Module – 1Business Environment

Reference: Economic Environment Misra & Puri Pg no:5-60

Characteristics / Nature of Modern Business• Large size• Oligopolistic character• Diversification• Global reach• Technology orientation• Change • Government control

Environment of BusinessEnvironment by definition is something external to an individual or an organization.

Business environment refers to all external factors which have direct or indirect bearing on the activities of business. The business environment is divided into

• Internal environment • External environment a. Micro environment b. Macro environment

Diagrammatic Representation of Business Environment

InternalEnvironment Business

Micro/ macro External

Environment

Internal Environment• Value system, • goals and objectives, • management structures, • relationship among the various constituents,• physical assets, • technological capabilities and human,

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• financial and marketing resources make the internal environment of business.

External EnvironmentExternal environment of business consists of institutions, organizations and forces operating outside the company. External environment can be classified into

• Micro Environment• Macro Environment

(1) Micro environmentThe micro environment refers to such players whose decisions and actions have a direct bearing on the company. Since modern business broadly has two aspects, viz., Production and selling of goods, the micro environment of business can be divided accordingly.

The most prominent performers in the micro environment are:• Suppliers of inputs• Workers and their unions• Customers market intermediaries • Competitors • Publics

(2) Macro environmentMacro environment comprises large societal and physical forces which affect the company and also the players in the company’s micro-environment.

Macro environment of a company refers to all those economic and non- economic factors which exercise their influence on the business activity in general and thus determine opportunities that a company may have to promote its business.

Macro environment can be classified into• Economic environment• Non-economic environment

Diagrammatic representation

Diagrammatic representation Diagrammatic representation

Business

political

Socio

cultural

Natural

Demographic

Technological

GlobalNational

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Economic Environment Since business is basically an economic activity, economic environment of business – both national and global – is of strategic importance.

In the economic environment of the country, • country’s economic system, • macroeconomic scenario , • phase of business cycle through which the company is passing, • organization of the financial system and • economic policies of the government are the most important elements.

1.Economic System a. Capitalism b. Socialism2. Macro-economic Scenario a. High rates of growth b. Inflation c. High rates of savings and investment d. Fiscal imbalance e. Balances of payments f. Deficits

Phases of business cycle a. Prosperity b. Recession c. Depression d. Stagflation

Financial SystemEconomic Policies a. Industrial policy b. Trade policy c. Monetary policy d. Fiscal policy

Non-Economic EnvironmentThe non- economic environment of business can be classified as:

• Political environment• Legal environment• Socio-cultural environment• Demographic environment• Technological environment• Natural environment

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(a) Political Environment

(b) Legal EnvironmentThe governments sets the legal framework within which business operate. Legislations defining property and business organizations, laws of contracts and bankruptcy, mutual obligations of labour and management and a multitude of laws and regulations constraining the way business activities are carried out constitute legal environment of business.

Economic legislations, as these, are often called, have a direct bearing on the business. Economic legislations can be classified into two categories:

Legislations which have a facilitatory role. Ex: The Contract Act provides the rules for systematic exchange transactions.Legislations which are restrictive in nature. Ex: MRTP Act and FERA.

(c) Socio-cultural EnvironmentThe Social environment is made up of the attitudes, desires, expectations, degrees, of intelligence and education, beliefs and customs of people in a group or a society.

Culture is the heart of a particular group or society – what is distinctive about the way members interact with one another and with outsiders – and how they achieve what they do.Socio-cultural environment is made up of attitudes, desires, expectations, beliefs, faiths, customs of people besides their set of material practices through which people produce goods and services that they need for satisfying their wants.

Globalization of cultureMulticulturalism a. Caste b. Race c. Ethnic issues

Demographic EnvironmentDemographic factors like the Size and Growth rate of population, Life Expectancy, Age and sex composition of population, Work participation rate, Employment status, Rural-urban distribution, Educational levels, Religion, Caste, Ethnicity and Language are all relevant to business. Some of the issues are:

• Size and growth of population

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• Age structure of population• Urban-rural population• Burden of population on environment

Module – 3Economics Of Development

Meaning of Economy (or) Economic System An economy or economic system refers to the manner in which the various economic activities relating to production, distribution, exchange and consumption of goods and services are organised in a country, and the way in which the people of a country earn their living.

It comprises the farms ,factories, mines, shops, offices, banks, schools and colleges, transport systems, hospitals, defence, etc The economy of a country is divided into three sectors:

1. Primary Sector – agriculture, mining, forestry, fishing, etc.2. Secondary Sector – large scale and small scale industries.3. Tertiary Sector – services like transport, banking, insurance, trade, public

administration, defence, etc.

Classification of Countries (economy)The World Bank in its World Development Report (2005) has classified various countries of the world on the basis of their per capita Gross National Income (GNI) or (GNP). They are1.Low income countries – with per capita GNP of $765 and below. Ex : Myanmar, India, Ghana, Sudan, Nepal, Uganda.

2.Middle income countries – with per capita GNP between $766 and $9,385. Ex : China, Fiji, Brazil, Cuba, Egypt, Iran, Iraq, etc.

3. High income countries – with per capita GNP higher than $9,386. Ex : Australia, USA, UK, UAE, Canada, Spain, Germany, France, etc.

Types of EconomiesAn economy or economic systems can be classified into two types on the basis of the level of economic development attained by them. They are

1. Developed economy (advanced)2. Under-developed economy (backward)

Developed economyThe United Nations Experts in 1971have classified countries with per capita real national income of $1000 and $4000 a year as developed countries.

A developed economy is one which is economically advanced and whose economy is

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characterized by large industrial and service sectors and high levels of income per head.

Under-developed / developing economyAn economy where the per capita real income is less than $1000 a year is considered an under-developed economy.

A under-developed economy is characterised by• Low per capita income• Chronic mass poverty• Predominance of agriculture• Obsolete methods of production and social organisation• Under-utilization of manpower and natural resources

India as a Developing EconomyReference - B.S.Raman: pg 19-21 HRK: pg 11-14

Meaning of a Developing Economy Developing economy, no doubt, refers to an under-developed economy. But this term is mostly used to refer to that under-developed economy which is not stagnant, but has started developing by making use of its natural and human resources. The following changes in the Indian Economy over the last five decades clearly prove that India is a developing economy.

Increase in national income 1950-51 – Rs. 9,142 crores 2001-02 – Rs. 18,64,292 croresIncrease in per capita income 1950-51 – Rs. 255 2001-02 – Rs. 17,978Increase in investment 1950-51 – Rs. 1,960 crores 2001-02 – Rs.15,25,639 croresIncrease in agricultural production (food grains) 1950-51 – 50.8 mn. tonnes 2001-02 – 212 mn. tonnes Increase in industrial Production Increase in social over-headsStructural changes

Progress in Science and TechnologyProgress in Banking and Financial sectorReduction in inequalities in income and wealthImprovement in living standardsDesirable changes in society

Determinants of Economic Development ( Reference – Ruddar Dutt and

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Sundaram: pg12-14 )

Economic development implies the process of securing levels of productivity in all sectors of economy and this in turn, is a function of the level of technology.

