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BANKING Q. #: What is Commercial Bank? Also mention its relative functions?
1. COMMERCIAL BANK:
A bank bank is a fina financ ncia ial l inst instit itut ute e whic which h give gives s mone money y and and cred credit it. . It acce accept pts s depo deposi sits ts from from indi indivi vidu dual als, s, firm firms s and and companies at a lower rate of interest and gives at higher rate of interest to those who need them. A bank thus is a profit earning institute.
According to Crowther, “A bank is a firm which collects mone money y from from those those who have have it spare spare. . It lends lends money money to those who require it.” In the word of Mr. Parking, “A bank is a firm that takes depo deposit sits s from from hous househo ehold lds s and and firms firms and make makes s loan loans s to other households and firms.” ⇒
FUNCTIONS OF COMMERCIAL BANK:
A commercial bank performs a variety of functions. These functi functions ons are classi classifie fied d under under two main main heads, heads, (1) Primar Primary y functions (2) Secondary functions 1) Primary Functions: The primary functions of commercial bank are as under: (a) (a) Acce Accept ptin ing g of depos deposit its s (b) (b) Adva Advanc ncin ing g of money money/M /Mak akin ing g loans. (a) Accepting of deposits: The first first import important ant functi function on of commer commercia cial l bank bank is to acce accept pt depo depos sits its from rom thos those e who can can save save but but can’t an’t mak make profitable use of their saving themselves. In order to attract the saving from different persons and institutions, the bank maintaining the three types of accounts. (i) Current Current Accoun Account: t: A curren current t accoun account t is one which can be operated operated continuous continuously ly without without any restrict restrictions ions. . The customer customer can can draw draw cheq cheque ues s agai agains nst t the the acco accoun unt. t. Ther Theref efor ore e the the bank bank usua usuall lly y does doesn’ n’t t pay pay the the inte intere rest st on the the curr curren ent t acco accoun unt t deposits. The current account holder receive cheque book and regular statement containing details of money paid in and paid out. (ii) Saving Saving Account: Account: The aim of this account is to encourage encourage and mobilize savings of the people. Saving account is genera generally lly opened opened by person persons s of small small income income. . The banks banks pay interest on this type of deposits. However, the banks normally place restrictions on their frequent withdrawal.
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(iii) Fixed Deposit Account: Fixed deposits are kept with the banks for a specified period of time. The rate of interest on fixed also called “term deposit” are fairly high. The longer period of deposit, the high is the rate of interest. (b) Advancing of money/Making loans: The second major function of commercial bank is to make loan loan to busine businessm ssman, an, trader traders, s, export exporters ers, , househ household olders ers etc. etc. Thes These e loan loans s are are made made agai agains nst t docu docume ment nts s of titl title e of good goods, s, marketable securities and personal securities of the borrowers etc. etc. The The loan loanin ing g of mone money y may may be in any any of the the foll follow owin ing g forms. (i) (i) Cash Cash Cred Credit it: : It is very very comm common on form form of borr borrow owin ing g by busin business ess concer concerns. ns. The bank bank advanc advances es loan loan to the commer commercia cial l and and indu indust stri rial al unit units s agai agains nst t the the secu securi rity ty of good goods. s. The The borro borrower wer if permit permitted ted to draw draw within within the cash cash credit credit limit limit sanctioned by the bank. The interest is charged only on the amount of money withdrawn by the borrower. (ii) Loans: The commercial bank grant short and long term loan to individual, firms, and companies mostly against securities. The amount of loan is credited to the borrowers’ account who withdraws it as per his requirement. 2) Secondary Functions: Secondary functions of commercial bank are classified as under: (a) Agency Functions (b) Utility Functions (a) Agency Functions: The agency function bank act as agent of there customer in various ways as: (i) Collection of Cheques: It acts as agents to its customers in the collection and payment of cheques and bills. (ii) Collection of dividends: The bank provides a very useful service in the collection of dividends or interest earned on shares held by its customers. (iii) (iii) Purchase Purchase or Sale of securitie securities: s: The bank, if authoriz authorized ed by customers, customers, purchase purchases s or sells sells securitie securities s on his behalf and adds another benefit to its portfolio. (b) (b) Utilit Utility y Funct Functio ions ns: : A bank perf perfor orms ms a numb number er of other other general utility services to its clients which are given below: (i) Issue of Traveler’s Cheque: The bank also issues travel traveler’ er’s s cheque cheques s for the conven convenien ience ce of the travel travelers ers and charges a nominal commission. (ii) (ii) Expo Export rt Prom Promot otio ion n Cell Cell: : In orde order r to boos boost t (pus (push) h) the the expo export rts s of the the coun countr try, y, the the bank banks s have have esta establ blis ishe hed d expo export rt promotion cells. These cells provide information and guidance to the exporters at no extra cost.
