ECONOMICS - II

RESERVE BANK OF INDIA

The Reserve Bank of India was set up in 1935 (by the RBI Act, 1934) as a private bank with
two extra functions: -

 regulation and control of the banks in India

 being the banker of the government

After nationalisation in 1949, it emerged as the central banking body of India and
governments have been handing over different functions to the RBI as given below: -

1. It is the issuing agency of the currency and coins (Under section 22 of the RBI
Act,1934).
2. Distributing agent for currency and coins issued by the Government of India.
3. Government Banker, Adviser and agent to government,
4. Announces the credit and monetary policy for the economy.
5. Stabilising the rate of inflation.
6. Stabilising the exchange rate of rupee
7. keeper of the foreign exchange reserves
8. Agent of the Government of India in the IMF.
9. Performing a variety of developmental and promotional functions under which it did
set up institutions like IDBI, SIDBI, NABARD, NHB etc.

Credit and Monetary Policy

Definition - The policy by which the desired level of money flow and its demand is regulated
is known as the credit and monetary policy.

Monetary policy refers to the policy of the central bank with regard to the use of monetary
instruments under its control to achieve the goals specified in the RBI Act, 1934.

All over the world it is announced by the central banking body of the country - as the RBI
announces it in India.

The primary objective of monetary policy is to maintain price stability while keeping in mind
the objective of growth. Price stability is a necessary precondition to sustainable growth

Instruments of Monetary Policy are broadly classified into two types: -

1. Quantitative or General measures

2. Qualitative or selective measures

There are many tools by which the RBI regulates the desired/required kind of the credit and
monetary policy are: -

1. CRR
2. SLR
 3. Bank Rate
4. Repo Rate
5. Reverse Repo Rate
6. PLR

CRR - Cash Reserve Ratio - Cash form of reserves - 1970s

 The cash reserve ratio is the ratio (fixed by the RBI) of the total deposits of a bank in
India which is kept with the RBI in the form of cash.
 The average daily balance that a bank shall maintain with the Reserve Bank as a share
of such per cent of its NDTL (net demand and time liabilities deposits) that the
Reserve Bank may notify from time to time in the Gazette of India.
 Another weapon available to RBI for credit control is the use of variable cash reserve
requirements. Under the RBI Act, 1934, every commercial bank has to keep certain
minimum cash reserves with RBI- initially, it was 5 per cent against demand deposits
and 2 per cent against time deposits - these are known as the statutory cash reserves.

SLR - Statutory Liquidity ratio - Non-cash form of reserves - 1970s

 The statutory liquidity ratio (SLR) is the ratio (fixed by the RBI) of the total deposits
of a bank which is to be maintained by the bank with itself in non-cash form
prescribed by the government.
 The share of NDTL that banks shall maintain in safe and liquid assets, such as,
unencumbered government securities, cash and gold. Changes in SLR often influence
the availability of resources in the banking system for lending to the private sector.
 Statutory - by law, Liquidity ratio - Which can be easily converted into cash.
 The lesser the amount of SLR, the more banks have to lend outside.
 Apart from cash reserve requirements which commercial banks have to keep with RBI
(under RBI Act, 1934), all commercial banks have to maintain (under section 24 of
the Banking Regulation Act, 1949) liquid assets in the form of cash, gold and
unencumbered approved securities. This is known as statutory liquidity requirements.

Bank Rate - 1970s

 Rate at which RBI lends money to commercial banks for longer period of time (365+)
 It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange
or other commercial papers.
 The Bank Rate is published under Section 49 of the Reserve Bank of India Act, 1934.
 This rate has been aligned to the MSF rate and, therefore, changes automatically as
and when the MSF rate changes alongside policy repo rate changes.
 The clients who borrow through this route are the GoI, state governments banks,
financial institutions, co-operative banks, NBFCs, etc.

Repo Rate - 1992

  Rate at which RBI lends money to commercial banks for shorter period of time (364
days’ maximum)
 The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to
banks against the collateral of government and other approved securities under the
Liquidity Adjustment Facility (LAF).
 Repo means repossessing or repurchasing.
 Basically, this is an abbreviated form of the 'rate of repurchase' and in western
economies it is known as the 'rate of discount'.
 In practice it is not called an interest rate but considered a discount on the dated
government securities, which are deposited by institution to borrow for the short term.
 When they get their securities released from the RBI, the value of the securities ifs
lost by the amount of the current repo rate. This rate functions as the benchmark rate
for the inter-bank short-term market (i.e., call money market) in India.
 Higher the repo rate costlier the loan banks forward and vice versa.
 It has direct impact on the nominal interest rates of the bank's lending.

Reverse Repo Rate - 1996

 The (fixed) interest rate – currently 50 bps below the repo rate – at which the Reserve
Bank absorbs liquidity, on an overnight basis, from banks against the collateral of
eligible government securities under the LAF.
 It is the rate of interest the RBI pays to its clients who offer short-term loan to it.
 It is the reverse of the repo rate and this was started in November 1996 as part of
liquidity Adjustment Facility (LAF) by the RBI.
 It is reverse of the repo rate and this was started in November 1996 as part of liquidity
Adjustment Facility (LAF) by the RBI.
 In practice, financial institutions operating in India lend their surplus funds with the
RBI for short term period and earn money.
 It has a direct bearing on the interest rates charged by the banks and the financial
institutions on their different forms of loans.
 This tool was utilised by the RBI in the wake of over money supply with the Indian
banks and lower loan disbursal to serve twin purposes of cutting down banks losses
and the prevailing interest rate.

Marginal standing facility - 2011

 Last option given by RBI to commercial banks once they exhaust all borrowing
options including the liquidity adjustment facility by pledging through government
securities, which has lower rate (i.e., repo rate) of interest in comparison with the
MSF.
 MSF - Penal rate. The MSF would be a penal rate for banks and the banks can borrow
funds by pledging government securities within the limits of the statutory liquidity
ratio.
  A facility under which scheduled commercial banks can borrow additional amount of
overnight money from the Reserve Bank by dipping into their Statutory Liquidity
Ratio (SLR) portfolio up to a limit [currently two per cent of their net demand and
time liabilities deposits (NDTL)] at a penal rate of interest, currently 50 basis points
above the repo rate.
 This provides a safety valve against unanticipated liquidity shocks to the banking
system.
 This scheme has been introduced by RBI with the main aim of reducing volatility in
the overnight lending rates in the inter-bank market and to enable smooth monetary
transmission in the financial system.
 The MSF rate and reverse repo rate determine the corridor for the daily movement in
the weighted average call money rate.

Marginal Stabilising scheme - 2004

 This instrument for monetary management was introduced in 2004.

 Surplus liquidity of a more enduring nature arising from large capital inflows is
absorbed through sale of short-dated government securities and treasury bills. The
cash so mobilised is held in a separate government account with the Reserve Bank

Types of Monetary System

1. Contractionary Monetary Policy or Dear Money Policy
1. It is pursued to control Inflation
2. CRR is increased. Due to this increase lending capacity of the banks decrease
3. SLR is also increased
4. Bank rate is increased. This leads to RBI charging higher rate of interest on bank
lending due to which banks borrow less from RBI.
5. Repo Rate is increased
6. Reverse Repo Rate is also increased. This leads to, RBI paying more interest on
Banks deposits. Thus Banks prefer to deposit extra money with RBI instead of giving
loans to public.
7. It is called Dear Money Policy as loans get expensive for the public

2. Expansionary Monetary Policy or Cheap Money Supply

1. This policy is adopted to increase money supply in the economy in order to stimulate
economic growth.
2. It is also pursued to overcome recession.
3. CRR, SLR, Repo Rate, Re Repo Rate, Bank Rate should be reduced.
4. It is called Cheap Money policy as interest rates are low thus borrowing money
becomes cheap.
Since 2010 RBI has adopted Contractionary Money Policy. In 2009 to stimulate economic
growth after global recession, RBI adopted Expansionary Monetary Policy
Discounting of Bill
If the holder of the bill needs funds, he can approach the bank for encashment of the bill
before the due date. The bank shall make the payment of the bill after deducting some interest
(called discount in this case). This process of encashing the bill with the bank is called
discounting the bill. The bank gets the amount from the drawee on the due date.

