
benefited compared to the poor fixed-income earners. Saving propensities of the former are
considerably higher. As a result, aggregate savings of the community becomes larger which can be
used for capital formation to accelerate the level of economic development. Further, deficit-led
inflation tends to reduce consumption propensities of the public. Such is called ‘forced savings’
which can be utilized for the production of capital goods. Consequently, a rapid economic
development will take place in these countries.

43
Deficit Financing and Income Distribution: It is said that deficit financing tends to widen income
inequality. This is because of the fact that it creates excess purchasing power. But due to inelasticity
in the supply of essential goods, excess purchasing power of the general public acts as an incentive
to price rise. During inflation, it is said that rich becomes richer and the poor becomes poorer. Thus,
social injustice becomes prominent.

However, all types of deficit expenditure, not necessarily tend to disturb existing social justice. If
money collected through deficit financing is spent on public good or in public welfare programmes,
some sort of favourable distribution of income and wealth may be made. Ultimately, excess dose of
deficit financing leading to inflationary rise in prices will exacerbate income inequality. Anyway,
much depends on the volume of deficit financing.

METHODS OF DEFICIT FINANCING

• Borrowing from the Central Bank- Raising funds from the RBI in the form of new
currency is one of the important instruments for the government in this regard.

• Issue of New Currency- The government may either borrow from the Central Bank
in the form of new currency or issue new currency itself to increase the money
circulation in the economy.

• Withdrawal of its accumulated cash balances from the RBI

OBJECTIVES OF DEFICIT FINANCING

• To finance war-

• Remedy for depression

• Economic development-

• For payment of interest -

• To overcome low tax receipts.

• To overcome the losses of public sector enterprises

• For implementing anti-poverty programmes.

• To finance war- Deficit financing has generally being used as a method of financing war
expenditure. During the time of war, it becomes difficult to mobilize adequate resources;
hence, deficit financing is used as a means of raising funds.

• Remedy for depression - In developed countries deficit financing is used as an instrument of

economic policy for removing the conditions of depression. Prof. Keynes has also advocated
for deficit financing as a remedy for depression and unemployment.

• Economic development- The main objective of deficit financing in an under developed

country like India is to promote economic development. The use of deficit financing in fact
becomes essential for financing the development plans.

• For payment of interest - Loan which are taken by the govt. are supposed to be repaid with
their interest for that government needs money deficit financing is an important tool to get
the income for the repayment of loan along with the interest.

44
 • To overcome low tax receipts.

• To overcome the losses of public sector enterprises

• For implementing anti-poverty programmes.

FISCAL CONSOLIDATION

The measures that are taken to improve the fiscal deficit comes under the process of fiscal
consolidation.

Through fiscal consolidation, the government tries for:

• Improvement in revenue receipts

• Better alignment in the public expenditure

• FISCAL STIMULUS

• Fiscal stimulus may refer to Greater public spending or Tax cuts.

• In both cases, the government wants to boost economic growth.

• In the majority of cases, government bailout packages are also types of fiscal stimulus

ADVANTAGES OF DEFICIT FINANCING IN INDIA

· Firstly, as deficit financing does not impinge any trouble either to the taxpayers or to the lenders
who lend their surplus money to the government, this technique is most popular to meet
developmental expenditure. Deficit financing does not take away any money from anyone’s pocket
and yet provides massive resources.

· Secondly, in India, deficit financing is associated with the creation of additional money by
borrowing from the Reserve Bank of India. Interest payments to the RBI against this borrowing come
back to the Government of India in the form of profit. Thus, this borrowing or printing of new
currency is virtually a cost-free method. On the other hand, borrowing involves payment of interest
cost to the lenders.

· Thirdly, financial resources (required for financing economic plans) that a government can mobilize
through deficit financing are certain and known beforehand. The financial strength of the
government is determinable if deficit financing is made. As a result, the government finds this
measure handy.

· Fourthly, deficit financing has certain multiplier effects on the economy. This method encourages
the government to utilize unemployed and underemployed resources. This results in more incomes
and employment in the economy.

· Fifthly, deficit financing is an inflationary method of financing. However, the rise in prices must be
a short run phenomenon. Above all, a mild dose of inflation is necessary for economic development.
Thus, if inflation is kept within a reasonable level, deficit financing will promote economic
development, thereby, neutralizing the disadvantages of price rise.

· Finally, during inflation, private investors go on investing more and more with the hope of earning
additional profits. Seeing more profits, producers would be encouraged to reinvest their savings and
accumulated profits. Such investment leads to an increase in income, thereby, hereby setting the
process of economic development rolling.

45
MERITS OF FISCAL POLICY OF INDIA

• capital formation

• mobilisation of resources

• incentives to savings

• inducement to private sector

• reduction of inequality

• export promotion

• alleviation of poverty and unemployment

Adverse Effects of Deficit Financing

Deficit financing has several adverse effects on economy. Important evil effects of deficit financing
are given below.

· Leads to inflation - Deficit financing may lead to inflation. Due to deficit financing money supply
increases and so does the purchasing power of the people, which increases the aggregate demand
and thud, the prices increase.

· Adverse effect on saving- Deficit financing leads to inflation and inflation affects the habit of
voluntary saving adversely. In fact, it becomes impossible for people to maintain the previous rate of
savings in the state of rising prices.

· Adverse effect on Investment - Deficit financing affects investment adversely. When there is
inflation in the economy, the trade unions tend to demand an increase in wages, for which they
engage in strikes and lock outs. This is turn decreases the efficiency of labour and creates
uncertainty in the business, which decreases the extent of investment in the country.

· Inequality - in case of deficit financing income distribution becomes unequal. During deficit
financing deflationary pressure can be seen on the economy which makes the rich, richer and the
poor, poorer. The fixed wage earners are badly affected and their standard of living deteriorates.

· Problem of balance of payment - Deficit financing leads to inflation. A high price level as
compared to other countries makes the exports more expensive On the other hand rise in domestic
income and price may encourage people to import more commodities from abroad. This creates a
deficit in balance of payment, and the balance of payment becomes unfavourable.

· Change in the pattern of investment- Deficit financing leads to inflation. During inflation, prices
rise and reach to a very high level in that case people instead of indulging into productive activities
they start practising speculative activities.

DRAWBACKS OF FISCAL POLICY OF INDIA

• instability

• defective tax structure

• inflation

• negative return of public sector growing inequality

46
NATIONAL INCOME

National Income is defined as

the sum total of all the goods and services produced in a country, in a particular period of time.

Normally this period consists of one year duration, as a year is neither too short nor long a period.

National product is usually used synonymous with National income

“National Income is the sum of factor income earned by the normal residents of a country in the
form of wages, rent, interest and profit in an accounting year.”

Concepts of National Income

There are different concepts of National Income, namely

GNP, GDP, NNP, Personal Income and Disposable Income

Gross Domestic Product (GDP)

Gross Domestic Product is the market value of the final goods and services produced within the
domestic territory of a country during one year inclusive of depreciation.

Components of GDP

In GDP we find different components of income namely

(1) Wages and salaries

(2) Rent

(3) Interest

(4) Dividends

(5) Undistributed Profit

(6) Mixed income

(7) Direct taxes.

GDP at market price

GDP at Market Price is estimated by deducting the value of intermediate consumption from the
value of output produced by all the producers within the domestic territory of a country.

In other words, it is estimated as the sum total of gross value added at the market price

47
Gross National Product (GNP)

GNP at market price is sum total of all the goods and services produced in a country during a year
and net income from abroad.

GNP is the sum of Gross Domestic Product at Market Price and Net Factor Income from abroad.

While calculating GNP, the final goods and services of the following are considered:

(a) Consumer goods and services.

(b) Gross private domestic income.

(c) Goods and services produced by Government.

(d) Net income from abroad.

Approaches to GNP

There are three different approaches to GNP, namely income approach, expenditure approach and
product approach.

1. Income approach

In income approach, we find the different categories of Income namely;

(1) Wages and salaries

(2) Rents

(3) Interest

(4) Dividends

(5) Undistributed corporate profits

(6) Mixed incomes

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(7) Direct taxes

(8) Indirect taxes

(9) Depreciation

(10) Net income from abroad.

2. Expenditure approach

In expenditure approach, we find the different categories of expenditure namely,

(1) Private consumption expenditure

(2) Gross domestic private income

(3) Net foreign income

(4) Government expenditure on goods and services.

3. Product approach

In product approach, we find the following categories of output.

(1) Final market value of goods and services

(2) Less cost of intermediate goods.

Personal Income

Prof. Peterson defines Personal Income as “the income actually received by persons from all
sources in the form of current transfer payments and factor income.”

Total income received by the citizens of a country from all sources before direct taxes in a year.

