Chapter IV

The Financial System

Aim
The aim of this chapter is to:

define financial system

introduce money market instruments

explain the Gilt Edged Market

Objectives
The objectives of this chapter are to:

discuss the features of dated securities

explain the primary and secondary market reforms

describe the features of capital market reforms

Learning outcome
At the end of this chapter, you will be able to:

enlist the major reform initiatives

explain the concept of buy back ordinance

compare Fiscal, Monetary and Credit Policy

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4.1. Introduction to Financial System

Financial system is the system that allows the transfer of money between savers and borrowers. It comprises a
set of complex and closely interconnected financial institutions, market, services, practices and transaction. The
fundamental function of any financial system is to promote efficiency in the process of exchange or trade in real
goods and services. This contributes to economic welfare of a country.

4.2 Money Market

Money Market is the market for short term funds; it is distinct from the capital market.
The money market is better known as a place for large institution and government to manage their short-term cash
needs. Individual investors can access to the market through a variety of different securities.

4.2.1 Money Market in India

The Money Market in India is a monetary system that involves lending and borrowing of short-term funds. Indian
money market has exponential growth just after globalisation initiative in the year 1992. The performance of money
market in India has been outstanding from past 20 years. The evolution of money market and its structure has been
integrated into overall deregulation process of the financial sector.

4.2.1.1 Types of Money Market Instruments in India

Money market instruments take care of the borrowers short-term needs and render the required liquidity to the
lender. The varied types of money market instruments are as follows:

Money Market Instruments

Treasury Bills Treasury bills are the short-term financial instruments that are issued by the Central Bank of the
(T-Bills) country. It is one of the safest money market instruments as it is void of market risks, though the
return on investments is not that huge.
Repurchase Repurchase agreements are also called repos. Repos are short-term loans that buyers and sellers
Agreement agree upon for selling and repurchasing. Repo transactions are allowed only among RBI-approved
securities like state and central government securities
Commercial Commercial papers are usually known as promissory notes which are unsecured and are generally
paper issued by the companies and financial institutions. The purpose of with which they are issued are
for financing of inventories, accounts receivable, and setting short-terms liabilities or loans.
Certificate of A certificate of deposit is a borrowing note for the short- term just similar to that of a promissory
Deposit note. The bearer of a certificate of deposit receives interest. The maturity date, fixed rate of interest
and a fixed value - are the three components of a certificate of deposit.
Bankers Bankers acceptance is also a short-term investment plan that comes from a company or a firm
Acceptances backed by a guarantee from the bank. The guarantee states that the buyer will pay the seller at
a future date.

Table 4.1 Types of money market instruments in India

Thus money usually serves the role of equilibrating the short-term liquidity position of banks.

4.3 Gilt Edged Market or the Government Securities Market

Government securities are the securities issued by the government for raising a public loan or as notified in the
official Gazette. They consist of government promissory note, bearer bond, stock or bond held in Bond Ledger
Account. They may be in the form of treasury bills or dated government securities. Individuals can also invest in
the government securities, but not in large quantum.

Gilt Edged Market

The Gilt Edged Market is specifically aimed at the finance professional and investors who need to known the inner
working of gilt market.

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There are some other Gilt Edge Securities issued by the government.

4.3.1 Dated Securities

They are generally fixed maturity and coupon usually carry semi-annual coupon. They are so called because they
are identified by their date of maturity and the coupon. The key features of these securities are:
They are issued at face value.
Coupon or interest rate is fixed at the time of issuance and remains constant till redemption of the securities.
The tenor of the security is also fixed.
Interest/coupon payment in made on a half yearly basis on its face value.
The security is redeemed at par on its maturity date.

4.3.2 Zero Coupon Bonds

These are bonds issued at the discount to face value and redeemed at par. The key features of these securities are:
They are issued at a discount to the face value.
The tenor of the securities is also fixed.
The securities do not carry any coupon/interest rate. The difference between the issue price and the face value
is return on this security.
The security is redeemed at par on its face value.

4.3.3 Partly Paid Stock

The payment of principal amount is made in installments with in a given time period. It meets the need of the
investors with regular flow of funds and need of the government when it does not need funds immediately. The
key features of these securities are:
They are issued at face value, but this amount is paid in installments over a specified period.
Coupon or interest rate is fixed at the time of issuance, and remains constant till the redemption of the
securities.
The tenor of the securities is also fixed.
Interest/ coupon payment is made on a half yearly basis on its face value.
The security is redeemed at par on its face value.

4.3.4 Floating Rate Bonds

These are bonds with variable interest rates with fixed percentage over a benchmark rate. There may be a gap and
a floor rate attached by fixing a maximum and minimum interest rate payable. The key features of these securities
are as follows
They are issued at face value
Coupon/interest rate is fixed as a percentage over a predefined or a benchmark rate at the time of issuance. The
benchmark rate may be a treasury bill, bank rate and so on.
Though the benchmark rate does not change, the rate of interest may vary according to the change in the
benchmark rate till redemption of securities.
The coupon/interest payment is made on a half yearly basis on its value.
The security is redeemed at par on its maturity date.

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4.3.5 Capital Index Bonds

There are the bonds where the interest rate is fixed over the wholesale price index. These provide investors with an
effective hedge against inflation. The key features of these securities are as follows:
They are issued at face value.
Coupon/interest rate is fixed as a percentage over the wholesale piece index at the time of issuance. Therefore
the actual rate of interest varies according to the change in the wholesale price index.
The tenor of the security is fixed.
The coupon/interest payment is made on a half yearly basis on its value.
The principal redemption is linked to the wholesale price index.

4.4 Capital Market Reforms

Capital market reform enables the capital market to embrace new ideas and techniques affecting the capital market.
Capital market liberalisation is one of such reforms which is adopted by various countries to strengthen their
economy.
A capital market is a place that handles buying and selling of the securities.
This is the ideal place where both the government and the companies can raise their funds.
Economic theories are made and implemented to reform the functionalities of the capital market.
The prime objective behind all the policies and reforms was to strengthen the capital market.
The concept of CP is not restricted to the share and bonds in developed counties only but has influenced the
developing and underdeveloped countries.
Therefore the economic or financial change in any one county will affect the capital market of the other country
in real time.

