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Reserve Ratios directly affect the reserve base, while Bank Rate Policy affects indirectly by variations in the cost of acquiring the reserves. The use of any one instrument rather than another at any point is determined by the nature of the situation and the range of influence it is desired to wield as well as the rapidity with which the change is required to be brought about. The effects of Bank Rate changes are not confined to the banking system and the short-term money market; it has wide repercussions on the economy as a whole. Open market Operations are suitable for carrying out day-to-day adjustments on even smaller scale. A change in Reserve Ratios produces an impact at once and affects the banks generally. i. Bank Rate Policy: The Bank Rate Policy is a very important technique used in the monetary policy for influencing the volume or the quantity of the credit in a country. The bank rate refers to rate at which the central bank (i.e., RBI) rediscounts bills and prepares of commercial banks or provides advance to commercial banks against approved securities. It is \"the standard rate at which the bank is prepared to buy or rediscount bills of exchange or other commercial paper eligible for purchase under the RBI Act\". The Bank Rate affects the actual availability and the cost of the credit. Any change in the bank rate necessarily brings out a resultant change in the cost of credit available to commercial banks. If the RBI increases the bank rate than the volume of commercial banks borrowing from the RBI gets reduced. It deters banks from further credit expansion as it becomes a more costly affair. Even with increased bank rate the actual interest rates for a short-term lending go up checking the credit expansion. On the other hand, if the RBI reduces the bank rate, borrowing for commercial banks will be easy and cheaper. This will boost the credit creation. As per the Bank rate theory, 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. Thus, any change in the bank rate is normally associated with the resulting changes in the lending rate and in the market rate of interest. However, the efficiency of the bank rate as a tool of monetary policy depends on existing banking network, interest elasticity of investment demand, size and strength of the money market, international flow of funds, etc. The importance of Bank rates lies in the fact that it acts as a pace-setter to all the other rates of interests. ii. Open Market Operation (OMO): The open market operation refers to the purchase and/or sale of short term and long-term securities by the RBI in the open market. This is very effective and popular instrument of the monetary policy. The OMO is used to wipe out shortage of money in the money market, to influence the term and structure of the interest 51 CU IDOL SELF LEARNING MATERIAL (SLM)

rate and to stabilize the market for government securities, etc. It is important to understand the working of the OMO. If the RBI sells securities in an open market, commercial banks and private individuals buy it. This reduces the existing money supply as money gets transferred from commercial banks to the RBI. Contrary to this when the RBI buys the securities from commercial banks in the open market, commercial banks sell it and get back the money they had invested in them. Obviously, the stock of money in the economy increases. This way when the RBI enters in the OMO transactions, the actual stock of money gets changed.Normally during the inflation period in order to reduce the purchasing power, the RBI sells securities and during the recession or depression phase it buys securities and makes more money available in the economy through the banking system. Thus, under OMO there is continuous buying and selling of securities taking place leading to changes in the availability of credit in an economy. However, there are certain limitations that affect OMO viz; underdeveloped securities market, excess reserves with commercial banks, indebtedness of commercial banks, etc. iii.Variations in the Reserve Ratios: The Commercial Banks have to keep a certain proportion of their total assets in the form of Cash Reserves. Some parts of these cash reserves are their total assets in the form of cash. Apart of these cash reserves are also to be kept with the RBI for the purpose of maintaining liquidity and controlling credit in an economy. These reserve ratios are named as Cash Reserve Ratio (CRR) and a Statutory Liquidity Ratio (SLR). The CRR refers to some percentage of commercial bank's net demand and time liabilities which commercial banks have to maintain with the central bank and SLR refers to some percent of reserves to be maintained in the form of gold or foreign securities. In India the CRR by law remains in between 3-15 percent while the SLR remains in between 25-40 percent of bank reserves. Any change in the VRR (i.e., CRR + SLR) brings out a change in commercial banks reserves positions. Thus, by varying VRR commercial banks’ lending capacity can be affected. Changes in the VRR helps in bringing changes in the cash reserves of commercial banks and thus it can affect the banks credit creation multiplier. RBI increases VRR during the inflation to reduce the purchasing power and credit creation. But during the recession or depression it lowers the VRR making more cash reserves available for credit expansion. a. Cash Reserve Ratio (CRR): It is defined as that portion of total deposits which a commercial bank is required to keep with the RBI in the form of cash reserves. In 2013, it was 4.0% which implies that every commercial bank has to keep 4% of its total deposits with the RBI. In a situation of excess demand, RBI raises the CRR. This will reduce the cash deposits left with commercial banks to be loaned out. This is another method to control the availability of credit. 52 CU IDOL SELF LEARNING MATERIAL (SLM)

b. Statutory Liquidity Ratio (SLR): It is defined as that portion of total deposits which a commercial bank has to keep with itself in the form of liquid assets. In a situation of excess demand, RBI raises the SLR. The result is the reduction in surplus cash reserves of commercial banks which can be offered for credit. This will discourage credit in an economy. The SLR in India, at present is 21.50 % for entire net demand and time liabilities of scheduled commercial banks. 3.4.2 SELECTIVE CREDIT REGULATIONS / QUALITATIVE METHODS: Qualitative instruments are also referred as selective instruments of the RBI's monetary policy. These instruments are utilized for differentiating between various uses of credit; for instance, they can be utilizedin favour of encouraging export over import or essential over non-essential credit supply. This instrument has an influence on both borrowers and lenders. RBI uses following qualitative rules: i. Fixing Margin Requirements: When specific part or proportion of loan is not financed or offered by the bank is termed as Margin. Alternatively, it is that proportion of the loan which borrower need to arrange first before applying for loan in the bank. The amount of loan is dependent on this margin that means variation in margin will introduce change in loan amount. This method is employed to ensure the necessary availability of credit supply for the needy sector and discourage it for other non-essential sectors. Such objective is fulfilled by maintaining high for the non-necessary sectors and lowering the margin for other needy sectors. For instance: If the RBI categorized agriculture sector as necessary sector then margin will be decreased and even bank can offer upto 90 percent of loan. ii. Consumer Credit Regulation: Under this method, consumer credit supply is regulated through hire-purchase and instalments sale of consumer goods. Under this method the down payment, instalments amount, loan duration, etc. is fixed in advance. This can help in checking the credit use and then inflation in a country. iii. Publicity: This is yet another method of selective credit control. Through its Central Bank (RBI) publishes various reports stating what is good and what is bad in the system. This published information can help commercial banks to direct credit supply in the desired sectors. Through 53 CU IDOL SELF LEARNING MATERIAL (SLM)

its weekly and monthly bulletins, the information is made public and banks can use it for attaining goals of monetary policy. iv. Credit Rationing: Central Bank fixes credit amount to be granted. Credit is rationed by limiting the amount available for each commercial bank. This method controls even bill rediscounting. For certain purpose, upper limit of credit can be fixed and banks are told to stick to this limit. This can help in lowering banks credit exposure to unwanted sectors. v. Moral Suasion: It implies to pressure exerted by the RBI on the Indian banking system without any strict action for compliance of the rules. It is a suggestion to banks. It helps in restraining credit during inflationary periods. Commercial banks are informed about the expectations of the central bank through a monetary policy. Under moral suasion central banks can issue directives, guidelines and suggestions for commercial banks regarding reducing credit supply for speculative purposes vi. Control through Directives: Under this method the central bank issue frequent directives to commercial banks. These directives guide commercial banks in framing their lending policy. Through a directive the central bank can influence credit structures, supply of credit to certain limit for a specific purpose. The RBI issues directives to commercial banks for not lending loans to speculative sector such as securities, etc. beyond certain limit. vii. Direct Action: Under this method the RBI can impose an action against a bank. If certain banks are not adhering to the RBI's directives, the RBI may refuse to rediscount their bills and securities. Secondly, RBI may refuse credit supply to those banks whose borrowings are in excess to their capital. Central bank can penalize a bank by changing some rates. At last, it can even put a ban on a particular bank if it does not follow its directives and work against the objectives of the monetary policy. These are various selective instruments of the monetary policy. However, the success of these tools is limited by the availability of alternative sources of credit in economy, working of the Non-Banking Financial Institutions (NBFIs), profit motive of commercial banks and undemocratic nature off these tools. But a right mix of both the general and selective tools of monetary policy can give the desired results. [Reference: https://blog.finology.in/] 54 CU IDOL SELF LEARNING MATERIAL (SLM)

3.5 IMPACT OF MONETARY POLICY: Impact of cut in CRR on Interest Rates: From time to time, RBI prescribes a CRR or the minimum amount of cash that banks have to maintain with it. The CRR is fixed as a percentage of total deposit. As more money chases the same number of borrowers, interest rates come down. Impact of change in SLR and Gilt Products on Interest Rates: SLR reduction is not so relevant in the present context for two reasons. First, as part of the reform process, the government has begun borrowing at market-related rates. Therefore, banks get better interest rates compared to what they used to get earlier for their statutory investments in government securities. Second, banks are still the main source of funds for the government. This means that despite lower SLR requirements, banks investment in government securities will go up as government borrowing rises. As a result, bank investment in gilts continues to be high despite the RBI bringing down the minimum SLR to 25% a couple of years ago. Therefore, for the purpose of determining the interest rates, it is not the SLR requirement that is important but the size of the government’s borrowing programme. As government borrowing increases, interest rate, too, rise. Besides, the gilts also provide another tool for the RBI to manage interest rates. The RBI conducts OMO by offering to buy or sell gilts. If it feels that interest rates are too high, it may bring them down by offering to buy securities at a lower yield than what is available in the market Impact of Open Market Operation: The monetary policy of the seventies and first half of the eighties had excluded the open market operations instrument. This is because active Government securities market was non-existent. Active Government securities market could not emerge because of the fact that rates of interest offered on Government paper that is, treasury bills and dated Government securities were much below prevailing market rates of interest. Late Prof. S. Chakravarty, the head of Monetary Reforms Committee recommended raising of interest rates on Government securities to ensure profitability of banks and activism of the open market operations. This recommendation was accepted and in the late eighties interest rates of Government securities were raised. In the post reform period, as a first step yields on government securities were made market determined by sale of Government securities through open auction. Furthermore, the interest rate structure was simultaneously rationalised and banks were given the freedom to determine their prime lending rates and other main rates of interest. These measures by RBI facilitated the use of open Market operations as an effective instrument for liquidity management including control of short-term fluctuations in the foreign exchange market. 55 CU IDOL SELF LEARNING MATERIAL (SLM)

