Merger and Consolidation of Public Sector Banks

Merger and Consolidation of Public Sector Banks

This article deals with ‘Merger and Consolidation of Public Sector Banks.’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

Bank Mergers

  • 2016 : At Gyan Sangam II , it was decided that since Public Sector Banks aren’t performing well, there is need to consolidate banks by merging small banks with State Bank of India, Punjab National Bank , Bank of Baroda , Canara Bank etc. as Anchor Banks.
  • Crux : government is working on a consolidation of public sector banks with a view to creating 3-4 global-sized banks and reducing the number of state-owned banks to about 10-12.

Mergers happened till now

  • 2017 : SBI’s 5 Associated Banks & Bhartiya Mahila Bank merged with SBI .
  • 2019 : Vijaya & Dena Bank merged with Bank of Baroda . 
  • 2019 : Oriental Bank of Commerce and United Bank of India merged into Punjab National Bank .
  • 2019 : Syndicate Bank merged with Canara Bank .
  • 2019 : Andhra Bank and Corporation Bank merged with Union Bank of India .
  • 2019 : Allahabad Bank merged with Indian Bank .
Merger and Consolidation of Public Sector Banks
Merger and Consolidation of Public Sector Banks

Points in favour of Merger of Banks

  • (Economic Survey 2020) It will help to place more Indian Banks in the top 100 banks of the world  . It is sine quo none to have atleast 6-8 top-100 banks of the world in India, if we want to make India a financial hub of Asia and channelize global savings towards India to make India $ 5 trillion economy. Currently , India has just one bank in top 100 banks of the world (SBI = 55 Rank) while China has 18.
Number of top 100 banks in countries

India needs atleast 6-8 global 
banks in Top-100 to make India 
a $ 5 Trillion economy. 
(Economic Survey 2020)
  • Earlier State Bank of Saurashtra (2008) & Indore (2010) merger into SBI was successful . Hence, previous experience is pleasant.
  • Larger banks provide financial stability and act as engines of growth in times of trouble. Eg Chinese Banks in 2008 .
  • It will lead to  branch rationalisation and reduce operating costs .
  • Larger Public Sector Banks can support the corporate sector better in overseas acquisitions  as done by Chinese Banks.
  • For compliance with BASEL III Norms, if big bank like Consolidated SBI issue shares , they can fetch good response .
  • Enhanced geographical reach: For example, Vijaya Bank has strength in the South while Bank of Baroda and Dena Bank had a stronger base in Western India. That would mean wider access for both the proposed new entity and its customers.
Merger of Banks

Points against Merger of Banks

  • Mergers eat up a lot of top management time . At a time when Public Sector Banks  need razor focus to deal with NPA menace , mergers will be very distracting .
  • Large banks aren’t necessarily efficient banks : The quest to create an Indian banking giant is old one when world looked  in awe at the Japanese banking giants . But their big size emboldened them to do excessive lending and ultimately they  had to be bailed out by taxpayers money  .
  • The merged State Bank of India is likely to be five times larger than its nearest competitor and can stifle the competition .
  • Setback to corporate governance :The merger sends out a poor signal of a dominant shareholder (the government) dictating decisions that impact the minority shareholders .
  • Banks will lose their regional identities .
  • Political Implications : Kerala Legislative Assembly has passed resolution that State Bank of Travancore’s merger with SBI will affect state’s economic growth negatively.
  • Protests: Addressing the concerns of unions and shareholders will be challenging.
  • Harmonization of Technology: It is a big challenge as various banks are currently operating on different technology platforms.

Best way to Merge : Merge banks that are complementary . Eg : Bank of Baroda with Dena and Vijaya Bank so that lay offs aren’t large .

Privatisation of Banks

  • Government is also reducing its shareholding to less than 50% in a Public Sector Banks .
  • Eg :
    • Government owned UTI Mutual Fund applied for UTI Bank License in 90s => Scam => UTI Bank privatised into Axis Bank
    • 2018 : IDBI Bank  Privatisation

IDBI Privatisation

Present Structure

  • Government had 81% ownership in IDBI Bank Limited. But Unlike in the other public sector banks, the government could reduce its stake in IDBI Bank  below 50%, because this bank is not governed by the Bank Nationalisation Act, 1969 .
  • June 2018 : Government was unable to find suitable private sector buyer for IDBI Bank. Hence, Government has started discussions with LIC to pick up a controlling stake of 51% (from  around 11% ) in a  deal of around Rs 10,000 crore .
  • March 2019 : RBI changed categorisation of IDBI to private sector lender following acquisition of majority stake by LIC
  • Budget 2020 : Finance Minister announced that Government will sell remainder 41% shares of IDBI Bank as well.
IDBI Privatisation
Positive Government  has not to  worry about BASEL-recapitalization of IDBI.
LIC can market its insurance policies to IDBI consumers (using bancassurance model) .
Negative IDBI Bank is the worst performing state-owned lender with NPAs as on March 31, 2018 of 28% .
– IRDAI do not permit LIC to raise its shareholding in a single listed entity beyond 15% to ensure that the Corporation does not put policyholders’ money at risk, and has a diversified portfolio.
Funds at the disposal of LIC are  policyholders’ money. Using those funds to buy a badly performing bank will deprive them from optimal returns .

History of Banking System

History of Banking System

This article deals with ‘History of Banking System.’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

Financial Intermediaries

  • Institutions that channel funds between surplus and deficit agents are called financial intermediaries.
Financial Intermediaries
  • These include Banks, Insurance companies , pension funds, mutual funds etc. .
Financial Intermediaries

Banking System

Type of Banks

Type of Banks

Scheduled Commercial Banks

When RBI is satisfied that a bank has (Paid Up Capital + Reserves =) Minimum 5 Lakhs  & it is not conducting business in a manner harmful to its depositors, then such bank is listed in the 2nd Schedule of RBI Act, and it is known as a Scheduled Bank.

