Foreign exchange reserves

Forex reserves are generally held in the form of gold reserves, hard currencies such as Dollar, Pound
Sterling and other international financial assets, SDRs. Etc.. In order to accumulate foreign exchange
reserves a nation must earn foreign exchange by exporting goods and services ( current a/c surplus) and
non borrowing types of capital a/c surplus
There is a difference between the term international liquidity and term foreign exchange reserves. The
term international liquidity is a broad term which covers foreign exchange reserves plus other forms of
foreign means of payments. Foreign exchange reserves are the part and parcel of international liquidity.
International Liquidity refers to all accepted means of international payments available to a country for the
settlement of international trade transactions
Historically, reserves were used to back up a countrys home currency. It is necessary to maintain the
value of domestic currency. Adequate amount of Reserves help the nation to maintain the exchange rate
at normal levels. It is necessary for market intervention
Reserves also help countries to manage risks they face.. It helps to boost confidence in both the country
and its currency. In case inadequate reserves, the exchange rate may fall dramatically or profit seeking
speculators or currency manipulators sell a countrys currency. Reserves also help countries to manage
risks they face. The term Foreign exchange reserve refers to various types of forex reserves held by a
nation to meet external payments and obligations. A nation must have adequate foreign exchange
reserves to meet its short term and long term commitments otherwise the nation will face serious macro
economic problems and financial crises. The amount of foreign exchange reserves depends upon the
degree of openness of the country and Size of the country from the point of view of population and GDP.
It also depends upon the degree of participation in global trade.
OBJECTIVES OF HOLDING FOREIGN EXCHANGE RESERVES:
1) To create confidence in the Foreign Exchange Market:- The very fact that the monetary authority of
the country or the Central Bank of the country possesses a comfortable surplus of foreign exchange
reserve create confidence in the in the foreign exchange market of the country The knowledge and
information of having enough forex with the government imparts a sense of confidence in the market.
2) To deal with volatility in foreign exchange market: Foreign exchange market becomes less volatile
when it is known that the monetary authorities are capable of managing the market with the help forex at
their disposal.
3) To control irrational speculations:- Foreign exchange reserves act as a buffer to deal with speculative
attack on currency . In an open economy system, exchange rate fluctuate. Speculators usually tries to take
advantages of market. Any instability may give-rise to serious repercussions. Larger foreign exchange
reserves helps to defend itself from speculative attacks on the domestic currency.
4) To create capacity for market intervention : Though under flexible exchange rate the market plays a
major role, yet it is necessary to intervene in the market to maintain the exchange rate within margin
5) To create buffer to deal with the external vulnerability due hot money movements: In an open
system the foreign capital flows in and out freely. Speculators usually tries to take advantages of market.
Any instability may give rise to serious repercussions. Hence the intervention is necessary and it is
possible only with sufficient the forex, a buffer against external vulnerability.

6) To Overcome Financial Risks : Large reserves of forex reserves help to make the currency stronger.
Sufficient reserves help to overcome financial risks in international trade. Large buffer stocks help in
protecting against volatility of domestic currency
ADEQUACY CRITERIA :An adequate stock of reserves is necessary for the smooth functioning of the
international monetary system, expansion of world trade. How ever, how much foreign exchange reserve
should a country maintain is not precisely defined.
a) Under fixed exchange rate system the country need to hold more foreign exchange reserves for
necessary market intervention, b) If country follows flexible exchange rate system then there is no need
for the country to hold more foreign exchange reserves. The foreign exchange rate automatically gets
adjusted as per market forces of demand for and supply of foreign exchange. C) In case country follows
managed floating exchange rate system it has to intervene into the foreign exchange market occasionally
to iron out erratic fluctuations in the foreign exchange rate. The country is required to keep more foreign
exchange reserves
There are diverse views on the amount of reserves to be maintained by a nation. Historically, developing
countries used hold reserves to the value of three to four months imports.
The amount of foreign exchange reserves depends upon the degree of openness of the country and Size of
the country from the point of view of population and GDP. The larger the participation, more will be the
need to maintain foreign exchange reserves.
In addition to size of participation other factors the determines the demand for foreign exchange reserves
are. (i) size of the country 2) size of participation 3) Size of current account deficit (4) capital account
vulnerability (5) opportunity cost of holding reserves, (vi) International cooperation etc.
Traditionally, the adequacy of reserves is determined by a simple rule, that is, the stock of reserves should
be equivalent to a few months of imports. Such adequacy criterion arises from the fact that official flows
of reserves are adequately balanced to absorb shocks in external payments. Many economists suggest
different quantitative ratio of gross reserve to annual imports as a criterion to judge the adequacy.
Robert Triffin after studying the case of 12 leading countries came to conclusion that 25% annual
import bill as reserves l.
Tarapore committee on Capital Account Convertibility suggested three indicators for evaluating the
adequacy of foreign exchange reserves.
I) Sufficient Reserve to meet at least six months of import bill
ii) Three months import cover plus half of annual debt service payments
iii) Proportion of short-term debt and portfolio stock should not exceed 60% reserves.
Indias approach to reserve management: Since 1990s India has been witnessing a steady increase in
Indias forex reserves. Thanks to the LPGM program of government of India . On August 2012, forex
reserve of India stood at 289.169 billion dollars. This has given confidence to foreign investors who are
responding positively to growth story of India in the form of FDI and FPI.
Question:- Discuss the significance of foreign exchange reserves

