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INTRODUCTION

The word fisc means ‘state tres asury’ and fiscal policy refers to policy

concerning the use of ‘state treasury’ or the govt. finances to achieve the macroeconomic

goals.

“any decision to change the level, composition or timing of govt. expenditure or to vary the

burden ,the structure or frequency of the tax payment is fiscal policy

Federal taxation and spending policies designed to level out the business cycle and

achieve full employment, price stability, and sustained growth in the economy. Fiscal policy

basically follows the economic theory of the 20th-century English economist John Maynard

Keynes that insufficient demand causes unemployment and excessive demand leads to

inflation. It aims to stimulate demand and output in periods of business decline by

increasing government purchases and cutting taxes, thereby releasing more disposable

income into the spending stream, and to correct overexpansion by reversing the process.

Working to balance these deliberate fiscal measures are the so-called built-in stabilizers,

such as the progressive income tax and unemployment benefits, which automatically

respond counter cyclically. Fiscal policy is administered independently of Monetary Policy

by which the Federal Reserve Board attempts to regulate economic activity by controlling

the money supply. The goals of fiscal and monetary policy are the same, but Keynesians

and Monetarists disagree as to which of the two approaches works best. At the basis of

their differences are questions dealing with the velocity (turnover) of money and the effect

of changes in the money supply on the equilibrium rate of interest (the rate at which money

demand equals money supply.

Measures employed by governments to stabilize the economy, specifically by

adjusting the levels and allocations of taxes and government expenditures. When the

economy is sluggish, the government may cut taxes, leaving taxpayers with extra cash to

spend and thereby increasing levels of consumption. An increase in public-works spending

may likewise pump cash into the economy, having an expansionary effect. Conversely, a

decrease in government spending or an increase in taxes tends to cause the economy to

contract. Fiscal policy is often used in tandem with monetary policy. Until the 1930s, fiscal

policy aimed at maintaining a balanced budget; since then it has been used

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"countercyclically," as recommended by John Maynard Keynes, to offset the cycle of

expansion and contraction in the economy. Fiscal policy is more effective at stimulating a

flagging economy than at cooling an inflationary one, partly because spending cuts and tax

increases are unpopular and partly because of the work of economic stabilizers.

Fiscal policy is manifested in a government's policies on taxation and expenditures.

To obtain funds for their operation, government units generally collect some form of taxes.

The expenditure of these funds not only provides goods and services for constituents, but

has a direct impact on the economy. For example, if expenditures are larger than the funds

received by the government, the resulting deficit tends to stimulate the economy, as goods

and services are produced for government purchase. In contrast, if a government runs a

surplus by not spending all the funds it collects, economic growth will generally be curtailed,

as the surplus funds are removed from circulation in the economy

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DEFINITION OF FISCAL POLICY

Fiscal policy is the means by which a government adjusts its levels of spending in

order to monitor and influence a nation’s economy.

Fiscal policy is that part of government policy which is concerned with razing

revenue through taxation and other means and deciding on the level and pattern of

expenditure.

In other wards the term fiscal policy refers to the expenditure a government

undertakes to provide goods and services and to the way in which the government finances

these expenditures.

Objectives of Fiscal Policy

1. To achieve desirable price level:

The stability of general prices is necessary for economic stability. The maintenance

of a desirable price level has good effects on production, employment and national income.

Fiscal policy should be used to remove; fluctuations in price level so that ideal level is

maintained

2. To Achieve desirable consumption level:

A desirable consumption level is important for political, social and economic

consideration. Consumption can be affected by expenditure and tax policies of the

government. Fiscal policy should be used to increase welfare of the economy through

consumption level.

3. To Achieve desirable employment level:

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The efficient employment level is most important in determining the living standardof

the people. It is necessary for political stability and for maximization of production. Fiscal

policy should achieve this level.