Impact of Bank Rate: Before 1991, changes in bank rate as an instrument of monetary control were quite rare. The bank rate remained unchanged at 10 per cent in the whole decade 1981-91. In the post-reform period Reserve Bank has moved towards a situation in which changes in bank rate give signals to the commercial banks and other financial institutions about the emerging financial situation of the economy so that they could adjust their interest rates accordingly, Besides, bank rate serves as a reference rate on the basis of which commercial banks can fix their- prime lending rates. To control inflationary pressures in the Indian economy Reserve Bank raised bank rate from 10 per cent to 11 per cent in July 1991 and further to 12 per cent in October 1991. Raising of lending rates of interest on the advances to the businessmen was intended to discourage demand for credit. However, it may be noted that the role of bank rate as an instrument of credit control is limited because of the following factors: First, before mid-1990s, because of the administered nature of interest rates the bank rate was not used as a reference rate by the banks for the purpose of fixing their lending rates. Secondly, even now when lending rates of banks have been freed, there is not much refinance being made available at the bank rate so that banks can ignore this as a reference in setting their own lending rates. Thirdly, at present lending rates of interest are determined by demand for and supply of funds in the money market. In fact, the monetary policy regarding bank rate is itself influenced by the prevailing economic situation. Impact of Liquidity Adjustment Facility (LAF): Another important change in the instrument of monetary policy is the introduction of Liquidity Adjustment Facility (LAF) from June 2000 to adjust on a daily basis liquidity in the banking system so that it remains within reasonable limits. Besides, through Liquidity Adjustment Facility, the RBI regulates short-term interest rates while its bank rate policy serves as a signalling device for its interest rate policy in the intermediate period. These short-term interest rates of RBI are called repo rate and reverse repo rate. Impact on Domestic Industry and Exporters: The exporters look forward to the monetary policy since the Central Bank always makes an announcement on export refinance, or the rate at which the RBI will lend to banks which have advanced pre-shipment credit to exporters. A lowering of these rates would mean lower borrowing costs for the exporter. Impact on Stock Markets and Money Supply: Most people attribute the link between the amount of money in the economy and movements in stock markets to the amount of liquidity 56 CU IDOL SELF LEARNING MATERIAL (SLM)

in the system. This is not entirely true. The factor connecting money and stocks is interest rates. People save to get returns on their savings. A hike in interest rates would tend to suck money out of shares into bonds or deposits; a fall would have the opposite effect. This argument has survived econometric tests and practical experience. Impact of Money Supply on Jobs, Wages and Output: At any point of time, the price level in the economy is determined by the amount of money floating around. An increment in the money supply- currency with the public demand deposits, and time deposit – increases prices all around because there is more currency moving towards the same goods and services. Typically, the RBI follows a least inflation policy, which means that its money market operations as well as changes in the bank rate are generally designed to minimise the inflationary impact of money supply changes. Since most people can generally see through this strategy, it limits the impact of the RBI’s monetary moves on jobs or production. The markets, however, move to the RBI’s tune because of the link between interest rates and capital market yields. The RBI’s policies have maximum impact on volatile forex and stock markets. The jobs, wages, and output are affected over the long run, if the trends of high inflation or low liquidity persist for a very long period. If the wages move slower than other prices, higher inflation will drive real wages lower and encourage employers to hire more people. This, in turn, ramps up production and employment. This was the theoretical justification of a long term trend that showed that higher inflation and employment went together, whereas, when inflation fell, unemployment increased. Impact on Money Supply: The RBI uses the interest rate, OMO, changes in the CRR are the most popular instruments used. Under the OMO, the RBI buys or sells government bonds in the secondary market. By absorbing bonds, it drives up bond yields and injects money into the market. When it sells bonds, it does so to suck money out of the system. The changes in CRR affect the amount of free cash that banks can use to lend—reducing the amount of money for lending cuts into overall liquidity, driving interest rates up, lowering inflation, and sucking money out of markets. Primary deals in government bonds are a method to intervene directly in markets, followed by the RBI. By directly buying new bonds from the government at lower than market rates, the RBI tries to limit the rise in interest rates that higher government borrowings lead to. [Reference: https://smallbusiness.chron.com/] 3.6 FISCAL POLICY: The term fiscal has been derived from the Greek word fisc, meaning a basket to symbolize the public purse. Fiscal policy thus means the policy related to the treasury of the government. Fiscal policy is a part of general economic policy of the government which is primarily concerned with the budget receipts and expenditures of the government. All welfare projects are completed under this policy. It also suggests measures to control economic 57 CU IDOL SELF LEARNING MATERIAL (SLM)

fluctuations which may become violent and create great upheavals in the socio-economic structure of the economy. It also outlines the influence of resource utilization on the level of aggregate demand through affecting the level of aggregate consumption and investment expenditure. 3.6.1 Concept and Meaning: Fiscal policy means the use of taxation and public expenditure by the government for stabilization or growth. The fiscal policy is concerned with the raising of government revenue and incurring of government expenditure. To generate and to incur expenditure, the government frames a policy called budgetary policy or fiscal policy. So, the fiscal policy is concerned with government expenditure and government revenue. Fiscal Policy has to decide on the size and pattern of flow of expenditure from the government to the economy and from the economy back to the government. So, in broad term, fiscal policy refers to that segment of national economic policy which is primarily concerned with the receipts and expenditure of central government. In other words, fiscal policy refers to the policy of the government with regard to taxation, public expenditure and public borrowings. The importance of fiscal policy is high in underdeveloped countries. The state has to play active and important role. In a democratic society direct method are not approved. So, the government has to depend on indirect methods of regulations. In this way, fiscal policy is a powerful weapon in the hands of government by means of which it can achieve the objectives. Fiscal policy is the term used to describe all of the government’s decisions regarding taxation and spending. When governments want to increase the money available to populace, they lower the taxes and raise spending (expansionary fiscal policy); in contrast, when they want to decrease the money available to populace, they raise the taxes and lower spending (contractionary fiscal policy) Government spending and the policies guiding the public expenditure of the government do influence macroeconomic conditions. These policies affect tax rates, interest rates and government spending, in an effort to control the economy. Fiscal policy is the means by which a government adjusts its levels of spending in order to monitor and influence a nation’s economy. Fiscal policy and monetary policy go hand in hand with each other. Both are interdependent on each other. Fiscal policy serves as an important tool to influence the aggregate demand. The instruments of fiscal policy are government spending and taxation. Depending upon existing situation of the economy, government can employ either expansionary or contractionary fiscal policy. Expansionary fiscal policy increases the aggregate demand whereas contractionary or deflationary fiscal policy reduces the aggregate demand. Changes in the level, timing and composition of government spending and taxation have an important effect on the economy. 58 CU IDOL SELF LEARNING MATERIAL (SLM)

Fiscal policy is the policy of government related to its own expenditure and taxes in order to influence the aggregate demand (AD). It is one of the very important demand –side policies. Demand –side policies focus on changing the AD or shifting the AD curve in the aggregate demand and aggregate supply (AD-AS) model in order to achieve the goals of price stability, full employment, and economic growth. There are four components of AD: consumer spending(C), investment spending (I), government spending (G), and net exports(X-M), where X=exports and M=imports. Fiscal policy influences all of these four components of AD. Government can influence ‘C’ by imposing taxes on consumers, i.e., personal income taxes. It can influence ‘I’ by imposing taxes on business profits. Similarly, government can easily change its own spending. It influences ‘X-M’ by means of subsidies provided to the domestic producers, import tax, and so on. Different economist has given different definitions of Fiscal policy as follows: According to Culbarston, “By fiscal policy we refer to government actions affecting its receipts and expenditures which we ordinarily taken as measured by the government’s receipts, its surplus or deficit.” The government may offset undesirable variations in private consumption and investment by compensatory variations of public expenditures and taxes. Arthur Smithies defines fiscal policy as “a policy under which the government uses its expenditure and revenue programmes to produce desirable effects and avoid undesirable effects on the national income, production and employment.” Though the ultimate aim of fiscal policy in the long-run stabilisation of the economy, yet it can be achieved by moderating short-run economic fluctuations. In this context, Otto Eckstein defines fiscal policy as “changes in taxes and expenditures which aim at short-run goals of full employment and price-level stability. According to U. Hicks “Fiscal policy is concerned with the manner in which all the different elements of public finance, while still primarily concerned with carrying out their own duties, may collectively be geared to forward the aims of economic policy.” 3.6.2: Objectives of Fiscal Policy: The fiscal policy is designed to achieve the following objectives: Development by Effective Mobilization of Resources: The principal objective of fiscal policy is to ensure rapid economic growth and development. This objective of economic growth and development can be achieved by Mobilization of Financial Resources. The central and the state governments in India have used fiscal policy to mobilize resources. The financial resources can be mobilized by: 59 CU IDOL SELF LEARNING MATERIAL (SLM)

 Taxation: Through effective fiscal policies, the government aims to mobilize resources by way of direct taxes as well as indirect taxes because most important source of resource mobilization in India is taxation.  Public Savings: The resources can be mobilized through public savings by reducing government expenditure and increasing surpluses of public sector  Private Savings: Through effective fiscal measures such as tax benefits, the government can raise resources from private sector and households. Resources can be mobilized through government borrowings by ways of treasury bills, issue of government bonds, etc., loans from domestic and foreign parties and by deficit financing. Efficient Allocation of Financial Resources: The central and stategovernments have tried to make efficient allocation of financial resources. These resources are allocated for Development Activities which includes expenditure on railways, infrastructure, etc. While Non-development Activities includes expenditure on defence, interest payments, subsidies, etc. But generally, the fiscal policy should ensure that the resources are allocated for generation of goods and services which are socially desirable. Therefore, India's fiscal policy is designed in such a manner so as to encourage production of desirable goods and discourage those goods which are socially undesirable. Reduction in Inequalities of Income and Wealth: Fiscal policy aims at achieving equity or social justice by reducing income inequalities among different sections of the society. The direct taxes such as income tax are charged more on the rich people as compared to lower income groups. Indirect taxes are also more in the case of semi-luxury and luxury items, which are mostly consumed by the upper middle class and the upper class. The government invests a significant proportion of its tax revenue in the implementation of Poverty Alleviation Programmes to improve the conditions poor people in society. Price Stability and Control of Inflation: One of the main objectives of fiscal policy is to control inflation and stabilize price. Therefore, the government always aims to control the inflation by reducing fiscal deficits, introducing tax savings schemes, Productive use of financial resources, etc. Employment Generation: The government is making every possible effort to increase employment in the country through effective fiscal measure. Investment in infrastructure has resulted in direct and indirect employment. Lower taxes and duties on small-scale industrial (SSI) units encourage more investment and consequently generate more employment. Various rural employment programmes have been undertaken by the Government of India to solve problems in rural 60 CU IDOL SELF LEARNING MATERIAL (SLM)

areas. Similarly, self-employment scheme is taken to provide employment to technically qualified persons in the urban area. Balanced Regional Development: Another main objective of the fiscal policy is to bring about a balanced regional development. There are various incentives from the government for setting up projects in backward areas such as Cash subsidy, Concession in taxes and duties in the form of tax holidays, Finance at concessional interest rates, etc. Reducing the Deficit in the Balance of Payment: Fiscal policies attempts to encourage exports by way of fiscal measures like Exemption of income tax on export earnings, Exemption of central excise duties and customs, Exemption of sales tax and octroi, etc. The foreign exchange is also conserved by providing fiscal benefits to import substitute industries, imposing customs duties on imports, etc. The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve balance of payments problem. In this way adverse balance of payment can be corrected either by imposing duties on imports or by giving subsidies to exports. Capital Formation: The objective of fiscal policy in India is also to increase the rate of capital formation so as to accelerate the rate of economic growth. An underdeveloped country is trapped in vicious (danger) circle of poverty mainly on account of capital deficiency. In order to increase the rate of capital formation, the fiscal policy must be efficiently designed to encourage savings and discourage and reduce spending Increasing National Income: The fiscal policy aims to increase the national income of a country. This is because fiscal policy facilitates the capital formation. This results in economic growth, which in turn increases the GDP, per capita income and national income of the country. Development of Infrastructure: Government has placed emphasis on the infrastructure development for the purpose of achieving economic growth. The fiscal policy measure such as taxation generates revenue to the government. A part of the government's revenue is invested in the infrastructure development. Due to this, all sectors of the economy get a boost. Foreign Exchange Earnings: Fiscal policy attempts to encourage more exports by way of Fiscal Measures like, exemption of income tax on export earnings, exemption of sales tax and octroi, etc. Foreign exchange provides fiscal benefits to import substitute industries. The foreign exchange earned by way 61 CU IDOL SELF LEARNING MATERIAL (SLM)

of exports and saved by way of import substitutes helps to solve balance of payments problems. 3.6.3 Role of Fiscal Policy: 1. Allocation: The provision for social goods, or the process by which total resource use is divided between private and social goods and by which the mix of social goods is chosen. This provision may be termed as the allocation function of budget policy. Social goods, as distinct from private goods, cannot be provided for through the market system. The basic reasons for the market failure in the provision of social goods are: firstly, because consumption of such products by individuals is non rival, in the sense that one person’s partaking of benefits does not reduce the benefits available to others. The benefits of social goods are externalised. Secondly, the exclusion principle is not feasible in the case of social goods. The application of exclusion is frequently impossible or prohibitively expensive. So, the social goods are to be provided by the government. 2. Distribution: Adjustment of the distribution of income and wealth to assure conformance with what society considers a ‘fair’ or ‘just’ state of distribution. The distribution of income and wealth determined by the market forces and laws of inheritance involve a substantial degree of inequality. Tax transfer policies of the government play an important role in reducing the inequalities in income and wealth in the economy. 3. Stabilization: Fiscal policy is needed for stabilization, since full employment and price level stability do not come about automatically in a market economy. Without it the economy tends to be subject to substantial fluctuations, and it may suffer from sustained periods of unemployment or inflation. Unemployment and inflation may exist at the same time. Such a situation is known as stagflation. The overall level of employment and prices in the economy depends upon the level of aggregate demand, relative to the potential or capacity output valued at prevailing prices. Government expenditures add to total demand, while taxes reduce it. This suggests that budgetary effects on demand increase as the level of expenditure increases and as the level of tax revenue decreases. 4. Economic Growth: Moreover, the problem is not only one of maintaining high employment or of curtailing inflation within a given level of capacity output. The effects of fiscal policy upon the rate of growth of potential output must also be allowed for. Fiscal policy may affect the rate of saving and the willingness to invest and may thereby influence the rate of capital formation. 62 CU IDOL SELF LEARNING MATERIAL (SLM)