4.4.1 Primary Market Reforms

Entry barrier for unlisted companies modified as dividend payment in immediately preceding 3 years.
A listed company required to meet the entry norm only if the post-issue net worth becomes more than five times
the pre-issue net worth.
Companies required to adjust their partly paid-up shares fully paid up or forfeiting the same, before making
public/rights issue.
Unlisted companies are allowed to freely price its securities provided they have shown net profit in the immediately
preceding 3 years subject to its fulfilling the existing disclosure requirements.
The Promoters contribution for public issues made uniform at 20% irrespective of the issue size.
Written consent from share holders in regard to lock-in made compulsory for securities to be offered for
promoters contribution.
Appointment of Registrar to an issue, for rights issues made mandatory.
A provision made regarding disclosure of the share holding of the promoters whose names figure in the paragraph
on Promoters and their background in the offer document.
The SEBI (Registrars to an Issue and Share Transfer Agents) Rules and Regulations 1993 have been amended
to provide for an arms length relationship between the Issuer and the Registrar to the Issue. It has now been
stipulated that no Registrar to an Issue can act as such for any issue of securities made by any corporate, if the
Registrar to the issue and the Issuer Company are associates.
Only body corporate to be allowed to function as Merchant Bankers.

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 The Financial System

4.4.2 Secondary Market Reforms

Both, short and long sales will have to be disclosed to the exchange at the end of each day. They would be regulated
through the imposition of margins.
Custodians required by SEBI to appoint a Compliance Officer who will interact with the SEBI regarding
compliance and reporting issues.
SEBI will have monthly meetings with the Association of Custodial Agencies of India (ACAI) before incorporating
any changes that have an impact on settlement of transactions of institutional investors.
Stock exchanges asked to modify the listing agreement to provide for payment of interest by companies to
investors from the 30th day after the closure of a public issue.
Uniform good-bad delivery norms and procedure for time bound resolution of bad deliveries through Bad
Delivery Cells prescribed. Bad Delivery Cell procedure has helped to standardise norms.
All exchanges to institute the buy-in or auction procedure being followed by the National Stock Exchange.

4.5 Buy Back Ordinance

The Government promulgated the much awaited Ordinance on 31st October allowing companies to buyback their
shares. This act was welcomed by the Industry as it was considered a major step to revive the sagging capital market.
Features of this act are as follows:
It allows companies to buyback their own shares up to 25 percent of the paid-up capital and free reserves.
It also provides full freedom to make inter-corporate investment and loans to other companies bodies.
It also allows issuing sweat equity by companies in the ordinance.
It also allows the promoters of a company to make an open offer to purchase the shares of its subsidiary.

4.5.1 Buy Back and Experience with MNCs

Royal Philips electronics of Netherlands, the Dutch parents of Philips India Limited, announced its first offer to
buy back the shares of its Indian subsidiary, in the year 2000 October. This open offer was initially made for 23
percent of the outstanding shares that was held by the institutional investors, private bodies and general public.
With this, Philips became one of the MNC in India to offer buy back option to its shareholder. Fund managers who
held these companies stocks felt that allowing buy back of shares was one of the most favorable developments in
India stock market.

The buy back companies indicated that the management was not valuing their shares. This resulted in an increase
in the price, bringing it closer to the intrinsic value and providing investors with a higher price for their investment
in the company.

4.5.2 Banking Sectors Reforms

Banking sector reforms were initiated as part of overall economic reforms in the country and wide ranging reforms
covering industry, trade, taxation, external sector, banking and financial sectors.

The most significant achievement of banking sector reforms has been the marked improvement in the financial
health of commercial bank in terms of capital adequacy, profitability and asset quality.

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4.5.3 Major Reforms Initiatives

Some of the major reforms initiatives that have changes the face of Indian banking and financial sectors are as
follows:
Interest rate deregulation. Interest rates on deposits and lending have been deregulated with the banks enjoying
greater freedom to determine their rates.
Adoption prudential norms in terms of capital adequacy, asset classification, income recognition, provisioning,
exposure limits, and investments fluctuation reserve and so on.
Government equity in banks has been reduced and strong banks have been allowed to access the capital market
raising additional capital.
Several new institutions have been set up including the National Securities Depositories Ltd., Central Depositories
Services Ltd., Clearing Corporation of India Ltd., Credit Information Bureau India Ltd.
New areas have been opened up for bank financing: insurance, credit cards, infrastructure financing, leasing,
gold banking, besides of course investment banking, asset management, factoring and so on.
New private sector banks have been set up and foreign banks permitted to expand their operations in India
including through subsidiaries. Banks have also been allowed to set up Offshore Banking Units in Special
Economic Zones.

There is no doubt that banking sectors reforms have increased the profitability, productivity and efficiency of the
bank. Hence because of these there have been improvements in overall capital adequacy of bank.

4.6 An Introduction to Fiscal, Monetary and Credit Policy

The basics of each one of these policies are discussed below:

4.6.1 Fiscal Policy

Fiscal Policy is an important method to determine public revenue and expenditure. This is a policy under which
government uses its expenditure and revenue program to produce desirable effects and to avoid undesirable effects
on the national income, production and employment.

Basic objectives of fiscal policy may be regarded as follows:

To achieve desirable price level: The maintenance of a desirable price level has good effect on production,
employment and national income.
To achieve desirable consumption level: A desirable consumption level is important for political, social and
economic consideration. This can be affected by the expenditure and tax policies of the government.
To achieve desirable employment level: The efficient employment level is most important in determining the
living standard of the people. It is necessary for stability and for maximum production.
To achieve desirable income distribution: The distribution of income determines the type of economic activities
and the amount of saving. It is related to price, consumption and employment.
Increase in capital formation: In under-developed counties deficiency of capital is the main reason for under-
development. Large amount are required for industry and economic developments.
Degree of inflation: In under-developed countries, a degree of inflation is required for economic development

Fiscal Reforms in India

A comprehensive fiscal reforms program at the Central Government level was initiated only at the beginning of the
1990s, and as part of economic adjustment program initiate in 1991-92.
Fiscal reforms in the state were necessitated by:
Growing fiscal imbalances.
Sluggishness in the central transfers resulting in falling tax to GDP ratio.

