CENTRAL BANK/RESERVE BANK OF INDIA

CENTRAL BANK/RESERVE BANK OF INDIARole/Function of Central Bank/RBI1.Bank of Note IssueThe central bank has the sole monopoly of note issue in almost every country. The currency notes printed and issued by the central bank become unlimited legal tender throughout the country.In the words of De Kock, "The privilege of note-issue was almost everywhere associated with the origin and development of central banks."However, the monopoly of central bank to issue the currency notes may be partial in certain countries. For example, in India, one rupee notes are issued by the Ministry of Finance and all other notes are issued by the Reserve Bank of India.The main advantages of giving the monopoly right of note issue to the central bank are given below:(i) It brings uniformity in the monetary system of note issue and note circulation.(ii) The central bank can exercise better control over the money supply in the country. It increases public confidence in the monetary system of the country.(iii) Monetary management of the paper currency becomes easier. Being the supreme bank of the country, the central bank has full information about the monetary requirements of the economy and, therefore, can change the quantity of currency accordingly.(iv) It enables the central bank to exercise control over the creation of credit by the commercial banks.(v) Granting of monopoly right of note issue to the central bank avoids the political interference in the matter of note issue.

Role/Function of Central Bank/RBI2. Banker to Government:The Reserve Bank acts as the banker, agent and adviser to Government of India:(a) It maintains and operates government deposits,(b) It collects and makes payments on behalf of the government,(c) It helps the government to float new loans and manages the public debt,(d) It sells for the Central Government treasury bills of 91 days duration,(e) It makes 'Ways and Means' advances to the Central and State Governments for periods not exceeding three months,(f) It provides development finance to the government for carrying out five year plans,(g) It undertakes foreign exchange transactions on behalf of the Central Government,3. Agent to the GovernmentAs an Agent to the government, the central bank collects taxes and other payments on behalf of the government. It raises loans from the public and thus manages public debt. It also represents the government in the international financial institutions and conferences. ) It acts as the agent of the Government of India in the latter's dealings with the International Monetary Fund (IMF), the World Bank, and other international financial institutions4.Adviser to the GovernmentAs a financial adviser to the lent, the central bank gives advise to the government on economic, monetary, financial and fiscal matters such as deficit financing, devaluation, trade policy, foreign exchange policy, etc.

Role/Function of Central Bank/RBI5.Custodian of Cash Reserves of Commercial BankCentral bank is the bank of banks. This signifies that it has the same relationship with the commercial banks in the country which they have with their customers. It provides security to their cash reserves.The exact form of this function has varied from country to country. . In some countries, however, the banks are compelled by law to hold deposit balances with the central bank called as Cash Reserves and this gives it an additional tool to regulate credit creation by them. The legal provision to this effect was first introduced in US. Later, it was adopted in India also. RBI has found it a very effective regulatory tool and has used it very extensively. Every Bank is under the statutory obligation to keep a certain minimum of cash reserves with the Reserve Bank. The purpose of these reserves is to enable the Reserve Bank to extend financial assistance to the scheduled banks in times of emergency and thus to act as the lender of the last resort.Again, the choice of exact percentage and its revision is left to the discretion of the RBI. The current CRR is 4% and as per the amendment to the Banking Regulation Act in September 1972 it can be raised to 15% if the Reserve Bank considers it necessary,Through this CRR the RBI regulates the money supply in the market and controls the inflation . If the inflation is high RBI increases CRR (Cash Reserve Ratio). Thus Banks have to maintain higher cash reserves with RBI and thus reduces the money available with Banks for giving it on credit. In other words the money supply in the market reduces which lowers the spending and ultimately the demand for goods decreases and consequently decreases the inflation rate.During times of recession RBI reduces CRR. Thus Banks have to maintain lower reserves with the RBI which increases the money available with them for giving it on credit. This increases the money supply in the market which increases spending and ultimately demand for goods increases and this gives stimulus to economy.

Role/Function of Central Bank/RBI6.Lender of the Last Resort:Central bank works as lender of the last resort for commercial banks because in the times of need it provides them financial assistance and accommodation. Whenever a commercial bank faces financial crisis, central bank as lender of the last resort comes to its rescue by advancing loans and the bank is saved from being failed. Central bank helps commercial banks by discounting their bills and securities.7.Clearing House Function:All the commercial banks have their accounts with the central bank. Therefore, central bank settles the mutual transactions of banks and thus saves all banks contacting each other individually for setting their individual transactions, in this way; the unnecessary cash transactions between individual banks are avoided.The clearing house function of the central bank has the following advantages:(i) It economies the use of cash by banks while settling their claims and counter-claims.(i) It reduces the withdrawals of cash and these enable the commercial banks to create credit on a large scale.(ii) It keeps the central bank fully informed about the liquidity position of the commercial banks

Role/Function of Central Bank/RBI8.Credit Control:This is a very important function. These days, the most important function of central bank is to control the volume of credit for bringing about stability in the general price level or inflation and accomplishing various other socio-economic objectives. There are number of methods which a central bank may use for controlling the volume of credit such as bank rate, open market operations, change in cash reserve ratio and various selective controls.9.Custodian of Foreign Exchange Reserves:Central bank of a country is also a custodian of its official foreign exchange reserves. This arrangement helps the authorities in managing and co-ordinating the monetary matters of the country more effectively. This is because there is a direct association between foreign exchange reserves and quantity of money in the market. The foreign exchange reserves are influenced by international capital movements, international trade credits and so on. Because of the interaction between the domestic money supply, price level and exchange reserves, the central bank frequently faces several contradictory tendencies which have to be reconciled.

