01What Economics Studies

The subject in one line

Economics is the study of how people, firms and governments allocate limited resources to produce, distribute and consume goods and services. Every question it asks reduces to four: what to produce, how to produce, for whom to produce, and at what price to sell.

The four definitions of economics

Four economists defined the subject four different ways. Each definition is named after what it puts at the centre.

Macro vs Micro

The two founding economists

Adam Smith — Father of Modern Economics & of Microeconomics

Key work: An Inquiry into the Nature and Causes of the Wealth of Nations (1776), known simply as The Wealth of Nations.

Self-interest: if each individual pursues their own gain, the economy as a whole benefits.

The Invisible Hand: unseen market forces of demand and supply push a free market toward efficiency without government direction.

Laissez-faire: a policy of least interference — let the market run itself.

John Maynard Keynes — Father of Macroeconomics

Key work: The General Theory of Employment, Interest and Money (1936).

Context: written in response to the Great Depression of 1929 — a stock-market crash followed by deep downturn, deflation and mass unemployment.

Core argument: against strict laissez-faire. Government intervention is necessary to manage animal spirits and revive an economy in a downturn.

Economic systems

Classified by three things: who owns resources, what the motive is, and how large the government's role is.

Classification of goods

Two tests decide which of four boxes a good falls into.

Excludability

Can you stop a non-payer from using it? Excludable — you must pay (a ticket). Non-excludable — you cannot keep anyone out (air, a free video).

Rivalry

Does one person's use reduce what's left for others? Rivalrous — if I eat the apple, you cannot. Non-rivalrous — my watching the sunset does not reduce yours.

Opportunity cost

The value of the next best alternative given up. Sunlight and air have zero opportunity cost — they are abundant, so nothing is sacrificed to get them.

Free rider problem

Attaches to public goods — people enjoy the benefit without paying, e.g. using a street light while dodging taxes.

Sectors of the economy

Primary — red collar

Activities drawing directly on nature: agriculture, fishing, hunting, forestry, mining. Called the backbone of the Indian economy because it employs the most people.

Secondary — blue collar

Turns raw material into product: manufacturing, construction, electricity generation, food processing. Backbone of industrialised nations such as China. Underdeveloped in India — the economy jumped straight to services and skipped a full industrialisation phase.

Tertiary — white collar

The service sector; produces intangibles: teaching, transport, banking, hospitality, retail.

Quaternary

Knowledge-based work: IT professionals, R&D, consultants.

Quinary — gold collar

Highest-level decision making and policy creation: top government officials, CEOs, research scientists, policymakers.

• LFPR = Labour Force Participation Rate.
• Share of women engaged in the primary sector: 62.8%.
• A high tertiary GDP share normally signals development — but in India it partly signals a skipped industrialisation phase.

How industries are classified

The same factory can be sorted four different ways depending on what the question asks about.

Public Sector Undertakings — the Ratna grades

Central Public Sector Enterprises (CPSEs) are graded by performance. Each grade buys a board more freedom to spend without asking Delhi first. Status is granted by the Department of Public Enterprises (DPE).

Outsourcing

Outsourcing is hiring an outside party to perform a service or make a good that the company previously did in-house. Firms do it to cut costs, buy specialised skill, or free themselves to focus on core work — IT services, customer support, payroll.

It is a feature of globalisation, not a synonym for it. Globalisation is the integration of economies; outsourcing is one business practice that integration makes possible.

Other classifications

Organised vs unorganised

Organised: registered with government, follows labour law, job security, fixed hours, PF/pension — government jobs, MNCs.

Unorganised: unregistered, irregular wages, no security, no benefits. More than 90% of Indian workers are here. The e-Shram portal was launched to register them.

Real vs financial sector

Real: actual production of goods and services using land, labour and raw material. Financial: financial assets — mutual funds, stocks, banking services.

Aids (auxiliaries) to trade

Support services that move goods from producer to consumer — transport, banking, insurance, warehousing, advertising. They are support, not raw material.

Positive vs normative economics

Positive: facts and data, "what is", scientifically verifiable — "the unemployment rate is 20%".

Normative: opinion and value judgement, "what ought to be" — "unemployment should be 5%".

Parallel economy

An unsanctioned sector running on black money — unaccounted income or income from illegal activity. It makes government policy ineffective because this money is neither taxed nor tracked.

02Scarcity, Choice and Utility

The central problem

Economics exists because of a permanent conflict: resources are limited, human wants are unlimited.

Scarcity

Money, land, labour and time are all finite.

Choice

Because resources are limited, an economy cannot produce everything — it must decide how to allocate.

Production Possibility Curve (PPC)

The PPC — also called the Production Possibility Frontier (PPF) — shows every maximum combination of two goods an economy can produce with its existing resources and technology, when those resources are fully and efficiently employed.

It is the geometric answer to scarcity: because resources are limited, producing more of one thing forces you to produce less of another. The curve draws that trade-off.

Assumptions — the curve only holds if all four are true

1. The economy produces only two goods.
2. Resources are fixed in quantity during the period.
3. Technology is constant.
4. Resources are fully and efficiently employed.
5. Resources are transferable between the two goods — but not equally efficient in both. This last one is what gives the curve its shape.

The schedule — watch the sacrifice grow

An economy producing wheat and cloth, moving resources from wheat into cloth one step at a time:

Every extra unit of cloth costs more wheat than the one before — 1, then 2, then 3, then 4, then 5. That rising sacrifice is increasing opportunity cost, and it is the single most important thing the PPC teaches.

Plotting it

Slope and shape

Slope — always downward (negative)

More of one good means less of the other. There is no point on a PPC where both rise.

Marginal Rate of Transformation (MRT)

The slope of the PPC — the units of one good sacrificed to gain one more unit of the other.

Units of Wheat sacrificed ΔY MRT = ───────────────────────────── = ──── Units of Cloth gained ΔX

In the schedule above, MRT runs 1 : 1 → 2 : 1 → 3 : 1 → 4 : 1 → 5 : 1. MRT rises as you move down the curve.

Shape — concave to the origin (bowed outward)

Because MRT increases. Rising opportunity cost and concavity are the same fact stated two ways.

The straight-line exception

If resources were equally efficient in producing both goods, opportunity cost would stay constant and the PPC would be a straight line with a constant MRT.

This is also what you get with a simple budget problem: with ₹6,000 and both shoes and jeans priced at ₹1,000, every pair of jeans costs exactly one pair of shoes — always 1 : 1. That gives a straight line, not a bowed curve, because money converts into either good at a fixed rate.

Shifts of the curve

A movement along the PPC is just reallocation. A shift of the whole curve means the economy's capacity itself has changed.

Law of Variable Proportions — the short run

Here one factor is variable and the rest are fixed. Think of a fixed one-acre field to which you keep adding more workers. The law describes what happens to output as you do.

The schedule

The three stages

Three relationships worth memorising

Returns to Scale — the long run

Now nothing is fixed. All factors change together, in the same proportion. The question is whether output keeps pace.

The distinction that gets tested

Economies of scale

The cost advantage of operating at a larger scale. As output grows, fixed costs spread over more units and efficiency improves — so average cost per unit falls.

Diseconomies of scale set in past a point: the firm becomes too big to manage, coordination costs rise, and average cost per unit starts climbing again. This is what produces the U-shaped long-run average cost curve.

Opportunity cost

The value of the next best alternative given up when you make a choice.

• Buy jeans instead of shoes → the shoes you didn't buy are the opportunity cost.
• Prepare for SSC instead of taking a banking job → the banking job is the opportunity cost.

Free goods — air, sunlight — carry no opportunity cost. They are abundant, not scarce, so nothing is sacrificed to obtain them.

Utility

Utility is the satisfaction or benefit you get from consuming a good or service.

Marginal Utility (MU)

The extra satisfaction from consuming one more unit.

Law of Diminishing Marginal Utility

As you keep consuming more units of the same good, the satisfaction from each successive unit falls. The first golgappa is bliss; by the tenth the maza is gone.

Indifference Curve (IC)

A curve joining every combination of two goods that gives the consumer the same level of satisfaction — they are "indifferent" between all points on it.

Shape

Convex to the origin (a rectangular hyperbola).

Slope

Marginal Rate of Substitution (MRS) — the rate at which a consumer will give up one good for another while staying equally satisfied.

Key property

Two indifference curves never intersect.

