BHARATHIAR UNIVERSITY

MBA (HR)

COURSE 2.8

BUSINESS ENVIRONMENT
AND ETHICS
(Notes For Examination)

Prepared By
Dr Abbas T. P
drtpabbas@gmail.com

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 2.8. Business Environment and Ethics
Unit I
Q1. Business Environment
The environment of any organization is the aggregate of all conditions,
events and influences that surround and affect it.
Types of Environment
Environment can be divided into the following three broad categories:
a. Internal Environment: Internal environment is internal to the
organization and it is controllable. Important internal factors are:
1. Culture and Value System: Organizational culture and values system
not only influences the operations and behaviour, it also influences the
choice of business.
2. Mission and Objectives: The mission and objectives of the company
guide priorities, direction, of development, business philosophy and
business policy.
3. Management Structure and Nature: Structure is about the hierarchical
relationship, span of management relationship between different
functional areas.
4. Human Resource: It deals with factors like manpower planning,
recruitment and selection and development, compensation,
communication and appraisal.
Besides this, internal environment also includes:
 Corporate resources
 Production/ operation of goods and services
 Finance and accounting system and methods
 Marketing and distribution.
b. Macro Environment: Macro Environment consist of factors external to
the industry that may have significant impact on the firm’s strategies. The
broad dimensions are:
1. Political Environment: It is the political environment of the country
which decides the fortune of the business in a country.
2. Regulatory and Legal Environment: Regulatory and legal
environments play vital role by telling dos and don’ts to business.
3. Demographic: It is Demographic environment which decides the
marketing mix for the organization.

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 4. Socio Culture: Socio culture variable like the beliefs, value system,
attitudes of people, their demographic composition have a major
impact on their personality and behaviour style.
5. Technological: Technological forces present wide range of
opportunities and threats which have to be accounted for.
6. Global Environment: It consists of all those factors that operates at
the transnational, cross cultural and across the border level which
have an impact on the business of an organization.
7. Economic Environment: It consists of macro level factors related to
the means of production and distribution of wealth, which have an
impact on the business of an organization
8. National Competitive Advantage: Despite globalization number of
industries is clustered in specific and small number of countries.
c. Micro Environment: Microenvironment refers to the environment
which an organization faces in its specific arena. All the business decision
like new business, pricing, distribution channel, promotion strategy,
product portfolio, etc., depends upon the competitive position of the firm.
The state of competition in an industry is a composite of 5 competitive forces.
1. Threat of New Entrant: A new entrant in an industry represents a
competitive threat to the established firms. There are various entry
barriers which hinders the entry of new entry. The barriers are:
 Economies of Scale: Existing large firms enjoy low cost per unit.
They have enough room to reduce price as they may be selling
product at such a low price that new player could not produce it at
that cost as it might be producing small quantity.
 Cost disadvantage independent of scale: Besides economies of
scale existing firm have other many cost advantages as
proprietary product knowledge such as patent, favourable access
to raw material, favourable location, etc.
 Learning and Experience Curve: Established companies have an
advantage of learning curve.
 Product Differentiation: A new entrant must overcome the brand
loyalty of the existing brands.
 Capital requirement: New entrants required capital not only to
establish new business but also to compete from established firms.
 Switching Cost: The costs incurred in switching from one supplier
to another supplier also resists the customer to go for new vendor.

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  Access to Distribution: The middleman is reluctant to deal with
the product which is new to market and they usually prefer only
established products.
2. Bargain Power of Supplier: Suppliers have no bargain power when
there are many suppliers and supply exceeds demand and supplier
competes with each other to grab the order. On the other hand,
bargain power is very high when suppliers have expertise or supplier
is working at economies of scale or supplier augment the product in
interest of consumer or supplier also finance the buyer.
3. Bargain Power of Buyer: Buyer enjoys a significant bargain power
when sellers are many and buyers are few or when production
capacity exceeds the demand. Buyer can bargain for reduction of
prices, quantity discount, better quality at same price, better after sale
service and they can even ask for credit or finance facility.
4. Threat of Substitute: Strong competitive pressure from substitute
product depends upon three factors
(a) Whether attractively priced substitutes are available.
(b) Whether the buyers view the substitutes as being satisfactory in
terms of quality, performance and other relevant attributes,
(c) Whether buyers can switch to substitutes easily.
The presence of readily available and attractively priced substitutes
creates competitive pressure.
5. Rivalry among Competing Sellers: The intensity of rivalry among
competing sellers is a function of how vigorously they employ such
tactics as lower prices, colourful features, expanded customer service,
longer warranties, special promotions and new product introductions.
All this leads to adverse impact on the profits of the firm.

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Q.2. SOCIAL RESPONSIBILITY OF BUSINESS
The social responsibility of business means various obligations or
responsibilities or duties that a business-organization has towards the
society within which it exists and operates from.
The obligation can be divided into four responsibilities:
1. Discretionary Obligation – These refer to voluntary contributions
made by a business for the benefit of the society without any
government intervention.
2. Ethical Obligation – These obligations make a business responsible to
follow and respect the social and cultural norms laid down by the
society.
3. Legal Obligation – It is the responsibility of every business to abide
with the laws of the county and follow the legal rules and regulations
laid down by the government.
4. Economic Obligation – Since every business aims to earn profit, it is
the responsibility of every business to generate surplus cash and use
it towards further development or welfare of the society.
Responsibility towards Different Interest Groups
i. Responsibility towards owners
Owners contribute capital and bear the business risks. The primary
responsibilities of business towards its owners are to:
1. Run the business efficiently
2. Proper utilization of capital and other resources.
3. Growth and appreciation of capital.
4. Regular and fair return on capital invested.
ii. Responsibility towards investors
Investors are those who provide finance by way of investment in debentures,
bonds, deposits etc. The responsibilities of business towards its investors
are:
1. Ensuring safety of their investment,
2. Regular payment of interest,
3. Timely repayment of principal amount.
iii. Responsibility towards employees
Business needs employees to work for it. These employees put their best
effort for the benefit of the business. The responsibilities of business towards
its employees include:

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 1. Fair treatment.
2. Timely and regular payment of wages and salaries.
3. No discrimination on the basis of sex, cast or creed.
4. Fair Appraisal system.
5. Healthy and safe working environment.
6. Establishment of fair work standards and norms.
7. The provision of labour welfare facilities.
8. Opportunity for better career prospects.
9. Recognition, appreciation and encouragement of skills and
capabilities of the workers.
10. Installation of an efficient grievances handling system.
11. An opportunity for participating in managerial decision
12. Timely training and development.
13. Family welfare schemes.
14. Proper working conditions and welfare amenities.
15. Job and social security.
16. Better living conditions like housing, transport, canteen, crèches etc.
iv. Responsibility towards suppliers
Suppliers are businessmen who supply raw materials and other items
required by manufacturers. The responsibilities of business towards
suppliers are:
1. Giving regular orders for purchase of goods.
2. Dealing on fair terms and conditions.
3. Availing reasonable credit period.
4. Timely payment of dues.
v. Responsibility towards customers
The business should provide the following facilities:
1. Providing products and services of proven quality.
2. Products and services must be able to take care of the needs of the
customers.
3. There must be regularity in supply of goods and services
4. Price of the goods and services should be reasonable and affordable.
5. Regular R&D to augment the product and to innovate the product.
6. To ensure that product is reached to customer.
7. To supply goods at reasonable price.
8. To provide required after sale service.
9. To fulfil its commitments impartially and courteously.
10. To provide sufficient information about the product.
11. To ensure that product supplied doesn’t have any adverse effect.
12. To hear and redress the genuine grievances of customer.