Capital formation in turn affects productivity growth, so that fiscal policy is a significant factor in economic growth. 3.7 DIFFERENCE BETWEEN MONETARY AND FISCAL POLICY: Both “Monetary Policy” and “Fiscal Policy” are used to regulate the economy, i.e. to either increase or decrease the pace of economic growth to some extent. Let us consider the major differences between them as follows: Monetary Policy:  Monetary Policy is the policy determined and implemented by the Reserve Bank of India with no intervention by the Government of India.  In a Monetary Policy the RBI intervenes in a host of ways to control inflation monitor interest rates and control money supply in the economy. For example, the central bank may intervene to hike interest rates and thereby control inflation in the economy. On the other hand if inflation is low, it may cut interest rates in the economy.  The main aim of RBI’s monetary policy is to keep a check on inflation and maintain an optimum level of GDP growth at the same time. If RBI raised the interest rate too high then that might help in checking inflation but at the same time deter economic activity and slow down GDP growth and if they keep the rates too low then that will promote economic activity but it will also spur inflation. They have to keep a balance between both so one is not sacrificed for the sake of the other.  Monetary policy is carried out by RBI and manifests itself by setting interest rates like the Repo and Reverse Repo as well as determining levels of CRR and SLR which influence money supply and credit flow in the economy.  It may also improve liquidity by cutting the cash reserve ratio for banks.  The Reserve Bank of India also conducts open market operations, wherein the central bank, buys and sells government bonds.  The monetary policy regulates the cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial banks.  The monetary policy aims to maintain the price stability, full employment and economic growth. It can carry out open-market operations (OMO), control credit, and vary the reserve requirements.  The monetary policy is different from fiscal policy as the former brings about a change in the economy by changing money supply and interest rate, whereas fiscal policy is a broader tool of the government. Fiscal Policy 63 CU IDOL SELF LEARNING MATERIAL (SLM)

 Fiscal Policies are largely determined by the government of India. Fiscal policy is the policy that determines how the government spends money, and taxes people to pay for those expenses. This would include measures like tweaking with the direct and indirect tax collection to control the fiscal deficit.  When the government's deficit runs high it may add a slew of taxes to boost revenues. However, it has to be cautious as the same could also backfire.  Fiscal policy largely aims at stabilizing the economy; boosting revenues for the government and helping the economy grow. The government uses its tax levers to help the economy.  While “Monetary Policy” is the tool in the hands of the Central Bank to regulate the economy, “Fiscal Policy” on the other hand, is the tool in the hands of the “government” to regulate the economy. So, if the government wants to help the economy to speed up, it may decide to reduce taxes so that people have higher disposable incomes to spend on goods and services. This naturally would lead to an increase in demand and supply and thereby stimulate all the interlinked industries.  Secondly, the government may also decide to increase its own spending by way of building infrastructure such as airports, railways, bridges and roads. There are several ancillary sectors that get impacted the moment the government decides to increase its spending. The demand for the production of organizations operating in these sectors increases bringing profits and prosperity.  On the other hand, if the government decides to slow down the economy because of “running away” inflationary growth, it will do the opposite by way of increasing taxes and decreasing its own spends.  The fiscal policy can be used to overcome recession and control inflation. It may be defined as a deliberate change in the government revenue and expenditure to influence the level of national output and prices. During the times of recession when government increases its spending or cuts taxes – that’s termed as a fiscal stimulus package the instruments of fiscal policy are used to boost the economy. India has had three fiscal stimulus packages following the last recession which involved tax cuts and boosts in spending, and were similar to stimulus measures used by countries around the world. Also, government can reduce its expenditures or raise taxes during inflationary times.  Fiscal policy aims at changing aggregate demand by suitable changes in government expenditure and taxes. 3.8 TECHNIQUES OF FISCAL POLICY 3.8.1: Taxation Policy: Taxes are the main source of revenue for the government. Government levies both direct and indirect taxes in India. Direct taxes are those which are paid directly by the assessee to the 64 CU IDOL SELF LEARNING MATERIAL (SLM)

government e.g., income tax, wealth tax, etc. Indirect taxes are paid indirectly by the public to the government i.e., the taxes are charged by trader/manufacturer from the public and then paid to government e.g., excise duty, custom duty, value added tax (VAT), service tax, etc. Direct taxes are progressive in nature i.e., the rate of tax increases with the increase in level of income/wealth so people with low income will pay tax at lower rates and people with higher income will pay tax at higher rates. Indirect taxes are not progressive. These are charged from all segments of the society at the same rate, i.e. both rich and poor have to pay indirect taxes at the same rate. In India, in the year 2007-08, direct taxes constituted 49 percent of the total tax collection and indirect taxes constituted 51 percent. Main purposes of the taxation policy in India are as follows:  Mobilisation of Resources: Tax revenue in India has been rising every year. Government mobilizes resources through taxation for economic development. In the year 2007-08, about 64 percent of revenue of central and state government of India came from tax revenue. Rate of taxes have come down but the collection of tax has increased.  To Promote Saving: For this purpose various tax concession, tax deductions are given on savings e.g., Provident Fund, National saving Certificates, Life Insurance Policies, Government Bonds, Mutual Funds, etc.  To Promote Investment: Various tax rebates, tax concessions and tax holiday benefits are given to promote the investment in remote and backward or rural areas. Similarly, tax rebates and concessions are given to export-oriented units, so as to encourage investment in these industries.  To Bring Equality of Income and Wealth: To achieve this objective different kinds of progressive direct taxes are levied e.g. income tax, wealth tax, etc. i.e., rate of tax is increased with the increase in the income. Similarly, excise duties are levied at higher rate on luxury goods and at lower rates on necessary goods. Tax Structure of Government of India: India has a well-developed tax structure with clearly demarcated authority between Central and State Governments and local bodies. Central Government levies taxes on the following:  Income Tax: Tax on income of a person  Customs duties: Duties on import and export of goods  Central Goods and Service Tax (CGST): Indirect Tax levied on manufacture, sale and consumption of goods and services.  Integrated Goods and Service Tax (IGST): For inter-state transfer of goods and services. State Governments can levy the following taxes: 65 CU IDOL SELF LEARNING MATERIAL (SLM)

 State Goods and Service Tax (SGST): Indirect Tax levied on Intrastate manufacture, sale and consumption of goods and services.  Stamp duties and Land Revenue: Since land is a matter on which only State Governments can govern, thus the Stamp duties on transfer of immovable properties are levied by State Governments.  State Excise on Liquor and certain agricultural goods. Apart from the above, certain powers of taxation have been devolved in the hands of local bodies. These local governing bodies can levy taxes on water, property, shop and establishment charges etc. Direct Taxes: They are called so as the burden of taxation falls directly on the tax payer. Under the Income Tax Act, 1961 The Central Government levies direct taxes on the income of individuals and business entities as well as Non business entities also. The taxation level depends on the residential status of individuals. The thumb rule of residential status is that an individual becomes resident in India if he has remained in India for more than 182 days in a particular residential year. If he becomes resident in India, then his global income i.e. income earned even outside India is taxable in India. This has to be noted very carefully by Expatriates on deputation to India. They need to plan their stay in such a manner as to avoid becoming a resident in India. The following para explains this in a slightly more detailed manner: Tax Resident: An individual is treated as resident in a year if present in India: 1. For 182 days during the year or 2. For 60 days during the year and 365 days during the preceding four years. A resident who was not present in India for 730 days during the preceding seven years or who was non-resident in nine out of ten preceding years treated as not ordinarily resident. A person not ordinarily resident is taxed like a non-resident but is also liable to tax on income accruing abroad if it is from a business controlled in or a profession set up in India. What is taxable for a Non-Resident? Non-residents are taxed only on income that is received in India or arises or is deemed to arise in India. He is entitled to get benefit of any double taxation avoidance agreement that his country of residence has signed with India. Then he shall be liable for taxes at rates mentioned in the Indian domestic tax laws or the rates mentioned in the Double Taxation Avoidance Agreement whichever is lower. What is taxable for a Resident? The global income of a resident is taxable irrespective of whether earned or related or received in India. 66 CU IDOL SELF LEARNING MATERIAL (SLM)

Amounts invested in certain investments like Employee Provident Fund, Public Provident Fund, Tax saving Fixed Deposits, are also eligible for deduction under section 80C upto Rs.1,50,000 per year. Corporate Taxation: The rate at which Corporates are taxed in India is 30% plus a 3% cess. Thus the total comes to 30.9%. Further if the taxable income is more than Rs. 10 million, then there is an additional surcharge of 12% on the base tax rate. Dividend Distribution Tax (DDT): Under Section 115-O of the Income Tax Act, any amount declared, distributed or paid by a domestic company by way of dividend shall be chargeable to dividend tax. So if a company declares divided, it has to pay an effective rate of 16.995% on the dividends declared. This is apart from the 30.9 % taxes mentioned above. The rationale for this tax is that after paying this tax, the dividend so declared becomes tax free in the hands of the recipient of dividend. Minimum Alternative Tax (MAT): Normally, a company is liable to pay tax on the income computed in accordance with the provisions of the income tax Act, but many a times due to exemptions under the income tax Act, there is huge actual profit as shown in the profit and loss account of the company but no taxable income. To overcome this issue, and in order to bring such companies under the income tax act net, the concept of Minimum Alternate Tax (MAT) has been introduced. The present rate of MAT is 19.05%. Another aspect which must be looked into is the concept of Withholding Taxes; also called as Tax Deduction at Source (TDS). Tax Deduction at Source (TDS): As per the provisions of the Indian tax laws, certain payments are covered under tax withholding norms. Under this, the person responsible for making any payment is required to withhold a certain specified percentage of the payment amount as taxes and deposit it with the Government treasury. In addition, the person is required to prepare a certificate of tax deduction and provide it to the person on whose behalf the deductions are made. Every quarter i.e., 3 months, returns have to be filed by the deduct or and credit must be given to the deducted in the returns. The following are the areas where tax withholding is most common in the Indian scenario: 67 CU IDOL SELF LEARNING MATERIAL (SLM)

Salaries: The salaried employees of the drawing beyond the minimum taxable salary would be covered under the tax withholding requirements and annual tax withholding returns are to be submitted with the Revenue authorities. Contractors:Payments made to a contractor for carrying out any work would require withholding of tax at source from such payments, if certain threshold limits are crossed. Typical examples of such payments will include:  Advertising payments  Broadcasting and telecasting payments  Office renovation payments  Vehicle hire payments  Catering payments.  Job Work  Courier Professional Services: Payments made for professional and technical fees to Doctors, Chartered Accountants, Lawyers, Management Consultants, Engineers, Architects and other professionals would fall under this section and tax would be required to be withheld from their payments. Such withheld tax shall be deposited with the Government. Rentals:Payments for rentals would attract tax deduction at source. Indirect Taxes Indirect tax is generally imposed on suppliers or manufacturers who pass it on to the consumers using their good or services. The following are the list of Indirect Taxes as: 1. Service Tax: Applicable on the services provided by a company and paid by the recipient of their services, collected by and deposited with the central government. 2. Value Added Tax: Popularly known as VAT, it is levied on the sale of movable goods or goods sold directly to the customers. It is exacted by the respective state governments on intra-state sales. 3. Excise duty: Levied on the goods produced or manufactured in India, paid by the manufacturers of different goods. It is often recovered from the customers. 4. Custom Duty: Applicable on the goods which are imported into India from other countries. In some cases, it is also levied on the goods being transported out of India. 5. Entertainment tax: Levied on all financial transactions related to entertainment such as movie shows, amusement parks, video games, arcades, and sports activities, charged by the respective state governments. 68 CU IDOL SELF LEARNING MATERIAL (SLM)

