UPSC Prelims Research: Indian Economy 2013

Q. Disguised unemployment generally means

(a) large number of people remain unemployed

(b) alternative employment is not available

(c) marginal productivity of labour is zero

(d) productivity of workers is low

Answer: (c) marginal productivity of labour is zero

Disguised unemployment:

• Disguised unemployment occurs when part of the labour force is either left without jobs or operates redundantly, such as the productivity of the workforce is effectively zero. It is unemployment which has no impact on aggregate production.
• An economy shows hidden unemployment when productivity is poor, and too many workers also occupy few jobs.
• Disguised unemployment often occurs in developed countries whose large populations generate labour-force surpluses. It can be distinguished by low productivity and mostly follows informal labour markets and agricultural labour markets, capable of consuming large labour quantities.
• Disguised, or secret, unemployment can refer to any portion of the non-employed population at maximum potential. Still, it is often not counted within the national economy in official unemployment stats.
  • This may include those who work far below their capacities, those whose jobs have little overall productivity benefit, or any category that is not currently searching for a job but is capable of doing value work.

Types of Disguised Unemployment

• Underemployment:
  • In certain conditions, people who do part-time work can qualify as disguised unemployment if they wish to obtain and can do a full-time job. It also includes those who accept work well below their skill set.
  • In such situations, hidden unemployment can also be called “underemployment,” including those who operate at some capacity but not at maximum capacity.
• Illness and Disability:
  • Another category which can be included is those who are sick or partially disabled. Though they may not function actively, they may be able to be successful within the economy.
  • In the case of disability, this type of disguised unemployment is temporary and classified while someone is seeking assistance with disabilities. That means the individual is often not regarded as part of a nation’s unemployment statistics.
• No Longer Looking for Work:
  • Whatever the cause, if a person ceases searching for jobs, he or she is often no longer considered unemployed when it comes to measuring the unemployment rate. Many nations require that an individual actively pursue employment to be counted as unemployed.

Q. Which one of the following groups of items is included in India’s foreign-exchange reserves?

(a) Foreign-currency assets, Special Drawing Rights (SDRs) and loans from foreign countries

(b) Foreign-currency assets, gold holdings of the RBI and SDRs

(c) Foreign-currency assets, loans from the World Bank and SDRs

(d) Foreign-currency assets, gold holdings of the RBI and loans from the World Bank

Answer: (b) Foreign-currency assets, gold holdings of the RBI and SDRs

Foreign Exchange Reserves:

• Foreign Exchange Reserves (also called Forex Reserves) are reserve assets held by a central bank in foreign currencies.
• These may include foreign currencies, bonds, treasury bills, and other government securities.
• Reserves are denominated and expressed in the US dollar, which is the international numeraire for the purpose.
• RBI is the custodian of the Foreign exchange reserves in India.
• India’s foreign exchange reserves comprise of;
  • Foreign currency assets (FCAs):These are maintained in currencies like the US dollar, euro, pound sterling, Australian dollar and Japanese yen.
  • Gold
  • SDR (Special Drawing Rights): This is the reserve currency with IMF.
  • RTP (Reserve Tranche Position): This is the reserve capital with IMF.
• The biggest contributor to India’s Forex reserves is foreign currency assets, followed by gold.
• Purpose:
  • They are used to back liabilities on their own issued currency, support the exchange rate and set monetary policy.
  • To ensure that RBI has backup funds if their national currency rapidly devalues or becomes altogether insolvent.
  • If the value of the Rupee decreases due to an increase in the demand of the foreign currency, then RBI sells the dollar in the Indian money market so that depreciation of the Indian currency can be checked.
  • A country with a good stock of forex has a good image at the international level because the trading countries can be sure about their payments.
  • A good forex reserve helps in attracting foreign trade and earns a good reputation with trading partners.
• Significance of Rising Forex Reserves:
  • Comfortable Position for the Government: The rising forex reserves give comfort to the government and the RBI in managing India’s external and internal financial issues.
  • Managing Crisis: It serves as a cushion in the event of a Balance of Payment (BoP) crisis on the economic front.
  • Rupee Appreciation: The rising reserves have also helped the rupee to strengthen against the dollar.
  • Confidence in Market: Reserves will provide a level of confidence to markets and investors that a country can meet its external obligations.

Q. An increase in the Bank Rate generally indicates that the

(a) Market rate of interest is likely to fall

(b) Central Bank is no longer making loans to commercial banks

(c) Central Bank is following an easy money policy

(d) Central Bank is following a tight money policy

Answer: (d) Central Bank is following a tight money policy

Bank Rate:

• Bank Rate is the interest rate at which a country’s central bank lends money to domestic/commercial banks, usually in the form of relatively short-term loans.
  • In India, the central bank is the Reserve Bank of India (RBI).
• Commercial banks are not required to keep any collateral as security when borrowing at Bank Rate.
  • There is no repurchasing agreement and obligation to repay on a particular date.
• Section 49 of the Reserve Bank of India Act, 1934, governs the publication of the Bank Rate.
• This rate is linked to the MSF rate, therefore it adjusts automatically when the MSF rate changes, as well as when the policy repo rate changes. Bank rate is slightly higher than Repo Rate.
• Determination of Bank Rate:
  • The Reserve Bank of India (RBI) is the authority in India to determine the Bank Rate.
  • The RBI in its bi-monthly monetary policy review announces the bank rate based on the macroeconomic situation.
  • The Bank Rate is announced keeping in mind the primary goal of inflation targeting.
  • If the Bank rate is decreased then it increases the money supply in the economy as the banks borrow and lend it to customers. On the other hand, if the Bank rate is increased it will inhibit the money supply in the economy.