Disposable Income

Prof. Peterson defined Disposable Income as “the income remaining with individuals after deduction
of all taxes levied against their income and their property by the government.”

Disposable Income refers to the income actually received by the households from all sources. The
individual can dispose this income according to his wish, as it is derived after deducting direct taxes.

Real Income

Goods and services produced in terms of money at current prices will not express/indicate real state
often.

Hence, real income is the national income expressed in terms of a general level of prices of a
particular year, considered as the base year.

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Per capita Income

Percapita Income is derived from dividing national income from the total population of the country.

Stages of Business Cycle

The business cycle is the periodic but irregular up and down movement in economic activities,
measured by fluctuations in real gross domestic product and other macro economic variables.

A business cycle consists a sequence of four phases.

1. Contraction: It refers to a slowdown in the pace of economic activity. It is the lower turning point
of a business cycle.

2. Expansion – It involves increasing pace of economic activity.

3. Peak – the upper turning of a business cycle. It is the peak i.e. highest point of an economic
activity.

4. Recession – it occurs if a contraction is severe enough. A deep trough is called a slum or

depression

GDP
- GDP is one of the best indicators to measure the growth rate of an economy.

- It is a measure of the value of all final goods and services produced in an economy during
the year.

- It is used to calculate national income and as an indicator of economic growth.

- considerable implications on the growth and expansion of business activities.

- NNP indicates the rate of economic growth while PCI indicates increase in the standard of
living of people.

- influence the nature and size of demand and government policies related to business.

Low per capita income means low purchasing power of consumers and thus low demand for
products or services, so a business man has to reduce the price of his commodity to increase its sale
by reducing the cost of production or by selling low cost brands.

Rising level of per capita income leads to better prospects for business and increasing demand of
well known brands.

National Income and Distribution of Income

An increase in national income and equitable distribution of income have a positive effect on
business enterprises by creating opportunities for business units to expand their production
capacity.

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A lower national income leading to lower per capita income and an inequitable distribution of
income has an opposite effect.

in Indian economy which shows that one fourth of population are below the poverty line which
indirectly influences the growth of Indian economic activities negatively.

Thus the income level has important implications for product development, pricing, distribution
systems and other marketing strategies.

How income level plays a role in:

Product development

Pricing

Distribution system….

Nature and Structure of the Economy

India is a mixed economy

Both central planning and market mechanism are used to guide and direct the economy.

The structure of an economy can be determined by considering the contribution of different sectors
primary, secondary and tertiary in the national income.

The primary sector includes agriculture, forestry and fishery.

The secondary sector consists of mining, manufacturing, construction, electricity, gas and water
supply.

The tertiary sector includes services like trade, transport, storage, communication, banking,
insurance services etc.

In India growth rate of the secondary and tertiary sectors has been more than double that of the
primary sector as economy grows.

These structural changes have significant impact on business environment.

Population and Economic Development

In India population has been increasing at very fast pace and it has been estimated that it is going to
surpass china by 2045.

Thus India is the second largest market in terms of number of consumers.

Population is required for utilization of available physical resources in an economy but rapid growth
of population retards economic and social development of the country as it leads to excessive
pressure on existing resources to meet increasing demand, reduction in per capita income and living
standard, retard agricultural development due to increasing pressure on land, low rate of capital
formation due to lesser savings, high level of unemployment.

Urbanization and its Impact

population living in urban areas.

Industrialization or the migration of people

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Large urban areas help to enlarge markets which encourage large scale of production to get
economies of scale with specialization, innovation and inventions of advanced technology, efficient
transport and communication services.

Economies of scale help to reduce the cost of production and thus promote economic growth in an
economy.

But unplanned urbanization leads to increase in unemployment and population below the poverty
line because of exploitation of people working in unorganized sectors, increasing use of capital
intensive technology in urban areas and concentration of income in few hands.

Planned urbanization helps in rural development because cities and towns plays a significant role in
supplying required inputs like essential commodities, seeds fertilizers tractors and other agricultural
machinery and consumer items to the rural areas and in marketing the output of the rural economy

Rate of Inflation
Inflation means the process in which the general price level records a sustained and appreciable rise
over a period of time.

An inflation rate below 5% may be considered as a booster of profits which motivates investment
and higher production.

But inflation rate higher than 5% leads to decrease in economic growth by increasing cost for
business, reducing savings and investment and by increasing uncertainty and risk.

It arises because of demand pull factors i.e. the excess of aggregate demand over excess supply and
Cost push factors i.e. sudden increase in price of inputs, sharp rise in wage rate, tax rates

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Money Supply
Money supply in an economy determines liquidity in the market, interest rate structure, cost of
capital to business and the rate of inflation.

Thus growth rate of output is related to the growth of money supply.

Increase in money supply raises the level of aggregate demand in the economy which may lead to
inflation.

Thus excess of money supply creates inflation and its shortage causes liquidity crunches.

It is controlled by the central bank of a country

BUSNIESS THAT PROSPER DURING EXCESS MONEY SUPPLY? AND VICA VERSA

Foreign Exchange Reserves

it constitutes foreign currency assets, central bank's holdings and special drawing rights.

It is an important indicator of macroeconomic environment as it indicates country's ability to pay for

imports, discharge its external debt liabilities and stabilizes the exchange rate.

Absence of adequate foreign exchange reserves decreases a country's international credibility and
can destabilize the economy by devaluating the country's currency as wide fluctuations in exchange
rate create uncertainty in foreign trade, encourage speculation and discourage investment by
foreign companies

Foreign Trade
Foreign trade (export and import) indicates the degree of a country's openness or globalization.

The composition of foreign trade reflects the nature of an economy like a high level of foreign trade
indicates economic liberalization, degree of international competitiveness and globalization.

On the other hand its low level indicates a country's inward orientation and poor international
economic relations

STUDY THE FOLLOWING GOVERNMENT DEPARTMENTS / INSTITUTIONS

1. NITI AAYOG (a successor to 5 year plan programme)

2. DIPP (Department of Industrial Policy & Promotion)

3. DGTR (Directorate General of Trade remedies)

4. KVIC (Khadi and village industries commission)

FINANCIAL REGULATORS

RBI

SEBI : https://www.sebi.gov.in/ -

IRDA: (Insurance Regulatory and Development Authority of India)

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AMFI: (Association of Mutual Funds in India)

FMC (FORWARD MARKET COMMISSION)

MODULE 3: TECHNOLOGICAL ENVIRONMENT

“A firm that is unable to cope with technological changes may not survive.”

Technology is understood as the application of scientific knowledge to practical tasks.

• Technology reaches people through the business.

• Technology changes fast.

• Businessmen should always be alert to the changed technology.

• They should adopt the changed technology to the business processes.

Technological factors exercise considerable influence on business.

Advances in the technologies have facilitated product improvements and introduction of new
products and have considerably improved the marketability of the products.

A business may have to dramatically change their operating strategy as a result of changes in the
technological environment.

G.K. Galbraith defines technology as a

“systematic application of scientific or other organized knowledge to practical tasks.”

Technology is one of the factors to evaluate the global competitiveness of the firms.

“technology includes the tools – both machine (hard technology) and way of thinking (soft
technology) – available to solve problems and promote progress between and among societies”

FEATURES OF TECHNOLOGICAL ENVIRONMENT:

• technology changes fast.

• The time gap between idea and implementation is falling rapidly.

• New developments must be adopted & new ideas explored

• The effects of technology are widespread.

• Technology is reinforcing in its own. Technology makes technology possible.

• Technological environment is a complex set of knowledge, ideas, and methods.

• Technological environment is dynamic.

THE TECHNOLOGY CYCLE

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 • Following classification, technology management involves carefully implementing five
stages :-

• 1. Awareness phase

• 2. Acquisition Phase

• 3. Adaptation Phase

• 4. Advancement Phase

• 5. Abandonment Phase

COMPONENTS / ELEMENTS OF TECHNOLOGICAL ENVIRONMENT

1. INNOVATION

2. GOVT.POLICY ON TECHNOLOGY

3. TECHNOLOGICAL ORIENTATION

4. RESEARCH AND DEVELOPMENT

5. TECHNOLOGY ABSORPTION

6. TECHNOLOGICAL OBSOLESCENCE

1. INNOVATION;

factor that provides competitive advantage.

Introduction of a new product, use of new method of production, opening of new market, exploring
a new source of raw material supply, reorientation of an industry or some of the forms of
innovation.

Product and process of innovations.

• Product innovation refer to improving the performance and safety of the product.

• Process innovation makes the product cheaper.

CLASSIFICATION OF INNOVATION:

• RADICAL INNOVATION – a basic technology innovation that establishes a new functionality

• INCREMENTAL INNOVATION – a change in an existing technology system that does not

alter functionality but incrementally improves performance, features, safety or quality or
lowers cost.