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 13. To avoid any type of union formation and to reap monopoly profits
14. Unfair means like under weighing the product, adulteration, etc. must
be avoided.
vi. Responsibility towards competitors
Competitors are the other organizations involved in a similar type of
business. The responsibilities of business towards its competitors are
1. Not to offer exceptionally high sales commission to distributers,
agents etc.
2. Not to offer to customers heavy discounts and /or free products in
every sale.
3. Not to defame competitors through false or ambiguous
advertisements.
vii. Responsibility towards government
The various responsibilities of business towards government are:
1. Setting up units as per guidelines of government
2. Payment of fees, duties and taxes regularly as well as honestly.
3. Not to indulge in monopolistic and restrictive trade practices.
4. Conforming to pollution control norms set up by government.
5. Not to indulge in corruption through bribing and other unlawful
activities.
viii. Responsibility towards society
The various responsibilities of business towards society are:
1. to help the weaker and backward sections of the society
2. to preserve and promote social and cultural values
3. to generate employment
4. to protect the environment
5. to conserve natural resources and wildlife
6. to promote sports and culture
7. to provide assistance in the field of developmental research on
education, medical science, technology etc.
8. Promotion of small scale industry
9. Development of region in which they are operating
10. Social development of region in which organization is working

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Q.3. ROLE OF GOVERNMENT IN BUSINESS
Government performs many different roles in business and economy. These
roles are essential to provide the platform to excel the competiveness of
businesses domestically, to ensure the balanced regional growth,
constitutional framework, infrastructural improvement and public utilities.
The following roles are played by the government in business.
1. Regulatory Role: Listed below are the major objectives of regulating the
business functioning:
 To regulate monopoly in the market
 To provide balanced regional growth
 To encourage small and new enterprises
 To regularize or standardize the functions of private and public sector
The process of regulating business activities is mainly done by two ways:
 Discretionary Measures
 Non-Discretionary Measures
Discretionary measures involve the direct measures by the discretion of
administrative authority. These include
 fixation of prices of commodities,
 quantitative restrictions on export or import,
 rationing on supplies of goods,
 distribution of scare recourses for optimum utilization of resources,
 licensing the goods like hazardous chemicals, etc.
These discretionary measures are performed at the firm level or industry
level. While regulating, government makes sure that interest of all sections
should be maintained.
Non-Discretionary Measures include the control without any administrative
discretion of an authority. These measures are exercised at macro level
through fiscal and monetary policies. For example:
 imposing different taxes on different products at different places,
 amending customs tariffs,
 regulating the bank interest by changing repo rates or reverse repo
rates,
 regulating money supply and credit creation and
 granting subsidies to different industries.
In India, the regulatory role is exercised in following manner:-
(a) The Companies Act, 2013: It is an act to consolidate and amend the
law relating to companies.

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(b) The Banking Laws (Amendments) Act, 2012: This is an act to
further amend various acts that was in force for better functioning of
banking sector to help businesses and other economic activities.
(c) The Securities and Exchange Board of India (Amendment) Act,
2013: This is an Act which further amends the Securities and Exchange
Board of India Act, 1992 for directing the functioning of SEBI.
(d) The National Food Security Act, 2013: This act provides for food
and nutritional security in human life cycle, by ensuring access to
adequate quantity and quality of food at affordable prices.
(e) Consumer Protection Act, 1986: This is an act to protect the interest
of consumers in India.
(f) Industrial Policy: Industrial Policies aim at development of
Industrial Structure by Liberalization, Privation and Globalization.
(g) MRTP Act: The Monopolistic and Restrictive Trade Practices Act,
1969, make sure that the operation of the economic system does not
result in monopolies
(h) Foreign Exchange Regulation Act: It is an Act to consolidate and
amend laws related to foreign exchange for the conservation of the
foreign exchange resources of the country.
(i) Commercial Law: This act has been made with a view to order
operational aspects of trade and business. It includes acts like India
Contract Act, Sales of Goods Act, Negotiable Instruments Act,
Arbitration Act, etc.
2. Entrepreneurial Role
Sometimes private sector is unable to establish its venture in some area due
to constraints like lack of capital, lack of know how or restrictions by
government. For this, the government has to perform the entrepreneurial
role by entering the market with its ownership through public sector.
In the entrepreneurial role, the government acts as an entrepreneur in form
of public sector ventures like
 Transportation: IRCT Ltd, DMRC Ltd;
 Communication MTNL, BSNL;
 Electricity and Power BSES, NDPL;
 Companies like BHEL, PGCIL, IRCON ltd
3. Promotional Role
In promotion role, government does not regulate or control the activities of
business, however, supports the business activities by promoting the better

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environment, advanced infrastructure, offering various incentives to
endorse economic activities in the business.
The following are major functions performed in promotional role:-
 To provide basic infrastructure for smooth functioning of business
activities
 To have coordination among public, private, joint and cooperative
sectors
 To have balanced growth among all section
4. Planning Role
Government of India acts as a planner to secure optimum utilization of
resources. In 1950, Planning Commission was set up by Government of
India with an objective for mobilization of resources and to formulate the
plans for the development of the nation.
Basically, there are two types of planning i.e. centralized and decentralized
planning. In Centralized planning, plans come from central level and passed
to state level. In Decentralized planning, the plans are initiated from the
bottom i.e. from individual unit say panchayat level, sectoral level, regional
level and national level.

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 Q.4. POLITICAL SYSTEM AND ITS INFLUENCE ON BUSINESS
There are many external environmental factors that affect business
negatively and positively. Business managers must address these factors
and make decisions that minimize the impact of external environment.
These factors include political factors, economic, social, technological,
legal and environmental.
Political factors and environment of a country impacts any business
organization and can also introduce a risk factor that can cause the
business to suffer losses or compromise over its profit stream.
Political environment can change because of the policies and actions of the
prevailing government at every level, federal to local level. It is very
important that a business should plan for the variability in the policies
and regulations of the government to maintain a stable business
environment.
Definition
Political factors are government regulations that influence business
operation positively and negatively. Managers must keep a bird’s eye view
over political factors. These factors may be current and impending
legislation, political stability and changes, freedom of speech, protection
and discrimination laws are factors affecting business operation and
activities
List of political factors that affect businesses
 Corruption level
 Trade control
 Bureaucracy
 Tariffs
 Freedom of the press
 Competition regulation
 Regulation and deregulation
 Education law
 Discrimination law
 Antitrust law
 Data protection law
 Employment law
 Health and safety law
 Environmental law

