Monetary and Fiscal Policy of India

Agenda
• Introduction
• Monetary Policy
– Role & Objectives
– Instruments
– Inflation
• Fiscal Policy
– Role & Objectives
– Budget -> Revenue and Expenditure
– Taxation -> Structure
– Fiscal Deficit
• Reviews
• Conclusion
INTRODUCTION
Monetary Policy
Monetary Policy –Meaning….

Reserve Bank of India states that,

• Monetary policy refers to the use of instruments under the
control of the central bank to regulate the availability, cost and
use of money and credit.
Objectives
• Maintaining price stability
• Ensuring adequate flow of credit to the productive Sectors
of the economy to support economic growth
• Rapid economic growth
• Balance of payment equilibrium
• Full employment
• Equal income distribution
Methods
• The RBI aims to achieve its objectives of economic growth
and control of inflation through various methods.

These methods can be grouped as:

– General/ quantitative methods
– Selective/ qualitative methods
General/ Quantitative methods

• These methods maintain and control the total quantity or

volume of credit or money supply in the economy.
– Open Market Operations
• Open market operations indicate the buying/ selling of govt. securities in the open
market to balance the money supply in the economy

– Deployment of Credit
• The RBI has taken various measures to deploy credit in different sectors of the
economy. The certain percentage of the bank credit has been fixed for various sectors
like agriculture, export etc.
Direct Instruments
Cash reserve ratio (CRR)
 The money supply in the economy is influenced by CRR.

 It is the ratio of a bank’s time and demand liabilities to be kept in reserve with the RBI.

 The RBI is authorized to vary the CRR between 3% and 15%.

Statutory liquidity ratio (SLR):

 Under SLR, banks have to invest a certain percentage of its time and demand liabilities in govt.
approved securities.

 The reduction in SLR enhances the liquidity of commercial banks.

 Indirect Instruments
 Liquidity Adjustment Facility (LAF):
– Consists of daily infusion or absorption of liquidity on a repurchase basis,
through repo (liquidity injection) and reverse repo (liquidity absorption)
auction operations, using government securities as collateral.
i. Repo Rate:
– Repo rate is the rate at which the RBI lends short-term money to the banks
against securities. When the repo rate increases borrowing from RBI
becomes more expensive.
ii. Reverse Repo Rate:
– The rate at which RBI borrows from commercial banks.
• Marginal Standing Facility (MSF):
 Instituted under which scheduled commercial banks can borrow over night at their discretion up to one per cent
of their respective NDTL at 100 basis points above the repo rate to provide a safety valve against unanticipated
liquidity shocks

• Bank rate:
 Bank Rate is the rate at which central bank of the country (in India it is RBI) allows finance to commercial
banks.
 Bank Rate is a tool, which central bank uses for short-term purposes.
 Any upward revision in Bank Rate by central bank is an indication that banks should also increase deposit rates
as well as Base Rate / Benchmark Prime Lending Rate.

• Market Stabilization Scheme (MSS):

 Liquidity of a more enduring nature arising from large capital flows is absorbed through sale of short-dated
government securities and treasury bills.
 The mobilized cash is held in a separate government account with the Reserve Bank.
 SELECTIVE/ QUALITATIVE MEASURES
• The RBI directs commercial banks to meet their social obligations through selective/ qualitative
measures.
• These measures control the distribution and direction of credit to various sectors of the economy.

 CEILING ON CREDIT

 MARGIN REQUIREMENTS

 DISCRIMINATORY RATES OF INTEREST

FACTORS AFFECTING MONETARY POLICY
 There exist a non-monetized sector
 Excess of non-banking financial institutions (NBFI)
 Existence of unorganized financial market
 Money not appearing in an economy
 Time lag affects success of monetary policy
 Monetary policy and fiscal policy lacks coordination
INFLATION
• Inflation is broadly understood as the general rise in the
prices of goods and services year on year, inflation is a more
complex phenomena associated with the money supply and
currency values.
Problems caused by Inflation
• High and persistent inflation imposes significant socio-economic costs.
• High inflation distorts economic incentives by diverting resources away from
productive investment to speculative activities.
• Inflation reduces households saving as they try to maintain the real value of
their consumption.
• If domestic inflation remains persistently higher than those of the trading
partners, it affects external competitiveness through appreciation of the real
exchange rate.
The Reserve Bank’s current assessment suggests that the threshold level of
inflation for India is in the range of 4–6 per cent.
How does monetary policy affect inflation and other problems?

decreases
raises
FISCAL POLICY
Meaning
• Fiscal policy deals with the taxation and expenditure
decisions of the government. These include, tax policy,
expenditure policy, investment or disinvestment strategies
and debt or surplus management.
OBJECTIVES OF FISCAL POLICY
• Increase in capital formation.
• Degree of Growth.
• To achieve desirable price level.
• To achieve desirable consumption level.
• To achieve desirable employment level.
• To achieve desirable income distribution.
Fiscal Policy there are three possible
positions
• A Neutral position applies when the budget outcome has
neutral effect on the level of economic activity where the govt.
spending is fully funded by the revenue collected from the tax.
• An Expansionary position is when there is a higher budget
deficit where the govt. spending is higher than the revenue
collected from the tax.
• An Contractionary position is when there is a lower budget
deficit where the govt. spending is lower than the revenue
collected from the tax.
The Two Main instruments of fiscal policy
• Revenue Budget
• Expenditure Budget
Direct Tax Indirect Tax

• Individual Income Tax & • central excise (a tax on

Corporate Tax. manufactured goods)
• Wealth Tax @ 1% • VAT @ 12.5%
• Tax deducted at source • service tax @ 12%
• customs duty
• Educational tax @ 3%
 Expenditure Budget
• The central government is responsible for issues that usually concern the country as a
whole like national defense, foreign policy, railways, national highways, shipping,
airways, post and telegraphs, foreign trade and banking.

• The state governments are responsible for other items including, law and order,
agriculture, fisheries, water supply and irrigation, and public health.

• Some items for which responsibility vests in both the Centre and the states include
forests, economic and social planning, education, trade unions and industrial disputes,
price control and electricity.