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 • NEXT GENERATION TECHNOLOGY – a change in an existing technology system that does
not alter functionality but dramatically improves performance, features, safety or quality
and opens up new applications

MAJOR REASONS WHY INNOVATIONS FAIL:

• the better mousetrap no one wanted

• the me – too product meeting a competitive brick wall

• ineffective marketing

• environmental factors ignorance

• technological dog products

• price crunch

2. GOVERNMENT POLICY ON TECHNOLOGY:

• Technology policy of the govt. is an important element of technological environment govt.

policy towards foreign technology is a critical factor.

• Ex. A govt. may favour or disfavour certain types of technologies.

• In countries like India, the over emphasis on indigenous technology led to high cost and
distorted developments.

• The liberalized govt policy since 1991 paved the way for more technological collaborations
and import of latest technology.

3. TECHNOLOGICAL ORIENTATION:

It reduces labour, improves quality, provide better customer service or change the way the firm
operates.

4. RESEARCH AND DEVELOPMENT:

Continuous research and development is carried out world wide to make updated technology.

Business enterprises spend huge amounts on conducting research into technology.

5. TECHNOLOGY ABSORPTION:

Much of the successful growth has due to the purchase of updated technologies from abroad.

There is a time lag between countries in the adoption and diffusion of technologies.

Developing countries generally lag behind the developed once. Even among the developed
countries, the technology absorption is not similar.

6. TECHNOLOGICAL OBSOLESCENCE:

Modernization of business through planned obsolescence is technology management constant

efforts are always made to drive-out old and out dated technology.

When new technology is developed, old methods become obsolete.

SOURCES OF TECHNOLOGICAL DYNAMICS

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 • innovative drive of the company

• customer needs / expectations

• demand conditions

• suppliers offerings

• competitive dynamics

• substitutes

• social forces

• research facilities

• government policy

A…. SOCIAL IMPLICATIONS

High Expectations of Consumers

• Technology has contributed to the emergence of affluent societies, who want more of many
things than more of same things, like varieties of products, superior in quality, free from pollution,
more safe, & more comfortable.

• This calls for substantial investment in R&D.

• One important compulsion for investing in technological advances is customer’s high expectations
regarding design sophistication, quality, delivery, schedules, & prices

• Industry owners in Japan swear by the dictum – the customer is a god who is always right.

• High expectations of consumers pose a challenge & an opportunity to the owners of business
institutions.

System Complexity

• Technology has resulted in complexity

• Modern machines work better & faster no doubt, But if they fail, they need the services of
experts for repairs

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 • They fail often because of their complexity

• A machine or a system is composed of several hundred components, All parts must work in
tandem to accomplish a desired task

• Management is, therefore, under pressure to keep the whole system working all the time.

Social change

• Change in social life (economic basis of society) (an invention may displace thousand of workers,
yet the same invention may result in the creation of a new city somewhere else & create even
more jobs than it originally destroyed)

• Changes pattern of social life (An invention may open new employment opportunities to
women, radically change hours spent at work & in the family, increase available leisure time,
open jobs to youth, & deny them to middle-aged or old workers)

• Status differences are likely to be created (In India, the employees in foreign collaborations are
paid much more than are paid in other local Indian companies, though they do the same job in
the same field)

• Behavior of individual in society (the way we cook, communicate, use media & work are
affected by technology)

• Social Systems

• • technology creates a distinct type of social system, namely, the knowledge society

• • In the knowledge society, use & transfer of knowledge & information, rather than manual
skill, dominates work & employs the largest portion of labour force

• • The knowledge-worker will have to show why he should be retained, what benefit he can offer
to the organisation, & how he can add value to whatever the organisation does

• • He will have to create new jobs in consultation with his employer

• • A job will then become a joint venture

• • When this happens, the worker can forget pension plans.

• B… ECONOMIC IMPLICATIONS:

• A. Increased productivity:

• Technology has contributed to increased productivity in terms of quantity and quality.

• the most fundamental effect of technology is greater productivity in terms of both quality &
quantity

• • This is the main reason why technology at all levels is adopted

• • As a result of productivity improvements, real wages of employees tend to rise & prices of some
products decline.

• Eg.

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• modern factories are now able to produce 10 seconds to produce one car and with a fewer
defects, thanks to the introduction of “SIX-SIGMA” quality programmes.

• B. Spending on research and development :

• Firms are require to consider, decide and take action on research and development.

• Allocation of resources on research and development, technology transfer, time of introducing

technology, replacement of old technology by new one, own or out source the technology,
product or process innovation, and spending vast amount on research and development.

• Important question to answer:

• Should a firm develop its own R&D facility or outsource technology?

• C. Jobs tend to be more intellectual:

• A job lither to handled by an illiterate and un stilled worker now requires the services of an
educated and competent worker.

• Arrangement of a production setup determines who will be near whom, work flow determines
who needs to talk to whom.

• Introduction of new technology dislocates some workers

• This makes it obligatory on the part of business houses to retrain its employees & to

• rehabilitate those displaced & un-trainable

• D. Techno structure problems:

• traditional incentives fail to motivate

• retention is a problem

• difficulty in placing people in a pattern

• E. Bio professional and multi professional managers:

• Today’s business needs bio professional and multi professional managers, attention needs to be
focused on KNOW- How (technology) and Do-How (management).

• F. Increased regulation and stiff opposition:

• Technological advancement invites opposition from the people who beat that new innovations
are a threat to ecology, privacy, simplicity, process innovation and product innovation and even
the human race.

• G. Insatiable demand for capital:

• Technology demands huge investments of capital.

• Acquiring new ideas, and their adoption, educating, training, and maintain of the technocrats and
managers – call for heavy investment.

• Rise and decline of products and organizations:

• Change in technology and new technology destroys the existing products and organizations.

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• Eg: TV affected the businesses of radio-broadcasting companies and movies. A typical product
and have a life-cycle of introduction-growth-maturity-decline-and abandonment.

• A new technology may spawn a major industry but it may also destroy an existing one

• Redefinition of business boundaries:

• Companies may find themselves in a different business due to technological changes.

• Eg: Xerox in the US landed itself in such position in its copier business, thanks to the success of
Japanese firms in miniaturing - products. Because Japanese firms introduced smaller-sized
copiers, Xerox found itself selling to different distribution channels.

• Technology change gives rise to product substitution and differentiation.

• Eg: plastics replaced many uses of steel. Automatic-robotics-CAD/CAM have bestowed cost and
quality advantages on many companies.

• broaden / narrow existing boundaries

• impact on prevailing definitions of individual companies

• product substitution and product differentiation

• innovations

• C…. TECHNOLOGY AND PLANT LEVEL IMPLICATIONS:

• Technology and organization structure:

• Where the companies use fast-changing-technology, matrix structures are common.

• Organisations, which use small-batch technology make one-of –a-kind small quantities of
products.

• Organizations with a mass production technology produce large volumes of production. Eg: cars,
razor-blades, soft drinks. Organizations with continuous process technology produce continuously
with little variation in output.

• B. Fear of risk:

• Technology is always the fear of risk.

• Eg: Du Pont’s corfam, an intended substitute for the forecasted shortage of shoe-leather.

• After an investment of $300 million, the company abandoned the project in 1971 due to quality
and cost problems.

• C. Resistance to change:

• Adapting new technology is expensive and risky.

• Eg: Bajaj Auto Ltd., The company claims to be No:2 in the world of manufacture of two-wheelers.
During the last two decades, the company could not develop a self-starting scooter.

• Specifically, resistance to change stems from the following reasons :-

• 1. Psychological or social commitments to existing products, process & organisation,

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• 2. Sizable capital investments in long-life single-use facilities,

• 3. Low profits & reduced rate of growth,

• 4. Small size or fragmented activities,

• 5. Complacent top management,

• 6. Industry norms & associations or cartels that perpetuate industry-bound thinking,

• 7. Lack of successful entrepreneurial models to emulate, &

• 8. Powerful labour resistance to changes in methods.

• D. Total quality management:

• Almost all organizations have introduced TQM. Managers search out for improved policies and
activities. Employees must search for newer and better ways of doing things.

• E. E-commerce and E- business:

• E-commerce through internet is made possible through technology. E-business emphasizes

integration of systems, processes, organizations, value chains and operates through INTERNET.

