This article deals with ‘Priority Sector Lending .’ This is part of our series on ‘Economics’ which is an important pillar of the GS-3 syllabus. For more articles, you can click here.
Introduction
The basic principle in Economics states that ‘No Risk-No Reward’ & ’High Risk-High Reward’.
Hence, Banks will charge a high rate of interest from farmers, students, small entrepreneurs, etc. To tackle this, RBI in the 1980s came with PSL norms.
Who is covered under Priority Sector Lending (PSL)?
The following classes of Banks are required to give a certain percentage of their total loans to Priority Sector
Domestic Scheduled Commercial Bank (Public and Private) = 40%
Foreign Scheduled Commercial Bank (SCB) = 40%
RRB = 75 %
Small Finance Banks = 75%
Urban Cooperative Banks: 65% in FY 2024-25 which will be increased to 75% in FY2025-26
Cooperative Banks (other than Urban Coop Banks) = No Requirement
What includes PSL?
Category
% SCB
Weaker Sections
10%
Agriculture & Allied Activities
10%
Marginal & Small farmer
8%
– Added as a new category in April 2016. – Earlier Agriculture and Allied Activities were given 18% but due to broad categories, small & marginal farmers weren’t getting anything.
Micro-Enterprise – Khadi-Village industry
7.50%
All other PSL categories
4.5%
These include 1. Small & Medium Enterprises 2. Affordable housing loans to beneficiaries under PMAY 3. Food Processing Companies 4. Vermicompost, Biofertilizer and Seed Production 5. Student-Education Loans (up to Rs.10 lakh) 6. Social Infrastructure (schools, health care, drinking water and sanitation facilities) 7. Renewable Energy Projects (windmills, solar etc.)
Total PSL
40%
Note: For Foreign Banks with less than 20 branches, 40% PSL is there, but there is no internal classification. Their consolidated PSL should be 40%.
Revised Priority Sector Lending Norms
RBI announced this in 2024 to promote PSL in districts with low average loan sizes.
Incentive Framework: To incentivise the banks in giving loans in districts with lower credit flow (less than Rs.9k per person), more weight, i.e. 125%, will be given to fresh PSL disbursed in those districts.
Disincentive Framework: To disincentivise the banks in giving loans in districts with higher loan availability (higher than 42k per person), less weight, i.e. 90%, will be given to fresh PSL disbursed in those districts.
For rest of the districts, there will be no change with weight being 100%.
Benefits of Priority Sector Lending
It helps in channelizing credit to the vulnerable section.
PSL helps in financial inclusion.
PSL provides higher social returns on lending.
It helps in the diversification of the credit portfolio of the banks.
Credit Formalization: It helps break the hold of non-institutional lenders, especially in rural areas.
Issues with Priority Sector Lending
Rising NPA: Second Narsimham Committee (1998) observed that 47% of all NPAhave come from PSL. It recommended ending the system of PSL for the betterment of the Banking Sector.
Lethargy in Lending: Most banks seem reluctant to lend to the priority sectors due to higher NPAs, more administrative costs etc.
Not used for the intended purpose, especially in the Agriculture sector. The loan given to farmers under PSL is to increase productivity, but it is used for unproductive purposes like marriages and other social obligations.
Targeting issues: Suitcase farmers benefit instead of poor farmers.
Increased Costs: The administrative costs of PSL loans are high.
Deter banks from expanding their scale of lending as the more they lend, the more they will have to contribute to PSL.
What if the PSL quota is not met?
Most banks aren’t able to meet their PSL quotas. In this case, they have to invest the remainder in RIDF or SIDF as the case may be
Indian Banks + Foreign banks (with 20 or more branches)
1. RIDF =Rural infra. Development fund
Managed by NABARD
For funding rural infrastructure projects
2. UIDF = Urban Infrastructure Development Fund
New Fund announced in Budget 2023
Managed by National Housing Bank (NHB)
For funding urban infrastructure projects, especially in Tier-2 cities.
Foreign Banks with less than 20 branches
SEDF= Small Enterprises development fund
Managed by SIDBI
But the problem with both of the above is that money is given for the long term, i.e. around 20 years. Hence, banks’ money is gone for a long time which they cant use & as a result, they suffer in the meantime. To address this, RBI came with Priority Sector Lending Certificates.
Priority Sector Lending Certificates
In this arrangement, the overachieving Banks can sell their excess PSL in the form of ‘certificates’ to underachieving banks without transferring the loan assets or its risk.
Four kinds of PSLCsare traded through RBI’s e-Kuber Portal, viz
This article deals with ‘Rural Banking.’ This is part of our series on ‘Economics’, which is an important pillar of the GS-3 syllabus. For more articles, you can click here.
Steps taken to promote Rural Banking
1. Before Independence
During the British Raj & initial years of independence, Banks (& insurance companies) operated in Urban Areas only.
Result: Villagers used to rely on money lenders, who lend money at exorbitant rates & people remained in debt & poverty forever.
2. After Independence
1950s
Cooperative Banks/Societies
1955
Birth of SBI & ICICI
1960s
Bank Nationalisation (1960 & 1969)
1969
Lead Bank Scheme
1975
Regional Rural Banks (RRB) setup
1980s
NABARD setup + Bank Nationalisation(2nd Round)
Early
90s
Self Help Group & Bank Linking
Late 90s
Kisan Credit Card
Mid
2000s
– No Frills Account – Banking Business Correspondent – Interest Subvention Schemes on Crop Loans
Present
RRB Amendment + Payment Banks
Lead Bank Scheme
During the 1960s, Narsimham Committee recommended that the responsibility of development should be given to banks. Hence, Lead Bank Scheme was launched.
In 1969, the State Bank of India and its subsidiaries, along with 14 National Banks and 3 Private Banks, were selected under the Lead Bank Scheme. Every district was given to a specific bank (called Lead Bank) making it responsible for the development of Banking in that district.
Later, in 1975, these banks were asked to set up subsidiary banks in their districts known as Regional Rural Banks.
Rural Infrastructure Development Fund (RIDF)
RIDF was started in the mid-1990s.
NABARD operates RIDF.
This fund provides cheap loans to state & state-owned corporations so that they can complete projects related to
Medium & Minor Irrigation
Community Irrigation Wells
Soil Conservation
Village Knowledge Centres
Watershed
Management
Desalination Plants in Coastal Areas
Flood
Protection
Building Schools & Anganwadi Centres
Forest Development
Building Toilet Blocks
Cold Storage
Rural Roads & Bridges
Banks who don’t meet their Priority Sector Lending requirements provide money to RIDF.
A Cooperative Bank is a financial entity that belongs to its members, who are at the same time the owners and the customers of their bank.
These banks work on the principle of NO PROFIT & NO LOSS and ONE MEMBER, ONE VOTE.
They are subjected to CRR & SLR requirements. However, the requirements are less than for commercial banks.
PSL requirements are not applicable to them.
They can be Scheduled or Non-Scheduled.
They were instrumental in dismantling the hegemony of money lenders in rural finance.
Before the nationalization drive took place in the 1960s, Cooperative Banks constituted 80% of institutional credit. But after the nationalization of banks, their share decreased significantly due to stiff competition from commercial banks.
Due to the One Member, One Vote, they suffer from caste politics.
These banks don’t have an all-India presence & are present in selected regions like Gujarat, Maharashtra, Andhra Pradesh and Tamil Nadu, where the cooperative movement was strong.
In 2018, RBI allowed Urban Cooperatives to voluntarily transform into Small Finance Banks, with conditions. Consequently, Shivalik Mercantile Cooperative Bank became a Small Finance Bank in 2021.
Comparison
Commercial
Cooperative
Banking Regulation Act
Yes
Yes
(Since 1966)
CRR and SLR requirements
Yes
Yes (
but lesser than Commercial Banks)
PSL
Yes
No
Who can borrow?
Anyone
Only
Members
Voting Power
Proportionate
to Shareholding
One Member, One Vote
Profit Motive
Yes
No Profit, No Loss
Presence
All
India
Present all over India but mainly concentrated in Gujarat, Maharashtra, Andhra & Tamil Nadu.
Who Regulates Cooperative Banks?
Earlier, Cooperative Banks were under the dual regulation of RBI and the Registrar of Cooperative Societies, as shown in the figure below. But this led to delays in the corrective actions, which culminated in corruption and the fall of banks (like Punjab and Maharashtra Cooperative Bank)
Hence, Banking
Regulation Act has been amended, and the problem of dual regulation has been
solved wrt Urban and Multi-State Cooperative Banks. Now, RBI has been made the
sole regulator in the case of Urban and Multi-State Cooperative Banks.
Rural Co-Operative Banks
Structure and Funding of Rural Co-operative banks is as follows
Rural Cooperative Bank Structure (Example)
Challenges
Rural Cooperatives suffer from huge NPAs. The NPA level in these banks was around 25% in 2015.
Due to 1 person 1 vote, they suffer from Casteism during voting. After getting elected, elected officials serve people belonging to their caste only.
Although SARFAESI Act powers are given to these banks, these banks don’t take action on defaulters due to political backing.
Deposits are very low because rates are not competitive against Scheduled Commercial Banks & Post Office Deposits. Hence, they have to depend on NABARD funding.
Large-scale manipulation goes on in District Central Cooperative Banks (DCCBs) and PACS as their operations are not digitalized and aren’t connected to Core Banking Solution. During demonetization, District Cooperative Banks changed black money in the back-date.
