UNIT 3

ECONOMIC ENVIRONMENT
Meaning
The economic environment refers to the external factors and conditions that influence the
economic decisions and activities of individuals, businesses, and governments within the
economy. This includes factors such as economic policies, interest rates, inflation, and
international trade agreements, laws and regulations, as well as broader macroeconomic
trends such as economic growth and development.
Economic environment
Understanding the economic environment is important for making informed decisions in
areas such as business strategy, investment, and public policy. Some of the few facts related
to it are stated below.
 The economic environment is the sum total of all factors that affect the economy. It
includes both macro and microeconomic factors.
 The former includes such factors as inflation, interest rates, and GDP growth.
 Macroeconomic factors include consumer spending, business investment, and
employment levels.
The economic system acts as the basis for determining the degree of private business. There
are several types of economic system followed across nations. Some nations have free market
economies or capitalist economies whereas some have centrally planned economy or socialist
economy. There are also some countries which follow the mixed economy, i.e., carrying
characteristics of both capitalist and socialist economies.
1. ELEMENTS OF ECONOMIC ENVIRONMENT (MACROECONOMIC
FACTORS)
I. Gross Domestic Product (GDP)
Gross domestic product (GDP) is the total output of economic activity in a country within a
certain period of time (usually one year).
GDP includes all investments made into business ventures, consumer spending and
government spending. GDP can be used as a tool to measure how a country's economy is
doing. If GDP is increasing, it can mean that a country's economy is growing.
II. Exchange Rates
 An exchange rate is a rate at which one currency can be exchanged for another.
 Exchange rates are constantly changing and they determine how much of one
currency has to be given up to receive a certain amount of another currency.
Eg: Currently, with 1 Dollar you can currently buy Rupees 80.
III. Taxation
There are two types of taxes to consider.
 Direct taxes are taxes on income, wealth and profit.
Income taxes are taxes people have to pay on their income made from working (salary),
owning assets or trading. Corporate taxes are taxes companies have to pay on their profits.
 Indirect taxes are taxes levied on spending.
This includes VAT, which is a standard rate charged on most purchases.
IV. Inflation
Inflation is the continual increase in average prices in the economy.
During inflation, the purchasing power of money decreases. A rise in price levels - or
inflation - means that a unit of a currency (ie £ 1) will buy you less than it did previously.
V. Fiscal Policy
Fiscal policy is a type of government policy that impacts taxation and government spending.
It can either be expansionary with the aim of increasing economic activity by increasing
government spending and/or decreasing taxation. Fiscal policy can also be contractionary,
which aims to decrease economic activity by increasing taxation and/or decreasing
government spending.
VI. Monetary Policy
Monetary policy involves changing the supply of money in an economy.
Monetary policy involves adjusting interest rates, manipulating exchange rates, and
controlling the money supply. The purpose of monetary policy is to keep inflation rates stable
and low to promote economic growth.
2. EFFECTS OF ECONOMIC ENVIRONMENT ON BUSINESSES
Gross Domestic Product and Decision-Making
 GDP can be used as a tool to let investors know whether the economy is growing or
decreasing. If economic prospects are positive (economy growing), it could signal to
investors that it is a good time to invest in businesses, encouraging investment.
 Economic growth can also mean that consumers are spending more on average, which
increases businesses' profits. This could be a good time for businesses to invest in
expansion and growth, as their profits are high and investors are more likely to invest
during favorable economic conditions.
 However, the opposite may also hold true. If GDP is decreasing, the economy might
be contracting. Consumers are spending less, resulting in low business profitability.
During an economic recession, investment is also likely to decrease.
Exchange Rates and International Markets
Exchange rates are an important factor for international markets.
If your business is operating in the UK, your main source of income will most likely be in
GBP (£). If you are looking to expand to a foreign country, ie Germany, it is more favorable
for you to do so when you can exchange £1 for a high rate of EUR.
It would be more profitable for you to invest when the EUR is valued lower than GBP, as you
get more for your investment - it is cheaper for you to invest abroad. However, if you were
looking for foreign investment, it may be more likely that the German company would invest
in your company when the GBP is valued lower than usual.
Taxation's Impact on Businesses
 Direct taxation can influence business decisions significantly. The level of influence,
however, is dependent on the type of business you operate. As mentioned earlier,
income taxes are part of direct taxation. Changes in the rate of income taxes impact
consumer spending.
 If there was an increase in taxation rates for income, consumers will most likely spend
less, as their disposable income decreases. This is especially prominent for businesses
operating in the luxury industry (ex. luxury holidays or designer goods).
 Businesses manufacturing necessities and food products are less likely to be impacted
by higher direct taxation.
 Indirect taxation can also influence business decisions. An increase in VAT will
decrease consumer spending, as consumers now have to pay higher prices when
purchasing goods and services. Again, certain industries will be affected more than
others, depending on the price elasticity of demand for the product. For example,
consumers will continue purchasing basic necessities even if their prices increase.
Effects of Inflation
Inflation will also impact business decision making. In markets where inflation is increasing,
consumers spend less, as their purchasing power decreases. This will lead to lower profits for
certain businesses.
Impacts of Fiscal Policy
When expansionary fiscal policy is implemented (lower taxes, higher government spending),
consumers will likely demand more goods and services - spend more. This can increase the
profitability of a business and encourage growth or expansion.
When contractionary fiscal policy is implemented, consumers demand less and therefore
spend less on products and services. A contractionary policy may also increase
unemployment. When consumers spend less, certain businesses are once again, more heavily
impacted than others.
Impacts of Monetary Policy
 Monetary policy can impact firms in different ways mainly due to changes in interest
rates. Not all businesses are affected equally.
 Small businesses that portray a high rate of borrowing, and have access to less
financial reserves, will be impacted by high interest rates significantly.
 Sometimes high interest rates can also lead smaller firms to bankruptcy. Larger
businesses that do not rely on borrowing as much as small firms, and have access to a
larger financial reserve, will be less impacted by high interest rates.
 3. GDP
 Gross domestic product (GDP) is the total monetary or market value of all the
finished goods and services produced within a country’s borders in a specific time
period. As a broad measure of overall domestic production, it functions as a
comprehensive scorecard of a given country’s economic health.
 Though GDP is typically calculated on an annual basis, it is sometimes calculated on
a quarterly basis as well.
 The calculation of a country’s GDP encompasses all private and public consumption,
government outlays, investments, additions to private inventories, paid-in
construction costs, and the foreign balance of trade. Exports are added to the value
and imports are subtracted.
 Of all the components that make up a country’s GDP, the foreign balance of trade is
especially important.
 The GDP of a country tends to increase when the total value of goods and services
that domestic producers sell to foreign countries exceeds the total value of foreign
goods and services that domestic consumers buy. When this situation occurs, a
country is said to have a trade surplus.
Types of Gross Domestic Product
Nominal GDP
 Nominal GDP is an assessment of economic production in an economy that includes
current prices in its calculation. In other words, it doesn’t strip out inflation or the
pace of rising prices, which can inflate the growth figure.
 Nominal GDP is used when comparing different quarters of output within the same
year. When comparing the GDP of two or more years, real GDP is used. This is
because, in effect, the removal of the influence of inflation allows the comparison of
the different years to focus solely on volume.
Real GDP
 Real GDP is an inflation-adjusted measure that reflects the number of goods and
services produced by an economy in a given year, with prices held constant from year
to year to separate out the impact of inflation or deflation from the trend in output
over time. Since GDP is based on the monetary value of goods and services, it is
subject to inflation.
 Rising prices tend to increase a country’s GDP, but this does not necessarily reflect
any change in the quantity or quality of goods and services produced. Thus, by
looking just at an economy’s nominal GDP, it can be difficult to tell whether the
figure has risen because of a real expansion in production or simply because prices
rose.
 Economists use a process that adjusts for inflation to arrive at an economy’s real GDP.
By adjusting the output in any given year for the price levels that prevailed in a
reference year, called the base year, economists can adjust for inflation’s impact. This
way, it is possible to compare a country’s GDP from one year to another and see if
there is any real growth.
  Real GDP is calculated using a GDP price deflator, which is the difference in prices
between the current year and the base year. For example, if prices rose by 5% since
the base year, then the deflator would be 1.05. Nominal GDP is divided by this
deflator, yielding real GDP. Nominal GDP is usually higher than real GDP because
inflation is typically a positive number.
 Real GDP accounts for changes in market value and thus narrows the difference
between output figures from year to year. If there is a large discrepancy between a
nation’s real GDP and nominal GDP, this may be an indicator of significant inflation
or deflation in its economy.
GDP Per Capita
 GDP per capita is a measurement of the GDP per person in a country’s population. It
indicates that the amount of output or income per person in an economy can indicate
average productivity or average living standards. GDP per capita can be stated in
nominal, real (inflation-adjusted), or purchasing power parity (PPP) terms.
 At a basic interpretation, per-capita GDP shows how much economic production
value can be attributed to each individual citizen. This also translates to a measure of
overall national wealth since GDP market value per person also readily serves as a
prosperity measure.
 Per-capita GDP is often analyzed alongside more traditional measures of GDP.
Economists use this metric for insight into their own country’s domestic productivity
and the productivity of other countries. Per-capita GDP considers both a country’s
GDP and its population. Therefore, it can be important to understand how each factor
contributes to the overall result and is affecting per-capita GDP growth.
 If a country’s per-capita GDP is growing with a stable population level, for example,
it could be the result of technological progressions that are producing more with the
same population level. Some countries may have a high per-capita GDP but a small
population, which usually means they have built up a self-sufficient economy based
on an abundance of special resources.
GDP Growth Rate
 The GDP growth rate compares the year-over-year (or quarterly) change in a
country’s economic output to measure how fast an economy is growing. Usually
expressed as a percentage rate, this measure is popular for economic policymakers
because GDP growth is thought to be closely connected to key policy targets such as
inflation and unemployment rates.
 If GDP growth rates accelerate, it may be a signal that the economy is overheating
and the central bank may seek to raise interest rates. Conversely, central banks see a
shrinking (or negative) GDP growth rate (i.e., a recession) as a signal that rates should
be lowered and that stimulus may be necessary.
GDP Formula
GDP can be determined via three primary methods. All three methods should yield the same
figure when correctly calculated. These three approaches are often termed the expenditure
approach, the output (or production) approach, and the income approach.

