Flash-Cards-for-IAS-Prelims-2018-Eco-Day-14
70 Days WAR Plan

Day#14 Static Flash Cards Economic & Social Development [70 Days WAR Plan]

Causes of Inflation; Small Finance Banks (SFBs); Repo Rate; Reverse Repo Rate; Real Effective Exchange Rate (REER); Difference between GDP Deflator and other Price Indices; Liabilities of Government of India; Nominal GDP; Real GDP; Gross Domestic Product (GDP); Zero Based Budgeting; Silk Road Economic Belt (SREB) initiative; Public Debt; etc.
By IT's Core Team
April 04, 2019

 

 

 

Public Debt, sometimes also referred to as government debt, includes small saving and provident funds. Right or Wrong?

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Answer:

Wrong

Right statement:

  • Public debt does not include small savings, provident funds and other accounts, reserve funds and deposits.

Enrich Your Learning:

Public Debt

  • Public debt, sometimes also referred to as government debt, represents the total outstanding debt (bonds and other securities) of a country’s central government.
  • Public debt as a percentage of GDP is usually used as an indicator of the ability of a government to meet its future obligations.
  • It is an important source of resources for a government to finance public spending and fill holes in the budget.
  • Public debt can be split into internal (money borrowed within the country) and external (funds borrowed from non-Indian sources).
  • However, it does not include small savings, provident funds and other accounts, reserve funds and deposits.

India’ Public Debt:

  • India recorded a government debt equivalent to 68 percent of the country’s Gross Domestic Product in 2017. This is a comfortable figure because it is well below 100% and leaves the country room to borrow more in the event of a financial crisis.
  • Government Debt to GDP in India averaged 73.24 percent from 1991 until 2017, reaching an all-time high of 84.20 percent in 2003 and a record low of 66 percent in 1996.
  • In India, most government debt is held in long-term interest bearing securities such as national savings certificates, rural development bonds, capital development bonds, etc.
  • The Government has been publishing an annual Status Paper on Government Debt since 2010-11, which provides a detailed analysis of the Government’s debt position.

 

 

 

What are the economic implications of ‘Silk Road Economic Belt (SREB)’ initiative launched by china in 2013?

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Answer:

Enrich Your Learning:

Silk Road Economic Belt (SREB) initiative

  • The Silk Road Economic Belt (SREB) initiative, launched by china in 2013 as the Central Asian component of the Eurasian Belt and Road Initiative (BRI), is a trade and infrastructural developmental initiative.
  • It is also called Belt and Road Initiative or One Belt One Road (OBOR).
  • In the ancient days, China, and much of East Asia, was connected to the rest of the world through a route that got its name from China’s biggest export – silk. China is again looking to rebuild a route that will connect Asia, Africa and Europe – a new Silk Road.
  • It consolidates China’s existing economic investments and security-building measures, while launching new projects to link the regions of Central Asia and South Asia more closely with China.

Objectives of the SERB initiative:

  • Finding outlets for excess capacity of its manufacturing and construction industries
  • Increasing economic activity in its relatively underdeveloped western region
  • Creating alternative energy supply routes to the choke points of the Straits of Hormuz and Malacca, through which almost all of China’s maritime oil imports pass
  • Through BRI, China can strengthen its influence over swathes of Asia and Africa, buttressing its ambitions to be a maritime power, and developing financing structures parallel to (and eventually competing with) the Bretton Woods system.
  • It is also the most ambitious global infrastructure project ever envisaged by one country.

Why is SREB important for China?

