Showing posts with label ECONOMIC GLOSSARY. Show all posts
Showing posts with label ECONOMIC GLOSSARY. Show all posts

Friday, January 25, 2013

Inventory Control Methods

There are many methodologies used for inventory control, here are those methods, along with their benefits and limitations:

Min-Max System: In this method, after a careful examination of you inventory needs, you set two lines – one at the top and one at the bottom of how much of each product you must keep on hand. When you reach the bottom line, you order enough of that product so you won’t go above the top line. As long as you’re somewhere in the middle, you’re okay.

Benefit: This method is simple and it makes the task of balancing inventory fairly straightforward.

Limitation: Its simplicity could lead to trouble because you might order too many products or run out before they arrive.

Two-Bin System: In this system, you have a main bin and a backup bin of products. You normally use the main bin, but once you run out and need to reorder, you use the backup bin to fill orders until the new products are received.

Benefit: You’ve always got spare products for emergencies and sudden rises in demand.

Limitation: The products in the backup bin could spoil or become obsolete unless they are cycled into the main bin every now and then. Also, you need to keep an eye on your carrying costs.

ABC Analysis: Separate your products into three groups: A, B and C. Expensive items go into A, less-expensive items go into B, and small parts and other inexpensive items go into C. This way, you can organize your data and know how long it will take to order different parts and products, based on which group they’re in.

Benefit: Now this is more like it. This system doesn’t set rigid standards on how many products to keep on hand; it simply tells you how long it will take to order those products. You can do the rest with the help of inventory control software.

Limitation: It still requires a lot of work to maintain healthy inventory levels.

Order-Cycling System: Forget constantly checking your inventory. This system lets you do inventory checks at set intervals (e.g. 30 days) and reorder products that are likely to run out by the next check.

Benefit: If you’re REALLY good at inventory management, you might be able to pull this off. It certainly doesn’t require as much time as other methods.

Limitation: This system is risky and costly! Doing a physical inventory check every 30 days or so will get expensive quickly. And there’s no margin for error on ordering the right amount of products at each check.

There you go! Now you can decide which of these inventory control methods will work best for your organization, depending on your size, products and needs.

Sunday, September 30, 2012

Financial Inclusion

Financial Inclusion is the process of ensuring access to appropriate financial products and services needed by all sections of the society in general and vulnerable groups such as weaker sections and low income groups in particular at an affordable cost in a fair and transparent manner by mainstream institutional players.
The vulnerable section in India today also accrue a major proportion of credit and other financial services and products from the uninstitutional players like local moneylenders etc. These players charge exorbitant interest rates, non transparent practices and other stringent terms and conditions on the financial services. The aim of financial inclusion is to provide access to institution credit and other financial services to the section which hitherto have remained outside the coverage of institutional players.

Extent of Financial Exclusion -Global
  • 2.5 billion Adults, just over half of world’s adult population, do not use formal financial services to save or borrow.
  • 2.2 billion of these unserved adults live in Africa, Asia, Latin America, and the Middle East.
  • Of the 1.2 billion adults who use formal financial services in Africa, Asia, and the Middle East, at least two-thirds, a little more than 800 million, live on less than $5 per day.
Hence, financial exclusion is not an India specific problem but a global one.

Extent of Financial Exclusion -India

  • In India, almost half the country is unbanked.
  • Only 55 per cent of the population has deposit accounts and 9 per cent have credit accounts with banks.
  •  India has the highest number of households (145 million) excluded from Banking. 
  • There was only one bank branch per 14,000 people.
  • In 6 lakh villages in India, rural branches of Schedule Commercial Banks including Regional Rural Banks number 33,495 only.
  • Only a little less than 20% of the population has any kind of life insurance and 9.6%  of the population has non‐life insurance coverage.
  • Just 18 per cent had debit cards and less than 2 per cent has credit cards.

Financial Inclusion- Need

  • It is now widely acknowledged that financial exclusion leads to non accessibility, non-affordability and non-availability of financial products. 
  • Limited access to funds in an underdeveloped financial system restricts the availability of their own funds to individuals and also leads to high cost credit from informal sources such as moneylenders.
  • Due to lack of access to a bank account and remittance facilities, the individual pays higher charges for basic financial transactions.
  • Absence of bank account also leads to security threat and loss of interest by holding cash. All these impose real costs on individuals.
  • Prolonged and persistent deprivation of banking services to a large segment of the population leads to a decline in investment and has the potential to fuel social tensions causing social exclusion.
Thus, financial inclusion is an explicit strategy for accelerated economic growth and is considered to be critical for achieving inclusive growth in the country.

Financial Inclusion – Steps Taken in the Past

  • Co-operative Movement
  • Setting up of State Bank of India
  • Nationalisation of banks
  • Lead Bank Scheme
  • Regional Rural Banks
  • Service Area Approach
  • Self Help Groups

Financial Exclusion –Why did the approach fail?

  • Absence of Banking Technology
  • Absence of Reach and Coverage
  • Absence of Viable Delivery Mechanism
  • Not having a Business Model
  • Rich have no compassion for poor

Current scenario w.r.t. Financial Exclusion

  • Focus on Inclusive Growth
  • Banking Technology has arrived
  • Realisation that Poor is bankable

The Indian Way- Multi Agency Approach

  • Financial Stability and Development Council (FSDC) mandated to focus on Financial Inclusion and Financial Literacy
  • Financial Sector Regulators including the Reserve Bank committed to FI Mission
  • Financial Inclusion is a mammoth task- financial services through mainstream financial institutions to 6 lakh villages

​Banking Correspondent Model

The Reserve Bank of India has initiated several policy measures to ensure financial inclusion and increase the outreach of the banking sector. A major initiative taken by the Bank in this direction is the introduction of the business correspondent model.
Under this model RBI has permitted banks to use the services of intermediaries such as business facilitators and correspondents to provide banking services for ensuring greater financial inclusion and increasing the outreach of the banking sector
By using the Information Technolgy now intermediaries are allowed to extend the banking services in the areas which are bankable. 

What has been done so far

  • ICT based Business Correspondent (BC) Model for low cost door step banking services in remote villages .
  • RBI Board approved Financial Inclusion Plans (FIPs) of banks for 3 years, starting April 2010 .
  • Roadmap to cover villages of above 2000 population by march 2012
  • Availability of minimum four banking products through ICT model has been ensured
  • Mandatory opening of 25 % of new branches in unbanked rural centers.
  • KYC documentation requirements significantly simplified for small account
  • Guidelines for convergence between Electronic Benefit Transfer and FIP have been issued.
  • Pricing for banks totally freed . Interest rates on advances totally deregulated.

Approach adopted by RBI- Some Specifics

  • Achieving planned, sustained and structured Financial inclusion.
  • Technology-To be fixed first
  1. ​All Bank branches must be on Core Banking Solution (CBS). All Regional Rural Banks (RRBs) to be on CBS by September 2011.
  2. Multi-channel approach (Handheld devices, mobiles, cards, Micro-ATMs, Branches, Kiosks, etc.)
  3. Front-end devices transactions must be seamlessly integrated with the banks’ CBS.

Coverage- Ensuring Transparency

What is meant by Banking Coverage?
A village is covered by banking service if either a bank branch is present or a Banking Correspondent is physically present or visiting that village.
Twin Aspects of Financial Inclusion
Financial Inclusion and Financial Literacy are twin pillars. While Financial Inclusion acts from supply side providing the financial market/services what people demand, Financial Literacy stimulates the demand side – making people aware of what they can demand.