Economic development thus depends upon two sets of factors:1. Non-Economic Factors2. Economic Factors

Non-Economic FactorsNon-economic Factors includes social attitudes, political conditions, human endowments and efficient governance.

• Religious beliefs• Political Instability• Family System• Development of Education• Nature of People

Economic Factors• Capital Formation• Capital-output Ratio• Growth of Population• Building Human Capital• Availability of Natural Resources• Climatic Conditions • Level of Technology

Major Issues of Developments (Reference – Ruddar Dutt and Sundaram: pg 10-12)• Low per capita income and low rate of economic growth• High proportion of people below the poverty line• Low level of productive efficiency due to inadequate nutrition and malnutrition• Imbalance between population size, resources and capital• Problem of employment• Instability of output of agriculture and related sectors• Imbalance between heavy industry and wage goods• Imbalance in distribution and growing inequalities

Business CyclesThe business cycle is an alternate expansion and contraction in overall business activity, as evidenced by fluctuations in aggregate economic activity such as GNP, industrial production, employment and income.

According to J.M.Keynes “ A trade cycle is composed of periods of good trade characterized by rising prices and low unemployment percentages, alternating with

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periods of bad trade characterized by fall in prices and high unemployment percentages.”

Phases of a Business CycleA business cycle will have 5 different phases or stages. They are

1. Depression 2. Recovery3. Prosperity or full employment4. Boom or overfull employment5. Recession

(1) DepressionDuring this period business activity in the country will be much below normal level. It is characterized by a short fall in production, mass unemployment, fall in prices, low wages, contraction of credit, a high rate of business failures and an atmosphere of all round pessimism. The USA experienced 2 longest depressions in the history i.e during 1873-1879 and 1929-1932.

(2) RecoveryDuring this period business activity increases. The industrial production and volume of employment steadily increases. The prices and wages increases. The recovery may take place due to the following reasons:

• New government expenditure• Exploitation of new sources of energy • Innovations • Investment in new areas• Changes in the techniques of production

(3) Prosperity This stage is characterized by high capital investment in basic industries, expansion of bank credit, high prices , high profits, high rate of formation of new business enterprises and the full employment. The longest sustained period of prosperity occurred in the USA between 1923 and 1929.

(4) BoomIt is the stage of rapid expansion in business activity resulting in high stocks and commodity prices, high profits and over-full employment. A situation develops in which the no. of jobs exceeds the no. of workers in the market. Such a situation is known as over-full employment. Profits will further increase. This will lead to more investment and in turn further raise in price level and inflation.

(5) RecessionIn this stage more business enterprises fail, prices collapse and confidence is shaken. Building construction slows down and unemployment increases. There is fall in income,

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expenditure, demand, prices, and profits. The recession will have cumulative effect on the working of the economy. USA experienced recession in 1957-1958.

Diagrammatic Representation

Characteristics of Business CyclesBusiness cycle is a wave like movement.• The cyclical fluctuations are recurrent in nature.• The upward or downward swing of the business cycle is self reinforcing.• Business cycle contains self generating forces.• They are all pervasive in their effects.• The peak and the trough of a business cycles are not symmetrical. • In cyclical fluctuations the prices and the production generally rise or fall together.• The cyclical upward and downward swings move parallel with production and

monetary demand. • The cyclical fluctuations are felt more in capital goods industries than in consumer

goods industries.• They are not periodical in nature.• Prices of manufactured goods are comparatively rigid while that of agricultural goods

are normally flexible.• The cyclical fluctuation tend to be not only national but also international in

character.

Importance of Agriculture to Indian Economy1.Provides largest employment 60 % of working population2. Greater share in national income 23 % of national income3. Supply of food to people 212.22 mn tonnes of food grains in 2003-044. Industrial development

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5. Contribution to foreign trade Share of agricultural exports in total exports is 10%6. Source of revenue to government7. Source of capital formation8. Market for industrial products9. Good national defence10. Price Stability Agricultural commodities account for 80% of total consumption expenditure11. Development of tertiary sector 12. Influence on government budgets13. Supply of fodder14. Influences general price level15. Involves low capital16. Supplier of raw materials17. Main role in consumption basket 60% of household consumption and 85% of household commodity consumption is of agricultural products.18. Source of revenue and also exports19. Political and social significance

Importance of Industrialisation in India1. Employment generation2. Larger production3. Increase in national income and per capita income4. Promotion of agriculture5. Development of agriculture6. Increase in productive capacity7. Use of potential resources 8. Contribution of export trade9. National defence10. Balanced development11. More revenue to government12. Changes in the outlook of people13. Expansion of markets14. Economic stability and self sufficiency15. Proper balance between industry, agriculture and tertiary sector16. Urbanisation17. Stable growth of the economy

The Importance of Transport in the Economic Development of India • Development of market• Large scale of production• Facilitates territorial division of labour• Price stability• Mobility of labour and capital

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• Growth of towns and cities• Employment generation• Facilities agricultural development• Helps industrial development• Social benefits• National defence• Efficient administration• Unity• Meeting emergencies• Place and time utility• Breaking the isolation• Development of trade and commerce• Solution to population problem• Revenue to government• Efficient use of resources• Facilitates balanced regional development

Importance of Foreign Trade in the Economic Development of India• helps India to import plant and machinery, raw materials and technical know-how.• helps to import goods like petroleum, metals, etc.• helps India to export goods which are in surplus.• widens the market for our products.• contributes to expansion of domestic industries.• contributes to growth of national income.• contributes to improvement in the civilisation of our people. International Trade is an

index of civilisation. • contributes to economic co-operation between India and other countries.• Gives employment to a large number of people.• Gives encouragement to the exploitation of unexploited resources of the country.

The Role of Communication System in the Economic Development• Supply of necessary information• Motivation• Development of industries, commerce and trade• Development of transport• Bringing buyers and sellers together• Accelerating the growth rate• Easy contact• Improving global competitiveness• Attracting foreign direct investment

Module – 4National Income Accounting

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Reference : Ahuja – Pg 15-35

National Income According to J.R Hicks, “National income consists of a collection of goods and

services reduced to a common basis by being measured in terms of money”. According to the National Income Committee of India-1951, “A national income

estimate measures the volume of commodities and services turned out during a given period, counted without duplication”.

Important Points• National income refers to the income of a country, Ex: India• Its measurement refers to a specified period of time, say 1year• National income includes all goods and services which have exchange value,

counting each one of them only one.

Different Concepts of National Income1. Gross Domestic Product (GDP)2. Net Domestic Product (NDP)3. Gross National Product (GNP)4. Net National Product (NNP)5. National Income at Factor Cost (NI)6. Personal Income (PI)7. Disposable Personal income (DPI)

Gross Domestic Product• GDP is the aggregate money value of all final goods and services produced by

normal residents as well as non-residents in the domestic territory of a country during a year.

