MBA605_Business Environment and Regulatory Framework (1)

Economic Environment 45 methods. Similarly, the State determines the assortment and the amount of goods and services that may be consumed by individuals. Just as there is no “pure” capitalist economy in the world, there is no pure command economy. However, some economies, like the erstwhile Soviet economy, come near to this system, and they are generally regarded as command economies. However, as mentioned earlier, significant changes have been taking place in the socialist systems. Socialist economies have moved towards market socialism characterised by increasing role for private enterprises. Evaluation of Socialism Socialism has become a very appealing and flexible concept that it was aptly remarked that socialism is a cap that has lost its shape because many different people have worn it. Indeed, there has been a large variety of socialism. Democratic socialism strives to achieve a trade-off between the free enterprise system and State capitalism. Merits The merits of such a system are: 1. It seeks to prevent concentration of economic power and achieve fair distribution of wealth and income. 2. Use of national resources for the benefit of the society as a whole. 3. National planning and resource allocation with a view to clearly defined objectives and priorities. 4. Government directions and control to serve the interests of the society. Demerits Communism and State capitalism have, however, a number of drawbacks. Important among these are the following: 1. Civil liberties are suppressed under communism. Under communism, man becomes a mere cog in the machine. If a free fair election is conducted in the totalitarian countries, it is doubtful if people will vote for the status quo. CU IDOL SELF LEARNING MATERIAL (SLM)

46 Business Environment and Regulatory Framework 2. There is no consumer sovereignty in totalitarian systems. The State decides what and how much people shall consume. 3. The central planning authority commands the resource allocation, investment and development pattern. But the views of the authority need not always be the right. As criticisms are not tolerated, there is limited scope for accommodating different views and making critical evaluations. 4. As private enterprise is not allowed, the talents of the enterprise would not be fully utilised. 5. People may lack incentive to work hard in the absence of private property. 6. The absence of freedom of choice of occupation is undemocratic. Because of the drawbacks of totalitarian socialism mentioned above, a number of socialist systems today are ‘mixed’ systems where there are both the private enterprise regulated by the State and the State enterprise. Liberal democratic socialism has its own merits; it strives to achieve the positive results of private enterprise, democratic rights and State regulation. As pointed out elsewhere, there was a lot of liberalisation, in the recent decades, in the centrally planned economies; most of them are rapidly becoming market economy. 2.6 Mixed Economic System The mixed economy, which shares certain features of private capitalism and State capitalism, is characterised by the co-existence of public and private sectors, and the overall government regulation of the economy. “The primary difference between the mixed economy and market socialism is the relatively greater importance of individual decision-making, private property and the reliance on market-determined prices to guide the allocation of resources. The mixed economy differs from competitive capitalism with respect to the share of collective decision- making in the economy”. In a mixed economic system, “there is wide latitude for govern participation. The government may function as a mediator between conflicting economic groups as well as consumer of the end-product of business and labour. Government may also attempt to guide the CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Environment 47 direction of the economy through the imposition of restrictions and grant of privileges to the private sector as well as by some form of planning.” Mixed Economy of India India has been following a mixed economic system. The Industrial Policy Resolution of 1948 gave a mixed economy orientation to the economic development of the nation by establishing public sector monopoly in some important industries. A very strong foundation for the mixed economy was laid by the Industrial Policy Resolution of 1956 which substantially expanded the scope of the public sector by exclusively reserving to the public sector the future development of 17 of the most industries and assigning a dominant role to another 12 very important industries. However, the economic liberalisation ushered in 1991 substantially reduced the future role of the public sector by throwing open all but a few industries to the private sector. But, public sector is very important in a number of industries. Today, most industries are characterised by the coexistence of both the public and private sectors. The salient features of the mixed economy of India are the following: 1. Coexistence of:  Public sector,  Private sector,  Joint sector, and  Co-operative sector. 2. Effective Government control of the economy through polices, guidelines and laws. 3. Substantial presence of public sector in important industries/sectors. 4. Competition between public sector enterprises and also enterprises of other sectors in a number of industries/sectors. Evaluation of the Mixed Economic System The mixed economic system seeks to combine the merits of both the free enterprise system and State capitalism and to minimise the drawbacks of both the systems. CU IDOL SELF LEARNING MATERIAL (SLM)

48 Business Environment and Regulatory Framework Merits 1. The mixed economic system can help achieve faster growth because of use of resources and capabilities of both the State and private sector. 2. Substantial presence public sector in important sectors can be a countervailing force against abuses by private sector. 3. The mixed economic system can help prevent concentration economic power to the common detriment. 4. In developing economies where there is scarcity of entrepreneurship and capital, the public sector has a very important role in fostering economic development. 5. Public sector often pays special attention to the development of priority sectors and backward areas. 6. Public sector in India played a very important role in the development of the infrastructure and basic and heavy industries. 7. Private sector too has played a very important role in India’s economic development. 8. There are several cases of the resources, skills and experiences of the public sectors have pooled together (joint sector enterprises) for development of several important sectors. 9. In several industries and sectors, industrial democracy and development have been achieved through the co-operative sector. 10. The global economic crisis that erupted in 2008 highlights the significance of the mixed economic system. In short, mixed economic system, consisting of public, private, joint and co-operative sectors, played a very important role in the economic development of India. Demerits 1. Too much emphasis on the public sector, as was the case in India until 1991, can result in the inefficiency and irresponsibility of public sector. 2. Too much emphasis on the public sector, as was the case in India until 1991, also results in not utilising the resources and capabilities of the private sector optimally. CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Environment 49 3. The monopoly position given to the public sector in many industries/sectors in India retarded their development in particular and the overall economic development in general. 2.7 Economic Systems in Transition The economic-political systems across the world have undergone significant changes over the decades, particularly since the late 1970s when communist China dramatically moved from marx to the market. This was followed by other communist/centrally planned economies. While there are not radical differences in the philosophies of major political parties in some countries, the situation is quite different in some others. The government system in a number of countries, including several countries which are making rapid economic progress and having liberal policies towards foreign capital and technology, is not very democratic. That does not mean that they are not good to make business with. As a matter of fact, in several such countries, the procedures are simpler and decisions are quicker than in some of the democratic countries. Until the political and economic changes ushered in the late 1980s and in the early 1990s in the Eastern Europe, and erstwhile USSR, these countries were a separate block by themselves with several common characteristics. Private enterprises were very limited and State trading, particularly counter trade, was the rule. There were a lot of restrictions on imports and foreign business. This did not, of course, mean that the communist system was insurmountable for multinationals or other foreign firms. Under such a system, in several instances, winning over the top brass of the party or government was a strategy to obtain business. It may be noted that although companies like PepsiCo were kept out of India they were going better with countries like USSR. In the past, public sector was assigned a very important role in many non-communist, particularly the developing, countries too. In India, for example, where the industrial policy wanted the public sector “to gain control over the commanding heights of the economy” limited the scope of the private enterprise, both domestic and foreign. Even in areas where foreign capital was allowed, there was ceiling on the foreign equity participation. Further, in the past, foreign firms in many developing countries were under the fear of nationalisation. The clock, however, CU IDOL SELF LEARNING MATERIAL (SLM)

50 Business Environment and Regulatory Framework has turned a full circle in most of the communist and many other countries. Privatisation has progressed at an amazing speed. The erstwhile communist countries and the Peoples’ Republic of China where the communist party is still in power, are on the rapid road from marx to the market. As against the past suspicion of and antagonism against foreign capital and technology, a large number of the developing countries, including the former communist ones, are in a competition to woo foreign capital and technology. As a result, there has been an influx of foreign investment to these countries. Although the trend of the direction of government policies across the world appears to be broadly one of convergence, there are lots of differences in the restrictions and regulations of business, scope of foreign business, trade policies, procedures, incentive systems and so on. Coalition governments of different political parties are becoming common. Sometimes, the constituents of the coalition are parties with very different economic ideologies, making the scenario complex or confusing/uncertain. State’s role or extent of State’s involvement in the economy can affect the business environment. When public sector was assigned a major role in the industrial development and industrial licensing was very widely applicable, the Central Government in India had an imposing position in deciding the location of projects and type and size of enterprises. However, the substantial reduction in the role of the public sector and delicensing drastically changed the situation and now State Governments have a much greater role and freedom than in the past in the industrial development, including promotion of FDI. Communist China today is a paradise of foreign capitalism. In recent years, China was the second/third recipient of FDI. China has the largest number of foreign affiliates of MNCs. There has been a surge in FDI outflow from China. There has been a rapid rise in the number of Chinese MNCs. In 2019, China had the second largest number of Fortune 500 companies (world’s largest 500 companies in terms of sales). Including 10 Taiwanese companies, China with 129 (compared to 121 American companies) firms had the largest number of Fortune 500 firms. The economic policy of India too has undergone dramatic changes, characterised by substantial delicensing, privatisation and opening up for FDI, as explained in Units 3 and 9. CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Environment 51 There is a universal trend towards political decentralisation. This indicates some shifts in the power centres firms have to deal with. The number of politically independent nations has been on the increase as a result of the splitting up of what was once a single country into several ones. Case 1 Mckinsey’s Agenda for India’s Economic Reforms An era of economic reforms ushered in India in 1991. However, even after a decade, the progress of the reforms and the performance of the economy presented a picture that was far from satisfactory. The state of and the Government’s approach towards reforms even appeared to be confusing. The Union Budget Speech for 2001-02 had several proposals for further reforms so much so that it was hailed as the initiation of the second generation of the reforms. However, some of these proposals came in for opposition even from the ruling parties. It is against this background that the McKinsey Global Institute (MGI) — an arm of the international consultancy, McKinsey and Company — presented to the Prime Minister of India, on 6th September 2001, a report titled India: The Growth Imperative, containing a 13-item prioritised reform agenda that would make India “a very different country in ten years time” — with a GDP growth of 10 per cent per annum, doubling of real per capita income and 75 million new jobs outside agriculture by 2010. Unless GDP grows at closer to 10 per cent a year, India could face unemployment as high as 16 per cent by 2010. The MGI has studied India’s economy to see what is holding back growth and what policy changes might accelerate it and according to this study, with the right new policies, GDP growth of 10 per cent a year is within India’s reach. The Report is based on a detailed examination of 13 sectors—two in agriculture, five in manufacturing and six in services. Together, they accounted for 26 per cent of India’s GDP and 24 per cent of its employment. The researchers these findings identified the barriers to productivity and output growth in each of these sectors in a bottom-up, rigorous manner and quantified their impact. These findings were then extrapolated to the overall economy. According to the MGI Report, there are three main barriers to faster growth.  The multiplicity of regulations governing product markets (i.e., regulations that affect either the price or output in a sector). CU IDOL SELF LEARNING MATERIAL (SLM)

