BUSINESS ENVIRONMENT

UNIT 2: ECONOMIC ENVIRONMENT

MEANING
Economic factors which have their affect on the
working of the business is known as economic
environment. Economic environment is very dynamic
and complex in nature.

1. Economic Conditions
2. Economic System
3. Economic Policies
4. Global Environment
5. Economic Legislations
Economic Conditions
Economic Policies of a business unit are largely affected by the economic conditions of an
economy such as standard of living, purchasing power of public, demand and supply,
distribution of income. Business cycle is another economic condition that is very important
for a business unit.

Main Economic Conditions:-

I. Stages of Business Cycle: Prosperity, Recession, Depression, Recovery

II. National Income, Per Capita Income and Distribution of Income
III. Rate of Capital Formation
IV. Demand and Supply Trends
V. Inflation Rate in the Economy
VI. Industrial Growth Rate, Exports Growth Rate
VII. Interest Rate prevailing in the Economy
VIII. Trends in Industrial Sickness
IX. Efficiency of Public and Private Sectors
X. Growth of Primary and Secondary Capital Markets
XI. Size of Market
Economic Systems
An Economic System of a nation or a country may be
defined as a framework of rules, goals and
incentives that controls economic relations among
people in a society.
Economic Policies
Government frames economic policies. Economic Policies affects the different business units in different
ways. All the business enterprises frame their policies keeping in view the prevailing economic policies.

1. Monetary Policy:- The policy formulated by the central bank of a country to control the supply and the
cost of money (rate of interest), in order to attain some specified objectives is known as Monetary Policy.

2. Fiscal Policy:- It may be termed as budgetary policy. It is related with the income and expenditure of a
country. Fiscal Policy works as an instrument in economic and social growth of a country. It is framed by
the government of a country and it deals with taxation, government expenditure, borrowings, deficit
financing and management of public debts in an economy.

3. Foreign Trade Policy:- It also affects the different business units differently. E.g. if restrictive import
policy has been adopted by the government then it will prevent the domestic business units from foreign
competition and if the liberal import policy has been adopted by the government then it will affect the
domestic products in other way.

4. Foreign Investment Policy:- The policy related to the investment by the foreigners in a country is
known as Foreign Investment Policy. If the government has adopted liberal investment policy then it will
lead to more inflow of foreign capital in the country which ultimately results in more industrialization
and growth in the country.

5. Industrial Policy:- Industrial policy of a country promotes and regulates the industrialization in the
country. It is framed by government. The government from time to time issues principles and guidelines
under the industrial policy of the country.
Global/International Economic
Environment
The role of international economic environment is
increasing day by day. If any business enterprise is
involved in foreign trade, then it is influenced by not
only its own country economic environment but also
the economic environment of the country from/to
which it is importing or exporting goods. There are
various rules and guidelines for these trades which are
issued by many organizations like World Bank, WTO,
United Nations.
Economic Legislations
Governments of different countries frame various
legislations which regulates and control the business.
 Economic Reforms
Economic liberalization in India can be traced back to the late 1970s,
however, economic reforms began in earnest only in July 1991.
The 1991 Balance of Payments crisis forced India to procure a $1.8 billion
IMF loan which led to adoption of major economic reform. In response
to the crisis, the government immediately introduced stabilization
measures to reduce the fiscal deficit. The fiscal tightening and
devaluation of the rupee by approximately 25% adequately reduced the
current account deficit.
The financial sector reforms since the early 1990s could be analytically
classified into two phases.
First generation of reforms: aimed at creating an efficient,
productive and profitable financial sector which would function in an
environment of operational flexibility and functional autonomy.
Second generation reforms: which started in the mid-1990s, the
emphasis of reforms has been on strengthening the financial system
and introducing structural improvements.
Economic Reforms
In the first phase, the economy grew at more than 6 % coupled with full
macroeconomic stability. This compares with a growth rate of 3.5 % during 1950-
1980.
The rate of inflation was low and foreign exchange reserves were sufficient to
finance imports for more than eight months.
Rising incomes have helped bring down poverty. According to official figures,
the proportion of poor in total population declined from 40% in 1993-1994 to
26% in 2000.
The stabilization efforts of 1991 successfully warded off financial collapse. The
Government went beyond short-term stabilization efforts and began addressing
the underlying causes of India’s economic woes. Led by Dr. Manmohan Singh,
the government initiated a reversal of the historic policies of regulation and
government intervention with broader reforms like market determined
exchange rates, liberalization of interest rates, reductions in tariffs.
ACHIEVEMENTS OF ECONOMIC REFORMS
A) INDUSTRIAL SECTOR REFORMS
Industrial policy prior to reforms resulted in heavy industry in
a state monopoly. Other industries were either subject to strict
industrial licensing or reserved for the small-scale sector.
The reforms were directed towards freeing up the domestic
economy from state control. State monopoly was abolished in
virtually all sectors, which have been opened to the private
sector. The License Raj is a thing of the past. The small-scale
industry reservation persisted but even here there is progress.
Apparel, with its large export potential, was opened to all
investors.
 Industrial sector reforms have opened up the economy
broadly to competition; reduced reservations for some small-
scale industries.
B) FISCAL AND ADMINISTRATIVE REFORM

