MP & FP SINCE1991

Question 1

Events which led to 1991 reforms

Answer 1

License Raj:

Protectionism

Focus on Public Sector:

High Fiscal Deficit

Rising Inflation

Depleting Foreign Exchange Reserves Gulf War Impact:

Loss of Investor Confidence Assassination of Rajiv Gandhi

New Government with a Mandate for Change

World Bank and IMF Pressure

Question 2

Liberalisation of 1991

Answer 2

Reduction of government controls and regulations on various industries.
Removal of licensing requirements (the ‘License Raj’) for most sectors, allowing businesses greater freedom to operate.
Easing restrictions on foreign investments, encouraging more multinational companies to set up in India.
Lowering of import tariffs to allow increased competition from international goods.

Question 3

Privatization

Answer 3

Disinvestment of shares in Public Sector Undertakings (PSUs), meaning the sale of government ownership to private individuals or companies.
Opening up sectors previously reserved for the public sector to private competition.
Intended to improve efficiency, reduce the fiscal burden on the government, and raise funds.

Question 4

Globalization

Answer 4

Integration of the Indian economy with the global economy.
Reduced trade barriers and greater opportunities to export Indian goods and services.
Encouragement of foreign investment in India, bringing capital and technology.

Question 5

Industrial Delicensing under liberalisation

Answer 5

Before: To manufacture cars, a company needed a specific license from the government, limiting the number of businesses in a sector.
After: No more licenses needed. This led to companies like Maruti Suzuki, Hyundai, Ford, and others entering the market, causing greater choice for consumers, and increased production in the auto sector.

Question 6

Foreign Direct Investment (FDI): under lib

Answer 6

Before: Foreign companies like Coca-Cola were forced to leave India due to ownership restrictions.
After: Relaxed regulations allowed MNCs (Multinational Corporations) like Pepsi, Coca-Cola, Nestle, and many others to establish operations throughout India. This brought in capital, jobs, and new technologies.

Question 7

Trade Policy Reforms: lib

Answer 7

Before: Importing a foreign-made computer involved massive taxes, making them cost-prohibitive for most Indians.
After: Reduced tariffs and quotas made computers, electronics, and other goods more affordable, improving quality of life and leading to technology booms like the IT sector in cities like Bangalore.

Question 8

Financial Sector Reforms: lib

Answer 8

Before: Government banks had strict controls on interest rates, making it difficult for businesses to get loans.
After: Private banks like HDFC, ICICI, and others were allowed to flourish, expanding credit availability and boosting investment.

Question 9

Privatization

Disinvestment of PSUs:

Answer 9

Before: Government-owned companies like Air India had near-monopoly status with limited quality or service options.
After: The government sold partial ownership in these companies, bringing in private sector expertise. While sometimes controversial, this improved management in certain cases, and brought new players into the market that competed against inefficient PSUs.

Question 10

Globalization

Increased Exports:

Answer 10

Before: Indian companies focused mostly on the domestic market.
After: Trade barriers lowered and the focus was on making Indian industries globally competitive. This led to a rise in exports of textiles, IT services, and pharmaceuticals, providing a major boost to the economy.

Question 11

Globalization

Foreign Investment & Outsourcing:

Answer 11

Before: Few foreign companies invested in India due to restrictions and a bureaucratic environment.
After: Improved business climate attracted foreign investment and India became a hub for outsourcing, particularly in IT and business processing, creating vast numbers of jobs.

Question 12

Positive Impacts of LPG reforms of 1991 on AGRICULTURE SECTOR

Answer 12

Increased Investment - food processing industries and agricultural infrastructure

Diversification and Export Opportunities - higher-value and export-oriented crops

Technological Improvements: seeds, fertilizers, and agricultural machinery

Reduced Subsidies (Mixed Impact) cost-conscious

Question 13

Negative Impacts of LPG reforms of 1991 on AGRICULTURE SECTOR

Answer 13

Lack of direct investment in irrigation and rural infrastructure.
Higher costs for farmers due to reduced subsidies on fertilizers and energy.
Exposure to global price volatility and cheaper imports hurt farmers.
Increased farmer debt, contributing to the agrarian crisis.
Widened inequality within the agricultural sector.

Question 14

Positive Impact of LPG reforms of 1991 on industrial SECTOR

Answer 14

End of the License Raj: Removing bureaucratic hurdles unleashed entrepreneurial energy and boosted industrial growth.
Increased Competition: Foreign competition forced domestic industries to become more efficient and innovative.
New Investment and Growth: The improved business environment attracted investment, fueling a boom in various sectors.
Rise of Indian Multinationals: Indian firms became globally competitive and expanded their footprints internationally.