They are under the dual supervision of RBI and the Registrar of Cooperative Societies (RCS) of the respective states. It has led to poor supervision and control.
Solution
Close down PACS & form LAMPS (LArge Sized Multipurpose Society) in their place. Their operations will not be restricted to giving loans. Apart from banking, LAMPS will also be involved in food processing, supplying fertilizers and seeds etc.
Urban Cooperative Banks (UCBs)
Traditionally, the area of operation of the UCBs was confined to metropolitan, urban or semi-urban centres and catered to the needs of small borrowers, including MSMEs, retail traders, small entrepreneurs, professionals and the salaried class. However, there is no formal restriction as such, and today UCBs can conduct business in the entire district in which they are registered, including rural areas.
UCBs are suffering from losses.
Reasons for losses
Poor Governance: UCBs are dominated by builders and manipulators. They indulge in Zombie-lending. E.g., Punjab and Maharashtra Cooperative Bank kept on doing zombie-lending to a weak company called HDIL due to corrupt nexus between directors and HDIL owners. When HDIL failed, the NPA of the bank increased exponentially, and the depositor’s money was stuck in the bank.
Stiff Competition: Urban Cooperatives are facing stiff competition from Small Finance Banks and FinTech Companies to attract new customers.
High NPA: The level of NPAs in Urban Cooperatives is high (10.9% as of September 2023).
Although they are given powers under the SARFAESI Act, bank officials don’t use them because debtors are their friends and relatives.
Steps taken
RBI’s 4-tiered Regulatory Framework for Urban Cooperative Banks: To ensure the safety of deposits in Urban Cooperative banks, a 4-tiered Regulatory Framework has been introduced. It will ensure that banks with more deposits are subjected to stricter regulations (explained in the diagram below).
National Urban Cooperative Finance and Development Cooperation: It is an umbrella organization for UCBs set up in 2024 on the recommendations of the NS Vishwanathan Committee. Such Umbrella Organizations are also present in countries such as the USA, Canada, France, etc., where cooperative banks (Credit Unions) thrive. Its primary functions include
Expand the number of UCBs.
Extend the liquidity and capital support to UCBs. It is registered with RBI as non-deposit taking NBFC and UCBs can subscribe to its capital.
Facilitate UCBs to comply with regulatory compliance .
Setup IT infrastructure for shared use of members. It will enable UCBs to provide wide array of services to their clients at lower cost.
In 2020, the power of the Union and State Government’s Registrar for Cooperative Societies to regulate the Cooperative Banks had been scrapped. These Cooperative Banks have been brought under the direct regulation of RBI. It will ensure effective regulation and curtail scams such as PMC Bank (Punjab and Maharashtra Cooperative Bank).
Banking (Regulation) Act has been amended, and according to the new provisions, 51% of the Directors should have knowledge of accountancy, banking, economics or law. This will solve the problem of the nomination of directors based on political considerations.
RBI has offered all Urban Cooperative Banks to convert to Small Finance Banks so that RBI can have more regulation over these Banks. But most UCBs are least interested in converting because of the benefits accruing from present loopholes.
RBI is forcing shutdowns (reduced from 1900 (2004) to 1500 (2018)) and mergers (Maharashtra = 72 mergers between 2004 to 2018) due to frauds and scams.
This marks the end of ‘rural banking.’ For more articles, CLICK HERE.
This article deals with ‘Differential Banks (Payment Banks, Small Area Banks, Local Area Banks etc.).’ This is part of our series on ‘Economics’ which is an important pillar of the GS-3 syllabus. For more articles, you can click here.
Differential Banks vs. Universal Banks
Differential Banks are different from Universal Banks in the following ways
Universal Banks
Differential Banks
Branches
Universal Banks can open Branch anywhere. For example: SBI, ICICI etc.
Differential Banks have geographical restrictions on branch opening. For Example: Local Area Bank (LAB), Regional Rural Banks (RRB) etc.
Money acceptance
Universal Banks can accept both Time & Demand Deposits of any amount
Restrictions are there. Eg: Payment Bank: Can accept the maximum amount of Rs 1 lakh only in deposit.
Give Loans to
Anyone
Restrictions are present. Eg: 1. Small Finance Bank, Regional Rural Bank: must give 75% to Priority Sector. 2. Payment Bank can’t give loans.
In 1975, the government appointed MM Narsimham Committee to look into Rural Banking.
Observations of the Narsimham Committee were as follows:-
The staff of the Banks has expertise in banking & financial matters but is not aware of rural people’s problems.
Primary Agriculture Credit Societies (PACS) have members from villages & are aware of the needs and problems of the villagers.
Recommendation: CREATE HYBRID OF BOTH, i.e. BANKS HAVING FINANCIAL STRENGTH OF COMMERCIAL BANKS & GRASSROOT PROBLEM AWARENESS OF COOPERATIVES. Hence, the concept of RRB came to being.
As a result, Regional Rural Banks (RRBs) were first set up on 2 October 1975 under RRB Act.
Presently, there are 43 RRBs in India (Click Here for the List)
Client of RRBs
RRB
provide loan & saving facilities to villagers & they include
Farmers
Rural Entrepreneurs
Agricultural Labourers
Cooperative societies
Rural Artisans
Primary Agricultural Credit Societies
Structure
RRBs are sponsored by Commercial Banks
Sponsor Bank provides training to the staff of RRB.
Sponsor Bank also provides initial capital to set up RRB.
RRB operates in selective districts & doesn’t have all India presence.
The provisions of Priority Sector Lending (PSL) are applicable to RRB (75% of loans should be PSL).
According to the original RRB Act, paid up capital ( ownership) of RRBs was in the ratio i.e. Central Government: State Government: Sponsor Bank = 50: 35: 15
Failure of RRBs
Due to excessive lending towards social banking & catering to highly weaker sections, these banks started to incur huge losses by the early 1980s.
Private & Public banks too started to operate in rural areas, which resulted in low deposits in RRBs. As a result, RRBs had to depend on NABARD for credit.
Debt waivers to farmers & NPA also created a lot of problems.
Subsequently, following the suggestions of the Kelkar Committee, the government stopped opening new RRBs in 1987—by that time, their total number stood at 196.
Steps to revive
RRB Amendment Act, 2015
Earlier shareholding requirements – Central : State : Sponsor Bank = 50:15:35 .
After Amendment, Centre, State & Sponsor Bank’s cumulative shareholding can reduce up to 51%.
In 2005, the amalgamation process of RRBs with their’ Parent Banks’ was initiated so these banks could become more viable (As of 2024, there are only 43 RRBs ).
RBI enabled the RRBs to avail the benefits through the Liquidity Adjustment Facility (LAF).
The obligation of concessional loans has been abolished & RRBs have started to charge commercial interest rates on lending.
Target client restrictions have been ended & RRBs can now serve anybody.
Dr KC Chakrabarty Committee has recommended that CAR/CRAR for RRBs should also be 9% & to achieve this, the government should recapitalize RRBs.
Note – Recently launched Priority Sector Lending Certificates (PSLC) will help them because RRBs do a lot of PSL.
2. Local Area Banks (LAB)
In 1996, Manmohan Singh (as Finance Minister) mooted to start Local Area Bank (LAB).
They are licensed under Banking Regulation Act but not included in the 2nd Schedule of the RBI Act.
The vision was to increase financial inclusion.
Conditions
They can operate only in Rural & Semi-Urban Areas.
LAB can operate in a maximum of 3 geographically contiguous districts.
LAB can open only 1 branch in an Urban / District city.
PSL norms apply to LABs as well. 40% of loans should go to Priority Sector.
They are not Scheduled Commercial Banks because their names are not mentioned in RBI Act.
MSME loans given by LABs aren’t covered under the Credit Guarantee Scheme of the Government.
Farm loans aren’t covered under Interest Subvention Scheme.
State/Central PSUs/Institutes don’t open accounts in them.
Branch expansion is heavily restricted in rural & semi-urban areas.
They can’t get loans from RBI at Bank Rate /MSF.
They can’t get refinance from NABARD /SIDBI.
Operating Banks
10 Licenses were given at that time & only 2 are operating presently.
LABs were in the news in 2016 when applications for Small Financial Banks were called. Usha Thorat Committee allowed them to apply for Small Finance Banks & one out of them, i.e. Capital Local Area Bank based in Punjab got the license to open Small Finance Bank
3. Payment Banks
What are Payment Banks?
Payment Banks are a new stripped-down type of bank expected to reach customers mainly through mobiles rather than traditional bank branches.
Payment Banks were formed under the recommendations of the Nachiket Mor Committee. Consequently, in 2015, RBI granted ‘in-principle’ approval for payment banks to 11 entities. There are 5 in the market now.
Established
Headquarter
Airtel Payments Bank
2017
New Delhi
Fino Payments Bank
2017
Mumbai
India Post Payments Bank
2018
New Delhi
Jio Payments Bank
2018
Mumbai
NSDL Payments Bank
2018
Mumbai
Note: Out of the 11 bank entities which got in-principle approval, 3 surrendered their licenses without starting operations and 3 started their business but are defunct now
1. Vodafone m-Pesa 2. PayTM Payments Bank 3. Aditya Birla Payments Bank
PayTM Payments Bank was stopped by the RBI to take new customers and accepting deposits in 2024 due to non-compliance of regulatory norms.
Characteristics of Payment Banks
1. Target Audience
Small Businessmen, Poor (domestic) Immigrant Workers and the Rural Population.