Role/Function of Central Bank/RBI10. Regulation of Exchange Rate:A related function, which is assigned to the central bank, is the regulation and stabilization of the exchange rate. This task is facilitated when the central bank is also the custodian of official foreign exchange reserves. As regards expertise and competence central bank of the country is the best agency to which the task of regulating and stabilizing exchange rate should be assigned. The central bank happens to be the apex institution of the entire financial system of the country. It is in possession of maximum data and has the expertise 'of estimating the financial trends and the type of corrective measures needed. 11. Other Functions:It is believed that an underdeveloped country requires an all-frontal approach in solving its problems of poverty and growth. Though regulation of the volume of money and credit and its other dimensions, the central bank plays a key role in its growth policy, much more is needed to make it really effective. Viewed in this manner, the functions of a central bank come to cover a much wider field than is conventionally considered in the case of central banks of developed countries.Let us consider the developmental role of a central bank with reference to our own country. At the time of Independence, our entire financial system (including our bank jpig sector) was very weak. Modern banking services were scarcely available in rural and semi-urban areas. The, banking system contained several small and weak banks. There was a need to strengthen them through amalgamations and mergers. Similarly, the banking industry was in the grip of some unhealthy practices which risked their own lives and Jeopardised the interest of the depositors. They were in need of better regulation and supervision.

Role/Function of Central Bank/RBIUnder the Banking Regulation Act,1949 and its various amendments, the Reserve Bank has been given extensive powers of supervision and control over the banking system. These regulatory powers relate to the licensing of banks and their branch expansion; liquidity of assets of the banks; management and methods of working of the banks; amalgamation, reconstruction and liquidation of banks; inspection of banks; etc.12. Ordinary Banking Functions:The Reserve Bank also performs various ordinary banking functions:(a), It accepts deposits from the central government, state governments and even private individuals without interest,(b) It buys, sells and rediscounts the bills of exchange and promissory notes of the scheduled banks without restrictions,(c) It grants loans and advances to the central government, state governments, local authorities, scheduled banks and state cooperative banks, repayable within 90 days,(d) It buys and sells securities of the Government of India and foreign securities,(e) It buys from and sells to the scheduled banks foreign exchange for a minimum amount of Rs. 1 lakh,(f) It can borrow from any scheduled bank in India or from any foreign bank,(g) It can open an account in the World Bank or in some foreign central bank.(h) It accepts valuables, securities, etc., for keeping them in safe custody.(i) It buys and sells gold and silver.

Role/Function of Central Bank/RBI13.Miscellaneous Functions:In addition to central banking and ordinary banking functions, the Reserve Bank performs the following miscellaneous functions:(a) Banker's Training College has been set up to extend training facilities to supervisory staff of commercial banks. Arrangements have been made to impart training lo the cooperative personnel,(b) The Reserve Bank collects and publishes statistical information relating to banking, finance, credit, currency, agricultural and industrial production, etc. It also publishes the results of various studies and review of economic situation of the country in its monthly bulletins and periodicals.14.Promotional and Developmental Functions:Besides the traditional central banking functions, the Reserve Bank also performs a variety of promotional and developmental functions:(a) By encouraging the commercial banks to expand their branches in the semi-urban and rural areas, the Reserve Bank helps (i) to reduce the dependence of the people in these areas on the defective unorganised sector of indigenous bankers and money lenders, and (ii) to develop the banking habits of the people(b) By establishing the Deposit Insurance Corporation, the Reserve Bank helps to develop the banking system of the country, instills confidence of the depositors and avoids bank failures,(c) Through the institutions like Unit Trust of India, the (Reserve Bank helps to mobilise savings in the country,(d) Since its inception, the Reserve Bank has been mating efforts to promote institutional agricultural credit by developing cooperative credit institutions.(e) The Reserve Bank also helps to promote the process of industrialisation in the country by setting up specialized institutions for industrial finance,(f) it also undertakes measures for developing bill market in the country.

Role/Function of Central Bank/RBI15.Forbidden Business:Being the central bank of the country, the Reserve Bank:(a) Should not compete with member banks and(b) should keep its assets in liquid form to meet any situation of economic crisis.Therefore, the Reserve Bank has been forbidden to do certain types of business:(a) It can neither participate in, nor directly provide financial assistance to any business, trade or industry,(b) It can neither buy its own shares not those of other banks or commercial and industrial undertakings,(c) It cannot grant unsecured loans and advances,(d) It cannot give loans against mortgage security,(e) It cannot give interest on deposits.(g) It cannot purchase immovable property except for its own offices.

Monetary Policy of Central Bank (RBI)Monetary Policy is the process by which monetary authority of a country, generally a central bank controls the supply of money in the economy by exercising its control over interest rates in order to maintain price stability and achieve high economic growth.[1] In India, the central monetary authority is the Reserve Bank of India (RBI). is so designed as to maintain the price stability in the economy.Types of Monetary Policy-Expansionary Monetary PolicyIn times of recession when the Central Bank wants to stimulate or increase output and demand this policy is used. This policy increases money supply which in turn increases demand and output/production. The tools used to increase money supply are by making use of open market purchases of Government Securities, lowering CRR and decreasing the Bank rate.Contractionary Monetary PolicyIn times of increasing inflation the Central Bank wants to reduce demand . Thus this policy reduces money supply which in turn decreases demand and inflation. The tools used to decrease money supply are by making use of open market sale of Government securities, increasing CRR and increasing the Bank rate.Monetary Policy of Central Bank (RBI)Objectives of Monetary Policy-Price StabilityPrice Stability implies promoting economic development with considerable emphasis on price stability. The main focus to control price level/inflation and to see that it does not go out of control.Controlled Expansion Of Bank Credit/Money SupplyOne of the important functions of RBI is the controlled expansion of bank credit and money supply with special attention to seasonal requirement for credit without affecting the output.Promotion of Fixed InvestmentThe aim here is to increase invested in fixed assets so that productivity can be increased..Restriction of InventoriesOverfilling of stocks and products becoming outdated due to excess of stock often results is sickness of the unit. To avoid this problem the central monetary authority carries out this essential function of restricting the inventories. The main objective of this policy is to avoid over-stocking and idle money in the organization.Monetary Policy of Central Bank (RBI)Promotion of Exports and Food Procurement OperationsMonetary policy pays special attention in order to boost exports and facilitate the trade. It is an independent objective of monetary policy.Desired Distribution of CreditMonetary authority has control over the decisions regarding the allocation of credit to priority sector and small borrowers. This policy decides over the specified percentage of credit that is to be allocated to priority sector and small borrowers.Equitable Distribution of CreditThe policy of Reserve Bank aims equitable distribution to all sectors of the economy and all social and economic class of peopleTo Promote EfficiencyIt is another essential aspect where the central banks pay a lot of attention. It tries to increase the efficiency in the financial system and tries to incorporate structural changes such as deregulating interest rates, ease operational constraints in the credit delivery system, to introduce new money market instruments etc.Reducing the RigidityRBI tries to bring about the flexibilities in the operations which provide a considerable autonomy. It encourages more competitive environment and diversification. It maintains its control over financial system whenever and wherever necessary to maintain the discipline and prudence in operations of the financial system.