  • The slowdown in the Chinese economy and excess production of steel, cement and machinery that it cannot consumed has forced the Chinese government to search for new markets for its products.
  • Also, many of China’s production sectors have been facing overcapacity since 2006. The Chinese leadership hopes to solve the problem of overproduction by exploring new markets in neighbouring countries through OBOR. The OBOR initiative will provide more opportunities for the development of China’s less developed border regions.
  • China also intends to explore new investment options that preserve and increase the value of the capital accumulated in the last few decades. OBOR has the potential to grow into a model for an alternative rule-maker of international politics and could serve as a vehicle for creating a new global economic and political order.
  • China has cash and deposits in Renminbi equivalent to USD 21 trillion, or two times its GDP, and expects that the massive overseas investment in the BRI will speed-up the internationalization of the Renminbi.
  • China can also benefit from the New Silk Road project through other means like the easing up of growth of state-owned enterprises as well as an increase in the Chinese people’s income.

Who are interested and who are not?

  • Most of the countries in Asia and all of India’s neighbours, except Bhutan (Bhutan has no diplomatic relations with China), are willing to take part in the project.
  • While some countries like Pakistan and Afghanistan are keen on OBOR, countries like India and Indonesia are wary because of the shift in status quo that this project could cause in sensitive areas like Kashmir and the South China Sea.

Scepticism over SREB:

Contracts and jobs

  • Experts has doubted serious concerns as major part of the contracts and jobs will be given to Chinese firm and people. There has been serious reservation and protest by people in different countries over the implementation of OBOR.

Debt trap:

  • Analysts have pointed how China is pushing countries in its debt trap by giving loans to countries for unviable projects and increasing Beijing’s leverage.
  • Pakistan is already fallen victim of the Chinese debt trap as it has taken USD 50 billion dollar at the market which is going to balloon to USD 90 billion over a 30-year period.
  • Similarly, countries like Sri Lanka and Cambodia has fallen in the Chinese debt trap.

 

 

 

How do (i) Money supply (ii) National debt (iii) Cost push and Demand pull effects and (iv) Exchange rates cause inflation?

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Answer & Enrich Your Learning:

What is Inflation?

  • Inflation is the long term rise in the prices of goods and services caused by the devaluation of currency.

Causes of Inflation

Increase in the money supply:

  • When the Government decides to put more money into circulation at a rate higher than the economy’s growth rate, the value of money can fall because of the changing public perception of the value of the underlying currency.
  • As a result, this devaluation will force prices to rise due to the fact that each unit of currency is now worth less. When a government decides to print new currency, they essentially water down the value of the money already in circulation causing inflation.

National Debt:

  • As a country’s debt increases, the government can either raise taxes or print more money to pay off the debt.
  • A rise in taxes will cause businesses to react by raising their prices to offset the increased corporate tax rate causing inflation. In latter case, printing more money can also raise inflation.

Demand-Pull effect

  • According to demand-pull effect, as wages increase within an economic system, people will have more money to spend on consumer goods. This increase in liquidity and demand for consumer goods results in an increase in demand for products.
  • As a result of the increased demand, companies will raise prices to the level the consumer will bear in order to balance supply and demand which causes inflation.
  • In other words, Demand-pull inflation occurs when aggregate demand for goods and services in an economy rises more rapidly than an economy’s productive capacity.

Cost-Push Effect

  • According to Cost-push effect, when companies are faced with increased input costs like raw goods and materials or wages, they will preserve their profitability by passing this increased cost of production onto the consumer in the form of higher prices.
  • The sharp rise in the price of imported oil during the 1970s provides a typical example of cost-push inflation.
  • Rising energy prices caused the cost of producing and transporting goods to rise. Higher production costs led to a decrease in aggregate supply and an increase in the overall price level.

Exchange Rates

  • When the exchange rate goes down such that the Indian currency become less valuable relative to foreign currency, foreign commodities and goods will become more expensive to Indian consumers causing potential inflation.

Corporate Decisions:

  • Companies that make popular items frequently raise prices simply because consumers are willing to pay the increased amount.

 

 

 

Banks with a small finance bank license can provide basic banking service of acceptance of deposits and lending. Who are the eligible promotors of Small Finance Banks (SFBs)?

