Professional Documents
Culture Documents
development activities allocation of funds critical analysis of the recent fiscal policy of
Government of India. Balance of Payments: Nature structure major components causes for
disequilibrium in balance of payments correction measures.
Fiscal Policy
The term Fisc in English means treasury. Hence policy concerning treasury or Government
exchequer is known as Fiscal Policy.
Fiscal policy is that part of Government policy which is concerned with raising revenues through
taxation and other means deciding on the level and pattern of expenditure it operates through
budget. However, generally the expenditure exceeds the revenue income of the Government. In
order to meet this situation, the Government imposes new taxes or increases rates of taxes, takes
internal or external loans or resorts to deficit financing by issuing fresh currency.
Thus, the collective form of policies of imposing taxation, taking loans or deficit financing is
known as fiscal policy. The authors have defined it as follows:
By fiscal policy is meant the use of public finance or expenditure, taxes, borrowing and financial
administration to further our national income objective. Buchler
Changes in Government expenditure and taxation designed to influence the pattern and level of
activity. J. Harry and Johnson
Fiscal policy is a policy under which the Government uses its expenditure and revenue
programmes to produce desirable effects and avoid undesirable effects on national income,
production and employment. - Arthur Smithies
There are mainly three constituents of the fiscal policy; these are: (i) taxation policy, (ii) public
expenditure policy, and (iii) public debt policy. All these constituents must work together to
make the fiscal policy sound and effective.
Objectives of fiscal policy
1. Capital formation
2. Mobilization of resources
3. Incentives to savings
4. Inducement to private sector
5. Alleviation of poverty and unemployment
6. Reduction in inequality
PUBLIC REVENUES
Any public authority or Government needs income for the performance of a variety of functions
and meeting its expenditure. The income of the Government through all sources is called public
income or public revenue. According to Dalton, public income can be classified as Public
Revenue and Public
Any public authority or Government needs income for the performance of a variety of functions
and meeting its expenditure. The income of the Government through all sources is called public
income or public revenue. According to Dalton, public income can be classified as Public
Revenue and Public Receipts.
Public Revenue:
Public revenue refers to income of a Government from all sources raised, in order to meet public
expenditure. Public revenue consists of taxes, revenue from administrative activities like fines,
fees, income from public enterprises, gifts and grants.
Public Receipts
It includes public revenue plus the receipts from public borrowings, the receipts from sale of
public assets and printing and issuing new currency notes. It includes other sources of public
income along with public revenue. Public Revenue can be classified as Tax Revenue and Non -
Tax Revenue.
Sources of
o Public Reevenue
Tax Reveenue:
ng to Hugh Dalton,
Accordin D "a tax is a com
mpulsory conntribution im
mposed by a public authhority,
irrespectiive of the ex
xact amount of service rendered
r to tthe tax payeers in return and not impposed
as a penaalty for any legal
l offencee."
Personal Income Tax: Personal Income Tax is levied on the taxable income of individuals and
Hindu Undivided Families (HUFs). Here various exemptions and deductions are allowed.
Corporate Tax: Corporate Tax is levied on taxable income of registered corporate firms. Under
various sections of Income Tax Act, exemptions and deductions are allowed.
Other Direct Taxes: There are various other direct taxes & their share is negligible. For eg :-
Interest tax, wealth tax, estate duty, expenditure tax etc.
Customs Duty: Customs Duty is levied on imports and on selective exports. In 2009-10, customs
duty revenue to Central Government was estimated at Rs. 84,244 crore.
Excise Duty: Excise duty is levied on goods produced. Over the years the rate of Excise duty has
been reduced on most of the items. In 2009-10, excise duty revenue of Central Government was
estimated at Rs. 1,04,659 crores.
Service Tax : Service tax was introduced in 1994-95. In February 2010, service tax was reduced
to 10% from12%. About 117 services were subject to service tax. In 2009-10. Service tax of
central Government was Rs. 58,454 crore.
Non - Tax Revenue
The revenue obtained by the Government from sources other than tax is called non - tax
revenue.
1) Administrative Revenues:
The Government gets revenue from public for administrative work in following forms :-
Fees: A fee is charged by the public authorities for rendering service to the members of public.
There is no compulsion involved in case of fees. For Eg. Fees charged for issuing licenses,
passports, registrations, filing of court cases etc.