4. To achieve desirable income distribution:

The distribution of income determines the type of economic activities the amount of

savings. In this way, it is related to prices, consumption and employment. Income

distribution should be equal to the most possible degree. Fiscal policy can achieve equality

in distribution of income.

5. Increase in capital formation:

In under-developed countries deficiency of capital is the main reason for

under-development. Large amounts are required for industry and economic development.

Fiscal policy can divert resources and increase capital.

6. Degree of inflation:

In under-developed countries, a degree of inflation is required for economic

development. After a limit, inflationary be used to get rid of this situation

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3

GOVERMRNT VIEW ON FISCAL POLICY

Central Government

Against this fiscal background and after three years of discussion, India enacted the

FRBMA in August 2003. The FRBMA covers only the central government and its stated

objective is to ensure inter-generational equity in fiscal management, achieve fiscal

sustainability necessary for long-term macro-economic stability, and improve the

transparency of central government fiscal operations. In July 2004, a set of implementing

rules came into force. Similar to most FRLs around the world, the FRBMA establishes the

broad framework for conducting fiscal policy by setting out both procedural as well as

numerical rules.7

The procedural rules of the FRBMA specify the principles of transparency and

accountability in designing, implementing and assessing fiscal policy. They require the

government to commit up-front to a monitorable fiscal policy strategy over a multiyear

period, and to report and publish fiscal outcomes and strategy changes on a routine basis.

The bill prescribes the submission to parliament of yearly statements on medium-term fiscal

policy, the fiscal policy strategy, and a macroeconomic framework that outline rolling targets

for prescribed fiscal indicators. These statements should include the underlying

macroeconomic assumptions, the policies of the government including relating to taxation,

expenditure, borrowing, and key fiscal measures. Fiscal targets are monitored by the

Ministry of Finance, which prepares quarterly reports on the trends in revenue and

expenditure. These reports are sent to parliament for information. If substantial deviations

from the fiscal targets were to occur, the Minister of Finance is obliged to present to

parliament an explanation of the deviations and remedial measures to address them.

However, there is no timeframe by which the deviations need to be addressed, and failure

to meet the targets does not trigger any explicit sanction.

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The FRBMA and the associated rules set out fiscal targets in a multiyear context. The Act

includes a single, medium-term, zero-current-balance target for the central government to

be achieved by March 2008. The associated rules, meant to guide the execution of the

provisions of the Act, set out the following numerical rules: (i) reduction of current deficit by

at least 0.5 per cent of GDP in each financial year beginning with 2004/05; (ii) reduction of

the fiscal deficit by at least 0.3 percent of GDP in each financial year so that the fiscal deficit

is brought down to not more than 3 per cent of GDP at the end of March 2008; (iii) limit of

0.5 percent of GDP on the incremental amount of guarantees given by the central

government; and (iv) initial annual limit on debt accumulation of 9 percent of GDP, to be

progressively reduced by at least one percentage point of GDP each year. Precise

accounting definitions of the relevant target indicators are not provided in the legislation.

The original deadline to meet the above specified targets was postponed to March 2009 (in

2005/06) and then again to March 2010 in the 2008/09 Budget. According to the Act,

breaches of th e fiscal targets are allowed on grounds of national security or national

calamity or such other exceptional grounds as the Central government may specify.

Adoption of Fiscal Rules and Fiscal Adjustment Across India’s States

The variation in the timing of enactment of FRLs across India’s states can be used to

investigate whether there is a relationship between the adoption of fiscal rules and the

observed fiscal adjustment. Specifically, for each of India’s 17 states, we construct a

timevarying state-specific indicator, which equals the interaction of (i) an indicator for

whether the state has ever enacted a FRL, and (ii) an indicator specifying whether the time

period is the post-FRL enactment period. Since all of the states’ FRLs include a target for

current deficit (following the TFC’s recommendations), we choose the current deficit as a

share of GSDP as the measure of fiscal stance. In order to better capture the states’ own

fiscal effort, we refine the current deficit measure by excluding resource transferred from

the center, as well as interest payments. We then regress this measure of the current deficit

as a share of GSDP on the post-FRL indicator. We include year fixed-effects to control for

economy-wide changes (such as economic growth, higher revenues at the central level,

implementation of the TFC recommendations) and state fixed-effects to control for time-

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invariant 1heterogeneity in fiscal conditions across India’s states. All specifications also

control for the (log of) state GSDP, the lagged value of the debt to GSPD ratio, and an

indicator for the adoption of the VAT at the state level.