INFLATION - A persistent increase/rise in the general level of prices and decrease in value
of money. If the price of one good has gone up, it is not inflation, it is inflation only if the
prices of most goods have gone up. Inflation is defined as the rate (%) at which the general
price level of goods and services is rising, causing purchasing power to fall. 
INFLATION IN INDIA

Every economy calculates its inflation for efficient financial administration as the multi-
dimensional effects of inflation make it necessary. India calculates its inflation on two price
indices i.e., the wholesale price index (WPI) and the consumer price index (CPI). While the
WPI inflation is used at the macro level policy making, the CPI inflation is used for micro
level analysis. The inflation at the WPI is the inflation of the economy. Both the indices
follow the 'point to point' method and may be shown in points (i.e., digits) as well as in
percentage relative to a particular base year.

DEMAND PULL INFLATION

Inflation created and sustained by excess of aggregate demand for goods and services over
the aggregate supply. In other words, demand pull inflation takes place when increase in
production lags behind the increase in money supply. Demand-Pull Inflation is commonly
described as “too much money chasing too few goods”.

Demand pull inflation - The inflation resulting from an increase in aggregate demand is
called demand pull inflation. Such inflation may arise from any individual factor that
increases aggregate demand, but the main ones that generate ongoing increases in aggregate
demand are:

1. Increase in money supply

2. Increase in government purchases
3. Increase in the price level in the rest of the world.

COST-PUSH INFLATION

 Due to 'inflation tax' the price of goods and services in India have been rising as the
government took alternative recourse to increase its revenue receipts. We see it taking
place due to higher import duties on the raw materials also. The non-value added tax
structure of India in the past was also having cascading effect on the prices of
commodities in the country. The government needed higher revenues to finance its
planned development.
  Inflation which is created and sustained by increase in cost of production which is
independent of the state of demand (e.g. Trade unions can bargain for higher wages
and hence contributes to inflation).
 Cost Push inflation - Inflation can result from a decrease in aggregate supply.
 The two main sources of decrease in aggregate supply are: -
An increase in wage rates and an increase in the price of raw materials.
 These sources of a decrease in aggregate supply operate by increasing costs, and the
resulting inflation is called cost push inflation.
 Definition: Cost push inflation is inflation caused by an increase in prices of inputs
like labour, raw material, etc. The increased price of the factors of production leads to a
decreased supply of these goods. While the demand remains constant, the prices of
commodities increase causing a rise in the overall price level. This is in essence cost
push inflation.
 Description: In this case, the overall price level increases due to higher costs of
production which reflects in terms of increased prices of goods and commodities which
majorly use these inputs. This is inflation triggered from supply side i.e. because of less
supply. The opposite effect of this is called demand pull inflation where higher demand
triggers inflation.
 Apart from rise in prices of inputs, there could be other factors leading to supply side
inflation such as natural disasters or depletion of natural resources, monopoly,
government regulation or taxation, change in exchange rates, etc. Generally, cost push
inflation may occur in case of an inelastic demand curve where the demand cannot be
easily adjusted according to rising prices.

VARIANTS OF INFLATION

1. Philips Curve -
 The Phillips curve is an economic concept developed by A. W. Phillips (in his
paper 'The relation between Unemployment and the rate of change of
money wage rates in the United Kingdom, 1861-1957')showing
that inflation and unemployment have a stable and inverse relationship. The
theory states that with economic growth comes inflation, which in turn should
lead to more jobs and less unemployment. 
 Philips curve is a graphic curve which advocates a relationship between
inflation and unemployment in an economy.
 Inflation and unemployment has an inverse relationship. Lower the inflation,
higher the unemployment and higher the inflation, lower the unemployment.

2. Bottleneck Inflation -
 This inflation takes place when the supply falls drastically and the demand
remains at the same level.
 Such situation arises due to supply-side accidents, hazards or mismanagement
which is also known as 'structural inflation'.
 This would be put in the 'demand-pull inflation' category
  With few exceptional years, India has been facing the typical problem of
bottleneck inflation (i.e., structural inflation) which arises out of shortfalls in
the supply of goods, a general crisis of a developing economy, rising demand
but lack of investible capital to produce the required level of goods.
 Whenever the government managed to go for higher growths by managing
higher investible capital it had inflationary pressures on the economy (seen
during 1970s and 1980s, especially) and growth was sacrificed at the altar of
lower inflation.
 Thus, the supply-side mismatch remained a long drawn problem in India for
higher inflation
 Bottle neck inflation is a variant of Demand pull inflation.
 Bottleneck is the inefficiency, inability or hindrance which the supply side
faces to equal the demand.

3. Core Inflation
 This nomenclature is based on the inclusion or exclusion of the goods and
services while calculating inflation.
 Popular in western economies, core inflation shows price rise in all goods and
services excluding energy (Crude oil) and food articles.
 In India, it was first time used in the financial year 2000-2001 when the
government expressed that it was under control- it means the prices of
manufactured goods were under control
 Basically, in the western economies, food and energy are not the problems for
the masses, while in India these two segments play the most vital role for
them.

4. Inflation Premium
 The benefit of debtor during inflation time is called Inflation Premium.
 The bonus brought by inflation to the borrowers is known as the inflation
premium.
 The interest banks charge on their lending is known as the nominal interest
rate which might not be the real cost of borrowing paid by the borrower to the
banks.
 To calculate the real cost, a borrower is paying in its loan, the nominal rate of
interest is adjusted with the effect of inflation and thus the interest rate we get
is known as the real interest rate.
 Real interest is always lower than the nominal interest if the inflation is taking
place - the difference is the inflation premium.
 At times, to neutralise the effects of inflation premium, the lender takes the
recourse to increase the nominal rate of interest.

5. Inflation targeting
  The announcement of an official target range for inflation is known as
inflation targeting.
 It is done by the Central Bank in an economy as a part of their monetary
policy to realise the objective of a stable rate of inflation.
 India, commenced inflation targeting in February 2015 when an agreement
between the GOI and the RBI was signed related to it - the Agreement on
Monetary Policy Framework. The agreement provides the aim of inflation
targeting in this way - "it is essential to have a modern monetary framework to
meet the challenge of an increasingly complex economy. Whereas the
objective of monetary policy is to primarily maintain price stability, while
keeping in mind the objective of growth".
 In May 2016, the Reserve Bank of India (RBI) Act, 1934 was amended to
provide a statutory basis for the implementation of the flexible inflation
targeting framework.
 The amended RBI Act also provides for the inflation target to be set by the
Government of India, in consultation with the Reserve Bank, once in every
five years. Accordingly, the Central Government has notified in the Official
Gazette 4 per cent Consumer Price Index (CPI) inflation as the target for the
period from August 5, 2016 to March 31, 2021 with the upper tolerance limit
of 6 per cent and the lower tolerance limit of 2 per cent.
 The Central Government notified the following as factors that constitute
failure to achieve the inflation target:(a) the average inflation is more than the
upper tolerance level of the inflation target for any three consecutive quarters;
or (b) the average inflation is less than the lower tolerance level for any three
consecutive quarters.
 Prior to the amendment in the RBI Act in May 2016, the flexible inflation
targeting framework was governed by an Agreement on Monetary Policy
Framework between the Government and the Reserve Bank of India of
February 20, 2015.

