Monetory and Fiscal policy

Monetary and fiscal policies

The Monetary and Fiscal policies are two important

instruments employed by the authorities to influence the
behaviour and performance of the financial sector and the
economy in general.
Monetary policy refers to the use of instruments within the
central of the Central Bank (RBI) to influence the level of
aggregate demand for goods and services or to influence the
trend in certain sectors of the economy.
Monetary policy operates through varying the cost and
availability of credit.
 Measure of money supply

 M1- Currency with public and deposits (demand deposits with

banks and other deposits with RBI)
 M2- M1+ Post office savings deposits
 M3- M1+ Time deposits with banks.
 M4- M3+ Total post office deposits.
 Instruments of monetary policy

General- It affects the total quantity of credit and thus

impact the economy generally.
There are 3 general instruments of credit control

Bank Rate- The minimum rate at which the central bank

provides financial accommodation to commercial banks.
Thus an increase in the bank rate means an increase in the
rate of interest charged by the central bank on its advances
to commercial banks, consequently it leads to rise in the
rate of interest charged by commercial banks to their
customers
Open Market operations- The purchase and sales of
foreign exchange, gold, govt securities and even company shares
by central bank is known as open marketing operations.
Through open Market operations, the central bank seeks to
influence the economy either by increasing the money supply or
by decreasing the money supply.
To increase the money supply the central bank buys securities
from commercial banks and public. A sale of securities by the
central bank will have the effect of reducing the money supply.
Variable reserve ratio- Commercial banks have to
maintain a certain percentage of their deposits in the form of
balances with the central bank (RBI) and the variation in the
reserve requirement affect the credit creating capacity of
commercial banks.
 Cash Reserve Ratio (CRR)- The minimum amount which
commercial banks are required to keep in form of cash according
to their total time and demand deposits. Variation in the CRR
affects money supply in the economy. Raising of CRR restricts
liquidity in thee system while reduction in CRR increase money
supply.
 Statutory Liquidity Ratio (SLR)- A part of cash Reserve ratio
SLR is the minimum amount of liquid asset kept in liquid form;
of the total time and demand liability.
At present SLR is 25%. Thus it ensures that with every increase
in the cash reserve requirements, the overall liquidity obligations
are also raised.
Selective Credit Regulation: Selective Credit controls relate to the
distribution or direction of available credit supplies. It is attained by
giving concessions to priority sectors. Thus it aims to discourage such
activity which are considered to be relatively inessential or less
desirable.
 Techniques of selective Credit control
 Minimum margins for lending against specific securities.
 Ceiling on the amounts of credit for certain purposes
 Discriminatory rates of interest charges on certain types of advances.

While imposing selective credit controls, it is ensured that credit fro

production, the movement of commodities and exports in not affected.
 Fiscal Policy

Fiscal policy is that part of Government policy which is concerned with

raising revenue through taxation and other means and deciding on the
level and pattern of expenditure. Thus Fiscal policy operates through
the budget

Fiscal policy is seen as the major way of controlling economy. It has two
main roles
a. To remove any severe deflationary and inflationary gaps.
b. To smooth out the fluctuation in the economy associated with the
business cycle.

The first role is to prevent the occurrence of fundamental disequilibrium

in the economy, where as the second role involves reducing govt
expenditure or raising taxes
Union Budget as an Instrument of Growth and its
impact on Business.

The constitution of India provides that

 No tax can be levied or collected except by authority of law

 No expenditure can be incurred for public funds except in manner
provided in the constitution.
 The executive authorities must spend public money in the manner
sanctioned by the parliament.
 The Budget

The budget is an estimate of Government expenditure and revenue for the

coming financial year, presented to the Parliament by Finance Minister
on last day of February
It is also known as Annual Financial Statement. All the receipts and
disbursement of the Union Govt are kept under 2 separate headings

 Consolidated Fund of India- It includes all revenues received, loans

raised and money received in repayment of loans by the Union Govt.
No money can be withdrawn from this fund except under the authority
of an Act of parliament.
 Public Account of India- It comprises of, all other receipts and
disbursements such as deposits, service funds and remittance.
 The Structure of the budget

Vertically Budget is divided into Revenue (receipts) and

Expenditure (disbursements). However, horizontally it is
divided into Revenue account and Capital account. This
led to further subcategorizing revenue side into Revenue
Receipts and Revenue Expenditure and Expenditure side
into Capital Receipt and Capital Expenditure
Revenue Expenditure- All the current expenditure of the
Govt on administration,
Capital Expenditure- All the Capital transaction of the
Govt
Revenue Receipts- Revenue from taxes.
Capital Receipts- Market loans, external aid, income
from repayment
 Importance of the Budget

The budget strive to give maximum support to forces that can

move the country forward on the path of growth with stability
and social justice with stability & social justice. The budget
should set the stage fro the achievement of economic and
social goals.
Certain sectors or industries get significantly impacted by the
Budget proposal like tax proposals or budgetary allocations.
1. Accelerate the pace of economic development by mobilizing
resources for the public sector and their optimal allocation.
2. To bring about improvement in production in the private
sector in accordance with the national priorities.
3. To bring about improvement in income distribution
4. To promote exports and encourage import substitution.
5. To achieve economic stabilization.