Scheduled Banks Non-Scheduled Banks
Are bound to maintain CRR with RBI and maintain SLR as mandated by the RBI . Not required to maintain SLR and CRR .
As a benefit , they are eligible to borrow  funds via Liquidity Adjustment Facility (Repo and Bank Rates) It depends on RBI’s discretion to allow them to borrow via this mechanism .
Can be subdivided into two parts 1) Scheduled Commercial Banks e.g. SBI, Axis , PNB, ICICI Bank etc. 2) Schedule Cooperative Banks like Haryana Rajya Sahakari Bank  etc. Hundreds of cooperative banks are non-Schedule Banks.

Topic : History of Banking System in India

History of Banking System in India before Independence

  • Present Banking System was introduced in the western world and was later introduced in India during the British Raj.
  • History of  Banking system in India goes to 19th century (then known as Agency Houses ).
  • During British Times, there were two type of Banks
British Banks East India Company established Banks in 3 Presidencies
1. Bengal : 1806
2. Bombay : 1840
3. Madras : 1843
1921 : These three merged to form  Imperial Bank of India . Later, it was nationalised and became SBI . It targeted British  Army officers , Civil Servants & Judges.  
Swadeshi Banks These were setup by the Indians , parallel to the British Banks.
First Indian Bank was Allahabad Bank(1856).
Other – Bank of Baroda (backed by Gaekwads of Baroda) , Punjab National Bank (role  was played by Lala Lajpat Rai in it’s formation) , Punjab & Sind Bank (by Bhai Vir Singh) .
These banks targeted big merchants particularly raw material exporters  

But neither helped in financial inclusion .

Birth of RBI

  • By the early 1930s,  there were large number of banks operating in India . They were registered under the Company Law and regulations on this sector were not present. But problem arose during The Great Depression(1929) which started in USA . Due to this, demand of Indian exports in the foreign market  decreased and Indian merchants started to default .  Consequently , large number of Indian banks collapsed.
  • To deal with such situation and bring banking sector under regulation,  British Indian government setup Reserve Bank of India in 1934 under the recommendations of Hilton Young Royal Commission.

History after Independence

Two important steps were taken by Government of India

  • Nationalisation of RBI
  • Banking Regulation Act,1949 : It empowered RBI to control & regulate Banking sector in India .

Nationalisation of Banks

Nationalisation of banks :  SBI Case (1st Round )

1955 Imperial Bank was nationalised & renamed SBI . (At the same time, Nationalisation of Insurance Companies also done)
1960 8 Banks were nationalised & made subsidiaries to State Bank of India
1963 Two subsidiary Banks were merged  (State Bank of Bikaner & State Bank of Jaipur) leading to the formation of  State Bank of Bikaner & Jaipur
2008 State Bank of Saurashtra merged  with Parent Bank .
2010 State Bank of Indore merged with Parent Bank .
Till recent times There were  5 subsidiaries of SBI
1. State Bank of Bikaner & Jaipur
2. State Bank of Hyderabad
3. State Bank of Mysore
4. State Bank of Patiala
5. State Bank of Travancore  
2017 All subsidiaries merged into Parent Bank
History of Banking System

Nationalisation of Banks :  Except SBI (2nd Round)

  • 1969 :  14 Banks having deposits of more than ₹ 50 Crore were nationalised (2019 : 50 years have passed i.e. Golden Jubilee of Nationalisation.)
  • 1980 : 6 more banks Nationalised having deposits more than ₹200 Crore .
Nationalised in 1969 Punjab National Bank, Canara Bank etc .
Nationalised in 1980 Punjab & Sind Bank, Vijaya Bank, Oriental Bank of Commerce etc.

Reasons of Nationalisation

  • To remove control & concentration of economic power in the hands of few industrialists .
  • Due to misuse of funds by owners .
  • Due to tendency of banks to ignore the needs of small scale industrial sector & agriculture .
  • To remove concentration of banking sector mostly in Urban areas .

Objectives after Nationalisation

  • To open more banks in rural & semi urban areas & to collect saving from these areas .
  • To provide credit facilities to areas defined as Priority Sector in economy.

Has the nationalisation of private banks benefitted India?

  • According to Economic Survey (2020) , due to nationalisation of banks ,  allocation of banking resources to rural areas, agriculture, and priority sectors have increased. For example in the period from 1969-1980
    • Number of rural Bank branches increased ten-fold.
    • Credit to rural areas increased twenty-fold.
    • Credit to agriculture expanded forty-fold, reaching 13% of GDP from a starting point of 2% of GDP .
  • But Economic Survey (2020) doubts  whether these benefits were entirely caused by Nationalization as the period also saw various other events like green revolution, anti-poverty programmes (like Integrated Rural Development Programme) and policies of RBI (such as RBI’s 4:1 formula).

Issues faced by Public Sector Banks due to Bank Nationalisation

  • Since government was the majority shareholder of the banks, it started to give loans at populistic ‘Government Administered Interest Rates’  which decreased the profitability of the banks.
  • Banks were forced to give loans to fund unviable projects based on political considerations which increased the NPAs of Public Banks as the recovery of such loans was low. In 2019 public sector banks reported NPAs of Rs. 7.4 lakh crore amounting to about 80 per cent of the NPAs of India’s banking system.
  • Public Sector Banks account for 92.9% of the cases of bank fraud, a large majority (90%) were related to advances, suggesting poor quality of screening and monitoring processes for corporate lending adopted by Public Sector Banks.
  • PSBs perform poorly on Return-on-Assets (RoA), Return-on-Equity (RoE) etc when compared with  Private Banks. Public Sector Banks are having negative RoA presently.   
performance of Public Sector Banks
  • Politicisation of Bank Boards happened with government placing it’s favourites in the Board of Directors irrespective of their knowledge and talent. This reduced the professionalism in the banks.
  • Due to above reasons, RBI feared that banks can collapse. Hence, it mandated high Cash Reserve Ratio (CRR)  , reducing the funds at the disposal of bank for loan purposes.
  • Large staff was hired in banks , even more than what was required, to create government jobs. This led to unionization of staff and inefficient customer services. Frequent hartals of bank employees were observed in the period after nationalization.
NO OF BANK EMPLOYEES

Side Topic : Number of Public Sector Banks Today

  • Public Sector Banks = 13 ( on July 2020 including Post Payment Bank).