52 Business Environment and Regulatory Framework  Distortions in the land markets.  Widespread government ownership of businesses. Table C.1.1: The Reform Route to Faster GDP Growth India (status quo) 5.5% Product market barriers 2.3% Land market barriers 1.3% Government ownership 0.7% Others (include poor transport infrastructure and labour market reforms) 0.35% India (with complete reforms) 10.0% The MGI has estimated that together these inhibit GDP growth by around 4 per cent in a year. In contrast, it was found that the factors more generally believed to retard growth — inflexible labour laws and poor transport infrastructure — while important, constrain India’s economic performance by less than 0.5 per cent of GDP a year. Therefore, it would be a mistake to focus growth policies exclusively on these familiar problems. To raise India’s growth trajectory, a broader reform agenda is required. The Report argues that removing the main barriers to growth would enable India’s economy to grow as fast as China’s, at 10 per cent a year. Annual growth in labour productivity would double to 8 per cent. Some 75 million new jobs would be created, sufficient not only to ward off the looming crisis in employment, but also to reabsorb any workers that might be displaced by productivity improvements. In order to overcome the main hurdles to growth and to ensure that India’s economy grows as fast as it must, the government will have to adopt a deeper, faster process of reform immediately. The MGI has identified 13 policy changes the government should enact. See Table C.1.2. It may be noted that the McKinsey proposals have many thing in common with the recommendations made by some official bodies as well as by others in India. See Box C.1.1. CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Environment 53 Category Action Table C.1.2: Reform Measures Required Key sectors directly affected Product market 1. Eliminate reservation of all products for  836 manufactured goods small-scale industry; start with 68 sectors accounting for 80 per cent of output of reserved sectors 2. Equalise sales tax and excise duties for all  Hotels and restaurants categories of players in each sector and  Manufacturing (e.g., steel, strengthen enforcement textiles, apparel)  Retail trade 3. Establish effective regulatory framework  Power and strong regulatory bodies  Telecom  Water supply 4. Remove all licensing and quasi-licensing  Banking restrictions that limit number of players  Dairy processing in affected industries  Petroleum marketing  Provident fund management  Sugar 5. Reduce import duties on all goods to  Manufacturing levels of South-East Asian Nations (10 per cent) over 5 years 6. Remove ban on foreign direct investment  Insurance in retail sector and allow unrestricted foreign direct investment in all sectors  Retail trade Land market 7. Resolve unclear real estate titles by’  Telecom setting up fast-track courts to settle  Construction disputes, computerising land records, freeing all property from constraints on  Hotels and restaurants sale, and removing limits on property’ ownership 8. Raise property taxes and user charges for  Retail trade municipal services and cut stamp duties (tax levied on property transactions to promote development of residential and commercial land and to increase liquidity of land market) CU IDOL SELF LEARNING MATERIAL (SLM)

54 Business Environment and Regulatory Framework Government 9. Reform tenancy laws to allow rents to ownership move to market levels 10. Privatise electricity sector and all central  Airlines and state government-owned companies; in electricity sector, start by privatising  Banking and insurance distribution; in all other sectors, first  Manufacturing and mining privatise largest companies  Power  Telecom 11. Reform labour laws by repealing Section  Labour-intensive 5-B of the Industrial Disputes Act; manufacturing and introducing standard retrenchment- service sectors compensation norms; allowing full flexibility in use of contract labour 12. Transfer management of existing transport  Airports infrastructure to private players, and contract out construction and management  Ports of new infrastructure to private sector  Roads 13. Strengthen extension services to help  Agriculture farmers improve yields The Effects of Reform According to the MGI report, if India immediately removes all the existing barriers to higher productivity, the resulting increases in labour and capital productivity will boost growth in overall GDP to 10 per cent a year; they will release capital for investment worth 5.7 per cent of GDP; and they will generate 75 million new jobs outside agriculture, in modern as well as transitional sectors. (The report observes that India’s economy has three types of sector: modern sectors with production processes resembling those in modern economies — provide 24 per cent of employment and 47 per cent of output; transitional sectors provide 16 per cent of employment and 27 per cent of output; and agricultural sectors provide 60 per cent of employment and 26 per cent of output. Transitional sectors comprise those informal goods and services consumed by a growing urban population: street vending domestic service, small-scale food processing and cheap, mud housing, to name a few. The transitional businesses typically require elementary skills and very little capital, so they tend to absorb workers moving out of agriculture.) CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Environment 55 Removing all the productivity barriers would almost double growth in labour productivity to 8 per cent a year over the next ten years. The modern sectors would account for around 90 per cent of the growth, while it would remain low in the other two sectors. In fact, productive in the modern sectors of the economy would increase almost three times over the next 10 years. Though there may be small improvements in agricultural productivity, mainly from yield increases, the massive rise in agricultural productivity which mechanised farming has supported in developed countries is unlikely to occur in India for another ten years, at least, while there is still a surplus of low-cost rural labour to deter farmers from investing in advanced machines. Enterprises in the transitional sectors have inherently low labour productivity because they use labour-intensive “low- tech” materials, technologies or business formats. So although these sectors will grow to meet the rising urban demand, their labour productivity will remain about the same. If all the barriers were removed, capital productivity in the modern sectors would grow by at least 50 per cent. Increased competition would force managers to eliminate the tremendous time and cost overruns on capital projects and low utilisation of installed capacity which they can get away with now, especially in state-run enterprises. Regulation to ensure healthy competition, equitably enforced, would prevent unwise investments common today. Although many policymakers and commentators believe it would take investment equivalent to more than 35 per cent of GDP, an almost unattainable amount, to achieve a 10 per cent GDP growth rate in India, McKinsey’s analyses suggest that, at the higher levels of labour and capital productivity, India can achieve this rate of GDP growth with investment equivalent to only 30 per cent of GDP a year for a decade. According to the Report, although still a challenge, this rate is certainly achievable, since removing the barriers that hinder productivity will unleash extra funds for investment, equivalent to the consequent drop in the public deficit and the increase in FDI. These sources, by themselves, would be sufficient to increase investment from its current level of 24.5 per cent of GDP to 30.2 per cent. The funds would be released in the following manner: Removing the barriers to labour productivity would generate extra revenue for the government through more efficient taxation — particularly on property — and from privatisation, and the government would save what it now spends on subsidies to unprofitable state-owned enterprises. As a result, its budget deficit would CU IDOL SELF LEARNING MATERIAL (SLM)