Isoquant curve

Same idea, but on the producer's side: a curve showing combinations of inputs (labour and capital) that produce the same quantity of output. Its slope is the Marginal Rate of Technical Substitution (MRTS).

03Demand, Supply and Elasticity

Demand

The quantity of a good consumers are willing and able to buy at a particular price in a given period. Both halves matter — willingness alone is a wish, ability alone is not demand.

Law of demand: price and quantity demanded move in opposite directions, holding everything else constant (ceteris paribus — income, price of other goods, consumer preferences).

Movement vs shift — the classic confusion

Exceptions to the law of demand

Giffen goods

Low-income, non-luxury, essential items (rice, bread). Demand rises when price rises and falls when price falls — the reverse of the law.

Veblen goods

Luxury goods bought for status — the snob effect. A higher price makes them more desirable. E.g. iPhone, Mercedes.

Supply and equilibrium

Supply — the amount producers are willing and able to provide at a given price in a given period. Price and quantity supplied have a direct, positive relationship, so the supply curve slopes upward: producers make more when they are paid more.

Equilibrium

The point where the demand curve intersects the supply curve. Here, quantity demanded = quantity supplied. The price at that point is the equilibrium price or market clearing price.

Equilibrium is not fixed. If demand rises, the demand curve shifts right and the equilibrium point moves.

Price elasticity of demand

How strongly quantity demanded responds to a change in price.

Income elasticity

How quantity demanded responds to a change in real income.

• Normal goods: income ↑ → demand ↑. Positive relationship, curve shifts right.
• Inferior goods: income ↑ → demand ↓, and income ↓ → demand ↑. The relationship runs the other way.

Cross-price elasticity

How a change in the price of one good affects demand for another. Example: Pepsi's price rises 10% and Coke's demand rises 5%.

04Market Structures

05Inflation

What inflation is

Inflation is a sustained rise in the general price level of goods and services over a period of time. As prices rise, the purchasing power of money falls — each rupee buys less than before. Inflation erodes the real value of money.

Who gains, who loses

Borrow ₹10,000 today and repay it after a year of high inflation: the ₹10,000 you hand back cannot buy what it could when you took it. The real value of the debt has shrunk.

Fisher's Quantity Theory of Money

Irving Fisher also gave the Money Illusion concept. His quantity theory links money supply, velocity, prices and transactions.

Holding V and T constant, an increase in M raises P. So expanding the money supply feeds directly into inflation, which in turn cuts consumers' purchasing power.

Types of inflation by rate

Causes of inflation

Imported inflation

Global prices rise, and a country that imports essentials imports the price rise with them.

Chain: India imports crude oil → crude gets costlier globally → petrol/diesel rise → transport cost rises → vegetables and milk get costlier.

Seigniorage (inflation tax)

The profit the government makes by printing currency. It is called a tax because printing money causes inflation, which quietly reduces the value of the cash in your pocket. You never paid, but you lost value.

Measuring inflation

Weights — where the two baskets differ

WPI leans on manufactured goods; CPI leans on food, because that is where household spending actually goes.

The four CPIs

Producer Price Index (PPI)

Average change in selling prices received by domestic producers. CPI is the buyer's view; PPI is the seller's view. It captures prices at the factory gate, before taxes and distribution — a leading indicator, because those cost increases reach consumers later. Tracks raw materials, intermediate goods and finished products.

Headline inflation

The raw CPI figure, including everything — food and energy included. This is the number in the news and the one that hits daily life.

Core inflation

Inflation with the volatile items stripped out — food and fuel.

Core Inflation = Headline Inflation − Volatile Inflation (Food + Fuel)

Index of Industrial Production (IIP)

CPI and WPI measure prices. IIP measures volume — the growth of industrial production over a period.

• Published by: National Statistical Office (NSO), MoSPI.
• Base year: 2011–12 (upcoming 2022–23).
• Covers: manufacturing, mining, electricity.

The eight core industries

They carry roughly 40.27% of the total IIP weight — so if they do well, overall industrial growth usually follows. In descending order of weight:

1. Refinery products — highest weight, heavily dependent on imported crude
2. Electricity
3. Steel
4. Coal
5. Crude oil
6. Natural gas
7. Cement
8. Fertilizers

Nine variants of inflation

1. Disinflation

A fall in the rate of inflation. Prices still rise, just more slowly — 10% → 8% → 5%. Usually caused by tighter monetary policy slowing money supply growth.

2. Deflation

A general decrease in prices — negative inflation. Purchasing power of money rises. Sounds good, is not: it signals a shrinking economy. The cycle is vicious — falling prices make consumers delay purchases, which cuts demand further, which cuts production and costs jobs.

3. Stagflation

Stagnation + Inflation: high inflation together with low growth, and therefore high unemployment. Caused when production of goods and services slows or declines. It defies the Phillips Curve — normally high inflation comes with low unemployment, but here the economy is stagnant and prices still rise.

4. Shrinkflation

Companies cut the size or quantity while keeping the price the same. A stealth tactic to hide rising costs without a visible price hike — chips bags with more air than chips, a beverage bottle going from 320 ml to 250 ml. You pay the same for less.

5. Bottleneck / structural inflation

Supply cannot keep up with demand because of choke points — labour shortages, raw material scarcity, shipping delays. An economic traffic jam: everyone is ready to spend, but a narrow road in logistics forces the whole system into a costly crawl.

6. Skewflation

A sharp price rise in one or two specific sectors (food, energy) while everything else is stable or falling. Overall inflation looks deceptively low, but consumers feel the pinch in daily essentials.

7. Reflation

A deliberate fiscal or monetary push to stimulate the economy after a recession or deflation — lower interest rates, higher government spending, tax cuts. The goal is to "re-inflate" prices and demand. The challenge is stopping it before it turns into uncontrolled inflation.

8. Inflationary gap

Aggregate Demand exceeds aggregate Supply at full employment. Excess spending that no extra goods can match — the economy is overheating. Factories and labour are already at their limit, so the extra demand only pushes prices up. Fix: raise taxes or cut spending to cool the market.

9. Inflation targeting

A framework where the central bank sets a specific percentage as its annual inflation goal and adjusts rates (like the repo rate) to stay inside a comfort zone. In India: RBI's target is 4%, with a tolerance band of ±2% — so 2% to 6%. Creates transparency and predictability for planning.

Depression vs Recession

06Unemployment

Unemployment is a situation where a person is actively searching for work but cannot find it. Someone not looking for work is not counted as unemployed.

In India the data is collected by the National Sample Survey Office (NSSO), using three approaches:

Types of unemployment

1. Structural

Skill mismatch — the workforce's skills don't match what available jobs need. Driven by technology (AI, advanced machinery) replacing manual labour or demanding new skills. The jobs exist; the workers don't qualify.

2. Educated

Graduates and post-graduates unable to find suitable work. Mostly urban India. An engineering graduate who lacks practical, industry-relevant skills.

3. Frictional

Short-term, while a person moves between jobs. Also called search or voluntary unemployment. Resigning to look for something better, or to prepare for CGL.

4. Disguised

More people working than the task needs. Marginal productivity of the extra workers is zero — remove them and output doesn't change. A family of five on a farm that needs three. Most common in rural agriculture.

5. Cyclical / economic

Caused by business cycles. In a recession (Great Recession, COVID-19) demand falls and layoffs follow; when the economy revives, jobs return. Mostly capitalist / urban sectors.

6. Seasonal

Tied to specific times of year. Farmers between sowing and harvest; sellers of fireworks at Diwali or colours at Holi.

7. Classical

Also real wage unemployment. Real wages are set above the market-clearing level — by unions or minimum wage laws — so more people want jobs than firms will hire.

8. Natural

The lowest unemployment a healthy economy can sustain without triggering inflation. Even in a boom, some frictional and structural unemployment always exists because people switch jobs and skills keep changing. Hence "natural".

Main worker vs marginal worker

07National Income — Concepts and Methods

Definition and scope

National Income is the total monetary value of all final goods and services produced by a country's residents (nationals) in a given period, normally a financial year.

It is a macroeconomic concept. Where microeconomics studies the utility one person derives, macroeconomics asks how the entire country performs.

Who built the numbers

Dadabhai Naoroji — the pioneer

First to estimate India's national income.

Book: Poverty and Un-British Rule in India, in which he propounded the Drain Theory — how British rule drained India's wealth.

Founded the East India Association (1866) in London.