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(iii) (iii) Advice Advice on Financ Financial ial Matter Matters: s: Someti Sometimes mes the banks banks give give v va aluab luable le advic dvice es on vari arious ous fina financ ncia ial l matt matter ers s to the their customers. (iv) (iv) Safe Safe Cust Custod ody y of Valua aluabl ble e: The The bank anks kee keep val valuabl uable e ornaments, documents etc, for safe custody.
Q. #: What are the different types of Commercial Bank?
2. KINDS OF COMMERCIAL BANK:
Follow Following ing are the main main kinds kinds of commer commercia cial l bank, bank, which which are given below. (i) (i) Stat State e Bank Bank: : Ever Every y civi civili lize zed d coun countr try y now now has has its its own own centra central l bank bank or state state bank. bank. The primar primary y functi functions ons of state state bank are to arrange the flow of money and credit in order to promote efficiency and stability in the country. In Pakistan State Bank of Pakistan is the country’s central bank. (ii) Commercial Commercial Bank: Bank: Commercia Commercial l Banks Banks are those those banks banks which which are are enga engage ged d in perf perfor ormi ming ng the the rout routin ing g duti duties es of bank bankin ing g busin business ess. . They They collec collect t surplu surplus s money money from from the people people. . They They make loans and advances in the form of O/D (overdraft) cash credit. Commercial Banks are also providing agency service and utility services. The banks in short are considered the life blood blood of econom economic ic societ society. y. In Pakist Pakistan, an, the NBP, NBP, UBL, UBL, HBL, HBL, MCB, etc. are performing the functions of commercial banks. (iii) Foreign Exchange Bank: The Foreign Exchange Bank mainly deals with international trade. These banks take the responsibility of settlement of foreign exchange and arrange the the forei oreig gn busi usiness ness in Pakis akist tan. an. All the nat nationa ionali liz zed comm commer erci cial al bank banks s have have been been allo allowe wed d to do the the busi busine ness ss of exchange banks. (iv) (iv) Saving Saving Center Center Bank: Bank: Saving Saving Banks Banks are those those banks banks which which coll collec ect t and and keep keep smal small l savi saving ng of peop people le. . The The savi saving ng bank banks s invest invest the funds funds in the safe safe way govern governmen ment t securi security. ty. Post Post offi office ces s and and savi saving ng cent center ers s perf perfor orm m the the busi busine ness ss of savi saving ng banks of Pakistan. (v) Agriculture Development Bank: Agriculture Banks are setup to provid provide e the financ financial ial assist assistanc ance e to the agricu agricultu lture. re. The agriculture banks provide short term credit to the farmers for the purchasing of seeds. They also make medium term advances for buying Tracters and modern technology. ADBP (Agriculture Deve Develo lopm pmen ent t Bank Bank of Paki Pakist stan an) ) was was setu setup p in 1981 1981, , to meet meet financial requirement of agriculture.
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(vi) Industria Industrial l Developm Development ent Bank: Bank: These These banks banks mainly mainly provide provide m med ediu ium m and and long long term term cred credit it to the the indu indust stri ries es. . Sinc Since e the the industrial bank have long-term deposit. They are in a position to perm permit it long long term term inve invest stme ment nt in indu indust stri ries es. . In Paki Pakist stan an Industria Industrial l Bank was setup setup in 1961, 1961, other institution institutions s engaged engaged in prov provid idin ing g fina financ ncia ial l assi assist stan ance ce to indu indust stri ries es are are PICI PICIC C commercial bank, NDFC bank etc…
Q. #: What are the different type of customer of Commercial Bank?
3. TYPES OF CUSTOMERS:
Every commercial bank is anxious to increase its cust custom omer ers s. How However ever, , every very one one can’t an’t be acce accept pte ed as its its customer. Only those persons who are competent in law to enter into a contract contract can be considered considered as customers. customers. The customer customers s of a bank can mainly divide into two categories categories (1) Ordinary Ordinary Customers Customers and (2) Special Special Customers. Customers. Ordinary Customers Customers are those who are competent to inter into contract under the laws of land. And individual, a body corporate, a firm can open an acco accoun unt t with with the the bank bank. . The The bank bank befo before re acce accept ptin ing g one one as a cust custom omer er weig weighs hs the cust custom omer er’ ’s fina financ nci ial posit ositi ion, on, his his char charac acte ter, r, hone honest sty, y, soci social al stan standi ding ng and and good good will will in the the society. The special customers are those who are dealt with as spec specia ial l ones ones lega legall lly. y. The The rela relati tion onsh ship ip betw betwee een n bank bank and and special type of individual customers are governed by the legal rules enforced in the country. The special types of individual customers of the commer commercia cial l banks banks are (i) Minor Minor (ii) (ii) Lunati Lunatic c (iii) (iii) Drunka Drunkard rd (iv) (iv) Marr Marrie ied d Women omen (v) (v) Purda urdah h Obse bservin rving g Women omen and and (vi) vi) Illiterate persons. (i) Minor Customer: Customer: A person person who has not attained the age of 18 years is a minor. A minor cannot enter into a contract. Therefore, any contract with minor is void. However, a bank can accept & open a minor’s account if it is dire direct cted ed by the the Guar Guardi dian an Cour Court. t. The The Cour Court t appo appoin ints ts a guar guardi dian an of a mino minor r who who obta obtain ins s and and sign signs s the the pres prescr crib ibed ed opening form of the account himself. He gives his won specimen signatures for the operating of the account. On attaining the age of majority which is 21 years, the minor is allowed to open and operate the account himself. (ii) Lunatic Customer: A person who is incapable of understan understanding ding, , is of unsound unsound mind, mind, cannot cannot enter into contract contract