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  Tax policy
 Government stability and changes
 Government participation in trade unions
 Import limitations on quantity and quality of the product
 Legislation that manages environment pollution
 Consumer e-commerce and protection
 Intellectual property law
How Political Factors Affecting Business Environment
Political factors can impact a business by making the market environment
more or less friendly for that business. Typically, governments have a
great deal of power over businesses and many times, there is not much
that businesses can do about it.
Political factors can impact businesses in various ways. These external
environmental factors can add in a risk factor which can lead to a major
loss in business. These factors can change the entire results and hence,
companies should be able to deal with both local as well as international
political outcomes.
What Political Factors Affect Business Environment
 Tax and economic policies: Increasing or decreasing rate of taxes
is a good example of a political component. Government regulations
may raise the tax rate for some businesses and can lower the same
for others due to specific reasons. This decision will directly impact
businesses.
 Political stability: Lack of political stability within a country can
significantly impact the operations of a business. This can especially
be true for businesses that are operating on the global scale.
 Foreign Trade Regulations: Every business has a need to expand
business operation to other countries. However, political
background of a country can influence the desire for a business to
expand its operations. Tax policies that are particularly controlled
by the government can induce a particular business to expand
operations in different regions, whereas, other tax policies can
hinder the process of business expansion for some industries.
 Employment Laws: Employment laws are made to protect the
rights of employees and include every aspect of employer-employee
relationship.

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 Effects of political factors on businesses
1. Government changes in their rules and regulations could have an
impact on business.
2. The political condition of a country affects its commercial setting.
The economic environment affects the business presentation.
3. The absence of political stability affects business operations, most
especially for those companies who operate internationally.
4. Obtaining political risk insurance is a method to manage political
risk. Firms that have international operations uses this kind of
protection to decrease exposure to risk.
Importance of judicious political environment
Businesses should check their political environment. The changes in
political factors can impact company strategies because of these reasons:
 Government view business as a crucial vehicle for social
improvement.
 The government is responsible for protecting the public interest.
 A stable political system can affect the petition of a particular local
market.
 Governments pass legislations that can also influence the
relationship between the firm and the suppliers, customers and
other companies.
 The government is the primary consumer of products and services.
 Government actions impact the economic environment.

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Q.5. CONSTITUTION & BUSINESS
The Constitution of India is not only a document which tell about the
formation and running of Govt. Rather it influences the life of every
individual.
Directive Principles of State Policy
Directive Principles, in its most simple form, are the Guidelines in the
Indian Constitution to the State. These guiding principles are meant for
promoting the ideal of social and economic democracy.
The directive principles are non-justifiable in nature. They cannot be
enforced by the court of law for their violation. Part IV, Articles 36-51 of the
Indian constitution constitutes the Directive Principles of State Policy
which contain the broad directives or guidelines to be followed by the State
while establishing policies and laws.
Features of Directive Principles
The Directive Principles consist of the following guidelines for the States:
 The State should strive to promote the welfare of the people.
 Maintain social order through social, economic and political justice.
 The State should strive towards removing economic inequality.
 Removal of inequality in status and opportunities.
 To secure adequate means of livelihood for the citizens.
 Equal work opportunity for both men and women.
 Prevent concentration of wealth in specific pockets of the society.
 Prevention of child abuse and exploitation of workers.
 Protection of children against moral and material abandonment.
 Free legal advice to avail of justice by the economically weaker section.
 Assistance to the needy including the unemployed, sick, disabled and
old people.
 Ensure proper working conditions and a living wage.
 Promotion of cottage industries in rural areas.
 Free and compulsory education for children below the age of 14years.
 Economic and educational uplift of the SC and ST and other weaker
sections of the society.
 Prohibition of alcoholic drinks, recreational drugs and cow slaughter.
 Preservation of the environment by safeguarding the forests and the
wild life.

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 Protection of monuments, places and objects of historic and artistic
interest and national importance against destruction and damage.
 Promotion and maintenance of international peace and security, just
and honourable relations between nations.
Classification of the Directive Principles
The Directive Principles are divided into the following three categories:
1. Socialistic Principles
These principles reflect the ideology of socialism. Following Articles state
the guidelines of Socialistic Principles of state policy:
 Article 38: To promote the welfare of the people by securing a social
order and to minimise inequalities in income, status, facilities and
opportunities.
 Article 39: To secure
(a) the right to adequate means of livelihood for all citizens;
(b) the equitable distribution of material resources;
(c) prevention of concentration of wealth and means of production;
(d) equal pay for equal work for men and women;
(e) preservation of the health and strength of workers; and
(f) Opportunities for healthy development of children.
 Article 39 A: To promote equal justice and to provide free legal aid to
the poor.
 Article 41: To secure the right to work, to education and to public
assistance in cases of unemployment, old age, sickness and disablement.
 Article 42: To make provision for just and humane conditions for work
and maternity relief.
 Article 43: To secure a living wage, a decent standard of life and social
and cultural opportunities for all workers.
 Article 47: To raise the level of nutrition and the standard of living of
people and to improve public health.
2. Gandhian Principles
These principles are based on Gandhian ideology. Following Articles state
the guidelines of Gandhian Principles of state policy:

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 Article 40: To organise village panchayats and give them with
necessary powers and authority to enable them to function as units of
self-government.
 Article 43: To promote cottage industries on an individual or co-
operation basis in rural areas.
 Article 46: To promote the educational and economic interests of SCs,
STs and other weaker sections of the society and to protect them from
social injustice and exploitation.
 Article 47: To prohibit the consumption of intoxicating drinks and
drugs which are injurious to health.
 Article 48: To prohibit the slaughter of cows, calves and other milk and
draught cattle and to improve their breeds.
3. Liberal–Intellectual Principles
The principles counted in this category signify the ideology of liberalism.
Following articles state the guidelines of Liberal–Intellectual Principles of
state policy:
 Article 44: To secure for all citizens a uniform civil code throughout the
country.
 Article 45: To provide early childhood care and education for all
children until they complete the age of six years.
 Article 48: To organise agriculture and animal husbandry on modern
and scientific lines.
 Article 49: To protect monuments, places and objects of artistic or
historic interest.
 Article 50: To separate the judiciary from the executive in the public
services of the State.
 Article 51: To promote international peace and security and maintain
just and honourable relations between nations

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UNIT II
Q.6. ETHICS
Ethics is a branch of social science. It deals with moral principles and social
values. It helps us to classify, what is good and what is bad.
Business ethics are not different from ethics in normal sense. It is ethics
applied in conduct of business activity.
Business ethics generally deals with what is right or wrong in the business.
Ethics is not only desirable but is essential for the smooth functioning of
business.
Features of Business Ethics: There are eight major features of business
ethics −
(a) Code of Conduct − Business ethics lets us know what to do and what
not to do. Businesses must follow this code of conduct.
(b) Based on Moral and Social Values − Business ethics offers some
moral and social principles for conducting a business.
(c) Protection to Social Groups − Business ethics protect various social
groups including consumers, employees, small businesspersons,
government, shareholders, creditors, etc.
(d) Offers a Basic Framework − Business ethics is the basic framework
for doing business properly. It constructs the social, cultural, legal,
economic and other limits in which a business must operate.
(e) Voluntary − Business ethics is meant to be voluntary. It should be self-
practiced and must not be enforced by law.
(f) Requires Education & Guidance − Businessmen should get proper
education and guidance about business ethics.
(g) Relative Term − Business ethics is a relative term. It changes from one
business to another and from one country to another.
(h) New Concept − Business ethics is a relatively newer concept.
Principles of Business Ethics: The important principles of business
ethics are as follows −
(a) Avoid Exploitation of Consumers − Do not cheat and exploit
consumer.
(b) Avoid Profiteering − Unscrupulous business activities such as
hoarding, black-marketing, selling banned or harmful goods to earn
exorbitant profits must be avoided.