First Asian to become a member of the British Parliament.

Presided over three sessions of the Indian National Congress, including the famous 1906 Calcutta session.

Published the newspaper Rast Goftar.

P.C. Mahalanobis — the institution builder

Chaired the National Income Committee (1949), formed after independence to put data collection on a formal footing.

Known as the Father of Statistics in India; established the Indian Statistical Institute (ISI).

The Second Five-Year Plan was built on the Mahalanobis Model.

V.K.R.V. Rao

Used a scientific approach to calculate national income and gave the two-sector economy classification.

Circular flow of income

A model of the continuous movement of goods, services, resources and money. The expenditure of one sector is the income of another.

The loop: households supply resources to firms → firms supply goods and services to households → households spend on those goods → firms pay income back to households.

The models

• 2-sector: Households + Firms.
• 3-sector: + Government (adds taxes, subsidies, transfer payments).
• 4-sector: + Rest of the World (adds exports and imports).

Injections vs leakages

The three methods of calculation

All three should give the same answer — they look at the same flow from three angles: production, distribution and disposition.

1. Value Added Method (Production / Output)

Focuses on the production side. It sums the value added at each stage, rather than the total output at each stage.

Adding the outputs gives ₹1,500 — wrong, because the cotton is counted four times. Adding value added gives ₹800, which equals the final good's price.

Double counting

Counting the value of intermediate goods more than once. Avoid it by counting only final goods, or by summing value added.

Gross Value Added (GVA)

The sum of value added across all sectors: GVA = GVA₁ + GVA₂ + … + GVAₙ

2. Income Method

Focuses on the distribution side — sums all income earned by the factors of production within the domestic territory.

• Compensation to employees — total wages and salaries.
• Operating surplus — business profit, rent and interest, after wages.
• Mixed income — income of the self-employed and unincorporated businesses, where labour income and capital income cannot be separated. E.g. a doctor running their own clinic.

3. Expenditure Method

Adds up all spending in the economy. The most commonly used method.

Goods and variables

Types of final goods

Consumer goods

Non-durables: consumed immediately or quickly — food, drinks, milk.

Durables: last a long time — TV, fridge, AC, cars.

Capital goods

Physical goods businesses use to produce other goods, and which are not consumed in the process — e.g. a machine that makes T-shirts.

Inventory

Items a business keeps in stock — raw materials, work-in-progress, finished goods. Sales up → inventory decumulates. Sales down → inventory accumulates. Can be planned or unplanned.

Stock vs flow

08The Aggregates — GDP, GNP, NDP, NNP

The four base aggregates

Gross Domestic Product (GDP_MP)

Total value of all final goods and services produced within the territory of a country during a financial year.

Second-hand goods are never counted — that would be double counting.

The concept was developed by Simon Kuznets for a US Congress report in 1934.

Gross National Product (GNP_MP)

Total value of goods and services produced by the nationals (citizens) of a country, whether they live inside or outside it.

Depreciation is the fall in an asset's monetary value over time. It applies to capital goods. Anything "Net" means depreciation has been removed.

Market Price vs Factor Cost

National Income proper

National Income = NNP at Factor Cost (NNP_FC). Break the name apart and you have the definition:

• Net — depreciation (wear and tear of machinery) has been deducted.
• National — it captures the income of the country's people, not just its territory.
• Factor Cost — it reflects actual earnings of the factors (wages, rent, interest, profit), not market prices distorted by taxes.

Real vs Nominal GDP

The GDP Deflator is also called Implicit Price Deflator and Price Index.

• India's GDP is calculated by: National Statistical Office (NSO), under MoSPI.
• Base year: 2011–12. A committee has been set up to revise it to 2022–23.

Per capita income and PPP

Purchasing power is the quantity of goods and services a given amount of money can buy — "a common basket of goods". Purchasing Power Parity (PPP) compares economies using that basket instead of market exchange rates.

By PPP, India ranks 3rd in the world, after the USA and China.

Three more aggregates worth knowing

Gross National Income (GNI)

The income counterpart of GNP — total income earned by a country's residents at home and abroad. GNI per capita (PPP $) is the income indicator used inside the Human Development Index.

Gross Fixed Capital Formation (GFCF)

Net investment in physical, tangible assets within an economy — machinery, factories, infrastructure. It counts both government and private investment.

Why it matters: a rising GFCF as a share of GDP signals long-term expansion and growing productive capacity. It is the cleanest single read on whether an economy is building for the future or just consuming.

Incremental Capital Output Ratio (ICOR)

The additional capital investment needed to produce one additional unit of output. A measure of capital efficiency.

Lower ICOR = higher productivity — less capital needed per unit of extra output.

Where it comes from: ICOR is central to the Harrod-Domar growth model, which guided the formulation of India's First Five-Year Plan.

Income measures at the personal level

Personal Income (PI)

Total income of an individual from all sources, before taxes.

PI = National Income + Income received but not earned − Income earned but not received PI = NI + Government transfers + Net interest paid by government − Corporate tax − Payment for social security PI = NI + Transfer payments − Undistributed corporate profit

Transfer payments: subsidies, scholarships, pensions.

Personal Disposable Income (PDI)

What is left after personal taxes and other mandatory deductions — the money actually available to spend or save.

Potential GDP

The total output an economy would produce if all its resources were fully utilised. The gap between potential and actual GDP is the slack in the economy.

09The Union Budget

Definition and constitutional basis

A Budget is an approximation of revenue (receipts) and expenditure over a specified period — normally a fiscal year, 1 April to 31 March.

Mandate

The President shall cause the AFS to be laid before both Houses of Parliament.

Presentation

Laid in the name of the President, but presented by the Finance Minister.

Prepared by

Department of Economic Affairs, Ministry of Finance.

Halwa Ceremony

Customary event marking the start of budget document printing. Officials involved are "quarantined" — kept in isolation — to preserve secrecy until presentation.

Budget history and trivia

Railway Budget

Vote on Account and the Economic Survey

Vote on Account — Article 116

An advance grant letting the government withdraw money from the Consolidated Fund of India for essential expenses (salaries, pensions) before the full Budget is passed.

Duration: typically 2 months (1/6th of the year).

Scope: covers expenditure only. It cannot alter taxes or introduce new schemes.

Economic Survey

A "report card" analysing the previous financial year's performance and outlining future trends.

Timing: presented to Parliament usually one or two days before the Union Budget.

Prepared by: Department of Economic Affairs, under the guidance of the Chief Economic Adviser (CEA).

Functions of the Budget

Structure — receipts and expenditure

Asset

A resource with economic value, owned or controlled, expected to give future benefit — gold, property.

Liability

An obligation to fulfil a debt or duty to another party — repayment of a loan.

The Government Budget splits into Receipts and Expenditure, each of which splits into Revenue and Capital.

Revenue

Funds the government collects to finance its activities and public services — mainly taxes, plus fees, fines and duties.

Capital

Physical or financial resources used to produce value. Splits into capital receipts and capital expenditure.

Capital receipts

Receipts that either create a liability or reduce a government asset.

Capital expenditure

Acquiring, creating or upgrading long-term assets — property, infrastructure, equipment. It creates assets and reduces liabilities. Examples: repayment of loans, loans given, developmental expenditure, roads, schools, hospitals.

Order of government expenditure

The single largest item in the Union Budget is interest payment on past borrowing.

Where the rupee comes from and goes

10Taxation

Direct vs indirect taxes

The split rests on incidence (who bears the burden) versus impact (who pays the government).

Goods and Services Tax (GST)

Nature

A destination-based consumption tax.

Introduced by

The 101st Constitutional Amendment Act.

In force from

1 July 2017.

First state to ratify

Assam.

GST Council

A constitutional body under Article 279A. 33 members — 2 from the Centre + 31 from States/UTs with legislature. Chairperson: Union Finance Minister.

Other taxes

Surcharge

An additional tax on individuals with income above a specified limit. Levied under Article 271 and not shared with states.

Cess

A tax levied for a specific purpose. Collected by the Central Government and not shared with states.

Pigouvian tax

A tax on activities that create negative externalities, designed to reduce the harm.

Paper taxes

Taxes that exist only on paper and contribute almost nothing to revenue. Also called nominal or symbolic taxes. Examples: wealth tax, gift tax, estate duty — now abolished.

The Laffer Curve

Plots tax rate against government revenue. Beyond a certain point, raising the tax rate reduces total revenue.