India’s fiscal policy is a key part of its overall economic

history and central to its growth prospects. It was a major
contributor to the 1991 BOP crisis, and in the future,
persistent budget deficits may hinder the country's
economic growth.
The shortfalls of India’s public services and infrastructure
are quite obvious, and a miserable fiscal policy is a major
reason for this gross underinvestment.
While inadequate public revenues and low rates of public
savings have contributed to India’s fiscal shortcomings, the
heart of the problem lies in India’s public expenditures and
management systems.
What has been done

India’s fiscal reforms focused on generating revenue through:

Rationalizing the tax structure and increasing compliance.
• Lowered taxes (individual, corporate, excise and custom),
Broadened the tax base; •
Simplified laws and procedures to close loopholes and
increase compliance including using technology to better
track tax payments.
The rapid growth momentum in the post-FRBMA (Fiscal
Responsibility Budget Management Act) period (2004-05 to
2010) helped change the composition of taxes, deepen the
process of rationalization of taxes and widen the base.
However, revenue receipts were at 11% of GDP in 2007-08
declined to 9.8% in 2008-09.
C) SUBSIDY
As much as 0.7 percent of GDP goes into fertilizer subsidies. Much of this subsidy
goes to support the inefficient domestic fertilizer industry rather than farmers.
Bulk of the food subsidy has failed to reach the poor. Between food and fertilizer
subsidies, there is scope for generating savings worth more than 1 percent of GDP.
The budgetary subsidies rose from 1.6% of GDP in 2003-04 to 2.2% of GDP in
2008-09 with 1.7% (BE) for 2009-10.
Institutional reforms with focus on nutrient based subsidy for fertilizers, direct
cash transfers and sustainable pricing of petroleum products.
The Economic Survey 2009-10 says that subsidies given to food, fertilizer, diesel
and kerosene, have a "questionable" impact and recommends the government to
decontrol their prices as freeing prices from government control could help
deploy large resources for financing other vital activities in the economy that
could promote productivity and eradicate poverty.
In July 2010 the petrol prices have been deregulated as a step to reduce
budgetary deficit by reducing massive subsidies provided to the state-run
oil companies. Kerosene and Cooking Gas still remain subsidized with an
upward revision in prices.
 D) INTERNATIONAL TRADE
In 1991, import licensing was pervasive with goods divided
into banned, restricted, limited permissible, and subject to
open general licensing (OGL).
Imports were also subject to excessively high tariffs.
The exchange rate was highly over-valued. (Rs/$ 17.943)
Strict exchange controls applied to not just capital account
but also current account transactions.
Foreign investment was subject to stringent restrictions.
Companies were not permitted more than 40 % foreign
equity unless they were in the high-tech sector or were
export-oriented. As a result, foreign investment amounted
to a paltry $100-200 million annually.
REFORMS MEASURES
However, post economic reforms import licensing has been completely
abolished.
The highest tariff rate came down to 45 % with the average tariff rate declining
to less than 25%.
The foreign investment regime became as liberal as in other developing Asian
countries. •
Liberalized trade in service and technology industries; •
Improved recognition of international intellectual property rights; •
Allowed 100% ownership in firms in a large majority of industries (excluding
banks, insurance, telecommunications, and airlines);
Having moved from barring foreign ownership to encouraging foreign
investment, India has made significant progress in opening its economy. Yet,
while its foreign investment inflows increased from 0.5% of GDP in 1991 to 4.1%
in 2000, these figures are dwarfed by other emerging Asian markets, particularly
China. The overall growth of investment in India was in the range of 15-16% in last
few years, however it plunged to negative 2.4% in 2008-09 due to Global
Economic crisis led slowdown.
E) FINANCIAL SECTOR REFORMS
Because the BOP crisis prompted reforms of the financial system, this
sector has experienced some of the most extensive improvements.
India must continue to deepen its financial sector in order to guarantee
adequate access to capital for its most dynamic industries.
What’s Been Done
India has implemented reforms that have led to relatively well-
functioning capital markets which include • Liberalized interest
rates; •Abolished cumbersome approval requirements for
financial transactions; • Liberalized capital markets through the
abolition of the Controller of Capital Issues, which controlled all
funding activities of large manufacturing corporations; • Allowed
companies to have greater access to funds. Foreign banks were
allowed freely to open branches in India, Banking sector has
been privatized.
 F) AGRICULTURE
Economic reforms initially bypassed agriculture.
Besides fertilizers among others, farmers needed
adequate supply of water and electricity. These were
provided free of charge but their supply is highly
unreliable. Farmers should reap benefit of full market
price for their product rather than be subject to a
procurement price below the market price.
Further, export restrictions needed to be phased out.
However, sectoral investment in agriculture grew by 26.0
% in 2008-09 as compared to 16.5% of 2007-08 and thus
there was a rebound in investments related to
agriculture.
G) MONETARY POLICY
The monetary policy framework, post liberalization,
made a phased shift from direct instruments of monetary
management to an increasing reliance on indirect
instruments. However, as appropriate monetary
transmission cannot take place without efficient
price discovery of interest rates and exchange rates
in the overall functioning of financial markets, the
corresponding development of the money market,
Government securities market and the foreign
exchange market became necessary. Reforms in the
various segments, therefore, had to be coordinated.
REFORM MEASURES
Indian financial sector has become more competitive,
efficient, and stable.
Effective monetary management has enabled price stability
while ensuring availability of credit to support investment
demand and growth in the economy.
Finally, the multi-pronged approach towards managing
capital account in conjunction with prudential and
cautious approach to financial liberalisation has ensured
financial stability in contrast to the experience of many
developing and emerging economies. This is despite the fact
that we faced a large number of shocks, both global and
domestic.
H) FOREIGN TRADE POLICY
Industrial policy prior to the reforms was characterized by multiple
controls over private investment which limited the areas in which
private investors were allowed to operate, and often also determined the
scale of operations, the location of new investment, and even the
technology to be used.
A great deal was achieved at the end of ten years of gradualist
reforms.
1. Most central government industrial controls being dismantled.
The list of industries reserved solely for the public sector -- which used
to cover 18 industries, including iron and steel, heavy plant and
machinery, telecommunications and telecom equipment, minerals, oil,
mining, air transport services and electricity generation and distribution
-- has been drastically reduced to 3: defense aircrafts and warships,
atomic energy generation, and railway transport. Industrial
licensing by the central government has been almost abolished except
for a few hazardous and environmentally sensitive industries.
2.The requirement that investments by large industrial
houses needed a separate clearance under the
Monopolies and Restrictive Trade Practices Act to
discourage the concentration of economic power was
abolished and the act itself is to be replaced by a new
competition law which will attempt to regulate
anticompetitive behavior in other ways.
3. The main area where action has been inadequate relates to
the long standing policy of reserving production of certain
items for the small-scale sector. The industrial and trade
policy reforms have gone far, though they need to be
supplemented by labor market reforms.
I) FOREIGN INVESTMENT POLICY
The reform process has deregulated the economy and stimulated
domestic and foreign investments, taking India firmly into the
forefront of investment destinations.
The Government, keen to promote investment in the country has
radically simplified and rationalised polices, procedures and
regulatory aspects.
Foreign investment is welcome in almost all sectors, except
those of strategic concern ( for instance, defence and atomic
energy).
Since the initiation of the economic liberalisation process in
1991, sectors such as automobiles, chemicals, food
processing, oil & natural gas, petrochemicals, power,
services, and telecommunications have attracted
considerable investments. Today, in the changes investment
climate, India offers exciting business opportunities in virtually
every sector of the economy.
Incentives to promote investments