I. The Expenditure Approach

The expenditure approach, also known as the spending approach, calculates spending by the
different groups that participate in the economy. The U.S. GDP is primarily measured based
on the expenditure approach. This approach can be calculated using the following formula:
GDP=C+G+I+NX
C=Consumption
G=Government spending
I=Investment
NX=Net exports
GDP=C+G+I+NX
C=Consumption
G=Government spending
I=Investment
NX=Net exports
All of these activities contribute to the GDP of a country. Consumption refers to private
consumption expenditures or consumer spending. Consumers spend money to acquire goods
and services, such as groceries and haircuts.
Consumer confidence, therefore, has a very significant bearing on economic growth. A high
confidence level indicates that consumers are willing to spend, while a low confidence level
reflects uncertainty about the future and an unwillingness to spend.
Government spending represents government consumption expenditure and gross investment.
Governments spend money on equipment, infrastructure, and payroll. Government spending
may become more important relative to other components of a country’s GDP when
consumer spending and business investment both decline sharply. (This may occur in the
wake of a recession, for example.)
Investment refers to private domestic investment or capital expenditures. Businesses spend
money to invest in their business activities. For example, a business may buy machinery.
Business investment is a critical component of GDP since it increases the productive capacity
of an economy and boosts employment levels.
The net exports formula subtracts total exports from total imports (NX = Exports - Imports).
The goods and services that an economy makes that are exported to other countries, less the
imports that are purchased by domestic consumers, represent a country’s net exports. All
expenditures by companies located in a given country, even if they are foreign companies, are
included in this calculation.

II. The Production (Output) Approach

The production approach is essentially the reverse of the expenditure approach. Instead of
measuring the input costs that contribute to economic activity, the production approach
estimates the total value of economic output and deducts the cost of intermediate goods that
are consumed in the process (like those of materials and services). Whereas the expenditure
approach projects forward from costs, the production approach looks backward from the
vantage point of a state of completed economic activity.
III. The Income Approach
The income approach represents a kind of middle ground between the two other approaches
to calculating GDP. The income approach calculates the income earned by all the factors of
production in an economy, including the wages paid to labor, the rent earned by land, the
return on capital in the form of interest, and corporate profits.
The income approach factors in some adjustments for those items that are not considered
payments made to factors of production. For one, there are some taxes, such as sales taxes
and property taxes, that are classified as indirect business taxes.
In addition, depreciation, which is a reserve that businesses set aside to account for the
replacement of equipment that tends to wear down with use, is also added to the national
income. All of this together constitutes a nation’s income.
4. POPULATION GROWTH
 Population Growth can be defined as the increase in the number of people in a given
area. Population growth can be measured in a neighborhood, country, or even global
level.
 Population growth is the increase in the number of people in a given area.
 Census is the official count of the population in the country

Thomas Malthus famously had a theory on the dangers of exponential population growth.
Malthus believed that population growth was always exponential and food production was not
— leading to humans being unable to survive and eventually causing population growth to
slow down. This theory was proven incorrect since technology has played a large role in
increasing production for an increasing population.

Population Growth Types

Let's go over the different population growth types. There are two different types of
population growth: exponential and logistic.
Exponential
Exponential growth rate is growth that increases rapidly with passing time. In a graph,
exponential growth increases upward and has a "J" shape. Let's take a look at a graph:
The graph above shows us what exponential growth looks like over time. Population size
increases by a larger amount with each passing year. The result is a "J" shaped curve with a
rapidly increasing population growth rate.
Logistic
Logistic growth rate is growth that slows down with passing time. In a graph, logistic growth
rate increases and then flattens out, resulting in an "S" shaped curve. Let's take a look at a
graph below:

The graph above shows us what logistic growth looks like over time. Population growth
initially increases, then levels out after a certain point in time. The result is an "S" shaped
curve and a slower population growth rate.
Population Growth's Economic Effects:
Population growth and economic growth are closely related to one another. For example,
productivity is an important factor in economic growth. How might productivity be important
to population growth?
A greater population means that there is a larger workforce. A larger workforce means that
there is potential for higher productivity to produce more goods — this results in greater
output (GDP)! Not only is there a greater supply of workers, but there is also a greater
demand for goods and services as well. Greater demand and supply will lead to an increase in
overall economic growth.
The opposite can also be true. A greater population may not result in a larger workforce. The
problem? There are more people demanding more goods without the proper supply of them
— the low supply is due to the low workforce. As opposed to our previous example, this is
not good for economic growth and can lead to many problems due to scarcity.
Positive Effects
Greater population growth can result in economic growth. More people in a country means
that there is more access to labor; more access to labor results in more goods being produced
and demanded — resulting in economic growth! More people in a country will also result in
higher tax revenues for the government. The government can use the increased tax revenue
on building infrastructure or improving welfare programs. Lastly, a higher population
increases the probability of innovation in the free market.
Population growth's positive economic effects are clear — more people can yield more
output, tax revenue, and innovation in the market. With these outcomes, why wouldn't a
country push for high population growth?
Negative Effects
Greater population growth may exacerbate the problem of resource scarcity. If a country is
barely providing resources to its current population, what will happen if there is an
exponential growth in population? People will not be able to access resources since there will
be too many people demanding too few resources. Population growth can also put pressure
on certain areas where people migrate to, such as cities. Cities tend to have more people
living in them as opposed to rural areas; as such, cities can become overburdened with too
many people living in them. Traffic congestion and pollution are often problems in these
areas.
5. URBANIZATION
Meaning
Urbanization refers to the increasing shift in the number of people living in urban areas and a
decrease in those living in rural areas.
Causes of urbanization
Push Factors Pull Factors
Poverty or a bad A higher number of employment opportunities
economy and better-paying work
Loss of land Easier access to higher-quality education
Natural disasters Easier access to healthcare
War and conflict The perception that city life offers a better
quality of life