CONVERTIBLITY OF CURRENCY
currencies without prior permission of the monetary Currency convertibility is an essential requirement of
free trade. Convertibility of a currency means free exchange of a currency into other currencies in forex
market at market rate. According to IMF As long as domestic currency can be freely transformed into
foreign currency at a unified rate the currency is regarded as convertible A convertible currency is one
which can be converted into other currencies at the market rate with out any restrictions. It implies
the freedom to buy or sell foreign exchange for the following international transactions. on convertible or
Controlled currency cannot be converted into foreign authority.
A convertibility currency can be freely converted into any other currency.. Some countries follow
the system of multiple exchange rates for convertibility, therefore , such currencies cannot be regarded
as convertible. The currency convertibility concept originated in Britton Woods Agreement The currency
convertibility has two different interpretations. Current account convertibility & Capital account
convertibility.

Current account convertibility means convertibility of a currency on the current account of

balance of payments. It relates to the removal of restriction on payments relating to the imports and
exports of goods, services and factor income. It implies the freedom to buy or sell foreign exchange
for the following international transactions: All payments due in connection with foreign trade,
Payments due as interest on loans & income from other investments. Payments of moderate amount
of amortization of loans Moderate remittances for family living expenses

Capital account convertibility: Capital account convertibility lies at the heart of globalization
&financial liberalization. CAC refers to the freedom to convert local financial assets into foreign
financial assets and vice versa at the market determined rate of exchange. Capital account convertibility
leads to the removal of the restrictions on payments relating to the capital transactions like inflow and
outflow of short-term and long-term capital. The process of globalization and liberalization has resulted
into openness of economies with integration of different economies In the world. Capital account
liberalization lies at the heart of globalization &n financial liberalization

CONVERTIBILITY OF INDIAN RUPEE .

1) Until 1993 Indian Rupee was not convertible Rupee is non convertible since independence. There
were restrictions on even current account transactions. The serious BOP deficits of 1980s forced India
to keep strict restrictions on the current account transactions. As a part of the LPGM program rupee was
made partially convertible( current a/c) since 1992

2) Introduction of LERMS: As a first step in the direction of convertibility, the Liberalized Exchange
Rate Management System was introduced in 1992. Through LERMS partial convertibility in current
account was tried for the first time. It was dual exchange rate system under which two exchange rates
were allowed. 40% of the current a/c receivables at official rate & and the balance of 60% at market
rate. . However LERMS was in force for only one year and from 1993, the scheme of 40:60 was
scrapped and as a pleasant surprise to everybody, Indian rupee was made fully convertible in
current account in the year 1994.
However Capital a/c convertibility is still a pending or contentious issue

3) CAPITAL ACCOUNT CONVERTIBILITY OF INDIAN RUPEE : There is a lot of pressure from

international community for capital a/c convertibility . In 1997, a committee headed by. Tarapore, was

asked to study the issue & suggest the possibility of implementation of CAC. The committee prescribed
capital a/c convertibility on the following grounds

Tarapore committee on CAC- or Advantages of CAC

CAC leads to inflow of foreign capital to supplement the domestic resources CAC also allows
resident Indians to hold on internationally diversified assets abroad. CAC will keep an Effective
Control on Hawala transactions: Before the introduction of current account convertibility, Hawala route
was very active for the remittance of funds. By allowing free convertibility remittance of funds will take
place through proper channel. CAC encourages exports due to increasing profitability of exports.
CAC leads to import substitution and export promotion. CAC will motivate NRIs to remit funds to
India. CAC helps to arrive at real value to the currency. CAC enables on alignment of domestic
financial markets with global financial markets
How ever the recommendations of the Tarapore committee was not accepted and implemented
because of international financial crises such as the banking Crisis in south Asia, currency failures in
Brazil and Russia in 2001. and recent Euro zone crises

Issues associated with CAC or objections to CAC : Serious objections

are raised against the

implementation of full convertibility of Rupee because 1) It would stimulate Hot money movement and

flight of capital; sudden inflow and outflow of short term funds may disturb the working of domestic
economy ii) It is difficult to absorb the sudden inflows. The nation may not be in a position to absorb
of capital outflows due to weak economic fundamentals iii) Speedy implementation of Trade sector
reforms Total capital decontrol appears to be difficult until the trade sector reforms are completed in India
iv) The fiscal consolidation, capital convertibility cannot be established until fiscal consolidation is
complete.