6. Inflation Accounting
 During lending, Inflation is taken into account, it is called Inflation
Accounting.
 When a firm calculates its profits after adjusting the effects of current level of
inflation, this process is known as inflation accounting.
 Such profits are the real profit of the firm which could be compared to a
historic rate of inflation (Inflation of the base year)

7. Inflation Taxation
 Inflation is itself a tax.
 Inflation erodes the value of money and the people who hold currency suffer
in this process.
  As the governments have authority of printing currency and circulating it into
the economy (as they do in the case of deficit financing), this act functions as
an income to the governments.
 This is a situation of sustaining government expenditure at the cost of people's
income.
 This looks as if inflation is working as a tax. This inflation tax is also called
seignorage - It means; inflation is always the level to which the government
may go for deficit financing - level of deficit financing is directly related by
the rate of inflation.
 It could also be used by the governments in the form of prices and income
policy under which the companies pay inflation tax on the salary increases
above the set level prescribed by the government.
 It has 2 perspectives - Hidden tax and slab fixing economic tool

8. Inflationary gap (Budget Surplus)

 The excess of total government spending above the national income (i.e.,
fiscal deficit) is known as the inflationary gap.
 This is intended to increase the production level which ultimately pushes the
prices up due to extra-creation of money during the process.
 The gap between the real demand and surplus in the economy which lead to
inflation is called inflationary gap.

9. Deflationary gap (Budget Deficit)

 The shortfall in total spending of the government (i.e., fiscal surplus) over the
national income creates deflationary gap in the economy.
 This is a situation of producing more than the demand and the economy
usually heads for a general slowdown in the level of demand, this is also
known as the output gap.
 The gap which creates deflation which decreases the prices.

10. Shoe-leather Cost inflation - Increased costs of transactions caused by inflation or

shoe-leather costs are the result of people trying to avoid holding money.
A shoe-leather cost is one of the impacts of inflation.
In a period of high inflation people are discouraged to hold large amounts of cash
because its value deteriorates quickly relative to the rising prices in the economy.
As a result, people tend to hold most of their money in a bank account and keep only
very small amounts of cash with them. This causes them to make regular trips to their
bank to withdraw cash to pay for goods and services. These regular trips wear out
their shoe-leather, thus creating a 'shoe-leather cost'.
The shoe-leather cost is now used more generally to describe all the costs associated
with having to hold small amounts of cash
11. Skewflation

Economists usually distinguish between inflation and a relative price increase.

'Inflation' refers to a sustained, across-the-board price increase, whereas 'a relative
price increase' is a reference to an episodic price rise pertaining to one or a small
group of commodities. This leaves a phenomenon where there is a price rise of one or
a small group of commodities over a sustained period of time, without a traditional
designation, 'Skewflation' is a relatively new term to describe thus category of price
rise.
In India, food prices rose steadily during the last months of 2009 and the early
months of 2010, even though the prices of non-food items continued to be relatively
stable. As this somewhat unusual phenomenon stubbornly persisted, policymakers
conferred on how to bring it to an end. The term 'skewflation' made an appearance in
internal documents of the Government of India, and then appeared in print in the
Economic Survey 2009-18 GoI, MoF.
The skewdness of inflation in India in the early months of 2010 was obvious
from the fact that food price inflation crossed the 20 percent mark in multiple months,
whereas wholesale price index(WPI) inflation never once crossed 11 Percent. It may
be pointed out that the skewflation has gradually given way to a lower-grade
generalised inflation (with the economy in the middle of 2011 inflating at around 9
per cent with food and non-food price increases roughly at the same level).

12. Inflation Spiral

An inflationary situation in an economy which results out of a process of wage and
price interaction. 'when wages press prices up and prices pull wages up' is known as
the inflationary spiral. It is also known as the wage-price spiral. This wage price
interaction was seen as a plausible cause of inflation in the year 1935 in the US
economy, for the first time.

13. Stagflation

 A situation in an economy when inflation and unemployment both are at

higher levels, contrary to conventional belief.
 Such a situation first arose in 1970s in the US economy (average
unemployment rate above 6 per cent and the average rate of inflation above 7
percent) and in many Euro-American economies. This took place as a result of
oil prices increases of 1973 and 1979 and anticipation of higher inflation. The
stagflationary situation continued till the early 1980s.
 Conventional thinking that a trade-off existed between inflation and
unemployment (i,e,, philips curve) was falsified an several economies
switched over to alternative ways of economic policies such as monetaristic
and supply-side economics.
  When the economy is passing through the cycle of staggnation (i.e., long
period of low aggregate demand in relation to its productive capacity) and the
government shuffles with the economic policy, a sudden and temporary price
rise is seen in some of the goods - such inflation is also known as stagflation.
Stagflation is basically a combination of high inflation and low growth.

14. Reflation

 Reflation is a situation often deliberately brought by the government to reduce

unemployment and increase demand by going for higher levels of economic
growth.
 Governments go for higher public expenditures, tax cuts, interest rate cuts, etc.
 Fiscal deficit rises, extra money is generally printed at higher level of growth,
wages increase and there is almost no improvement in unemployment.
 Reflation can also be understood from a different angle- when the economy is
crossing a cycle of recession (low inflation, high unemployment, low demand,
etc.) and government takes some economic policy decisions to revive the
economy from recession, certain goods see sudden and temporary increase in
their prices, such price is also known as reflation.

15. Base effect

 It refers to the impact of the rise in price level (i.e., last year's inflation) in the
previous year over the corresponding rise in the price levels in the current
years (i.e., current inflation).
 If the price index had risen at a high rate in the corresponding period of the
previous year, lending to a high inflation rate, some of the potential rise is
already factored in, therefore, a similar absolute increase in the price index in
a current year will lead to a relatively lower inflation rates.
 On the other hand, if the inflation rate was too low in the corresponding period
of the previous year, even a relatively smaller rise in the price index will
arithmetically give a high rate of current inflation,

12) HEADLINEINFLATION:

 A measurement of price inflation that takes into account all types of inflation that an
economy can experience.

 It also counts changes in the price of food and energy. Because food and energy prices
can rapidly increase while other types of inflation can remain low, headline inflation
may not give an accurate picture of how an economy is behaving.
 In India, headline inflation is measured through the WPI – which consists of 676
commodities (services are not included in WPI in India). 
 It is measured on year-on-year basis i.e., rate of change in price level in a given month
vis a vis corresponding month of last year. This is also known as point to point
inflation.
13) COREINFLATION:

 An inflation measure which excludes transitory or temporary price volatility as in the

case of some commodities such as food items, energy products etc. It reflects the
inflation trend in an economy.
 It is, therefore, a preferred tool for framing long-term policy.