 Modernization theorists argue in favor of urbanization. From their perspective, the

effects of urbanization in developing countries are that they help shift cultural values
and promote economic development.
  Dependency theorists argue that when current conditions in urban areas are taken into
account, urbanization is a continuation of colonialism. They argue, amongst other
things, that urbanization hinders development and creates growing social inequality.
 Living conditions for the poor in urban areas are often worse compared to those living
in rural areas.
Significance of Urbanization
 Some of the beneficial effects of urbanization include job development, technical and
infrastructure improvements, better transportation and communication, educational
and medical facilities, and higher living standards.
 Urban living is linked with higher levels of literacy and education, better health,
longer life expectancy, greater access to social services, and enhanced opportunities
for cultural and political participation.
 Urbanization and economic growth are strongly related in terms of industrialization,
employment generation, and increase in productivity.
Advantages of Urbanization
Urbanization concentrates the labor force
'Concentrate', in this sense, means that large numbers of the workforce move to and reside in
the same area (often big cities). This, in turn, allows for:
Industrial development, along with an increased number of jobs
Increases in tax revenues for local governments, enabling more efficient public services and
more effective improvements to infrastructure as reach is increased
Urbanization promotes ‘modern’, Western cultural ideas
Modernization theorists like Bert Hoselitz (1953) argue that urbanization occurs in cities
where individuals learn to accept change and aspire to accumulate wealth. Put plainly, the
increase in economic and social opportunities experienced in cities promotes the spread of
Western, capitalist ideals.
For proponents of modernization theory like Hoselitz and Rostow, the decline of 'traditional'
beliefs and their replacement with 'modern' ideas is at the core of accelerating development
within a country. This is because these all limit or prevent a universal and equal promise of
growth and reward, spurred on by individual competition.
Examples of 'traditional' ideas that they see as detrimental include: patriarchal systems,
collectivism, and ascribed status.
However, the impacts of urbanization in developing countries have not been as beneficial as
modernization theorists believe. To outline some of the problems of urbanization in
developing countries, we shall turn to the perspective of dependency theory.
Drawbacks of urbanization
Dwelling crisis: There is a continuous scarcity of housing as the number of people living in
metropolitan areas grows.
Overcrowding: Overcrowding, urban congestion is a constant, and it is an element that is
growing day by day as more people and immigrants migrate to cities and towns in quest of a
better living.
Unemployment: Lack of highly skilled jobs is most prevalent in metropolitan areas,
especially among educated individuals.
Slums: Industrialization is fast-paced but there is a shortage of developed land for housing.
The increasing migration of rural immigrants to the city, and the inflated prices of land
beyond the urban poor contribute to the rise of slums and squatters in metropolitan areas.
Sewage infrastructure: In most metropolitan areas, insufficient sewage infrastructure is
observed concerning the rapid population growth.
Health crisis: Communicable illnesses like typhoid, dysentery, plague, and diarrhea
eventually can spread rapidly. The COVID-19 pandemic is a live example of how
overpopulated cities and medical facilities collapse under the weight of a pandemic.
Pollution: The need for transportation increases with the increase in population, resulting in
traffic congestion and pollution.
Urban Heat Islands (UHI): These are significantly warmer urban areas than their surrounding
rural areas due to human activities. Urban Heat Island is a major problem associated with
rapid urbanization.
Crime rates: Shortage of resources, overcrowding, higher poverty rates, unemployment, and
a loss of social services and education lead to social issues such as violence, drug misuse, and
crime.
6. FISCAL DEFECIT
Meaning
When the government spends more than its total income, such a situation is called a fiscal
deficit. It is calculated by subtracting the total income from the total expenditure and is either
expressed in absolute terms or as a percentage of the GDP (Gross Domestic Product).
 Every time the government borrows money for spending beyond its earning, it is
covering up the shortfall in the income compared with its spending. This shortfall or
gap between the two is called the fiscal deficit.
 It can occur due to a major rise in the capital expenditure required for creating long
term assets or providing financial assistance to poor farmers, labors and other
vulnerable sections of the society. The government finances these deficits by
borrowing money from the capital markets. They can do this by issuing bonds or from
the central bank.
  A high fiscal deficit every year hints that the government has been spending beyond
its means. Economists need to keep an eye on the fiscal deficits to determine how
much the government is exceeding its income.
 Components that make up the total income of the government in the form of revenue
receipts and non-tax revenues.
 Components of revenue receipts a. Income tax b. GST and taxes of Union territories
c. Custom duties d. Union excise duties e. Corporation tax.
 Sources of non-tax revenues a. Interest received through loan recovery b. Receipts of
union territories c. Dividends and profits d. External grants e. Other non-tax revenues
 The income generated from all these sources is then spent on capital expenditure,
revenue expenditure, payment of interest and grants-in-aid (for creating capital assets)
by the government and is termed as total expenditure.
Components of Fiscal Deficit
The fiscal deficit is composed of two components, namely income and expenditure. The
components are discussed in brief in the following lines:
Components of total income of the government
These consist of two variables, which are revenue generated from various taxes such as GST,
taxes from union territories, custom duties, corporation tax, etc. They are collected by the
centre and the non-tax revenues that consist of dividends and profits, interest receipts, and
other non-tax revenues.
Components of expenditure
The government expenditure consists of capital expenditure and revenue expenditure such as
salary and pension payments, grants for creation of capital assets, infrastructure, healthcare,
and interest payments.
Fiscal deficit is calculated as a percentage of the GDP
Calculating Fiscal Deficit
Fiscal Deficit = Total Expenditure (Revenue Expenditure + Capital Expenditure) –
(Revenue Receipts + Recoveries of Loans + Other Capital Receipts (all Revenue
and Capital Receipts except loans taken)

Gross Fiscal Deficit (GFD) of the government is the surplus of its total expenditure, current
and capital, as well as loans net of recovery, above revenue receipts (including external
grants) and non-debt capital receipts.
A fiscal deficit happens because of events like a major increase in capital expenditure or due
to revenue deficit.
Capital expenditure is incurred to create long-term assets like buildings, factories,
infrastructure development, etc.
Fiscal deficit serves as an indicator of how well the government is managing its finances.
A recurring high fiscal deficit implies that the government has been spending beyond its
means.
However, the fiscal deficit is seen in almost every economy while the fiscal surplus is quite
rare. The high fiscal deficit is not always a negative thing if the amount is utilised for
constructing roads, airports, infrastructure, etc. since these will generate revenue in the long
run.
Fiscal Consolidation refers to the policies undertaken by governments (national and sub-
national levels) to reduce their deficits and accumulation of debt stock. Read all about fiscal
consolidation in the linked article.
Fiscal deficit can be calculated by finding the difference between the total income and the
total expenditure done by the government. The total income of the government is calculated
by including taxes, non-debt capital receipts and other forms of revenue except borrowings.
Fiscal Deficit = Total expenditure by the government (revenue and capital expenditure) -
Total income of the government (loan recovery, revenue and non-revenue receipts)
For example, if the GDP of a country is ₹100 lakh crore and the difference between total
income and expenditure is ₹10 lakh crore then the fiscal deficit is 10%.
Types of fiscal deficit
Budget deficit: Total expenditure as reduced by total receipts
Revenue deficit: Revenue expenditure as reduced by revenue receipts.
Fiscal Deficit: Total expenditure as reduced by total receipts except borrowings.
Primary Deficit: Fiscal deficit as reduced by interest payments.
Effective Revenue Deficit: Revenue deficit as reduced by grants for the creation of
capital assets.
Monetized Fiscal Deficit: The part of the fiscal deficit which is covered by the
borrowing from the RBI.
Impacts on the Economy
 The long-term macroeconomic impacts of fiscal deficits are subject to debate. If the
deficit arises due to short-term spending projects such as infrastructure spending or
business grants, these sectors commonly see a boost in operations and profitability. If
the deficit increases because receipts have fallen, either through tax cuts or a decline
in business activity, this activity will not usually stimulate the economy.
 Politicians and policymakers rely on fiscal deficits to expand popular policies, such as
welfare programs and public works. Both conservative and liberal administrations
tend to run deficits in the name of tax cuts, stimulus spending, welfare, public good,
infrastructure, war financing, and environmental protection.
 Some economists argue against government budget deficits for crowding out private
borrowing and distorting interest rates. However, fiscal deficits have remained
popular among government economists since Keynes legitimized them in the 1930s.
Expansionary fiscal policy forms the basis of Keynesian anti-recession techniques and
provides an economic justification for spending money with reduced short-term
consequences.
 7. PER CAPITA INCOME