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Answer:

Eligible promoters:

  • Resident individuals/professionals with 10 years of experience in banking and finance
  • Companies and societies owned and controlled by residents will be eligible to set up small finance banks.
  • Existing Non-Banking Finance Companies (NBFCs), Micro Finance Institutions (MFIs), and Local Area Banks (LABs) that are owned and controlled by residents can also opt for conversion into small finance bank

Enrich Your Learning:

Small Finance Banks (SFBs)

  • Small finance banks are a type of niche banks in India. Banks with a small finance bank license can provide basic banking service of acceptance of deposits and lending.
  • The Reserve Bank of India issued guidelines for setting up SFBs in 2014.
  • SFBs clients include small business units, small farmers, Micro, Small and Medium Enterprises (MSMEs) and various other unorganised sectors.
  • The minimum paid-up equity capital for small finance banks shall be Rs. 100 crore.

Objective of establishment of Small Finance Banks (SFBs)

  • Provision of savings vehicles
  • Supply of credit to small business units, small and marginal farmers, micro and small industries and other unorganised sector entities, through high technology-low cost operations.

Activities of SFBs:

  • The small finance bank shall primarily undertake basic banking activities of acceptance of deposits and lending to unserved and underserved sections including small business units, small and marginal farmers, micro and small industries and unorganised sector entities.
  • There will not be any restriction in the area of operations of small finance banks.

Can SFB be converted into universal banks?

  • Yes, but it will require to fulfilling minimum paid-up capital / net worth requirement as applicable to universal banks, its satisfactory track record of performance as a small finance bank and the outcome of the Reserve Bank’s due diligence exercise.

Background:

  • Local Area Banks (LABs) was set up in 1996 by the RBI which were low cost structures providing efficient and competitive financial intermediation services in a limited area of operation, i.e., primarily in rural and semi-urban areas.
  • LABs were required to have a minimum capital of Rs. 5 crores and an area of operation comprising three contiguous districts. Presently, four LABs are functioning satisfactorily in India.
  • Taking into account the above and that small finance banks can play an important role in the supply of credit to micro and small enterprises, the RBI decided to licence new “small finance banks” in the private sector.
  • RBI has set guidelines in 2014 for licensing of small finance banks in the private sector. Including the issues relating to their size, capital requirements, etc.

Difference between Small bank, Payments Bank and Commercial bank:comm bank11111

Key facts:

  • There are two types of licenses which are granted by the RBI namely ‘Universal bank licenses’ and ‘Differentiated bank licenses’.
  • Differentiated banks licenses serves a specific demographic region instead of the general mass as a whole. Small Finance Bank (“SFB”) caters different type of customers, mainly the ones who are not being serviced by the big commercial banks.

 

 

 

Unlike a traditional budget that is based on previous budgets, Zero-based budgeting prepare the budget from the scratch. What are other difference between Zero-based budgeting and Traditional budgeting?

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Answer & Enrich Your Learning:

Zero Based Budgeting (ZBB)

  • Zero-based budgeting is an approach to plan and prepare the budget from the scratch. Zero-based budgeting starts from zero, rather than a traditional budget that is based on previous budgets.
  • The primary objective of zero-based budgeting is the reduction of unnecessary cost by looking at where costs can be cut.zero based dd

Differences between Traditional Budgeting and Zero Base Budgeting

  • In traditional Budgeting, the previous year’s budget is taken as a base for the preparation of a budget. Whereas, each time the budget under zero-based budgeting is created, the activities are re-evaluated and thus started from scratch.
  • Traditional Budgeting works on cost accounting principle, thereby, it is more accounting oriented. Whereas the zero-based budgeting is decision oriented.
  • In the traditional budgeting, justification of the line items and expenses are not at all required. On the other hand, in zero-based budgeting, proper justification is required, taking into account the cost and benefit.
  • In traditional budgeting, the top management take decisions regarding any amount that will be spent on a particular product. In contrast, in zero-based budgeting, the decision regarding the spending a specific sum on a particular product is on the managers.
  • Zero-based budgeting is better than traditional budgeting when it comes to clarity and responsiveness.
  • Traditional budgeting follows a monotonous approach while zero-based budgeting follows a straightforward approach.