6. Stamp Duty: Levied on the transfer of immovable property located within the state, charged by the State Government and may vary in rates. Also applicable on all legal documents. 7. Securities Transaction Tax: Levied at the time of trade of securities through Indian Stock Exchange. In India, there are many different Indirect Taxes which are applicable on different kinds of goods, imports, manufacturing and services. GST: Merging of various indirect taxes As there are many different types of indirect taxes levied on the expense incurred by a buyer, the government has made an effort to simplify the taxing process and merged all these indirect taxes into a common indirect tax called the Goods and Service Tax (GST). Merging of all these taxes has reduced the hassles of compliances associated with all these indirect taxes, improving tax governance in the country. Introduced in 2017, the GST has eliminated the cascading effect of multiple taxes. 3.8.2 Public Expenditure Policy: It influences the economic activities of a country to a great extent. In 2007-08, share of public expenditure in national income was 14.5 percent. Public expenditure may be of two kinds i.e. developmental and non-developmental, Developmental expenditure is of great importance with reference to the economic growth of the country. Developmental activities like development of means of transport, extension means of irrigation, completion of power projects and expansion of educational and health facilities requires huge amount of capital that cannot be contributed by the private sector alone, so increase in public expenditure is must. The following measures undertaken by the Government can help to increase the public expenditure which is as follows:  Development of Public Enterprises: Basic and heavy industries requires huge capital and also involves more risks. So, private sector in the country cannot setup such establishment without any support. Since Industrial Policy, 1956 resolution, Government of India is actively involved in development of such industries.  Support to Private Sector: In order to accelerate the rate of economic growth in the country, government is encouraging private sector by giving various subsidies, concessional loans, tax concessions, etc.  Development of Infrastructure: Government spends huge amount for the development of infrastructure that includes development of railways, power projects, roads, air ports, ports, hospitals, bridges, dams, etc. which is important prerequisites for the economic development of any nation.  Social Welfare: Government spends huge amount on public health, education, safe drinking water, sanitation, welfare of weaker section of society, etc. 69 CU IDOL SELF LEARNING MATERIAL (SLM)

3.8.3 Public Debt Policy: Government needs lot of funds for the economic development of the country. No government can mobilise so much funds by way of taxes alone. There are many reasons for it, viz. a) most of the population is poor; b) adverse effect of more taxes on savings and investments; c) taxes are levied only till taxable capacity of the people. It therefore, becomes inevitable for the government to mobilise resources for economic development by resorting to public debt. Public debt is obtained from two kinds of sources: o Internal Debt: It should be mobilised in a manner that it has no adverse effect on private investment. It is more beneficial to collect small savings as it encourages the people to save more. Special efforts should be made to mobilise rural small savings. In India, small savings are being collected from large number of people through commercial banks and post offices. Internal debt constituted 95.9 percent of total public debt in the year 2007-08. o External Debt: India cannot meet its financial requirements from internal debt alone. It has got to borrow from abroad as well. The main advantage of foreign loans is that these loans are received in foreign currency. External debt constituted 95.9 percent of total debt in the year 2007-08. 3.8.4 Deficit Financing Policy: It refers to financing the budgetary deficit. Budgetary deficit here means excess of government expenditure over government income (including borrowings). Deficit financing in India means, “Taking loan from the Reserve Bank of India by the government to meet the budgetary deficit”. Reserve Bank gives this loan by issuing new currency notes. Consequently, money supply increases. Increase in money supply leads to fall in the value of money. Fall in value of money in turn leads to increase in price level. So, deficit financing should be kept low as it leads to price rise in the economy. But in India, level of income is low. As a result, power to save in is also and their taxable capacity is also low. Due to low saving, there is a low rate of capital formation which leads to low rate of economic growth. Hence to accelerate the rate of economic growth, it becomes inevitable to increase saving and investment. Deficit financing is a kind of forced savings. On account of deficit financing, price level rises and people get less number of goods in exchange for the same amount of money than before. Government of India has also been taking resort to deficit financing since the beginning of the plans. Thus, due to deficit financing, on the one hand, necessary funds are made available for economic growth and on the other, inflation in the country increases. It is, therefore, essential that deficit financing be kept with safe limits. Presently our government is not using deficit financing for meeting its financial requirements. [Reference: https://www.oliveboard.in/] 70 CU IDOL SELF LEARNING MATERIAL (SLM)

3.9 FISCAL POLICY REFORMS INTRODUCED BY THE GOVERNMENT OF INDIA: 1. Simplification of Taxation System: With a view to simplify the taxation system as recommended by Raja Chelliah Taxation Reform Committee, ex-Finance Minister Dr. Manmohan Singh and Finance Minister Sh. Chidhambaram have taken several steps. These measures have provided big relief to tax payers. It is also imperative that administrative machinery should be made efficient and honest with simplification of taxation system. 2. Improving Tax to GDP Ratio: In recent years government has taken several measures to improve tax-GDP ratio. In year 2002-03 this ratio was 14.4 percent. In the year 2009-10 it has improved to 16.6 percent. It shows that scope of tax has increased. 3. Reduction in Rates of Direct Taxes: Policy of fiscal reforms aims at lowering the rate of taxes. Tax revenue is to be increased by reducing the tax rate. Government of India has been gradually lowering the rates of direct and indirect taxes in its successive budgets. In 1997-98 budgets, the maximum rate of income tax was reduced to 30 percent. Rate of Corporation Tax has also been reduced. In the budget for the year 2009-10, maximum rate of income tax is 30 percent. As a result of these reforms, collection of tax revenue has increased considerably. Although rates of taxes have been reduced yet the tax revenue has been rising constantly. In 1990-91, direct tax revenue was 1.9 percent of gross domestic product (GDP). In 2009-10, it rose to 6 percent of GDP. Of the total tax revenue, the ratio of direct tax revenue has increased from 19% in the year 1990-91 to 58% in the year 2009-10. Consequent upon different reform measures taken in respect of direct taxes, revenue from taxes has increased appreciably. 4. Reforms in Indirect Taxes: For the last many years the government has been making persistent efforts to reform the indirect tax structure e.g. lowering of the tax rates, increasing scope of tax, etc. Under reforms concerning customs, import duties were gradually reduced so as to bring down the cost of production. It has enabled the domestic industry to compete in the international market. Reduction in import duty has brought down the prices of imported goods to the benefit of the consumers. In year 2001-02, government adopted Central Value Added Tax (CENVAT). In CENVAT, three tier excise duties of 8%, 16% and 24% are started. In the year 2008-09 and 2009-10, excise duty rates have been reduced to boost aggregate demand, so as to protect the domestic economy from global recession. In place of retail sales tax, Value Added Tax has been introduced. All states /UTs have implemented VAT w.e.f. April 1, 2005. VAT is charged on value addition at each stage of production or distribution. For example, when raw materials are changed into work in process, some value addition takes place. 71 CU IDOL SELF LEARNING MATERIAL (SLM)

Similarly, when work in process is converted into finished goods, again some value addition takes place. In VAT, tax is charged on each stage of value addition. In VAT, three tax rates have been determined, for gold and silver VAT rate is 1%, for basic goods it is 4% and for other commodities, VAT rate is 12.5%. 5. Introduction of Service Tax: In the year 1994-95, service tax has been started in India. In year 2007-08, rate of service tax was 12 percent. In year 2009-10, service tax rate has been reduced to 10 percent. Initially this tax was applicable on a few seconds but now 114 services have been covered under this tax. 6. Reduction in Non-plan Government Expenditure: One of the major objectives of fiscal reforms was to put a check on unnecessary government expenditure. Government took several measures in this direction; for example superfluous appointments were banned, disinvestments in public enterprises incurring chronic losses. As a result of these measures, total non-plan expenditure of the central government that stood at 17.3 percent of GDP in 1990-91 came down to 11.3 percent in 2009-10. Thus, the central government has partially succeeded in scaling down percentage of non-plan expenditure. However, non-plan expenditure of government in absolute monetary terms instead of going down has actually been on increase. Rise in the non-plan expenditure of the government must be a matter of concern in so far as economic development is concerned. 7. Reduction in Subsidies: Central Government has to make huge payments by way of subsidies, for instance, fertilizer subsidies, export subsidies, food subsidies, etc. Government has been making serious efforts to reduce subsidies. No doubt, the total amount being spent on subsidies has been rising, but as a percentage of GDP it has been falling. In 1990-91, subsidies constituted 2.3 percent of GDP but in 2007-08 their share fell to 1.4 percent. But in the year 2008-09, it again increased to 2.2% of GDP. In 2009-10, subsidies constituted 1.8% of GDP. 8. Improvement in Tax Collection: For improving tax collection and to check tax evasions various schemes have been launched by government from time to time viz., - allotting Permanent Account Number (PAN), strengthening the norms of Tax Deduction at Source (TDS), Special Bearer Bond Scheme, Voluntary Disclosure Schemes, making e-filing of tax returns mandatory for certain assesses, extension of e-payment, facility of taxes, etc. Tax authorities have been given wide powers to conduct tax-raids. 72 CU IDOL SELF LEARNING MATERIAL (SLM)

9. Closure of Sick Public Sector Companies: Government has been closing loss making and sick public sector companies. This step has been taken to reduce the burden of these loss making units on government exchequer. 10. Disinvestment of Public Sector Units: Disinvestment here refers to selling the shares of public sector units to private hands. Through disinvestment government gets huge funds. This has enabled the government to overcome financial crunch. 11. Efforts to Reduce Government Administrative Expenses: For this government has offered attractive voluntary retirement scheme to its employees to overcome the problem of over staffing. Government has banned or reduced sanctioning new posts in some of its departments. Government has also reduced grants to various states, and privately managed institutions. 12. Enactment of Fiscal Responsibility and Budget Management Act: Government has enacted Fiscal Responsibility and Budget Management Act, 2003. The main purpose of this Act is to reduce fiscal deficit and for this, the target has been fixed for reducing fiscal deficit with the minimum annual reduction of 0.5 % of Gross Domestic Product (GDP). 13. Reduction in Central Sales Tax (CST): Government has reduced CST from 3 % to 2% from June 1, 2008. From 1st April 2011, CST has been abolished. 14. Introduction of Goods and Service Tax (GST): Central government is gradually reducing central sales tax, excise duty on goods and is increasing service tax. Government is moving towards imposing a uniform tax on goods and services named GST with effect from April 1, 2011. Goods and Service Tax is a comprehensive value added tax on goods and services levied and collected on the value added at each stage of sales and purchase. GST will have two components, comprising of Central GST and State GST. [https://www.economicsdiscussion.net/] 3.10 SUMMARY The Major objectives of Monetary and Fiscal Policies are:  To increase the rate of investment and capital formation, so as to accelerate the rate of economic growth.  To increase the rate of saving and discourage actual and potential consumption. 73 CU IDOL SELF LEARNING MATERIAL (SLM)