Tuesday, August 7, 2012

India’s NSE became the World’s Largest Bourse in Equity Segment as per WFE’s Global Ranking

As per the latest global ranking compiled and published by the World Federation of Exchanges (WFE) in August 2012, the National Stock Exchange of India (NSE) become the world’s largest bourse in terms of the number of trades in equity segment for the first six months of 2012. A total of 735474 trades took place in the equity segment of NSE in the January-June period of 2012, making it the world’s largest exchange on this parameter. NSE was followed by NYSE Euronext and Nasdaq OMX at the second and the third positions.
Industry experts attributed the recent position of NSE acquired by the bourse to growing investor base, use of latest technology and new products. NSE's platform is connected to two lakh trading terminals in more than 2000 towns and cities across the country.
NSE is the second largest exchange globally after Korea Exchange for index options. Eurex was the third largest exchange worldwide in terms of total number of index options traded during the first six months of 2012.
BSE recorded a total of 187824 trades during this period in its equity segment. The total number of listed companies is much larger in case of the BSE, the exchange however lags behind NSE significantly in terms of volume and value of trades.
The latest data published by WFE indicated that investors from tier-three cities contributed more than 45 per cent of total cash market retail turnover in the financial year 2011- 12. The tier-three cities account for more than half of the total retail investor base on NSE platform.

Thursday, August 2, 2012

Credit Rating

Credit rating is done for debt instruments such as debentures, fixed deposits, commercial papers, bonds, etc.
The company which issues debt instruments is called an issuer or issuing company. The issuer, issues these instruments to collect finance from the investors.
The investor looks at the credit rating of the instrument and the issuer before investing. If the credit rating is a high, investor will invest in the company. That is, he will purchase the debentures, etc. issued by that company. If the credit rating is low, he will not purchase the debentures, etc. of that company. So, credit rating guides the investor while investing.
Credit rating is an opinion about a debt instrument and its issuer. It tells the investor, whether the debt instrument is safe or risky. That is, it tells whether the company will be able to pay the interest and repay the principal amount in time. Credit rating is only an opinion. It is not a recommendation. It does not ask an investor to buy, hold or sell an instrument.
So, credit rating is an opinion about the future ability and legal obligation of the issuer to make timely payments of principal amount and interest on their debt instruments. Credit rating is done by independent credit-rating agencies like S & P, which is based in USA, while CRISIL, CARE and ICRA Ltd., which are based in India. Credit rating is done by experts after examining various factors. The rating is expressed in alphabetical or alphanumeric symbols. For e.g. if the rating of debenture is AAA (Triple A), then it is considered to have the highest safety for the investor. However, if the credit rating is D, then the debenture is considered to be very risky for the investor. The issuing company asks the credit-rating agency to rate its instrument. This is done before issuing the instrument. The agency collects and studies information about the issuing company. Then it gives a rating for the instrument. This rating is not permanent. It is reviewed periodically.

Benefits of Credit Rating to Investors

The advantages, importance or benefits of credit rating to the investors are:
  1. Helps in Investment Decision : Credit rating gives an idea to the investors about the credibility of the issuer company, and the risk factor attached to a particular instrument. So the investors can decide whether to invest in such companies or not. Higher the rating, the more will be the willingness to invest in these instruments and vise-versa.
  2. Benefits of Rating Reviews : The rating agency regularly reviews the rating given to a particular instrument. So, the present investors can decide whether to keep the instrument or to sell it. For e.g. if the instrument is downgraded, then the investor may decide to sell it and if the rating is maintained or upgraded, he may decide to keep the instrument until the next rating or maturity.
  3. Assurance of Safety : High credit rating gives assurance to the investors about the safety of the instrument and minimum risk of bankruptcy. The companies which get a high rating for their instruments, will try to maintain healthy financial discipline. This will protect them from bankruptcy. So the investors will be safe.
  4. Easy Understandability of Investment Proposal : The rating agencies gives rating symbols to the instrument, which can be easily understood by investors. This helps them to understand the investment proposal of an issuer company. For e.g. AAA (Triple A), given by CRISIL for debentures ensures highest safety, whereas debentures rated D are in default or expect to default on maturity.
  5. Choice of Instruments : Credit rating enables an investor to select a particular instrument from many alternatives available. This choice depends upon the safety or risk of the instrument.
  6. Saves Investor's Time and Effort : Credit ratings enable an investor to his save time and effort in analyzing the financial strength of an issuer company. This is because the investor can depend on the rating done by professional rating agency, in order to take an investment decision. He need not waste his time and effort to collect and analyse the financial information about the credit standing of the issuer company.

Benefits of Credit Rating to Company

The merits, advantages, benefits of credit rating to the issuing company are:
  1. Improves Corporate Image : Credit rating helps to improve the corporate image of a company. High credit rating creates confidence and trust in the minds of the investors about the company. Therefore, the company enjoys a good corporate image in the market.
  2. Lowers Cost of Borrowing : Companies that have high credit rating for their debt instruments will get funds at lower costs from the market. High rating will enable the company to offer low interest rates on fixed deposits, debentures and other debt securities. The investors will accept low interest rates because they prefer low risk instruments. A company with high rating for its instruments can reduce the cost of public issue to raise funds, because it need not spend heavily on advertising for attracting investors.
  3. Wider Audience for Borrowing : A company with high rating for its instruments can get a wider audience for borrowing. It can approach financial institutions, banks, investing companies. This is because the credit ratings are easily understood not only by the financial institutions and banks, but also by the general public.
  4. Good for Non-Popular Companies : Credit rating is beneficial to the non-popular companies, such as closely-held companies. If the credit rating is good, the public will invest in these companies, even if they do not know these companies.
  5. Act as a Marketing Tool : Credit rating not only helps to develop a good image of the company among the investors, but also among the customers, dealers, suppliers, etc. High credit rating can act as a marketing tool to develop confidence in the minds of customers, dealer, suppliers, etc.
  6. Helps in Growth and Expansion : Credit rating enables a company to grow and expand. This is because better credit rating will enable a company to get finance easily for growth and expansion.

Demerits of Credit Rating

The disadvantages, limitations or demerits of credit rating are listed below.
  1. Possibility of Bias Exist : The information collected by the rating agency may be subject to personal bias of the rating team. However, rating agencies try their best to provide an unbiased opinion of the credit quality of the company and/or instrument. If not, they will not be trusted.
  2. Improper Disclosure May Happen : The company being rated may not disclose certain material facts to the investigating team of the rating agency. This can affect the quality of credit rating.
  3. Impact of Changing Environment : Rating is done based on present and past data of the company. So, it will be difficult to predict the future financial position of the company. Many changes take place due to changes in economic, political, social, technological, legal and other environments. All this will affect the working of the company being rated. Therefore, rating is not a guarantee for financial soundness of the company.
  4. Problems for New Companies : There may be problems for new companies to collect funds from the market. This is because, a new company may not be in a position to prove its financial soundness. Therefore, it may receive lower credit ratings. This will make it difficult to collect funds from the market.
  5. Downgrading by Rating Agency : The credit-rating agencies periodically review the ratings given to a particular instrument. If the performance of a company is not as expected, then the rating agency will downgrade the instrument. This will affect the image of the company.
  6. Difference in Rating : There are cases, where different ratings are provided by various rating agencies for the same instrument. These differences may be due to many reasons. This will create confusion in the minds of the investor.

Structure of Indian Money Market

The entire money market in India can be divided into two parts. They are organised money market and the unorganized money market. The unorganised money market can also be known as an unauthorized money market. Both of these components comprise several constituents. The following chart will help you in understanding the organisational structure of the Indian money market.