 Per capita income is a measure of the amount of money earned per person in a nation
or geographic region. Per capita income is used to determine the average per-person
income for an area and to evaluate the standard of living and quality of life of the
population. Per capita income for a nation is calculated by dividing the country's
national income by its population.
 Per capita income counts each man, woman, and child, even newborn babies, as a
member of the population. This stands in contrast to other common measurements of
an area's prosperity, such as household income, which counts all people residing under
one roof as a household, and family income, which counts as a family those related by
birth, marriage, or adoption who live under the same roof.
Implications of Per Capita Income
Considering per capita income is such a widely used economic tool, it is important to know
the important implications of such a measurement. Such implications are depicted below:
Wealth Management
The main purpose of per capita income – to present the average income of a nation – is a
great tool to manage wealth among nations. Using the ratio explicitly, an increase in PCI
allows national leaders to realize their prosperity and successful economic initiatives during
the year.
When per capita income decreases, it allows national leaders to prepare and analyze what
happened and to plan measures to reverse the trend.
National Aid
Considering that per capita income presents a nation’s mean income, it is a helpful tool to
assess which countries require aid.
Specifically, within the United Nations, making such information available allows
organizations to assess a nation’s wealth and see what assistance needs to be provided. If the
nation is experiencing an economic downturn, programs and activities can be implemented to
help the nation out of its slump.
Developmental Opportunities
When a nation experiences high per capita income, large organizations are more likely to
pursue developmental opportunities within that nation.
Used more commonly within regions, PCI is a tool used by businesses. For example, the per
capita income is higher in the state of California compared to New Mexico. As the
composition of the states suggests, more industrialization and development lies within
California.
Drawbacks of Per Capita Income
When using per capita income, the user must be aware of some of the drawbacks and flaws
inherent in the calculation. The drawbacks are explained in detail below:
Inflation
When comparing per capita income over time, this measurement does not consider the
adjustment needed to account for inflation. Without accounting for inflation, the figure tends
to overestimate the exact effects of economic growth for a region or nation.
Income Distribution
Considering per capita income is a mean value, the figure does not accurately reflect proper
income distribution. In most cases, income distribution is heavily skewed due to the wide
differences between households making below-average income and households that are
considered “economically rich.”
Exchange Rates
Using per capita income as a tool for international comparison, the measurement does not
account for exchange rates. Not accounting for the exchange rate may dilute the presentation
of the standard of living. To be more precise, per capita income should adjust for differences
in purchasing power parity between countries.
Variable Measurements
As mentioned before, per capita income uses the entire population of a select area rather than
just individuals who earn income. As such, people who do not earn are taken into
consideration. It results in a less accurate depiction of average income compared to just
measuring the employed demographic of the population.
Impacts on per capita income on business
More Per Capita Income means more economic growth
The population of a country like India is always on the rise, the Indian population is set to get
number 1 place before the Indian economy ranking number 1. A growing population usually
brings down the per capita income as the number of people increase but the earnings remain
pretty much the same.

However, if an economy has set itself and has a good and stable Per Capita Income then they
can adjust to the growing population which helps the economy to grow and stay afloat. Indian
economy today ranks 6th and is projected to rank 3rd by 2030 even with a growing
population, thus, growing population is a hindrance to economic growth only if the Per
Capita Income is not very good.
Per Capita Income helps bring in technology
Good Per Capita Income allows the country to bring in technological advancements. This
increases productivity and earnings. When the earnings and productivity go up so does the
GDP. This circle keeps going on and this, in turn, helps the economy to grow. Any book of
the Indian economy can be picked to understand this flow of Per Capita Income that helps
push up the Indian economy.
Lifestyle advancements
Per Capita Income increases the expenditure amount of an individual or a household. The
more the per capita income the higher the disposable income. Higher disposable income
means more buying of goods and services by the people. These expenses bring the money
flow and this money flow in the book of the Indian economy is what tells us that more Per
Capita Income means more economic growth
8. FIVE YEAR PLAN
The five-year plan is a method of planning economic growth over limited periods by the use
of quotas. It was used first in the Soviet Union and later in other socialist states. India's first
five-year plan was launched in 1951. The 12th five-year plan concluded in 2017 and the five-
year plans got terminated. The five-year plan is now replaced by the NITI Aayog’s 3-year
action agenda, 7-year strategy paper and 15-year vision document.
Economic planning in India began after the country's independence in 1950 when it
was thought important for the country's economic growth and development.
This was carried out through the Planning Commission (1951-2014) and the NITI
Aayog's (2015-2017) Five-Year Plans, which were established, implemented, and
monitored.
Under the socialist influence of first Prime Minister Pt. Jawahar Lal Nehru, the idea of
five-year economic planning was borrowed from the Soviet Union.
The first eight Indian five-year plans focused on expanding the public sector through
massive investments in heavy and basic sectors, but since the start of the Ninth five-
year plan in 1997, the focus has moved to make the government a growth facilitator.
Each five-year plan began on April 1 and ended on March 31 of the following year,
therefore five-year plans cover five financial years by convention.
 Between the third and fourth five-year plans, three annual plans were introduced. The
Indira government launched the fifth five-year plan, but the Janta Alliance
government abandoned it one year before it was supposed to conclude.
In 1978, the Janta government implemented the Rolling plan in place of a regular
plan.
From 1978 to 1983, this rolling plan was known as the 6th plan, but after the Janta
government was deposed, the incumbent Indira government abandoned it and
established its own sixth plan in 1980.
Because India's economy was in disarray in 1990-92, the Eighth Five-Year Plan began
two years later than planned.
Five-Year Plans: Long-term goals
To raise the living standards of India's citizens, a high growth rate is required.
For prosperity, there must be economic stability.
An economy that is self-sufficient.
Reducing inequality and promoting social justice
The economy is being modernized.
Planning Commission
 The Planning Commission of India was a government body that formulated India's
Five-Year Plans, among other things. The planning commission was tasked with
ensuring that everyone could participate in community service.
 The Planning Commission reported directly to the Prime Minister of India. It was
founded on March 15, 1950, under Prime Minister Jawaharlal Nehru's presidency. The
Central/Union Government established the Planning Commission, which was not
established by the Constitution or statute.
 The Planning Commission was established by a resolution issued by the Indian
government in March 1950. The government's key objectives were to push for a rapid
rise in Indians' living standards through successful resource exploitation, higher
output, and opportunities for everyone to engage in the service of society.
 The Planning Commission was entrusted with assessing all of the country's resources,
enhancing valuable resources, developing plans for the most productive and balanced
use of resources, and establishing priorities. Pandit Nehru was the first Chairman of
the Planning Commission. It was dissolved in 2014, and NITI Aayog took its place.
First Five Year Plan
It was established under the leadership of Jawaharlal Nehru from 1951 to 1956.
It was based on the Harrod-Domar model, but with some modifications.
Its main focus was on the country's agricultural development.
This plan was a success, with a 3.6% growth rate (more than its target of 2.1% ).
At the conclusion of this strategy, the country had five IITs.
Second Five Year Plan
It was established between 1956 and 1961, under Jawaharlal Nehru's leadership.
It was created using the P.C. Mahala Nobis Model from 1953.
Its main focus was on the country's industrial development.
 This plan fell short of its target growth rate of 4.5%, achieving 4.27% instead.
However, many experts rejected this idea, and India suffered a payment problem in
1957 as a result.
Third Five Year Plan
It was created between 1961 and 1966, under Jawaharlal Nehru's leadership.
The plan is also known as the 'Gadgil Yojna,' after D.R. Gadgil, the Deputy Chairman
of the Planning Commission.
The plan's principal goal was to make the economy self-sufficient. Agriculture was
emphasized, as was the improvement in wheat production.
India was involved in two wars during the implementation of this plan: (1) the Sino-
India conflict of 1962 and (2) the Indo-Pakistani war of 1965.
These battles exposed our economy's weaknesses and moved attention to the defense
industry, the Indian Army, and price stabilization (India witnessed inflation).
Due to wars and drought, the plan failed. The target growth rate was 5.6%, but the
actual rate was only 2.4%.

Plan Holidays
 From 1966 to 1969, the government announced three annual plans known as Plan Holidays in
response to the failure of the previous plan.
 The Indo-Pakistani and Sino-Indian wars were the primary causes of the plan's cancellation,
resulting in the failure of the third Five-Year Plan.
 Annual plans were made during this period, and agriculture, its related sectors, and the
industry sector were given equal attention.
 In order to boost the country's exports, the government announced a rupee devaluation.

