Traditional vs Socialist vs Capitalist vs Anarcho Capitalism vs Mixed Economy, Formal vs Informal Economy

 

Traditional Economy: 

• A traditional economy is an original and primitive economic system. 
• The traditions, customs, and belief system of the economy define the nature of   the goods and the services to be produced in an economy, as well as the rules and manner of their distribution. 
• Example: Tribal Communities.

CAPITALIST ECONOMY:

• The purchasing power /desire /demand /wants rather than the basic needs of the people decides what goods are to be  produced and  distributed among people .
• As the control is in the hands of industrialist ,then methods of production will always be selected in the manner in which it is more and more profitable to the businessmen. 
• The produced goods and services are distributed as per the demand /purchasing power of the people.
• Most of the countries in today’s world are moving towards Capitalist mode of Economies.
• Ex. Cheaper housing  for the poor is the basic need of the masses but this demand don’t create demand in the market sense because the poor do not have the purchasing power to support the demand. 

SOCIALIST ECONOMY:

• In a socialist society , the government which decides what goods are to be produced. 
• The decision is  in accordance with the needs rather than the demands  of the society. 
• It is assumed that the government knows what is good for the people of the country and so it takes care of the needs of the people and the desires of individual consumers are not given much importance.
• Ideally, a socialist society has no private property since everything is owned by the state. 
• The methods used for production are labour intensive creating more and more of the jobs.
• In principle, distribution under socialism is supposed to be based on what people need and not on what they can afford to purchase. 
• Example: The then USSR and China of 1990,s and Cuba.

MIXED ECONOMY:

• In the mixed Economy, both the government and the market together answer the three questions of what to produce, how to produce and how to distribute what is produced.
•  In a mixed economy, the market will provide whatever goods and services it can produce well and it is concerned about the demand /desires/purchasing power  of the society. 
• On the other hand, the government will provide essential goods and services which the market fails to do. 
• India is the classic case of mixed Economy.

Anarcho Capitalism : 

• A radical concept of Political state which advocates for demolition of state and talks of police and legal services to be provided by  the private sector .
• Javier Milei ,the rpesident of Argentina is of this ideology and considered to be the ultra right.

INFORMAL ECONOMY: 

• The informal sector, informal economy, or grey economy is the part of an economy that is not part of the formal system ie it is neither taxed, nor accounted in government records. 
• Unlike the formal economy, activities of the informal economy are not included in Gross Domestic Product (GDP).
• Ex. any nearby shop from which you make purchases without any bill.

FORMAL ECONOMY:

• All the activities of an economy which pay taxes to the government and are accounted in the government records. 
• This economy constitutes a part of Gross Domestic Product (GDP). 
• Example: All the purchases from any mall in which you receive the bill.

Output vs Outcome, OUTCOME BASED BUDGETING

Output vs Outcome:

Outputs are tangible results of an activity which are short term, immediate and quantifiable

while

Outcomes are long term results having a long-lasting impact, qualitative and more focussed on qualitative aspect rather of merely quantitative aspect.

To understand:

01.Total sanitation campaign came into force in 1999 and on records there were toilets constructed in rural areas throughout the country but still people defecated in open.

Construction of toilets in numbers is Output while habit of using toilet is outcome.

Conclusively in case of TSC, output was there but outcome was not there.

02.Sarve Shiksha Abhiyan (SSA) is operational since 2002 and target was to educate all children between 6-14 age by 2010.

But ASER report-2023 published by NGO PRATHAM observed that over 50 % of the children in the age group of 14-18 years are not able to do elementary calculations.

So, bringing children to school is output but learning abilities is outcome, and ASER report clearly highlights that aspect.

Outcome Based Budgeting (OBB):

In view of such examples, outcome budgeting becomes of significance. In terms of Outcome Budgeting, Outcomes refer to the ultimate products and results of various government initiatives and interventions, These are represented in terms of qualitative targets and achievements, enhancing the comprehensiveness of the technique.