The evidence of the effect of fiscal rules on fiscal performance in India’s states is weak.

According to our simple empirical exercise, the conventional measure of the current deficit

significantly declines once a state adopts an FRL (columns (1)-(3)).13 The result is robust

to varying the time-period covered or using alternative estimation techniques (such as the

Arellano Bond dynamic panel GMM estimator). However, once the measure of current

deficit is refined to exclude the resources transferred by the center (columns (4)-(9)), the

coefficient on the post-FRL indicator becomes not only statistically insignificant but declines

substantially in magnitude. Fiscal rules do not appear to be associated in a statistically

significant manner with greater fiscal adjustment at the state level.

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Fiscal Policy And Macroeconomic Goals

• Economic Growth: By creating conditions for increase in savings & investment.

• Employment: By encouraging the use of labour-absorbing technology

• Stabilization: fight with depressionary trends and booming (overheating) indications

in the economy

• Economic Equality: By reducing the income and wealth gaps between the rich and

poor.

• Price stability: employed to contain inflationary and deflationary tendencies in the

economy.

The purpose of Fiscal Policy:

Reduce the rate of inflation.

Stimulate economic growth in a period of a recession.

Basically, fiscal policy aims to stabilize economic growth, avoiding the boom and bust

economic cycle.

Instruments of Fiscal Policy

• Budgetary surplus and deficit

• Government expenditure

• Taxation- direct and indirect

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• Public debt

• Deficit financing

Budgetary surplus and deficit

• “A budget is a detailed plan of operations for some specific future period”

• Keeping budget balanced (R=E) or deficit (R<E) or surplus (R>E) as a matter of

policy is itself a fiscal instrument.

• An accumulated deficit over several years (or centuries) is referred to as the

government debt

• A deficit is a flow. And a debt is a stock. Debt is essentially an accumulated flow of

deficits

Government expenditure

It includes :

• Government spending on the purchase of goods & services.

• Payment of wages and salaries of government servants

• Public investment

• Transfer payments

Taxation- direct and indirect

• Meaning : Non quid pro quo transfer of private income to public coffers by means of

taxes.

• Classified into

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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.

Public debt

• Internal borrowings

1. Borrowings from the public by means of treasury bills and govt. bonds

2. Borrowings from the central bank (monetized deficit financing)

• External borrowings

1. foreign investments

2. international organizations like World Bank & IMF

Public Expenditure

In simple terms a public expenditure is the amount spent by the government for the welfare

of the citizens, for instance Defence expenditure, Interest Payments, Medical expenses,

Infrastructure expenses and etc. Public expenditure can basically be divided into two State

Government Expenses (Capital Account Expenditure) and Central Government Expenses

(Revenue Account Expenditure).

Public expenditure (Old)

The table includes some of the most important expenditures of the Central and State

Government.

Some expenses are a common i.e. are made by both state and centre, like Infrastructure

(the local roads are a part of State government expenses and the highways or express 10

highways are a part of Centre) the centre has NHAI for that purpose, Medical Facilities like

108 and Civil hospital are expenses of State government and Polio booth and AIDS

campaign are a part of Centre’s expenses.

Public expenditure (New as found in Budget 1987-'88)

Planned Expenditure- Agriculture expenses (Subsidies and irrigation), Industrial expenses

(SEZ’s and Tax Holidays), Science and Technology (Bhabha Atomic Research Centre),

Social and Economics Services (salaries to the employees and Grants to the non-profitable

organisations).

