Fiscal Policy & Monetary Policy

Fiscal Policy deals with the revenue and expenditure policy of the Govt. The word fiscal has been derived from the word ‘fisk’ which means public treasury or Govt. funds.

Latest Update about Fiscal Policy of India:

The Union Budget 2021 has signaled the emphasis on the Development Financial Institutions (DFIs) in the pursuit of long-term infrastructure creation for the revival of the economy.
The establishment of the Dispute Resolution Committee (DRC) has been proposed in the Union Budget 2021 that can help provide quick relief to taxpayers in tax disputes.

Objectives of Fiscal Policy

The following are the objectives of the Fiscal Policy:

Higher Economic Growth
Price Stability
Reduction in Inequality

The above objectives are met in the following ways:

Consumption Control – This way, the ratio of savings to income is raised.
Raising the rate of investment.
Taxation, infrastructure development.
Imposition of progressive taxes.
Exemption from the taxes provided to the vulnerable classes.
Heavy taxation on luxury goods.
Discouraging unearned income.

What are the components of Fiscal Policy?

There are three components of the Fiscal Policy of India:

Government Receipts
Government Expenditure
Public Debt

Aspirants should note that all the receipts and expenditures of the government are credited and debited from the following:

Consolidated Fund of India
Contingency Fund of India
Public Account of India

Download the notes on the types of funds in India from the linked article.

Government Receipts

The categorization of the government receipts is given below:

Revenue Receipt

· Tax Revenue

· Direct Tax

· Indirect Tax

· Non Tax Revenue

· Fees

· License and Permits

· Fines and Penalties, etc

Capital Receipt

· Loans Recovery

· Disinvestments

· Borrowing and other liabilities

Debt Trap – Situation where the borrower has to borrow again for the payment of an installment on the previous debt. A borrower unable to meet debt service obligations without borrowing is known to be in a debt trap.

Direct Tax Code Bill 2010

It hasn’t been implemented yet. The bill seeks to replace the following taxes:

Income Tax Act of 1961
Wealth Tax Act of 1957

Disinvestment

When the government sells or liquidates its assets of Central Public Sector Enterprises, State Public Sector Enterprises or other assets; it is referring to disinvestment. This approach caters to the objective of fiscal burden reduction.

Government Expenditure

There are two classifications of public expenditure:

Revenue Expenditure – It is a recurring expenditure:

· Interest Payments

· Defense Expenses

· Salaries to Central Government employees, etc are examples of revenue expenditure

Capital Expenditure – It is a non-recurring expenditure

· Loans repayments

· Loans to public enterprises, etc.

Fiscal Consolidation

The measures that are taken to improve the fiscal deficit come under the process of fiscal consolidation. Through fiscal consolidation, the government tries for:

Improvement in revenue receipts
Better alignment in the public expenditure

The government introduced the FRBM Act aiming for fiscal consolidation. Read about it below:

Fiscal Responsibility and Budget Management Act (FRBMA), 2003

The objective of this FRBM Act is to impose fiscal discipline on the government.

It means fiscal policy should be conducted in a disciplined manner or a responsible manner i.e. government deficits or borrowings should be kept within reasonable limits and the government should plan its expenditure in accordance with its revenues so that the borrowing should be within limits.

Fiscal Federalism

It refers to the distribution of resource between centre and states.

The distribution of taxes between centre and states is mentioned in the 7^th schedule of the Indian constitution.

There are 3 lists where the taxes are distributed

Union List
State List
Concurrent List

In general terms, the Monetary Policy of a country is a regulatory policy which enables the central bank or monetary authority of the country to control the supply of money, availability of bank credit, and the cost of money (or rate of interest). In this article, we will look at the objectives of the monetary policy in India.

Monetary Policy in India

In India, the Monetary Policy is an important tool for the economic management of the country. The Reserve Bank of India (RBI) is the central bank of the monetary authority of India. it controls the supply of money and bank credit.

It is responsible for ensuring that the banking system meets the legitimate credit requirements and not for unproductive or speculative reasons.

Objectives of the Monetary Policy in India

‘Growth with Stability’ is the backbone of the monetary policy in India. The policy helps in the regulation of the availability, cost, and use of money. Here are the primary objectives of the monetary policy in India:

Growth with Stability

Traditionally, the monetary policy in India was focused on controlling inflation. This was done through the contraction of money supply and credit. However, this resulted in poor growth of the economy.

Therefore, RBI adopted a new policy of growth with stability. In simple terms, this means that the RBI will provide sufficient credit for the increasing needs of the different sectors of the economy. Also, it will control inflation within a certain limit.

Regulation, Supervision, and Development of Financial Stability

Financial stability is the ability of an economy to absorb shocks and ensure that people retain confidence in the financial system of the country. Internal and External shocks can threaten the financial stability of a country and destabilize its financial system.

Therefore, the RBI gives a lot of importance to maintaining confidence in the country’s financial system through adequate regulation and controls. It also ensures that the objective of growth is not sacrificed. Therefore, we can say that the RBI focuses on the regulation, supervision, and development of financial stability.

