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C.

1 Risk Management in Banking Sector


BASEL-1
In 1988,The Basel Committee on Banking Supervision (BCBS) introduced capital measurement system
called Basel capital accord,also called as Basel 1. . It focused almost entirely on credit risk, It defined
capital and structure of risk weights for banks.
The minimum capital requirement was fixed at 8% of risk weighted assets (RWA). India adopted Basel 1
guidelines in 1999.

BASEL-2
In 2004, Basel II guidelines were published by BCBS, which were considered to be the refined and
reformed versions of Basel I accord.
The three pillars of BASEL-3 can be understand from the following figure---

Pillar 1: Minimum Capital Requirements


Pillar 1 of the new capital framework revises the 1988 Accords guidelines by aligning the minimum
capital requirements more closely to each banks actual risk of economic loss. The minimum capital
adequacy ratio would continue to be 8% of the risk-weighted assets (as per RBI, it is 9%), which will
cover capital requirements for credit, market and operational risks.
Estimating Capital required for Credit Risks
For estimating the capital required for credit risks, a range of approaches such as Standardised,
Foundation Internal Rating Based (IRB) and Advanced IRB are suggested.
Under the Standardised Approach, preferential weights ranging from 0% to 150% would be assigned
to assets based on the external credit rating agencies, approved by the national supervisors in
accordance with the criteria defined by the Committee.
Under Internal Rating Based (IRB) Approach, banks would be allowed to estimate their own
Probability of Default (PD) instead of standard percentages such as 20%, 50%, 100% etc. For this
purpose, two approaches namely Foundation IRB and Advanced IRB are suggested. In case of
Foundation IRB approach, RBI is required to set rules for estimating the value of Loss Given Default
(LGD) and Exposure at Default (EAD), while under Advanced IRB approach, banks would be allowed
to use their own estimates of LGD and EAD.
Estimating Capital required for Market Risks
The Narasimham Committee II on Banking Sector Reforms had recommended that in order to capture
market risk in the investment portfolio, a risk-weight of 5% should be applied for Government2 and
other approved securities for the purpose of capital adequacy. The Reserve Bank of India has
prescribed 2.5% risk-weight for capital adequacy for market risk on SLR and non-SLR securities with
effect from March 2000 and 2001 respectively, in addition to appropriate risk-weights for credit risk.
Further the banks in India are required to apply the 2.5% risk-weight for capital charges for market risk
for the whole investment portfolio and 100 % risk-weight on open gold and forex position limits.
Estimating Capital required for Operational Risks
For operational risk, three approaches namely Basic Indicator, Standardised and Internal measurement
have been provided.
Under the Basic Indicator approach, banks have to hold capital for operational risk equal to the fixed
percentage (Alpha) of average annual gross income over the previous three years.
K BIA = GI x alpha
Where
K BIA = the capital charge under the Basic Indicator Approach
GI = average annual gross income over the previous three years.
alpha = fixed percentage
In fact, under the above approach, the additional capital required for operational risk is 20% of the
minimum regulatory capital (i.e., 20 % of 9 % = 1.8 % of the total risk weighted assets)
The standardised approach builds on the basic indicator approach. It divides the banks activities into
8 business lines corporate finance, trading and sales, retail banking, commercial banking, payment
and settlement, agency services, asset management and retail brokerage. The capital charge for
operational risk is arrived at based on fixed percentage for each business line.
The Internal measurement approach allows individual banks to use their own data to determine capital
required for operational risk
Thus, under BASEL II, the denominator of the minimum capital ratio will consist of three parts the
sum of all risk weighted assets for credit risk, plus 12.5 times (reciprocal of 8 % minimum risk based
capital ratio) the sum of the capital charges for market risk and operational risk. The multiplicatory
factor of 12.5 has been introduced in order to enable banks to create a numerical link between the
calculation of capital requirement for credit risk and the capital requirement for operational and market
risks. In case of capital requirement for credit risk, calculation of capital is based on the risk weighted
assets. However, for calculating capital requirement for operational and market risk, the capital charge
itself is calculated directly.
Regulatory Capital
-------------------------------------------------------------------------- = Desired Capital ratio (CAR)
Risk weight Asset for capital risk 12.5 (Market + Operational Risks) Ratio (CAR)

Pillar 2: Supervisory Review Process


Pillar 2 of the new capital framework recognises the necessity of exercising effective supervisory review
of banks internal assessments of their overall risks to ensure that bank management is exercising sound
judgment and had set aside adequate capital for these risks. To be more specific

those organisations should hold higher levels of capital than the minimum requirements in Pillar 1
would specify and to see whether there is any need for remedial actions.

processes for measuring and managing their risks, they will help to create implicit incentives for
organisations to develop sound control structures and to improve those processes.

Thus, the supervisory review process is intended not only to ensure that banks have adequate capital
to support all the risks in their business, but also to encourage banks to develop and use better risk
management techniques in monitoring and managing their risks.
Pillar 3: Market Discipline
Pillar 3 leverages the ability of market discipline to motivate prudent management by enhancing the
degree of transparency in banks public reporting. It sets out the public disclosures that banks must
make that lend greater insight into the adequacy of their capitalisation. The Committee believes that,
when market place participants have a sufficient understanding of a banks activities and the controls
it has in place to manage its exposures, they are better able to distinguish between banking
organisations so that they can reward those that manage their risks prudently and penalise those that
do not (NEDfi Databank Quarterly, 2004).
Thus, adequate disclosure of information to public brings in market discipline and in the process
promotes safety and soundness in the financial system. The Committee proposes two types of
disclosures namely Core and Supplementary. Core disclosures are those which convey vital
information for all institutions while Supplementary disclosures are those required for some. The
Committee recommends that all sophisticated internationally active banks should make the full range
of core and supplementary information publicly available. The Committee also has emphasised the
importance of timeliness of information. For the purpose, it has recommended disclosure on semi-
annual basis and for internationally active banks on a quarterly basis.

BASEL-3

v In 2010, Basel III guidelines were released. These guidelines were introduced in response to the financial
crisis of 2008.
v In 2008, Lehman Brothers collapsed in September 2008, the need for a fundamental strengthening of the
Basel II framework had become apparent.
v Basel III norms aim at making most banking activities such as their trading book activities more capital-
intensive.
v The guidelines aim to promote a more resilient banking system by focusing on four vital banking
parameters viz. capital, leverage, funding and liquidity.
v Presently Indian banking system follows basel II norms.
v The Reserve Bank of India has extended the timeline for full implementation of the Basel III capital
regulations by a year to March 31, 2019.
IMPORTANT POINTS REGARDING TO THE IMPLEMENTATION OF BASEL-3
Government of India is scaling disinvesting their holdings in PSBs to 52 per cent.
Government will soon infuse Rs 6,990 crore in nine public sector banks including SBI, Bank of
Baroda (BoB), Punjab National Bank (PNB) for enhancing their capital and meeting global risk
norms.
This is the first tranche of capital infusion for which the government had allocated Rs 11,200 crore
in the Budget for 2014-15.
The government has infused Rs 58,600 crore between 2011 to 2014 in the state-owned banks.
Finance Minister Arun Jaitley in the Budget speech had said that "to be in line with Basel-III norms
there is a requirement to infuse Rs 2,40,000 crore as equity by 2018 in our banks. To meet this huge
capital requirement we need to raise additional resources to fulfill this obligation.
Need for Basel III in INDIA
1. Firstly ,The most important reason is that as India connects with the rest of the world, and as
increasingly Indian banks go abroad and foreign banks come on to our shores, we cannot afford
to have a regulatory deviation from global standards. Any deviation will hurt us.
2. Secondly, if we ought to maintain a low standard regulatory regime this will put Indian banks
at a disadvantage in global competition.
Therefore, It is becomes important that Indian banks have the cushion provided by this risk
management system to withstand shocks from external systems, especially as we deepen our
links with the global financial system.
In India, Basel III regulations has been implemented from April 1, 2013 in phases and it will be
fully implemented as on March 31, 2019.
Challenges For Its Implementation In India
1. Capital Since nearly 2.4 lakh crore rupees are required for its implementation in India.
2. Liquidity-During the global crisis 2008, the apparently strong banks of the world ran into
difficulties when the inter bank wholesale funding market witnessed a seizure. Thus in Indian
context, it would mean an additional burden of maintaining liquidity along with the SLR
requirement.
3. Technology- BCBS is in the process of making significant changes in standard approach for
computing RWAs for all three risk areas. Banks may need to upgrade their systems and
processes to be able to compute capital requirements based on revised standard approach.
4. Skill development -Implementation of the new capital accord requires higher specialized
skills in banks.
5. Governance-One can have the capital, the liquid assets and the infrastructure. But corporate
governance will be the deciding factor in the ability of a bank to meet the challenges. Strong
capital gives financial strength, it cannot assure good performance unless backed by good
corporate governance.
Steps Taken by Government
(i) GOI has allowed banks to access markets to raise capital while maintaining a minimum 52%
shareholding.
(ii) Govt. also launched a scheme called INDRADHANUSH to revamp PSBs. This scheme seeks
to improve the efficiency and functioning of banks thereby reducing the bad assets. And also
plans to infuse Rs 70,000 crore in the banking system over next 5 years.
In this regard government also announced two banks as DSIBs i.e. SBI and ICICI, based on the
criteria of size, interconnectedness, complexity and substitutability.
Note: According to new Basel-III norms, which kick in from March 2019, Indian banks need
to maintain a minimum capital adequacy ratio (CAR) of nine per cent, in addition to a capital
conservation buffer, which would be in the form of common equity at 2.5 per cent of the risk
weighted assets

Basics of Derivatives: Forward, Futures and Swap


DERIVATIVES DEFINED
A derivative is an instrument whose value is derived from the value of one or more basic variables
called bases (underlying asset, index, or reference rate) in a contractual manner. The underlying asset
can be equity, commodity, forex or any other asset.
The major financial derivative products are Forwards, Futures, Options and Swaps.
Forward Contracts
A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. The
main features of this definition are
_ There is an agreement
_ Agreement is to buy or sell the underlying asset
_ The transaction takes place on a predetermined future date
_ The price at which the transaction will take place is also predetermined.
The basic features of a forward contract are given in brief here as under:
1. Forward contracts are bilateral contracts, and hence, they are exposed to counterparty risk. There is
risk of non-performance of obligation either of the parties, so these are riskier than to futures contracts.
2. Each contract is custom designed, and hence, is unique in terms of contract size, expiration date, the
asset type, quality, etc.
3. In forward contract, one of the parties takes a long position by agreeing to buy the asset at a certain
specified future date. The other party assumes a short position by agreeing to sell the same asset at the
same date for the same specified price. A party with no obligation offsetting the forward contract is
said to have an open position. A party with a closed position is, sometimes, called a hedger.
4. The specified price in a forward contract is referred to as the delivery price. The forward price for a
particular forward contract at a particular time is the delivery price that would apply if the contract
were entered into at that time. It is important to differentiate between the forward price and the
delivery price. Both are equal at the time the contract is entered into. However, as time passes, the
forward price is likely to change whereas the delivery price remains the same.
5. In the forward contract, derivative assets can often be contracted from the combination of underlying
assets, such assets are oftenly known as synthetic assets in the forward market.
6. In the forward market, the contract has to be settled by delivery of the asset on expiration date. In
case the party wishes to reverse the contract, it has to compulsory go to the same counter party, which
may dominate and command the price it wants as being in a monopoly situation.
7. In the forward contract, covered parity or cost-of-carry relations are relation between the prices of
forward and underlying assets. Such relations further assist in determining the arbitrage-based
forward asset prices.
8. Forward contracts are very popular in foreign exchange market as well as interest rate bearing
instruments. Most of the large and international banks quote the forward rate through their forward
desk lying within their foreign exchange trading room. Forward foreign exchange quotes by these
banks are displayed with the spot rates.
9. As per the Indian Forward Contract Act- 1952, different kinds of forward contracts can be done like
hedge contracts, transferable specific delivery (TSD) contracts and non-transferable specify delivery
(NTSD) contracts. Hedge contracts are
freely transferable and do not specific, any particular lot, consignment or variety for delivery.
Transferable specific delivery contracts are though freely transferable from one party to another, but
are concerned with a specific and predetermined
consignment. Delivery is mandatory. Non-transferable specific delivery contracts, as the name
indicates, are not transferable at all, and as such, they are highly specific.
Future Contracts
A future contract is effectively a forward contract which is standardized in nature and is exchange
traded. Future contracts remove the lacunas of forward contracts as they are not exposed to
counterparty risk and are also much more liquid. The standardization of the contract is with respect to
_ Quality of underlying
_ Quantity of underlying
_ Term of the contract
Advantages of Futures:
- Transparency and efficient price discovery. The market brings together divergent categories of buyers
and sellers.
- Elimination of Counterparty credit risk.
- Access to all types of market participants. (Currently, in the Forex OTC markets one side of the
transaction has to compulsorily be an Authorized Dealer).
- Standardized products.
- Transparent trading platform.
Limitations of Futures:
- The benefit of standardization which often leads to improving liquidity in futures, works against this
product when a client needs to hedge a
specific amount to a date for which there is no standard contract - While margining and daily settlement
is a prudent risk management policy, some clients may prefer to not incur this cost in favor of OTC
forwards, where collateral is usually not demanded
futures contracts have following features in brief:
Standardization
One of the most important features of futures contract is that the contract has certain standardized
specification, i.e., quantity of the asset, quality of the asset, the date and month of delivery, the units of
price quotation, location of settlement, etc. For example, the largest exchanges on which futures
contracts are traded are the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange
(CME). They specify about each term of the futures contract.
Clearing House
In the futures contract, the exchange clearing house is an adjunct of the exchange and acts as an
intermediary or middleman in futures. It gives the guarantee for the performance of the parties to each
transaction. The clearing house has a number of members all of which have offices near to the clearing
house. Thus, the clearing house is the counter party to every contract.
Settlement Price
Since the futures contracts are performed through a particular exchange, so at the close of the day of
trading, each contract is marked-to-market. For this the exchange establishes a settlement price. This
settlement price is used to compute the profit or loss on each contract for that day. Accordingly, the
members accounts are credited or debited.
Daily Settlement and Margin
Another feature of a futures contract is that when a person enters into a contract, he is required to
deposit funds with the broker, which is called as margin. The exchange usually sets the minimum
margin required for different assets, but the broker can set higher margin limits for his clients which
depend upon the credit-worthiness of the clients. The basic objective of the margin account is to act as
collateral security in order to minimize the risk of failure by either party in the futures contract.
Tick Size
The futures prices are expressed in currency units, with a minimum price movement called a tick size.
This means that the futures prices must be rounded to the nearest tick. The difference between a futures
price and the cash price of that asset is known as the basis. The details of this mechanism will be
discussed in the forthcoming chapters.
Cash Settlement
Most of the futures contracts are settled in cash by having the short or long to make cash payment on
the difference between the futures price at which the contract was entered and the cash price at
expiration date. This is done because it is inconvenient or impossible to deliver sometimes, the
underlying asset. This type of settlement is very much popular in stock indices futures contracts.
Delivery
The futures contracts are executed on the expiry date. The counter parties with a short position are
obligated to make delivery to the exchange, whereas the exchange is obligated to make delivery to the
longs. The period during which the delivery will be made is set by the exchange which varies from
contract to contract.
Regulation
The important difference between futures and forward markets is that the futures contracts are
regulated through a exchange, but the forward contracts are self regulated by the counter-parties
themselves. The various countries have established Commissions in their country to regulate futures
markets both in stocks and commodities. Any such new futures contracts and changes to existing
contracts must by approved by their respective Commission. Further, more details on different issues
of futures market trading will be
discussed in forthcoming chapters.
Future v/s FORWARD

exchange.
marked to the market on a daily basis.
Options Contracts
Options are the most important group of derivative securities. Option may be defined as a contract,
between two parties whereby one party obtains the right, but not the obligation, to buy or sell a
particular asset, at a specified price, on or before a specified date. The person who acquires the right is
known as the option buyer or option holder, while the other person (who confers the right) is known
as option seller or option writer. The seller of the option for giving such option to the buyer charges an
amount which is known as the option premium.
Options can be divided into two types: calls and puts. A call option gives the holder the right to buy
an asset at a specified date for a specified price whereas in put option, the holder gets the right to sell
an asset at the specified price and time. The specified price in such contract is known as the exercise
price or the strike price and the date in the contract is known as the expiration date or the exercise date
or the maturity date.
The asset or security instrument or commodity covered under the contract is called as the underlying
asset. They include shares, stocks, stock indices, foreign currencies, bonds, commodities, futures
contracts, etc. Further options can be American or European.
A European option can be exercised on the expiration date only whereas an American option can be
exercised at any time before the maturity date.
Call Option
A right to BUY the underlying asset at predetermined price within specified interval of time is called a
CALL option.
Put Option
A right to SELL the underlying asset at predetermined price within a specified interval of time is called
a PUT option
Types of Options
Options have several features, certainly more than forwards and futures making several
differentiations possible in the basis products of calls and puts. Based on several considerations the
options can be categorized in a number of ways, such as:
Based on nature of exercise of options
Based on how are they generated, traded, and settled
Based on the underlying asset on which options are created
Nature of Exercise: American Versus European
Based on the timing of exercise the options can be either American or European. American options can
be exercised at any point of time before the expiry date of the option, while European options are
exercisable only upon maturity.
Nature of Markets: OTC Versus Exchange Traded
Options can also be categorized as OTC or exchange traded depending upon where and how they are
created, traded, and settled. Options may be like it forward contracts, which are specific and negotiated
by two contracting parties mutually with direct negotiations, known as OTC, or they can be like futures
which may be bought and sold on the specific exchanges where the two contracting parties may not be
known to each other but instead
enter into a contract on the floor/screen of an exchange. In the exchange-traded options the contracts
need to be standardized, while an OTC product is tailor-made to the requirements of the parties
concerned.
The standardization of option contract would be in at the discretion of the exchange and is done in
terms of Quantity of Underlying Asset Only specific quantity of the underlying asset could be traded
on the exchange and need to be predetermined.
Strike Prices
Only specific strike prices can be handled in a standardized product traded on the exchanges. OTC
products can have any strike price as agreed by the two contracting parties.
Expiration Dates
Like strike price the expiration dates too must be known before trading can take place in options at the
exchanges. Nature of Exercise of Option Whether the options are American or European in nature too
must be known to traders in options.
Ways of Settlement
Options can be settled either by delivery of underlying asset or by cash settlement, which is closing out
by exchanging the differential of price at initiation and closing out. Cash settlement at the expiry is
done by exchanging difference between the exercise price and price of the underlying asset. It can also
be settled by the cancellation of the contract by entering into an equal and opposite contract to the
original one.
Nature of Underlying Assets
Like forwards and futures, options too can have any asset as underlying. Options on stocks, indices,
commodities, currencies, and interest rates are available either OTC or on exchanges. Though not
available in India as of now, options on commodities are traded internationally on agricultural
products, live stock, food products, energy, and metals.
Options are also available on various currencies, such as US dollar, euro, yen, pound, etc. in major
exchanges in the USA and Europe as also other parts of the world. Options on currencies are mostly
OTC.
Besides, options are also traded on the exchanges on futures contracts rates. Options on futures have
futures contract as underlying asset, which give the buyer a right to buy (call) or sell (put) the specified
futures contract within or at specified time. Naturally, the expiry of the futures contract must extend
beyond that of option contract.
Similarly, options can also be traded on interest rates, either on cash assets such as treasury bonds and
notes, or on interest rate futures contracts. These options serve the same purposes as do the options on
stocks and indices.
Options on stocks and stock indices are most common. Several exchanges across the world offer
options on indices and stock. National Stock Exchange (NSE) in India offers options on several indices
such as Nifty, a broad-based index of 50 stocks from banking, information technology, infrastructure,
etc.
Presently these options cover limited exercise prices and cover periods up to three months. However,
internationally options for longer periods of up to two to three years are also available. NSE attempts
to provide minimum j five strike pricestwo ITM, one ATM, and two OTM at any point of time).
Naked (Uncovered) and Covered Option
Naked or uncovered options are those which do not have offsetting positions, and therefore, are more
risky. On the other hand, where the writer has corresponding offsetting position in the asset underlying
(he option is called covered option. Writing a simple uncovered (or naked) call option indicates toward
exposure of the option writer to unlimited potential losses. The basic aim is to earn the premium. In
period of stable or declining prices, call option writing may result in attractive profits by capturing the
time value of an option. The strategy of writing uncovered calls reflects an investors expectations and
tolerance for risk.
A covered option position involves the purchase or sale of an option in combination with an offsetting
(or opposite) position in the asset which underlies the option. As observed earlier, the writer of the call
option incurs losses when stock prices rise, and put writers incur losses when prices fall. In such
situation, the writer can cover the short put with a short position and short call with a long position in
the underlying asset. This can be stated as:
Covered call sale = Short call + Long futures
Covered put sale = Short put + Short futures

Warrants and Convertibles


Warrants and convertibles are other important categories of financial derivatives, which are frequently
traded in the market. Warrant is just like an option contract where the holder has the right to buy shares
of a specified company at a certain price during the given time period. In other words, the holder of a
warrant instrument has the right to purchase a specific number of shares at a fixed price in a fixed
period from an issuing company. If the holder exercised the right, it increases the number of shares of
the issuing company,
and thus, dilutes the equities of its shareholders. Warrants are usually issued as sweeteners attached
to senior securities like bonds and debentures so that they are successful in their equity issues in terms
of volume and price. Warrants can be detached and traded separately.
Warrants are highly speculative and leverage instruments, so trading in them must be done cautiously.
Convertibles are hybrid securities which combine the basic attributes of fixed interest and variable
return securities. Most popular among these are convertible bonds, convertible debentures and
convertible preference shares. These are also called equity derivative securities. They can be fully or
partially converted into the equity shares of the issuing company at the predetermined specified terms
with regards to the conversion
period, conversion ratio and conversion price. These terms may be different from company to
company, as per nature of the instrument and particular equity issue of the company. The further
details of these instruments will be discussed in the respective chapters.
SWAP Contracts
Swaps have become popular derivative instruments in recent years all over the world. A swap is an
agreement between two counter parties to exchange cash flows in the future. Under the swap
agreement, various terms like the dates when the cash flows are to be paid, the currency in which to be
paid and the mode of payment are determined and finalized by the parties. Usually the calculation of
cash flows involves the future values of one or more market variables.
There are two most popular forms of swap contracts, i.e., interest rate swaps and currency swaps. In
the interest rate swap one party agrees to pay the other party interest at a fixed rate on a notional
principal amount, and in return, it receives interest at a floating rate on the same principal notional
amount for a specified period. The currencies of the two sets of cash flows are the same. In case of
currency swap, it involves in exchanging of interest flows, in one currency for interest flows in other
currency. In other words, it requires the exchange of cash flows in two currencies. There are various
forms of swaps based upon
these two, but having different features in general.

Changing Landscape of Banking sector

Key actors/acts in the New Banking Landscape


Let us see what would be the impact of these themes/developments on the key actors/acts in the new
banking landscape.
1Customers, employees, owners and regulators comprise the key stakeholders in the banking system.
In the emerging landscape, the banks would have to contend with a set of customers who are more
educated, better informed and well-networked. The banks may probably be forced to hard sell their
products and services using a variety of media across the physical and the virtual world. As the
complexity of the products/services demanded by the customers increases, the banks would have to
not only focus on upgradation of skillsets of their employees but also on their retention. Also the new
competition would potentially pull down the ROEs that the owners currently enjoy rendering it
difficult to persuade future investors to put in more capital in the banks. In case of public sector banks,
the ownership structure itself may change with Government bringing down its stake in these banks.
They would, thus, also join the race to seek private capital.

As we have witnessed, the regulators across the globe have been particularly very severe on failings of
the regulated entities on the consumer protection, money laundering and fair market conduct front.
This regulatory activism is evident in the frequency and quantum of penalties levied on banks
worldwide. Post crisis, the banks in US and Europe alone have been forced to cough up approximately
$230 bn in penalties and legal cost so far2. Next two years are likely to see another $70 bn being forked
out by the banks for the same reasons. These are staggering numbers. We have also seen some
enforcement actions in our jurisdiction but these are pretty benign in comparison. Believe me; Indian
regulators have been relatively more tolerant thus far. Some of you who have overseas operations are
well aware of the tough stance that the host regulators adopt. Banks would need to gear up to face
stricter regulatory regime.
The new banking landscape would impact the processes currently in vogue in the sector.
1. Competition and Consolidation
Competition and consolidation in the sector is an impending development that the banks would have
to contend with sooner rather than later. Two new private sector banks should start operating within
this calendar year. Further, the small finance banks and payments banks might mark their presence,
may be, later in the year or by early next year and so. There could be consolidation and mergers
between the existing market players. No doubt, the pie is big enough to accommodate new players and
there is plenty of opportunity for the well-organised and mainstream regulated players to wean away
the customers from unregulated shadow banking entities. But, the existing players can afford to stay
in denial at their own peril. We have seen competition giving a tough run to the monopoly players. It
has happened in the aviation sector, the telecom sector and there is no reason why it would not happen
in the banking sector. And believe me, this is not the end of new competition for you. RBI has been
indicating about the possibilities of the bank licensing process being put on tap or introducing more
varieties of differentiated banks. Also, there is a healthy appetite from the foreign banks to enter this
country.
The entry of new competitors alone would not mean dramatic changes soon. Banking is a
business of scale which the new players cannot build overnight. New banks would start small and scale
up over a period of time. Not only would there be a competition for business but also for talent. The
processes would be forced to be more efficient.
2. Technology
I have already talked about a paradigm shift being brought about by technology in the way the social
interactions are taking place. Growing mobile and internet penetration has opened new avenues for
the entrepreneurs. This is reflected in the way the new age customer transacts her business. If all
traditional businesses have been impacted by technology, banking could not have remained
unaffected. As a flip-side to its well-documented advantages in terms of efficiency and effectiveness of
service delivery, technology has also fast tracked the process of customer alienation- first in the form
of ATMs and then in the form of internet and mobile banking. In this sense, banks have become faceless
entities. This transition calls for a change in the way the banks interact with and retain their customers.
I will shortly return to the expectations built around the integration of technology in the banking
services and its impact on the banks.
3. Risk Management
Risk Management in banks is of the same vintage as the banks themselves. The banks are in the
business of taking risks and hence they need to have a risk management framework in place. Its been
more than a decade and a half since RBI first released the risk management guidelines for banks in
India. But, my own sense is that risk management has been pursued in our banking system more under
compliance compulsions and has not been dovetailed in the banks businesses processes as much as
they ought to have been. As the complexity in the financial world grows, the banks would need to
carefully consider and set their risk appetite after duly evaluating their capital level as also the skillsets
of the officials entrusted with the management of risks.
As I said before, the defining elements of the new India would have far-reaching impact on each
of the actors and the acts in the new banking landscape. These elements would interplay and provide
shape to the new banking order. It would be interesting for you to pick up these 7 contours, 4 actors
and 3 acts and interplay them to build probable business scenarios. You may be amazed to see the
range of possibilities and challenges. Let me now return to the subject of technology, which is widely
perceived as the be all and end all of the new in banking.
4. Technology- A Great Enabler
I would begin by quoting Brett King, the author of famous book Bank 3.0.
Customers dont use channel or products in isolation of one another. Everyday customers would
interact with banks in various ways. They might wire money to a third party, visit ATM to withdraw
cash, go online to check salary credit, pay an utility bill , use their credit card to purchase some goods
from a retailer , fill out a personal loan application online, ring up the call center to see what their credit
card balance is or report a lost card. More sophisticated they are, they may also trade some stocks,
transfer some cash from their Euro A/c to USD a/c put up a lump sum in a Mutual Fund or sign up a
home insurance policy online.
The above statement denotes the diverse set of banking applications which technology can
support In fact, there is a need of a single channel solution to multiple product offerings. It must,
however, be remembered that technology is just an enabler and not a panacea for all ills. Most, if not
all, Indian banks have invested heavily in web-based and mobile-based delivery solutions. Each of
these channels is supported by a different vendor and each one uses different technology which
increases complexity and involves cost. Further, technology is ever evolving and adoption of new
technology for staying contemporaneous is a costly proposition. Hence, unless we are able to optimally
exploit all the capabilities of the technology enabled delivery solutions, we could be looking at
unproductive investments.
While there is a lot of euphoria around the adoption of mobile banking and mobile payments,
the model has been relatively less successful barring a few countries where the right environmental
factors existed. I am talking here about the delivery of financial and payment services by using the
mobile device rather than its use as an access channel for internet banking etc. In the Indian context, an
objective analysis would reveal various reasons for slow adoption. On the other hand, there are
technical issues like type of handsets, variety of operating systems, encryption requirements, inter-
operable platforms or the lack of it, absence of standardised communication structures, difficulty in
downloading application, time lag in activation etc. These get accentuated by the operational
difficulties in on-boarding merchants and customers and customer ownership issues. The interplay of
these factors has stymied the deployment and adoption of mobile banking as an effective and widely
accepted delivery channel. Issues of coordination and cooperation between banks and telcos, is another
aspect which acts as either a driver or a barrier to the adoption of mobile banking. These issues need
to be quickly resolved if the mobile has to serve as an influential delivery channel for distributing
banking products and services in India.
Let me also highlight some opportunities that technology throws up. Take for example the
results displayed on the Google search page which is personalized. Each time an individual runs a
search at Google, the website collates details of the sites visited/links clicked by that individual and
loads more of those websites his/her future searches. There are more ATM transactions than searches
on the Google webpage at present. However, the kind of personalisation Google has achieved in its
searches has not been attempted in the area of advertisement on ATMs. This could be an area for the
banks and their software vendors to work on in future so as to generate further sales leads.

How payments banks will change Indias banking landscape


The new crop of payments banks, that will spring up over the next year or so, promises to change the
countrys banking landscape, altering the way transactions take place. At the core of this change will
be the mobile phone.
Indias payments market today is estimated at $15.5 trillion (excluding inter-bank clearing and CCIL).
The share of mobile banking, Bank of America Merrill Lynch estimates, may rise to 10% in seven years
from 0.1% currently, with the value increasing 200 times to $3.5 trillion. People are likely to use mobiles
for making payments through all key channels including even RTGS ad payments through paper may
fall to less than 2%, the brokerage believes.
Such a transformation would necessarily change the way banks operate. How they stay competitive in
an environment where a clutch of payments banks is presentwho cannot lend but can borrow up to
a limitwill depend on how quickly they tweak their business models; while payments banks are
unlikely to be big disruptors in the near term, they may make life just a little difficult for incumbents.
While plain vanilla payments banks could capture some share of the payments volumes, its the bank
centric model thats likely to succeed given the regulations in favour of having a bank account. As
BoAML observes, telcos and payments banksonce they become operationalare unlikely to cause
any disruption in India as the customer franchise will remain with the banks.
Public Sector Reforms

BACKGROUND TO THE ECONOMIC REFORM


After a long history of low growth of 3-3.5% per annum the Indian economy ascended to a higher
growth path during the 1980s. A sustained annual growth rate in GDP of 5.6% was recorded during the
Seventh Five Year Plan period (1985-90) During this period the annual industrial growth was about 8.5%,
with the manufacturing sector growing at an annual rate of 8.8%. This growth was achieved by a
sustained level of investment of about 22.7% of GDP, on average, during the period. Although there was
some improvement in the savings rate from about 19.6% of GDP during the Sixth Plan period (1980-85) to
an average of 20.3% during the 7th plan period, this still left a substantial investment savings gap of about
2.4% of GDP over this five year period. The savings rate of the household and private corporate sector
did increase from about 15.9% of GDP during 1980-85 to 18.0% in 1985-90. However, savings of the
Government sector turned from a positive 1.2% of GDP during 1980-85 to register negative savings of
1.6% of GDP during 1985-90. The performance of the public corporate sector improved significantly
between the early and late 1980s. Its contribution to national savings increased from 2.5% of GDP in
1980-85 to 3.9% of GDP in 1985-90.