• F. Flexible manufacturing system:

• Integration of computer aided design, engineering and manufacturing workers need more
training and higher skills

• Technological change provides an opportunity to change business models

• Any technological advancement will result in :-

• the expanded availability of a range of products & services

• substitution of capital for labour, leading to higher productivity & lower costs

• increases in sales or power for the innovating organisation relative to its competitors

• initiation of changes in behaviour among customers, suppliers, employees, or society,

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• TECHNOLOGY MECHANISMS

Patented products

TECHNOLOGY AND PORTER’S FIVE FORCES

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 DEVELOPING OR ACQUIRING TECHNOLOGY

Favoured if technology is a key Appropriate for technologies which Often important if speed is
competitive advantage are important, but which do not confer important – i.e. no time for
Business may have experience of competitive advantage (e.g. packaging) learning
achieving first-mover advantage Business may want to “follow & May be essential if the
Requires strong insights into imitate” rather than be a market technology is complex or if it is
technology and market needs innovator providing competitors with an
Business must also be willing to New technology may be well beyond advantage
take commercial and financial the skills and experience of the Acquisitions are high risk – have
risks business to be sure that the right
helps limit commercial and financial technology is being bought
risk
A good link with “outsourcing”
The technology adoption lifecycle is a sociological model that describes the adoption or acceptance
of a new product or innovation, according to the demographic and psychological characteristics of
defined adopter groups.

The process of adoption over time is typically illustrated as a classical normal distribution or "bell
curve".

• innovators – had larger farms, were more educated, more prosperous and more
risk-oriented

• early adopters – younger, more educated, tended to be community leaders, less

prosperous

• early majority – more conservative but open to new ideas, active in community and
influence to neighbours

• late majority – older, less educated, fairly conservative and less socially active

• laggards – very conservative, had small farms and capital, oldest and least educated

E COMMERCE

E-commerce means buying and selling of products or services over electronic systems such as the
internet and other computer networks

• Online shopping web sites for retail sales direct to consumers

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 • Providing or participating in online marketplaces, which process third-party
business-to-consumer or consumer-to-consumer sales

• Business-to-business buying and selling

• Gathering and using demographic data through web contacts and social media

• Business-to-Business (B2B) electronic data interchange

• Marketing to prospective and established customers by e-mail or fax (for example,

with newsletters)

• Online financial exchanges for currency exchanges or trading purposes

• Dealing in goods and services through the electronic media and internet is called as
E-commerce.

• E-Commerce or E-business involves carrying on a business with the help of the

internet and by using information technology like Electronic Data Interchange (EDI).

• It relates to a website of a vendor selling or providing services directly from its

portal to the customers.

• They use a digital shopping cart system and allow payment through credit card,
debit card or electronic fund transfer payments.

• The e-commerce industry helps in reducing costs in managing orders while also
interacting with a wide range of suppliers and trading partners.

• It also involves any form of business transaction in which the parties interact
electronically rather than by physical exchanges or direct physical contact.

• The e-commerce has transformed the way business is done in India.

• The Indian e-commerce market is expected to grow to US$ 200 billion by 2026

• growth of the industry has been triggered by increasing internet and smartphone
penetration.

• The ongoing digital transformation in the country is expected to increase India’s

total internet user base to 829 million by 2021 from 636.73 million in FY19.

Concept of E–commerce in India

• Multi product E-commerce

• Single Product E-commerce

• Types of E-commerce Business to Business (B2B)

• Business to Consumer (B2C)

• Consumer to Consumer (C2C)

• Consumer to Business (C2B)

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 • Business to Business to Consumer (B2B2C)

GOVERNMENT INITIATIVES

Since 2014, the Government of India has announced various initiatives namely, Digital India, Make in
India, Start-up India, Skill India and Innovation Fund.

Some of the major initiatives taken by the government:

• Government e-Marketplace (GeM) signed a Memorandum of Understanding (MoU)

with Union Bank of India to facilitate a cashless, paperless and transparent payment
system for an array of services in October 2019.

• In February 2019, the Government of India released the Draft National e-Commerce
Policy which encourages FDI in the marketplace model of e-commerce

• In order to increase the participation of foreign players in the e-commerce field, the
Indian Government hiked the limit of foreign direct investment (FDI) in the E-
commerce marketplace model for up to 100 per cent (in B2B models).

GOVERNMENT INITIATIVES

Some of the major initiatives taken by the government (cont’):

• The heavy investment of Government of India in rolling out the fiber network for
5G will help boost ecommerce in India

• In the Union Budget of 2018-19, government has allocated Rs 8,000 crore (US$ 1.24
billion) to BharatNet Project, to provide broadband services to 150,000 gram
panchayats

• As of August 2018, the government is working on the second draft of e-commerce

policy, incorporating inputs from various industry stakeholders.

• E COMMERCE & SME

• The e-commerce industry been directly impacting the micro, small & medium enterprises
(MSME) in India by providing means of financing, technology and training and has a
favourable cascading effect on other industries as well.

• The Indian e-commerce industry has been on an upward growth trajectory and is expected
to surpass the US to become the second largest e-commerce market in the world by 2034.

• Technology enabled innovations like digital payments, hyper-local logistics, analytics driven
customer engagement and digital advertisements will likely support the growth in the
sector.

• The growth in e-commerce sector will also boost employment, increase revenues from
export, increase tax collection, and provide better products and services to customers in
the long-term.

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ACTIVITIES OF E-COMMERCE

• Increasing the speed of service delivery.

• Use of computer networks to search and retrieve information for human

• Buying and selling of information, products and services via computer network.

• Faster customer response and improve services quality

• Advertising on the internet.

• Online electronic commerce payments just like electronic funds transfer.

BENEFITS OF E-COMMERCE

• The global nature of the technology.

• Low cost.

• Opportunity to reach hundreds of millions of people.

• Interactive nature.

• Variety of possibilities.

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 • Rapid growth of the supporting infrastructures.

• BUSINESS MODELS FOR E COMMERCE

• REVENUE MODEL

• online companies generate revenues from multiple income streams such as advertising,
subscription, affiliate marketing etc. Online models not only sell goods or services but also
contacts (e.g. banner) and information (e.g. user-data)

1. Advertising Revenue Model

Typically, fees are generated from advertisers in exchange for advertisements, which is
ultimately the classic principal among the revenue models besides sales. Even if
representatives of major media companies complain about earning less money with online
advertising than with advertising in print or TV, the figures indicate steadily rising revenues.

The advertising revenue model is based on contacts making it one of the indirect sources of
revenue. The conventional version is display-marketing - for example wallpaper, super banner,
rectangle, skyscraper- which is paid according to traffic (invoice per CPC/cost-per-click or CPX/cost-
per-action)

Examples

• Google (e.g. AdWords and AdSense)

• Facebook

• New York Times (Marketing)

• Subscription Revenue Model

Users are charged a periodic (daily, monthly or annual) fee to subscribe to a service. Many sites
combine free content with premium membership, i.e. subscriber- or member-only content.
Subscription fees do not depend on transactions. Subscribers use the content as long and often as
they want

Examples

Publishers and content services, e.g. newspapers, magazines, tv channels - they provide text,
audio or video content to users who subscribe for a fee to get access to the service or to download
the new issue: New York Times, Netflix

3 TRANSACTION FEE REVENUE MODEL

A company receives commissions based on volume for enabling or executing transactions.

The revenue is generated through transaction fees by the customer paying a fee for a transaction
to the operator of a platform.

The company is a market place operator providing the customer with a platform to place his
transactions. During this process the customer may be presented as a buyer as well as a seller. To
actively participate in this e-market, customers must register, so both parties of a transaction
taking place are identified. From a business perspective, the offer is determined by others as
customers offer their goods online and are acting as sellers.

The amount of the transaction fee can be both – fixed and percentage calculated.

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Examples

• eBay

• Amazon

4 SALES REVENUE MODEL

Wholesalers and retailers of goods and services sell their products online. The main benefits for
the customer are the convenience, time savings, fast information etc. The prices are often
more competitive. In terms of online sales there are different models such as market places as
common entry points for various products from multiple vendors.

Examples

• the shops of single companies, sometimes based on web-catalogs

• e-tailers operating solely over the web: Amazon marketplaces

• AFFILIATE REVENUE MODEL

The affiliate program is an online distribution solution which is based on the principle of
commission. Merchants advertise and sell their products and services through links to partner-
websites. It is a pay-for-performance model: Commissions are only paid for actual revenue or
measurable success.

An affiliate-link includes a code, which identifies the affiliate. That’s how clicks, leads or sales
are tracked. The affiliate therefore acts as the interface between merchants and customers. This
model leads to a win-win situation: the merchants sell their products or services and the affiliates
get their commissions. Variations include banner exchange, pay-per-click and revenue sharing
programs.

The affiliate model is well-suited for the web and therefore very popular.

Examples

• Amazon

• BUSINESS MODELS BASED ON STRATEGIES

• Business-to-Consumer (B2C)

In a Business-to-Consumer E-commerce environment, companies sell their online goods to

consumers who are the end users of their products or services. Usually, B2C E-commerce web
shops have an open access for any visitor, meaning that there is no need for a person to login in
order to make any product related inquiry.