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(c) Encourage Healthy Competition − A healthy competitive
atmosphere that offers benefits to the consumers must be encouraged.
(d) Ensure Accuracy − Accuracy in weighing, packaging and quality of
supplying goods to the consumers has to be followed.
(e) Pay Taxes Regularly − Taxes and other duties to the government
must be honestly and regularly paid.
(f) Get the Accounts Audited − Proper business records, accounts
audited by authorized persons and authorities should be maintained.
(g) Fair Treatment to Employees − Fair wages or salaries, facilities and
incentives must be provided to the employees.
(h) Keep the Investors Informed − The shareholders and investors must
know about the financial and other important decisions of the company.
(i) Avoid Injustice and Discrimination − Avoid all types of injustice
and partiality to employees. Discrimination based on gender, race,
religion, language, nationality, etc. should be avoided.
(j) No Bribe and Corruption − Do not give expensive gifts, commissions
and payoffs to people having influence.
(k) Discourage Secret Agreement − Making secret agreements with
other business people to influence production, distribution, pricing etc.
are unethical.
(l) Service before Profit − Accept the principle of "service first and profit
next."
(m) Practice Fair Business − Businesses should be fair, humane, efficient
and dynamic to offer certain benefits to consumers.
(n) Avoid Monopoly − No private monopolies and concentration of
economic power should be practiced.
(o) Fulfil Customers’ Expectations − Adjust your business activities as
per the demands, needs and expectations of the customers.
(p) Respect Consumers Rights − Honour the basic rights of the
consumers.
(q) Accept Social Responsibilities − Honour responsibilities towards the
society.
(r) Satisfy Consumers’ Wants − Satisfy the wants of the consumers as
the main objective of the business is to satisfy the consumer’s wants. All
business operations must have this aim.

2.8 – Business Environment and Ethics 18 | P a g e

(s) Service Motive − Service and consumer's satisfaction should get more
attention than profit-maximization.
(t) Optimum Utilization of Resources − Ensure optimum utilization of
resources to remove poverty and to increase the standard of living of
people.
(u) Intentions of Business − Use permitted legal and sacred means to do
business. Avoid Illegal, unscrupulous and evil means.
Ethical Decision Making
Michael Davis proposed a seven step guide to ethical decision making;
1. State problem. State your possible ethical problem that makes you
uncomfortable or creates a conflict of interest.
2. Check facts. Many problems disappear upon closer examination of the
situation, while others change radically.
3. Identify relevant factors. For example, the persons involved, applicable
laws, professional codes or standards, other practical constraints.
4. Develop a list of options. What other actions or decisions are available
to you besides the original one that started you thinking?
5. Test the options using any one of the following:
a. Harm test: Does this option do less harm than the alternatives?
b. Defensibility test: Could I defend this choice of option before a
committee of peers, or a Congressional committee
c. Reversibility test: Would I still think this choice of option was good?
d. Colleague test: What might my profession’s governing board or
ethics committee say about this option?
e. Organization test: What does my organization’s ethics officer or
legal counsel say about this?
f. Virtue test: Would a virtuous person do this
6. Make a choice based on steps 1-5.
7. Review steps 1-6. What could you do to make it less likely that you would
have to make such a decision again?
a. Are there any precautions you can take as an individual?
b. Is there any way to have more support next time?
c. Is there any way to change your organization?

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Q.7. CORPORATE GOVERNANCE
Corporate governance – Definition and Meaning
Corporate governance is the system of rules, practices and processes by
which a company is directed and controlled. Corporate governance
essentially involves balancing the interests of a company's many
stakeholders, such as shareholders, management, customers, suppliers,
financiers, government and the community.
Since corporate governance also provides the framework for attaining a
company's objectives, it encompasses practically every sphere of
management, from action plans and internal controls to performance
measurement and corporate disclosure.
Scope of Corporate Governance
Corporate Governance covers the following functional area of governance:
1. Preparation of the company’s financial statements
2. Internal controls
3. Review of the compensation arrangements for senior executives
4. The way in which individuals are nominated for positions on the board
5. The resources made available to directors in carrying out their duties
6. Oversight and management of risk.
Principles of Corporate Governance
Commonly accepted principles of corporate governance include:
1. Rights and equitable treatment of shareholders: Organizations should
respect the rights of shareholders and help shareholders to exercise
those rights.
2. Interests of other stakeholders: Organizations should recognize that they
have legal, contractual, social and market driven obligations to non-
shareholder stakeholders, including employees, investors, creditors,
suppliers, local communities, customers and policy makers.
3. Role and responsibilities of the board: The board needs sufficient
relevant skills and understanding to review and challenge management
performance.
4. Integrity and ethical behaviour: Integrity should be a fundamental
requirement in choosing corporate officers and board members.
Organizations should develop a code of conduct for their directors and
executives that promotes ethical and responsible decision making.
5. Disclosure and transparency: Organizations should clarify and make
publicly known the roles and responsibilities of board and management

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 to provide stakeholders with a level of accountability.
Role/Importance of Corporate Governance
The role of effective corporate governance is of immense significance to
society. It can be summarized as follows:
1. It ensures efficient use of resources
2. It makes the resources flow to those sectors where there are efficient
production of goods and services.
3. It provides for choosing the best managers to administer the scarce
resources.
4. It helps the managers to remain focused on improving performance.
5. It pressurizes the organization to comply with the laws, regulations and
expectations of society.
6. It assist the supervisor in regulating the entire economic sector without
partiality and nepotism.
7. It increases the shareholders’ value which attract more investors.
8. It helps in increasing market share and sales.
9. Employees are more satisfied in the organizations which follows
corporate governance policies.
10. It reduces the procurement and inventory cost.
11. It helps in establishing good rapport with distributors.
Mechanism and Control
Corporate governance mechanisms and controls are designed to reduce the
inefficiencies that arise from moral hazard and adverse selection. There are
both internal monitoring systems and external monitoring systems.
(a) Internal corporate governance controls
Internal corporate governance controls monitor activities and then take
corrective actions to accomplish organisational goals.
Examples include:
 Monitoring by the board of directors: The board of directors, with its
legal authority to hire, fire and compensate top management,
safeguards invested capital. Regular board meetings allow potential
problems to be identified, discussed and avoided.