Fiscal Consolidation
The domestic macro economic imbalance in the late 1980s was manifested in an increasing rate of
Government dissavings which reached a little over 2% of GDP in 1989-90 and rose further to about 2.2%
of GDP in 1990-91. This deteriorating government savings rate was, over time, caused, in part, by the low
returns that the government has received from public sector investments, and increasing levels of
subsidies. This domestic macro economic imbalance during the 1980s reflected itself in an increasing
current account deficit which averaged about 2.4% of GDP during the late 1980s. Whereas this in itself is
not too high a current account deficit by the standard of many countries, it was unsustainable because of
the low export/GDP ratio in the relatively closed Indian economy. Hence, although the economy
performed better during the whole of the decade of the 1980s than in the previous two decades, the
growing macro economic imbalances had become unsustainable by the middle of 1990 and the economy
found itself in deep crisis by mid 1991. The balance of payments situation was precarious with reserves
at a level of about US $ 1.3 billion amounting to only about two weeks of imports; inflation had reached
double digits; a drop in international confidence resulted in a sharp decline in capital inflows through
commercial borrowings and non residents deposits. The record of high industrial and GDP growth
experienced over the previous six years had begun to turn negative because of the severe import squeeze
that had had to be imposed in 1990-91. (see Ian Little and Vijay Joshi(1994) for a full discussion of the
factors leading upto the 1991)

A programme of fiscal consolidation was started in July 1991 in order to achieve a significant
reduction in the fiscal deficit. Some key subsidies have been eliminated such as those for exports, and
others, such as those for fertilisers and for the public sector, have been reduced. A generalised expenditure
containment programme was instituted. Alongwith these measures on the expenditure side
corresponding attempts have also been made to improve the quality of taxation. A far reaching tax reform
has been attempted in all the three major sources of central government revenues: income tax, excise and
customs. Significant success was achieved in the reduction of the gross fiscal deficit of the central
government from a level of about 8.4% of GDP in 1990-91 to 5.9% in 1991-92 and 5.7% in 1992-93. However
the deficit increased once again to 7.3% in 1993-94 despite the government target of only 4.7% ). This was
partly caused by a large shortfall in revenues which itself was because of a slow recovery of the industrial
sector. A fiscal deficit of 6.7% of GDP in 1994-95 showed some improvement but even this was higher
than the targeted 6.0%, despite bouyant revenues.

On the expenditure side an important impact of the stabilisation programme is a decreasing


proportion of expenditures which are characterised as developmental expenditure. At the central
government level these have reduced from about 57.6% of total government expenditure in 1980-81 to
54.3% in 1990-91 to 46.5% as budgeted for 1994-95. The corresponding proportions for State Governments
are 70.1% in 1980-81, 68.8% in 1990-91 and 64.5% in 1994-95. Consequently, the government contribution
to capital formation in the country has been declining proportionately at all levels of the government. For
public sector enterprises the general implication of these stabilisation measures and the budgetary
situation in the foreseable future is that budgetary resources both for investment as well as for current
expenditure purposes are at a declining trend.

Monetary policy is also being conducted in a manner consistent with this direction in fiscal policy.
The government has moved to eliminate its automatic access to the Reserve Bank of India (the Central
Bank) for funding its budget deficits so that they will not be automatically monetised. Government bor-
rowing has shifted to market related interest rates and 364 day treasury bills have been introduced to
facilitate such borrowings. The consequence of all these changes is that the budgetary cost of non tax
resources is no longer hidden and will increasingly reflect market resource costs. Thus low cost budgetary
resources will no longer be available for investment or for other expenditures in public enterprises.
Structural Reforms
These measures of short term economic management were accompanied by far reaching
structural reforms in the area of industrial policy aimed at enhancing productivity and strengthening
competitiveness in the industrial sector. The policy towards foreign investment was restructured to
attract foreign investment. More recently policy changes have been made to invite foreign investment in
core infrastructure areas like power and telecom also, areas which had earlier been the preserve of the
public sector.
Much of Indian industry had operated in a protected framework since the 1950s when the broad
contrours of the Indian system of command and control was largely put in place(see Mohan and Aggarwal
1990). Many sectors in manufacturing were reserved for the exclusive operation of public sector
enterprises; capacity controls on new entry protected the private sector as well from competition,and
extensive trade controls and high tariffs insulated much of the Indian industrial economy from external
competition.

While, over the years, a well-diversified industrial structure had been established, barriers to
entry, and limits on growth in the size of firms, led to a proliferation of licensing arrangements and an
increase in the degree of monopoly in many product markets. There was inadequate emphasis on
reduction of costs, upgradation of technology, and improvement of quality standards. A major
deregulation of the domestic industrial sector was therefore introduced by the Industrial Policy Statement
of July 1991. As a result of this reform programme Indian industry is now substantially deregulated.
Whereas, earlier, entry into most areas of industry was controlled by the Government through the
issuance of capacity based licenses, entry regulations have now been abolished for all projects except for
a short list of 16 industries which are mainly related to security, strategic, environmental or social
concerns. Similarly, whereas earlier large firms had to seek additional prior governmental approval for
expansion of existing projects and for investment in new projects under the Monopolies and Restrictive
Trade Practices Act (MRTP), these regulations have also been abolished. The system of Phased
Manufacturing Programmes, which was earlier designed to enforce progressively higher degrees of local
content no longer exists. Industrial location restrictions, which were earlier widespread now exist to only
a limited extent in large cities, and are based on environmental considerations. Public sector location
decisions were particularly affected by non commercial locational considerations. A significant number
of industries had earlier been reserved for the public sector. Now no manufacturing sector is so reserved
except for petroleum and defence equipment. Consequently, with the abolition of such restrictions, entry
into the industrial sector is now substantially free including almost all areas in which public sector
manufacturing enterprises currently operate.

Alongwith the deregulation of the industrial sector for domestic investment the provisions
related to foreign investment have also been substantially liberalised so that there is no bar against foreign
investment in any area. Automatic approval is available for direct investment upto 51% foreign equity
ownership in a specified list of high priority industries. In all other areas discretionary approval is being
given on a relatively liberal basis. Correspondingly, automatic approval is available for foreign
technology agreements in all industries but within certain payment guidelines. Consequently foreign
entry has also been substanially deregulated in the manufacturing sector and is taking place at an
accelerated rate. Overall, it is expected that all of these measures put together will provide significantly
increased competition in all areas of the manufacturing sector, and particularly those that have earlier
been reserved exclusively for public sector enterprises. In fact, over 20,000 industrial investment
intentions have been filed since the July 1991 reform: this is about 60 per cent higher, on an annual basis,
than the investment intentions exhibited in the 4-5 years prior to 1991. The total investment implied by
these intentions is over US $ 140 billion in aggregate: a very significant increase over earlier periods.
Almost 3000 foreign investment approvals have been given involving total intended foreign equity in
these projects of over US $ 7 billion. The total investment in projects which have foreign equity would
constitute about 20-25 per cent of all industrial investment intentions. It is estimated that about 40-50%
per cent of total investment intentions will fructify. Intentions have been recorded in almost all segments
of the manufacturing sector: thus there is substantical evidence that new competition will be evident in
most sectors, including those in which the public sector enterprises currently exist. There will be few, if
any, monopolies once these new industrial projects are implemented

The programme of deregulation of domestic industry and foreign investment has also been
accompanied by substantial changes in the trade and payment system. The exchange rate has been
successively adjusted over the last three years to a new level and is now market determined. The rupee
is now convertible on the current account. The earlier trade regime had been characterised by widespread
quantitative controls on imports and by high tariffs. Almost all quantitative controls have now been
removed except on the imports of consumer goods. In particular, whereas earlier most capital goods
imports were subjected to strict quantitative controls based on certification of local non availability, and
many raw materials and intermediate goods were only importable by specified public sector agencies,
these imports have now been completely freed. A substantial tariff reform has also been under way.
Maximum tariffs have been reduced successively from over 300% in 1990-91 to 50% today. Similarly
import duties on capital goods and intermediate products have been reduced from over 85% in 1990-91
to 25% in 1995. The most substantial reduction has taken place in the tariffs on capital goods and raw
materials. Thus increasing competition has been introduced in the very products that public sector
enterprises manufactured through the opening of imports and substantial reduction in tariffs.

The Indian financial sector is almost entirely government owned. Prior to 1969 most of the banks
were privately owned. Now all the major banks are owned by the government as are the term lending
institutions, the insurance companies and pension and provident funds. However, major reforms have
been introduced in the banking system so as to enhance its effectiveness in the mobilisation and
deployment of national savings. The statutory liquidity ratio is being progressively reduced to provide
banks with much greater flexibility in the deployment of their resources. Interest rates have also been
deregulated so that bank lending rates will now depend solely on their costs of funds and operating
efficiency. Any channels that may have existed earlier for favourable treatment of the public sector have
also been abolished. The entry of new private banks is being encouraged and some of the term lending
institutions have been made effectively autonomous with government equity falling below 50 per cent.
But much more remains to be done in this sector.

Significant reforms have been introduced in the capital market. Earlier, capital issues were
controlled by the Ministry of Finance: they decided on when new issues could be made and determined
their prices. Now, the issue and prices of new capital offerings have been freed and are being determined
by the companies themselves. Firms are now free to raise resources in the capital market. Market forces
determine prices and volumes as in most developed capital markets. Alongwith this deregulation in the
domestic capital market, Indian firms now also have access to other channels for raising resources from
external sources. Indian markets are open for direct portfolio investment by foreign institutional
investors; they can also access international capital markets through the floatation of Euro issues by way
of foreign currency convertible bonds or ordinary shares through Global Depository Receipts( GDRs).
The consequence of these financial sector and capital market reforms is that it has become feasible for the
private sector to raise large volumes of resources for investment in large projects that may not have been
as easy earlier.

Taken together, the fiscal consolidation programme and the structural reform programme is
having substantial impact on the current and future operation of public sector enterprises.

Impact of Economic Reforms on Public Sector Enterprises


The opening of new entry both by domestic private firms and by foreign firms has injected
substantial new competition in all the areas where manufacturing public sector enterprises exist. In the
earlier situation, many areas were reserved for the public sector and therefore PSEs had monopoly
presence in many sectors. It was therefore feasible for them to operate even within the operational
constraints that are typically posed by public sector ownership. Decision making governed by rules,
regulations, procedures etc. that are characteristic of governmental operation did not handicap the
operations of commercial enterprises in the absence of competition. Cost plus pricing and administered
pricing regimes were also feasible in that environment. Moreover, many commodities produced by the
public sector such as steel, non-ferrous metals, and coal, among others, were governed by price and
distribution controls. Since imports were restricted in most capital goods industry, intermediate goods,
and raw materials, public sector enterprises in these areas had a captive domestic market while facing no
competition from imports either. Pressures for continued investment in modernisation and technology
upgradation were also non existent.

The situation has now been completely changed as a consequence of domestic and external
deregulation encouraging new entry and providing free imports. Public sector enterprises now have to
compete in the market with private enterprises: they have to compete for resources, for markets, for
personnel, and for technology. The addition of new communication technologies has made the need for
fast and flexible commercial decision making much more important than the public enterprises have been
accustomed to in the past. Overall, the impact of the economic reform on public enterprises requires much
greater operational autonomy than exists at present, or it requires privatisation.
Another characteristic of the public sector enterprises (PSEs) in India in the planning system was
the existence of a closed circle in the heavy industry sector within public sector enterprises. In the steel
sector, for example, the PSEs sourced their inputs such as coal and iron ore either from their own capitive
mines or other PSEs. As part of the steel industry programme, other PSEs such as the Heavy Engineering
Corporation (HEC) were also created to supply capital equipment required for the steel making
enterprises. Similarly other equipment manufacturing enterprises were expected to source their steel
requirements from the public sector steel enterprises. Captive engineering consultancy organisations
were also created for providing the design back up for PSE projects. The PSEs were expected, in general,
to provide a preference to other PSEs for sourcing their raw materials, intermediate goods and capital
goods from their PSEs. In all cases, in the absence of competing private enterprises in these sectors and in
the absence of imports, there was little choice. With PSEs now being permitted to source their inputs
freely including imports, this itself adds to the new competition being faced by PSEs. Corresponding
changes in policy which give them greater freedom for deciding on their sourcing and output composition
are therefore required.

Budget constraints are becoming evident. The PSEs are facing increasing difficulty in finding
adequate resources for making new capital expenditure and for the provision of subsidies required by
non profit making PSEs. In addition, capital expenditure decisions of public enterprises are also subject
to detailed governmental budgetary procedures which are in essence unavoidable.

The decision to make new capital investments in public enterprises has to be subjected to public
scrutiny through both
planning and budgetary processes. Thus the managements of PSEs have limited control on the future
strategy for their enterprises. Moreover, the application of public resources for capital investment by PSEs
has necessarily to be scrutinised carefully. This inevitably leads to substantial delays in decision making,
actual allocation, and implementation. With greater fiscal restraints this process is likely to become even
more difficult than it has been in the past. At the same time, the constraints that existed earlier for private
companies on the resource side have now been removed. There is also much greater freedom in making
technology choice. Earlier, it was probably easier for public sector enterprises to obtain large volumes of
resources through the plan process, than it was for private enterprises. With the onset of budgetary
restraints and opening of capital markets the situation has become reversed and private sector companies
can now find large volumes of resources both more easily and quickly.
In summary, therefore, the market structure is in the process of becoming much more competitive
than it has been in the past. The added competition provided by new foreign investment and by imports
makes for a completely changed environment for public sector enterprises. The economic environment is
no longer characterised by commands and controls: free prices and markets are increasingly the order of
the day. Consequently, public sector enterprises are likely to be more handicapped than before in
comparison with competing private enterprises in making decisions for new capital expenditure, for
making new technology choices and for introducing flexibility in product composition. With the
introduction of new competition on the product side this will make their task availability to compete even
more difficult.

Disinvestment
Definition of Disinvestment
At the very basic level, disinvestment can be explained as follows:
Investment refers to the conversion of money or cash into securities, debentures, bonds or any other
claims on money. As follows, disinvestment involves the conversion of money claims or securities into
money or cash.
Disinvestment can also be defined as the action of an organisation (or government) selling or
liquidating an asset or subsidiary. It is also referred to as divestment or divestiture.
In most contexts, disinvestment typically refers to sale from the government, partly or fully, of a
government-owned enterprise.
A company or a government organisation will typically disinvest an asset either as a strategic move for
the company, or for raising resources to meet general/specific needs.
Objectives of Disinvestment
The new economic policy initiated in July 1991 clearly indicated that PSUs had shown a very negative
rate of return on capital employed. Inefficient PSUs had become and were continuing to be a drag on
the Governments resources turning to be more of liabilities to the Government than being assets. Many
undertakings traditionally established as pillars of growth had become a burden on the economy. The
national gross domestic product and gross national savings were also getting adversely affected by low
returns from PSUs. About 10 to 15 % of the total gross domestic savings were getting reduced on
account of low savings from PSUs. In relation to the capital employed, the levels of profits were too
low. Of the various factors responsible for low profits in the PSUs, the following were identified as
particularly important:
Price policy of public sector undertakings
Underutilisation of capacity
Problems related to planning and construction of projects
Problems of labour, personnel and management
Lack of autonomy
Hence, the need for the Government to get rid of these units and to concentrate on core activities was
identified. The Government also took a view that it should move out of non-core businesses, especially
the ones where the private sector had now entered in a significant way. Finally, disinvestment was also
seen by the Government to raise funds for meeting general/specific needs.
In this direction, the Government adopted the 'Disinvestment Policy'. This was identified as an active
tool to reduce the burden of financing the PSUs. The following main objectives of disinvestment were
outlined:
To reduce the financial burden on the Government
To improve public finances
To introduce, competition and market discipline
To fund growth
To encourage wider share of ownership
To depoliticise non-essential services

Importance of Disinvestment
Presently, the Government has about Rs. 2 lakh crore locked up in PSUs. Disinvestment of the
Government stake is, thus, far too significant. The importance of disinvestment lies in utilisation of
funds for:
Financing the increasing fiscal deficit
Financing large-scale infrastructure development
For investing in the economy to encourage spending
For retiring Government debt- Almost 40-45% of the Centres revenue receipts go towards
repaying public
debt/interest
For social programs like health and education
Disinvestment also assumes significance due to the prevalence of an increasingly competitive
environment, which makes it difficult for many PSUs to operate profitably. This leads to a rapid erosion
of value of the public assets making it critical to disinvest early to realize a high value.
Disinvestments-A Historical Perspective
For the first four decades after Independence, the country was pursuing a path of development in
which the public sector was expected to be the engine of growth. However, the public sector overgrew
itself and its shortcomings started manifesting in low capacity utilisation and low efficiency due to over
manning, low work ethics, over capitalisation due to substantial time and cost over runs, inability to
innovate, take quick and timely decisions, large interference in decision making process etc. Hence, a
decision was taken in 1991 to follow the path of Disinvestment.

Period from 1991-92 - 2000-01


The change process in India began in the year 1991-92, with 31 selected PSUs disinvested for Rs.3,038
crore. In August 1996, the Disinvestment Commission, chaired by G V Ramakrishna was set up to
advice, supervise, monitor and publicize gradual disinvestment of Indian PSUs. It submitted 13 reports
covering recommendations on privatisation of 57 PSUs.Dr R.H.Patil subsequently took up the
chairmanship of this Commission in July 2001.However, the Disinvestment Commission ceased to exist
in May 2004.
The Department of Disinvestment was set up as a separate department in December, 1999 and was
later renamed as Ministry of Disinvestment from September, 2001. From May, 2004, the Department of
Disinvestment became one of the Departments under the Ministry of Finance.
Against an aggregate target of Rs. 54,300 crore to be raised from PSU disinvestment from 1991-92 to
2000-01, the Government managed to raise just Rs. 20,078.62 crore (less than half). Interestingly, the
government was able to meet its annual target in only 3 (out of 10) years. In 1993-94, the proceeds from
PSU disinvestment were nil over a target amount of Rs. 3,500 crore.

The reasons for such low proceeds from disinvestment against the actual target set were:
1. Unfavorable market conditions
2. Offers made by the government were not attractive for private sector investors
3. Lot of opposition on the valuation process
4. No clear-cut policy on disinvestment
5. Strong opposition from employee and trade unions
6. Lack of transparency in the process
7. Lack of political will
This was the period when disinvestment happened primarily by way of sale of minority stakes of the
PSUs through domestic or international issue of shares in small tranches. The value realized through
the sale of shares, even in blue chip companies like IOC, BPCL, HPCL, GAIL & VSNL, however, was
low since the control still lay with the government.
Most of these offers of minority stakes during this period were picked up by the domestic financial
institutions. Unit Trust of India was one such major institution.

Period from 2001-02 - 2003-04


This was the period when maximum number of disinvestments took place. These took the shape of
either strategic sales (involving an effective transfer of control and management to a private entity) or
an offer for sale to the public, with the government still retaining control of the management. Some of
the companies which witnessed a strategic sale included:
BHARAT ALUMINIUM CO.LTD.
CMC LTD.
HINDUSTAN ZINC LTD.
HOTEL CORP.OF INDIA LTD. (3 PROPERTIES: CENTAUR HOTEL,JUHU BEACH, CENTAUR
HOTEL AIRPORT,MUMBAI & INDO HOKKE HOTELS LTD.,RAJGIR)
HTL LTD.
IBP CO.LTD.
INDIA TOURISM DEVELOPMENT CORP.LTD.(18 HOTEL PROPERTIES)
INDIAN PETROCHEMICALS CORP.LTD.
JESSOP & CO.LTD.
LAGAN JUTE MACHINERY CO.LTD.,THE
MARUTI SUZUKI INDIA LTD.
MODERN FOOD INDUSTRIES (INDIA) LTD.
PARADEEP PHOSPHATES LTD.
TATA COMMUNICATIONS LTD.
The valuations realized by this route were found to be substantially higher than those from minority
stake sales.
During this period, against an aggregate target of Rs. 38,500 crore to be raised from PSU disinvestment,
the Government managed to raise Rs. 21,163.68 crore.

Period from 2004-05 - 2008-09


The issue of PSU disinvestment remained a contentious issue through this period. As a result, the
disinvestment agenda stagnated during this period. In the 5 years from 2003-04 to 2008-09, the total
receipts from disinvestments were only Rs. 8515.93 crore.

2009-10-2015-16
A stable government and improved stock market conditions initially led to a renewed thrust on
disinvestments. The Government started the process by selling minority stakes in listed and unlisted
(profit-making) PSUs. This period saw disinvestments in companies such as NHPC Ltd., Oil India Ltd.,
NTPC Ltd., REC, NMDC, SJVN, EIL, CIL, MOIL, etc. through public offers.
However, from 2011 onwards, disinvestment activity slowed down considerably. As against a target
of Rs.40,000 crore for 2011-12, the Government was able to raise only Rs.14,000 crore. However, the
subsequent years saw some improvement and the Government was able to raise Rs. 23,857 crore
against a target of Rs. 30,000 crore (Revised Target : Rs. 24,000 crore) in 2012-13 and Rs. 21,321 crore
against a target of Rs. 54,000 (Revised Target : Rs. 19,027 crore) in 2013-14. The achieved target dropped
to Rs. 24,338 crore against a target of Rs. 58,425 crore in 2014-15 and Rs. 18,409 crore against a target of
Rs. 69,500 (Revised Target : Rs. 30,000 crore) in 2015-16.

2016-17 onwards
The NDA Government has set an ambitious disinvestment target of Rs. 56,500 crore. As such, 2016-17
is likely to see some big ticket disinvestments taking place.

Disinvestment Policy
The policy on disinvestment has evolved considerably through Presidents address to Joint Sessions of
Parliament and statement of the Finance Ministers in their Budget Speeches.
The salient features of the Policy are:
(i) Public Sector Undertakings are the wealth of the Nation and to ensure this wealth rests in the
hands of the people, promote public ownership of CPSEs;
(ii) While pursuing disinvestment through minority stake sale in listed CPSEs, the Government will
retain majority shareholding, i.e. at least 51 per cent of the shareholding and management control
of the Public Sector Undertakings;
(iii) Strategic disinvestment by way of sale of substantial portion of Government shareholding in
identified CPSEs upto 50 per cent or more, alongwith transfer of management control.

What are the salient features of Current Disinvestment Policy?


Only minority stake to be disinvested (49% equity) in profitable CPSEs
Management control of profitable CPSEs to remain with Government
Disinvestment on a case-by-case basis
Citizens have a right to own part of the shares of CPSEs retail shareholding should increase
Disinvestment of majority stake (51% equity) in loss-making CPSEs that cannot be revived

Approach for Disinvestment

(a) Disinvestment through minority stake sale


On 5th November 2009, Government approved the following action plan for disinvestment in profit
making government companies:
(i) Already listed profitable CPSEs (not meeting mandatory shareholding of 10 per cent which
stands revised to 25 per cent) are to be made compliant through Offer for Sale (OFS) by the
Government or by the CPSEs through issue of fresh shares or a combination of both;
(ii) Unlisted CPSEs with no accumulated losses and having earned net profit in three preceding
consecutive years to be listed;
(iii) Follow-on public offers would be considered, taking into consideration the needs for capital
investment of CPSEs on a case by case basis, and the Government could simultaneously or
independently offer a portion of its equity shareholding;
(iv) All cases of disinvestment are to be decided on a case by case basis;
(v) The Department of Investment and Public Asset Management (DIPAM) is to identify CPSEs in
consultation with respective administrative ministries and submit proposal to Government in
cases requiring Offer for Sale of Government equity.
(b) Strategic Disinvestment
(i) To be undertaken through a consultation process among different Ministries/Departments,
including NITI Aayog.
(ii) NITI Aayog to identify CPSEs for strategic disinvestment and advice on the mode of sale,
percentage of shares to be sold of the CPSE and method for valuation of the CPSE.
(iii) The Core Group of Secretaries on Disinvestment (CGD) to consider the recommendations of NITI
Aayog to facilitate a decision by the Cabinet Committee on Economic Affairs (CCEA) on strategic
disinvestment and to supervise/monitor the process of implementation.
(c) Comprehensive management of GoIs investment in CPSEs
(i) The Government recognises its investment in CPSEs as an important asset for accelerating
economic growth and is committed to the efficient use of these resources to achieve optimum
return.
(ii) The Government will achieve these objectives by adopting a comprehensive approach for
addressing critical inter-linked issues such as leveraging of assets to attract fresh investment,
capital restructuring, financial restructuring, etc.
(iii) Different options for optimal utilization of Governments investment in CPSEs will be assessed
to adopt suitable investment management strategies to improve investors confidence in the
CPSEs and support their market capitalization which is essential for raising fresh investment
from the capital market for their expansion and growth.
(iv) Efficient management of investment in CPSEs shall be ensured through rationalization of
decision making process for all related issues and seamless inter-departmental coordination in
the matter.

methods of disinvestment of minority stake in CPSEs


Initial Public Offering (IPO) - offer of shares by an unlisted CPSE or the Government out of
its shareholding or a combination of both to the public for subscription for the first time
Further Public Offering (FPO) - offer of shares by a listed CPSE or the Government out of its
shareholding or a combination of both to the public for subscription
Offer for Sale (OFS) of shares by Promoters through Stock Exchange mechanism - method
allows auction of shares on the platform provided by the Stock Exchanges; extensively used by
the Government since 2012
Institutional Placement Program (IPP) - only Institutions can participate in the offering
CPSE Exchange Traded Fund (ETF) - ETF monetizes the shareholding in those CPSEs which
form part of the ETF basket

How much has been raised from disinvestment?


Method of sale Disinvestment Receipts (Rs. crore)
Minority Sales 136,445
Strategic Sale 6,344
Residual Sale 6,398
Other transactions like special dividends, control premium, cross-holdings, sale of shares to
employees, etc 5,374
Total 154,562

Disinvestment target and achievement (Last 5 years)


Year Target (in Rs. crore) Amount realized (in Rs. crore)
2009-10 No target fixed 23,553
2010-11 40,000 22,144
2011-12 40,000 13,894
2012-13 30,000 23,956
2013-14 40,000 15,819
2014-15 36,925 1,771

National Investment Fund


Government had constituted the National Investment Fund (NIF) in November, 2005 into which the
proceeds from disinvestment of Central Public Sector Enterprises were to be channelized. The corpus
of NIF was to be of a permanent nature and NIF was to be professionally managed to provide
sustainable returns to the Government, without depleting the corpus.Selected Public Sector Mutual
Funds, namely UTI Asset Management Company Ltd., SBI Funds Management Private Ltd. and LIC
Mutual Fund Asset Management Company Ltd. were entrusted with the management of the NIF
corpus. As per this Scheme, 75% of the annual income of the NIF was to be used for financing selected
social sector schemes which promote education, health and employment. The residual 25% of the
annual income of NIF was to be used to meet the capital investment requirements of profitable and
revivable PSUs.

In view of the difficult economic situation caused by the global slowdown of 2008-09 and a severe
drought in 2009-10, Government approved a change in the policy for utilization of disinvestment
proceeds (5th of November 2009) by granting a one-time exemption to utilize the disinvestment
proceeds directly for selected Social Sector Schemes allocated by Department of Expenditure/ Planning
Commission. This exemption was to be operational for the period April 2009-March 2012. In view of
the persistent difficult condition of the economy, the exemption from channelizing the disinvestment
proceeds in the NIF was further extended by another year i.e. from April 2012 to March 2013

In order to align the NIF with the disinvestment Policy, Government decided (17th January 2013) that
the disinvestment proceeds, with effect from the fiscal year 2013-14, will be credited to the existing NIF
which is a Public Account under the Government Accounts and the funds would remain there until
withdrawn/invested for the approved purposes. It was also simultaneously decided that the NIF
would be utilized for the following purposes:

(i) Subscribing to the shares being issued by the CPSE on rights basis so as to ensure that 51%
ownership of the Government in CPSEs is not diluted.

(ii) Preferential allotment of shares of the CPSE to promoters as per SEBI (Issue of Capital and
Disclosure Requirements) Regulations, 2009 so that Government shareholding does not go down
below 51% in all cases where the CPSEs desire to raise fresh equity to meet their Capex programme.
(iii)Recapitalization of public sector banks and public sector insurance companies so as to strengthen
them by further capital infusion towards achieving the Basel III norms.

The Government further approved inclusion of the following purposes also, to be financed from the
NIF (21st February, 2013).
(i) Investment by Government in RRBs/IIFCL/NABARD/Exim Bank;
(ii) Equity infusion in various Metro projects;
(iii) Investment in Bhartiya Nabhikiya Vidyut Nigam Limited and Uranium Corporation of India Ltd.
(iv) Investment in Indian Railways towards capital expenditure.

Use of disinvestment proceeds - National Investment Fund (NIF)


Created in Nov 2005 - Proceeds from disinvestment of CPSEs to be channelized in NIF
During 2009 2013, Rs.83,548 crore disinvestment receipts and income from NIF were spent on select
social sector schemes like Jawaharlal Nehru National Urban Renewal Mission, Accelerated Irrigation
Benefits Programme, Rajiv Gandhi Gramin Vidyutikaran Yojana, Accelerated Power Development and
Reform Programme, Indira Awas Yojana, and National Employment Guarantee Scheme
In 2013, Government decided that the NIF would be utilized for subscribing to shares of CPSEs
including Public Sector Banks (PSBs) and Public Sector Insurance Companies, recapitalisation of
Financial Institutions (FIs), capital expenditure in Indian Railways, etc
In 2013-14, entire disinvestment proceeds were used for capital expenditure in Indian Railways

Achievements of Department of Disinvestment


Raised Rs.1.55 lakh crore as disinvestment revenues
50 CPSEs listed - CPSEs constitute over 14% of the total market capitalisation of listed Indian
companies
Peoples ownership: retail investors own an average of 5% of the shares while public shareholding is
about 25% (on average) in listed CPSEs
All listed CPSEs made compliant with minimum public shareholding requirement of 10%, which was
mandated by SEBI till July 2014; Efforts to increase minimum public shareholding to 25% in listed
CPSEs as recently mandated by SEBI
New methods of disinvestment introduced CPSE Exchange Traded Fund - Provides investors with
low-cost, low-risk and well-diversified equity product with discounts
National Investment Fund constituted in 2005 allows use of disinvestment proceeds as per the
priorities of Government

Classification of PSU
The Maharatnas
Maharatna Scheme was introduced for Central Public Sector Enterprises (CPSEs), with effect from 19th
May, 2010, in order to empower mega CPSEs to expand their operations and emerge as global giants.
The objective of the scheme is to delegate enhanced powers to the Boards of identified large-sized
Navratna CPSEs so as to facilitate expansion of their operations, both in domestic as well as global
markets.
Following CPSEs have been identified as Maharatnas:
1. BHARAT HEAVY ELECTRICALS LTD.
2. COAL INDIA LTD.
3. GAIL (INDIA) LTD.
4. INDIAN OIL CORP.LTD.
5. NTPC LTD.
6. OIL & NATURAL GAS CORP.LTD.
7. STEEL AUTHORITY OF INDIA LTD.
Source: Department of Public Enterprises (as on Oct, 2014)
Eligibility Criteria for grant of Maharatna status
CPSEs fulfilling the following criteria are eligible to be considered for grant of Maharatna status:
i. Having Navratna status
ii. Listed on the Indian stock exchange, with a minimum prescribed public shareholding under SEBI
regulations
iii. An average annual turnover of more than Rs. 20,000 crore during the last three years
iv. An average annual net worth of more than Rs.10,000 crore during the last three years
v. An average annual net profit of more than Rs. 2,500 crore during the last 3 years
vi. Significant global presence or international operations
The Navratnas
The Miniratna Category I and Schedule A CPSEs, which have obtained excellent or very good
rating under the Memorandum of Understanding system in three of the last five years, and have
composite score of 60 or above in the six selected performance parameters, namely,
(i) net profit to net worth,
(ii) manpower cost to total cost of production/services,
(iii) profit before depreciation, interest and taxes to capital employed,
(iv) profit before interest and taxes to turnover,
(v) earning per share and
(vi) inter-sectoral performance.