Old Private Banks

  • All the Big Private Banks were nationalised.
  • But there were Small Private Banks whose deposits were less than limits and they were not nationalised.
  • These Banks are now called Old Private Banks .
  • There are 12 such banks in India .
  • These are Scheduled Banks and have to maintain Cash Reserve Ratio & Statutory Liquidity Ratio .
  • Examples : Catholic Syrian Bank, Dhanlaxmi Bank, Federal Bank, Jammu and Kashmir Bank etc. .

Narsimham Committee and (Rise of ) New Private Sector Banks

After the 1980 nationalization, Public Sector Banks had a 91% share in the national banking market which has reduced to 70% in recent times. Reduced stake has been absorbed by New Private Banks (NPBs) which came up in early 1990s after liberalization. This brings us to the topic of New Private Banks .

Share of different banks in India

Private Sector Banks

1991: Balance of Payment crisis finally forced Govt. to set up a Committee for Banking Sector Reforms under the former RBI Governor M Narsimham . He recommended :

  • Government should decrease its shareholding in Public Sector Banks.
  • The resources of the banks come from the general public and are held by the banks in trust that they are to be deployed for maximum benefit of the depositors.  Even the government had no business to endanger the solvency, health and efficiency of the nationalised banks under the pretext of using banks, resources for economic planning, social banking, poverty alleviation, etc.
  • RBI should decrease CRR and SLR .
  • Priority Sector Lending (PSL) given to agriculture and Small Scale Industries (SSIs) should be phased out gradually as they had already grown to a mature stage . They don’t require any special support; two decades of interest subsidy were enough.
  • Govt. should not dictate interest rates to Banks .
  • Liberalize the branch expansion policy .
  • Allow entry of New Private Banks and New Foreign Banks.

This led to 3 Rounds of Banking Licenses

1st Round (1993-95) 10 licenses were given to open following banks.
1. ICICI
2. HDFC
3. Indus
4. DCB
5. UTI => later Axis bank
6. IDBI => now owned by LIC
7. Global Trust Bank => Merged with Oriental Bank
#8-9-10: Bank of Punjab, Centurion Bank, Times Bank were merged into HDFC  
2nd Round (2001-04)  2 licenses were given in 2nd Round
1. Kotak Mahindra
2. Yes Bank   
3rd Round (2013) Bimal Jalan Committee made selections:
1. Bandan Microfinance  (A Microfinance company based in West Bengal) 
2. IDFC (An infra finance NBFC based in Maharashtra). Later on, another NBFC “Capital First” merged so renamed into IDFC-First

Side Topic : Number of Private Banks in India

  • 22 Presently ( after IDBI is privatised)

On Tap System of Banking License

  • Present System : Start & Stop System
    • RBI issues notification and interested entities can apply at that time only..
    • Till now , 3 such rounds have happened
  • New Proposed : On Tap System
    • In this system , there will be no deadline for application. No need to wait for notification.
    • When entity thinks that it is fit to become Bank , they can approach RBI with application.
    • RBI has issued guidelines regarding this too.

No one has applied for Banking License through this route yet .

Foreign Commercial Banks

  • In Nehruvian Socialist Economy there was disdain & apprehensions about Foreign Banks. Only a handful of them were allowed to open branches. But, Post-Narasimham-Reform, foreign banks approval policy was liberalized.
  • 1991 : M Narsimham Committee recommended to allow Foreign Banks on reciprocal basis . Government accepted this proposal.
  • There are 44 Foreign Banks in India
Foreign Commercial Banks in India
  • Foreign Bank has to first open Indian Subsidiary registered in India under Companies Act .

Core Banking Solution

  • Core Banking Solution (CBS) is networking of branches, which enables Customers to operate their accounts, and avail banking services from any branch of the Bank on CBS network, regardless of where he maintains his account. The customer is no more the customer of a Branch. He becomes the Bank’s Customer.
  • It has helped in converting Branch Banking to Branchless Banking .

This marks end of article on “History of Banking System.’

Exchange Rate Regimes

Exchange Rate Regimes

This article deals with ‘Exchange Rate Regimes .’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

Types of Exchange Rates

1 . Fixed Exchange Rate

  • When the central bank of a country itself decides the exchange rate of local currency to foreign currency .
  • Eg : Consider an imaginary situation where RBI fix exchange rate of 1$ = 10 ₹.  If excess dollars are entering in the market, the RBI will print more ₹ to absorb the excess dollars and if less dollars are entering the market, the central bank will sell the (previously acquired) dollars from its forex reserve to ensure ₹ doesn’t weaken.
  • It was in operational in India upto March 1992 .

Challenge : External Shocks & Fixed Exchange Rate

  • In some situation, if demand of  foreign currency in India increases exponentially, then previous equilibrium which was maintained by RBI will disturb. Initially, RBI will try to stabilize the situation by selling $s from its forex reserve. But, since RBI will not have infinite amount of dollars in its reserve ultimately it will be forced to be devalue ₹.
  • Hence, the biggest drawback of Fixed Exchange rate regime is that it is highly prone to external factors .

Side Note :Devaluation

  • This is used by Central Bank in the Fixed Exchange Rate Economy  to cope with situations as seen above.
  • Implications of above devaluation is as follows 
    1. Demand of foreign currency will decrease because ( say) what work can be earlier done with ₹10 lakh abroad will now need 11 Lakh . So, some people will abandon their plan.
    2. Exports of country will increase because for importer of other country, price of things coming from country which devalued its currency will decrease
1$ = ₹10 1 $ =11 ₹
1 Thumbs Up = ₹10  i.e.  $ 1 1 Thumbs up = 10 ₹ i.e. $ 10/11 

2 . Floating Exchange Rate

  • Central Bank of the country doesn’t intervene at all & exchange rate is determined by the market forces of demand and supply.
  • USA and UK are the major economies following this system
  • But in this case , exchange rate is very volatile .
  • Along with that, this system is also prone to currency speculation .