Fourth Five Year Plan

Under the leadership of Indira Gandhi, it lasted from 1969 to 1974.
This plan had two primary objectives: expansion with stability and gradual self-
sufficiency.
14 major Indian banks were nationalized during this period, and the Green Revolution
began. The 1971 Indo-Pakistani War and the Bangladesh Liberation War occurred.
One of the Plan's major goals was to implement family planning programs.
This plan failed, with a growth rate of only 3.3% compared to the aim of 5.7%.
Fifth Five Year Plan
It lasted from 1974 to 1978.
The Garibi Hatao, employment, justice, agricultural output, and defense were all
prioritized in this plan.
In 1975, the Electricity Supply Act was changed, a Twenty-Point Program was started,
the Minimum Needs Programme (MNP) was established, and the Indian National
Highway System was established.
This plan was overall successful, with a growth rate of 4.8% vs the aim of 4.4%.
The freshly elected Moraji Desai government put an end to this scheme in 1978.

Rolling Plan
The Rolling Plan had effect from 1978 to 1990, following the end of the fifth Five-Year Plan.
The Rolling Plan was rejected by Congress in 1980, and a new sixth Five-Year Plan was
introduced.
Under the Rolling plan, three plans were introduced:
Sixth Five Year Plan
Under the leadership of Indira Gandhi, it lasted from 1980 until 1985.
The plan's main goal was to achieve economic liberalization by eliminating poverty
and creating technological self-sufficiency.
It was built on Yojna investment, infrastructure changes, and a growth model trend.
Its target growth rate was 5.2%, but it really grew at 5.7%.
Seventh Five Year Plan
It lasted from 1985 to 1990, and Rajiv Gandhi was the prime minister during that
time.
This plan's aims include the creation of a self-sufficient economy, possibilities for
gainful employment, and technological advancement.
With a focus on 'food, work, and productivity,' the Plan planned to increase foodgrain
output, increase employment possibilities, and raise productivity.
The private sector was given precedence over the public sector for the first time.
Its goal growth rate was 5.0%, but it ended up at 6.01%.
Eighth Five Year Plan
It lasted from 1992 to 1997, with P.V. Narasimha Rao as its leader.
The development of human resources, such as employment, education, and public
health, was given primary importance in this strategy.
The New Economic Policy of India was launched by the Narasimha Rao government
during this plan.
Rapid economic growth (highest annual growth rate so far – 6.8%), high growth in
agriculture and allied sectors, and manufacturing sector, growth in exports and
imports, and improvement in trade and current account deficit were some of the
significant economic outcomes during the eighth plan period. Despite the fact that the
public sector's portion of total investment had fallen to around 34%, a strong growth
rate was attained.
This plan was a success, with an annual growth rate of 6.8% compared to the aim of
5.6.
Ninth Five-Year Plan
Under the leadership of Atal Bihari Vajpayee, it lasted from 1997 to 2002.
The plan's main goal was "Growth with Social Justice and Equality."
It was launched on the 50th anniversary of India's independence.
This strategy fell short of its 6.5% growth target, achieving a rate of 5.6% instead.
Tenth five-year plan
It lasted from 2002 to 2007, with Atal Bihari Vajpayee and Manmohan Singh as its
leaders.
The goal of this strategy was to double India's per capita income in the next ten years.
It aimed to get the poverty rate down to 15% by 2012.
Its goal growth rate was 8.0%, but it only reached 7.6%.

Eleventh Five-Year Plan

It lasted from 2007 to 2012, and Manmohan Singh was the prime minister during that
time.
C. Rangarajan was in charge of preparing it.
The main focus of the conference was "rapid and more inclusive growth."
It grew at an annual pace of 8%, compared to a projection of 9% growth.
Twelfth Five-Year Plan
It lasted from 2012 to 2017, with Manmohan Singh as its head.
The main focus of the conference is "Faster, More Inclusive, and Sustainable
Growth."
Its target growth rate was set at 8%.
Post Five Year Planning era
 For a long time, there had been a feeling that centralized planning, with its one-size-
fits-all approach, could only go so far in a country as diverse and large as India.
 As a result, the NDA government abolished the Planning Commission and replaced it
with the NITI Aayog. As a result, there were no thirteen Five Year Plans, but a five-
year defense plan was created.
 It's vital to understand that the NITI Aayog's documents have no financial
implications. They are only government policy guide maps.
 Because it lacks financial powers, the three-year action plan simply serves as a
general road map for the government. It does not define any plans or allocations.
9.FINANCIAL SYSTEMS
A financial system is a set of institutions, such as banks, insurance companies, and stock
exchanges, that permit the exchange of funds. Financial systems exist on firm, regional, and
global levels. Borrowers, lenders, and investors exchange current funds to finance projects,
either for consumption or productive investments, and to pursue a return on their financial
assets. The financial system also includes sets of rules and practices that borrowers and
lenders use to decide which projects get financed, who finances projects, and terms of
financial deals.
Financial markets involve borrowers, lenders, and investors negotiating loans and other
transactions. In these markets, the economic good traded on both sides is usually some form
of money: current money (cash), claims on future money (credit), or claims on the future
income potential or value of real assets (equity). These also include derivative instruments.
Derivative instruments, such as commodity futures or stock options, are financial instruments
that are dependent on an underlying real or financial asset's performance. In financial
markets, these are all traded among borrowers, lenders, and investors according to the normal
laws of supply and demand.
In a centrally planned financial system (e.g., a single firm or a command economy), the
financing of consumption and investment plans is not decided by counterparties in a
transaction but directly by a manager or central planner. Which projects receive funds, whose
projects receive funds, and who funds them is determined by the planner, whether that means
a business manager or a party boss.

Most financial systems contain elements of both give-and-take markets and top-down central
planning. For example, a business firm is a centrally planned financial system with respect to
its internal financial decisions; however, it typically operates within a broader market
interacting with external lenders and investors to carry out its long-term plans.
10.COMMERCIAL BANKS
Commercial banks play an important role in the country's Financial Institution System.
Commercial banks are profit-making institutions that accept deposits from the general public
and lend money (loans) to individuals such as households, entrepreneurs, and businessmen.
The primary goal of these banks is to make money through interest, commissions, and other
means. The Reserve Bank of India, India's central bank and supreme financial authority,
regulates the operations of all commercial banks.
Meaning
 Commercial Banks operate under the Banking Companies Act, 1956.
 Any banking organization that deals with the deposits and loans of businesses are
referred to as a commercial bank.
 Commercial banks issue bank checks and drafts and accept term deposits.
 Through installment loans and overdrafts, commercial banks also serve as
moneylenders.
 Commercial banks also provide a variety of deposit accounts, including checking,
savings, and time deposits.
 These institutions are run for profit and are owned by a group of people.
 A commercial bank's main source of income is the difference between the two rates
which it charges borrowers and pays depositors.
Classification of Commercial Banks
Commercial banks in India are classified into two broad categories based on ownership and
management control, namely:
 Public Sector Banks
 Private Sector Banks
Public sector banks account for the majority of the banking business in India and are divided
into two types:
  State Bank of India
 Nationalized Banks