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 Internal control procedures and internal auditors: Internal
control procedures are policies implemented by an entity's board of
directors, audit committee, management and other personnel to provide
reasonable assurance of the entity achieving its objectives related to
reliable financial reporting, operating efficiency and compliance with
laws and regulations. Internal auditors are personnel within an
organization who test the design and implementation of the entity's
internal control procedures and the reliability of its financial reporting
 Remuneration: Performance-based remuneration is designed to relate
some proportion of salary to individual performance. It may be in the
form of cash or non-cash payments such as shares and share options,
superannuation or other benefits.
 Monitoring by large shareholders and/or monitoring by banks
and other large creditors: Given their large investment in the firm,
these stakeholders have the incentives, combined with the right degree
of control and power, to monitor the management
(b) External corporate governance controls
External corporate governance controls encompass the controls external
stakeholders exercise over the organization. Examples include:
 Competition
 Debt covenants
 Demand for and assessment of performance information
 Government regulations
 Managerial labour market
 Media pressure
 Takeovers
 Proxy firms

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UNIT III
Q.8. GLOBALISATION
Globalisation is a modern term used to describe the changes in societies and
the world economy that result from dramatically increased international
trade and cultural exchange.
The IMF defines Globalisation as “the growing economic interdependence of
countries worldwide through increasing volume and variety of cross-border
transactions in goods and services, freer international capital flows and
more rapid and widespread diffusion of technology”
With globalisation, people around the globe are more connected to each
other than ever before. Information and money flow more quickly than ever.
Goods and services produced in one part of the world are increasingly
available in all parts of the world. International travel is more frequent.
International communication is commonplace.
Characteristics of Globalisation
1. Over the past two decades, there is a rapid Globalisation of markets
and production.
2. The Globalisation of markets implies that national markets are
merging into one huge marketplace.
3. Erosion of national sovereignty and national borders through
international agreements leading to organizations like EU.
4. Development of Global Financial System.
5. Reduced transportation costs.
6. The Globalisation of production implies that firms are basing
individual productive activities at the optimal world locations for the
particular activities.
7. Two factors seem to underlie the trend toward Globalisation: declining
trade barriers and changes in communication, information and
transportation technologies.
8. Since the end of World War II, there has been a significant lowering
of barriers to the free flow of goods, services and capital.
9. Increase in international flow of capital.
10. Increase in the share of the world economy controlled by multinational
corporations.

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11. Increased role of international organizations such as WTO, IMF that
deal with international transactions.
12. Increase of economic practices like outsourcing, by multinational
corporations.
13. Intellectual Property Restrictions.
14. Supranational recognition of intellectual property restrictions (e.g.
patents granted by China would be recognized in the US).
15. As a consequence of the Globalisation of production and markets,
world trade has grown faster than world output, foreign direct
investment has surged and imports have penetrated more deeply into
the world's industrial nations.
16. The developments in communication and information processing
technology have helped firms link their worldwide operations into
sophisticated information networks.
17. Development of a global telecommunications infrastructure and
greater trans-border data flow, using Internet communication
satellites and telephones.
18. Increases in the number of standards applied globally; e.g. copyright
laws and patents.
Impact of Globalisation on Corporations
Globalisation has influenced the every part of the Globe. Corporations are
changing their strategies and are reorganizing their function to cope up with
the changed scenario. In the changed scenario, they are reorganizing and
bringing changes, including:
a.Designing in Global Environment
With globalization, companies adopt global design strategies. Global design
has cost benefits that are very attractive to today’s manufacturer, but adds
new Product Lifecycle Management challenges and intensifies existing
problem areas such as protecting intellectual property. Designing products
in a distributed approach makes classic control, communication and
collaboration even more challenging, requiring better management of
product innovation, product development and engineering processes and
new approaches to sharing product designs.
b.Production Location Selection
With globalisation, companies are opting for a production strategy which
intended to reduce production cost by concentrating manufacturing

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operations wherever in the world they could be carried out most cost
effectively.
c.Rationalized Production
Companies produce different components or different portions of their
product line in different parts of the world to take advantage of low labour
costs, capital and raw materials. This is rationalized production.
d.Vertical Integration
Vertical Integration is a company’s control of the different stages in a value
chain of making of product - from raw material to production to final
distribution of product. As international trade barriers are eliminating,
organizations can combine resources located in more than one country.
e.Product Strategy
To cross borders, organization has to face a very critical question of product
standardization vs. product adaptation. With globalization, standardization
enabled the advantages in low cost production and distribution of products
and services. In many goods, however, product adaptation is essential to
meet the local conditions or preferences.

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Q.9. MULTINATIONAL CORPORATIONS
The word "Multinational" is a combined word of "Multi" and "National",
which when combined refers to numerous countries.
Multinational Corporations (MNCs) are defined as enterprises that are
headquartered in one country but have operations in two or more countries.
Sometimes it is difficult to know if a firm is a MNC because multinationals
often downplay the fact that they are foreign held. For example most of
people in India are unaware that Bata is a Canadian company, Nestle is a
Swiss company and Cadbury is British company.
Benefits of Being MNCs
Benefits of being a MNC include:
1. Survival: Business organizations in countries that are smaller in size
or with shortage of diverse resources and opportunities do their
business outside their territory as a survival option. Even in big
countries, organization do business outside their territory to find new
markets for their product and cheap source of resources to remain
competitive and to survive.
2. Growth of Overseas Market: This is the biggest reason of going
abroad. In last 20 years many economies have opened their doors for
world. This resulted in big opportunity in terms of Market.
3. Diversification: Every organization wants to diversify the risk and
internationalization is a good manner to diversify the risk.
4. Source of Resources: Organizations go abroad in search of
economical source of supply. A truly global firm always locates its
processing in the best available location in the world and outsources
HR and other physical resources from the best suited place in the
world.
5. To Protect Market Share: Firms also become MNCs in response to
increased foreign competition and a desire to protect their home
market share.
6. Tariff and Non-Tariff Barrier: Organizations establish their
operation overseas to deal with tariff and non-tariff barriers.
7. Technology Expertise: A reason for becoming an MNC is to take
advantage of technological expertise by manufacturing goods directly
(by FDI) rather than allowing others to do it under a license. Many
MNCs feel it unwise to give another firm access to proprietary
information such as patent, trademarks, or technological expertise.

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 8. To have an access to Economical Human Resource: Many a times
Companies cross borders to have an access to the economical human
resource.
Advantages of MNCs
 Increase Investment: The primary argument in favour of MNCs is that
they enable investment into less developed countries which is essential
for their growth.
 Technological Transfers: Any MNC operating in a certain country
needs to have an agreement to transfer of technology which would turn
out to be very beneficial for the host country, since technological
advancements require huge research and development funds that the
developing countries just do not have.
 Transfer of skills: Like transfer of technology, MNCs also bring with
them a wealth of knowledge and experience. Their staff is amongst the
best in the world and employees from the less developed countries learn
plethora of skills from them
 Increase in Tax revenue: An increase in tax revenue is also an added
benefit. This can be used to finance projects that lead to development of
infrastructure, causing economic development.
 Reduces gap between capital and labour: MNCs help in reducing
gap between capital and labour by creating jobs and employment and
revenue for the local population.
 Encourages competition: MNCs encourage entrepreneurship and
breeds a culture of competition. Increasing competitiveness amongst
local companies cause them to improve their own goods and services by
increasing their efficiency.
 Improves Balance of Payments: An added benefit of foreign direct
investment is that it helps the Balance of Payments of both, the capital
and current accounts, of the host country.
Criticism of MNCs:
Critics of MNCs state that the cons far outweigh the pros that MNCs bring
to host countries.
 Colonialism: MNC's are seen as an offshoot of western colonialism.
 Unmatchable influence: The power, influence and reach of MNCs
have enabled them to pressurize governments into letting them become
more competitive via the implementation of national policies that is
conductive to their end goals.