RBI measures in the direction of Capital Account Convertibility : At present CAC is allowed,
subject to conditions: However govt of India is seriously considering CAC at the earliest RBI has
initiated number of steps towards the full CAC 1) Resident Indians are permitted to invest up-to USD
1,00,000 in international securities.2). Resident Indians allowed maintaining foreign currency accounts.
The accounts, to be known as resident foreign currency (domestic) accounts, can be used to invest forex
received while on visit to any place outside India by way of payment for services 3) Indian banks
located in Special Economic Zones are permitted to conduct banking operations, in foreign currencies.
4). Mutual funds have been allowed to invest up to $1 billion in listed companies abroad 5) Indian
companies are permitted to invest in companies abroad - acquire immovable property- and retain of
ADR and GDR proceeds without limit

Tarapore committee-2 The committee was reconstituted

once again in 2006 to suggest a road map

for achieving Full Capital Account Convertibility .The recommendations, will be implemented by the
RBI in a phased manner so as to achieve the desired level of capital account convertibility (CAC) by
2011-12.
Question: Explain the concept of convertibility of currency. Should India go for Capital Account Convertibility ?

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Foreign exchange Risk and its management

Foreign exchange risk or currency risk is type of risk caused by unexpected changes in the exchange
rate . Foreign exchange risk arises due to fluctuating rates of exchange. It is caused by uncertainty and
volatility of exchange rate.3. It is linked to fluctuating rates of exchange. When the exchange rate
fluctuate, the exporters and importers are uncertain of the amount of money they receive and required to
pay.

Factors Affecting Exchange Rate Risk:- Basically, Exchange rate risk arises on account 1)
Exchange Rate System: Unlike fixed exchange rate, flexible exchange is inherently risky due to
unexpected fluctuations 2) Hot money movements: Unexpected inflow and out flow of funds in search of
better returns make exchange rates volatile and risky. 3) Speculative purchase and sale of currencies
make exchange rates volatile and risky: 4) Strength of the Economy Weak economic fundamentals
make the domestic currency fragile and risky. A strong economy with a strong currency may be able to
withstand risks related to changes in exchange rate.

Types of foreign exchange risk:

Transaction Exposure Risk: It is the outcome of various types of transactions like international trade,
borrowing and lending in foreign currencies , FDI,FPI transactions. When the exchange rates may move
up or down the participants cash flow get affected.
Translation Exposure Risk: It is the extent to which the firms financial reporting is affected by exchange
rate movements. Exchange rate fluctuations will have a significant impact on the firms reported earnings
and hence on the stock price.
Contingent Exposure Risk: happens when the firm bids for foreign projects or negotiates for other
contracts or in the case of Foreign Direct Investments. The waiting period involves uncertainty as to
whether the receipt will happen or not.

Measures to Cover the risk:

Risk is an integral part of foreign exchange markets. Exchange rate risks need to be managed very
effectively and cautiously so that the participants do not suffer losses in the process of thin trading
activities. In the floating or flexible exchange rate system the possibility of fluctuation and there by high
risk. It can not be avoided. However it can be minimized through appropriate strategies. They are
Exchange Risk Avoidance: In this case exchange risk is eliminated by doing business locally i.e. by
introducing import substitution methods
Diversification of sourcing: When sources of purchases are changed now and then, exchange risks can
minimized. Such a strategy is followed by many firms to minimize or spread the risk of exchange rate
fluctuations.

Forward exchange Transactions/ dealings: Under flexible exchange rate system the possibility of
wide fluctuation is high. Therefore both exporters and importers try to protect their position through a
forward agreements. By entering into such an arrangement foreign exchange participants can minimize
the possible risk.
2. Swap agreements: Swap arrangement also undertaken to cover the risk in the forward deal. Usually
the banks which enter into a forward sale agreement to sell at a certain rate (forward rate ) would

cover their risk by entering a forward purchase agreement simultaneously with another bank. Such
swaps help the bank to cover risk by matching the outflow and inflow of dollars and also earn profit based
on swap margin.

3. HEDGING It is a cover taken by participants to protect themselves against the risk arising out of
exchange rate fluctuations. Firms tries cover foreign exchange rate fluctuations through Hedging. They
transact in forward market to cover the risk. Hedging helps the firms cover the risk arising out of changes
in exchange rates. It is essential for those firms which have large amounts receivables or
commitments to pay in foreign currencies.
The strategy of hedging involves 1) Taking long position in currencies which is likely to appreciate and
short position in currency which is likely to depreciate 2) Minimize hard currency liabilities and
Postpone soft currency liabilities. 3) In case, the local currency is expected to appreciate, then the
hedging Strategy would be to increase the stock of local currency, speed up the collection, buy local
currency forward, reduce imports of soft currency goods, reduce local currency borrowing, delay
remittance.