• outcome-based budgeting is one of the prominent budgeting methods currently practiced in India.
• OBB involves outlining and estimating the results of each program or scheme that has been developed.
• In OBB, program outcomes are evaluated not merely in monetary terms but also through physical achievements expressed in actual figures, such as learning abilities of students.
• Additionally, outcomes are conveyed in terms of qualitative targets and accomplishments to enhance the overall technique's comprehensiveness.
• This method assesses the developmental outcomes of all government programs and determines whether funds have been utilized for their intended purposes, including the effectiveness of financial expenditure.
• The outcome budget contributes to improved service delivery, informed decision-making, program performance evaluation, communication of program objectives, enhanced program effectiveness, cost-effective budgeting, accountability establishment, and better management of schemes.
• Outcome budgeting shifts the focus of government programs from being oriented around expenditures to being focused on results.
• In India, the Performance Budget was integrated with the Outcome Budget in 2007-08, resulting in a single document known as the Outcome Budget.

As on date in India, All ministries are required to prepare outcome budgets and presents it to Finance Ministry to ensure that budgeting is directed towards achieving specific targets.

Public Debt to GDP Ratio

 

Public Debt to GDP Ratio:

The debt-to-GDP ratio is the metric comparing a country's public debt to its Gross Domestic Product (GDP).

Significance of Public Debt to GDP Ratio:

By comparing country's debt, with what it produces, the Debt-to-GDP ratio reliably indicates that particular country’s ability to pay back its debts. As per FRBM Act, the Debt to GDP ratio should be around 60%.

•        40% for Central Government

•        20% for the State Government.

Analysing India's Debt to GDP Ratio in Figures:

• Centre’s outstanding debt reduced from 50.5% of GDP in 2013-14 to 48.1% in 2018-19 .
• Subsequently, it shot up to 50.7% in 2019-20 and 60.8% in 2020-21, before marginally dipping to 55.9% in 2022-23, 56.9% in 2023-24 and a budgeted 56% in 2024-25.
• Increase in debt was on account of additional public health and social safety net expenditure requirements – amid a drying up of revenues during  Covid-19.

India’s public debt (combined liabilities of the Central and State governments) to Gross Domestic Product (GDP), at constant prices, increased to a record high of 105.23 per cent in 2021(Economic survey 2023). 

Analysing World's Debt to GDP Ratio in Figures :

Across the world, General government debt climbed from 108.7% of GDP in 2019 to 133.5% in 2020 and 121.4% in 2022 for the US; from 97.4% to 115.1% and 111.7% for France; from 85.5% to 105.6% and 101.4% for the United Kingdom; and from 60.4% to 70.1% and 77.1% for China during these years. 

Impact of High Debt to GDP ratio on Economy:

•        Crowding Out Effect.

•        Major Part of Budget going to Interest Payments.

•        Poor ratings by Credit Rating Agencies.

•        Higher Borrowing Cost.

•        Privatisation of Loss-making PSUs

How to control debt:

 Public Debt to GDP Ratio is usually quoted as:

 Public Debt ratio / GDP at current market prices. 

Higher the denominator, lower the ratio 

Denominator is directly proportional to ----------GDP and inflation. So GDP and inflation should be higher to lessen public debt to GDP ratio.

During 2003-04 to 2010-11 when general government debt plunged from 84.4% to 66.4% of GDP. 

That period, also witnessed an average annual GDP growth of 7.4% in real and 15%-plus in nominal terms after adding inflation, thus reining in public debt to GDP ratio.

Reasons for increase in Public Debt Ratio :

• Bank Recapitalisation,
• UDAY bonds,
• Small Share of Taxes in National Income, 
• Imperfect Tax System 
• Increase in public spending in response to Covid-19, and the fall in tax revenue and economic activity.

Sterlisation, Market Stabilization Scheme

 

STERLISATION: 

• Monetary action in which a central bank limits the effect of inflows and outflows of  foreign capital on the money supply.
•  It involves open market operations undertaken by RBI to neutralize the impact of  associated  foreign exchange operations.

DYNAMICS OF STERLISATION:

BOP should be zero in the accounts of RBI. 

When FDI and FPI increases 

                        ↓

 BOP becomes positive.

                        ↓

 + BOP should be neutralized 

                        ↓

RBI purchased extra Dollar 

                        ↓

Injection of Rupee in the economy 

                        ↓

Inflation in the economy and depreciation of Rupee.

                        ↓

RBI sell G-Sec to absorb liquidity 

                        ↓ 

Economy gets stabilized 

This whole process that starts with influx of foreign currency to the stabilization of Rupee is referred to as sterilization.

