Flash-Cards-for-IAS-Prelims-2018-Economy-Day-34
70 Days WAR Plan

Day#34 Static Flash Cards Economic & Social Development [70 Days WAR Plan]

Masala Bonds; Gross National Product (GNP); Differences between Marginal Cost of Funds based Lending Rate (MCLR) and Base Rate (BR); Demand-pull inflation; CPI (Rural, Urban, Combined); Currency Internationalization; Cost push inflation; Deficit financing; Relation between Core inflation & Headline inflation; Broad Money;
By IT's Core Team
April 24, 2019

 

 

 

What is Broad Money?

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Answer:

  • Broad money M3 is a measure of money multiplier that shows the mechanism by which reserve money creates money supply in the economy.

Enrich Your Learning:

  • It is the most inclusive method of calculating a country’s money supply which is the totality of assets that households and businesses can use to make payments or to hold as short-term investments such as currency, funds in bank accounts and anything of value resembling money.
  • M3 = M1 + Time deposits with commercial banks (Fixed deposits, Recurring deposits). Where M1 is Currency with public + Demand deposit in all banks (e.g. current account, savings account) + Other deposits with RBI.
  • It is dependent on two variables, namely currency deposit ratio and reserve deposit ratio.
  • It includes currency with the public and deposits.
  • Broad money includes notes and coins but also saving accounts and deposits in a savings account and can also include Treasury Bills and gilts.
  • Broad money does not include assets, such as long-term dated securities and shares. Although these can be sold, they are not included in terms of broad money because they fall in the category of assets rather than money.

 

 

 

Core inflation considers commodity prices while headline inflation does not. Right OR Wrong?

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Answer:

Right Statement:

  • Headline inflation considers the price of all the goods and services, but Core inflation considers the prices of all goods and services except commodity prices (like prices of vegetables, fruits etc) and oil prices.

Enrich Your Learning:

Relation between Core inflation & Headline inflation:

  • Core Inflation excludes the inflation caused by volatile price commodities such as food and energy.
  • Headline inflation includes inflation due to prices of all the commodities (including commodities like food and energy).
  • Headlines and core inflation are used to set monetary policy in India by RBI. Headline includes volatile inputs like food and energy in the CPI basket which are seldom affected by short term demand- supply shocks.
  • This is done because the prices of commodities and oil fluctuate very frequently and give us unstable numbers. So, many economists prefer to take core instead of headline inflation in order to get stable numbers over time.

 

 

 

Revenue deficit is the ideal indicator of deficit financing. Right OR Wrong?

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Answer:

Right Statement:

  • The fiscal deficit is the ideal indicator of deficit financing.

Enrich Your Learning:

Deficit financing:

  • Deficit financing is the practice in which a government spends more money than it receives as revenue, the difference being made up by borrowing or minting new funds.
  • Deficit financing means the direct addition to gross national expenditure through budget deficits whether the budget deficits are on revenue or on capital account.
  • It is the budgetary situation where expenditure is higher than the revenue. It finances the excess expenditure with outside resources.
  • The expenditure revenue gap is financed by either printing of currency or through borrowing.
  • Nowadays most governments both in the developed and developing world are having deficit budgets and these deficits are often financed through borrowing. Hence the fiscal deficit is the ideal indicator of deficit financing.
  • The root factor that cause deficit in the budget is the revenue deficit. Revenue deficit is the difference between revenue receipts and revenue expenditure in an accounting sense.
  • In India, there is no budget deficit or monetized fiscal deficit at present.
  • The leading deficit indicator to measure the health of the budget in the Indian context is fiscal deficit that represents borrowing by the government from the domestic financial market by issuing bonds or treasury bills.

Various indicators of deficit in the budget are:

  • Budget deficit = total expenditure – total receipts
  • Revenue deficit = revenue expenditure – revenue receipts
  • Fiscal Deficit = total expenditure – total receipts except borrowings
  • Primary Deficit = Fiscal deficit- interest payments
  • Effective revenue Deficit-= Revenue Deficit – grants for the creation of capital assets
  • Monetized Fiscal Deficit = that part of the fiscal deficit covered by borrowing from    the RBI.

Objectives of deficit financing:

  • Deficit financing is used as the simple and effective fiscal device to meet the financial requirements of the government during emergencies such as war.
  • An effective fiscal instrument to control the economic fluctuations and to raise the level of the employment and output.
  • In developing countries, deficit financing is considered as a method to mobilize resources for planned economic development.
  • To raise the level of effective demand and thereby to stimulate private spending in a de­pression economy.
  • To mobilize surplus labour and other idle and unutilized resources during depression, for achieving economic development.
  • In developing economies, the main objective of deficit financing is to remove the vital issue such as unemployment, poverty and income inequality.

