Fiscal Policy

Meaning Of Fiscal Policy

The fiscal policy is concerned with the raising of government revenue and incurring of
government expenditure. To generate revenue and to incur expenditure, the government frames
a policy called budgetary policy or fiscal policy.
Or
It refers to a policy concerning the use of state treasury or the government finances to achieve
the macro-economic goals
Or
Government policy of changing its taxation and public expenditure programs intended to
achieve its objective.
Or
Government uses its expenditure and revenue program to produce desirable effects on
National Income, production and employment.

Counter Cyclical Fiscal Policy

Fiscal or Budgetary Policy: Are the Revenue and Public

Expenditure Policy

It is based on the relationship between them

It generates additional purchasing power during depression

Contracts purchasing power during expansion

Importance of Fiscal Policy

Government activities are enlarged.

Tax- Revenue and Expenditure accounts for large proportion of

GNP.

Government effects the Economic activities through gap between

government receipts and borrowings.

It indicates the level of overall borrowings by the government.

It is the indicator of fiscal health of the economy.

Objectives of Fiscal Policy

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.

Development by effective Mobilization of Resources

Efficient allocation of Financial Resources
Reduction in inequalities of Income and Wealth
Price Stability and Control of Inflation
Employment Generation
Balanced Regional Development
Reducing the Deficit in the Balance of Payment
Capital Formation
Increasing National Income
Development of Infrastructure
Foreign Exchange Earnings

Objectives of Fiscal Policy

Cont

Development by effective Mobilization of Resources

The principal objective of fiscal policy is to ensure rapid economic growth and development. This
objective of economic growth and development can be achieved by mobilization of Financial
Resources
The central and the state governments in India have used fiscal policy to mobilize resources.
The financial resources can be mobilized by :

Taxation : Through effective fiscal policies, the government aims to mobilize resources by way of
direct taxes as well as indirect taxes because most important source of resource mobilization in
India is taxation.

Public Savings : The resources can be mobilized through public savings by reducing
government expenditure and increasing surpluses of public sector enterprises.

Private Savings : Through effective fiscal measures such as tax benefits, the government can
raise resources from private sector and households. Resources can be mobilized through
government borrowings by ways of treasury bills, issue of government bonds, etc., loans
from domestic and foreign parties and by deficit financing.

Objectives of Fiscal Policy

Cont

Efficient allocation of Financial Resources

The central and state governments have tried to make efficient allocation of financial resources.
These resources are allocated for Development Activities which includes expenditure on
railways, infrastructure, etc. While Non-development Activities includes expenditure on
defense, interest payments, subsidies, etc.
But generally the fiscal policy should ensure that the resources are allocated for generation of
goods and services which are socially desirable. Therefore, India's fiscal policy is designed in
such a manner so as to encourage production of desirable goods and discourage those goods which
are socially undesirable.

Reduction in inequalities of Income and Wealth

Fiscal policy aims at achieving equity or social justice by reducing income inequalities among
different sections of the society.
The direct taxes such as income tax are charged more on the rich people as compared to lower
income groups. Indirect taxes are also more in the case of semi-luxury and luxury items, which
are mostly consumed by the upper middle class and the upper class. The government invests a
significant proportion of its tax revenue in the implementation of Poverty Alleviation Programs to
improve the conditions of poor people in society.

Objectives of Fiscal Policy

Cont

Price Stability and Control of Inflation

One of the main objective of fiscal policy is to control inflation and stabilize price. Therefore, the
government always aims to control the inflation by Reducing fiscal deficits, introducing tax
savings schemes, Productive use of financial resources, etc.

Employment Generation
The government is making every possible effort to increase employment in the country through
effective fiscal measure. Investment in infrastructure has resulted in direct and indirect
employment. Lower taxes and duties on small-scale industrial (SSI) units encourage more
investment and consequently generates more employment. Various rural employment programs
have been undertaken by the Government of India to solve problems in rural areas. Similarly,
self employment scheme is taken to provide employment to technically qualified persons in the urban
areas.