• High rates discourage investment and consumption.
• Workers reduce effort if extra income will be heavily taxed.
• At a 0% rate revenue is zero; at a 100% rate revenue is also zero. The optimum sits somewhere between.

The two tax reform committees

Finance Commission devolution

The government has accepted the 16th Finance Commission's recommendation of a 41% share of the divisible pool for states, plus Finance Commission grants (rural and urban local body grants, disaster management grants).

11Deficits and Fiscal Management

Types of budget

The five deficits

Fiscal consolidation targets

• Central Government targets a debt-to-GDP ratio of 50 ± 1 percent by 2030.
• Fiscal deficit in BE 2026–27: 4.3% of GDP.

FRBM Act, 2003

Fiscal Responsibility and Budget Management Act — an Act of Parliament to improve fiscal discipline, ensure better management of public funds, and reduce the fiscal deficit.

Under it, the government must present three statements with the Budget:

1. Medium-Term Fiscal Policy Statement — sets 3-year fiscal targets.
2. Fiscal Policy Strategy Statement — outlines financial objectives and strategies.
3. Macroeconomic Framework Statement — assesses economic conditions such as GDP growth.

Deficit financing

The concept was popularised by John Maynard Keynes.

Fiscal policy

Fiscal policy is the government's strategy to manage the economy by adjusting taxes, government spending and borrowing. It is used to control inflation or deflation, unemployment and growth.

12Money — Evolution, Types and Demand

Liquidity

Liquidity is how easily an asset converts into cash without losing value. It measures speed and ease of exchange.

• Money has the highest liquidity — it is already cash, so no conversion is needed.
• Gold beats a bike. Gold has high acceptability — walk to a jeweller and get cash immediately. A bike takes time to sell and usually goes at a distress price.
• Demand deposits (savings, current) are more liquid than term deposits (FDs).

The barter system

During the Harappan Civilisation there was no standardised currency. The economy ran on the Barter System — exchanging goods directly for goods.

Money solved all three. It removed the need for a double coincidence of wants, and it let people specialise in professions other than farming — a teacher can earn money and buy food instead of growing it.

Types of money

1. Fiat money

Currency the government declares legal tender. Issued by a central bank (RBI in India) and not backed by any commodity like gold or silver.

Critical condition: its face value must exceed its intrinsic value (the metal or paper cost).

Why it matters: India discontinued the old thick ₹5 coins because they were being smuggled and melted for razor blades — the metal was worth more than ₹5, so the coins vanished from circulation.

2. Fiduciary money

Accepted purely on trust between payer and payee. Examples: cheques, tokens, bitcoins. Unlike fiat money, acceptance is not mandatory by law — if trust breaks (a cheque bounces), acceptance falls away.

3. Plastic money

Electronic money — payment by electronic fund transfer instead of cash. Debit cards (spend only what you have), credit cards ("spend now, pay later" — borrowed money), and prepaid cards.

4. Hot money

Funds investors shift rapidly between countries or markets to chase short-term gains. Highly volatile — pulled out fast when conditions worsen. Example: Foreign Portfolio Investment (FPI).

Functions of money

Money is also highly portable and durable.

Why people hold money — Keynes' three motives

Speculative demand and interest rates

There is an inverse relationship between the market interest rate (r) and speculative demand for money.

Interest is the opportunity cost — the price — of holding a money balance.

The Liquidity Trap

An economic situation where interest rates are extremely low and people prefer to hold cash rather than invest or spend it.

• Infinite elasticity: demand for money becomes perfectly elastic.
• Graph: the liquidity preference curve becomes horizontal.
• Consequence: monetary policy becomes ineffective. Even if the RBI increases money supply to spur spending, people simply hold the extra cash waiting for better rates.

13Money Supply and Monetary Aggregates

Where money sits in the system

1. Currency in circulation

Currency with the public — money held by ordinary people for spending.

Currency with banks (vault cash) — held for daily operations. Not part of money supply for credit creation, because it is idle, not lent out.

2. Deposits with banks

Demand deposits (DD) — withdrawable anytime; savings and current accounts; highly liquid.

Term deposits (TD) — fixed for a set period; FD, RD; less liquid.

3. Deposits with the RBI

Bankers' deposits — CRR balances banks keep with the RBI.

Other deposits — from foreign central banks, international bodies (IMF, World Bank), government institutions.

4. Postal deposits

Held with the Post Office Savings Bank (POSB); includes both demand and term types.

High-Powered Money (M0)

Also called Reserve Money, Monetary Base, or Base Money. It is the total currency produced by the RBI and Government of India — the total liability of the monetary authority.

• Currency in circulation here includes both currency with the public and vault cash with banks.
• Bankers' deposits with RBI — e.g. CRR.
• Called "high-powered" because it is the base for credit creation. But vault cash and CRR are not directly used by the public for transactions.

The four aggregates

14Banking and the Reserve Bank of India

The business of banking

Banks accept deposits from the public and provide loans to borrowers. The difference between the interest charged on loans (say 9%) and the interest paid to depositors (say 7%) is the bank's profit — the spread.

Types of deposits

Demand liabilities (demand deposits)

Withdrawable at any time. Savings accounts, current accounts (used for business, usually 0% interest).

Time liabilities (term deposits)

Locked for a fixed tenure; early withdrawal attracts a penalty. Fixed Deposits (FD), Recurring Deposits (RD).

NDTL — Net Demand and Time Liabilities

The total deposits held by a bank. It determines funds available for lending and is the base for calculating RBI's reserve requirements.

Banks prefer time deposits — the funds are stable, so they can be lent more aggressively.

The Reserve Bank of India

The central bank of the country, often called the "Bank of all Banks" because it manages, controls and regulates the entire banking system.

Nationalisation

The government acquired full shareholding from private players.

First Governor

Sir Osborne Smith

First Indian Governor

Sir C.D. Deshmukh

Current Governor

Sanjay Malhotra (verify — this changes)

Logo

A tiger and a palm tree

Functions of the RBI

1. Regulator of banks — "Bank of Banks"

Regulates the banking system primarily under the Banking Regulation Act, 1949. Grants licences to banking companies, regulates CRR and SLR, and ensures banks meet criteria before operating.

2. Monetary authority

Formulates and implements monetary policy to control inflation, manage money supply and ensure credit flow. Uses instruments like the repo rate.

3. Currency printing and management

RBI prints and manages banknotes. Exception: the ₹1 note and all coins are issued by the Ministry of Finance (Government of India).

4. Publication of reports

Financial Stability Report (FSR) — biannual, June and December; assesses risks to the financial system.

Handbook of Statistics on the Indian Economy — annual.

5. Lender of last resort

The final source of funding for commercial banks when they cannot secure loans elsewhere during a crisis.

Printing presses and mints

Clean Note Policy

• Introduced: 1999.
• Objective: banks must not pass soiled, torn or scribbled notes to customers; such notes go back to the RBI.
• Legal basis: Section 35A of the Banking Regulation Act, 1949.

Classification of the Indian banking system

Scheduled banks are those listed in the Second Schedule of the RBI Act, 1934.

Evolution of Indian banking

The arc runs from colonial institutions to nationalised banks, driven by the need to shift from Class Banking to Mass Banking.

First bank in India

Bank of Hindustan, 1770, Calcutta.

First Indian-owned bank

Allahabad Bank, 1865.

Nationalisation of banks

The six banks of 1980: Andhra Bank, Corporation Bank, New Bank of India (later merged with PNB in 1993), Oriental Bank of Commerce, Punjab & Sind Bank, Vijaya Bank.

The Narasimham Committees

Functions of a commercial bank

A. Primary functions

Accepting deposits — the bank's liability. Demand deposits (savings, current) and time deposits (FD, RD).

Advancing loans — the bank's asset, because they generate interest income.

B. Secondary functions

Overdraft facility — lets a customer withdraw more than their balance; essentially a short-term loan based on credit score and history.

Agency functions — the bank acts as the customer's agent: fund transfers, collecting income tax on the government's behalf.

General utility functions — locker facility (if items are stolen or lost the bank is liable to compensate, up to a limit), providing information, financial management, issuing guarantees.

Regional Rural Banks (RRBs)

Commercial banks clustered in cities and trade hubs because that was profitable. RRBs were created to serve rural areas, farmers and weaker sections that commercial banks ignored.