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with the banker as customer. If an account is already existence of a same person but his mental status is disturbed, the bank on knowing the customer going insane will immediately stop stop paymen payment t from from his accoun account t and suspen suspend d all transa transacti ctions ons till he receives receives either either satisfact satisfactory ory evidence evidence of his recovery or an order is received from the court. (iii (iii) ) The The Drun Drunka kard rd Cust Custom omer er: : If a pers person on is in stat state e of intoxi intoxicat cation ion & is not in senses senses, , he cannot cannot open an accoun account t with a bank. The main condition of valid contract with a bank is between persons who are of sound mind. However, if a person is drunk, is of sound mind, he may open & operate an account with a bank. (iv) The Married Women Customer: Customer: Man & Woman Woman are equal in the eyes of law for the purpose of making a contract. A married woman has every right to enter into contract with a bank and open an account. A married woman is as good as a male member of the society so far as law is concerned. She can open any type type of acco accoun unt t incl includ udin ing g Fore Foreig ign n Curr Curren ency cy Acco Accoun unt t in her her name. If may here be noted that a married woman cannot make her husband responsible for the debt incurred by her. It is a sole responsibility of the married woman to repay the loans and advances made in her name by bank. (v) The Purdah Purdah Observin Observing g Woman Woman Custom Customer: er: The bank bank has to be very cautions in opening an account of Purdah observing lady. She She cann cannot ot be trea treate ted d at par par as with with othe other r wome women. n. Befo Before re accept accepting ing a Purdah Purdah observ observing ing woman woman as custom customer, er, the banker banker m mus ust t carr carry y out out a thor thorou ough gh scru scruti tiny ny (ins (inspe pect ctio ion) n) abou about t the the identity of woman. A very close referee of introducer, from the the poin point t of view view of the the part partie ies, s, the the cust custom omer er and and bank banker er should confirm the identity of the Purdah observing lady. (vi) The Illiterate Person Customer: An illiterate person from the banker’s point of view is the person who cannot put his signatures. He uses his thumb impressions in place of signatures for identification. The banker has, therefore, to be very cautions in honoring the cheques of illiterate person. The banker banker usuall usually y takes takes the follow following ing precau precautio tions ns in this this regard. ⇒ A Certified photograph of an illiterate person is pasted on the signature card for identification. ⇒ At least two left hand thumb impressions are placed in place of specimen signatures for identification. identification.
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Q. #: What precautions are usually usually undertaken by bank, bank, before before cash advances?
4.PRECAUTIONS OF CASH ADVANCES:
The following are the precautions are usually undertaken by bank, these are given below. (i) The custom customer er to be Honest Honest, , Respon Responsib sible le and Trustw Trustwort orthy: hy: Before advancing loans against goods or documents of title of goods, the banker must be thoroughly satisfy himself about the honest honesty, y, trustw trustwort orthy hy and experi experienc ence e of the borrow borrower er in the trade or business. (ii) (ii) Famili Familiari arity ty with with differ different ent market markets: s: The banker banker must must be familiar with the up & down of the price in the commodities, against which he gives to advance loan earlier. The up-to-date know knowle ledg dge e of the the diff differ eren ent t mark market et enab enable les s the the bank banker er to regulate the margin for loans against produce goods. (iii) Readily saleable commodities: The banker should advance loan against against those those commoditie commodities s which are of seasonal nature & are readily saleable in the market. (iv) (iv) Poss Posses essi sion on of Good Goods: s: In orde order r to secu secure re the the loan loan the the b ban anke ker r shou should ld take take pass passio ions ns actu actual al or cons constr truc ucti tive ve of the the goods. He should also have a direct contract with the owner or the agent who is in possession of commodities. (v) Storing Storing of goods in the bank’s Godown: Godown: The banker banker should not allow the goods to remain in the godown of the customer unless the key of the godown and the services of the watchman transferred to the bank. (vi) (vi) Comm Commod odit itie ies s havi having ng Stab Stable le Mark Market et: : The The bank banker er shou should ld prefer to advance loans against those commodities whose demand is less less inel inelas asti tic. c. The The good goods s with with stab stable le mark market ets s are are less less liable to market fluctuations. (vii (vii) ) Pro Proper per Eval Evalu uatio ation n: The The ban banker ker shou shoul ld accu accur ratel ately y ascertain the prices of commodities pledge for loan. He can get get info inform rmat atio ion n abou about t the the pric prices es from from comm commod odit itie ies s brok broker er, , journals and daily news papers. (viii) Insurance of Goods Pledged: The banker must also insure the goods of the customer pledged with the bank against loss of fire, theft, etc. up to their full value.