Monetary Policy of Central Bank (RBI)Tools of Monetary PolicyOpen Market OperationsAn open market operation is an instrument of monetary policy which involves buying or selling of government securities from or to banks and financial institutions. This mechanism influences the reserve position of the banks, yield on government securities and cost of bank credit. The RBI sells government securities to contract/reduce the flow of credit(Contractionary Monetary Policy) and buys government securities to increase credit flow (Expansionary Monetary Policy). Open market operation makes bank rate policy effective and maintains stability in government securities market.Cash Reserve RatioCash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves or balances .Higher the CRR with the RBI lower will be the money supply/liquidity in the system (Contractionary Monetary Supply) and lower CRR will increase money supply (Expansionary Monetary Supply)RBI is empowered to vary CRR between 15 percent and 3 percent. But as per the suggestion by the Narshimam committee Report the CRR was reduced from 15% in the 1990 to 5 percent in 2002. As of today the CRR is 4 percent. Statutory Liquidity RatioEvery financial institution has to maintain a certain quantity of liquid assets with themselves at any point of time of their total time and demand liabilities. These assets can be cash, precious metals, approved securities like bonds etc. The ratio of the liquid assets to time and demand liabilities is termed as the Statutory Liquidity Ratio. There was a reduction of SLR from 38.5% to 25% because of the suggestion by Narshimam Committee. The current SLR is 23%.[5]

Monetary Policy of Central Bank (RBI)Bank Rate Policy[6]Bank rate is the rate of interest charged by the RBI for providing funds or loans to the banking system. This banking system involves commercial and co-operative banks, Industrial Development Bank of India, EXIM Bank, and other approved financial institutes. Funds are provided either through lending directly or rediscounting or buying money market instruments like commercial bills and treasury bills. Increase in Bank Rate increases the cost of borrowing by commercial banks which results into the reduction in credit volume to the banks and hence declines the supply of money/liquidity. Increase in the bank rate is the symbol of tightening/contractionary monetary policy. Bank rate is also known as discount rate. The current Bank rate is 9%.Credit CeilingIn this operation RBI issues prior information or direction that loans to the commercial banks will be given up to a certain limit. In this case commercial bank will be tight in advancing loans to the public. They will allocate loans to limited sectors. Few example of ceiling are agriculture sector advances, priority sector lending.Credit Authorization SchemeCredit Authorization Scheme was introduced in November, 1965 when P C Bhattacharya was the chairman of RBI. Under this instrument of credit regulation RBI as per the guideline authorizes the banks to advance loans to desired sectors.[7]

Monetary Policy of Central Bank (RBI)Moral suasion:Moral suasion means persuasion and request. To arrest inflationary situation central bank persuades and request the commercial banks to refrain from giving loans for speculative and non-essential purposes. On the other hand, to counteract deflation central bank persuades the commercial banks to extend credit for different purposes.Central bank also appeals commercial banks to extend their wholehearted co-operation to achieve the objectives of monetary policy. Being the monetary authority directions of the central bank are usually followed by commercial banks.Prescription of margins requirements:Generally, commercial banks give loan against stocks or securities. While giving loans against stocks or securities they keep margin. Margin is the difference between the market value of a security and its maximum loan value. Let us assume, a commercial bank grants a loan of Rs. 8000 against a security worth Rs. 10,000. Here, margin is Rs. 2000 or 20%.If central bank feels that prices of some goods are rising due to the speculative activities of businessmen and traders of such goods, it wants to discourage the flow of credit to such speculative activities. Therefore, it increases the margin requirement in case of borrowing for speculative business and thereby discourages borrowing. This leads to reduction is money supply for undertaking speculative activities and thus inflationary situation is arrested.On other contrary, central bank can encourage borrowing from the commercial banks by reducing the margin requirement. When there is a grater flow of credit to different business activities, investment is increased. Income of the people rises. Demand for goods expands and deflationary situation is controlled.Thus, margin requirement is a significant tool in the hands of central bank to counter-act inflation and deflation.

Monetary Policy of Central Bank (RBI)Repo Rate and Reverse Repo RateRepo rate is the rate at which RBI lends to commercial banks generally against government securities. Reduction in Repo rate helps the commercial banks to get money at a cheaper rate and increase in Repo rate discourages the commercial banks to get money as the rate increases and becomes expensive.. The increase in the Repo rate will increase the cost of borrowing and lending of the banks which will discourage the public to borrow money and will encourage them to deposit. As the rates are high the availability of credit and demand decreases resulting to decrease in inflation. Reverse Repo rate is the rate at which RBI borrows money from the commercial banks. This increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the policy. As of December 2012, the repo rate is 8% and reverse repo rate is 7%.Consumer credit regulation:Now-a-days, most of the consumer durables like T.V., Refrigerator, Motorcar, etc. are available on installment basis financed through bank credit. Such credit made available by commercial banks for the purchase of consumer durables is known as consumer credit.If there is excess demand for certain consumer durables leading to their high prices, central bank can reduce consumer credit by (a) increasing down payment, and (b) reducing the number of installments of repayment of such credit.On the other hand, if there is deficient demand for certain specific commodities causing deflationary situation, central bank can increase consumer credit by (a) reducing down payment and (b) increasing the number of installments of repayment of such credit.