56 Business Environment and Regulatory Framework decrease by around 4 per cent of GDP, an amount which would then become available for private investment elsewhere. According to the Report, productivity growth and increased investment will create more than 75 million new jobs outside agriculture in the next 10 years compared to the 21 million projected as a result of current policies. But while most of the productivity gains and 32 million of the new jobs will, indeed, appear in the modern sectors, 43 million new jobs will be created in the transitional sectors, making the move to town worthwhile for low paid and underemployed agricultural workers. Agricultural wages will therefore rise. Although there will be job losses in government dominated sectors like steel, retail banking and power, these will be more than offset by new jobs in transitional and modern sectors such as food processing, retail trade, construction, apparel and software. More workers with more disposable income will stimulate more demand for goods and services. Greater demand will create opportunities for further investment, in turn creating more jobs. The migration of labour between sectors is a feature of all strongly growing economies and should be welcomed by policymakers. For even though increasing productivity may displace labour, it stimulates more overall employment. The Report counsels that while the Central Government must take die lead, State Governments will have a crucial supporting role to play: one-third of the reforms required—those concerning the land market and power sectors—lie in their hands. However, State Governments will need careful guidance from the centre. Central Government should identify for each state the critical areas for reform; design model laws and procedures for the states to adapt and enact; and encourage them to inclement the reforms with financial incentives. Box C.1.1: Reform Proposals Prime Minister’s Economic Advisory Council Report  End controls on movement and stocking of agricultural commodities  Revise the procurement policy; limit role of FCI  Abolish Milk and Milk Products Control Order and retention price scheme for fertilisers  Involve private sector in agricultural R&D CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Environment 57  Reduce import tariffs to 12 per cent by 2005  End small-scale sector reservation  Amend labour laws to facilitate companies to restructure  Speed up the privatisation process The Ahluwalia Task Force on Employment Opportunities  End all controls on agriculture and ease regulations on food processing  Liberalise leasing of land to enable commercialisation of agriculture  End small-scale reservation  Repeal the Rent Control Act; reduce stamp duties; liberalise land use rules  Allow FDI in retail; encourage modern supermarkets and department stores  Reform labour laws Questions 1. Evaluate the recommendations of the McKinsey Report. 2. Discuss the implications of each of the recommendations for business. 3. Assuming that McKinsey’s recommendations are worth accepting, what are the essential conditions/requirements for implementing them? 2.8 Summary The scope of private business and the extent of government regulation of economic activities depends to a very large extent on the nature of the political/economic system, which is an important part of the business environment. Important economic systems are capitalism, socialism and mixed economic system. Capitalism is an economic system characterised by private ownership and utilisation of productive resources, individual freedom to make production and consumption decisions, and minimal State regulation. Within the wide spectrum of socialism, there is indeed a variety of systems. On the one end, there are the communist countries characterised by State capitalism, and on the other end, there are the democratic socialist nations with dominant private sector. The mixed economy, which shares certain features of private capitalism and State capitalism, is CU IDOL SELF LEARNING MATERIAL (SLM)

58 Business Environment and Regulatory Framework characterised by the co-existence of public and private sectors, and the overall government regulation of the economy. 2.9 Key Words/Abbreviations 1. Mixed economy: An economic system combining private and state enterprise 2. Socialism: Socialism, is generally understood as an economic system where the means of production are either owned or controlled by the State and where the resource allocation, investment pattern, consumption income distribution etc. are directed and regulated by the State. 3. Public Sector: the part of an economy that is controlled by the state. 4. Private Sector: the part of the national economy that is not under direct state control. 5. Joint Sector: Joint sector consists of business undertakings wherein the ownership, control and management are shared jointly by the Government, the private entrepreneurs and the public at large. 6. Co-operative Sector: An autonomous association of persons united voluntarily to meet their common economic, social, and cultural needs and aspirations through a jointly- owned and democratically-controlled enterprise 2.10 Learning Activity 1. Examine how the nature of the mixed economy of India has changed since the early 1990s. ----------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------- CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Environment 59 2.11 Unit End Questions (MCQs and Descriptive) A. Descriptive Type Questions (i) Long Answer Questions 1. Give a brief description of the important factors of economic environment of business. 2. Discuss how the changes in the economic environment of India have influenced the business scenario. 3. Critically examine the capitalist economic system. 4. Examine the features of socialism and the merits and demerits of socialism. 5. Discuss the strengths and weaknesses of the mixed economy of India from the socio- economic and business point of view. (ii) Short Answer Questions 1. Briefly describe how different economic policies impact business. 2. Compare and contrast modern capitalism and market socialism. 3. Write a note on the economic conditions which impact business. 4. What are the salient features of the mixed economy of India? 5. What are the important features of socialist economy? B. Multiple Choice/Objective Type Questions 1. Indian economic system is: (a) Capitalistic economy (b) Socialistic economy (c) Mixed economy (d) Public economy 2. Free enterprise economy refers to: (a) Capitalist economy (b) Socialist economy (c) Mixed economy (d) Public economy CU IDOL SELF LEARNING MATERIAL (SLM)

60 Business Environment and Regulatory Framework 3. Market economy refers to: (a) Capitalist economy (b) Socialist economy (c) Mixed economy (d) Public economy 4. Monetary policy is formulate and administered by: (a) Central government (b) Central bank (c) Commercial banks (d) State governments 5. Laissez-faire system refers to: (a) Free enterprise economic system (b) Mixed economic system (c) Socialist system (d) Communism Answers 1. (c), 2. (a), 3. (a), 4. (b), 5. (a). 2.12 References Text References 1. R.A. Musgrave and P.B. Musgrave, The Theory of Public Finance, Kogakusha Ltd., Tokyo, 1976, p. 6. 2. Ibid., p.6 3. Ibid.. 4. Ibid. Suggested Readings 1. Marshall Dimock, Business and Government. 2. Francis Cherunilam, Business and Government. 3. Giacomo G. Corneo, Is Capitalism Obsolete? A Journey through Alternative Economic Systems. CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Environment 61 4. Paul R. Gregory and Robert C. Stuart, The Global Economy and Its Economic Systems. 5. Gavrav Datt and Aswani Mahajan, Indian Economy, S. Chand & Co., New Delhi. Web Resources 1. www.india.gov.in/handbook-statistics-indian-economy 2. www.indiabudget.gov.in/economicsurvey 3. https://www.academia.edu/39010588/Megatrends_and_their_Use_in_Economic_ Analyses_of_Contemporary_Challenges_in_the_World_Economy  CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT 3 ECONOMIC POLICIES Structure: 3.0 Learning Objectives 3.1 Introduction 3.2 Monetary Policy 3.3 Fiscal Policy 3.4 Goods and Services Tax (GST) 3.5 Role/Importance of the Budget/Fiscal Policy 3.6 Global Trends in Business and Management 3.7 Some Important Emerging International Economic and Business Trends 3.8 Foreign Capital and Collaboration 3.9 Foreign Investment in India 3.10 FDI in Different Sectors 3.11 Impact of FDI in India 3.12 Summary 3.13 Key Words/Abbreviations 3.14 Learning Activity 3.15 Unit End Questions (MCQs and Descriptive) 3.16 References CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 63 3.0 Learning Objectives After studying this unit, you will be able to:  Get a general understanding of monetary and fiscal policies, and their significance for business.  Get a general picture of global trends in business and management.  Discuss the types of foreign investment.  Learn the important foreign invest policy of Government of India.  Evaluate the impact of foreign investment in Indian business. 3.1 Introduction The monetary and fiscal policies affect the financial sector and the economy in general. They can also be attuned to influence specific sectors or industries or segments. Both monetary and fiscal operations have repercussions on the whole economy, affecting the price level, the balance of payments, the levels of industrial activity and employment. While the monetary policy influences economic trends, especially investment, through the cost and availability of credit, fiscal policy directly affects the financial resources and purchasing power in the hands of the public. In a country which has adopted a programme of planned economic development, in which the public sector has an important part to play, fiscal policy is concerned largely with effecting structural changes in the economy, while monetary policy aims at regulating investment in the private sector and short-run management of the economy. When economic objectives are set, both monetary and fiscal policies should aim at achieving these objectives. If they are to be successful, a close co-ordination of monetary and fiscal policies is necessary, for they are complementary and not competitive. The economic liberalisation across the world has set in and strengthened certain important trends in global business. The liberalisations have led to a surge in foreign capital flows and CU IDOL SELF LEARNING MATERIAL (SLM)

64 Business Environment and Regulatory Framework collaborations. The international capital flows have serious repercussions on the economy, industrial structure and growth pattern. 3.2 Monetary Policy Monetary Policy refers to the use of instruments within the control of the Central Bank to influence the level of aggregate demand for goods and services or to influence the trends in certain sectors of the economy. Monetary policy operates through varying the cost and availability of credit, thus producing desired changes in the assets pattern of credit institutions, principally commercial banks. These variations affect the demand for, and the supply of credit in the economy, and the level and nature of economic activities. The modern economy is regarded as a credit economy in the sense that credit forms the basis of most of the economic activities in such an economy. The level and nature of economic activities such an economy, obviously, are influenced by the cost and availability of credit. The central bank’s policies that affect the demand for and the supply of money, therefore, are very important to the industrial and commercial sectors. In a developed economy, credit forms a very important component of money supply. Instruments (Tools) of Monetary Policy The instruments of monetary policy (methods of credit control) may be broadly divided into: 1. General (Quantitative) methods; and 2. Selective (Quantitative) methods. The general methods affect the total quantity of credit and affect the economy generally. The selective methods, on the other hand, affect certain select sectors. In other words, under the selective methods, certain qualitative distinctions are made between different sectors and segments of the economy; and selectivity is applied in regulating the flow of credit. The statutory basis for the regulation of credit in India is embodied in the Reserve Bank of India Act and the Banking Regulation Act. The former Act confers on the Bank the usual powers available to central banks generally, while the latter provides special powers of direct regulation of the operation of commercial and co-operative banks. CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 65 1. General Credit Controls There are three general or quantitative instruments of credit control, namely, the Bank Rate, Open Market Operations and Variable Reserve Requirements. In considering the general methods of credit control, it is important to stress that these are closely interrelated and have to be operated in co-ordination. All the three instruments affect the level of bank reserves. Open Market Operations and the Reserve Requirements directly affect the reserve base, while the Bank Rate produces its impact indirectly by variations in the cost of acquiring the reserve. (i) Bank Rate Policy The Bank Rate, also known as the Discount Rate, is the oldest instrument of monetary policy. The traditional definition of Bank Rate is that it is the rate at which the central bank discounts – or, more accurately, rediscounts – eligible bills. However, today, the term Bank Rate is used in a broader sense and refers to the minimum rate at which the central bank provides financial accommodation to commercial banks in the discharge of its function as the lender of the last resort. The Bank Rate policy seeks to affect both the cost and availability of credit. The availability depends largely on the statutory requirements regarding the eligibility of bills for rediscounting, and securities for collateral for advances, as also the maximum period for which the credit is available. As the central bank is the lender of the last resort, a commercial bank which is loaned up can obtain financial accommodation (i.e., loan) from the central bank and re-lend it to its own customers. An increase in the Bank Rate means an increase in the rate of interest charged by the central bank on its advances to commercial banks. Hence, an increase in the Bank Rate compels commercial banks to raise the rate of interest they charge on their loans and advances to their customers and vice versa. CU IDOL SELF LEARNING MATERIAL (SLM)