2. CRR
Banks have to keep Cash Reserve Ratio (CRR) just as Scheduled Commercial Banks.
3. Entry Capital
Payment Banks require ₹ 100 crores as entry capital/
4. Features
Payment Banks can hold up to ₹ 2 Lakh in Current or Saving account.
But they cant involve in any credit risk, i.e. can’t give loans to others. However, they can invest in SLR-approved securities.
They must maintain the Capital Adequacy Ratio (CAR) of 15% (compared to ordinary Banks which are required to maintain a CAR of 9%).
They can issue debit cards and ATM cards usable on ATM networks of all banks. But they can’t issue credit cards.
They can offer transactions, transfers and remittances through a mobile.
Since Payment Banks can become Banking Correspondents of Universal Banks, the customer can use the same account as that of Universal Bank and take services of Payment Bank from that account.
The Payment bank will enjoy all the rights and responsibilities of Scheduled Commercial Banks.
Payments Banks must use the word ‘Payments’ in their name to differentiate them from other banks.
Working of Payment Banks
Case Study of m-Pesa: Why India should get Payment Banks (case study)
M-Pesa is Kenya’s Payment bank.
M = Mobile & Pesa = Money in Swahili .
It provides banking services through mobile and works in the same way as Payment Banks. Nachiket Mor Committee recommended starting Payment Banks based on the success story of m-Pesa in Kenya.
Benefits of Payment Banks
Help in Financial Inclusion: It is uneconomical for traditional banks to open branches in every village, but mobile coverage is a promising low-cost platform.
Remittances at Zero Cost: Their main target is migrant labourers. It will tap India’s domestic remittance market.
Increase in the disposable income of poor migrant families: Since Remittances will happen at zero cost, it will increase disposable income in the hands of low-income migrant families.
These banks will help in the easy implementation of Direct Benefit Transfer.
They will help in moving India towards a less-cash society.
They will create job opportunities in the form of Payment Bank’s Agents.
Problems with Payment Banks
Low Revenue: Payment Banks can’t undertake any lending businesses and can only invest in SLR-approved securities.
Banks are already offering most services that payments banks can offer. Hence, offering a new and differentiated proposition will not be easy for Payment Banks.
RBI has launched Unified Payment Interface (UPI), giving a blow to the business plans of Payment banks.
Regulatory Issues: PayTM Payments bank was closed as it did not comply with the regulatory norms.
As a result, after initial enthusiasm in applying for payment banks, companies like Tech Mahindra, Sanghvi’s, and Cholamandalam Investment have opted out.
Side Topic: Indian Post
Post office as Financial Intermediary
In September 2018, India Post Payment Bank was
launched.
All 1.55 Lakh Post Offices werelinked to Payment Bank System.
3 lakh Postmen and Grameen Dak Sewaks now provide on-the-door banking facilities.
India Post Payment Bank has all the features & benefits of Payment Banks like 1. Up to 2 lakh deposit 2. 4% interest Rate 3. Debit Card facility 4. Free withdrawals from own ATMs and Punjab National Bank’s ATMs and 5. No minimum balance (with the added benefit that they already have post office infrastructure).
They have also partnered with Bajaj Alliance Life Insurance (BALIC) to sell insurance policies.
Till September 2023, more than 6 crore accounts have been opened across country including 96 lakh in Aspirational Districts.
Post office as Financial Intermediary
Indian Post is the oldest & largest organization involved in resource mobilization in India.
It has a huge network of 1.55 lakh post offices, 3 lakh postmen & 5 lakh employees.
90% of the post offices are present in Rural areas.
Earlier, too, it provided a wide array of ‘financial services’ such as saving and other time deposit accounts, Public provident funds, Monthly Investment schemes, and National saving certificates.
It comes to rescue the government when the banking system cannot deliver cash benefits such as under MGNREGA, Old age/disability Pension Schemes, etc.
Post offices worldwide have gone through this transformation in many countries & experience was quite successful there. Most notable is Royal Post in the UK, which, apart from Banking services, also provides mobile and broadband services. The US is also considering such plans.
It can free bigger commercial banks to concentrate on competitive commercial operations leaving social security works to be handled by Postal Bank.
4. Small Finance Banks
The purpose of the small banks will be to provide a whole suite of basic banking products, such as deposits and supply of credit but in a limited area of operation (contiguous districts in a homogenous cluster of states or union territories).
These are modelled on Community Banks of USA.
In Community Banks, Employees of banks know almost every family and therefore are well aware of their assets, credit history, financial position and business. As a result, MSME Industry, Retail Businessmen and Farmers can take loans from them without any problem.
Indian Parallels of Community Banks
Old Private Banks like Catholic Syrian Bank of Kerala, Nainital Bank etc.
Local Area Banks
Regional Rural Banks
Microfinance Institutions
Unlike big PSBs (like SBI) and New Private Banks (like Axis, ICICI Bank), their employees know their customers very well.
Hence, Nachiket Mor Committee (2014) recommended the creation of Small Financial Banks based on the Community Banks of the USA. Their target customer base include unserved, underserved, small and marginal farmers along with MSMEs. Even Indian parallels can get an SFB license. At last, 10 contenders got provisional license. e.g., Capital Area Bank (Punjab), Au Financiers (Jaipur) etc.
Later 2 more licenses were issued
Shivalik Small Finance Bank: Shivalik Mercantile Cooperative Bank became a Small Finance Bank, and it became the first Urban Cooperative to transition into a Small Finance Bank in 2021.
Unity Small Finance Bank: Centrum Financial Services and PhonePe entered into banking by forming Unity Small Finance Bank in 2021.
They can open bank branches with the condition that 25% of branches should be in rural unbanked areas.
The maximum loan size and investment limit exposure to single/group borrowers/issuers would be restricted to 15% of capital funds.
Loans and advances of up to ₹25 lakhs, primarily to micro-enterprises, should constitute at least 50 per cent of the loan portfolio.
They can evolve into Universal Banks after 5 years, subject to RBI’s discretion.
5. Wholesale Bank
It has not formed yet. RBI has proposed it in 2017.
Wholesale Bank will be regulated under the Banking Regulation Act.
They can only accept deposits larger than Rs.10 crore from big investors. Apart from that, they will raise money by issuing bonds.
It will not give a loan to a retail /common person. It will only lend in wholesale markets such as the infrastructure sector or corporates.
PSL norms are applicable but at the wholesale level. They will finance big projects in Priority Sector and can sell extra PSL certificates to Scheduled Banks to fulfil their targets.
Why do we need Wholesale Banks?
India needs huge investments in the Infrastructure Sector (₹40 trillion in the next decade). But there are issues.
The government is the biggest spender in the infrastructure sector (45% of total infrastructure spending). But government can’t invest more because of Fiscal Deficit problems.
The next biggest investor is banks. But they too cant invest more due to NPA Problem.
To get more investment in infrastructure, the government plans
to come up with Wholesale Banks.
The tenor of the infrastructural loans is very long, and therefore it does not incentivize institutions like Banks. Thus there is a need for separate infrastructure banks. Wholesale Banks will perform that work.
Right now, NBFCs are not under the supervision of RBI (and act somewhat like Shadow Banks) and are not covered under SARFAESI to recover their Bad Loans. It is not in the government’s interest to let them continue because they don’t have protection cover of CRR & SLR. By making Wholesale Banks, bigger NBFCs can be made to come under RBI’s regulatory supervision.
Apart from that, they will help Banks to achieve their PSL Targets. They will invest huge amounts in PSL Projects and then issue their PSL Certificates which Banks can buy.
Last Updated: Jan 2025 (Merger and Consolidation of Public Sector Banks)
Table of Contents
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 an important pillar of the GS-3 syllabus. For more articles, you can click here.
Bank Mergers
In 2016, it was decided in Gyan Sangam II that since Public Sector Banks aren’t performing well, there is a need to consolidate banks by merging small banks with the State Bank of India, Punjab National Bank, Bank of Baroda, Canara Bank etc. as Anchor Banks.
The crux of the matter is the government is working on a consolidation of public sector banks to create 3-4 global-sized banks and reduce 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.
Points in favour of Merger of Banks
It will help in placing more Indian Banks in the top 100 banks of the world. It is sine quo non to have at least 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 a $ 5 trillion economy. Currently, India has just one bank in the top 100 banks (SBI = 55 Rank), while China has 18.
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. E.g. Chinese Banks in 2008.
It will lead to branch rationalization and reduce operating costs.
Larger Public Sector Banks can support the corporate sector better in overseas acquisitions as done by Chinese Banks.
To comply with BASEL III Norms, if big banks like consolidated SBI issue shares, they can fetch a 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 the proposed new entity and its customers.
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 the NPA menace, mergers will be very distracting.
Large banks aren’t necessarily efficient banks: The quest to create an Indian banking giant is an old one when the 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 had passed the resolution that the State Bank of Travancore’s merger with SBI would negatively affect the state’s economic growth.
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 complementary banks. E.g., Bank of Baroda with Dena and Vijaya Bank so that layoffs aren’t large.
Last Updated: Jan 2025 (History of Banking System)
Table of Contents
History of Banking System
This article deals with the ‘History of Banking System.’ This is part of our series on ‘Economics’, which is an important pillar of the GS-3 syllabus. For more articles, you can click here.
Financial Intermediaries
For the economy to function
properly, savings must be channelled into investments. But there is a conflict
here between savers and businesses/corporates.