 To diversify the flow of investment and spending from unproductive uses to socially most desirable channels.  To check sectoral imbalances.  To reduce widespread inequalities in income and wealth.  To improve the standard of living of the masses by providing social goods on a large scale.  Neutrality of money;  Exchange rate stability and equilibrium in the balance of payments;-  Price stability and control of business cycle;  Full employment;  Economic growth; The Industrial Policy of 1948 broadly divided industries into four categories. Small-scale industrial sector was decided to develop on co- operative lines as far as possible. The main thrust of the 1948 Industrial Policy was to lay the foundation of a mixed economy. The Act focused mainly on granting license for new undertakings, especially regarding location, size, etc. The Act also empowered the government to prescribe prices, methods, volume of production and the channels of distribution. The economic growth and development of the country is mix of various plans, policies, efforts, strategies and efficient utilization of resources. The fiscal and monetary policy together is very important in the overall development of the country and helps to build the robust path for future development. The reforms introduced in both the policies have helped Indian economy to sail smoothly through global slowdown. Today, Indian economy is emerging as a strong economy in the world and the backbone of such successful status is our solid monetary and fiscal policies with effective instruments that help to continue the journey of growth and development. 3.11 KEYWORDS  Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency.  Fiscal policy is the term used to describe all of the government’s decisions regarding taxation and spending.  Instrument - a means by which something is affected or done.  Tax Resident: An individual is treated as resident in a year if present in India:  For 182 days during the year or  For 60 days during the year and 365 days during the preceding four years.  Disinvestment of Public Sector Units: Disinvestment here refers to selling the shares of public sector units to private hands. 74 CU IDOL SELF LEARNING MATERIAL (SLM)

3.12 LEARNING ACTIVITY 1. Why it is important to understand the liquidity and ranking for measure of Money? ___________________________________________________________________________ _____________________________________________________________________ 2. Compare Public Debt and Expenditure Policy ___________________________________________________________________________ ____________________________________________________________________ 3.13 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Explain the meaning of monetary Policy. 2. Discuss the relationship of money supply with Monetary Policy. 3. Present the comparison of Qualitative and Quantitative methods of Monetary Instrument 4. What is the purpose of Fiscal Policy? 5. Why Taxes are the main source of revenue for the government? Long Questions 1. What are the objectives of Monetary Policy? Explain it. 2. Explain General Methods of Monetary Instrument. 3. Justify the role of Fiscal Policy 4. What is TDS? What are the areas where TDS is applicable? 5. Discuss the Impact of Fiscal Policy Reforms B. Multiple Choice Questions 1. Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a ___________________to ensures price stability and general trust in the currency. a. Inflation rate or interest rate b. Bank rate c. Cash Reserve Ratio d. Statutory Liquidity Ratio 2. If the RBI opts for a cheap or easy credit policy by reducing interest rates, the _______________in the economy can be encouraged. 75 CU IDOL SELF LEARNING MATERIAL (SLM)

a. Investment level b. Bank rate c. Economic development d. Infrastructure development 3. Which measure of money is taken into account in formulating macroeconomic objectives of the economy every year? a. M1 b. M2 c. M3 d. M4 4. The resources can be mobilised through _______________by reducing government expenditure and increasing surpluses of public sector a. Private Savings b. Mutual Funds c. Public Savings d. Taxation 5. State Governments can levy ________________ tax. a. Service Tax b. Custom Duties c. Stamp Duties d. Income Tax Answers 1 – a; 2- b; 3 – a; 4 -d; 5 – c. 3.14 SUGGESTED READINGS Text Books:  Francis Cherunilam , Business and Environment, Text and Cases, [Himalaya Publishing House],  T R Jain, Mukesh Trehan and Ranju Trehan, Indian Business Environment– VK Enterprise  C. Fernando, Business Environment Kindle Edition, Pearson  K.Aswathappa, Essentials Of Business Environment, Himalaya Publishing House 76 CU IDOL SELF LEARNING MATERIAL (SLM)

 SHAIKH SALEEM, BUSINESS ENVIRONMENT, Pearson  Ian Worthington, Chris Britton, The Business Environment, Financial Times/ Prentice Hall. Reference Books:  Engineering Economic-Dr. Rajan Mishra by University Science Press  The Gazette of India, Ministry of Law and Justice, New Delhi. No.311, June’16, 2006.  Morrison J, The International Business Environment, Palgrave  MISHRA AND PURI, Indian Economy, Himalaya Publishing House, New Delhi  Business Environment Raj Aggarwal Excel Books, Delhi  Strategic Planning for Corporate Ramaswamy V McMillan, New Delhi  Dahl Modern political analysis. Englewood Cliffs, N.J: Prentice-Hall. Open Text Source:  Dhamija, Dr. Ashok (2009). Prevention of Corruption Act. LexisNexis India. p. 2049. ISBN 9788180385926.  Subrata K. Mitra and V.B. Singh. 1999. Democracy and Social Change in India: A Cross-Sectional Analysis of the National Electorate. New Delhi: Sage Publications. ISBN 81-7036-809-X (India HB) ISBN 0-7619-9344-4 (U.S. HB).  Bakshi; P M (2010). Constitution of India, 10/e. Universal Law Publishing Company Limited. pp. 48–.ISBN 978-81-7534-840-0.  International Journal of Scientific and Research Publications, Volume 2, Issue 12, December 2012  https://courses.lumenlearning.com/ 77 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT 4: GLOBAL BUSINESS TRENDS 78 Structure 4.0 Learning Objective 4.1 Introduction 4.2 Global Business 4.2.1 Concept 4.2.2 Nature 4.2.3 Scope 4.3 Global Trends 4.3.1 Need of Foreign Capital 4.3.2 Types of Foreign Capital 4.3.3 Initiatives by Indian Government to Attract Foreign Capital 4.4 Foreign capital 4.4.1 Definition of Foreign Collaboration: 4.4.2 Types of Foreign Collaboration 4.5 Foreign collaboration 4.6 Economic trends in Indian industries 4.7 Summary 4.8 Keywords 4.9 Learning Activity 4.10 Unit End Questions 4.11 Suggested Readings 4.0 LEARNING OBJECTIVE After studying this Unit, you will be able to  Explain the significance of Globalization  Outline the Global Trends  Compare the different types of Foreign Capital  Define the Role of Foreign Collaboration  Highlight the economic trends in India CU IDOL SELF LEARNING MATERIAL (SLM)

4.1 INTRODUCTION Globalization – a new habit, necessity and important aspect of Economic civilization across the World. Globalization has not only proved beneficial for large corporates but it has created opportunity for the small businesses as well as for nations, consumers and overall economy. The connectivity of the people and business throughout the World that has resulted in birth of global culture and lead to political and economic integration. In Late 1970’s, the word globalization was coined first. The modes of transportation, the spread of telephone networks and affordable internet services are the main reason behind the spread of Globalization. With the current situation of COVID-19 pandemic the consumption of high-tech gadgets, laptops and internet has increased. World economic activities and various services are using online platform that has changed the pace and dimension of globalization. Globalization has become very important aspect for every business. As business needs resources and availability of the resources are not specific to one region. It encourages the movement of raw material from one region to other; from one country to other country thus leading to export and import of goods. Even the finished goods are traded to enjoy the quality and utility offered. The increase in market share, easy access to raw material and availability of talent which is ready to migrate has encourage the transnational business and enjoy it benefits. 4.2 GLOBAL BUSINESS: 4.2.1 Concept Business which is conducted internationally in more than one country is termed as an International business. It involves transactions of goods & services between the two countries. These transactions are conducted at the global level & across national borders. International businesses are very large in size as they are performed at a global level. Their scales of operation are vast in size. International businesses provide employment to a large number of peoples. It is served as an important source for earning foreign exchange for the country. All payments in these businesses are done in foreign currencies of different countries. These businesses help in improving the standard of living of people in different countries by supplying high-quality goods. International business is of different types like imports & exports, franchising, licensing, foreign direct investment, etc. International businesses provide employment to a large number of peoples. It is served as an important source for earning foreign exchange for the country. All payments in these businesses are done in foreign currencies of different countries. 4.2.2 Nature International Restrictions 79 CU IDOL SELF LEARNING MATERIAL (SLM)

In international business, there is a fear of the restrictions which are imposed by the government of the different countries. Many country’s governments don’t allow international businesses in their country. They have trade blocks, tariff barriers, foreign exchange restrictions, etc. These things are harmful to international business. Benefits to Participating Countries It gives benefits to the countries which are participating in the international business. The richer or developed countries grow their business to the global level and they get maximum benefits. The developing countries get the latest technology, foreign capital, employment opportunities, rapid industrial development, etc. This helps developing countries in developing their economy. Therefore, developing countries open up their economy for foreign investments. Large Scale Operations International business contains a large number of operations at a time because it is conducted on a large scale globally. Production of the goods at a large scale, they have to fulfil the demand at a global level. Marketing of the product is also conducted at a large scale to make them aware of the product. First, they fulfil the domestic demand and then they export the surplus in the foreign markets. Integration of Economies International Business combines the economies of many countries. The companies use the finance, labour, resources, and infrastructure of the other countries in which they are working. They produce the parts in different countries, assembles the product in other countries and sell their product in other countries. Dominated by Developed Countries International business is dominated by developed countries and their MNC’s. Countries like U.S.A, Europe, and Japan all are the countries that are producing high-quality products, they have people working for them on high salaries. They have large financial and other resources like the best technology and Research and Development centers. Therefore, they produce good quality products and services at low prices. They help them to capture the world market. Market Segmentation International business is based on market segmentation on the basis of the geographic segmentation of the consumers. The market is divided into different groups according to the demand of the consumers in different countries. It produces goods according to the demand of the consumers of the different market segmentations. Sensitive Nature 80 CU IDOL SELF LEARNING MATERIAL (SLM)

International Business is highly affected by economic policies, political environment, technology, etc. It can play a positive role to improve the business and can also be negative for the business. It totally depends on the policies made by the government; it can help in expanding the business and maximizing the profits and vice-versa. 4.2.3 Scope Foreign Investments Foreign investment is an important part of international business. Foreign investment contains investments of funds from the abroad in exchange for financial return. Foreign investment is done through investment in foreign countries through international business. Foreign investments are two types which are direct investment and portfolio investment. Exports and Imports of Merchandise Merchandise are the goods which are tangible. (those goods which can be seen and touched.) As mentioned above merchandise export means sending the home country’s goods to other countries which are tangible and merchandise imports means bringing tangible goods to the home country. Licensing and Franchising Franchising means giving permission to the new party of the foreign country in order to produce and sell goods under your trademarks, patents or copyrights in exchange of some fee is also the way to enter into the international business. Licensing system refers to the companies like Pepsi and Coca-Cola which are produced and sold by local bottlers in foreign countries. Service Exports and Imports Services exports and imports consist of the intangible items which cannot be seen and touched. The trade between the countries of the services is also known as invisible trade. There is a variety of services like tourism, travel, boarding, lodging, constructing, training, educational, financial services etc. Tourism and travel are major components of world trade in services. Growth Opportunities There are lots of growth opportunities for both of the countries, developing and under- developing countries by trading with each other at a global level. The imports and exports of the countries grow their profits and help them to grow at a global level. Benefiting from Currency Exchange International business also plays an important role while the currency exchange rate as one can take advantage of the currency fluctuations. For example, when the U.S. dollar is down, you might be able to export more as foreign customers benefit from the favourable currency exchange rate. 81 CU IDOL SELF LEARNING MATERIAL (SLM)