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 Introduction of reforms-linked assistance as a part of Medium term Fiscal reforms on the basis of the
recommendations of the Eleventh Finance Commission.
Adjustment program taken in some of the states, which was linked to borrowing from multilateral agencies.

Techniques for Fiscal Policy are as follows:

Taxation policy: By the amendment in India Tax law 1961, government of India has the power to make new
taxation policy according to the current Indian economic situation. Government can increase or decrease the
tax rate exemption for collecting more tax for previous year income.
Public expenditure policy: This is very useful to reduce the public expenditure. Government has divided
total expenditure into two major categories one is developed expenditure and the other one is non-developed
expenditure. There are 4 broad categories such as defence expenditure, education and health expenditure, subsidy
and internal public debt.
Deficit financing policy: If above two techniques do not work to create balance the government budget,
government can get loan from the central bank to adjust the deficit.
Seignior age: This is also technique to take benefits by issuing new notes and it is important role to make fiscal
policy. Seignior age is part of public finance and governments meager earning sources like income tax and
VAT.
Public debt policy: Public Debt means, loan is taken by government to fulfill government expenditure.
Government has to make this policy very seriously. If there is any other source, then government should use to
pay government expenditure or reducing expenditure is better than taking loan.

4.6.2 Monetary and Credit Policy

The main aim to introduce monetary and credit policy was to reduce the annual inflation rate and provide credit
support for production. Money supply was reduced considerably, mainly because of a slow growth rate in bank
deposited and a decline in the growth of reserve money.

The major instruments of a countrys monetary policy are:

Bank Rate
Liquidity Reserve Ratio
Open Market Operations

There are some of the factors that can influence changes in the Monetary Policy stands:

Factors Affecting the Monetary Policy Stands

Inflation Liquidity Credit off-take Interest Rate
There are two inflation rates High liquidity is an The credit off-take The RBI has indicated
that are being talked about. The area of concern for in the retail category stable interest rates in
consumer Price Index (CIP) policy maker. Many is still quite low as the current scenario.
based, inflation rate is one. analysts believe this compared to the Benchmark interest rate
It is a very high level at the excess liquidity is previous years. such as Bank Rate, Case
moment mainly due to high one of the reasons Reserve Ratio (CRR)
food price inflation. The other that would trigger and Repo Rate are kept
one is the Wholesale Price some actions from the unchanged at 6 percent,
Index (WPI) based inflation policymakers in the 4.5 percent and 4.5
which covers a much border coming credit policy percent respectively.
range of goods that is quoted at review.
a low level.

Table 4.2 Monetary policy stands

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Summary
The Financial System is the system that allows the transfer of money between savers and borrowers
The fundamental function of any financial system is to promote efficiency in the process of exchange or trade
in real goods and services
The money market is better known as a palace for large institution and government to manage their short-term
cash needs
Types of money market instruments in India are Treasury Bills, Repurchase Agreement, Certificate of deposit
and Bankers acceptances.
The Gilt Edged Market is specifically aimed at the finance professionals and investors who need to known the
inner working of gilt market
Capital market reform enables the capital market to embrace new ideas and techniques affecting the capital
market. Capital market liberalisation is one such capital reform that is adopted by various countries to strengthen
their economy
Primary market reforms provide a relationship that lasts longer period between the Issuer and the Registrar to
the issue. Only body corporate to be allowed to function as merchant bankers
In secondary market reforms there must be an officer who will interact with SEBI regarding complaints and
reporting issues
Buy Back Ordinance was one of the most awaited acts by the companies as here they could buy back their
shares. The companies have the freedom to make inter-corporative investment
One of the major achievements of the banking sectors is the improvement made in the financial health of
commercial bank in capital adequacy, profitability and quality
Banking sectors have increased the productivity and efficiency of the bank
It is the method to determine public revenue and expenditure. Objective of fiscal policy is to achieve price level,
consumption level, employee level, income distribution, to increase capital formation and degree of inflation
There are some techniques used for fiscal policy such as taxation policy, public expenditure, deficit financing
policy, seignior age and public debt policy
Importance of fiscal policy is to reduced the annual inflation rate and also provide credit support for
production
Some of the factors that can influence changes in fiscal policy are inflation, liquidity, credit off-take and interest
rate

References
Indian Capital Market: Recent Developments and Policy Issues [Online]. Available at: <http://www.adb.org/
documents/books/rising_to_the_challenge/india/india-cap.pdf>. [Accessed 26 April 2011].
Monetary Policy [Online]. Available at: <http://finance.indiamart.com/investment_in_india/monetary_policy.
html>. [Accessed 26 April 2011].

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Recommended Reading
Hubbard, R. G., 2008. Money, the Financial System, and the Economy, 6th ed., Pearson Addison-Wesley.
Stigum, M. L., 1990. The money market, 3rd ed., Dow Jones-Irwin.
Burton, M., & Bruce, B., 2009. The Financial System and the Economy: Principles of Money and
Banking, 5th ed., M.E. Sharpe.

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Business, Government & Society

Chapter V
The Political System

Aim
The aim of this chapter is to:

define democracy

describe the evolution and history of democracy

explain the different forms of democracy

Objectives
The objectives of this chapter are to:

examine the controversies regarding constitutional reforms

discuss the features of the judicial reforms in India

differentiate between direct and indirect democracies

Learning outcome
At the end of this chapter, you will be able to:

discuss different constitutional reforms in India

explain the evolution of democracy

understand the concept of political system

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5.1 The Political System
A political system is a system of government. It is usually compared to the legal system, economic system, cultural
system, and other social systems.

5.2 Evolution and History of Democracy

The word "democracy," as well as the concept it represents, can be traced back to the area surrounding the
Mediterranean Sea. The beginnings of democracy can be credited to the Greeks of the sixth century BC. The word
comes from two Greek words: demos, meaning "the people," and kratein, meaning "to rule." These two words are
joined together to form democracy, literally meaning "rule by the people" (Pious).

Athens, one of the most advanced city-states to arise in ancient Greece, was the first society in the world to develop
a democracy, and even today it is an example and a basis for governments around the world.