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 2 Business-to-Business (B2B)

In a Business-to-Business E-commerce environment, companies sell their online goods to other

companies without being engaged in sales to consumers. In most B2B E-commerce
environments entering the web shop will require a log in. B2B web shop usually contains
customer-specific pricing, customer- specific assortments and customer-specific discounts.

3 Consumer-to-Business (C2B)

In a Consumer-to-Business E-commerce environment, consumers usually post their products or

services online on which companies can post their bids. A consumer reviews the bids and selects the
company that meets his price expectations.

4 Consumer-to-Consumer (C2C)

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In a Consumer-to-Consumer E-commerce environment consumers sell their online goods to
other consumers. A well-known example is eBay.

DEVELOP AN IDEA OR BASIC BUSINESS MODEL ADRESSING ANY ONE OF THE FOLLOWING

• E-WASTE

• TRAFFIC MANAGEMENT IN URBAN CITY

• E-LEARNING PLATFORM

• INTELLECTUAL PROPERTY

• Intellectual property refers to creations of the mind: inventions; literary and artistic works;
and symbols, names and images used in commerce. Intellectual property is divided into two
categories:

• Industrial Property includes patents for inventions, trademarks, industrial designs and
geographical indications.

• Copyright covers literary works (such as novels, poems and plays), films, music, artistic works
(e.g., drawings, paintings, photographs and sculptures) and architectural design.

• Rights related to copyright include those of performing artists in their performances,

• producers of phonograms in their recordings, and broadcasters in their radio and television
programs

INTELLECTUAL PROPERTY RIGHTS (IPR)

Intellectual property rights are like any other property right. They allow creators, or owners, of
patents, trademarks or copyrighted works to benefit from their own work or investment in a
creation.

These rights are outlined in Article 27 of the Universal Declaration of Human Rights, which provides
for the right to benefit from the protection of moral and material interests resulting from authorship
of scientific, literary or artistic productions.

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The importance of intellectual property was first recognized in the Paris Convention for the
Protection of Industrial Property (1883) and the Berne Convention for the Protection of Literary and
Artistic Works (1886). Both treaties are administered by the World Intellectual Property Organization
(WIPO).

What is a Patent?

A patent is an exclusive right granted for an invention – a product or process that provides a new
way of doing something, or that offers a new technical solution to a problem. A patent provides
patent owners with protection for their inventions. Protection is granted for a limited period,
generally 20 years.

Patents provide incentives to individuals by recognizing their creativity and offering the possibility of
material reward for their marketable inventions. These incentives encourage innovation, which in
turn enhances the quality of human life.

Patent protection means an invention cannot be commercially made, used, distributed or sold
without the patent owner’s consent. Patent rights are usually enforced in courts that, in most
systems, hold the authority to stop patent infringement. Conversely, a court can also declare a
patent invalid upon a successful challenge by a third party.

What rights do patent owners have?

A patent owner has the right to decide who may – or may not – use the patented invention for the
period during which it is protected. Patent owners may give permission to, or license, other parties
to use their inventions on mutually agreed terms. Owners may also sell their invention rights to
someone else, who then becomes the new owner of the patent. Once a patent expires, protection
ends and the invention

enters the public domain. This is also known as becoming off patent, meaning the owner no longer
holds exclusive rights to the invention, and it becomes available for commercial exploitation by
others.

What is a trademark?

A trademark is a distinctive sign that identifies certain goods or services produced or provided by an
individual or a company. Its origin dates back to ancient times when craftsmen reproduced their
signatures, or “marks”, on their artistic works or products of a functional or practical nature.

Over the years, these marks have evolved into today’s system of trademark registration and
protection. The system helps consumers to identify and purchase a product or service based on
whether its specific characteristics and quality – as indicated by its unique trademark – meet their
needs.

Trademark protection ensures that the owners of marks have the exclusive right to use them to
identify goods or services, or to authorize others to use them in return for payment. The period of
protection varies, but a trademark can be renewed indefinitely upon payment of the corresponding

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fees. Trademark protection is legally enforced by courts that, in most systems, have the authority to
stop trademark infringement.

In a larger sense, trademarks promote initiative and enterprise worldwide by rewarding their owners
with recognition and financial profit. Trademark protection also hinders the efforts of unfair
competitors, such as counterfeiters, to use similar distinctive signs to market inferior or different
products or services.

The system enables people with skill and enterprise to produce and market goods and services in the
fairest possible conditions, thereby facilitating international trade.

MODULE 4: INTERNATIONAL BUSINESS ENVIRONMENT

International business includes any type of business activity that crosses national borders.

international business is defined as

“organization that buys and/or sells goods and services across two or more national boundaries,
even if management is located in a single country.”

Elements of international business env

Politics

MNC

EXCHANGE RATE

TRADE TREATIES

FUNDING

MARKETS

SPECIAL DIFFICULTIES IN INTERNATIONAL BUSINESS

• Political and legal differences

The political and legal environment of foreign markets is different from that of the domestic. The
complexity generally increases as the number of countries in which a company does business
increases. It should also be noted that the political and legal environment is not the same in all
provinces of many home markets.

For example, the political and legal environment is not exactly the same in all the states of India.

• Cultural differences

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The cultural differences, is one of the most difficult problems in international marketing. Many
domestic markets, however, are also not free from cultural diversity.

• Economic differences

The economic environment may vary from country to country

• Differences in the currency unit

The currency unit varies from nation to nation. This may sometimes cause problems of currency
convertibility, besides the problems of exchange rate fluctuations. The monetary system and
regulations may also vary.

• Differences in the language

An international marketer often encounters problems arising out of the differences in the language.
Even when the same language is used in different countries, the same words of terms may have
different meanings. The language problem, however, is not something peculiar to the international
marketing. For example: the multiplicity of languages in India.

• Differences in the marketing infrastructure

The availability and nature of the marketing facilities available in different countries may vary
widely. For example, an advertising medium very effective in one market may not be available or
may be underdeveloped in another market.c

• Trade restrictions

A trade restriction, particularly import controls, is a very important problem, which an international
marketer faces.

• High costs of distance

When the markets are far removed by distance, the transport cost becomes high and the time
required for affecting the delivery tends to become longer. Distance tends to increase certain other
costs also.

• Differences in trade practices

Trade practices and customs may differ between two countries.

MULTINATIONAL CORPORATION

The multinational company (MNC) is a company involved in producing and marketing its outputs in
several countries. The outputs may be goods, services, or various combinations of both.

The capacity to act simultaneously in numbers of countries sets the MNC clearly apart from the
domestic company.

A Domestic company has all its operating assets and organizational subunits (departments, divisions,
subsidiaries) in its home country.

It may on occasion engage in exporting or importing by transacting with foreign firms, but its own
capacity to function is limited to the domestic market.

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Some MNCs are motivated by profits, some by raw material, and some by markets, some by
diversification, some by the stability that diversification of markets and operating environments
may offer.

Many pursue several or all of these objectives.

Furthermore, the objectives vary with time, with place, and with circumstances.

From the market perspective, some MNCs cater to individual consumers, some to government
procurement, some to the industrial sector, and some to the military.

Some MNCs operate in a competitive marketing atmosphere, other in oligopolistic rivalry, and some
in monopolistic autonomy

FEATURES OF MNCS:

1. MNCs have managerial headquarters in home countries, while they carry out operations in a
number of other (host) countries.

2. A large part of capital assets of the parent company is owned by the citizens of the company's
home country.

3. The absolute majority of the members of the Board of Directors are citizens of the home country.

4. Decisions on new investment and the local objectives are taken by the parent company.

5. MNCs are predominantly large-sized and exercise a great degree of economic dominance.

6. MNCs control production activity with large foreign direct investment in more than one
developed and developing countries.

Types of MNCs

• Equity-based MNCs

Many older MNCs obtained their multinational capacities through direct foreign investments.

They either built from ground up or bought the equity of the desired capital assets, such as assembly
plants, pharmaceutical laboratories, department stores, banks, flour mill, or whatever operating
facilities they use.

Either way, they became owners of these operating entities.

Equity ownership provides the basis for managerial control over the foreign-based entities and
opens the way for their affiliation or integration with one another internationally by the
headquarters firm.

The MNCs in which the managerial control derives from equity ownership of affiliated enterprises in
different host economies fall into four main types:

1) Resource-based companies. The main mission of these companies is to produce raw

materials, such as metallic ores, oil, rubber, and tropical plantation crops (bananas, coffee,
dates). Many of these are among the very oldest MNCs, with roots in the colonial era.