CAUSES OF INFLATION
1. Factors on Demand Sides –
 Increase in money supply
 Increase in Export
 Increase in disposable income
 Deficit financing
 Foreign exchange reserves
2. Factors on Supply Side
 Rise in administered prices
 Erratic agriculture growth
 Agricultural price policy
 Inadequate industrial growth
3. Black money (fake currency)
4. Increase in public expenditure
5. Decrease in the aggregate supply of goods and services

Measures to Control Inflation

1. Monetary Measures
A. Quantitative Methods
 Raising the Bank rate - To control inflation the central bank increases the bank
rate. With this cost of borrowing of commercial banks from central bank will increase
so the commercial banks will charge higher rate of interest on loans. This discourages
borrowings and thereby helps to reduce the money in circulation.
 Open Market Operations - During inflation , the central bank sells the bills
and securities. These cash reserves of commercial banks will decrease as they
pay central bank for purchasing these securities. Thus the loan able funds with
commercial banks decrease which leads to credit contraction.
 Variable Reserve Ratio - The commercial banks have to keep certain
percentage of their deposits with the central bank in the form of cash reserve.
During inflation, the central bank increases this cash reserve ratio this will
reduce the lending capacity of the banks.
B. Qualitative methods
 Fixation of Margin requirements - Commercial banks have to maintain certain
fixes margins while granting loans. In inflation central bank raises the margin
to contract credits and reduces the price level.
  Regulation of consumer credit - For purchase of durable consumer goods on
installment basis, rules regarding payments are fixed. During inflation initial
payment is increased and the number of installments is reduced. These result
in credit contraction and fall in prices.
 Control through Directives - Certain directives are issued by central bank to
commercial banks and they are asked to follow them while lending. This keeps
in check the volume of money.
 Rationing of credit - The central bank regulates the amount and purpose for
which credit is granted by commercial banks.
 Moral Suasion - this refers to request made by the central bank to commercial
banks to follow its general monetary policy.
 Direct action - Direct action is taken by central bank against commercial banks
if they do not follow the monetary policy laid by it
 Publicity - The central bank undertakes publicity to educate commercial bank
and public about the trends in money market. By undertaking these measures
the central bank can control the money supply and help to curb inflation.
 Credit Control
 Issue of new currency
2. Fiscal Measures
 Reduction in Unnecessary Expenditure
 Increase in taxes
 Increase in savings
 Surplus Budgets
 Public Debts
 To increase in production
 Rational wage policy
 Price Control
 Rationing

1) Recession: 

 Recession is a slowdown or a massive contraction in economic activities. A

significant fall in spending gene rally leads to a recession.
 Such a slowdown in economic activities may last for some quarters thereby
completely hampering the growth of an economy. In such a situation, economic
indicators such as GDP, corporate profits, employments, etc., fall.
 This creates a mess in the entire economy. To tackle the menace, economies generally
react by loosening their monetary policies by infusing more money into the system,
i.e., by increasing the money supply.
 This is done by reducing the interest rates. Increased spending by the government and
decreased taxation are also considered good answers for this problem. The recession
which hit the globe in 2008 is the most recent example of a recession.
  Recessions generally occur when there is a widespread drop in spending (an adverse
demand shock). This may be triggered by various events, such as a financial crisis, an
external trade shock, an adverse supply shock or the bursting of an economic bubble. 

2) DEPRESSION: 

 A state of the economy resulting from an extended period of negative economic

activity as measured by GDP. 
 It is often described as a more severe form of a recession that leads to extended
unemployment, a spike in credit defaults, broad declines in income and production,
currency devaluation and a deflationary economy.
 The level of productivity in an economy falls significantly during a depression. Both
the GDP (gross domestic product) and GNP (gross national product) show a negative
growth along with greater business failures and unemployment.
 When a recession continues to take its toll on any economy, the built in process
triggers further cuts in investment as well as consumption spending due to loss of
confidence among investors and consumers. Also, the financial crisis may lead to
decreased availability for credit. Excessive fluctuations happen in relative value of
currency. Overall trade and commerce get reduced. The Great Depression of 1929 is
considered to be the most classic example of a depression in economic history.

UNEMPLOYMENT
CONCEPT OF UNEMPLOYMENT

In India, a person working 8 hours a day for 273 days in a year is regarded as employed on a
standard person year basis. Thus, a person to be called an employed person, must get
meaningful work for a minimum of 2184 hours in a year. The person who does not get work
even for this duration, is known as unemployed person.

TYPES OF UNEMPLOYMENT

1. Structural Unemployment - Structural unemployment is the situation in which a

country is unable in providing job to all job – seekers because the resource available
in the country are limited. It refers to one more situations where the skills and location
of unemployed workers do not match the unfilled vacancies. It can happen because
investment has failed to keep pace with growth in labour force. The remedy calls for
major investment in new industries, training of workers, or large scale migration from
depressed regions.
Basically, India’s unemployment is structural in nature. It is associated with
the inadequacy of productive capacity to create enough jobs for all those who are able
and willing to work.
Structural unemployment is unemployment that results when there are more
people seeking jobs in a labor market than there are jobs available at the current wage rate
2. Disguised Unemployment - This refers to the situation of unemployment that is not
open for everyone to see; it remains invisible. For example, in Indian villages, where
most of the unemployment exists in this from, people are found to be apparently
engaged in agricultural activities. But such employment is mostly a work-sharing
device i.e., the existing work is shared, how so ever large may be the number of
workers. In such a situation, even if many workers are withdrawn, the same work will
continue to be done by fewer people. It follows that all the workers are not needed to
maintain the existing level of production. The contribution of such labourers to
production is, thus, zero or near zero.
Marginal value of additional worker is zero (e.g. issue in agriculture).
1. Underemployment - It is a situation under which employed people are contributing
to production less than they are capable of. For example, a diploma holder in
engineering, if for the want of an appropriate job, starts shoe-shining, may be said to
be underemployed. Apparently, he may be deemed as working and earning in a
productive activity and in this sense contributing something to production. But, in
reality, he is not working to his capability, or to his full capacity. He is, therefore, not
fully employed. Here, too, his underemployment is disguised.
Settling down par down than our potential. e.g., a person who is capable to be
a manager, is working only as a clerk.
2. Open Unemployment - Under this category, fall all those who have no work to do.
They are able to work and are also willing to work, but there is no work for them.
Such unemployment is in the nature of involuntary idleness. They are to be found
partly in villages, but largely in cities. Such unemployment can be seen and counted
in terms of the number of such persons. Hence, it is called open unemployment. Open
unemployment is to be distinguished from disguised unemployment and
underemployment in the sense that while in the case of former, workers are totally
idle, in the latter two types, they appear to be working and do not seem to be idling
away their time.
3. Educated Unemployment - It is concerned with joblessness among the educated i.e.,
matriculate and higher educated. Of these, there may be some suffering from open
unemployment. There may again be others who are underemployed or belonging to
the category of what we have earlier termed as underemployment. The latter type of
unemployed persons may not be getting work suitable to their qualification to enable
them to make full use of their capacities. Mostly towns and cities are facing this
problem of educated unemployment. Even when a person who is educated/trained and
skilled, fails to obtain a suitable job suited to his qualifications, he is to be educated
unemployed.
4. Cyclical Unemployment - Associated with the downswing and depression phases of
business cycle, is to be found in capitalist or market oriented developed economies.
Caused by the lack of coordination among the innumerable decision-makers in the
fields of savings and investment, the trade cycle, in its downward phase, renders many
persons as unemployed. It is caused by trade cycles at regular intervals. Generally
capitalist economies are subject to trade cycles. The down swing in business activities
 results in unemployment. Cyclical unemployment is normally a shot-run
phenomenon.
Cyclical unemployment is the difference between the actual rate of unemployment
and the natural rate of unemployment.