Non-Planned Expenditure- Interest payments (Public and State Debt), Defence, Pensions,

Loans and finance to the state and foreign embassy expenses.

Public Debt

Public debt is the total amount of borrowing by the government (State or the Central

Government) internally or externally. Now there are questions like Public debt a good or

bad idea? The answer is it is good upto an extent that i.e. to an extent the government can

pay or else this might land the government into a so called “Debt trap”. A Debt Trap is

simply a chain of borrowing to pay the debts. There are two types of Debts Internal and

External. Internal debt (Rs. 33 Lac Cr.) is borrowings by the government from within the

country in terms of Treasury bills issued by the government, loans from the financial sector

and etc. External debt (Rs. 1.37 Lac Cr.) is borrowings from outside the country in terms of

Bonds issued in the international market, loans from international institutions like IMF,

World bank or any foreign country. Public Debt has had increase since India started

Developing and as the debt increased the interest payment increased, in 2008-’09 it was

31.5 % of the non-planed expenses and further increased to 33.8% in 2010-’11 excessive

interest payments have been a major concern for the Indian government now.

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The Golden Rule

The Government's fiscal policy framework is based on the five key principles set out

in the Code for fiscal stability - transparency, stability, responsibility, fairness and

efficiency.

The Code requires the Government to state both its objectives and the rules

through which fiscal policy will be operated. The Government's fiscal policy

objectives are:

• over the medium term, to ensure sound public finances and that spending and

taxation impact fairly within and between generations; and

• over the short term, to support monetary policy and, in particular, to allow the

automatic stabilisers to help smooth the path of the economy.

• These objectives are implemented through two fiscal rules, against which the

performance of fiscal policy can be judged. The fiscal rules are:

• the golden rule: over the economic cycle, the Government will borrow only to invest

and not to fund current spending; and

• the sustainable investment rule: public sector net debt as a proportion of GDP will be

held over the economic cycle at a stable and prudent level. Other things being equal,

net debt will be maintained below 40 per cent of GDP over the economic cycle.

• The fiscal rules ensure sound public finances in the medium term while allowing

flexibility in two key respects:

• the rules are set over the economic cycle. This allows the fiscal balances to vary

between years in line with the cyclical position of the economy, permitting the

automatic stabilisers to operate freely to help smooth the path of the economy in the

face of variations in demand; and

• the rules work together to promote capital investment while ensuring sustainable

public finances in the long term. The golden rule requires the current budget to be in

balance or surplus over the cycle, allowing the Government to borrow only to fund

capital spending. The sustainable investment rule ensures that borrowing is

maintained at a prudent level. To meet the sustainable investment rule with

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confidence, net debt will be maintained below 40 per cent of GDP in each and every

year of the current economic cycle.

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Fiscal policy in action

the effects of the fiscal policy in action as follow

The rise in AD leads to an increase in real national income, ceteris paribus, unemployment

would fall to 3% but at a cost of higher inflation

AD therefore shifts to the right to AD1

AD=C+I+G+(X-M)

Apart from G, C and I are also likely to be affected directly or indirectly by the policy

change.

If government ‘reduces taxes’ (remember the subtleties) and or increases spending,

it will have various effects:

Assume an initial equilibrium position with a level of National Income giving an

unemployment rate of 5% (U = 5%)

Fiscal Policy influences AD in the short term but can be used to affect AS in the long

run – depending on the nature of the policy.

Try your hand at Fiscal Policy by going to the Virtual Economy

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Measures of Fiscal Policy

Features of the Indian Tax System

Tax system in India is very rigid and unclear. Every country has its own Tax system

depending upon type of income there citizens have, developed countries have a

simple and clear system as the government there is very efficient in mobilising

resources gained from Tax and hence because unequal distribution of income in

Under develop and developing nations the tax system is rigid. The economy does

yield enough for the government to collect taxes as they want/estimate and but the

whole mechanism does not work the way it is supposed to work. The features of the

Tax system can be divided into two i.e. +’s and –‘s.

