Monetory and Fiscal Policy

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Monetory and Fiscal policy


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Monetary and fiscal policies

The Monetary and Fiscal policies are two importantinstruments employed by the authorities to influence the

behaviour and performance of the financial sector and theeconomy in general.

Monetary policy refers to the use of instruments within thecentral of the Central Bank (RBI) to influence the level ofaggregate demand for goods and services or to influence thetrend in certain sectors of the economy.

Monetary policy operates through varying the cost andavailability of credit.


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Measure of money supply

y M1- Currency with public and deposits (demand deposits withbanks and other deposits with RBI)

y M2- M1+ Post office savings deposits

y M3- M1+ Time deposits with banks.

y M4- M3+ Total post office deposits.


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Instruments of monetary policy

General- It affects the total quantity of credit and thusimpact the economy generally.

There are 3 general instruments of credit control

Bank Rate- The minimum rate at which the central bankprovides 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 advancesto commercial banks, consequently it leads to rise in therate of interest charged by commercial banks to theircustomers


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y Open Market operations- The purchase and sales offoreign exchange, gold, govt securities and even company sharesby central bank is known as open marketing operations.

Through open Market operations, the central bank seeks toinfluence the economy either by increasing the money supply orby decreasing the money supply.

To increase the money supply the central bank buys securitiesfrom commercial banks and public. A sale of securities by thecentral bank will have the effect of reducing the money supply.


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y Variable reserve ratio- Commercial banks have tomaintain a certain percentage of their deposits in the form ofbalances with the central bank (RBI) and the variation in thereserve requirement affect the credit creating capacity of

commercial banks.


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y Cash Reserve Ratio (CRR)- The minimum amount whichcommercial banks are required to keep in form of cash accordingto their total time and demand deposits. Variation in the CRRaffects money supply in the economy. Raising of CRR restricts

liquidity in thee system while reduction in CRR increase moneysupply.

y Statutory Liquidity Ratio (SLR)-A part of cash Reserve ratioSLR 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 increasein the cash reserve requirements, the overall liquidity obligations

are also raised.


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Selective Credit Regulation: Selective Credit controls relate to thedistribution or direction of available credit supplies. It is attained bygiving concessions to priority sectors. Thus it aims to discourage suchactivity which are considered to be relatively inessential or less

desirable.y Techniques of selective Credit control

y Minimum margins for lending against specific securities.

y Ceiling on the amounts of credit for certain purposes

y Discriminatory rates of interest charges on certain types of advances.

While imposing selective credit controls, it is ensured that credit froproduction, the movement of commodities and exports in not affected.


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Fiscal Policy

Fiscal policy is that part of Government policy which is concerned withraising revenue through taxation and other means and deciding on thelevel and pattern of expenditure. Thus Fiscal policy operates throughthe budget

Fiscal policy is seen as the major way of controlling economy. It has twomain roles

a. To remove any severe deflationary and inflationary gaps.

b. To smooth out the fluctuation in the economy associated with thebusiness cycle.

The first role is to prevent the occurrence of fundamental disequilibriumin the economy, where as the second role involves reducing govtexpenditure or raising taxes


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Union Budget as an Instrument of Growth and itsimpact on Business.

The constitution of India provides that

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

y No expenditure can be incurred for public funds except in manner

provided in the constitution.

y The executive authorities must spend public money in the mannersanctioned by the parliament.


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The Budget

The budget is an estimate of Government expenditure and revenue for thecoming financial year, presented to the Parliament by Finance Ministeron last day of February

It is also known as Annual Financial Statement. All the receipts and

disbursement of theU

nion Govt are kept under 2 separate headings

y Consolidated Fund of India- It includes all revenues received, loansraised and money received in repayment of loans by the Union Govt.No money can be withdrawn from this fund except under the authorityof an Act of parliament.

y Public Account of India- It comprises of, all other receipts anddisbursements such as deposits, service funds and remittance.


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The Structure of the budget

y Vertically Budget is divided into Revenue (receipts) andExpenditure (disbursements). However, horizontally it isdivided into Revenue account and Capital account. Thisled to further subcategorizing revenue side into RevenueReceipts and Revenue Expenditure and Expenditure sideinto Capital Receipt and Capital Expenditure

y Revenue Expenditure- All the current expenditure of theGovt on administration,

y Capital Expenditure- All the Capital transaction of theGovt

y Revenue Receipts- Revenue from taxes.y Capital Receipts- Market loans, external aid, income

from repayment


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Importance of the Budget

The budget strive to give maximum support to forces that canmove the country forward on the path of growth with stabilityand social justice with stability & social justice. The budgetshould set the stage fro the achievement of economic andsocial goals.

Certain sectors or industries get significantly impacted by theBudget proposal like tax proposals or budgetary allocations.

1. Accelerate the pace of economic development by mobilizingresources for the public sector and their optimal allocation.

2. To bring about improvement in production in the privatesector in accordance with the national priorities.

3. To bring about improvement in income distribution4. To promote exports and encourage import substitution.5. To achieve economic stabilization.

Documents

Monetory and Fiscal Policy