Monetory and Fiscal Policies

Topic: BusinessComparative Analysis
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Last updated: June 24, 2019

CURRENT INDIAN MONETARY AND FISCAL POLICIES MONETARY POLICY: Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment. Monetary policy differs from fiscal policy, which refers to taxation, government spending, and associated borrowing FISCAL POLICY: The Word “Fisc” means ‘state treasury’ so ‘Fiscal Policy’ refers to policy concerning the use of ‘state treasury’ or the Govt.

Finances to achieve the macro economic goals. Fiscal Policy is defined as the govt. Programme of taxation, expenditure, & other financial operation to achieve national goals The two main instruments of fiscal policy are government expenditure and taxation. Changes in the level and composition of taxation and government spending can impact the following variables in the economy: * Aggregate demand and the level of economic activity; * The pattern of resource allocation; * The distribution of income.

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MONETARY DIFFER FROM FISCAL POLICY:Two important tools of macroeconomic policy are Monetary Policy and Fiscal Policy. The Monetary Policy regulates the supply of money and the cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial banks. The Monetary Policy aims to maintain price stability, full employment and economic growth. The Reserve Bank of India is responsible for formulating and implementing Monetary Policy. It can increase or decrease the supply of currency as well as interest rate, carry out open market operations, control credit and vary the reserve requirements.The Monetary Policy is different from Fiscal Policy as the former brings about a change in the economy by changing money supply and interest rate, whereas fiscal policy is a broader tool with the government.

The Fiscal Policy can be used to overcome recession and control inflation. It may be defined as a deliberate change in government revenue and expenditure to influence the level of national output and prices. For instance, at the time of recession the government can increase expenditures or cut taxes in order to generate demand. On the other hand, the government can reduce its expenditures or raise taxes during inflationary times.Fiscal policy aims at changing aggregate demand by suitable changes in government spending and taxes.

The annual Union Budget showcases the government’s Fiscal Policy. OBJECTIVES OF MONETARY POLICY: * Maximum feasible output. * High rate of growth. * Growth in employment ; income * Price stability. * Stability of Forex ; national currency * Inflation Control * Greater equality in the distribution of income and wealth. Healthy balance in balance of payments (BOP) SOME MONETARY POLICY TERMS: 1. Bank Rate Bank rate is the minimum rate at which the central bank provides loans to the commercial banks.It is also called the discount rate.

Usually, an increase in bank rate results in commercial banks increasing their lending rates. Changes in bank rate affect credit creation by banks through altering the cost of credit. 2. Cash Reserve Ratio All commercial banks are required to keep a certain amount of its deposits in cash with RBI. This percentage is called the cash reserve ratio.

The current CRR requirement is 8 per cent. 3. Inflation Inflation refers to a persistent rise in prices. Simply put, it is a situation of too much money and too few goods. Thus, due to scarcity of goods and the presence of many buyers, the prices are pushed up.The converse of inflation, that is, deflation, is the persistent falling of prices. RBI can reduce the supply of money or increase interest rates to reduce inflation. 4.

Money Supply (M3) This refers to the total volume of money circulating in the economy, and conventionally comprises currency with the public and demand deposits (current account + savings account) with the public. The RBI has adopted four concepts of measuring money supply. The first one is M1, which equals the sum of currency with the public, demand deposits with the public and other deposits with the public.

Simply put M1 includes all coins and notes in circulation, and personal current accounts. The second, M2, is a measure of money, supply, including M1, plus personal deposit accounts – plus government deposits and deposits in currencies other than rupee. The third concept M3 or the broad money concept, as it is also known, is quite popular. M3 includes net time deposits (fixed deposits), savings deposits with post office saving banks and all the components of M1.

5. Statutory Liquidity Ratio Banks in India are required to maintain 25 per cent of their demand and time liabilities in government securities and certain approved securities.These are collectively known as SLR securities. The buying and selling of these securities laid the foundations of the 1992 Harshad Mehta scam.

6. Repo A repurchase agreement or ready forward deal is a secured short-term (usually 15 days) loan by one bank to another against government securities. Legally, the borrower sells the securities to the lending bank for cash, with the stipulation that at the end of the borrowing term, it will buy back the securities at a slightly higher price, the difference in price representing the interest. . Open Market Operations An important instrument of credit control, the Reserve Bank of India purchases and sells securities in open market operations. In times of inflation, RBI sells securities to mop up the excess money in the market. Similarly, to increase the supply of money, RBI purchases securities. HIGHLIGHTS OF CURRENT MONETARY POLICY : * Repurchase rate, or short-term lending rate, hiked to 8 percent from 7.