+’s of the Indian Tax system

Increasing Receipts

Since 1950 there has been huge increase in Tax and Non-Tax receipts, in 1950-’51

the net Tax income was 357 Crores of the Central government which increased to

9,388 Crores in 1980-’81 and in 2001-’02 it increased to 5,63,685 Crores. The

reason behind this seems to be increasing base of the Tax structure and the

awareness about the importance of paying taxes, moreover there has been similar

increase in the income of the people(also because of high Inflation an d reduction in

the internal value ofIndian Rupee) which has enable the government to earn more in

terms of Tax and Non-Tax income. The Non- Tax revenue also a similar hike in

1950-’51 the income was 49 Crores which increased to 2.20 lac Crores in 2010-’11

which are explained by a reason of increasing Privatisation and

Liberalisation.Examples of Tax Revenue are Income tax, corporate tax, wealth tax

and etc. Examples of Non-Tax Revenue are Fines, Penalties, income on lending to

state government or private companies.

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Direct and Indirect Taxes

Fine balance has been maintained in the direct and indirect tax over the years, in

2009-’10 the direct taxes were 44% and indirect taxes stood at 56%. An imbalance

between these taxes can create problems with income inequality suggested OECD.

SLAB system

The Income tax Slab system has been fantastic feature of the Tax system, according

to the recent change incomes upto Rupees 1,80,000 there shall be no tax liability of

an individual. This has given rise to incomes to those who earn low and those who

earn more than 8,00,000 shall be liable to pay 30% tax on the same and hence this

would make them earn about 5,60,000. This shows how much impact the Income

Tax Slabs have on the income disparity.

Service Tax (Good as well as bad)

The service tax was first introduced in the Union Budget in 1994-’95 as a result of a

recommendation of Chelliah Committee. A service tax is a tax that is levied on

services provided to a consumer for instance on those like communication services,

education providers, Entertainment, General Insurance and etc. One of the best

illustrations of service tax is that we pay on while buying a movie ticket or while

buying coldrinks and popcorn in a multiplex, those high prices are a result of service

tax they pay over the services they provide. Currently there are 112 services over

which the service tax is levied. The service tax is levied at 10% according to the

union budget 2010-’11.

Tax on Luxury Items

Taxes on Luxury goods and services have been increased over the years with

introduction of more of these goods and services, this has been in vision to reduce

the income inequalities. While there is an increase in service tax people those who

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use them have to pay more hence expenses increase and savings decrease to bring

the disparity closer as those who earn a minimum amount will not be able to have

these Luxuries.-’s of the Indian Tax system

Tax on Agriculture

The agriculture department has not been taxed enough, about 65% of the whole of

India is involved in agriculture sector and 20% of the total National Income comes

from Agriculture sector but the Tax received from the same stands at 0.0060% which

was about 26 Crores (Agriculture Income Tax). The balance that all the sectors have

into their share in Taxes has been largely odd, further due to number of reasons the

revenue has been highly decreasing in the agriculture sector.

Tax Arrears

There have been so many instances of taxes not being paid, according to March

2008 survey the amount of unpaid Direct taxes came to 80,160 Crores and indirect

taxes came to 23,622 Crores. And there are more unpaid taxes in relation to excise

and customs. These arrears are a result of ignorance, inefficient& lengthy law

process and tax system. The consequence of not paying taxes shall be made clear

to the citizens; there should be change in the tax laws to reduce these arrears which

will help in recovering the arrears as well.

Refer for recent news on Tax Arrears:

http://www.dnaindia.com/money/report_ahmedabad-owes-rs4800-crore-to-income-

tax-department_1360764

Tax Evasion

Some of the features of the tax system have allowed people to evade paying taxes;

HUL (Hindu Undivided Family) is one of them. People pay taxes on the name of the

family being undivided and save a lot of tax. This has led to an increase in the

amount of black money that is in the circulation in the market.