Flexible exchange rate system

Under the flexible Exchange rate system, the rate of exchange is freely determined by the
interaction between demand and supply of foreign exchange market. The exchange rates are
not rigidly fixed up but are allowed to float with the changing conditions. Govt, or the
central bank normally does not interfere in the market
ARGUMENTS FOR FLEXIBLE EXCHANGE RATE SYSTEM
Smooth Adjustment in Balance of Payments:: Flexible exchange Exchange rate refers to the
price of one currency in terms of another. Exchange rate is determined by the monetary
authorities( Fixed rate ) or market by demand and supply forces (Flexible rate). The world has
experienced broadly two types of exchange rates. Fixed and (ii) Flexible exchange rates.
rates helps in smooth adjustment in the balance of payments .The adjustments in BOP takes
place automatically. When there is a deficit in the balance of payments, the external value of the
currency falls. This encourages exports, discourages imports and ultimately brings about
equilibrium in the balance of payments
Simple and automatic: The flexible exchange rate system is simple. The exchange rate moves
freely to equate demand & supply and the problem of scarcity or surplus is automatically solved.
Monetary Autonomy: The flexible exchange rates enables automatic adjustments in economic
variables. It allows the country to adopt an independent monetary policy to maintain economic
stability. Flexible exchange rate system provides sufficient monetary autonomy to the central
banks. Each government is free to follow its macroeconomic policies. There is no need to follow
any basic rules of fixed exchange system ( Market intervention by central banks)
Flexible exchange system promotes Economic Stability: According to Milton Friedman the
flexible exchange rate system helps to maintain economic stability. It is better to allow exchange
rate to appreciate or depreciate rather than artificial price changes
No need to maintain huge foreign exchange reserves. Fixed exchange rate system
necessitates huge foreign exchange reserves funds to maintain the rate. Flexible system does

require any such foreign exchange equalization fund. Since the exchange rate moves freely,
there is no need to maintain large-scale reserves. The flexible exchange rate system solves the
problem of international liquidity automatically.

Promotes free trade: Flexible exchange rate promotes free trade. It does not require the use
of exchange control which may be necessary under the fixed exchange rate system.
Limitations of flexible exchange rate system
Fluctuations create uncertainly: frequent fluctuations in the exchange rates create an
environment uncertainty for exports and importers. They remain unsure about the amount
required for the payment or the one which they expect to receive.
Irrational Speculation: Under flexible exchange rate, speculation is continuous. Speculators
may have a wrong assessment of the strength and weakness of different currencies. Such
wrong judgments lead to irrational speculation and destabilization of the exchange rate.
Inflationary in Nature: Flexible exchange rate,. has an inherent inflationary bias because
depreciation increases prices of traded goods but appreciation does not cause parallel reduction
in prices. Thus flexible exchange rate may result in frequent increase in prices
Adverse effect on Investment and Borrowing: Foreign investment is discouraged due to
uncertainty. So also, in the case of international lending and borrowing. Thus the flexible
exchange rate, is not conducive for promoting economic growth.
Poor International Co-operation:
Flexible exchange rate system does not allow the
exchange rate to be determined in the market; it is not binding on them to establish co-ordination
with other countries.
Unstable because of small trade Elasticity of demand: Any change in exchange rate may
create instability because it may increase the price more than it decreases the quantity of
imports. Depreciation also may not increase exports if demand elasticity is small. Therefore if the
demand elasticity (of import and export) is small, flexible exchange rate may not bring the
desired result.

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ARBITRAGE
Arbitrage refers to making a risk free profit out of discrepancies between the interest rate
differentials & forward rate differentials ( forward discount or forward premium). When
exchange rate given currency differ in different markets, one can make risk free profit by buying
from a low priced market and selling the same in the high price market.
Arbitrage refers to the simultaneous purchase of a financial asset in a low price market and sale
in a higher price market. This process leads to equalization of prices of an asset in all the markets.
Finally, difference in prices exists if at all, is not more than transport or transaction cost.
Arbitrage operations are conducted in stock markets, Currency markets. An interesting type of
arbitrage is Inter bank arbitrage. Different Banks offer different bids and ask rates. An
Arbitrageur can take advantage of the situation, Let us illustrate this with an example. Following
are the quotes of bank A and bank B. INR/$ 61.50/61.60 and 61.40/61.45 The rates are close to
each other. Therefore an arbitrager can take the advantage of the situation. The profit earned is
without any risk and blocking capital
Foreign exchange Arbitrage will take advantage of the different exchange rates prevailing in
various foreign exchange markets due to interest rate differentials. Let us explain this with an
example suppose Rs. = $ exchange rate prevailing in India is Rs. 61 = 1$ and in London Rs.
62 = 1$. Arbitrager will purchase dollars from Mumbai foreign exchange market and sell it in
London, earning a profit of Rs. 1 per dollar. In the process, increasing demand for dollars in
Mumbai market will push up the prices to Rs. 61.50 and more supply of dollar will bring down
the price of dollar London to Rs. 61.50. Arbitrage, therefore helps equalize the exchange rate
indifferent markets
When only two currencies and two countries are involved in arbitrage, it is is called two-point
arbitrage. When three currencies and three monetary authorities are involved, we have three
point arbitrage
INTEREST RATE ARBTRAGE It is a type of foreign exchange arbitrage. There is a close
interrelationship between exchange rates, interest rates .The theory of interest arbitrage states that
Interest rates for comparable short term Investments in different countries & currencies must
differ by the some proportion as the spot rate differs from the forward exchange rate. In other
words, the annualized percentage difference between interest rates must be equal to the
annualized percentage difference between the spot rate and forward rate.
It arises on account of difference in real interest rate and difference in forward discount/ premium
rates in different financial centers. If the real interest rates between the countries differ then

arbitrage takes place. For example, the real interest rate in India is 6% and in USA it is 4 % then
funds will flow from US to India, to take the advantage of the difference in real interest rate. The
process will lead to an increase in money supply in India leading to a lower real interest rate and
shortage of dollars in USA and consequent increase in real interest rate. Due the development of
communication system, the dealers can use the situation to their advantage. Purchase of the
foreign currency to make the investment and offsetting with forward sale (swap) of the
foreign currency to cover the foreign exchange risk..