5.3 Forms of Democracy

Representative: This involves the selection of government officials by the people. If the head of state is also
democratically elected then it is called democratic republic. Democracy also incorporates elements such as
referendums. A characteristic of representative-democracy is that while the representatives are elected by the people
to act in their interest, they retain the freedom to exercise their own judgment as how best to do so.
Parliamentary and Presidential forms of Democracies: Presidential and Parliamentary systems are the two
possible forms of Government in a democracy. These two forms of government have their own distinctive
characteristics and their own respective merits and demerits:
In the Parliamentary system the Prime Minister and Chief Minister are totally dependent upon their respective
Legislatures in the matter of selection of Ministers. On the other hand, they are accepted to select men of
vision, integrity, ability, professional knowledge and practical experience. On the other hand, the President
is not hampered by such considerations. He is not tied to, or subordinate to, the legislature. He is free to
choose his cabinet of ministers from outside the members of the legislature.
In Parliamentary system the ministers are not able to provide effective leadership; they have to be dependent
on the civil servants. On the other hand in Presidential system ministers have the necessary expertise, and
are not dominated by the civil servants.
As the ministers are chosen from party men in the Parliamentary form, the party is deprived of capable
persons needed to keep the organization united, homogenous, strong and viable. Because of this the party
organization grows week and indiscipline. The Presidential system is largely free from this drawback,
as well as from rivalry and friction between the party bosses and the ministerial wing. The party and the
government thus work in harmony.
Direct Democracy: In general, the term "direct democracy" usually refers to citizens making policy and law
decisions in person, without going through representatives and legislatures. In direct democracy the elected
representative can be recalled any time the electorate feels that he or she is not up to the mark. All the important
issues are settled through the process of plebiscite or referendum
Indirect Democracy: Indirect democracy is a political process in which the people control the government through
elected political official. This is also called as republic. Thus government officials are essentially allowed to
make all decisions free from any further supervision
Liberal Democracy: This is a representative democracy where elected representatives that hold the decision
making power are moderated by the constitution that emphasizes protection of the rights and freedoms of
individual in the society
Constitutional Democracy: The Union Government of India created a National Commission to review the
working of its constitutions, which has seen 76 amendments of the American Constitutions since 1787. This
commission was supposed to review the working of the constitution in the following areas:
Parliamentary democracy
Electoral reforms
Centre-state relations

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Enlargement of fundamental rights

Effectuation of fundamental duties of the citizens
Socio-economic development

5.4 Controversy Regarding Constitutional Reforms

What is the article about Reforms Suggestions

This is temporary in nature which
grants special status to Jammu and
Kashmir.
Notwithstanding anything in this
constitution, the provision of the
Article 370
article 238 shall not be applicable in
relation of the state of J&K and the
power of Parliament to make laws for
the said state shall be limited.
The president of India was granted
with all the powers of the state
government through the office of
the Governor, and to place their
Article 356 legislature under the authority of
parliament.
Some political parties At least 20 percent of
are of the opinion the legislators should be
that there is no elected indirectly from
need for reviewing universities and other
the constitution as professional bodies to
the process of the Improve the quality of
amendment allows legislative work
much flexibility to
the executive and the
legislature.
This gave Indian This article must be
constitution some used very sparingly in
amount of unitary the extreme cases as a
character, though the measure of the last restore,
main purpose is to give when all other alternatives
more power to central fail.
government to preserve
the unity and integrity
of the nation.

Table 5.1 Constitutional reforms

5.5 Judicial Reforms in India

Indian Judiciary system has become a decaying institution that has no internal mechanism or will or strength to
adapt to the changing times. Hence the Indian Judiciary system is badly in need of reforms. The statutes, laws and
by-law are outdated and are based on the ancient principles of laws. There are some urgent judicial reforms in the
following areas.

We want long-term reforms on various aspects. We should have

Legislative reform to remove the bottlenecks that are adversely affecting the adjudication
Strengthening the Bar
Strengthening legal education
Legislative reform to strengthen the powers of judges to control judicial processes to ensure just and efficient
outcomes in line with international reforms in this direction
Satisfactory framework for judicial accountability

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Summary
The world democracy was invented in Athens, to describe the revolutionary system of government. The democracy
in Athens was the first ever democracy and was the most important in ancient times
Political system is the set of formal legal institution that constitute a government or state
Democracy is the form of government which belongs to the people, being elected by the people and for the
people. USA is an example of the presidential form of democracy, whereas UK is an example of the parliamentary
form of democracy
The Indian constitution is in the direct need of reforms. They have been controversies regarding different
aspects of reforms
There are different forms of democracy such as representative democracy, parliamentary and presidential form
of democracy, direct democracy, indirect democracy, liberal democracy and constitution democracy
The Indian Constitution provides a detailed insight into the entire government structure, basic rights and duties
of the citizen and special provisions. There are a total of 395 Articles in the constitution of India
The Indian judicial system is badly in need of reforms. The main areas the judicial reforms are warranted are as
follows: Judicial appointment and accountability mechanisms, the speedy justice mechanism, crime investigation
mechanism and justice system

References
Varieties of democracy [Online]. Available at: <http://en.wikipedia.org/wiki/Varieties_of_democracy>. [Accessed
26 April 2011].
Different Systems of Democracy [Online]. Available at: < http://www.democracy-building.info/systems-
democracy.html>. [Accessed 26 April 2011].

Recommended Reading
Lemont, E. D., 2006. American Indian Constitutional Reform and the Rebuilding of Native Nations, University
of Texas Press, p.343.
Thomson, B., 2002. A Century of Controversy: Constitutional Reform in Alabama, University of Alabama
Press.
Quddus, A., 2001. The political parties and the constitutional reforms in British-India, 1909-1947, Gatidhara.

