Prelims Revision -Indian Economy: Key Terms

Fixed Rate System vs Floating Rate System

• If government or RBI fix the exchange rate of a currency (and does not allow any variations according to demand and supply forces in market), such a system is called Fixed Rate system.
• It is also called Bretton Woods system or Pegged Currency System. India was following this kind of system till 1975 and partial controls till 1993.
• Since this currency valuation mechanism is artificial, most of the countries including India changed to Floating Rate System where currency market determines the value of a currency.

Rupee Devaluation vs Rupee Depreciation

• The term devaluation is used when the government reduces the value of a currency under Fixed Rate System. When the value of currency fall under Floating Rate System, it is called depreciation. 
• Revaluation is a term which is used when there is a rise of currency to the relation with a foreign currency in a fixed exchange rate.
• In floating exchange rate correct term would be appreciation.
• Altering the face value of a currency without changing its foreign exchange rate is a redenomination, not a revaluation.

Exports vs Falling in Indian Rupee Value : The local currency effect

• A devaluation means that more local currency is needed to purchase imports and exporters get more local currency when they convert the export proceeds (the foreign exchange that they get for their exports).
• In other words: imports become more expensive – and exporters earn more money. This is supposed to discourage imports – and to encourage exports and, in turn, to reduce trade deficits. Clear,uh?
  That was an explanation giving stress to the local currency angle. Let’s see the same case analyzing the volume effect.

Government Budgeting:

The term ‘Budget’ is not mentioned in Indian Constitution. The related term mentioned is ‘Annual Financial Statement’.

1. Article 265: provides that ‘no tax shall be levied or collected except by authority of law’. [ie. Taxation needs approval of Parliament.]
2. Article 266: provides that ‘no expenditure can be incurred except with the authorisation of the Legislature’ [ie. Expenditure needs approval of Parliament.]
3. Article 112: President shall, in respect of every financial year, cause to be laid before Parliament, Annual Financial Statement.

Railway Budget: (Now Merged: So very vcry important)

• The Budget of the Indian Railways is presented separately to Parliament and dealt with separately. But the receipts and expenditure of the Railways form part of the Consolidated Fund of India and the figures relating to them are included in the ‘Annual Financial Statement’.

Vote on Account

• The discussion on the Budget begins a few days after its presentation. Since Parliament is not able to vote the entire budget before the commencement of the new financial year (ie. within 1 month or so), the necessity to keep enough finance at the disposal of Government in order to allow it to run the administration of the country remains. A special provision is, therefore, made for “Vote on Account” by which Government obtains the Vote of Parliament for a sum sufficient to incur expenditure on various items for a part of the year.
• Vote on Account is a special provision in every budget (and not only in an interim budget) by which Government obtains the Vote of Parliament for a sum sufficient to incur expenditure on various items for a part of the year, usually two months. Vote on Account deals only with expenditure part. But interim budget as well as full budget has both receipt and expenditure side.
• So presentation and passing of vote on account is the first stage in the budget passing process. Vote on Account is necessary for the working of the government till the period the full budget is passed.

Cut Motions: Policy Cut, Economy Cut, and Token Cut

• You might have noticed about the Demand for Grants while going through Indian Budget.
• These are demands usually made in respect of the grant proposed for each Ministry.
• But Parliament being the authority to check the expenditure of the government, it may not approve all demands. Cut motions are motions in the parliament moved to reduce the amount of a demand.

Cut motions

A motion may be moved to reduce the amount of a demand in any of the following ways:-

1. Disapproval of Policy Cut Motions

• A Disapproval of Policy Cut motion is moved so that the amount of the demand be reduced to Re.1.
• It represents the disapproval of the policy underlying the demand.
• A member giving notice of such a motion shall indicate in precise terms the particulars of the policy which he proposes to discuss.
• The discussion shall be confined to the specific point or points mentioned in the notice and it shall be open to members to advocate an alternative policy.