Limitations of The Domestic Market If the domestic market of a country is small then the international business is a good option for the growth of the business in the host country. Depression of domestic market firms will force to explore foreign markets. 4.3GLOBAL TRENDS: 1. Global banking structure: Domestic banking institutions are slowly increasing their exposure to international assets and liabilities. To quote, the US financial crisis had an impact on other international economies due to exposure of the latter economies in structurally created international mortgage assets. With the advent of modern technology, domestic banking institutions are converting into global banking institutions. These increasing international exposures are substantially driving global business strategies. 2. Sustainable and clean energy: Climate change agreements are talk of the town these days. The emerged markets like, the US, UK, European Union (EU), Japan, etc, are entering into agreements in taking emerging markets to the path of sustainability and usage of clean energy. The countries are deriving ways in procuring clean energy from international shores. Consequently, these agreements are seriously impacting the way businesses are conducted in domestic a well as international markets. 3. Increasing economic power of emerging markets: The contribution of the emerging markets in overall global factors is increasing over the years. The acronym 'BRICS' comprising Brazil, Russia, India, China and South Africa is gaining importance since the last decade. The said economies are expected to outperform other emerged markets in coming future owing to the existence of diverse opportunities in the wake of middle class strata of society, technological revolutions, infrastructure advancements, education levels, socio- cultural factors, etc. So, due to these opportunistic factors, emerging markets are considered to be an important import and export destinations for the international players thereby driving business strategies. 4. Increasing Privatization: Slowly, the international economies are moving toward privatizing corporate affairs. Public-private partnerships and divestment programs are core parts of these strategies undertaken in worldwide markets. The role of government in channelizing funds is slowly reducing, i.e. capitalism is state of the art philosophy which international economies are following. Obviously, these changing patterns are having an impact on international business environment. 5. Technological revolution: With the advent of information and communication technology, new business opportunities are emerging. Cloud computing is a new way of handling business operations worldwide. Mobile phones and broadband connections are changing the way of doing businesses by promoting virtual teams. Moreover, the role of government in enhancing the use of technology is quite commendable. For instance, the 82 CU IDOL SELF LEARNING MATERIAL (SLM)

concept of 'smart city' under the flagship of present National Democratic Alliance (NDA) government clearly reflects the importance that is being placed on the technological revolutions that the government attempts to introduce. For this, the government is also considering international financial flows. 6. Changing Demographic features: Owing to globalization, consumers' tastes and preferences are changing over the years. More and more women candidates are getting employment in industrial and financial houses. Growing e-commerce platforms are helping consumers and prospective customers in buying and even selling through international platforms. The said platforms are creating new employment avenues for the people. For instance, Japanese economy is witnessing aging population, however, it is finding respite in selling its products to the worldwide consumers. 7. International arbitration: These days international arbitrators are playing an important role in directing global business strategies. The disputes which are outside the purview of domestic rules and regulations are referred to international arbitrators. The existence of these agencies is not only resolving the said disputes but also promoting and enhancing confidence among the business fraternities for entering into international trade relationships. 8. Competitive advantage: In today's scenario, most of the emerged markets are witnessing slower growth rates, so, this situation is placing an important role that the emerging markets can play in driving international growth rates. Increasing trade relations with the emerging markets vividly highlight the growing importance and competitive advantage of the said economies. 9. Regional and economic blocs: Lastly, these regional and economic blocs, like EU, ASEAN nations, etc., are slowly increasing cooperation among the international economies. The said economies are opening up their respective domestic economies for the international investors. Consequently, these regional and economic blocs are having an impact on the global business environment. 10. Global Supply Chain: In the global economy, managing a supply chain requires dealing with trade and tariff controls, quality regulations, and international relationships. Global supply chain management is highly specialized and complicated. Some firms even do nothing but manage supply chains for other companies, whereas some other companies offer the service in addition to their core activity. For example, the following promotion appears on the FedEx website: FedEx Supply Chain is a third-party logistics provider that can support supply chain requirements throughout the product lifecycle, from kitting and product packaging through end-of-life services such as liquidation and recycling. 83 CU IDOL SELF LEARNING MATERIAL (SLM)

The World Bank estimates that 13 percent of the world’s gross domestic product (GDP) was earned from moving and storing goods around the planet in 2016. 4.4FOREIGN CAPITAL Introduction: Foreign capital, MNCs and globalization are closely linked. Globalization is made possible by the emergence and growth of multinational corporations, which in turn, act as funnels and sources of foreign capital. Foreign capital and technology are very important to develop the hitherto untapped natural resources of developing countries. In the following sections, we will study the role of foreign capital in the developing countries. One of the most important characteristics of developing economies is their low savings and poor capital formation. It is this feature of the developing countries that keeps them poor for ages and makes it difficult for them to get out of the quagmire of poverty in which they have been wallowing for centuries. However, this deficiency of capital has not restrained them from attending to the task of quickening the process of economic growth. It has in fact steeled their resolve to industrialize themselves fast, as in the case of India which launched an ambitious programme of industrialization during the Second Five Year Plan. Since the country did not have sufficient capital resources, it had to depend on foreign capital, as was the case with other developing countries. Foreign capital comes to a country in different forms, the most important of them being FDI. A major source of FDI is multinational corporations, which we have discussed earlier 4.4.1 Need Of Foreign Capital: The following are some of the factors that call for foreign capital to a developing country such as India. 1. To sustain a high level of investment: If an underdeveloped country wants to industrialize itself quickly, it has to raise its quantity of capital resources substantially to invest in multiple industrial segments. To raise such a large amount of capital, a poor country with low savings cannot but seek foreign capital to bridge the resource gap between savings and investment. 2. To bridge the technology gap: One of the primary reasons for an underdeveloped country to remain in a state of poverty is the low technology it uses at all levels of its productive activity. If they have to develop their economies through industrialization they have to come out of the low level equilibrium in which they find themselves. To ensure higher level of growth, it is imperative for them to import cutting edge technology from the 84 CU IDOL SELF LEARNING MATERIAL (SLM)

developed countries. Foreign capital usually brings in such technology in the form of private foreign investment or as joint venture. In the Indian case, our industry was able to fill up the technology gap through (a) import of export services, (b) training imparted to Indian personnel and (c) educational, research and training institutions set up in collaboration with foreign experts. 3. To exploit natural resources: Most of the developing countries are richly endowed with huge deposits of natural and mineral resources. India, for instance, is said to be a “Veritable darling of nature,” and possess enough and to spare of coal, iron ore, hydro carbon, etc. That is why it is said that “India is a rich country inhabited by poor people”. However, notwithstanding these huge mineral and other resources, we are not able to tap and exploit them to the benefit of the country's development. Therefore, developing countries seek the expertise and technical skills of advanced countries to prospect, exploit and make effective use of these resources. 4. To initiate growth by undertaking initial risk: Initiating the process of economic growth in underdeveloped countries where there is an acute paucity of private entrepreneurs is a Herculean task. In such cases, foreign capital is preferred to undertake the risk of investment and provide the initial incentive for industrialization. Once foreign entrepreneurs bring in capital and technical enterprise, bear risk and uncertainty involved in the process of industrialization in an unindustrialized country and pave the way for the growth of industries, domestic entrepreneurs can take over and continue the process with greater ease. 5. To developbasic infrastructure: Both at the beginning and during the process of economic growth of developing economies, it has been found that one of the major obstacles is lack of adequate infrastructure and the feeble attempt to develop it for want of indigenous capital and incentives. Infrastructure development, especially in power, irrigation, roads, railways, sea transport and air connectivity is absolutely essential to enable a developing economy grow. Even after almost six decades of planning economic development, India finds growth in infrastructure tardy and inadequate to meet the developmental needs of the economy. We have to depend on international financial institutions such as the World Bank, Asian Development Bank, International Development Association, etc. to help us develop our infrastructure. Even less- and medium-developed countries such as Malaysia and Singapore have come forward to invest in our infrastructure. 85 CU IDOL SELF LEARNING MATERIAL (SLM)

6. To bridge the foreign exchange gap: While planning and executing the process of economic growth of their economies, poor countries need to have adequate foreign exchange to import plants, equipment and machinery, technical expertise and industrial raw materials. As producers of primary products, they can only export low-priced agricultural products such as food grains, tea, coffee, sugar and spices. But with an ever- increasing population, they find it difficult to create surpluses for exports after catering to the huge domestic captive market. Thus, a rising mismatch between demand and supply of foreign exchange, and the problems arising out of unfavourable balance of payments, drive the poor countries seek foreign exchange by inviting foreign capital. 4.4.2 Types of Foreign Capital Foreign capital consists of two main forms: (i) private foreign investment and (ii) foreign aid. Private foreign investment can be either (a) direct foreign investment, or (b) indirect foreign investment. When a private foreign investor either establishes a branch of his business or a subsidiary in the host country, it is called direct foreign investment. Multinational corporations which establish their subsidiaries in developing countries such as India belong to this category. Hindustan Lever, Procter & Gamble, Coca-Cola India, etc. are examples of MNCs incorporated outside India, but having their subsidiary companies in India. When these MNCs open their subsidiaries in a host country, they bring with them a number of modern industrial inputs such as technological expertise, plant, machinery, equipment, managerial skills, marketing and sales techniques which benefit the host country immensely. If a developing country absorbs these skill sets, it will permeate in its industrial structure and widen and (c) creditor capital from official sources in host country's companies. The Indian government provides data on foreign investment of the categories provided in Figure 4.3.1. 86 CU IDOL SELF LEARNING MATERIAL (SLM)

Foriegn Direct Indirect Foriegn Investment Investment SIA and FIPB GDRs approved FII investment RBI and NRI Off-shore Funds Fig 4.1: TYPES OF FOREIGN CAPITAL SIA – Secretariat for Industrial Approval; FIPB- Foreign Investment Promotion Board RBI-Reserve Bank of India; NRI-Non-Resident Indian GDR-Global Depository Receipts FII-Foreign Institutional Investor In India foreign direct investment may further take the form of (i) wholly owned subsidiary (ii) joint venture and (iii) acquisitions, Foreign portfolio investment may be (i) Investment by Foreign, Institutional Investors (FIIs) including Non-Resident Indian (MRIs) (ii) Investment in (a) Global Depository Receipts (GDRs) and (b) Foreign Currency Convertible Bonds (FCCBs). Private foreign investment in India can be further classified as follows: 1. Foreign Aid: It consists of loans and grants. Loans may be taken from individual countries or from institutional agencies like World Bank, IMF and International Financial Corporation. Usually loans are taken for medium and long term capital needs of a country. Loans impose a heavy burden on the borrower country because they are to be repaid, along with interest, called surviving of loans. Loans may be tied because of restrictions. Such restrictions may be in the form of end use or in the form of source. Grants are given by public or private charitable organisations. 87 CU IDOL SELF LEARNING MATERIAL (SLM)

They are given for relief purposes and immediate use grants may be time bound and can be used only for specific purpose. Loans involve repayment obligations, whereas grants are non- refunded. It is important to see that grants are properly utilized for the specified purpose. Any foreign capital in the form of aid should be pledged on the basis of its purpose, mode of repayment, cost to the borrower and political considerations. For it is not only uncertain, usually not extended for public sector but for consumer goods industries and do not create means for its repayment. It is therefore better to create ‘trade’ rather than ‘aid’ from a foreign country 2. Private Foreign Investment: It is of two types – (i) Foreign Direct Investment (ii) Foreign Portfolio Investment. Foreign investment and collaboration with a forcing nation are closely interrelated, but they are different from each other. Capital investment is participation of a foreign country in capital of recipient country’s enterprises. Collaboration, on the other hand means providing technical and managerial knowhow, licensing franchise, trade-marks and patents by a host country to home country. Foreign Direct Investment (FDI) FDI is an investment made by a company or individual who us an entity in one country, in the form of controlling ownership in business interests in another country. FDI could be in the form of either establishing business operations or by entering into joint ventures by mergers and acquisitions, building new facilities etc. Foreign Portfolio Investment (FPI) Foreign Portfolio Investment (FPI) is an investment by foreign entities and non-residents in Indian securities including shares, government bonds, corporate bonds, convertible securities, infrastructure securities etc. The intention is to ensure a controlling interest in India at an investment that is lower than FDI, with flexibility for entry and exit. Foreign Institutional Investment (FII) Foreign Portfolio Investment (FPI) is an investment by foreign entities in securities, real property and other investment assets. Investors include mutual fund companies, hedge fund companies etc. The intention is not to take controlling interest, but to diversify portfolio ensuring hedging and to gain high returns with quick entry and exit. The differences in FPI and FII are mostly in the type of investors and hence the terms FPI and FII are used interchangeably. Other Kinds of Foreign Investments 88 CU IDOL SELF LEARNING MATERIAL (SLM)

