MONETRY AND FISCAL POLICY, UNION BUDGET, STATE BUDGET AND FINANCE

COMMISION

• MONETARY POLICY FISCAL

POLICY

• UNION BUDGET

CONTENT

Monetary policy is the process by which

monetary authority of a country, generally a central bank controls the supply of money in the economy by exercising its control over interest rates in order to maintain price stability and achieve high economic growth. in India, the central monetary authority is the  RBI.

MONETRY POLICY

The money supply or money stock, is the total amount of

monetary assets available in an economy at a specific time.

M1: Usually described as the money supply. (currency with the

public - notes & coins in circulation) and deposits – demand

deposits with bank & other deposits with RBI.

M2:M1+Post office savings bank deposits.

M3:M1+Time deposit with the bank. ( i.e. Money Supply + FD with

Banks)

M4:M3+Total Post office deposits.

MEASURE OF MONEY STOCK

Money supply comprises currency with the public and demand

deposits. The budgetary operation of the government affect money

supply. If govt. meets its budgetary deficit by borrowing from RBI , there will be an increase in money supply.

Demand deposit are important determinant of money supply which may originate in two ways – active or passive creation. Passive creation takes place when bank opens deposit account against cash or check drawn on other banks. Active creation takes place when banks create deposit by extending credits.

Central banking instruments operate by varying the cost and availability of credit and these produce desired changes in patterns of commercial banks. The capacity of banks depends upon their cash reserves , a substantial portion of reserves being generally held in form of balances with RBI.

MONETARY POLICY AND MONETARY SUPPLY

General Methods (Quantitative Methods) - Affect total quantity of credit and affect economy generally Selective Methods (Qualitative Methods)- Affect certain select sectors

INSTRUMENTS OF MONETARY POLICY

General credit controls Bank rate policy Open market operation Variable Reserve Ratio SLR Selective Credit Regulation Moral Suasion

INSTRUMENTS OF MONETARY POLICY

The bank rate, also known as the discount rate, is the rate of

interest charged by the RBI for providing funds or loans to the banking system. This banking system involves commercial and co-operative banks, Industrial Development Bank of India, EXIM Bank, and other approved financial institutes. Funds are provided either through lending directly or buying money market instruments like commercial bills and treasury bills. Increase in Bank Rate increases the cost of borrowing by commercial banks which results into the reduction in credit volume to the banks and hence declines the supply of money. Increase in the bank rate is the symbol of tightening of RBI monetary policy. As of 1 January 2013, the bank rate was 8.75% and from August 2013 bank rate is 10.25%

Bank Rate Policy – Lender of last resort

Every financial institute have to maintain a

certain amount of liquid assets from their time and demand liabilities with the RBI. These liquid assets can be cash, precious metals, approved securities like bonds etc.

The ratio of the liquid assets to time and demand liabilities is termed as Statutory Liquidity Ratio There was a reduction from 38.5% to 25%.The current SLR is 23%.

Statutory Liquidity Ratio

Cash Reserve Ratio is a certain percentage

of bank deposits which banks are required to keep with RBI in the form of reserves or balances .

Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa.RBI is empowered to vary CRR between 15 percent and 3 percent.

As of January 2013, the CRR is 4.00 percent.[

Cash Reserve Ratio or Variable Reserve Ratio

Repo rate is the rate at which RBI lends to

commercial banks generally against government securities. Reduction in Repo rate helps the commercial banks to get money at a cheaper rate and increase in Repo rate discourages the commercial banks to get money as the rate increases and becomes expensive

Repo Rate

Reverse Repo rate is the rate at which RBI

borrows money from the commercial banks. The increase in the Repo rate will increase the cost of borrowing and lending of the banks which will discourage the public to borrow money and will encourage them to deposit.

As the rates are high the availability of credit and demand decreases resulting to decrease in inflation. This increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the policy. As of October 2011, the repo rate is 8.25 and reverse repo rate is 7.25

Reverse Repo Rate

Selective methods of credit control regulate

the use of credit by discriminating between essential and non-essential purposes.

The central bank may prohibit or caution banks against particular type of securities.

May prescribe margins against secured advances.

Selective Credit Controls

The RBI can issue directives to banks in

respect of : 1) Their lending policies – the purpose for

which advances may or may not be granted. 2) The margins to be maintained on secured

advances 3) The rate of interest charged.

Qualitative Control Measures

Moral persuasion and direct action - When

commercial banks pursue an unsound credit policy or borrow excessively, the RBI may refuse to grant loans.

The RBI may charge penal rate of interests – direct action

Moral persuasion involves persuading the banks not to ask for further loans.

Moral Suasion

FISCAL POLICY

"Fiscal policy is the part of the government policy which is concerned with the raising revenue

through taxation and other means to decide on the level and pattern of expenditure“

It operates through budget – which is estimate of government revenue and expenditure for financial year. 