66 Business Environment and Regulatory Framework The importance of the Bank Rate lies in the fact that it acts as a pace-setter to all the other rates of interests. In a well-developed money market, all the market rates quickly and effectively respond to a variation in the discount rate. An increase in the Bank Rate implies an increase in the cost of credit and vice versa. The demand for credit usually varies with the variation in the cost of credit. The central bank can, therefore, hope to bring about a contraction in the money supply by raising the Bank Rate and an expansion in the money supply by lowering it. As per the theory of Bank Rate, an increase in the Bank Rate reduces the extent of borrowings from the money market, the level of inventory holding, investment, employment and prices. A reduction in the Discount Rate has the opposite effects. The central bank may, therefore, attempt to contain an inflationary situation by raising the Bank Rate and fight a depression or recession by lowering it. (ii) Open Market Operations Open Market Operations refer broadly to the purchase and sale by the central bank of a variety of assets, such as foreign exchange, gold, Government securities and even company shares. In India, however, in practice, they are confined to the purchase and sale of Government securities. Under the Open Market Operations, the central bank seeks to influence the economy either by increasing the money supply or by decreasing the money supply. To increase the money supply, the central bank buys securities from commercial banks and public. For instance, if the Reserve Bank of India buys securities worth ` 100 crores, in the first instance the reserves of the commercial banks and currency with the public will increase by ` 100 crores. However, the ultimate increase in money supply might be much more than this. When the central bank purchases securities from commercial banks, the increase in their reserves might result in a multiple credit creation. Sometimes, the purchase from the public may lead to an increase in the reserves of the banking system and credit expansion if the sellers of securities deposit the receipts with commercial banks. A sale of securities by the central bank has the opposite effects. CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 67 (iii) Variable Reserve Ratios Commercial banks in every country maintain, either by the requirement of law by or custom, a certain percentage of their deposits in the form of balances with the central bank. The central bank has the power to vary this reserve requirement; and the variation in the reserve requirements affect the credit creating capacity of commercial bank. For instance, if the reserve requirement is 10 per cent, the maximum amount the bank can lend is equivalent to 90 per cent of the total reserves. If the reserve ratio is raised to 20 per cent, the bank cannot lend more than 80 per cent of the total reserves. The Reserve Bank of India is empowered to vary the cash reserve ratio between 3 percent and 15 per cent of the total demand and time liabilities. To facilitate the flexible operation of this system, the RBI has also been vested with the power to require the scheduled banks to maintain with it additional cash reserves, computed with reference to the excess of their total demand and time liabilities over the level of such liabilities on the base date to be notified by the Reserve Bank, subject to the proviso that the total reserve to be maintained with the Bank should not exceed 15 per cent of their demand and time liabilities. Statutory Liquidity Ratio (SLR) Action has also been taken to prevent banks from offsetting the impact of variable reserve requirements by liquidating their Government security holdings. The Banking Regulation Act has been amended, requiring all banks to maintain a minimum amount of liquid assets which shall not be less than a certain specified percentage of their demand and time liabilities in India, exclusive of the cash balances maintained under Section 42 of the Reserve Bank of India Act in the case of schedule banks, and exclusive of the cash balances maintained under Section 18 of the Banking Regulation Act in the case of non-scheduled banks. This ensures that with every increase in the cash reserve requirements, the overall liquidity obligations are also correspondingly raised. 2. Selective Credit Regulation Selective and qualitative credit control refers to regulation of credit for specific purposes or branches of economic activity. While general credit controls operate on the cost and total volume of credit, selective controls relate to the distribution or direction of available credit supplies. It may be mentioned here that some element of selectivity can be imparted to general credit CU IDOL SELF LEARNING MATERIAL (SLM)

68 Business Environment and Regulatory Framework controls also by giving concessions to priority sectors or activities. This has often been done in India. Selective credit controls are considered to be a useful supplement to general credit regulation. The aim of selective controls is to discourage such forms of activity as are considered to be relatively inessential or less desirable. Selective credit controls have been used in Western countries to prevent the demand for durable consumer goods outrunning the supply, and generating inflationary pressure. The Banking Regulation Act confers on the Reserve Bank the power to give directions to banking companies, either generally or to any banking company or group of banking companies in particular, as to — (a) The purposes for which advances may or may not be made; (b) The margin to be maintained in respect of secured advances; (c) The maximum amount of advances or other financial accommodation which, having regard to the paid-up capital, reserves and deposits of a banking company and other relevant considerations, may be made by that banking company to any one company, firm, association of persons or individual; (d) The maximum amount up to which, having regard to the considerations referred to in clause (c) guarantees may be given by a banking company on behalf of any one company, firm, association of persons or individuals; and (e) The rate of interest and other terms and conditions on which advances or other financial accommodation may be made or guarantees may be given. The Reserve Bank is also empowered to issue, from time to time, to banking companies generally or to any banking company in particular, such directions as it deems fit in the public interest; or in the interest of banking policy; or to prevent the affairs of any banking company from being conducted in a manner detrimental to the interests of the depositors; or in a manner prejudicial to the interests of the banking company, or to secure the proper management of any banking company generally. The banking companies or the banking company, as the case may be, shall be bound to comply with such directions. CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 69 The techniques of selective credit controls used generally are: (a) Minimum margins for lending against specific securities; (b) Ceilings on the amounts of credit for certain purposes; and (c) Discriminatory rates of interest charged on certain types of advances. In India, selective credit controls are operated under all the three techniques. While imposing selective controls, care is generally taken to ensure that credit for production, the movement of commodities and exports, is not affected. Selective controls are focused mainly on credit to traders financing inventories. Moral Suasion: In addition to the above-mentioned methods of credit control, both quantitative and qualitative, it may be noted that the use has also been made in this country of moral suasion. 3.3 Fiscal Policy Fiscal Policy is that part of Government policy which is concerned with raising revenue through taxation and other means and deciding on the level and pattern of expenditure. The fiscal policy operates through the budget. The Budget is an estimate of Government expenditure and revenue for the ensuing financial year, presented to Parliament (in case of Union Budget) usually by the Finance Minister. Occasionally, in times of financial crisis, interim Budgets may be introduced later in the year to increase taxation, expenditures etc. Sometimes, there may be slight modifications in taxation and expenditure without the formality of a revised budget. 3.4 Goods and Services Tax (GST) The Constitution of India had earmarked separate sources of revenue for the Union and the States. There was Union List in the Constitution which included the taxes earmarked for the Union Government and a State List in of taxes. Besides, there was a Concurrent List consisting of a few taxes. CU IDOL SELF LEARNING MATERIAL (SLM)

70 Business Environment and Regulatory Framework Several reforms of the Indian tax system had been carried out in the past. However, a comprehensive reform and streamlining of the system was long overdue until the Goods and Services Tax (GST) was introduced in 2017. The Goods and Services Tax (GST) introduced with effect from 1st July, 2017 has merged a number taxes into one. More specifically, the GST in India has subsumed 17 Central and State taxes and 26 cesses, i.e., all these taxes and cesses have been replaced by a single tax, called the GST. It is a comprehensive, multi-stage, destination-based tax that is levied on every value addition. In short, GST is an indirect tax levied on the supply of goods and services. It is one indirect tax for the entire country. Under the GST regime, the tax will be levied at every point of sale. In case of intra-state sales, Central GST and State GST will be charged. Inter-state sales will be chargeable to Integrated GST. Principles of Tax Subsumation The principles followed to subsume the various Central, State and Local levies are the following:  Taxes or levies to be subsumed should be primarily in the nature of indirect taxes, either on the supply of goods or on the supply of services.  Taxes or levies to be subsumed should be part of the transaction chain which commences with import/manufacture/production of goods or provision of services at one end and the consumption of goods and services at the other.  The subsumation should result in free flow of tax credit in intra- and inter-State levels.  The taxes, levies and fees that are not specifically related to supply of goods and services should not be subsumed under GST.  Revenue fairness for both the Union and the States individually would need to be attempted. CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 71 Taxes Subsumed in GST A number of Central and State Taxes were subsumed in GST. Central Taxes Subsumed in GST The following Central taxes were subsumed in GST:  Additional Excise Duties.  The Excise Duty levied under the Medicinal and Toiletries Preparations (Excise Duties) Act 1955.  Service Tax.  Additional Customs Duty, commonly known as Countervailing Duty (CVD).  Special Additional Duty of Customs – 4% (SAD).  Surcharges and Cesses levied by Centre are also likely to be subsumed wherever they are in the nature of taxes on goods or services. This may include cess on rubber, tea, coffee, national calamity contingent duty etc.  Central Sales Tax to be phased out. State Taxes Subsumed in GST The following State taxes were subsumed in GST:  VAT/Sales tax.  Entertainment tax (unless it is levied by the local bodies).  Luxury tax.  Taxes on lottery, betting and gambling.  State Cesses and Surcharges insofar as they relate to supply of goods and services.  Octroi and Entry Tax.  Purchase Tax. CU IDOL SELF LEARNING MATERIAL (SLM)