First RRB

Prathama Bank — established 2 October 1975 (Gandhi Jayanti), at Moradabad, Uttar Pradesh.

Act

Formalised under the RRB Act, 1976.

Kelkar Committee

Recommended stopping the opening of new RRBs to focus on viability.

15Monetary Policy and Its Tools

Monetary policy is the RBI's regulation of money supply and interest rates to maintain price stability, control inflation and support growth. Its tools split into quantitative (control the volume of money) and qualitative (control the direction of credit).

Reserves banks must maintain

The RBI requires banks to hold part of their NDTL in reserve, so they always have enough to meet an emergency.

• CRR floor removed: an RBI amendment removed the statutory floor limit for CRR, so the RBI can push it below earlier limits if needed.
• Narasimham Committee (1991) recommended reducing SLR so banks would not be forced to lock large funds in government securities. Banks still hold G-Secs voluntarily for safety, liquidity and stable returns.

Quantitative tools

1. Cash Reserve Ratio (CRR)

See above.

2. Statutory Liquidity Ratio (SLR)

See above.

3. Bank Rate

The rate at which the RBI lends to commercial banks for long-term needs. No collateral required. Higher bank rate → costlier borrowing → money supply falls. Lower bank rate → cheaper loans → liquidity rises.

4. Open Market Operations (OMO)

Buying and selling of government securities by the RBI in the open market. Also referred to as sterilisation.

• Outright purchase: RBI buys or sells G-Secs with no repurchase agreement.
• Repo: banks borrow from RBI using G-Secs as collateral, with a promise to repurchase later.
• Reverse repo: RBI invites banks to park surplus funds with it in exchange for G-Secs.

5. Marginal Standing Facility (MSF)

An emergency lending facility introduced in 2011–12 for banks facing an acute shortage of funds.

• Overnight loans at a penal rate, usually 1% (100 basis points) above the repo rate.
• Collateral required — banks may use G-Secs from within their SLR quota, i.e. dip into mandatory reserves.
• Only scheduled commercial banks are eligible.
• Borrowing limit: generally 1–2% of NDTL.

Liquidity Adjustment Facility (LAF)

The framework through which the RBI manages short-term liquidity. Earlier, repo + reverse repo together formed the LAF.

• From 2022–23, the reverse repo rate was removed from LAF and replaced by the Standing Deposit Facility (SDF) rate, which now acts as the floor of the interest rate corridor.
• SDF lets banks park surplus funds with the RBI without providing collateral. It is a liquidity absorption tool.
• The legal provision for SDF came in the Union Budget 2018–19; the RBI operationalised it in 2022.

Base rate and the interbank market

Base rate

The minimum rate below which banks may not lend, except in cases specified by the RBI.

Interbank lending market

Banks borrow short-term from each other to manage liquidity and meet regulatory requirements.

Call money rate

The interest rate on short-term overnight loans between banks and financial institutions. Determined with reference to the reverse repo rate and MSF.

Monetary Policy Committee (MPC)

Established

2016, on the recommendations of the Urjit Patel Committee.

Structure

6 members — 3 from the RBI (Governor, Deputy Governor, Executive Director) and 3 appointed by the Government of India.

Chairperson

RBI Governor, who holds the casting vote in a tie.

Function

Decides the policy rates (repo, etc.) to control inflation.

Meets

Bi-monthly — every two months.

Money multiplier

The maximum extent to which money supply can expand from a change in bank deposits.

When CRR rises, banks keep more in reserve and have less to lend. Fewer loans mean less money creation — so the multiplier falls. And vice versa.

Policy stance — the summary table

Qualitative tools

Selective tools that control the use and direction of credit in specific sectors, rather than the total quantity.

1. Changing margin requirements

RBI raises the margin (what borrowers must pay upfront) for non-essential sectors to curb borrowing, and lowers it for priority sectors like agriculture to encourage lending.

2. Consumer credit regulation

RBI sets rules on loan instalments, down payments and repayment periods in advance — managing inflation by controlling how much people can borrow.

3. Moral suasion

Persuasion and implicit pressure. RBI advises banks to follow its monetary policy rather than compelling them.

4. Credit rationing

RBI caps the total loans and credit banks may issue to certain sectors, fixing credit supply per bank and per sector to ensure balanced lending.

16Financial Institutions and Inclusion

NABARD

National Bank for Agriculture and Rural Development

Established

12 July 1982, on the recommendation of the B. Sivaraman Committee (1979), under the NABARD Act, 1981. HQ: Mumbai.

Functions

Rural credit — loans and financial assistance for agriculture and rural development.

Supervision — oversees Cooperative Banks and RRBs.

Refinancing — funds banks rather than the public. NABARD does not lend directly to individuals.

Schemes

Facilitates PMAY, Kisan Credit Cards (KCC), RuPay Kisan Cards.

E-Shakti & LEDP (2015) — digitisation of SHGs and livelihood/enterprise development.

SHG–Bank Linkage Programme (1992) — links Self Help Groups to banks to widen financial access.

Regulatory and development bodies

Microfinance

MFIs — Microfinance Institutions

Provide micro-loans plus credit, savings, insurance and remittances to low-income people.

No collateral required, for households with annual income up to ₹3 lakh.

Father of the microfinance system

Muhammad Yunus — won the 2006 Nobel Peace Prize for founding the Grameen Bank in Bangladesh.

First microfinance institution

SEWA Bank (Self Employed Women's Association), established 1974 in Ahmedabad.

NBFCs

Non-Banking Financial Companies provide various banking services but do not hold a banking licence.

NBFCs by specialisation

• Gold loans: Muthoot Finance, Manappuram Finance
• Asset / vehicle finance: Shriram Finance, Mahindra Finance
• Consumer / personal finance: Bajaj Finance, Tata Capital
• Infrastructure finance: Power Finance Corporation (PFC), REC Limited

Capital requirements

NBFC-MFI

• Registered and regulated by the RBI.
• Provide micro-loans to low-income individuals, especially rural, without access to formal banking.
• Established on the recommendations of the Malegam Committee (2010), which investigated problems in the MFI sector.

Financial inclusion — schemes and bodies

PMJDY — Pradhan Mantri Jan Dhan Yojana

Launched 2014. Objective: financial inclusion through universal access to banking — at least one bank account per household. The flagship name whenever a question says "financial inclusion".

IPPB — India Post Payments Bank

Uses the post office network and postmen (dakiyas), equipped with smartphones and biometric devices, to deliver doorstep banking to the unbanked.

QR Card: IPPB issues a physical QR card instead of a PIN-based debit card. Transactions are authenticated by scanning the QR code plus biometric verification.

BCSBI — Banking Codes and Standards Board of India

Released the "Code of Bank's Commitment to Customers" in 2006, setting minimum standards of banking practice for member banks dealing with individual customers.

Stand-Up India

Promotes entrepreneurship among SC/ST and women borrowers through bank loans for greenfield enterprises.

EXIM Bank — Export-Import Bank of India

Finances, facilitates and promotes India's foreign trade. Sits alongside NABARD (rural), SIDBI (MSME) and SEBI (securities) in the apex-institution match-the-column questions.

Priority Sector Lending (PSL)

The RBI mandates that banks direct a fixed portion of lending to sectors affecting large segments of the population.

ANBC = Adjusted Net Bank Credit.

Sub-targets

• Agriculture: 18%
• Weaker sections (SC, ST, women): 12%

If a bank misses the target, the shortfall is deposited into the Rural Infrastructure Development Fund (RIDF), managed by NABARD.

Urban Cooperative Banks (UCBs)

UCBs face dual regulation:

• RBI — banking functions, prudential norms, monetary policy.
• Registrar of Cooperative Societies (RCS) — incorporation, management, elections, audit.

MUDRA and PMMY

Pradhan Mantri Mudra Yojana (PMMY) promotes financial inclusion by providing micro-credit to small businesses.

MUDRA (Micro Units Development & Refinance Agency Ltd.) — launched 8 April 2015, funded 100% by SIDBI.

Payment and Settlement Systems Act, 2007

• All payment systems in India — UPI, NEFT, RTGS, credit cards — are regulated by the RBI under this Act.
• It gives the RBI legal authority to supervise any system enabling payments between a payer and a beneficiary.

17Money Market, NPAs and Basel Norms

Money market vs capital market

Money market instruments

Call money

Repaid within 1 day (less than 24 hours) — overnight requirements.