Public Sector Banks

 These are banks in which the Government of India owns a majority stake.
 This group includes the State Bank of India, India's largest commercial bank.
 The State Bank of India Act, 1955, established the State Bank of India by converting
the then-existing Imperial Bank of India into the State Bank of India.
 Following the formation of the State Bank of India in 1955, another 14 banks were
nationalized between 1969 and 1991. These were the banks with more than 50 crores
in national deposits.
 Another six banks were nationalized in 1980, bringing the total to twenty.
 The formation of the State Bank Group was intended to accelerate the expansion of
banking facilities in rural areas.
 The decision to nationalize the major commercial banks was made with the goal of
opening a large number of branches throughout the country, particularly in rural areas
and mobilizing large amounts of deposits for the purpose of lending to productive
purposes.
 Currently, there are a total of 12 Nationalised Banks in India.
Private Sector Banks
 There are two types of private sector banks – Old Private Sector Banks and New
Private Sector Banks.
 Old Private Sector Banks are those private sector banks that existed at the time of
nationalization.
  No new banks could be established in India prior to 1993.
 The Reserve Bank of India issued guidelines for the establishment of new private
sector banks in India in 1993.
 The majority of a bank's share capital is held by private individuals. These banks are
set up as limited-liability corporations.
 Private sector banks include ICICI Bank, Axis Bank, HDFC, and others.
Regional Rural Banks
 Regional Rural Banks were established in accordance with the provisions of an
Ordinance promulgated on September 26, 1975, and the RRB Act, 1976, with the goal
of ensuring adequate institutional credit for agriculture and other rural sectors.
 RRBs can only operate in the areas that have been designated by Gol as covering one
or more districts in the state.
 RRBs are jointly owned by Gol, the relevant State Government, and Sponsor Banks;
the issued capital of an RRB is divided among the owners in the proportions of 50%,
15%, and 35%, respectively.
Foreign Banks
 These banks are registered and have their headquarters in another country, but they
have branches in our country.
 As of now, there are approximately 46 foreign banks operating in India in 2021.
 Foreign banks in India include HSBC, Citibank, Standard Chartered Bank, and others.
Nonscheduled commercial Banks
 These banks are not added in the Second Schedule of the Reserve Bank of India Act,
1934.
 Nonscheduled commercial banks in India include Capital Local Area Bank Ltd -
Phagwara (Punjab), Krishna Bhima Samruddhi Local Area Bank Ltd, Mahbubnagar
(Andhra Pradesh), Subhadra Local Area Bank Ltd., Kolhapur (Maharashtra), and
others.
Functions of Commercial Banks
1.Primary Functions
Accepts Deposits
A commercial bank's first primary function is to accept deposits in the form of current,
savings, and fixed deposits.
Gives Loans and Advances
The second major function of a commercial bank is to make loans and advances, primarily to
businessmen and entrepreneurs, and to earn interest on those loans and advances.
This is, in fact, the bank's primary source of revenue.
A bank reserves a portion of its deposits and lends the remainder to borrowers in the form of
cash credit, demand loans, short-term loans, and overdrafts.
Cash Credit
An eligible borrower has first sanctioned a credit limit in this function of a commercial bank,
and within that limit, he is allowed to withdraw a certain amount on a given security.
Demand Loans
In this function of a commercial bank, the entire loan amount is paid in one lump sum by
crediting it to the borrower's loan account.
Short-term Loans
In this commercial bank function, short-term loans are made against collateral as personal
loans to finance working capital or as priority sector advances. The entire amount is repaid in
one installment or in a series of installments over the loan period.
Secondary Functions
Discounting Bills of Exchange
Bill discounting is a service provided by commercial banks to their depositors. A bill of
exchange is a promise to pay a specific amount of money at a specific point in the future. It
can also be encased earlier by using a commercial bank's discounting process.
Credit Creation
Commercial banks use this function to accept deposits and advance loans by keeping small
amounts of cash on hand for day-to-day transactions.
When a bank advances a loan, it opens an account in the customer's name and does not pay
him in cash, but instead allows him to withdraw funds by cheque as needed.
Financing Foreign Trade
Commercial banks offer their customers the option of financing foreign trade by accepting
foreign bills of exchange and collecting them from foreign banks.
These banks also conduct other foreign exchange transactions, such as buying and selling
foreign currency.
Overdraft Facility
An overdraft is a loan that allows a customer with a current account to overdraw his account
up to a predetermined limit.
In this function of a commercial bank, the bank allows a depositor to withdraw an amount
greater than the balance in his account.
Agency Functions of Bank
The bank acts as a customer's agent and receives a commission for performing agency
functions, such as:
 Collection and transfer of funds
 Payments of various items
 Purchase and sale of shares and securities
  Collection of dividends and interest
 Letters of reference

General Utility Services

 Customers can also get a variety of general utility services from banks. These are as
follows:
 Banks provide travelers and gift cheques to their customers.
 Customers can keep their ornaments and important documents safe in lockers.
 It allows you to underwrite securities issued by government, public, or private
entities.
Significance of Commercial Banks
 They encourage saving and increase the rate of capital formation.
 They are a source of finance and credit for a country's a trade and industry.
 By establishing branches in backward and remote areas of a country, they promote
balanced regional development.
 Bank credit enables entrepreneurs to innovate and invest in large and small-scale
industries, accelerating a country's economic development process.
 They contribute to the growth of priority sectors such as agriculture, small-scale
industry, retail trade, and export.
 They assist a country's commerce and industry in expanding their field of operation.
Limitations of Commercial Banks
 Banks were asked to open branches in rural and underserved areas where basic
infrastructure such as roads, communication, transportation, education, and safe
buildings for bank operations do not exist.
 There is a problem with even the security of bank employees in some places.
 Because all public sector banks provide the same service, there has been fierce
competition in deposit mobilization.
 There are several financial institutions that provide financing to the same borrowers,
including commercial banks, cooperative banks, regional rural banks, and state
financial corporations.
 Because of these numerous organizations and the lack of coordination among these
institutions, duplicate financing, over-financing, or under-financing has occurred.
 Though commercial banks have made spectacular efforts to meet the financial needs
of the agricultural sector and its allied activities, a more vigorous effort is still
required, as commercial banks' total assistance to the agricultural sector is not even
10% of their needs.
 The number of banks in rural areas is quite inadequate in comparison to the need for
banking services, as evidenced by the fact that only 5% of villages are served by
banks.
 Commercial banks have branches in various parts of the country, but they are not
evenly distributed.
 Around half of the branches are concentrated in the Southern and Western regions.
  States like Assam, Jammu & Kashmir, Manipur, Nagaland, Orissa, Tripura, Uttar
Pradesh, and West Bengal are underbanked.
 Financing of priority sectors, the opening of branches in rural as well as unbanked and
backward areas, granting low-interest loans to weaker sections, increase in salary and
establishment costs, and increase in overdue resulted in a decline in the rate of
profitability of most commercial banks in India.
 The banking industry has been subjected to all of the constraints of the public sector
as a result of its nationalization which has resulted in its low efficiency.
 These include managers' bureaucratic attitudes, a lack of initiative, red-tapism,
excessive delays, a lack of commitment, responsibility, and indifference to work,
among other things.
 Bank nationalization has resulted in political interference and political pressure at all
levels of the banking system.
 The liberal credit policy, which is necessary to meet the credit needs of the weaker
sections, the agricultural sector, and so on, has resulted in the insecurity of bank funds
and, ultimately, depositors' money.
 A loose credit policy has also resulted in a sluggish recovery.
 Many nationalized banks have multiple branches in the same area. As a result, each of
them faces unfair and unnecessary competition in deposit mobilization.
11. FINANCIAL INSTITUTIONS
Financial institutions are the economic entities that help individuals and businesses with
several financial services, enabling them to deposit, save, invest, and manage their monetary
resources.
Types of Financial Institutions
There is a wide range of such institutions operating around the world. However, the
commonly identified types are as follows:
#1 – Central Banks
These are the financial entities that monitor and oversee the procedures of the other financial
or banking institutions in the nation. They do not deal with individual customers directly.
Instead, they finance other retail banks. In short, these are banks for the banks. Every
economy has a separate central bank and is named differently. For example, in the United
States, the Federal Reserve Bank is the central bank.
#2 – Commercial Banks
Retail and commercial banks
are widely available to serve the financial needs of individuals and businesses. From
depositing money to borrowing amounts to buy property, these banks act as saviors for
people in need to secure their future financially. Some of the products that these banks offer
include savings accounts, personal loans, mortgage loans, certificates of deposits (CDs),
credit cards, etc.
#3 – Non-Banking Institutions
Non-banking financial institutions (NBFIs) are entities that neither acquire a valid banking
license nor do they allow customers to deposit amounts. However, these entities can offer
alternative financial facilities to customers, including investment, consultation, brokerage,
transmission, and risk pooling services.