Zero Based Budgeting Advantages

  • Efficiency: It helps a business in the allocation of resources efficiently (department-wise) as it does not look at the previous budget numbers.
  • Accuracy: This budgeting approach makes all departments relook every item of the cash flow and compute their operation costs.
  • Budget inflation: It compensates the weakness of incremental budgeting of budget inflation.
  • Coordination and Communication: It provides better coordination and communication within the department and motivation to employees by involving them in decision-making.
  • Reduction in redundant activities: This approach leads to identify doing things by eliminating all the redundant or unproductive activities.

Zero Based Budgeting Disadvantages

  • High Manpower Turnover: It require the involvement of a large number of employees. Many departments may not have adequate human resource and time for the same.
  • Time-Consuming: It is highly time-intensive for a company to do annually as against incremental budgeting approach, which is a far easier method.
  • Lack of Expertise: Providing an explanation for every line item and every cost is a problematic task and requires training for the managers.

 

 

 

Which GDP is a measure of the value of the economy’s output that is not adjusted for inflation? Nominal GDP or Real GDP?

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Answer:

  • Nominal GDP

Enrich Your Learning:

Nominal GDP

  • The nominal GDP is the value of all the final goods and services that an economy produced during a given year.
  • In other words, it is a macroeconomic measure of the value of the economy’s output that is not adjusted for inflation.
  • It is calculated by using the prices that are current in the year in which the output is produced.
  • The nominal GDP takes into account all of the changes that occurred for all goods and services produced during a given year. If prices change from one period to the next and the output does not change, the nominal GDP would change even though the output remained constant.

Real GDP

  • The real GDP is the total value of all of the final goods and services that an economy produces during a given year, accounting for inflation.
  • In other words, it is a macroeconomic measure of the value of the economy’s output adjusted for price changes (inflation or deflation).
  • It is calculated using the prices of a selected base year. To calculate Real GDP, one must determine how much GDP has been changed by inflation since the base year, and divide out the inflation each year.
  • The real GDP determines the purchasing power net of price changes for a given year.
  • It transforms the money-value measure, nominal GDP, into an index for quantity of total output.

Gross Domestic Product (GDP)

  • GDP is the final value of the goods and services produced within the geographic boundaries of a country during a specified period of time, normally a year.
  • GDP growth rate is an important indicator of the economic performance of a country.

Measurement of GDP:

  • Output Method: This measures the market value of all the goods and services produced within the borders of the country. GDP (as per output method) = Real GDP (GDP at constant prices) – Taxes + Subsidies.
  • Expenditure Method: This measures the total expenditure incurred by all entities on goods and services within the domestic boundaries of a country. GDP (as per expenditure method) = C + I + G + (X-IM) C: Consumption expenditure, I: Investment expenditure, G: Government spending and (X-IM): Exports minus imports, that is, net exports.
  • Income Method: It measures the total income earned by the factors of production, that is, labour and capital within the domestic boundaries of a country. GDP (as per income method) = GDP at factor cost + Taxes – Subsidies.
  • In India, contributions to GDP are mainly divided into 3 broad sectors – agriculture and allied services, industry and service sector.
  • In India, GDP is measured as market prices and the base year for computation is 2011-12. GDP at market prices = GDP at factor cost + Indirect Taxes – Subsidies

Significance of GDP:

  • GDP is used by economists to determine the health of the economy and whether an economy is growing.
  • GDP growth over consecutive quarters indicates the economy is expanding. If GDP growth and economic growth continue, this could signal that there might be a risk of inflation and policymakers should raise interest rates to help abate those consequences of growth.
  • If the GDP growth is negative over two or more consecutive quarters, this is considered a recession. This indicates to policy makers that measures to increase economic activity, like lowering the interest rate or printing more money, are necessary to maintain stability.
  • GDP data can also indicate how other countries or economic regions measure against each other.