Fines and Penalties: Fines or penalties are imposed as a form of punishment for breach of law or
non - fulfillment or failure to observe some regulations. Fines are compulsory payments without
quid-pro-quo. For Eg. Fines are imposed for rash driving, not disclosing taxable income,
travelling without tickets etc.
In modern day grants from one Government to another is an important source of revenue. Grants
are provided by Central Government to State Governments or by State Governments to local
authorities to carry out their functions. Grants from foreign countries are known as foreign aid.
PUBLIC EXPENDITURE
PUBLIC DEBT
Public debt refers to Government debt. It refers to Government borrowings from individuals,
financial institutions, organizations and foreign countries. If revenue collected through taxes and
other sources is not adequate to cover expenditure, the Government may resort to borrowings.
Thus public debt is one of the instruments to cover deficits in budget.
Over the years, the public debt of Central Government and that of State Governments has
increased during the planning period. In short, public debt refers to obligations of Governments,
particularly those evidenced by securities, to pay sums to the holders at some future date.
Borrowed funds are utilized for development and non-development activities.
Internal Debt: Government borrowings within the country are known as internal debt. Public
loans floated within the country are called internal debt. The various internal sources from which
the Government borrows include individuals, banks, business firms and others. The various
instruments of internal debt include market loans, bonds, treasury bills, ways and means
advances etc.
External Debt: Borrowings by the Government from abroad is known as external debt. The
external debt comprises of Loans from World Bank, Asian Development Bank, etc. External
loans help to take up various developmental programmes in developing and underdeveloped
countries.
Short Term Debt: Loans for a period of less than one year are known as short - term debt. For
Ex. The treasury bills are issued by RBI on behalf of the Government to raise funds for a period
of 91 days and 182 days. Interest rates on such loans are very low. To cover the temporary
deficits in budget short - term loans are taken.
Medium - Term Debt: The period of medium term debt is normally for a period above one year
and up to 5 years. One of the main forms of medium term debt is by way of market loans. The
interest rates on medium term loans are reasonable. These are preferred to meet expenditure on
health, education, relief work etc.
Long - Term Debt: Loans for a period exceeding 5 years are called long - term debt. One of the
main forms of long term loans is by way of issue of bonds. Long term debt is required for the
purpose of retirement of debts and also for the purpose of development projects.
Productive Debt: Public debt is said to be productive when it is raised for productive purposes
and is used to add to the productive capacity of the economy. These loans are normally long -
term in nature. These loans are utilized on development activities such as infrastructure
development like roadways, railways, airports, seaports, power generation, telecommunications
etc.
Unproductive Debt: An unproductive debt is one which does not yield any income. It does not
add to the productive assets of the country. For Ex. debts utilized for transfer payments in form
of subsidies, old age pension, special incentives to weaker sections etc.
Redeemable and Irredeemable Debt
Redeemable Debt: Loans which Government promises to pay off at some future date are called
redeemable debts. Their maturity period is fixed. The Government has to make arrangements to
repay the principal and interest on due date.
Irredeemable Debt: Loans for which no promise is made by the Government regarding their
exact date of repayment are called irredeemable debts. Such debt has no maturity period. The
Government may pay interest regularly. Normally, Government does not resort to such
borrowings.
Funded Debt: Funded debt is normally obtained on long - term basis. The interest on funded
debt must be paid regularly. But the Government has the option to repay the principal. If market
conditions are favorable Government may repay it before maturity.
Unfunded Debt: Unfunded debts are of short term. They are also known as floating debt.
Unfunded debts are incurred to meet temporary needs of the Government. The rate of interest is
low. There is no special fund created to repay this debt.
Announcement of long term fiscal policy was in the direction of determining the relationship
between planning in India and the process of making the budget. During the course of this
budget speech 1985-86, the finance Minister and promised to adopt such long term fiscal policy
which will be co-terminus with the period of plan.
The objectives of long term fiscal plan are to achieve all those objectives which are directly
related to the alleviation of poverty. The main objectives of fiscal policy are
Taxation
Additional 2% surcharge for the super-rich with income of over Rs. 1 crore.
Agriculture
Infrastructure
PPP model for infrastructure development to be revitalised and Govt. to bear majority of
the risk.