4 – Credit Unions
The institutions offer traditional banking services but are not publicly traded entities. They
are established and operated by the members, the ultimate shareholders. These associations
use and reinvest the money received as an interest to keep the costs low. As a result, they
become the better choices for members to fulfill their financial needs. These entities enjoy
tax-exempt status as not-for-profit organizations
#5 – Investment Entities
The investment banks and brokerage firms fall under this non-depository category. The
investment firms help corporations, governments, and other entities build capital, raise funds,
and gain financial advice. These entities, as brokerage ventures, let customers acquire
finances by investing in securities, like stocks, mutual funds, bonds, and exchange-traded
funds (ETFs). In addition, it acts as a guide to startups or companies in conducting complex
transactional processes. They also offer advice for initiating fruitful mergers and acquisitions
(M&A).
#6 – Thrift Institutions
Also referred to as savings and loan associations, these entities allow up to 20% of total
lending to customers, who are also their owners. They help individuals enjoy opening
accounts and acquiring personal loans and home mortgages.
#7 – Insurance Companies
These financial institutions allow individuals and businesses have policies against monthly
premiums, which they are subject to pay at regular intervals. In addition, these schemes offer
coverage or protection to assets against any financial risk they remain exposed to.
Functions
Though the financial institutions aim to ensure a healthy economy, there are other minor and
major roles they play to ensure they achieve their final goal.
The primary function of these institutions is to regulate the money supply. With the regular
flow of money, the financial entities keep the financial ecosystem active. The money supply
process must be efficient, given the wide use of money in carrying out transactions.
One of the most common functions of these institutions is banking and investment services.
They serve individual customer needs, be it a person or a business. They allow them to
deposit their money, save it, earn interest, and invest further. In addition, as a non-banking
institution, they also offer consultation facilities to customers and help them know the pros
and cons of investing in a financial product, be it stocks, bonds, ETFs, mutual funds, etc.
For startups, their investment advice works and helps them build huge capital by opting for
Initial Public Offering (IPO) to raise sufficient funds. Moreover, by keeping the financial
ecosystem active, these institutions ensure being ready to manage any financial risk and
foster the economic growth of a nation.

12. RBI
The RBI (Reserve Bank of India) is the central bank of the country. The RBI came into
existence on 01st April, 1935 in accordance with the provisions of the Reserve Bank of India
Act, 1934. The Central Office of the RBI was initially incorporated in Kolkata but later
moved to Bombay in 1937 permanently. The Central Office (Bombay) is where the Governor
of RBI presides and formulates the policies. The following RBI study notes is intended to
guide finance aspirants for upcoming competitive exams.
The RBI was originally privately owned. However, after its nationalization in the year 1949,
the RBI became fully-owned by the government of India. As of October 2020, Mr.
Shaktikanta Das has been the governor of RBI with deputy governors being Shri M.
Rajeshwar Rao, Dr. M. D. Patra, Shri M. K. Jain, and Shri B. P. Kanungo.
The primary function of the RBI is to control and regulate the monetary policy concerning
the Indian Rupee. Besides, its other functions include issuance of currency, operating the
currency, maintaining monetary stability in the country, and sustaining the country’s credit
system. Let us learn more about the RBI through the following study notes in terms of its
structure, functions, importance, monetary policy committee, and more to prepare for UPSC
Indian Economy and other banking exams.
Composition of the Reserve Bank of India
All the affairs of the RBI are regulated by a central board of directors. Following are the
important details regarding the structure of the Reserve Bank of India:
 The board of RBI follows the guidelines of the RBI Act and is appointed by the
government of India
 The directors of RBI are either appointed or nominated for a term of four years
 The official directors include: one full-time governor and not more than four deputy
governors
 Non-official Directors: 10 directors nominated by the government from miscellaneous
sectors along with 02 government officials
 Others: 04 directors, one each from four regional boards
Functions of the RBI
Now that we have a better understanding of the meaning and structure of the Reserve Bank of
India, let us also see the various functions undertaken by the central bank of India. For every
banking and finance job aspirant, knowing the functions of RBI is mandatory not only from
the examination point of view but also for the practical knowledge purposes. Given below are
some of the major functions performed by the RBI:
Monetary Authority: As a monetary authority, the RBI is responsible for supervising the
monetary policies, implementing the monetary policies, and ensuring price stability in the
country with respect to the national economic growth.
Issuing Notes: The RBI is entrusted with the responsibility of providing the public with
adequate supply of currency coins and notes. Besides, the RBI is also in-charge of
maintaining the quality of the currency notes and coins, their exchanges and destruction of
the ones that are not applicable for circulation.
Banker to the government: The RBI acts as an Agent, Banker, and Adviser to the
government of India and all the states. It performs all the banking functions of the Central
and the State governments along with tendering useful advice on economic and monetary
policies. It also provides overdraft facilities to both the central and the state government.
Foreign reserve management: The Reserve Bank of India is in-charge of maintaining the
foreign exchange rates by buying and selling the foreign currencies. It is responsible to buy
and sell the foreign currency in the Forex market when its demand increases and vice-versa.
Developmental functions: Apart from the above, the RBI also performs a wide array of
developmental functions to support the national objectives including making institutional
arrangements for agricultural finance and so on.
Collection and publication of data: The RBI regularly collects and compiles the data based
on banking and financial operations, FDIs, BOP, Exchange Rate and industries, prices, etc. of
the Indian economy. For that, the RBI publishes a monthly publication indicating the relevant
and most updated numbers on a regular basis.
Controls credit supply: Undertaking the function of controlling the credit supply in the
economy, the RBI uses two methods, which are qualitative and quantitative techniques. When
the RBI observes that the economy has sufficient money supply and it may cause an inflation
in the economy, it squeezes the money supply through the tight monetary policy and vice
versa.
Promotional functions: The RBI’s promotional functions includes promoting banking habits
and enhancing the banking system, providing training to the banking staff, supporting the
agriculture sector and cooperative sector, developing a financial system, exporting promotion
through refinance facility and extending support for industrial finance.
Supervisory functions: Apart from the monetary functions, the RBI is also entrusted with
certain non-monetary roles. These include giving license to the banks, bank inspection and
enquiry, controlling over non-banking financial institutions, and periodic review of the
working of the commercial banks.
Lender of the last resort: One of the prime functions of the RBI is that it acts as the lender of
the last resort. Wherein, the banks can approach the Reserve Bank of India when they are in
need of funds. The RBI lends money to all the commercial banks across the country. As per
the Banking Regulation Act, 1949, the RBI is entrusted with the extensive powers to control
and supervise the nation-wide banking system.
RBI’s Instruments of Monetary Policy
The RBI’s monetary policy is a set of regulatory policies wherein it maintains its control over
the supply of currency within the economy to achieve general economic goals. The main
instruments of monetary policies of the RBI are: Cash Reserve Ratio, Statutory Liquidity
Ratio, Bank Rate, Repo Rate, Open Market Operations, and Reverse Repo Rate. Now let us
have a brief understanding of all these RBI’s instruments of monetary policy below:
CRR: The Cash Reserve Ratio (CRR) is the particular amount of bank deposits which the
banks are required to keep with the RBI in the form of balances or reserves. An increase in
the CRR with the RBI results in a decrease of the liquidity in the money supply and vice
versa. During inflation, the RBI increases the CRR and vice versa.
SLR: The Statutory Liquidity Ratio (SLR) is the number of liquid assets out of their total
time and demand liabilities which all the financial institutions are required to maintain at any
given point of time. In case of inflation, the RBI increases SLR and vice versa.
OMO: Open Market Operations (OMO) are the instruments which involve buying and/or
selling of securities like the government bonds to or from the public and banks. The RBI sells
the government securities in order to regulate the flow of credit in the economy and buys the
government securities to increase the credit flow.
Bank Rate Policy: Also known as the discount rate, the bank rate refers to the interest
charged by the RBI for lending loans and funds to the banking system. When the bank rate
increases, the cost of borrowing by commercial banks results in reduction in the credit
volume to the banks and so the supply of money reduces and vice versa.
Repo Rate: It is the rate of interest at which the RBI lends short-term money to the banks in
order to control inflation, money supply, and economic growth. During inflation, the
government increases the repo rate to reduce the money supply and vice versa when it is
deflation.
Recent Developments by the RBI
Following are some of the recent developments introduced by the Reserve Bank of India
amid the economic crisis due to the Covid-19 pandemic.
The RBI decided to extend the enhanced borrowing facility provided to the banks to meet the
SLR until September 30, 2020.
The RBI also extended the relaxation on the minimum daily maintenance of the CRR at 80%
till September 2020.
With a view to strengthen the governance in the commercial banks, the RBI proposed to
restrict promoters from holding the CEO position for more than 10 years.
The RBI approached the Centre seeking an extension of tenure of external members on its
rate-setting panel until March 2021 due to the Covid-19 pandemic situation.
The RBI announced another round of the bond-swapping program billed as India’s Operation
Twist in order to help monetary transmission.
The RBI said it is creating a Payments Infrastructure Development Fund in order to promote
digital payments across the country. An initial contribution of INR 250 crore will be made by
the RBI with a view to cover half the fund.
India brought cooperative banks under the regulatory framework of the RBI by amending the
70-year-old Banking Regulation Act through a presidential decree.
13.STOCK EXCHANGE
Meaning
A stock exchange is an important factor in the capital market. It is a secure place where
trading is done in a systematic way. Here, the securities are bought and sold as per well-
structured rules and regulations. Securities mentioned here includes debenture and share
issued by a public company that is correctly listed at the stock exchange, debenture and bonds
issued by the government bodies, municipal and public bodies.
Typically, bonds are traded Over-the-Counter (OTC), but a few corporate bonds are sold in a
stock exchange. It can enforce rules and regulation on the brokers and firms that are enrolled
with them. In other words, a stock exchange is a forum where securities like bonds and stocks
are purchased and traded. This can be both an online trading platform and offline (physical
location).
Functions of Stock Exchange
Following are some of the most important functions that are performed by stock exchange:
Role of an Economic Barometer: Stock exchange serves as an economic barometer that is
indicative of the state of the economy. It records all the major and minor changes in the share
prices. It is rightly said to be the pulse of the economy, which reflects the state of the
economy.
Valuation of Securities: Stock market helps in the valuation of securities based on the factors
of supply and demand. The securities offered by companies that are profitable and growth-
oriented tend to be valued higher. Valuation of securities helps creditors, investors and
government in performing their respective functions.
Transactional Safety: Transactional safety is ensured as the securities that are traded in the
stock exchange are listed, and the listing of securities is done after verifying the company’s
position. All companies listed have to adhere to the rules and regulations as laid out by the
governing body.
Contributor to Economic Growth: Stock exchange offers a platform for trading of securities
of the various companies. This process of trading involves continuous disinvestment and
reinvestment, which offers opportunities for capital formation and subsequently, growth of
the economy.
Making the public aware of equity investment: Stock exchange helps in providing
information about investing in equity markets and by rolling out new issues to encourage
people to invest in securities.
Offers scope for speculation: By permitting healthy speculation of the traded securities, the
stock exchange ensures demand and supply of securities and liquidity.
Facilitates liquidity: The most important role of the stock exchange is in ensuring a ready
platform for the sale and purchase of securities. This gives investors the confidence that the
existing investments can be converted into cash, or in other words, stock exchange offers
liquidity in terms of investment.
Better Capital Allocation: Profit-making companies will have their shares traded actively, and
so such companies are able to raise fresh capital from the equity market. Stock market helps
in better allocation of capital for the investors so that maximum profit can be earned.
Encourages investment and savings: Stock market serves as an important source of
investment in various securities which offer greater returns. Investing in the stock market
makes for a better investment option than gold and silver.
Features of Stock Exchange:
A market for securities- It is a wholesome market where securities of government, corporate
companies, semi-government companies are bought and sold.
Second-hand securities- It associates with bonds, shares that have already been announced by
the company once previously.
Regulate trade in securities- The exchange does not sell and buy bonds and shares on its own
account. The broker or exchange members do the trade on the company’s behalf.
Dealings only in registered securities- Only listed securities recorded in the exchange office
can be traded.
Transaction- Only through authorized brokers and members the transaction for securities can
be made.
Recognition- It requires to be recognized by the central government.
Measuring device- It develops and indicates the growth and security of a business in the
index of a stock exchange.
Operates as per rules– All the security dealings at the stock exchange are controlled by
exchange rules and regulations and SEBI guidelines.
14.NON BANKING FINANCIAL COMPANIES
Meaning
NBFC stands for Non-Banking Financial Company. They are financial institutions that
provide financial services to customers but do not hold a banking license. This means that
NBFIs cannot accept deposits from the general public, which is one of the key functions of a
traditional bank.
Non-Banking Financial Institutions are among the most important topics for the UPSC IAS
exam. It covers a significant part of the Economy in the GS Paper 3 Syllabus and current
events in UPSC prelims.
This article will provide all the necessary information on Non-Banking Financial Institutions,
such as features of non-banking financial institutions, types of non-banking financial
institutions in India, the role of non-banking financial institutions and the impact of non-
banking financial institutions.
A Non-Banking Financial Companies (NBFC) is a firm that engages in activities such as:
 obtaining loans and credit facilities,
 buying bonds, stocks, or shares,
 leasing property,
 financing assets,
 providing insurance,
 exchanging currencies,
 operating hedge funds,
The engaging in chit
Reserve Bank transactions,
of India etc.
defines a non-banking financial company as registered under the
Companies Act 1956.