5. Frictional Unemployment -This type of unemployment characterises developed

economies as they push towards further development. At a higher level of
development, many changes take place in the industrial structure of these economies,
with old industries, contracting and dying out, and new industries coming up.
In such a situation, it is necessary that workers move from industry to
industry, leaving those which are decaying and joining those which are leading the
way to further growth and which promise higher wages and rewards. In between the
time of leaving and joining, the time for which the workers get no work, is a period of
unemployment, called frictional unemployment. This period can be used for getting
training and/or acquiring new skills. Such unemployment is, therefore, a necessary
price for progress.
6. Seasonal Unemployment - Seasonal unemployment is the unemployment caused by
seasonal variations in production or demand or both. When the workers engaged in a
particular work or occupation, get employment only for a limited period and remain
idle for the remaining period, it is called seasonal unemployment. It is very common
in Indian agriculture. Agricultural workers in India do not get work throughout the
year. They remain unemployed for about three to four months in a year, unless they
find some temporary employment during this period.
7. Technological Unemployment - Technological unemployment is the unemployment
caused by technical progress; the skills of particular types of worker are made
redundant because of changes in the methods of production, usually by substituting
machines for manual services.
8. Natural Rate of Unemployment - The natural rate of unemployment is the normal
unemployment rate around which the actual unemployment rate fluctuates; the
unemployment rate that arises from the effects of frictional and structural
unemployment.
The natural rate of unemployment is unemployment caused by supply side
factors rather than demand side factors
M.Freidman argued the Natural rate of unemployment would be determined
by institutional factors such as :
i. Availability of job information
ii. Skills and education
iii. Degree of labour mobility
iv. Flexibility of the labour market
v. Hysteresis - A rise in unemployment caused by a recession

NATURE OF UNEMPLOYMENT

Nature of unemployment in India may be summed up as under:

 1. Inadequate Work-. One aspect of the problem is the non availability of work to the
extent needed for entire labour-force. For those in disguised unemployment, it means
that they are not getting work to engage themselves fully during their working hours.
If they seem to be working, they are infact sharing the existing work. Actually almost
each one is under-employed, so that none is working to one's full capacity.
Among them, there are some who are only seasonally employed. For rest of
the time, they are either without work or do some other odd jobs or share with others
on some other work. Disguised unemployment account for a major proportion of the
work-force, mostly in agriculture and activities allied to it.
Besides those in disguised unemployment, there are those in open
unemployment. These are the workers who just do not have any work to do. Such
unemployed persons are also found mostly in the rural areas. Their number, taking
both the rural and urban unemployed, though small as against those in disguised
unemployment, is on the increase.
2. Low-Productivity Work - Another aspect of the problem concerns income of those
employed. Most of them are very poor because their earnings are very small, which in
turn, are caused by low-productivity of their work. These poor people are working
because they can hardly afford to remain unemployed and wait for high-paid jobs.
They engage themselves in any work that comes their way and any income, they are
offered. With labour-force increasing and productivity remaining almost the same,
average income remains very small. The reality, however, is that most of such
employed are no better than those totally unemployed, as both the categories of
workers are living at subsistence level.
3. Chronic or Structural - Unemployment in our country is in nature, a chronic/
permanent one, and is rooted in the underdeveloped character of economy. It is the
incapacity of our low-level economy to offer adequate work opportunities to labour-
force that has given rise to this problem. It is, thus, the supply-side of employment-
situation which is at fault. Unless the economy develops and per head capital
increases, the deficient supply-side will continue.

CAUSES OF UNEMPLOYMENT IN INDIA

Important causes of unemployment in India may be summarised as follows -

1. Jobless Growth - Economic growth is usually expected to generate employment.

However, in India, most of the economic growth has been jobless. For 30 years from
1950-51 to 1980-81, GDP growth rate was as low as 3.6 per cent per annum. At this
rate of economic growth, many jobs could not be created. GDP growth accelerated to
5.6 per cent per annum in the 1980s and stayed at this level in the 1990s. At this
higher rate of GDP growth, one would normally expect that many new employment
opportunities would be forthcoming. But this was not to be. During last two decades,
there was a steep decline in employment elasticity in almost all the major sectors.
2. Increase in Labour Force - Over the years, mortality rate has declined rapidly
without a corresponding fall in birth rate and the country has, thus, registered an
unprecedented population growth. This was naturally followed by an equally largle
 expansion in labour force. In Indian context, social factors affecting labour supply are
also as much important as demographic factors. Since Independence, education
among women has changed their attitude towards employment. Many of them now
compete with men for jobs in the labour market. The economy has, however, failed to
respond to these challenges and the net result is continuous increase in unemployment
backlog. In rural areas, unemployment has increased mainly in disguised form, in
urban areas it is open and visible.
3. Inappropriate Technology - In India, while capital is a scarce factor, labour is
available in abundant quantity. Under these circumstances, the country should have
labour-intensive techniques of production. However, not only in industries, but also in
agriculture, producers are increasingly substituting capital for labour.
According to W.A. Lewis in his 'Theory of Economic Growth' stated - "In all
those countries where unskilled labour is available in excess supply, great care is
needed in exercising choice in respect of technique because monetary wage fails to
reflect the real cost of labour. Lewis asserts that investment in such a situation in
capital equipments may be profitable to individual capitalists, but it is certainly not
beneficial to the society, because it increases unemployment and not production"
4. Inappropriate Education System - The education system in India is defective. It is,
in fact, the same education system which Macaulay had introduced in this country
during the colonial period. According to Gunnar Myrdal, India's education policy
does not aim at the development of human resources. It merely produces clerks and
lower cadre executives for the Government and private concerns. Myrdal considers all
those who receive merely this kind of education not only as inadequately educated but
also wrongly educated. Any education system which fails to develop human resources
properly, would need drastic changes like unemployment.
5. Neo-liberal Economic Policy - With the introduction of neo-liberal structural reforms
in India, income inequalities have increased. The income inequalities have increased
during the decade of economic reforms. Growing income inequalities generally lead
to demand constraints and unemployment. Hence, neo-liberal economic policy of the
government aggravated the unemployment situation.
6. Underdevelopment - It is stressing that Indian economy, by and large, continues to
be in a state of underdevelopment. The volume of economic activities, determined
largely by agriculture, is low. The non agricultural sector, in particular the modern
industrial sector, which could provide increasing avenues of employment, is growing
at a very slow pace.
The slow capital formation over a long period also inhabited the growth-
potential of activities in agricultural and industrial sector.
Inadequacy of irrigation facilities, shortage of fertilizers and power,
unsatisfactory transport facilities etc., all caused by the slow growth of capital-goods
sector, have adversely affected the expansion rate of work opportunities in
agriculture.
Similarly, the development of industries has also been hindered by the non-
availability of machines, power, transport, essential raw materials, etc.
 7. Inadequate Employment Planning - Employment planning in India has not
contributed adequately to the solution of this problem. Employment till recently did
not form an integral part of planning strategy in the sense that this objective was never
quantified as a time bound programme. No consideration was given in the plans for
devising an appropriate wage-rate policy as an instrument of employment expansion
or promotion of labour intensive techniques in a big way.
8. Rapid Population Growth - The rapid growth of population, in particular since
1951, has adversely affected the employment situation largely in two ways. In the first
place, it has directly affected it by making large additions to labour force. The second
consequence of rapid population growth has been to worsen indirectly the
unemployment situation by reducing the resources for capital formation.

The important causes of Unemployment in India are as follows:

1. Rapid growth of population and increase in labour force.
2. Underdevelopment of the economy.
3. Slow growth in the agricultural sector.
4. Defective system of education.
5. Absence of manpower planning.
6. Degeneration of village industries.
7. Inappropriate technology.
8. Slow growth of industrial sector.
9. Immobility of labour.
10. Jobless growth.