Under this scheme, the Government has delegated higher powers to CPSEs having a comparative
advantage and the potential to become global players. Presently, the Navratna CPSEs are:-
1. BHARAT ELECTRONICS LTD.
2. BHARAT PETROLEUM CORP.LTD.
3. CONTAINER CORP.OF INDIA LTD.
4. ENGINEERS INDIA LTD.
5. HINDUSTAN AERONAUTICS LTD.
6. HINDUSTAN PETROLEUM CORP.LTD.
7. MAHANAGAR TELEPHONE NIGAM LTD.
8. NATIONAL ALUMINIUM CO.LTD.
9. NBCC (INDIA) LTD.
10. NEYVELI LIGNITE CORP.LTD.
11. NMDC LTD.
12. OIL INDIA LTD.
13. POWER FINANCE CORP.LTD.
14. POWER GRID CORP.OF INDIA LTD.
15. RASHTRIYA ISPAT NIGAM LTD.
16. RURAL ELECTRIFICATION CORP.LTD.
17. SHIPPING CORP.OF INDIA LTD.,THE
The Miniratnas(I and II) 71 Miniratna
Criteria for grant of Miniratna status :-
The CPSEs which have made profits in the last three years continuously and have positive net
worth are eligible to be considered for grant of Miniratna status.
Category I CPSEs
AIRPORTS AUTHORITY OF INDIA 2. ANTRIX CORP.LTD. BALMER
LAWRIE & CO.LTD.
BEML LTD. BHARAT COKING COAL LTD. BHARAT
DYNAMICS LTD.
BHARAT SANCHAR NIGAM LTD.
BRIDGE & ROOF CO.(INDIA) LTD. CENTRAL COALFIELDS LTD. CENTRAL
WAREHOUSING CORP.
CHENNAI PETROLEUM CORP.LTD.
COCHIN SHIPYARD LTD. DREDGING CORP.OF INDIA LTD. GARDEN
REACH SHIPBUILDERS & ENGINEERS LTD.
GOA SHIPYARD LTD. HINDUSTAN COPPER LTD.
HINDUSTAN NEWSPRINT LTD.
HINDUSTAN PAPER CORP.LTD. HLL LIFECARE LTD. HOUSING &
URBAN DEVELOPMENT CORP.LTD.
INDIA TOURISM DEVELOPMENT CORP.LTD. INDIAN RAILWAY CATERING &
TOURISM CORP.LTD.
INDIAN RARE EARTHS LTD. IRCON INTERNATIONAL LTD.
KAMARAJAR PORT LTD.
KIOCL LTD. MAHANADI COALFIELDS LTD. MISHRA
DHATU NIGAM LTD.
MMTC LTD. MOIL LTD. MSTC LTD. NATIONAL SEEDS CORP.LTD.
NATIONAL FERTILIZERS LTD. NHPC LTD. NORTH EASTERN
ELECTRIC POWER CORP.LTD.
NORTHERN COALFIELDS LTD. NUMALIGARH REFINERY LTD.
ONGC VIDESH LTD.
PAWAN HANS LTD. PROJECTS & DEVELOPMENT INDIA LTD. RAIL
VIKAS NIGAM LTD.
RAILTEL CORP.OF INDIA LTD. RASHTRIYA CHEMICALS & FERTILIZERS LTD.
RITES LTD.
SECURITY PRINTING & MINTING CORP.INDIA LTD. SJVN LTD. SOUTH EASTERN
COALFIELDS LTD.
STATE TRADING CORP.OF INDIA LTD.,THE TELECOMMUNICATIONS
CONSULTANTS INDIA LTD.
THDC INDIA LTD. WAPCOS LTD. WESTERN COALFIELDS LTD.

Category II CPSEs
BHARAT PUMPS & COMPRESSORS LTD. BROADCAST ENGINEERING
CONSULTANTS INDIA LTD.
CENTRAL MINE PLANNING & DESIGN INSTITUTE LTD. CENTRAL RAILSIDE
WAREHOUSING CO.LTD.
EDCIL (INDIA) LTD. ENGINEERING PROJECTS (INDIA) LTD.
FCI ARAVALI GYPSUM & MINERALS INDIA LTD. FERRO SCRAP NIGAM LTD.
HMT (INTERNATIONAL) LTD. HSCC (INDIA) LTD.
INDIA TRADE PROMOTION ORGANISATION INDIAN MEDICINES
PHARMACEUTICAL CORP.LTD.
MECON LTD. MINERAL EXPLORATION CORP.LTD.
NATIONAL FILM DEVELOPMENT CORP.LTD. NATIONAL SMALL
INDUSTRIES CORP.LTD.,THE
PEC LTD. RAJASTHAN ELECTRONICS &
INSTRUMENTS LTD.
Portfolio Investment
A portfolio investment is an investment made by an investor who is not involved in the
management of a company. This is in contrast to direct investment, which allows an investor to
exercise a certain degree of managerial control over a company.

Portfolio investment is defined as cross-border transactions and positions involving equity or
debt securities, other than those included in direct investment or reserve assets.
The characteristic feature of securities is their negotiability. that is, their legal ownership is
readily transferable from one unit to another unit by delivery or endorsement
Negotiable instruments are designed to be traded on Negotiable instruments are designed to
be traded on organized markets

Portfolio investments include transactions in equity securities, such as common stock,
and debt securities, such as banknotes, bonds, and debentures.[1]
Portfolio investments are passive investments, as they do not entail active management or
control of the issuing company. Rather, the purpose of the investment is solely financial gain, in
contrast to foreign direct investment (FDI), which allows an investor to exercise a certain degree
of managerial control over a company. For international transactions, equity investments where
the owner holds less than 10% of a company's shares are classified as portfolio
investments.[2] These transactions are also referred to as "portfolio flows" and are recorded in
the financial account of a country's balance of payments.
They are categorized in two major parts: foreign institutional investment and investments by
non-residents. According to the Institute of International Finance, portfolio flows arise through
the transfer of ownership of securities from one country to another.[3]
Portfolio investment covers a range of securities, such as stocks and bonds, as well as other types
of investment vehicles. A diversifiedportfolio helps spread the risk of possible loss because of
below-expectations performance of one or a few of them.

What is an international portfolio investment?
A grouping of investment assets that focuses on securities from foreign markets rather than
domestic ones. An international portfolio is designed to give the investor exposure to growth
in emerging and international markets and provide diversification.

FINANCIAL INCLUSION
Financial inclusion is the delivery of financial services at affordable costs to sections of
disadvantaged and low income segments of society.
According to the Rangarajan Committee Report, 2008, financial inclusion is, "The process of
ensuring access to financial services and timely and adequate credit where needed by vulnerable
groups such as weaker sections and low income groups at an affordable cost"
The Reserve Bank of India (RBI) stated in December 2009 that the facilities under financial
inclusion are not restricted merely to opening of bank accounts, but also includes other financial
services such as credit facility, remittance facility, and financial advisory services.
The aim is to support safe and sound spread of new modes of quality yet low-cost financial
service delivery capable of reaching the poor and help provide a framework of incentives to banks,
insurance and non-bank players while ensuring fair competition.

Facilities Identified Under Financial Inclusion

1. Savings product and accounts.


2. Payment and remittance services.
3. Credit facility.
4. Financial advice.
5. Loans and insurance.
6. Mortgage.
7. Entrepreneurial credit.
Importance of Financial Inclusion
It helps in enhancing financial literacy of the vulnerable and weaker section of society through
financial advice and decreases dependence on unreliable and expensive finance.
Financial inclusion promotes innovation for cost-effective delivery of financial products through the
use of technology.
It helps the poor stabilize their income and build productive assets.
Financial inclusion leads to economic growth by mobilizing greater savings into productive
investments.
It helps in enhancing financial literacy of the vulnerable and weaker section of society through
financial advice. Also, decreases dependence on unreliable and expensive finance.
Financial inclusion promotes innovation for cost-effective delivery of financial products through the
use of technology.
It helps the poor stabilize their income and build productive assets.
Transaction history of previously served people can be transformed into an asset, which the
customer could use to access financial services during lean periods as well.
Financial Inclusion promotes competition and helps provide market-based incentives delivery of
sustainable financial access.

MODELS FOR FINANCIAL INCLUSION


1. Business Correspondent Based Model
In 2006, RBI permitted banks to engage intermediaries to provide banking services and increase their
reach.
These intermediaries, called business correspondents (BC) or business facilitators (BF) were allowed
to provide banking services as agents of bank at places other than bank premises.
RBI's Working Group for Reviewing the Business Correspondent Model also recommended the types
of individuals or entities who could act as BCs or BFs in the rural and semi-urban areas.
The BCs are permitted to carry out transactions on behalf of the bank as agents.
The BFs can refer clients, pursue the clients' proposal and facilitate the bank to carry out its
transactions, but not transact on behalf of the bank.
BCs and BFs undertake facilitation of the following services:
Identifying borrowers and fitment of financial activities.
Collecting and preliminary processing of loan applications including verifying primary
information.
Creating awareness about savings and other products.
Educating and advising on managing money, and debt counselling.
Processing and submitting applications.
Promoting and nurturing self-help groups (SHG) or joint-liability groups (JLG)
Post-sanction monitoring and handholding of SHGs, JLGs, credit groups and others.
Following-up for recovery.
Operators in BC and BF Models
NGOs and MFIs under Societies,Trust Acts.
Grocery, chemist and fair-price shop owners.
PCO operator
Petrol pump owner.
Retired teachers.
SHGs linked to banks.
2. Financial Inclusion via `No Frills' Banks Accounts and Micro-credit
3. Non-business Correspondent Based Model
The non-business correspondent based model makes use of technology to provide banking services to
rural and semi urban areas; technologies such as cellular phones, broadband and ITeS services and
mobile banks are being promoted for delivery of financial services to unbanked, but potential areas.
Technologies in Use in Non-BC Model
1. Mobile Banking.
2. Banks on Wheels.
3. Integrated ITeS (It enabled Services).
ROLE OF TECHNOLOGY FOR FINANCIAL INCLUSION
Among the key constraints cited world over in achieving significant financial inclusion is the cost of
servicing small value and unprofitable customer segments or providing credit facilities to those with
irregular income history.
The combination of IT and mobile telephony along with other IT-enabled services has emerged as a
viable solution for greater financial inclusion.
Essentially, this combination of technologies minimizes the need for setting up physical branches at
all locations with trained persons to man them.
It allows the servicing banks to improve efficiency and provides for use of multiple channels to work
together as an inter-connected system.
The rapid growth of technology and communication infrastructure in India is a great enabler for
establishing rural information infrastructure.
Short Message Service (SMS), Unstructured Supplementary Services Delivery (USSD), Wireless
Application Protocol (WAP), General packet radio service (GPRS), phone-based applications such
as Java 2 Micro Edition (J2ME)/Binary Runtime Environment for Wireless (BREW), Subscriber
Identity Module (SIM) - based application, and Near Field Communication (NFC) are the various
technology applications available, which can help improve the level of financial inclusion in the
country.
Providing branchless banking services through mobile phones helps banks access with lower
investment.
Significant telecommunications and technology penetration in rural areas is a positive aspect of
enhancing banking reach and affordability.
Existing technology providers for financial inclusion in rural areas have concluded as follows:
Building rural information infrastructure is possible using technology.
There is demand for such information systems from service providers.
Computerization of may prove the primary agricultural cooperative societies (PACS) may prove
to be beneficial with potential for improving governance through linkage to the credit delivery
system.
ATM-based mobile service delivery systems can be deployed in rural areas using available
mobile telephony technologies.
Key Technologies enabling Financial Inclusion
Financial services through mobile telephony
Micro, Mobile, and Biometric ATMs
Internet-enabled Kiosks and PCs
Biometric handheld device
Smart cards and POS terminals

Some of the commonly promoted distribution technologies for financial inclusion in India include
the following:

IT-enabled Kiosks for Financial Inclusion-


IT-Kiosks are among the most common forms of delivering products for financial inclusion.
They are small and self-operated IT-enabled centers that provide the customers with banking
features such as cheque or cash deposit, internet banking, non-cash ATM transaction and teller
enquiries.
Kiosks are located in areas where the financial inclusion initiative is likely to lead to significant
increase in transactions volume as well as the number of users.
Importance of Kiosk-
1. Increases banking outreach.
2. Helps scale-up number of users.
3. Reduces opportunity cost and time.
4. Handles significantly higher transactions volume.
5. Helps maintain record of account and information.
6. Ensures reliability and security of information.

A. Mobile phone based financial services


India had about 771.18 million mobile-phone users as of January 2011. According to the Telecom
Regulatory Authority of India (TRAI), 9 million new users subscribe to a mobile service every
year. Mobile based financial services refers to a broad range of financial activities that consumers
can access using their mobile phones. Mobile-phone transactions include the use of network
airtime or e-currencies for deposit, transfer of funds or credits, and payment of services. Mobile
based banking services, mainly, fall under two categories:
Mobile banking (m-banking)
Since mobile technology has the potential to reach out to the large unbanked population in remote
areas, mobile banking provides technology support for increasing outreach for financial inclusion.

Mobile payments (m-payments)


With the help of mobile payments, even a remotely located banking customer can conduct payment
transactions via a mobile device without the help of an intermediary.

B. Automated Teller Machines (ATM)


Since ATMs are computerized telecommunications devices providing facilities for financial
transactions in a public space without the need for a cashier, human clerk or bank teller - they
rely on authorization of a financial transaction by the card issuer or other authorizing institution
via a communication network.
Several new-technology ATM devices have been designed to improve financial services in rural
and remote areas so that even the illiterate customers in unbanked areas can avail ATM facilities.
They include biometric-, mobile- and micro-ATMs.
Biometric ATM:-
Enables the illiterate and semi-literate customers to avail ATM facilities.
Eliminates the need for pin numbers; thumb impression of the cardholder is scanned and stored
for authentication - users scan their thumb to access their account through the ATM.
Mobile ATM:-
Provides ATM services on a van; the van moves to pre-determined places providing facilities
such as opening of accounts and handling enquiries; it helps in providing ATM facilities to
customers is unbanked areas.
Provides banking access to biometric card holders also.
Micro ATM:-
Provides a low-cost ATM alternative with basic features such as cash withdrawal and balance
enquiry.
Can be located at easily accessible locations where rural people visit frequently, such as petrol
pumps and markets.
C. Biometric handheld device:-
It is a handheld device for use by BCs.
The device provides facility for thumb impression scanning or retina detection for user
identification.
While images can be read by the device, it can also provide audio confirmations of transactions
and issue receipts.
D. Smart cards and POS:-
Smart cards help store all customer information including a photographs and finger prints.
The smart card user can deposit or withdraw by swiping it at a point-of-service (POS) terminal,
which saves transactions information for uploading on the bank's main servers.

GOVERNMENT INITIATIVES FOR FINANCIAL INCLUSION


Through RBI, the Government of India has introduced several initiatives since the 1906s to
increase the reach of banking services in the country
1. No frills accounts
2. BC model
3. SHG-bank linkage programme
4. Relaxation in KYC norms.
5. Introducing KCC.
6. Launch of UID
Starting the facility of 'No-Frill Account', overdraft facility in saving Bank Accounts,
liberalization in branch expansion norms, formulation of policies for setting up of ATMs,
introducing technology-based products and services, initiating facility for pre-paid cards,
developing a financial literacy program, etc., are few initiatives taken in this direction.
In order to address the need of banks in rural areas, the Finance Ministry has directed all banks
to provide appropriate banking facilities to places having population over 2,000 by March 2012
using branchless banking, through business correspondents.
Accordingly, the banks have formulated their road maps through the forum of state level banker
committees for financial inclusion and have identified over 73,000 habitants having a population
of over 2,000 for providing banking facilities.
According to RBI, the number of no-frill accounts has increased from 489,497 in 2006 to about
33 million in 2009.
The total number of SHG linked with banks has also increased to 6.9 million in 2010 from 82,000
in 1999-2000.
The total loan disbursed via SHG-bank linkage in 2009-2010 was US$ 3,212 million (INR 144,533
million) as compared to US$ 30.2 million (INR 1,360 million) in 1999-2000.
The growth is indicative of India's level of commitment towards greater financial inclusion.
The use of technology in expanding the banking outreach has been an area of focus for the Indian
Government.
Technological innovation has not only enabled a broader reach for consumer banking and
financial services, but has enhanced its capacity for continued and inclusive growth.
Banks and financial institutions rely on gathering, processing, analyzing information in order to
improve its service and meet the expectations of customers.

RBI and the Government have taken the following steps to increase the reach of banking services
using technological advancements:
In 2006-07, the Government of India initiated pilot projects to use smart cards with biometric
identification for opening bank accounts; system integration was initiated to link mobile or
handheld-connectivity devices to banking infrastructure to ensure that the transactions are
recorded in the banks' books on real-time basis.
RBI ensures that banks adopt smart card-based Electronic Benefit Transfer (EBT) mechanism.
The bank also reimburses the commercial banks a part of the cost of opening accounts with
biometric access or smart cards.
ATMs can be located without prior authorisation.
In addition, the RBI announced, a US$ 112 million, Financial Inclusion Technology Fund (FITF)
in 2007 to meet the cost of technology adoption.
The objectives of FITF are to:
1. Enhance investment in ICT for promoting financial inclusion.
2. Stimulate research and technology in financial inclusion
3. Increase the technological absorption capacity of financial service providers and users
4. Encourage an environment of innovation and cooperation among the stakeholders

C.6 Alternate source of finance, private and social cost-benefit, Public-Private Partnership

Alternate source of finance


Alternative finance
Alternative finance refers to financial channels and instruments that have emerged outside of the
traditional finance system such as regulated banks and capital markets. Examples of alternative
financing activities through 'online marketplaces' are reward-basedcrowdfunding, equity
crowdfunding, peer-to-peer consumer and business lending, invoice trading third party payment
platforms. Alternative finance instruments include cryptocurrencies such as Bitcoin, SME mini-
bond, social impact bond, community shares, private placement and other 'shadow banking'
mechanisms. Alternative Finance differs to traditional banking or capital market finance through
technology-enabled 'disintermediation', which means utilising third party capital by connecting
fundraisers directly with funders, in turn, reducing transactional costs and improve market
efficiency.

Alternative source of funding is the new buzz word in the financial sector. Very simply it is
innovation centered around various financial instruments that looks to simplify the borrowing and
lending process and help businesses in their financial goals. Alternative sources of funding became
very popular, especially after the financial crisis (2008) resulted in failure of number of Banks and
stringent Basel III Capital adequacy norms being made applicable. Banks have stopped lending to
ventures and individuals they consider risky and as a result a large number of the population fell
outside the traditional channels of finance.
Very soon consumer behavior shifted to new players, which came to be known as alternate sources of
funds, which looked to carry out financial activities digitally. Such has been the growth of these
alternate sources of funds, which are primarily peer-to-peer sites, that bankers like Vikram Pandit,
the former Citigroup chief executive, have also realized its importance when he became part of a
group that invested $2.7 million in a P2P site called Orchard.

As institutional investors increasingly look at grabbing a piece of peer-to-peer, many are calling it as
the next level of banking. A look at the segments fueling the frenzy:

1. Equity based Crowdfunding as an emerging alternative to fund business: Equity based


Crowdfunding generally relates to startups and early stage companies generating funds by offering
equity in the company in lieu of money. In such a scenario the company solicits funds online and
does not tap into the primary capital markets. A crowdfunding platform in this case acts as an
intermediary between investors and the company.
Private equity, VC firms, and angel investors have been the primary source of funding for startups,
but some have broken the shackles by offering equity to the general public at a very early stage. Some
examples of equity crowdfunding platforms are Syndicate Room, Crowdcube, Kickstarter and
Seedrs.

Across the world there are different rules and regulations governing such platforms and in India,
SEBI is undertaking active discussions with stakeholders to come up with a suitable policy. Such
platforms and sites have gained popularity and is doing very well across the world as it provides a
viable alternative outside the traditional financial system for SMEs and startups to raise money.
Taping the primary market in the form of IPOs is an expensive proposition and very time consuming.
Raising funds through the equity sale on a Crowdfunding site is possible at a fraction of a cost and is
relatively faster. For the investor it provides a new investment product and the ability to be a part of
a company that can see the rapid growth and provide considerable returns. On the risks, the greatest
these sites face is that investors may not have adequate understanding about the risks involved or
knowledge of the product. Investor protection seems to be an area of concern for raising equity funds
through Crowdfunding platforms.

2. Business loan funding through peer to peer platforms: Traditionally, for every business the
primary source to raise loans to scale up or as working capital came from banks. However, banks
often want collaterals and small businesses and ones engaged in the service sector find it extremely
difficult. Also, compared to bigger and established companies, banks often charge a higher rate of
interest for smaller companies as they view such loans risky.
Online P2P sites seek to connect interested lenders with borrowers, thereby eliminating
intermediaries and costs. Borrowers now have an attractive option to raise money to fund their
business needs, mostly without the need for collaterals and at much lower rates compared to banks,
while investors that are sitting on idle cash have the option to get returns that are very lucrative.

Globally platforms like Fundingcircle.com and in India platforms like Faircent.com provide
businesses an alternative source to raise working capital. In a validation of the model Google has
earlier this year tie-up with Lending Club in the US to provide small business loans to its technology
partners. In the UK even big banks have warmed up to the idea as Royal Bank of Scotland entered
into a deal with two peer-to-peer lending platforms, Funding Circle and Assetz Capital, to provide
SMEs with another route of finance. This is in sync with the UK government's overall plans to offer
innovative and wider options in funding.

3. Personal loans financing through peer to peer platforms: Personal loans are one of the most
popular products on a P2P platform and sees active participation. An unsecured loan, personal loan
is used for different purpose like for a wedding, vacation, refurbishing their homes, paying credit
card outstanding among others. Often called an "all-purpose loan", personal loans are a great source
of liquidity. The flip side being personal loans carries a high rate of interest and can cause a
considerable burden to your wallet. P2P platforms have become lucrative primarily because it can
offer considerably lower rates of interest. By connecting borrowers directly with lenders, rates of
interest on a personal loan have been considerably reduced. It also does away with the high cost of
operation that banks have to factor in. Personal loan on a P2P site is also helpful to people who may
not be able to secure a loan from a bank, but has an alternate source in raising funds when a private
lender may be willing to lend.
Sites like Lendingclub.com and Zopa.com and us in India have done brisk business in personal loans.
In fact Lending Club has gone on to become the largest P2P site in the US and is preparing a $5bn
initial public offering.

4. Crowdfunding invoice financing companies like: Crowdfunding invoice financing companies are
a boon for SMEs, who often face liquidity issue and are in need of cash. With invoice financing,
companies can sell their invoice immediately for cash at a small percentage rather than wait for a
month or more for the payment to come. This enables companies to get cash almost immediately and
ensure liquidity is not an issue. The reverse also happens under Supply Chain Finance where a
company's suppliers can be paid within a short span of time by funders on the crowd platform. The
company in turn pays the funders the full amount on the original settlement day. This ensures a
company's supplier base stays healthy and they have good access to working capital UK-based
Platformblack.com is a great example of this and has been doing innovative work in this sector.
5. Crowdfunding education loans: Crowdfunding education loans are in vogue in countries like the
US where the cost of education is considerably very high and the country faces about a trillion dollar
in student loan debt. On the backdrop of a slow economy, student loans today have some of the
highest delinquency rates. Social Finance (www. sofi.com) or SoFi is an example of a P2P site that
rallies a school's alumni to be accredited investors and then refinance loans to current students and
recent graduates. Such sites offer lower fixed rate of interest and claims to provide good borrower
protections. Other sites like GoFundMe and Indiegogo are not exactly an education loan P2P site, but
give the option for a student to raise money in the form of donations to fund their study. The trend
has not caught up in India, but we do have social ventures like Milaap and Rangde that aims to
crowd fund education of underprivileged children.
Private and social cost-benefit
Social cost. Social cost in economics may be distinguished from "private cost". Economic theorists
model individual decision-making as measurement of costs and benefits. Social cost is also
considered to be the private cost plus externalities.

What is meant by private cost?


The marginal private cost is the cost to the firm of producing a given good or service. There may also
be external costs from production and these are added to the private cost to give the total social cost.

What are the social benefits?


Social benefit is the total benefit to society from producing or consuming a good / service. Social
benefit includes all the private benefits plus any external benefits of production / consumption. If a
good has significant external benefits, then the social benefit will be greater than the private benefit.

What is the marginal social benefit?


Marginal Social Benefit (MSB) The marginal social benefit, is the total benefit to society, from one
extra unit of a good.

3 Types of Costs and their Benefits in Economics


Types of costs and their benefits in economics are as follows: 1. Private Costs and Benefits 2. External
Costs and Benefits 3. Social Costs and Benefits.
1. Private Costs and Benefits:
Private costs for a producer of a good, service, or activity include the costs the firm pays to purchase
capital equipment, hire labor, and buy materials or other inputs. While this is straightforward from
the business side, it also is important to look at this issue from the consumers perspective. Field, in
his 1997 text, Environmental Economics provides an example of the private costs a consumer faces
when driving a car:1
The private costs of this (driving a car) include the fuel and oil, maintenance, depreciation, and even the drive
time experienced by the operator of the car.
Private costs are paid by the firm or consumer and must be included in production and consumption
decisions. In a competitive market, considering only the private costs will lead to a socially efficient
rate of output only if there are no external costs.
The rainforests, in the Amazon region of Brazil, are being cleared at a relatively rapid rate. The firms
that are engaged in logging, in the forests, are only taking into account private costs and benefits.
Private costs (as noted in the previous unit) are the costs borne by those who are directly involved in
the decision to consume or produce a product.
In the case of a logging company, private costs will include, for example, the cost of transporting the
wood and the cost of labour. Private benefits are the benefits received by those directly involved in
the consumption and production of a product. The private benefit, logging company receives from
selling the wood, is the revenue it earns. The company will continue cutting down trees, as long as
the revenue received by it exceeds it costs.
2. External Costs and Benefits:
External costs, on the other hand, are not reflected on firms income statements or in consumers
decisions. However, external costs remain costs to society, regardless of who pays for them. Consider
a firm that attempts to save money by not installing water pollution control equipment. Because of
the firms actions, cities located down river will have to pay to clean the water before it is fit for
drinking, the public may find that recreational use of the river is restricted, and the fishing industry
may be harmed. When external costs like these exist, they must be added to private costs to
determine social costs and to ensure that a socially efficient rate of output is generated.
When firms produce products and households consume them, they often affect other people. For
example, someone smoking in a factory may harm the health of other workers and a clothing firm,
that dumps waste into a river, may damage the fishing stocks of a fish farmer and harm the
environment.
The effects on third parties, due to the consumption and production activities of others, are known as
external costs and external benefits. External costs caused by the logging companies may include
damage to wildlife habitats, loss of plant species that could be used to develop medicines, global
warming and interference with the lifestyle of local tribes.
External benefits may include reduced transport costs for tourist firms in the area due to construction
of roads by logging companies. While making its decisions on the number of trees to be cut down, a
logging company will not take these external costs and benefits into account.
3. Social Costs and Benefits:
Social costs include both the private costs and any other external costs to society arising from the
production or consumption of a good or service. Social costs will differ from private costs, for
example, if a producer can avoid the cost of air pollution control equipment allowing the firms
production to imposes costs (health or environmental degradation) on other parties that are
adversely affected by the air pollution. Remember too, it is not just producers that may impose
external costs on society. Lets also view how consumers actions also may have external costs using
Fields previous example on driving:
The social costs include all these private costs (fuel, oil, maintenance, insurance, depreciation, and operators
driving time) and also the cost experienced by people other than the operator who are exposed to the congestion
and air pollution resulting from the use of the car.

Social costs are the total costs of an economic activity to society. The social cost of cutting down trees
in the Amazon, will consist of both external and private costs. When social costs exceed private costs,
there are external costs involved.
Social benefits are the total benefits to the society, arising from an economic activity. They include
both private and external benefits. Again, where social benefits are greater than private benefits,
external benefits exist.
The level of output which will cause maximum benefit to the society (socially optimum output) will
occur when the social benefit of the last unit produced is equal to the social cost of that unit. If the
social cost exceeds the social benefit, it implies that too many resources are being devoted to the
production of the product.
Society would benefit from reducing its output. In contrast, if the benefit society would gain from
producing more of the product is greater than the cost to society of producing more output and then
more resources should be devoted to its production.
A case, where the social cost (in most countries) exceeds the social benefit, is the use of road space by
private cars. When people are thinking of making a trip in their car, they take into account the private
costs and benefits, that is the cost and benefits to themselves. If the benefits received by them by
undertaking the journey exceed the costs for example the cost of petrol and wear and tear on the
vehicles, they will make the journey.
What they do not consider is the external costs caused by them, including air pollution, noise
pollution, congestion and accidents. A number of governments, including Singapore and the UK,
have introduced road pricing schemes.
These seek to charge the full costs of their journeys. Different amounts are charged according to when
and where people drive. Someone driving along a deserted country road is likely to cause lower
external costs than someone driving into a city center at peak time.

Public-Private Partnership
A publicprivate partnership (PPP, 3P or P3) is a government service or private business venture
that is funded and operated through a partnership of government and one or more private sector
companies.

What is a p3 project?
A P3 project is a contractual agreement between a public entity and private entity that: Transfers the
responsibility of a facility's engineering, construction, operation and/or maintenance to the private
sector for a defined period of time.

What is PPP model in India?


Public-private partnership (PPP) is a funding model for a public infrastructure project such as a new
telecommunications system, airport or power plant. The public partner is represented by the
government at a local, state and/or national level.
Main Characteristics of PPPs
Risk-sharing between public and private sectors.
Long-term relationship between parties.
Public service and ultimate regulatory responsibility remain in public sector.
Defining Public Private Partnerships
1.1 Public Private Partnership means an arrangement between a government / statutory entity /
government owned entity on one side and a private sector entity on the other, for the provision of
public assets and/or public services, through investments being made and/or management being
undertaken by the private sector entity, for a specified period of time, where there is well defined
allocation of risk between the private sector and the public entity and the private entity receives
performance linked payments that conform (or are benchmarked) to specified and pre-determined
performance standards, measurable by the public entity or its representative.
1.2 Essential conditions in the definition are as under: i.Arrangement with private sector entity: The
asset and/or service under the contractual arrangement will be provided by the Private Sector entity to
the users. An entity that has a majority non-governmental ownership, i.e., 51 percent or more, is
construed as a Private Sector entity1. ii.Public asset or service for public benefit: The facilities/ services
being provided are traditionally provided by the Government, as a sovereign function, to the people. To
better reflect this intent, two key concepts are elaborated below:
(a)Public Services are those services that the State is obligated to provide to its citizens or where the
State has traditionally provided the services to its citizens.
(b)Public Asset is that asset the use of which is inextricably linked to the delivery of a Public Service, or,
those assets that utilize or integrate sovereign assets to deliver Public Services. Ownership by
Government need not necessarily imply that it is a PPP.
iii. Investments being made by and/or management undertaken by the private sector entity:
The arrangement could provide for financial investment and/or non-financial investment by the
private sector; the intent of the arrangement is to harness the private sector efficiency in the delivery of
quality services to the users.
iv. Operations or management for a specified period:
The arrangement cannot be in perpetuity. After a pre-determined time period, the arrangement
with the private sector entity comes to a closure.
v. Risk sharing with the private sector: Mere outsourcing contracts are not PPPs.
vi. Performance linked payments: The central focus is on performance and not merely provision of
facility or service.
vii. Conformance to performance standards:
The focus is on a strong element of service delivery aspect and compliance to pre-determined and
measurable standards to be specified by the Sponsoring Authority.
1.3 The above definition puts forth only the essential conditions for an arrangement to be designated as
a Public Private Partnerships (PPP). In addition to these, some of the desirable conditions or good
practices for a PPP include the following:
a. Allocation of risks in an optimal manner to the party best suited to manage the risks;
b. Private sector entity receives cash flows for their investments in and/or management of the PPP
either through a performance linked fee payment structure from the government entity and/or through
user charges from the consumers of the service provided;
c. Generally a long term arrangement between the parties but can be shorter term dependent for
instance on the sector or focus of PPP;
d. Incentive and penalty based structures in the arrangement so as to ensure that the private sector is
benchmarked against service delivery;
e. Outcomes of the PPP are normally pre-defined as output parameters rather than technical
specifications for assets to be built, though minimum technical specifications might be identified. Such a
structure is expected to leave room for innovation and technology transfer in project execution /
implementation by the private sector entity.

1.4 The models where ownership of the underlying asset remains with the public entity during the
contract period and project is transferred back to the public entity after the termination contract are the
preferred forms of Public Private Partnership models. The final decision on the form of PPP is a
determinant of the Value for Money analysis.

1.5 Some of the commonly adopted forms of PPPs include management contracts, build-operate-
transfer (BOT) and its variants, build-lease-transfer (BLT), design-build-operate-transfer (DBFOT),
operate-maintain-transfer (OMT), etc.

1.6 Build-own-operate (BOO) model is normally not the supported form of Public Private Partnership
in view of the finite resources of the Government and complexities in imposing penalties in the event of
non-performance and estimation of value of underlying assets in the event of early termination.
Government of India does not recognise service contracts, Engineering-Procurement-Construction
(EPC) contracts and divestiture of assets as forms of PPP.