Structure of Indian Money Market

Components, SubMarkets of Indian Money Market:

After studying above organisational chart of the Indian money market it is necessary to understand various components or sub markets within it. They are explained below.
  1. Call Money Market : It an important sub market of the Indian money market. It is also known as money at call and money at short notice. It is also called inter bank loan market. In this market money is demanded for extremely short period. The duration of such transactions is from few hours to 14 days. It is basically located in the industrial and commercial locations such as Mumbai, Delhi, Calcutta, etc. These transactions help stock brokers and dealers to fulfill their financial requirements. The rate at which money is made available is called as a call rate. Thus rate is fixed by the market forces such as the demand for and supply of money.
  2. Commercial Bill Market : It is a market for the short term, self liquidating and negotiable money market instrument. Commercial bills are used to finance the movement and storage of agriculture and industrial goods in domestic and foreign markets. The commercial bill market in India is still underdeveloped.
  3. Treasury Bill Market : This is a market for sale and purchase of short term government securities. These securities are called as Treasury Bills which are promissory notes or financial bills issued by the RBI on behalf of the Government of India. There are two types of treasury bills. (i) Ordinary or Regular Treasury Bills and (ii) Ad Hoc Treasury Bills. The maturity period of these securities range from as low as 14 days to as high as 364 days. They have become very popular recently due to high level of safety involved in them.
  4. Market for Certificate of Deposits (CDs) : It is again an important segment of the Indian money market. The certificate of deposits is issued by the commercial banks. They are worth the value of Rs. 25 lakh and in multiple of Rs. 25 lakh. The minimum subscription of CD should be worth Rs. 1 Crore. The maturity period of CD is as low as 3 months and as high as 1 year. These are the transferable investment instrument in a money market. The government initiated a market of CDs in order to widen the range of instruments in the money market and to provide a higher flexibility to investors for investing their short term money.
  5. Market for Commercial Papers (CPs) : It is the market where the commercial papers are traded. Commercial paper (CP) is an investment instrument which can be issued by a listed company having working capital more than or equal to Rs. 5 cr. The CPs can be issued in multiples of Rs. 25 lakhs. However the minimum subscription should at least be Rs. 1 cr. The maturity period for the CP is minimum of 3 months and maximum 6 months. This was introcuced by the government in 1990.
  6. Short Term Loan Market : It is a market where the short term loan requirements of corporates are met by the Commercial banks. Banks provide short term loans to corporates in the form of cash credit or in the form of overdraft. Cash credit is given to industrialists and overdraft is given to businessmen.

Indian Money Market - Features

Every money is unique in nature. The money market in developed and developing countries differ markedly from each other in many senses. Indian money market is not an exception for this. Though it is not a developed money market, it is a leading money market among the developing countries.

Indian Money Market has the following major features or characteristics :-
  1. Dichotomic Structure : It is a significant aspect of the Indian money market. It has a simultaneous existence of both the organized money market as well as unorganised money markets. The organized money market consists of RBI, all scheduled commercial banks and other recognized financial institutions. However, the unorganized part of the money market comprises domestic money lenders, indigenous bankers, trader, etc. The organized money market is in full control of the RBI. However, unorganized money market remains outside the RBI control. Thus both the organized and unorganized money market exists simultaneously.
  2. Seasonality : The demand for money in Indian money market is of a seasonal nature. India being an agriculture predominant economy, the demand for money is generated from the agricultural operations. During the busy season i.e. between October and April more agricultural activities takes place leading to a higher demand for money.
  3. Multiplicity of Interest Rates : In Indian money market, we have many levels of interest rates. They differ from bank to bank from period to period and even from borrower to borrower. Again in both organized and unorganized segment the interest rates differs. Thus there is an existence of many rates of interest in the Indian money market.
  4. Lack of Organized Bill Market : In the Indian money market, the organized bill market is not prevalent. Though the RBI tried to introduce the Bill Market Scheme (1952) and then New Bill Market Scheme in 1970, still there is no properly organized bill market in India.
  5. Absence of Integration : This is a very important feature of the Indian money market. At the same time it is divided among several segments or sections which are loosely connected with each other. There is a lack of coordination among these different components of the money market. RBI has full control over the components in the organized segment but it cannot control the components in the unorganized segment.
  6. High Volatility in Call Money Market : The call money market is a market for very short term money. Here money is demanded at the call rate. Basically the demand for call money comes from the commercial banks. Institutions such as the GIC, LIC, etc suffer huge fluctuations and thus it has remained highly volatile.
  7. Limited Instruments : It is in fact a defect of the Indian money market. In our money market the supply of various instruments such as the Treasury Bills, Commercial Bills, Certificate of Deposits, Commercial Papers, etc. is very limited. In order to meet the varied requirements of borrowers and lenders, It is necessary to develop numerous instruments.

Recent Reforms in Indian Money Market

Indian Government appointed a committee under the chairmanship of Sukhamoy Chakravarty in 1984 to review the Indian monetary system. Later, Narayanan Vaghul working group and Narasimham Committee was also set up. As per the recommendations of these study groups and with the financial sector reforms initiated in the early 1990s, the government has adopted following major reforms in the Indian money market.
Reforms made in the Indian Money Market are:-
  1. Deregulation of the Interest Rate : In recent period the government has adopted an interest rate policy of liberal nature. It lifted the ceiling rates of the call money market, short-term deposits, bills rediscounting, etc. Commercial banks are advised to see the interest rate change that takes place within the limit. There was a further deregulation of interest rates during the economic reforms. Currently interest rates are determined by the working of market forces except for a few regulations.
  2. Money Market Mutual Fund (MMMFs) : In order to provide additional short-term investment revenue, the RBI encouraged and established the Money Market Mutual Funds (MMMFs) in April 1992. MMMFs are allowed to sell units to corporate and individuals. The upper limit of 50 crore investments has also been lifted. Financial institutions such as the IDBI and the UTI have set up such funds.
  3. Establishment of the DFI : The Discount and Finance House of India (DFHI) was set up in April 1988 to impart liquidity in the money market. It was set up jointly by the RBI, Public sector Banks and Financial Institutions. DFHI has played an important role in stabilizing the Indian money market.
  4. Liquidity Adjustment Facility (LAF) : Through the LAF, the RBI remains in the money market on a continue basis through the repo transaction. LAF adjusts liquidity in the market through absorption and or injection of financial resources.
  5. Electronic Transactions : In order to impart transparency and efficiency in the money market transaction the electronic dealing system has been started. It covers all deals in the money market. Similarly it is useful for the RBI to watchdog the money market.
  6. Establishment of the CCIL : The Clearing Corporation of India limited (CCIL) was set up in April 2001. The CCIL clears all transactions in government securities, and repose reported on the Negotiated Dealing System.
  7. Development of New Market Instruments : The government has consistently tried to introduce new short-term investment instruments. Examples: Treasury Bills of various duration, Commercial papers, Certificates of Deposits, MMMFs, etc. have been introduced in the Indian Money Market.
These are major reforms undertaken in the money market in India. Apart from these, the stamp duty reforms, floating rate bonds, etc. are some other prominent reforms in the money market in India. Thus, at the end we can conclude that the Indian money market is developing at a good speed.

Public Debt In India

During recent years, public debt in India has been growing at an alarming rate. The under developed nature of the economy & institutional credit deficiencies makes the financing of economic development a complicated problem.  Hence the government has to play a key role in stimulating the rate of capital formation & in promoting the economic development of the economy.

So public debt can be used by the government as means for mobilising the resources.
Internal Debt
The internal debt is a major component of public debt of the central government of India.
The following are the various components of internal debt. 

1. Market Loan
These have a maturity period of 12 months or more at the time of issue and are generally interest bearing. The government issues such loans almost every year. These loans are raised in the open market by sale of securities or otherwise. Total market loans as at the end of March 2005 are estimated at Rs. 7,58,999 crores. 

