External Sector

It is that sector of an economy which deals with economic activities with the external world. includes export, import, FDI etc.



All of India's transactions with external world fall into either current account or capital account.

Current Account

All the short term transactions are recorded here.

• Import & export (difference is the trade balance)
• Interest from loans
• foreign investment in shares (Portfolio investments)

Maintained by the central bank (RBI) on behalf of the govt.

India had current account surplus only during 2000-2003.

Trade Deficit

It is the monetary value difference between import and export of goods.

Capital Account

All the long term transactions are recorded here.

• FDI
• Long term loans
• issuance of external bonds
• private remittance

There is no deficit or surplus calculation here like the current account.

Convertibility

It is the ability of domestic currency to convert into foreign currency with ease.

India currently allows full convertibility in Current account (after 1991 liberalization) but partial convertibility on Capital Account

Raghuram Rajan says full convertibility will happen in few years, but India requires some curb as of now. 

In May-August 2013, capital control helped the country when fed tapering saw as many as over USD 20 billion being pulled out of the country by foreign investors. It even helped in averting any situation akin to currency meltdown of Asian economies that happened in 1997-98

some more

Banks

Banks

1. Commercial Banks
• deals mainly with general public
• SBI, ICICI etc.
• RBI is the regulator
2. Industrial Development Banks
• target group is industries
• provides medium/ long term finance
• IDBI, IFCI, IIBI
• also NABARD, SIDBI,NHB
3. RRBs (NABARD is the regulator)
4. Cooperative Banks
• SCBs
• District level or Urban based
• PACs

Rural Banking

Players

• Commercial Banks
• RRBs
• Cooperatives
• MFIs etc.

Initiatives

• Bank nationalization
• Priority Sector Lending
• RIDF (operated by NABARD)
• RRBs on the recommendations of Narasimhan committee
• Amalgamation of RRBs
• Kisan Credit Card (KCC)
• SHG-Bank Linkage
• Banking Correspondent (BC)
• 2006 : Interest Subvention scheme
• Swabhimaan scheme

Financial Inclusion

Initiatives

• 1969 : Lead Banking Scheme
• 2005 : Basic savings account
• 2011 : Swabhimaan (target extended in 2012 budget speech)
• 2006 : BC
• Ultra Small Branches (USBs)
• Kiosk Banking is being mooted

Issues/ challenges

• NPA
• Capital/ Fund shortage- cannot raise fund from capital market
• Rural banking

http://www.thehindu.com/opinion/columns/C_R_L__Narasimhan/the-elusive-quest-for-autonomy/article6996234.ece

Security Market

Insurance Sector

It is a kind of 'risk spreading'. and solves two purpose

• a safety/security for the individual
• acts as financial intermediary

Insurance policies are purchased at fixed premiums.

Life Insurance

Non-life general Insurance (health, micro insurance etc.)

Reinsurance

Specialized Insurance

Insurance Penetration = Premium underwritten/GDP (2.3% in 2000 to 4%)

Insurance Density = Premium underwritten/Total population

Development of Insurance Industry in India
1956 : Life insurance sector was nationalized and LIC was set up. LIC had been the biggest investor for public sector (Govt and PSUs, recently even for Railways)
1971 : General insurance sector was nationalized. GIC started operation with 4 holding companies.
1993 : Insurance Reforms Committee under ex-RBI Governor RN Malhotra
1994 : Malhotra committee recommendations

• Decontrolling of the sector -> IRDA act, 1999
• restructuring of GIC -> in 2000
• restructuring Tariff Authority Committee
• setting up a regulatory authority -> IRDA in 2000

1999 : Year of Insurance reforms
2000 : GIC was reconstituted as the sole reinsurer
2002 : GIC is no longer the holding company for the four. They are directly owned by GoI.