Question 15

Negative Impact of LPG reforms of 1991 on industrial SECTOR

Answer 15

Job Losses: Some inefficient industries faced closure or downsizing, leading to job losses.
Rise of Inequality: The benefits of industrial growth were unevenly distributed across sectors and skill levels.
Infrastructure Constraints: Inadequate infrastructure continued to limit the full potential of industrial growth.
Environmental Concerns: Rapid expansion often came at the cost of environmental regulations.

Question 16

Positive Impact of LPG reforms of 1991 on financial SECTOR

Answer 16

Efficiency & Competition: Liberalization reduced government control and allowed for more private and foreign banks. This increased efficiency and led to better financial services.
Access to Credit: Easier access to loans for businesses and individuals spurred economic growth.
Capital Market Development: Reforms helped develop India’s capital markets, giving businesses new ways to raise funds and investors new opportunities.
Innovation: The market-driven environment encouraged new financial products and services.

Question 17

Negative Impact of LPG Reforms on the Financial Sector

Answer 17

Financial Risks: Greater market exposure also brings the potential for financial instability.
Inequality: Benefits weren’t always evenly distributed, and some groups remained without access to the formal financial system.

Question 18

India’s Fiscal Deficit in the Post-Reform Period

1990s

Answer 18

The fiscal deficit was a major problem in the pre-reform era, reaching over 8% of GDP at times. The 1991 reforms initially aimed to bring this down.

Question 19

India’s Fiscal Deficit in the Post-Reform Period
Early 2000

Answer 19

Improvements, then Deterioration: The deficit showed improvement in the initial post-reform years but started rising again in the late 1990s and early 2000s. This was due to factors like increased spending on subsidies and public sector salaries

Question 20

FRBM Act (2003)

Answer 20

key measure introduced to control the fiscal deficit, this act set targets to progressively reduce it. This helped put some discipline on government spending for a period.

Question 21

Statistics (Approx.) of fiscal deficit

Answer 21

1990-91: >8% of GDP
Early 2000s: Declined, but still around 5-6% of GDP
2008 Crisis Impact: Rose again
Recent Years: Concerns over high deficits remain, often in the 6-7% range of GDP.

Question 22

Objectives - Fiscal Responsibility and Budget Management (FRBM) Act, 2003

Answer 22

Financial Discipline: The Act promotes responsible spending by the government by setting targets for reducing the fiscal deficit (the difference between government expenditure and revenue).
Macroeconomic Stability: By encouraging fiscal prudence, the FRBM Act aims to create a stable economic environment with controlled inflation and healthy growth.
Improved Public Fund Management: The Act ensures transparency and accountability in how the government spends public money.
Inter-generational Equity: It strives to ensure the burden of government debt doesn’t fall disproportionately on future generations.

Question 23

Key Features - FRBM ACT

Answer 23

Fiscal Deficit Targets: The FRBM Act initially set a target to reduce the fiscal deficit to 3% of GDP by 2008.
**Flexibility: **These targets have been revised and amended over the years to account for various economic factors.
Medium-Term Fiscal Framework: The Act mandates the government to present a medium-term fiscal policy statement alongside the annual budget, outlining fiscal projections for the next three years.
Transparency: The Act promotes transparency by requiring the government to present documents like the Fiscal Policy Strategy Statement and Macroeconomic Framework Statement along with the budget

Question 24

Revenue Enhancement Measures taken to control fiscal deficit post-reform period

Answer 24

Widening of the Tax Base: Reforms focused on broadening the tax base to bring more individuals and businesses into the tax net, increasing the overall tax revenue.
Tax Reforms: Simplification of tax laws, the introduction of the Goods and Services Tax (GST), and efforts to reduce tax evasion helped improve tax collection efficiency.
Disinvestment: Proceeds from the sale of government equity in Public Sector Undertakings (PSUs) provided a source of non-tax revenue.
Reduction of Subsidies: Gradual reduction in subsidies on food, fertilizer, and fuel helped curb expenditure. This was a politically sensitive area, requiring careful calibration to balance social needs with fiscal realities.

Question 25

Expenditure Control Measures taken to control fiscal deficit post-reform period

Answer 25

Expenditure Prioritization: Emphasis on directing spending towards productive investments in infrastructure, social programs with a clear development focus, and away from less essential areas.
Re-evaluation of Subsidies: Moving towards more targeted subsidy programs and ensuring the benefits reach intended beneficiaries instead of broad and inefficient subsidies.
Controlling Salary Bills: Efforts to manage the growth of public sector salaries and benefits.
**Monitoring and Evaluation: **Implementing robust public expenditure management systems to improve efficiency, track outcomes, and reduce wasteful spending.