Balanced Regional Development

Another main objective of the fiscal policy is to bring about a balanced regional development.
There are various incentives from the government for setting up projects in backward areas such
as Cash subsidy, Concession in taxes and duties in the form of tax holidays, Finance at
concessional interest rates, etc.

Objectives of Fiscal Policy

Cont

Reducing the Deficit in the Balance of Payment

Fiscal policy attempts to encourage more exports by way of fiscal measures like Exemption of
income tax on export earnings, Exemption of central excise duties and customs, Exemption of sales
tax and octroi, etc.
The foreign exchange is also conserved by Providing fiscal benefits to import substitute
industries, Imposing customs duties on imports, etc.
The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve
balance of payments problem. In this way adverse balance of payment can be corrected either by
imposing duties on imports or by giving subsidies to export.

Capital Formation
The objective of fiscal policy in India is also to increase the rate of capital formation so as to
accelerate the rate of economic growth. An underdeveloped country is trapped in vicious (danger)
circle of poverty mainly on account of capital deficiency.
In order to increase the rate of capital formation, the fiscal policy must be efficiently designed to
encourage savings and discourage and reduce spending.

Objectives of Fiscal Policy

Cont

Increasing National Income

The fiscal policy aims to increase the national income of a country. This is because fiscal policy
facilitates the capital formation. This results in economic growth, which in turn increases the
GDP, per capita income and national income of the country.

Development of Infrastructure
Government has placed emphasis on the infrastructure development for the purpose of
achieving economic growth. The fiscal policy measure such as taxation generates revenue to
the government. A part of the government's revenue is invested in the infrastructure
development. Due to this, all sectors of the economy get a boost.

Foreign Exchange Earnings

Fiscal policy attempts to encourage more exports by way of Fiscal Measures like, exemption of
income tax on export earnings, exemption of sales tax and octroi, etc. Foreign exchange
provides fiscal benefits to import substitute industries. The foreign exchange earned by way of
exports and saved by way of import substitutes helps to solve balance of payments problem

Tools of Fiscal Policy

Tools of
Fiscal Policy
Public
Revenue
Revenue
Receipt

Tax

Direct Tax

Capital
Receipt

Non- Tax

Indirect Tax

Public
Expenditure
Revenue
Expenditure

Capital
Expenditure

Public Expenditure (Payments)

Revenue Expenditure

Interest Payments
Major Subsidies
Defense

Capital Expenditure

Expense on administration
Repayment of Loans
Extension of fresh loans to
the state govt by the central
Loans to public enterprise
Expense on Irrigation
project
Sectoral development

Public Revenue (Receipts)

Revenue Receipts

Tax

Capital Receipts

Non- Tax Receipts

Fines and Penalties

Fees
Profits of PSU
Govt Interest
Grants and Gifts

Recovery of Govt loans

Disinvestment of PSU
Market Borrowings
Internal and International
sources

Public Revenue (Receipts)

Direct Tax

Income Tax
Corporate Tax
Wealth Tax
Gift Tax

Indirect Tax

Sales Tax
Excise Tax
Custom
Service Tax

Effect of Public Expenditure on the

Economy
Public Expenditure

An increase in PE raises the level of GNP.

PE increases the purchase of goods and services
Increases household incomes
Increases Govt Indirect tax revenues
Increase the flow of funds in the economy
Increases private Income and thereby the Private Expenditure

Effect of Public Revenue on the

Economy
Public Revenue

Total amount received.

Taxation is a measure of transferring funds from private purses
to the public coffers.
Withdrawal of funds from the private use.
Has a deflationary impact on GNP
Reduces Disposable income and reduces private expenditure

Concept of Deficit

Deficit: Total government expenditure is more than government receipts.

Budgetary Deficit:
Revenue Deficit:

Total Expenditure Total Revenue

Revenue Expenditure Revenue Receipts

Fiscal Deficit:

Total Expenditure Total Revenue (Excluding Govt. Borrowing)

Primary Deficit:

Fiscal Deficit Interest Payments

What is Fiscal Deficit?