Role of NBFCs in Financial System

Nonbank financial companies (NBFCs) in India play a crucial role in the financial sector.
They provide a wide range of financial services and contribute to the overall economy in the
following ways:
Financial Inclusion: NBFCs help promote financial inclusion by extending credit and
financial services to underserved population segments.
Credit Access: NBFCs complement the banking sector by providing access to credit for
individuals and businesses who may not meet the stringent requirements of traditional banks.
Sector-Specific Financing: It is specialized in catering to specific sectors such as vehicle
financing and housing finance.
Rural and Agriculture Development: NBFCs play a significant role in supporting rural and
agricultural development.
Employment Generation: NBFCs contribute to job creation by facilitating financing for small
and medium enterprises (SMEs) and supporting entrepreneurship.
Innovation and Flexibility: NBFCs often demonstrate greater flexibility and innovation in
their products and services, adapting to evolving market demands and customer needs.
Financial Stability: It contributes to the country's overall financial stability by providing an
alternative source of credit.
Market Development: NBFCs enhance the overall depth and breadth of the financial market
by offering a diverse range of financial products, promoting competition, and encouraging
innovation in the financial sector.
Types of Non Banking Financial Institutions with Examples in Detail
The following are some examples of nonbank financial institutions: insurance companies,
venture capitalists, money exchanges, some microloan groups, and pawn shops. These non-
bank financial institutions compete with banks, offer services that aren’t always fit for banks,
and focus on particular industries or demographics.
Asset Finance Company (AFC)
An AFC is an organisation that conducts the financing of tangible assets as its primary
business.
A company’s principal business is any operation that generates at least 60% of its total assets
and income from financing tangible assets that support economic activity.
Investment Company (IC)
Any business that engages in the acquisition of securities as its primary business and is a
financial institution is referred to as an IC.

Loan Company (LC)

LC refers to any company that is a financial institution and conducts the provision of finance
as its primary business. This includes making loans, advances, and other types of financial
commitments for activities other than its own.
Infrastructure Finance Company (IFC)
 IFC is a non-banking finance business that:
 invests at least 75% of its total assets in infrastructure loans;
 has a minimum of Rs 300 crore in net owned funds;
 has a minimum credit rating of “A” or similar;
 has a CRAR of 15%.
Systemically Important Core Investment Company (CIC-ND-SI)
A Core Investment Company (CIC) is a Non-Banking Financial Company (NBFC) that
engages in the acquisition of shares and securities and invests at least 90% of its net assets.
Non-Banking Financial Company (IDF-NBFC)
 IDF-NBFC is a business that has been registered as an NBFC to make it easier for
long-term funding to flow into infrastructure projects.
 IDF-NBFC raises funds by issuing bonds with a minimum 5-year maturity that are
denominated in rupees or dollars.
 IDF-NBFCs may only be sponsored by Infrastructure Finance Companies (IFC).
Non-Banking Financial Company – Factors (NBFC-Factors)
NBFC-Factor is a non-deposit-taking NBFC with factoring as its main line of business.
NBFC-Factor means a non-banking financial company that meets the principal business
criteria:
whose financial assets in the factoring business constitute at least 75 percent of its total
assets, has Net Owned Funds of Rs. 5 crores, has been granted a certificate of registration by
the RBI under Section 3 of the Factoring Regulation Act, 2011.
Mortgage Guarantee Companies (MGC)
MGC are financial organizations with a net owned fund of Rs 100 crore and a mortgage
guarantee business that accounts for at least 90% of their business turnover or at least 90% of
their gross income.