Notice money

Repaid within 2 to 14 days.

Treasury Bills (T-Bills)

Short-term debt instruments issued by the Government of India but managed and issued by the RBI.

Tenors: 91 days, 182 days, 364 days. All under a year, so they are money market instruments.

Zero-coupon securities — they pay no regular interest. Issued at a discount to face value and redeemed at face value. A ₹100 T-Bill issued at ₹95 returns ₹5 as the investor's profit at maturity.

Interbank offer rates

Asset classification and NPAs

To a bank a loan is an asset; to the borrower it is a liability. Assets are classified by repayment performance.

Willful defaulters — borrowers who have the capacity to repay but deliberately choose not to. Vijay Mallya is the standard example.

Recovery mechanisms

Bad Banks

A financial entity set up specifically to buy NPAs from commercial banks. This clears the commercial bank's balance sheet so it can lend again, while the bad bank focuses on recovering the money.

India's structure, announced in Budget 2021:

• NARCL — National Asset Reconstruction Company Limited: acquires the bad loans.
• IDRCL — India Debt Resolution Company Limited: manages the assets and tries to sell them.

SARFAESI Act, 2002

Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act.

Empowers banks to seize the collateral of defaulting borrowers without going to court first. A major tool against willful defaulters.

Insolvency and Bankruptcy Code (IBC), 2016

Insolvency = the financial state of being unable to pay debts. Bankruptcy = the legal declaration of that insolvency.

Objective: resolve the Twin Balance Sheet Problem — banks stressed with bad loans and corporates stressed with debt, at the same time.

Process: initiates the Corporate Insolvency Resolution Process (CIRP). Time limit 180 days, extendable by 90 days = 270 days total, to decide whether to revive or liquidate.

Adjudicating bodies: NCLT (National Company Law Tribunal) for initial cases; NCLAT (Appellate Tribunal) for appeals.

Basel Norms

Banking systems are globally interconnected — a major failure like Lehman Brothers in 2008 spreads worldwide. Basel Norms (Basel Accords) are international regulations to strengthen banks and manage risk.

Established by

Bank for International Settlements (BIS), headquartered in Basel, Switzerland.

Framed by

Basel Committee on Banking Supervision (BCBS), formed by central bank governors of the G10 countries in 1974.

Goal

Make banks act as "shock absorbers" — hold enough capital cushion.

Risk Weighted Assets (RWA)

Different loans carry different risk — a loan to the government is 0% risk, a loan to a volatile business may be 100%. Capital is calculated against this weighted risk.

Tier 1 capital

Core capital — equity, disclosed reserves. Highly liquid and permanent.

Tier 2 capital

Supplementary capital — subordinated debt, undisclosed reserves. Less liquid.

18Balance of Payments and the 1991 Reforms

What BoP is

Balance of Payments is a systematic record of all financial transactions — imports, exports, investments — between a country and the rest of the world over a period, usually a year. It works like a balance sheet for a country's external dealings.

BoP has two main accounts: the Current Account and the Capital Account.

Current Account

Scans all incoming and outgoing goods and services — the actual trade happening. Three sub-categories:

Capital Account

Monitors capital transactions — the purchase and sale of assets, both financial and non-financial, such as land, property and stocks.

FDI routes and sectoral limits

• Automatic route — no government approval needed.
• Government route — mandatory approval required.
• Defence: up to 74% via automatic route; beyond 74% (up to 100%) requires the government route.
• Insurance: now allowed up to 100% via the automatic route.

Current Account Deficit (CAD)

A CAD occurs when a country imports more goods, services and capital than it exports. It includes the balance of trade, net income from abroad, foreign aid and net current transfers.

• A deficit means the country is a net borrower from the rest of the world to finance its imports.
• India's position: generally runs a CAD, currently around 1.2% of GDP. The RBI's comfort level is 2–2.5%.
• Historical exception: from 2000 to 2003 India ran a Current Account Surplus, driven by a boom in services exports (IT/BPO) and reduced imports.

Trade balance — the vocabulary

India's trade policy — before and after 1991

The 1991 Balance of Payments crisis

Also called the Currency Crisis.

The situation

By 1990–91 India's foreign exchange reserves had run down badly.

Import cover: only two weeks — a fortnight of essential imports.

The country could not pay for essential imports or service its foreign debt.

The solution

India approached the IMF for a bailout loan. The IMF agreed, but imposed strict conditions requiring structural reform.

Architects of reform

PM: P.V. Narasimha Rao. FM: Dr. Manmohan Singh.

LPG Reforms, 1991

Introduced as part of the New Economic Policy.

L — Liberalisation (Udarikaran)

Removing unnecessary government restrictions and controls.

Abolition of License Raj — industrial licensing scrapped for most sectors.

Tariff reduction — import duties lowered.

Deregulation of markets to encourage competition.

P — Privatisation (Nijikaran)

Transfer of ownership, management or control of public sector enterprises to the private sector, to improve efficiency and reduce the government's financial burden.

G — Globalisation (Vaishvikaran)

Integrating the national economy with the global economy — free flow of goods, services, capital, technology and labour across borders. Outcome: opening up to FDI and foreign technology.

WTO and its predecessor

India joined the WTO in 1995, deepening its integration into global trade. UNCTAD (United Nations Conference on Trade and Development) works on integrating developing countries into the world economy; its standing executive body is the Trade and Development Board.

19Forex, Currency and Exchange Rates

Foreign exchange reserves

Assets held by a nation's central bank (RBI in India). They exist to provide import cover and to protect the economy against external shocks — recessions, wars, currency volatility.

During the 1991 crisis India had cover for two weeks. Today India holds enough to cover close to a year of imports.

IMF and World Bank

• Headquarters: Washington D.C. — both.
• Bretton Woods Conference, 1944 — officially the United Nations Monetary and Financial Conference. 44 nations, 730 delegates. It created the IMF and World Bank, the "twin organisations".
• It also created the IBRD (International Bank for Reconstruction and Development), now part of the World Bank.
• Context: 1929–30 Great Depression in the USA.

Major IMF reports — released twice a year

1. World Economic Outlook (WEO)
2. Global Financial Stability Report (GFSR)
3. Fiscal Monitor (FM)

Top borrowers of the IMF include Argentina and Egypt.

Nostro and Vostro accounts

Currency valuation — the four-word table

A currency's value changes for two reasons: market forces or government intervention.

Depreciation in practice

$1 = ₹80 moves to $1 = ₹90. You now need more rupees for the same dollar. Exporters benefit — they earn more rupees per dollar sold.

Appreciation in practice

$1 = ₹90 moves to $1 = ₹80. You need fewer rupees per dollar. Importers benefit — foreign goods get cheaper.

When devaluation works

Devaluation is most beneficial if the volume of exports rises proportionately to the drop in price.

Types of currency

1. Hard currency

High liquidity and universal acceptability; easily converted; widely trusted. E.g. US Dollar.

2. Soft currency

Easily available in the forex market, with lower liquidity and acceptability. Because it is abundant, demand is relatively low. E.g. Indian Rupee and currencies of developing nations.

3. Hot currency

A currency that enters and exits an economy rapidly. As countries cut dependence on the dollar, it leaves those economies fast — "hot" in that context.

4. Heated currency

A domestic currency under high pressure of depreciation, dropping fast against a hard currency.

5. Cheap currency

Government follows an expansionary policy and repurchases its bonds before maturity → injects liquidity → high supply → depreciation → currency becomes "cheap".

6. Dear currency

Government follows a contractionary policy and sells bonds → soaks up liquidity → low supply → appreciation → currency becomes "dear".

India's exchange rate regime

LERMS — Liberalised Exchange Rate Management System. A dual exchange rate system allowing a partial float: some rates set by the market, others by the government. It marked the transition from a fixed regime to a market-determined one.

NEER and REER

To judge the rupee against multiple trading partners rather than just the dollar, economists use "effective" exchange rates.

NEER — Nominal Effective Exchange Rate

The weighted average of bilateral exchange rates against a basket of foreign currencies. Weights reflect trade importance — the USD carries a higher weight if trade with the US is large.

An increase in NEER indicates appreciation of the rupee. It does not adjust for inflation.

REER — Real Effective Exchange Rate

NEER adjusted for inflation (relative prices).

REER = NEER − Inflation Differential

FERA, FEMA and convertibility

Convertibility of the rupee

How easily a country's currency can be converted into gold or another currency.