• It is a geographical or territorial concept.• GDP = GNP – net factor income from abroad

Net Domestic product• NDP refers to the market value of all final goods and services produced during a

period of one year after making allowance for depreciation changes.• NDP = GDP – Depreciation

Gross National Product• GNP is defined as the total market value of all final goods and services produced

during a year in a country.• GNP is a monetary measure.• GNP includes the market value of only final goods and services.• It is a flow measure of output of goods and services during a year / currently

produced goods.• GNP refers to the value of goods and services currently produced by normal

residents of a country.

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• The depreciation or replacement value of the fixed assets is not deducted

Net National Product• This refers to the net production of goods and services in a country during a year. • NNP = GNP – the value of capital depreciated during the year. • NNP is a highly useful concept in the study of growth economics.

National Income at Factor Cost• It refers to the total of all income payments earned by the factors of production in

the form of rent, wages, interest, and profit during a given year.• NI = NNP – Indirect Taxes + subsidy

Personal Income• It is that income which is actually received by the individuals and households in a

country during a year from all sources. • PI = NI – Corporate income tax

-- social security contributions -- undistributed corporate profits + transfer payments This concept is useful in estimating the potential purchasing power of the individuals in an economy.

Disposable personal Income• It is that part of personal income which is left behind after the payment of personal

direct taxes is called disposable personal income.• DPI = PI – Personal direct taxes• DPI = Consumption + Saving

Uses / Practical Importance of National Income Estimates• Economic Position• Contribution of Different Sectors• Distribution of National Income among the Factors of Production• Economic Planning• International Comparison• International Payments• Help to Backward Countries• Role of Public and Private Sectors• Grant-in Aids to States• Anti-Inflationary and Deflationary Measures• Reveals the Cyclical behavior of an economy

Difficulties in the Measurement of National income• Treatment of Non-monetary Transactions• Treatment of Government activities in national income accounts• Treatment of income generated by foreign firms• Illiteracy

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• Non- availability of statistical data• Existence of barter transactions• Difficulty in calculating depreciation• Lack of professional competency• Problem of consideration of goods and services• Commodities of self-consumption

Difficulties of Measuring National Income in Developing countries• Prevalence of non-monetized transactions• Illiteracy• Incomplete Occupational specialisation• Agricultural and industrial production is unorganized• Lack of adequate statistical data

Trends in National Income Growth and StructureI. Trends in net national product and per capita income

II. Annual growth rates during the plansIII. Trends in distribution of national income by industrial originIV. Trends in the share of the public sectorV. Urban and rural income break-up

VI. Share of organised and unorganised sector in NDP

National Income Estimates in IndiaAccording to the National Income Committee, “ A national income estimate measures the volume of commodities and services turned out during a given period, counted without duplication”.

Pre-independence period estimates Post-independence period estimates National income committee and C.S.O estimates

Circular Flow of Income Two Sector Model Without Savings

Households and Firms Two Sector Model With Savings

S = Y – C Where Y = income S = savings C = consumption

Case 1 : S > I Case 2 : S = I Case 3 : S < I

Three Sector Model (Government) T = T1 + T2

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Four Sector Model Firm + Household + Government income and Expenditure + Exports and Imports S + T + M = I + G + X

Module: 5(a)Capital Structure

Meaning of Capital StructureCapital Structure refers to the various sources from which the long-term funds are raised.

The Capital Structure refers to the proportion of equity capital, preference capital, reserves, debentures and other long-term debts to the total Capitalization.

Characteristics of a sound Capital Structure • Simplicity• Profitability• Flexibility• Intensive use of funds• Conservation• Provision for meeting future contingencies• Control over the company• Economy in cost of maintaining different securities

Forms/Patterns of Capital Structure • Equities only• Equities and preference shares• Equity shares and debentures• Equities, preference shares and debentures

Factors determining capital structureTwo types

• Internal factors or controllable factors• External factors or uncontrollable factors

Internal factors• Financial leverage • Growth & stability• Cost of capital• Asset structure• Retaining control• Purpose of finance

External factors

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• Size of the company• Nature of company• Cost of floatation• Interest rates• Taxation policy• Fluctuation in stock market• Availability of funds

Pecking order theoryInternal DebtIssue of DebtEquity Shares

Business riskUncertainty about – demand, sales, price, costs, etc.

Leverage:- Meaning and Definition

The Dictionary meaning: “An increased means for accomplishing some purpose”.

In financial analysis: Leverage is ability of using fixed costs to enhance the potential returns to a firm.

There are 2 types of fixed costs:1) Fixed operating costs(rent, depreciation, etc.)2) Fixed financial costs(interest, cost of debt, etc.)Is also called ‘GEARING’ in USA

James Horne has defined“Leverage as the employment of an asset or funds for which the firm pays

a fixed cost or fixed return”.

Christy and Roder defined

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“Leverage as the tendency for profits to change at a faster rate than sales”.

Types of leverageFinancial leverageThe use of long term fixed interest and dividendBearing securities like debentures and preference shares along with equity is called financial leverage or trade on equity.

FL = EBIT EBT

DFL = Percentage change in EPS Percentage change in EBIT

Operating leverageThe operating leverage occurs when a firm has fixed cost which must be recovered irrespective of sales volume. The fixed cost remaining the same the percentage change in operating revenue will be more than the percentage more than the sales

OL = contribution EBIT

DOL=Percentage change in EBIT Percentage change SALES

Combined leverageCombined leverage shows the relationship between the change in sales and corresponding variation in taxable income.

Combined leverage = operating leverage X financial leverage

Contribution = EBIT X EBITEBIT/operating profit EBT

= contribution earnings before tax

DCL = Percentage change in EPS Percentage change in SALES

FINANCIAL LEVERAGE

Q 1. A Ltd. Company has equity share capital of Rs. 5,00,000 dividend into share of Rs. 100 each. It wish to raise further Rs. 3,00,000 for expansion cum modernization plans. The company plans the following financing schemes.

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(a) all common stock . (b) Rs. One lakhs in common stock and Rs. 2 lakh in 10% debentures. (c) All through debentures at 10 % interest pa. (d) All debt in common stock and Rs. 2 lakh in preference capital with the rate of dividend at 8% The Company’s existing earnings before interest and tax (EBIT) is Rs.1,50,000. The corporate rate of tax is 50%.

You are required to determine the earnings per share (EPS) in each plan and comment on Financial Leverage.

SOLUTION PLAN 1 PLAN 2 PLAN 3 PLAN 4

earnings before interest and tax 1,50,000 1,50,000 1,50,000 1,50,000 Less : Interest _ 20,000 30,000 __ 1,50,000 1,30,000 1,20,000 1,50,000Less : tax @ 50% 75,000 65,000 60,000 75,000 _______ _______ _______ ______Earnings after tax 75,000 65,000 60,000 75,000Less : preference dividend at 8% __ __ __ 16,000 _______ _______ _______ ______Earnings available for common 75,000 65,000 60,000 59,000 stockholdersNo. of common shares 8,000 6,000 5,000 6,000

Earnings per share (EPS) Rs. 9.375 Rs. 10.83 Rs. 12 Rs. 9.83

Financial leverage = EBIT 1 1.15 1.25 1 EBT

COMMENTSSince EPS as well as degree of financial leverage is highest in financial plan 3 it should be accepted. The company should raise Rs. 3 lakh only through debt.