The Drawbacks of Using GDP in Calculations:

  • GDP as a whole does not indicate standard of living.
  • It does not include any black market economies.
  • It also does not include other forms of unreported labor.
  • It does not include environmental costs of economic output.

 

 

 

Classify the Government liabilities. What was the total Central government liability in terms of GDP in 2016-17?

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Answer:

  • Central government liability was 46% of GDP while general government liabilities was 68% of GDP in 2016-17.

Enrich Your Learning:

Liabilities of Government of India

  • A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
  • The liability of Indian government was nearly 70 lakh crores in 2016-17. Central government liability was 46% of GDP while general government liabilities was 68% of GDP in 2016-17.
  • Government liabilities have been broadly classified as debt contracted against the Consolidated Fund of India (defined as Public Debt) and liabilities in the Public Account, called Other Liabilities.
  • Public debt is further classified into internal and external debt. Internal debt consists of marketable debt and non-marketable debt. Government dated securities and Treasury Bills, issued through auctions, together comprises marketable debt.
  • Intermediate Treasury Bills issued to State governments and select Central Banks (14 days ITB), special securities issued to National Small Savings Fund (NSSF), etc., are part of non-marketable internal debt.
  • Other Liabilities include liabilities on account of Provident Funds, Reserve Funds and Deposits, Other Accounts, etc.
  • Government published its first Debt Management Strategies (DMS) on December 31, 2015. The objective of the debt management strategy (DMS) is to secure the Government’s funding at all times at low cost over the medium /long-term while avoiding excessive risk.
  • The DMS revolves around three broad pillars, viz., low cost, risk mitigation and market development.

 

 

 

GDP deflator is the ratio of real GDP to the nominal GDP. True OR False.

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Answer:

Right statement

  • GDP deflator is the ratio of nominal GDP to the real GDP.

Enrich Your Learning:

GDP Deflator

  • The GDP deflator is the ratio of the value of goods and services an economy produces in a particular year at current prices to that of prices that prevailed during the base year.
  • It is also called implicit price deflator which is a measure of inflation.
  • This ratio helps show the extent to which the increase in gross domestic product (GDP) has happened on account of higher prices rather than increase in output.

GDP Deflator calculation:

GDP Deflator             =          Nominal GDP  x 100
                                                      Real GDP

  • It is calculated by dividing nominal GDP by real GDP and then multiplying by 100.
  • Nominal GDP is the market value of goods and services produced in an economy, unadjusted for inflation which is the GDP measured at current prices.
  • Real GDP is nominal GDP, adjusted for inflation to reflect changes in real output which is the GDP measured at constant prices.

Difference between GDP Deflator and other Price Indices:

  • There are other measures of inflation too like Consumer Price Index (CPI) and Wholesale Price Index (or WPI), however GDP deflator is a much broader and comprehensive measure.
  • GDP deflator reflects the prices of all domestically produced goods and services in the economy whereas, other measures like CPI and WPI are based on a limited basket of goods and services, thereby not representing the entire economy.
  • Another important distinction is that the basket of WPI (at present) has no representation of services sector.
  • The GDP deflator also includes the prices of investment goods, government services and exports, and excludes the price of imports. Changes in consumption patterns or the introduction of new goods and services are automatically reflected in the deflator which is not the case with other inflation measures.
  • WPI and CPI are available on monthly basis whereas deflator comes with a lag (yearly or quarterly, after quarterly GDP data is released). Hence, monthly change in inflation cannot be tracked using GDP deflator, limiting its usefulness.

 

 

 

Real Effective Exchange Rate (REER) is the weighted average of a country’s currency in relation to an index or basket of other major currencies. What are its limitations?

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Answer:

Limitations of the Real Effective Exchange Rate:

  • It doesn’t take into account price changes, tariffs or other factors affecting trade. In other words, the amount of trade being done with a country can be impacted by many factors.
  • The REER would be impacted in case of central banks adjusting monetary policy which can lower or raise interest rates in their home country resulting in money flows strengthening the currency exchange rate.