Fiscal Policy of IndiaIn economics fiscal policy is the use of government revenue collection (taxation) and expenditure (spending) to influence the economy (GDP).[1] The two main instruments of fiscal policy are government taxation and changes in the level and composition of taxation and government spending can affect the following variables in the economy-Aggregate demand and the level of economic activity;The distribution of income;The pattern of resource allocation within the government sector and relative to the private sector.Fiscal policy refers to the use of the government budget to influence economic activity.GDP= C+I+G+(X-M)C- ConsumptionI-InvestmentG-Government Purchases (Spending)(X-M)- Exports-Imports.Thus if Government Purchases(Spending )G is increased then GDP will automatically increase.

Fiscal Policy of IndiaTypes of Fiscal Policy-Neutral fiscal policy- It is usually undertaken when an economy is in equilibrium. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity.Expansionary fiscal policy- It involves government spending exceeding tax revenue, and is usually undertaken during recessions. Let's say that an economy has slowed down. Unemployment levels are up, consumer spending is down and businesses are not making any money. A government thus decides to fuel the economy's engine by decreasing taxation, giving consumers more spending money while increasing government spending in the form of buying services from the market (such as building roads or schools). By paying for such services, the government creates jobs and wages that are in turn pumped into the economy In the meantime, overall unemployment levels will fall.With more money in the economy and less taxes to pay, consumer demand for goods and services increases. This in turn rekindles businesses and turns the cycle around from stagnant to active.If, however, there are no reins on this process, the increase in economic productivity can cross over a very fine line and lead to too much money in the market. This can cause inflation.

Fiscal Policy of IndiaContractionary fiscal policy It occurs when government spending is lower than tax revenue, and is usually undertaken to pay down government debt or reduce inflation.When inflation is too strong, the economy may need a slow down. In such a situation, a government can use fiscal policy to increase taxes in order to suck money out of the economy. Fiscal policy could also dictate a decrease in government spending and thereby decrease the money in circulation. Of course, the possible negative effects of such a policy in the long run could be a sluggish economy and high unemployment levels.

Balance of PaymentBalance of payments is a systematic record of all economic transactions ,visible as well as invisible, in a period, between one country and the rest of the world. It shows the relationship between one country's total payments to all other countries and its total receipts from them. Balance of payments thus is statement of payments and receipts on international transactions.Payments and receipts on international account are on 3 accounts:(a) the current account;(b) the capital account; and(c) reserve account.Kindleberger defines balance of payments as "a systematic record of all economic transactions between the residents of the reporting country and the residents of foreign countries during a given period of time.

In the words of Benham, "Balance of payments of a country is a record of the monetary transactions over a period with the rest of the world.Balance of Payment= Current Account +Capital Account+ Reserve Account

Balance of PaymentFeatures of Balance of PaymentsBalance of Payments has the following features:(i) It is a systematic record of all economic transactions between one country and the rest of the world.(ii) It includes all transactions, visible as well as invisible.(iii) It relates to a period of time. Generally, it is an annual statement.(iv) It adopts a double-entry book-keeping system. It has two sides: credit side and debit side. Receipts are recorded on the credit side and payments on the debit side.(v) When receipts are equal to payments, the balance of payments is in equilibrium; when receipts are greater than payments, there is surplus in the balance of payments; when payments are greater than receipts, there is deficit in the balance of payments.(vi) In the accounting sense, total credits and debits in the balance of payments statement always balance each other.

Balance of PaymentFeatures of Balance of PaymentsBalance of Payments has the following features:(i) It is a systematic record of all economic transactions between one country and the rest of the world.(ii) It includes all transactions, visible as well as invisible.(iii) It relates to a period of time. Generally, it is an annual statement.(iv) It adopts a double-entry book-keeping system. It has two sides: credit side and debit side. Receipts are recorded on the credit side and payments on the debit side.(v) When receipts are equal to payments, the balance of payments is in equilibrium; when receipts are greater than payments, there is surplus in the balance of payments; when payments are greater than receipts, there is deficit in the balance of payments.(vi) In the accounting sense, total credits and debits in the balance of payments statement always balance each other.

Balance of PaymentCurrent Account- It is sum of Balance of trade of Visible item (Merchandise) , Balance of trade of Services, Investment income and Net transfer payments.Balance of TradeVisible Items/Merchandise-This includes exports and imports of goods. While the export earn foreign exchange for the nation and are a credit item on the current account, the imports use up foreign exchange and are a debit item.Services- Services are another important constituent of the current account. Most nations buy services from and sell services to other nations. These services are consultancy, transportation, warehousing, travel & tourism etc. They are either using up or earning foreign exchange.The difference between a nations exports of goods and services and its imports of goods and services is its balance of trade.If the exports of goods and services (Credit Side) are less than imports of goods and services (Debit Side), a nation is said to have a trade deficit.A trade surplus on the other hand occurs when the exports of goods and services of a nation are more than their imports.Investment Income:The 3rd item in the current account is the investment income. The citizens of a nation hold foreign assets (stocks, bonds and real assets like buildings and factories. Dividend, interest, rent and profits paid to such asset holders are a source of foreign exchange. Conversely when foreigners earn dividends, interest and the profits on the assets held by them in the nation foreign exchange is used up. Thus . Income received on capital invested abroad is the credit item and income paid on capital borrowed from abroad is the debit item. The net amount from this is also added to current account.Balance of PaymentNet Transfer Payments- Transfer payments from a nation to the foreigners are use of foreign exchange (debit)and transfer payments from foreigners to a nation are source of foreign exchange (credit). Some of this transfer payments are from private citizens in the form of gifts and donations and some are from Government in form of payment of salaries to ambassadors and high commissioners etc). The term net transfers refers to the difference between payments from the nation to the foreigners and payments from foreigners to the nation. If we add net exports and imports of goods, net exports and imports of services, net investment income and net transfer payments we get the balance on current account.