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 Technological fraud: Technological transfer agreements are not
always kept. Even if technological transfer happens, the technology
passed onto the country is usually obsolete in nature or is patented so it
would be of little use to the host country on a global scale.
 Little or No accountability: MNCs comprise of international bodies
which function beyond the state authorities, in terms of decision making
power and the power they hold over monetary assets.
 Undermine Social and Economic Rights: MNCs' can easily
undermine economic and social rights. Their interference leads to social
and economic hazards for the public
 Strangles Competition: The superiority of MNC's throttle
competition by local manufacturers, resulting a lot of them leaving the
field, leaving the MNC's to monopolies the economy.
 Unmatched budgets: The MNCs have a huge advertising budget,
which enables them to portray a much better image in the eyes of the
local populace.
 Human Right abuses: The Multinational Corporation allows for
abuses of human rights to take place internationally.
 Environmental impacts: MNCs want to produce in ways that are as
efficient and as cheap as possible and this may not always be the best
environmental practice.

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Q.10. GATT
General Agreement on Tariffs and Trade (GATT) was a legal agreement
between many countries, whose overall purpose was to promote
international trade by reducing or eliminating trade barriers such as tariffs
or quotas.
According to its preamble, its purpose was the "substantial reduction of
tariffs and other trade barriers and the elimination of preferences, on a joint
and mutually advantageous basis."
GATT was signed by 23 nations in Geneva on October 30, 1947 and took
effect on January 1, 1948. It remained in effect until the World Trade
Organization (WTO) established on January 1, 1995. GATT and its
successor WTO, have successfully reduced tariffs.
Three Provisions of GATT
GATT had three main provisions.
1. The most important requirement was that each member must confer
most favored nation status to every other member. That means all
members must be treated equally when it comes to tariffs.
2. Second, GATT prohibited restriction on the number of imports and
exports. The exceptions were:
 When a government had a surplus of agricultural products.
 If a country needed to protect its balance of payments because its
foreign exchange reserves were low.
 Developing countries that needed to protect new industries.
 In addition, countries could restrict trade for reasons of national
security.
3. The third provision was added in 1965 with joining of more developing
countries in GATT and it wished to promote them. Developed countries
agreed to eliminate tariffs on imports of developing countries to boost
their economies.
Pros of GATT
 For 47 years, GATT reduced tariffs. This boosted world trade 8 percent
a year during the 1950s and 1960s.
 By 1995, there 128 members, generating at least 80 percent of world
trade.
 By increasing trade, GATT promoted world peace.

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 By showing how free trade works, GATT inspired other trade
agreements. It set the stage for the European Union.
 GATT also improved communication by providing incentives for smaller
countries to learn English.
Cons of
 Low tariffs destroy some domestic industries, contributing to high
unemployment in those sectors.
 By the 1980s, the nature of world trade had changed. GATT did not
address the trade of services, for example, financial services.
 GATT reduced the rights of a nation to rule its own people.
 GATT destabilized small, traditional economies.

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Q.11. WTO
The World Trade Organization (WTO) is an intergovernmental organization
that regulates international trade. The WTO officially commenced on 1
January 1995 replacing the GATT.
WTO is the largest international economic organization in the world. The
WTO deals with regulation of trade in goods, services and intellectual
property between participating countries by providing a framework for
negotiating trade agreements and a dispute resolution process aimed at
enforcing participants' adherence to WTO agreements
Functions of WTO
The most important functions of the WTO are:
 It oversees the implementation, administration and operation of the
covered agreements.
 It provides a forum for negotiations and for settling disputes
 It review and propagate the national trade policies
 It facilitate the implementation, administration and operation of this
Agreement
 It provide the forum for negotiations among its members.
 It administer the Settlement of Disputes.
 It administer Trade Policy Review Mechanism.
Principles of WTO
 Principle of Most-Favoured-Nation Treatment: With respect to
tariffs on exports and imports, the most advantageous treatment
accorded to the products of any country must be accorded immediately
and unconditionally to the like products of all other members.
 Principle of National Treatment: With respect to internal taxes,
internal laws, etc., applied to imports, the products of all other Members
must be treated equivalent with like domestic products.
 Principle of General Prohibition of Quantitative Restrictions: No
prohibitions or restrictions other than duties, taxes or other charges
shall be instituted or maintained by any Members.
Organizational Structure of WTO
The General Council has the following subsidiary bodies which oversee
committees in different areas:

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1. Council for Trade in Goods: There are 11 committees under the
jurisdiction of the Goods Council each with a specific task.
2. Council for Trade-Related Aspects of Intellectual Property
Rights: It deals with the intellectual property in the WTO.
3. Council for Trade in Services: It is responsible for the administration
of the functioning of the General Agreement on Trade in Services.
4. Trade Negotiations Committee: It deals with the current trade talks
round.
WTO Agreements
The WTO administers about 60 different agreements. Some of the most
important agreements are:
1. The Agreement on Agriculture came into effect with the establishment
of the WTO at the beginning of 1995.
2. The General Agreement on Trade in Services was created to extend the
multilateral trading system to service sector.
3. The Agreement on Trade-Related Aspects of Intellectual Property
Rights sets down minimum standards for many forms of intellectual
property (IP) regulation.
4. The Agreement on the Application of Sanitary and Phytosanitary
Measures sets constraints on policies relating to food safety as well as
animal and plant health.
5. The Agreement on Technical Barriers to Trade ensures that technical
negotiations and standards do not create unnecessary obstacles to trade.
6. The Agreement on Customs Valuation prescribes methods of customs
valuation that Members are to follow.
7. In December 2013, the biggest agreement within the WTO was signed
and known as the Bali Package

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UNIT IV
Q.12. FISCAL POLICY
Fiscal policy is the projected balance sheet of the country, prepared by the
Finance Minister of the state. It is through fiscal policy that the government
tries to correct inequalities of income and wealth.
Fiscal policy is implemented through Budget, which is statement of state’s
revenue and expenditure.
Objectives of Fiscal Policy
The following are objectives of fiscal policy:-
1. Development by effective Mobilization of Resources
2. Efficient allocation of Financial Resources
3. Reduction in inequalities of Income and Wealth
4. Price Stability and Control of Inflation
5. Employment Generation
6. Balanced Regional Development
7. Capital Formation
8. Reducing the Deficit in the Balance of Payment
9. Foreign Exchange Earnings
Constituents of Fiscal Policy
There are mainly four instruments or constituents of the fiscal policy.
1. Budget,
2. Public revenue
3. Public expenditure and
4. Public debt.
1. Budget: A budget is an estimate of government expenditures and
revenues for a fiscal year, usually presented to the parliament by the finance
minister.
There are three types of budgetary policies:
i. Balanced budget policy: When the government keeps its total
expenditure equal to its revenue.
ii. Deficit budget policy: When the government spends more than its
expected revenue.
iii. Surplus budget policy: When the government follows a policy of keeping
its expenditure considerably below its current revenue.
2. Public Revenue: The government needs income for performing a variety
of functions. The income of the government which is obtained through