2. Bonds

The Government borrows funds by way of issue of bonds. The government obtains funds through the issue of bonds such as National Rural Development Bonds, Central Investment Bonds. The bonds are issued at different maturity periods, which may range from 3 years to 10 years period. They provide medium-term to long-term funds to the government.

3. Treasury Bills
A major source of short-term funds for the government is obtained by issue of treasury bills. At present, government issues 91 day and 364 day treasury bills. The treasury bills are purchased by commercial banks and others. 

4. Special Floating and Other Loans

These represents India's contribution towards share capital of international financial institutions like IMF, World Bank, International Development Agency and so on. These are non-negotiable and non-interest bearing securities. The Government of India is liable to pay the amount at the call of these institutions. Accordingly, it is a short-term debt upon the Government of India.

5. Special securities issued by RBI
The government obtains temporary loans for a period of maximum 12 months from RBI and issues special securities, which are non-negotiable and non-interest bearing. Such securities provide short term funds to the Government.

6. Ways and Mean Advances
The Government of India obtains ways and means advances from the Reserve Bank of India to meet its short period expenditure. These debts are purely temporary in nature and are usually repaid within three months.

7. Securities against small savings

Since 1999-2000, under the new accounting system, national small savings have been converted into the Central Government securities. As a result there has been a sharp increase in internal debt and corresponding decline in small savings.

External Debt

External debt refers to the liabilities of the Indian Government, public sector, private sector and financial institutions to overseas parties.
The government of India has raised foreign loans from U.S.A, U.K, France, U.S.S.R, Japan, etc.
External Debt rose from Rs. 31,525 crores in 1990-91 to Rs. 68,392 crores in 2005-06.
The external debt can be broadly divided into two groups :

A. Long term debt :
  1. Multilateral borrowings,
  2. Bilateral borrowings
  3. Loans from IMF, World Bank, etc.
B. Short term debt :
It is to be noted that the overall external debt of India comprises of Government debt and Non-government debt. The Government debt is owed by Govemment authorities, both Central and State Governments, whereas the non-Government debt is owed by private parties in India. In terms of composition, India's external debt has shifted in favour of private debt over the last decade.

 Other Internal Liabilities
The government does not include liabilities under Public Debt. However, the government is liable to make repayment of these liabilities. 

1. Small Savings

In recent years small savings have increased due to rising money income in the economy.
Recently the Government of India launched a number of small savings instruments. These include 9% Relief Bonds 1987, Kisan Vikas Patras, Indira Vikas Patras, etc.

2. Provident Funds
Provident funds are divided into two categories :-
  1. Employee Provident Funds meant for employees.
  2. Public Provident Funds meant for general public.

3. Other accounts

Other accounts include Postal Insurance and Life Annuity Fund, Borrowings against Compulsory Deposits, Income Tax Annuity Deposit, Special Deposit of Non-Government Provident Fund and Outstanding Amount.

4. Reserve Funds and Deposits
Reserve Funds and Deposits are divided into two categories :-
  1. Interest bearings and
  2. Non-interest bearings.
They include depreciation and reserve funds of Railways, Department of Post, Telecommunication, Deposits of Local Funds, Departmental and Judicial Deposits, Civil Deposits, etc.

Friday, June 29, 2012

Repurchase Agreements (Repo)

Repo is a money market instrument, which enables collateralised short term borrowing and lending through sale/purchase operations in debt instruments.
Under a repo transaction, a holder of securities sells them to an investor with an agreement to repurchase at a predetermined date and rate. In the case of a repo, the forward clean price of the bond is set in advance at a level which is different from the spot clean price by adjusting the difference between repo interest and coupon earned on the security.
In the money market, this transaction is nothing but collateralised lending as the inflow of cash from the transaction can be used to meet temporary liquidity requirement in the short term money market at comparable cost.
A repo is also sometimes called a ready forward transaction as it is a means of funding by selling a security held on a spot (ready) basis and repurchasing the same on a forward basis.
When an entity sells a security to another entity on repurchase agreement basis and simultaneously purchases some other security from the same entity on resell basis it is called a double ready forward transaction.
Reverse Repo
A reverse repo is the mirror image of a repo. For, in a reverse repo, securities are acquired with simultaneous commitment to resell. Hence whether a transaction is a repo or a reverse repo is determined only in term of who initiated the first leg the transaction. When the reverse repurchase transaction matures, the counter party returns the security to the entity concerned and receives its cash along with the profit spread. One factor which encourages an organisation to enter into reverse repo is that it earns some extra income on its otherwise idle cash.
Repo Period
Repo period could be overnight, term, open or flexible. Overnight repos last only one day. If the period is fixed and agreed in advance it is a term repo where either party may call for the repo to be terminated at any time although requiring one or two days’ notice. Though there is no restriction on the maximum period for which repos can be undertaken generally term repo are for an average period of one week. In an open repo there is no such fixed maturity period and the interest rate would change from day to day depending on the money market conditions.
Types of Repos
Broadly, there are four types of repos available in the international market when classified with regard to maturity of underlying securities, pricing, term of repo etc. They comprise buy-sell back repo, classic repo, bond borrowing and lending and tripartite repos.
  1. Buy-Sell Back Ropo – Under a buy-sell repo transaction the lender actually takes position of the collateral. Here a security is sold outright and brought back simultaneously for settlement on a later date. In a buy-sell repo the ownership is passed on to the buyer and hence he retains any coupon interest due on the bonds. The spot buyer/borrower of securities in affect earns the yield on the underlying security plus or minus difference between these and the repo interest rate.
  2. Classic Repo – Is an initial sale of securities with a simultaneous agreement to repurchase them at a later date. In the case of this type of repo the start and end prices of the securities are the same and the separate payment of “interest” is made.
  3. Bond Lending/Borrowing – In a bond lending/borrowing transaction, the customer lends bonds for an open ended or fixed period in return for a fee. The fee charged would depend on the type of underlying instrument, size and term of the loan and the credit rating of the counterparty. The transaction would be taken care of by an agreement on securities lending and cash or other securities of equal value could be provided as collateral in the transaction.
  4. Tripartite repo – Under a tripartite repo a common custodian/clearing agency arranges for custody, clearing and settlement of repos transactions. They operate under a standard global master purchase agreement and provides for DVP system, substitution of securities, automatic marking to market, reporting and daily administration by single agency.
This type of arrangement minimises credit risk and can be utilized when dealing with clients with low credit rating.