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Lack of Continuity

With an unstable economy there comes an unstable system as well. The tax system

has undergone huge changes since its inception. The Income Tax slabs increases

every year, there are new items that are included every year, in a nutshell there are

changes in the tax system that do not yield much of growth or development in terms

of reducing income inequalities and an efficient use of the same.

Narrow Base

There are a number of taxes which do not yield enough for the government to make

maximum utilisation. Taxes like wealth tax, income tax, capital gain and etc only

cover 0.7% of the Population. Because of Tax evasion and improper tax system

people who earn more can even avoid tax through number of ways.

http://www.deccanherald.com/content/187531/only-277-percent-indias-

population.html

High tax on basic necessity

Excessive tax on basic necessities like fuel has been a huge concern. The

government earns plenty on the taxes levied on such basic items that every single

citizen needs, the result is high inflation and increasing cost of living. Taxes are

usually levied to manage the flow of income but in India taxes on basic necessity has

crossed all limits, over that the government has not been able to subsidise the oil

producing companies increasing the pressure for them to increase prices of the

same.

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BUDGET

• “A budget is a detailed plan of operations for some specific future period”

• It is an estimate prepared in advance of the period to which it applies.

COMPONENTS OF BUDGET

• Revenue receipts

• Capital receipts

• Revenue expenditure

• Capital expenditure

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19

Where The Rupee Comes From

service & other taxes7%

excise17%

customs12%

income tax13%

corporation tax21%

borrowings19%

non-debt capital reciepts1%

non-tax revenue10%

Where Does The Rupee Goes To

state's share of taxes & duties18%

non plan assistance to states5%

planned state assistance7%

central plan20%interest

20%

defence12%

subsidies7%

other non plan exp.11%

Chart Title

Government Income

• Tax Revenue

• Sale of Government Services – e.g. prescriptions, passports, etc.

• Borrowing (PSNCR)

Public Sector Income

Enhancement in the st

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state's share of taxes & duties18%

non plan assistance to states5%

planned state assistance7%

central plan20%interest

20%

defence12%

subsidies7%

other non plan exp.11%

Chart Title

Fiscal policy is the economic term that defines the set of principles and decision of

government in setting the level of public expenditure and how the expenditure is funded.

In economics, fiscal policy is the use of government spending and revenue

collection to influence the economy

Fiscal policy can be contrasted with the other main type of economic policy, monetary

policy, which attempts to stabilize the economy by controlling interest rates and the supply

of money. The two main instruments of fiscal policy are government spending and taxation.

Changes in the level and composition of taxation and government spending can impact on

the following variables in the economy:

Aggregate demand and the level of economic activity;

The pattern of resource allocation;

The distribution of income.

Fiscal policy refers to the overall effect of the budget outcome on economic activity. The

three possible stances of fiscal policy are neutral, expansionary, and contractionary:

A neutral stance of fiscal policy implies a balanced budget where G = T (Government

spending = 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 a net increase in government

spending (G > T) through rises in government spending, a fall in taxation revenue, or

a combination of the two. This will lead to a larger budget deficit or a smaller budget

surplus than the government previously had, or a deficit if the government previously

had a balanced budget. Expansionary fiscal policy is usually associated with a

budget deficit.

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A contractionary fiscal policy (G < T) occurs when net government spending is

reduced either through higher taxation revenue, reduced government spending, or a

combination of the two. This would lead to a lower budget deficit or a larger surplus

than the government previously had, or a surplus if the government previously had a

balanced budget. Contractionary fiscal policy is usually associated with a surplus.

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Methods of funding

Governments spend money on a wide variety of things, from the military and police to

services like education and healthcare, as well as transfer payments such as benefits.

This expenditure can be funded in a number of different ways:

Taxation

Seignorage, the benefit from printing money

Borrowing money from the population, resulting in a fiscal deficit

Consumption of fiscal reserves.