Interest arbitrage may be uncovered or covered

Uncovered Arbitrage:-- In this system, arbitrageurs would take a risk to make profit by
investing in a high interest bearing risk free securities in a foreign market.. His earnings would be
according to his calculations if the currency of the foreign market where he invested does not
depreciate. If currency the depreciation is equal to the difference in interest rate, the investor
would not incur loss. However, if the depreciation more than interest rate differential, then the
arbitrageur will end up in loss .
If a trader from U.S.A. invests in risk free Indian security at 4 % more than what he gets at home
for a period of 3 months, his profits will be 1 percent. This is based on the assumption of
exchange rate remains the same. If Indian rupee depreciates more than 1 percent during this
period the U.S.A. dealer will lose, whereas, if the Indian rupee appreciates, his earnings will be
more than what he estimated at the time of investment
Covered interest rate Arbitrage: When Interest rates for same period differ In two different
countries / currencies, the arbitrageurs can make risk free profit by borrowing the currency in low
Interest market and simultaneously investing the same in high interest market. However, as the
currencies borrowed & invested are different, there is a possibility of foreign exchange risk
For covering the exchange risk the arbitrageur enters into forward contract while borrowing .
By covering exchange rate risk through forward contract, arbitrageur make profit borrowing of
low interest and investing of high interest.
covered interest arbitrage refers to the spot purchase of the foreign currency to make the
investment and offsetting simultaneous forward sale (swap) of the foreign currency to cove
foreign exchange risk. It is nothing but a combination of two contracts-Arbitrage and
hedging
Investors would like to avoid the foreign exchange risk. Hence ,the interest arbitrage is usually
covered. The covered interest arbitrage refers to the purchase of the foreign currency to make
the investment and offsetting with forward sale (swap) of the foreign currency to cover the
foreign exchange risk..
Covered Interest Arbitrage Parity:
Once the covered arbitrage continues, the difference in interest gain diminishes and finally the
gain arising out of interest arbitrage completely disappears. The reasons are:

When funds are transferred from USA to India, the interest rate rises in USA and declines in
India, as the supply of funds decreases in USA and increases in India. As a result the interest rate
on funds decreases in USA and increases in India.
Secondly, 1) the purchase of rupee in the market increases the spot rate and 2) sale of dollars in
the forward market reduces its forward rate. Thus the forward discount on rupee rises. The above
reasons, that is, the interest differential in favor of India declining and forward discount on rupee
rising, the net gain will be less. The reduced gain should be taken as cost of covering risk.
The difference in interest rates in monetary centers of different countries and the forward
premium and discount which lead to a outflow or inflow of foreign currency may ultimately
result in elimination of gain out of arbitrage.

Merits of flexible Exchange Rate

Smooth adjustment in exchange Rate : the balance of payments automatically. When
there is a deficit in the balance of payments automatically. When there is a deficit in the
balance of payments, the external value of the currency falls. This encourages exports,
discourages imports and ultimately brings about equilibrium in the balance of payments.
Simple and automatic: The flexible exchange rate system is simple. The exchange rate
moves freely to equate demand & supply and the problem of scarcity or surplus is
automatically solved.
Eases Liquidity Problem: Since the exchange rate moves freely, there is no need to
maintain large-scale reserves. The flexible exchange rate system solves the problem of
international liquidity automatically.
Continuous adjustments.: So a prolonged disequilibrium is automatically avoided.
Helps to maintain domestic stability with minimum interference: The free exchange
rates enables automatic adjustments in economic variables. It allows the country to
adopt an independent monetary policy to maintain economic stability.
Promotes free trade: Flexible exchange rate promotes free trade. It does not require
the use of exchange control which may be necessary under the fixed exchange rate
system.
Suitable to promote full employment: Flexible exchange rates reflect the true costprice structure relationship. They are more suitable to countries seeking to follow a
policy a full employment.

Demerits of Flexible Exchange Rate:

Instability and uncertainty: The Flexible exchange rates lead to instability and
uncertainty. This reduces the volume of investments and international trade. Due to
increasing risks, long-term investments are curtailed.
Destabilizing effect; Flexible exchange rates have a destabilizing effect on a countrys
production and allocation of factors of production. From the point of view of domestic
stability, fixed exchange rates are superior to flexible exchange rates.
Speculation: Under flexible exchange rate system there will be more speculation
causing further fluctuations.