72 Business Environment and Regulatory Framework Taxes Not Subsumed in GST There are a number of taxes which are not subsumed in GST such as basic customs duty, surcharge on customs duty, customs cess, safeguard duty, anti-dumping duty, state excise, stamp duty, property tax levied by local bodies, central excise on petroleum, profession tax, license fee on entry of vehicles, securities transaction tax etc. Components of GST There are three taxes applicable under the GST system:  CGST: Collected by the Central Government on intra-state sale (e.g., within Kerala).  SGST: Collected by the State Government on an intra-state sale (e.g., within Kerala).  IGST: Collected by the Central Government for inter-state sale (e.g., Maharashtra to Kerala). Merits of GST GST is commonly described as an indirect, comprehensive, broad based consumption tax. The Dual GST which would be implemented in India will subsume many consumption taxes. The objective is to remove the multiplicity of tax levies thereby reducing the complexity and remove the effect of tax cascading. The GST has subsumed all those taxes that are earlier levied on the sale of goods or provision of services by either Central or State Government. Subsumation of large number of taxes and other levies allows free flow of larger pool of tax credits at both Central and State level. Finance Minister Arun Jaitley extolled: “There will be check on inflation, tax avoidance will be difficult, tax rates will be lower compared to earlier, the country’s GDP will benefit and the extra resources the States and Centre will get will be used to serve the poor.” Other major merits of GST are: 1. GST, which has subsumed a large number of taxes and levies, has substantially reduced the complexity of multiplicity of taxes. This will result in a great relief for the government, business community and consumers. 2. GST has made the tax system more systematic and simpler than the previous regime. CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 73 3. GST has made the tax system more transparent. 4. GST has helped to widen the tax base and improve compliance. 5. It is reported that Audit trails created as part of the GST system have improved transparency, enhanced voluntary registration and widened the tax base. Tax collections are expected to go up significantly with further follow-up of audit trails and data crunching. 6. A great merit of GST is the removal of the cascading tax effect. In simple words, cascading tax effect means a tax on tax. It is a situation wherein a consumer has to bear the load of tax on tax and inflationary prices as a result of it. GST avoids this cascading effect as the tax is calculated only on the value add at each stage of transfer of ownership. 7. GST promotes economic unification of the country. Under the GST, one tax, one nation, one market become the rule. 8. The removal of barriers to trade will reduce cost and promote economic growth. 9. GST is expected to have favourable impact on prices. 10. Tax evasion is more difficult under the GST compared to the previous system. While GST has definite merits, its proper structuring and implementation pose challenges. Challenges The GST system, as it was introduced in India, was not flawless. It is pointed out that the groundwork required for its launch was incomplete. But it needed to be got started. The transition to the GST has not been painless. The new tax system calls for rationalisation of rates, and procedural and administrative gearing up. (some rationalisation of the tax rates was done in July 2008). Although it was expected that prices of many goods will come down, consumers have not realised the price benefits in many areas where it should have happened. Profiteering by traders have been rampant, even challenging government interventions. Country-wide GST requires sophisticated integrated IT infrastructure and familiarisation of the business community with it. There is need for proper awareness creating particularly among small businessmen. CU IDOL SELF LEARNING MATERIAL (SLM)

74 Business Environment and Regulatory Framework The GST has caused a lot disruptions in the economy. The GST system, which was to shake up the modus operandi of the economic transactions in the country to put it on a smooth running track was described by Finance Minister Arun Jaitley, as a disruptor. In its first year, GST has caused widespread disruptions resulting in production and job losses. Addressing the teething troubles and putting in place a proper administrative system are hard challenges. Conclusion GST, undoubtedly, was a much-needed reform. We may note that there are about 165 countries across the world which have adopted GST. (France was the first country to introduce this system in 1954.) We must, therefore, think that such a reform was long overdue. The complexities of the tax system of the vast country made its introduction a very hard task. Reviewing the GST in operation in its first year, Finance Minister Jaitley observed that the changeover in India was rather smooth compared to countries all over the world where GST caused a major disruption. The Finance Minister confided that the best of GST in terms of its contribution to society is yet to come. 3.5 Role/Importance of the Budget/Fiscal Policy There is no other Government measure that affects the whole economy as the Budget. No wonder, all sections of the people await the Annual Budget with mixed feelings – anxiety, fear and hope. The endeavour of the Finance Minister is to present a Budget which gives maximum support to forces that can move the country forward on the path of growth with stability and social justice. The Budget should set the stage for the achievement of economic and social goals. The importance of functional finance and pump priming are recognised all over the world. In India, today, about a half of the GDP is channeled into the Government sector by the Union, State and UT Budgets and disbursed by the Union, State and UT Governments under various development and non-development heads. These indicate the development and distributive importance and implications of the Budgetary operations. There has been a steep increase in the Government expenditures, both in absolute and relative terms. The total budgetary expenditures (of the Centre , States and Union Territories) are CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 75 about 50 per cent of the GDP today. The Central Government expenditures alone account for over one-fourth of the GDP today. In a developing economy like India, the Budget policy has to serve the following purposes: 1. Accelerate the pace of economic development by mobilising resources for the public sector and their optimal allocation; 2. Effect improvement in production in the private sector in accordance with the national priorities; 3. Effect improvements in income distribution; 4. Promote exports and encourage import substitution; and 5. Achieve economic stabilisation. To serve these purpose, apart from the judicious allocation of the budgetary resources, various fiscal incentives and disincentives are also employed by the Budget. An examination of the Budget Proposals will make these very clear. 3.6 Global Trends in Business and Management This section gives some conspicuous global business trends/strategies. Global Networking of Operations and Globalisation of Supply Chain A very important development that has boosted international economic integration, particularly of the developing countries, is the phenomenon described by terms such as globalisation of supply chain, product/production fragmentation, global sourcing or production sharing. An estimated one-third of all manufactures trade involves outsourced parts and components. In an intensely competitive market, only those firms who win the race in satisfying the consumers vis-à-vis product features and performance, price, delivery, services etc. can survive. It is, therefore, necessary to take a holistic view of the business system that encompasses the key determinants of the success of a firm in the value chain. CU IDOL SELF LEARNING MATERIAL (SLM)

76 Business Environment and Regulatory Framework A product’s value chain starts with R&D and product development, passes through various value-adding activities associated with production, marketing and ends with customer relations management. Major components of the value chain are shown in Figure 3.1. The location of the production/supply of each of the component of the system is decided in such a way that it contributes to the optimisation of the system. Design Procurement Logistics Distribution Logistics Research and Development Module Production Wholesale Sales Organisational Practices System Production Retail Sales Product Technology Final Assembly Advertising Process Technology Testing Brand Management Training Quality Control After-sales Service Inventory Management Packaging Fig. 3.1: The Global Value Chain of Product Components (Adopted from UNCTAD, World Investment Report, 2002) A business system entails the integration and management of diverse activities. On the one extreme, a firm may undertake all of these different activities, carrying on the whole production process and doing all the other operations encompassing the business system. On the other extreme, a firm can outsource most, even the whole, of these. Many firms now concentrate on its core competence/business and outsource the rest. The R&D and product development may be done in one or more countries, the production may be carried out in the same or some other country/countries using technology and other inputs sourced globally, employing global financing, and marketed globally. Globalisation of supply chain often implies fragmentation of production process and participation of many firms and countries in the production and marketing of products. Globalisation of supply chain is widespread with MNCs. The increased freedom for factors and functions to move within the international production systems of TNCs facilitated by the liberalisations has been the major facilitator of this. Linkages can now be more easily established with suppliers, buyers and even competitors, and they can reach across the world. They may also involve other foreign affiliates or local (i.e., domestically owned) firms. Many products available CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 77 in the market with the label made in a specific country are global products in the sense that various phases of its business process from R&D to marketing are carried out in different countries. One of the most important strategic decisions in international business is the mode of entering the foreign market. On the one extreme, a company may do the complete manufacturing of the product domestically and export it to the foreign market. On the other extreme, a company may do, by itself, the complete manufacturing of the product to be marketed in the foreign market there itself. There are several alternatives in between these two extremes. The choice of the most suitable alternative is based on business environment, i.e., the relevant factors related to the company, the home country and the foreign market. Important globalisation strategies pertaining to the foreign market entry are listed in Figure 3.2. Foreign Market Entry and Operating Strategies Exporting Contractual Production/Assembly Arrangements Facility in Foreign Market * Direct Exporting * Licensing/ * Assembly Operations * Indirect Franchising * Wholly Owned * Strategic Alliance Exporting * Contract Manufacturing Facility (From home Manufacturing * Joint Venture country/ third country) Mergers and Acquisitions Fig. 3.2: Foreign Market Entry and Operating Forms Mergers and Acquisitions (M&As) International mergers and acquisitions (M&As) has been a dominant strategy of many MNCs, particularly large ones, to expand their business globally. Many small firms too employ this strategy. The privatisation trend across the world in all categories of economies and the liberalisation of FDI regime have given a boost to the cross-border M&As. The trend of CU IDOL SELF LEARNING MATERIAL (SLM)