Challenges ahead for the sector

Major issues plaguing the sector

Govt. Policy initiatives

Bancassurance
Banks as agents to sell insurance policies
3 business models are here
2000 : this model came into existence in India after GoI and RBI permitted

The Insurance Bill

Finally passed in Mar 2015, while the initial bill was introduced in 2008

Salient Features

• FDI cap to increase from 26% to 49%
• IRDA to have more powers
• to levy higher penalty on violation of laws 
• impose a ceiling on expense management 
• fix remuneration for agents (commission)
• A policy can be called to question within 3 years on misstatement of facts
• no rejection of claims after 3 years
• ambit of health insurance got increased
• foreign insurers cannot issue policy in India without prior IRDA permission, even in SEZs

Benefits

1. more coverage / distribution points
2. simpler products
3. more transparency in features
4. less dependance on agents
5. 26% to 49%
1. more variety in products
2. more professionalism
6. flexibility in paying premiums through installments
7. faster claim settlement
8. bring credibility to the sector globally
9. simplification of norms for expansion of reinsurance sector
10. issues
1. in cases of M&A, bill proposes to curb regulator's power

http://www.livemint.com/Home-Page/thCYUdcyPVbDUPU3cDSbCJ/Theres-more-to-the-insurance-Bill-than-just-hike-in-FDI.html?utm_source=copy

http://www.business-standard.com/article/pf/7-benefits-if-insurance-bill-is-passed-114102600673_1.html

http://mrunal.org/2014/01/banking-bancassurance-compulsory-broker-model-irda-vs-banks-issue-benefits-challanges-insurance-penetration-financial-inclusion-nachiket-committee.html

Further Reading
1. Ramesh Singh

2. NIOS Material
3. Hindu Article

Financial Intermediaries & Financial Market

Who are they?

Channelize surplus money (savings) from Investors (individual households & companies) and producers.

And, the place where this exchange of surplus money takes place is the Financial Market.

2 separate segments

1. Money Market (caters to short-term (upto 364 days) fund requirements)
2. Capital Market (caters to long term fund requirements) 

Money Market in India

Organized

8 instruments are available here to cater to different needs

• Treasury Bills
• CDs
• Commercial Bills
• Commercial Papers
• Mutual Funds
• Repo and reverse repo
• Cash Management Bill

Players

• Government
• Corporates
• Banks
• Individuals etc.

Unorganized

• Local money lenders
• Indigenous Bankers
• Small/ Big Businessmen 

Capital Market in India

Players

1. Banks
2. Financial Institutions
1. AIFIs
1. SIDBI
2. NHB
3. EXIM Bank
4. NABARD
2. SFIs
1. RCTC
2. TFCL
3. Investment Institutions (now not in vogue)
1. GIC
2. LIC
3. UTI
4. SLFIs
1. SFCs
2. SIDCs
3. NBFCs
4. Security Market players
1. Mutual Fund Companies
2. Insurance Companies 
3. Pension and Provident Funds

Inflation and how to check it

Inflation is caused by mismatch in the money supply in the economy.
Money supply is determined by

RBI manages money supply through its Monetary Policy Framework

http://www.thehindubusinessline.com/economy/govt-announces-details-of-new-insurance-pension-schemes/article6950744.ece


RBI can follow tight monetary policy to control the money supply in the economy by

• Raising LAF or repo rate (now 7.75%)
• raising CRR (now 4%)
• raising SLR (now 23%)
• raising Bank rate
• Open Market Operations
• Qualitative measures

By Govt through fiscal Policy

http://www.thehindu.com/business/Economy/india-overhauls-monetary-policy-using-inflation-targets/article6951461.ece

Inflation - An overview

Inflation 

A general price rise sustained over a period of time.

http://www.thehindu.com/business/ready-reckoner-what-isdeflation-and-is-it-bad/article7692832.ece

Type of Inflation	Cause
Inflation	Price Rise
Deflation	Fall in general level of prices
Stagflation
Reflation

Causes of Inflation

Demand-Pull

depends on the money supply (available money ) in the system. This can be measured as below -

• Keynesian school (favours lowering demand)
• goods in short supply are imported or not exported
• wage revision
• interest on loans are raised
• Monetarism school
• monetary policy tool for proper money supply

Cost-Push

• Keynesian School
• reducing excise duties on raw materials
• wage revision
• Monetarism school
• monetary policy tool for proper money supply

monetary policy tools does not work if price rise is taking place in items of everyday use.

monetary policy tools are used by RBI where other (fiscal) measures are used by govt. (Box 4.2 of economic survey 2012-13)