Income Inequalities in India

In India, there are income inequalities. In India, there is no official organization to
compile data on income distribution. However, various attempts have been made by
several organizations and individuals to study the pattern of income distribution since
1950s.
Pattern of Income Distribution in 1950s: According to estimates of Lydall and NCAER,
the top 10% of the households received about 35% of the total income. The NCAER

study indicates that the bottom 20% of the households received 4 to 5% of the total
income.
Pattern of Income Distribution in 1960s: The studies conducted by NCAER, Ojha and
Bhatt and Kanta Ranadive estimate show that, the top 20% had a share of about 47% of
the total households income. All the studies also point out that the bottom 20% of the
households had a share of 7.5% of household income.
Pattern of Income Distribution in 1970s: The top 20% accounted for 40% of the
consumption expenditure in urban areas, an 38% of the consumption expenditure in
the rural areas.
The World Bank Estimates: The World Bank provided estimates for 1970s, 1980s, and
1990s. Over the years from 1790 to 1990s, there has been a slow reduction in the
income inequalities.
World Development Report, 2003: According to World Development Report, 2003, the
top 10% of Indias population has 33.5% of the total income, and the bottom 10% has
only 3.5% of the income in the country.

The main causes of income inequalities:

Law of Inheritance: Defective Land Holdings: Unequal Distribution of Income and
Wealth: Social Discrimination: Differences in Skills: Poor Implementation of Government
Schemes: Inflation: Illiteracy: High Birth Rate among Poor: Unemployment: Malpractices
by Money Lenders: Inherited Debt: Low Efficiency among Poor: Faulty Regional
Development: Over dependence on Agriculture:
GOVERNMENT MEASURES TO REDUCE INEQUALITIJES IN INDIA
EMPLOYMENT MEASURES
LAND REFORMS
FISCAL MEASURES
FOOD SECURITY MEASURES
RURAL DEVELOPMENT MEASURES

Foreign exchange reserves

The term foreign exchange reserves are associated with the system of
international payments of a country. The term international liquidity in very
broad which encompasses foreign exchange
reserves to settle the
international obligation a nation must have adequate foreign exchange
reserves. In order to accumulate foreign exchange reserves a nation must
earn foreign exchange by exporting goods and services. There reserves are
generally hold in the form of gold, Dollar, Pound Sterling and other strong
currencies of the world plus other international financial assets, S.D.Rs. Etc.
There is a difference between the term international liquidity and term
foreign exchange reserves
The term international liquidity is a broad term which encompasses foreign
exchange reserves while foreign exchange reserves is a very narrow term in
the realm of meeting the balance of payments deficit and settling other
international obligation. It is a part and parcel of international liquidity.
International Liquidity refers to all accepted means of international payments
available to a country for the settlement of international trade transactions.
The foreign exchange reserves held by the country depends upon the system
of foreign exchange rate followed by a country. If a country follows fixed
exchange rate system the country will have to hold more foreign exchange
reserves to maintain the desired foreign exchange rate. If aI country follows
flexibly foreign exchange rate system then the country need not possess
more foreign exchange reserves. The foreign exchange rate automatically
gets adjusted as per the twin market forces of demand for and supply of
foreign exchange. When a country follows managed floating exchange rate
system it has to intervene into the foreign exchange market to iron out undue

for erotic fluctuations in the foreign exchange rate as such it is required to

keep more foreign fluctuations in the foreign e rate as such it is required to
keep more foreign exchange reserves. The demand to hold foreign exchange
reserves also depends upon the size of the demand to hold foreign exchange
reserve also depends upon the size of the country from the point of view of
population and GDP. The larger the size of population and GDP the more will
be demand for holding the foreign exchange reserves.
How much forex should a country hold depends on many factors. The
important of them are: (i) size of the country (ii) current account deficit (iii)
capital account vulnerability (iv) vulnerability of exchange rate flexibility and
(v) opportunity cost.
OBJECTIVES OF HOLDING FOREIGN EXCHANGE RESERVES:
Spreading confidence in the Foreign Exchange Market:- The very fact that
the monetary authority of the country ie the Central Bank of the country
possesses
a confortable surplus of foreign exchange reserve spreads
confidence in the in the foreign exchange market of the country and as such
brings stability.
To curb the speculative tendency:- The speculators create instability in the
country to avoid the speculation the Central Bank used the foreign exchange
reserves.
Enhancing the capacity to intervene in foreign exchange markets: Though
under flexible exchange rate the market plays a major role, yet it is
necessary to intervene in the market to maintain the exchange rate within
margin
Limiting external vulnerability: In an open system the foreign capital flows in
and out freely. Speculators usually tries to take advantages of market. Any
instability may give rise to serious repercussions. Hence the intervention is
necessary and it is possible only with sufficient the forex, a buffer against
external vulnerability.
Providing confidence to the markets: The knowledge and information of
having enough forex with the government imparts a sense of confidence in
the market.
Reducing volatility in foreign exchange market: Foreign exchange market
becomes less volatile when it is known that the monetary authorities are
capable of disciplining market with the help forex at their disposal.
Creating Confidence:
Foreign exchange reserves may help the countries
manage the international financial risks they face. They also infuse
confidence in both the country and currency.