20Poverty, Human Development and Inequality

What poverty is

Poverty is a state in which an individual lacks the financial resources and essentials for a basic standard of living. It is not just about money — it has environmental, legal, social, economic and political causes and effects.

Poverty by persistence

How India measures poverty

Poverty is measured by checking income or consumption. Below a set minimum, a person is Below the Poverty Line (BPL).

Estimation is carried out by NITI Aayog's task force, using data captured by the National Sample Survey Office (NSSO) under MoSPI.

Pre-independence estimates

Naoroji used the concept of a "Prisoner's Menu" — the cost of basic jail rations of flour, rice and dal — to calculate subsistence cost. He was also the first person to estimate India's national income.

Post-independence committees

Planning Commission figures (Tendulkar basis): Rural poverty 25.7%, Urban 13.7%, Overall 21.9%.

Trends and state-wise poverty

Multidimensional Poverty Index (MPI)

Global MPI

Introduced in 2010 by UNDP (United Nations Development Programme) and OPHI (Oxford Poverty and Human Development Initiative).

Uses 10 indicators across 3 dimensions — Health, Education, Standard of Living — to capture both the incidence and the intensity of poverty.

National MPI

Launched by NITI Aayog in November 2021, measuring poverty in India using 12 indicators, based on National Family Health Survey (NFHS) data.

Current position

• Multidimensional poverty in India has declined since 2005–06.
• According to NITI Aayog, 24.82 crore people escaped multidimensional poverty in the last 9 years.
• Uttar Pradesh — largest number of people lifted out of poverty since 2005–06.
• Highest MPI (most poverty): Bihar. Lowest MPI (least poverty): Kerala.

Head Count Ratio (HCR)

The percentage of a population living below the poverty line. Also called the poverty headcount index.

Human Development Index (HDI)

Created

1990, by Mahbub ul Haq (Pakistani economist) and Amartya Sen (Indian economist).

Amartya Sen

First Indian economist to win the Nobel Prize in Economics (1998).

Other indices

Export Preparedness Index (EPI)

Published by NITI Aayog. Built on 4 pillars: Policy, Business Ecosystem, Export Ecosystem, Export Performance.

Multidimensional Vulnerability Index (MVI)

Published by the UNGA (United Nations General Assembly). Measures structural vulnerability and lack of structural resilience across three dimensions: Economic, Environmental, Social.

Global indices — who publishes what

Nearly every index question is really a "who publishes it" question. Learn the publisher first, the parameters second.

The capability approach

Amartya Sen's framework, and the philosophical foundation of the HDI. It argues that development should be judged by what people are actually able to do and be — their real freedoms and capabilities — rather than by income or utility alone.

• Strength: it looks past averages to whether a person can genuinely live the life they value.
• Main criticism: capabilities are hard to operationalise and measure consistently across societies.
• IHDI — Inequality-adjusted HDI — discounts the HDI for how unevenly health, education and income are spread. When inequality is high, IHDI falls well below HDI.

Sustainable Development Goals

• Before the SDGs, the world followed the Millennium Development Goals (MDGs), with a target deadline of 2015.
• Adopted: 2015, by UN member countries in New York.
• Effective from: 1 January 2016. Target year: 2030.
• 17 Goals and 169 Targets, aimed at ending poverty, protecting the planet and ensuring prosperity.

Consumption, savings and the multiplier

Marginal Propensity to Consume (MPC)

The portion of additional income that a person spends rather than saves — how much consumption rises when income rises by one unit.

Value range: 0 to 1. MPC is lower at higher income levels.

A high MPC means people spend a larger share of extra income, producing a bigger rise in overall expenditure across the economy. A low MPC (like 0.1 above) means most of the extra income is saved.

Autonomous expenditure

Spending that occurs regardless of the level of income — it is independent of income.

Measuring inequality — Lorenz Curve and Gini

Lorenz Curve

A graphical representation of income inequality or wealth distribution.

Line of equality: a 45° diagonal representing perfect equality, where everyone has the same income.

The Lorenz curve always lies below the line of equality. The farther the curve from the diagonal, the higher the inequality.

Gini Coefficient

Derived from the Lorenz Curve to give inequality a single number.

SEZ and the National Infrastructure Pipeline

Special Economic Zones (SEZ)

Purpose: promote exports, attract investment, generate employment, earn foreign exchange, develop infrastructure.

Policy announced: 2000. SEZ Act enacted: 2005.

Asia's first Export Processing Zone (EPZ) was set up at Kandla, Gujarat, in 1965.

Challenges: MAT (Minimum Alternate Tax) imposed on SEZ developers and units reduced their attractiveness. The Sunset Clause — tax holidays under Section 10AA of the Income Tax Act apply only to units that began operations before 1 April 2020.

National Infrastructure Pipeline (NIP)

A government initiative for world-class infrastructure and better quality of life.

Duration: 2020–2025 (5 years). Total investment: ~₹111 lakh crore.

Share: Centre 39%, States 39%, Private sector 22%.

Largest sectors: Energy (~₹25 lakh cr), Roads (~₹20 lakh cr), Urban (~₹16 lakh cr), Railways (~₹14 lakh cr).

21Planning in India

Pre-independence plans

Land reforms — the four pillars

The overall purpose was a structural change in the ownership of landholdings — ending feudal exploitation and reducing inequality. Four measures did the work.

The slogan for the whole programme was "Land to the Tiller". The Land Ceiling Act came in 1976.

The agricultural revolutions

The two phases of the Green Revolution

The planning machinery

Inspiration

Five-Year Plans were borrowed from the USSR. Joseph Stalin introduced them there in 1928 to industrialise the Soviet Union.

Planning Commission

Established March 1950.

Nature: an extra-constitutional and non-statutory body — an executive body. Not mentioned in the Constitution, not created by an Act of Parliament.

Function: design and formulate the Five-Year Plans.

Chairman: Prime Minister (ex-officio). Deputy Chairman: appointed by the PM. Members: Cabinet Ministers and the Planning Minister.

Dissolved 2014, replaced by NITI Aayog on 1 January 2015.

National Development Council (NDC)

Established August 1952. Its job was to approve and implement the plans that the Planning Commission designed. Chairman: Prime Minister.

The four objectives of the Five-Year Plans

1. Growth — growth in GDP.
2. Modernisation — integrating new technology.
3. Self-reliance — inward-looking trade strategy; produce domestically instead of importing.
4. Equity — development of all.

The plans also carried long-term goals to be achieved over 20 years — this longer vision is called a Perspective Plan.

Inward-looking vs outward-looking strategy

The Five-Year Plans — the master table

Plan-by-plan key facts

First Plan (from 1 April 1951)

• Dams: Bhakra Nangal on the Sutlej (highest gravity dam); Hirakud on the Mahanadi, Odisha (longest dam); Nagarjuna Sagar on the Krishna.
• Education: IITs established — IIT Kharagpur (1951) was the first. Others followed: Bombay (1958), Kanpur (1959), Madras (1959), Delhi (1961).
• Land reform: policy of "Land to the Tiller" — ownership rights to actual cultivators, aiming to abolish the Zamindari system.
• Community Development Programme (CDP) launched 1952.
• The Land Ceiling Act came later, in 1976.

Second Plan

• Three steel plants: Rourkela, Odisha (German collaboration); Durgapur, West Bengal (British); Bhilai, Chhattisgarh (USSR).
• The Industrial Policy Resolution of 1956 was the foundational policy for this plan.
• Karve Committee (1955) — the Village and Small-Scale Industries Committee, chaired by D.G. Karve, to promote rural development through small-scale and cottage industries alongside heavy industrialisation.

Third Plan and the Plan Holiday

Reasons for failure — the triple shock:

• Indo-China War (1962) — funds diverted from development to defence.
• Indo-Pak War (1965) — further drain on resources.
• Severe drought (1965–66) — a massive food crisis.

Key institutions created:

• Food Corporation of India (FCI) — 14 January 1965.
• Agricultural Prices Commission (APC) — 1 January 1965, to recommend MSP. Later renamed CACP (Commission for Agricultural Costs and Prices).
• IDBI — 1 July 1964. UTI — Act 1963, established 1 February 1964.

Plan Holiday (1966–69): a break in Five-Year Plans caused by war and drought. India turned to the "New Agriculture Strategy" — the Green Revolution, with widespread adoption of HYV seeds. Phase 1 in the mid-1960s–1970s; phase 2 in the mid-1970s.