2. Economy Cut Motions

• An Economy Cut motion is moved so that the amount of the demand be reduced by a specified amount.
• It represents the economy that can be effected.
• Such specified amount may be either a lump sum reduction in the demand or omission or reduction of an item in the demand.
• The notice shall indicate briefly and precisely the particular matter on which discussion is sought to be raised and speeches shall be confined to the discussion as to how economy can be effected.

3. Token Cut Motions

• A Token Cut motion is moved so that that the amount of the demand be reduced by Rs.100.
• This is to ventilate a specific grievance which is within the sphere of the responsibility of the Government of India.
• The discussion thereon shall be confined to the particular grievance specified in the motion.

Speaker to decide admissibility

• The Speaker shall decide whether a cut motion is or is not admissible under these rules and may disallow any cut motion when in his opinion it is an abuse of the right of moving cut motions or is calculated to obstruct or prejudicially affect the procedure of the House or is in contravention of these rules.

Notice of cut motions

• If notice of a motion to reduce any demand for grant has not been given one day previous to the day on which the demand is under consideration, any member may object to the moving of the motion, and such objection shall prevail, unless the Speaker allows the motion to be made.

Tax Expenditure:

• Tax Expenditure corresponds to relaxations given when tax burden becomes difficult for the sustainability of a particular sector.
• Tax exemptions or incentives are given in the form of lower rates of tax relative to normal rates.
• Tax expenditures are revenue losses attributable to tax provisions that often result from the use of the tax system to promote social goals without incurring direct expenditures. 
• Normally these exemptions are generated for particular purposes as tax incentives.

Tax Expenditure and its importance in Indian Economy

• The term ‘tax expenditure’ is associated with budget. Though many are familiar with the concept of subsidies and its impact on Indian Economy, it seems not every one know the details of tax-expenditure. Tax-expenditure more or less has the same impact as subsidies as a necessary evil.
• Tax expenditures can take many forms. Some result from tax provisions that reduce the present value of taxable income through deferral allowances, or special exclusions, exemptions, or deductions from gross income. Others affect a household’s after-tax income more directly through tax credits or preferential rates for specific activities.

Tax Exemptions given are called Tax Expenditure?

• If government didn’t give any tax exemptions, this deducted amount would have belonged to government itself. Though Tax Expenditure are not direct spending by government, the concept of tax expenditure is that, government is giving back money to achieve certain social goals, like strengthening housing sector or industrial sector.
• But in actual sense, Government is not collecting money to be re-distributed later, but gives away tax exemptions.

Tax Expenditure Budget

• The tax expenditure budget comprises the estimated revenue losses attributable to various exclusions, exemptions, deductions, nonrefundable credits, deferrals, and preferential rates in the tax code.
• These provisions reduce the income tax liabilities of individuals or businesses that undertake certain types of activities.

What is Fiscal Deficit?

The fiscal deficit is the difference between the government’s total expenditure and its total receipts (excluding borrowing). Fiscal deficit in layman’s terms corresponds to the borrowings and liabilities of the government. As per the technical definition, Fiscal Deficit = Budgetary Deficit + Borrowings and Other Liabilities of the government.

• Note: Deficit differs from debt, which is an accumulation of yearly deficits. The elements of the fiscal deficit are revenue deficit and capital expenditure.
• Note: Revenue deficit is the difference between the government’s revenue expenditure and total revenue receipts.

What is Current Account Deficit (CAD)?

• Current Account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid).
• The right way to fill the gap is by increasing the exports and decreasing the imports, which is a step easier said than done.

Sectors of Economy: Primary, Secondary, Tertiary, Quaternary and Quinary:

Primary activities:

• Primary activities are directly dependent on environment as these refer to utilisation of earth’s resources such as land, water, vegetation, building materials and minerals. It, thus includes, hunting and gathering, pastoral activities, fishing, forestry, agriculture, and mining and quarrying.
• People engaged in primary activities are called red-collar workers due to the outdoor nature of their work.