Savers: Want instant access to their savings in case of unexpected expenditure.
Businesses/Corporates: Want promise that they will not be forced to repay loans prematurely.
Banks
can solve this problem by acting as an intermediary between savers and
businesses (Ben Bernanke et al. )
Financial Intermediaries include Banks, Insurance Companies, Pension Funds, Mutual Funds etc.
Banking System
Type of Banks in India
Scheduled Commercial Banks
When RBI is satisfied that a bank has (Paid Up Capital + Reserves) of at least 5 Lakhs & it is not conducting business in a manner harmful to its depositors, such bank is listed in the 2nd Schedule of RBI Act, and it is known as a Scheduled Bank.
It is different from the Non-Scheduled Banks in the following ways
Scheduled Banks
Non-Scheduled Banks
– Scheduled Banks are bound to maintain Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) as mandated by the RBI.
They are not required to maintain SLR and CRR.
– They are eligible to borrow funds via Liquidity Adjustment Facility (Repo and Bank Rates).
It depends on RBI’s discretion to borrow via this mechanism.
It can be subdivided into 1. Scheduled Commercial Banks, e.g. SBI, Axis, PNB, ICICI Bank etc. 2. Schedule Cooperative Banks like Haryana Rajya Sahakari Bank etc. 3. Schedule Payment Banks like PayTM Payment Bank, Fino Payments Bank etc.
Hundreds of Cooperative Banks are non-Schedule Banks.
Topic: History of the Banking System in India
History of the Banking System in India before Independence
Present Banking System was initially introduced in the Western World and was later introduced in India during the British Raj.
During British times, there were two types of Banks
1. British Banks
East India Company established Banks in 3 Presidencies.
Bengal
1806
Bombay
1840
Madras
1843
In 1921, these three merged to form the Imperial Bank of India. Later, it was nationalized and became SBI.
It provided services to British Army officers, Civil Servants & Judges.
2. Swadeshi Banks
These were set up by the Indians parallel to the British Banks.
First Indian Bank to be opened was Allahabad Bank (1856). Later, other banks such as Bank of Baroda (backed by Gaekwads of Baroda), Punjab National Bank (role was played by Lala Lajpat Rai in its formation), Punjab & Sind Bank (by Bhai Vir Singh) etc. were established.
These banks targeted big merchants, particularly raw-material exporters.
But neither of these helped in financial inclusion.
Birth of RBI
By the early 1930s, many banks were operating in India. They were registered under the Company Law, and regulations on this sector were not present. But the problem arose during The Great Depression (1929), which started in the USA. Due to this, the demand for Indian exports in the foreign market decreased, and Indian merchants began to default.
Consequently, a large number of Indian banks collapsed.
To deal with such a situation and bring the banking sector under regulation, the British Indian government set up the Reserve Bank of India in 1934 under the recommendations of the Hilton Young Royal Commission.
Imperial Bank was nationalized & renamed SBI. (At the same time, the Nationalization of Insurance Companies was also done)
1960
8 Banks were nationalised & made subsidiaries of the State Bank of India.
1963
Two subsidiary Banks were merged (State Bank of Bikaner & State Bank of Jaipur), leading to the formation of the 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
Nationalisation of Banks: Except SBI (2nd Round)
1969: 14 Banks having deposits of more than ₹ 50 Crore were nationalized.
1980: 6 more banks Nationalized, having deposits of 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 a few industrialists.
Due to misuse of funds by owners.
Due to the tendency of banks to ignore the needs of small-scale industrial sector & agriculture.
To remove the concentration of banking sector mostly in the Urban areas.
Objectives after Nationalisation
To open more banks in rural & semi-urban areas & to collect savings from these areas.
To provide credit facilities to areas defined as Priority Sector in the economy.
Has the Nationalisation of Private Banks benefitted India?
According to the Economic Survey (2020), banking resources to rural areas, agriculture, and priority sectors have increased due to the nationalisation of banks. For example, in the period between 1969-90
The number of Rural Bank branches increased ten-fold.
Credit to rural areas increased twenty-fold.
Agriculture Credit expanded forty-fold.
The US Banking System shows the inefficiencies of the Private Banking System during the successive financial scams, including the Subprime crisis of 2008, lending to subprime borrowers, bias against the people of colour etc. These things have not happened in India as the banks were nationalised.
But at the same time, 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 the 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 the government was the majority shareholder of the banks, it started to give loans at populistic ‘Government Administered Interest Rates’, which decreased the banks’ profitability.
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.
Public Sector Banks account for 92.9% of bank fraud cases. A large majority (90%) were related to advances, suggesting the 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.
The politicization of Bank Boards happened with the government placing its favorites in the Board of Directors irrespective of their knowledge and talent. It reduced the professionalism in the banks.
Due to the above reasons, RBI feared that banks could collapse. Hence, it mandated a high Cash Reserve Ratio (CRR), reducing the funds at the disposal of banks for loan purposes.
A large staff was hired in banks, even more than required, to create government jobs. It led to the unionization of staff and inefficient customer services. Frequent hartals of bank employees were observed in the period after nationalisation.
PSB officers are subjected to extra scrutiny by the Central Vigilance Commission and CAG. Officers are wary of taking risks in lending or in renegotiating bad debt due to fears of harassment under the veil of vigilance investigations.
Side Topic: Number of Public Sector Banks Today
Public Sector Banks = 12 ( on Jan 2025)
Old Private Banks
All the Big Private Banks were nationalized. But there were Small Private Banks whose deposits were less than limits and weren’t nationalized. 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 nationalisation, Public Sector Banks had a 91% share in the national banking market which has reduced to 70%. The reduced stake has been absorbed by New Private Banks (NPBs), which came up in the early 1990s after liberalization. It brings us to the topic of New Private Banks.
Private Sector Banks
The Balance of Payment crisis of 1991 finally forced the government
to set up a Committee for Banking Sector
Reforms under the former RBI
Governor M Narsimham. He recommended following
Government should decrease its shareholding in Public Sector Banks.
The banks’ resources came from the general public and were held by the banks in trust that they were to be deployed for the 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 bank’s resources for economic planning, social banking, poverty alleviation, etc.
RBI should decrease Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (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.
Government 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 Licences
1st Round (1993-95)
10 licenses were given to open the following banks. 1. ICICI 2. HDFC 3. Indus 4. DCB 5. UTI (later became Axis bank) 6. IDBI (presently owned by LIC) 7. Global Trust Bank (later merged with Oriental Bank) 8-9-10: Bank of Punjab, Centurion Bank, and Times Bank were later merged into HDFC
2nd Round (2001-04)
2 licenses were given in the 2nd Round 1. Kotak Mahindra 2. Yes Bank
3rd Round (2013)
Bimal Jalan Committee made selections 1. Bandhan Bank (Originally, a Microfinance company based in West Bengal) 2. IDFC (Originally, an infra finance NBFC based in Maharashtra).
Side Topic: Number of Private Banks in India
21 presently (these include both Old and New Private Banks).
On Tap System of Banking License
Earlier System: Start & Stop System
RBI issued notification and interested entities can apply at that time only..
Till now, 3 such rounds have happened
The new system proposed in 2016: On Tap System
In this system, there will be no deadline for application. Hence, there is no need to wait for notification.
When an entity thinks it is fit to become a bank, it can approach RBI with the application.
RBI has issued guidelines regarding this too.
In 2021, RBI gave Small Banking License to Unity Small Finance Bank through this route.
In 2023, the PRAVAAH Portal was started, where companies can apply for licenses from the RBI
The following company can apply for Bank License via the ‘On-Tap’ System
The company must have a minimum of 500 crores paid-up capital.
The company must have 10 years of record in the banking/finance sector.
Initially, it must be controlled by Indians (100% shareholding should be with Indians).
Applicant must be willing to open a minimum of 25% branches in rural areas.
They have to maintain CRR, SLR, PSL etc.
But large industrial houses and NBFCs can’t open banks via this route.
Foreign Commercial Banks
In the Nehruvian Socialist Economy, there was disdain & apprehensions about Foreign Banks. Only a handful of them was allowed to open branches. But, Post-Narasimham Reforms, foreign banks approval policy was liberalized.
In 1991, M Narsimham Committee recommended allowing Foreign Banks on a reciprocal basis. The government accepted this proposal.
There are 44 Foreign Banks in India
AB Bank
Abu Dhabi Commercial Bank
American Express Banking
ANZ Banking Group
Bank of America
Bank of Bahrain and Kuwait
Barclays Bank
BNP Paribas
Citibank
Commonwealth Bank of Australia
CCRB
Credit Agricole
Credit Suisse
DBS Bank
Deutsche Bank
Doha Bank
FirstRand Bank
Industrial and Commercial Bank of China
Industrial Bank of Korea
JP Morgan Chase Bank
JSC VTB Bank
KBC Bank
KEB Hana Bank
Krung Thai Bank
Mashreq Bank
Mizuho Bank
National Bank of Australia
National Bank of Abu Dhabi
PT Bank
Maybank Indonesia
Sberbank
SBM Bank
Shinhan Bank
Societe Generale
Sonali Bank
Standard Chartered Bank
Sumitomo Mitsui Banking Corporation
Bank of Nova Scotia
Bank of Tokyo
The Hongkong and Shanghai Bank
Royal Bank of Scotland
United Overseas Bank
Westpac Bank
Woori Bank
First, foreign banks have to open an Indian Subsidiary registered in India under the Companies Act.