Market Stabilization Scheme (MSS): 

• Monetary management tool used by the Reserve Bank of India to suck out sudden excess liquidity from the market through issue of securities like Treasury Bills, Dated Securities etc. on behalf of the government.
• Surplus liquidity arising from sudden large capital inflows is absorbed through sale of temporary short-dated government securities and treasury bills. The money raised under MSS is kept in a separate account called MSS Account and not used by the government and hence it does not have any impact on Budget deficit.
• The interest cost is shown separately in the Budget and interest payment liability against this scheme is called carrying cost.
• MSS was used in 2004 for the first time in the wake of inflow of dollar in India. It was also invoked during the times of demonetization.

 

Gradation of different rates :

 SDF<Reverse Repo< Repo < MSF (Bank Rate)

Liquidity Adjustment Facility: REPO vs Reverse REPO vs Variable Rate Reverse Repo, Marginal Standing facility vs Standing Deposit Facility

 

Liquidity Adjustment Facility:

Monetary policy tool, primarily used by the RBI, to manage liquidity and provide economic stability by using REPO and Reverse REPO as tool. RBI adopted in 1998 on recommendation of Narasimham committee.

Repo Rate: 

The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).

REPO Rate is inversely proportional to the liquidity with the banks. All other rates except REPO rate are decided by RBI governor.

DYNAMICS OF REPO:

If REPO Rate increases ----------------funds will be costlier to consumers ---------------borrowing by people will be less resulting into-------- less Liquidity in the economy 

If REPO Rate decreases --------------- funds will be cheaper to consumers --------------- borrowing by people will be more resulting into ------more Liquidity in the economy

Repo Rate History :

• Since the inception of the Liquidity Adjustment Facility on June 5, 2000, the REPO rate is currently quite low. 
• Repo rate was around 9 % during June 2000 and reached the peak during Aug. 2000 to 16 % in the wake of  rising oil prices making  oil imports more expensive and import inflation in the country.
• As of Nov 2024, it is in the range of 6.5 %.

Marginal Standing Facility (MSF): 

• Monetary arrangement announced by the RBI in the year 2011-12, MSF is a penal rate at which banks can borrow money from the RBI over and above their  borrowing capacity  from the RBI under the LAF window. 
• MSF is always fixed at a higher rate than the Repo rate. 
• Banks can borrow funds under MSF by pledging government securities within the limits of the statutory liquidity ratio (banks cant pledge SLR securities while borrowing under REPO window).
• MSF has been introduced by RBI with the main aim of reducing volatility in the overnight lending rates in the inter-bank market and to enable smooth monetary transmission in the financial system .
• MSF (marginal standing facility) is available on all days of the week, throughout the year.

Reverse Repo Rate:

The interest rate at which the RBI borrows money from banks for the short term often overnight  is defined as Reverse Repo Rate. It is done against the collateral of eligible government securities under the LAF. It is basically done to absorb the liquidity from the market. It is of two types ie 

• Reverse Repo and 
• Variable Reverse Repo.

If Reverse REPO Rate increases----------- the bank will park money with RBI --------- Liquidity with banks will decrease ---------- loans will be costlier to the customers -----------less liquidity in the economy.

If Reverse REPO Rate decreases------------the bank will withdraw money from RBI--------Liquidity with banks will increase --------------- cheaper loans to the customers --------- more liquidity in the economy.

Variable Rate Reverse Repo (VRRR) Auction:

• If the Economy is flush with liquidity, then RBI Since January 2021, had been absorbing money from the banking system via VRRR auctions. 
• RBI ask banks to keep their deposit money with RBI and RBI will pay interest above reverse repo rate (and below repo rate) BUT the rate will be decided through auction. 
• For example, RBI wants to absorb Rs. 50,000 crore liquidity then RBI will select those banks which quotes (asks for) minimum interest rate above reverse repo rate. This VRRR auction can be for overnight or for longer period. At present, VRRR auctions have tenors of 7, 14 and 28 days.