Balance of PaymentThe balance on current account shows how much a nation has spent on foreign goods, services, investment income and transfer payments relative to how much it has earned from other nations.When the balance on current account is negative then a nation has spent more on foreign goods and services, investment income payments and transfers than it has earned through sales of its goods and services, investment income and transfer payment received.If a nations current account net balance for a particular year is negative that means its net wealth position vis-a vis the rest of the world must decrease. In such a situation it is said that there is deficit balance of payment on current account.If a nations current account net balance is positive credit is more than debit we say that their surplus balance of payment on current account.Balance of PaymentCapital Account- It reflects changes in foreign assets and foreign liabilities of the nation. This includes investments, loans and bank capital. The capital inflow is credit and capital outflow is -debit.The main elements of Capital Account are as follows-Investments1.Foreign Direct Investment (FDI)- It is relatively for long term. When FDI flows into the nation foreign exchange increases and it will be on credit side. For eg Allianz picks up 26% stake in life insurance arm of Bajaj Auto Ltd and forms Bajaj Allianz Life Insurance Co. Ltd. But when a nations citizens/firm make such investments abroad foreign exchange goes out and it is a debit entry. For eg Tata Tea buying out Tetley.Balance of Payment2. Portfolio Investment- Portfolio investment represents sales and purchase of foreign financial asset such as Shares and bonds. Unlike FDI, they dont involve management control in the companies in which investment is made.Whenever a foreign investor or FII buys shares of companies listed on Indian exchanges BSE or NSE it involves a foreign investment in Indian shares and this is foreign exchange inflow and it will be on credit side. But when an Indian investor makes an investment in companies listed on foreign stock exchanges like Dow Jones, NASDAQ, Hang Sang then there is outflow of foreign exchange and it will be debit entry.

Balance of PaymentPrivate Capital flows- These are the loans received/given by the Private residents from/to the Private non-residents. A loan with less than 1 year is called short term capital flow and loan with term greater than 1 year is called long term capital flow. Loan received by Indian from foreigners are capital inflows and are credits and loan given to foreigners by Indians are capital outflows and hence debits. Officials- This refers to changes in foreign assets and liabilities of the Government of domestic country. A loan taken by the Government from a foreign country will mean increase in liabilities. But this result in foreign exchange inflow and hence it represents credit entry. But when Government of domestic country gives loan to a foreign country it represents foreign exchange outflow and hence it appears on debit side. If the domestic country purchases asset in the foreign country it will result in increase of asset of the country but this will result in foreign exchange outflow and will be a debit entry.Balance of PaymentBanking Capital: Banking Capital includes changes in foreign assets and liabilities of the foreign branch of an Indian Bank. Foreign assets are loan given by the foreign branches of Indian Banks and as this result in outflow of foreign exchange it is a debit entry. Foreign liabilities are the deposits held by the foreign branches of Indian banks and as this results in inflow of foreign exchange it is a credit entry.Thus Capital account balance is net balance between credit and debit entries of Foreign Direct Investment, Portfolio investment, Private Capital flows, Officials, Banking Capital. It may be surplus or deficit. If the net of foreign exchange inflow(credit) is more than net of foreign exchange outflow (debit)t then it will be surplus and viceversa..Balance of PaymentOfficial Reserves-These are government owned international assets. These are held/owned by the Monetary Authority or Central Bank of the Country like RBI.These reserves are composed ofA)GoldB) Convertible foreign currencies like Dollars, Euros, Japanese Yen, U.K.s Pound etc.C)Special Drawing Rights.These reserves are used to account for deficit or surplus.For examples of the home country BOP is in deficit then that deficit has to be financed from this reserves by selling Gold, SDRs or foreign exchange assets or even borrow from IMF or Central Banks of other countries.Similarly if the home country has a surplus BOP then it means there will be increase in reserves of the country.Exchange RatesExchange rate is the rate at which one countrys currency can be exchanged for another.For eg 1 USD= 54 INRIncrease in the value of exchange rate is appreciation of exchange rate and decrease in value of exchange rate is depreciation or devaluation of exchange rate.For eg if 1 USD= 55 INR then USD has appreciated and INR has depreciated.If 1 USD = 53 INR then USD has depreciated and INR has appreciated.Initially we started with fixed exchange rate system but finally gave way to floating or market determined exchange rate system.While Governments in most nations still intervene to ensure that exchange rate movements are orderly, the exchange rates today are by and large determined by the unregulated forces of supply and demand.Exchange rates play an important role in determining the performance of an economy.If the exchange rate of a country depreciates then the exports of that country become more attractive and cheaper than the other country and consequently the export increases. At the same time the imports becomes more expensive. So the imports decrease and demand for domestic goods rises. As a result of increase in exports and demand for domestic goods output increases and GDP also increases.Exchange RatesFactors on which the Exchange Rates depend/Determinants of Exchange Rates1. InflationIf inflation in the India is relatively lower than elsewhere, then Indian exports will become more competitive and there will be an increase in demand for Rupee to buy Indian goods. Also foreign goods will be less competitive and so Indian citizens will buy less imports.Therefore countries with lower inflation rates tend to see an appreciation in the value of their currency.2. Interest Rates If Indian interest rates rise relative to elsewhere, it will become more attractive to deposit money in the India. You will get a better rate of return from saving in Indian banks, Therefore demand for Rupee will rise. Higher interest rates cause an appreciation in the currency. This is known as hot money flows and is an important short run factor in determining the value of a currency.