3. Managed Floating Exchange Rate

  • It is the middle path between the two extremes (floating and fixed).
  • In this, Central Bank will not decide the exchange rate . In the ordinary days, Central Bank will let the market forces of supply and demand decide the exchange rate. But if there is too much volatility, then Central Bank will intervene by buying or selling the foreign reserves to keep the volatility under control.
  • Canada, Japan , India (since 1992–93) etc. follow Managed Floating Exchange Rate.

Exchange Rate in India

1928 to 1948 ‘Rupee’ was linked with the British Pound Sterling .
1948 to 1975 After formation of IMF, India shifted to the fixed currency system and committed to maintain rupee’s exchange rate in terms of gold or the US ($ Dollar).
1975 to 1992 RBI started determining rupee’s exchange rate with respect to the exchange rate movements of the basket of world currencies (£, $, ¥, DM, Fr.) .
1992 India shifted to Managed Floating Exchange Rate .

NEER & REER

We keep on reading in newspaper that ₹ has weakened against $. Does that really mean ₹ is weak currency & has become fragile?  Nope , because US is not the only country we trade with & $ is not the only currency that we use to do all of our transactions

  1. If we want to objectively measure volatility of ₹, we have to compare volatility with multiple currencies .
  2. 1$= ₹50 or 1$ = ₹40 doesn’t decide demand of goods & services between India & USA . This also depend on relative Inflation .

For this we use NEER & REER

1 . NEER

  • Nominal Effective Exchange Rate
  • It is the weighted average of bilateral nominal exchange rates of home currency in term  of foreign currencies.

2. REER

  • Real Effective Exchange Rate
  • Weighted Average  of  nominal exchange rates adjusted for inflation. Hence, it captures inflation differentials between India & its major trading partners .
  • REER  = NEER X ( Indian Inflation (CPI)  / US Inflation ) .

What we get with help of NEER & REER?

  • If REER > 100 : currency is overvalued
  • REER < 100 : currency is undervalued

Trends

Indian ₹ is overvalued (since REER > 100) and according to Economic Survey , this is bad for Indian Exports)

Trends of REER

Purchasing Power Parity (PPP)

  • It is a hypothetical concept that tries to compare exchange rate of two currencies through their purchasing power in respective countries.
  • For example , if 1packet of bread in India costs ₹ 20 whereas it costs $2 in USA then Dollar to Rupee exchange rate (PPP) will be $1 = ₹ 10.
  • According to OECD, in PPP terms  $1=₹ 17 .
  • This exchange rate can happen in real life, if both the countries have Floating Exchange Rate without any intervention of the respective Central banks; and if the bilateral trade is free of protectionism.
  • If we look into GDP of various countries in terms of PPP, then India is the third largest economy of the world. The ranking is 1) USA , 2) China , 3) India , 4) Japan and 5) Germany .

The Great Fall of Indian Rupee

1947 
1990 
48 
2008 
1995 
0-1 $ 
2005 
= Rs conversion 
2018 
civilspedia.com 
2020

Why this happened ?

  • Turkish Currency Crisis : Americans started to sell their bonds and shares from Turkey . This thing spilled over to other ‘Developing economies’ (including India)
  • Capital moving out  because of rising interest rates in US making it more attractive to invest there.
  • In 2019-20 , India rupee continued to weaken towards $1=77₹ because Corona virus pandemic . Due to this,  foreign investors started pulling out money from India and investing in US .

What India did to fight ?

  • FPI investment limits relaxed to attract foreign investors to India .
  • Currency Swap Agreements like with Japan , India has 75 billion $ Currency Swap Agreement.
  • Currency Swap Agreements  with Indian Banks .
  • Agreement with countries like Iran to buy Crude Oil directly in ₹.

Forex Reserves of India

Forex Reserves of India

This article deals with ‘Forex Reserves of India .’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

Current Status of Forex Reserves of India

  • The total foreign currencies (of different countries) an economy possesses at a point of time is its ‘foreign currency reserves or forex reserves’.
  • India’s forex reserves, is about $460 billion (Jan 2020) .
  • It is enough to finance 11 months of imports, compared to 7.8 months in March 2014 (just before the Narendra Modi government came to power and 2.5 months in March 1991 (which forced the country to seek International Monetary Fund assistance). 
  • Ranking of Foreign Reserves with RBI
    1. Foreign Currency and Foreign Currency Assets
    2. Gold
    3. IMF’s SDR
    4. SDR’s Reverse Tranche Position
  • World Ranking of Forex Reserves ( India 8th  and China topped with 3.2 Trillion Forex)
Rank Country Forex
1 China $ 3.2 trillion
2 Japan $1.2 trillion
3 Switzerland $812 billion
  —— ———–
8 India $ 460 billion

Currency Swap Agreements of India

  • Central Banks of different countries sign Currency Swap Agreements with each other to help each other in time of crisis.
  • India-Japan has signed such agreement for Swap in time of Crisis to the tune of $ 75 Billion.
  • Such agreements have been signed by India with various other countries.

Side Topic : How China reached to top position  in foreign exchange Reserve ?

  • Term used by Economic Survey for this phenomenon is ‘China’s Mercantile Policy‘ . Under this policy, China refrains from imports from other countries but at the same time, exports are encouraged.
  • China restrains from Imports in following ways
IT SOE (State Owned Enterprises)  opaquely controls the domestic market
Pharma Inordinate delay in clearance
Food SPS agreements used to ban
Manufacturing Domestic products are too cheap
  • And at the same time, Exports are promoted  by
    • Keeping Yuan Undervalued
    • SOE get cheap loans
    • Subsidies are provided on large scale
    • tech-piracy is neglected
    • Coal , iron, rare earth metals are also exported

Manipulators of Currency

  • US Treasury Department makes list of countries which manipulate their currency .
  • Conditions to include any country in this list : 3 conditions .
    • Trade surplus of over $20 billion with the US .
    • Current account surplus of 3% of the GDP with rest of the world.
    • Persistent foreign exchange purchases of 2% plus of the GDP over 12 months. 
  • In 2018,  India was included in this list. But , India was removed in 2019.
  • Countries which are included in this list includes countries
    1. China
    2. Germany
    3. Japan
    4. South Korea
    5. Switzerland.