Basel Committee

The Basel Committee on banking supervision provide a forum for regular cooperation on banking supervision matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. It seeks to do so by exchanging information on national supervisory issues, approaches and techniques, with a view to promoting common understanding.
At times, the committee uses this common understanding to develop guidelines and supervisory standards in areas where they are desirable. In this regard the committee is best known for its international standards on capital adequacy; the core principles for effective banking supervision; and the Concordat on cross-border banking supervision.
The committee encourages contacts and cooperation among its members and other banking supervisory authority. It circulates the supervisors throughout the world both published and unpublished papers proving guidance on banking supervisory matters. Contacts have been further strengthen by an International Conference for Banking Supervisors (ICBS) which takes place every two years. The Committee's Secretariat is located at the Bank for International Settlement in Basel, Switzerland, and is staffed mainly by professional supervisors on temporary secondment from member institutions. In addition to undertaking the secretariat work for the committee and its many expert sub-committees, it stands ready to give advice to supervisory authorities in all countries. Wayne Byres is the Secretary General of the Basel Committee.
The committee does not poses any formal supranational supervisory authority, and its conclusions do not, and were never intended to, have legal force. Rather, it formulates broad supervisory standards and guidelines and recommends statements of best practice in the expectation that individual authority will take steps to implement them through detailed arrangements-statutory or otherwise-which are best suited there own national systems. In this way, committee encourages convergence towards common approaches and common standards without attempting detailed harmonisation of member countries' supervisory techniques.
The committee reports to the central bank governors and Heads of Supervision of its member countries. It seeks their endorsements for their major initiatives. These decision cover very wide range of financial issues. On important objective of the committee's work has been to close gaps in international supervisory coverage in pursuit of two basic principles: that no foreign banking establishment should escape supervision; and that supervision should be adequate. To achieve this, the committee has issued a long series of documents since 1975.
In 1988, the Committee decided to introduce a capital measurement referred to as the Basel Capital Accord. This system provided for the implementation of a credit risk measurement. Framework with a minimum capital standard of 8 percent by end-1992 since 1988, this framework has been progressively introduced not only in member countries but also in virtually all other countries with internationally active banks. In June 1999, the committee issued a proposal for a revised Capital Adequacy Framework.
The proposed capital framework consist of three pillars: minimum capital requirement which seek to refine the standardised rules set forth in the 1988 accord; supervisory review of an institutions' internal assessment process and capital adequacy; and effective use of disclosure to strengthen market discipline as the complement to supervisory efforts. Following extensive interaction with banks, industry groups and supervisory authorities that are not members of the committee, the revised framework was issued on 26th June 2004. This text serves as the basis for national rule-making and for banks to complete their preparation for the new framework implementation.
Over the past few years, the committee has moved more aggressively to promote sound supervisory standard worldwide. In close collaboration with many jurisdictions which are not members of the committee in 1997 it developed a set of "core principles for effective banking supervision", which provides a comprehensive blueprint for an effective supervisory system. To facilitate implementation and assessment the committee in Oct 1999 developed the "core principles methodology". The core principles and methodology were revised recently and released in Oct 2006.
In order to enable a wider group of countries to be associated with the work being pursued in Basel, the committee has always encouraged contacts and cooperation between its members and other banking supervisory authorities.

Member countries:
Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong-Kong, India, Indonesia, Italy, Japan, Luxembourg, Mexico,-Netherlands, Russia, Saudi Arabia, Singapore, South Africa, South Korea, Spain, Sweden, Switzerland, Turkey, UK, US.

Basel II

The Basel II Framework describes a more comprehensive measure and minimum standard for capital adequacy for national supervisory authorities are now working to implement through domestic rule-making and adoption procedures. It seeks to improve on the existing rules by aligning regulatory capital requirements more closely to the underlined risks the banks face. In addition, the Basel II Framework intended to promote a more forward-looking approach to capital supervision, one that encourage banks to identify the risks they may face, today and in the future and to develop or improve their ability to manage those risks. As a result, it is intended to be more flexible and better able to evolve with advances in markets and risk management practices.
The efforts of the Basel Committee on banking supervision to revise the standard governing the capital adequacy of internationally active banks achieved a critical milestone in the publication of an agreed text in June 2004.
In Nov 2005, the committee issued an updated version of the revised framework incorporating the additional guidance set forth in the committee's paper. The application of Basel II trading activities and the treatment of double default effects (July 2005).
On 4th July 2006, the committee issued a comprehensive version of the Basel II Framework. Solely as a matter convenience to readers, this 2004 Basel II Framework, the elements of the 1988 accord that were not revised during the Basel II process, the 1996 Amendment to the capital accord incorporate market risks, and the 2005 paper on the application of Basel II to trading activities and the treatment if double default effects. No new elements have been introduced in this compilation.

Basel III

Basel III is a comprehensive set of reform measures, developed by the Basel Committee on banking supervision, to strengthen the regulation, supervision and risk management of the banking sector. These measures aim to :
  • improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source
  • improve risk management and governance
  • strengthen banks' transparency and disclosures.
The reforms target:
  • bank level, or microprudential, regulation, which will help raise the resilience of individual banking institutions, to periods of stress.
  • macropurdential, system wide risk that can build across the banking sector as well as the procyclical amplification of these risks over time.
The two approaches to supervision are complementary as greater resilience at the individual bank level reduces the risk of system wide shocks.

Recommendations of Narasimham Committee on Banking Sector Reform – 1998

For Banking System
  • Pending the emergence of markets in India where market risk can be covered, it would be desirable that capital adequacy requirements take into account market risk in addition to credit risks.
  • In the next three years, the entire portfolio of Government securities should be marketed to market and this schedule of adjustment should be announced earliest.
  • The risk weight for a Government guarantee advance should be the same as for other advances.
  • Foreign exchange open position limits should carry a 100% risk weight.
  • An asset be classified as doubtful if it is in the substandard category for 18 months in the first instance and eventually for 12 months and loss if it has been so identified but not written off.
  • Banks and financial institutions should avoid the practice of “evergreening” by making fresh advances to their troubled constituents only with a view to setting interest dues and avoiding classification of the loan in question as NPAs.
  • Average level of net NPAs for all banks should be reduced to below 5% and 3% by the year 2000 and 2002, respectively, and net NPAs to 3% and 0% by these dates.
  • Banks should introduce calculation of interest as monthly rests.
  • There should be 100% computerization of bank’s operations. Unless 100% computerisation is made, it may not be feasible to implement the recommendation.
  • It is also necessary to tone up the legal machinery for speedy disposal of collateral taken as security for the advance.
  • Banks should bring out revised Operational Manual and update them regularly.
Structural Issues
  • DFIs should, over a period of time, convert themselves to banks.
  • If a DFI does not acquire a banking license with a stipulated time it would be categorized as a non-banking finance company.
  • Mergers between banks and between banks and DFIs and NBFCs need to be based on synergies and locational and business specific complementarities of the concerned institutions and must obviously make sound commercial sense.
  • A ‘weak bank’ should be one whose accumulated losses and net NPAs exceeds its net worth or one whose operating profits less its income on recapitalization bonds is negative for three consecutive years.
  • The policy of licensing new private banks (other than local area banks) may continue. The start-up capital requirement is Rs. 100 crore where set in 1993 and these may be reviewed.
  • Foreign banks may be allowed to setup subsidiaries or joint ventures in India. Such subsidiaries or joint ventures should be treated on par with other private banks and subject to the same conditions with regard to branches and directed credit as these banks.
  • All NBFCs are statutorily required to have a minimum net worth of Rs. 25 lakh if they are to be registered.
  • Then minimum period of FD be reduced to 15 days and all money market instruments should likewise have a similar reduced minimum duration.
  • Foreign institutional investors should be given access to the Treasury Bill market.
  • The Board for Financial Regulation and Supervision (BFRS) should be given statutory powers and be reconstituted in a way to be composed of professionals.
  • RBI should totally withdraw from the primary market in 91 days Treasury Bills.

Economics: The Basics

When wants exceed the resources available to satisfy them, there is scarcity. Faced with scarcity, people must make choices. Economics is the study of the choices people make to cope with scarcity. Choosing more of one thing means having less of something else. The opportunity cost of any action is the best alternative forgone.

Microeconomics - The study of the decisions of people and businesses and the interaction of those decisions in markets. The goal of microeconomics is to explain the prices and quantities of individual goods and services.
Macroeconomics - The study of the national economy and the global economy and the way that economic aggregates grow and fluctuate.  The goal of macroeconomics is to explain average prices and the total employment, income, and production.

Positive statements - Statements about what is.
Normative statements - Statements about what ought to be.
Ceteris paribus - Other things being equal” or “if all other relevant things remain the same.

The fallacy of composition - What is true of the parts may not be true of the whole. What is true of the whole may not be true of the parts.
The post hoc fallacy - The error of reasoning from timing to cause and effect.
Economic efficiency - Production costs are as low as possible and consumers are as satisfied as possible with the combination of goods and services that is being produced.
Economic growth - The increase in incomes and production per person. It results from the ongoing advance of technology, the accumulation of ever larger quantities of productive equipment and ever rising standards of education.
Economic stability - The absence of wide fluctuations in the economic growth rate, the level of employment, and average prices.