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Business, Government & Society

Chapter VI
International Linkage

Aim
The aim of this chapter is to:

define general agreement on trade and services

describe the objectives of WTO

explain the different stages of settlement for disputes

Objectives
The objectives of this chapter are to:

examine the nature of WTO

enlist the agreements in WTO

differentiate between GATT and WTO

Learning outcome
At the end of this chapter, you will be able to:

discuss the objectives of WTO and GATT

explain the various agreements of WTO

understand the concept of TRIPS

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6.1 GATT and WTO
The General Agreement on Tariffs and Trade (GATT) was first signed in 1947. The agreement was designed to
provide an international forum that encouraged free trade between member states by regulating and reducing tariffs
on traded goods and by providing a common mechanism for resolving trade disputes.
The GATT functioned as an organisation, conducting 8 rounds of talk addressing various trade issues and
resolving international trade disputes. The Uruguay Round agreement was approved and implemented by the
U.S. Congress in 1994 December. The general Agreement on Trade and Tariff has culminated into the World
Trade Organisation.

The World Trade Organisation (WTO) is the most powerful legislative and judicial body in the world. By promoting
the "free trade" agenda of multinational corporations above the interests of local communities, working families,
and the environment, the WTO has systematically undermined democracy around the world.

A. The Main Principle of WTO is:

To Promote fair competition
To encourage economic and development reforms
To increase predictability through transparency
To lower trade barriers for free trade
To ensure fair treatment to local and foreigners

B. Objectives of the WTO

With manifold objectives like helping trade flow smoothly, freely, fairly and predictably it has become capable of
organising trade and commerce over the Globe through the mantra of liberalisation, privatisation and globalisation.
It is stepping forward with objectives like:
Rejecting all forms of protectionism
Removing trade barriers and eliminating discriminatory treatment in international trade through successive
multilateral trade negotiations
Providing a fair, predictable and open rule-based trading system through overseeing the implementation of
multilateral trade rules and enforcing legally binding obligations
Providing a mechanism for settling trade disputes
Integrates developing and least developed economies into the world trading system.

GATT- General Agreement on Tariffs and Trade WTO- World Trade Organisation
1 GATT was a provisional legal agreement WTO is an organisation with permanent agreements
2. There are contracting parties in GATT While there are members in WTO
3. GATT deal only with trades in goods WTO deals with services and intellectual property
rights
4. There are no effective enforce mechanism in GATT There are effective enforcement in WTO

Table 6.1 Comparison GATT and WTO

6.2 Agreement under WTO

The WTO agreements are the results of the 1986-94 Uruguay Round negotiation, which was signed at the Marrakesh
ministerial meeting in April 1994. There are about 60 agreements, annexes, decision and understanding that were
there in WTO. This agreements fall into a simple structure with six main parts which are as follows:
An Umbrella Agreement ( Agreement Establishing the WTO)
Agreement for Goods
Agreements for Services

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Agreement for intellectual property

Agreement for dispute settlement
Agreement for reviews of governments trade policies

There is a meeting of all the members of WTO regarding the decision making of WTO. This meeting is held every
two years and the members of this meeting are countries or customs unions.

6.3 Agriculture and WTO

The WTO Agreement on Agriculture was one of the many agreements which were negotiated during the Uruguay
Round. The implementation on this agreement started with effect from 1st January, 1995. There are some products
which are not included as the part of this agreement is rubber, jute, sisal, abaca and coir.

6.3.1 Salient Features

The WTO Agreement on the Agriculture contains provision in 3 broad areas, they are as follows:
Market Access: The new rule for market access in agriculture products includes tariffication, tariff reduction and
access opportunities. Tariffication means that all the non-tariff barriers such as minimum import price, variable
levies and state trading measures and so on, need to be abolished and converted into an equivalent tariff. There
should be reduction in tariff by 24 percent in 10 years in developing countries
Domestic Support : There are three box categories in domestic support such as
Amber Box: Domestic policies that have a direct effect on production and trade, have to be cut back. The
members of WTO calculated how munch support is provided per year to the agriculture sector. Developed
countries cut 20 percent of the support, developing countries agreed to cut 13 percent and the least developed
countries need not make any cuts. This type of support is called as Amber box
Green Box: In Green Box there are measures with minimal impact on trade that can be used freely. They
include government services such as research, diseases control and food security. They also include payment
made directly to the farmers.
Blue Box: This also permits direct payment to the farmers, but the farmers are requested to limit their
production.
Exports Subsidies the agriculture agreement prohibited export subsides on agricultural products unless the
subsidies are mentioned in lists of commitments. Where they are listed, the agreement requires WTO member
to cut both the amount of money they spend on export subsidies and the quantities of exports that received
subsidies.

6.4 Agreement on Sanitary and Phytosanitary Measures

The WTOs agreement on Sanitary and Phytosanitary Measures, discusses the impact, with regards to its effect on
food regulation at both the federal and state levels. This is the separate agreement on food safety, animal and plant
health standards. There are basic obligations on SPS measures such as:
Should be applied only if necessary, to protect life or health and not to be more trade restrictive than required
Should be based on scientific principles and not maintained without sufficient scientific evidence
Should not constitute arbitrary or unjustifiable treatment or a disguised restriction on trade

6.5 Agreement on Technical Barriers to Trade

The Technical Barriers to trade Agreement deals with procedure of testing, standard, regulation and certification,
so they do not create unnecessary obstacles.
The agreement recognises countries rights to adopt the standards they consider appropriate for the protection
of the environment or to meet other consumer interests.
In order to prevent too much diversity, the agreement encourages countries to use international standards, but
it does not require them to change their level of protection.

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6.6 Agreement on Textile and Clothing (ATC)
ATC came in to force since 1995. The Agreement on textile and clothing (ATC) is one of the most important sectoral
agreements emerging out the Uruguay Round Multilateral trade Negotiations MTNs.

The most significant aspect of ATC is that unlike other WTO Agreements it is only a transitional agreement aimed
at facilitating the elimination of the managed trade in textile and clothing.

6.7 General Agreement on Trade in Services

The general Agreement on Trade on Services stands as a monument to the proposition that services can be subjected
to international trade rules similar to those for good. It also states that the inclusion of services is essential in a world
economy that is increasingly dependent on those services.

