Monetary and Fiscal Policies

Monetary Policies Monetary Policy refers to the use of instrument within the control of the Central Bank to influence the level of aggregate demand for goods and services or to influence the trends in certain sectors of economy. It is a non-physical control mechanism as against physical controls like output control, capacity and licensing. Change in the quantum of savings and their characteristic has prepared the Indian economy for indirect management. The saving rate has gone up from 10% of GDP to over 20% by 1992. The second consideration is the perceptible fall in the incidence of poverty. Monetary Policy in a broad sense refers to monetary measures (BR, OMO, VRR) and non-monetary measures (wage and price control and budgetary operations) that influence the cost and supply of money. Monetary Policy in its narrow sense refers to the steps taken by the Central Bank to achieve socio-economic objectives like price stabilization, full employment, and faster economic growth.

Measure of Money Stock The RBI employs the following four measures of money stock: M1 usually described as the money supply. Also narrow money. The components of money supply are currency with public (notes in circulation, circulation of rupee coins and circulation of smaller coins) and deposit with banks and other deposits with the RBI. M2 - M2 is M1 + Post Office Savings. (Rs 3,85, 569 crores as on March 2001) M3 M3 is M1 + Time Deposit with banks. (Rs. 1500,000 crores as on March 2002) Called broad money representing the aggregate monetary resources of the entire banking sector. The representative sources of M3 are: The net bank credit to the government; Bank credit to commercial sector;
Macro Economic Indicators: Monetary & Fiscal

Prof. Arjun Madan, 2005 Policy ISB&M

Net foreign exchange asset of banking sector; and Government currency liabilities to the public. M4 M4 is M3+ total Post Office Deposits. (Rs. 13, 32,060 crores as on March 2001)

Evaluation of Monetary Policy (Criticism) Monetary Policy has been characterized as one of controlled expansion. RBI has failed both in expansion and control of money and credit in our economy. The major component of increase in money supply was the RBI credit to the Central Government. RBI did not play any effective role in controlling inflation. The growth of money supply was much higher than the growth in output. Fiscal indiscipline has made the monetary policy an exercise in futility. The RBI regulates only the commercial banks and has no or little control over NBFCs and indigenous bankers.

Review of Monetary System (Chakravarty Committee) The first ever review of Monetary System was done in 1925 by Hiltin Young Commission. After independence the RBI was burdened to help in the mobilization of resources for planned economic development through the Monetary System. This resulted in inflationary pressures on the economy. In 1982 the RBI appointed a committee to review the Monetary System under the chairmanship of Prof. Sukhamoy Chakravarty. The committee recommended that the Monetary System should be consistent with planned priorities. The mobilized savings should become socially purposive. Higher fiscal discipline.
Macro Economic Indicators: Monetary & Fiscal

Prof. Arjun Madan, 2005 Policy ISB&M

Mobilization of public savings in greater degrees. Higher savings from PSEs, and Improve efficiency in revenue gathering. The Monetary Policy was also reviewed by Vaghul Committee in 1987. In 1991 the Narasimhan Committee made comprehensive recommendation of financial market reforms.

Fiscal Policy A government policy concerned with raising revenue through taxation and other means and deciding the level and pattern of expenditure. World over the governments are using this policy to achieve such objectives as: o Accelerating the rate of investment; o Promoting socially desirable investment; o Achieving rapid economic development; o Achieving fully employment; o Promoting foreign trade; o Reducing inequalities of income; and o Establishing a welfare estate. The Budget The fiscal policy operates through budget. It is an estimate of government expenditure and revenue for a year. According the Constitution of India: o No tax can be levied or collected except by authority of law. o No expenditure can be incurred from public fund except in the manner provided in the constitution. o The executives must spend public money only in the manner sanctioned by the Parliament / State Legislature.
Prof. Arjun Madan, 2005 Policy ISB&M Macro Economic Indicators: Monetary & Fiscal

It is presented by the FM in the Parliament on the last working day of February every year. Discussion on the budget follows on later dates and then budget demands are put to vote. When the budget is passed in the Parliament it goes to the President for his assent. Tax proposals of the budget are embodied in the Finance Bill. The revenue and expenditure of the govt. are audited by CAG.

Deficits Budgetary Deficit o Total Assets Total Expenditure (C & R) Revenue Deficit o Revenue Receipts Revenue Expenditure Fiscal Deficit o Revenue Receipts + Certain non-debt Capital Receipts Total Expenditure (inclusive of loans) Monatized Deficit (Increase in net credit from RBI to CG) o Net Increase of TBs with RBI + Contribution of RBI to Market Borrowings of the CG

Prof. Arjun Madan, 2005 Policy ISB&M

Macro Economic Indicators: Monetary & Fiscal

Budgetary Resources

Revenue Receipts Tax Revenue Non-Tax Revenue

Capital Receipts

Direct

Indirect

Dividend (PSU) Admin Revenues Grants & Aids Socio-Eco Services MktBorrowings PF / Gratuity Govt. Bonds

IT Sale Tax Corp. Tax Excise Duty Wealth Tax Customs Duty Cap. Gain Tax Service Tax Interest Tax

Budgetary Expenditure

Plan

Non-Plan

Revenue Central Plan Defence (C) Agriculture Energy Industry Transport & Comm. Science & Tech Environment Soc. Ser. & Othrs. Central Asst. to State Plan

Capital Central Plan Plan Projects Soc & Community Dev. Eco. Development Loan to Foreign Govt. Defence General Services Central Asst. to State Plan

Revenue Interest Defence (R) Subsidies Police Pensions Eco Service Grants

Capital

Loan to PSEs Loans to SG/UT

Prof. Arjun Madan, 2005 Policy ISB&M

Macro Economic Indicators: Monetary & Fiscal

 Prof. Arjun Madan, 2005 Policy ISB&M

Macro Economic Indicators: Monetary & Fiscal