Inflation Types

1. Low
2. Galloping
3. Hyperinflation

Other Terms/Concepts
Reflation
Stagflation


Measuring Inflation

1. By price indices such as WPI or CPI
2. By help of GDP deflator method

Effects of Inflation

1. Redistributes wealth from creditors to debtors
2. Lending institutions suffer
3. shows a rise in demand
4. Investment is boosted in the short run because
1. higher inflation suggests higher demand
2. cost of loan is lowered
5. shoe leather cost of inflation
6. on tax
7. on ex
8. export segment benefits by volume
9. imports become costlier
10. on trade balance
11. increases employment in the short run (Philips curve)
12. increases nominal value of wages while real value falls (dearness allowance)

Comfort Zone of Inflation - Inflation Targeting as part of monetary policy

Further Reading

1. Mrunal article

2. Ramesh Singh

Economy Basics

All of us want to earn our income in order to spend and save (thereby increasing our economic wealth and well being). Income earning, spending and saving are called Economic Activities. These activities are interrelated and interdependent.
For income generation, goods and services are produced (Production process) from resources. Mere possession of resources does not entail income or wealth. So in production process or flow of production, human resources gets combined with natural and manmade environment with certain social and technological structure.
Part of the income is spent on these products by consumers (Consumption) and rest goes to savings (investment).

Economics is the discipline that studies the economic activities of mankind.
&
Economy is the system where these activities take place.

Economy provides - 

• Goods
• Intermediate Goods   [by the economic nature of its use]
• Finished/ Final Goods  [by the economic nature of its use]
• Producer (or Capital) goods [constitutes the total investment]
• Consumer goods
• Single use
• durable
• Services 
• Producer
• Single use
• Consumer
• Single use

Vital Processes or Activities of Economy

Production

Consumption

Investment through Savings

Stock investment
Fixed investment

The part of final goods that are capital goods constitute Gross Investment of an economy.

Net Investment = Gross Investment - Depreciation

Saving = Income - Consumption Expenditure

Savings are routed to investment via Financial Intermediaries.

Sectors of Economy

Economic Activities are broadly classified into different categories which are known as sectors of economy.

Primary Sector - comprises all those economic activities that use various natural resources. 

Secondary Sector - comprises all those economic activities that uses output of primary sector as raw materials.

Tertiary Sector - It is like a horizontal providing services to all the above sectors.

Types of Economy 

Classification is based on i) relative contribution of particular sector in total production and ii)ration of dependent population on the sector.

Agrarian Economy

Industrial Economy

Service Economy

constitute different stages in the growth of an economy.

National Income

Three methods to measure this.

i)   Income method

ii)   Expenditure method

iii)  Product Method

GDP, NDP, GNP, NNP

GDP = Gross value of all the goods and services produced in the territory of a country (India) during a period of time (generally for a year)

NDP = GDP - Depreciation

GNP = GDP + Net Factor income from abroad 

Net Factor income from abroad = Factor income by domestic factors of production (Indian resources) employed abroad - 
Factor income by foreign factors of production employed in India

NNP = GNP - Depreciation

All these measures can be evaluated - 

i) at factor cost

ii) at market price (factor price/market price = factory price + ex-factory price)

NNPFC = NI = NNPMP - Indirect Taxes + Subsidies

NI = PI + UP + Corporate Tax + Net interest Payments - Net Transfers

PI = PDI + Tax payments + Non-tax payments

National Disposable Income = NNPMP + other current transfers from abroad

In India and in most developing economies, income is calculated at factor cost. why?

The price can be constant or current.

Again India (and most developing economies) calculate income at constant prices. why?

Income of a person or the country can be

• Nominal (measured at current prevailing prices)
• Real      (measured at constant prices) 
• Disposable

GDP Deflator = Nominal GDP/ Real GDP

GDP Deflator is a measure of change in prices. Other two being 

• WPI
• CPI
• for rural
• for urban
• for both

New Changes in the National Income Calculation

Jan 2015 : CSO changed 

• base year from 2004-05 to 2011-12
• methodology

Result : Revised GDP for FY2014-15 is 7.4%, up by 1.5% from 2013-14

Skepticism because

• new manufacturing GDP includes not only the value of production of a business unit, but also distribution (marketing and selling) costs. So, the share of corresponding services should have been reduced
• macroeconomic indicators do not show a significant positive change : The rate of Gross Fixed capital Formation (GFCF) has fallen over the year w.r.t GDP
• lack of clarity