Core Banking Solution
Core Banking Solution (CBS) is the networking of branches, enabling customers to operate their accounts and avail banking services from any branch of theBank on the 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.
Entry of Business Houses in the Banking Sector
Procedure to open a new bank
Register the company with the Ministry of Corporate Affairs.
The company has to issue IPO in the share market after taking SEBI’s permission to arrange the capital.
Then, the company has to take permission from RBI through the ‘On Tap’ System.
After doing this, the company will initially get a Non-Scheduled Bank License. After some years, when RBI is confident that the bank has good health, RBI will upgrade the license of the Bank to Scheduled Commercial Bank.
Analysis: Should private houses be allowed to open banks
Arguments in favour
More competition will lead to better services, higher interest rates and better customer services.
Existing banks have stressed balance sheets due to high NPAs. Hence, they have become over cautious while giving new loans. The entry of fresh banks will re-invigorate the lending process.
It will help the ‘shadow banks’ such as IL&FS and DHFL to become banks and come under the proper supervision of RBI.
Based on the above arguments, PK Mohanty Committee, to review the corporate structure for Indian Private Sector Banks (2020), recommended allowing private houses’ entry into the banking sector.
Arguments against
Connected Lending: In Connected lending, promoters of the bank lends loan at favourable terms to the companies owned by that group. The issue of connected lending was rampant in India from 1947 to 1958, which led to the failure of 361 banks in India during that phase.
Circular Banking: It has the potential to lead to circular banking under which a bank controlled by Corporation A lends a loan at favourable terms to Corporation B and a bank controlled by Corporation B lends a loan at favourable terms to Corporation A. In the process, the interests of the depositors are jeopardized.
The higher competition will lead to excessive loan disbursement and misspelling of the banking products to gain new customers and retain the old customers. These types of practices led to Subprime Crisis in 2007-08. After the subprime crisis, most countries have become cautious to such ideas.
History: Corporate houses were active in the banking sector till five decades ago, when the banks promoted by them were nationalized in the late sixties amid allegations of connected lending and misuse of depositors’ money.
RBI cannot effectively regulate the existing banks as shown by various scams like Yes Bank-Rana Kapoor Scam, ICICI-Vodafone Loan Scam, Punjab National Bank-Nirav Modi Scam etc. Hence, it is not guaranteed that RBI will be able to regulate the new banks effectively.
Large industrial houses face severe corporate governance issues, as epitomized by Ratan Tata- Cyrus Mistry and Narayan Murthy-Vishal Sikka controversy. In such a situation, allowing them to open banks is not advisable.
Banks controlled by big business houses can be misused for nefarious activities such as money laundering.
It can create very powerful oligarchs with large economic power.
Even regulators in developed countries don’t encourage the entry of business houses in the banking sector.
Considering the above discussion, the risks outweighs the
benefits. Government can take steps to strengthen the corporate structure and
health of the present banking sector.
This marks the end of the article on “History of Banking System.’
Last Updated: Jan 2025 (Convertibility of Current Account & Capital Account)
Table of Contents
Convertibility of Current Account & Capital Account
This article deals with ‘Convertibility of Current Account & Capital Account .’ This is part of our series on ‘Economics’, which is an important pillar of the GS-3 syllabus. For more articles, you can click here.
Why restrictions on Convertibility?
Central Bank can’t manage a floating exchange rate regime all the time. Otherwise, Forex reserve will get empty. Hence, quantitative restrictions are placed on the conversion of ₹ to foreign currency.
There can be two types of restrictions, i.e. on the Current Account & Capital Account.
Current Account Convertibility
Current account convertibility means the freedom to convert currency for current transactions in terms of outflows and inflows.
In the case of India, Current Account is fully convertible (since 1994) & there are no quantitative restrictions. It means ₹ is fully convertible into another currency for current account transactions & vice versa is also true.
Capital Account Convertibility
Full capital account convertibility means :
A foreign investor can convert any amount of foreign currency to Indian Rupees and invest in any asset in India without any restriction. This investor can also sell the investment without any restriction, convert the resulting Indian Rupee amount to a foreign currency and take it out of the country.
A Domestic Investor can convert Indian Rupee to foreign currency and invest in any asset abroad without any restriction.
A Domestic Investor can raise any amount from External Market and convert it into Indian Rupees to invest that amount in India.
₹ is not fully convertible on the capital account. But after the S.S. Tarapore Committee (1997) recommendations on Capital Account Convertibility, India has been moving toward allowing full Capital Account Convertibility.
There are the following limitations on Capital Account Convertibility
Indian corporates are allowed full Convertibility of up to $ 500 million annually for oversea ventures.
Individuals are allowed to invest in foreign assets, shares, etc., up to $ 2,50,000 per annum.
Liberalised Remittance Scheme (LRS)
LRS was started by Government in 2004.
Under the scheme, an Indian resident (including a minor) is allowed to take out up to $2,50,000 from India either for a current Account or capital account transaction. (e.g. paying for college fees abroad, buying shares, bonds, properties, and bank accounts abroad.)
Issue: Panama papers allege various Bollywood celebrities used the LRS window to shift money from India to tax havens for tax avoidance.
Debate : Should there be Full Capital Account Convertibility?
There is an ongoing debate that there should be full capital account convertibility.
Arguments in favour of full Capital Account Convertibility
If the capital account is fully convertible, India can attract more FDI, FPI and ECB to India, creating new jobs & pushing economic growth.
It will increase the choices for investments– Investors get the opportunity to base their investment and consumption decisions on world interest rates and world prices for tradeable.
Various committees like SS Tarapore Committee have also accepted this.
Arguments against Capital Account Convertibility
IMF study says there is no correlation between full Capital Account convertibility & business growth.
It could lead to the export of domestic savings.
Companies that would get money in $ via ECB would be returned in $s only. But this is not favourable in times of Exchange rate volatility.
If our currency falls, the whole system can collapse, as happened in the East Asian Crisis of 1997. India & China survived the crisis because both didn’t have full capital account convertibility.
Various committees, like HR Khan Committee, have rejected full Capital Account Convertibility.
Side Topic: East Asian Financial Crisis
Before 1997, All East Asian Economies deliberately kept their currencies undervalued to boost export. (like China is doing now)
All these countries had full capital account convertibility. Foreign investment was quite high, and GDP growth was in double digits.
Thailand’s steel & automaker companies filed for bankruptcy. Foreign investors panicked and started to pull out $s from similar companies from all South East Asian Nations. As a result, their currencies & economies collapsed. E.g.: Indonesian Rupiah collapsed from 1$ = 2,000 to 1$ = 18,000 Indonesian Rupiah.
It led to high inflation culminating in rioting & political instability.
On the other hand, India and China survived this tumultuous period because their capital account wasn’t fully convertible. Hence, investors couldn’t pull off their investments overnight due to restrictions under Capital Account convertibility.
SS Tarapore Committee (1997)
The recommendations of the committee were as follows
He was in favour of Full Capital Account convertibility, but he also feared that a crisis like East Asian Crisis could happen in India too. For this, he advised that there should be some conditions before doing that
Conditions
Conditions
India’s situation
Forex
to sustain 6 months of imports
Yes, India has a forex of more than $550 billion (i.e. Can sustain
11 months of imports)
Fiscal
Deficit of 3.5% of GDP
Target for 2020 is 3.5% (but
will be breached due to Corona pandemic induced slowdown)
Inflation
should be between 3-5% (for 3 years)
Under
the new Monetary Policy Framework, it should be contained between 2-6%
This article deals with ‘Forex Reserves of India .’ This is part of our series on ‘Economics’, which is an important pillar of the GS-3 syllabus. For more articles, you can click here.
Current Status of Forex Reserves of India
Forex is the external assets that are readily available and controlled by the monetary authority for direct financing of external payment imbalances, for indirectly regulating the magnitude of such imbalances through exchange market intervention to affect the currency exchange rate and other purposes.
In Oct 2024, India had a Forex Reserve of $700 billion, enough to finance about 11.9 months of imports. In March 1991, it was reduced to just 2.5 months of import coverage (which forced the country to seek International Monetary Fund assistance).
Ranking of Foreign Reserves with RBI
Foreign Currency and Foreign Currency Assets
Gold
IMF’s SDR
Reverse Tranche Position in the IMF
World Ranking of Forex Reserves ( India 6th 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
—-
———
————-
6
India
$700 billion (Oct 2024) (Covering 11.9 months of imports)
In recent past, India has seen rise in the Forex Reserves. The reasons behind the rise include
Increase in Foreign Direct Investment and Foreign Portfolio Investment in India.
Remittances sent by NRIs.
Reason for maintaining High Forex Reserves
It reduces the risk of external vulnerabilities such as high oil prices or Fed Tapering.
Exchange Rate Management: High Forex allows occasional RBI intervention to curb excessive volatility in the foreign exchange market.
It increases the investor’s confidence in the economy of the country.
It will help India to become a regional leader by signing currency swap agreements with other neighbours such as Sri Lanka, Bangladesh etc.
Issues with maintaining more than required Forex
While reserves are imperative in both preventing crisis situations
and mitigating their impact, there are issues with maintaining more than
required Forex Reserves. The problems with maintaining more than required Forex
reserves include
Lost Opportunity Cost: Holding more than the required Forex Exchange reserve has opportunity cost because the stored money could be used for improving infrastructure and social services (like health and education)
Increase borrowing cost: Borrowing in foreign currency has high borrowing cost and is vulnerable to volatility in the exchange rate
Is India’s Forex Reserves enough?