Apart from FDIs and FIIs, there are other kinds of investments emanating from abroad which are discussed in the following sections: NRI Investments Non-resident Indians (NRI) are increasingly remitting foreign exchange to India. Presently, NRIs have replaced the Chinese as the ethnic group that sends the largest amounts to their countries of origin. Investments by NRIs are permitted liberally in the country so as to give them wider investment opportunities. RBI's policy with respect to NRI deposit schemes ensures capital flows from abroad at a low rate of interest. Global Depository Receipts A Global Depositary Receipt (GDR) is a financial instrument used by private markets to raise capital denominated in either US dollars or euros. GDRs are certificates issued by investment bankers to the general public against the issue of shares of some foreign country. GDRs are issued by investment bankers to the general public in more than one country against the issue of shares in a foreign company. The shares held by a foreign bank are traded as domestic shares, but are offered for sale globally through the various bank branches. If any company wants to issue GDR to raise funds from a foreign country, it follows the following steps: (i) The company contacts the merchant banker of the home country (ii) after obtaining approval from the RBI; then (iii) it contacts the investment banker of a foreign company, (iv) then the investment banker will purchase the shares from the merchant banker and (v) then issue it to public through green shoe option. These instruments are called EDRs when private markets want to obtain Euros. Reliance Industries Ltd. was the first company to raise funds through a GDR issue. A GDR is a dollar denominated financial instrument traded in stock exchanges in USA and Europe. When such an instrument is traded only in the United States, is called American Depository Receipts (ADRs). GDR represents a given number of underlying equity shares. While the GDR is quoted and traded in dollars, the equity shares it represents are denominated in rupees. A company issues its shares to an intermediary known as Depository in whose names the shares are registered. It is the issues the GDR subsequently. The actual possession of the GDR is with another intermediary and the agent of the depository referred was the custodian. Thus, even when a GDR represents the equity shares of the issuing company, it has a distinct identity of its own. In fact, it is not even entered into the books of the issuer. Indian companies have been accessing global markets through GDRs. The Indian Government has laid down that the total foreign investment, made either directly or indirectly, through the GDR route shall not exceed 51 per cent of the issued and subscribed 89 CU IDOL SELF LEARNING MATERIAL (SLM)

capital of the issuing company. This will be apart from the maximum limit of 30 per cent equity, which can be accessed by offshore funds, FIIs or NRIs through the secondary market. American Depository Receipts ADRs represent ownership in the shares of a non-US company and trades in US financial markets. With the use of ADRs, the stock of many foreign companies is traded on US stock exchanges. ADRs enable US investors to purchase shares in companies of foreign countries without going through cross-border transactions. ADRs prices are marked in US dollars, pay dividends in US dollars, and are traded like the shares of US-based companies. Every ADR is offered by a US depositary bank and can represent a fraction of a share, a single share, or multiple shares of the foreign stock. One who owns an ADR is entitled to acquire the foreign stock it represents, but American investors generally find it more convenient simply to own the ADR. The price of an ADR often tracks the price of the foreign stock in its home market, adjusted for the ratio of ADRs to foreign company shares. Individual shares of a company belonging to another nation represented by an ADR are called American Depositary Shares (ADS). One can either obtain new ADRs by offering the corresponding domestic shares of the corporation with the depositary bank that manages the ADR programme or, as an alternative one can source existing ADRs in the secondary market. The second option can be used either by buying the ADRs on an American stock exchange or through buying the particular domestic shares of the company on their primary exchange and then “swap” them for ADRs; these swaps are known as “Cross book swaps” and mostly constitute the bulk of ADR secondary trading. Foreign Currency Convertible Bonds (FCCB) FCCB is a kind of convertible bond, issued in a currency different than the issuer's domestic currency, implying thereby that the money being raised by the issuing company is in the form of a foreign currency. This is a powerful instrument by which the company in particular and the country raises the money in the form of a foreign currency. A convertible bond is a blend of a debt and equity instrument. It acts like a bond by making regular coupon and principal payments, but at the same time these bonds also give the bondholder the option to convert the bond into stock. The Ministry of Finance, Government of India, defines FCCB thus: “Foreign Currency Convertible Bonds” means bonds issued in accordance with this scheme and subscribed by a non-resident in foreign currency and convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on the basis of any equity related warrants attached to debt instruments. 90 CU IDOL SELF LEARNING MATERIAL (SLM)

These types of bonds are highly profitable instruments to both investors and issuers. The investors get the safety of guaranteed payments on the bond and are also enabled to profit from any large price appreciation in the company's stock. Bondholders, on the other hand, benefit by this appreciation by means of warrants attached to the bonds, which are activated when the price of the stock reaches a cut-off point. Due to the equity side of the bond, which adds value, the coupon payments on the bond are lesser for the company, thereby reducing its debt-financing costs. These are the criteria for the issuing of FCCB:  Government of India's (i.e., The Department of Economic Affairs, Ministry of Finance) prior permission is required to any company who wish to raise foreign funds by issuing FCCBs  The applicant company intending to issue the FCCB should have, for a minimum period of 3 years, consistent track record  The FCCBs shall be denominated in any freely convertible foreign currency, while the ordinary shares of an issuing company shall be denominated in Indian rupees  The issuing company should, as per regulation, deposit the ordinary shares or bonds to a Domestic Custodian Bank. The custodian bank in its turn instructs the Overseas Depositary Bank to issue GDRs or Certificates to non-resident investors against the shares or bonds held by it. INITIATIVES BY INDIAN GOVERNMENT TO ATTRACT FOREIGN CAPITAL Several significant measures were announced by the Government since 1991 to attract the inflow of foreign capital. 1. Automatic permission up to 51 per cent for high-tech industries: In 1991, under the aegis of the New Economic Policy, the Indian Government released a list of high- technology industries the investment for which automatic permission was given for FDI up to 51 per cent foreign equity, raised ultimately to 100 per cent for several such priority industries. 2. Foreign equity holdings in tourism-related industries: The new policy also permitted foreign equity holdings in hitherto closed sectors such as hotels, tourist-related activities and in international trading companies. 3. Foreign equity participation in the power sector: The Government also permitted 100 per cent foreign equity participation for setting up power plants in the country to augment the much-needed power supply. The investors in the power sector were allowed to repatriate their profits and incentives, if any. Foreign investors were allowed 100 per cent subsidiaries if they bring investment exceeding USD 50 million. Foreign investors who brought in an investible fund exceeding USD 50 million were allowed to establish 100 per cent operating subsidiaries without restrictions on their number. 91 CU IDOL SELF LEARNING MATERIAL (SLM)

4. Use of trademarks and repatriation of royalty allowed: Moreover, foreign companies have now been permitted to use their trademarks on domestic sales effective from 14 May, 1992. They are also allowed now to pay royalty on brand name/trademark as percentage of net sales in the event of transfer of technology to Indian enterprise. 5. Employment of foreign technicians allowed: Prior to 1991, engaging foreign technicians and testing of locally developed technology abroad required case-specific approval by the Government, causing inordinate delay. This requirement has now been dispensed with. 6. Concessions for NRI investments: NRIs and companies owned by them have now been permitted to invest up to 100 per cent equity in high priority industrial segments. These investors are also allowed to repatriate their capital and profits. NRIs can now invest up to 100 per cent of equity in hospitals, hotels, sick industries, export houses, trading houses, star trading houses, etc. In a significant reversal of policy, NRIs are now allowed to buy dwellings without obtaining permission of the Reserve Bank. 7. Investments in sunrise industries: FDIs are now permitted in airports, development of integrated townships, urban infrastructure, tea sector, films, advertising, insurance, telecom sector, oil refining and courier services subject to certain approvals and ceilings fixed by the Government from time to time. 8. Concessions with regard to disinvestment: With regards to disinvestment of equity by foreign investors, it is no longer necessary to fix prices determined by the Reserve Bank. It has been now permitted at market rates on stock exchanges from 15 September, 1992 with repatriation of the proceeds of such disinvestment being now allowed. 9. From January 2004, 100 per cent FDI permitted in petroleum and publications: With effect from January 2004, the Government of India permitted FDI limit to 100 per cent participation in the petroleum sector, and in publications such as printing scientific and technical magazines, periodicals and journals. 10. Foreign investment in private banks raised: Foreign investment in Indian private sector banks has been raised to 74 per cent. As per this provision, the total foreign investment in a private bank will be subject to a ceiling of 74 per cent, while at all times at least 24 per cent of the paid-up capital of the banking company will be held by Indian residents except in respect of a wholly owned subsidiary of a private bank. 11. Press Note 18 scrapped in January 2005: One of the important irritants to a surge of FDI inflow into the country was Press Note 18. According to the Press Note 18, if a foreign company has a joint venture in India, the application has to be sent through the Foreign Investment Promotion Board (FIPB). This provision implied that the foreign investors were made to give the detailed circumstances under which they found it necessary to set up a new joint venture in India or enter into new technology transfer. Naturally, foreign investors regarded Press Note 18 as an impediment that stood in the way 92 CU IDOL SELF LEARNING MATERIAL (SLM)

of their investment in India. Doing away with this Note implies that now new joint ventures and collaborations will be based on the decision of partners on their own volition without any government interference. Establishment of The Investment Commission Among the several initiatives taken by the Government of India to attract capital, both foreign and domestic, for augmenting investment in Indian industry, the establishment of the Investment commission was a significant one. In 2004, the Government has constituted the Investment Commission, which is to interact with industry groups/houses in India and large companies abroad with a view to promote investments in the country, especially in sectors where there is a great need for investment but sufficient amount has not been attracted so far. The Commission is mandated to secure a certain level of investments every year. It will also recommend to the Government both on policies and procedures to facilitate greater FDI inflows into India. The Commission submitted its report to the Government on 7 July, 2006, set a USD 15 billion FDI target by 2007–08 and suggested that the Government allow 49 per cent FDI in retail, contract labour in all areas and automatic route for all investments within the sectoral cap. The Commission has also recommended setting up special economic zones in areas such as auto components, textiles, electronics and chemicals. It has strongly suggested a level- playing field for the private sector in sectors where public sector dominates and for creating a special high-level fast track mechanism for priority sector projects. 4.5FOREIGN COLLABORATION 4.5.1 Definition of foreign collaboration: 93 CU IDOL SELF LEARNING MATERIAL (SLM)

Fig 4.2: Foreign Collaboration meaning In general, the definition of foreign collaboration can be stated as follows. “Foreign collaboration is an alliance incorporated to carry on the agreed task collectively with the participation (role) of resident and non-resident entities.”Alliance is a union or association formed for mutual benefit of parties. Foreign collaboration is such an alliance of domestic (native) and abroad (non-native) entities like individuals, firms, companies, organizations, governments, etc., that come together with an intention to finalize a contract on some tasks or jobs or projects. In finance, the definition of foreign collaboration can be specified as follows. “Foreign collaboration includes ongoing business activities of sharing information related to financing, technology, engineering, management consultancy, logistics, marketing, etc., which are generally, offered by a non-resident (foreign) entity to a resident (domestic or native) entity in exchange of cheap skilled and semi-skilled labour, inexpensive high-quality raw-materials, low cost hi-tech infrastructure facilities, strategic (favourable) geographic location, and so on, with an approval (permission) from a governmental authority like the ministry of finance of a resident country.” Foreign collaboration is thus an alliance (a union or an association) formed for mutual benefit of collaborating parties. Foreign collaboration is a mutual co-operation between one or more resident and non-resident entities. In other words, for example, an alliance (a union or an association) between an abroad based company and a domestic company forms a foreign collaboration. It is a strategic alliance between one or more resident and non-resident entities. Only two or more resident (native) entities cannot make a foreign collaboration possible. For its formation and as per above definitions, it is mandatory that one or more non-resident (foreign) entities must always collaborate with one or more resident (domestic) entities. Before starting a foreign collaboration, both entities, for example, a resident and non-resident company must always seek approval (permission) from the governmental authority of the domestic country. During an ongoing process of seeking permission, the collaborating entities prepare a preliminary agreement. According to this preliminary agreement, for example, the non- resident company agrees to provide finance, technology, machinery, know-how, management consultancy, technical experts, and so on. On the other hand, resident company promises to supply cheap labour, low-cost and quality raw-materials, ample land for setting factories, etc. After obtaining the necessary permission, individual representative of a resident and non- resident entity sign this preliminary agreement. Signature acts as a written acceptance to each other's expectations, terms and conditions. After signatures are exchanged, a contract is executed, and foreign collaboration gets established. Contract is a legally enforceable agreement. All contracts are agreements, but all agreements need not necessarily be a contract. After establishing foreign collaboration, resident and non-resident entity start 94 CU IDOL SELF LEARNING MATERIAL (SLM)