Difference between Bank Rate and Repo Rate

Parameter	Bank Rate	Repo Rate
Meaning	The Bank Rate is applied to loans made by the central bank to commercial banks.	Repo Rate is applied to the central bank’s repurchase of securities sold by commercial banks.
Collateral	No collateral is required	Securities, bonds and agreements are given as collateral
Impact	Directly impact customers as it impacts long term lending.	The Repo rate is handled by the banks and doesn’t impact the customers directly.
Rate	Higher than Repo due to no collateral and long term nature.	Lower than Bank Rate as there is a collateral and repurchase obligation.
Duration of loan	Bank rate caters to long term requirements of commercial banks	Repo Rate focuses on short term financial lending.

Q. In India, deficit financing is used for raising resources for

(a) Economic development

(b) Redemption of public debt

(c) Adjusting the balance of payments

(d) Reducing the foreign debt

Answer: (a) Economic development

Deficit financing:

• Deficit financing is nothing but financing the budget deficit incurred due to excess government expenditures. 
  • It means generating funds to finance the deficit which results from excess expenditure over revenue. The gap is being covered by borrowing from the public by the sale of bonds or by printing new money.
• Deficit financing is a necessary evil in a welfare state as the states often fail to generate tax revenue which is sufficient enough to take care of the expenditure of the state.
  • The basic intention behind deficit financing is to provide the necessary impetus to economic growth by artificial means.
• Means of Deficit Financing:
  • External Aid: This is the best way to finance the deficit even if they are coming with soft interest rates.
  • External Borrowings: This is the next best way to manage the fiscal deficit with the condition that they are coming with a cheap rate of interest and are of long term.
  • Internal Borrowings: It is the third best way to finance the deficit. But it hampers the investment prospects of the government and the public sector.
  • Printing Currency: It is the last resort to finance the deficit and should be used only in exceptional circumstances. Its negative effects on the economy are: it increases inflation proportionally and it also increases pressure on the government for increasing wages and salaries of government employees-ultimately increasing government expenditure.
• Purpose of Deficit Financing
  • To finance defence expenditures during war
  • To lift the economy out of depression so that incomes, employment, invest­ment, etc. all rise
  • To activate idle resources as well as divert resources from unproductive sectors to productive sectors with the objective of increasing national income and, hence, higher economic growth
  • To raise capital formation by mobilizing forced savings made through deficit financing
  • To mobilize resources to finance massive plan expenditure

Q. Priority Sector Lending by banks in India constitutes the lending to

(a) agriculture

(b) micro and small enterprises

(c) weaker sections

(d) All of the above

Answer: (d) All of the above

Priority Sector Lending:

• Priority Sector means those sectors which the Government of India and Reserve Bank of India consider as important for the development of the basic needs of the country and are to be given priority over other sectors. The banks are mandated to encourage the growth of such sectors with adequate and timely credit.
• The categories of priority sector are as follows
  • Agriculture
  • Micro, Small and Medium Enterprises
  • Export Credit
  • Education
  • Housing
  • Social Infrastructure
  • Renewable Energy
  • Others

Weaker sections under Priority sector

Priority sector loans to the following borrowers will be considered under Weaker Sections category

Sl.No	Category
1.	Small and Marginal Farmers
2.	Artisans, village and cottage industries where individual credit limits do not exceed Rs 1 lakh
3.	Beneficiaries under Government Sponsored Schemes such as National Rural Livelihoods Mission (NRLM), National Urban Livelihood Mission (NULM) and Self Employment Scheme for Rehabilitation of Manual Scavengers (SRMS)
4.	Scheduled Castes and Scheduled Tribes
5.	Beneficiaries of Differential Rate of Interest (DRI) scheme
6.	Self Help Groups
7.	Distressed farmers indebted to non-institutional lenders
8.	Distressed persons other than farmers, with loan amount not exceeding Rs 1 lakh per borrower to prepay their debt to non-institutional lenders
9.	Individual women beneficiaries up to Rs 1 lakh per borrower
10.	Persons with disabilities
11.	Minority communities as may be notified by Government of India from time to time

Priority Sector Lending Targets:

• Domestic Scheduled Commercial Banks and Foreign Banks with 20 branches and above:
  • Total Priority Sector: 40% of Adjusted Net Bank Credit (ANBC) or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher.
  • Agriculture: 18% of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure, with a target of 8% specifically for Small and Marginal Farmers.
  • Micro Enterprises: 7.5% of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure.
  • Advances to Weaker Sections: 12% of ANBC or Credit Equivalent Amount of Off-Balance Sheet Exposure.
• Foreign Banks with less than 20 branches:
  • Total Priority Sector: 40% of Adjusted Net Bank Credit (ANBC) or Credit Equivalent Amount of Off-Balance Sheet Exposure, whichever is higher.
  • Out of the total, up to 32% can be in the form of lending to exports, and not less than 8% should be allocated to any other priority sector.
• Regional Rural Banks:
  • Total Priority Sector: 75% of Adjusted Net Bank Credit (ANBC).
  • However, lending to Medium Enterprises, Social Infrastructure, and Renewable Energy is considered for priority sector achievement only up to 15% of ANBC.
  • Agriculture: 18% of ANBC.
  • Micro Enterprises: 7.5% of ANBC.
  • Advances to Weaker Sections: 15% of ANBC.
• Small Finance Banks:
  • Total Priority Sector: 75% of Adjusted Net Bank Credit (ANBC).
  • Agriculture: 18% of ANBC.
  • Micro Enterprises: 7.5% of ANBC.
  • Advances to Weaker Sections: 12% of ANBC.
• Priority Sector Lending (PSL) targets are designed to ensure that banks contribute to the development of specific sectors crucial for the overall economic growth and social well-being of the country.