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 2) Public utility companies. These companies, which include military arsenals, differ from other
economic sectors in that they are either natural monopolies or they serve a monopolistic
(single buyer) market such as the national airline of the host nation.

3) Manufacturing companies. Foreign investment incentive programs have been the common
device for luring inbound industrial incentive. Intricate schemes of tax privilege, protection
against import competition, relaxation of foreign exchange restriction, and government loan
guarantees are parts of such arrangements.

4) Service industry MNCs. The largest components of this category are banks, carriers, retail
stores and firms that sell similar management services have followed the
multinationalization of industrial companies.

• Technology-Based MNCs

A new generation of MNCs has started to emerge in which the source of multinational managerial
control is technology, including management expertise, instead of ownership of operating assets.
These are known as no equity MNCs.

The hotel, mining, and construction industries have pioneered this new generation of MNCs. They
offer an increasingly viable alternative to the older, equity-based model.

• Management Contracts

The main vehicles of the no equity MNC are long-term contracts with owners of suitable operating
facilities, such as hotels or mining properties.

Often the contracts are either formally or informally sanctioned by the host government.

Under such a contract the owners will let the MNC take over possession and management of the
business and the MNC will obligate itself to share profits with the owners by some agreed-upon
formula

• Production Sharing Arrangements

In mining, crude oil production, and other resource-based businesses, profit sharing may be replaced
by output sharing. These arrangements provide that the MNC not only may produce in an extractive
sector (iron ore, coal, petroleum), but also must meet specific obligations for the development of
indigenous supplier industries, for training engineers and managers and for keeping pace with
developments in the industry concerned. This formula rests on an agreed sharing of the output of
the venture.

For instance, if the contract provides of 40: 60 output sharing of a mining property, the MNC will
retain 40 percent of the tonnage and turn over to the owners or, what is more typical, market on the
owners’ behalf the remaining 60 percent.`

• Industrial Lease Agreements

These are contracts under which an owner, sometimes a government corporation, leases a complete
industrial facility, such as a factor or chemical laboratory, to an MNC. The rent consists normally of a
fixed annual sum plus a scale of payments based on the output of the plant. Such lease
arrangements are as yet limited to manufacturing activities in which there have been rapid
technological advances or in which complex specialized facilities are required.

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 • Technology Transfer Agreements

In the high technology industries (electronics, aircraft, computers, bio-chemicals) where the host
government places the highest priority on indigenous production capability, the new mode is a joint
venture between the MNC, whose responsibility it is to provide the technology, and one or several
indigenous companies, which are responsible for financing, often with government assistance.

DRIVERS OF GLOBALISATION

Modes of Foreign Investment

• Entering into contract with the Firms of host country for Sale of MNCs Products

• Establishing Subsidiaries in various countries

• Opening up of Branches Abroad

• Entering into Joint Ventures

• Entering into contract with the Firms of host country for Sale of MNCs Products:

• A multinational firm can enter into contract with the Firms of host country for exporting the
products manufactured/produced by it in the home country to them for sale in their
countries. In such a case, a multinational firm gets an opportunity to sell its product in the
foreign markets and control all aspects of sale operations.

• Establishing Subsidiaries in various countries:

• Another mode for investment abroad by a multinational firm is to set up a wholly owned
subsidiary to operate in the foreign country. In this case a multinational firm has complete
control over its business operations. It ranges from the production of its product or service
to its sale to the ultimate use or consumers. It includes all marketing, operating and other
activities necessary to reach the ultimate end user. The subsidiary acts as an independent
entity in regard to make the product accessible to the user. A subsidiary of a multinational
corporation in a particular country is set up under the Acts which are operative in that
region/country.. However, it enjoys some independence from the parent company.

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• Opening up of Branches Abroad:

• One more important aspect of the operations of MNC’S in this global village approach is
instead of establishing its subsidiaries; Multinational Corporation can set up their branches
in other countries. In this era of globalisation whole globe is treated as a single market.
Thereby following this approach the control remains in the hand of the company originated
in the home country. Various branches of the company are established across nations. The
scale of operations is widened covering various geographical regions. Being branches they
do not act and enjoy complete freedom in their business, legal, operative or other decisions.
They are always linked with their parent company.

• Entering into Joint Ventures:

• The multinational corporations can enter into joint ventures with foreign firms to either
produce its product or to get their product manufactured by he host country from their
domestic companies.

• A multinational firm may set up its business operation in collaboration with foreign local
firms to obtain raw materials not available in the home country. More often, to reduce its
overall production costs multinational companies set up joint ventures with local foreign
firms to manufacture inputs or subcomponents in foreign markets to produce the final
product in the home country

• MNCs - Critics and Defenders

• Because of their visibility across the globe, international businesses have invited criticisms.
They have defenders too.

• 1. Challenge to Nation-state Sovereignty

• The developing countries want control of their economies and want to achieve their
economic, political, and social objectives. The power of the MNCs can influence each of
these objectives and in doing so may be obliged to give up some power and independence in
exchange for the wealth an MNC may bring.

• 2. Inequities

• One of the most enduring and persistent complaints about alleged inequities by LDCs is that
prices of raw materials extracted from their countries, while prices of imported
manufactured goods from industrialized countries are rising. This they say creates a growing
inequity. Other perceived inequities include avoidance of taxes and giving the best
management jobs to MNC home-country citizens.

• 3. Interference with Economic Objectives

• Interference can occur in many ways. For example, an MNC may wish to locate a plant in an
area of prosperity when the host country would prefer its location in an underdeveloped
region. MNC demands of local support can add to host-country expenditures for
infrastructure. Since MNCs typically do their research and development at home, host
countries become technologically dependent on the MNCs for innovation. The MNCs have
the strength to attract bank loans that otherwise might be available for local businesses.

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 • 4. Social Disruption

• The introduction of different mores, habits, behaviors, and ethical values, new products,
management styles, distribution systems, more money, and technology, do affect local ways
of thinking and doing things.

• 5. Environmental Degradation

• Many nations are becoming more concerned about the impact of MNCs on their
environment. Environmental concerns are rapidly moving higher in the chain of priorities
throughout the world.

• 6. Imperialism

• Many of the awakening nations look on foreign managers with fear and distrust as the
embodiment of an old, not easily forgotten, exploitative colonialism.

• 7. Symbol of Frustration and Antipathy

• The LDCs have grievances about their position in the world that have nothing to do with the
MNC but the MNC is a convenient visible target for their anger.

• 8. MNCs and Technology

• The technology brought in by MNCs is hardly suitable to less developed countries. Such
technology is highly capita intensive but developing countries need a labour intensive one. In
addition, technology brought in by MNCs is highly expensive.

• BALANCE OF PAYMENT

• Acc. to Benham:–

• “Balance of payment of a country is a record of the monetary transactions over a period of

time with the rest of the world.”

• Acc. to Kindlebergr :–

• The balance of payment of a country is a systematic record of all economic transactions

between its residents and residents of foreign countries”

According to the RBI, balance of payment is a statistical statement that shows

1. The transaction in goods, services and income between an economy and the rest of the
world,

2. Changes of ownership and other changes in that economy's monetary gold, special drawing
rights (SDRs), and financial claims on and liabilities to the rest of the world, and

3. Unrequited transfers. The balance-of-payments accounts of a country record the payments

and receipts of the residents of the country in their transactions with residents of other
countries. If all transactions are included, the payments and receipts of each country are,
and must be, equal. Any apparent inequality simply leaves one country acquiring assets in
the others.

BOP is a wider term and includes:

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1. Visible Items: Those items which are visible/ touchable/ tangible/ physical – i.e., they can be seen
and measured and touched! BOP includes the export and import of such physical goods.

2. Invisible Items: Are those which cannot be seen (and hence invisible) or touched but can be felt
mainly services. The import and export of services is included like banking/consultancy services of IT/
Legal/ Architecture/ Management/ CA etc./ insurance and logistics services.

3. Unilateral Transfers: As the name suggests are transactions which are one way

. 4. Capital Transfers: Are transfer of title or ownership of capital assets across borders. It includes
purchase/ sale of capital assets like land, building, plant and machinery etc. but across borders

• The balance of payments of a country is a systematic record of all economic transactions

between the residents of a country and the rest of the world.

• It presents a classified record of all receipts on account of goods exported, services rendered
and capital received by residents and payments made by theme on account of goods
imported and services received from the capital transferred to non-residents or foreigners

• Balance of payment refers to the recording of all economic transactions of a given country
with rest of the world.

• Each country has got to enter into economic transactions with other countries of the world.

• As a result of such transactions it receive payment and make payment to other countries.

• So balance of payment is a statement of accounts of these receipts and payments.