AIIMS in Jammu and Kashmir, Punjab, Tamil Nadu, Himachal Pradesh, Bihar and
Assam.
Defence
Allocation of Rs. 2,46,726 crore; an increase of 9.87 per cent over last year.
Welfare Schemes
JAM trinity (Jan Dhan Yojana, Aadhaar and Mobile) to improve quality of life and to
pass benefits to common man.
Six crore toilets across the country under the Swachh Bharat Abhiyan.
MUDRA bank will refinance micro finance organisations to encourage first generation
SC/ST entrepreneurs.
Welfare Schemes
New scheme for physical aids and assisted living devices for people aged over 80
Govt. to use Rs. 9,000 crore unclaimed funds in PPF/EPF for Senior Citizens Fund.
Renewable Energy
Renewable energy target for 2022: 100K MW in solar; 60K MW in wind; 10K MW in
biomass and 5K MW in small hydro
Tourism
Development schemes for churches and convents in old Goa; Hampi, Elephanta caves,
Forests of Rajasthan, Leh palace, Varanasi , Jallianwala Bagh, Qutb Shahi tombs at
Hyderabad to be under the new tourism scheme.
Gold
New scheme for depositors of gold to earn interest and jewellers to obtain loans on their
metal accounts.
Financial Sector
NBFCs registered with the RBI and having asset size of Rs 500 crore and above to be
considered as financial institution under Sarfaesi Act, 2002, enabling them to fund SME
and mid-corporate businesses
BALANCE OF PAYMENTS
The balance of payments (BOP) is the method countries use to monitor all international
monetary transactions at a specific period of time. Usually, the BOP is calculated every quarter
and every calendar year.
The Balance of Payments is the statistical record of a countrys international transactions over a
certain period of time presented in the form of double-entry bookkeeping.
It is a double entry system of record of all economic transactions between the residents of the
country and the rest of the world carried out in a specific period of time.
It takes into account the export and import of both visible and invisible items.
Balance of payments of a country is a record of the monetary transactions over a period with
rest of the world. -Benham
NATURE OF BOP
1. Systematic
Sy Reecord: It is a systematicc record of rreceipts andd payments oof a countryy with
otther countriees.
2. Fixed
F Period
d of Time: Itt is a statement of accouunt pertaininng to a givenn period of time,
usually one year.
y
3. Comprehensi
C iveness: it includes alll the three items. (Viisible, invissible and caapital
trransfers)
4. Double
D Entryy System: Reeceipts and payments arre recorded on the basiss of double entry
syystem.
STRUCT
TURE OF BOP
B
Debit Sid
de: Debit sid
de comprisess all the paym
ments made.
I. Current
C Accoount: The cu urrent accou unt records all the incoome-related flow. This flow
co o account of trade in goods and services annd transfer ppayments am
ould arise on mong
co
ountries.
a. Merch handise Trad de: Trade in n goods connsists of expport and im mport is calleed as
merchhandise tradee. Merchand dise export arre those expports in a couuntry i.e., salles of
goodss to resident of another country, are a source of rreserves.
b. Invisib ble Export: The
T invisible exports aree those expoorts where saales of servicce are
credit and purchasses of servicces are debiteed.
II. Capital
C Accoount: The capital accou unt record m movements on accountt of internattional
pu
urchase or sale
s of assetss. Assets incclude any foorm in whichh wealth maay be held m money
held as cash or in the form of bank deposits, shares, debentures, other debt instruments,
real estate, land, factories, antiques.
III. Official Reserves: Official reserves include gold, reserves of convertible foreign
currencies, which are the means of international payments. Foreign currencies may be
held in the form of balances with foreign central banks or foreign Govt. securities.
IV. Unilateral Transfer Account: These refer to one sided transfer from one country to the
other. It terms as a gift which include private remittances, Government grants etc. These
are not trading transactions.
Though the credit and debit are written balanced in the balance of payment account, it may not
remain balanced always. Very often, debit exceeds credit or the credit exceeds debit causing an
imbalance in the balance of payment account. Such an imbalance is called the disequilibrium.
Disequilibrium may take place either in the form of deficit or in the form of surplus.