Exchange Rates3.Change in Competitiveness If Indian goods become more attractive and competitive this will also cause the value of the Exchange Rate to rise as foreigners will need more Indian rupee to purchase Indian goods. This is important for determining the long run value of the Rupee. This is similar factor to low inflation.4. Balance of Payments A deficit on the current account means that the value of imports (of goods and services) is greater than the value of exports. If this is financed by a surplus on the financial / capital account then this is OK. But a country who struggles to attract enough capital inflows to finance a current account deficit, will see a depreciation in the currency. (For example current account deficit in US of 7% of GDP was one reason for depreciation of dollar in 2006-07)5. Government Debt. Under some circumstances, the value of government debt can influence the exchange rate. If markets fear a government may default on its debt, then investors will sell their bonds causing a fall in the value of the exchange rate. For example, Ireland debt problems in 2008, caused a rapid fall in the value of the Ireland currency and Greece crisis.For example, if markets feared the India would default on its debt, foreign investors would sell their holdings of Indian bonds. This would cause a fall in the value of the rupee.Exchange Rates6.Government InterventionSome governments attempt to influence the value of their currency. For example, China has sought to keep its currency undervalued to make Chinese exports more competitive. They can do this by buying US dollar assets which increases the value of the US dollar to Chinese Yuan.7.Price of OilA large portion of Indias import payment is mainly for payment of oil. Internationally, crude prices are named as BRENT, NYMEX, and Dubai Crude. Whenever there is any hike in the oil price per barrel, the Indian Rupee depreciates against the US Dollar. As such, the Indian Government buys more USD against INR to honour the import liability, resulting in heavy demand for USD. Consequently, the Indian rupee depreciates against USD.8.Natural CalamitiesNatural calamities may also affect the currency market for a short period of time. In August 2005, Hurricane Katrina affected the entire region around the Gulf of Mexico. This region contributes around one-third of US oil production and accounts for around half of the nations refining capacity. Besides, a large part of US oil imports reaches ports in this area. The hurricane caused a huge loss in production of crude oil and natural gas. It affected the prices of crude oil and prices shot up to around USD70 per barrel in a very short time. Automatically, the oil price increased globally and at the same time affected the exchange rate. Since India had to buy more USD to honour its import liability, the Rupee became weaker by around 60-65 paise against the USD.

TaxationThe most important source of revenue of the government is taxes. The act of levying taxes is called taxation. A tax is a compulsory charge or payment imposed by government on individuals or corporations. The persons who are taxed have to pay the taxes irrespective of any corresponding return from the goods or services by the government. The taxes may be imposed on the income and wealth of persons or corporations and the rate of taxes may vary.Canons of TaxationCanons of Taxation are the main basic principles (i.e. rules) set to build a 'Good Tax System'.Canons of Taxation were first originally laid down by economist Adam Smith in his famous book "The Wealth of Nations".In this book, Adam smith only gave four canons of taxation. These original four canons are now known as the "Original or Main Canons of Taxation".As the time changed, governance expanded and became much more complex than what it was at the Adam Smith's time. Soon a need was felt by modern economists to expand Smith's principles of taxation and as a response they put forward some additional modern canons of taxation.

TaxationAdam Smith's Four Main Canons of Taxation A good tax system is one which is designed on the basis of an appropriate set of principles (rules). The tax system should strike a balance between the interest of the taxpayer and that of tax authorities. Adam Smith was the first economist to develop a list of Canons of Taxation. These canons are still regarded as characteristics or features of a good tax system.1. Canon of EquityThe principle aims at providing economic and social justice to the people. According to this principle, every person should pay to the government depending upon his ability to pay. The rich class people should pay higher taxes to the government, because without the protection of the government authorities (Police, Defence, etc.) they could not have earned and enjoyed their income. Adam Smith argued that the taxes should be proportional to income, i.e., citizens should pay the taxes in proportion to the revenue which they respectively enjoy under the protection of the state.

Taxation2. Canon of CertaintyAccording to Adam Smith, the tax which an individual has to pay should be certain, not arbitrary. The tax payer should know in advance how much tax he has to pay, at what time he has to pay the tax, and in what form the tax is to be paid to the government. In other words, every tax should satisfy the canon of certainty. At the same time a good tax system also ensures that the government is also certain about the amount that will be collected by way of tax.3. Canon of ConvenienceThe mode and timing of tax payment should be as far as possible, convenient to the tax payers. For example, land revenue is collected at time of harvest & income tax is deducted at source. Convenient tax system will encourage people to pay tax and will increase tax revenue.4. Canon of EconomyThis principle states that there should be economy in tax administration. The cost of tax collection should be lower than the amount of tax collected. It may not serve any purpose, if the taxes imposed are widespread but are difficult to administer. Therefore, it would make no sense to impose certain taxes, if it is difficult to administer.

TaxationAdditional Canons of Taxation Activities and functions of the government have increased significantly since Adam Smith's time. Government are expected to maintain economic stability, full employment, reduce income inequality & promote growth and development. Tax system should be such that it meets the requirements of growing state activities.Accordingly, modern economists gave following additional canons of taxation.5. Canon of ProductivityIt is also known as the canon of fiscal adequacy. According to this principle, the tax system should be able to yield enough revenue for the treasury and the government should have no need to resort to deficit financing. This is a good principle to follow in a developing economy.6. Canon of ElasticityAccording to this canon, every tax imposed by the government should be elastic in nature. In other words, the income from tax should be capable of increasing or decreasing according to the requirement of the country. For example, if the government needs more income at time of crisis, the tax should be capable of yielding more income through increase in its rate.

Taxation7. Canon of FlexibilityIt should be easily possible for the authorities to revise the tax structure both with respect to its coverage and rates, to suit the changing requirements of the economy. With changing time and conditions the tax system needs to be changed without much difficulty. The tax system must be flexible and not rigid.8. Canon of SimplicityThe tax system should not be complicated. That makes it difficult to understand and administer and results in problems of interpretation and disputes. In India, the efforts of the government in recent years have been to make the system simple.9. Canon of DiversityThis principle states that the government should collect taxes from different sources rather than concentrating on a single source of tax. It is not advisable for the government to depend upon a single source of tax, it may result in inequity to the certain section of the society; uncertainty for the government to raise funds. If the tax revenue comes from diversified source, then any reduction in tax revenue on account of any one cause is bound to be small.

TaxationClassification of Taxes on basis of degree of progression of taxProportional taxA tax is called proportional when the rate of taxation remains constant as the income of the tax payer increases. In this system all incomes are taxed at a single uniform rate, irrespective of whether tax payers income is high or low. The tax liability increases in absolute terms, but the proportion of income taxed remains the same.