Theories on International Trade

Theories on International Trade

This article deals with ‘Theories on International Trade .’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

Introduction

  • International Economics is that branch of economics which is concerned with the exchange of goods and services between two or more countries .
  • The subject matter of International Economics includes large number of segments :-
    1. Pure Theory of Trade : It includes issues like causes for foreign trade, composition, direction and volume of trade,  exchange rate,  balance of trade and balance of payments .
    2. Policy Issues : It includes  policy issues such as free trade vs. protection, use of taxation, subsidies and dumping, currency convertibility, foreign aid, external borrowings and foreign direct investment.
    3. International Cartels and Trade Blocs .
    4. International Financial and Trade Regulatory Institutions : Most important of which are IMF, WTO  and World Bank.

Theories of International Trade

1 . Mercantilist Theory

  • It takes  an us-versus – them view of trade.
  • According to Mercantilist Theory, World Trade remains same. Hence, one country gains by damaging the other. Increase in trade of one country means loss of some other country. Hence, nation’s wealth and power are best served by increasing exports and receiving payments in gold, silver and precious metals.
  • From the 16th to 18th century, economists believed in mercantilism. One of the leading proponent of Theory of Mercantilism was Thomas Munn (Director of English East India Company) .

2 . Adam Smith’s Theory of Absolute Cost Advantage

  • Adam Smith was in favour of free trade.
  • According to Adam Smith, the basis of international trade was absolute cost advantage. Trade between two countries would be mutually beneficial when one country produces a commodity at an absolute cost advantage over the other country which in turn produces another commodity at an absolute cost advantage over the first country.
  • Example / Illustration

Take example of India and China in production of Wheat and Cloth . Suppose, one labourer in India can produce 20 units of wheat and 6 units of cloth while that in China can produce 8 units of wheat and 14 units of cloth.

Country Wheat production by one labourer Cloth production by one labourer
India 20 units 6 units
China 8 units 14 units

Hence, India has an absolute advantage in the production of wheat over China and China has an absolute advantage in the production of cloth over India. Therefore, India should specialize in the production of wheat and import cloth from China. China should specialize in the production  of cloth and import wheat from India. This kind of trade would be mutually beneficial to both India and China.

3 . Ricardo’s Theory of Comparative Cost Advantage

  • According to David Ricardo’s Theory of Comparative Cost Advantage , a country can gain from trade when it produces at relatively lower costs. It means, even when a country enjoys absolute advantage in both goods, the country would specialize in the production and export of those goods which are relatively more advantageous. Similarly, even when a country has absolute disadvantage in production of both goods, the country would specialize in production and export of the commodity in which it is relatively less disadvantageous .
  • Example / Illustration
Units of labour required to produce one unit Cloth  Wheat Domestic Exchange Ratios
USA 100 120 1 wheat =1.2 cloth
India 90 80 1 wheat=0.88 cloth

In the illustration,  India has an absolute advantage in production of both cloth and wheat.  However, India should concentrate on the production of wheat in which she enjoys a comparative cost advantage. For America the comparative cost disadvantage is lesser in cloth production. Hence America will specialize in the production of cloth and export it to India in exchange for wheat.

4 . Heckscher and Ohlin’s Factor – Proportions Theory

  • Capital-abundant country will export the capital –intensive goods. E.g. USA exporting Aeroplanes
  • Labour-Abundant Country will export labour-intensive goods. E.g. India exporting cotton  .
Theories on International Trade

Industrial Policies of India

Industrial Policies of India

This article deals with ‘Industrial Policies of India.’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

Introduction

  • Economic development of a country particularly depends on the process of industrialisation. At the time of Independence, India inherited a weak and shallow industrial base. Therefore , during the post–Independence period, the Government of India put special emphasis on the development of a solid industrial base.
  • From time to time Government of India declared their Industrial Policies which basically moulded the nature & structure of Indian economy.

Industrial Policy Resolution, 1948

  • Announced on 8 April,1948 .
  • It was decided that model of the economy would be Mixed Economy’.
Central List Important industries were here like coal, power, railways ,civil aviation, ammunition, defence etc. .
State List Industries of medium importance were put here – medicine, textile, cycles, 2 wheelers .
Rest industries Rest of industries were left open for all private sector investment with many having compulsory licensing provisions.
  • Policy was to be reviewed  after 10 years.

Industrial Policy Resolution,1956

Government was encouraged by previous success & announced it after 8 years only. This policy structured the nature of economy till 1991.

Main provisions of Policy

1 . Reservation of Industries

  • Clear-cut classification was made into three schedules
Schedule A Contains 17 areas  in which centre was given monopoly. Industries setup under this provision were called Public Sector Undertakings (PSUs) (by 1991 number of PSU=254). PSU included those industries as well which were taken over between 1960 to 1980 under nationalisation drive .
Schedule B 12 areas in which state was supposed to take up initiative with more expansive follow-up by private sector. It also included the provisions of Compulsory licensing Neither state nor private sector had monopoly in these industries .
Schedule C All areas not covered in Schedule A & B. Private sector has provisions to setup industries. Many of them had provision of licensing .

2 . Provision of Licensing

  • All Schedule B & number of Schedule C industries came under this .
  • This provision is also called LICENCE- QUOTA -PERMIT RAJ.

3 . Expansion of Public Sector

  • Expansion of public sector was pledged for accelerated industrialisation & growth of economy .
  • Emphasis was on heavy industry .