CONSEQUENCES OF UNEMPLOYMENT IN INDIA

Unemployment is the root of a number of social and economic problems because when a
person is unemployed or even underemployed, he or she is unable in managing bread and
butter for himself and his family. It causes a bundle of problems. Some of the important
problems are as under:-

1. Poverty - Poverty can be defined as a social phenomenon in which a section of the

society is unable in fulfilling even the basic necessities of life. When a substantial
segment of society is deprived of the minimum level of living and continues at a base
subsistence level, the society is said to be plagued with mass poverty. In India, the
generally accepted definition of poverty is based on the minimum level of living
rather than a reasonable level of living.
The term 'Poverty' is used in two references - Absolute Poverty and
Relative Poverty.
Absolute poverty of a person means that his income is so meagre that he lives
below the minimum subsistence level. He is not in a position to fulfill his basic
necessities. On the other hand, relative poverty means the inequality of income in the
society. In the society, we find that some people are very rich while other persons are
very poor. Form this point of view, we may say that USA is a rich country and India
is a poor country.
 Poverty line has been defined in India on the basis of nutrition intake.
According to Indian Planning commission, it is 2400 calories per person per day in
rural areas and 2100 calories per person per day in urban areas. Poverty is the
immediate consequence of unemployment because when a person is unemployed, he
earns nothing and becomes poor. As per the estimates of 1999-2000, 26.1% of the
total population of labour country was living below the poverty line. As per the
estimates of 2004-05, 21.8% of the total population of country was living below the
poverty line.
2. Income Inequalities - Unemployment causes income inequalities also. Indian
economy is beset with gross economic inequalities. There are inequalities in income,
with a very few cornering a very large chunk of total income and very large number
getting a very small proportion. These inequalities are more severe in respect of the
consumption level of the few at the top and the many at the bottom.
3. Under–Utilisation of Resources - An important economic consequence of
unemployment is that a lot of resources available in the country remain under-utilised.
Perhaps it is the reason why India is said to be a rich country, inhabited by the poor.
We have vast natural resources but we are unable in utilising these resources to the
desired extent. We fail to produce what we can and what we should. The single most
important cause responsible for this situation is unemployment and underemployment.
4. Social Problems - Unemployment is the mother of a number of social problems,
mainly because of two reasons: firstly, an unemployed person has nothing to do. He
has no work to engage with. This situation causes dispute, misunderstanding, quarrels,
etc. Secondly, an unemployed person has no source of income. In most of the cases,
such persons fail to provide required food, clothes, shelter, medicines, etc for
themselves and their family. It compels them to do what they do not like to do and
should not do. It causes the crimes of theft, dacoity, robbery etc.

SUGGESTED REMEDIAL MEASURES

1. Expanding Volume of Work - Foremost solution to the problem of unemployment
lies in enlarging the opportunities for work. This needs to be done to clear the backlog
of unemployment and to provide jobs to the large additions being made to labour-
force. The work to be expanded has to be both in the sphere of wage-employment and
self-employment.
2. Raising Capital Formation - It is also necessary that the accumulation of capital is
stepped up. It helps employment expansion in two principal ways:
One, it becomes possible to maintain the existing activities, as also to expand
the current activities and to set up new ones. An increase in agricultural production
depends much upon new irrigation facilities, more implements, etc. In the same way,
setting up of industrial and service activities requires capital assets as buildings,
machinery, etc.
Secondly, capital formation directly generates employment in capital goods
sector. The production of 'mother machines' i.e., the machines which produce
 machines, give rise to employment. This also provides capital goods for the
production for consumer goods and services.
Thirdly, a rise in capital formation will add to the capital stock of country.
This will, by raising capital per worker, increase substantially the productivity of
labour and raise the income of those who work.
3. Appropriate Mix of Production Techniques - . It is also necessary to choose such a
combination of capital-intensive and labour-intensive technologies of production as
may generate maximum employment.
4. Special Employment Programmes - it is necessary, as an interim measure, to
undertake special employment programmes. Different types of people for whom
special employment programmes are needed, are landless agricultural labourers,
marginal farmers, village artisans, tribal people living in the remote areas of country
as also the people living in the hilly areas. Specific employment programmes have to
be such as suit specific group of people and specific areas. These programmes may be
in the form of direct employment as rural capital works, or in the form of providing
assets like animals, sewing machines, hand/power driven looms etc., or these may be
in the form of the supply of infrastructural facilities like marketing, credit etc. to help
them.
5. Manpower Planning

MINIMUM SUPPORT PRICE

1. Minimum Support Price (MSP) is a form of market intervention by the Government

of India to insure agricultural producers against any sharp fall in farm prices - a
guarantee price to save farmers from distress sale.
2. Minimum Support Price is the price at which government purchases crops from the
farmers, whatever may be the price for the crops. Minimum Support Price is an
important part of India’s agricultural price policy.
3. The MSPs are announced at the beginning of the sowing season for certain crops on
the basis of the recommendations of the Commission for Agriculture costs and prices
(CACO,1985).
4. The Cabinet Committee on Economic Affairs (CCEA), Government of India,
determines the Minimum Support Prices (MSP) of various agricultural commodities
in India based on the recommendations of the Commission for Agricultural Cost and
Prices (CACP).
5. The major objectives are to support the farmers from distress sales and to procure
food grains for public distribution.
6. In case the market price for the commodity falls below the announced minimum price
due to bumper production and glut in the market, government agencies purchase the
entire quantity offered by the farmers at the announced minimum price.
7. In the absence of such a guaranteed price, there is a concern that farmers may shift to
other crops causing shortage in these commodities.
8. The MSPs are fixed at incentive level, to fulfil the following purposes :
 a) to induce more investment by the farmers in the farm sector
b) to motivate farmers to adopt improved crop production technologies and
c) to enhance production and thereby farmers income.

Determination of MSP

In formulating the recommendations in respect. Of the level of minimum support prices and
other non-price measures, the Commission takes into account, apart from a comprehensive
view of the entire structure of the economy of a particular commodity or group of
commodities, the following factors: -

1. Cost of production
2. Changes in input prices
3. Input-output price parity
4. Trends in market prices
5. Demand and supply
6. Inter-crop price parity
7. Effect on industrial cost structure
8. Effect on cost of living
9. Effect on general price level
10. International price situation
11. Parity between prices paid and prices received by the farmers.
12. Effect on issue prices and implications for subsidy

The Commission makes use of both micro-level data and aggregates at the level of district,
state and the country. The information/data used by the Commission, inter-alia include the
following: -

1. Cost of cultivation per hectare and structure of costs in various regions of the country
and changes there in;
2. Cost of production per quintal in various regions of the country and changes therein;
3. Prices of various inputs and changes therein;
4. Market prices of products and changes therein;
5. Prices of commodities sold by the farmers and of those purchased by them and
changes therein;
6. Supply related information - area, yield and production, imports, exports and domestic
availability and stocks with the Government/public agencies or industry
7. Demand related information - total and per capita consumption, trends and capacity of
the processing industry;
8. Prices in the international market and changes therein, demand and supply situation in
the world market;
9. Prices of the derivatives of the farm products such as sugar, jaggery, jute goods,
edible/non-edible oils and cotton yarn and changes therein;
10. Cost of processing of agricultural products and changes therein;
11. Cost of marketing - storage, transportation, processing, marketing services, taxes/fees
and margins retained by market functionaries; and
 12. Macro-economic variables such as general level of prices, consumer price indices and
those reflecting monetary and fiscal factors.