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Q. #: What What is Stat State e relative functions.
5. STATE BANK OF
Bank Bank
of
Paki Pakist stan an? ?
Also Also
ment mentio ion n
its its
PAKISTAN:
The State Bank of Pakist Pakistan an was establis established hed on 1st July 1948, it is the central bank of Pakistan. The head office of SBP is at Karachi & branches are at Lahore, Peshawar, Quetta, Faisalaba Faisalabad, d, Rawalpindi Rawalpindi, , Islamabad Islamabad, , Multan, Multan, Sialkoat, Sialkoat, Sukkur, Sukkur, and Hyderabad. The state bank is the leader of all the other banks banks. . It doesn’ doesn’t t compet compete e for profit. profit. It has right right t issue issue notes (currency). It is bank of Govt. and commercial bank. It cont contro rols ls the the opera perat tion ion of oth other bank banks s for mone moneta tary ry and and economic stability in the country. The state bank is managed by a central board of directors. It includes one Governor, one more deputy Governor, and nine directors nominated by the Federal Government. There is also an executive committee which is empowered to transit bus busin ines ess s on beha behalf lf of the the cent centra ral l boar board d of dire direct ctor ors. s. The The Chief Executive of the bank is the governor, who controls and dire direct cts s the the affa affair irs s of the the bank bank on beha behalf lf of the the cent centra ral l board. The central directorate of SBP has the department over 5,000 employees the departments are: (i) Administ Administrati rative ve Department Department (ii) Accounts Accounts Departme Department nt (iii) (iii) Agr Agric icul ultu ture re Cred Credit it Depa Depart rtme ment nt (iv) (iv) Audi Audit t Depa Depart rtme ment nt (v) (v) Banking Control Department (vi) Banking Inspection Department (vii (vii) ) Engi Engine neer erin ing g Depa Depart rtme ment nt (viii (viii) ) Exch Exchan ange ge Depa Depart rtme ment nt (ix) Legal Division Department (x) Public Relation Department (xi) (xi) Resear Research ch Depart Departmen ment t (xii) (xii) Statis Statistic tical al Depart Departmen ment(x t(xii) ii) Security Department (xiv) Training Department. ⇒
FUNCTIONS OF STATE BANK OF PAKISTAN:
(a) The Bank of note issue: The State Bank has the soul right for the issuance of notes. The bank has issued currency notes of rupees rupees 10,20, 10,20,50, 50,100 100,50 ,500,1 0,1000 000,50 ,5000, 00, the notes notes are issued issued unde under r fixe fixed d mini minimu mum m rese reserv rve e syst system em. . The The bank bank keep keeps s 30% 30% in goal goals s or fore foreig ign n exch exchan ange ge, , & 70% 70% in form form of secu securi riti ties es; ; therefore notes issued by the bank are fully convertible. (b) Banker to Government: The State Bank deal as a bank to the central and provincial government. It accepts deposits of the
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government. It pays cheques on behalf of the government. It pays cash for payment of salaries & wages. It provides loan to the Govt. for ninety days. It transfers fund from one account to another account & from one place to another place. The bank pays no interest on govt. accounts. (c) Agent to the Government: Government: The State Bank of Pakistan Pakistan as an agent receives loan for government payments, interest on debts and discount on treasury bills as control the foreign exchange. (d) Advisor to Government: The State Bank also acts as advisor to the govt. in all financial matters. Since the State Bank is directly involve in the money and foreign exchange markets. It also also prov provid ides es advi advice ce to comm commer erci cial al bank bank & othe other r fina financ ncia ial l institution & to commerce & industries in general. (e) Exchange Exchange Control: Control: The State Bank is authorize authorized d to control control foreign exchange. It has control over the foreign receipts and payments. The bank has exchange control department for control on the foreign exchange operations. (f) (f) Cont Contro roll ller er of Cred Credit it: : The The bank bank cont contro rols ls the the volu volume me of credit credit it is necess necessary ary for the econom economic ic develo developme pment nt of the countr country. y. The credit credit is contro controlle lled d by the bank bank rate, rate, policy policy open market operation. It is the most important function of the bank. (g) Custodian Custodian of Foreign Exchange: Exchange: The State Bank of Pakistan Pakistan acts as a custodian of forex. It gives gold, silver, foreign currency, foreign bills at other securities. Such reserves are necessary for making payments to the other countries. The bank controls the movement of capital. (h) Remittance Facilities: The State Bank of Pakistan provides facilities for transfer of money from one to another place to the members’ bank. The bank doesn’t receive any commission for it.