Priority Sector Lending Certificates (PSLCs):

• Priority Sector Lending Certificates (PSLCs) are a mechanism to enable banks to achieve the priority sector lending target and sub-targets by purchase of these instruments in the event of shortfall.
• This also incentivizes surplus banks as it allows them to sell their excess achievement over targets thereby enhancing lending to the categories under priority sector.
• Under the PSLC mechanism, the seller sells fulfilment of priority sector obligation and the buyer buys the obligation with no transfer of risk or loan assets.

Q. A rise in general level of prices may be caused by

1. an increase in the money supply
2. a decrease in the aggregate level of output
3. an increase in the effective demand

Select the correct answer using the codes given below.

(a) 1 only
(b) 1 and 2 only
(c) 2 and 3 only
(d) 1, 2 and 3

Answer: (d) 1, 2 and 3

Notes:

• The increase in the general level of prices may be caused by many factors like an increase in the money supply, a decrease in the aggregate level of output, an increase in the effective demand, an increase in income, the rapid growth of population, etc.
• Increase in general price level or inflation has two influencing factors Demand-pull inflation and Cost-push inflation.
  • Demand-pull inflation occurs when aggregate demand for goods and services in an economy rises more rapidly than an economy’s productive capacity. One potential shock to aggregate demand might come from a central bank that rapidly increases the supply of money.
    • The  decrease in aggregate level of output and increase in the effective demand also lead to inflation.
    • The increase in the money supply will generate inflation and increase more customer spending. The rate of interest will become low.
    • Various variables might cause an increase in aggregate demand. Some of them are
      • Fiscal Stimulus
      • Population Pressure
      • Increase in Net Exports
      • Monetary Stimulus
      • Policy Decisions
  • Cost-push inflation, on the other hand, occurs when prices of production process inputs increase.
    • The following reasons can cause production costs to rise.
      • Employees’ salaries being raised
      • Raw material prices increasing
      • Firms profit margins
      • Import prices
      • Increase in indirect taxes

Impact of Inflation

• Positive Impacts:
  • Increased Profits for Producers
    • In most cases, inflation benefits the producers of goods. They make more money because they can sell their products at higher prices.
  • Increased Investment Returns
    • During periods of inflation, investors and entrepreneurs are given additional incentives to invest in productive activities. As a result, they benefit from higher returns.
  • Increase in production output
    • When producers receive the appropriate investment, they produce more goods and services. As a result, inflation causes an increase in product/service production.
• Negative Impacts:
  • Real-Income falls for groups with fixed income.
    • An individual’s true income is the purchasing power of his income money. To put it another way, Real Income=Money Income/Price Level.
    • This means that people on fixed incomes, such as salaried workers, pensioners, and the like, will see a drop in real income. To put it another way, their purchasing power will reduce.
  • Income Distribution Inequality Rises
    • Profits for business owners and entrepreneurs rise as a result of inflation.
    • As a result, income inequality becomes more pronounced during this time period.
    • People in fixed-income groups, on the other hand, see a decrease in their real income.
  • Disturbs the Planning Process
    • Inflation raises the prices of goods, raw materials, and factor services. As a result, the government must spend more money to complete any investment project initiated during the planning period.
    • If the government fails to raise more financial resources through savings or taxation, the entire planning process is thrown off.

Q. Which one of the following is likely to be the most inflationary in its effect?

(a) Repayment of public debt

(b) Borrowing from the public to finance a budget deficit

(c) Borrowing from banks to finance a budget deficit

(d) Creating new money to finance a budget deficit

Answer: (d) Creating new money to finance a budget deficit

Notes:

• Deficit financing means generating funds to finance the deficit which results from excess expenditure over revenue. The gap is being covered by borrowing from the public by the sale of bonds or by printing new money. Deficit financing is inherently inflationary.
• Since deficit financing raises aggregate expenditure and, hence, increases aggregate demand, the danger of inflation looms large. Printing new currency notes increases the flow of money in the economy. This leads to an increase in inflationary pressures which leads to a rise of the prices of goods and services in the country. And since inflation is revealed with a lag, it is often too late before governments realize, they have over-borrowed. Higher inflation and higher government debt provide grounds for macroeconomic instability.

What Causes a Budget Deficit?

• Both levels of taxation and spending affect a government’s budget deficit. Common scenarios that create deficits by reducing revenue and increasing spending include:
  • A tax structure that undertaxes high-wage earners but overtaxes low-wage earners.
  • Increased spending on programs like Social Security, Medicare, or military spending.
  • Increased government subsidies to targeted industries.
  • Tax cuts that decrease revenue but provide corporations with funds to increase employment.
  • Low GDP, or gross domestic product, results in lower tax revenue.
• Budget deficits may occur as a way to respond to certain unanticipated events and policies, such as the increase in defense spending.

What can be Done to Manage Fiscal Deficit and National Debt in India?