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Sale of assets (e.g., land).

Funding the deficit

A fiscal deficit is often funded by issuing bonds, like treasury bills or consols. These

pay interest, either for a fixed period or indefinitely. If the interest and capital repayments

are too large, a nation may default on its debts, usually to foreign creditors.

Consuming the surplus

A fiscal surplus is often saved for future use, and may be invested in local (same

currency) financial instruments, until needed. When income from taxation or other sources

falls, as during an economic slump, reserves allow spending to continue at the same rate,

without incurring additional debt.

Economic effects of fiscal policy

Governments use fiscal policy to influence the level of aggregate demand in the

economy, in an effort to achieve economic objectives of price stability, full employment, and

economic growth. Keynesian economics suggests that adjusting government spending and

tax rates are the best ways to stimulate aggregate demand. This can be used in times of

recession or low economic activity as an essential tool for building the framework for strong

economic growth and working toward full employment. The government can implement

these deficit-spending policies to stimulate trade due to its size and prestige. In theory,

these deficits would be paid for by an expanded economy during the boom that would

follow; this was the reasoning behind the New Deal.

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Governments can use budget surplus to do two things: to slow the pace of strong

economic growth, and to stabilize prices when inflation is too high. Keynesian theory posits

that removing funds from the economy will reduce levels of aggregate demand and contract

the economy, thus stabilizing prices.

Some classical and neoclassical economists argue that fiscal policy can have no

stimulus effect; this is known as the Treasury View, which Keynesian economics rejects.

The Treasury View refers to the theoretical positions of classical economists in the British

Treasury, who opposed Keynes' call in the 1930s for fiscal stimulus. The same general

argument has been repeated by neoclassical economists up to the present. From their point

of view, when government runs a budget deficit, funds will need to come from public

borrowing (the issue of government bonds), overseas borrowing, or the printing of new

money. When governments fund a deficit with the release of government bonds, interest

rates can increase across the market. This is because government borrowing creates

higher demand for credit in the financial markets, causing a lower aggregate demand (AD),

contrary to the objective of a budget deficit. This concept is called crowding out; it is a

"sister" of monetary policy.

In the classical view, fiscal policy also decreases net exports, which has a mitigating

effect on national output and income. When government borrowing increases interest rates

it attracts foreign capital from foreign investors. This is because, all other things being

equal, the bonds issued from a country executing expansionary fiscal policy now offer a

higher rate of return. In other words, companies wanting to finance projects must compete

with their government for capital so they offer higher rates of return. To purchase bonds

originating from a certain country, foreign investors must obtain that country's currency.

Therefore, when foreign capital flows into the country undergoing fiscal expansion, demand

for that country's currency increases. The increased demand causes that country's currency

to appreciate. Once the currency appreciates, goods originating from that country now cost

more to foreigners than they did before and

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The fiscal policy of 2012-13

It has been calibrated with two fold objectives – first, to aid economy in growth revival; and

second, to bring down the deficit from 2011-12 level so as to leave space for private

sector credit as the investment cycle picks up. Being the first year of the 12th Five Year

Plan, an ambitious outlay which is 22.1 per cent higher than RE 2011-12 has been

provided. Even with higher increase in plan allocation, fiscal deficit has been reduced from

5.9 per cent of GDP in RE 2011-12 to 5.1 per cent in BE 2012-13. With policy measures, it

is estimated that non-plan expenditure could be controlled with a growth of 8.7 per cent in

BE 2012-13 over RE 2011-12. This would result in overall expenditure increase of 13.1

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per cent in BE 2012-13 over RE 2011-12. As percentage of GDP, total expenditure is

estimated to marginally reduce to 14.7 per cent in BE 2012-13 from 14.8 per cent in RE

2011-12.