Problems on Leverages:A simplified income statement of Zenith Ltd. is given below. Calculate the Operating leverage, Financial leverage, & combined leverage.

Sales 10,50,000/-

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Variable cost 7,67,000/-Fixed cost 75,000/-Interest 1,10,000/-Tax 30%

Soln :-

Sales 10,50,000(-)Variable cost 7,67,000

Contribution 2,83,000(-)Fixed cost 75,000

EBIT 2,08,000(-)Interest 1,10,000

EBT 98,000(-)TAX(30%) 29,400

NET Income 68,000

Operating leverage = contribution EBIT = 2,83,000 2,08,000 = 1.36

Financial leverage = EBIT EBT = 2,08,000 98,000 = 2.12Combined leverage = Operating Leverage X Financial Leverage =1.36 X 2.12 =2.88

Module – 5 Structure Of Industries

( References: Dutt & Sundaram Misra & Puri B S Raman HRK)

Structure / Classification of Industries (HRK – 204-209)

Large Scale Industries : Large Scale Industries are those industries which invest huge amounts of capital, reaping the benefits of division of labour and producing goods on a large scale involving fixed capital investment of more than Rs.10 Cr but less than Rs.100 Cr.

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Medium Scale Industries : Medium Scale Industries are those industries which are organised on a medium scale, and produce goods on a medium scale by using machines, hired labour and power involving fixed capital investment of more than Rs.1 Cr but less than Rs.10 Cr.

Small Scale Industries: Small-scale industries are those industries which are organised on a small-scale, and produce goods on a small scale by using machines, hired labour, and power. Ex: Ready garments, paper, electrical goods, etc.

Agro-industries and Ancillary Industries: Industries which produce goods by using agricultural raw-materials are called agro-industries. Ex: jute, oil, sugar, cotton textiles, etc

Industries which produce spare parts, components, etc required by the large industries are called ancillary industries.

Cottage Industries: A cottage industry is one which is carried on mainly in a house with the help of the members of the family and with the help of simple and hand-operated tools. Ex: pottery, toy-making, weaving, carpet-making, wood work, agarbhatti, etc.

Manufacturing Industries:Any industry which is engaged in the conversion of raw materials into finished goods fit for consumption with the help of men and machines is generally known as manufacturing industry. Ex: conversion of iron ore into iron and steel, wood pulp into paper, etc

Industrial Development Under Five Year Plans( B S Raman – 258-267 Dutt & Sundaram – 636-640)

India implemented five year plans and industrial development became an integral part of India’s development planning.

High priority was given to programmes of Industrialization on account of following reasons:

o The country was industrially backward and the establishment of new industries of industries on a big scale and development of the traditional industries was an imperative necessity.

o Productivity of labour is the highest in manufacturing Industries.o Development of the industrial sector is a pre-condition for agricultural

development.o Industrialization induces development of other sectors. Development of transport,

communications and energy is still more dependant on industrial growth.o Despite the secondary importance given to industry, the annual rate of growth of

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industrial output was about 6%.o The overall production of industrial goods increased by 39%.o Capital goods industries like iron and steel were expanded.o A number of public sector industries like HMT, penicillin factory, etc were

established.o A number of industries like petroleum-refining, cement, penicillin, etc were set

up.o Infrastructural facilities like power, transport and communication were expanded

considerably.

Second Five-year plan (1956-61)• This plan was based on the Industrial Policy Resolution of 1956 which

envisaged a big expansion of Public sector.• It was really an industrial plan.• Total investment in industries was Rs. 1,180 crores (27% of total plan).• The annual rate of growth was 7.25%.• Industrial production increased by 46%.

• Three major public sector steel plants were set up at Rourkela in Orissa, Bhilai in MP and Durgapur at WB.

• This plan witnessed a major diversification of the industrial spectrum.• Most of the investments were in Heavy and Basic Industries.• Tractors, motor cycles, scooters, etc were produced for first time in India.• Good progress was also recorded in modernization and re-equipment of jute,

cotton textiles and sugar industries.• Good progress was made in the production of consumer goods like

fans,radio,etc.• About 60 industrial estates comprising 1000 small factories were set up.

Third Five-year plan (1961-66)• Rs.1726 crores(20% of total plan) was allotted for the development of industries

and mining.• The annual rate of growth was 7.9%.• UTI and IDBI were set up in 1964.• A no. of industries like aluminium, automobiles, textiles, etc achieved rapid

growth.• Mining and extractive industries also showed progress.• Despite the over-all under-achievement of targets this plan reflected the first stage

of intensive development leading to a self –reliant and self-generating economy.• Mining and extractive industries also showed progress.• Despite the over-all under-achievement of targets this plan reflected the first stage

of intensive development leading to a self –reliant and self-generating economy.

Fourth Five-year plan (1969-74)

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• This plan was based on the industrial policy of 1977.• Rs 5298 crores (23%) was allotted.• The actual growth rate was 5% as against 8%.• This plan aimed to enlarge capacities in export promotion and import substitution

industries.• Public sector enterprises had started earning profits.

Fifth Five-year plan (1974-78)• This plan was formulated to achieve the twin objectives of self-reliance and

growth with social justice.• Rs.16,660 cr (26%) was allocated.• Actual growth rate was 6% as against 8%• This plan took many bold steps such as • Removing the restriction on the private sector• Monopolistic undertakings• Foreign investments in India

Sixth Five-year plan (1980-85)• This plan was a very ambitious plan.• It was based on the industrial policy of1980.• Rs.22,200 cr (22.8%) was provided.• Actual growth rate was only 3.7% as against 7%.• There was a shortfall in the production of many industrial goods like cement, iron and

steel, etc.• Industrial progress during this period was most disappointing.

Seventh Five-year plan ( 1985-90)• This plan laid emphasis on the development of infrastructural facilities,

modernisation, upgradation of technology, reduction in cost, accelerated growth in selected industries.

• This plan was a success as annual growth rate was 8%.• Total outlay for industries was Rs. 22,460 cr.• The govt had liberalised industrial licensing policy to provide incentives to industries.• Encouragement of ‘Sunrise’ industries such as telecom, bio-tech, computers, etc.• Industries were encouraged to adopt technologies like laser, robotics, fibre-optic, etc

for enhancing productivity.• About 30% of industries had installed Pollution Control systems.

Eighth Five-year Plan (1992-97)• This plan was formulated under Economic Liberalisation and was based on the

industrial policy of 1991.• During this period, the private sector has developed considerable managerial,

technological, financial and marketing strengths.