1.7 Government commits to the spirit of partnership amongst all the stakeholders public, private, end
users and community. While the current initiatives on having a strong public community private
partnerships would continue, with the growing capacity and maturity of the stakeholders concerned
under a PPP arrangement, Government would in due course selectively consider newer models of
partnerships which would be simpler, flexible and engage increased participation amongst the
contracting parties.
Box1: PPP Models supported by the Government

User-Fee Based BOT models - Medium to large scale PPPs have been awarded mainly in the energy and
transport sub-sectors (roads, ports and airports). Although there are variations in approaches, over the
years the PPP model has been veering towards competitively bid concessions where costs are recovered
mainly through user charges (in some cases partly through VGF from the government).

Annuity Based BOT models In sectors/projects not amenable for sizeable cost recovery through user
charges, owing to socio-political-affordability considerations, such as in rural, urban, health and
education sectors, the government harnesses private sector efficiencies through contracts based on
availability/performance payments. Implementing annuity model will require necessary framework
conditions, such as payment guarantee mechanism by means of making available multi-year budgetary
support, a dedicated fund, letter of credit etc. Government may consider setting-up a separate window
of assistance for encouraging annuity-based PPP projects. A variant of this approach could be to make a
larger upfront payment (say 40% of project cost) during the construction period.

Performance Based Management/ Maintenance contracts In an environment of constrained economic


resources, PPP that improves efficiency will be all the more relevant. PPP models such as performance
based management/maintenance contracts are encouraged. Sectors amenable for such models include
water supply, sanitation, solid waste management, road maintenance etc.
Modified Design-Build (Turnkey) Contracts: In traditional Design-Build (DB) contract, private
contractor is engaged for a fixed-fee payment on completion. The primary benefits of DB contracts
include time and cost savings, efficient risk-sharing and improved quality. Government may consider a
Turnkey DB approach with the payments linked to achievement of tangible intermediate construction
milestones (instead of lump-sum payment on completion) and short period maintenance / repair
responsibilities. Penalties/incentives for delays/early completion and performance guarantee
(warranty) from private partner may also be incorporated. Subsequently, as the market sentiment turns
around these projects could be offered to private sector through operation-maintenance-tolling
concessions.

1.8 Unsolicited Bid/ Swiss Challenge Proposals

Unsolicited bids/Swiss Challenge proposals are not preferred by the Government. The discomfort with
the use of unsolicited proposals in the public sector is on grounds of lack of transparency, and lack of
fair and equal treatment of potential bidders. There are elements of informational asymmetry and
bidding asymmetry between an Original Proponent (OP) and its competitors. The bidding asymmetry is
due to time and price asymmetries. Since only the OP essentially gets an opportunity to make the BAFO
(Best and Final Offer) after one or more rounds of negotiation an opportunity that is denied to its
competitors who are not authorized to submit an equal number of negotiated responses. In exceptional
circumstances, in sectors not traditionally associated with PPP structures or where procurement of
proprietary technology is involved, variants of the approach could be considered for development, with
prior approval of the competent authority, provided the VfM analysis establishes such a decision.
Corporate Governance in Banking Sector
1. Introduction
Corporate governance is the acceptance by management of the inalienable rights of shareholders as
the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is
about commitment to values, about ethical business conduct and about making a distinction between
personal and corporate funds in the management of a company.
Corporate governance deals with laws, procedures, practices and implicit rules that determine a
companys ability to take managerial decisions through its claimantsin particular, its shareholders,
creditors, customers, the State and employees. Good corporate governance involves a commitment of
a company to run its businesses in a legal, ethical and transparent manner - a dedication that must
come from the very top and permeate throughout the organization. That being so, much of what
constitutes good corporate governance has to be voluntary. Law and regulations can, at best, define
the basic framework - boundary conditions that cannot be crossed. Although corporate governance
still remains an ambiguous and misunderstood phrase, particularly in India. There is no unique
structure of corporate governance in the developed world; nor is one particular type
unambiguously better than others. Thus, one cannot design a code of corporate governance for
Indian companies by mechanically importing one form or another as some of the Indian corporate
houses thinks to do and Indian corporates can no longer afford to ignore better corporate practices.
As India gets integrated in the world market, Indian as well as international investors will demand
greater disclosure, more transparent explanation for major decisions and better shareholder value.
Most of the Indian Corporates misunderstood the concept of corporate governance as just the
compliance of the company law prevailing in the country. But in actual, its not just the compliance of
company law that corporate governance requires but its a self-regulatory concept rather than
compliance of few laws to avoid penalties. The quantity, quality and frequency of financial and
managerial disclosure, the extent to which the board of directors exercise their fiduciary
responsibilities towards shareholders, the quality of information that management share with their
boards, and the commitment to run transparent companies that maximize long term shareholder
value cannot be legislated at any level of detail. Instead, these evolve due to the catalytic role played
by the more progressive elements within the corporate sector and, thus, enhance corporate
transparency and responsibility. The basic fundamentals for which Corporate Governance has started
are as listed in this slide:
Transparency: A company is required to transact their business in a manner which is highly
transparent and their books of accounts should reflect the same.
Accountability: Corporate Governance ensures the accountability of Board of Directors or senior
management to the various stake holders within and outside the company.
Control: To protect the interest of the shareholders the Apex monitoring body i.e. SEBI exercise
control over the management of company through various compliances.
Trusteeship: Board of directors must act as the trustees of the stakeholders and Good Corporate
Governance ensures the same.
Ethics: Good ethical practices are the mainstay of any successful corporate governance and ensures
fairness in all its activities.
Credibility:
Trust:
Good Governance Protects:
Shareholders Employees Customers Public Supervisors
Corporate Governance Defined
Corporate governance relates to the internal means by which corporations are operated and
controlled. OECD
Corporate governance is the system by which companies are directed and controlled. Cadbury
Report, 1992
Corporate Governance - Sources of Influence
Governments, through laws
Securities regulators/stock exchanges
Industry associations
Auditors
Market participants
Supervisors

2. Historical Background
It is believe that the World wide privatization wave, Mergers and takeovers, deregulation and capital
market integration, Scandals and failures at major corporations are some of the strong reasons that
imitated debate over Corporate Governance all over the world. In 1991 the Government of United
Kingdom appointed the Cadbury committee with a broad mandate to address the financial aspects
of corporate governance. The committee was chaired by Sir Adrain Cadbury, CEO Cadbury
Confectionery. In December 1992 the committee issued its report, the cornerstone of which was the
code of Best practice, which presents the committees recommendations on the structure and
responsibilities of corporate boards of Directors.
The years since liberalization have witnessed wide-ranging changes in both laws and regulations
driving corporate governance as well as general consciousness about it. Perhaps the single most
important development in the field of corporate governance and investor protection in India has been
the establishment of the SEBI in 1992 and its gradual empowerment since then. Established primarily
to regulate and monitor stock trading, it has played a crucial role in establishing the basic minimum
ground rules of corporate conduct in the country. Concerns about corporate governance in India
were, however, largely triggered by a spate of crises in the early 90s the Harshad Mehta stock
market scam of 1992 followed by incidents of companies allotting preferential shares to their
promoters at deeply discounted prices as well as those of companies simply disappearing with
investors money. 25 These concerns about corporate governance stemming from the corporate
scandals as well as opening up to the forces of competition and globalization gave rise to several
investigations into the ways to fix the corporate governance situation in India. One of the first among
such endeavors was the CII Code for Desirable Corporate Governance developed by a committee
chaired by Rahul Bajaj. The committee was formed in 1996 and submitted its code in April 1998. Later
SEBI constituted two committees to look into the issue of corporate governance the first chaired by
Kumar Mangalam Birla that submitted its report in early 2000 and the second by Narayana Murthy
three years later.
The SEBI committee recommendations have had the maximum impact on changing the corporate
governance situation in India. The Advisory Group on Corporate Governance of RBIs Standing
Committee on International Financial Standards and Codes also submitted its own
recommendations in 2001. In December 2009, the Ministry of Corporate Affairs (MCA)
published a new set of Corporate Governance Voluntary Guidelines 2009, designed to
encourage companies to adopt better practices in the running of boards and board committees,
the appointment and rotation of external auditors, and creating a whistle blowing mechanism.

3. Corporate Governance for Banks


Nowhere is proper corporate governance more crucial than for banks and financial institutions.
Given the pivotal role that banks play in the financial and economic system of a developing country,
bank failure owing to unethical or incompetent management action poses a threat not just to the
shareholders but to the depositing public and the economy at large. Understanding this issue, the
World Bank was one of the earliest economic organizations to study the issue of corporate
governance and suggest certain guidelines. The World Bank report on corporate governance
recognizes the complexity of the concept and focuses on the principles such as transparency,
accountability, fairness and responsibility that are universal in their applications. Corporate
governance is concerned with holding the balance between economic and social goals and between
individual and communal goals. The governance framework is there to encourage the efficient use of
resources and equally to require accountability for the stewardship of those resources. The aim is to
align as nearly as possible, the interests of individuals, organizations and society. The foundation of
any corporate governance is disclosure. Openness is the basis of public confidence in the corporate
system and funds will flow to those centers of economic activity, which inspire trust. This report
points the way to establishment of trust and the encouragement of enterprise. It marks an important
milestone in the development of corporate governance.
Two main features set banks apart from other business the level of opaqueness in their functioning
and the relatively greater role of government and regulatory agencies in their activities. The
opaqueness in banking creates considerable information asymmetries between the insiders
management and outsiders owners and creditors. The very nature of the business makes it
extremely easy and tempting for management to alter the risk profile of banks as well as siphon off
funds. It is, therefore, much more difficult for the owners to effectively monitor the functioning of
bank management. Existence of explicit or implicit deposit insurance also reduces the interest of
depositors in monitoring bank management activities.

It is partly for these reasons that prudential norms of banking and close monitoring by the central
bank of commercial bank activities are essential for smooth functioning of the banking sector.
Government control or monitoring of banks, on the other hand, brings in its wake, the possibility of
corruption and diversion of credit of political purposes which may, in the long run, jeopardize the
financial health of the bank as well as the economy itself. The reforms have marked a shift from
hands-on government control interference to market forces as the dominant paradigm of corporate
governance in Indian banks. Competition has been encouraged with the issue of licenses to new
private banks and more power and flexibility have been granted to the bank management both in
directing credit as well as in setting prices.

Why is corporate governance important for financial institutions? (RBI)


While good governance is essential for any entity, it has deeper significance for financial institutions.
There are many compelling reasons, some of which are:
a. Financial institutions are central to economic activity banks and a large part of the non-banking
financial system (the shadow banking system) undertake credit intermediation. Failures of financial
institutions would thus impede the economic growth and would cause serious damage to the system.
Economies take longer time to rebound from financial crisis than the business cycle recessions.
b. Financial institutions operate on a higher leverage. As per a study by the Bank for International
Settlement (BIS) for the period 1995-2009, compared to non-financial institutions that had a leverage of
about 3, banks operated at a leverage of 18.3 while non-bank financial firms had a leverage of 12.1.
Higher leverage makes financial intermediaries more vulnerable to shocks. From a systemic
perspective, the inheren procyclicality of the financial system leads to the build up of high leverage
during upturn phase of the economy which amplifies booms and busts. Therefore, while the
procyclicality issues need to be dealt with from a financial stability perspective, it is apparent that these
financial institutions must be well governed for achieving financial stability.
c. Financial institutions, especially banks, deal in peoples savings and trust of customers forms the
cornerstone of their existence. Any breach of trust leading to loss of confidence is bound to lead to
a run, not just on a particular bank but on others too who are perceived to have weakness or even
similar business models. The non bank financial intermediaries who lose the trust of their lenders
would not be able to raise resources at a reasonable cost making it hard for them to operate efficiently
and profitably. All these can lead to snowballing effect impairing the functioning of the entire financial
system due to interconnectedness. Good governance ensures customers and other stakeholders trust
in banks and non-banking financial intermediaries.
d. Among the financial intermediaries, banks occupy a special place due to their centrality in the
transmission of monetary policy and the functioning of the payment and settlement systems. They also
are the beneficiaries of deposit insurance which may weaken their incentive for strong management
monitoring as well as monitoring by other stakeholders including depositors. Good corporate
governance would ensure strong internal controls which would offset the weakened incentive for
monitoring. A robust and stable banking system is an absolute necessity for a well-functioning
economy
4. The specificity of the corporate governance of banks
A banks failure to follow good practices in corporate governance and the lack of effective
governance are among the most important internal factors which may endanger the solvency of a
bank. Corporate governance in banks differs from the standard (typical for other companies), which
is due to several issues:
i) banks are subject to special regulations and supervision by state agencies (monitoring
activities of the bank are therefore mirrored); supervision of banks is also exercised by the
purchasers of securities issued by banks and depositors.
ii) the bankruptcy of a bank raises social costs, which does not happen in the case of other
kinds of entities collapse; this affects the behavior of other banks and regulators;
iii) regulations and measures of safety net substantially change the behavior of owners,
managers and customers of the banks; rules can be counterproductive, leading to
undesirable behavior management (take increased risk) which expose well-being of
stakeholders of the bank (in particular the depositors and owners);
iv) between the bank and its clients there are fiduciary relationships raising additional
relationships and agency costs;
v) problem principal-agent is more complex in banks, among others due to the asymmetry of
information not only between owners and managers, but also between owners, borrowers,
depositors, managers and supervisors;
vi) the number of parties with a stake in an institutions activity complicates the governance of
financial institutions.

In the case of banks therefore, corporate governance needs to be perceived as a need of such conduct
of an institution, which would force the management to protect the best interests of all stakeholders
and ensure responsible behavior and attitudes. Corporate fairness, transparency and accountability
are thus the main objectives of corporate governance.
One must have in mind that there is no one model of corporate governance adaptable to all banks.
Other goals, and therefore supervisory systems, will be in banks: private, co-operative and state; in
the local and global banks; universal banks and investment (etc.); though priorities remain the same.

BASEL II Recommendation: The Basel Committee on Banking Supervision is a committee, of


banking supervisory authorities, established by the Central Bank Governors of the G10 developed
countries in 1975. The Committee in 1988 introduced the Concept of Capital Adequacy framework,
known as Basel Capital Accord, with a minimum capital adequacy of 8 percent[10]. It also issued a
consultative document titled The New Basel Capital Accord in April 2003, to replace the 1988
Accord, which re-enforces the need for capital adequacy requirements under the current conventions.
This accord is commonly known as Basel II and is currently under finalization. Basel II is based on
three pillars:
Pillar 1 Minimum Capital Requirements
Pillar 2 Supervisory Review Process
Pillar 3 Market Discipline
Enhancing Corporate Governance in Banks
The Basel committee had issued, in August 1999, a guidance paper entitled Enhancing Corporate
Governance for Banking Organizations to supervisory authorities worldwide to assist them in
promoting the adoption of sound corporate governance practices by banks in their countries[11]
Importance of Corporate Governance for Banks
From a banking industry perspective, corporate governance involves the manner in which their
boards of directors and senior management govern the business and affairs of individual banks,
affecting how banks set their corporate objectives, run day-to-day operations, consider the interests of
various stakeholders, align corporate activities with the expectation that banks will operate in a safe
and sound manner and in compliance with applicable laws and regulations and protect the interests
of depositors.
Sound Corporate Governance Practices for Banks
According to the paper some of the best corporate governance practices for banks include
establishing strategic objectives and a set of corporate values communicated throughout the
organization, strong risk management functions, special monitoring of risk exposures, setting and
enforcing clear lines of responsibility, etc.
Role of RBI In Promoting Corporate Governance: The growing competitiveness and
interdependence between banks and financial institutions in local and foreign markets have increased
the importance of corporate governance and its application in the banking sector. Corporate
governance in banks can be achieved through a set legal, accounting, financial and economic rules
and regulations. To make sure that the competence and integrity in banking sector is maintained, the
need for uniform standards of the concept of governance in private and public sector is emphasized.
The regulatory framework implemented by the central bank can affect the overall well being of
banking sector.
Best Practices of Banking System In Corporate Governance: Good governance can be built based on
the business practices adopted by the board of directors and management. Many bank failures in the
past have been attributed to inadequate and insufficient management which enabled the banks to
accept low quality assets and assume additional risks that extend beyond the level appropriate for
the banks capacity[12].
Important commandments for ensuring corporate governance in banks are:
Banks shall realize that the times are changing
Banks shall establish an Effective, Capable and Reliable Board of Directors
Banks shall establish a Corporate Code of Ethics for themselves
Banks shall consider establishing an office of the Chairman of the Board
Banks shall have an effective and Operating Audit Committee, Compensation Committee and
Nominating/ Corporate Governance Committee
Banks shall consider Effective Board Compensation
Banks shall disclose the information
Banks shall recognize that duty is to establish Corporate Governance Procedures that will serve to
enhance shareholder value
Recent Scenario
Recent steps taken by Banks in India for Corporate Governance are:
Introduction of non executive members on the Board
Constitution of various Committees like Management Committee, Audit Committee, Investors
Grievances Committee, ALM Committee etc.
Gradual implementation of prudential norms as prescribed by RBI
Introduction of Citizens Charter in Banks
Implementation of Know Your customer (KYC) concept.

5. Role of RBI in Corporate Governance of Banks in India


RBI is the central bank in India. Banks in India are regulated by RBI. The RBI has moved to a model
of governance by prudential norms rather from that of direct interference, even allowing debate
about appropriateness of specific regulations among banks. Along with these changes, market
institutions have been strengthened by government with attempts to infuse greater transparency and
liquidity in markets for government securities and other asset markets. This market orientation of
governance disciplining in banking has been accompanied by a stronger disclosure norms and stress
on periodic RBI surveillance. From 1994, the BFS inspects and monitors banks using the CAMELS
approach. Audit committees in banks have been stipulated since 1995. Greater independence of
public sector banks has also been a key feature of the reforms. Nominee directors from government
as well as RBIs are being gradually phased off with a stress on Boards being more often elected than
appointed from above.
There is increasing emphasis on greater professional representation on bank boards with the
expectation that the boards will have the authority and competence to properly manage the banks
within the broad prudential norms set by RBI. Rules like non-lending to companies who have one or
more of a banks directors on their boards are being softened or removed altogether, thus allowing
for related party transactions for banks. The need for professional advice in the election of
executive directors is increasingly realized. As for old private banks, concentrated ownership remains
a widespread characteristic, limiting the possibilities of professional excellence and opening the
possibility of misdirecting credit. Corporate governance in co-operative banks and NBFCs perhaps
need the greatest attention from regulators. Rural co-operative banks are frequently run by politically
powerful families as their personal entity with little professional involvement and considerable
channeling of credit to family businesses. It is generally believed that the new private banks have
better and more professional corporate governance systems in place.

Banking Regulation Act, 1949 and Corporate Governance


In India banks are subject to the Banking Regulation Act, 1949.Therefore it is very important to refer
it for corporate governance in Banks. For the proper transparency and better composition of board of
the banking institutes/companies the Act needs some amendments and the principle of corporate
governance should be incorporated within the Act to make it mandatory for the banks to follow it,
instead of giving the option of voluntary compliance.

6. International Standards of Corporate governance for banks and financial institutions OECD
The liberalization and deregulation of global financial markets led to efforts to devise international
standards of financial regulation to govern the activities of international banks and financial
institutions. An important part of this emerging international regulatory framework has been the
development of international corporate-governance standards. The OECD has been at the forefront,
establishing international norms of corporate governance that apply to both multinational firms and
banking institutions. In 1999, the OECD issued a set of corporate governance standards and
guidelines to assist governments in their efforts to evaluate and improve the legal, institutional, and
regulatory framework for corporate governance in their countries. The OECD guidelines also provide
standards and suggestions for stock exchanges, investors, corporations, and other parties that have a
role in the process of developing good corporate governance. Such corporate-governance standards
and structures are especially important for banking institutions that operate on a global basis. To this
extent, the OECD principles may serve as a model for the governance structure of multinational
financial institutions.
In its most recent corporate governance report, the OECD emphasized the important role that
banking and financial supervision plays in developing corporate-governance standards for financial
institutions. Consequently, banking supervisors have a strong interest in ensuring effective corporate
governance at every banking organization. Supervisory experience underscores the necessity of
having appropriate levels of accountability and managerial competence within each bank.
Essentially, the effective supervision of the international banking system requires sound governance
structures within each bank, especially with respect to multi-functional banks that operate on a
transnational basis. A sound governance system can contribute to a collaborative working
relationship between bank supervisors and bank management.

Basel Committee
The Basel Committee on Banking Supervision (Basel Committee) has also addressed the issue of
corporate governance of banks and multinational financial conglomerates, and has issued several
reports addressing specific topics on corporate governance and banking activities. The Basel
Committee adopted the Capital Accord in 1988 as a legally non-binding international agreement
among the worlds leading central banks and bank regulators to uphold minimum levels of capital
adequacy for internationally-active banks. The New Basel Capital Accord (Basel II) contains the first
detailed framework of rules and standards that supervisors can apply to the practices of senior
management and the board for banking groups. Bank supervisors will now have the discretion to
approve a variety of corporate-governance and risk-management activities for internal processes and
decision-making, as well as substantive requirements for estimating capital adequacy and a
disclosure framework for investors. For example, under Pillar One, the board and senior
management have responsibility for overseeing and approving the capital rating and estimation
processes. Senior management is expected to have a thorough understanding of the design and
operation of the banks capital rating system and its evaluation of credit, market, and operational
risks. Members of senior management will be expected to oversee any testing processes that evaluate
the banks compliance with capital adequacy requirements and its overall control environment.
Senior management and executive members of the board should be in a position to justify any
material differences between established procedures set by regulation and actual practice. Moreover,
the reporting process to senior management should provide a detailed account of the banks internal
ratings-based approach for determining capital adequacy.

5.2 CODE FOR INDEPENDENT DIRECTORS


The Code is a guide to professional conduct for independent directors. Adherence to These standards
by independent directors and fulfillment of their responsibilities in a Professional and faithful manner
will promote confidence of the investment community, particularly minority shareholders, regulators
and companies in the institution of independent directors.

I. Guidelines of professional conduct:


An independent director shall:
(1) Uphold ethical standards of integrity and probity;
(2) act objectively and constructively while exercising his duties;
(3) exercise his responsibilities in a bona fide manner in the interest of the company;
(4) Devote sufficient time and attention to his professional obligations for informed and balanced
decision making;
(5) Not allow any extraneous considerations that will vitiate his exercise of objective independent
judgment in the paramount interest of the company as a whole, while concurring in or dissenting from
the collective judgment of the Board in its decision making;
(6) Not abuse his position to the detriment of the company or its shareholders or for
The purpose of gaining direct or indirect personal advantage or advantage for any associated person;
(7) Refrain from any action that would lead to loss of his independence;
(8) Where circumstances arise which make an independent director lose his Independence, the
independent director must immediately inform the Board accordingly;
(9) Assist the company in implementing the best corporate governance practices.

II. Role and functions:


The independent directors shall:
(1) Help in bringing an independent judgment to bear on the Boards deliberations Especially on issues
of strategy, performance, risk management, resources, key appointments and standards of conduct;
(2) bring an objective view in the evaluation of the performance of board and management;
(3) scrutinize the performance of management in meeting agreed goals and objectives and monitor the
reporting of performance;
(4) satisfy themselves on the integrity of financial information and that financial control and the
systems of risk management are robust and defensible;
(5) safeguard the interests of all stakeholders, particularly the minority shareholders;
(6) Balance the conflicting interest of the stakeholders;
(7) Determine appropriate levels of remuneration of executive directors, key managerial personnel and
senior management and have a prime role in appointing and where necessary recommend removal of
executive directors, key managerial personnel and senior management;
(8) Moderate and arbitrate in the interest of the company as a whole, in situations of conflict between
management and shareholders interest.

III. Duties:
The independent directors shall
(1) Undertake appropriate induction and regularly update and refresh their skills,
Knowledge and familiarity with the company;
(2) Seek appropriate clarification or amplification of information and, where necessary, take and follow
appropriate professional advice and opinion of outside experts at the expense of the company;
(3) Strive to attend all meetings of the Board of Directors and of the Board committees of which he is a
member;
(4) Participate constructively and actively in the committees of the Board in which they are
chairpersons or members;
(5) strive to attend the general meetings of the company;
(6) Where they have concerns about the running of the company or a proposed action, ensure that these
are addressed by the Board and, to the extent that they are not resolved, insist that their concerns are
recorded in the minutes of the
Board meeting;
(7) keep them well informed about the company and the external environment in which it operates;
(8) Not to unfairly obstruct the functioning of an otherwise proper Board or Committee of the Board;
(9) Pay sufficient attention and ensure that adequate deliberations are held before approving related
party transactions and assure themselves that the same are in the interest of the company;
(10) Ascertain and ensure that the company has an adequate and functional vigil mechanism and to
ensure that the interests of a person who uses such mechanism are not prejudicially affected on account
of such use;
(11) Report concerns about unethical behavior, actual or suspected fraud or violation of the companys
code of conduct or ethics policy;
(12) Acting within his authority, assist in protecting the legitimate interests of the
Company, shareholders and its employees;
(13) Not disclose confidential information, including commercial secrets, technologies, advertising and
sales promotion plans, unpublished price sensitive information, unless such disclosure is expressly
approved by the Board or required by law.

IV. Manner of appointment:


(1) Appointment process of independent directors shall be independent of the company management;
while selecting independent directors the Board shall ensure that there is appropriate balance of skills,
experience and knowledge in the Board so as to enable the Board to discharge its functions and duties
effectively.
(2) The appointment of independent director(s) of the company shall be approved at the meeting of the
shareholders.
(3) The explanatory statement attached to the notice of the meeting for approving the appointment of
independent director shall include a statement that in the opinion of the Board, the independent
director proposed to be appointed fulfils the conditions specified in the Act and the rules made there
under and that the proposed director is independent of the management.
(4) The appointment of independent directors shall be formalized through a letter of appointment,
which shall set out:
(a) The term of appointment;
(b) The expectation of the Board from the appointed director; the Board-level committee(s) in which
the director is expected to serve and its tasks;
(c) The fiduciary duties that come with such an appointment along with accompanying liabilities;
(d) Provision for Directors and Officers (D and O) insurance, if any;
(e) The Code of Business Ethics that the company expects its directors and employees to follow;
(f) The list of actions that a director should not do while functioning as such in the company; and
(g) The remuneration, mentioning periodic fees, reimbursement of expenses for participation in the
Boards and other meetings and profit related commission, if any.
(5) The terms and conditions of appointment of independent directors shall be open for inspection at
the registered office of the company by any member during normal business hours.
(6) The terms and conditions of appointment of independent directors shall also be posted on the
companys website.

V. Re-appointment:
The re-appointment of independent director shall be on the basis of report of performance evaluation.
VI. Resignation or removal:
(1) The resignation or removal of an independent director shall be in the same manner as is provided
in sections 168 and 169 of the Act.
(2) An independent director who resigns or is removed from the Board of the company shall be
replaced by a new independent director within a period of not more than one hundred and eighty days
from the date of such resignation or removal, as the case may be.
(3) Where the company fulfils the requirement of independent directors in its Board even without
filling the vacancy created by such resignation or removal, as the case may be, the requirement of
replacement by a new independent director shall not apply.

VII. Separate meetings:


(1) The independent directors of the company shall hold at least one meeting in a year, without the
attendance of non-independent directors and members of management;
(2) All the independent directors of the company shall strive to be present at such meeting;
(3) The meeting shall:
(a) Review the performance of non-independent directors and the Board as a whole;
(b) Review the performance of the Chairperson of the company, taking into account the views of
executive directors and non-executive directors;
(c) Assess the quality, quantity and timeliness of flow of information between the company
management and the Board that is necessary for the Board to effectively and reasonably perform their
duties.

VIII. Evaluation mechanism:


(1) The performance evaluation of independent directors shall be done by the entire Board of Directors,
excluding the director being evaluated.
(2) On the basis of the report of performance evaluation, it shall be determined whether to extend or
continue the term of appointment of the independent director.

5.3 Setting Fit and proper criteria for Directors of banks:


Taking cue from the recommendations of the Ganguly Committee Report, the concept of fit and
proper criteria for directors of banks was formally enunciated in November 2003. It included the
process of collecting information, exercising due diligence and constitution of a Nomination
Committee of the Board to scrutinize the declarations made by the bank directors. Accordingly, all the
banks in the private sector have carried out, through their nomination committees, the exercise of due
diligence in respect of the directors on their Boards. In some cases, where the track record of the
directors was not considered satisfactory, the directors vacated their positions. In regard to some
others, there is an on-going process to ensure fit and proper status of the directors.
In this regard, it may be useful to distinguish the issue of the composition of the Board from the fit and
proper status of individual non-executive directors and chief executives. The first relates to collective
expertise on the Board available to meet the competitive challenges before the bank to ensure
commercial activity while maintaining soundness. The existing legal provisions in regard to banks
stipulate specific areas of background that a director should be drawn from. The Directors should be
from professional areas such as accountancy, banking, economics, finance, agriculture, etc. But it does
not specify the extent or degree of professionalism or expertise required in regard to that area. Hence,
it is left to the good faith of the shareholders to elect directors from the various specified areas with
qualifications and experience that is appropriate to the bank. In regard to PSBs, such good faith is
expected when directors are nominated by the Government.
However, when the issue of fit and proper status of non-executive directors comes up, the norms only
seek to ensure that the candidate should not have come to the adverse notice of the law and regulations
or any professional body so that there is no objection from RBI. In the case of non-executive directors
not satisfying the fit and proper criteria, there is a prescribed due process to be followed by the RBI
to disqualify such directors, which includes opportunities to be heard. The position in regard to the
CEOs of the private sector banks is on a different footing where RBI exercises its judgment on the
suitability of the candidates proposed; in as much as the approval of the RBI is required for the
appointment. These provisions are broadly consistent with global best practices though there is scope
for enhancing effective implementation.
Keeping in view the importance of Corporate Governance even in PSBs, the Government of India at
the behest of RBI carried out amendments to the Banking Companies (Acquisition and Transfer of
Undertakings) Act 1970/1980 and the State Bank of India (Subsidiary Banks) Act 1959 to include new
sections providing for applicability of Fit and Proper criteria for elected directors on the Boards of
PSBs. Accordingly guidelines were issued in Nov 2007 to prescribe Fit and Proper criteria to be
fulfilled by the persons being elected as directors on the Boards of Nationalised banks under the
provisions of Section 9(3)(i) of Banking Companies (Acquisition and Transfer of Undertakings) Act
1970/80.
Continuing surveillance of Fit and Proper criteria is maintained on continuous basis. Under these
provisions, Nationalised banks are required to form a committee consisting of minimum three directors
(all independent and non-executive directors) from amongst the Board of Directors to examine and
certify that none of these directors disqualify for being Fit and proper. Moreover, in some banks
directors are also exposed to high level of training to fine tune their expert domains to enable them to
more effectively contribute to the governance of banks. The Corporate Governance systems have
evolved over a period of time to cover all types of banks to develop a sound and strong financial
system. After the Corporate Governance System is established in banks, there could be conspicuous
change in the quality of governance.

6. SEBI Guidelines on corporate Governance in Banks:


The Securities and Exchange Board of India (SEBI) had constituted a Committee on Corporate
Governance and circulated the recommendations to all stock exchanges for implementation by listed
entities as part of the listing agreement vide SEBIs circular SMDRP/Policy/CIR-10/2000 dated
February 21, 2000. However it had at that time exempted body corporates such as public and private
sector banks, financial institutions, insurance companies and those incorporated under separate
statute. SEBI has now suggested to RBI to consider issuing appropriate guidelines to banks and
financial institutions so as to ensure that all listed companies would have uniform standards of
corporate governance. As requested by SEBI, it has now been proposed that the SEBI Committees
guidelines may be taken up for adoption by those commercial banks listed in stock exchanges so that
they can harmonize their existing corporate governance requirements with the requirements of SEBI,
wherever considered appropriate.