STANDING DEPOSIT FACILITY :

• The idea of an SDF was first mooted in the Urjit Patel Monetary Policy Committee report in 2014 but it could finally be implemented in April 2022.It is an additional tool of Monetary policy for absorbing liquidity without any RBI collateral. 
• When there is huge liquidity in the system and the central bank has to absorb that huge  amount of money from the banking system through the reverse repo window, it becomes difficult for it to provide the required volume of government securities in return. 
• As the SDF is a collateral-free arrangement, RBI need not to give collateral for liquidity absorption .
• SDF rate is higher than Reverse Repo rate, it provides  banks a greater incentive to use the SDF window to park their excess money.  
• Though SDF is for overnight deposits but it retain the flexibility to absorb liquidity of longer tenors. 

VRRR vs SDF :

• VRRR transactions sought for G-Sec as collaterals while there is no such requirement in case of SDF.
• SDF is active throughout the year while VRRR is discretionary of RBI and it is invoked as and when RBI thinks so because of liquidity in the market.
• The SDF will replace the fixed rate reverse repo (FRRR) as the floor of the liquidity adjustment facility corridor. Both the standing facilities — the MSF (marginal standing facility) and the SDF will be available on all days of the week, throughout the year.

Corridor: 

• The Corridor in the monetary policy of the RBI refers to the area between MSF  which is the emergency lending rate and SDF which is the liquidity absorption rate. 
• Marginal Standing Facility is the upper ceiling of the Corridor, whereas the Standing Deposit Facility constitutes the lower floor.  
•  The repo rate is usually placed in the middle of the corridor. 

Money Market

 

Money Market:

• Market Place where very short-term debt instruments are traded.
• Short term investment means investment in assets up to one year with high level of  liquidity.
•  The transactions in Money market can be at retail or wholesale level.
• At the wholesale level, it involves large-volume trades between institutions and traders while at  the retail level, it includes money market mutual funds bought by individual investors and money market accounts opened by bank customers. 
• The borrowing and lending in the money market is on unsecured basis. 
• The RBI is the most significant constituent of Money market and the money market is also regulated by RBI.

Money market securities consist of following instruments:

• Call Money /Notice Money/Term Money
• Inter Bank Term Deposits
• Treasury Bills 
• Commercial Bills 
• Certificate of Deposits
• Repurchase Agreements (REPO)
• Collateralized Borrowing and Lending Obligations
• Tri Party Repo Dealing System 

Basel Norms /Accord,BASEL I,Basel II,Basel III,Liquidity Coverage Ratio,Leverage Ratio

 

Basel Norms /Accord:

• Basel accords are the set of international banking regulations issued by the Basel Committee on Banking Supervision from time to time.
• The goal of Basel norms is to coordinate banking regulations across the globe and strengthen the international banking system. 
• As per the accord, bank's capital consists of Tier 1 capital and Tier 2 capital.
• Tier 1 capital is a bank's core capital, whereas tier 2 capital is a bank's supplementary capital. 
• A bank's total capital is calculated by adding its tier 1 and tier 2 capital together.

BASEL  I---

• BASEL 1 focused only on credit risk where credit risk is the possibility of a loss resulting from a borrower’s failure to repay a loan.
• BASEL 1 norms recommended for  Banks  to hold capital equal to 8% of their Risk-weighted assets (RWA) - At least, 4% in Tier I Capital and more than 8% in Tier I and Tier II Capital
• The target of BASEL 1 was to be achieved by 1992 .
• India adopted BSAEL 1 in 1999.

ISSUES with BASEL 1:

The problem was that the risk weights in BASEL 1 do not attempt to take account of risks other than credit  risk,viz., market risks, liquidity  risk and operational risks which can be major cause of  insolvency  exposure to the banks.

Basel II:

• Basel II was introduced in 2004
• It laid down guidelines for capital adequacy with refined definitions, risk management  and disclosure requirements. 
• Basel II attempts to integrate Basel capital standards with national regulations.
• Basel II attempts to create standards and regulations on how much capital financial institutions need to put aside. 
• Banks need to put aside capital to reduce the risks associated with its investing and lending practices.
• It sought for use of external ratings  agencies to set the risk weights for corporate, bank and sovereign claims. 

Operational risk: 

• Risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. 
• Risk can be legal including exposures to fines, penalties, or punitive damages resulting  from supervisory actions, as well as private settlements. 

Shortcoming in Basel II norms led to the Global Financial  crisis of 2008.