Disequilibrium of Deficit arises when our receipts from the foreigners fall below our payment to
foreigners. It arises when the effective demand for foreign exchange of the country exceeds its
supply at a given rate of exchange. This is called an 'unfavorable balance'.
Disequilibrium of Surplus arises when the receipts of the country exceed its payments. Such a
situation arises when the effective demand for foreign exchange is less than its supply. Such a
surplus disequilibrium is termed as 'favorable balance'.
Various causes of disequilibrium in the balance of payments or adverse balance of payments are
as follows:
1. Population Growth
Most countries experience an increase in the population and in some like India and China the
population is not only large but increases at a faster rate. To meet their needs, imports become
essential and the quantity of imports may increase as population increases.
2. Development Programmes
Developing countries which have embarked upon planned development programmes require
importing capital goods, some raw materials which are not available at home and highly skilled
and specialized manpower. Since development is a continuous process, imports of these items
continue for the long time landing these countries in a balance of payment deficit.
3. Demonstration Effect
When the people in the less developed countries imitate the consumption pattern of the people in
the developed countries, their import will increase. Their export may remain constant or decline
causing disequilibrium in the balance of payments.
4. Natural Factors:
Natural calamities such as the failure of rains or the coming floods may easily cause
disequilibrium in the balance of payments by adversely affecting agriculture and industrial
production in the country.
5. Cyclical Fluctuations
Business fluctuations introduced by the operations of the trade cycles may also cause
disequilibrium in the country's balance of payments. For example, if there occurs a business
recession in foreign countries, it may easily cause a fall in the exports and exchange earning of
the country concerned, resulting in a disequilibrium in the balance of payments.
6. Inflation
An increase in income and price level owing to rapid economic development in developing
countries, will increase imports and reduce exports causing a deficit in balance of payments.
The superior marketing of the developed countries have increased their surplus. The poor
marketing facilities of the developing countries have pushed them into huge deficits.
8. Flight of Capital
Due to speculative reasons, countries may lose foreign exchange or gold stocks People in
developing countries may also shift their capital to developed countries to safeguard against
political uncertainties. These capital movements adversely affect the balance of payments
position.
9. Globalization
Due to globalization there has been more liberal and open atmosphere for international
movement of goods, services and capital. Competition has been increased due to the
globalization of international economic relations. The emerging new global economic order has
brought in certain problems for some countries which have resulted in the balance of payments
disequilibrium.
CORRECTION MEASURES
Solution to correct balance of payment disequilibrium lies in earning more foreign exchange
through additional exports or reducing imports. Quantitative changes in exports and imports
require policy changes. Such policy measures are in the form of monetary, fiscal and non-
monetary measures.
The monetary methods for correcting disequilibrium in the balance of payment are as follows:-
1. Deflation
Deflation means falling prices. Deflation has been used as a measure to correct deficit
disequilibrium. A country faces deficit when its imports exceeds exports.
Deflation is brought through monetary measures like bank rate policy, open market operations,
etc or through fiscal measures like higher taxation, reduction in public expenditure, etc. Deflation
would make our items cheaper in foreign market resulting a rise in our exports. At the same time
the demands for imports fall due to higher taxation and reduced income. This would build a
favorable atmosphere in the balance of payment position. However Deflation can be successful
when the exchange rate remains fixed.
2. Exchange Depreciation
Exchange depreciation means decline in the rate of exchange of domestic currency in terms of
foreign currency. This device implies that a country has adopted a flexible exchange rate policy.
Suppose the rate of exchange between Indian rupee and US dollar is $1 = Rs. 40. If India
experiences an adverse balance of payments with regard to U.S.A, the Indian demand for US
dollar will rise. The price of dollar in terms of rupee will rise. Hence, dollar will appreciate in
external value and rupee will depreciate in external value. The new rate of exchange may be say
$1 = Rs. 50. This means 25% exchange depreciation of the Indian currency.
Exchange depreciation will stimulate exports and reduce imports because exports will become
cheaper and imports costlier. Hence, a favourable balance of payments would emerge to pay off
the deficit.
Exchange depreciation raises the prices of imports and reduces the prices of exports. So the
terms of trade will become unfavourable for the country adopting it.
3. Devaluation
Devaluation refers to deliberate attempt made by monetary authorities to bring down the value of
home currency against foreign currency. While depreciation is a spontaneous fall due to
interactions of market forces, devaluation is official act enforced by the monetary authority.