• Fiscal Discipline and Consolidation:
  • Adhering to fiscal consolidation targets, as outlined in the FRBM Act is crucial.
  • The government should aim to gradually reduce the fiscal deficit-to-GDP ratio to ensure sustainable public finances.
  • Implementing prudent fiscal policies, including expenditure rationalisation, revenue enhancement measures, and subsidy reforms, can help in reducing the reliance on borrowing and mitigating fiscal imbalances.
• Enhancing Revenue Mobilisation:
  • Strengthening tax administration and compliance to broaden the tax base and improve revenue collection.
  • Exploring avenues for diversifying revenue sources, such as introducing new taxes or levies on luxury goods, wealth, or environmental taxes.
• Rationalising Expenditures:
  • Conducting a comprehensive review of government expenditures to identify inefficiencies and prioritise spending in key areas such as healthcare, education, and infrastructure.
  • Implementing measures to curb non-essential spending and subsidies, while ensuring targeted support for vulnerable populations.
• Debt Management Strategies:
  • Developing a prudent debt management strategy to optimise borrowing costs and minimise refinancing risks.
  • Diversifying the investor base and sources of financing, including domestic and international markets, to mitigate exposure to market volatility.
• Long-Term Structural Reforms:
  • Undertaking structural reforms aimed at improving the efficiency and competitiveness of the economy, including labour market reforms, ease of doing business initiatives, and governance reforms.
  • Addressing structural bottlenecks and challenges in sectors such as agriculture, manufacturing, and services to unleash growth potential and enhance fiscal sustainability.

Q. Supply of money remaining the same when there is an increase in demand for money, there will be

(a) a fall in the level of prices

(b) an increase in the rate of interest

(c) a decrease in the rate of interest

(d) an increase in the level of income and employment

Answer: (b) an increase in the rate of interest

Notes:

• Inflation occurs when the aggregate quantity of goods demanded at any particular price level is rising more quickly than the aggregate quantity of goods supplied at that price level.
• If the money supply grows faster than overall economic growth, inflation will occur. If the difference between the money supply growth and the growth of the economy becomes too wide, hyperinflation occurs.
• Central banks use interest rates to control demand and inflation. If inflation is high, they raise their target for short-term interest rates. Higher interest rates make borrowing costs less attractive for firms and consumers, which leads to less demand for goods and investment.
• Since inflation is caused by demand outstripping supply, lowering demand to bring it in line with supply relieves the pressures that were raising prices. 

There are several situations that occur where increases in the money supply do not cause inflation.

• Economic growth may match money supply growth. If the level of economic growth is equal to the level of money supply growth, prices traditionally remain stable.
• There are variations in the velocity of money circulating. In a recession, the Fed may choose to increase the money supply; however, the spending patterns of consumers will vary during this period—including periods of decreased spending due to higher unemployment and less disposable income.
• The economy has spare room to grow. During a recession, an economy is not operating at full capacity. Though an increase in the money supply provides additional resources, there may be minimal to no demand for additional capital as the economy grapples with stunted economic growth.

Q. Which of the following grants/grant direct credit assistance to rural households?

1. Regional Rural Banks
2. National Bank for Agriculture and Rural Development
3. Land Development Banks

Select the correct answer using below.

(a) 1 and 2 only
(c) 1 and 3 only
(b) 1 and 3 only
(d) 1, 2 and 3

Answer: (b) 1 and 3 only

Notes:

• Regional Rural Banks and Land development banks provide direct credit assistance to rural households in the form of loans etc.
• NABARD do not provide direct assistance. It “refinance” the assistance by other institutions.

Regional Rural Banks (RRBs)

• RRBs are government-owned scheduled commercial banks of India that operate at the regional level in different states of India.
• They serve the country’s rural areas and provide them with basic banking and other financial-related services.
• Origin:
  • The Narasimham Committee on Rural Credit (1975) recommended the establishment of Regional Rural Banks (RRBs).
  • The establishment of RRBs finds its route in the ordinance passed on 26th September 1975 and the RRB Act 1976. 
  • Prathama Grameen Bank was the first RRB bank and was established on 2nd October 1975.
• Functions:
  • To provide basic banking facilities to rural and semi-urban areas.
  • To effect some governmental functions, such as the disbursal of wages under the MGNREGA policy.
  • To provide other bank-related facilities such as locker facility, internet banking, mobile banking, debit and credit cards, etc.
  • Grant credit facilities to people in rural areas, such as small farmers, artisans, small entrepreneurs, etc.
  • To accept deposits from people.
• Regulation: Regional Rural Banks are regulated by RBI and supervised by the National Bank for Agriculture and Rural Development (NABARD).
• Ownership: RRBs are jointly owned by the Government of India (GOI), the Sponsor Bank and the concerned State Government with share proportions of 50%, 35% & 15%, respectively.
• Management: The Board of Directors manages these banks, overall affairs, which consists of one Chairman, three Directors as nominated by the Central Government, a maximum of two Directors as nominated by the concerned State Government, and a maximum of three Directors as nominated by the sponsor bank.

National Bank for Agriculture and Rural Development (NABARD)

• NABARD is a financial institution that was set up by the Indian government to promote sustainable agriculture and rural development in the country.
• The functions of NABARD include the propagation of technological innovations, financial and non-financial solutions, and institutional development.
• The government of India established NABARD under the outlines of the National Bank for Agriculture and Rural Development Act 1981.
• It refinances all the financial institutions that finance the rural development projects for Agriculture and Rural Development or NABARD as it is the specific bank for looking after all agriculture and rural developments in the country.

Land development bank

• A land development bank, abbreviated LDB, is a special kind of development bank in India. It is a quasi-commercial type that provides services such as accepting deposits, making business loans, and offering basic investment products.
• The main objective of the LDB is to promote the development of land, agriculture and increase the agricultural production.
• The LDB provides long-term finance to members directly through its branches.
• The sources of funds of land development banks can include:
  • Share capital from state or private sources
  • Deposits from members or non-members
  • Issue of debentures
  • Accepting deposits
  • Reimbursements of subsidies from the government
  • Other funds
• Land development banks provide long-term funds for various agriculture related projects besides development of land and business. The borrowing capacity of a member is generally determined according to the number of shares he holds in the bank.
  • The loans granted by land development bank is typically repayable within a 20 to 30-year period.
• Normally, loans are granted up to 50% of the value of the land or up to 30 times the revenue. Loans are granted only after a thorough verification of security title-deeds as well as the necessity for the loan.
• The rates of interest for LT loans are generally low and within the paying capacity of farmers. They are around 11 to 12%.