5 percent  * Reverse repurchase rate, or short-term borrowing rate, hiked to 7 percent from 6. percent  * Cash reserve ratio retained at 6 percent * Statutory liquidity ration retained at 24 percent * Bank rate untouched at 6 percent * Inflation expected to remain elevated for few more months  * Moderation in inflation seen toward latter part of year  * Projection on annual inflation for year-end at 7 percent, against 9. 4 percent now  * Projection on growth left unchanged at 8 percent for current fiscal  * Intention to maintain interest rate environment that moderates inflation  * Policy also tuned to manage risk of falling growth Measures to manage liquidity without undue stress on financial system  * Outlook for global crude oil prices uncertain in the near future  * High global commodity prices may also exert pressure on domestic inflation  * High global crude prices, domestic fuel subsidies will impact inflation  * This year’s monsoon may impact yields of grains, pulses, oilseeds and cotton  * Inadequate supplies may keep prices of eggs, meat, fish, milk and pulses high  * Government’s fiscal deficit target of 4. percent now a major challenge  * Real estate markets have remained firm * Next mid-quarter review of monetary policy Sep 16 * Second quarter review of monetary policy Oct 25 EXPECTED OUTCOMES: * Contain inflation by reining in demand side pressures, and anchor inflation expectations.

* Sustain growth in the medium-term by containing inflation. OUTLOOK AND PROJECTIONS Growth Inflation FISCAL POLICY – OBJECTIVES: General Objectives – Aimed at achieving macroeconomic goals Specific Objectives – Related to any typical problems of economy. FISCAL POLICY AND MACROECONOMIC GOALS ECONOMIC GROWTH : By creating conditions for increase in savings ; interest * EMPLOYMENT : By encouraging the use of labour and technology * STABILIZATION : Fight with depressionary trends ; booming indications in the economy * ECONOMIC EQUALITY : By reducing the Income ; wealth gaps between the rich ; poor * PRICE STABILITY : Employed to contain Inflationary ; Deflationary tendencies in the Economy INSTRUMENTS: * Budgetary Surplus ; Deficit * Govt.

Expenditure * Taxation – Direct ; Indirect * Public Debt * Deficit Financing FISCAL POLICY AFFECT ON THE ECONOMY Aggregate demand which is the total demand for goods and services in the economy depends on three main variables : * Consumption * Private investment ; * Government Spending When the Govt. Increases its expenditure then it spurs the aggregate demand in the economy. A higher aggregate demand in turn will stimulate output, growth ; employment. Whereas if the govt. lowers its spending then it decreases the aggregate demand ; hence slow down the growth of economy THE PURPOSE OF FISCAL POLICY: * Reduce the rate of inflation. * Stimulate economic growth in a period of a recession.

Basically, fiscal policy aims to stabilize economic growth, avoiding the boom and bust economic cycle. INSTRUMENTS OF FISCAL POLICY * Budgetary surplus and deficit * Government expenditure * Taxation- direct and indirect * Public debt * Deficit financing Budgetary surplus and deficit * “A budget is a detailed plan of operations for some specific future period” * Keeping budget balanced (R=E) or deficit (R;E) or surplus (R;E) as a matter of policy is itself a fiscal instrument. * An accumulated deficit over several years (or centuries) is referred to as the government debt * A deficit is a flow.And a debt is a stock. Debt is essentially an accumulated flow of deficits Government expenditure * It includes : * Government spending on the purchase of goods ; services.

* Payment of wages and salaries of government servants * Public investment * Transfer payments Taxation- direct and indirect * Meaning: Non quid pro quo transfer of private income to public coffers by means of taxes. * Classified into 1. Direct taxes- Corporate tax, Div. Distribution Tax, Personal Income Tax, Fringe Benefit taxes, Banking Cash Transaction Tax 2.Indirect taxes- Central Sales Tax, Customs, Service Tax, excise duty. Public debt * Internal borrowings 1. Borrowings from the public by means of treasury bills and govt.

bonds 2. Borrowings from the central bank (monetized deficit financing) * External borrowings 1. foreign investments 2.

international organizations like World Bank ; IMF 3. market borrowings THE GOLDEN RULE The Government’s fiscal policy framework is based on the five key principles set out in the Code for fiscal stability – transparency, stability, responsibility, fairness and efficiency.The Code requires the Government to state both its objectives and the rules through which fiscal policy will be operated. The Government’s fiscal policy objectives are: * over the medium term, to ensure sound public finances and that spending and taxation impact fairly within and between generations; and * over the short term, to support monetary policy and, in particular, to allow the automatic stabilisers to help smooth the path of the economy.