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• The outlay was Rs. 40,670 cr (19% of total plan).• Over all 9.5% growth rate has been achieved.• The factors for the slow growth fo industrial sector:• Could not face foreign competition as a reduction of import duties.• Under utilisation of domestic capacity• Dumping by foreigners

Ninth five-year plan (1997-2002• This plan was a failure as the actual growth rate was only 5% as against 8% of target.• This plan allocated Rs. 69,972 cr for industry.• The internal and external factors are responsible for slowdown.• The failure can be attributed to the fall in public sector investment .• Lack of external demand resulting from slowdown in world economy decelerated the

growth of industrial sector.Changes in Industrial Structure During the Planning Period(Misra & Puri – 479-481)• Increase in the Share of industrial Sector in GDP:• The share of industry in GDP at factor cost increased from 13.3% in 1950-51 to

24.6% in 2003-04.• Building up of Heavy and Capital Goods Industries:• Growth of Infrastructure Industries: Infrastructure industries include:

i. Electricity ii. Coal

iii. Steeliv. Crude petroleumv. Petroleum refinery

vi. Cement A Well Diversified Industrial Structure:o Machinery:

1950-59--- 1.2% 1990-99 --- 12.7%

o Chemicals: 1950-59 --- 5.7% 1990-99 --- 12.4%

o Non metallic Mineral products: 1.6% to 4.6%

o Transport Equipment: 3.4% to 6.5%

o Rapid Growth of Consumer Durables:o The rate of growth of this industry in 1980-85 was 14.4% and in 2003-04 was

11.6%.o Emphasis on Chemicals, Petrochemicals and Allied Industries in 1980s:o Emergence of Public Sector:

1950 – 5 PSUs with Capital of Rs.29 Crore

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2003 – 227 PSUs with Capital of Rs. 4,18758 Crore

Change in Industrial Structure in 1990s• Shifts in favour of consumer goods and intermediate goods• Structural changes within basic industries and capital goods industries• Changes within the consumer goods sector• Changes within the intermediate goods sector• Declining role of public sector

Public Sector EnterprisesReference: Dutt and Sundaram – 188-204 B S Raman -- 213-221,HRK

• The Industrial Policy Resolution of 1956 gave the public sector a strategic role in the Indian economy.

• Public enterprises or public sector refers to that sector which is owned and managed by the central government or the state government or a body set up by the government to direct the undertaking in the public interest.

• Forms or Types of Public Enterprises:i. Departmental undertakings : Railways, Defence, etc

ii. Statutory Corporations : LIC, the Indian Airlines Corporations, etciii. Government Companies : Heavy Electricals Ltd, HMT Ltd, etciv. Holding Company : Steel Authority of India Ltd.

Objectives of Public Sectora. To promote rapid economic development through creation and expansion of

infrastructureb. To generate financial resources for developmentc. To create employment opportunities d. To promote redistribution of wealth and incomee. To promote balanced regional growthf. To promote exports and import substitutiong. To encourage SSIs

Role of Public Sector in Indian Economy• Capital Formation• Development of Infrastructure• Development of Defence Industries• Development of Basic and Key industries:• Iron and steel, cement, etc• Development of Power projects• Development of Banking and Insurance• Balanced Regional development• Balanced Economic Growth• Strong Industrial Base

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• Economies Of Scale• Removal of Regional Disparities• Import Substitution• Export Promotion• Expansion of Employment Opportunities• Source of Revenue to the Government • Saving in Foreign Exchange• Better Allocation and Utilisation of Resources• Diversity of Projects

Problems and Shortcomings of the Public Sectoro Mounting Losseso Price Policy of Public Enterpriseso Delay in Completion of the Projectso Increase in Costs of Constructiono Poitical factors influence decision about Locationo Over-Capitalizationo Under-Utilization of Capacityo Unfavourable Input-output Ratioo Use of Manpower Resources in excess of actual requirementso Faulty Planning and Controlso Inefficient Managemento Bureaucratic Procedures and Red-tapismo Labour Problem resulting in Strikes and Lockoutso Higher Capital Intensity -- Low Employment Generationo Shortage of Raw materials and Power

Remedies / Measures to be taken for the Performance of Public Sectoro Reduction in Unproductive Expenditureo Utilisation of Installed Capacityo Better Utilisation of manpower and materialso Proper Planning and Controlo Improvement of Efficiency of Managemento Suitable Price Policyo Making them Autonomous o Improvement of Industrial Relationso Motivation of Staff and Workers

Joint SectorReference: D&S-222-226,B S Raman- 224-225

• Joint Sector Enterprises refer to economic enterprises or industries which are owned and managed jointly by the Government and the Private sector.

• Ex: Madras Fertilizers, the Cochin Refineries, etc.

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• Rationale behind Joint Sector Enterprises: To combine the financial resources of the Government with the managerial skill of the private entrepreneurs for the successful running of the economic enterprises.

Types of Joint Sector Enterprises1. Existing Private Enterprises : through the conversion of bonds or debentures into

equity shares.2. Existing Public Sector : through the sale of equity shares of such enterprises to

private entrepreneurs.3. New enterprises set up by the Government jointly with the Private entrepreneurs.

Role / Benefits of Joint Sector Enterprises in Indiaa. Social Control over Industriesb. Better Industrial Growthc. Broad-basing of Industrial Entrepreneurship d. Prevent monopolies and concentration of Economic powere. Mobilisation of Financial Resourcesf. Mobilisation of Techno-managerial Resourcesg. State-sponsored Industrialisationh. Extension of Public Controli. Failure of Public and Private Sectorsj. Acceleration of Economic Growthk. Run on Efficient lines and earn sufficient Profitsl. Effective instrument for ensuring Balanced Regional Growth

Private SectorDutt & Sundaram – 217-221 B S Raman – 222-224

• Private Sector or Private Enterprises refers to that sector which is owned and managed by private individuals.

• A private enterprise is controlled either by an individual investor or a joint stock company or a group of individuals or public or private limited companies.

• Private sector is purely profit motive.

Role of Private Sector in India1. Help third world countries in their economic development2. Agriculture : this sector which is completely managed by the private enterprises

contributes 25% of GNP an 60% of employment in 2001.3. Dominates the Trading Sector4. Dominant in forestry, fishing, railways, construction, etc.5. Contribution to national income of country6. Development of large no. of small scale and cottage industries7. Production of a variety of goods8. Efficient management

Limitations Of Private Sector

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I. Emphasis on Non-priority IndustriesII. Emergence of monopoly power and concentration

III. Industrial disputesIV. Industrial sickness

Small Scale Industries (SSI)Misra & Puri – 571-585

Small-scale industries are industries which are organised on a small-scale and produce goods with the help of small machines, hired labour and power.

The investment limit for a SSI is Rs 1 crore SSIs plays a pivotal role in India in terms of employment and growth has recorded

a high rate of growth.