Q. Consider the following statements:

1. Inflation benefits the debtors.
2. Inflation benefits the bondholders.

Which of the statements given above is/are correct?

(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Answer: (a) 1 only

Notes:

• Inflation redistributes wealth from creditors to debtors i.e. lenders suffer and borrowers benefit out of inflation.
• Inflation brings benefit to borrowers (debtors) while the profit on the bonds gets eroded (higher the inflation lower the return on bonds through interest).
  • Since, Bondholders have lent money (to debtor) and received a bond in return. So he is a lender, he suffers (and Debtor benefits from inflation).

Q. Consider the following liquid assets:

1. Demand deposits with the banks
2. Time deposits with the banks
3. Savings deposits with the banks
4. Currency

The correct sequence of these assets in the decreasing order of liquidity is

(a) 1-4-3-2
(b) 4-3-2-1
(c) 2-3-1-4
(d) 4-1-3-2

Answer: (d) 4-1-3-2

Money Supply:

• The money supply is the total amount of currency and other liquid assets in a country’s economy on a given date. Cash and deposits that can be utilised almost as quickly as cash are included in the money supply. 
  • It needs to be noted that total stock of money is different from total supply of money.
  • Supply of money is only that part of total stock of money which is held by the public at a particular point of time.
• The circulating money involves the currency, printed notes, money in the deposit accounts and in the form of other liquid assets.
• Money supply is typically categorized into different measures or aggregates, each representing a different component of the overall money stock.
  • Different monetary aggregates, such as M0, M1, M2, M3, M4, and so on, are used to measure and express the money supply.
• RBI publishes figures for four alternative measures of money supply, viz. M1, M2, M3 and M4.
  • M1 = CU + DD
  • M2 = M1 + Savings deposits with Post Office savings banks
  • M3 = M1 + Net time deposits of commercial banks
  • M4 = M3 + Total deposits with Post Office savings organisations (excluding National Savings Certificates)
• CU is currency (notes plus coins) held by the public, and DD is net demand deposits held by commercial banks.
• The word ‘net’ implies that only deposits of the public held by the banks are to be included in money supply.
  • The interbank deposits, which a commercial bank holds in other commercial banks, are not to be regarded as part of money supply.
• M1 and M2 are known as narrow money. M3 and M4 are known as broad money.
• These gradations are in decreasing order of liquidity.
  • M1 is most liquid and easiest for transactions whereas M4 is least liquid of all.
  • M3 is the most commonly used measure of money supply. It is also known as aggregate monetary resources.
• India’s central bank, the Reserve Bank of India (RBI), employs various tools such as Open Market Operations, CRR, SLR, Repo Rate, Reverse Repo Rate, etc. to manage money supply.

Currency in Circulation

• Currency in circulation refers to cash or currency within a country that is physically used to conduct transactions between consumers and businesses.
  • Monetary authorities of central banks pay attention to the amount of physical currency in circulation because it represents one of the most liquid asset classes.
• Currency in Circulation includes notes in circulation, rupee coins and small coins.
• The RBI has the sole right to issue currency notes. The Government of India is the issuing authority of coins and supplies coins to the Reserve Bank on demand.

Q. The balance of payments of a country is a systematic record of

(a) All import and export transactions of a country during a given period of time, normally a year

(b) Goods exported from a country during a year

(c) Economic transaction between the government of one country to another

(d) Capital movements from one country to another

Answer: (a) All import and export transactions of a country during a given period of time, normally a year

Notes:

• Balance of Payments (BoP) is a record of transactions between people of a country and the rest of the world in commodities, services, and assets over a specific time period, generally a year.
• The current account and the capital account are the two primary accounts kept by BoP.

Q. The Reserve Bank of India regulates the commercial banks in matters of

1. Liquidity of assets
2. Branch expansion
3. Merger of banks
4. Winding-up of banks

Select the correct answer using the codes given below:

(a) 1 and 4 only
(b) 2, 3 and 4 only
(c) 1, 2 and 3 only
(d) 1, 2, 3 and 4

Answer: (d) 1, 2, 3 and 4

Notes:

• RBI is called the banker’s bank and regulates the banking sector in India.
• By using mechanisms like CRR, SLR etc, it keeps a check on liquidity of assets of the banks.
• Moreover, RBI also sets rules and regulations concerning merger of banks, their winding-up operations and branch expansion.

Functions of the RBI:

• Monetary Authority:
  • It implements and monitors the monetary policy and ensures price stability while keeping in mind the objective of growth.
  • An amendment to RBI Act, 1934, was made in May 2016, providing the statutory basis for the implementation of the flexible inflation targeting framework. 
  • Section 45ZB of the amended RBI Act, 1934, also provides for an empowered six-member Monetary Policy Committee (MPC) to be constituted by the Central Government by notification in the Official Gazette.
• Regulator and Supervisor of the Financial System:
  • Prescribes broad parameters of banking operations within which the country’s banking and financial system functions such as issuing licenses, branch expansion, liquidity of assets, amalgamation of banks etc.
  • Objective: maintain public confidence in the system, protect depositors’ interest and provide cost-effective banking services such as commercial banking, co-operative banking, to the public.
• Manager of Foreign Exchange:
  • Manages the Foreign Exchange reserves of India.
  • It facilitates external trade and payment and promotes orderly development and maintenance of foreign exchange market in India.
  • It also maintains external value of rupee.
• Issuer of Currency:
  • Issues and exchanges or destroys currency and coins not fit for circulation.
  • Objective: to give the public adequate quantity of supplies of currency notes and coins and in good quality.
• Developmental Role:
  • Performs a wide range of promotional functions to support national objectives such as making institutional arrangements for rural or agricultural finance.
  • Commercial banks lend loans to small-scale industrial units as per the directives (Priority Sector Lending) issued by the Reserve Bank of India time to time.
• Financial Inclusion:
  • The Reserve Bank has selected a bank led model for financial inclusion in India. RBI has undertaken a series of policy measures. Some of the important ones are:
    • No Frills Accounts – account either with nil or very low minimum balance as well as charges that would make such accounts accessible to vast sections of population.
    • Use of Technology – devices such as ATMs, hand held devices to identify user accounts through a card and biometric identifier, Deposit taking machines and Internet banking and Mobile banking facility to provide the banking services to all sections of society with more ease.
• Related Functions:
  • Banker to the Government: performs merchant banking function for the central and the state governments.
  • It is entrusted with central govt.’s money, remittances, exchange and manages its public debt as well.
  • Banker to banks: maintains banking accounts of all scheduled banks. It also acts as lender of last resorts by providing fund to banks.

Q. Which of the following constitute Capital Account?

1. Foreign Loans
2. Foreign Direct Investment
3. Private Remittances
4. Portfolio Investment

Select the correct answer using the codes given below.

(a) 1, 2 and 3
(b) 1, 2 and 4
(c) 2, 3 and 4
(d) 1, 3 and 4

Answer: (b) 1, 2 and 4

Capital Account:

• The capital account keeps track of capital inflows and outflows that have a direct impact on a country’s international assets and liabilities.
• All international trade transactions involving citizens of one country and citizens of other countries are covered.
• The capital account demonstrates how the ownership of a country’s assets and liabilities has changed over time.
• Foreign investment, such as FDI and FPI, immovable properties, intangible assets, trade credits, borrowings from other nations, banking capital, and changes in the foreign exchange reserve are all components of the capital account.
• The capital account also includes NRI deposits, SDRs, and funds held in foreign nations, among other things.
• The capital account is used to finance current account deficits and to absorb current account surpluses.
• Because the capital account deals with financial transfers, it has no direct impact on the nation’s output, revenue, or employment.
• A surplus in the capital account shows that money is flowing into the country, whereas a deficit suggests that money is flowing out.

Balance on the Capital Account

• The net value of all the credits and debits gives the balance on the capital account.
• When the credit items are more than the debit items, it leads to a capital account surplus and indicates the net inflow of capital in the country.
• When the debit items are more than the credit items then it leads to a deficit in the capital account which indicates the net outflow of capital from the country.
• India generally is on a Capital Account Surplus as it attracts a huge share of foreign investments into the country.

Components of Capital Account

• Foreign direct investment (FDI)
  • When foreign citizens purchase Indian capital assets such as firms, industrial complexes, machines, and so on, the capital account is credited. The capital account shows a debit for FDI investments made by Indians in foreign nations.
• Foreign portfolio investment (FPI)
  • When foreign residents buy stocks, government bonds, corporate bonds, and other securities, these purchases are recorded as a credit to the capital account. The purchase of securities and bonds by Indian residents in foreign nations is recorded as a debit in the capital account.
• External Commercial Borrowings
  • It involves financial transactions involving private sector organizations or individuals, as well as the government, borrowing money from foreign countries.
  • The receipts from outside the country, such as loan repayments from foreign citizens, are recorded as a credit in the capital account.
  • The capital account shows a debit for financial transactions involving lending to foreign countries by private sector companies, people, and the government, as well as the repayment of loans acquired from foreign countries.
• Foreign Investments
  • Foreign investments in Indian firms, government bonds, real estate, and other assets are recorded as a credit in the capital account since they result in a foreign exchange inflow.
  • Investments made by Indian citizens in foreign stocks and shares, government bonds, and real estate, among other things, are recorded as a debit in the capital account since they result in a foreign exchange outflow.
• Foreign Exchange Reserves
  • The foreign exchange reserves of a country are the financial assets held by the central bank (in India, the Reserve Bank of India).
  • In the Balance of Payments, these reserves act as a financing component.
  • Any withdrawal from the foreign exchange reserves is represented as a credit in the capital account, while any addition to the reserves is shown as a debit.
  • The BOP account shows the fluctuations in foreign exchange reserves, not the actual foreign exchange reserves.
• External Assistance
  • Borrowings as External Assistance refers to borrowing by a country for the purpose of assisting another country. It has a lower interest rate than what is available on the open market.
  • India receives external assistance from various multilateral agencies such as the World Bank Group, Asian Development Bank, European Investment Bank, New Development Bank, etc.

Q. In the context of Indian economy, ‘Open Market Operations’ refers to

(a) borrowing by scheduled banks from the RBI

(b) lending by commercial banks to industry and trade

(c) purchase and sale of government securities by the RBI

(d) None of the above

Answer: (c) purchase and sale of government securities by the RBI

Open Market Operations:

• Open Market Operations (OMOs) are market operations conducted by RBI by way of sale/ purchase of government securities to/from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis.
• If there is excess liquidity, RBI resorts to sale of securities and sucks out the rupee liquidity.
• Similarly, when the liquidity conditions are tight, RBI buys securities from the market, thereby releasing liquidity into the market.
• It is one of the quantitative (to regulate or control the total volume of money) monetary policy tools which is employed by the central bank of a country to control the money supply in the economy.

Operation Twist:

• The simultaneous buying and selling of Government securities through Open Market Operations of nearly Rs.10000 crores each is called Operation Twist.
• In this mechanism, the RBI sold the short term G-secs and bought long term G-secs from the market.
• This will increase the price of long term G-secs in the market due to its demand and reduce its yield.