 

 

 

What is the cost push inflation?

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Answer & Enrich Your Learning:

  • Cost push inflation is inflation caused by an increase in prices of inputs like labour, raw material, etc.
  • The increased price of the factors of production leads to a decreased supply of these goods. While the demand remains constant, the prices of commodities increase causing a rise in the overall price level. This is the cost push inflation.
  • In this case, the overall price level increases due to higher costs of production which reflects in terms of increased prices of goods and commodities which majorly use these inputs.
  • This is inflation triggered from supply side i.e. because of less supply. The opposite effect of this is called demand pull inflation where higher demand triggers inflation.
  • Apart from rise in prices of inputs, there could be other factors leading to supply side inflation such as natural disasters or depletion of natural resources, monopoly, government regulation or taxation, change in exchange rates, etc.
  • Generally, cost push inflation may occur in case of an inelastic demand curve where the demand cannot be easily adjusted according to rising prices.

 

 

 

What does ‘Masala Bond’ mean?

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Answer:

  • The term “Masala Bonds” is used to refer to rupee-denominated borrowings by Indian entities in overseas markets.

Enrich Your Learning:

  • The International Finance Corp (IFC), the investment arm of the World Bank, issued a Rs 1,000 crore bond in November 2014.
  • The purpose of issue was to fund the infrastructure projects in India. IFC named them ‘masala’ bonds to reflect the Indian flavor. The term masala bonds have been used ever since.
  • Before masala bonds, corporates raised finance from international market through external commercial borrowings called ECBs.

The following are the reason to issue masala bonds:

  • It helps the Indian companies to diversify their bond portfolio as previously they one issued corporate bonds. Masala bonds are an addition to their bond portfolio.
  • It helps the Indian companies to tap a large number of investors as these bonds are issued in the offshore market.
  • Masala bonds will help in building up foreign investors’ confidence in Indian economy and currency which will strengthen the foreign investments in the country.
  • Masala Bonds will also help enhancing internationalization of Indian Rupee. As such, enabling banks to issue masala bonds opens a window to a much larger investment pool while simultaneously addressing the problem of currency mismatches which had existed with previous international bond issues.
  • An offshore investor earns better returns by investing in Masala bonds rather than by investing in his home country. For example, if he had invested in the bond offered in his home country the US, the bond yield is hardly 2% whereas if he invests in rupee denominated masala Bond the yield ranges from 5.00% to 7.00%.
  • In India many long-term debts stressed projects especially infrastructure and power are stalled due to capital shortage, long-term Masala bonds is lucrative for power, road and infra companies.
  • This will contribute to capital account, thus balancing Balance of Payment.

 

 

 

The use by a country of its own currency in conducting international trade outside of its borders is referred to as:

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Answer:

  • Currency Internationalization

Enrich Your Learning:

  • The widespread use of a currency outside the original country in which it was created for the purposes of conducting transactions between sovereign states.
  • The level of currency internationalization for a currency is determined by the demand other countries have for that currency.
  • This depends on the amount of business that is performed between the countries and/or the perceived value of the currency as a good store of value.
  • Full capital account convertibility and development of offshore centres are other enabling conditions for internationalisation.
  • According to the IMF (2011), economic fundamentals such as the economy‘s size and trade network, depth and liquidity of capital markets, as well as the stability and convertibility of the currency are important determinants that support currency internationalisation.

 

 

 

The CPI (Rural, Urban, Combined) is released by which body?

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Answer:

  • The CPI (Rural, Urban, Combined) is released by Central Statistics Office (CSO).

Enrich Your Learning:

CPI (Combined):

  • The CPI (Rural, Urban, Combined) on Base 2012=100 is being released for the month of November 2017.
  • The Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation releases it.

Wholesale Price Index (WPI):

  • Office of Economic Advisor (OEA), Department of Industrial Policy and Promotion, Ministry of Commerce and Industry calculates the WPI.
  • Figures related to Wholesale Price Index are published by the Office of Economic Advisor (Ministry of Commerce & Industry).

Consumer Food Price Index (CFPI):

  • The Consumer Food Price Index (CFPI) is released by Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation (MOSPI).
  • It releases the CPFI for three categories -rural, urban and combined – separately on an all India basis with effect from May 2014.

CPI Industrial Worker (IW):

  • CPI (IW) is released by Labour Bureau, an attached office under Ministry of Labour & Employment.
  • The CPI(IW) and CPI for Agricultural Labourers CPI (AL) and Rural Labourers CPI (RL) compiled are occupation specific and centre specific and are compiled by Labour Bureau.
  • This means that these index numbers measure changes in the retail price of the basket of goods and services consumed by the specific occupational groups in the specific centres.