• BALANCE OF TRADE is the difference between the value of exports and imports of goods i.e.
visible items only. Thus,
Balance of Trade = Export of visible items – Import of visible items

• DIFFERENCE BETWEEN BOP & BOT Balance of Payments (BOP) is the summary of all the
‘economic’ transactions India has had with the rest of the world (ROW) in a financial year.
Balance of Trade (BOT) is just the summary of the total exports and the total imports of India
in a financial year. Balanced BOP is when forex payment and receipts are equal. Surplus BOP
is when the forex receipts are more than the payments. Deficit BOP is when the forex
payments are more than the receipts. Surplus BOT is when the exports are more than
imports – it is a ‘favourable BOT’. Deficit BOT is when the imports are more than the exports
– it is ‘unfavourable BOT’. BOP summarizes all the inter-country transactions
(ALLinternational transactions) and is a wider term which includes BOT. So, BOT forms a part
of BOP. Whereas BOT is a narrower term, and includes only the summary of export and
import of Visible Items.

FEATURES OF BALANCE OF PAYMENTS :–

• 1. Systematic Record

• It is a systematic record of receipts and payment of a country.

• 2. Double Entry System

• Receipts and payments is based on the double entry system.

• 3. Fixed Period of Time

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 • It is a statement of account related to a given period of time usually one year.

• 4. Comprehensive

• Balance of payment includes receipts and payments of all items government and non-
government.

IMPORTANCE OF THE BALANCE OF PAYMENTS

• BOP records all the transactions that create demand for and supply of a currency. This
indicates demand-supply equation of the currency. This can drive changes in exchange rate
of the currency with other currencies.

• BOP may confirm trend in economy’s international trade and exchange rate of the
currency. This may also indicate change or reversal in the trend.

• This may indicate policy shift of the monetary authority (RBI) of the country.

The various components of a BOP statement

• A. Current Account

• B. Capital Account

• IMF

• SDR Allocation

• Errors & Omissions

• Reserves and Monetary Gold

Current Account

Records flows of exports, imports, investment income, and international financial transfers. •
Merchandise trade export and import of tangible goods • Services payments and receipts for legal
and consulting fees, royalties, tourist expenditures • Investment income payments and receipts of
interest, dividends, and other income on foreign investments • Unilateral Transfers “unrequited”
payments (e.g. Foreign aid). ➢ If the debits exceed the credits, then a country is running a trade
deficit. ➢ If the credits exceed the debits, then a country is running a trade surplus.

 BOP on current account refers to the inclusion of three balances of namely – Merchandise
balance, Services balance and Unilateral Transfer balance.

 In other words it reflects the net flow of goods, services and unilateral transfers (gifts).

 The net value of the balances of visible trade and of invisible trade and of unilateral transfers
defines the balance on current account.

 a record of international transactions that do not create liabilities

Capital Account

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  The capital account records all international transactions that involve a resident of the
country concerned changing either his assets with or his liabilities to a resident of another
country.

 Transactions in the capital account reflect a change in a stock – either assets or liabilities.

 a record of international transactions that do create liabilities; the capital and financial
account includes official and private sales and purchases of financial assets, such as bonds.

 All capital transactions between the countries are monitored through the capital account.
Capital transactions include purchasing and selling assets (non-financial) like land and
properties.

 The capital account also includes the flow of taxes, purchase and sale of fixed assets etc., by
migrants moving out/into a different country. The deficit or surplus in the current account is
managed through the finance from the capital account and vice versa. There are three major
elements of a capital account:

 Loans and borrowings – It includes all types of loans from the private and public sectors
located in foreign countries.

 Investments – These are funds invested in corporate stocks by non-residents.

 Foreign exchange reserves – Foreign exchange reserves held by the country’s central bank
to monitor and control the exchange rate do impact the capital account.

 Capital account: Records sales to foreigners of a country’s financial assets and a country’s
purchases of foreign financial assets. • The capital account is composed of Foreign Direct
Investment (FDI), portfolio investments, and other investment. • Direct investment involves
acquisitions of controlling interests in foreign businesses. • Portfolio investment represents
investment in foreign shares and bonds that does not involve acquisition of control. • Other
investment includes bank deposits, currency investment, trade credit and the like.

The Reserve Account

 Three accounts: IMF, SDR, & Reserve and Monetary Gold are collectively called as The
Reserve Account.

 The IMF account contains purchases (credits) and re-purchase (debits) from International
Monetary Fund.

 Special Drawing Rights (SDRs) are a reserve asset created by IMF and allocated from time to
time to member countries.

 It can be used to settle international payments between monitary authorities of two

different countries.

 The Reserve Account: The Reserve Account of BOP records changes in the amount of
“official” reserve assets held by the Central Bank of that country. • Official reserves assets
include gold, foreign currencies, SDRs, reserve positions in the IMF. • If a country must make
net payment to foreigners because of BOP deficit, the country could either run down its
official reserve assets or borrow a new from foreigners.

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  The Special Drawing Right (SDR) is an interest-bearing international reserve asset created
by the IMF in 1969 to supplement other reserve assets of member countries. The SDR is
based on a basket of international currencies comprising the U.S. dollar, Japanese yen, euro,
pound

 The value of the SDR is set daily by the IMF on the basis of fixed currency amounts of the
currencies included in the SDR basket and the daily market exchange rates between the
currencies included in the SDR basket.

 SDRs are only allocated to IMF members that elect to participate in the SDR Department.
Currently all members of the IMF are participants in the SDR Department.

 SDRs can be held and used by member countries, the IMF, and certain designated official
entities called "prescribed holders" (see below)—but it cannot be held, for example, by
private entities or individuals. Its status as a reserve asset derives from the commitments of
members to hold and exchange SDRs and accept the value of SDRs as determined by the
Fund. The SDR also serves as the unit of account of the IMF and some other international
organizations, and financial obligations may also be denominated in SDR.

 sterling and Chinese Renminbi.

For example, if India buys mobile phones from China, and has no other transactions with China, the
Chinese must end up holding INR, which they may hold in the form of bank deposits in the India or in
some other Indian investment. The payments Indians make to China for mobile phones are balanced
by the payments Chinese make to Indian individuals and institutions, including banks, for the
acquisition of Indian assets. Put another way, China sold India mobile phones , and India sold China
INR or INRdenominated assets such as treasury bills

THE GENERAL RULE IN BOP ACCOUNTING ¢ If a transaction earns foreign currency for the nation, it is
a credit and is recorded as a plus item. ¢ If a transaction involves spending of foreign currency, it is a
debit and is recorded as a negative item.

Favourable Balance of Payment

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When receipts are more than

payments then balance of payment turn favourable.

B=R-P>0

Unfavourable Balance of Payment

Balance of payments is

Unfavourable when its payments are more than its receipts.

B=R-P<0

Equilibrium in Balance of Payments

Balance of payment is in

Equilibrium when payment is equal to the receipts.

B=R-P=0

CAUSES OF UNFAVOURABLE BALANCE OF PAYMENT :

• Import of Machinery

The first cause of unfavourable balance of trade is import of machinery. India imported the large
amount of machinery during the World War II. So these imports caused disequilibrium in the balance
of payment.

• Price Disequilibrium

there has been wide difference in the domestic prices of the goods and the prices of goods in foreign
countries. Due to inflation domestic prices have increased more than the increase in prices of
foreign goods. This lead to increase in imports and decrease in exports

• Foreign Competition

Now a days foreign competition is growing. India mainly exports jute, tea. Sri Lanka and Indonesia is
India’s rival. This has adversely affected our exports.

• Import of War Equipment

During the World War India import the large amount of war equipment. These imports also caused
disequilibrium in the balance of payment

• Payment of Interest on Foreign Debts

India borrowed the foreign debts in large amount. The interest on these debts is also due. The huge
interest burden also caused disequilibrium in the balance of payment.

• Less Growth in Exports

Government promote various export promotion scheme but out exports are still less than our
imports. Therefore growth rate of exports is less than the growth rate of imports. So this is also
caused disequilibrium in the balance of payment.

• Poor Quality of Industrial Production

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The quality of product is also caused the disequilibrium in the balance of trade. Our quality of
product is not good so the export can not be increased. The growth rate of export is still.

• Expenditure on Foreign Embassies

India had to establish its political relations with other countries. It had to set up its embassies in
foreign countries. It was an expensive affair. So this caused in disequilibrium in balance of payment.

• Backward Technology

Now a day competition is growing. Our technology of production is not good. So our quality is not
good. Therefore Backward Technology is also caused in disequilibrium in balance of payment.

• More demand on Consumption Goods

In the post war period, demand not only of foreign goods but also of Indian goods went up. Because
of increase in the population their demand within the country has gone up. So export of these goods
has gone down very much.