Significance of SSIs in the Economic Development of India1. Expansion of SSI sector and its share in Industrial Output : No of SSI units rose from 79.6 lakhs in 1994-95 to 114.0 lakhs in 2003-04. The rate of growth of output exceeded 10% from 1994 to 1997.2. Employment Generation: 1994-95 – 191.4 lakh people 2003-04 – 271.4 lakh people3. Efficiency of Small-Scale Industries:

At the all-India level, the SSI is more efficient than the large scale sector.4. Equitable distribution of National Income5. Mobilisation of capital and Entrepreneurial Skills6. Regional dispersal of Industries7. Contribution to Exports8. Sustains Agricultural Development9. Less Industrial Disputes10. Decentralisation of Industries11. Contribution to National Income12. Foreign Exchange Earnings

Problems of SSIs Misra & Puri – 582-585

i. Finance and Creditii. Inverted tariff structure and raw material availability

iii. Machines and other equipmentiv. Problems of marketing v. Infrastructural constraints

vi. Delayed paymentsvii. Problem of sicknessviii. Poor databaseix. Adverse effects of economic reforms and globalisationx. Inefficient management

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xi. Competition from large scale industriesxii. Burden of local taxes

Measures to Reduce Sickness among SSI Credit and Finance Marketing Assistance Allocation of Raw materials, Imported Component and Equipment Technical Assistance Industrial Estates

Small-scale Industrial Policy,1991Misra & Puri-579

The main features of policy were:1. Investment for Tiny Enterprises was raised from Rs.2 lakh to Rs.5 lakh.2. Proposed a separate package for the promotion of SSIs.3. Provided Equity Participation by other industrial units in the SSIs not exceeding

24% of the total shareholdings.4. Introduction of new Legal form of organisation of business, namely restricted or

limited partnership.5. Proposed to meet the entire credit demand of SSIs.6. Scope of National Equity Fund and Single Window Scheme was enlarged.7. Provided priority to SSIs in the Government Purchase Programme.8. Accorded in allocation of indigenous raw materials.9. Envisaged market promotion of SSI products to be undertaken by Cooperatives,

PSUs and other agencies.10. Proposed a scheme of Integrated Infrastructure Development for SSI to facilitate

location of industries and to promote co-ordination b/w Industry and agriculture.

Multinational CorporationsIshwar C Dingra – 552-560

An MNC is one which undertakes FDI, i.e., it owns or controls income generation assets in more than one country, and in doing so produces goods or services outside its country of origin ,i.e, engages in international production.

Characteristics of MNCsThe MNCs are multi-process, multi-product and multi-national composite enterprises.

1. Giant size2. International Operations3. Oligopolistic Character4. Spontaneous Evolution5. Collective Transfer of Resources

Significance Of MNCsImpact area Potential benefits

1. Capital 1. Provision of scarce capital

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2. Technology

3. Exports and balance of payments4. Diversification

resources.2. Provision of sophisticated

technology not available in host country

3. Access to superior distribution and marketing systems

4. MNCs command technology and skill required for diversification of industrial base and for the creation of backward and forward linkages

Actual impact of MNCs1. Capital

2. Technology

3. Exports and balance of payments

4. Diversification

1. Insignificant net flow Large dividend remittances Large technical payments

2. Costly ‘over-import’ Problems with advanced technology Problems with technical support

3. Higher import propensity than domestic companies

Negative BOP effects4. Increased foreign influence in key

sectors

Module – 7 - Money and Banking

Commercial Banking Structure In India• Indian commercial banks are called Joint Stock Banks as they are organized in the

form of joint stock companies.• Under the Reserve bank Of India Act,1934, the commercial banks in India are

classified into:i. Scheduled Commercial banks

ii. Non-scheduled Commercial Banks

Scheduled Commercial Banks• Scheduled commercial banks are those banks which are included in the second

schedule of the Reserve Bank of India, having a paid-up capital and reserve together Rs.5 lakh and above.

• As on March 2004, there were 286 schedule commercial banks in the country

Non-scheduled Commercial Banks• Non-scheduled banks are those whose total paid-up capital and reserve fund is less

than Rs.5 lakh and whose name is not included in the second schedule of RBI

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Act,1934.• At present, there are only two non-scheduled banks in the country.

Diagrammatic Representation

Diagrammatic Representation

Scheduled Commercial Banks

Public sector banks Private sector banks

Nationalised banks

SBI andits associates

Indian private sector banks

Foreign banks

Old private sector banks

New private sector banks

Nationalisation Of banks• Nationalisation of banks is nothing but the government taking control of those banks

which were owned by private people.• This was the milestone in the history of Indian Banking.• There are 20 nationalised banks which carry out 90% of banking business in the

country.

Nationalisation on 19 July 19691. Central Bank of India2. Bank of India3. Punjab National bank4. Bank of Baroda5. United Commercial Bank6. Canara Bank7. United Bank of India8. Dena Bank9. Syndicate Bank10. Union Bank Of India11. Allahabad Bank12. Indian Bank13. Bank of Maharashtra14. Indian Overseas Bank

Nationalisation on 15 April 1980

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1) New Bank of India2) Vijaya Bank3) Andhra Bank4) Corporation Bank5) Punjab and Sidh bank6) Oriental Bank of Commerce

Causes of Nationalisationa. Concentration of Economic Powerb. Neglect of Agricultural Sectorc. Misuse of Power by Directorsd. Credit to Anti-social Elementse. Neglect of Small Unitsf. Plan Objectives Ignoredg. Insufficient Mobilisation of Resourcesh. Unbalanced Growth

Objectives of Nationalization To prevent concentration of wealth and economic power in the hands of few

people. To prevent control and administration of banks by few people To prevent misuse of funds To provide required finance to priority sectors To provide banking facilities to unbanked and rural areas To provide deposit security to deposit holders To mobilise resources of the country To make the banks respond to plan objectives To bring banks under the control of RBI To prevent the flow of bank credit to anti-social elements To provide atmosphere for balanced growth of banking in the country.

Arguments Against Nationalisationa. Results in the political interference in the functioning of banks.b. Leads to bureaucratic dictatorship.c. Results in inefficiencyd. Banks suffer lossese. Results in corruptionf. Leads to flow of funds to unworthy sectorsg. Results in the disclosure of banking secrets

Achievements Of Nationalisation Branch Expansion

In 1969 – 8,260 bank branches In 2002 – 67,284 bank branches

Deposit Mobilisation

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In 1969 – 4,665 crores In 2002 – 16,22,579 crores

Developmental Functions Finance to Priority Sectors

In 1969 – 505 crores (2% of total bank credit) In 2002 – 3,41,291 crores (43.7%)

Increase in Total Transactions In 1969 – 4,664 crores of Deposits In 2002 – 12,59,128 crores of Deposits

Differential Rate of Interest Profit Making

During 1999-2000 – Rs.13,064 crores of profits. Safety Finance to Public Sectors

Functions of the Reserve Bank of India• Bank of Issue• Banker to Government• Bankers’ Bank and lender of the last resort• Controller of Credit

a. Quantitative Methods1. Bank rate2. Variable cash reserve ratio (CRR)3. Statutory liquidity ratio (SLR)4. Open market operations (OMO)

b. Qualitative Credit controls/selective credit control1. Minimum margin for lending2. Ceiling on amount of credit3. Discriminatory rate of interest

• Custodian of Foreign Exchange Reserves• Supervisory Functions• Promotional Functions

Recommendations of the Narasimhan Committee, 1991Reference: Dutt and Sundaram Pg:853

• Aimed At :1. Ensuring a degree of operational feasibility2. Internal autonomy for the public sector banks in their decision making process3. Greater degree of professionalism in banking operations

Important Recommendations :1. Directed Investment

a. Statutory Liquidity Requirements: The committee recommended that the government should reduce SLR from

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38.5% to 25%.b. Cash Reserve Ratio CRR should be reduced from 15% to 3-5%.