Progressive taxWhen the rate of taxation increases as the tax payers income increases, it is called a progressive tax. In this system, the rate of tax goes on increasing with every increase in income.

TaxationRegressive taxationA regressive tax is one in which the rate of taxation decreases as the tax payers income increases. Lower income is taxed at a higher rate, whereas higher income is taxed at a lower rate. However absolute tax liability may increase.

Degressive taxationA tax is called degressive when the rate of progression in taxation does not increase in the same proportion as the increase in income. In this case, the rate of tax increases up to a certain limit, after that a uniform rate is charged. Thus degressive tax is a combination of progressive and proportional taxation. This type of taxation is often used in case of income tax. This is the case of income tax in India as well.

TaxationTaxes can be classified into various types on the basis of form,nature,aim and method of taxation. the most common and traditional classification is to classify into direct and indirect taxes.Direct taxesA direct tax is that tax whose burden is borne by the same person on whom it is levied. The ultimate burden of taxation falls on the person on whom the tax is levied. It is based on the income and property of a person. Thus income tax, corporation tax on companys profits, property tax, capital gains tax, wealth tax etc are examples of direct taxes.

Indirect taxesAn indirect tax is that tax which is initially paid by one individual, but the burden of which is passed over to some other individual who ultimately bears it. It is levied on the expenditure of a person. Excise duty, sales tax, custom duties etc are examples of indirect taxes.

TaxationDirect TaxesIndividual Income Tax: Income Tax Act, 1961 imposes tax on the income of the individuals or Hindu undivided families Tax rates are prescribed by the government in the Finance Act, popularly known as Budget, every year.

Taxable Income Slab for AY 2013-14Rate %For Individual below 6o years- Income Up to 200000

NilFor Individual from 60 to 80 years-Income Up to 250000NilFor Individual from 0 to 60 years-Income-2000001- 50000010 %For individual above 80 years Income up to 500000NilIncome from 500001-100000020 %Income 1000001 and upwards30%Education Cess of 3% is also applicable to Income Tax computed as per above slabTaxationCorporation Tax: The companies and business organizations in India are taxed on the income from their worldwide transactions under the provision of Income Tax Act, 1961. A corporation is deemed to be resident in India if it is incorporated in India or if its control and management is situated entirely in India. Current Corporate tax is 30 % with 3 % education cess on tax amount.Wealth Tax-Wealth tax, in India, is levied under Wealth-tax Act, 1957. Wealth tax is a tax on the benefits derived from property ownership. The tax is to be paid year after year on the same property on its market value, whether or not such property yields any income. Similar to income tax the liability to pay wealth tax also depends upon the residential status of the assessee. The assets chargeable to wealth tax are Guest house, residential house, commercial building, Motor car, Jewelry, bullion, utensils of gold, silver, Yachts, boats and aircrafts, urban land, cash in hand (in excess of INR 50,000 for Individual & HUF only),etc. Wealth tax is charged @ 1% of the amount by which the net wealth exceeds Rs. 30,00,000 Lakhs.45TaxationCapital Gains TaxThe central government also charges tax on the capital gains that is derived from the sale of the assets. The capital gain is the difference between the money received from selling the asset and the price paid for it. Capital gain also includes gain that arises on transfer (includes sale, exchange) of a capital asset and is categorized into short-term gains and long-term gains. The Long-term Capital Gains Tax is charged if the capital assets are kept for more than three years or 12 months in the case of securities and shares that are listed under any recognized Indian stock exchange or mutual fund. Short-term Capital Gains Tax is applicable if the assets are held for less than the aforesaid period.In case of the long term capital gains, they are taxed at a concession rate. Normalcorporate income tax rates are applicable for short term capital gains. In case of the short term and long term capital losses, they are allowed to be carried forward for 8 consecutive years. For shares or equity oriented mutual fund short term is 15 % and long term is nil . For other assets for individuals STCG is progressive slab rates and for a firm or company it is 30%. LTCG is 20% with indexation and 10 % without indexation for both individuals and firms.

TaxationINDIRECT TAXESCentral GovernmentExcise DutyThe central government levies excise duty under the Central Excise act of 1944 and the Central Excise Tariff Act of 1985. Central Excise duty is an indirect tax levied on goods manufactured in India and meant for domestic consumption. The Central Board of Excise and Customs under the Ministry of Finance, administers the excise duty. Central Excise Duty arises as soon as the goods are manufactured. It is paid by a manufacturer, who passes on its incidence to the customers.Customs DutyCustoms duty in India falls under the Customs Act 1962 and Customs Tariff Act of 1975. Customs duty is the tax levied on goods imported into India as well as on goods exported from India. Taxable event is import into or export from India. Additionally educational cess is also charged. The customs duty is evaluated on the value of the transaction of the goods. The Central Board of Excise and Customs under the Ministry of Finance manages the customs duty process in the country. The rate at which customs duty is applicable on the goods depends on the classification of the goods determined under the Customs Tariff. It should be noted that preferential/concessional rates of duty are also available under the various Trade Agreements.