Q. #: What is World Bank? Also Also discuss discuss its its relative relative functions functions and criticism.
6. WORLD BANK:
The The name name Worl World d Bank Bank has has too too diff differ eren ent t fina financ ncia ial l real real existence. It’s also called International Bank for Reconstruction & Development (IBRD) & International Development Association (IDA). The World Bank is international bank for reconstruction and development was established in 27th December 1945. The bank started operation on 25th June 1946. The IBRD has it is head office at Washington DC, USA.
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The manage managemen ment t is vested vested with with the board board of govern governors ors, , consist one governor from each member country and 22 full time executive directors. The board normally meets ones a year. The govern governor or of the bank have have delega delegated ted their their many many powers powers to a board board of Execut Executive ive Direct Directors ors, , 5 direct directors ors appoin appointed ted by five five members like, USA, Japan, Germany, France, UK, being a largest stock holders and 17 are elected by the governor representing the other other member member countr countries ies. . The Board Board of Direct Directors ors perfor performs ms its duties on a full time basis. The president of the bank is the Chairman of the Board. The world bank provide assistance for many projects like, electr electrici icity ty power, power, transp transport ort, , agricu agricultu lture, re, rural rural and urban urban deve develo lopm pmen ents ts, , wate water r and and sewe sewera rage ge deve develo lopm pmen ent, t, popu popula lati tion on, , heal health th, , educ educat atio ion, n, hous housin ing g deve develo lopm pmen ent, t, abou about t 75% 75% of the the landin landing g is for roads roads plans, plans, power power statio station, n, agricu agricultu lture re and industries. The IRBD loans are for 20 years or less with a gress period of 5 years. The loans are made to government or entiti entities es which which can sure sure govern governmen ment t guaran guarantie ties s of repaym repayment ent. . The World Bank on the whole has help increasing the pare of economic development of different countries of the world. ⇒
FUNCTION OF WORLD BANK:
Principal functions of World Bank are as under: i) To assist in the reconstruction and development of member coun countr trie ies s by faci facili lita tati ting ng the the inve invest stme ment nt of capi capita tal l for for productive purpose. ii) To promote and supplement private foreign investment. iii) To give performance more useful and urgent projects. iv) To assist in bringing about a smooth transaction for war time to peace time economy. v v) ) To ensu ensuri rin ng tha that it is loan oan help help in the the rais raisin ing g the stan standa dard rd of livi living ng of the the peop people le in the the borr borrow owin ing g memb member er countries. vi) World Bank helps now the poorer countries of the world it provides recovery of advice & information besides the making loans. ⇒
CRITICISM ON WORLD BANK:
The workin working g of World World Bank Bank is critic criticize ized d on the follow following ing grounds. i) The World Bank charges a very high rate of interest on its loan. ii) There is discrimination in advancing loan to member Europe & Western countries of smaller both in area and population, they have received large amount of loans where Asia and Africa
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both both is rich rich in natura natural l resour resources ces are being being given given up stamp stamp motherly treatment. iii) The loan given by World Bank to the developing countries is too small small to play play an effect effective ive role in develo developin ping g their their economy.
Q. #: What is money? Also define its functions.
7. MONEY:
M Mon oney ey is diff diffic icul ult t conc concep ept t to defi define ne. . The The term term mone money y means purchasing power, something which buys things. In other words money is purchasing power that can exercise and imme immedi diat ate e dema deman nd on good oods and servi ervice ces s. Obvio bviou usly sly such such purchasing power must be generally accept as means of payments, payments, medium of exchange, exchange, historicall historically y in remember remember able things have served, as money in the modern world. However, in the the most ost coun ountrie tries s mone oney the supp supply ly of consi onsist sts s of (i) (i) Currency Money (ii) Deposit Money. (i) Currency Money: It is in the form of coins & paper notes. It is legal tender money. It is the money which must by law is accept accepted ed in paymen payments ts of money money obliga obligatio tion. n. In very very backwa backward rd countries currency money is the main item of money. (ii) (ii) Deposi Deposit t Money: Money: Demand Demand Deposi Deposit t or accoun accounts ts in the bank bank fulfill charging all the conditions necessary to be designated as money, money, cheque cheques s which which presen present t demand demand deposi deposit t inspit inspite e are purchasing power they buy goods & services. ⇒
FUNCTIONS OF MONEY:
1) Money as a medium of exchange: In all all mark market et tran transa sact ctio ions ns, , mone money y is used used to pay pay for for good goods s and and serv servic ices es. . The The sale sale or purc purcha hase se of good goods s is done done thro throug ugh h mone money. y. Mone Money, y, in othe other r word words, s, acts acts as a medi medium um of exch exchan ange ge and and help helps s in over overco comi ming ng the the diff diffic icul ulty ty of doub double le coincidence of wants of the barter economy. The use of money as a medium of exchange has helped in promoting efficiency in the economy. It has reduced much of the time spent in exchanging goods and services. It has also promo promoted ted effici efficienc ency y by allowi allowing ng people people to specia specializ lize e in any area area in whic which h they they have have comp compar arat ativ ive e adva advant ntag age e and and rece receiv ive e mon money ey paym paymen ents ts for for labo labour ur. . The The use use of mone money y as medi medium um of exch exchan ange ge has has perm permit itt ted more ore spe special cializ iza ation tion by low lowerin ering g transaction cost and encouraging division labour. 2) Money as standard of deferred payments: Another function of money is that it is used as a mean of settling debts maturing in the future. In modern economy, most
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of the business is done on credit. Goods are brought and sold on the promise to pay money on a certain date in future. Debts are stated and paid terms of units of account. 3) Influence on income and consumption: The use of money has a direct bearing on the levels of income income and consum consumpti ption on n the countr country. y. All produc productio tion n takes takes place place for the market market and the factor factor paymen payments ts (rent, (rent, wages, wages, inte intere rest st and and prof profit it) ) are are made ade in mone oney. The The highe igher r the the production, the higher are the remuneration to the factors and vice versa.