GATS provide trade in services around the globe and it includes all services in framework for future deliberations.
There are four ways of trading in services:

Modes of general
agreement on trade and
services

Cross Border Supply or Mode 1

services supplied from one country to
another

Consumption abroad or Mode 2

consumer making use of services in
another country

Commercial Presence or Mode 3

a foreign company setting up subsidiaries
to provide services in another country

Presence of Natural Persons or Mode 4

individuals travelling from one country
to supply services in another country

Fig. 6.1 Modes of general agreement on trade in services

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6.8 General Agreement on Trade Related Aspects of Intellectual Property Rights

The WTOs Agreement on Trade- Related Aspects of Intellectual Property Rights, negotiated in the year 1986-1994.
This agreement introduced intellectual property rules into the multilateral trading system for the first time.
The areas covered by this agreement are:

The areas covered by

this agreement

Tradmarks Industrial Geographical

Copyrights &
including Designs indicators
related rights
service marks
Fig. 6.2 General agreement on trade related aspects of intellectual property rights

6.8.1 Enforcement of TRIPS

Enforcement of TRIPS contains provisions on general obligations, civil and administrative procedures and remedies.
It also provides provisions for measures, special requirements related to border measures and criminal procedure.

WTO members should implements these provisions in their laws and in actual practices. It also states that the court
should have the right, under certain conditions, to order the disposal of pirated goods.

6.9 Agreement on Subsidies and Countervailing Measures

The two important features of this agreement are: it disciplines the use of subsidies and it regulated the action that
a country can take to counter the effect of subsidies.
It also states that a country can use the WTO disputes to seek the withdrawal of subsidy or to remove of its adverse
effects. The country can also launch its own investigation and ultimately change extra duty on the subsidised imports
that are found to be hurting the domestic producers.
There are two categories of subsidies: prohibited and actionable subsidies:

Prohibited Subsidies Actionable Subsidies

Subsidies that require certain recipients to meet It states that the complaining country should
certain export targets or to use domestic goods show that the subsidy has an adverse effect on its
instead of imported goods interests.
They are prohibited because they are specially There are three type of damage they can cause:
designed to distort international trade subsidies can hurt domestic industry in an importing
They can be challenged in the WTO dispute country, can hurt rival exporters and can hurt the
settlement procedure. exporters trying to compete in the subsidising
countrys domestic body.

Table 6.2 Categories of subsidies

6.10 Agreement on Safeguards from Imports

The Agreement on safeguard of the WTO establishes rules for the application of safeguard measures by the member
countries. It is a temporary import restriction that a country is allowed to impose on a product. This is applicable
only if the imports of that product are increasing so as to cause serious injuries to the domestic industry that produces
similar competitive products.

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Rule set for this agreement are as follows:
Member countries must conduct an investigation before they apply a safeguard measure
They must make a formal determination that the import of the product is impairing injuries on domestic
industry
Countries are requested to provide a public notice to all the interested parties for applying safeguard measure
To give exporters an opportunity to present their views

6.11 Agreement on Trade Related Investments Measures

In TRIMs, the members of WTO have agreed not to apply certain investment measure reacted to trade in goods that
restricts the trade. There are some prohibited measures in TRIMs:
Achieve a certain level of local content
Produce locally
Export a given level of goods
Balance the amount of imports with the amount of exports
Transfer technology or proprietary business information to local person
Balance foreign exchange inflow and out flow

6.12 Agreement on Government Procurement

The GPA establishes a framework of rights and obligations for the members of WTO who have signed it. It states
that the signatories have agreed that the suppliers of goods and services in other signatory countries will be treated
same as the domestic suppliers. It also covers that the rules, regulations and laws related to government procurement
will be transparent and fair.

6.13 Settlement of Disputes

Settling disputes is the responsibility of the Dispute Settlement Body. The DSB is hereby established to administer
rules and procedures, except those which are covered in the agreement. DSB has the authority to establish panels,
adopt panel, appellate body report, and maintain surveillance implementation of ruling and recommendations.

Before taking any action, the countries in dispute

have to talk to each other and see if they can settle
First their difference by themselves.
Stage If this fails then this goes to the director of the WTO
Stages of to mediate and try to help the in other way.
Settlement
of Disputes If the consultation fails in first stage, the complaining
country can ask for a panel to be appointed.
Second The country can block the creation of the panel once,
Stage but when the DSB meets for second time, then the
appointment can not be blocked.

Fig. 6.3 Stages of settlement of disputes

6.14 Imposition of Penalties

The country that is the target of the complaint must follow the recommendations of the panel report. It must state
its intention to do so at a Dispute Settlement Body meeting, which is held within 30 days of the report adoption. If
the complying with the recommendation found impartial, the member will be given a reasonable period of time
to do so. If it fails to act within the given time period, it has to enter into negotiations with the complying country.

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Business, Government & Society

If there is no satisfactory compensation after 20 days from the other side, the complaining side may ask the DSB
for imposing limits to trade against the other country.

6.15 Foreign Exchange Management Act

The Foreign Exchange Management Act (FEMA) has been introduced as a replacement for the earlier Foreign
Exchange Regulation Act. This was introduced because the earlier act did not fit with in the post liberalisation
policies. The significant change brought in FEMA was that it made all offenses regarding foreign exchange civil
offenses, as opposed to criminal offenses as dictated by FERA.

Except with the general or special permission of the Reserve Bank, no person can:
Deal in or transfer any foreign exchange or foreign security to any person not being an authorised person.
Make any payment to or for the credit of any person resident outside India in any manner.
Enter into any financial transaction in India as consideration for or in association with acquisition or creation
or transfer of a right to acquire, any asset outside India by any person.
No person resident in India can acquire, hold, own, possess or transfer any foreign exchange, foreign security
or any immovable property situated outside India.

6.16 Global Competitive Index

The World Economic Forum has been trying to shed light on the question of why some of the countries are able
to grow on sustained basis for prolonged period of Time. It brings key representatives from the private sectors and
corporate world together with a broader spectrum of senior policymaker in government, this creates opportunities
for the exchange of ideas and experiences on best practices.

6.16.1 Composition of the Growth Competitive Index

The Growth Competitive Index is composed of three components indices:
The Technology Index ( TI)
The Public institutions index (PII)
The Macroeconomic environment index (MEI)

These indices are calculated on the basis of both hard data and survey data. The response to the Executive
Opinion Survey is what is referred to as Survey data.
The sample of counties is divided into two groups: core innovators and the non-core innovators.