Enrich Your Learning:

Real Effective Exchange Rate (REER):

  • The real effective exchange rate (REER) is the weighted average of a country’s currency in relation to an index or basket of other major currencies.
  • This weights are decided by comparing, within the index, the relative trade balance of a country’s currency against each country.
  • An increase in REER implies that exports become more expensive and imports become cheaper; therefore, an increase indicates a loss in trade competitiveness.
  • For Example, If India has trade relationships with U.S. and Australia whereby the U.S. does 70% of its trading with India and 30% for Australia.
  • S. dollar exchange rate would comprise 70% of the basket. A move in the U.S. dollar would have a larger impact on the basket than a move in the Australian dollar.
  • In case of the exchange rates moved significantly, however the weighted average of the basket didn’t change, it could mean that the other currencies moved in the opposite direction offsetting the move of the first currency.
  • It is used to understand how well a currency is doing with respect to other currencies and also with respect itself in the past.

The Difference Between REER and a Spot Exchange Rate:

  • A spot exchange rate is the price to exchange one currency for another for delivery on the earliest possible value date.
  • The spot exchange rate is for a currency between two countries, such as the euro, which is the exchange rate between the U.S. and the eurozone. The REER is a basket of currencies and a weighted average based on how much the countries trade with the base currency.

 

 

 

What are the effects of increase/decrease of ‘Repo rate’ on Banking system as well as on economy of a country?

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Answer & Enrich Your Learning:

What is Repo Rate?

  • Repo rate refers to the rate at which commercial banks borrow money from the Reserve Bank of India (RBI) in case of shortage of funds.
  • Technically, Repo stands for ‘Repurchasing Option’.
  • It is a contract in which banks provide eligible securities such as Treasury Bills to the RBI while availing overnight loans.
  • As per February 2019, the repo rate is 6.25% per annum.

Effects of Repo rate:

Impact on the Banking System:

Increase in Repo Rate:

  • Higher lending rates which may lead to a slowdown of the lending business for the banking sector, which will have an impact on their profitability.
  • Higher equated monthly instalment for existing borrowers and higher rate of credit for new borrowers.
  • Banks may also hike the rate of bank deposit offered to customers to attract more inflow of funds into the banking system.

Reduction in Repo Rate:

  • Banks can borrow from Reserve Bank of India at a cheaper rate.
  • Banks may offer credit to its end customer at a reduced rate.
  • Increased lending business will boost the profitability of the overall banking system.

Impact of Repo rate on economy:

  • It is one of the main tools of RBI to keep inflation under control. In the event of inflation, RBI increase repo rate as this acts as a disincentive for banks to borrow from the RBI.
  • On the other hand, when the RBI needs to o flow cash into the system, it lowers repo rate. Consequentially, businesses and industries find it cheaper to borrow money for different investment purposes.

What is Reverse Repo Rate?

  • A Reverse Repo Rate is a rate that RBI offers to banks when they deposit their surplus cash with RBI for shorter periods.
  • As per February 2019, the reverse repo rate is 6.00%.
  • Reserve Bank of India increases the reverse repo rate with the objective to flush out the excess liquidity in the financial system by keeping check on inflation rate.

Significance of Repo rate and Reverse repo rate:

  • Repo and reverse repo are the most effective and efficient tools used by the Reserve Bank of India to achieve price stability and to boost economic development.
  • Repo rate and reverse repo rate are among the most crucial monetary policy instruments available to the RBI.
  • There is considerable rise in borrowing by commercial banks through repo route which makes it an important element of India’s monetary policy framework. The constant nature of the balance between Repo and Reverse-Repo makes it more powerful in the Indian banking system.

 

 

 

 

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    Debt Management Strategy (DMS) was released/prepared by the Department of Economic Affairs (DEA), Ministry of Finance in consultation with the RBI.

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