As evident from the graph above, India’s Forex reserves have reduced. But it should not be a cause of worry as India has enough Forex Reserves based on the following yardsticks.
#1 IMF’s Guidotti–Greenspan Rule
According to Guidotti-Greenspan Rule, the country should have enough Forex Reserves to cover the short-term external debt.
Indian Forex Reserves comfortably meets this rule.
#2 RBI’s Tarapore Committee
According to Tarapore Committee, the country should have enough Forex Reserves to pay for 6 months’ imports.
Indian Forex Reserves comfortably meets this rule as well (Indian Forex Reserves can pay for more than 9 months’ imports).
Side Topic: How did China reach the top foreign exchange reserve position?
The term used for this phenomenon is ‘China’s Mercantile Policy’. Under this policy, China refrains from imports from other countries, and at the same time, exports are encouraged.
China restrains from imports in the following ways
IT
SOEs
(State Owned Enterprises) opaquely control the domestic market
Pharma
Inordinate delay in clearance
Food
SPS agreements used to ban imports
Manufacturing
Domestic products are too cheap
At the same time, Exports are promoted by
Keeping Yuan undervalued
SOE get cheap loans
Subsidies are provided on a large scale
Tech-piracy is neglected
Side Topic: Manipulators of Currency
US Treasury Department makes a list of countries which manipulate their currency.
3 Conditions to include any country in this list
A trade surplus of over $20 billion with the US.
The current account surplus is 3% of the GDP with the 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.
This article deals with ‘Balance of Payment.’ This is part of our series on ‘Economics’ which is important pillar of GS-3 syllabus . For more articles , you can click here.
Introduction
Balance of Payment is the summary/account sheet made by the country’s central bank that shows the cash flow between residents of a country with the rest of the world for a specified time period, typically a year.
A payment to a foreign country is a debit transaction, whereas a payment received from a foreign country is a credit transaction.
Outgoing
-ive
Incoming
+ive
The IMF decides the format, and all data is presented in dollars for the comparison’s sake.
If the Balance of Payment of all countries is added, the answer will be zero (because one nation’s credit becomes the other’s debit).
Components of Balance of Payment
Balance of
Payment comprises two parts: Current Account and Capital Account.
Current Account
The Current Account is the record of trade in goods and services, transfer of income (in the form of profit, interest and dividend) and transfer payments.
Capital Account
Capital Account records all international transactions of assets. An asset is any one of the forms in which wealth can be held, for example, money, stocks, bonds, Government debt, etc.
Part 1: Current Account
Note: In the Economic Survey, 2023 (which was published on 31/Jan/23), they have published only partial data from April to December-2022. Hence, instead of going into the exact data of each component, we will look into general trends. Even UPSC asks about general trends in the exam.
Visible Part and Balance of Trade (BoT)
The movement of goods (export and import) is also known as ‘visible trade’ because the movement of goods between countries can be verified physically by the customs authorities of a country.
Balance of Trade is the net difference between the export & import of goods.
India always has a trade deficit because Indian imports are always more than exports.
Imports & Exports of Goods
Major Exports
1. Petroleum Products (14% of all exports) 2. Gems and other precious metal Jewellery 3. Organic and Inorganic Chemicals 4. Drug and Biologicals 5. Iron and steel
Major Imports
1. Petroleum: Crude (22% of all imports) 2. Electronic goods 3. Coal and coke 4. Gold 5. Chemicals
But there is a danger of a slowdown in Indian exports due to the fear of a global recession.
RoDTEP Scheme
Under RoDTEP, tax credit earned by the merchant can be used to settle (1) Customs Duty, (2) excise duty and VAT on the export of fuel, (3) electricity duty on the export of electricity and APMC Mandi fees on the export of agricultural raw material.
Remission of Duties & Taxes on Exported Products (RoDTEP) has replaced MEIS (Merchandise Exports from India Scheme) as MEIS was declared against WTO obligations and also due to the shortcoming that MEIS tax credits can be used to settle Customs Duty only.
Steps to Improve Export Competitiveness of India
Some suggestions from Economic Surveys of recent years are as follows
1. Change in mindset
Indian policymakers and businesses will have to change their mindset. They shouldn’t only produce what they can make with ease. Instead, they should focus on what the world needs from India.
2. Product Basket and Destination Diversification
India should focus on Product basket and destination diversification. It can be achieved by signing more FTAs to enhance trade opportunities.
3. Logistics
Government should focus on improving the logistics to make Indian exports more competitive.
4. Sign FTAs
India should sign Free Trade Agreements with as many nations as possible.
5. Currency Rate
India should make sure that the Indian Rupee is not overvalued.
Most of the time, it has been observed that REER is greater than 100. As a result of the overvaluation of the Indian Rupee, Indian exports are expensive compared to our competitors like Vietnam and Bangladesh.
6. Promote Make in India
India should make a solid industrial base and encourage export-oriented manufacturing (as China did in the past).
7. Combine Assemble in India with Make In India
‘Assemble in India for the world’ should be integrated with the ‘Make in India’. By doing so, India can raise its export market share to about 3.5 per cent by 2025 and 6 per cent by 2030.
8. Use GI Tags
India should export products like Darjeeling Tea, Basmati rice etc.
9. Other suggestions
India should reduce the import of petroleum by promoting ethanol blending of ethanol.
India needs to utilize SEZ potential properly due to numerous policy issues.
The Government has introduced Export Preparedness Index to evaluate State’s capacity and potential to export goods. It will guide the stakeholders to strengthen the export ecosystem accordingly in a particular area.
Invisible Part & Balance of Invisibles
Balance of Invisibles is the difference between the export & import of Invisibles, i.e. Services, Income and Transfers.
Generally, the Balance of Invisibles is positive for India.
1. Service
India has always been a surplus in Services due to the well-developed IT and BPO sectors.
Hence, the general trend is that India is a surplus in Services.
Note – The general trend is that Trade in Goods and Services (combined) is negative because Trade Deficit is much larger than the Surplus in Services.
Major exports and imports of India in services are
Exported Services
1. Software, IT and BPO services (40% of all service exports) 2. Transportation 3. Travel tourism 4. Financial
Imported
Services
1. Business Services (like digital advertisements) 2. Foreign Travel 3. Fees for using the intellectual property of foreign entities
Service Export from India Scheme (SEIS)
The government introduced this scheme to increase the export of Services from India.
Under this, for the export of Services worth every $100, Commerce Ministry transfers $ 5 to the Scrip Wallet of that firm, which can be used for paying tax liabilities.
2. Income
Income consists of profit earned by FDIs, interest on loans & dividends earned by investors.
It has to be noted that whenever a foreign investor invests in any country, he will get back a dividend (in case of equity) or interest (in case of debt) or profit (in case a company like Amazon is doing FDI in India). These incomes are counted in the Current Account.
The general trend is that India is a deficit in Income.
3. Transfer
It includes three things.
Remittances (sent to India by Indians living abroad and by foreigners residing in India to their native countries (e.g. Nepal))
Gifts
Donations
According to World Bank’s Remittance Report, India receives the largest amount of remittance (about $100bn), followed by (2) Mexico, (3) China, (4) the Philippines and (5) Egypt.
The general trend is that India is a surplus in Transfers.
Current Account of India (Final Stats)
The Current Account is in balance when receipts on the Current Account are equal to the payments on the Current Account. A surplus Current Account means that the country is a net lender to other countries, and a deficit Current Account implies that the country is a net borrower from other countries.
India
generally has a DEFICIT CURRENT ACCOUNT.
Based on a historical perspective, India can sustain a CAD of 2.5-3.0% of GDP without getting into an external sector crisis.
Note:
From 2001 to 04, India had a Current Account Surplus because Indian exports to
Western economies were booming, especially in the wake of the BPO revolution in
India.
Current Account Deficit is not considered good
If CAD increases, the currency of the country weakens.
For a country like India, which has high imports, it increases the cost of imports impacting the economy negatively.
CAD for 2023-24 can be a challenge as
The prices of commodities that India imports (like petroleum, gold etc.) have reached record-high levels. Additionally, there is strong pent-up domestic demand for foreign goods in India.
Due to the slowdown in the advanced economies, the global demand for Indian goods is low.
The rupee has been weakening against the US dollar, further increasing the cost of imports.
Side Topic : Major Importers and Exporters of India
Importers of Indian Products
1. USA (16% of India’s exports are sent to the USA) 2. United Arab Emirates 3. Netherlands 4. China
Exporters to India
1. China (14% of all Indian imports are from China) 2. USA 3. United Arab Emirates 4. Saudi Arab 5. Iraq
It has to be noted that
India has a large Trade Deficit with China, Saudi Arabia, Iraq, Germany, South Korea, Switzerland and Indonesia.
India has been diversifying its export destinations. E.g., South Africa, Brazil, Saudi Arabia etc.
Part 2: Capital Account
The Capital Account is the second account, recording all international purchases and sales of assets such as money, stocks, bonds, etc., for a specified time, usually a year.
Investment – FDI & FPI
What constitutes Foreign Direct Investment (FDI) ?
According to Arvind Mayaram Panel, more than 10% of equity investment made by a foreign entity into an Indian company with the motive of getting involved in the management of that Indian company is known as FDI.
E. g. : Walmart of USA has 77% stakes in Flipkart.
What constitutes Foreign Portfolio Investors (FPI) ?