4 . Regional Disparity

  • To tackle regional disparities, upcoming PSUs were to be setup more in backward areas (although it was completely against Theory of Industrial location).

5 . Emphasis on Small Industry

  • Committed on promoting small scale industries as well as Khadi & Village industry .

6 . Agriculture Sector

  • Agriculture sector was pledged as priority .

Industrial Policy of 1969

  • It was aimed at solving the short comings of Industrial Policy of 1956.
  • Experts & Industrialists were of view that licensing was serving opposite purpose than  it was mooted . Main aim behind Licensing policy was socialist & nationalist feeling so that
    1. Exploitation of resources could be done for development of all.
    1. Price-control of goods purchased from licensed industries .
    2. Checking concentration of economic power .  
    3. Channelizing investment into desired direction.
  • But licensing policy wasn’t serving this purpose as  
    1. Powerful industrial houses were able to procure fresh licenses at expense of budding entrepreneurs.
    2. Older & well established business houses were capable of creating hurdles for new ones with help of different kinds of trade practices & forcing  latter to agree for sell-out & takeovers .
  • Industrial Policy of 1969 introduced Monopolistic & Restrictive Trade Practices(MRTP)  Act. Main features of MRTP act were
    1. It was aimed at checking & regulating trade & commercial practices of the firms along with checking the monopoly & concentration of economic power.
    2. Firms with assets worth ₹ 25 crore (which was later increased to ₹50 crore in 1980 and ₹100 crore in 1985) or more were put under obligation of taking permission from government of India before expansion, greenfield venture & takeover of other firm .
    3. For redressal of prohibited & restricted practices of trade, Government setup MRTP Commission.

Industrial Policy Statement , 1973

1 . Core Industries

  • Policy introduced new classification of Core Industries.
  • It includes 6 industries which were of fundamental importance for development of other industries –  Iron & Steel ,Cement, Coal, Crude Oil, Oil Refining & electricity
  • Note : At that time there was 6 Core Industries. Now they are 8
    1. Coal 
    2. Crude Oil 
    3. Cement 
    4. Fertilizer 
    5. Electricity 
    6. Refinery Products 
    7. Natural Gas 
    8. Steel

2. Private Companies

  • Private Companies may apply for licenses under Core industries if they aren’t covered under Schedule A .
  • They were eligible only if their total assets were above ₹20 crore.

3. Reserved List

  • Some industries were put under reserved list in which only MSME could setup industry .

4. Joint Sector

  • It allowed partnership between center, states & private sector for setting up some industries.
  • Government had discretionary power to exit such venture in future.
  • Intention was to promote private sector with government support.

5. FERA

  • Foreign Exchange Regulation Act was introduced to regulate foreign exchange in India .
  • It was draconian law according to experts which hampered countries growth.

6. Foreign Investment

  • Limited permission of foreign investment was given with MNCs being allowed to setup subsidiaries in India .

Industrial Policy Statement, 1977

  • Political setup at centre changed so did economic policy.
  • There was more inclination towards Gandhi -Socialistic view & anti-Indira stance.

Main Features

  • Foreign investment in unnecessary areas prohibited ( in practice it was complete no) . During this period, Coca-Cola, IBM and Chrysler were made to exit India. 
  • Emphasis was placed on village industry with redefinition of small & cottage industry.
  • Decentralised industrialisation was given attention with objective of linking masses to process of industrialisation .
  • Khadi & Village industry was to be reconstructed  .
  • Serious attention was given to level of production & prices of essential commodities of everyday use .

Industrial Policy Resolution , 1980

  • Return of same old party & Industrial Policy was revised again in 1980 .
  • Foreign investment via technology transfer route was allowed .
  • MRTP limit was increased to ₹50 crore to promote setting up of bigger industries .
  • Industrial licensing was justified .
  • Overall liberal attitude followed towards the expansion of private industries .

Industrial Policy Resolution  of 1985 & 86

  • Industrial Policy Resolution of 1985 & 86 were very much similar in nature & latter tried to promote initiatives of former
    1. Foreign investment further simplified & more areas were opened . Dominant method of foreign investment was still technology transfer but foreign MNC can hold upto 49% in their subsidiary.
    2. MRTP limit was increased to ₹100 crore .
    3. Provision of industrial licensing was further simplified & remained for 64 industries only.
    4. Higher level of attention was given to sunrise industries such as telecommunication, computerisation & electronics.
    5. Modernisation & profitability aspects of PSU emphasised.
    6. Some relaxation was given in FERA regime concerning use of foreign exchange permitted so that essential technology could be assimilated.  into Indian industry & international standard can be achieved
    7. Many technology missions launched in Agricultural sector.
  • These industrial policies were mooted out by government when developed world was pushing for formation of WTO.
  • These provisions were attempted at liberalising the economy without any slogan of economic reform . The government of the time  wanted to go for kind of economic reforms which India pursued after 1991 but it lacked required political support.
  • By end of 1980s , India was in grip of severe Balance of Payment crisis with higher inflation (over 17%)  & high fiscal deficit (8%). This was magnified by Gulf war & high prices of oil . This led to Balance of Payment crisis, IMF bailout &  1991 LPG reforms

New Industrial Policy (NIP) of 1991 – LPG Reforms

Situation of India leading to LPG reforms

  • India was in severe Balance of Payment crisis in 1991 . Reasons for this were several interconnected factors which were growing unfavourable for Indian economy
    • Gulf war of 1990-91 : prices of oil became higher leading to fast  depletion of Indian Foreign currency reserves .
    • Sharp decline in private remittances from overseas Indian workers in Middle East  in wake of gulf war.
    • Inflation peaking near 17% & fiscal deficit of central government reaching 8.4%.
    • By month of June 1991 , Indian Forex has declined to just 2 weeks of import coverage .
  • Financial support that India got from IMF to fight out  Balance of Payment crisis of 1990-91 were having a tag of structural readjustment as condition to be fulfilled by Government of India.
  • With this policy the government kickstarted the very process of reform in the economy, that is why the policy is taken more as a process than a policy.