Question 26

Other Fiscal Measures taken to control fiscal deficit post-reform period

Answer 26

Borrowing Strategies: The government focused on responsible borrowing strategies and diversifying debt sources to manage the fiscal deficit without creating excessive debt burdens.
Adherence to FRBM Act: Though targets were amended, the overall framework of the Fiscal Responsibility and Budget Management Act provided guiding principles for maintaining fiscal discipline.

Question 27

Structural Factors for persistent deficit during post-reform period

Answer 27

**Tax Structure: **Despite improvements, India’s tax-to-GDP ratio remains relatively low by international standards. Factors like a large informal sector and complex tax laws hinder efficient revenue collection.
**Subsidy Burdens: **Subsidies on fertilizer, food, and fuel place significant strain on the government’s budget. Though targeted reforms are underway, fully eliminating or significantly reducing them is a politically sensitive issue.
**Infrastructure Spending: **India has a massive infrastructure deficit, requiring large public investments in roads, railways, power, and other areas crucial for economic growth. This creates expenditure pressures.
**Inefficient Public Sector Undertakings: **Many state-owned enterprises operate at a loss, requiring continued government support, contributing to the deficit.

Question 28

Cyclical Factors for persistent deficit during post-reform period

Answer 28

Economic Slowdowns: During economic downturns, tax revenues decline while demand for social safety nets and government stimulus spending increases. This naturally worsens the fiscal deficit.
External Shocks: Events like global financial crises or oil price spikes disrupt the Indian economy, affecting revenues and expenditures, thus destabilizing the deficit.

Question 29

Political Considerations for persistent deficit during post-reform period

Answer 29

Populist Spending: Political decisions aimed at electoral gains often lead to increased spending on subsidies, welfare schemes, or public sector salaries, straining fiscal resources.
**Suboptimal Borrowing: **When deficits persist, there can be an overreliance on borrowing to bridge the gap, potentially increasing the debt burden long-term.

Question 30

Institutional Factors for persistent deficit during post-reform period

Answer 30

**Rigid Fiscal Targets: **The FRBM Act initially set stringent deficit targets which proved difficult to achieve consistently, particularly considering economic fluctuations.
Weak Expenditure Management: Issues with budget formulation, timely spending, and tracking outcomes within government programs can lead to inefficiencies and leakage of funds.

Question 31

Revenue Enhancement measures to achieve sustainable fiscal consolidation

Answer 31

Expanding the Tax Base:
**Rationalizing Tax Rates: **Aim for a moderate tax rate structure while minimizing exemptions and loopholes to reduce tax avoidance and improve collections.
Focus on Non-Tax Revenue: Explore avenues to increase non-tax revenue sources like asset monetization of non-core government assets, spectrum auctions, and user fees for certain public services
Improving Tax Administration

Question 32

Expenditure Management measures to achieve sustainable fiscal consolidation

Answer 32

Targeted Subsidies
Public Expenditure Review

Zero-Based Budgeting: Apply zero-based budgeting principles to justify spending in each program rather than basing budgets on incremental increases from previous years.

Outcome-Focused Spending: Allocate resources towards programs with proven outcomes in critical areas like health, education, and infrastructure.

Question 33

Responsible Debt Management as a measure of fiscal consolidtion

Answer 33

Prudent Borrowing: Borrow primarily for productive investments and infrastructure development that yields long-term economic returns.
Debt Sustainability Analysis: Regularly assess debt sustainability levels and tailor borrowing strategies to minimize risks and avoid excessive debt burdens.
Refinancing High-Interest Debt: Explore opportunities to refinance existing high-interest debt with lower-cost debt to reduce interest payments.

Question 34

Additional measures for fiscal consolidation

Answer 34

Structural Reforms: Implement structural reforms to boost the inherent growth potential of the economy, which ultimately leads to increased revenue generation.
**Strong Fiscal Framework: **Ensure adherence to the FRBM Act principles with the flexibility to address cyclical economic challenges.
Transparency and Accountability: Enhance transparency in government budgeting and expenditure tracking to build trust and reduce inefficiencies

Question 36

Evolution of Monetary Policy in India

Pre-Independence Era (Upto 1947)

Answer 36

No central bank.
Silver standard: Rupee value linked to silver price.
Unstable exchange rates.
Limited monetary policy tools.

Question 37

Evolution of Monetary Policy in India

Pre-Reform Period (Pre-1991)

Answer 37

Monetary policy focused on administrative controls and credit rationing by RBI (Reserve Bank of India).
Limited role for market forces in interest rate determination.
Focus on supporting priority sectors (agriculture, industry) through directed credit.