Import of capital goods at concessional customs duty

(subject to fulfilment of certain export obligations).
Liberalisation of external commercial borrowing norms, tax
holiday, and concessional tax treatment for certain sector.
Several State Government offer incentives, such as subsidy
on fixed capital, loans at concessional rates of interest, and
attractive power rates.
While several incentives are project specific, a number of
firms have been successful in negotiating favourable
investment terms with the State Government concerned.
Telecommunication Services
Telecommunications services were a state monopoly
and constituted a major bottleneck on the conduct of
business activity.
Today, the private sector has become an active
participant in the telecommunications sector, and the
New Telecom Policy issued in 1999 set the target of
providing telephones on demand by the year 2002.
The provision of cellular mobile as well as fixed service
was open to the private sector including foreign
investors. As a result, the telecommunications services
in India went through a revolution.
OTHER ACHIEVEMENTS
Insurance has been opened to private investors, both domestic and
foreign.
Diesel oil and gas prices have undergone some increases.
The value added tax has undergone substantial rationalization.
Infrastructure reforms: •Investments to improve airports and road
networks; • Privatized successfully a small number of ports and roads; •
Improved the reach of the telecom sector.
Virtually no sector of the economy—industry, agriculture, or services—
can achieve successful transformation without adequate supply of power.
Reforms involving privatization of power generation and distribution
were undertaken in several states.
The need for the expansion of primary education is well recognized. But
needed as well are reforms in the area of higher education. Universities in
India also remain a state monopoly. With the need to cut the fiscal deficit,
the state has no resources to spare. Therefore, like most other countries
including Bangladesh and People’s Republic of China, India must allow
the entry of private universities.