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sources such as taxes, grants, fees and borrowings are called public income
or public revenue.
Generally, government revenue implies the income raised from the public
by the state through taxes. There are various other non-tax sources of public
revenue such as taxes, price, fees, fines, penalties, gifts, profits and special
assessments.
Public revenue is divided into two groups:
 Tax revenue and
 Non-tax revenue.
The revenue raised by the government through various direct and indirect
taxes is known as tax revenue.
Direct taxes are those which are imposed on individuals or householders,
Direct taxes include income tax, corporate tax, interest tax, wealth tax,
estate duty, expenditure tax, etc.
Indirect taxes are those which are imposed on equity at some point in the
system. Examples of indirect taxes include excise duty, customs duty,
service tax etc.
The revenue obtained by the Government from sources other than tax is
called non-tax revenue. This includes fees, fines and penalties, profits of
government enterprises, gifts and grants, etc.
3. Public Expenditure: Public Expenditure refers to Government
Expenditure. The Public Expenditure is incurred on various activities for
the welfare of the people and also for the economic development.
All public expenditure classified into:
a) Non-plan expenditure
b) Plan expenditure
a.Non-plan Expenditure: Non-plan expenditure of the central govt. is
divided into
 Revenue expenditure and
 Capital expenditure
Revenue expenditure includes interest payment, defense revenue
expenditure, major subsidies, interest and other subsidies, debt relief to
farmers, postal deficit, police, pension and other general services, social
service, economic service and grants to states and union territories and
grants to foreign government.
Capital non plan expenditure includes such items as: Defense capital

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expenditure, loans to public enterprises, loans to states and union territories
and loans to foreign government.
b.Plan Expenditure: Plan expenditure is to finance central plans, such as
agriculture, rural development irrigation and flood control, energy industry
and minerals transport, communications, science and technology and
environment, social services and others and Central assistance for Plans of
the state and Union Territories.
4.Public Debt: Borrowing by the government leads to public debt. Public
debt is the debt which the government owes to its subject or to the nationals
of other countries. The government can borrow from individuals, business
enterprises and banks. It can borrow from within the country and from
outside the country. The main objectives of government borrowings are to
meet the budgetary deficit, to finance development plans and to fight
depression.
Fiscal Policy and Economic Growth
Fiscal policy is a potent tool in the hands of Govt. to regulate the economic
growth. Fiscal policy plays a leading role in effecting savings in the economy.
Budgets play a direct role in capital accumulation and economic growth in
an underdeveloped country.
Through the fiscal policy govt. can also encourage the growth of particular
industries and in particular areas. For this, industries are provided with
specific tax concessions and subsidies.
Impact of Fiscal Policy on Business
Fiscal policy decisions have large impact on the regular decisions and
conduct of organizations. Fundamentally fiscal policy implies how
government taxes us and how it uses the cash.
Increased taxation makes the cost of products and administrations
excessive, lessening interest for them and decreasing occupation.
Lower taxes mean more disposable wage for shoppers and more money for
organizations to put resources into employments and supplies.
Low interest rates mean lower interest expense for organizations and higher
disposable wage for customers.
Lower home loan rates may spur the home industry, which is generally
useful for the development business. High interest rates can have the
inverse effect for organizations.

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Q.13. TAX STRUCTURE
India offers a well-structured tax system for its population. Taxes are the
largest source of income for the government. This money is deployed for
various purposes and projects for the development of the nation.
Taxes are determined by the Central and State Governments along with
local authorities like municipal corporations. The government cannot
impose any tax unless it is passed as a law.
Types of Taxes
There are two ways to classify different types of taxes in India:
1. Taxes Levied by the Central Government and State
Governments
 By the Central Government: These include income taxes, custom
duties, corporation taxes, excise duties, estate duty and more
 By the State Government: Taxes on agricultural incomes, VAT,
electricity consumption and sale taxes, land revenues, tolls and
more
 By the Local Civic Bodies: Municipal corporations and other local
governing bodies collect taxes like property taxes
2. Direct and Indirect Taxes
 Direct Taxes: These taxes are directly paid by the individuals to
the respective governments. The most important examples include
income tax, capital gains tax, perquisite tax, corporate tax and
securities transaction tax.
 Indirect Taxes: These taxes are not directly paid to the
governments but are collected by the intermediaries who sell or
arrange products and services. Service tax, sales tax, octroi, customs
duty, value added tax and excise duty are some of the top examples.
Direct Tax
It is a tax levied directly on a taxpayer who pays it to the Government and
cannot pass it on to someone else.
Direct taxes imposed in India
Some of the important direct taxes imposed in India are mentioned below:
 Income Tax- It is imposed on an individual who falls under the
different tax brackets based on their earning or revenue and they

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 have to file an income tax return every year after which they will
either need to pay the tax or be eligible for a tax refund.
 Estate Tax– Also known as Inheritance tax. It is raised on an estate
or the total value of money and property that an individual has left
behind after their death.
 Wealth Tax– Wealth tax is imposed on the value of the property
that a person possesses.
 Corporate Tax: Paid by companies and corporations on their
profits.
 Gift Tax: An individual receiving the taxable gift pays tax to the
government.
 Fringe Benefit Tax: Paid by an employer that provides fringe
benefits to employees, and is collected by the state government.
Advantages of direct taxes
 It curbs inflation: The Government often increases the tax rate
when there is a monetary inflation which in turn reduces the
demand for goods and services and as a result of descending
demand, the inflation is bound to condense.
 Social and economic balance: Based on every individual’s
earnings and overall economic situation, the Government has well-
defined tax slabs and exemptions in place so that the income
inequalities can be balanced out.
Disadvantage of direct taxes?
 Direct taxes come with a handful of disadvantages. But, the very
time-consuming procedures of filing tax returns is a taxing task
itself.
Indirect Tax
It is a tax levied by the Government on goods and services and not on the
income, profit or revenue of an individual and it can be shifted from one
taxpayer to another.
A few indirect taxes that were earlier imposed in India:
 Customs Duty- It is an Import duty levied on goods coming from
outside the country, ultimately paid for by consumers and retailers
in India.

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  Central Excise Duty– This tax was payable by the manufacturers
who would then shift the tax burden to retailers and wholesalers.
 Service Tax– It was imposed on the gross or aggregate amount
charged by the service provider on the recipient.
 Sales Tax– This tax was paid by the retailer, who would then shifts
the tax burden to customers by charging sales tax on goods and
service.
 Value Added Tax (VAT)– It was collected on the value of goods or
services that were added at each stage of their manufacture or
distribution and then finally passed on to the customer.
GST as Indirect Tax
With the implementation of Goods & Services Tax (GST), we have already
witnessed a number positive changes in the fiscal domain of India. The
various taxes that were mandatory earlier are now obsolete. Not just that,
GST is making sure the slogan “One Nation, One Tax, One Market” becomes
the reality of our country and not just a dream.
The biggest relief of GST so far is clearly the elimination of the ‘cascading
effect of tax’. Cascading effect of tax is a situation wherein the end-consumer
of any goods or service has to bear the burden of the tax to be paid on the
previously calculated tax and as a result would suffer an increased or
inflated price.
Under the GST regime, however, the customer is exempted from the tax
they would otherwise pay as a result of the cascading effect.