 

Definition

Fiscal Policy is the main part of Economic Policy and Fiscal Policy's first word Fiscal is taken from French word Fisc  it means treasure of Govt. So we can define fiscal policy as the revenue and expenditure policy of Govt. of India .It is prime duty of Government to make fiscal policy . By making this policy , Govt. collects money from his different resources and utilize it in different expenditure . Thus fiscal policy is related to development policy . All welfare projects are completed under this policy

Development of Country

Employment Reduction of Inequality

OBJECTIVE OF FISCAL POLICY

Techniques of Fiscal Policy

Taxation Policy 

→ If Govt. will increase taxes , more burden will be on the public and it will reduce production and purchasing power of public .

→ If Govt. will decrease taxes , then public's purchasing power will increase and it will increase the inflation.

Govt. Expenditure Policy 

There are large number of public expenditure like opening of govt schools , colleges and universities , making of bridges , roads and new railway tracks . In all above projects govt has paid large amount for purchasing  and paying wages and salaries all these expenditure are paid after making govt. expenditure policy . Govt. can increase or decrease the amount of public expenditure by changing govt. budget .

So , govt. expenditure is technique of fiscal policy by using this , govt. use his fund  first on very necessary sector and other will be done after this .

3. Deficit Financing Policy 

If Govt.'s expenditures are more than his revenue , then govt. should have to collect this amount . This amount is deficit and it can be fulfilled by issuing new currency by central bank of country . But , it will reduce the purchasing power of currency . More new currency will increase inflation and after inflation value of currency will  decrease . So, deficit financing is very serious issue in the front of govt. Govt. should use it , if there is no other source of govt. earning .

Public Debt Policy

If Govt. thinks that deficit financing is not sufficient for fulfilling the public expenditure or if govt. does not use deficit financing , then govt. can take loan from  world bank , or take loan from public by issuing govt. securities and bonds . But it will also increase the cost of debt in the form of interest which govt. has to pay on  the amount of loan . So, govt. has to make strong budget for this and after this amount is fixed which is taken as debt. This policy  can also use as the technique of fiscal policy for increase the treasure of govt.

The three possible stances of fiscal policy are neutral,

expansionary and contractionary. The simplest definitions of these stances are as follows:

A neutral stance of fiscal policy implies a balanced economy. This results in a large tax revenue. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity.

An expansionary stance of fiscal policy involves government spending exceeding tax revenue.

A contractionary fiscal policy occurs when government spending is lower than tax revenue.

Stances of fiscal policy

After issuing new notes for payment of govt. of

expenses , inflation of India is increasing rapidly and in this inflation , prices of necessary goods are increasing at a high rate. Living of poor person has become difficult . So , these sign shows the failure of Indian fiscal policy.

Govt. fiscal policy has failed to reduce the black money . Even large amount of  money of past minister is in the form of black money which is deposited in Swiss Bank.

Limitation of Fiscal Policy 

  "TOTAL REVENUE SHOULD BE GREATER

THAN THE EXPENDITURE“

FISCAL DEFICIT

Issue of bonds

Bonds refer to debt instruments bearing interest on maturity.

Treasury Bills They are the instrument of short-term borrowing

by the Government of India , issued as promissory notes under discount.

Gilt-edged securities  A constituent account maintained by a 

custodian bank for maintenance and servicing of dematerialized government securities owned by a retail customer.

BORROWING

The budget is the annual announcement of

the government’s fiscal policy changes. It announces the tax changes proposed for the following tax year and also how the government plan to spend the revenue.It is an instrument for fulfilling the obligations of the states It is a political statement of the priorities set by the government. It shows the financial transaction of the year.

Budget

The union budget The union budget which is yearly affair

comprehensive display of govt. finance

The structure of the budget

State budgets Estimate of the receipt and expenditures are

presented by state govt.

Finances of the union and states Sources of revenue union

Taxes on income other than agriculture income

BUDGET

Sources of revenue for the state

Land revenue including the assessment collection revenue

Duties respect of suction of agriculture land Concurrent list

Stamp duties other than duties or fees collected by judicial stamp

The finance commission

BUDGET CONT….

Accelerate the phase of economy Effective improvement in production in private

sector Effective improvement in income distribution Promote exports and encourage imports

substitution Achieve economic stabilization

IMPORTANCE OF BUDGET

Revenue receipts Capital receipts Revenue expenditure Capital expenditure

THUS A BUDGET HAS TWO MAIN COMPONENTS :[A] RECEIPTS ,[B]

EXPENDITURE.