The Modern economy
Economy - A mechanism that allocates scarce resources among alternative uses. This mechanism achieves five things: What, How, When, Where, Who.
Decision makers -  Households, Firms, Governments.
Household - Any group of people living together as a decision-making unit.  Every individual in the economy belongs to a household.

Firm - An organization that uses resources to produce goods and services. All producers are called firms, no matter how big they are or what they produce.  Car makers, farmers, banks, and insurance companies are all firms.
Government - A many-layered organization that sets laws and rules, operates a law-enforcement mechanism, taxes households and firms, and provides public goods and services such as national defense, public health, transportation, and education.
Market - Any arrangement that enables buyers and sellers to get information and to do business with each other.

Role of Government
Not so very long ago, economic planning and public ownership of the means of production were the wave of the future. Planners cannot find out what needs to be done to co-ordinate the production of a modern economy. Even if a technically feasible plan could be drawn up, there is no reason to believe it will be implemented.
How could a central planner know better than the consumers what the individual woman wants? Planners can only provide users with what they believe they should want. Because prices bear no relation to costs, there is no way to calculate what production needs to increase and what production needs to be reduced.

The state has three functions:

  • To provide things - known as public goods - that the market cannot provide for itself; 
  • To internalize externalities or remedy market failures; 
  • To help people who, for a number of reasons, do worse from the market or are more vulnerable to what happens within it than society finds tolerable. 

In addition to providing public goods, governments directly finance or provide certain merit goods. Such goods are consumed individually. But society insists on a certain level or type of provision.
The role of the state in a modern market economy is, in short, pervasive. The difference between poor countries and richer ones is not that the latter do less, but that what they do is better directed (on the whole) and more competently executed (again, on the whole).
The first requirement of effective policy is a range of qualities credibility, predictability, transparency and consistency.
The more the government focuses on its essential tasks and the less it is engaged in economic activity and regulation, the better it is likely to work and the better the economy itself is likely to run.
If one needs a large number of bureaucratic permissions to do something in business, the officials have an opportunity to demand bribes.
Once it is known that a government is prepared to create such exceptional opportunities, there will be lobbying to create them.
Then there is not just the corruption of the government, but the waste of resources in such 'rent-seeking' or 'directly unproductive profit-seeking activities'.
Governments are natural monopolies over a given territory. One of the strongest arguments for an open economy is that it puts a degree of competitive pressure on government.

Factors of Production
Factors of production - The economy’s productive resources; Labor, Land, Capital, Entrepreneurial ability.
Land - Natural resources used to produce goods and services. The return to land is rent.
Labor - Time and effort that people devote to producing goods and services.  The  return to labour is wages.
Capital - All the equipment, buildings, tools and other manufactured goods used to produce other goods and services. The return to capital is interest.
Entrepreneurial ability - A special type of human resource that organizes the other three factors of production, makes business decisions, innovates, and bears business risk. Return to entrepreneurship is profit.

Economic Coordination
Markets - Coordinate individual decisions through price adjustments.
Command mechanism - A method of determining what, how, when, and where goods and services are produced and who consumes them, using a hierarchical organization structure in which people carry out the instructions given to them.
Market economy - An economy that uses a market coordinating mechanism.
Command economy - An economy that relies on a command mechanism.
Mixed economy - An economy that relies on both markets and command mechanism.

Production Possibility Frontier
The quantities of goods and services that can be produced are limited by the available resources and by technology.  That limit is described by the production possibility frontier.
Production Possibility Frontier (PPF) - The boundary between those combinations of goods and services that can be produced and those that cannot.
Production efficiency - When it is not possible to produce more of one good without producing less of some other good.  Production efficiency occurs only at points on the PPF.
Economic growth - Means pushing out the PPF. The two key factors that influence economic growth are technological progress and capital accumulation.
Technological progress - The development of new and better ways of producing goods and services and the development of new goods.
Capital accumulation - The growth of capital resources.
Absolute Advantage - If by using the same quantities of inputs, one person can produce more of both goods than some one else can, that person is said to have an absolute advantage in the production of both goods.
Comparative Advantage - A person has a comparative advantage in an activity if that person can perform the activity at a lower opportunity cost than anyone else.

Law of Demand
Demand curve - Shows the relationship between the quantity demanded of a good and its price, all other influences on consumers’ planned purchases remaining the same.
Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded.

  1. Substitution effect
  2. Income effect.

As the opportunity cost of a good increases, people buy less of that good and more of its substitutes.
Faced with a high price and an unchanged income, the quantities demanded of at least some goods and services must be decreased.
Substitute - A good that can be used in place of another good.
Complement - A good that is used in conjunction with another good.
Normal goods - Goods for which demand increases as income increases.
Inferior goods - Goods for which demand decreases as income increases.
If the price of a good changes but everything else remains the same, there is a movement along the demand curve.
If the price of a good remains constant but some other influence on buyers’ plans changes, there is a change in demand for the good.
A movement along the demand curve shows a change in the quantity demanded and a shift of the demand curve shows a change in demand.

Law of Supply
Law of supply – Other things remaining the same, the higher the price of a good, the greater is the quantity supplied.
Supply of a good depends on:

  1. The price of the good; 
  2. The prices of factors of production; 
  3. The price of other goods produced; Expected future prices; 
  4. The number of suppliers; 
  5. Technology.

Supply curve - Shows the relationship between the quantity supplied and the price of a  good, everything else remaining the same.
If the price of a good changes but everything else influencing suppliers’ planned sales remains constant, there is a movement along the supply curve.
If the price of a good remains the same but another influence on suppliers’ planned sales changes, supply changes and there is a shift of the supply curve.
A movement along the supply curve shows a change in the quantity supplied.  The entire supply curve shows supply.  A shift of the supply curve shows a change in supply.

Equilibrium: A situation in which opposing forces balance each other.  Equilibrium in a market occurs when the price is such that the opposing forces of the plans of buyers and sellers balance each other.  The equilibrium price is the price at with the quantity demanded equals the quantity supplied. The equilibrium quantity is the quantity bought and sold at the equilibrium price.
When both demand and supply increase, the quantity increases. The price may increase, decrease, or remain constant.
When both demand and supply decrease, the quantity decreases. The price may increase, decrease, or remain constant.
When demand decreases and supply increases, the price falls. The quantity may increase, decrease, or remain constant.
When demand increases and supply decreases, the price rises and the quantity increases, decreases, or remains constant.

The total revenue from the sale of a good equals the price of the good multiplied by the quantity sold. An increase in price increases the revenue on each unit sold.  But an increase in price also leads to a decrease in the quantity sold. Whether the total expenditure increases or decreases after a price hike, depends on the responsiveness of demand to the price.
Price elasticity of demand – A measure of the responsiveness of the quantity demanded of a good to a change in its price, other things remaining the same. It is the percentage change in demand divided by percentage change in price.
Inelastic demand - If the percentage change in the quantity demanded is less than the percentage change in price, then the magnitude of the elasticity of demand is between zero and 1, and demand is said to be inelastic.
If the quantity demanded remains constant when the price changes, then the elasticity of demand is zero and demand is said to be perfectly inelastic.
Elastic demand - If elasticity is greater than 1, it is elastic.
If the quantity demanded is indefinitely responsive to a price change, then the magnitude of the elasticity of demand is infinity, and demand is said to be perfectly elastic.

When markets do not work 
Price ceiling -  A regulation that makes it illegal to charge a price higher than a specified level. When a price ceiling is applied to rents in housing markets, it is called a rent ceiling.
Black market - An illegal trading arrangement in which buyers and sellers do business at a price higher than legally imposed price ceiling.
Minimum wage law - A regulation that makes hiring labor below a specified wage illegal.
Externalities – Social costs, but no private costs.