On a review by RBI of the existing corporate governance requirements in banks, it is observed that
many of the recommendations in regard to the following stand implemented in banks and may not
require further action towards implementation in respect of these guidelines for the present.
(a) Optimum combination of executive and non-executive directors in the Board
(b) Pecuniary relationship or transactions of the non-executive directors vis--vis the bank
(c) Independent Audit Committees, their constitution, chairmanship, power, roles, responsibilities,
conduct of business, etc
(d) Remuneration of Directors (in case of private sector banks)
(e) Periodicity /number of board meetings
(f) Disclosure by management to the board about the conflict of interest
(g) Information to shareholders regarding appointment/re-appointment of directors, Display of
quarterly results/presentation to analysts on the web- site
h) Maintenance of office by non-executive Chairman.
(i) Reviewing with the management by the Audit Committee of the board the annual Financial
statements before submission to the Board, focusing primarily on:

Any changes in accounting policies and practices,


Major accounting entries based on exercise of judgment by management,
Qualifications in draft audit report,
Significant adjustments arising out of audit, compliance with accounting
standards,
Compliance with stock exchange and legal requirements concerning financial statements, and
The going concern assumption.

The Audit Committee of the board may look into the reasons for default in payment to depositors,
debenture holders, shareholders (non-payment of dividends) and creditors, wherever there are any
cases of defaults in payment. SEBI Committees recommendations on other additional functions to be
entrusted to the Audit Committee may be complied with by the listed banks as per listing agreement.
As regards the appointment and removal of external auditors, the practice followed in banks is more
stringent than that recommended by the Committee and hence will continue. Further, fixation of audit
fee and also approval of payment for any other services are already subject to the instructions of RBI.
As regards recommendation for obtaining a certificate from auditors regarding compliance of
conditions of Corporate Governance, it may be stated that the compliance of banks with RBI
instructions is already being verified by the statutory auditors. Therefore, a separate certificate from
the auditors is not considered necessary.

With a view to further improving the Corporate Governance standards in banks, the following
measures are now recommended for implementation.
(a) In the interest of the shareholders, the private sector banks and public sector banks which have
issued shares to the public may form committees on the same lines as listed companies under the
Chairmanship of a non-executive director to look into
redressal of shareholders' complaints.
(b) All listed banks may provide un-audited financial results on half yearly basis to their shareholders
with summary of significant developments.

7. Impact of Corporate Governance norms in banks:


The RBI move to strengthen Corporate Governance led to seminal changes in the bank administration.
The sustained profitability, lower level of non-performing assets, improved return on assets etc are
some of the laud indicators of the sustaining policy of operating sound banking system. Moreover, the
movement of share prices in the market, increased appetite of investors to look at banks for investment
in bank centric equity market further speaks of broad market opinion of banks performance and
reflection of market confidence. The corporate governance framework in banks has been strengthened
through regulation, supervision and by maintaining constant interaction with the management. They
cover identification of responsibilities of the Boards of banks, disclosure and transparency in published
accounts, and shareholder and stakeholder rights and controls. The rating on management (M) which
has been introduced as part of the CAMELS (Capita, Asset Quality, Management, Earnings, Liabilities
and Systems) supervisory process takes into account the working of the board and its committees
including the Audit committee, effectiveness of the management in ensuring regulatory compliance
and adequacy of control exercised by the head/controlling offices. This model has been further
modified to include risk based supervision. The new evolution is intended to manage influx of a range
of financial risks entering the market with their nuances.

Moreover, the audit function is an important element of the corporate governance process and the
independence of this function is crucial to good corporate governance. Audit Committee of the
Boards, constituted at the instance of RBI; performs the role of overseeing concerns about internal
controls and recommendations for their improvement. In order to ensure both professionalism and
independence of these committees, Chartered Accountant directors on the boards of banks are
mandatory members and the Chairman or Chief Executive Officer is not to be part of the Audit
Committee. Foreign banks are not insisted upon to have local audit committee for their Indian
branches. Their branches can have a compliance function that reports to their head office on the
branches compliance with RBI inspection findings and features arising out of internal inspections
and statutory audit. RBI has Nominee directors on the boards of all PSBs and some of the old private
sector banks. Further, the Government also nominates directors on the boards of all PSBs. Of late, RBI
has been withdrawing its nominees from the boards of well-managed old private banks.

In order to improve the effectiveness of the non-official directors and bring in effective corporate
governance at the board level in banks, guidelines have been issued focusing the attention of directors
on certain areas such as (i) the prescribed calendar of reports / returns to be placed before the Board /
Managing Committee of the bank (iv) corrective action required to be taken by the bank on issues of
supervisory concern (v) adherence to the deadlines for complying with various action points
committed under Monitor able Action Plan during discussions in Annual Financial Inspection findings
as well as achievement of targets agreed during Memorandum of Understanding (MOU) discussions
with RBI. Further, the guidelines also require the directors to keep watch on matters which come to the
board of the banks as also what should have come to the board and to inform the Department of
Banking Supervision on matters of supervisory concern.

8. Impact of Corporate Governance Policies in Banks:


Post reform period led to many banks accessing capital market to shore up their capital adequacy ratio,
an essential prescription of Basel-I then and Basel II now. Subscription of banks equity is a function
of public confidence which stems from governance policies. The Red Herring Prospectus lodged by
banks as required by the capital market regulator, the Securities and Exchange Board of India (SEBI)
reflects not only the numerical performance of banks as enunciated in Section-I of this paper but is also
an indicator of present and future governance policies pursued by banks.
The movement of stock prices is a further reflection of demand and supply of bank shares in the stock
market. The entry of new Private Sector Banks and PSBs accessing capital market opened up new
opportunities to the investors. It was heartening to note that in the next few years, the bank shares had
picked up demand and popularity.

The spurt in the capital market index is a manifestation of investor opinion on the performance,
potential and standard of governance of banks. Though there may not be direct correlation between
market movement of bank shares and corporate governance policies, the overall long run market
opinion precipitates on this basis. Such practices form the fundamental strength of the banks and
their ethical commitments. As the risk perception changes, volume of business goes up, new line of
activities spur, competition heightens further, the Corporate governance practices need to be fine
tuned to meet the emerging challenges.

Conclusion
Weak and ineffective corporate governance mechanisms in banks are pointed out as the main factors
contributed to the 2008 financial crisis, because of which even Lehman Brothers was collapsed. In
India Satyam scandal is the best example for eye opening and since then regulatory authorities have
become more serious about Corporate Governance. In India CII, SEBI, RBI and professional institutes
like ICSI and ICAI are the main stakeholders of banking sector in India. These institutes have setup
different committees to study and recommend the most suitable and best techniques for Good
Corporate Governance. ICSI even setup a Corporate Governance Award which given away every
year to one corporate house for implementing and following best practices of Corporate Governance.
The globalization of financial markets necessitates minimum international standards of corporate
governance for financial institutions that can be transmitted into financial systems in a way that will
reduce systemic risk and enhance the integrity of financial markets. The principles of corporate
governance for financial institutions, as set forth by the OECD and the Basel Committee, are also
have been influential in determining the shape and evolution of corporate-governance standards in
many advanced economies and developing countries and India is one of them. But I am of the view
that many more changes are required for the best practice of corporate governance in Banks in India,
especially in Regional Rural banks and Co-operative banks.

Role of e-governance in addressing the issues of corruption and inefficiency in the Govt. sector
Introduction
The e in e-Governance stands for electronic. Thus, e-Governance is basically associated with
carrying out the functions and achieving the results of governance through the utilization of ICT
(Information and Communications Technology).
While Governance relates to safeguarding the legal rights of all citizens, an equally important aspect
is concerned with ensuring equitable access to public services and the benefits of economic growth to
all. It also ensures government to be transparent in its dealings, accountable for its activities and
faster in its responses as part of good governance.
However, this would require the government to change itself its processes, its outlook, laws, rules
and regulations and also its way of interacting with the citizens. It would also require capacity
building within the government and creation of general awareness about e-Governance among the
citizens
ICT
provides efficient storing and retrieval of data, instantaneous transmission of information, processing
information and data faster than the earlier manual systems, speeding up governmental processes,
taking decisions expeditiously and judiciously, increasing transparency and enforcing accountability.
It also helps in increasing the reach of government both geographically and demographically.
In India, the main thrust for e-Governance was provided by the launching of NICNET in 1987 the
national satellite-based computer network. This was followed by the launch of the District
Information System of the National Informatics Centre (DISNIC) programme to computerize all
district offices in the country for which free hardware and software was offered to the State
Governments. NICNET was extended via the State capitals to all district headquarters by 1990. In the
ensuing years, with ongoing computerization, tele-connectivity and internet connectivity established
a large number of e-Governance initiatives, both at the Union and State levels.

Types of Government Interaction in e-governance.


G2G: Government to Government
G2C: Government to Citizen
G2B: Government to Business
G2E: Government to Employee

Some Initiatives in the same field


1. Government to Citizen (G2C) Initiatives:
Computerization of Land Records: In collaboration with NIC. Ensuring that landowners get
computerized copies of ownership, crop and tenancy and updated copies of Records of Rights (RoRs)
on demand.
Bhoomi Project: Online delivery of Land Records. Self-sustainable e-Governance project for the
computerized delivery of 20 million rural land records to 6.7 million farmers through 177
Government-owned kiosks in the State of Karnataka
Gyandoot: It is an Intranet-based Government to Citizen (G2C) service delivery initiative. It was
initiated in the Dhar district of Madhya Pradesh in January 2000 with the twin objective of providing
relevant information to the rural population and acting as an interface between the district
administration and the people.
Lokvani Project in Uttar Pradesh: Lokvani is a public-private partnership project at Sitapur District
in Uttar Pradesh which was initiated in November, 2004. Its objective is to provide a single window,
self-sustainable e-Governance solution with regard to handling of grievances, land record
maintenance and providing a mixture of essential services.
Project FRIENDS in Kerala: FRIENDS (Fast, Reliable, Instant, Efficient Network for the
Disbursement of Services) is a Single Window Facility providing citizens the means to pay taxes and
other financial dues to the State Government.The services are provided through FRIENDS Janasevana
Kendrams located in the district headquarters.
e-Mitra Project in Rajasthan: e-Mitra is an integrated project to facilitate the urban and the rural
masses with maximum possible services related to different state government departments through
Lokmitra-Janmitra Centers/Kiosks.
e-Seva (Andhra Pradesh): This project is designed to provide Government to Citizen and e-
Business toCitizen services. The highlight of the eSeva project is that all the services are delivered
online to consumers /citizens by connecting them to the respective government departments and
providing online information at the point of service delivery.
Admission to Professional Colleges Common Entrance Test (CET):
With the rapid growth in the demand as well as supply of professional education, the process of
admission to these institutions became a major challenge in the early 1990s. Recourse was then taken
to ICT to make the process of admission transparent and objective. One of the pioneering efforts was
made by Karnataka. The State Government decided to conduct a common entrance test based on
which admission to different colleges and disciplines was made.
2. Government to Business (G2B) Initiatives:
e-Procurement Project in Andhra Pradesh and Gujarat:
To reduce the time and cost of doing business for both vendors and government.
MCA 21: By the Ministry of Corporate Affairs. The project aims at providing easy and secure online
access to all registry related services provided by the Union Ministry of Corporate Affairs to
corporates and other stakeholders at any time and in a manner that best suits them.
3.Government to Government (G2G) Initiatives:
Khajane Project in Karnataka: It is a comprehensive online treasury computerization project of the
Government of Karnataka. The project has resulted in the computerization of the entire treasury
related activities of the State Government and the system has the ability to track every activity right
from the approval of the State Budget to the point of rendering accounts to the government.
SmartGov (Andhra Pradesh): SmartGov has been developed to streamline operations, enhance
efficiency through workflow automation and knowledge management for implementation in the
Andhra Pradesh Secretariat.

National E-governance Plan


The National e-Governance Plan (NeGP) has been formulated by the Department of Electronics and
Information Technology (DEITY) and Department of Administrative Reforms and Public Grievances
(DARPG) in 2006.

The NeGP aims at improving delivery of Government services to citizens and businesses with the
following vision: Make all Government services accessible to the common man in his locality,
through common service delivery outlets and ensure efficiency, transparency & reliability of such
services at affordable costs to realise the basic needs of the common man.
Central government initiatives as mission mode projects (MMP)
e-office
The Government of India has recognized the need to modernize the Central Government offices
through the introduction of Information and Communications Technology. e-Office is aimed at
increasing the usage of work flow and rule based file routing, quick search and retrieval of files and
office orders, digital signatures for authentication, forms and reporting components.

Immigration, Visa and Foreigners Registration & Tracking (IVFRT)


India has emerged as a key tourist destination, besides being a major business and service hub.
Immigration Check Post is the first point of contact that generates public and popular perception
about the country, thus necessitating a state of the art system for prompt and user-friendly services.

UID
The unique identification project was conceived as an initiative that would provide identification for
each resident across the country and would be used primarily as the basis for efficient delivery of
welfare services. It would also act as a tool for effective monitoring of various programs and schemes
of the government.

Pensions
The pensions MMP is primarily aimed at making the pension/ retirement related information,
services and grievances handling mechanism accessible online to the needy pensioners, through a
combination of interactive and non-interactive components, and thus, help bridge the gap between
the pensioners and the government.

Banking
The Banking MMP is yet another step towards improving operational efficiency and reducing the
delays and efforts involved in handling and settling transactions. The MMP which is being
implemented by the banking industry aims at streamlining various e-services initiatives undertaken
by individual banks. Implementation is being done by the banks concerned, with the banking
Department providing a broad framework and guidance.

Posts
Modernization of Postal Services has been undertaken by the Department of Posts through
computerization and networking of all post offices using a central server-based system, and setting
up of computerized registration centers (CRCs).

State Mission Mode projects


e-Governance in Municipalities
It is a unique initiative of the Government of India conceptualized under the umbrella of the overall
National e-Governance Plan (NeGP) and the Jawaharlal Nehru National Urban Renewal Mission
(Jnnurm) aimed at improving operational efficiencies within Urban Local Bodies (ULBs).
Crime and Criminal Tracking Network & Systems
Crime and Criminal Tracking Network & Systems (CCTNS) MMP aims at creating a comprehensive
and integrated system for enhancing the efficiency and effective policing at all levels and especially at
the Police Station level through adoption of principles of e-Governance, and creation of a nationwide
networked infrastructure for evolution of IT-enabled state-of-the-art tracking system.

Public Distribution System


Computerization of the PDS is envisaged as an end-to-end project covering key functional areas such
as supply chain management including allocation and utilization reporting, storage and movement of
food grains, grievance redressal and transparency portal, digitization of beneficiary database, Fair
Price Shop automation, etc.

Health
ICT for programme management has been undertaken by the Ministry of Health & Family
Welfare in the Mother and Child Tracking System (MCTS) programme and the Ministry
envisages a more comprehensive use of ICT including for Hospital Information Systems, supply
chain management for drugs and vaccines, providing ICT tools to ASHA and ANM workers,
programme management of National Rural Health Mission (NRHM), etc through this MMP.

e-panchayat
The Panchayati Raj Institutions (PRIs) are saddled with the problems of inadequate physical and
financial resources, technical capabilities and extremely limited computerization. As a result, the
potential of PRIs as the preferred delivery channel for the schemes of State and Centre as well as for
citizen services has not been fully realized. While some computerization efforts for PRIs have been
made by NIC over the years, the e-Governance revolution sweeping the country has not touched the
PRIs yet in significant measure. The Ministry of Panchayati Raj, Government of India has therefore
decided to take up the computerization of PRIs on a mission mode basis.

e-District
e-District is one of the 31 Mission Mode Projects under National e Governance Plan (NeGP) with
the DIT, GoI being the nodal ministry. This project aims at providing support to the basic
administrative unit i.e. District Administration by undertaking backend computerization to
enable electronic delivery of high volume citizen centric government services which would
optimally leverage and utilize the three infrastructure pillars of State Wide Area Networks
(SWAN), State Data Centers (SDC) and Common Service Centers (CSCs) to deliver services to the
citizen at his doorsteps.

National Land Records Modernization Programme (NLRMP)


A Project for Computerization of Land Records (CLR) was launched in 1988-89 with the intention
to remove the inherent flaws in the manual system of maintenance and updation of Land
Records. In 1997-98, the scheme was extended to tehsils to start distribution of Records of Rights
to landowners on demand. The focus of the entire operation has always been to employ state of
the art information technology (IT) to galvanize and transform the existing land records system
of the country.

Integrated Mission Mode Projects

e-procurement
Ministry of Commerce & Industry (Department of Commerce) has been nominated as the Nodal
Ministry for implementation of e-Government Procurement (e-GP) Mission Mode Projects
(MMP). The vision of the e-Procurement MMP is To create a national initiative to implement
procurement reforms, through the use of electronic Government procurement, so as to make
public procurement in all sectors more transparent and efficient.

e-Courts
The e-Court Mission Mode Project (MMP) was conceptualized with a vision to transform the
Indian judiciary by making use of technology. The project had been developed, following the
report submitted by the e-Committee under Supreme Court on national policy & action plan on
implementation of information communication tools in Indian judiciary.

A clear objective to re-engineer processes and enhance judicial productivity both qualitatively and
quantitatively to make the justice delivery system affordable, accessible, cost effective, transparent
and accountable.

e-Biz
The e-Biz Mission Mode Project, being executed by Department of Industrial Policy and
Promotion (DIPP), Ministry of Commerce and Industry, Government of India, was
conceptualized with the vision. Its vision is To transform the business environment in the
country by providing efficient, convenient, transparent and integrated electronic services to
investors, industries and business throughout the business life cycle.

Common Services Centres


The CSCs would provide high quality and cost-effective video, voice and data content and
services, in the areas of e-governance, education, health, telemedicine, entertainment as well as
other private services. A highlight of the CSCs is that it will offer web-enabled e-governance
services in rural areas, including application forms, certificates, and utility payments such as
electricity, telephone and water bills.

Recent Initiatives

Direct Cash transfer


To facilitate disbursements of Government entitlements like NREGA, Social Security pension,
Handicapped Old Age Pension etc. of any Central or State Government bodies, using Aadhaar
and authentication thereof as supported by UIDAI.
Aadhar Enabled Payment system (AEPS) :
AEPS is a bank led model which allows online interoperable financial inclusion transaction
through the Business correspondent of any bank using the Aadhaar authentication. This has
helped in financial inclusion. The four Aadhaar enabled basic types of banking transactions are
as follows:-
Balance Enquiry
Cash Withdrawal
Cash Deposit
Aadhaar to Aadhaar Funds Transfer
Digital India program

This programme has been envisaged by Department of Electronics and Information Technology
(DeitY). The vision of Digital India aims to transform the country into a digitally empowered society
and knowledge economy. The programme will be implemented in phases from the current year till
2018.

The Digital India is transformational in nature and would ensure that Government services are
available to citizens electronically. It would also bring in public accountability through mandated
delivery of governments services electronically, a Unique ID and e-Pramaan based on authentic and
standard based interoperable and integrated government applications and data basis.

The program aims at providing digital infrastructure as a utility to every citizen as well as high-speed
internet as a core utility in all gram panchayats. The overall scope of this program is to prepare India
for a knowledge future, to make technology central to enabling change and to become an
umbrella program covering many departments

MyGov citizen portal


Prime Minister launched an online platform mygov.nic.in to engage citizens in the task of good
governance ( surajya ) as he completed 60 days in office on Saturday. MyGov is a technology-driven
platform that would provide people with the opportunity to contribute towards good governance.

E-Kranti scheme
This is project for linking the internet with remote villages in the country. This scheme will
broaden the reach of internet services to the rural areas in the country. The fundamental features
of this scheme will be making the records handy to the government with ease. It also includes
Expansion of internet and commencement of IT-based jobs in rural areas. It will also boost the
use of mobile phones and computers in rural areas. It will also expand the use of IT in agriculture
and retail trade too.

Digital Cloud for every Indian


Certificates issued by the government education, residential, medical records, birth
certificates, etc. are to be stored in individual digital lockers and a communication protocol
established for government departments to access them without physically having to see the
hard copy. The purpose of government is that copies of certificates issued by the government
itself not to be carried around by people to government offices for various services.

M-governance
M-Governance is not a replacement for e-Governance, rather it complements e- Governance. M-
Governance, is the use of mobile or wireless to improve Governance service and information
anytime, anywhere. Mobile applications also rely on good back office ICT infrastructure and work
processes. It has potential of using mobile phones as input devices in certain areas where last mile
connectivity becomes issues for simple data inputs of critical importance for decision making in
government departments.

M-Governance is not a new concept. The private sector has been greatly leveraging these of mobile
phones for delivery of value added services for the following which however are mostly SMS based:
Banking, Media, Airlines, Telecom, Entertainment, News, Sports, Astrology, and Movie Tickets Etc.

M-governance has increased the productivity of public service personnel, improving the delivery of
government information and services, increasing channels for public interactions and Lower costs
leading to higher participation of people.

Recent thrust to m-governance is being provided through USSD Services Unstructured


Supplementary Services Data (USSD) is a session based service unlike sms which is store and
forward service. It can be used by the user to send command to an application in text format. USSD
acts as a trigger for the application

Government initiatives for m-governance

Mobile Seva
It aims to provide government services to the people through mobile phones and tablets. It has
been developed as the core infrastructure for enabling the availability of public services through
mobile devices.

Mobile Seva enables the integration of the mobile platform with the common e-Governance
infrastructure consisting of State Data Centers (SDCs), State Wide Area Networks (SWANs), State
and National Service Delivery Gateways (SSDGs/NSDG).

It enables a government department to integrate both web and mobile based services seamlessly and
enhances the access to electronic services tremendously leveraging the very high penetration of
mobile phones, especially in rural areas

A Mobile Applications Store (m-App Store) has also been developed by DeitY as part of Mobile
Seva. The Mobile Governance Portal and the m-App Store can be accessed at http://mgov.gov.in/.
The m-Appstore currently hosts over 240 live mobile applications. The live applications can be
downloaded and installed free of cost on a mobile phone by any person.

The project, mobile seva has won the second prize at the prestigious United Nations Public
Services Awards in the category Promoting Whole of Government Approaches in the Information
Age for Asia Pacific.

A few years ago, Kerala launched Dr. SMS, an m-health information system, for providing
information on medical facilities available in the locality of the resident.
Goa followed, with a mobile governance initiative for issuing alerts for receipt of government
applications and complaints and status tracking.
Next came Maharashtra. It adopted a similar traffic management system through mobile alerts.
A laudable initiative launched by the Greater Hyderabad Municipal Corporation in September
tries to use technology in a mobile phone-based Intelligent Garbage Monitoring System enables
sanitary supervisors to report the status of cleaning of garbage bins through their GPS-enabled
mobile phones. Centralised reports as well as those of individual bins can be generated with the
system.

Advantages of e-governance

Following are the advantages of E-Governance


Speed: Technology makes communication speedier. Internet, Phones, Cell Phones have reduced the
time taken in normal communication.

Cost Reduction: Most of the Government expenditure is appropriated towards the cost of stationary.
Paper-based communication needs lots of stationary, printers, computers, etc. which calls for
continuous heavy expenditure. Internet and Phones makes communication cheaper saving valuable
money for the Government.

Transparency: Use of ICT makes governing profess transparent. All the information of the
Government would be made available on the internet. The citizens can see the information whenever
they want to see. But this is only possible when every piece of information of the Government is
uploaded on the internet and is available for the public to peruse. Current governing process leaves
many ways to conceal the information from all the people. ICT helps make the information available
online eliminating all the possibilities of concealing of information.

Accountability: Once the governing process is made transparent the Government is automatically
made accountable. Accountability is answerability of the Government to the people. It is the
answerability for the deeds of the Government. An accountable Government is a responsible
Government.

Convenience: E-Government brings public services to citizens on their schedule and their venue.

Improved Customer Service: E-Government allows to redeploy resources from back-end processing to the
front line of customer service.

Increased access to information: E-Government improves the accessibility of government information to


citizens allowing it become an important resource in the making the decisions that affect daily life and so it
helps in empowerment of citizens

Disadvantages of e-governance
Electronic governments also consist on certain disadvantage. The main disadvantage of an electronic
government is to move the government services into an electronic based system. This system loses
the person to person interaction which is valued by a lot of people.
In addition, the implementation of an e-government service is that, with many technology based
services, it is often easy to make the excuse (e.g. the server has gone down) that problems with the
service provided are because of the technology.
The implementation of an e government does have certain constraints. Literacy of the users and the
ability to use the computer, users who do not know how to read and write would need assistance. An
example would be the senior citizens. In general, senior citizens do not have much computer
education and they would have to approach a customer service officer for assistance. And also in case
of rural people, it gives scope for middle man, who distort the information.
Studies have shown that there is potential for a reduction in the usability of government online due
to factors such as the access to Internet technology and usability of services and the ability to access to
computers
Even though the level of confidence in the security offered by government web sites are high, the
public are still concerned over security, fear of spam from providing email addresses, and
government retention of transaction or interaction history. There has been growing concern about the
privacy of data being collected as part of UID project. The security of cyber space and misuse of data
is still holding back the citizens to full adaptation of Aadhar card.
Challenges in e-governance

There are large numbers of potential barriers in the implementation of e-Governance. Some
hindrance in the path of implementation, like security, unequal access to the computer technology by
the citizen, high initial cost for setting up the e government solutions and resistance to change.
Challenges identified as trust, resistance to change, digital divide, cost and privacy and security
concerns.

Trust
Trust can be defined along two dimensions: as an assessment of a current situation, or as an innate
personality traitor predisposition. The implementation of public administration functions via e-
government requires the presence of two levels of trust. The first is that the user must be confident,
comfortable and trusting of the tool or technology with which they will interact. The second
dimension of trust pertains to trust of the government].

There has to be a balance between ensuring that a system prevents fraudulent transactions and the
burden that extensive checks can take place on people who are honest.

Recently, confidential information on military veterans was compromised when a


computer containing their personal information was lost. This type of incident can erode trust and
user confidence in government systems. Trust, along with financial security, are two critical factors
limiting the adoption of e-government services.

Resistance to change
The innovation diffusion theory states that over time an innovation will diffuse through a population,
and the rate of adoption will vary between those who adopt early, referred to as early adopters and
to those who adopt the innovation much later, referred to as laggards.

The resistant to change phenomenon can explain much of the hesitation that occurs on the part of
constituents in moving from a paper based to a Web-based system for interacting with government.

Citizens, employees and businesses can all have their biases with respect to how transactions should
be processed. However, government entities and public policy administrators cannot ignore the
changes that occur as a result of the implementation of information and communication technology
(ICT

Education about the value of the new systems is one step toward reducing some of the existing
resistance. It can also be particularly useful for a leader or manager, to buy into the new system at an
early stage in the adoption process

Digital Divide
The digital divide refers to the separation that exists between individuals, communities,
and businesses that have access to information technology and those that do not have such access.

Social, economic, infrastructural and ethno-linguistic indicators provide explanations for the presence
of the digital divide.

Economic poverty is closely related to limited information technology resources

An individual living below poverty line does not afford a computer for himself to harness the
benefits of e-government and other online services. As the digital divide narrows, broader adoption
of e-government in the public domain becomes possible. Economic poverty is not the only cause of
digital divide. It can also be caused by the lack of awareness among the people. Even some of the
economic stable people dont know about the scope of e -governance.

Awareness can only help to bring users to that service delivery channel once. It cannot guarantee
sustained use of the system unless the system is also designed in such a way as to deliver satisfactory
outcome. Procedures need to be simplified to deliver concrete benefits and clear guidelines provided
to encourage their use by the actual end users and reduce users dependence
on middlemen/intermediaries

Cost
Cost is one of the most important prohibiting factor that comes in the path of e-governance
implementation particularly in the developing countries like India where most of the people living
below the poverty line. Elected officers and politician dont seem to be interested in implementing e-
governance

Privacy and Security


There will be three basic levels of access exists for e-government stakeholders: no access to a Web
service; limited access to a Web-service or full-access to a Web service, however when personal
sensitive data exists the formation of the security access policy is a much more complex process with
legal consideration. With the implementation of e-government projects, effective measures must
be taken to protect sensitive personal information. A lack of clear security standards and protocols
can limit the development of projects that contain sensitive information such as income, medical
history.

Conclusion
We have seen how the concept of e-governance and m-governance has evolved in Indian scenario
and how much it is required for transparency and accountability on the part of government and at
the same time it is also a toll to increase the participation of people in policy making by empowering
them with the right information at right time. The penetration of internet, telecommunication services
in India has increased in the last decade and this gives a ray of hope to the citizens of India to fight
with the long persisting problems of poverty, corruption, regional disparity and unemployment. But
at the same time, due to slow pace of project completion, red-tape and resistance from the side of
government employees and citizens too has not given the desired result.

How does E-governance help to reduce the corruption?


E-governance polices are used to provide the best services to the citizens, create more transparency
and reduce the corruption. Now the governments have to chosen to go online in departments such as
customs, income tax, sales tax and property tax which are highly corrupt and citizens have interface
with these departments. Egovernance introduces competition which improves services level and
reduce the corruption. All the Egovernance application focuses on a single objective that is to reduce
corruption.
E-governance: anti-corruption strategies
E-government introduces transparency in all its decisions, actions, performance, rules and all kind
of data.
Build accountability for access the information through internet.
Entry point for simplification of rules & reengineering processes.
Makes decision traceable.
Provide documentation to citizens for follow up.
Automates processes to take away discretion.
Introduces competition among different department of government services.
Types of corruption facing by the citizens:
Administrative corruption
Collusion
Extortion

E-governance: anti-corruption strategies:- E-government introduces transparency in all its decisions,


actions, performance, rules and all kind of data.
1. Build accountability for access the information through internet.
2. Entry point for simplification of rules & reengineering processes.
3. Makes decision traceable.
4. Provide documentation to citizens for follow up.
5. Automates processes to take away discretion.
6. Introduces competition among different department of government services.

Role of E-government to Reduce Corruption


Corruption considered To the extent that increased transparency, accountability and predictability (of
rules and procedures) are made priorities, e-government may offer a weapon against corruption.
There are different action can be taken by e-governance to reduce corruption. Many governments
chosen the entire department must be on-line like customs, income tax, sales tax, and property tax.
Every services of government must be delivering online to every citizen all over the country. E-
government can lead to centralizes data which can be used for improving audit and analysis. Each
decision can be traceable that is useful to exposure of wrong doing things and fear of embarrassment
can be a deterrent to corrupt practices. E-government introduces competition which improves service
level and reduces corruption. Take strict actions for complains of citizens that submitted against
corrupt practices. The information present in a manner that leads to transparency of rules and their
application in specific decisions, increasing accountability by building the ability to trace decisions,
actions to individual civil servants represent the successive stage to counter corruption.
E-government, however, does not guarantee the end of corruption. Officials who master technology-
empowered processes can find new opportunities for rent seeking. Under such circumstances, e-
government may simply cause an inter-generational shift in corruption toward younger, more tech-
literate officials. One especially sensitive issue, right from the start, is whether fighting corruption
should be part of the e-government vision. Each society must answer that question for itself. If
fighting corruption is included in the vision, the next key question is when to announce the anti-
corruption goal to the public. If fighting corruption is publicly announced as a major part of the e-
government agenda, it could help build coalitions and public pressure for anti-corruption results.
However, publicity too early in the e-government process runs the risk of causing fear and resistance
from corrupt officials, who are likely to exert negative pressure even upon their uncorrupt colleagues.
Another option is to not publicize the anti-corruption goals of an e-government program but rather
sell e-government (especially within the government) as a program to accomplish other goals such
as improving government services, increasing attractiveness of the country for investment, reducing
costs to the public/business or improving the competitiveness of the local private sector. Given the
sensitivity of these issues, involvement of non-government stakeholders in the discussion is
important.

The Union Budget


The Budget documents presented to Parliament comprise, besides the Finance Minister's Budget
Speech, of the following:
A. Annual Financial Statement (AFS)
B. Demand for Grants (DG)
C. Appropriation Bill
D. Finance Bill
E. Memorandum Explaining the Provisions in the Finance Bill, 2016
F. Macro-economic framework for the relevant financial year
G. Fiscal Policy Strategy Statement for the financial year
H. Medium Term Fiscal Policy Statement
I. Expenditure Budget Volume -1
J. Expenditure Budget Volume -2 (Part A and Part B)
K. Receipts Budge
L. Budget at a glance
M. Highlights of Budget
N. Status of implementation of Announcements made in Finance Minister's Budget Speech of the previous
financial year

Direct and Indirect taxes


DIRECT TAXES

Those taxes whose burden cannot be shifted to others and the person who pays these to the
government has to bear it are called direct taxes. In other words direct tax is imposed on an
individual or a group of individuals, which affects them directly i.e, which they have to pay to the
government directly. The direct tax can be of different types:

1 Income Tax:- The tax imposed on an individual or a group of individuals on their annual incomes
is known as income tax. Every individual whose annual income exceeds a certain specified limit is
required, under the Income Tax Act, to pay a part of his income in the form of income tax. Its rates
are announced in the beginning of each financial year by the central government.
Financial Year: The period from 1st April to 31st march is taken as a financial year i.e. every financial
year begins on 1st April and ends on 31st march of the consecutive year.