MARKET INTERVENTION SCHEME

1. The market intervention scheme (MIS) is similar to MSP which is implemented on
the request of state governments for procurement of perishable and horticultural
commodities in the event of fall in market price.
2. The scheme is implemented when there is at least 10 percent increase in production
or 10 percent decrease in the ruling rates over the previous normal year.
3. Proposal of MIS is approving on the specific request of State/UT governments if the
State/UT governments is ready to bear 50 percent loss incurred on its implementation.

PROCUREMENT PRICES

1. The MSP is announced before sowing, while the procurement price was announced
before harvesting - the purpose is to encourage the farmers to sell a bit more and get
encouraged to produce more.
2. FCI, the nodal central agency of Government of India, along with other State
Agencies undertakes procurement of wheat and paddy under price support scheme .
Coarse grains are procured by State Government Agencies for Central Pool as per the
direction issued by Government of India on time to time. The procurement under
Price Support is taken up mainly to ensure remunerative prices to the farmers for their
produce which works as an incentive for achieving better production.
3. Before the harvest during each Rabi / Kharif Crop season, the Government of India
announces the minimum support prices (MSP) for procurement on the basis of the
recommendation of the Commission of Agricultural Costs and Prices (CACP) which
along with other factors, takes into consideration the cost of various agricultural
inputs and the reasonable margin for the farmers for their produce.

ISSUE PRICE

GREEN REVOLUTION

It is the introduction of new techniques of agriculture which became popular by the name of
Green Revolution in early 1960s at first for wheat and by the next decade for rice, too. It
revolutionised the very traditional idea of food production by giving a boost by more than
25o per cent to the productivity level. The Green revolution was centred around the use of the
high yielding variety (HYV) of seeds developed by the US agro-scientist Norman Borlaug.
The new wheat seeds which he developed in vivo claimed to increase its productivity by
more than 200 per cent.

In India, in 1960-61 a new technology was tried as a pilot project in seven districts
and was called Intensive Agricultural District Programme (IADP). Later, the High yielding
varieties programme was also added and the strategy was extended to cover the entire
country. This strategy has been called for various name: modern agricultural technology,
seed-fertiliser-water technology or simply green revolution.
COMPONENTS OF THE GREEN REVOLUTION

The Green Revolution was based on the timely and adequate supply of many
inputs/components.

1. The HYV Seeds

They were popularly called the 'dwarf' variety of seeds with the help of repeated
mutations. These seeds were non-photosynthetic, hence non-dependent on sun rays
for targeted yields.
2. Chemical Fertilizers
The seeds were to increase productivity provided they got sufficient levels of nutrients
from the land. The level of nutrients they required could not be supplied with the
traditional compostes because they have low concentration of nutrients content and
required bigger area while sowing - it meant it will be shared by more than on eseed.
That is why a high concentration fertilizer was required which could be given to the
targeted seed only - the only option was the chemical fertilizers -urea (N),
phosphate(P), and potash(k).
3. The Irrigation
For controlled growth of crops and adequate dilution of fertilizers, a controlled means
of water supply was required. It was important compulsions - firstly the area of such
crops should be at least free of flooding and secondly, artificial water supply should
be developed.
4. Chemical pesticides and Germicides
As the new seeds were new and non-acclimatised to local pests, germs an diseases
than the established indigenous varieties, use of pesticides and germicides became
compulsory for result oriented and secured yields.
5. Chemical Herbicides and Weedicides
To prevent costlier inputs of fertilisers not being consumed by the herbs and the
weeds on the farmlands, herbicides and weedicides were used while sowing the HYV
seeds.
6. Credit, storage, marketing/distribution
For farmers to be capable of using the new and the costlier inputs of the green
revolution, availability of easy and cheaper credit was a must. As the farmlands
suitable for this new kind of farming was region-specific (as it was only Haryana,
Punjab and western Uttar Pradesh in India) storage of the harvested crops was to be
done in the region itself till they were distributed throughout the country.

IMPACT OF THE GREEN REVOLUTION

The green revolution had its positive as well as negative socio-economic and
ecological impacts on the countries around the world.

1. Socio-economic Impact
Food production increased in such a way that many countries became self-sufficient
and some even emerged as food exporting countries. But the discrepancy in farmers'
 income, it brought with itself increased and inter-personal as well as inter-regional
disparities/inequalities in India. Rise in the incidence of malaria due to water-logging,
a swing in the balanced cropping patterns in favour of wheat and rice etc., were
negative impacts.
2. Ecological Impact
The most devastating negative impact of the Green Revolution was the ecological
one.
i. Critical Ecological Crisis - On the basis of on-field studies it was found that
critical ecological crisis in the Green Revolution region are showing up -
a) Soil fertility being degraded (due to the repetitive kind of cropping
pattern being followed by the farmers as well as the excessive
exploitation of the land; lack of a suitable crop combination and the
crop intensity etc.)
b) Water table falling down (as the new HYV seeds required
comparatively very high amount of water for irrigation - 5 tonnes of
water needed to produce 1 kg of rice.
c) Environment degradation - due to excessive and uncontrolled use of
chemical fertilizers, pesticides and herbicides have degraded the
environment by increasing pollution levels in land, water and air. In
India it is more due to deforestation and extension of cultivation in
ecologically fragile areas. At the same time, there is an excessive
pressure of animals on forests - mainly by goats and sheeps).
ii. Toxic Level in Food chain - Toxic level in the food chain of India increased
to such a high level that nothing produced in India is fit for human
consumption. Basically, unbridled use of chemical pesticides and weedicides
and their industrial production combined together had polluted the land, water
and air to such an alarmingly high level that the whole food chain had been a
prey of high toxicity.

FOREX RESERVES

The total foreign currencies of different countries an possess at a point of time is its 'roeign
currency assets/reserves'. The forex reserves of an economy is its 'foreign currency assets'
added with its gold reserves, SDRs (Special Drawing rights) and Reserve Trenche in the IMF.

Thus, in a nutshell, Foreign Exchange Reserves include-

1. Reserves held in US Dollars, The Euro, The British Pound or the Japanese Yen
2. Foreign bank notes, foreign bank deposits, foreign treasury bills and short term and
long term foreign government securities
3. Gold reserves
4. Special Drawing Rights and International Monetary Fund reserve positions

THE FOREIGN EXCHANGE RESERVES OF INDIA CONSIST OF BELOW FOUR

CATEGORIES.
 Foreign Currency Assets
Foreign currency assets expressed in US dollar terms include the effect of
appreciation/depreciation of non-US currencies (such as Euro, Sterling, Yen) held in
reserves.
 Gold Reserves
The Reserve Bank holds 557.77 tonnes of gold; of which, 265.49 tonnes are held overseas in
safe custody with the Bank of England and the Bank for International Settlements (BIS).
Gold as a share of the total foreign exchange reserves in value terms (USD) stood at about 5.6
per cent as at end-March, 2016.
 Special Drawing Rights
Special Drawing Rights (SDRs) are supplementary foreign exchange reserve assets defined
and maintained by the International Monetary Fund. It was created in 1969 to supplement a
shortfall of preferred foreign exchange reserve assets, namely gold and the US dollar, the
SDR's value is defined by a weighted currency basket of four major currencies: the Euro, the
US dollar, the British pound, and the Japanese yen Currently, the value of one SDR is equal
to the sum of 0.423 Euros, 12.1 Yen, 0.111 pounds, and 0.66 US Dollars. This basket is
reevaluated every five years, and the currencies included as well as the weights given to them
can then change.
 Reserve Tranche Position
The primary means of financing the International Monetary Fund is through members'
quotas. Each member of the IMF is assigned a quota, part of which is payable in SDRs or
specified usable currencies ("reserve assets"), and part in the member's own currency. The
difference between a member's quota and the IMF's holdings of its currency is a country's
Reserve Tranche Position (RTP).Reserve Tranche Position is accounted among a country's
Foreign Exchange Reserves.