* These objectives are implemented through two fiscal rules, against which the performance of fiscal policy can be judged.The fiscal rules are: * the golden rule: over the economic cycle, the Government will borrow only to invest and not to fund current spending; and * the sustainable investment rule: public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level. Other things being equal, net debt will be maintained below 40 per cent of GDP over the economic cycle. * The fiscal rules ensure sound public finances in the medium term while allowing flexibility in two key respects: * the rules are set over the economic cycle.This allows the fiscal balances to vary between years in line with the cyclical position of the economy, permitting the automatic stabilisers to operate freely to help smooth the path of the economy in the face of variations in demand; and * the rules work together to promote capital investment while ensuring sustainable public finances in the long term. The golden rule requires the current budget to be in balance or surplus over the cycle, allowing the Government to borrow only to fund capital spending.

The sustainable investment rule ensures that borrowing is maintained at a prudent level. To meet the sustainable investment rule with confidence, net debt will be maintained below 40 per cent of GDP in each and every year of the current economic cycle. FISCAL POLICY 2011-2012 * TAXES * Personal income tax exemption limit raised to Rs 180,000 from Rs 160,000 for individual tax payers  * For senior citizens, the qualifying age reduced to 60 years and exemption limit raised to Rs 2. 50 lakh. * Citizens over 80 years to have exemption limit of Rs 5 lakh. * To raise minimum alternate tax to 18. percent from 18 percent * Direct tax proposals to cause 115 billion rupees in revenue loss  * Service tax rate kept at 10 percent * Peak rate of customs duty maintained at 10 per cent in view of the global economic situation.

* Basic customs duty on agricultural machinery reduced to 4. 5 per cent from 5 per cent. * Service tax on air travel increased by Rs 50 for domestic travel and Rs 250 for international travel in economy class. On higher classes, it will be ten per cent flat. * Electronic filing of TDS returns at source stabilised; simplified forms to be introduced for small taxpayers. Works of art exempt from customs when imported for exhibition in state-run institutions; this now extended to private institutions. * SUBSIDIES * Subsidy bill in 2011-12 seen at 1. 44 trillion rupees * Food subsidy bill in 2011-12 seen at 605.

7 billion rupees  * Fertiliser subsidy bill in 2011-12 seen at 500 billion rupees  * Petroleum subsidy bill in 2011-12 seen at 236. 4 billion rupees  * State-run oil retailers to be provided with 200 billion rupee cash subsidy in 2011-12 * FISCAL DEFICIT * Fiscal deficit seen at 5. 1 percent of GDP in 2010-11 Fiscal deficit seen at 4.

6 percent of GDP in 2011-12  * Fiscal deficit seen at 3. 5 percent of GDP in 2013-14 * SPENDING * Total expenditure in 2011-12 seen at 12. 58 trillion rupees  * Plan expenditure seen at 4. 41 trillion rupees in 2011-12, up 18.

3 percent. * REVENUE * Gross tax receipts seen at 9. 32 trillion rupees in 2011-12  * Non-tax revenue seen at 1. 25 trillion rupees in 2011-12  * Corporate tax receipts seen at 3. 6 trillion rupees * Customs revenue seen at 1.

52 trillion rupees in 2011-12 * POLICY REFORMS * To create infrastructure debt funds FDI policy being liberalised. * To boost infrastructure development with tax-free bonds of 300 billion rupees  * Food security bill to be introduced this year * To permit SEBI registered mutual funds to access subscriptions from foreign investments  * Raised foreign institutional investor limit in 5-year corporate bonds for investment in infrastructure by $20 billion  * Setting up independent debt management office; Public debt bill to be introduced in parliament soon  * Bills on insurance, pension funds, banking to be introduced. Constitution Amendment Bill for introduction of GST regime in this session. * New Companies Bill to be introduced in current session BIBILOGRAPHY: 1. www. rbi.

org. in 2. D N DWIVEDI : Managerial Economics 3. www. finance. indiamart. com/taxation/income_tax/rates 4.

www. mostlyeconomics. wordpress. com 5. www.

banknetindia. com/banking

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