Basel III:

• Basel II did not have any explicit regulation for the debt that banks could take on their books, and focused  more on individual financial institutions, while ignoring systemic risk.
• To avoid short term excessive debt, Basel III norms were proposed in 2010. 
• BASEL III focussed on four vital banking parameters viz. capital, leverage, funding and liquidity. 

Liquidity Coverage Ratio(LCR): 

• LCR require banks to hold a buffer of high quality liquid assets sufficient to deal with the cash outflows.
• The minimum LCR requirement will be to reach 100% on 1 January 2019. This is to prevent situations like "Bank Run". 

 Leverage Ratio > 3%: 

Leverage ratio was calculated by dividing Tier 1 capital by the bank's average total consolidated assets;. 

Capital Conservation Buffer, COUNTER CYCLICAL BUFFER, Bank Run

 

Capital Buffers:

• Under Basel norms, there are capital requirements that can be imposed on financial institutions in excess of minimum capital requirements. 
• The objective of these buffers is to counter the after effect of Economic shocks and losses on financial institutions’ assets.
• Capital buffers result in reduction of credit supply so as  to safeguard their own solvency. 
• Capital buffers are variable and flexible and penalties for  non compliances are less stringent than for violations of minimum capital requirements.

The Capital Conservation Buffer (CCB) : 

• CCB is a new concept introduced under BASEL III norms . 
• The concept is to buildup a “Capital Buffer" during good times so that the same can be utilized during stress. 
• The objective is to support the banks during the adverse economic environment conditions,
•  It will help increase banking sector resilience both going into a downturn .
• In India, the minimum capital requirement is 9 % . 
• The CCB should be by 2.5 % above minimum Capital ( The Total Works out to 9+2.5 =11.5 %)

COUNTER CYCLICAL BUFFER ( CCyB ):

• Counter-Cyclical Buffer for banks is intended to protect the banking sector against Losses that could be caused by cyclical systemic risks in the economy. 
• Counter-Cyclical Capital Buffer requires banks to hold additional capital at times when credit rapidly grows up . 
• The buffer can be reduced if the financial cycle turns favorable. 
• Currently, this is not introduced in India.

Capital Conservation Buffer (CCB) vs COUNTER CYCLICAL BUFFER :

• The CCB is a permanent requirement while  CCyB is a temporary measure.
• CCB is based on internal risk while  CCy B is for cyclical risks in credit variation and economic conditions

India and Capital Buffers :

As of  April 2023, Reserve Bank has been decided not to activate countercyclical capital buffer (CCyB) at this point as it is not required.

The framework on the countercyclical capital buffer (CCyB) was put in place by the Reserve Bank of India (RBI) in terms of guidelines in February 2015 wherein, it was advised that the CCyB would be activated as and when the circumstances warranted and that the decision would normally be pre-announced.

Bank Run:

• When several clients of a bank or other financial institution simultaneously withdraw their savings out of worry for the bank’s stability, this is known as a Bank Run. 
• The likelihood of default rises as more individuals withdraw their money, which encourages additional people to do the same. 
• Extreme circumstances may arise when the bank’s reserves are insufficient to cover the withdrawals.

Commercial Banks VS Cooperative Banks

Commercial Banks VS Cooperative Banks:

• Co-operative banks also perform the basic Banking functions but differ from commercial banks.
• Commercial banks are joint-stock companies under the companies' act of 1956, or Public Sector Bank under a separate act of a parliament whereas co-operative banks were established under the co-operative society's acts of different states.
• Commercial bank structure is branch banking structure whereas co-operative banks have a three tier setup.
• Certain sections of Banking Regulation Act of 1949 (fully applicable to commercial banks), are applicable to co-operative banks, resulting only in partial control by RBI of co-operative banks and Co-operative banks function on the principle of cooperation and not entirely on commercial parameters. 

• Primary (urban) cooperative banks are required to maintain certain amount of Cash Reserve and liquid assets while

• Non-scheduled (urban) cooperative banks, should maintain a sum equivalent to at least 3 per cent of their total demand and time liabilities in India on day-to-day basis

• Apart from cash reserve, every primary (urban) cooperative bank (scheduled/non-scheduled) is required to maintain liquid assets, not less than 25 %  of its demand and time liabilities, in the form of cash, gold or unencumbered approved securities in accordance with the provisions of Section 24 of the Banking Regulation Act, 1949 (As Applicable to Cooperative Societies).