4) Money is an instrument of making loans: Peop People le save save mone money y and and depo deposi sit t it in bank banks. s. The The bank banks s advance these savings to businessmen and industrialists. Money is thus the instrument by which saving are transferred into saving. 5) Money is a tool of monetary management: Money Money is import important ant tool tool of moneta monetary ry manage managemen ment. t. If the money is effectively used, it helps in increasing output and employment. Money is also an important factor in determining the distribution of income and wealth among the members of the society. 6) Instrument of economic policy: Money Money is an import important ant instru instrumen ment t of econom economic ic policy policy of the government. In order to achieve growth, reduce unem unempl ploy oyme ment nt and and main mainta tain in regu regula lar r expa expans nsio ion n of econ econom omic ic activity; money is the most powerful factor.
Q. #: What What is inflat inflation ion? ? Also Also mentio mention n its relati relative ve causes causes, , remedies and kinds.
INFLATION:
Inflation is a process in which the price is rising at a rapid rate and the money is losing its value. In the words of Gardner Ackley, “Inflation may be defined as a persistent and appreciable rise in general level of average of prices.” It may may here here denote denote that that rising rising genera general l level level of price price doesn’ doesn’t t mea mean n that that all all pric prices es are are nece necess ssar aril ily y risi rising ng. . Even Even duri during ng infl inflat atio ion, n, the the pric prices es of some some good goods s may may rema remain in rela relati tive vely ly consta constant nt and a few others others actual actually ly fallin falling. g. Inflat Inflation ion also also does not mean that prices of goods rise evenly or p pr ropor oporti tio onate nately ly. . Infla nflat tion ion is an upw upward ard mov movemen ement t in the the general general (average (average) ) level of prices. prices. In Pakistan Pakistan, , the general general p pri rice ce leve level l is pers persis iste tent ntly ly risi rising ng sinc since e Part Partit itio ion n of the the Subcon Subcontin tinent ent. . Prices Prices remain remained ed volati volatile le during during the decade decade of 1990’s ranging form 5.7% to 13% mainly because of declining econ econom omic ic grow growth th, , expa expans nsio iona nary ry poli polici cies es, , outp output ut set set back backs, s, high higher er taxe taxes s and and a depr deprec ecia iati tion on of Paki Pakist stan ani i rupe rupee. e. The The infl inflat atio ion n rate rate star starte ted d decl declin inin ing g form form 1998 1998 on ward ward due due to
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improved supply position of goods, strict budgetary measures. The inflation rate was 5.7% in 1998-99. It was brought down to 3.6% in 1992-2000 and further to 3.1% in 2002-03. The inflat inflation ion rate rate based based on the CPI (Consu (Consumer mer Price Price Index) Index) has averaged 4.6% during 2003-04. The slight rise in prices was the year 2004-05 mainly due to rise in the price of wheat and an increase in the international oil price. ⇒
CAUSES OF INFLATION:
The causes of inflation are generally grouped under two main heads (a) Demand Pull Inflation (b) Cost Push Inflation. A.
Demand Pull Inflation:
Demand Demand pull pull inflat inflation ion occurs occurs when when aggreg aggregate ate demand demand for goods goods exceed exceeds s aggreg aggregate ate supply supply of goods goods at curren current t prices prices, , thus leading to an increase in the price level. The factors of which bring about increase in aggregate demand for goods or rise rise in the the gene genera ral l leve level l of pric prices es are are grou groupe ped d unde under r two two sepa separa rate te head heads; s; (i) (i) Fact Factor ors s oper operat atin ing g on dema demand nd side side (ii) (ii) Factors operating on the supply side. (a) (a) Fact Factor ors s oper operat atin ing g on the the dema demand nd side side: : Thes These e are are the the fact factor ors s whic which h brin bring g cont contin inuo uous us rise rise in the the gene genera ral l pric price e level. (1) (1) Incr Increa ease se in mone money y supp supply ly: : An incr increa ease se in mone money y supp supply ly leads to an increase in money income. The increase in money income raises the aggregate demand for goods and services in the the coun countr try. y. The The supp supply ly of mone money y incr increa ease ses s when when the the govt govt. . resort resorts s to defici deficit t financ financing ing or the commer commercia cial l banks banks expand expand credit. When too much money chases too few goods, the result is an increase in general price level. (2) Increase in Governme Government nt expenditu expenditure: re: If there there is increase increase in govt govt. . expe expend ndit itur ure e due due to adop adopti tion on of deve develo lopm pmen ent t and and welf welfar are e acti activi viti ties es of the the coun countr try y has has to flig flight ht a war, war, it caus causes es as incr increa ease se in govt govt. . expen xpend ditur iture e which hich lead leads s to increase in aggregate demand for goods and services and hence the price level goes up. (3) Increase in private expenditure: A continuous increase in consumption and investment expenditure in the private sector raises the demand for goods and services and leads to inflationary rise in prices. (4) Increase in population: The rapid rising population exerts pressure on the demand for goods and services. If the supply of good goods s and and serv servic ices es fail fail to matc match h with with the the dema demand nd, , the the general price level moves upward.