ADEQUACY CRITERIA Traditionally the adequacy of reserves is determined by

a simple rule, that is, the stock of reserves should be equivalent to a few
months of imports. Such adequacy criterion arises from the fact that official
reserves serve as a precautionary balance to absorb shocks in external
payments. How much foreign exchange reserve should a country maintain is
not a precisely settled question. Many economists suggest some ratio of
gross reserve to annual imports as a criterion to judge the adequacy. In India,
the Report of the Committee on Capital Account Convertibility) proposed four
comprehensive indicators to be used for evaluating the adequacy of foreign
exchange reserves. I) Cover at least six months of import .ii) Three months
import cover plus half of annual debt service payments possibilities of leads
and lags. iii) The short-term debt and portfolio stock to be no more than 60
percent of the level of reserves. iv) I Net foreign exchange assets to currency
in circulation to be maintained around 70 percent with a minimum of 40
percent.
=========================

SOURCES OF PUBLIC REVENUE

The income of the government from all sources is called public revenue.
According to Dalton, public income can be classified as
Public Revenue consists of taxes, revenue from administrative activities like
fines, fees, income from public enterprises, gifts and grants. Public Receipts
includes public revenue plus the receipts from public borrowings, Public
Receipts includes public revenue plus the receipts from public borrowings, the
receipts from the sale of public assets and printing and issuing new currency
notes.
SOURCES OF PUBLIC REVENUE
A) TAX REVENUE The revenue raised by the government through various

taxes is known as tax revenue. Tax is a compulsory payment imposed

by the government. There is no direct quid pro quo between the tax
payers and the government as4) There Is no direct quid pro quo
between the tax payers and the government .Tax is levied to meet
public expenditure incurred by the government. Tax has to be paid

regularly and periodically as determined by the taxing authority. In

modern public3, taxes constitute a significant source of public revenue.
B) NON-TAX REVENUE The revenue obtained by the government from

sources other than tax is called non-tax revenue. The sources of nontax revenue are:
Fees : Fees are charged by the government for providing certain services
to the people, For e.g. court fees, passport fees, licensee fees for issuing
driving licenses. Fees are paid by those who receive some special
advantages. There exists quid pro quo. So fees differ from tax. Fees are
also different from prices. Fees are paid for administrative services.
Fines and Penalties : Fines and penalties are levied on offenders of laws as
punishment. The main object of such levies Is not to earn income but to
prevent the offending of laws. Hence they are insignificant sources of
revenue.
Special Assessment : When the government undertakes public projects like
^construction of roads, drainage system etc., It may confer special benefits
to those possessing properties nearby. The values of these properties may
rise. So the government Imposes special levy in proportion to the Incre se In
the value of the property, so as to recover a part of the cost of the project.
Special assessments are known as betterment levy in India.

POVERTY IN INDIA
Poverty is a situation in which a section of the society is unable to fulfill even
its basic necessities of life, i.e, food, clothing and shelter. The Task Force (on
Projections of Minimum Needs and effective demand) constituted by the
planning commission in 1977, defined the poverty line on The basis of
recommended Nutritional Requirements of 2400 calories per person per day
in rural areas and 2100 calories in urban areas. As per the latest estimates of
Dr Montec Singh Aluwalia, Dy Chairman planning commission, People who
earn less than Rs 32/- per capita income per day is to be treated as living
Below Poverty Line

Trends of Poverty in India

Decline in Poverty Rate: The overall poverty rate has declined in India
from 55% in 197374 to 26% in 1999-00. The rural poverty has declined from
56% in . 73-74 to 27% in 1999-00, The urban poverty has also declined from
49% in 1973-74 to 24% in 1999-00.

High Higher Rate of Poverty in Rural Areas: The incidence of poverty is high in case
of rural as compared to urban areas.
Low Poverty States: As per the poverty estimates of 1999-00, there is low incidence of
poverty in certain states like Jammu & Kashmir (3.5%), Goa (4.4%), followed by
Chandigarh (5.75%)
High Poverty States: As per the poverty estimates of 1999-00, there is high incidence
of poverty in states like Orissa (47%), Bihar (43%), followed by Madhya Pradesh (37%).
Number of Poor: Over the years the total number of poor in the country has declined
from 321 million in 1973-74 to 260 million in 1999-00.
High Incidence of Poverty among Weaker Sections: In India, there is high incidence of
poverty among the weaker sections of the society.
CAUSES OF POVERTY
Problem of Unemployment, High Growth of Population among poor, Poor
Implementation of Anti-Poverty Programmes, Slow Economic Development, Unequal
Distribution of Income and Wealth, Inflation, Inherited Debt, Malpractices by Money
Lenders, Excessive Social Expenditure, . Social Exploitation:
POVERTY ALLEVIATION MEASURES
The Government of India has initiated several measures to eradicate poverty. The major
poverty alleviation and employment generation programmes currently being
implemented include the following:
Swamajayanti Gram Swarozgar Yojana (SGSY) Under this scheme poor families are
provided with bank credit and government subsidy to set up self-employment micro
units. This scheme is a centrally sponsored scheme on a cost-sharing ratio of 75:25
between the Central Government and the States.
Pradhan Mantri Gramodaya Yojana (PMGY) :. Thi main objective of this scheme is to
improve the quality of life in ruralareas. PMGY initially focused on village level
development in five important areas ie Primary education, primary health ,drinking
watery, housing, and rural roads.
Antyodaya Anna Yojana: This scheme was launched in 2000. At present 2 crore
poorest families out of BPL (Below Poverty Line) families covered under Targeted
Public Distribution System BPL (Below Poverty Distribution System are benefited. 35
kgs of food grains per month were made available to each eligible family at a highly
subsidized rate. Wheat is provided at the rate ofRs.2pe kg and Rs.3 per kg for rice.
Annapurna Scheme: It aims at providing food security to meet the requirement of
those senior citizens who are eligible but not getting the pension under the National Old
Age Pension Scheme. 10 kg of food grains per person per month are supplied free of
cost.