Q. The national income of a country for a given period is equal to the

(a) total value of goods and services produced by the nationals

(b) sum of total expenditure

(c) sum of personal income of all individuals

(d) money value of final goods and services produced

Answer: (d) money value of final goods and services produced

Notes:

• It refers to the aggregate value of all the final goods and services produced in a country in a particular period of time (usually one financial year).
• National Income = C + I + G + (X – M)
  • Where,
    • C = Total Consumption Expenditure
    • I = Total Investment Expenditure
    • G = Total Government Expenditure
    • X = Export, M = Import
• It can be measured by Gross National Product (GNP), Gross Domestic Product (GDP), Gross National Income (GNI), Net National Product (NNP), Net National Income (NNI) and Per-Capita Income (PCI).
• National income= NNP _{@Market price} – indirect tax + subsidies.
  • NNP _{@Market price} = GNP – Depreciation
  • GNP=GDP + Net factor income from abroad.
• It should be noted that national income is not the sum of all incomes earned by all citizens, but only those incomes which accrue due to participation in the production process.
  • Individuals participate in the production process by supplying factors of production which they possess.

Q. To obtain full benefits of demographic dividend, what should India do?

(a) Promoting skill development

(b) Introducing more social security schemes

(c) Reducing infant mortality rate

(d) Privatization of higher education

Answer: (a) Promoting skill development

Notes:

• Promoting Skill Development will help India reap its benefits because a skilled younger population will help in creating employment as well as become employable ultimately increasing the rate of India’s Economic growth.

Demographic Dividend

• According to United Nations Population Fund (UNFPA), demographic dividend means, “the economic growth potential that can result from shifts in a population’s age structure, mainly when the share of the working-age population (15 to 64) is larger than the non-working-age share of the population (14 and younger, and 65 and older)”.
• With fewer births each year, a country’s working-age population grows larger relative to the young dependent population. With more people in the labor force and fewer children to support, a country has a window of opportunity for economic growth if the right social and economic investments and policies are made in health, education, governance, and the economy.

Demographic Dividend in India

• India has one of the youngest populations in an aging world. By 2020, the median age in India will be just 28, compared to 37 in China and the US, 45 in Western Europe, and 49 in Japan.
• Since 2018, India’s working-age population (people between 15 and 64 years of age) has grown larger than the dependant population — children aged 14 or below as well as people above 65 years of age. This bulge in the working-age population is going to last till 2055, or 37 years from its beginning.
• This transition happens largely because of a decrease in the total fertility rate (TFR, which is the number of births per woman) after the increase in life expectancy gets stabilised.
• A study on demographic dividend in India by United Nations Population Fund (UNFPA) throws up two interesting facts.
  • The window of demographic dividend opportunity in India is available for five decades from 2005-06 to 2055-56, longer than any other country in the world.
  • This demographic dividend window is available at different times in different states because of differential behaviour of the population parameters.

Advantages Associated with Demographic Dividend

• Better economic growth brought about by increased economic activities due to higher working age population and lower dependent population. It will be channelised in following ways:
  • Increased Labour Force that enhances the productivity of the economy.
  • Increased fiscal space created by the demographic dividend to divert resources from spending on children to investing in physical and human infrastructure.
  • Rise in women’s workforce that naturally accompanies a decline in fertility, and which can be a new source of growth.
  • Increase in savings rate, as the working age also happens to be the prime period for saving.
  • A massive shift towards a middle-class society, that is, the rise of aspirational class.
• Demographic dividend has historically contributed up to 15 % of the overall growth in advanced economies.
  • Japan was among the first major economies to experience rapid growth because of changing population structure.
  • The country’s demographic-dividend phase lasted from 1964 to 2004.
• Rapid industrialisation and urbanisation because of higher number of employment seeking population that would force higher economic activities.
• Rise in workforce: With more than 65% of working age population, India will rise as an economic superpower, supplying more than half of Asia’s potential workforce over the coming decades.
• Effective policy making: Fine-tuning the planning and implementation of schemes and programmes by factoring in population dynamics is likely to yield greater socio-economic impact and larger benefits for people.

Challenges Associated with Demographic Dividend

• Asymmetric demography: The growth in the working-age ratio is likely to be concentrated in some of India’s poorest states and the demographic dividend will be fully realized only if India is able to create gainful employment opportunities for this working-age population.
• Lack of skills: Most of the new jobs that will be created in the future will be highly skilled and lack of skill in Indian workforce is a major challenge. India may not be able to take advantage of the opportunities, due to a low human capital base and lack of skills.
• Low human development parameters: India ranks 130 out of 189 countries in UNDP’s Human Development Index, which is alarming.Therefore, health and education parameters need to be improved substantially to make the Indian workforce efficient and skilled.
• Informal nature of economy in India is another hurdle in reaping the benefits of demographic transition in India.
• Jobless growth- There is mounting concern that future growth could turn out to be jobless due to de-industrialization, de-globalization, the fourth industrial revolution and technological progress. As per the NSSO Periodic Labour Force Survey 2017-18, India’s labour force participation rate for the age-group 15-59 years is around 53%, that is, around half of the working age population is jobless.

What needs to be done?