78 Business Environment and Regulatory Framework concentrating on core business and selling non-core businesses also supported the M&A trend. M&As have been a major driver of FDI. M&As have been leading to consolidation in many industries. Here are some typical examples: One of the feature of the M&As is that M&As among large or dominant TNCs, resulting in even larger TNCs, seem to impel other major TNCs to move towards restructuring or making similar deals with other TNCs. The pharmaceutical, automobile, telecommunications and financial industries are typical example of industries in which such concentration can be observed. This trend significantly changes the industry structure. In several industries, like the automobile, the total number of major firms have undergone significant decline. In the pharmaceutical industry, many markets are now controlled by a small number of firms as a result of a string of M&As. Acquisition is a major globalisation strategy employed by many Indian companies. The most important destination of Indian acquisitions have been industrial economies, particularly North America and Western Europe. Other preferred destinations for acquisitions have been South East Asia, South Asia, Eastern Europe, South America, West Asia, Australia, New Zealand and Africa. Large industrial houses and many medium firms have forayed into foreign markets by M&As. Exporting Exporting, the most traditional mode of entering the foreign market, is quite a common one even now. International trade has been growing much faster than the world output resulting in greater world economic integration, i.e., globalisation. Exporting marks the first stage in the evolution of international business of many companies. As the international business grows or as the environment changes or to expand the business, it may become necessary to change the strategies. There are broadly two ways of exporting, namely, direct exporting and indirect exporting. The distinction between direct exporting and indirect exporting is on the basis of how the exporter carries out the transactions flow between himself and the foreign importer or buyer. In indirect export, the manufacturer utilises the services of various types of independent international marketing middlemen or co-operative organisations. In other words, when a CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 79 manufacturer exports indirectly, he transfers the responsibility for the selling job to some other organisation. On the other hand, in direct export, the responsibility for performing international selling activities rests on the product. When the export is direct, the producer makes direct sale to any one or more of the foreign customers. The indirect method is more popular with firms which are just beginning their exporting activities and with those whose export business is not considerable. Indirect exporting has this advantage that the firm does not have to build up an overseas marketing infrastructure. The risk involved is also less. This method is, therefore, advantageous for firms with small means and for those whose limited export business does not justify large investments in developing their own international marketing infrastructure. The main disadvantage of the indirect method of exporting is that the development of the overseas market depends to a very large extent on middlemen and not on the firm producing the export goods. Licensing and Franchising Licensing and Franchising, which involve minimal commitment of resources and effort on the part of the international marketer, are easy ways of entering foreign markets. Under international licensing, a firm in one country (the licensor) permits a firm in another country (the licensee) to use its intellectual property (such as patents, trademarks, copyrights, technology, technical know-how, marketing skill or some other specific skill). The monetary benefit to the licensor is the royalty or fees which licensee pays. In many countries, such fees or royalties are regulated by the government; it does not exceed five per cent of the sales in many developing countries. A licensing agreement may also be one of cross licensing, wherein there is a mutual exchange of knowledge and/or patents. In cross-licensing, a cash payment may or may not be involved. Franchising is described as “a form of licensing in which a parent company (the franchiser) grants another independent entity (the franchisee) the right to do business in a prescribed manner. This right can take the form of selling the franchisor’s products, using its name, production and CU IDOL SELF LEARNING MATERIAL (SLM)

80 Business Environment and Regulatory Framework marketing techniques, or general business approach.” One of the common forms of franchising involves the franchisor supplying an important ingredient (part, material etc.) for the finished product, like the Coca Cola supplying the syrup to the bottlers. Usually, franchising involves a combination of many of the elements mentioned above. The major forms of franchising are manufacturer-retailer systems (such as automobile dealership), manufacturer-wholesaler systems (such as soft drink companies), and service firm-retailer systems (such as lodging services and fast food outlets). Contract Manufacturing Under contract manufacturing, a company doing international marketing contracts with firms in foreign countries to manufacture or assemble the products while retaining the responsibility of marketing the product. This is a common practice in international business. Management Contracting Under the management contract, the firm providing the management know-how may not have any equity stake in the enterprise being managed. In short, in a management contract, the supplier brings together a package of skills that will provide an integrated service to the client without incurring the risk and benefit of ownership. Some Indian companies – Tata Tea, Harrisons Malayalam and AVT – have contracts to manage a number of plantations in Sri Lanka. Tata Tea also has a joint venture in Sri Lanka namely Estate Management Services Pvt. Ltd. Wholly Owned Manufacturing Facilities Companies with long-term and substantial interest in the foreign market normally establish fully owned manufacturing facilities there. As Drucker points out, “it is simply not possible to maintain substantial market standing in an important area unless one has a physical presence as a producer.”1 A number of factors like trade barriers, differences in the production and other costs, government policies etc. encourage the establishment of production facilities in the foreign markets. CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 81 Assembly Operations As Miracle and Albaum point out,2 a manufacturer who wants many of the advantage that are associated with overseas manufacturing facilities and yet does not want to go that far may find it desirable to establish overseas assembly facilities in selected markets. In a sense, the establishment of an assembly operation represents a cross between exporting and overseas manufacturing. Joint Ventures Joint venture is a very common strategy of entering the foreign market. In the widest sense, any form of association which implies collaboration for more than a transitory period is a joint venture (pure trading operations are not included in this concept). Such a broad definition encompasses many diverse types of joint overseas operations, viz., sharing of ownership and management in an enterprise, licensing/franchising agreements, contract manufacturing, management contracts etc. Three of the above have already been discussed in the preceding sections. The following paragraphs are confined to the first category referred to above, i.e., joint ownership ventures. What is often meant by the term joint venture is joint ownership venture. The essential feature of a joint ownership venture is that the ownership and management are shared between a foreign firm and a local firm. In some cases, there are more than two parties involved. A joint ownership venture may be brought about by a foreign investor buying an interest in a local company, a local firm acquiring an interest in an existing foreign firm or by both the foreign and local entrepreneurs jointly forming a new enterprise. It is also a common practice to split the local interest between a partner and various public participation (including public sector firms or industrial development organisations). Such a strategy may enable the international firm to retain much control despite a minority holding as the power of the remaining shares is spread out. Further, equity holding by the public would help the enterprise get some public support. Partnership with government organisation may help to obtain favourable treatment from the government. CU IDOL SELF LEARNING MATERIAL (SLM)

82 Business Environment and Regulatory Framework In countries where fully foreign owned firms are not allowed or favoured, joint venture is the alternative if the international marketer is interested in establishing an enterprise in the foreign market. Many foreign companies entered the communist, socialist and other developing countries by joint venturing. One important advantage of joint venturing is that it permits a firm with limited resources to enter more foreign markets than might be possible under a policy of forming wholly owned subsidiaries. In some cases, it is also possible to swap know-how (such as patent rights for equity) in forming joint venture as a means of securing ownership in foreign operations. Strategic Alliance Strategic alliance has been becoming more and more popular in international business. Also known by such names as entente and coalition, this strategy seeks to enhance the long-term competitive advantage of the firm by forming alliance with its competitors, existing or potential in critical areas, instead of competing with each other. Strategic alliance leverages critical capabilities, increases the flow of innovation and increases the flexibility in responding to market and technological changes. Strategic alliance is also sometimes used as a market entry strategy. For example, a firm may enter a foreign market by forming an alliance with a firm in the foreign market for marketing or distributing the former’s products. A US pharmaceutical firm may use the sales promotion and distribution infrastructure of a Japanese pharmaceutical firm to sell its products in Japan. In return, the Japanese firm can use the same strategy for the sale of its products in the US market. Strategic alliance, more than an entry strategy, is a competitive strategy. There are different types of alliances according to purpose or structure. Based on the description of the generic forms of coalitions by Michael Porter and Mark Fuller, Magsaysay classifies alliances according to purpose as follows: 1. Technology development alliances like research consortia, simultaneous engineering agreements, licensing or joint development agreements. CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 83 2. Marketing, sales and service alliances in which a company makes use of the marketing infrastructure etc. of another company, in the foreign market, for its products. This may help easy penetration of the foreign market and pre-emption of potential competitors. 3. Multiple activity alliance which involves the combining of two or more types of alliances. While marketing alliances are often single country alliances, as international firms take on different allies in each country, technology development and operations alliances are usually multi-country since these kinds of activities can be employed over several countries. Strategic alliances also differ according to how they are structured. They can be equity based (joint ventures) or non-equity based. Non-equity based alliances such as technology transfer agreements, licensing agreements, marketing agreements etc. are proving to be more dynamic, more constructive and more strategic, according to Magsaysay. As indicated above, several areas of business – from R&D to distribution – provide scope for alliance. Whether it is in R&D, manufacturing or marketing, an important objective of the collaboration is to maximise marginal contribution to fixed cost. 3.7 Some Important Emerging International Economic and Business Trends A mutually reinforcing profound combination of sweeping economic, political and demographic changes have been giving rise to a new global economic and business scenario characterised by:  A steady decline of the dominance of the developed countries.  A rapid rise of the developing countries in the world economic-business scenario. Table 3.1 highlights the old and the emerging global economic and business scenario and the growing business power of developing economies vis-à-vis developed economies. CU IDOL SELF LEARNING MATERIAL (SLM)