COMPONENTS OF BUDGET

RECEIPTS

A. REVENUE RECEIPTS [1+2 ] 1. TAX REVENUE 2. NON –TAX REVENUEB. CAPITAL RECEIPTS [3+5] 3.RECOVERY LOANS 4.OTHER RECEIPTS 5.BORROWING & OTHER LIABILITIES TOTAL RECEIPTS = A+B

COMPONERNTS OF BUDGET

RECEIPT ITEMS OF THE BUDGET

RECEIPT ITEMS OF BUDGET

REVENUE RECEIPTS

CAPITAL RECEIPTS

REVENUE RECEIPTS

• TAX REVENUE +

• NON-TAX REVENUE

• =REVENUE RECEIPTS

TAX REVENUE INCLUDES ALL THE REVENUES

EARNED THROUGH VARIOUS KINDS OF TAXES.TAXES ARE BROADLY DIVIDED INTO DIRECT & INDIRECT TAXES.

TAX REVENUE

1. CORPORATION TAX2. INCOME TAX3. INTEREST TAX4. WEALTH TAX5. GIFT TAX6. EXPENDITURE TAX

DIRECT TAXES

1. CUSTOM DUTIES2. EXCISE DUTIES3. SALES TAX4. SERVICE TAX

INDIRECT TAX

IT INCLUDES THE REVENUE ACCRUING TO

THE GOVERNMENT FROM SOURCES OTHER THAN TAX.THESE ARE ;

1. INTEREST RECEIPTS2. DIVIDENDS3. GRANTS4. FINES

NON TAX REVENUE

THESE INCLUDE BORROWING OF THE

GOVERNMENT.SINCE THESE RECEIPTS HAVE TO BE REPAID BY THE GOVERNMENT ,THE CAPITAL RECEIPTS ARE LIABILITIES.CAPITAL RECEIPTS INCLUDE PUBLIC BORROWING ,RECOVERY OF LOANS AND RESALE OF SHARES AND BONDS HELD BY THE GOVERNMENT.

CAPITAL RECEIPTS

EXPENDITURE ITEMS

EXPENDITURE

REVENUE EXPENDITURE

CAPITALEXPENDITURE

IT IS THE EXPENDITURE INCURRED FOR THE

DAY-TO-DAY FUNCTIONONG OF THE GOVERNMENT DEPARTMENTS AND VARIOUS SERVICES OFFERED TO THE PEOPLE, PAYMENT OF INTEREST ON BORROWINGS,SUBSIDIES ETC.

REVENUE EXPENDITURE WILL NOT RESULT IN THE CREATION OF ASSETS

REVENUE EXPENDITURE

IT IS THE EXPENDITURE INCURRED FOR THE

DAY-TO-DAY FUNCTIONONG OF THE GOVERNMENT DEPARTMENTS AND VARIOUS SERVICES OFFERED TO THE PEOPLE, PAYMENT OF INTEREST ON BORROWINGS,SUBSIDIES ETC.

REVENUE EXPENDITURE WILL NOT RESULT IN THE CREATION OF ASSETS

REVENUE EXPENDITURE

CAPITAL EXPENDITURE IS THE EXPENDITURE

INCURRED ON CREATING PERMANENT ASSETS.SUCH EXPENDITURE IS INCURRED ON ITEMS LIKE CONSTRUCTION OF BUILDINGS,ROADS,BRIDGES,CANALS,POWER PLANTS,CAPITAL EQUIPMENTS

CAPITAL EXPENDITURE

It is revenue without any liability. Revenue

receipts of government includes earning from tax incomes(like corporation tax, income tax, custom) and non tax income(like interest from bond, dividend from PSU). where as capital receipt include borrowing of the government like market loan and short term borrowing.

REVENUE RECEIPTS

Meaning : Non quid pro quo transfer of private

income to public coffers by means of taxes. Classified into

1. Direct taxes- Corporate tax, Div. Distribution Tax, Personal Income Tax, Fringe Benefit taxes, Banking Cash Transaction Tax

2. Indirect taxes- Central Sales Tax, Customs, Service Tax, excise duty.

Taxation

It includes : Government spending on the purchase of

goods & services. Payment of wages and salaries of government

servants Public investment Transfer payments

Government Expenditure

the Finance Commission, which came into existence in

1951, under Article 280 of the Indian Constitution, which states:

The President will constitute a Finance Commission within two years from the commencement of the Constitution and thereafter at the end of every fifth year or earlier, as the deemed necessary by him/her, which shall include a chairman and four other members.

Parliament may by law determine the requisite qualifications for appointment as members of the Commission and the procedure of selection.

The Commission is constituted to make recommendations to the president about the distribution of the net proceeds of taxes between the Union and States and also the allocation of the same amongst the States themselves. It is also under the ambit of the Finance Commission to define the financial relations between the Union and the States.

Finance Commission

Distribution of net proceeds of taxes between

Centre and the States, to be divided as per their respective contributions to the taxes.

Determine factors governing Grants-in Aid to the states and the magnitude of the same.

to make recommendations to president as to the measures needed to augment the Consolidated Fund of a State to supplement the resources of the panchayats and municipalities in the state on the basis of the recommendations made by the Finance Commission of the state.

Functions of Finance Commission