business together in the domestic country. Collaborating entities share their profits as per the profit-sharing ratio mentioned in their executed contract. The tenure (term) of the foreign collaboration is specified in the written contract. Examples of Foreign Collaboration: The examples of foreign collaboration between an Indian and abroad entity: ICICI Lombard GIC (General Insurance Company) Limited is a financial foreign collaboration between ICICI Bank Ltd., India and Fairfax Financial Holdings Ltd., Canada. ING Vysya Bank Ltd. is a financial foreign collaboration formed between ING Group from Netherlands and Vysya Bank from India. Tata DOCOMO is a technical foreign collaboration between Tata Teleservices from India and NTT Docomo, Inc. from Japan. Sikkim Manipal University (SMU) from India runs some academic programs through an educational foreign collaboration with abroad universities like Liverpool School of Tropical Medicine from UK, Loma Linda and Louisiana State Universities from USA, Kuopio University from Finland, and University of Adelaide from Australia. Objectives of Foreign Collaboration: The main intention or prime goal or objective of foreign collaboration is to: Improve the financial growth of the collaborating entities. Occupy a major market share for the collaborating entities. Reduce the higher operating cost of a non-resident entity. Make an optimum and effective use of resources available in the resident entity's country. Generate employment in the resident entity's country. This survey captures comprehensive information on various aspects of operations of Indian companies having technical collaboration with foreign companies during the reference period as per the schedule. In this survey round, 550 Indian companies responded, of which, 244 companies reported 334 foreign technical collaboration (FTC) agreements. The highlights of the survey results are presented below Highlights: Coverage: Out of the 244 companies which reported agreements during the period 2010-12, 144 were foreign subsidiaries (single foreign investor holding more than 50 per cent of total equity), 83 were foreign associates (foreign investors holding ranging between 10 per cent and 50 per cent of total equity) and the remaining 17 companies had less than 10 per cent equity participation and/or had only outward investment. Industry-wise distribution of agreements: The share of manufacturing and services sectors in the total FTC agreements had marginally increased in the ninth round. The share of construction sector and agriculture-related activities had declined when compared with eighth round of the survey Country-wise distribution of agreements: In terms of source of technology transfer, Japan, USA and Germany were the top three countries which together 95 CU IDOL SELF LEARNING MATERIAL (SLM)

accounted for around 55 per cent share in total FTC agreements of responding companies during the survey period. Type of assets transferred: Among the FTC agreements reported by companies, the agreements providing “Know-how transfer” had a share of 45.8 per cent, higher than that of 38.1 per cent in the eighth round of the survey. Modes of Payment: The share of agreements involving (a) royalty and lump-sum technical fees, (b) only royalty and (c) only lump-sum technical fees stood at 42.4 per cent, 30.4 per cent and 27.2 per cent, respectively. Export restrictive clauses: The proportion of FTC agreements with export restrictive clauses increased significantly in the manufacturing sector, when compared with the previous survey round. An analysis of country-wise agreements suggests that the share of agreements with export. Provision of exclusive rights: Any provision of exclusive rights to an Indian company in a FTC agreement, restricts the foreign collaborator from transferring such assets to other parties operating in India. The proportion of agreements providing exclusive rights on assets transferred under the agreements had increased significantly in manufacturing sector vis-à-vis the previous survey round. Value of Production: Total value of production of the FTC reporting companies increased from `890.7 billion in 2010-11 to `992.2 billion in 2011-12. The share of manufacturing sector in the total production had improved, whereas share of financial and insurance activities was lower when compared with the previous survey round. Profitability: The profitability of FTC reporting companies measured by ratio of gross profit to the capital employed increased from 9.8 per cent in 2010-11 to 10.1 per cent in 2011-12. Exports and Imports: Total exports of FTC reporting companies increased from `132.2 billion in 2010-11 to `156.6 billion in 2011-12 with manufacturing sector constituting the dominant share in exports. Imports of the FTC reporting companies increased marginally to `442.3 billion over this period with manufacturing sector holding the dominant share of import payments made by the FTC companies. 96 CU IDOL SELF LEARNING MATERIAL (SLM)

4.5.2Types of Foreign Collaboration: The following are the types of collaboration: 1. Technical collaboration: Technical collaboration is a contract whereby the developed country agrees to provide technical know-how, sophisticated machinery and any kind of technical assistance to the developing country. Technical collaboration enables to undertake research and development activities and innovation. 2. Marketing collaboration: Marketing collaboration is the agreement where the foreign collaborator agrees to market the products of the domestic company in the international market. Marketing collaboration creates value for customers and builds strong customer relationship. Marketing collaboration promotes export. 3. Financial collaboration: When the foreign contribution is in the form capital participation, that contract is known as foreign collaboration. When the foreign company agrees to provide capital or financial assistance to the domestic company that collaboration is known” as financial collaboration. 4. Consultancy collaboration: A Consultant is a professional who provides advice in a particular area of expertise such as management, accountancy, human resource, marketing, finance etc. Joint Ventures Takeover Consultancy Amalgmation Collaboration Merger 97 Fig: 4.3 Consultancy Collaboration CU IDOL SELF LEARNING MATERIAL (SLM)

Consultancy collaboration is the agreement between the foreign and the domestic company where the company agrees to provide managerial skills and expertise to the domestic company. This type of collaboration bridges the information gap. a. Joint Venture: Joint venture is a legal entity formed between two or more parties to undertake an economic activity together. In joint venture companies agree to share capital, technology, human resources, risks and rewards in a formation of a new entity under shared control. A joint venture takes place when two parties come together to undertake one project. It is a temporary partnership between the two organisations for achieving common goals. Once the goal is achieved, joint venture comes to an end. b. Amalgamation: Amalgamation means bringing of two or more business into single entity. In other words, amalgamation means blending together two or more undertakings into one undertaking. In this type of growth strategy two or more companies come together to form a new company. In amalgamation companies lose their individual identity. For example: one company called ABC. Another company called BCD. Now, ABC is running loss and BCD also running loss, so these two companies agreed to Amalgamate and a new company ABCD is formed. c. Merger: Merger is a combination of two companies into one company where one company loses its identity. It is an arrangement whereby the assets of two companies become vested under the control of one company. Merger happens when two firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated. The process of mergers and acquisitions has gained substantial importance in today’s corporate world. For example: Tata Steel acquired Corus Group. d. Take Over/Acquisition: Acquisition is a growth strategy in which a strong company acquires all the assets and liabilities of another company. When one company takes over another company and clearly established itself as the new owner, the purchase is called an acquisition. Takeover is a form of acquisition. There are two types of acquisitions; Friendly acquisitions and Hostile acquisitions. In a friendly acquisition the target company is formally informed about the acquisition and there is an agreement on corporate management and finance control. In a hostile acquisition, the owner loses their ownership and control of the company against their wishes 4.6 ECONOMIC TRENDS IN INDIAN INDUSTRIES The year 2020 saw unprecedented disruptions to lives and livelihood all across the world and India was no exception. As the nation waded through the pandemic-induced challenges, 98 CU IDOL SELF LEARNING MATERIAL (SLM)

industries had their fair share of learnings along the way. In this article, we assess the emerging industry trends and their adaption to the “new norms,” anticipate the possible economic outlook, and discuss the probable government actions that will be key in launching the economy on a sustainable recovery path. 2020: The year of crisis and opportunities for Indian industries The impact of the pandemic and lockdown was disproportionately felt across industries. While industries such as hospitality and manufacturing were impacted immediately, the impact on the financial sector was felt with a lag, as is evident from the quarterly GDP numbers. Since the economic unlock, the pace of rebound has been equally lopsided. Easing of movement restrictions, pent-up and festive demand, and the revival of several infrastructure projects by the government helped the manufacturing and construction sectors to bounce back relatively strongly. However, anxiety about health and sporadic regional lockdowns continued to weigh on the services sector, whose recovery has been relatively gradual. Here is a snapshot of the changing trends and experiences of a few select industries in 2020: Automotive industry: Sudden closure of factories leading to unprecedented supply chain disruptions and a collapse in demand acted as a double whammy for the industry. The micro, small, and medium enterprises (MSMEs) such as component manufacturers, dealers, and vehicle financing institutions were among the hardest hit. The industry, however, responded to the crisis through innovative ways, such as digitized and subscribed services, contactless sales, and doorstep delivery/pick-up to reach out to customers. Many firms are activating secondary supplier relationships and securing additional critical inventory and capacity while diversifying sources of import supply beyond China. To improve profits, several organized players are now entering the growing used-car market, which is predominantly dominated by the unorganized sector. Outlook: With the support of various government schemes and pent-up demand, the sector has somewhat rebounded. However, growth and jobs are expected to remain capped till the pandemic is over. Trade, hotels, travel, and tourism: Hospitality was probably one of the first few industries hit by the pandemic. Social distancing norms and mobility restrictions led to fewer travels and leisure activities even before the lockdown. Known for creating direct and indirect jobs and the promotion of regional economic and product development, this labour-intensive industry witnessed a sharp reduction in wages and job opportunities.3 Despite credit support and government schemes to several MSMEs in this sector, the rebound has been muted because of continued mobility restrictions and health anxieties among consumers. However, the sector has found mature ways to deal with the pandemic. Several hotels made their venues available for hospital beds and front-line health professionals. Businesses adopted new 99 CU IDOL SELF LEARNING MATERIAL (SLM)

models and concepts to survive, such as packages targeted at staycation and innovative delivery concepts. Outlook: The path to profitability may be far off as long as the pandemic persists. The sector’s revival will not only depend on domestic mobility but also on restrictions across international borders. This, in turn, will depend on synchronized efforts by world economies to curb the spread of infection, the success of which has been limited so far. Media and entertainment: This sector has been hit hard by unemployment and closed productions. During the pandemic, entities improvised and adopted innovative ways to reach out to their audiences, who have now turned to online platforms for music, films, and entertainment. Outlook: The broadcasting or streaming of live events is expected to offer lower financial returns. Temporary employment contracts and freelance arrangements may keep wage growth in this industry subdued. Retail industry for essential and nonessentials: Demand for essential goods remained strong while that of discretionary and nonessential goods declined. However, both these segments of the retail industry witnessed a perceivable tilt toward e-commerce services to cater to new shopping habits. With consumers preferring more online transactions to reduce exposure to infection, the retail and FMCG industries have been rethinking their business priorities and strategies to build a flexible distribution network and improve supply chains. Outlook: The industry will likely see increasing digitization, use of online services and data analytics, and alliances across manufacturers, distributors, promoters, and product developers to differentiate customer experiences, improve margins, and survive the competition. Pharmaceuticals and health sector: COVID-19 revealed the inadequacy of public health systems and infrastructure in addition to creating a shortage of well-trained health workers. With the support of government spending, however, the sector has ramped up health facilities such as ICU beds, ventilators, and testing capacities. The pandemic has presented an opportunity to shift to the digital medium and improve profitability with better technologies. For instance, trends such as telemedicine and the use of big data for maintaining health records are gaining momentum. Post–COVID-19, India aims to diversify sources or actively produce active pharmaceutical ingredients (APIs) and key starting materials, and reduce dependence on China for imports. Besides, India is likely to play a major role in vaccinating the world.6 With several vaccines queuing up for release soon, the industry has been increasing investment and building up capacity to meet the global demand. Outlook: The health sector and pharmaceutical industry will likely see increased investments as the government focuses more on improving and expanding the reach of existing health 100 CU IDOL SELF LEARNING MATERIAL (SLM)