Generally the international monetary fund advocates the policy of devaluation as a corrective
measure of disequilibrium for the countries facing adverse balance of payment position. When
India's balance of payment worsened in 1991, IMF suggested devaluation. Accordingly, the
value of Indian currency has been reduced by 18 to 20% in terms of various currencies. The 1991
devaluation brought the desired effect. The very next year the import declined while exports
picked up.
When devaluation is effected, the value of home currency goes down against foreign currency,
Let us suppose the exchange rate remains $1 = Rs. 10 before devaluation. Let us suppose,
devaluation takes place which reduces the value of home currency and now the exchange rate
becomes $1 = Rs. 20. After such a change our goods becomes cheap in foreign market. This is
because, after devaluation, dollar is exchanged for more Indian currencies which push up the
demand for exports. At the same time, imports become costlier as Indians have to pay more
currencies to obtain one dollar. Thus demand for imports is reduced.
Generally devaluation is resorted to where there is serious adverse balance of payment problem.
Limitations of Devaluation :-
Devaluation is successful only when other country does not retaliate the same. If
Devaluation is successful only when the demand for exports and imports is elastic.
Devaluation brings the imports down, When imports are reduced, the domestic supply of such
goods must be increased to the same extent. If not, scarcity of such goods unleash inflationary
trends.
A growing country like India is capital thirsty. Due to non availability of capital goods in India,
we have no option but to continue imports at higher costs. This will force the industries
depending upon capital goods to push up their prices.
When demand for our export rises, more and more goods produced in a country would go for
exports and thus creating shortage of such goods at the domestic level. This results in rising
prices and inflation.
Devaluation may not be effective if the deficit arises due to cyclical or structural changes.
4. Exchange Control
It is an extreme step taken by the monetary authority to enjoy complete control over the
exchange dealings. Under such a measure, the central bank directs all exporters to surrender their
foreign exchange to the central authority. Thus it leads to concentration of exchange reserves in
the hands of central authority. At the same time, the supply of foreign exchange is restricted only
for essential goods. It can only help controlling situation from turning worse. In short it is only a
temporary measure and not permanent remedy.
A deficit country along with Monetary measures may adopt the following non-monetary
measures too which will either restrict imports or promote exports.
1. Tariffs
Tariffs are duties (taxes) imposed on imports. When tariffs are imposed, the prices of imports
would increase to the extent of tariff. The increased prices will reduced the demand for imported
goods and at the same time induce domestic producers to produce more of import substitutes.
Non-essential imports can be drastically reduced by imposing a very high rate of tariff.
Drawbacks of Tariffs :-
Tariffs seek to establish equilibrium without removing the root causes of disequilibrium.
A new or a higher tariff may aggravate the disequilibrium in the balance of payments of a
country already having a surplus.
2. Quotas
Under the quota system, the Government may fix and permit the maximum quantity or value of a
commodity to be imported during a given period. By restricting imports through the quota
system, the deficit is reduced and the balance of payments position is improved.
Types of Quotas :-
import licensing.
Merits of Quotas :-
They are more effective even when demand is inelastic, as no imports are possible above the
quotas.
More flexible than tariffs as they are subject to administrative decision. Tariffs on the other hand
are subject to legislative sanction.
Demerits of Quotas :-
They are not long-run solution as they do not tackle the real cause for disequilibrium.
3. Export Promotion
The Government can adopt export promotion measures to correct disequilibrium in the balance
of payments. This includes substitutes, tax concessions to exporters, marketing facilities, credit
and incentives to exporters, etc.
The Government may also help to promote export through exhibition, trade fairs; conducting
marketing research & by providing the required administrative and diplomatic help to tap the
potential markets.
4. Import Substitution
A country may resort to import substitution to reduce the volume of imports and make it self-
reliant. Fiscal and monetary measures may be adopted to encourage industries producing import
substitutes. Industries which produce import substitutes require special attention in the form of
various concessions, which include tax concession, technical assistance, subsidies, providing
scarce inputs, etc.
Non-monetary methods are more effective than monetary methods and are normally applicable
in correcting an adverse balance of payments.
Domestic industries enjoying various incentives will develop vested interests and ask for such
concessions all the time.