Promoting Priority Sector

In India, the priority sector includes agriculture, export, small-scale enterprises, and the weaker section of the population. RBI consistently ensures that the banking system provides timely and adequate credit to these sections at affordable costs.

Employment Generation

The monetary policy of a country can influence the rate of investment and its allocation among the different economic activities of the country with varying labor intensities. Therefore, it helps in employment generation.

External Stability

As the imports and exports are increasing, India’s linkages with the global economy are getting stronger. Traditionally, the RBI determined the exchange rate and also controlled the foreign exchange market.

However, now RBI only has indirect control over external stability through managed flexibility. Through this mechanism, the RBI influences the exchange rate by buying or selling foreign currencies in the open market.

Encouraging Savings and Investments

In order to encourage people to save, the RBI offers attractive interest rates. Further, a high saving rate leads to investment.

Therefore, the monetary management via influencing interest rates can mobilize savings and thereby investments in the country.

Redistribution of Income and Wealth

Since the RBI controls inflation and deploys affordable credit to the weaker sections of the society, it can redistribute income and wealth to the weaker sections of the economy.

Regulation of NBFIs

NBFIs or Non-Banking Financial Institutions like IDBI, UTI, IFCI, etc. play an important role in the Indian economy. They help in the deployment of credit and also the mobilization of savings.

RBI does not directly control the functioning of these institutions. However, through the monetary policy, it can indirectly influence the policies and functions of the NBFIs.

Liberalization

The term liberalization denotes removing restrictions from certain private individual activity, typically pertaining to the economic system. Commonly, liberalization is used in the context of a government relaxing its previously imposed restrictions on economic or social policies.

Economic liberalization

Refers to a situation where inessential restrictions and controls are removed from a country’s economy to ensure that businesses and enterprises can maximize their contribution. It is, however, important to note that liberalization does not mean an uncontrolled economy.

Economic Liberalization in India

The Indian economy was liberalized in the year 1991. In India, the concept of economic liberalization was introduced to attain several objectives – industrialization, expansion in the role of private and foreign investment, and introducing a free market system. Restrictions were relaxed for private companies to enter several core industries, which were previously reserved for the public sector.

Economic liberalization in India was bolstered by its balance of payments crisis in 1985. This crisis rendered the country incapable of paying for its essential imports and servicing its debt payments. India was pushed to the brink of bankruptcy therein. As a response to it, the then finance minister of India, Dr. Manmohan Singh, introduced economic liberalization in India.

Features of Liberalization in India

Following are some of the features of liberalization that was initiated as a part of economic reforms of 1991 –

· Abolition of the previously existing License Raj in the country License or Permit Raj is a complicated system of regulations, licenses, and restrictions that were imposed to run and set up businesses between 1947 and 1990.

Reduction of interest rates and tariffs
Curbing monopoly of the public sector from various areas of our economy
Approval of foreign direct investment in various sectors
Economic liberalization in India integrated the above features and in general waived off several restrictions to become more private sector-friendly.

Objectives of Liberalization

The primary objectives of initiating liberalization in India can be summed up as follows – To solve India’s impending balance of payment crisis.

To boost the private sector’s participation in the development of India’s economy
To increase the volume of foreign direct investment in India’s businesses
To introduce competition between India’s domestic businesses
To maximize India’s economic potential by encouraging multinational and private companies to expand.
To usher in globalization for the Indian economy
To regulate export and import and promote foreign trade, Impact of Liberalization on Indian Economy

Advantages and Disadvantages

When it comes to discussing the impacts of liberalization, it is crucial to look at both the positive and negative ramifications on our country’s economy.

Advantages:

Free Capital Flow in The Economy - Liberalization has enabled free movement of capital in our country, allowing companies to access the same easily from investors. In the pre-liberalization period, undertaking lucrative projects was taboo due to the dearth of capital, which was rectified in 1991, initiating higher growth rates.

Diversification of Investor Portfolio - post-liberalization, investors has the liberty to invest a percentage of their portfolio into a diversified asset class, thus generating more profit.

Improvement of Stock Market Performance - Relaxation of economic laws also leads to a rise in the stock market’s value, thus encouraging more trading among investors.

Impact on The Agricultural Sector - Even though the impact of liberalization on the agricultural sector cannot be measured accurately, in the period post-1991, there was a significant modification in cropping patterns throughout the country.

Disadvantages:

Economic Destabilization - Such a severe economic reform led to the redistribution of political and economic power that destabilized the Indian economy to quite an extent.

Increased Competition from MNCs - In the period of pre-liberalization, multinational companies had no role to play in the Indian economy. However, soon after, Indian companies faced increased competition from MNCs, which threatened the existence of several smaller firms.

FDI impact on The Banking Sector - Lifting restrictions from foreign direct investment in the banking and insurance sectors led to a downfall in the government’s stakes in both these sectors.

Increase of Acquisitions and Mergers - The increased scope of mergers and acquisitions in the post-liberalization period has posed a threat to the employees of smaller firms. In the event of a merger with bigger companies, employees of the smaller firms had to undergo rigorous re-skilling that led to a stagnation of productivity.

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Fiscal Policy & Monetary Policy in Indian economy