Assessment Year: The year next to a particular financial year is called the assessment year for that
financial year, e.g. for financial year 2005-06, the assessment year is 2006-07.

Permanent Account Number: An individual is given a permanent account number (PAN) by the
income tax department. He or she is obliged to file an income tax return of the financial year by a
specified date of the subsequent financial year.

2. Wealth Tax:- The tax imposed on the wealth (property as well as money) of an individual is called
wealth tax. The exemption limit for wealth tax is Rs 5, 00,000. In addition one residential house or a
part thereof is exempted from the wealth tax.

3. Gift Tax:- If an individual transfers any of his movable or immovable property voluntarily to any
other individual it is called a gift. If the value of a gift exceeds a specified limit then the person giving
the gift has to pay gift tax to the government where as the person receiving the gift need not pay any
tax. A controversial issue in public finance is concerned with whether in the tax structure of an
economy, direct or indirect tax should be preferred. Indeed both direct taxes and indirect taxes have
their merits and demerits and therefore a good tax system should contain a proper mix of these two
types of taxes. Direct taxes, it may be recalled are those which are levied directly on the individuals
and firms and their burden is borne by those on whom these are levied.

4. Corporation 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. In case of non resident corporations, tax is levied on the income which is earned
from their business transactions in India or any other Indian sources depending on bilateral
agreement of that country.

5. Property Tax: Property tax or 'house tax' is a local tax on buildings, along with appurtenant land,
and imposed on owners. The tax power is vested in the states and it is delegated by law to the local
bodies, specifying the valuation method, rate band, and collection procedures. The tax base is the
annual ratable value (ARV) or areabased rating. Owner-occupied and other properties not producing
rent are assessed on cost and then converted into ARV by applying a percentage of cost, usually six
percent. Vacant land is generally exempted from the assessment. The properties lying under control
of Central are exempted from the taxation. Instead a 'service charge' is permissible under executive
order. Properties of foreign missions also enjoy tax exemption without an insistence for reciprocity.

6. Inheritance (Estate) Tax: An inheritance tax (also known as an estate tax or death duty) is a tax
which arises on the death of an individual. It is a tax on the estate, or total value of the money and
property, of a person who has died. India enforced estate duty from 1953 to 1985. Estate Duty Act,
1953 came into existence w.e.f. 15th October, 1953. Estate Duty on agricultural land was discontinued
under the Estate Duty (Amendment) Act, 1984. The levy of Estate Duty in respect of property (other
than agricultural land) passing on death occurring on or after 16th March, 1985, has also been
abolished under the Estate Duty (Amendment) Act, 1985.
Merits of Direct Taxes:

1. The larger burden of the direct taxes falls on the rich people who have capacity to bear these and
the poor people with less ability to pay have to bear less burden.

2. Direct taxes are important instrument of reducing inequalities of income and wealth.

3. Unlike indirect taxes, direct taxes do not cause distortion in the allocation of resources. As a result
these leave the consumers better off as compared to indirect taxes.

4. Revenue elasticity of direct taxes, especially if they are of progressive type is quite high. As the
national income increases, the revenue on these taxes also rises a great deal.
5. Demerits of Direct Taxes

1. In the direct taxation, people are aware of their tax liability and therefore they would try to avoid
or even evade the taxes. The practice and possibility of tax evasion and avoidance is more in direct
taxes than in case of indirect taxes.

2. Direct taxes are generally payable in lump sum or even in advance and become quite inconvenient.

3. Another demerit of direct taxes is their supposed effect on the will to work and save. It is assessed
that work (given Income) and leisure are two alternatives before any taxpayer. If therefore, a tax is
imposed say on income, the taxpayer will find that the return from work has decreased as compared
with return from leisure. He therefore tries to substitute leisure for work.

INDIRECT TAXES
Indirect taxes are those whose burden can be shifted to others so that those who pay these taxes to the
government do not bear the whole burden but pass it on wholly or partly to others. Indirect taxes are
levied on production and sale of commodities and services and small or a large part of the burden of
indirect taxes are passed on to the consumers. Excise duties on the product of commodities, sales tax,
service tax, customs duty, tax on rail or bus fare are some examples of indirect taxes.

The overall control for administration of Direct Taxes lies with the Union Finance Ministry which
functions through Income Tax Department with the Central Board of Direct Taxes (CBDT) at its apex.
The CBDT is a statutory authority functioning under the Central Board of Revenue Act, 1963. It also
functions as a division of the Ministry dealing with matters relating to levy and collection of Direct
Taxes. The Central Excise Department spread over the entire country administers and collects the
central excise duty. The apex body that is responsible for the policy and formulation of rules is the
Central Board of Excise and Customs which functions under the control of the Union Finance
Ministry. The Central Excise officers are also entrusted with the administration and collection of
Service tax and the Customs duty.

1 Excise Duty The tax imposed by the government on the manufacturer or producer on the
production of some items is called excise duty. The liability to pay excise duty is always on the
manufacturer or producer of goods. The duty being a duty on manufacture of goods, it is normally
added to the cost of goods, and is collected by the manufacturer from the buyer of goods. Therefore it
is called an indirect tax. This duty is now termed as "Cenvat". There are three types of parties who
can be considered as manufacturers-

Those who personally manufacture the goods in question

Those who get the goods manufactured by employing hired labour

Those who get the goods manufactured by other parties

For example, excise duty on the production of sugar is an indirect tax because the manufacturers of
sugar include the excise duty in the price and pass it on to buyers. Ultimately it is the consumers on
whom the incidence of excise duty on sugar falls, as they will pay higher price for sugar than before
the imposition of the tax.

In order to attract Excise duty liability, following four conditions must be fulfilled:

a) The duty is on "goods".

b) The goods must be "excisable"

c) The goods must be "manufactured" or produced.

d) Such manufacture or production must be "in India"


Additional Information on Excise Duty

Goods : These are the entities, which can be weighted, measured and marketed. e.g. steel, cloth,
computer software, gas, etc. Those commodities having very short life are not goods, if not
marketable in that short period, even if there is a specific entry in the tariff. Excise duty can only be
levied on those items, which are manufactured in India but excluding goods produced or
manufactured in Special Economic Zones (SEZ). Thus, excise levy cannot be imposed on imported
goods.

Payment of excise duty : In case of Non-SSI (Small Scale Industries) i.e., normal assesses the excise
duty is payable monthly, and for SSI (availing exemption based on turnover) it is payable quarterly.
The duty on the goods removed from the factory or the warehouse during the month shall be paid by
the 5th of the following month in case of Non-SSI and by 15th for SSI. In case of delayed payment,
interest should also be deposited at the rate of 13% p.m or Rs 1,000 per day for the period of delay
after 5th or 15th whichever is applicable, whichever is higher, along with the duty.

Payment by debit in Cenvat credit account: Under the Cenvat credit scheme, the assessee is allowed
credit of duty paid on inputs or capital goods, which are used in or in relation to manufacture of the
final products, and the credit can be utilized towards payment of duty on the final products. Credit is
allowed on inputs and capital goods except LDO (light diesel oil), HSD (high speed diesel) and motor
spirit. Also, instant credit is allowed immediately on the inputs being received into the factory.
However credit is not allowed if final products are exempted from duty
Exemption from Payment of Excise Duty: Central excise rules grant exemption from duty if goods
are exported under bond, except exports to Nepal and Bhutan. Similarly, goods manufactured in
Special Economic Zones (SEZ) are not excisable and hence no excise duty can be levied on goods
manufactured in SEZ. Certain other items, which are exempted for excise duty, are enlisted in
Annexure-'A', given at the end of this lesson.

Generally 16% excise duty and 2% cess on it are imposed on most goods, but government can fix
different tariff values for different classes of goods or goods manufactured by different classes or sold
to different classes of buyers. Few exceptions like the following are there in case of Textile sector.
Valuation for Excise Duty

Specific duty: It is the duty payable on the basis of certain unit e.g. duty on cigarettes is on length
basis, sugar per quintal basis, matches per 100 boxes, marble slabs and tiles per square meter basis
and colour TV by screen size in cm, if MRP is not written on the carton.

Tariff Value: Government from time to time fixes tariff value. Government can fix different tariff
values for different classes of goods manufactured by different classes or sold to different classes of
buyers.

i. MRP based valuation : The provisions are as follows: i) The goods should be covered under
provisions of Standards of Weights and Measures Act. ii) Central Government can permit reasonable
abatement (deductions) from the retail sale price. iii) Central Government has to issue a notification
in Official gazette specifying the commodities for which the provision is applicable and the
abatement permissible. For example, government had issued a notification to reduce the excise duty
on cosmetics and toilet preparations on MRP basis printed on the carton after allowing abatement of
50%. In such cases, if MRP printed on carton is Rs 50 and if the duty on cosmetics & toilet
preparations is 20%, the duty @ 20% will be payable on Rs 25 (i.e after allowing 50% abatement of
MRP of Rs 50). Thus duty payable per pack will be Rs. 5.00.

ii. Assessable Value: The basic provision of assessable value, when excise duty is chargeable on
excisable goods with reference to value will be transaction value on each removal of goods.
Transaction value is defined as the price actually paid or payable for the goods, when sold and
includes in addition to the amount charged as price, any amount that the buyer is liable to pay,
including any amount charged for advertising or publicity, marketing and selling organization
expenses, storage, outward handling, servicing, warranty, commission or any other matter, but does
not include the amount of excise duty, sales tax and other taxes.------------------------
2. Customs Duty

Custom duty is a form of indirect tax. Standard English dictionary defines the term "custom" as
duties imposed on imported or less commonly exported goods. This term is usually applied to those
taxes which are payable upon goods or merchandise imported or exported. It is also defined as tax
imposed by the government on the import of items (goods). The Customs Act was formulated in 1962
to prevent illegal imports and exports of goods. Besides, all imports are sought to be subject to a duty
with a view to affording protection to indigenous industries.
Additional Information on Customs Duty

Education cess @2% : With effect from 10.09.2004 an education cess has been levied on items
imported into India. It is leviable @2% on the aggregate of customs duties leviable on such goods.

No duty on pilfered goods: If any imported goods are pilfered after the unloading thereof and before
the proper officer has made on order for clearance for home consumption or deposit in a warehouse,
the importer shall not be liable to pay the duty leviable on such good. The term "pilfer" means to steal
especially in small quantities.

Abatement of duty on damaged goods: The term 'damage' denotes physical damage to the goods.
This implies that the goods are not fit to be used for the purpose for which they are meant. The
damaged goods get some % of abatement of damage in the customs duty.

Exemption: Article 265 of the Indian Constitution provides that 'no tax shall be levied or collected
except by authority of law. The power of the central government to alter the duty rate structure is
known as delegated legislation and this power is always subject to superintendence and check by
parliament. If the central government is satisfied that it is necessary in the public interest so to do,
then whole or part of customs duty can be exempted from the customs duty.

Additional duty of Customs: Apart from the customs duty levied as a percentage of the value of
goods, the following example illustrates the method of computing the additional duty of customs.-----
----------------------
3. Sales Tax

Tax paid by the consumer on the purchase of some items is called the sales tax. Rates of sales tax
depend upon the nature of the goods purchased by the consumer.-----------------

4. Service Tax: The service providers in India except those in the state of Jammu and Kashmir are
required to pay a Service Tax under the provisions of the Finance Act of 1994. The provisions related
to Service Tax came into effect on 1st July, 1994. Under Section 67 of this Act, the Service Tax is levied
on the gross or aggregate amount charged by the service provider on the receiver. However, in terms
of Rule 6 of Service Tax Rules, 1994, the tax is permitted to be paid on the value received. The
interesting thing about Service Tax in India is that the Government depends heavily on the voluntary
compliance of the service providers for collecting Service Tax in India.

5. Securities Transaction Tax (STT): STT is a tax being levied on all transactions done on the stock
exchanges. STT is applicable on purchase or sale of equity shares, derivatives, equity oriented funds
and equity oriented Mutual Funds. Current STT on purchase or sell of an equity share is 0.075%. A
person becomes investor after payment of STT at the time of selling securities (shares). Selling the
shares after 12 months comes under long term capital gains and one need not have to pay any tax on
that gain. In the case of selling the shares before 12 months, one has to pay short term capital gains
@10% flat on the gain. However, for a trader, all his gains will be treated as trading (Business) and he
has to pay tax as per tax sables. In this case the transaction tax paid by him can be claimed
back/adjusted in tax to be paid.
6. Value Added Tax

Under the Indian constitution, the States have the exclusive powers to levy tax on the sales of goods.
The tax on the inter-state trade is levied by central government, and is called Central Sales Tax (CST).
It is proposed to abolish CST in phased manner. Due to various defects in the Sales Tax System, the
Govt, has introduced a new system called Value Added Tax (VAT) in place of State Sales Tax.

VAT is a multi-point tax levied and collected on the value added to goods at different stages of sale. It
is a method of taxing by stages. The method consists of levying a tax on the value added to a product
at each stage of production or distribution. It is another form of sales tax where tax is collected in
stages rather than collection of the tax at the first or last point. VAT, in simple terms, is a multi-point
levy on each of the entities in the supply chain with the facility of set-off of input tax i.e. that is, the
tax paid at the stage of purchase of goods by a trader and on purchase of raw materials by a
manufacturer. Only the value addition in the hands of each of the entities is subject to tax. For
instance, if a dealer purchases goods for Rs 100 from another dealer and a tax of Rs 10 has been
charged in the bill, and he sells the goods for Rs 120 on which the dealer will charge a tax of Rs 12 at
10 per cent, the tax payable by the dealer will be only Rs 2, being the difference between Rs. 12 the tax
collected and Rs. 10 tax already paid on purchases. Thus, the dealer has paid tax at 10 per cent on Rs
20 being the value addition of goods in his hands.
CHARACTERISTICS OF VAT
1. It is simple, modern and transparent tax system.

2. It is a multipoint tax with credit for the tax paid at preceding stage.

3. Small traders (whose turnover is up to Rs10 lakhs) are outside VAT.

4. VAT replaces a number of taxes like turnover tax, luxury tax, surcharge etc.

5. VAT being efficient is considered to be better than sales tax.

6. VAT has four rates instead of the large number of rates under sales tax.

7. Composition scheme for small dealer having turnover above taxable quantum of Rs 10 lakhs but
below 50 lakhs.

8. VAT eliminates cascading by providing credit of taxes paid on inputs and only taxing value
addition.
Advantages of VAT
1. Self-assessment by dealers.

2. Higher revenue growth from states.

3. Set off for input tax paid on previous purchases.

4. Other taxes to be eliminated.

5. Fairness in the taxation system. Visits to tax department will reduce.


6. Help to reduce tax evasion and corruption.

7. Uniform rates of VAT will boost fair trade.

8. VAT does not lead to price rise.

9. VAT is easier to enforce.


Disadvantages of VAT

1. Record keeping systems and procedure will need to re-strengthen with Tax Authorities in order to
claim input tax credit.

2. VAT may lead to tax evasion if false input credits are submitted by dealers.
Difference between VAT and Sales Tax
SALES TAX VAT

1. complex system. 1. simplified tax system.

2. different slabs of tax 2. only four slabs of tax

3. collected at one point i.e. first or last. 3. charged at each stage

4. no tax levied on value addition on 4. tax on each value addition subsequent sales

5. problems of multiple taxation 5. a set off is given for previous purchases

6. discouragement to disclosure 6. encouragement to disclosure


Merits of Indirect Taxes
1. Indirect taxes are usually hidden in the prices of goods and services being transacted and, therefore
their presence is not felt so much.

2. If the indirect taxes are properly administered, the chances of tax evasion are less.

3. Indirect taxes are a powerful tool in moulding the production and investment activities of the
economy i.e. they can guide the economy in its resource allocation.
Demerits of Indirect taxes

1. It is claimed and very rightly that these taxes negate the principle of ability- to-pay and are
therefore unjust to the poor. Since one of the objectives is to collect enough revenue, they spread over
to cover the items, which are purchased generally by the poor. This makes them regressive in effect.

2. If indirect taxes are heavily imposed on the luxury items then this will only help partially because
taxing the luxuries alone will not yield adequate revenue for the State.

3. Direct taxes take away a part of the purchasing power of the taxpayer and that has the effect of
reducing demand and prices. On the other hand, indirect taxes are added to the sale prices of the
taxed goods without touching the purchasing power in the first place. The result is that in their case
inflationary forces are fed through higher prices, higher costs and wages and again higher prices.

Tax sources of Revenue: Union Budget 2016-17

Tax Revenue 2016-16 2016-17


Corporation 452969.68 493923.55
Taxes on Income 299051.24 353173.68
Wealth Tax -- --
Customs 209500.00 230000.00
Union Excise Duties 284142.34 318669.50
Service Tax 210000.00 231000.00
Other Taxes and Duties on Commodities and -- --
Services
Taxes of Union Territories 3947.83 4121.08
Total-Tax Revenue 1459611.09 1630887.81

Non-tax sources of Revenue

Definition: Non-Tax Revenue is the recurring income earned by the government from sources other
than taxes.

Description: The most important receipts under this head are interest receipts (received on loans
given by the government to states, railways and others) and dividends and profits received from
public sector companies.

Various services provided by the government - police and defence, social and community services
such as medical services, and economic services such as power and railways -- also yield revenue for
the government. Though the Railways are a separate department, all their receipts and expenditure
are routed through the Consolidated Fund.
Non Tax Revenue Receipts are those revenue receipts which are not generated by Taxing the public.
Money which the Government earns as Dividends and profits from its profit making public
enterprises (PSUs).
Interest which the Government earns on the money lent by it to external or internal borrowers.
Thus this revenue receipts may be in foreign currency as well as Indian Rupees.
The money which the government receives out of its fiscal services such as stamp printing,
currency printing, medal printing etc.
Money which the Government earns from its General Services such as power distribution,
irrigation, banking services, insurance, and community services etc. which make the part of
the Government business.
Money which the government accrues as fees, fines, penalties etc.
Grants the Government of India receives from the external sources. In case of the state
Governments, it may be the internal grant from the central Government.
In recent times, spectrum auctions have been one of the major sources of non-tax revenues for
the government. We note here, that despite it looks that spectrum amount should be a capital
receipt, it is shown as a non-tax revenue receipt in budget documents as one time spectrum
charges levied on telecom players.
1: Income from direct sale of goods/services
DevAnand works as a tourist guide- he gets fees for services
DevAnand also own a bookstore near the railway station. He also earns money by selling
goods= books, magazines, souvenirs and (mostly) Rozgaar Samachaar.
^since he gets this money every year(=short term), and it is in recurring nature (because hell earn it
every year)=> therefore, well write this on left hand side of table (Revenue part).
2: Income from Khairaat (Grant/charity/donation)
Once in a while, Dev also receives funding from UNESCO, Archeological survey, culture ministry
and foreign NGOs.
These are grants/aid = Not loans = Dev doesnt need to repay them in 10-20 years. So we
cannot put them under Capital part (right side of the table). Therefore, well put them on left
hand side of table (Revenue)
#3: income from investment
So far, Dev made money from selling goods/services, he also got some grants/charity/donations.
he will invest some of this money into:
Investment in What will Dev earn?
1. Shares of LIC, ONGC etc Dividend
2. Bank savings account / fixed deposit Interest
3. in his own bookstore @railway station Profit

Union Budget 2016-17 : Non-tax Revenue

Interest Receipts, Dividends and Profits 2015-16 2016-


17
Interest Receipt 23142 29620
Dividends and Profits (Dividends from Public Sector 'Enterprises and on other 118271 123780
investments, Dividend/Surplus of Reserve Bank of India, Nationalised Banks
& Financial Institutions)
Fiscal Services (Currency, Coinage and Mint (Profit from circulations of coins, 703 703
Others)
General Services (Administrative Services, Public Service Commission, Police, 14713 14867
Supplies and Disposals, Supplies and Disposals
Social Services (Education, Sports, Art and Culture, Medical and Public 5195 8297
Health, Family Welfare, Housing, Urban Development,
Economic Services (Agriculture and Allied Activities, Irrigation and Flood 92324 141450
Control, Energy, Industry & Minerals, Transport, Communication, Science,
Technology and Environment, General Economic Services)
Railway Revenue as per Railway Budget
Grants-in-aid and Contribution
Non Tax Revenue of Union Territories 1288 1339
Grand Total 258575 322921

GST CONCEPT & STATUS


Introduction The introduction of Goods and Services Tax (GST) would be a very significant step in
the field of indirect tax reforms in India. By amalgamating a large number of Central and State taxes
into a single tax, it would mitigate cascading or double taxation in a major way and pave the way for
a common national market. From the consumer point of view, the biggest advantage would be in
terms of a reduction in the overall tax burden on goods, which is currently estimated at 25%-30%.
Introduction of GST would also make Indian products competitive in the domestic and international
markets. Studies show that this would instantly spur economic growth. Last but not the least, this tax,
because of its transparent character, would be easier to administer.
Salient Features of GST
The salient features of GST are as under:
(i) GST would be applicable on supply of goods or services as against the present concept of tax on
the manufacture of goods or on sale of goods or on provision of services.
(ii) GST would be a destination based tax as against the present concept of origin based tax.
(iii) It would be a dual GST with the Centre and the States simultaneously levying it on a common
base. The GST to be levied by the Centre would be called Central GST (CGST) and that to be levied
by the States would be called State GST (SGST).
(iv) An Integrated GST (IGST) would be levied on inter-State supply (including stock transfers) of
goods or services. This would be collected by the Centre so that the credit chain is not disrupted.
(v) Import of goods or services would be treated as inter-State supplies and would be subject to IGST
in addition to the applicable customs duties.
(vi) For an initial period of two years or as further extended on the recommendation of the Goods &
Services Tax Council (GSTC), a non- vatable Additional Tax not exceeding 1% on inter-State supply
of goods would be levied and collected by the Centre and assigned to the originating State. The Select
Committee of the Rajya Sabha has recommended that this tax should be levied only when the supply
is made for a consideration.
(vii) CGST, SGST & IGST would be levied at rates to be mutually agreed upon by the Centre and the
States under the aegis of the GSTC.
(viii) GST would replace the following taxes currently levied and collected by the Centre:
a) Central Excise duty
b) Duties of Excise (Medicinal and Toilet Preparations)
c) Additional Duties of Excise (Goods of Special Importance)
d) Additional Duties of Excise (Textiles and Textile Products)
e) Additional Duties of Customs (commonly known as CVD)
f) Special Additional Duty of Customs (SAD)
g) Service Tax
h) Cesses and surcharges insofar as far as they relate to supply of goods or services
(ix) State taxes that would be subsumed within the GST are:
a) State VAT
b) Central Sales Tax
c) Purchase Tax
d) Luxury Tax
e) Entry Tax (All forms)
f) Entertainment Tax (not levied by the local bodies)
g) Taxes on advertisements
h) Taxes on lotteries, betting and gambling
i) State cesses and surcharges insofar as far as they relate to supply of goods or services
(x) GST would apply to all goods and services except Alcohol for human consumption, Electricity
and Real Estate.
(xi) GST on petroleum products would be applicable from a date to be recommended by the GSTC.
(xii) Tobacco and tobacco products would be subject to GST. In addition, the Centre would continue
to levy Central Excise duty.
(xiii) A common threshold exemption would apply to both CGST and SGST. Taxpayers with a
turnover below it would be exempt from GST. A compounding option (i.e.to pay tax at a flat rate
without credits) would be available to small taxpayers below a certain threshold. The threshold
exemption and compounding scheme would be optional.
(xiv) The list of exempted goods and services would be kept to a minimum and it would be
harmonized for the Centre and the States as far as possible.
(xv) Exports would be zero-rated.

Given the passage of the Constitution (122nd) Amendment Bill, 2014 for Goods and Services Tax
(GST) in the Lok Sabha on 6th May, 2015, the Government of India seems committed to replace all
the indirect taxes levied on goods and services by the Centre and States and implement GST by 2016.
With GST, it is anticipated that the tax base will be comprehensive, as virtually all goods and services
will be taxable, with minimum exemptions.
GST the game changer: GST will be a game changing reform for Indian economy by developing a
common Indian market and reducing the cascading effect of tax on the cost of goods and services. It
will impact the Tax Structure, Tax Incidence, Tax Computation, Tax Payment, Compliance, Credit
Utilization and Reporting leading to a complete overhaul of the current indirect tax system.
GST will have a far reaching impact on almost all the aspects of the business operations in the
country, for instance, pricing of products and services; supply chain optimization; IT, accounting
and tax compliance systems.
Ten things to know about the GST Bill
Officially, the Constitution (One Hundred and Twenty-Second Amendment) Bill 2014.
It was introduced in the Lok Sabha on December 19, 2014 by Finance Minister Arun Jaitley.
The Bill seeks to amend the Constitution to introduce a goods and services tax (GST) which will
subsumes various Central indirect taxes, including the Central Excise Duty, Countervailing Duty,
Service Tax, etc. It also subsumes State value added tax (VAT), octroi and entry tax, luxury tax, etc.
The Bill inserts a new Article in the Constitution make legislation on the taxation of goods and
services a concurrent power of the Centre and the States.
The Bill seeks to shift the restriction on States for taxing the sale or purchase of goods to the supply of
goods or services.
The Bill seeks to establish a GST Council tasked with optimising tax collection for goods and services
by the State and Centre. The Council will consist of the Union Finance Minister (as Chairman), the
Union Minister of State in charge of revenue or Finance, and the Minister in charge of Finance or
Taxation or any other, nominated by each State government.
The GST Council will be the body that decides which taxes levied by the Centre, States and local
bodies will go into the GST; which goods and services will be subjected to GST; and the basis and the
rates at which GST will be applied.
Under the Bill, alcoholic liquor for human consumption is exempted from GST. Also, it will be up to
the GST Council to decide when GST would be levied on various categories of fuel, including crude
oil and petrol.
The Centre will levy an additional one per cent tax on the supply of goods in the course of inter-State
trade, which will go to the States for two years or till when the GST Council decides.
Parliament can decide on compensating States for up to a five-year period if States incur losses by
implementation of GST.
Question 1 : What is the justification of GST ?
Answer : There was a burden of tax on tax in
the pre-existing Central excise duty of the Government of India and sales tax system of the State
Governments. The introduction of Central VAT (CENVAT) has removed the cascading burden of
tax on tax to a good extent by providing
a mechanism of set off for tax paid on inputs and services upto the stage of production, and has
been an improvement over the pre-existing Central excise duty. Similarly, the introduction of
VAT in the States has removed the cascading effect by giving set-off for tax paid on inputs as well
as tax paid on previous purchases and has again been an improvement over the previous sales
tax regime.

But both the CENVAT and the State VAT have certain incompleteness. The incompleteness in
CENVAT is that it has yet not been extended to include chain of value addition in the distributive
trade below the stage of production. It has also
not included several Central taxes, such as Additional Excise Duties, Additional Customs Duty,
Surcharges etc. in the overall framework of CENVAT, and thus kept the benefits of
comprehensive input tax and service tax set-off out of the reach of manufacturers/dealers. The
introduction of GST will not only include comprehensively more indirect Central taxes and
integrate goods and services taxes for set-off relief, but also capture certain value addition in the
distributive trade.

Similarly, in the present State-level VAT scheme, CENVAT load on the goods has
not yet been removed and the cascading effect of that part of tax burden has remained unrelieved.
Moreover, there are several taxes in the States, such as, Luxury Tax, Entertainment Tax, etc. which
have still not been subsumed in the VAT. Further, there has also not been any integration of VAT
on goods with tax on services at the State level with removal of cascading effect of service tax. In
addition, although the burden of Central Sales Tax (CST) on inter-State movement of goods has
been lessened with reduction of CST rate from 4% to 2%, this burden has also not been fully
phased out. With the introduction of GST at the State level, the additional burden of CENVAT
and services tax would be comprehensively removed, and a continuous chain of set-off from the
original producers point and service providers point upto the retailers level would be
established which would eliminate the burden of all cascading effects, including the burden of
CENVAT and service tax. This is the essence of GST. Also, major Central and State taxes will get
subsumed into GST which will reduce the multiplicity of taxes, and thus bring down the
compliance cost. With GST, the burden of CST will also be phased out.

Thus GST is not simply VAT plus service tax, but a major improvement over the
previous system of VAT and disjointed services tax a justified step forward.
Question 2. What is GST? How does it work ?
Answer : As already mentioned in answer to Question 1, GST is a tax on goods and services
with comprehensive and continuous chain of set-off benefits from the producers point and
service providers point upto the retailers level. It is essentially a tax only on value addition at
each stage, and a supplier at each stage is permitted to set-off, through a tax credit mechanism,
the GST paid on the purchase of goods and services as available for set-off on the GST to be paid
on the supply of goods and services. The final consumer will thus bear only the GST charged by
the last dealer in the supply chain, with set-off benefits at all the previous stages.
The illustration shown below indicates, in terms of a hypothetical example with a
manufacturer, one wholeseller and one retailer, how GST will work. Let us suppose that GST rate
is 10%, with the manufacturer making value addition of Rs.30 on his purchases worth Rs.100 of
input of goods and services used in the manufacturing process. The manufacturer will then pay
net GST of Rs. 3 after setting-off Rs. 10 as GST paid on his inputs (i.e. Input Tax Credit) from gross
GST of Rs. 13. The manufacturer sells the goods to the wholeseller. When the wholeseller sells the
same goods after making value addition of (say), Rs. 20, he pays net GST of only Rs. 2, after
setting-off of Input Tax Credit of Rs. 13 from the gross GST of
Rs. 15 to the manufacturer. Similarly, when a retailer sells the same goods after a value addition
of (say) Rs. 10, he pays net GST of only Re.1, after setting-off Rs.15 from his gross GST of Rs. 16
paid to wholeseller. Thus, the manufacturer, wholeseller and retailer have to pay only Rs. 6 (= Rs.
3+Rs. 2+Re. 1) as GST on the value addition along the entire value chain from the producer to the
retailer, after setting-off GST paid at the earlier stages. The overall burden of GST on the goods is
thus much less. This is shown in the table below. The same illustration will hold in the case of
final service provider as well.
Question 3 : How can the burden of tax, in general, fall under GST ?
Answer : As already mentioned in Answer to Question 1, the present forms of CENVAT and
State VAT have remained incomplete in removing fully the cascading burden of taxes already
paid at earlier stages. Besides, there are several other
taxes, which both the Central Government and the State Government levy on production,
manufacture and distributive trade, where no set-off is available in the form of input tax credit.
These taxes add to the cost of goods and services through tax on tax which the final consumer
has to bear. Since, with the introduction of GST, all the cascading effects of CENVAT and service
tax would be removed with a continuous chain of set-off from the producers point to the retailers
point, other major Central and State taxes would be subsumed in GST and CST will also be phased
out, the final net burden of tax on goods, under GST would, in general, fall. Since there would be
a transparent and complete chain of set-offs,
this will help widening the coverage of tax base and improve tax compliance. This may lead to
higher generation of revenues which may in turn lead to the possibility of lowering of average
tax burden.

Question 4 : How will GST benefit industry, trade and agriculture ?


Answer : As mentioned in Answer to Question 3, the GST will give more relief to
industry, trade and agriculture through a more comprehensive and
wider coverage of input tax set-off and service tax set-off, subsuming of several Central and State
taxes in the GST and phasing out of CST. The transparent and complete chain of set-offs which
will result in widening of tax base and better tax compliance may also lead to lowering of tax
burden on an average dealer in industry, trade and agriculture.
Question 5 : How will GST benefit the exporters?
Answer : The subsuming of major Central and State taxes in GST, complete and
comprehensive set-off of input goods and services and phasing out of Central Sales Tax (CST)
would reduce the cost of locally manufactured goods and services. This will increase the
competitiveness of Indian goods and services in the international market and give boost to Indian
exports. The uniformity in tax rates and procedures across the country will also go a long way in
reducing the compliance cost.