Secondary activities:

• Secondary activities add value to natural resources by transforming raw materials into valuable products. Secondary activities, therefore, are concerned with manufacturing, processing and construction (infrastructure) industries.
• People engaged in secondary activities are called blue collar workers.

Tertiary activities

• Tertiary activities include both production and exchange. The production involves the ‘provision’ of services that are ‘consumed. Exchange, involves trade, transport and communication facilities that are used to overcome distance.
• Tertiary jobs = White collar jobs.

Quaternary activities

• Quaternary activities are specialized tertairy activities in the ‘Knowledge Sector’ which demands a separate classification. There has been a very high growth in demand for and consumption of information based services from mutual fund managers to tax consultants, software developers and statisticians. Personnel working in office buildings, elementary schools and university classrooms, hospitals and doctors’ offices, theatres, accounting and brokerage firms all belong to this category of services. Like some of the tertiary functions, quaternary activities can also be outsourced. They are not tied to resources, affected by the environment, or necessarily localised by market.

Quinary activities

• Quinary activities are services that focus on the creation, re-arrangement and interpretation of new and existing ideas; data interpretation and the use and evaluation of new technologies. Often referred to as ‘gold collar’ professions, they represent another subdivision of the tertiary sector representing special and highly paid skills of senior business executives, government officials, research scientists, financial and legal consultants, etc. Their importance in the structure of advanced economies far outweighs their numbers.The highest level of decision makers or policy makers perform quinary activities.
• Quinary = Gold collar professions.

Financial Market

• Financial market is the market that facilitates transfer of funds between investors/ lenders and borrowers/ users. Financial market may be defined as ‘a transmission mechanism between investors (or lenders) and the borrowers (or users) through which transfer of funds is facilitated’. It consists of individual investors, financial institutions and other intermediaries who are linked by a formal trading rules and communication network for trading the various financial assets and credit instruments. It deals in financial instruments (like bills of exchange, shares, debentures, bonds, etc).

Main functions of financial market

Let us now see the main functions of financial market.
(a) It provides facilities for interaction between the investors and the borrowers.
(b) It provides pricing information resulting from the interaction between buyers and sellers in the market when they trade the financial assets.
(c) It provides security to dealings in financial assets.
(d) It ensures liquidity by providing a mechanism for an investor to sell the financial assets.
(e) It ensures low cost of transactions and information.

Classification of Financial Market

A financial market consists of two major segments: (a) Money Market; and (b) Capital Market. While the money market deals in short-term credit, the capital market handles the medium term and long-term credit.

Financial Market Classification

1. 1. Money Market.
      1. Call Money.
      2. Treasury Bill.
      3. Commercial Paper.
      4. Certificate of Deposit.
      5. Trade bill.
   2. Capital Market.
      1. Securities Market
         1. Primary Market : IPOs, Book Building, Private Placements.
         2. Secondary Market : Equity Market, Debt Market, Commodity Market, Futures and Options Market. (Secondary Market can be basically divided into two – spot market and forward market. Forward market has two divisions – futures and options/derivatives. Again, there are two types of options – put option and call option.)
      2. Non-Securities Market
         1. Mutual Funds.
         2. Fixed Deposits, Savings Deposits, Post Office savings.
         3. Insurance.

Money Market

• The money market is a market for short-term funds, which deals in financial assets whose period of maturity is upto one year. It should be noted that money market does not deal in cash or money as such but simply provides a market for credit instruments such as bills of exchange, promissory notes, commercial paper, treasury bills, etc. These financial instruments are close substitute of money. These instruments help the business units, other organisations and the Government to borrow the funds to meet their short-term requirement.
• The Indian money market consists of Reserve Bank of India, Commercial banks, Co-operative banks, and other specialised financial institutions. The Reserve Bank of India is the leader of the money market in India. Some Non-Banking Financial Companies (NBFCs) and financial institutions like LIC, GIC, UTI, etc. also operate in the Indian money market.

Capital Market