INTERNATIONAL FINANCIAL INSTITUTIONS : THE IMF AND THE WORLD

BANK
Toward the end of the Second World War, in July 1944, representatives of the United States,
Great Britain, France, Russia, and 40 other countries met at Bretton Woods, a resort in New
Hampshire, to lay the foundation for the post-war international financial order. Such a new
system, they hoped, would prevent another worldwide economic cataclysm like the Great
Depression that had destabilized Europe and the United States in the 1930s and had
contributed to the rise of Fascism and the war.

Therefore, the United Nations Monetary and Financial Conference, as the Bretton Woods
conference was officially called, created the International Monetary Fund (the IMF) and the
World Bank to prevent economic crises and to rebuild economies shattered by the war.

WORLD BANK

The World Bank (WB) Group today consists of five closely associated institutions
propitiating the role of development in the member nations in different areas. The World
Bank is like a cooperative, made up of 189 member countries. These member countries, or
shareholders, are represented by a Board of Governors, who are the ultimate policymakers at
the World Bank. The term “World Bank” generally refers to the IBRD and IDA, whereas the
World Bank Group is used to refer to the institutions collectively.

1. IBRD
 The mission statement of the IBRD states that it "aims to reduce
poverty in middle-income and creditworthy poorer countries by
promoting sustainable development, through loans, guarantees, and
non-lending-including analytical and advisory-services."
 The International Bank for Reconstruction and Development is the
oldest of the WB institutions which started functioning (1945) in the
area of reconstruction of the war-ravaged regions (world war II) and
later for the development of the middle income and credit worthy
poorer economies of the world.
 Human development was the main focus of the developmental lending
with a very low interest rate (1.55 per cent per annum) - the areas of
focus being agriculture, irrigation, urban development, health care,
family welfare, dairy development etc. It commenced lending for India
in 1949.

 Supports long-term human and social development that private

creditors do not finance
 Preserves borrowers' financial strength by providing support in times
of crisis, when poor people are most adversely affected
 Promotes key policy and institutional reforms (such as safety net or
anti-corruption reforms)
 Creates a favorable investment climate to catalyze the provision of
private capital
 Facilitates access to financial markets often at more favorable terms
than members can achieve on their own
 India's borrowing from IBRD - Fiscal 2016 is 2820 Millions next to
peru 2850 Millions.
2. IDA (A world Bank Group, The world bank's fund for the poorest)
 The International Development Agency (IDA) which is also known as
the soft window of the WB was set up in 1960 with the basic aim of
developing infrastructural support among the member nations, long
term lending for the development of economic services.
 Its loans, known as credits are extended mainly to economies with the
less than 895 dollars per capita income.
 The credits are for a period of 35-40 years, interest free, except for a
small charge to cover administrative costs.
 Repayment begins after a 10 year grace period.
3. IFC
 The international finance corporation (IFC) was set up in 1956 which is also
known as the private arm of the WB.
  It lends money to private sector companies of its member nations.
 The interest rate charged is commercial but comparatively low.
 It finances and provides for private-public ventures and projects in partnership
with private investors and, through its advisory work, helps governments of
the member nations to create conditions that stimulate the flow of both
domestic and foreign private savings and investment.
 It focuses on promoting economic development by encouraging the growth of
productive enterprises and efficient capital markets in its member countries.
 it participates in an investment only when it can make a special contribution
that complements the role of market investors (as a foreign financial
investor(FFI).
 It also plays a catalytic role, stimulating and mobilising private investment in
the developing world by demonstrating that investments there too can be
preferable.

4. MIGA

 The Multilateral Investment Guarantee Agency set up in 1988 encourages foreign

investment in developing economies by offering insurance (guarantees) to foreign
private investors against loss caused by non-commercial (i.e., political) risks, such as
currency transfer, expropriation, war and civil disturbance.
 It also provides technical assistance to help countries disseminate information on
investment oppurtunities.

5. ICSID

 The International Centre for Settlement of Investment Disputes set up in 1966 is an

investment dispute settlement body whose decisions are binding on the parties.
 It was established under the 1966 Convention on Settlement of Investment
Disputes between states and nationals of other states. Though recourse to the
centre is voluntary, but once parties have agreed to arbitration, they cannot withdraw
their consent unilaterally.
 The ICSID Convention is a multilateral treaty formulated by the Executive Directors
of the World Bank to further the Bank’s objective of promoting international
investment.
 ICSID is an independent, depoliticized and effective dispute-settlement institution.
 Its availability to investors and States helps to promote international investment by
providing confidence in the dispute resolution process.
 It is also available for state-state disputes under investment treaties and free trade
agreements, and as an administrative registry.
 ICSID provides for settlement of disputes by conciliation, arbitration or fact-finding.
 It settles the investment disputes arising between the investing foreign companies and
the host countries where the investments have been done.
  India is not its member. It is believed that being signatory to it encourages the foreign
investment flows into an economy, but risks independent sovereign decisions, too.
 The World Bank established ICSID in 1966 to encourage both investors and
governments to undertake and receive foreign direct investment by providing a
neutral dispute resolution system. The ICSID provides arbitration services, which are
entered into on a voluntary basis, but once two parties agree to submit issue resolution
to ICSID, they are required to follow ICSID procedures until the verdict is rendered.
Furthermore, all member countries of ICSID are bound to recognize and enforce the
rulings that are made.

IMF

1. IMF and World Bank are popularly called the Bretton Woods' twins.
2. The International Monetary Fund (IMF) came up in 1944 whose Article came into
force on the December 27, 1945 with the main functions as
 exchange rate regulation,
 purchasing short term foreign currency liabilities of the member nations from
around the world,
 allotting special drawing rights (SDRs) to the member nations and
 the most important one as the bailor to the member economies in the function
of any BoP crisis.
3. The Main functions of the IMF are as given below :
 to facilitate international monetary cooperation
 to promote exchange rate stability and orderly exchange arrangements
 to assist in the establishment of a multilateral system of payments and the
elimination of foreign exchange restrictions; and
 to assist member countries by temporarily providing financial resources to
correct mal-adjustment in their balance of payments. (BoPs).
4. The Board of Governors of the IMF consists of one governor and one alternate
Governor from each member country. For India, Finance Minister is the ex-officio
governor while the RBI governor is the alternate governor on the board.

In simpler terms, the goals are to:

1) Facilitate the cooperation of countries on monetary policy, including providing

the necessary resources for both consultation and the establishment of
monetary policy in order to minimize the effects of international financial
crises.
2) Assist the liberalization of international trade by helping countries increase
their real incomes while lowering unemployment.
3) Help stabilize exchange rates between countries. Especially after the global
depression of the 1930s, it was considered vital to establish currencies that
could hold their value, serve as mediums of international exchange, and resist
any speculative attacks.
4) Maintain a multilateral system of payments that eliminates foreign exchange
restrictions. Countries are thus free to trade with each other without worrying
about the effects of interest rates and currency depreciation on their payments.
5) Provide a safeguard to members of the IMF against balance of payments
crises, i.e., when governments cannot balance the money they have with the
money they owe to other countries. IMF members can have the confidence to
adjust the imbalances in their national accounts without resorting to painful
measures that would hamper their prosperity, such as devaluing their currency
in relation to other countries'.
6) Try to reduce the effects of volatility in countries' balance of payments
accounts, the IMF helps assure that global trade and financial relationships can
continue at a steady rate without the risks of global depressions like that of the
1930s.