Fiscal deficit:
Is the difference between what the government spends and what it
earns.
It is expressed as a percentage of GDP.

India's fiscal deficit target for year 2015-16 is 3.9 %.

The government has promised to cut the deficit further to 3% of GDP in

the coming three years.

Unproductive
expenditure
by govt.

Huge
borrowings

Weak
revenue
mobilization

Increase in
subsidies
Payment of
interest

What
causes
deficit?
Tax evasion

Pensions

Defense
expenditure

Poor
performance
of public
sector

Fiscal Deficit over the years

Budgeted Expenditure of the central Govt

2015-16

Budgeted Receipts of the Central

Govt 2015-16

Kinds of Fiscal Policy

Fiscal Policy

Discretionary
Fiscal Policy

Anti- Recessionary
Fiscal Policy

Non- Discretionary /
Automatic
Fiscal Policy

Anti Inflationary
Fiscal Policy

AntiRecessionary
Fiscal Policy
Increase In Govt
Expenditure

Reduction In
Taxes

Anti-Inflationary
Fiscal Policy

Reducing Govt
Expenditure

Increase In
Taxes

Implication of Large Fiscal Deficit

Borrow from within and outside the country Leads to increase in
public debt and its burden

1)

2)

Financing through Deficit financing Leads to creation of Money and

may lead to rise in prises or Inflation

3)

Adversely effects Economic Growth

Due to large revenue deficit a smaller amount are left for productive
investment in Infrastructure and social capital (education and health)

More borrowing by Government leaves less resources for Private

sector Investment.

What should Govt. do?

In India, to reduce Fiscal Deficit the Govt has been curtailing Capital
Expenditure.

But it effects the Economic Growth

The Govt needs to cut Revenue Expenditure and raise Revenue

receipts ( mobilising Taxation)

Fiscal Policy strategy for 2015-16

Target a growth rate of 7.4 percent in current financial year on back of new
optimism and decisive policy environment

Budget 2015-15 has adopted a fiscal deficit target of 3.9 percent.

Rationalization of administered pricing policies in petroleum and natural gas

Removing bottlenecks in land acquisition bill

Revival of manufacturing sector in India with focus on the Make in India.

Liberalization of foreign direct investment

Push to financial inclusion program for inclusive growth

Fiscal Policy strategy for 2015-16

Cont

Delayed Financial Consolidation for 1 year.

Creating appropriate foreign currency reserves to counter adverse situation,

Our currency reserves hit a record high of $353.88 billion as of May 15.

Public spending needs to be stepped up in core sectors to tap the growth

potential.

Increasing states share in taxes from 32% to 42% (increase states share by
1.5 lakh crores)

Increase PPF limit to 1.5 lakh to increase saving under govt. scheme.

Push for GST bill

Financial Inclusion

Even after 60 years of independence, a large section of Indian

population still remain unbanked.

In the recent years the government and Reserve Bank of India has
been pushing the concept and idea of financial inclusion.

Financial inclusion is the delivery of financial services at affordable

costs to vast sections of disadvantaged and low income groups.

Why is financial inclusion needed in

India?

Steps taken by RBI to promote

financial inclusion
Initiation of no-frills account These accounts provide basic facilities of deposit and
withdrawal to accountholders makes banking affordable by cutting down on extra frills
that are no use for the lower section of the society.
Banking service reaches homes through business correspondents The banking
systems have started to adopt the business correspondent mechanism to facilitate
banking services in those areas where banks are unable to open brick and mortar
branches for cost considerations.
EBT Electronic Benefits Transfer To plug the leakages that are present in
transfer of payments through the various levels of bureaucracy, government has begun
the procedure of transferring payment directly to accounts of the beneficiaries