PL 480 Scheme: India imported wheat from the USA under this scheme to relieve hunger.

Fourth Plan

• President: V.V. Giri.
• Family Planning Programme introduced.
• 14 major banks nationalised (1969).
• First underground nuclear test — "Smiling Buddha" (1974).
• Drought Prone Area Programme (1973–74).

Fifth Plan

• Terminated one year early — the only Five-Year Plan that ran just 4 years.
• "Garibi Hatao" slogan — Indira Gandhi.
• Regional Rural Banks set up (1975).
• 20-Point Programme (1975) to reduce poverty and improve quality of life.
• Minimum Needs Programme (1974). Hill Area Development Programme initiated.

Rolling Plan (1978–80)

Introduced by the Janata Party / Morarji Desai government. Focus: GDP, employment and agricultural production. Abandoned when Indira Gandhi returned in 1980 and Five-Year Plans were reinstated.

Sixth Plan

• TRYSEM — Training Rural Youth for Self-Employment.
• IRDP — Integrated Rural Development Programme.
• NREP — National Rural Employment Programme (slack season employment).
• RLEGP — Rural Landless Labour Employment Guarantee Programme, launched 15 August 1983.
• NABARD established 12 July 1982, on the recommendation of the B. Sivaraman Committee.

Seventh Plan

• Jawahar Rozgar Yojana (1989) — formed by merging NREP + RLEGP.
• Department of Biotechnology set up.

Eighth Plan — the game changer

• Launched in 1992, after structural adjustment policies began.
• Economic and fiscal reforms; License Raj ended; the public sector's share in total investment fell to about 34%.
• Some 65% of the population was still employed in agriculture as late as 1990.
• Between 1950 and 1990, agriculture's GDP contribution declined sharply, but the population depending on it barely moved — 67.5% in 1950 to 64.9% by 1990.

Ninth to Twelfth Plans

• Pokhran-II (1998) — second nuclear test, code name Operation Shakti — fell in the Ninth Plan.
• After the Ninth Plan there was less focus on the public sector; the strategy leaned predominantly on the private sector.
• Tenth Plan: National Horticulture Mission, Jute Technology Mission, Micro Irrigation Programme. Goals included reducing gender gaps in literacy and wages, cutting infant and maternal mortality, potable water access, cleaning polluted rivers. India emerged as one of the fastest-growing economies by the end of this plan.
• Eleventh Plan: the global financial crisis overlapped with it.

NITI Aayog

National Institution for Transforming India.

• The Planning Commission was replaced in 2014; NITI Aayog was set up on 1 January 2015, and Five-Year Plans were discontinued.
• Chairman: Prime Minister of India.
• A non-constitutional body — a policy think tank for the Government of India.
• Designs and recommends policies and programmes; publishes reports on fiscal health, education quality, water management and more.

Industrial Policy Resolutions

IPRs are policy frameworks that regulate industrial growth, define the role of public and private sectors, and promote economic development.

1st IPR, 1948

• First official industrial policy of independent India.
• Led by Dr. Shyama Prasad Mukherjee (Industry & Commerce Minister).
• Declared the Indian economy a Mixed Economy.
• Start of the License Raj — government control over industry through licensing. Laid the foundation for public sector dominance.

2nd IPR, 1956

• Known as the "Economic Constitution of India".
• A framework for socialist industrial growth.

3rd IPR, 1977

• An extension of the 1956 policy, introduced by the Morarji Desai / Janata Party government.
• Emphasised growth of Small-Scale Industries (SSI).
• Introduced the "Tiny Unit" concept — enterprises with investment below ₹1 lakh.
• Restrictions on MNCs — focus on self-reliance.

4th IPR, 1980

• Introduced by the Indira Gandhi government.
• Shifted focus back to heavy industries.
• Encouraged foreign technology transfer and investment, alongside the FERA Act of 1973.
• The MRTP Act, 1969 (Monopolistic and Restrictive Trade Practices) was amended to remove asset threshold limits for MRTP companies.
• Investment limit for a tiny unit raised to ₹2 lakh.

5th IPR — New Industrial Policy, 1991

• Announced by the P.V. Narasimha Rao government, led by Dr. Manmohan Singh.
• End of the License Raj — most industries freed from licensing.
• Privatisation — disinvestment in PSUs.
• FDI opened in key industries.
• LPG reforms.
• Exit policy for sick units in the private sector, allowing a smooth exit without harming labour welfare.

The License Raj and its dismantling

What the License Raj was

A system of government permissions (licences) required to start, expand or diversify an industry, decide what to produce and in what quantity. It ran from the 1st IPR (1948) until 1991.

Commanding heights of the economy

The doctrine that the state should hold complete control over the vital industries — defence, atomic energy, railways, heavy industry — while leaving the rest to the private sector. This is the core theme of the IPR 1956.

Why it was criticised

Entry barriers — licences could be hoarded by incumbents to block competitors from entering or expanding.

Protected market, poor quality — with no competitive pressure, inefficiency persisted and consumers had little choice.

Red tape — excessive government control and delay.

Delicensing

The removal of industrial licensing and price controls — the central act of liberalisation in 1991. After it, only a short list of industries stayed reserved for the public sector, chiefly defence and atomic energy.

Directive → indicative planning

The core shift after 1991. Planning stopped directing what industry must do and began indicating broad directions while the market allocated resources.

Privatisation machinery

Disinvestment Commission

Set up in August 1996, chaired by G.V. Ramakrishna. Mandate: advise the government on the extent, mode and timing of selling government equity in PSUs.

Total privatisation

100% transfer of ownership of a public enterprise to private hands — as against partial disinvestment, where the government sells a minority stake and keeps control. The sale of BALCO (Bharat Aluminium Company) is the standard example of privatisation.

National Renewal Fund (NRF)

Established February 1992 as a social safety net for the reform period. It funded retraining, redeployment and compensation (including Voluntary Retirement Schemes) for workers displaced by industrial restructuring and the closure of sick PSUs.

Exit policy

Introduced with the 1991 policy — permits firms to close unviable operations smoothly, without abandoning the welfare of labour.

Related terms

Joint Sector

A partnership between the public sector (government) and the private sector. The Dutta Committee recommended establishing the Joint Venture Sector in Indian industry.

Disinvestment

Transfer of ownership, management or control of public sector enterprises to the private sector.

Shell company

A company that exists only on paper.

Round tripping

Domestic money leaves the country and returns disguised as "foreign investment".

22Government Schemes and Missions

Schemes are tested as one-line mappings: name → sector → the single distinguishing number or feature. Learn them in that shape and they stop blurring together.

Employment and income support

Food, farm and rural

Industry, logistics and infrastructure

Environment and the long horizon

Green Credit Programme (GCP)

Notified by the Ministry of Environment, Forest and Climate Change. Incentivises voluntary environmental action — tree plantation, water conservation — by generating tradeable "Green Credits". It deliberately goes beyond carbon to broader eco-restoration.

NDCs — Nationally Determined Contributions

A country's self-declared climate targets under the Paris Agreement, updated periodically.

Viksit Bharat @2047

Vision to make India a developed nation by 2047 — the centenary of independence. Spans economic growth, social progress, environmental sustainability and governance.

National Research Foundation (NRF)

Funds and seeds research across universities and institutions.

Socio-Economic and Caste Census, 2011

The SECC 2011 identified deprived rural households using two separate lists — and the exam asks for the counts.

23India and the World — Groupings and Corridors

Regional and plurilateral groupings

India's two neighbourhood doctrines

Corridors and agreements

IMEC — India-Middle East-Europe Economic Corridor

A multimodal network of shipping lanes and rail linking India → UAE → Saudi Arabia → Jordan → Israel → European Union.

Benefit to Indian exporters: significantly reduced transport time — cited as up to 40% — and lower logistics costs compared with the traditional Suez Canal route.

Connects: Asia and Europe. The two Middle Eastern anchors named in questions are Saudi Arabia and the UAE.

CEPA — Comprehensive Economic Partnership Agreement

A deep trade agreement covering goods, services and investment. India–Japan CEPA was signed in 2011, and led to Japanese Industrial Townships in India. India also has a CEPA with the UAE.

INSTC — International North-South Transport Corridor

Improves connectivity with Eurasia via Iran and Russia — the northern counterpart to IMEC's westward route.