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Q.14. DEFICIT FINANCING
Deficit financing is the budgetary situation where expenditure is higher
than the revenue. It is a practice adopted for financing the excess
expenditure with outside resources. The expenditure revenue gap is
financed by either printing of currency or through borrowing
Various indicators of deficit in the budget are:
1. Budget deficit = total expenditure – total receipts
2. Revenue deficit = revenue expenditure – revenue receipts
3. Fiscal Deficit = total expenditure – total receipts except borrowings
4. Primary Deficit = Fiscal deficit- interest payments
5. Effective revenue Deficit = Revenue Deficit – grants for the creation
of capital assets
6. Monetized Fiscal Deficit = that part of the fiscal deficit covered by
borrowing from the RBI.
Objectives of Deficit Financing
1. To finance war: Deficit financing has generally being used as a method
of financing war expenditure.
2. Remedy for depression: Deficit financing can be used as an instrument
of economic policy for removing the conditions of depression.
3. Economic development: The main objective of deficit financing is to
promote economic development.
4. Mobilization of Resources: Deficit financing is also used for the
mobilization of surplus, idle and unutilized resources in the country.
5. For granting subsidies: Granting subsidies is a very costly affair which
cannot meet with the regular income.
6. Increase in aggregate demand: Deficit financing leads to increase in
aggregate demand through increased public expenditure.
7. For payment of interest: Deficit financing is an important tool to get
the income for the repayment of loan along with the interest.
Adverse Effects of Deficit Financing
Important evil effects of deficit financing are given below.
1. Leads to inflation: Deficit financing may lead to inflation as it increases
money supply and the purchasing power of the people.

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2. Adverse effect on saving: Deficit financing leads to inflation and inflation
affects the habit of voluntary saving adversely.
3. Adverse effect on Investment: An inflation in the economy can adversely
affect the level of investment.
4. Inequality: Deficit financing makes the rich richer and the poor, poorer.
5. Problem of balance of payment: Deficit financing leads to a deficit in
balance of payment and the balance of payment will become
unfavourable.
6. Increase in the cost of production: Since the deficit financing leads to the
rise in the price level, the cost of development projects also rises.
7. Change in the pattern of investment: Deficit financing leads to inflation.
During inflation, instead of indulging in productive activities people
start doing speculative activities.

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Q.15. VAT
VAT is a kind of indirect tax on value added. Value Added taxation is a
percentage of tax on value added to the production or service at each selling
point.
VAT is paid at every stage from which good or service passes but it is paid
on the value added only and not on whole cost. Thus everybody in the
production and distribution chain pays the tax but only on the value added
at his level only.
Objectives of VAT
VAT is implemented with following objectives:
1. To remove the double taxation having cascading effect.
2. To eliminate multiplicity of taxes
3. To eliminate inter-state tax.
4. To reduce inspector Raj.
5. To make the tax structure simple, efficient and transparent.
6. To widen the tax net.
7. Coordinate revenue growth with development.
8. To create level playing field for industry and trade
Methods of VAT Calculation
The value added can be derived either by
(a) Subtraction method or
(b) Cumulative method.
(a) Subtraction Method: According to this method, VAT is calculated on
the difference between selling value and purchasing value of a
product/service at a predetermined tax rate. We can understand this by
following example:
Suppose
M is a raw material supplier
P is a Manufacturer
W is a Wholesaler
R is a retailer.
And VAT is at 10%
If M sales a product to P for Rs. 100 and pays tax at the applicable VAT rate
of 10%. It is assumed that M is a primary producer of product thus his input
can be assumed as zero. So the tax will be 10% of Rs. 100 that is Rs. 10.
Rs. 100 is the purchase price of P.

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Manufacturer P will add value to the product increasing its usability
through the manufacturing process. In this process he invest some money
and add his profit so his sale value is 200. Value added is the difference
value that is Rs. 200 - Rs. 100 = 100, tax @ 10 is Rs. 10.
The sale price of P is the purchase price of W the wholesaler. Wholesaler
will add his operating cost and profit and thus suppose his sale value is Rs.
250. At this point value addition in terms of money is Rs. 250 - 200 = 50 and
applicable VAT at the rate of 10% will be Rs. 5. The Retailer R purchases it
at Rs. 250 and sells it at Rs. 350 the value addition is Rs. 350 – Rs. 250 =
Rs. 100 and tax will be Rs. 10.
Total VAT collected at four stages = 10 + 10 + 5 + 10 = 35
Last point retail Sales Tax @ 10 on 350 = 35.
(b) Cumulative Method: As per cumulative method, tax is collected on
overall sale value. In this system accumulation takes place for the cost
increased for producing goods and profit added at each previous sage. In this
method, tax is computed on purchasing value is deducted from the amount
of tax computed on selling value. The difference amount of tax is payable to
Govt. by seller of product or service. Here the tax paid at previous stage is
set off against the total amount of tax on selling value for fixing net tax
liability of seller at each stage.
As in the example M sales a product to Mr. P for Rs. 100 and pays tax at the
applicable VAT rate of 10% or Rs. 10. As M is the primary producer of
product, his input could be assumed Zero. Hence the sale would be Rs. 100
and on this sale value of Rs. 100 @ 10% VAT would be Rs. 10.
This Rs. 100 is the purchase price of P. Manufacturer P will add value to the
purchased product. Assume that after adding all the cost incurred by him
and his own profit his sale value is Rs. 200. On this sale value of Rs. 200@
10% total VAT would be Rs. 20. As Raw material producer M has already
paid VAT on his sale value of Rs. 100 @ 10% Rs. 10 and Manufacturer P will
get credit/set - off for this tax. Hence net liability of VAT for P Rs. 10.
Similarly the sale value of Rs. 250 by wholesaler W would have net liability
of VAT of Rs. 5. And the sale value of Rs. 350 by Retailer R would also have
net liability of Rs.10.
Advantages of VAT
VAT has following advantages:
1. Simplicity: It is very simple tax system.
2. Transparency: It is a fully transparent.

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 3. No cascading effect: VAT avoids multiple taxation.
4. A few rates of tax: In VAT there is mainly four tax rates (0%, 1%, 4%,
12.5%).
5. Self-Assessment: It replaces existing system of inspection by built in
assessment by the dealers and internal auditing.
6. Less incentive to tax evasion (wider coverage): In VAT, a less amount
of tax is paid by everyone in a value chain and collects it from its
customer.
7. Revenue security: VAT represents an important instrument against
tax evasion.
8. Selectivity: VAT may be selectively applied to specific goods or
business entities.
VAT in India
The Indirect Taxes Inquiry Committee set up by Govt. of India in 1976
recommended the adoption of MANVAT (VAT at the manufacturing level)
in India. As a result the MODVAT (Modified Value Added Tax) scheme was
introduced with effect from May 1, 1986. Initially it covered selected items
in only 37 Chapters which was gradually extended to 77 chapters.
MODVAT was renamed as CENVAT (Central Value Added Tax) with effect
from April 1, 2000. All inputs used directly or indirectly are eligible for
CENVAT.
In addition to CENVAT, a central sales tax is also imposed on interstate
sales of goods. This tax is generally at 4%. Besides there is a provision of
10% service tax on various services.

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