 

 

 

What is Demand-pull inflation? and what are the demand-pull factors of inflation?

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Answer & Enrich Your Learning:

Demand-pull inflation:

  • Demand-pull inflation arises when there is an excess of demand for goods over their supply.
  • When there is persistent increase in demand and supply does not increase proportionately, then price tends to rise.
  • It happens when the level of aggregate demand grows faster than the underlying level of aggregate supply.

What are the demand-pull factors of inflation?

  • Increase in the disposable income and Consumption: When the common man has more money at his disposal, he will demand more goods. If there is a sharp increase in consumption and investment along with extremely confident businesses atmosphere, then there will be a rise in Aggregate Demand.
  • Exchange Rate: A depreciation of the exchange rate increases the price of imports and reduces the price of a country’s exports. Consumers will buy fewer imports, while exports grow. There will be an increase in Aggregate Demand.
  • Government Spending: An enormous increase in government spending will drive up Aggregate Demand.
  • Expectations: The expectation that inflation will rise often leads to a rise in inflation. Workers and firms will raise their prices to ‘catch up’ to inflation.
  • Monetary Growth: Increase in money supply by the RBI raises the money in circulation, which in turn raises demand for goods. If there is excessive monetary growth when they are too much money in the system chasing too few goods. The ‘price’ of a goodwill thus increases.
  • Growth in Black Money; growth in unaccounted money leads to more demand for goods.
  • Increase in Population; increase in population raises the number of consumers in the market. This, in turn, raises demand for goods.
  • Other causes include growing economy, expectation of inflation, over-expansion of the money supply, discretionary fiscal policy, strong brand itself created by marketing and technological innovation.

 

 

 

Both Marginal Cost of Funds based Lending Rate (MCLR) and Base Rate (BR) are set by RBI. Right OR Wrong?

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Answer:

Right Statement:

  • MCLR is set by the Banks or the particular lender while Base Rate was set by the RBI.

Enrich Your Learning:

Differences between Marginal Cost of Funds based Lending Rate (MCLR) and Base Rate (BR):

  • Base rate is based on average cost of funds, while MCLR is based on marginal/incremental cost of funds.
  • BR is a standard lending rate for commercial banks while MLCR the minimum interest rate, below which the banks cannot lend, except in some cases already stipulated by the RBI.
  • Base rate is calculated by considering minimum rate of return/profit margin, while MLCR is calculated by considering tenor premium.
  • The main difference between the calculation of base rate and MCLR is that the latter takes into account the marginal cost of funds. As marginal costs are charged on the basis of interest rates for various types of deposits, borrowings and return in net worth, it becomes sensitive to policy changes.
  • Base is also governed by operating expenses, and expenses needed to maintain cash reserve ratio, while MCLR is also determined by considering deposit rates and repo rates, along with operating costs and cost of maintaining cash reserve ratio.
  • In MCLR the interest rate charged depends on the Marginal Cost of Lending while in Base Rate it was the minimum interest rate that a bank can charge
  • MCLR is set by the Banks or the particular lender while Base Rate was set by the RBI.
  • MCLR is revised approx. every month while the Base Rate was not revised this frequently.

 

 

The total worth of all the goods and services produced in and outside a country over the period of one year by only its nationals is called as:

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Answer:

  • Gross National Product (GNP)

Enrich Your Learning:

  • Gross national product (GNP) is the value of all the finished goods and services made by a country’s residents and businesses in one year, regardless of production location.
  • GNP is an economic statistic that is equal to GDP plus any income earned by residents from overseas investments minus income earned within the domestic economy by overseas residents.
  • it is an estimate of total value of all the final products and services turned out in a given period by the means of production owned by a country’s residents.
  • It is a broad measure of a nation’s total economic activity.
  • It computes the value of all products manufactured by domestic companies, regardless of where they are made.
  • GNP includes income earned by citizens and companies abroad but does not include income earned and products manufactured by foreign residents or businesses within the country.
  • The figures used to assess GNP include the manufacturing of tangible goods (cars, furniture and agricultural products) and the provision of services (education, healthcare, and business services).
  • GNP does not include the services used to produce manufactured goods because their value is included in the price of the finished product.
  • Unlike gross domestic product (GDP), which defines production based on the geographical location of production. GNP can be greater than, equal to or lesser than the GDP depending on the magnitude of Net Income from abroad.
  • GNP does not distinguish between qualitative improvements in the state of the technical arts (e.g., increasing computer processing speeds), and quantitative increases in goods (e.g., number of computers produced), and considers both to be forms of “economic growth”.
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