New Industrial Policy of 1991

Triple pillars of New Economic Policy were Liberalization, Privatization and Globalization (LPG).

1 . Liberalisation

Liberalization refers to removal of governmental restrictions in all stages in industry.

1.1 De Licensing of Industries

  • Number of industries put under compulsory provision of licensing (Schedule B & C) were cut down to 18 in 1991. Now only 5 industries require license and these are
    1. Alcoholic Drinks
    2. Tobacco & cigar products
    3. Defence & electronics aerospace equipment
    4. Industrial Explosives including matchboxes
    5. Hazardous Chemicals*  (Nitrocellulose, Hydrocyanic Acids, Phosgene & MIC)

1.2 De-reservation of Industries

  • Industries which were reserved for Central government in IPR,56 were cut down to 8 from 17 at that time
  • Presently only three industries are reserved for central government
Nuclear Energy Present government is seriously considering proposal of allowing private sector to enter management of nuclear power plants .
Nuclear research Consist of mining , use , management, fuel fabrication, export-import, waste management of radioactive material & no country allow private industry in this .
Railways Many of the functions related to  railways have been allowed private entry but still private sector can’t enter as full fledged railway service provider

1.3 Location of industries

Industries were categorised into polluting & non polluting & highly simple provision deciding their location was announced

Non Polluting Can be setup anywhere
Polluting Can be setup atleast 25 km away from million cities

1.4 Abolition of phased production

  • Compulsion of phased production was abolished.
  • Now private firms can go for production of as many goods & models simultaneously as they want.

1.5 Abolition of MRTP

  • MRTP limit of ₹ 100 cr was abolished .
  • MRTP Act was replaced by Competition Act & MRTP commission replaced by Competition Commission of India (CCI) .

2 . Privatisation

2.1 Privatising PSUs

  • Converting public sector companies to private sector companies by reducing Government shareholding to below 50% . Eg : Hindustan Zinc Limited etc. .

2.2 Stopped Nationalisation

  • Stopped the practice of nationalisation. Eg : Tata Airlines in 1955 nationalised to Indian Airlines , Nationalisation of Banks etc.

2.3 More sectors opened

  • Private sector companies were allowed in Banking, Insurance, aviation, telecom and other sector .

3. Globalisation

3.1 Joined WTO

  • India joined the WTO-regime & gradually relaxed the tariff and non tariff barriers on the imported goods and services. 

3.2 Promotion of Foreign Investment

  • Promotion of foreign investment was encouraged through both routes i.e. FDI (Direct) & FPI (Portfolio) .

3.3 FERA by FEMA

  • Draconian FERA was replaced with Foreign Exchange Management Act (FEMA) which came into effect in 2000-01 with sunset clause of two years .

Need of New Industrial Policy

Why we need new Industrial Policy

  1. Technological changes like 4th Industrial Revolution, Artificial Intelligence & Automation have changed the nature of industries.
  2. Large number of systemic issues in economy : Labour Laws , Infra Bottlenecks, Logistic weakness etc.
  3. Demographic conditions have changed (With increasing number of old age people, now we have to focus on Longevity Dividend along with Demographic Dividend ).
  4. World has changed (China is losing Demographic Dividend)  .
  5. Nature of Indian economy has changed (49% is contributed by Service Sector)
  6. Rise of Multilateral Trade Agreements and threat it pose to Indian economy
  7. Climate Change Problem & Paris deal obligations  .

What new Industrial Policy should focus on ?

  • Technology & Innovation: Government should  provide incentives for artificial intelligence, internet of things, and robotics.
  • Ease of Doing Business should be emphasised to attract MNCs in India.
  • Infrastructure should be made world class to end logistic problems of Indian economy.
  • More focus on Skills & Employability  of new workers. 
  • Focus should be  on labour intensive sectors  such as textiles, leather and footwear industries etc. .
  • Sustainable and responsible industrialization to reduce the carbon emissions
  • Access to Capital for MSMEs .
  • Create global brands out of India.
  • Promote Innovation and R&D via Academia- industry linkages, transparent IPR regime and encouragement to Start-ups.

National Manufacturing Policy , 2011 & NMIZ

Aim

  1. To increase manufacturing’s share in  GDP to  25%   by 2022
  2. Create  100  million jobs
  3. Creation of NIMZ (NIMZ is important component of NMP, 2011)

NMIZ  / National Manufacturing & Investment Zone

  • NMIZ is an ‘industrial township’ containing Special Economic Zones, Industrial Parks  etc. 
  • NMIZ are given additional support by government e.g. 
    1. Tax incentives
    2. Relaxed norms for FDI approval 
    3. Providing Rail, Road, energy etc .
    4. Relaxations in the labour laws e.g.  easier hiring-firing norms
  • NIMZ will be treated as self governing bodies under Article 243(Q-c) of the Constitution.
  • India has 15 NMIZ like Manesar-Bawal Investment Region in Haryana etc.

Assemble in India

Assemble in India

This article deals with ‘Assemble in India.’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

Introduction

  • Economic Survey (2020) points towards the fact that, in just the five year period 2001- 2006, labour-intensive exports enabled China to create 70 million jobs for workers with just primary education.
  • But now, firms are looking for alternatives because
    1. US–China trade war : US has placed large tariffs on products manufactured in China.
    2. Increase in wages in China.

Side Note : Network Product

  • In modern production lines, entire production is not done at single place. Different components are made at different places and then integrated at some third place to make final product. Such final product is known as Network Product.
  • Eg : iPhone => it’s screen is made in South Korea, processor is made in Taiwan , Camera in Japan and designed in California (USA) but assembly of all components is done in China .