Question 38

Evolution of Monetary Policy in India

Early Reforms (1991-1998)

Answer 38

Gradual shift towards market-oriented monetary policy.
Introduction of Liquidity Adjustment Facility (LAF) for short-term liquidity management.
Partial liberalization of interest rates.

Question 39

Evolution of Monetary Policy in India

Phase of Disinflation (1998-2004)

Answer 39

Focus on controlling inflation and achieving price stability.
Increased use of repo rate as a key monetary policy tool.
Phasing out of administered interest rates.

Question 40

Evolution of Monetary Policy in India

Inflation Targeting Framework (2005-Present)

Answer 40

RBI adopted a formal inflation targeting framework with a medium-term target set by the government.
Repo rate became the main instrument for monetary policy signaling.
Increased transparency and accountability of RBI’s monetary policy actions.

Question 41

Evolution of Monetary Policy in India

Recent Developments (2020-Present)

Answer 41

Use of unconventional monetary policy tools like Long-Term Repo Operations (LTRO) during the COVID-19 pandemic.
Increased focus on financial inclusion and access to credit.
Growing importance of financial markets and instruments for monetary policy transmission

Question 42

What are the tools of monetary policy?

Answer 42

The methods a central bank uses to control the money supply, interest rates, and availability of credit to influence overall economic activity. These tools are essential for achieving goals like price stability, economic growth, and financial system health.

Question 43

What are the two main types of monetary policy tools?

Answer 43

Direct Tools: Have an immediate and forceful impact on money supply and interest rates.
Indirect Tools: Influence money supply and interest rates through their effect on the broader financial system, working primarily through market mechanisms.

Question 44

DIRECT TOOLS Reserve Requirements

Answer 44

Definition: The percentage of deposits that banks must hold in reserve at the central bank.
Impact:
Increasing reserve requirements limits the amount of money banks have available for lending, reducing the growth of the money supply and putting upward pressure on interest rates.
Decreasing reserve requirements frees up banks to lend more, potentially increasing the money supply and lowering interest rates.

Question 45

DIRECT TOOLS

Discount Rate

Answer 45

Definition: The interest rate charged by the central bank to commercial banks for short-term loans, serving as a “lender of last resort”.
Impact:
Lowering the discount rate makes it cheaper for banks to obtain funds, encouraging them to borrow and expand lending activities. This can lead to an increase in the money supply.
Raising the discount rate makes borrowing more expensive for banks, discouraging them from taking loans and potentially contracting the money supply.

Question 46

INDIRECT TOOLS
Open Market Operations (OMO)

Answer 46

Definition: The central bank buys and sells government securities (bonds) in the open market.
Impact:
Buying securities pumps money into the financial system, increasing banks’ reserves. This can boost lending activity and expand the money supply.
Selling securities takes money out of the financial system, decreasing bank reserves. This can tighten credit availability and slow the growth of the money supply.

Question 47

INDIRECT TOOLS
Interest Rate Targeting (Repo Rate)

Answer 47

Definition: The central bank sets a target for short-term interest rates in the interbank lending market. The repo rate is a commonly used target rate.
Impact:
By adjusting the target rate, the central bank influences the cost of borrowing throughout the entire financial system. Lowering the interest rate encourages borrowing, leading to an increase in the money supply and a decrease in interest rates for consumers and businesses.
Raising the interest rate makes borrowing more expensive, resulting in a potential decrease in the money supply and higher interest rates for borrowers.

Question 48

Reduced Emphasis on Direct Tools:

Answer 48

While reserve requirements remain a tool, their usage has lessened due to several factors:

Less Flexibility: Direct tools can be disruptive and have a blunt impact.
Market Orientation: Modern central banks prefer market-based mechanisms for greater efficiency and transparency.
Focus on Interest Rates: Repo rate adjustments allow for more targeted control over the money supply and interest rates.

Question 49

Consequences of Direct Tools:

Reserve Requirements:

Answer 49

Impact on Money Supply:
Increase: Reduces lendable reserves, contracting the money supply, and potentially raising interest rates.
Decrease: Increases lendable reserves, expanding the money supply, and potentially lowering interest rates.
Challenges:
Can be disruptive to the financial system if changed abruptly.
Less effective in influencing lending behavior compared to interest rate adjustments.

Question 50

Consequences of Direct Tools:

Credit Rationing:

Answer 50

Impact: Channeling credit towards specific sectors, potentially crowding out other sectors.
Challenges:
Difficult to administer fairly and efficiently.
Can create distortions in the financial system.