SUGGESTION TO CORRECT DISEQUILIBRIUM IN THE BALANCE OF PAYMENT

• Promotion of Exports

Promotion of exports is the best measure to correct an adverse balance of trade. For this export
industries should be provided raw material and transport facilities at reduced prices. So that price of
these goods is low

• Encourage to Foreign Investment

India has to encourage the foreign industries and multinational corporations to invest their capital
special facilities are provided to attract foreign capital. It leads to inflow of foreign exchange the
country

• Increase in Production

Government want to encourage exports it is essential that agricultural, industrial and mineral
production be increased. Raw material should be made available to export industries at
International prices. The government provide various facilities to industries to increase their
production

• Import Substitution

Import substitution plays an important role to correct an adverse balance of payments. Import
substitution means total or partial replacement of an imported product with domestic product of
the same functional requirements. This main objective is to reduce imports.

• Restriction on Inessential Imports

Another important method of correcting balance of Trade is restriction on imports. If the import are
restricted then balance of trade are automatically favourable

• Devaluation of Indian Currency

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Lowering of the value of domestic currency in terms of foreign currencies is called devaluation. A
country resorts to devaluation when its exports fall short of imports. As a result of devaluation,
imports become dearer and exports cheaper.

FOREIGN INVESTMENTS

Types of Foreign Investments:

• Foreign Direct Investment (FDI)

• Portfolio investment

o Foreign institutional investors (FII)

o investments in GDR, FDR, FCCB, ETC….

• FDI

• FDI stands for Foreign Direct Investment.

• It refers to the investment in a foreign country where the investor retains control over the
investment.

• It typically takes forms of starting a subsidary, acquiring a state in an existing firm or

starting a joint venture in the foreign country.

• The main feature of foreign direct investment is that native companies are managed by the
foreign companies.

• It includes foreign collaboration.

• It may be of following types :–

• a) Collaboration between Indian and Foreign Private companies.

• b) Collaboration between Indian Government and Foreign Government.

• c) Collaboration between Indian Government and Foreign Private Companies

CONTRIBUTION OF FOREIGN CAPITAL IN THE ECONOMIC DEVELOPMENT OF INDIA :–

i) Availability of Capital.

ii) Availability of Foreign Exchange.

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iii) Availability of Risk Capital.

iv) Helpful in Export Promotion.

v) Increase in Employment.

vi) Reduction in Inflation.

vii) Availability of Foreign Technology.

viii) Exploitation of Natural Resources.`

ADVANTAGES OF FDI:

• helps increase the investment level and thereby the income and employment in the host
country

• may increase tax revenue of the government

• facilitates transfer of technology to the recipient country

• bring a management revolution in the recipient country through employment of advanced

management techniques

• enable the country to increase its exports and reduce import requirements

• may stimulate domestic enterprise (for sourcing requirements)

• may help in increasing competition and break monopolies

• improves the quality and reduces the cost of inputs.

• LIMITATION OF FOREIGN CAPITAL :–

• i) Increase in Foreign Dependence.

• ii) More burden of External Debt.

• iii) Harmful for Domestic Produces.

• iv) Uncertainty.

• v) Problems of Debt Servicing.

• vi) Adverse effect on the Development of Indian Technology.

• vii) Unbalanced Regional Development.

• viii) Insufficient Development of Internal Financial Resources

FACTORS AFFECTING INTERNATIONAL INVESTMENT:

• rate of interest

• speculation

• profitability

• cost of production

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 • economic conditions

• government policies

• political factors

ECONOMIC TRADE POLICIES (PROTECTIONISM)

REASONS FOR GOVERNMENTAL INTERVENTION

Economic Reasons

• Preventing Unemployment

• Protecting Infant Industries

• Promoting Industrialization

• Improving Comparative Position

Non – Economic Reasons

• Maintaining Essential industries

• Dealing with unfriendly countries

• Maintaining Control

• Preserving National Identity

Economic Reasons

• Preventing Unemployment

• Economic employment of full employment

• Gaining jobs by limiting imports

• Other countries may retaliate

• Impact on other industries

• Protecting Infant Industries

• Government should shield an emerging industry from foreign competition by guaranteeing it a

large share of domestic market until it is ready to compete.

• Efficiency gains take time

• Economies of scale & experience curve translate into higher productivity

• Benefits include higher employment, lower social costs and higher tax revenues

• Promoting Industrialization

• Higher manufacturing base leads to higher per capita income

• Restricting imports leads to developing an industrial base

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• Increase FDI

• Export – led development for local consumption

• Nation building: Build infrastructure, rural development, skill building

• Improving Comparative Position

• Nation’s absolute economic welfare compared with other nations

• Balance of trade adjustments

• Gaining access to foreign markets

• Restrictions as bargaining tool

• Controlling prices

Non – Economic Reasons

• Maintaining Essential industries

• Protect essential domestic industries

• Financial inclusion of necessities

• Rural penetration at affordable prices

• Maintaining competitive advantages in essential industries.

• Water, electricity, banking, railways, etc.

• Dealing with unfriendly countries

• National defence

• Trade of strategic goods

• Used as a method to achieve political objectives

• Maintaining Control

• Governments give aid to and encourage imports from countries that join a political alliance or vote
in a preferred way within international bodies.

• Political motives

• Preserving National Identity

• Unifying sense of identity to be sustained

• National culture to be protected

• Defining boundaries for trade

Protectionism is the economic policy of restraining trade between nations, through methods such
as high tariffs on imported goods, restrictive quotas, and anti-dumping laws in an attempt to protect
domestic industries in a particular nation from foreign take-over or competition.

This contrasts with free trade, where no artificial barriers to entry are instituted

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 INSTRUMENTS OF TRADE CONTROL

Tariff Barriers Non – Tariff Barriers

• Import tariffs • Subsidies
• Export Tariffs • Tied Aids
• Transit Tariffs • Minimum Sale Price
• Quotas
• Embargoes
• Buy – Local Legislation
• Specific Permissions Required

TARIFF BARRIERS

• Directly affect the prices of goods traded

• Also called Duty or tax levied on goods traded internationally.

• Most common type of trade control

• Specific duty; Ad – Valorem duty; Compound duty.

Types of tariffs

i. Import tariffs: Collected by importing country

ii. Export tariffs: Collected by exporting country

iii. Transit tariffs: Collected by the country through which the goods have passed.

TARIFF BARRIERS:

Tariff barriers have been one of the classical methods of regulating international trade.

Tariffs may be referred to as taxes on the imports.

It aims at restricting the inward flow of goods from other countries to protect the country's own
industries by making the goods costlier in that country.

sometimes the duty on a product becomes so steep that it is not worthwhile importing it.

In addition, the duty so imposed also provides a substantial source of revenue to the importing
country.

In India, Customs duty forms a significant part of the total revenue, and therefore, is an important
element in the budget.

Some countries use this method of imposing tariffs and Customs duties to balance its balance of
trade.

A nation may also use this method to influence the political and economic policies of other
countries.

It may impose tariffs on certain imports from a particular country as a protest against tariffs imposed
by that country on its goods.

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NON TARIFF BARRIERS

• May directly affect either price or quantity of goods traded internationally.

TYPES OF NON – TARIFF BARRIERS

i. Subsidies: Direct assistance to companies, making them more competitive.

ii. Tied Aids: Loans to other countries, a part of which is spend in donor country. E.g.
Infrastructure, telecommunication.

iii. Minimum sale price: Goods sold at a price set by authorities after clearances.

iv. Quotas: Limiting the quantity of goods imported or exported at a given time frame.

v. Embargoes: Prohibits all forms of trade from a country or a category of goods.

vi. Buy – Local: Favouring domestic producers or goods of local origin.

vii. Specific Permissions: import or export license.

Subsidies - To protect existing businesses from risk associated with change, such as costs of labour,
materials, etc. Tariffs - to increase the price of a foreign competitor’s goods. ( Including restrictive
quotas, and anti-dumping measures.) on par or higher than domestic prices.

Quotas - to prevent dumping of cheaper foreign goods that would overwhelm the market.

Tax cuts- Alleviation of the burdens of social and business costs.

Intervention - The use of state power to bolster an economic entity.

NON - TARIFF MEASURES (BARRIERS)

To protect the domestic industries against unfair competition and to give them a fair chance of
survival various countries are adopting non-tariff measures. Some of these are :

Quantity Restrictions, Quotas and Licensing Procedures:-

Under quantity restriction, the maximum quantity of different commodities which would be allowed
to be imported over a period of time from various countries is fixed in advance.

The quota fixed normally depends on the relations of the two countries and the needs of the
importing country.

Here, the Govt. is in a position to restrict the imports to a desired level. Quotas are very often
combined with licensing system to regulate the flow of imports over the quota period as also to
allocate them between various importers and supplying countries.

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