Consumption & Utility
A household’s consumption choices are determined by

  • Budget constraint
  • Preferences

Utility - The benefit or satisfaction that a person gets from the consumption of a good or service.
Total utility - The total benefit or satisfaction that a person gets from the consumption of goods and services.
Marginal utility - The change in total utility resulting from a one-unit increase in the quantity of a good consumed.
Consumer equilibrium - A situation in which a consumer has allocated his or her income in the way that, given the prices of goods and services, maximizes his or her total utility.

Understanding Costs
Short run - Period of time in which the quantity of at least one input is fixed and the quantities of the other inputs can be varied.
Long run - Period of time in which the quantities of all inputs can be varied. Inputs whose quantity can be varied in the short run are called variable inputs. Inputs whose quantity cannot be varied in the short run are called fixed inputs.
Firm’s total cost - The sum of the costs of all the inputs it uses in production.
Fixed cost -The cost of a fixed input.
Variable cost - The cost of a variable input.
Total fixed cost - The total cost of fixed inputs.
Total variable cost - The cost of the variable inputs.
Marginal cost - The increase in total cost for increasing output by one unit.
Average fixed cost (AFC) - Total fixed cost per unit of output.
Average variable cost (AVC) - Total variable cost per unit of output.
Average total cost (ATC) - Total cost per unit of output.
Long-run average cost curve - Traces the relationship between the lowest attainable average total cost and output when both capital and labor inputs can be varied.
Economies of scale - As output increases, long-run average cost decreases.
Diseconomies of scale - As output increases, long run average cost increases.

Perfect Competition
There are many firms, each selling an identical product.
There are many buyers.
There are no restrictions on entry into the industry.
Firms in the industry have no advantage over potential new entrants.
Firms and buyers are completely informed about the prices of the product of each firm in  the industry.
Firms in perfect competition are said to be price takers. A price taker is a firm that cannot influence the price of a good or service.

Imperfect Competition
Monopoly - An industry that produces a good or service for which no close substitute exists and in which there is one supplier that is protected from competition by a barrier preventing the entry of new firms.
Price discrimination - The practice of charging some customers a lower price than others for an identical good or of charging an individual customer a lower price on a large purchase than on a small one, even though the cost of servicing all customers is the same.
Monopolistic competition - A market structure in which a large number of firms compete with each other by making similar but slightly different products.
Oligopoly - A market structure in which a small number of producers compete with each other.

Business Cycles
Economic developments should be judged in the context of trends and cycles.
Trends - The trend is the long-term rate of economic expansion.
Cycles - The cycle reflects short-term fluctuations around the trend. There are always a few months or years when growth is above trend, followed by a period when the economy contracts or grows below trend.
Long-term growth - In the long term the growth in economic output depends on the number of people working and output per worker. Output per worker grows through technical progress and investment in new plant, machinery and equipment. Investment and productivity are therefore the basis for continued and sustained economic expansion.
Recession -  A period during which real GDP decreases – the growth rate of real GDP is negative – for at least two successive quarters.
Consumption expenditure - The amount spent on consumption goods and services. Saving is the amount of income remaining after meeting consumption expenditures.
Savings – What remains out of income after consuming.
Capital - The plant, equipment, buildings, and inventories of raw materials and semi-finished goods that are used to produce other goods and services. The amount of capital in the economy is a crucial factor that influences GDP growth.
Investment - The purchase of new plant, equipment, and buildings and the additions to inventory.  Investment increases the stock of capital.  Depreciation is the decrease in the stock of capital that results from wear and tear and the passage of time.
Government Purchases - Governments buy goods and services, called government purchases, from firms.
Net taxes - Taxes paid to governments minus transfer payments received from governments.
Transfer payments - Cash transfers from governments to households and firms such as social security benefits, unemployment compensation, and subsidies.

Measuring Economic Activity
Total economic activity may be measured in three different but equivalent ways.
Add up the value of all goods and services produced in a given period of time, such as one year. Money values may be imputed for services such as health care which do not change hands for cash. Since the output of one business (for example, steel) can be the input of another (for example, automobiles), double counting is avoided by combining only "value added", which for anyone activity is the total value of production less the cost of inputs such as raw materials and components valued elsewhere.
A second approach is to add up the expenditure which takes place when the output is sold.
Since all spending is received as incomes, a third option is to value producers' incomes.

Gross domestic product - GDP is the total of all economic activity in one country, regardless of who owns the productive assets. For example, India’s GDP includes the profits of a foreign firm located in India even if they are remitted to the firm's parent company in another country.
Gross national product - GNP, is the total of incomes earned by residents of a country, regardless of where the assets are located. For example, India’s GNP includes profits from Indian-owned businesses located in other countries.

Omissions in GDP
Deliberate omissions: There are many things which are not in GDP, including the following.

  • Transfer payments - For example, social security and pensions.
  • Gifts. For example, $10 from an aunt on your birthday.
  • Unpaid and domestic activities. If you cut your grass or paint your house the value of this productive activity is not recorded in GDP, but it is if you pay someone to do it for you.
  • Barter transactions. For example, the exchange of a sack of wheat for a can of petrol.
  • Second-hand transactions. For example, the sale of a used car (where the production was recorded in an earlier year). 
  • Intermediate transactions. For example, a lump of metal may be sold several times, perhaps as ore, pig iron, part of a component and, finally, part of a washing machine (the metal is included in GDP once at the net total of the value added between the initial production of the ore and its final sale as a finished item).
  • Leisure. An improved production process which creates the same output but gives more recreational time is recorded in the national accounts at exactly the same value as the old process.
  • Depletion of resources. For example, oil production is recorded at sale price minus  production costs and no allowance is made for the fact that an irreplaceable part of the nation's capital stock of resources has been consumed.
  • Environmental costs. GDP figures do not distinguish between green and polluting industries. 
  • Allowance for non-profit-making and inefficient activities. The civil service and police force are valued according to expenditure on salaries, equipment, and so on (the appropriate price for these services might be judged to be very different if they were provided by private companies).
  • Allowance for changes in quality. You can buy very different electronic goods for the same inflation-adjusted outlay than you could a few years ago, but GDP data do not take account of such technological improvements.

Unrecorded transactions
GDP may under-record economic activity, not least because of the difficulties of keeping track of new small businesses and because of tax avoidance or evasion.
Deliberately concealed transactions form the black, grey, hidden or shadow economy. This is largest at times when taxes are high and bureaucracy is heavy. Estimates of the size of the shadow economy vary enormously. For example, differing studies put America's at 4-33%, Germany's at 3-28% and Britain's at 2-15%. What is agreed, though, is that among the industrial countries the shadow economy is largest in Italy, at perhaps one-third of GDP, followed by Spain, Belgium and Sweden, while the smallest black economies are in Japan and Switzerland at around 4% of GDP.
The only industrial countries that adjust their GDP figures for the shadow economy are Italy and America and they may well underestimate its size.

The expenditure measure of GDP is obtained by adding up all spending:
 consumption (spending on items such as food and clothing)
+ investment (spending on houses, factories, and so on)
= total domestic expenditure
+ exports of goods and services (foreigners' spending)
= total final expenditure
- imports of goods and services (spending abroad)

Government consumption - The level of government spending reflects the role of the state. Government consumption is generally 10-20% of GDP, although it is higher in countries such as Denmark and Sweden where the state provides many services. Changes in government spending tend to reflect political decisions rather than market forces.
Private consumption - This is also called personal consumption or consumer expenditure. It is generally the largest individual category of spending. In the industrialised countries, consumption is around 60% of GDP. The ratio is much higher in poor countries which invest less and consume more.
Investment - Investment is perhaps the key structural component of spending since it lays down the basis for future production. It covers spending on factories, machinery, equipment, dwellings and inventories of raw materials and other items. Investment averages about 20% of GDP in the industrialised countries, but is nearer 30% of GDP in East Asian countries.