TaxationService Tax Service tax was introduced in India way back in 1994 and started with mere 3 basic services viz. general insurance, stock broking and telephone. Subsequent Budgets have expanded the scope of the service tax as well as the rate of service tax. More than 100 services are subjected to tax under this provision. An education cess is also charged on the tax amount. The Central Board of Excise and Customs under the Ministry of Finance manages the administration of service tax.Securities Transaction Tax (STT)Transactions in equity shares, derivatives and units of equity-oriented funds entered in a recognized stock exchange attract Securities Transaction Tax. Service Tax, Surcharge and Education Cess are not applicable on STTTaxationState TaxesValue Added Tax (VAT)Sales tax charged on the sales of movable goods has been replaced with VAT in most of the Indian states since 2005. This was introduced to counter the rampant double taxation issues and resultant cascading tax burden that occurred due to the flaws inherent in the previous sales tax system. VAT, chargeable only on goods and does not include services, is a multi-stage system of taxation, whereby tax is levied on value addition at each stage of transaction in the supply chain. The term value addition implies the increase in value of goods and services at each stage of production or transfer of goods and services. VAT is a tax on the final consumption of goods or services and is ultimately borne by the consumer. VAT comes under the state list. Tax payers can claim credit for the taxes paid at earlier stages and purchasesTaxationStamp DutyIt is a tax that is levied on the transaction performed by means of a document or instrument as per the regulations of Indian Stamp Act, 1899. It is collected by the government of the state where the transaction is carried out. Stamp duty rates vary between the states.Stamp duty is paid on instruments, which are essentially a document to create, transfer, limit, extend, extinguish or record a right or liability. Document acquires legality once it is stamped properly after the payment of the requisite stamp duty charges. Stamp duty is payable for transfer of shares, share certificate, partnership deed, bill of exchange, shares, share transfer, leave and license agreement, debentures, gift deed, bank guarantee, bonds, demat shares, development agreement, demerger, power of attorney, home loans, houses & house purchase, lease deed, loan agreement and lease agreement.

TaxationState ExcisePower to impose excise on alcoholic liquors, opium and narcotics is granted to States under the Constitution and it is called State Excise. The Act, Rules and rates for excise on liquor are different for each State.In addition to the above taxes by the Central and State Governments the local bodies have the authority to levy tax on properties, octroi/entry tax on utilities like water etc.

Budget Deficit, Fiscal Deficit and Deficit FinancingBudget is prepared by the Government showing the expected income/receipts and expenditure for the coming financial year. Receipts comes from taxes (both direct and indirect), profits from Government owned Public Sector Undertakings like HPCL, BPCL, SBI, BSNL, LIC etc, interest from loan given to other country Governments or local bodies.The expenditure of Government are on developmental projects such as construction of roads, railways, production of utilities like energy, water etc and non developmental expenditure on large number of activities like Defense, Law, Police, Subsidies, Administration etc.If the receipts are equal to expenditure then budget is said to be balanced. If the receipts are more than expenditure then budget is said to be in surplus. If the receipts are less than expenditure then budget is said to be in deficit. But deficit is always neutralized by borrowings and this is called as deficit financing.Fiscal deficit measures that part of Government expenditure which is financed by borrowings. It is the excess expenditure over Governments own income or receipt.Budget Deficit, Fiscal Deficit and Deficit FinancingDeficit FinancingDeficit financing is defined as financing the budgetary deficit through public loans and creation of new money. Deficit financing in India means the expenditure which in excess of current revenue and public borrowing, the government may cover the deficit in the following ways.

1. By running down its accumulated cash reserve from RBI.

2. Issue of new currency by government it self.

3. Borrowing from reserve bank of India and RBI gives the loans by printing more currency notes.Objectives of deficit financing :

1. To finance war:- Deficit financing has generally being used as a method of financing war expenditure. During the war time through normal methods of raising resources. It becomes difficult to mobilize adequate resources. Therefore government has to adopt deficit financing.

2. Remedy for depression :- In developed countries deficit financing is used as on instrument of economic policy for removing the conditions of depression. Prof. Keynes has also advocated for deficit financing as a remedy for depression and unemployment

Budget Deficit, Fiscal Deficit and Deficit Financing3. Economic development:- The main objective of deficit financing in an under developed country like India is to promote economic development. The use of deficit financing in fact becomes essential for financing the development plan especially in underdeveloped countries.

4. Mobilization of Resources :- deficit financing is also used for the mobilization of surplus, ideal and unutilized resources in the country.

5. For granting subsidies :- In a country like India government grants subsidies to the producers to encourage them to produce a particular type of commodity, granting subsidies is a very costly affair which we cannot meet with the regular income this deficit financing becomes must for it.

6. Increase in aggregate demand :- Deficit financing loads to increase in aggregate demand through increased public expenditure. This increase the income and purchasing power of the people as a consequence there is an increase availability of goods and services and the production and employment level also increase.

7. For payment of interest:- Loan which are taken by the govt. are supposed to be repaid with their interest for that government needs money deficit financing is an important tool to get the income for the repayment of loan along with the interest.

8. To overcome low tax receipts.

9. To overcome the losses of public sector enterprises

10. For implementing anti poverty programme.

Budget Deficit, Fiscal Deficit and Deficit FinancingADVERSE EFFECTS OF DEFICIT FINANCING Deficit financing is not free from its deffects. It has its adverse effect on economy. Important evil effects of deficit financing are given below.

1. Leads to inflation :- Deficit financing may lead to inflation. due to deficit financing money supply increases & the purchasing power of the people also increase which increases the aggregate demand and the prices also increase.

2. Adverse effect on saving:- Deficit financing leads to inflation and inflation affects the habit of voluntary saving adversely. Infact it is not possible for the people to maintain the previous rate of saving in the state of rising prices.

3. Adverse effect on Investment ;- deficit financing effects investment adversely when there is inflation in the economy trade unions make demand for higher wages for that they go for strikes and lock outs which decreases the efficiency of Labour and creates uncertainty in the business which a decreases the level of investment of the country.

Budget Deficit, Fiscal Deficit and Deficit Financing4. Inequality :- in case of deficit financing income distribution becomes unequal. During deficit financing deflationary pressure can be seen on the economy which make the rich richer and the poor, poorer. The fix wage earners are badly effected and their standard of living detoriates thus no gap b/w rich & poor increases.

5. Problem of balance of payment :- Deficit financing leads to inflation. A high price level as compared to other countries will make the exports more expensive and thus they start declining. On the other hand rise in domestic income and price may encourage people to import more commodities from abroad. This will create a deficit in balance of payment and the balance of payment will become unfavorable.

6. Increase in the cost of production :- When deficit financing leads to the rise in the price level the cost of development projects also rises this means a larger dose of deficit financing is required on the port of government for completion of these projects.

7. Change in the pattern of investment:- Deficit financing leads to inflation. During inflation prices rise and reach to a very high level in that case people instead of indulging into productive activities they start doing speculative activities.