Indira Awaas Yojana: . Under this scheme houses are provided free e of cost to the
poor families belonging to Sc,ST and bonded labor families living below poverty line
Valmiki Ambedkar Awaas Yojana .This scheme aims at improving the living conditions
of the urban slum dwellers living below the poverty line who do not possess adequate
shelter. . The scheme has the primary objective of facilitating the construction and up
gradation of dwelling units for the slum dwellers
Public Distribution System: The government has introduced public distribution system.
The people are provided with essential commodities like food grains, sugar, cooking oil,
and such other items at lower prices through fair price shops. In order to make PDS
more responsive to the needs of the poor, the Targeted Public Distribution System
(TPDS) was introduced in 1997. Thi . This system attempts to target families below
poverty line (BPL) by providing food grains at heavily subsidized rates.

INDIAS POPULATION POLICY

Population control has been a priority area for sustaining the economic growth in the
country, Therefore, the Govemment has initiated policy measures to control population.
The main aim of population policies during the planning period was not only to control
the population but also to improve the quality of population.
The 1951 Population Policy: Realizing the need to control population, Government India
declared an official population policy called National Family Planning Programme in
l951.
Objectives of NFPP: To reduce birth rate considerably from 40 persons per 1000 to
about 25 persons per 1000
To reduce death rate from 27/1000 to less than 10/1000.
To educate masses on family welfare, so , so as to limit the family size to two children.
The 1976 Population Policy: The Population Policy, 1976 was completely different from
the earlier population policy of the government. . Prior to this policy, the family planning
was entirely voluntary. The government role was to motivate people to adopt family
planning and to provide clinical facilities. In other words, the government adopted
CLINICAL APPROACH prior to this policy.
Sixth Plan Programme on Population: The sixth plan (1980-85) placed a lot of
emphasis on population growth reduction. It placed emphasis on small family concept,
i.e., one child per family by the year 2000.
Eighth Plan Programme on Population: The eighth plan gave top priority to contain
population. It aimed at controlling population with people cooperation and with the help
of family welfare schemes.

National Population Policy, , 2000: The NPP, 2000 outlines immediate, medium term
and long-term objectives. Some of the important features of NPP, 2000 are:
To make school education upto age 14 free and compulsory, and reduce dropouts at
primary and secondary school levels to below 20 percent for both boys and girls.
To reduce infant mortality rate to below 30 per 1000 live births.
To reduce maternal mortality rate to below 100 per 1,00,000 live births.
To promote delayed marriage for girls, not earlier than 18 and preferably after 20 years
of age.
To prevent and control communicable diseases.
To achieve a stable population by 2045.
EVALUATION OF THE POPULATION POLICY
Overemphasis on Contraceptives:
Lack of Political Will:
Low Plan Outlay:
Problem of Literacy:
Poor Coordination:
Poor Implementation of Campaigns:
ACHIEVEMENTS: The following are the achievements of the population policies,
adopted since Independence in India:
Fall in Birth Rate: The birth rate has come down from 40/1000 in 1951 to 25.4/1000 in
2001.
Fall in Death Rate: The death rate has come down from 27/1000 in 1951 to 8.4/1000 in
2001.
Decline in Growth Rate of Population: The growth rate of population has come down
from 2.2% in 1971 to 1.7% in 2001.
Small Family Concept: The small family concept is being adopted by a good number of
families, especially among the middle class
Decline in Infant Mortality Rate: Better medical facilities and awareness have resulted
in low infant mortality rates from 146/1000 in 1951 to 64/1000 in 2001.
Improvement in Life Expectancy: The population policy has also resulted in
improvement in life expectancy from 32 years in 1951 to 65 years in 2001 due to better
health and medical born per woman. The total fertility rate has declined from about 6 in
1951 to 3.2 in 1999.

Increase in Couple Protection Rate: The percentage of couples effectively protected in

reproductive age group has significantly gone up from 10.4% in 1971 to 48.2% in 1999.