FPIs are foreign entities registered with SEBI and have up to 10% equity in an Indian Company.
FPIs are not involved in the management of a company. Their primary motive is to earn profit by buying and selling shares.
Note: Till 2019, the summation of all the FPIs in a company could be at most 24%. But in the 2019 Budget, the government removed the 24% cap.
Sector-wise Foreign Investment (FDI + FPI) Limit
Note: The list is not exhaustive and keeps changing frequently. For the latest limits, please cross-check government sources as well
100% FDI allowed
1. Single Brand Retail 2. E-commerce (marketplace model) 3. Defence Industry 4. Railway Infrastructure (Construction, operation and maintenance) 5. Industrial Parks 6. Telecom services 7. Pharma Companies 8. Contract manufacturing 9. Asset Reconstruction Company (ARC) 10. Floriculture, Horticulture, and Cultivation of Vegetables 11. Animal Husbandry, Pisciculture, Aquaculture, Apiculture 12. Plantation : Only in plantations of Tea, Coffee , Rubber , Cardamom , Palm oil and Olive oil tree plantations 13. Airports (both Greenfield and Brownfield projects) 14. Air Transport Services 15. Maintenance and Repair in air transport 16. Mining and Exploration of metal and non-metal ores 17. Coal and lignite 18. Exploration activities of oil and natural gas fields 19. DTH and Cable Networks 20. Non-news channels
74%
1. Private Banks 2. Private Security Agencies
51%
1. Multi Brand Retail Trading
49%
1. Insurance Company 2. Pension Sector Companies 3. Power Exchanges 4. FM and News channels
26%
1. Digital Media 2. Newspapers and periodicals
20%
1. Public Sector Banks
Prohibited
1. E-commerce ( inventory based model ) 2. Atomic energy 3. Railway operations (except Metro) 4. Tobacco Products like cigars , cigarillos and cigarettes 5. Real Estate Business and Farm Houses 6. Chit Funds and Nidhi Companies 7. Betting , Gambling, Casino & Lottery.
Foreign Investment Promotion Board (FIPB)
Foreign Investment is permitted either through:
Automatic Route: i.e. Foreign entities don’t require Indian Government’s approval.
Government Route: i.e. Approval of the Government is required prior to investment.
Earlier, this approval was given by FIPB. But, Budget 2017 removed this Board to promote Ease of Doing Business by removing Red-Tapism in bureaucratic decision-making and reducing the time for mergers and acquisitions.
Now, Government approval is given by the Commerce Ministry after consultation with the subject ministry.
FDI in India
1. Sector Wise
Sectors receiving maximum FDI in India are
Computer Hardware & Software (44%)
Construction (13%)
Services (8%)
2. Country-wise
Countries with maximum FDI in India are
Singapore
Mauritius
UAE
USA
3. States with Maximum FDI
Indian states having maximum FDI are
Gujarat (27%)
Maharashtra (27%)
Karnataka (13%)
4. State Wise Analysis
A state-wise analysis of FDI inflows to different Indian states shows a clear regional disparity in FDI inflows. Delhi, Haryana, Maharashtra, Karnataka, Tamil Nadu, Gujarat and Andhra Pradesh have together attracted more than 70 % of total FDI inflows to India during the last 15 years.
However, states with vast natural resources, like Jharkhand, Bihar, Madhya Pradesh, Chhattisgarh and Odisha, have not been able to attract foreign funds directly for investment in different sectors.
What government has done to attract FDI ?
The Government has abolished Foreign Investment Promotion Board (FIPB)
A number of sectors have been opened for FDI, including defence, construction, broadcasting, civil aviation etc.
Investor Facilitation Cell has been created under Invest India Program to guide, assist & handhold investors.
For some countries like Japan, a special program like Japan Plus has been started.
The Insolvency and Bankruptcy Code has been passed to make an exit from non-viable businesses easier.
“Foreign Investment Facilitation Portal (FIF Portal)” has been launched as the online single-point interface of the Government of India for investors to facilitate Foreign Direct Investment.
FDI & FPI Trends in India (2018-19)
FDI
FDI is positive for India as India attracts significant investments in FDI.
FPI
– There is no general trend for FPI, and it can be positive or negative depending on the situation. – In FY 2023, there was a net outflow of the FPI (mainly due to Fed Tapering).
Fed Tapering and FDI
The US
and other advanced economies are witnessing very high rates of inflation due to
the following reasons
Loans were provided at an ultra-low interest rate during the Covid pandemic to boost the economy.
Supply chain disruptions due to the Russia-Ukraine war.
To combat inflation, the Federal Bank of America (the equivalent of RBI of India) has started to increase their Repo Rate, thus making the loans expensive in the USA. This process is known as Fed Tapering.
Fed Tapering has an impact on India and other developing economies as well. When the Feds were following Easy Money Policy, US investors were investing their excess funds in India and other developing economies as the rate of return on the US bonds was extremely low. But when Feds started to increase Repo Rate, the Bond Yield on US bonds increased, and investors started to take their money out of India. E.g., the bond yield on a 10-year US bond was 0.54% in July 2020 and raised to 3.30% in Feb 2023.
Overall,
Fed Tapering has the following impacts on the Indian economy
Flight of FPI and FDI from India (as explained above)
The flight of investment leads to a fall in Rupee vis-à-vis US Dollars
The inflation from the US economy is exported the world over.
Loans
In loans, the Indian account is +ive.
Internally, Private External Commercial Borrowing is more than Sovereign foreign debt.
Such loans are beneficial during good times as borrowers could enjoy the benefits like lower interest rates, longer maturity, and capital gains. But sharp depreciation in local currency would mean a corresponding increase in debt service liability, as a more domestic currency would be required to buy the same amount of foreign exchange.
Composition of Indian Debt
Tenure Wise
Long Term (78%) more than Short Term (22%)
Sector Wise
Private Sector (80%) more than Public Sector (20%)
NRIs can deposit their $ (or other foreign currency) in Indian Banks via FCNR Accounts.
Interest to be paid on FCNR deposits is tied up with LIBOR (London Interbank Offered Rate).
Capital Surplus
India’s Capital Account is in Surplus.
Balance of Payment condition of India
The outcome of the total transactions of an economy with the outside world in one year is known as the Balance of Payment (BoP) of the economy. It is the net outcome of an economy’s current and capital accounts.
The Balance of Payment can be positive or negative. However, negative doesn’t mean it is unfavorable for the economy until it has the means to fill the gap with the help of its forex reserves.
Various conditions
Positive BoP
If the Balance of Payment is positive at the end of the year, the money is automatically transferred to the foreign exchange reserves of the economy.
Negative BoP
If the Balance of Payment is negative at the end of the year, the foreign exchange is drawn from the country’s forex reserves.
If the forex reserves cannot fulfil the negativity created by the BoP, it is known as a BoP crisis. India faced such a situation in 1991 when India was forced to take forex help from the IMF.
India’s BoP position (for 2022-23)
Only preliminary data was presented in the Economic Survey (2023). For period Apr-Dec 2022, India Balance of Payment -14 billion.
But India has forex reserves of more than $ 560 billion. Hence, India faced no problem in bridging the gap.
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 :-
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 .
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.
International Cartels and
Trade Blocs .
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 .
Last Updated: Jan 2025 (Industrial Policies of India)
Table of Contents
Industrial Policies of India
This article deals with ‘Industrial Policies of India.’ This is part of our series on ‘Economics’ which is an important pillar of the GS-3 syllabus. For more articles, you can click here.
Introduction
‘Industrialize or perish!’ – M. Visvesvaraya
Statistics about the Manufacturing Sector
With the
development of the economy, the percentage of people engaged in industry is
increasing, and its contribution to the net GDP of India is increasing as well.
a. Percentage of Indians employed in Manufacturing Sector
In 2018, 24% of Indians were employed in the Industrial sector.
b. Contribution of Manufacturing in India’s GDP
Its contribution to India’s total GDP is 29% (in 2018).
c . Indian companies in Fortune-500
There are 7 Indian companies on the Fortune-500 list. These are
Reliance Industries
155
State Bank of India
205
Indian Oil
212
ONGC
243
Rajesh Exports
348
Tata Motors
357
Bharat Petroleum
394
d . Growth Rate
Post-Covid, the Industrial Sector has started to revive and witnessed a strong growth of 9.5% in FY-2024.
Indian Industrial Policies – History
Industrialization is sine quo none for the economic development of any country. At Independence, India inherited a weak and shallow industrial base. Therefore, during the post–Independence period, the Government of India emphasized the development of a solid industrial base.
The Government of India has declared its Industrial policies at various times, which has changed the trajectory of the Indian economy.
Industrial Policy Resolution, 1948
It was announced in 1948.
It was decided that model of the economy would be ‘Mixed Economy’. It divided the economy into the following three lists
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
All rest industries were left open for all private sector investment, with many having compulsory licensing provisions.
The policy was to be reviewed after 10 years.
Industrial Policy Resolution,1956
The government was
encouraged by previous success & announced it after 8 years only. This
policy structured the nature of the economy till 1991.
Main provisions of Policy
1. Reservation of Industries
A
clear-cut classification was made into three schedules
Schedule A
– It contains 17 areas in which the centre enjoyed a monopoly. – Industries set up under this provision were called Public Sector Undertakings (PSUs). – PSU included those industries as well, which were taken over between 1960 and 1980 under the nationalization drive.