The Weightings for the core innovators are as follows:

Growth competitive Index for Core Innovators
= Technology index + public institution index +1/4 macroeconomic environment index

For the non-core innovators, it is calculated by simply averaging the three components indices:
Growth competitive index = 1/3 TI +1/3 PII + 1/3 MEI
The three components of composition of the growth competitive index look for the following questions:

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 Technology Index
Countrys position in technology
relative to world leaders.
Companies in the country not
interested in absorbing new
technology.
How much do companies in the
country spend on R&D relative
to other countries.
Extend of business collaboration
in R&D with local universities.
Public Institution Index Macroeconomic Environment Index
Is the judiciary in the country Is the countrys economy likely to be
independent from political in a recession next year?
influences of members of
government?
Property rights, including over Has obtaining credit for a company
financial asserts are clearly become easier or more difficult over
defined and well protected by the past years?
laws
Is the government neutral among Government surplus/deficit.
bidders when deciding among
public contractors?
Does organised impose National saving rate
significant costs on business?

Table 6.3 Components of competitive index

6.17 Corruption Perception Index

The goal of Corruption Perception Index is to provide data on extensive perceptions of corruption within the countries.
The CPI is a composite index, making use of survey of business people and assessments by the country analysts.
It consists of credible sources using diverse sampling frame and different methodologies.
Methodology:
The CIP gathers data from sources that span the last three years
All sources provide ranking of countries that is it includes an assessments of multiple countries
All sources measure the overall extent of corruption in public and political sectors
Evaluation of the extent of corruption in countries is done by non-resident experts.

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Business, Government & Society

Summary
GATT was an agreement on tariffs and its primary concern had been negotiations on matters related to trade
policy and tariff restriction.
The World Trade Organisation is the only global international organisation dealing with the rules of trades
between nations.
There are some new rules and commitments under agriculture are:
Market access, export subsidies and domestic support
Sanitary and Phytosanitary Measures is a separate agreement on food safety and animal and plant health
standard
Technical Barriers to Trade is an agreement to ensure that due to technical work such as testing, regulation
standard and certification do not create any unnecessary obstacles.
Subsidies and countervailing measure, in this agreement the two important things are: it disciplines the use of
subsidies and it regulates the actions which countries can take. There are two types of subsidies a). Prohibited
subsidies and b). Actionable subsidies.
Safeguard from inputs is an agreement made for restricting imports of products temporarily if it harms the
domestic industry.
Government Procurement, the main purpose of this agreement was to open up as much of business as possible
to increase international competition.
In settlement of disputes the main body in charge are the members of Dispute Settlement Body, they have the
sole authority to establish panels .
If a company is found to be guilty, they have to pay the penalties set by the Dispute settlement body; they should
submit a report with 30 days of the report adoption.
Foreign Exchange Management Act is a replacement of Foreign exchange Regulation Act. FEMA seeks offences
that is related to foreign exchange and civil offence.
FEMA extends all over India and it applicable to all branches, offices and agencies outside India owned by a
person resident in India.
Global Competitive Index is composed of three components such as :
The technology index, the public institutions index and the macroeconomic environment index.
The main goal of Corruption Perception Index is to provide data on extensive perception of corruption
within the country.

References
What is the WTO? [Online]. Available at: <http://www.wto.org/english/thewto_e/whatis_e/whatis_e.htm>.
[Accessed 26 April 2011].
GATT/WTO [Online]. Available at: <http://www.law.duke.edu/lib/researchguides/gatt.html>. [Accessed 26
April 2011].

Recommended Reading
Wolfrum R., Stoll, P., & Kaiser, K., 2006. WTO: Institutions and Dispute Settlement: Volume 2 of Max Planck
Commentaries on World Trade Law, BRILL.
World Trade Organisation, 2000. From GATT to the WTO: the Multilateral Trading System in the New Millennium,
Kluwer Law International
Narlikar, A., 2005. The World Trade Organisation: a Very Short Introductions, Oxford University Press.

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Chapter VII
Corporate Responsibility

Aim
The aim of this chapter is to:

define corporate governance

describe the concept of corporate governance

explain the trends in corporate governance

Objectives
The objectives of this chapter are to:

examine the corporate social responsibility

enlist the recommendations of the committee on corporate governance

describe the need for corporate governance

Learning outcome
At the end of this chapter, you will be able to:

discuss the key constituents of corporate governance

explain the aspects of corporate governance

understand composition of audit committee

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7.1 Corporate Governance

Corporate governance is one of the most talked topics in business. Corporate governance is define as the general set
of customs, regulation, habits and laws that determines to what end a firm should be run. It is a complex intersection
of law, morality, and economic efficiency. There are some progressive firms in India who have voluntarily put in
place a system of good corporate governance.

7.2 Trends in Corporate Governance

It is important that the management does not use their position and knowledge to access information about the
company and take advantage of the information asymmetry. To prevent this from happening, managers are expected
to disseminate information the material price in proper manner and with in time.
The issue of corporate governance involves shareholders and other stakeholders. The control and the reporting
functions of board, the role of the various committees of the board and the role of the management are considered
to be special when viewed from their perspective.
Corporate governance makes good governance for the efficiency of business enterprise and to create countrys
wealth and economy.
There are few companies in India, which have voluntarily established high standard of corporate governance.
But there are many more whose practices are a matter of concern.
An example of bad governance has been the allotment of promoters shares, on preferential basis at preferential
prices, this leads to further dilution of wealth of minority shareholders.
There are some companies, which are not paying adequate attention to the basic procedure for the services of
shareholders.
CG is considered an important instrument for the investors protection and therefore it is a priority on SEBIs
agenda.
Securities market regulators in almost all the developed and emerging market are concerned about the importance
of the subjects and need to raise the standards of corporate governance.
Besides in an environment in which emerging markets increasingly compete for global capital. It is evident
that global capital will flow to market which are better regulated and observe higher standard of transparency,
efficiency and integrity.

7.3 Recommendations of the Committee on the Corporate Governance

The committee considers two main issues along with the Ministry of Justices, separation of offices of chairmen of
the board of Directors from the office of chief executive and the other is disclosure of the compensation and options
granted to corporate officers.