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(5) Black Black money: money: The money money genera generated ted throug through h smuggl smuggling ing, , tax evasio evasion n etc. etc. raises raises the demand demand for luxury luxury and other other goods. goods. Hence black money is also one of the causes in raising the aggregate demand for goods and a rise in general price level. (b) (b) Fact Factor ors s caus causin ing g decr decrea ease se in supp supply ly of good goods: s: If the the increase in aggregate demand for goods and services is matched by by an incr increa ease se in the the supp supply ly of good goods, s, it will will not not caus cause e inflation inflationary ary situatio situation. n. When the aggregate aggregate supply of goods goods is at a slower pace than the growth in aggregate demand, it then causes causes inflationa inflationary ry rise in prices. prices. The following following factors factors are iden identi tifi fied ed for for rela relati tive vely ly slow slower er grow growth th in the the supp supply ly of goods. (i) Lagging agricultural & industrial production: The increase in popu popula lati tion on, , inco income mes, s, empl employ oyme ment nt and and urba urbani niza zati tion on exer exert t pressure on the demand for goods and services. However, the agricultural and industrial production grows at a slower pace, due to shortage of essential inputs like fertilizers, water, ceme cement nt, , iron iron etc. etc. When When aggr aggreg egat ate e dema demand nd for for good goods s and and services exceeds the aggregate supply of it, it causes a rise in the prices of agricultural and industrial goods. (ii) (ii) Inadeq Inadequat uate e infras infrastru tructu cture re facili facilitie ties: s: If, in a countr country y ther there e is shor shorta tage ge of powe power, r, tran transp spor ort t and and comm commun unic icat atio ion n facilities are slow and inefficient, it results in the slowing down of overall production of goods. When the supply of goods falls short of demand, the prices go up in the country. (iii) Long gestation period: If the time lag between investment and the production of goods is long, the shortage of goods will arise. This will also contribute to inflationary pressure in the economy. B.
Cost Push Inflation:
Cost push inflation occurs when there is an increase in the cost of produc productio tion n of goods goods and is not associat associated ed with with excess demand. The main causes of cost push inflation are: (1) (1) Incr Increa ease se in mone money y wage wage rate rate: : The The wage wage push push infl inflat atio ion n occu occurs rs when when stro strong ng labo labour ur unio unions ns mana manage ge to pres press s for for wage wage incr increa ease ses s in exce excess ss of labo labour ur prod produc ucti tivi vity ty. . Unit Unit cost cost of production is thereby raised. The rise in cost of production exerts pressure on sellers to increase prices of goods so as to get profit margin. (2) (2) Pro Profit fit push ush infla nflati tio on: If the prod produ ucers cers of cert certai ain n comm commod odit itie ies s have have mono monopo poly ly or near near mono monopo poly ly powe power r in the the market, they fix up higher profit margins arbitrarily without any increase in other elements of cost. When a few powerful firms increase the profit margins, the smaller firms also tend
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to mark up their profit margins. The higher profit margins, thus, inflate the price level. (3) (3) Mate Materi rial al push push infl inflat atio ion: n: If ther there e is incr increa ease se in the the prices of some basic materials such as gas, steel, chemicals, oil etc which are used directly or indirectly in almost all industries, it causes an increase in the cost of production and hence in the general price level. (4) (4) High Higher er taxe taxes: s: If the the gove govern rnme ment nt levi levies es new new taxe taxes s and and raises the rates of old taxes the producers generally shift the burden of taxes on to the consumers. The increases in the sellin selling g prices prices of the commod commoditi ities es push push up the inflat inflation ionary ary trend in the economy. (5) Import Import prices prices: : If prices prices of import imported ed goods goods increa increase, se, it also results in the contribution of inflation. ⇒
KINDS OF INFLLATION:
Inflation is of different types. It is generally classified on the following basis. •
On the Basis of Rate of Inflation:
(i) Creeping Inflation: It is a situation in which the rise in general price level is at a very slow rate over a period of time. Under creeping inflation, the price level raises upto a rate of 2% per annum. A mild inflation is generally considered a necessary condition of economic growth. (ii) Walking Inflation: Walking inflation is a marked increase in the rate of inflation as compared to creeping inflation. The price rise is around 5% annually. (iii) (iii) Runnin Running g Inflat Inflation ion: : Under Under runnin running g inflat inflation ion, , the price price increases is about 8% to 10% per annum. (iv) (iv) Gallop Galloping ing or Hyper Hyper Inflat Inflation ion: : Gallop Galloping ing inflat inflation ion is a full inflation. Keynes calls it as the final stage of inflation. It is a stage of inflation which starts after the level of full employment is reached. Here price level rises very rapidly within a short period. •
On the Basis of Degree of Control:
(i) Open Inflation: It is a stage when the rise in price level gets out of control. Milton Friedman describes it as “infla “inflatio tionar nary y proces process s in which which prices prices are permit permitted ted to rise rise with withou out t bein being g supp suppre ress ssed ed by gove govern rnme ment nt pric price e cont contro rol l or similar measures.