Wild Geese Flying Model

  • The pattern of entry, rise, survival, and relative decline of countries in the export market for Network Products follows the “wild- geese flying model”
  • This process started with Japan which later moved to South Korea , then Taiwan and China and so on.
    1. Japanese Companies (like Sony) first started to assemble Cameras ,TVs, Walkman etc. . When labour costs started to rise, they shifted their manufacturing to South Korea .
    2. Then South Korean Companies like Samsung and LG grew in export of Network Products . After some time, due to cost issues, they outsourced their manufacturing to China and Taiwan.
  • Hence, Network Goods assembly will continue to move from more advanced countries to less advanced countries. (for image, CLICK HERE)
  • Economic Survey is of the view that while Japan is in declining stage, most countries including China have reached the inflection point, India is at right stage to enter this and take place of China in assembly of Network Products thus providing us sufficient opportunity to grab.
Assemble in India

Why India should focus on Network Products and Assemble in India ?

  • MNCs are moving away from China due to trade war between China and US along with rising wages in China. Hence, India should grab the opportunity to shift large chunk of Assembly Lines from China to India .
  • Network Products accounted for nearly 30 per cent of world exports in 2018. Although India has lot of potential, India lags behind in export of Network Products. In 2018, Network Products exports accounted for 10% in India’s export basket, while these products account for about 50% of the total national exports of China, Japan and Korea
  • Economic Survey (2020) suggests that by integrating “Assemble in India for the world” into Make in India, India can raise its export market share to about 3.5% by 2025 and 6% by 2030. In the process, India would create about 4 crore well-paid jobs by 2025 and about 8 crore by 2030.

Reforms required

  • To attract MNCs to Assemble in India , India needs to
    1. Reform Taxation laws
    2. Reform Labour Laws
    3. Skill training of workers and middle level supervisors.
    4. Invest heavily in infrastructure and create world class roads, railways and ports .
    5. Sign large number of Free Trade Agreements so that India becomes part of  Global Value Chains
  • While the short to medium term objective is the large scale expansion of assembly activities by making use of imported parts & components, long term objective should be giving a boost to domestic production of parts & components (and create global giants like Samsung developed in Korea and Xiaomi, Huawei etc. developed in China).

Make In India

Make In India

This article deals with ‘Make In India (MII).’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here .

What is Make in India (MII) ?

It is a program started by Government of India with objective of making India a global hub of manufacturing, design and innovation .

Why we want to Make in India ?

  • Remove excess of population in Agriculture (42%) to be employed in Manufacturing Sector.
  • To reap Demographic Dividend by providing jobs to the youth in manufacturing sector.
  • Use Cheap Labour available in the country to fill the lacunae being left to China where labour wages have started to rise .
  • We have huge domestic demand in India & still importing from abroad . Why not make in India & save our foreign exchange ?
  • To address issues created by the fact that India directly jumped from Agricultural to Service sector economy without first passing through low skill manufacturing economy.

Make In India : 5 Pillars 

1 . Simplify Processes

  • Ease Regulatory framework and cut red-tapism so that investors can invest easily and entrepreneurs can setup industries .

2. Improve Infrastructure

  • End infra bottlenecks by investing in New Industrial corridors ,  smart cities, roads , railways and world class ports .

3. Focus on 10 Champion Sectors

  • Government has recognised ten ‘Champions sectors’  under Make in India 2.0, where
    • India has potential to become global champion
    • Which can drive double digit growth in manufacturing
    • Generate significant employment opportunities.
  • These include  Capital goods, Auto , Defence & Aerospace, Biotechnology, Pharmaceuticals , Food Processing, Gems & Jewellery, New & Renewable Energy, Construction, Shipping and Railways.

4.  Open up Sectors

  • India will open new sectors for investment .
  • Steps in this direction taken eg FDI in Defence 100% and Railways 100% is allowed .

5. IPR protection

  • Protection & Promotion of Intellectual Property Rights like Patents, GI , Copyrights , Trademarks  and Industrial Designs .

Initiatives in various sectors to promote Make in India

1 . Defence and Aviation Sector

  • Defence Procurement Procedure (DPP) under which government will give first priority to the indigenously designed developed and manufactured (IDDM)  equipment.
  • Defence Offset Norms which states that when government buys defence equipment from a foreign company, that foreign company has to procure certain percentage of  components from India.

2 . Food Processing

  • Opening up of new Mega Food Parks.
  • Starting SAMPADA Scheme to promote Food Processing Industry.

3 . Automobiles

  • To promote manufacturing of electric vehicles in India, FAME-India [Faster Adoption and Manufacturing of (Hybrid &) Electric Vehicles – India] has been started.

4 . Renewable Energy

  • Preference given to domestic manufacturers for purchasing equipment for Jawaharlal Nehru National Solar Mission.

5 . Textiles

  • India Handloom Brand has been launched.
  • Special Textile Package to increase jobs and machinery upgradation has been started.

Side Topic – Make Outside India (Budget 2015)

  • Under Act East Policy .
  • Setup manufacturing units in Cambodia , Myanmar, Laos & Vietnam(CMLV ) .
  • This will be implemented via Special Purpose Vehicle (SPV) .

Benefits

  • India will become part of regional value chain .
  • From CMLV export to countries having FTA with CMLV (eg China )  (India has not signed FTA with China but CMLV countries have signed FTA with  China which can be utilised by opening Indian factories in these countries) .

Problems with Make In India

1 . Directly Moving towards high skill model

  • What India ideally should have been doing is , moving from Agrarian Economy to  Low Skill Manufacturing to leverage our Demographic dividend.
  • But MII is trying to move directly to high skill jobs from agrarian economy .

2. Time of Launch

  • Government started Manufacturing led development model at a time of global slowdown   
  • Push in infrastructure sector would have been better policy at this time.

3. TAKES MORE TO INCREASE EXPORTS

  • Only making goods will not increase exports . Along with improving manufacturing , it requires currency undervaluation, signing FTAs on large scale  , labour rights exploitation etc. (like China did)  .

4. Danger from  Automation

  • Report from Citi group claims that increased use of automation will likely led to a renewed “onshoring” of production .

5. Blindly copying Chinese Model

  • Don’t follow China success story blindly. It will not replicate everywhere