Schedule B
– Schedule B consists of 12 areas where the state was supposed to take up the initiative with more expansive follow-up by the private sector. – It also included the provisions of Compulsory licensing. – Neither state nor private sector had a monopoly in these industries.
Schedule C
– Schedule C consists of all the areas not covered in Schedule A & B. – The private sector has provisions to set up industries. – Many of them had provision of licensing.
2. Provision of Licensing
All Schedule B & several Schedule C industries came under this.
This provision is also called LICENSE- QUOTA -PERMIT RAJ.
3. Expansion of Public Sector
The policy announced to expand the public sector for accelerated industrialization & growth of the economy.
Emphasis was on heavy industry.
4. Regional Disparity
Upcoming PSUs were set up more in backward areas (although it was entirely against the ‘Theory of Industrial Location’).
5. Emphasis on Small Industry
The policy was committed to promoting small-scale industries and the Khadi & Village industry.
6. Agriculture Sector
The agriculture sector was pledged as a priority.
Industrial Policy of 1969
It was aimed at solving the shortcomings of the Industrial Policy of 1956.
Experts & industrialists believed that licensing was serving the opposite purpose than it was mooted. The main aim behind the ‘Licensing policy’ was socialist & nationalist feeling so that
The exploitation of resources could be done for the development of all.
Price-control of goods purchased from licensed industries.
Checking concentration of economic power.
Channelizing investment into the desired direction.
But licensing policy wasn’t serving this purpose as
Influential industrial houses were able to procure new licenses at the expense of budding entrepreneurs.
Older & well-established business houses were capable of creating hurdles for new ones with the help of different kinds of trade practices & forcing the latter to agree to sell out & takeovers.
Industrial Policy of 1969 introduced the Monopolistic & Restrictive Trade Practices(MRTP) Act. The main features of the MRTP act were
It was aimed at checking & regulating trade & commercial practices of the firms and checking the monopoly & concentration of economic power.
Firms with assets worth ₹ 25 crores (which was later increased to ₹50 crores in 1980 and ₹100 crores in 1985) or more were obligated to take permission from the Indian government before expansion, greenfield venture & takeover of other firms.
For redressal of prohibited & restricted practices of trade, the government set up the MRTP Commission.
Industrial Policy Statement, 1973
1. Core Industries
The policy introduced a new classification of ‘Core Industries’.
It included six industries that were of fundamental importance for developing other industries – Iron & Steel, Cement, Coal, Crude Oil, Oil Refining & electricity.
Note: At that time, there was 6 Core Industries. Now there are 8
Coal
Crude Oil
Cement
Fertilizer
Electricity
Refinery Products
Natural Gas
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 crores.
3. Reserved List
Some industries were put under a reserved list in which only MSME could set up industry.
4. Joint Sector
It allowed partnership between centre, states & private sector for setting up some industries.
The government had discretionary power to exit such ventures in future.
The intention was to promote the private sector with government support.
5. FERA
Foreign Exchange Regulation Act was introduced to regulate foreign exchange in India.
According to experts, it was draconian law that hampered the country’s growth.
6. Foreign Investment
Limited permission of foreign investment was given, with MNCs being allowed to set up subsidiaries in India.
Industrial Policy Statement, 1977
Political set up at the 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 a redefinition of small & cottage industry.
Decentralized industrialization was given attention to link masses to the process of industrialization.
Khadi & Village industry was to be reconstructed.
Serious attention was given to the level of production & prices of essential of everyday use.
Industrial Policy Resolution, 1980
The
Congress party returned to power. As a result, Industrial Policy was revised in
1980. The main provisions of this policy were
Foreign investment via technology transfer route was allowed.
MRTP limit was increased to ₹50 crores to promote the 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 Resolutions of 1985 & 86 were very similar in nature & latter tried to promote initiatives of the former. The main provisions of this policy were
Foreign investment was further simplified & more areas were opened for foreign investment. The dominant method of foreign investment was still technology transfer, but foreign MNC can hold up to 49% in their subsidiary.
MRTP limit was increased to ₹100 crores.
Provision of industrial licensing was further simplified & remained for 64 industries only.
A higher level of attention was given to sunrise industries such as telecommunication, computerization & electronics.
The modernization & profitability aspects of PSU was emphasized.
FERA regime was relaxed.
Many technology missions were launched in the Agricultural sector.
It has to be noted that these policies were formulated when the developed world was going towards forming the World Trade Organization.
These provisions were attempted at liberalizing the economy without any slogan of economic reform. The government wanted to go for the kind of economic reforms India pursued after 1991 but lacked political support.
By the end of the 1980s, India was in the grip of a severe Balance of Payment crisis with higher inflation (over 17%) & a high fiscal deficit (8%). It was magnified by the Gulf war & the high prices of oil, ultimately leading to the Balance of Payment crisis, IMF bailout & 1991 LPG reforms.
India was in a severe Balance of Payment crisis in 1991. Reasons for this were several interconnected factors that were growing unfavourable for the Indian economy
Gulf war of 1990-91: Oil prices increased, leading to fast depletion of Indian Foreign currency reserves.
There was a sharp decline in private remittances from overseas Indian workers in the Middle East in the wake of the gulf war.
Inflation peaked at 17% & the central government’s fiscal deficit reached 8.4%.
By June 1991, Indian Forex declined to just 2 weeks of import coverage.
The financial support that India got from the IMF to fight out the Balance of Payment crisis of 1990-91 had a tag of structural readjustment as a condition to be fulfilled by the 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
1.1 De Licensing of Industries
The
number of industries put under the compulsory licensing provision (Schedule B
& C) was cut down to 18 in 1991. Now
only 5 industries require a license, and these are
Industries that were
reserved for the Central government in the Industrial Policy of 1956 were cut down to 8 from 17 at
that time. Presently only
three sectors are reserved for central government.
Nuclear Energy
The present government is seriously considering allowing the private sector to enter the management of nuclear power plants.
Nuclear research
Consist of mining, use, management, fuel fabrication, export-import, waste management of radioactive material & no country allows private industry in this.
Railways
Many of the functions related to railways have been allowed private entry, but still, the private sector can’t enter as a full-fledged railway service provider.
1.3 Location of industries
Industries were
categorized into polluting & non-polluting & highly simple provision
deciding their location was announced
Non-Polluting
Such industries can be set up anywhere.
Polluting
Such industries can be set up at least 25 km away from million cities.
1.4 Abolition of phased production
The 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
The MRTP limit of ₹ 100 cr was abolished.
MRTP Act was replaced by Competition Act & MRTP commission was replaced by Competition Commission of India (CCI).
2 . Privatisation
2.1 Privatizing PSUs
It was decided to convert the public sector companies to private sector companies by reducing Government shareholding to below 50%. E.g., Hindustan Zinc Limited.
2.2 Stopped Nationalization
The policy stopped the practice of nationalization. It means that the way Tata Airlines was nationalized to Indian Airlines or Banks were nationalized will not be used by the government in the future.
2.3 More sectors opened
Private sector companies were allowed to operate in banking, insurance, aviation, telecom and other sectors.
3 . Globalization
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. Foreign Direct Investment & Foreign Portfolio Investment.
3.3 FERA by FEMA
Draconian FERA was replaced with the Foreign Exchange Management Act (FEMA), which came into effect in 2000-01 with a sunset clause of two years.
Need of New Industrial Policy
Why we need a new Industrial Policy?
Technological changes like the 4th Industrial Revolution, Artificial Intelligence & Automation have changed the nature of industries.
Systemic issues in the economy: Indian economy faces a large number of systemic issues such as outdated labour laws, infrastructural bottlenecks, logistic weakness etc.
Changes in Demographic conditions: With an increasing number of old age people, the government needs to focus on Longevity Dividend and the Demographic Dividend.
Global Changes: The world has changed, and China is losing Demographic Dividends. India needs to take drastic steps to fill the vacuum.
The Indian economy has changed drastically since 1991. The service sector is contributing the highest share to Indian GDP.
The rise of Multilateral Trade Agreements poses a threat to the Indian economy.
India needs to formulate a new Industrial Policy to deal with the problem of Climate Change and comply with Paris deal obligations.
What should New Industrial Policy focus on?
Technology & Innovation: Government should provide incentives for artificial intelligence, the internet of things, and robotics.
The Ease of Doing Business should be emphasized to attract MNCs in India.
Infrastructure should be made world-class to end the logistic problems of the Indian economy.
More focus on the skills & employability of new workers.
The focus should be on labour-intensive sectors such as textiles, leather and footwear industries etc.
Sustainable and responsible industrialization to reduce carbon emissions should be emphasized.
Provide easy access to capital to the MSMEs.
Create global brands out of India.
Promote Innovation and R&D via Academia- industry linkages, transparent IPR regime and encouragement to Startups.
Side Topic: National Manufacturing Policy, 2011 & NMIZ
Aim
Increasing the manufacturing sector’s share in Indian GDP to 25% by 2022.
Target is to create 100 million jobs.
Create National Manufacturing & Investment Zone (NMIZ)(NMIZ is an essential 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 the government in the form of
Tax incentives
Relaxed norms for FDI approval
Providing Rail, Road, energy etc.
Relaxations in the labour laws, e.g. easier hiring-firing norms.
NIMZ is treated as a self-governing body under Article 243(Q-c) of the Constitution.
India has 15 NMIZ like Manesar-Bawal Investment Region in Haryana etc.