• Building human capital: Investing in people through healthcare, quality education, jobs and skills helps build human capital, which is key to supporting economic growth, ending extreme poverty, and creating a more inclusive society.
  • Skill development to increase employability of young population. India’s labour force needs to be empowered with the right skills for the modern economy. Government has established the National Skill Development Corporation (NSDC) with the overall target of skilling/ up skilling 500 million people in India by 2022..
  • Education: Enhancing educational levels by properly investing in primary, secondary and higher education. India, which has almost 41% of population below the age of 20 years, can reap the demographic dividend only if with a better education system. Also, academic-industry collaboration is necessary to synchronise modern industry demands and learning levels in academics.
    • Establishment of Higher Education Finance Agency (HEFA) is a welcome step in this direction.
  • Health: Improvement in healthcare infrastructure would ensure higher number of productive days for young labourforce, thus increasing the productivity of the economy.
    • Success of schemes like Ayushman Bharat and National Health Protection scheme (NHPS) is necessary. Also nutrition level in women and children needs special care with effective implementation of Integrated Child Development (ICDS) programme.
  • Job Creation: The nation needs to create ten million jobs per year to absorb the addition of young people into the workforce. Promoting businesses’ interests and entrepreneurship would help in job creation to provide employment to the large labourforce.
    • India’s improved ranking in the World Bank’s Ease of Doing Business Index is a good sign.
    • Schemes like Start-up India and Make in India , if implemented properly, would bring the desired result in the near future.
• Urbanisation: The large young and working population in the years to come will migrate to urban areas within their own and other States, leading to rapid and large-scale increase in urban population. How these migrating people can have access to basic amenities, health and social services in urban areas need to be the focus of urban policy planning.
  • Schemes such as Smart City Mission and AMRUT needs to be effectively and carefully implemented.

Q. Economic growth in country X will occur if

(a) there is technical progress in the world economy

(b) there is population growth in X

(c) there is capital formation in X

(d) the volume of trade grows in the world economy

Answer: (c) there is capital formation in X

Notes:

• Capital formation (investment) brings additional income/production in the economy which enhances growth.
• The capital formation in any country boosts its development as investment activities increases resulting in high production, increase in per-capita income, employment generation, the standard of living, poverty reduction, etc.
• The increase in population has both pros and cons for the economy. If the population is skilled then it will generate more output for the economy. But in case if the economy itself is not in a position to stand still then in such case it will prove a burden to the country.
• Technical progress refers to the introduction of new and improved technologies for the production of goods and services. Despite having their advantages, when these technologies enter the market it requires a heavy investment in training workers and sometimes these technologies replace human beings resulting in unemployment.
• The volume of trade may be favourable or non- favourable depending upon the overall trade surplus or deficit.

Economic Growth

• Economic growth is an increase in the production of economic goods and services, compared from one period of time to another.
• It can be measured in nominal or real (adjusted for inflation) terms.
• Traditionally, aggregate economic growth is measured in terms of gross national product (GNP) or gross domestic product (GDP), although alternative metrics are sometimes used.

Ways to generate economic growth:

• The first is an increase in the amount of physical capital goods in the economy.
  • Newer, better, and more tools mean that workers can produce more output per time period.
• The second method of producing economic growth is technological improvement.
  • Improved technology allows workers to produce more output with the same stock of capital goods, by combining them in novel ways that are more productive.
  • Example: The invention and use of Petroleum became a better and more productive method of transporting goods in process and distributing final goods more efficiently.
• The third way to generate economic growth is to grow the labour force.
  • All else equal, more workers generate more economic goods and services.
• The last method is increases in human capital.
  • This means labourers become more skilled at their crafts, raising their productivity through skills training, trial and error, or simply more practice. Savings, investment, and specialization are the most consistent and easily controlled methods.

Economic Development

• Economic development is defined as a sustained improvement in material wellbeing of society.
• Economic development is a wider concept than economic growth.
  • Apart from growth of national income, it includes changes – social, cultural, political as well as economic which contribute to material progress.
  • It contains changes in resource supplies, in the rate of capital formation, in size and composition of population, in technology, skills and efficiency, in institutional and organizational set-up. These changes fulfil the wider objectives of ensuring more equitable income distribution, greater employment and poverty alleviation.
• In short, economic development is a process consisting of a long chain of interrelated changes in fundamental factors of supply and in the structure of demand, leading to a rise in the net national product of a country in the long run.
• On the whole, the economic growth is a narrow term.
  • It involves increase in output in quantitative terms but economic development includes changes in qualitative terms such as social attitudes and customs along with quantitative growth of output or national income.
  • But, Economic development without growth is almost inconceivable.

Differences between Economic Growth and Economic Development

Parameter	Economic Growth	Economic Development
Concept	It is the positive change in the indicators of economy.	It is the quantitative and qualitative change in an economy.
Factors	Growth relates to a gradual increase in one of the components of Gross Domestic Product: consumption, government spending, investment, netExports.	Development relates to growth of human capital, decrease in inequality figures, and structural changes that improve the quality of life of the population.
Impact	It refers to the increment in amount of goods and services produced by an economy.	It refers to the reduction and elimination of poverty, unemployment and inequality with the context of growing economy.
Focus	This focuses on production of goods and services.	This focuses on distribution of resources.
Measurement	Economic Growth is measured by quantitative factors such as increase in real GDP or per capita income.	The qualitative measures such as HDI (Human Development Index), gender- related index, Human poverty index (HPI), infant mortality, literacy rate etc. are used to measure economic development.
Relevance	It reflects the growth of national or per capita income	It reflects progress in the quality of life in a country.
Time Frame	It is for short term/short period. It is measured in certain time frame/period.	It is a continuous and long-term process. Economic development does not have specific time period to measure.
Interaction	Economic growth is an automatic process that may or may not require intervention from the government	Economic development requires intervention from the government as all the developmental policies are formed by the government
Expectations	It is not concerned with happiness of public life	It is concerned with happiness of public life.
Application	Economic growth is more relevant metric for assessing progress in developed countries.	More relevant to measure progress and quality of life in developing countries.