Steps taken by current government to

promote financial inclusion
Micro Units Development Refinance Agency (MUDRA) Bank: MUDRA Bank will
refinance Micro-Finance Institutions through a Pradhan Mantri Mudra Yojana. In lending,
priority will be given to SC/ST enterprises. These measures will greatly increase the
confidence of young, educated or skilled workers who would now be able to aspire to
become first generation entrepreneurs; existing small businesses, too, will be able to
expand their activities.
The MUDRA Bank would primarily be responsible for
1)
Laying down policy guidelines for micro/small enterprise financing business
2)
Registration of MFI entities
3)
Regulation of MFI entities
4)
Accreditation /rating of MFI entities
5)
Laying down responsible financing practices to ward off indebtedness and
ensure proper client protection principles and methods of recovery.
6)
Development of standardized set of covenants governing last mile lending to MSME
7)
Promoting right technology solutions for the last mile
8)
Formulating and running a Credit Guarantee scheme for providing guarantees to the
loans which are being extended to micro enterprises
9)
Creating a good architecture of Last Mile Credit Delivery to micro businesses under
the scheme of Pradhan Mantri Mudra Yojana

Steps taken by current government to

promote financial inclusion

Financial Inclusion through Pradhan Mantri Jan Dhan

Yojana

1.

The Pradhan Mantri Jan Dhan Yojana (PMJDY), the biggest financial inclusion
initiative in the world, has surpassed original target of opening bank accounts
for 7.5 crore uncovered households in the country by 26th January, 2015, with
banks already opening 11.50 Crore accounts by 17th January 2015

2.

Out of the accounts opened, 60% are in rural areas and 40% are in urban
areas.

3.

Share of female account holders is about 51%.The Rupay cards have been
issued to more than 10 crore beneficiaries who will get a benefit of personal
accidental insurance of Rs. 1.00 Lac under the Yojana. In addition there is a
life insurance cover of Rs.30, 000 for eligible beneficiaries

Steps taken by current government to

promote financial inclusion

Financial Inclusion through Pradhan Mantri Suraksha

Bima Yojana and alikes

1.

Covers accidental death risk of Rs.2 lakh for a premium of just Rs.12 per year.
Similarly, the Atal Pension Yojana, will provide a defined pension, depending
on the contribution, and its period

2.

To encourage people to join this scheme, the Government will contribute 50%
of the beneficiaries premium limited to Rs 1,000 each year, for five years, in
the new accounts opened before 31st December, 2015

3.

The third Social Security Scheme is the Pradhan Mantri Jeevan Jyoti Bima
Yojana which covers both natural and accidental death risk of Rs.2 lakhs. The
premium will be Rs.330 per year, or less than one rupee per day, for the age
group 18-50.

Fiscal Consolidation
Fiscal Consolidation refers to the policies undertaken by
Governments (national and sub-national levels) to reduce
their deficits and accumulation of debt stock. Key deficits of
government are the revenue deficit and the fiscal deficit.
Steps taken for fiscal consolidation
.
.
.
.
.
.
.

Cut down subsidies.

Stop leakages in subsidies.
Reform the tax structure (implement GST).
Improve the performance of PSUs.
Recover black money
Control wasteful Government expenditures. (= take austerity measures)
Policy reforms such as FDI (to create environment conductive for economy =
that will automatically increase productivity and tax collection.)

Fiscal Consolidation as per budget

2015-16

As per the current budget presented by Arun Jaitley, the government has
delayed the current financial consolidation plan by one year by keeping the
fiscal deficit at 3.9 % as opposed to the earlier projected 3.6% as per the
earlier roadmap.

As per the government, The rationale behind postponing fiscal

consolidation is to maintain a fine balance between the need to continue
with policy of fiscal rectitude to provide sufficient space for monetary policy
easing on one hand, the need to adequately provide for social and welfare
programmes and to increase public spending in core sectors to give a fillip
to growth.
Government on the other hand has taken several measures in this direction
like Stop leakages in Subsidy through EBT and Jan DhanYojana ;
Commitment to introduce GST from April 2016 ; Disinvestment in various
non performing PSUs ; Initiatives like Make in India and Skill India to
promote industry.