2. Directed Credit Programmes3. The Structure Of Interest rates4. Structural Reorganization of the Banking Structure5. Nationalisation of banks6. Setting up of New banksForeign Banks8. Bad and Doubtful Debts9. Removal of Dual Control10. Autonomy to Banks11. Disinvestment12. Rural Banking Subsidiaries13. Recruitment of Staff 14. Computerization

Reform Of the Banking SectorDutt and Sundaram Pg:855

1. Statutory Liquidity Ratio (SLR) SLR on incremental net demand and time liabilities (DTL) has been reduced from 38.5% to 25% in 1997.

2. Cash Reserve Ratio (CRR) RBI reduced CRR from 15% to 5.5% in 2001. the purpose was to release funds locked up with RBI for lending to the industrial sectors .

3.Deregulation of Interest Rates Interest rates slabs were gradually reduced from 20 to 2 by 1995.

4. Prudential Norms The purpose was that commercial banks should reflect their financial positions more accurately and in accordance with international accounting practices.5. Capital Adequacy Norms: were fixed at 8% by RBI in 1992.6. Access to Capital Market: SBI was the first to raise through public issue over Rs. 1,400 crores as equity and Rs. 1,000 crores as bonds.7. Freedom of Operation8. New Private Sector Banks9. Local Area Banks: LABs help to mobilise rural savings and to channelise them into investment in local areas.10. Supervision of Commercial Banks RBI has set up a Board of Financial Supervision with an Advisory Council under the chairmanship of the Governor to strengthen the Supervisory and Surveillance system of

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banks and FIs11. Recovery of Debts: The Government of India passed “Recovery of Debts due to banks and FIs Act, 1993”. Six Special Recovery Tribunal have been set up.12. Phasing out of Directed Credit13. Competition

Measures of Money SupplyReference : Ahuja – 301--303

• From April 1977, the Reserve Bank of India has adopted four concepts of money supply in its analysis of the quantum of and variations in money supply.

• The four concepts of money supply are:1. Money Supply M1 or Narrow Money2. Money Supply M23. Money Supply M3 or Broad Money4. Money Supply M4

Money Supply Chart

Money Supply Chart

Money Supply and its determinants

M1=

Currency+

Demand Deposits+

Other deposits of RBI

M2=

M1+

Savings deposits with

Post-office Savings Banks

M3=

M1+

Time Deposits withthe Banks

M4=

M3+

Total Deposits of Post Office Savings

Organisation(excluding NSC)

Money Supply M1 or Narrow Money• Liquid measure of money supply• M1 = C + DD + OD• C = Currency with the public• DD = Demand deposits with the public in the commercial and Co-operative Banks• OD = Other deposits held by the public with the Reserve Bank of India• C (Currency with the Public) consists of the following:

1. Notes in Circulation2. Circulation of rupee coins asa well as small coins3. Cash Reserves on hand with all banks

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Money Supply M2• M2 = M1 + Savings Deposits with the post office savings bank• M2 is a broader concept of money supply

Money Supply M3 or Broad Money• M3 = M1 + Time deposits with the banks• Time deposits serve as store of value and represent savings of the people• Time deposits are very liquid.• M3 has become a popular measure of one supply.• M3 is used for monetary planning of the economy and setting target of growth of

money supply.• M3 also called as Aggregate Monetary Resources (AMR).

Money Supply M4M4 = M3 + Total deposits with Post Office Savings Organization.

Sources of Broad Money (M3) or Factors affecting Money Supply In India(Dutt & Sundaram-823)

• There are Five Factors / sources which contribute to the Aggregate Monetary Resources in the country:1. Net Bank Credit to Government (A+B)

A. RBIs net credit to Government i. Claims on Government

ii. Govt deposits with RBI B. Other Bank’s credit to Government2. Bank Credit to Commercial Sector ( A+B)

A. RBIs credit to commercial sectorB. Other bank’s credit to commercial sector

3. Net Foreign Exchange Assets of Banking Sector (A+B)A. RBIs net foreign exchange assetsB. Other bank’s net foreign exchange assets

4. Government’s Currency Liabilities to the Public5. Net Non-monetary Liabilities of the Banking Sector (A+B)

A. Net Non- monetary liabilities of RBIB. Net Non- monetary liabilities of banks.

Thus, M1 = 1+2+3+4+5

Monetary Policy Of the RBI / Measures of Control Imposed by RBI to Regulate Monetary Systems in India (Dutt and Sundaram – 902)

• Controlled expansion ( 1951-72)• RBIs Anti- Inflationary Monetary Policy since 1972.• Entry of RBI into Foreign Exchange Market

Major weapons of Monetary Policy / Control Measures

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• Credit Control:1. General Credit Controls

a. Bank rateb. Cash reserve ratioc. Statutory Liquidity Requirementsd. Open market Operations Of RBI

2. Selective and Direct Credit Controls• Credit Authorization Scheme (CAS)• Credit Monitoring Arrangement (CMA)

Module 8CURRENT ECONOMIC ISSUES

TOPICS• PUBLIC ACCOUNTS COMMITTEE• COMPTROLLER AND AUDITOR GENERAL

PUBLIC ACCOUNTS COMMITTEComposition The Public Accounts Committee consists of fifteen Members elected by Lok

Sabha every year

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Seven members of Rajya Sabha elected by that House in like manner are associated with the Committee

Appointment of Chairman The Chairman of the Committee is appointed by the Speaker from amongst the members of Lok Sabha elected to the Committee.

As a convention, starting from the Public Accounts Committee of 1967-68, a member of the Committee belonging to the main opposition party/group in the House is appointed as the Chairman of the Committee

A Minister is not eligible to be elected as a member of the Committee and if a member, after his election to the Committee, is appointed as a Minister, he ceases to be a member of the Committee from the date of such appointment

The term of office of the members of the Committee is one year

FUNCTIONS The Public Accounts Committee examines the accounts showing the

appropriation of the sums granted by Parliament to meet the expenditure of the Government of India

Committee also examines the various Audit Reports of the Comptroller and Auditor General on, expenditure by various Ministries/ Departments of Government and accounts of autonomous bodies.

To ascertain that money granted by Parliament has been spent by Government "within the scope of the demand".

The Committee examines various aspects of Government’s tax administration. The Committee identifies loopholes in the taxation laws and procedures and make

recommendations in order to check leakage of revenue.

COMPTROLLER AND AUDITOR GENERAL The Comptroller and Auditor General of India is the head of the Indian Audit and

Accounts Department CAG is an office which directs, monitors and controls all activities concerned

with audit, accounts and functions of the Department Offices of the Accountants General (Audit) are responsible for audit of all receipts

and expenditure of the State governments and audit of State Government companies, corporations and autonomous bodies

Offices of the Principal Directors of Audit are responsible for audit of the activities of the Union Government including Defence, Railways ,Postal, Telecommunications etc..