84 Business Environment and Regulatory Framework Table 3.1: Emerging Trends in Global Economic and Business Scenario The Past The Emerging The dominance of the developed countries in the Emerging markets grow faster than the markets of global economy was unchallenged. the Triad (North America, Japan and Western Europe). MNCs from the developed countries had unabated MNCs from emerging economies proliferate fast, dominance of the global market. as manifested by their increasing number in the Fortune 500. MNCs could invade the developing country MNCs from emerging economies successfully markets without effective resistance from the fight developed country MNCs in the home and domestic firms. foreign markets. Developed country firms acquired developing Cross-border M&As are a two-way phenomenon – country firms. Developing country firms acquire developed country firms including, in some cases, firms much larger in size than the acquirers. FDI flows were confined mostly to the Triad. Developing economies dominate in FDI inflows and their share of outflows has been rising. Advanced economies dominated the global trade. Emerging economies are rapidly increasing their global trade share – China is the largest merchandise exporter. Developing country markets were considered as Incremental demand in developing markets tend to marginal or peripheral. outstrip that in the developed ones. Developing countries were regarded as markets Emerging markets are sophisticated and for dumping obsolete technologies and products. innovative. R&D and innovation was the prerogative of Developing countries are endowed with enormous MNCs or research organisations of developed skill and R&D are flourishing. countries. Source: Francis Cherunilam, International Business –Text and Cases, 2020, PHI Learning. A major force shaping the new global economic-business scenario is the economic power shift between the developed and developing economies. Developing economies as a group are growing faster than developed economies and are increasing their global share of GDP, trade, investment and consumption. A number of developing countries hold out very good prospects for business in future because, mainly, of the following factors: CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 85  A steady increase in population  Fast economic growth  Growing entrepreneurship and growing global orientation and competitiveness of firms  Growing democratisation and individual freedom Few decades ago, China and India were not considered as very significant markets. But the situation has dramatically changed over the last three decades. Their GDPs have grown rapidly and China has emerged as the second largest economy in nominal terms and the largest in PPP terms. India was the 11th largest economy in 2009, but has become the 5th largest by 2019 (third largest in PPP). China and India are regarded as major growth engines of the world economy. Besides, the other BRICS (Brazil, Russia, India, China and South Africa) have also been growing fairly fast. In addition, there is a very diverse grouping of developing economies, described by Goldman Sachs (GS) as N-11 (Next 11) – Bangladesh, Egypt, Indonesia, Iran, Korea, Mexico, Nigeria, Pakistan, Philippines, Turkey and Vietnam. 3.8 Foreign Capital and Collaboration External finance, consisting of investment, aid, debt and emigrant remittance has become a major driver of socio-economic change in India, as in most other countries. Types of Foreign Investment As the Government of India’s foreign investment policy mentions about foreign direct investment (FDI) and foreign portfolio investment (FPI), it is desirable to clearly understand the meaning of these terms.  Foreign direct investment (FDI)  Foreign portfolio investment (FPI) While FDI is akin to promoter’s stake, FPI is akin to stock market investment. Foreign Direct Investment Foreign direct investment refers to investment in a foreign country where the investor retains control full or partial, over the use of the investment. It typically takes the form of starting a CU IDOL SELF LEARNING MATERIAL (SLM)

86 Business Environment and Regulatory Framework subsidiary, acquiring a stake in an existing firm or starting a joint venture in the foreign country. Direct investment and management of the firm concerned normally go together. UNCTAD’s World Investment Reports define foreign direct investment (FDI) as an investment involving a long-term relationship and reflecting a lasting interest and control by a resident entity in one economy (foreign direct investor or parent enterprise) in an enterprise resident in an economy other than that of the foreign direct investor (FDI enterprise or affiliate enterprise or foreign affiliate). FDI implies that the investor exerts a significant degree of influence on the management of the enterprise resident in the other economy. Such investment involves both the initial transaction between the two entities and all subsequent transactions between them and among foreign affiliates, both incorporated and unincorporated. FDI may be undertaken by individuals as well as business entities. According to the World Bank, foreign direct investment is net inflows of investment to acquire a lasting management interest (10 per cent or more of voting stock) in an enterprise operating in an economy other than that of the investor. It is the sum of equity capital, re- investment of earnings, other long-term capital, and short-term capital, as shown in the balance of payments. FDI may take the form of:  Greenfield investment, i.e., establishing an entirely new enterprise in a foreign country.  Acquisition, i.e., acquiring an existing firm, in part or full, in the foreign country. In the recent period, cross-border M&A has been the major driver of FDI. FDIs are governed by long-term considerations because these investments cannot be easily liquidated. Hence, factors like long-term political stability, government policy, industrial and economic prospects etc. influence the FDI decision, However, portfolio investments, which can be liquidated fairly easily, are influenced by short-term gains. Portfolio investments are generally much more sensitive than FDIs. Direct investors have direct responsibility with the promotion and management of the enterprise. Portfolio investors do not normally have such direct involvement with the promotion and management. However, large shareholders can get themselves or their CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 87 nominees appointed in the Board and influence the management. They can also influence the management by their voting power. FDI Flows and FDI Stock: There are two related but different measures of FDI: FDI flows and FDI stock. FDI flows refer to the new FDI during a specified period while the FDI stock measures the total amount of the FDI that exists at a point in time. These stocks are the sums of past flows of FDI. Flows of FDI comprise capital provided (either directly or through other related enterprises) by a foreign direct investor to an FDI enterprise, or capital received from an FDI enterprise by a foreign direct investor. FDI has three components: equity capital, reinvested earnings and intra-company loans. Foreign Portfolio Investment If the investor has only a sort of proprietary interest in investing the capital in buying equities, bonds, or other securities abroad, it is referred to as portfolio investment. That is, in the case of portfolio investments, the investor uses his capital in order to get a return on it, but has no much control over the use of the capital. Foreign portfolio investment (FPI), thus, is investment by individuals, firms, or public bodies (such as governments or government organisations) in financial instruments (such as stocks and government bonds). It is similar to stock market investment. FPIs play an increasingly influencing role in capital markets across the world. There are mainly two routes of portfolio investments in India:  Foreign Institutional Investments (FIIs).  Global Depository Receipts (GDRs), American Depository Receipts (ADRs) and Foreign Currency Convertible Bonds (FCCBs). GDRs, ADRs and FCCBs are instruments issued by Indian companies in the foreign markets for mobilising foreign capital by facilitating portfolio investment by foreigners in Indian securities. Since 1992, Indian companies, satisfying certain conditions, are allowed to access foreign capital markets by Euro issues. CU IDOL SELF LEARNING MATERIAL (SLM)