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(ii) Suppressed Suppressed Inflatio Inflation: n: Under Under this type of inflatio inflation, n, the gove govern rnme ment nt make makes s effo effort rts s to chec check k and and cont contro rol l the the rise rise in price level through price and rationing. When price level is suppre suppresse ssed d by the above above short short term term measur measures, es, it result results s in m man any y evil evils s such such blac black k mark market etin ing, g, hoar hoardi ding ng, , corr corrup upti tion on & profiteering. •
Inflation on the Basis of Causes:
(i) Demand Demand Pull Pull Inflat Inflation ion: : Inflat Inflation ion caused caused by increa increase se in aggreg aggregate ate demand demand, , not matche matched d by aggreg aggregate ate supply supply of goods, goods, resulting in rise of general price level is called demand pull inflat inflation ion. . Demand Demand pull pull inflat inflation ion to be simple simpler, r, occurs occurs when when the demand for goods and services in the country is more than their supply. The effective demand for goods increases due to many factors such as increase in money supply, increase in the demand for goods by the government, increase in the income of vario various us factor factors s of produc productio tion n etc. etc. In short, short, the excess excessive ive increase in the money supply causes inflationary conditions. Demand pull inflation is generally characterized by shortage of goods and shortage of workers. (ii) Cost Push Inflation: Cost push inflation occurs when the incr increa easi sing ng cost cost of prod produc ucti tion on push pushes es up the the gene genera ral l pric price e level. Cost pull inflation occurs when the economy is below full full employ employmen ment t with with prices prices rising rising even even though though there there is no shor shorta tage ge of good goods. s. Cost Cost push push infl inflat atio ion n is the the resu result lt of increase in wage costs unaccompanied by corresponding increase in productivity, rise in import prices of goods, depreciation in the externa external l value value of the currenc currency, y, higher higher mark up etc, etc, etc. (iii) (iii) Profit Profit Induce Induced d Inflat Inflation ion: : Profit Profit inflat inflation ion is in fact fact categorized under cost push inflation. When entrepreneur, due to their monopoly position raise the profit margin on goods. It may cause profit push inflation. (iv) (iv) Budget Budgetary ary Inflat Inflation ion: : When When the govern governmen ment t of a countr country y occurs the deficits in the budgets through bank borrowing and creating new money (Deficit Financing), the purchasing power of commodity increases without a simultaneous increase in the production of goods. This leads to rise in the general price level. (v) Moneta Monetary ry Inflat Inflation ion: : Milton Milton Friedm Friedman an is of the firm firm view view that inflation is always and anywhere a monetary phenomenon. According to him, inflation is caused by a too rapid increase in the money supply and by nothing else. (vi) Multi Casual Inflation: Inflation has a number of causes. It may be caused by increase in money supply, excessive wage
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demands, demands, excess aggregate aggregate demand for goods, goods, shortage shortage of goods goods etc. The chief cause of inflation in one year may not be in the next year. Since inflation is multi causal, therefore a variety of policy measures are needed to deal with it. •
On the Basis of Employment:
(i) Partial Inflation: Inflation: Accordin According g to J.M. Keynes, takes place place when the general price level rises partly due to an increase in the cost of production of goods and partly due to rise in supply of money before the full employment stage is reached. (ii) Full Inflation: Inflation: Full inflation inflation prevails when the economy economy has has reac reache hed d the the leve level l of full full empl employ oyme ment nt. . Any Any incr increa ease se in money supply beyond full employment. It is also called as real inflation.
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Anticipated versus Unanticipated Inflation:
(i) (i) Anti Antici cipa pate ted d infl inflat atio ion n is the the rate rate of infl inflat atio ion n whic which h majority of the individual believes will occur. When the rate of inflation (say 6%) turns out to be same (6%) we are then in a situation of fully anticipated inflation. (ii) Unanticipated inflation is that which comes as a surprise to majority of individuals. It can be higher or lower than the rate of anticipated inflation.