Question 6 : How will GST benefit the small entrepreneurs and small traders?
Answer : The present threshold prescribed in different State VAT Acts below which VAT is
not applicable varies from State to State. The existing threshold of goods under State VAT is Rs.
5 lakhs
for a majority of bigger States and a lower threshold for North Eastern States and Special Category
States. A uniform State GST threshold across States is desirable and, therefore, the Empowered
Committee has recommended that a threshold of gross annual turnover of Rs. 10 lakh both for
goods and services for all the States and Union Territories may be adopted with adequate
compensation for the States (particularly, the States in North-Eastern Region and Special
Category States) where lower threshold had prevailed in the VAT regime. Keeping in view the
interest of small traders and small scale industries and to avoid dual control, the States considered
that the threshold for Central GST for goods may be kept at Rs.1.5 crore and the threshold for
services should also be appropriately high. This raising of threshold will protect the interest of
small traders. A Composition scheme for small traders and businesses has also been envisaged
under GST as will be detailed in Answer to Question 14. Both these features of GST will
adequately protect the interests of small traders and small scale industries.
Question 7 : How will GST benefit the common consumers?
Answer : As already mentioned in Answer to Question 3, with the introduction of GST, all the
cascading effects of CENVAT and service tax will be more comprehensively removed with a
continuous chain of set-off from the producers point to the retailers point than what was possible
under the prevailing CENVAT and VAT regime. Certain major Central and State taxes will also
be subsumed in GST and CST will be phased out. Other things remaining the same, the burden
of tax on goods would, in general, fall under GST and that would benefit the consumers.
Question 8 : What are the salient features of the proposed GST model?
Answer : The salient features of the proposed model are as follows:

(i) Consistent with the federal structure of the country, the GST will have two components:
one levied by the Centre (hereinafter referred to as Central GST), and the other levied by
the States (hereinafter referred to as State GST). This dual GST model would be
implemented through multiple statutes (one for CGST and SGST statute for every State).
However, the basic features of law such as chargeability, definition of taxable event and
taxable person, measure of levy including valuation provisions, basis of classification etc.
would be uniform across these statutes as far as practicable.
(ii) The Central GST and the State GST would
be applicable to all transactions of goods and services except the exempted goods and
services, goods which are outside the purview of GST and the transactions which are
below the prescribed threshold limits.
(iii) The Central GST and State GST are to be paid to the accounts of the Centre and the States
separately.
(iv) Since the Central GST and State GST are to be treated separately, in general, taxes paid
against the Central GST shall be allowed to be taken as input tax credit (ITC) for the
Central GST and could be utilized only against the payment of Central GST. The same
principle will be applicable for the State GST.
(v) Cross utilisation of ITC between the Central GST and the State GST would, in general, not
be allowed.
(vi) To the extent feasible, uniform procedure for collection of both Central GST and State GST
would be prescribed in the respective legislation for Central GST and State GST.
(vii) The administration of the Central GST would be with the Centre and for State GST with
the States.
(viii) The taxpayer would need to submit periodical returns to both the Central GST authority
and to the concerned State GST authorities.
(ix) Each taxpayer would be allotted a PAN-
linked taxpayer identification number with
a total of 13/15 digits. This would bring the GST PAN-linked system in line with the
prevailing PAN-based system for Income tax facilitating data exchange and taxpayer
compliance. The exact design would be worked out in consultation with the Income-Tax
Department.
(x) Keeping in mind the need of tax payers convenience, functions such as assessment,
enforcement, scrutiny and audit would be undertaken by the authority which is collecting
the tax, with information sharing between the Centre and the States.

Question 9 : Why is Dual GST required ?


Answer : India is a federal country where both the Centre and the States have been assigned
the powers to levy and collect taxes through appropriate legislation. Both the levels of
Government have distinct responsibilities to perform according to the division of powers
prescribed in the Constitution for which they need to raise resources. A dual GST will, therefore,
be in keeping with the Constitutional requirement of fiscal federalism.
Question 10 : How would a particular transaction of goods and services be taxed
simultaneously under Central GST (CGST) and State GST (SGST)?
Answer : The Central GST and the State GST would be levied simultaneously on every
transaction of supply of goods and services except the exempted goods and services, goods which
are outside the purview of GST and the transactions which are below the prescribed threshold
limits. Further, both would be levied on the same price or value unlike State VAT which is levied
on the value of the goods inclusive of CENVAT. While the location of the supplier and the
recipient within the country is immaterial for the purpose of CGST, SGST would be chargeable
only when the supplier and the recipient are both located within the State.

Illustration I : Suppose hypothetically that the rate of CGST is 10% and that of SGST is 10%.
When a wholesale dealer of steel in Uttar Pradesh supplies steel bars and rods to a construction
company which is also located within the same State for, say Rs. 100, the dealer would charge
CGST of Rs. 10 and SGST of Rs. 10 in addition to the basic price of the goods. He would be
required to deposit the CGST component into a Central Government account while the SGST
portion into the account of the concerned State Government. Of course, he need not actually pay
Rs. 20 (Rs. 10 + Rs. 10) in cash as he would be entitled to set-off this liability against the CGST or
SGST paid on his purchases (say, inputs). But for paying CGST he would be allowed to use only
the credit of CGST paid on his purchases while for SGST he can utilize the credit of SGST alone.
In other words, CGST credit cannot, in general, be used for payment of SGST. Nor can SGST credit
be used for payment of CGST.

Illustration II: Suppose, again hypothetically, that the rate of CGST is 10% and that of SGST is
10%. When an advertising company located in Mumbai supplies advertising services to a
company manufacturing soap also located within the State of Maharashtra for, let us say Rs. 100,
the ad company would charge CGST of Rs. 10 as well as SGST of
Rs. 10 to the basic value of the service. He would be required to deposit the CGST component into
a Central Government account while the SGST portion into the account of the concerned State
Government. Of course, he need not again actually pay Rs. 20 (Rs. 10+Rs. 10) in cash as it would
be entitled to set-off this liability against the CGST or SGST paid on his purchase (say, of inputs
such as stationery, office equipment, services of an artist etc). But for paying CGST he would be
allowed to use only the credit of CGST paid on its purchase while for SGST he can utilise the
credit of SGST alone. In other words, CGST credit cannot, in general, be used for payment of
SGST. Nor can SGST credit be used for payment of CGST.
Question 11 : Which Central and State taxes are proposed to be subsumed under GST ?
Answer : The various Central, State and Local levies were examined to identify their
possibility of being subsumed under GST. While identifying, the following principles were kept
in mind:
(i) Taxes or levies to be subsumed should be primarily in the nature of indirect taxes, either
on the supply of goods or on the supply of services.
(ii) Taxes or levies to be subsumed should be part of the transaction chain which commences
with import/ manufacture/ production of goods or provision of services at one end and
the consumption of goods and services at the other.
(iii) The subsumation should result in free flow of tax credit in intra and inter-State levels.
(iv) The taxes, levies and fees that are not specifically related to supply of goods & services
should not be subsumed under GST.
(v) Revenue fairness for both the Union and the States individually would need to be
attempted.

On application of the above principles, the Empowered Committee has recommended that the
following Central Taxes should be, to begin with, subsumed under the Goods and Services Tax:

(i) Central Excise Duty


(ii) Additional Excise Duties
(iii) The Excise Duty levied under the Medicinal and Toiletries Preparation Act
(iv) Service Tax
(v) Additional Customs Duty, commonly known as Countervailing Duty (CVD)
(vi) Special Additional Duty of Customs - 4% (SAD)
(vii) Surcharges, and
(viii) Cesses.
The following State taxes and levies would be, to begin with, subsumed under GST:
(i) VAT / Sales tax
(ii) Entertainment tax (unless it is levied by the local bodies).
(iii) Luxury tax
(iv) Taxes on lottery, betting and gambling.
(v) State Cesses and Surcharges in so far as they relate to supply of goods and services.
(vi) Entry tax not in lieu of Octroi.

Purchase tax: Some of the States felt that they are getting substantial revenue from Purchase Tax
and, therefore, it should not be subsumed under GST while majority of the States were of the view
that no such exemptions should be given. The difficulties of the foodgrain producing States was
appreciated as substantial revenue is being earned by them from Purchase Tax and it was,
therefore, felt that in case Purchase Tax has to be subsumed then adequate and continuing
compensation has to be provided to such States. This issue is being discussed in consultation
with the Government of India.
Tax on items containing Alcohol: Alcoholic beverages would be kept out of the purview of GST.
Sales Tax/VAT could be continued to be levied on alcoholic beverages as per the existing practice.
In case it has been made Vatable by some States, there is no objection to that. Excise Duty, which
is presently levied by the States may not also be affected.

Tax on Tobacco products: Tobacco products


would be subjected to GST with ITC. Centre may be allowed to levy excise duty on tobacco
products over and above GST with ITC.

Tax on Petroleum Products: As far as petroleum products are concerned, it was decided that the
basket of petroleum products, i.e. crude, motor spirit (including ATF) and HSD would be kept
outside GST as is the prevailing practice in India. Sales Tax could continue to be levied by the
States on these products with prevailing floor rate. Similarly, Centre could also continue its levies.
A final view whether Natural Gas should be kept outside the GST will be taken after further
deliberations.

Taxation of Services : As indicated earlier, both the Centre and the States will have concurrent
power to levy tax on goods and services. In the case of States, the principle for taxation of intra-
State and inter-State has already been formulated by the Working Group of Principal
Secretaries/Secretaries of Finance/Taxation and Commissioners of Trade Taxes with senior
representatives of Department of Revenue, Government of India. For inter-State transactions an
innovative model of Integrated GST will be adopted by appropriately aligning and integrating
CGST and IGST.

Question 12 : What is the rate structure proposed under GST ?


Answer : The Empowered Committee has decided to adopt a two-rate structure a lower rate
for necessary items and items of basic importance and a standard rate for goods in general. There
will also be a special rate for precious metals and a list of exempted items. For upholding of special
needs of each State as well as a balanced approach to federal flexibility, it is being discussed
whether the exempted list under VAT regime including Goods of Local Importance may be
retained in the exempted list under State GST in the initial years. It is also being discussed whether
the Government of India may adopt, to begin with, a similar approach towards exempted list
under the CGST.

For CGST relating to goods, the States considered that the Government of India might also have
a two-rate structure, with conformity in the levels of rate with the SGST. For taxation of services,
there may be a single rate for both CGST and SGST.

The exact value of the SGST and CGST rates, including the rate for services, will be made known
duly in course of appropriate legislative actions.

Question 13: What is the concept of providing threshold exemption for GST?
Answer : Threshold exemption is built into a tax regime to keep small traders out of tax net.
This has three-fold objectives:
a) It is difficult to administer small traders and cost of administering of such traders is very
high in comparison to the tax paid by them.
b) The compliance cost and compliance effort would be saved for such small traders.
c) Small traders get relative advantage over large enterprises on account of lower tax
incidence.

The present thresholds prescribed in different State VAT Acts below which VAT is not applicable
varies from State to State. A uniform State GST threshold across States is desirable and, therefore,
as already mentioned in Answer to Question 6, it has been considered that a threshold of gross
annual turnover of Rs. 10 lakh both for goods and services for all the States and Union Territories
might be adopted with adequate compensation for the States (particularly, the States in North-
Eastern Region and Special Category States) where lower threshold had prevailed in the VAT
regime. Keeping in view the interest of small traders and small scale industries and to avoid dual
control, the States also considered that the threshold for Central GST for goods may be kept Rs.1.5
Crore and the threshold for services should also be appropriately high.

Question 14 : What is the scope of composition and compounding scheme under GST?
Answer : As already mentioned in Answer to Question 6, a Composition/Compounding
Scheme will be an important feature of GST to protect the interests of small traders and small
scale industries. The Composition/Compounding scheme for the purpose of GST should have an
upper ceiling on gross annual turnover and a floor tax rate with respect to gross annual turnover.
In particular there will be a compounding cut-off at Rs. 50 lakhs of the gross annual turnover and
the floor rate of 0.5% across the States. The scheme would allow option for GST registration for
dealers with turnover below the compounding cut-off.

Question 15 : How will imports be taxed under GST ?


Answer : With Constitutional Amendments, both CGST and SGST will be levied on import of
goods and services into the country. The incidence of tax will follow the destination principle and
the tax revenue in case of SGST will accrue to the State where the imported goods and services
are consumed. Full and complete set-off will be available on the GST paid on import on goods
and services.

Question 16 : Will cross utilization of credits between goods and services be allowed under
GST regime?
Answer : Cross utilization of credit of CGST between goods and services would be allowed.
Similarly, the facility of cross utilization of credit will be available in case of SGST. However, the
cross utilization of CGST and SGST would generally not be allowed except in the case of inter-
State supply of goods and services under the IGST model which is explained in answer to the
next question.
Question 17 : How will be Inter-State Transactions of Goods and Services be taxed under GST in
terms of IGST method ?
Answer : The Empowered Committee has accepted the recommendation for adoption of IGST
model for taxation of inter-State transaction of Goods and Services. The scope of IGST Model is
that Centre would levy IGST which would be CGST plus SGST on all inter-State transactions of
taxable goods and services. The inter-State seller will pay IGST on value addition after adjusting
available credit of IGST, CGST, and SGST on his purchases. The Exporting State will transfer to
the Centre the credit of SGST used in payment of IGST. The Importing dealer will claim credit of
IGST while discharging his output tax liability in his own State. The Centre will transfer to the
importing State the credit of IGST used in payment of SGST. The relevant information is also
submitted to the Central Agency which will act as a clearing house mechanism, verify the claims
and inform the respective governments to transfer the funds.

The major advantages of IGST Model are:

a) Maintenance of uninterrupted ITC chain on inter-State transactions.


b) No upfront payment of tax or substantial blockage of funds for the inter-State seller or
buyer.
c) No refund claim in exporting State, as ITC is used up while paying the tax.

d) Self monitoring model.


e) Level of computerisation is limited to inter-State dealers and Central and State Governments
should be able to computerise their processes expeditiously.
f) As all inter-State dealers will be e-registered and correspondence with them will be by
e-mail, the compliance level will improve substantially.
g) Model can take Business to Business as well as Business to Consumer transactions into
account.

Question 18 : Why does introduction of GST require a Constitutional Amendment?


Answer : The Constitution provides for delineation of power to tax between the Centre and
States. While the Centre is empowered to tax services and goods upto the production stage, the
States have the power to tax sale of goods. The States do not have the powers to levy a tax on
supply of services while the Centre does not have power to levy tax on the sale of goods. Thus,
the Constitution does not vest express power either in the Central or State Government to levy a
tax on the supply of goods and services. Moreover, the Constitution also does not empower the
States to impose tax on imports. Therefore, it is essential to have Constitutional Amendments for
empowering the Centre to levy tax on sale of goods and States for levy of service tax and tax on
imports and other consequential issues.

As part of the exercise on Constitutional Amendment, there would be a special attention to the
formulation of a mechanism for upholding the need for a harmonious structure for GST along
with the concern for the powers of the Centre and the States in a federal structure.

Question 19: How are the legislative steps being taken for CGST and SGST ?
Answer : A Joint Working Group has recently been constituted (September 30, 2009)
comprising of the officials of the Central and State Governments to prepare, in a time-bound
manner a draft legislation for Constitutional Amendment.
Question 20: How will the rules for administration of CGST and SGST be framed?
Answer : The Joint Working Group, as mentioned above, has also been entrusted the task of
preparing draft legislation for CGST, a for SGST and rules and procedures for CGST and
SGST. Simultaneous steps have also been initiated for drafting of legislation for IGST and rules
and procedures. As a part of this exercise, the Working Group will also address to the issues of
dispute resolution and advance ruling.

Fiscal Policy
Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor
and influence a nation's economy. It is the sister strategy to monetary policy through which a
central bank influences a nation's money supply

The government has control over both taxes and government spending. When the government
uses fiscal policy to increase the amount of money available to the populace, this is called
expansionary fiscal policy.Examples of this include lowering taxes and raising government
spending

What does the fiscal policy include?


Expansionary fiscal policy involves government spending exceeding tax revenue, and is usually
undertaken during recessions. Contractionary fiscal policy occurs when government spending is
lower than tax revenue, and is usually undertaken to pay down government debt.

Who is in control of fiscal policy?


Fiscal policy is a broad term used to refer to the tax and spending policies of the federal government.
Fiscal policy decisions are determined by the Congress and the Administration; the Federal
Reserve plays no role in determining fiscal policy.


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Fiscal Policy for 2016-17


13. Fiscal policy of 2016-17 is aimed at continuing the momentum of aiding the growth revival of the
economy and institutionalizing the co-operative federal fiscal relations while at the same time
continuing on the path of fiscal consolidation. Budget 2016-17 has tried to achieve a fine balance to
meet these objectives.
14. The fiscal policy of the Government needs to be guided by the larger macroeconomic needs of
higher investments for higher growth. The investment focus is primarily in the agricultural and rural
sectors, having substantial potential for higher growth. Higher levels of infrastructural investments
particularly in the roads sector including rural roads, railways, waterways, power etc. are the other
focus areas for supporting the goals of building up growth momentum. Keeping these in view, and in
order to further leverage upon the higher budgetary provision in these sectors, Government has
allowed additional extra budgetary resources of `31,000 crore through raising of bonds. The funds
will be raised through the public sector enterprises and other Government institutions like NABARD
and NHAI. The Government will bear the repayment/interest servicing obligations, except in the
case of NHAI. These measures are likely to boost the growth momentum in 2016-17, with early signs
of revival already visible during the current year.
15. On the deficits front, the fiscal policy of the Government in 2016-17 will continue to be guided by
the principles of gradual adjustments to achieve the fiscal consolidation targets as laid down in the
FRBM Act and Rules. The targeted adjustment on fiscal deficit by 0.4 per cent of GDP in 2016-17, is
far steeper than the correction of 0.2 per cent achieved during the current year. It may be seen that
fiscal deficit is estimated at 3.5 per cent of GDP in 2016-17 against 3.9 per cent estimated in the current
year. The accelerated adjustment on fiscal deficit will help the Government in reducing the debt to
GDP ratio at a faster pace. This in turn will help free up more resources out of the Government
revenues for developmental programmes and bring down the existing levels of interest payments as
a ratio of net revenues of the Centre.
16. In order to achieve the indicated fiscal consolidation and to correct the revenue-expenditure
imbalance, the Government focus in 2016-17 is on revenue corrections. However, Government will
continue with the process of rationalization in areas having further scope. The focus on DBT
including for subsidies has already shown positive results and will be expanded further. More areas
of potential savings are being examined and required action will be taken in due course. There is
however, limited scope for further expenditure rationalization in view of higher committed
components and persistent expenditure rationalization exercise carried out over last few years. The
details of the expenditure policy have been brought out subsequently in a separate section.
17. The structural nature of fiscal imbalance requires the focus to be shifted to revenue side
corrections. The Government policy on direct taxes has been to achieve growth in direct taxes by
broadening the tax base including minimising exemptions, ewhile maintaining a regime of moderate
tax rates. The corporate side however continues to
face challenges impacting the growth in direct tax collections. On the indirect taxes, excise duty
collections are already on a higher base while customs duty collections continue to be impacted by
the uncertain global conditions. The higher growth reliance on indirect taxes in 2016-17, will
therefore, be primarily on the excise duty and service tax. In the longer term, however, effort will be
to augment the gross tax to GDP ratio for sustainability purposes. The likely implementation of GST
in the near future will also give a boost to indirect tax collections. Keeping these in view the gross tax
to GDP ratio is estimated at 10.8 per cent of GDP in 2016-17 which is the same level as RE 2015-16.
The growth in the gross tax revenues is also estimated to come down to 11.7 per cent in 2016-17 as
against 17.2 per cent growth estimated in RE 2015-16 over the previous year.
18. Keeping in view the limitations on higher growth on tax side, reliance on revenue side correction
in 2016-17 and in the medium term rests primarily on non-tax revenues and non-debt capital receipts,
primarily disinvestment and stratgic disinvestment receipts. The details are discussed in Part C of
this Statement.
(1) Tax Policy
19. Fiscal consolidation strategy rests on two important pillars of gradual increase in tax-GDP ratio
and rationalization of expenditure as a percentage of GDP by curtailing non-developmental
expenditure. Tax policy of the Government therefore, remains an important tool in achieving the
projected goals of fiscal consolidation in the medium term.
20. During the initial phase of the fiscal consolidation period, the tax- GDP ratio had improved
significantly from 9.2 per cent in 2003-04 to 11.9 per cent in 2007-08. These gains were substantially
lost due to the counter-cyclical stimulus provided largely on the tax side during the global economic
crisis. The tax to GDP ratio was stagnating in the range of 10 per cent ever since. In RE 2015-16, the
ratio is estimated to improve substantially to 10.8 per cent of GDP. However, keeping in view the
already higher base particularly on excise duty, a moderate growth in tax revenues have been
projected for 2016-17. The tax to GDP ratio is estimated at the same level of 10.8 per cent. The tax
policy of 2016-17 have been brought out in the following paras.
Indirect Taxes
21. The indirect tax collections has shown a turnaround in the current fiscal and are likely to exceed
the 2015-16 Budget Estimate by a healthy margin. Indirect tax collections, during the period April to
January of financial year 2015-16 have shown a growth of about 34 per cent over the corresponding
period in previous year, partly on account of additional resource mobilization measures taken during
2014 and 2015, and partly on the back of underlying growth in overall economy.
22. With growth in indirect tax collections, the Indirect Tax to GDP ratio for 2015-16 would be about
5.2 per cent, as compared to about 4.4 per cent for 2014-15. This is largely on account of widening of
the tax base by comprehensive taxation of all services (except those in the Negative List or otherwise
exempt), increase in excise duty on petrol and diesel and pruning of exemptions in Customs, Central
Excise and Service Tax. In addition to the above, use of information technology, audits, speedier
adjudications, liquidation of arrears, speedy disposal of confiscated/ seized goods etc. has also
contributed to the indirect tax revenue collection growth.
23. Service Tax
23.1 In the Union Budget, 2015-16 the proposals have been made to increase the indirect tax-GDP
ratio by pruning the negative list and withdrawal of certain exemptions with regard to service tax.
23.2 The Service Tax rate was increased from 12 per cent plus Education Cesses to 14 per cent. The
Education Cess and Secondary and Higher Education Cess were subsumed in the revised rate of
Service Tax. Thus, effective increase in Service Tax rate was from 12.36 per cent (inclusive of cesses)
to 14 per cent. The new Service Tax rate came into effect from 1st June, 2015.
23.3 An enabling provision was made to empower the Central Government to impose a Swachh
Bharat Cess on all or any of the taxable services at a rate of 2 per cent of the value of such taxable
services with the objective of financing and promoting Swachh Bharat initiatives. This Cess was
levied from 15th November, 2015 at the rate of 0.5 per cent on taxable value of all taxable services
which were not covered in negative list or were not otherwise exempt.
23.4 Service Tax was levied on the service provided by way of access to amusement facility providing
fun or recreation by means of rides, gaming devices or bowling alleys in amusement parks,
amusement arcades, water parks, theme parks or such other places.
23.5 Service Tax was levied on service by way of admission to entertainment event of concerts,
nonrecognized sporting events (commercial sporting events), pageants, music concerts, award
functions, if the amount charged is more than `500 for right to admission to such an event.
23.6 The entry in the Negative List that covers service by way of any process amounting to
manufacture or production of goods was pruned to exclude any service by way of carrying out any
processes for production or manufacture of alcoholic liquor for human consumption. Consequently,
Service Tax was levied on contract manufacturing/job work for production of potable liquor for a
consideration with effect from 1st June, 2015.
23.7 Presently, services provided by the Government or a local authority, excluding certain specified
services, are in the Negative List. Service tax was applicable on the support service provided by the
Government or local authority to a business entity. An enabling provision was made in Finance Act,
2015, to exclude all services provided by the Government or local authority to a business entity from
the Negative List. These amendments have been notified and shall come into effect from 01.04.2016.
Thus, all services provided by the Government or local authority to a business entity, except the
services that are specifically exempted, or covered by any other entry in the Negative List, shall be
liable to Service Tax.
23.8 Exemption to construction, erection, commissioning or installation of original works pertaining
to an airport or port has been withdrawn. The other exemptions covered under S.No.14 of
notification No. 25/12-ST shall continue unchanged.
23.9 Exemptions has been withdrawn on the following services:
(a) services provided by a mutual fund agent to a mutual fund or assets management
company,
(b) distributor to a mutual fund or AMC,
(c) selling or marketing agent of lottery ticket to a distributor. Service tax on these services has
been levied on reverse charge basis.
23.10 In Budget 2016-17, some of the measures taken for resource mobilization on the service tax side
include,-
(a) An enabling provision has been made in the Finance Bill, 2016 to levy Cess on all taxable
services to finance and promote initiatives to improve agriculture. This cess shall come into force on
1st June, 2016 after enactment of the Finance Bill, 2016.
(b) Exemption on services provided by,- (i) a senior advocate or a partnership firm of
advocates to an advocate or partnership firm of advocates providing legal service; and (ii) a person
represented on an arbitral tribunal to an arbitral tribunal, is being withdrawn; and levy service tax
under forward charge
(c) Exemption to construction, erection, commissioning or installation of original works
pertaining to monorail or metro, in respect of contracts entered into after 1st March 2016 is being
withdrawn.
(d) Exemption to the services of transport of passengers, with or without accompanied
belongings, by ropeway, cable car or aerial tramway is being withdrawn.
(e) The Negative List entry that covers service of transportation of passengers, with or without
accompanied belongings, by a stage carriage is being omitted to levy Service Tax on the services
provided by way of transportation of passengers by air conditioned stage carriage only, at the same
level of abatement as applicable to the transportation of passengers by a contract carriage i.e. 60 per
cent without credit of inputs, input services and capital goods.
23.11 Measures are being taken to boost construction sector, promote affordable housing, promote
social security and moving towards a pensioned society. Efforts are also being made to reduce
litigation and provide certainty in taxation, ease of doing business, skill development and promote
make in India. A number of rationalization measures have also been taken.
24. Customs and Central Excise: 24.1 In order to achieve fiscal consolidation, the following measures
are proposed in the Budget 2016-17:
Clean Energy Cess [being renamed as Clean Environment Cess] levied on coal, lignite and
peat is being increased from `200 per tonne to `400 per tonne.
Infrastructure Cess @ 4 per cent is being levied on certain specified motor vehicles.
Excise duty on Aerated waters, lemonade and other waters, containing added sugar or other
sweetening matter or flavoured is being increased from 18 per cent to 21 per cent.
Additional Excise Duty on cigarettes is being increased on non-filter and filter cigarettes of
various lengths so that the aggregate of duties of excise on such cigarettes increases by about 10 per
cent.
Specific rates of Excise duty on Cigar and cheroots, Cigarillos, Cigarettes of tobacco
substitutes, Cigarillos of tobacco substitutes and other forms of tobacco substitutes is being increased
by about 10 per cent
Excise duty on Gutkha, chewing tobacco (including filter khaini) and jarda scented tobacco is
being increased from 70 per cent to 81 per cent, Excise duty on Unmanufactured tobacco is being
increased from 55 per cent to 64 per cent and Excise duty on pan masala is being increased from 16
per cent to 19 per cent. Accordingly, the deemed production and the duty payable per machine per
month for each of these tobacco products is being notified.
Excise duty on Aviation turbine fuel [ATF], other than for supply to aircraft under the
Regional Connectivity Scheme, is being increased from 8 per cent to 14 per cent.
Excise duty of 2 per cent (without CENVAT credit) and 12.5 per cent (with CENVAT credit) is
being imposed on branded readymade garments and made up articles of textiles of retail sale price of
Rs.1000 or more. Also, the tariff value is being increased from 30 per cent of the retail sale price to 60
per cent of the retail sale price.
Excise duty of 1 per cent (without CENVAT credit) and 12.5 per cent (with CENVAT credit) is
being imposed on Articles of Jewellery [excluding silver jewellery, other than studded with
diamonds/other precious stones].
Basic Customs Duty on Cashew nuts in shell is being increased from Nil to 5 per cent.
Direct Taxes
25. The Government policy on direct taxes has been to achieve growth in direct taxes by broadening
the tax base while maintaining a regime of moderate tax rates. Tax collection is the product of two
factors tax rates and tax base. There will be no change in; the rate of personal income tax and the
rate of tax for foreign companies in respect of income earned in the financial year 2016-17. However,
it is proposed that in the case of domestic companies having total turnover or gross receipts not
exceeding ` 5 crore in the financial year 2014-15, the income-tax shall be charged @ 29 per cent.
Besides, the domestic companies incorporated on or after 1st March, 2016 and engaged solely in
manufacture and production of articles and things, may, at their option, pay tax @ 25 per cent if they
do not claim any accelerated depreciation, investment allowance, profit linked deductions and
investment linked deductions. All other domestic companies shall be liable to tax @ 30 per cent in
respect of income earned in the financial year 2016-17, assessable in the assessment year 2017- 18.
26. It is further proposed that surcharge in the case of individuals, HUF, association of persons, body
of individuals and artificial persons, shall be increased from 12 per cent to 15 per cent if their total
income exceeds `1 crore. In all other cases the rate of surcharge shall continue to be the same as in the
financial year 2015-16.
27. The widening of tax base to achieve growth in tax collection is a continuous process which
involves both legislative as well as administrative measures. The major policy proposals in the Union
Budget 2016-17, intended to broaden the tax base and augment revenue, are as under :-
It is proposed to provide for additional chargeability of income exceeding ` ten lakh by way
of dividentd @ 10 per cent in the hands of shareholders being individuals/ HUFs/ firms.
In order to bring High Value Transactions in tax net & check cash economy, it is proposed to
levy Tax Collection at Source (TCS) on purchase of motor vehicles of value exceeding `10 lakh and
purchase in cash of any goods and services exceeding two lakh rupees.
To provide equalization levy @ 6 per cent of the amount of consideration for specified
services received or receivable by a nonresident not having Permanent Establishment (PE) in India,
from a resident in India who carries out business and profession or from a Non-Resident having PE
in India.
To provide that additional tax at maximum marginal rate shall be levied on the accreted
income represented by net assets on the date of conversion of a trust or institution from charitable
organization to a noncharitable one.

28. The administrative and technological initiatives to augment revenue are as under:-
A non-adversarial and non-intrusive tax regime to enhance ease of doing business is being
promoted through modernization of the business processes of tax administration. Extensive use of
information technology is being made for e-enablement of tax payer services. Filing of income tax
returns, various forms, audit reports, statements of tax deduction at source have been made
compatible with electronic filing and computerized processing. Concept of paperless assessment has
been introduced on pilot basis in order to minimize human interface of Income-tax department with
taxpayer in select Metros. Further, e-sahyog initiative has been launched to provide an online
mechanism to resolve mismatch without requiring taxpayers to attend the income tax office.
The e-filing portal of the Department has been very successful where the number of
registered users on the portal have gone upto 4.95 crore on 31st December, 2015. Electronic
Verification of Returns (EVC) as an alternative to verification by physical submission of signed ITR-V
by the taxpayers has been provided where the taxpayer can verify his return through internet
banking or AADHAAR based authentication process.
The non-filers Monitoring System (NMS) is a project undertaken by Income Tax Department
to prioritize action on non-filers with potential tax liabilities. Based on specific information available
in AIR, CIB data and TDS/ TCS returns, NMS cycle 1(2013), Cycle 2(2014) and Cycle 3(2015)
identified 12.19 lakh, 22.09 lakh and 44.07 lakh nonfilers, respectively, with potential tax liabilities.
The project led to collection of total tax amounting to `10,439.11 crore till date.

29. There has been increase in the direct tax collection during the year 2014-15 though at a lower rate
compared to 2013-14. The personal income-tax has shown a higher growth as compared to the
corporate income-tax. The personal income-tax increased by 9.16 per cent, whereas the corporate
income-tax showed a growth of 8.67 per cent.