88 Business Environment and Regulatory Framework FOREIGN INVESTMENT Foreign Direct Investment (FDI) Foreign Portfolio Investment (FPI) Wholly Joint Acquisition Investment Investment in Owned Venture by FIIs GDRs, FDRs, Subsidiary FCCBs etc. Fig. 3.3: Types of Foreign Investment 3.9 Foreign Investment in India Until the economic liberalisation started in 1991, India had a very restrictive policy towards foreign direct investment (FDI) and foreign portfolio investment (FPI) had not been permitted. However, since 1991, there has been a progressive liberalisation of FDI, characterised by an increase in the number of industries opened for FDI and an increase in the FDI cap (i.e., the share of FDI in the total equity of a company). Since 1992-93, FPI has also been progressively liberalised. Now, 100 per cent foreign investment through automatic route is permitted in a large number of manufacturing sectors, infrastructural and other service sectors, including financial services, and agriculture. There are several sectors where foreign investment is capped at 74 or 49 per cent. In a number of sectors, foreign investment is permitted only through government route. In some sectors, automatic route is applicable for foreign investment up to certain limit and beyond that government route is open. There are only a small number of sectors where foreign investment is prohibited These include lottery business: gambling and betting including casinos, chit funds and nidhi companies; certain types of real estate business or construction of farm houses; manufacturing of tobacco CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 89 products and the like; activities/sectors not open to private sector investment, e.g., (i) atomic energy and (ii) railway operations (other than permitted activities under the FDI policy). The major objectives of policy liberalisations for encouraging private investment, both domestic and foreign, are the following: 1. To harness the financial, technological, entrepreneurial and managerial potentials from across the globe for the socio-economic development of India. 2. To boost investment and accelerate economic growth. 3. To expand employment opportunities. 4. To help efficient implementation and timely completion of projects. 5. To increase competition to urge improvement in competitiveness by improving operational efficiencies, corporate restructuring and R&D. 6. To increases competition to enhance consumer choice and improve consumer satisfaction. Foreign investment policy liberalisation has been an ongoing process characterised by deepening (i.e., increasing the extend of liberation in a business sector) and widening (i.e., increasing the numbers of sectors where foreign investment is permitted). Entry Routes for Investments in India Under the Foreign Direct Investments (FDI) Scheme, investments can be made in shares, mandatorily and fully convertible debentures and mandatorily and fully convertible preference shares of an Indian company by non-residents through two routes:  Automatic Route: Under the Automatic Route, the foreign investor or the Indian company does not require any approval from the Reserve Bank or Government of India for the investment.  Government Route: Under the Government Route, the foreign investor or the Indian company should obtain prior approval of the Government of India (Foreign Investment Promotion Board (FIPB), Department of Economic Affairs (DEA) and Ministry of Finance or Department of Industrial Policy and Promotion, as the case may be) for the investment. CU IDOL SELF LEARNING MATERIAL (SLM)

90 Business Environment and Regulatory Framework 3.10 FDI in Different Sectors Government of India’s foreign invest policy permits FDI in a wide spectrum sectors. Infrastructure Sectors 100 per cent FDI is allowed under the automatic route in the power sector (except atomic energy), in a number of categories, subject to all the applicable regulations and laws: FDI up to 100 per cent is permitted under the automatic route for renewable energy generation and distribution projects subject to provisions of The Electricity Act, 2003. Foreign companies which have invested in renewal energy space in India include Suslon, Enercon, Vestas-RRB; NEG-Micon and Applied Materials (USA). The FDI policy allows 100 per cent FDI in private refineries through the automatic route and 26 per cent in government-owned refineries; 100 per cent FDI is also allowed in petroleum products, exploration, gas pipelines and marketing/retail through the automatic route. The foreign companies which have invested in the oil and gas sector in India include British Petroleum (UK), Cairn Energy (India), Shell (UK), BG Group (Scotland), Niko Resources (Canada), OILEX Limited (Australia) and Hardy Oil & Gas Plc. (UK). 100 per cent FDI under automatic route is permitted in several sectors of railway infrastructure, roads and highways, ports and shipping, air transport service, townships, housing, built-up infrastructure and telecom. Financial Services Foreign investment up to specified limit is permitted in several financial sectors including banking, insurance, credit information companies, non-banking finance business, asset reconstruction company; in infrastructure companies; in securities markets; infrastructure companies in Securities Markets; Pension Sector, Credit Information Companies etc. Pharmaceuticals FDI upto100 per cent is permitted through automatic route in greenfield projects and FDI upto 100 per cent is permitted through government route in brownfield projects in the pharmaceutical sector. Foreign companies which have invested in the pharma sector of India CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 91 include Teva Pharmaceuticals (Israel), Nipro Corporation (Japan), Procter & Gamble (USA), Pfizer (USA), GlaxoSmithKline (UK), Johnson & Johnson (USA), Otsuka Pharmaceutical (Japan) and AstraZeneca (Sweden-UK). Automobiles The economic reforms since 1991 led to a dramatic transformation of the automobile sector. Now, 100 per cent FDI is allowed under the automatic route in the auto sector, for manufacture of both automobiles and auto components, subject to all the applicable regulations and laws. At present, 21 domestic automobile manufacturers and 18 foreign automobile manufacturers are active in the automobile industry of the country in the manufacturing of automotive vehicles of different segments. Trading FDI up to 100 per cent is permitted through automatic route in cash and carry wholesale trading/wholesale trading (including sourcing from MSEs). FDI up to specified limits is permitted in a single-brand product retail trading and multi-brand retailing is permitted up to specified limits and subject to certain conditions. 3.11 Impact of FDI in India FDI has increased investments in India and helped to invigorate the growth of several sectors. The infrastructure is one sector which is benefiting significantly from FDI. Acceleration of growth of infrastructural sector is essential for the overall development of the economy. As pointed out earlier, a number of foreign companies have invested in power, renewable energy, oil and gas, railway infrastructure, ports, air service, telecom etc., giving a push to the development of these sectors. In the manufacturing sector, several industries have undergone tremendous transformation. The automobile sector has undergone a dramatic transformation. CU IDOL SELF LEARNING MATERIAL (SLM)

92 Business Environment and Regulatory Framework Excessive Liberalisation FDI permitted in a number of sectors is very excessive. This will hamper Indian entrepreneurship and will cause increasing foreign ownership of the Indian economy with all its consequences. India being a fast growing large economy, foreign companies would be very eager to be in India even without 100 per cent FDI. It is imprudent to permit 100 per cent FDI except in sectors where it is inevitable due to technological reasons. There is a strong feeling that brownfield foreign investment in the pharma sector would very adversely impact the generics drugs sector where India has several advantages. It could lead to foreign domination of this sector and cause increase in drug prices and spoil Indian firms’ global competitive advantage, besides draining out the income from India. Even in greenfield, permission for 100 per cent foreign investment is not desirable. As mentioned earlier, FDI will come in even at a lower cap because the Indian market is too attractive. The foreign investment in private banks up to 74 per cent is highly objectionable. If at all foreign capital is desirable in the banking sector, foreigners could have been asked to go to the greenfield route with sufficient rural presence too. Foreign investment in the insurance sector also is not likely to realise the benefits propagated but may cause draining income out of the country. Corporate retailing has several advantages. Studies have revealed that middle and lower income groups save significantly by shopping in large retail shops. However, even in single brand retailing, 100 per cent FDI is very undesirable. Privatisation of public sector units, including the sale of majority stake in bluechip oil company Bharat Petroleum Corporation Limited (BPCL), amounts to disintegrating and destabilising the industrial sector (and thereby the economy) of India built up over last seven decades, paving way for exploitation of the Indian economy by multinational corporate, leading to draining resources out of the country and impoverishing the nation. Critical sectors of India like heavy and basic industries, infrastructure, services and communication are coming under increasing foreign ownership and control. CU IDOL SELF LEARNING MATERIAL (SLM)

Economic Policies 93 3.12 Summary The Monetary and Fiscal Policies are two important instruments employed by the Central Bank (RBI) and government respectively to influence the behaviour and performance of the financial sector and the economy in general. Monetary Policy refers to the use of instruments within the control of the monetary authority (i.e., the Central Bank of the country – the Reserve Bank of India) to influence the level of aggregate demand for goods and services or to influence the trends in certain sectors of the economy. The Fiscal Policy is that part of Government policy which is concerned with raising revenue through taxation and other means, and deciding on the level and pattern of public expenditure. By far, the most far-reaching tax reform in India was the introduction of the Goods and Services Tax (GST) in 2017. The GST has merged a number taxes into one. It is an indirect tax levied on the supply of goods and services; it is one indirect tax for the entire country. There has been an increase in foreign investment flow to India. Although foreign investment has several beneficial impacts on Indian economy, the excessive liberalisation has serious deleterious effects. A very important global business practice is globalisation of supply chain. One of the most important strategic decisions in international business is the mode of entering the foreign market. 3.13 Key Words/Abbreviations 1. M&As: Mergers and Acquisitions 2. GST: Goods and Services Tax 3. FDI: Foreign Direct Investment 4. FPI: Foreign Portfolio Investment 5. FIIs: Foreign Institutional Investments 6. GDRs: Global Depository Receipts 7. ADRs: American Depository Receipts 8. FCCBs: Foreign Currency Convertible Bonds CU IDOL SELF LEARNING MATERIAL (SLM)

94 Business Environment and Regulatory Framework 3.14 Learning Activity 1. Analyse the impact of foreign investment in any Indian industry of your choice. ----------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------- 3.15 Unit End Questions (MCQs and Descriptive) A. Descriptive Types Questions (i) Long Answer Questions 1. Explain the monetary policy and its significance for business. 2. What is fiscal policy? Explain its significance for business. 3. Give a brief account of the trends in the global networking of business operations. 4. Discuss the foreign investment policy of India. 5. Evaluate the impact of foreign investment in India. (ii) Short Answer Questions 1. Write a note on goods and services tax (GST). 2. What are the important types of foreign investment? 3. Write a note global supply chain. 4. Differentiate between general and selective methods of credit control. 5. What is Bank Rate Policy? B. Multiple Choice/Objective Type Questions 1. Monetary policy is formulated and administered by: (a) Central bank of the country (b) Central government (c) State governments (d) Commercial banks CU IDOL SELF LEARNING MATERIAL (SLM)