The income measure of GDP is based on total incomes from production. It is essentially the total of:
wages and salaries of employees;
income from self-employment;
trading profits of companies;
trading surpluses of government corporations and enterprises;
income from rents.
These are known as factor incomes. GDP does not include transfer payments such as interest and dividends, pensions, or other social security benefits. The breakdown of incomes sheds additional light on economic behaviour because it is the counterpart to expenditure in what economists call the circular flow of money. It also provides a useful basis for forecasting inflation.

Labour force or workforce - The number of people employed and self-employed plus those unemployed but ready and able to work.
Three factors affect the size of the labour force: population, migration and the proportion participating in economic activity.
Population. Birth rates in most industrial countries fell to replacement levels or lower in the 1980s. This implies an older workforce and higher old-age dependency rates (the number of retired people as a percentage of the population of working age) in the future. 15-20% of the population in industrial economies will be over 65 years of age.
Developing countries have young populations with up to 50% under 15 years. This suggests an expanding working-age population with potential problems for housing and job creation.
Migration. In the industrial countries inflows of foreign workers increased since the late 1980s and a substantial number of illegal immigrants were granted amnesty in America, France, Italy and Spain. Foreign-born persons account for over 5% of the labour force in America, Germany and France; around 20% in Switzerland and Canada; and over 25% in Australia.
Inward migration may be a bonus for some economies. For example, German unification  boosted that country's productive potential. However, large numbers of refugees seeking asylum can have significant adverse effects on income per head.
Wealthier developing countries, especially oil producers, have large proportions of foreigners in their labour forces. Workers frequently make a substantial contribution to the balance of payments in their home countries by remitting savings from their salaries.
Participation. Participation rates (the labour force as a percentage of the total population) generally increased in the 1980s and 1990s with earlier retirement for men, especially in France, Finland and the Netherlands, generally offset by more married women entering the labour force, especially in America, Australia, Britain, New Zealand and Scandinavia.
Women account for a smaller proportion of the workforce in Muslim countries (20%) and a greater proportion in Africa (up to 50%) where they traditionally work on the land.
The unemployment rate. Usually defined as unemployment as a percentage of the labour force (the employed plus the unemployed). National variations are rife: Germany excludes the self-employed from the labour force; Belgium produces two unemployment rates expressing unemployment as a percentage of both the total and the insured labour force. By changing the definition, which governments are inclined to do, the unemployment rate can be moved up or, more usually, down by several percentage points.

The Balance Of Payments
Accounting conventions- Balance of payments accounts record financial flows in a specific period such as one year. Financial inflows are treated as credits or positive entries. Outflows are debits or negative entries. When a foreigner invests in the country, there is a capital inflow which is a credit entry. Conversely, the acquisition of a claim on another country is a negative or debit entry.
Debits = credits. The accounts are double entry, that is, every transaction is entered twice. For example, the export of goods involves the receipt of cash (the credit) which represents a claim on another country (the debit). By definition, the balance of payments must balance. Debits must equal credits.
Current = capital. One side of each transaction is treated as a current flow (such as a receipt of payment for an export). The other is a capital flow (such as the acquisition of a claim on another country). Arithmetically current flows must exactly equal capital flows.
The accounts build up in layers. Balances may be struck at each stage. What follows reflects the IMF'S methodology in the fifth edition of the

Balance of Payments Manual
Net exports of goods (exports of goods less imports of goods)
= the visible trade or merchandise trade balance
+ net exports of services (such as shipping and insurance)
= the balance of trade in goods and services
+ net income (compensation of employees and investment income)
+ net current transfers (such as payments of international aid and workers' remittances)
= the current-account balance (all the following entries form the capital and financial account)
+ net direct investment (such as building a factory overseas)
+ other net investment (such as portfolio investments in foreign equity markets)
+ net financial derivatives
+ other investment (including trade credit, loans, currency and deposits)
+ reserve assets (changes in official reserves), sometimes known as the bottom line
= overall balance
+ net errors and omissions
= zero

Thus the current account covers trade in goods and services, income and transfers. Non-merchandise items are known as invisibles. All other flows are recorded in the capital and financial account. The capital part of the account includes capital transfers, such as debt forgiveness, and the acquisition and/or disposal of non-produced, non-financial assets such as patents. The financial part includes direct, portfolio and other investment.
The balance of payments must balance. When we talk about a balance of payments deficit or surplus, we mean a deficit or surplus on one part of the accounts.

Fiscal Indicators
Fiscal indicators are concerned with government revenue and expenditure.
Level of government - Various problems of definition arise because of different treatment of financial transactions by central government, local authorities, publicly owned enterprises, and so on.
In an attempt to standardise, international organisations such as the OECD focus on general government, which covers central and local authorities, separate social security funds where applicable, and province or state authorities in federations such as in North America, Australia, Germany, Spain and Switzerland.
There is scope for manipulation, Spending can be shifted to publicly owned enterprises which are generally classified as being outside general government. Net lending to such enterprises is part of government spending, but it is not always included in headline expenditure figures.
Public spending may be classified in several different ways.
By level of government: central and local authorities, state or provincial authorities for federations, social security funds and public corporations.
By department: agriculture, defence, trade, and so on.
By function: such as environmental services, which might be provided by more than one department.
By economic category: current, capital, and so on.
Breaking down the economic effect of public spending into current and capital spending is a useful way to interpret it.

Current spending
Major categories of current spending include the following.
Pay of public-sector employees: this generally seems to rise faster than other current spending.
Other current spending: on goods and services such as stationery, medicines, uniforms, and so on.
Subsidies: on goods and services such as public housing and agricultural support.
Social security: including benefits for sickness, old age, family allowances, and so on; social assistance grants and unfunded employee welfare benefits paid by general government.
Interest on the national debt.

Taxes can be Progressive or regressive
Progressive taxes take a larger proportion of cash from the rich than from the poor, such as income tax where the marginal percentage rate of tax increases as income rises.
Proportional taxes take the same percentage of everyone's income, wealth or expenditure, but the rich pay a larger amount in total.
Regressive taxes take more from the poor. For example, a flat rate tax of Rs. 5000, takes a greater proportion of the income of a lower-paid worker than of a higher-paid worker.
Indirect taxes. Levied on goods and services, these include the following:
Value-added tax (VAT) charged on the value added at each stage of production; this amounts to a single tax on the final sale price.
Sales and turnover taxes which may be levied on every transaction (for example, wheat, flour, bread) and cumulate as a product is made.
Customs duties on imports.
Excise duties on home-produced goods, sometimes at penal rates to discourage activities such as smoking.
Indirect taxes tend to be regressive, as poorer people spend a bigger slice of their income. They are charged at either flat or percentage rates.

Budget deficits (spending exceeds revenues) boost total demand and output through a net injection into the circular flow of incomes. As with personal finances, a deficit on current spending may signal imprudence. However, a deficit to finance capital investment expenditure helps to lay the basis for future output and can be sustained so long as there are pri­vate or foreign savings willing to finance it in a non-inflationary way.
 Budget surpluses (revenues exceed expenditure) may be prudent if a government is building up a large surplus on its social security fund in order to meet an expected increase in its future pensions bill as  the population ages.
Tighter or looser. Fiscal policy is said to have tightened if a deficit is reduced or converted into a surplus or if a surplus is increased, after taking into account the effects of the economic cycle. A move in the opposite direction is called a loosening of fiscal policy.