The present Comptroller and Audit General of India is Mr. Vijayendra.N.Kaul

FUNCTIONS

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1. He can engage consultants and/or obtain professional services in conducting audit 2. He can make rules for maintenance of accounts3. Make regulations for carrying out the provisions relating to the scope and extent

of audit 4. To supervise and regulate external auditors' work under the Indian Companies Act 5. Appointment of external auditors.6. Access the computer systems of the auditees and suggest changes if any.7. CAG assists the Public Accounts Committee in examination of Accounts and

Audit reports.

COMMITTEE ON PUBLIC ACCOUNTS8. 15 members elected from lok sabha by every year9. 7 are elected from rajya sabha to associate with the committee

Process of electing Appointment of chairman Minister not to be Member of Committee

Term of the office

Functions Showing the appropriate of sums Examines the audit reports Usage of money Identifies loopholes in taxation laws Recommends in order to check leakage of revenue

Functions• Showing the appropriate of sums• Examines the audit reports• Usage of money• Identifies loopholes in taxation laws• Recommends in order to check leakage of revenue• Assistance by comptroller• Sub-committees• Evidence of officials• Ministers are not called before committee Reports Action taken on reports

Public Disinvestment Board

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Privatisation v/s disinvestment• The words privatisation and disinvestment are often used interchangeably.• Disinvestment leads to privatisation when the Government held equity is reduced to a

level when the company no longer remains a Government company

Privatisation has different nomenclature in different countries • Disinvestment.• Peopalisation.• Popular capitalism .• Denationalisation.• Prioritisation.• Industrial transition.• Economic democratisation.• Partners in development.• Transformation and restructuring.

Objectives of Ministry of Disinvestment• Releasing the large amount of public resources locked up in the non-strategic

PSEs for re-deployment in areas of high social priority.• To reduce the public debt.• Transferring the commercial risk to the private sector wherever it is willing to.• Releasing other tangible & intangible resources such as man power etc.

Emergence of disinvestment policy• Industrial policy 1991.• Rangarajan Committee 1993.• Disinvestment commission recommendations 1999.• Budget speech: 1998-99.• Budget speech: 2000-01.

Strategic and non-strategic classification• Arms and ammunitions.• Atomic energy.• Railway transport.• All other public sector enterprises to be considered as non-strategic.

The Department of Disinvestment• The Department of Disinvestment was formed on the10th December 1999.• With a view to establish a systematic policy approach to disinvestment and

privatisation.• To give a fresh impetus to the Government’s disinvestment programme.

TARGETED AND ACTUAL DISINVESTMENT YEAR TARGET

RECEIPTSACTUAL RECEIPTS

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1991-92 2500 3038

1993-94 3500 NIL

1994-95 4000 4853

1995-96 7000 362

1996-97 5000 380

1997-98 4800 902

1999-00 10000 1829

2000-01 10000 1870

2002-03 12000 3348

2003-04 14500 15547

Economic Survey (2004-05

Changing profile of PSUsPSUs Net profit 01-02 Net profit 02-03

ONGC 6198 10529IOC 2885 6115SAIL -304 1498GAIL 1186 1739SCI 242 275BSNL 5740 1444

All through the years now

The Government’s approach to PSUs has a three-fold objective: • revival of potentially viable enterprises• closing down of those PSUs that cannot be revived and • bringing down Government equity in non-strategic PSUs to 26 percent or lower

Government’s promise Government would continue to ensure that disinvestment does not result in alienation of national assets, which, through the process of disinvestment, remain where they are. It will also ensure that disinvestment does not result in private monopolies.

Criticisms• Privatisation of profit making public enterprises.

Mr. George Fernandes in NDA Govt.• Basic criticism – that the funds raised by selling family silver were used to pay

the butler.To set up disinvestment proceeds fund.

• Methodology for disinvestment.

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Open auction sale during 94-95 to allow NRIs to participate in the offer. • Creation of private monopoly in place of public monopoly.

Public sector monopoly is accountable for the parliament but private need not be……• Valuation of PSUs slated for disinvestment.

Eg: PAC quantified the loss to be of the order of Rs.3000 crores in 91-92 out of Rs.4950 crores raised.

Disinvestment policy and the future of PSUsThe recent changes in the culture of the PSUs as mentioned above also reinforces the fact that by disinvesting highly profitable PSUs, the government is trying to kill the goose which lays golden eggs.

OPERATING LEVERAGE• % change in operating revenue will be more than the % change in sales (FC remains

the same)• Any increase in sales, FC remaining the same, will magnify the operating revenueformulas……

contribution = sales- VC operating profit (EBIT) = sale - VC – FC or OP = contribution – FC

Example Following is the cost information of a firm:FC = 50,000VC = 70% of salesSales = 2,00,000 in previous year 2,50,000 in current yearFind out % change in sales and operating profits when:i) FC are not there (no leverage)

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ii) FC are there ( with leverage)

Solution:(i) Previous year

(Rs)Current year (Rs)

% change (Rs)

SalesLess: VC(70% of sales)Profit from operations

2,00,0001,40,000 60,000

2,50,0001,75,000 75,000

25 %25 %25 %

(ii) Previous year (Rs)

Current year (Rs)

% change (Rs)

SalesLess ; VC(70% of Sales)ContributionLess : FCProfit from operations

2,00,0001,40,000 60,000 50,000 10,000

2,50,0001,75,000 75,000 50,000 25,000

25 %25 %25 %

150 %

Comments:• In case (i) %change in sales & %change in OP is the same i.e. 25%• In case (ii) % change in profit (150%) is much more than the %change in sales (25%).• The FC element has helped in increasing profits.

COMPOSITE LEVERAGE• Operating leverage affects the income which is the result of production• Financial leverage is the result of financial decisions• Composite leverage focuses attention on the entire income of the concernComposite Leverage = operating leverage * financial leverage.

EX: The following figures relate to two companies P LTD Q LTDSales 500 1000Variable costs 200 300Contribution 300 700Fixed costs 150 400 150 300Interest 50 100Profit before tax 100 200

i) Calculate the OL, FL, CL.ii) Comment on the relative risk position of them.

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a) OL : As the OL for Q Ltd is higher than that of P Ltd ; Q ltd has a higher degree of operating risk. The tendency of profit to vary disproportionately with sales is higher for Q Ltd as compared to P Ltd.

b) F.L : Since FL for the two companies is the same both the companies have the same degree of financial risk, i.e. the tendency of net disproportionately is the same for P Ltd and Q Ltd.

C) C.L : As the combined leverage for Q Ltd is higher than P Ltd has overall higher risk as compared to P Ltd.

Calculation of Leverages P.Ltd Q.LtdO.P = contribution 300 700 EBIT 150 300 =2 =2.333

F.L = EBIT 150 300 EBT 100 200 = 1.5 = 1.5

C.L = OL*FL 300 700 100 200 = 3 = 3.5

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