Separation of the offices of Chairperson and chief executive

The committee is favorable to the introduction in French law of an alternative allowing the Board of Directors
to opt for combinational or separate offices for Chairperson and chief executive.
In separation, the rules of operation of the Board will be given to Chairperson of the Directors, by delimitation
in relation to the power of the chief executive.
In that situation, the chief executive officer will need to be director and will be appointed by the Board on
Chairpersons motion.
Regardless of the election made, the rules of the operation of the Board will have to be specifying clearly the
division of powers between the Board of Directors.
The ground for the justification of the election made by the Board of Directors between combination and
separation of the duties will need to be stated in the annual report.

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7.3.1 Key Constituents of Corporate Governance
The committee has identified the three key constituents of CG.
The Shareholder
The Board of Directors
The Management

7.3.2 Key Aspect of Corporate Governance

There are three key aspects of corporate governance, namely:
Accountability
Transparency
Equality of treatment for the entire shareholder.

7.3.3 Mandatory and Non-mandatory Recommendations

The committee felt that some of the recommendations are absolutely essential for the framework of corporate
governance and then virtually forms its core. Besides this some of the recommendations require changes of
statute.

Therefore the committee felt that the recommendations need to be divided into two categories mandatory and non-
mandatory
Those recommendations which are absolutely essential for the corporate governance can be defined with precision
and which can be enforced through the amendment of the listing agreement could be classified as mandatory
Others, which is either desirable or which may require changes of law, for the time being, is called as non-
mandatory

7.3.4 Schedule of Implementation

The committee recommended that while the recommendation should be applicable to all the listed companies, there
is a need for phasing out the implementation:
By all the entities seeking for the first time, at the time of listing
Within the financial year 200-2001, but not late than March 31st, 2001
Within the financial year 2001-2002, but not later than March 31, 2002
Within the financial year 2002-2003, but not later than March 31, 2003

This is mandatory recommendation

7.3.5 Composition of Board of Directors

This is as important as it determines the ability of the board to collectively provide leadership. This also ensures
that no individual or group of people can dominate the board.
The executive directors are involved in day to day management of the companies
The non-executive directors bring external and wider perspective and independence to the decision making
Executive and non-executive directors, a part of who are independent

This is a mandatory recommendation

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7.3.6 Compositions of the Audit Committee

The audit committee should have minimum three members, all being non-executive directors, with majority being
independent and at least one should have accounting and financial knowledge
The Chairperson of the committee should be an independent director
The Chairperson should be present at the annual general meeting, to answer shareholders
Financial director and the head of internal audit should be present at the meeting
The company secretary should act as the secretary to the committee

These are mandatory recommendations.

7.3.7 Frequency of Meetings and Quorum Requirements of the Audit Committee

The audit committee should meet thrice a year; one meeting must be held before finalisation of the annual account
and one every six months. The quorum should be either two members or one-third of the members.

7.3.8 Power of the Audit Committee

To investigate any activity within its terms of reference
To seek information from any employee
To obtain outside legal or other professional advice
To secure attendances of the outsiders with relevant experiences

All the above are mandatory recommendation.

7.3.9 Disclosure of Recommendation Package

It is very important for the shareholders to be informed of the remuneration of the directors of the company. There
are some disclosures for recommendation:
All the elements of remuneration packages of all the directors including salaries, benefits, bonuses, stock options,
pension and so on
Details of fixed component and performance linked incentive, along with performance criteria
Services contracts, notice period, severance fees
Stock option details, if any and whether issued at a discount as well as the period over which accrued and over
which exercisable.

This is a mandatory recommendation.

7.3.10 Accounting Standard and Financial Reporting

Over a period of time financial reporting and accounting standard in India have been upgraded. This is particularly
important from the angle of corporate governance. Recommendations regarding the financial reporting are as:
Consolidation of accounts of subsidies
Segmented reporting where a company has multiple lines of business
Disclosure and treatment related to party transactions
Treatment of deferred taxation

7.4 Corporate Social Responsibility

Corporate Social responsibility is a form of corporate self-regulation integrated into a business model. CSR is
the deliberate inclusion of public interest into corporate decision-making; this is required for the benefits of the
society.

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7.4.1 The Pyramid of Corporate Social Responsibility
It is suggested here that four kind of social responsibilities constitute total CSR: economic, legal, ethical and
philanthropic. Further more, these four categories or components of CSR might be depicted in a pyramid.

Economic
Responsibilities

Legal Responsibilities

Ethical Responsibilities

Philanthropic Responsibilities

Fig. 7.1 The pyramid of corporate social responsibilities

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Summary
The concept of corporate governance has been attracting public attention for quite some time in India
There are some Indian companies. Which have voluntarily establishes high standard of corporate governance,
but there are many more, whose practices are a matter of concern
There are also some companies which do not pay attentions to the problems of the shareholder
Every company or business starts out with its own set agenda, which differs from business to business. There
are lots of businesses that exist simply to make money
There are some others who seriously wish to provide a needed service to a community or to the world. Each of
these businesses has a corporate responsibility to the public, its shareholders and the world it trades in
As the boards provide stewardship of companies they play a significant role in their functioning
It has given a comprehensive list of recommendations to improve the fabric of corporate governance
Corporate governance is also working on their social responsibility
They are becoming increasingly aware of their roles in this regard to sustain business on long term basis.

References
Corporate Governance in India: Disciplining the Dominant Shareholder [Online]. Available at: <http://www.
iimahd.ernet.in/~jrvarma/papers/iimbr9-4.pdf>. [Accessed 26 April 2011].
The State of Corporate Governance in India [Online]. Available at: <http://www.in.kpmg.com/tl_files/pictures/
cg%20survey%20report.pdf>. [Accessed 26 April 2011].

Recommended Reading
Monks, R. A. G., & Minow N., 2008. Corporate Governance, 4th ed., John Wiley and Sons.
Fernando, A. C., 2009. Corporate Governance: Principles, Policies and Practices, Pearson Education India.
Colley, J. L., 2003. Corporate Governance, McGraw-Hill Professional.

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