(2) Expenditure Policy


30. There has been a wide debate within and outside the Government on whether the Government
should stick to the fiscal consolidation roadmap or allow for a relaxation keeping in view the needs of
higher levels of public expenditure. However, any attempt to raise fiscal deficit has to be viewed in
the larger monetary policy context of impact on policy rates. Keeping in view the negative fallouts of
higher Government borrowings on private investments and growth, the Government has decided to
stick with the existing fiscal consolidation roadmap.
31. While continuing on the path of fiscal consolidation, the expenditure policy of the Government in
2016-17, reflects a continuance of the policy of expenditure rationalization. The Government has also
tried to maintain an optimum balance between the revenue and capital and developmental plan and
non-plan components of expenditure. Total expenditure in BE 2016-17 is estimated to grow by 10.8
per cent over RE 2015-16. The plan expenditure within this has been given a higher growth of 15.3 per
cent. The details on the revenue-capital correction has already been discussed in the Medium-term
Fiscal Policy (MTFP) Statement. Growth in the non-plan revenue component has been controlled
despite additional provisions made for implementation of VII Central Pay Commission
recommendations and One Rank One Pension (OROP) in Defence Services.
32. On the non-plan side, rationalization of expenditure on major subsidies continues to be critical to
achieve the goal of fiscal consolidation. Expenditure on major subsidies with various initiatives in the
pipeline, is estimated to reduce to about 1.5 per cent of GDP in 2016-17 compared to 1.7 per cent of
GDP in RE 2015-16. Various initiatives of the Government to rationalize expenditure on Major
subsidies such as Direct Benefit Transfer (DBT), reforms in LPG subsidies as well as in the fertilizer
sector are also underway. It is expected that expenditure on major subsidies as a percentage of GDP
will further come down in future.
33. The exercise of rationalization of plan schemes was carried out during the year in consultation
with the Ministries/Departments for reducing the number of schemes to a fewer and outcome based
umbrella schemes. Further, in the backdrop of the implementation of the recommendations of the
14th Finance Commission, a Sub-Group of Chief Ministers on rationalization of Centrally Sponsored
Schemes was constituted by NITI Aayog. Based on its recommendations, the Government has
decided that the funding pattern of core of the core schemes will be retained on the existing sharing
pattern. The sharing pattern of the core schemes which form part of the National Development
Agenda, will be at 60:40 except for 8 North-Eastern and 3 Himalayan States for whom it has been
kept at 90:10. All other schemes have been kept in the Optional category with a sharing pattern of
50:50. For the Union Territories, the Centrally Sponsored Schemes will be funded 100 per cent by the
Central Government. The Government has also decided that from 2016-17 onwards, the
schemes/projects of national importance such has National Aids and STD Control Programme,
Pradhan Mantri Kaushal Vikas Yojana, programme with network externalities like Crime and
Criminal Control Network will be run as a Central Sector Scheme.

(3) Government Borrowings, Lending and Investments


34. In 2015-16, net market borrowings through dated securities at `4,56,405 crore were budgeted to
finance 82.1 per cent of Gross Fiscal Deficit (GFD). Other sources of financing were treasury bills,
external assistance, state provident funds, National Small Savings Fund (NSSF), etc. Total borrowing
requirement for 2016-17 has been budgeted at `6,00,000 crore. Net market borrowings of `4,26,670
crore through dated securities has been budgeted to finance nearly 80 per cent of GFD. A provision of
` 16,649 crore is also made to be realised through treasury bills. Thus, in terms of both the short-term
and medium term debt financing, the borrowings strategy during 2016-17 will continue to rely on
market oriented domestic sources with external sources financing only ***per cent of the fiscal deficit.
35. Prudent debt management is corner stone of good economic policy. Experience in other part of the
world has shown that vulnerability of debt profile to international shocks needs to be closely
monitored in emerging global economic order. In India, debt policy is driven by the principle of
gradual reduction of public debt to GDP ratio so as to further reduce debt servicing risk and create
fiscal space for other/developmental expenditure. The debt policy emphasizes maintaining stable,
low cost and prudent debt structure. Further, GoI in consultation with RBI have used marketoriented
active debt management since 2013-14 in the form of buyback and switching of shorter tenor G-
securities with longer tenors G-securities, with an objective to smoothen redemption pressure, reduce
rollover risk as well as utilizing the cash surplus.
36. One of the key features on countrys debt profile is diminishing proportion of external debt as
percentage of total liabilities of Central Government, which stands at 6.2 per cent as on March 31,
2015. Further, external borrowing is limited to multilateral/ bilateral loans from select development
partners and, thus, not exposed to reversal of capital flows and insulates the debt portfolio of the
Government from volatilities in international capital markets. However, low interest rates in the
international financial markets has provided the Government with an option to explore other sources
of external debt. The decision to issue foreign currency denominated sovereign bonds cannot be
based on cost considerations alone and will need to be assessed in the context of overall savings and
investment requirements of the economy.
37. The rollover risk in the Government debt portfolio continues to be low with weighted average
maturity of outstanding dated securities remaining close to 10.38 years as on February 29, 2016. This
is high compared to international standards. The weighted average yield of dated securities issued
during 2015-16 stood at 7.89 per cent as compared to 8.51 per cent during 2014-15, indicating lower
yield environment with falling inflation rates. The increased maturity of primary issuances without a
substantial increase in borrowings costs also reflects the greater demand for longer tenor securities
(by insurance companies and provident funds), which will continue to support the Government
efforts to elongate its maturity profile in the medium term.
38. Developing a liquid and vibrant secondary market for Government securities and broadening the
investor base are the key factors to ensure that debt is raised in a cost effective manner. Primary
issuance strategy of the Government remains focused on issuing new securities under benchmark
maturities and building volumes under existing securities to improve liquidity in the secondary
market. Broadening of investor base is another key factor in the stability of demand for Government
securities. With an objective of having a more predictable regime for investment by the foreign
portfolio investors (FPI), RBI, in consultation with the Government, has set out the medium term
framework (MTF) for FPI limits in Government securities. Accordingly, FPI investment is expected to
increase to 5 per cent of outstanding stock of Government securities by March 2018. Gold Schemes
launched by Government of India in November, 2015 has further broadened investment choice and
diversified investor base through increased participation of retail investors.
39. The Government is also moving toward alignment of administered interest rates with the market
rates. Interest rates on small savings are now linked with yields in secondary market for dated
securities.

(4) Contingent liabilities


40. In terms of Article 292 of the Constitution, Central Government gives guarantee for the repayment
of borrowings upon the security of the Consolidated Fund of India. The FRBM Rules prescribe a
ceiling of 0.5 per cent of GDP for incremental guarantees that the Government can assume in a
particular financial year. The Central Government extends guarantees primarily for the purpose of
improving viability of projects or activities undertaken by the Government entities with significant
social and economic benefits, as well as to fulfill the requirement in cases where sovereign guarantee
is a precondition for bilateral/multilateral assistance.
41. FRBM ceiling on guarantees which can be assumed by Government during a financial year has
resulted in reduced contingent liability to GDP ratio. The Ratio which stood at 3.3 per cent in 2004-05
is now reduced to 2.73 per cent in 2014-15. The disclosure statement on outstanding Guarantees as
prescribed in FRBM Rules, 2004 is appended in the Receipt Budget at Annex 5(iii). During the year
2014-15, net accretion to the stock of guarantees was Rs.41,456.13 crore, amounting to 0.33 per cent of
GDP, which is within the limit of 0.5 per cent set under the FRBM Rules.

C. Strategic priorities for ensuing year


42. The fiscal policy strategy on the receipts side in 2016-17, and in the medium term projection
period, rests primarily on augmentation of the Centres nontax revenues and non-debt capital
receipts. On the non-tax revenues, Budget 2016-17 provides for an increase of 25 per cent over RE
2015-16. As a result, the share of non-tax revenues as a percentage to GDP, is estimated to increase
from 1.9 per cent in RE 2015-16 to 2.1 per cent in BE 2016-17. To achieve these targets of NTR,
Government has already initiated some measures and others are expected to be implemented during
the course of next year.
43. To enhance revenues from dividends, Government has already taken action by making the rate of
dividend at 30 per cent applicable for all public sector enterprises. A majority of PSEs which were
paying dividend at 20 per cent will now pay 33 per cent higher dividends. Higher dividends can also
be taken if they do not have any significant capex plans. Further, with the huge shelf of spectrums
due for auction in 2016-17, substantially higher collections from telecom receipts are estimated next
year as well as in the medium term. There is also, substantial scope to enhance non-tax revenues
through increase in user fees/charges etc. The Government will take measures for optimal rate
revisions on products and services provided by the Government and its agencies. The rate revisions
will be carried out in consultation with concerned Ministries/Departments, while keeping in
consideration the social obligation needs of the Government. In the medium term therefore, the
growth in net revenues of the Centre relies substantially on the enhancement of the nontax revenues,
in particular, through receipts from spectrum auctions. This will provide a cushion till the tax to GDP
ratio achieves a higher growth trajectory.
44. Receipts from disinvestment of Government stake in PSUs have been estimated at Rs.56,500 crore
in BE 2016-17. This includes Rs.20,500 from strategic sale of assets. It is expected that with likely
recovery in the market conditions and new policy to be unveiled soon in this regard, the Government
will be able to carry out the targeted disinvestments/sale of assets in 2016-17.

(2) Broad principles underlying expenditure management


45. While Government has managed to control the expenditure through rationalization in the fiscal
consolidation phase, quality of expenditure remains an area that needs to be addressed. The ongoing
fiscal consolidation has been successful in taming the fiscal deficit; however the public finance on the
revenue side requires attention in the view of accomplishment of target set for the revenue deficit and
effective revenue deficit under the FRBM regime. This entails structural changes in the Plan spending
and definitive measures to contain Non-Plan spending within sustainable limits.
46. The Government has already started the process of outcome based budgeting by creation of two
separate verticles of capital expenditure and admin expenditure in every proposed scheme/project so
that tangible outcomes and physical progress can be measured. As already explained, a Sub-Group of
Chief Ministers on rationalisation of Centrally Sponsored Schemes was constituted by NITI Aayog.
Based on its recommendations, the Government has decided that the funding pattern of core schemes
viz., Krishi Vikas Yojana, Pradhan Manti Krishi Sinchai Yojana, National Health Mission, ICDS, etc.,
which form part of National Development Agenda, will be shared 90:10 for 8 North-Eastern and 3
Himalayan States and 60:40 between the Centre and the States. The Government has also decided
that from 2016-17 onwards, the schemes/projects of national importance like National Aids and STD
Control Programme, Pradhan Mantri Kaushal VikasYojana, programme with network externalities
like Crime and Criminal Control Network will be run as a Central Sector Scheme.
47. Widening and deepening of Direct Benefit Transfer (DBT) is another major reform area where
cash/ benefits are transferred directly in the bank accounts of beneficiaries, cutting several layers in
the delivery process. It makes a strategic shift in the subsidy delivery to the citizens of India. DBT
envisages achieving accurate targeting of beneficiaries, deduplication and reduction of fraud,
efficiency in delivery process, ensuring greater inclusion, elimination of waste, curbing leakage; and
thereby controlling expenditure with greater accountability and transparency. Thus, it intends to
reduce subsidy burden on exchequer and improve fiscal management.
48. Direct Benefit Transfers was rolled out in 121 districts for 27 selected Central Sector (CS) and
Centrally Sponsored Schemes (CSS) w.e.f. 1.1.2013 in phased manner. DBT in LPG (DBTL) was
launched on 1.6.2013. In December, 2014 DBT was extended across the country of 27 schemes and 8
new schemes including MGNREGA (for 300 selected districts) were brought on DBT platform. In
February, 2015 DBT was universalized to include all Central Sector/Centrally Sponsored Schemes of
all Ministries/Departments, where cash is transferred to individual beneficiaries. In the financial year
2015-16 (upto 31.12.2015), approximately 29.59 crore beneficiaries in various Government schemes
were paid Rs.44,035.21 crore through 103.43 crore transactions on DBT platform.
49. PAHAL a scheme for direct transfer of LPG subsidy to consumers has also been highly
successful in terms of de-duplication, accurate targeting and savings in administrative expenditure.
In MGNREGS about 96 per cent of scheme payment is on DBT mode. Cash transfer of Food subsidy
is being implemented on pilot basis in Union Territories of Chandigarh and Puducherry. Nine State
Governments have come forward to implement DBT in Kerosene in selected districts. With a view to
incentivize States/ UTs to implement DBT in Kerosene, it has been decided that the States will be
given cash incentives of 75 per cent of subsidy savings during the first two years, 50 per cent in the
third year and 25 per cent in the fourth year. Implementation of DBT has resulted in streamlining the
subsidy regime by simplifying the process, transferring benefits directly in the bank accounts of the
beneficiaries, del-duplication and elimination of fake /ghost beneficiaries thus bringing transparency
in the system. These initiatives will be further expanded during 2016-17.

D. Policy Evaluation
53. In 2015-16, the fiscal performance of the Government has been better than estimated on all
parameters. This has reinforced the belief in the fiscal policy strategy adopted by the Government,
which entailed fiscal consolidation along with corrections on revenue-capital imbalance. Government
successfully managed to contain itself within the lower fiscal deficit in nominal terms. In the bargain,
the FRBM targets on revenue/effective revenue deficit which appeared insurmountable till recently,
now appears to be within the striking range. It is estimated that with the continuance of the policy in
2016-17, the Government will be finally able to achieve all the FRBM targets within the stipulated
timeframe of 2017-18.
54. The real GDP growth of 7.6 per cent in 2015- 16 despite weak global demand and private
investments is indicative of the robustness of the macroeconomic fundamentals. Fiscal policy of the
Government in 2016-17, will continue to remain supportive. The enhanced level of public
investments targeted in 2016-17 in the major infrastructure sectors of power, railways, highways,
rural roads, waterways as well as in other focus areas of drinking water and sanitation, will continue
to create a more conducive environment for higher economic growth next year. With a more
conducive global economic environment and restoration of the domestic private sector confidence,
investments and growth in the Indian economy has the potential to scale new heights.
55. In conclusion, the fiscal outlook for 2016-17, seeks to achieve a much larger consolidation even
while providing for substantially higher revenue expenditure requirements on salaries and pensions.
However, there are some downside risks. To alleviate these risks, the Government will need to
deliver on the initiatives rolled out on non-tax revenues, carry out disinvestments/strategic sale of
assets as per the estimated targets and above all, ensure going through with the spectrum auctions, at
least in a phased manner.

Fiscal Responsibility and Budget Management Act (FRBMA) 2003


Under the Fiscal Responsibility and Budget Management Act (FRBMA) 2003, both the Centre and
States were supposed to wipe out revenue deficit and cut fiscal deficit to 3% of GDP by 2008-09, thus
bringing much needed fiscal discipline. Originally, the FRBM bill had given annual numerical targets
as well. But in the process of making it a law, the annual targets were dissolved and the act simply said
that the Centre will take appropriate measures to eliminate revenue deficit by March 31, 2008. The act
left the annual numerical targets to be formulated by the Central Government in the form of FRBM
rules under the FRBM Act 2000. However, the NDA government (which passed this act) was replaced
by UPA in 2004. The UPA-I Government notified the FRBM Rules in July 2004. As Parliament is the
supreme legislative body, the Act and the Rules legally bind the Finance Ministers and Governments.
The key provisions of the Act as well as FRBM rules are as follows: Every year the government will
bring down revenue deficit by 0.5% and eliminate it by 2007-08. Every year, the government will bring
down fiscal deficit by 0.3% and bring it down to 3% by 2007-08. Total liabilities of the Union
Government should not rise by more than 9% a year. Union Government would not give guarantee to
loans raised by PSUs and State governments for more than 0.5% of the GDP in aggregate. Union
Government would place three more documents along with the budget documents viz.
Macroeconomic Framework Statement, Medium Term Fiscal Policy Statement and the Fiscal Policy
Strategy Statement. At the end of second quarter, the Finance Minister would make a statement on the
trend of fiscal indicators and corrective measures taken thereof.
-----------------=-------------------------------=-----------------------=------------------------=-------------------=----------
What is the FRBM Act?
The Fiscal Responsibility and Budget Management Act was enacted by Parliament in 2003 to bring in
fiscal discipline. It received the Presidents assent in August the same year. The United Progressive
Alliance (UPA) government had notified the FRBM Rules in July 2004. As Parliament is the supreme
legislative body, these will bind the present finance minister P Chidambaram, and also future finance
ministers and governments.

How will it help in redeeming the fiscal situation?


The FRBM Rules impose limits on fiscal and revenue deficit. Hence, it will be the duty of the Union
government to stick to the deficit targets. It also empowers RBI for taking measures to control
Inflation. The Act also provide exception to government in case of natural calamity and national
security.

As per the initial targets, revenue deficit, which is revenue expenditure minus revenue receipts, have
to be reduced to nil in five years beginning 2004-05. Each year, the government is required to reduce
the revenue deficit by 0.5% of the GDP. The fiscal deficit is required to be reduced to 3% of the GDP
by 2008-09.It would mean reduction of fiscal deficit by 0.3 % of GDP every year. The implementation
of Act was put on hold in year 2007-08 due to global financial crisis and the need for fiscal stimulus.
In 2012 FRBM Act was amended and it was decided that the FRBM would target effective revenue
deficit in place of revenue deficit.

How are these targets monitored?


The Rules have mid-year targets for fiscal and revenue deficits. The Rules required the government to
restrict fiscal and revenue deficit to 45% of budget estimates at the end of September (first half of the
financial year).

-------------------------------=--------------------------------=----------------------------------=--------------------------------
--------
Amendments to the FRBM Act were introduced subsequent to the recommendations of 13th Finance
Commission.
Concept of Effective Revenue Deficit and Medium Term Expenditure Framework statement are
the two important features of amendment to FRBM Act in the direction of expenditure reforms.
Effective Revenue Deficit is the difference between revenue deficit and grants for creation of capital
assets. This will help in reducing consumptive component of revenue deficit and create space for
increased capital spending. Effective revenue deficit has now become a new fiscal parameter.
Medium-term Expenditure Framework statement will set forth a three-year rolling target for
expenditure indicators.
As per the amendments in 2012, the Central Government has to take appropriate measures to reduce
the fiscal deficit, revenue deficit and effective revenue deficit to eliminate the effective revenue deficit
by the 31st March, 2015 and thereafter build up adequate effective revenue surplus and also to reach
revenue deficit of not more than 2 % of Gross Domestic Product by the 31st March, 2015 and
thereafter as may be prescribed by rules made by the Central Government.
Further, the Central Government may entrust the Comptroller and Auditor-General of India to
review periodically as required, the compliance of the provisions of FRBM Act and such reviews shall
be laid on the table of both Houses of Parliament.
Vide the Finance Act 2015, the target dates for achieving the prescribed rates of effective deficit and
fiscal deficit were further extended. The effective revenue deficit which had to be eliminated by
March 2015 will now need to be eliminated only after 3 years i.e., by March 2018. The 3% target of
fiscal deficit to be achieved by 2016-17 has now been shifted by one more year to the end of 2017-18.
In the Union Budget 2016-17 it was proposed to constitute a Committee to review the
implementation of the FRBM Act and give its recommendations on the way forward. This was in
view of the new school of thought which believes that instead of fixed numbers as fiscal deficit
targets, it may be better to have a fiscal deficit range as the target, which would give necessary policy
space to the Government to deal with dynamic situations. There is also a suggestion that fiscal
expansion or contraction should be aligned with credit contraction or expansion respectively, in the
economy. While remaining committed to fiscal prudence and consolidation, Budget stated that a time
has come to review the working of the FRBM Act, especially in the context of the uncertainty and
volatility which have become the new norms of global economy.
The Union Cabinet chaired by the Honble Prime Minister on 6 April 2016 gave its approval to
Recommendations on Fiscal Deficit Targets and Additional Fiscal Deficit to States during Fourteenth
Finance Commission (FFC) award period 2015-20 under the two flexibility options recommended in
para 14.64 to 14.67 of its Report (volume I). FFC has adopted the fiscal deficit threshold limit of 3
per cent of Gross State Domestic Product (GSDP) for the States. Further, FFC has provided a year-to-
year flexibility for additional fiscal deficit to States. FFC, taking into account the development needs
and the current macro- economic requirement, provided additional headroom to a maximum of 0.5
per cent over and above the normal limit of 3 per cent in any given year to the States that have a
favourable debt-GSDP ratio (means if debt-GSDP is not more than 25%, then an additional 0.25%
fiscal deficit can be afforded) and interest payments-revenue receipts ratio (means if IP-RR is not
more than 10%, then an additional 0.25% fiscal deficit can be afforded) in the previous two years.
However, the flexibility in availing the additional fiscal deficit will be available to State if there is no
revenue deficit in the year in which borrowing limits are to be fixed and immediately preceding year.
If a State is not able to fully utilize its sanctioned fiscal deficit of 3 per cent of GSDP in any particular
year during the 2016-17 to 2018-19 of FFC award period, it will have the option of availing this un-
utilized fiscal deficit amount (calculated in rupees) only in the following year but within FFC award
period.
Further, the Government of India launched the scheme Ujwal DISCOM Assurance Yojana
(UDAY) for the financial and operational turnaround of state-owned Power Distribution Companies
(DISCOMs) in 2015. The scheme aims to reduce interest burden, reduce the cost of power, reduce
power losses in Distribution sector, and improve operational efficiency of DISCOMs. The scheme also
incentivizes the States by exempting State takeover of DISCOM debts from FRBM limits for two
years. [Under UDAY, States shall take over 75% of DISCOM debt as on 30 September 2015 over two
years - 50% of DISCOM debt shall be taken over in 2015-16 and 25% in 2016-17. Government of India
will not include the debt taken over by the States as per the above scheme in the calculation of fiscal
deficit of respective States in the financial years 2015-16 and 2016-17. States will issue bonds in the
market or directly to the respective banks / Financial Institutions (FIs) holding the DISCOM debt to
the appropriate extent. DISCOM debt not taken over by the State will be converted by the Banks / FIs
into loans or bonds with interest rate not more than the banks base rate plus 0.1%. Alternately, this
debt may be fully or partly issued by the DISCOM as State guaranteed DISCOM bonds at the
prevailing market rates which shall be equal to or less than bank base rate plus 0.1%. Further, States
have to take over the future losses of DISCOMs in a graded manner and shall fund them too.

------------------------------=-----------------------------------=------------------------------------=----------------------------
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Q. 2 : Explain the features of FRBM Bill 2003. OR
Write note on FRBM Bill.
Ans. A. FISCAL RESPONSIBILITY AND BUDGET MANAGEMENT BILL (FRBM) :-
In order to bring fiscal discipline and to implement a prudent fiscal policy the government
introduced the Fiscal Responsibility and Budget Management Bill 2000. The bill became an Act in
August, 2003. The FRBM Act 2003 was further amended. The FRBM Act 2003 (as amended) became
effective from 5th July 2004.
The main objectives of this Bill /Act are
1) To reduce fiscal deficit.
2) To generate revenue surplus.
3) To adopt prudent debt management.
B. FEATURES OF FRBM BILL / ACT
1. Revenue Deficit
The revenue deficit should be reduced to an amount equivalent to 0.5% or more of GDP every
year, beginning with in the financial year according to FRBM Rules 2004. Further FRBM Act, 2003
states that appropriate measures should be taken to eliminate revenue deficit by March, 2009, and
thereafter build a adequate revenue surplus.
2. Fiscal Deficit
The fiscal deficit should be reduced to 0.3% or more of the GDP every year, beginning with the
financial year 2004-05. The fiscal deficit should be brought down to 3% of GDP by March 2009.
3. Government Guarantees
The Central Government should not provide guarantees in excess of 0.5% of GDP in any financial
year, beginning with 2004-05. (For Eg. Guarantees for loans borrowed by State Governments, Public
Corporations etc.)
4. Additional Liabilities :-
The FRBM Rules 2004 states that the Central Government should not assume additional liabilities
in excess of 9% of GDP for financial year 2004-05 and progressive reduction of this limit by at least one
percentage point of GDP in each subsequent year.
5. Relaxation In Deficit Reduction Targets :-
The FRBM Act states that the revenue and fiscal deficit may exceed the targets specified in
Rules only on grounds of national security or national calamity or such other exceptional grounds as
the Central Government may specify.
6. RBI's Subscription To Government Securities :-
The RBI should not subscribe to primary issues of Central Government securities from the year
2006-07.
7. Transparency In Budgetary Process :-
The FRBM Act and Rules States that the Central Government should take suitable measures to
ensure greater transparency in fiscal operations. The Government is also required to submit
statements of receivables and guarantees and a statement of assets, at the time of presenting the
annual financial statement latest by Budget 2006-07.
8. Quarterly Reviews :-
The FRBM Act states that the Finance Minister to make a quarterly review of trends in receipts
and expenditure in relation to budget and place the outcome of such reviews before both the Houses
of Parliament.
9. Projection Of Fiscal Indicators :-
The FRBM Rules 2004 states that the Central Government should specify four fiscal indicators.
These are
a) Fiscal deficit as a percentage of GDP.
b) Revenue deficit as a percentage of GDP.
c) Tax revenue as a percentage of GDP.
d) Total outstanding liabilities as percentage of GDP.
10. Financial Statements
The Central Government should place in each financial year before houses of Parliament three
statements:-
a) Medium Term Fiscal Policy Statement.
b) Fiscal policy strategy statement.
c) Macro-economic Framework statement along with Annual Financial Statement and Demands
for
grants.
11. RBI Borrowings
The FRBM Act States that the Central Government shall not borrow from RBI except by way of
advances to meet temporary excess of cash disbursements over cash receipts.

Q.3: Evaluate the FRBM Act, 2003.


Ans. A) CRITICAL EVALUATION OF FRBM BILL 2003:-
Though the bill offers a credible commitment that the government is serious about reducing
fiscal deficit, yet it has certain limitations:-
1. Neglect Of Social Sector :-
The FRBM bill does not mention anything relating to social sector development. However,
investment in social sector such as health, education etc. is very important for the economic
development of the nation. (These notes are prepared by Kavita Coaching Classes).
2. Need To Increase Revenues :-
Revenue deficits are determined by the interplay of expenditures and revenues, both tax and
non-tax. Too often, attention gets focused only on expenditure side and revenue side is neglected.
Increasing non-tax revenue requires that public sector services be appropriately priced, which may be
difficult as the present society has got used to the subsidised education, health, food items etc.
3. Unfulfilled Targets :-
The FRBM Act required the government to reduce revenue deficit to zero by .March 2009, but
it increased to 4.4% of GDP during 2008-09 & further to 5.1% in 2009-10. Thus critics point out that the
targets set for deficit reduction are unrealistic.
4. Problem Of Subsidies :-
The government may be able to reduce revenue deficit by reducing subsidies. However, it is
quite likely that the government will be under severe pressure to continue the subsidies. This means,
the expenditure on productive areas may be reduced so as to accomodate subsidies, which in turn
would affect economic development of the nation.
5. False Assumptions :-
The FRBM Bill is based on the following assumptions :-
a) Lower fiscal deficit lead to higher growth.
b) Larger fiscal deficit lead to higher inflation.
c) Larger fiscal deficits increase external vulnerability of the economy.
These assumptions have been rejected by C. P. Chandrashekhar and Jayati Ghosh. They said
that the implementation of FRBM Bill will be detrimental to the material interest of most people. This
is because the reduction in public expenditure will affect growth and welfare.
6. Stable Growth Deficit :-
R. Chelliah points out that given the household financial savings in India, the overall fiscal
deficit termed as 'Stable Growth Deficit*, of Ibe government sector as a whole should be pegged at 6%
of GDP with revenue deficit being gradually phased out. Thus the target of 2% of fiscal deficit GDP
ratio stated in FRBM bill is not desirable from the view point of productive investment according to R.
Chelliah.
7. Neglect Of Development Needs :-
Today, the levels of capital expenditures by the government are miserably low in India. These
capital expenditures increase the efficiency and productivity of private investment and thus contribute
to the development process in the country. If Revenue Deficit is to be reduced to zero and GFD to 2%
of GDP as per the requirement of FRBM bill, it is the capital expenditure which will be sacrified and
thus will hinder further development of the country.
8. Non - Coverage Of State Governments :-
The provisions of the bill impose restrictions on only the Central Government but State
Governments are out of its scope. But, deficits of State Governments are as much or even a greater
problem. Hence, it will be necessary, if the start that has been made by FRBM bill is to be sustained,
then State Governments will also make similar commitments to pursue fiscal discipline.
9. Problem Of Quasi Deficits :-
Fiscal deficit is not a complete indicator of Government liabilities. For Eg.some of the PSUs
receive hidden subsidies from Government like oil bonds to oil and petroleum PSUs. These subsidies
are not shown in the budget, but they are the liabilities of Government. These are known as quasi-
deficits. Such deficits are beyond the scope of FRBM Act.
10. Creative Accounting :-
It is noted by the critics and IMF that the fiscal framework provided by FRBM bill may not
succeed as the budget rules can be by - passed by k: modifying accounting practices through creative
accounting.
B. CONCLUSION
The FRBM Act 2003 is a land mark legislative measure which can play an important role in
introducing fiscal discipline in future period of time.
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1. Current Ratio : It is the relationship between the current assets and current liabilities of a
concern.
Current Ratio = Current Assets/Current Liabilities
2. Net Working Capital : This is worked out as surplus of Long Term Sources over Long Tern
Uses, alternatively it is the difference of Current Assets and Current Liabilities.
NWC = Current Assets Current Liabilities
Current Assets : Raw Material, Stores, Spares, Work-in Progress. Finished Goods, Debtors, Bills
Receivables, Cash.
Current Liabilities : Sundry Creditors, Installments of Term Loan, DPG etc. payable within one year
and other liabilities payable within one year.

3. ACID TEST or QUICK RATIO : It is the ratio between Quick Current Assets and Current Liabilities.
The should be at least equal to 1.
Quick Current Assets : Cash/Bank Balances + Receivables upto 6 months + Quickly realizable
securities such as Govt. Securities or quickly marketable/quoted shares and Bank Fixed Deposits
Acid Test or Quick Ratio = Quick Current Assets/Current Liabilities
4. DEBT EQUITY RATIO : It is the relationship between borrowers fund (Debt) and Owners Capital
(Equity).
Long Term Outside Liabilities / Tangible Net Worth

Liabilities of Long Term Nature


Total of Capital and Reserves & Surplus Less Intangible Assets
5. PROPRIETARY RATIO : This ratio indicates the extent to which Tangible Assets are financed by
Owners Fund.

Proprietary Ratio = (Tangible Net Worth/Total Tangible Assets) x 100


The ratio will be 100% when there is no Borrowing for purchasing of Assets.
6. GROSS PROFIT RATIO : By comparing Gross Profit percentage to Net Sales we can arrive at the
Gross Profit Ratio which indicates the manufacturing efficiency as well as the pricing policy of the
concern.
Gross Profit Ratio = (Gross Profit / Net Sales ) x 100
Alternatively , since Gross Profit is equal to Sales minus Cost of Goods Sold, it can also be
interpreted as below :

Gross Profit Ratio = [ (Sales Cost of goods sold)/ Net Sales] x 100
7. OPERATING PROFIT RATIO :

It is expressed as => (Operating Profit / Net Sales ) x 100


Higher the ratio indicates operational efficiency
8. NET PROFIT RATIO :
It is expressed as => ( Net Profit / Net Sales ) x 100 It measures overall profitability.
9. STOCK/INVENTORY TURNOVER RATIO :
(Average Inventory/Sales) x 365 for days
(Average Inventory/Sales) x 52 for weeks
(Average Inventory/Sales) x 12 for months

Average Inventory or Stocks = (Opening Stock + Closing Stock)


-----------------------------------------
2

. This ratio indicates the number of times the inventory is rotated during the relevant accounting
period.
10. DEBTORS TURNOVER RATIO : This is also called Debtors Velocity or Average Collection
Period or Period of Credit given .
(Average Debtors/Sales ) x 365 for days
(52 for weeks & 12 for months)
11. ASSET TRUNOVER RATIO : Net Sales/Tangible Assets
12. FIXED ASSET TURNOVER RATIO : Net Sales /Fixed Assets
13. CURRENT ASSET TURNOVER RATIO : Net Sales / Current Assets
14. CREDITORS TURNOVER RATIO : This is also called Creditors Velocity Ratio, which determines
the creditor payment period.
(Average Creditors/Purchases)x365 for days
(52 for weeks & 12 for months)
15. RETRUN ON ASSETS : Net Profit after Taxes/Total Assets

16. RETRUN ON CAPITAL EMPLOYED :


( Net Profit before Interest & Tax / Average Capital Employed) x 100

Average Capital Employed is the average of the equity share capital and long term funds provided
by the owners and the creditors of the firm at the beginning and end of the accounting period.
17. RETRUN ON EQUITY CAPITAL (ROE) :
Net Profit after Taxes / Tangible Net Worth
18. EARNING PER SHARE : EPS indicates the quantum of net profit of the year that would be ranking
for dividend for each share of the company being held by the equity share holders.
Net profit after Taxes and Preference Dividend/ No. of Equity Shares
19. PRICE EARNING RATIO : PE Ratio indicates the number of times the Earning Per Share is covered
by its market price.
Market Price Per Equity Share/Earning Per Share

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