Thus most of the correction in fiscal deficit has been targeted through revenue

augmentation. It may be recalled that gross tax revenue as percentage of GDP declined

sharply from high of 11.9 per cent in 2007-08 to 9.7 per cent in 2009-10. It is now estimated

to increase from 10.1 per cent of GDP in RE 2011-12 to 10.6 per cent in BE 2012-13

(reflecting growth of 19.6 per cent over RE 2011-12). This level of growth

may look ambitious if seen in isolation. However, after netting off the impact of additional

resource mobilization proposed in indirect taxes, BE 2012-13 is estimated at a growth of

15.0 per cent over RE 2011-12.

In order to keep the overall expenditure under the estimated level, government has taken

certain decisions to control the growth of expenditure in subsidies and other related items.

Decision of the Government on move towards nutrient based subsidy (NBS) regime in

fertiliser is expected to reduce expenditure on this component of fertilser subsidy during

2011-12. At the same time, NBS regime is also expected to promote balanced use of

fertilizer leading to increase in agricultural productivity. 20. With respect to rationalization of

petroleum subsidy, government has already decontrolled the pricing of petrol. With the help

of AADHAAR (unique identity programme), it would be possible to attempt a direct cash

transfer mechanism in phased manner for LPG and kerosene which in turn may reduce the

subsidy requirement. States have been given this option to opt for direct cash transfer

mechanism.

Though in principle decision regarding decontrol of diesel price has been taken, the

implementation of this decision has not yet not taken place in view of

prevailing high international prices.

Tax Policy

During the fiscal consolidation period, the tax- GDP ratio improved significantly from 9.2 per

cent in 2003-04 to 11.9 per cent in 2007-08. This was achieved through rationalisation of

the tax structure (moderate levels and a few rates), widening of the tax base and reduction

in compliance costs through improvement in tax administration. The extensive adoption of 26

information technology solutions and reengineering of business processes have also

fostered a less intrusive tax system and encouraged voluntary compliance. These

measures have resulted in increased buoyancy in tax revenues till 2007-08 and helped in

fiscal consolidation. However, due to the stimulus measures undertaken during the crisis

period of 2008-09 and 2009-10 to insulate Indian economy from the adverse impact of

global economic crisis and lower growth in economy, the gross tax revenue as percentage

of GDP declined sharply to 9.7 per cent in 2009-10.

On the positive side, however, the results of these stimulus measures have helped in swift

and broad based recovery, particularly in manufacturing and services sector during 2010-

11. With the moderation in growth in 2011-12 and prevailing high inflation situation,

government had to further reduce taxes/duty on petroleum products. During 2011-12, gross

tax receipts as percentage of GDP is estimated to decline to 10.1 per cent from 10.3 per

cent in 2010-11. However, with partial roll back of stimulus measures in indirect taxes, it is

estimated that tax receipt as percentage of GDP would improve to 10.6 per cent.

Indirect taxes

In keeping with the overall thrust of fiscal policy, in the realm of indirect taxes too, the

stance during 2012-13 would be in favour of further fiscal consolidation. This agrees with

the medium term objective of enhancing the tax-GDP ratio both through base expansion as

well as administrative improvement. Among the latter, the emphasis is on more intense

deployment of Information Technology in business processes so that physical interface

between the taxpayer and the Department is reduced and return data critical for developing

compliance strategies and interventions is captured and updated seamlessly.

In the medium term, the most significant step from the point of view of broadening the tax

base and improving revenue efficiency through better compliance is the introduction of

Goods and Services Tax (GST). As far as Central taxes viz. Central Excise duties and

Service Tax are concerned, a fair amount of integration has already been achieved,

especially through the cross-flow of credits across the two taxes. Further measures such as

adoption of a common return format are proposed in the Budget. It would be possible to

realise full integration of the taxation of goods and services only when the State VAT is also

subsumed and a full-fledged GST is launched. The Constitution Amendment Bill to put in

place the enabling legal framework has already been introduced in the Lok Sabha and is 27

currently being examined by the Standing Committee on Finance. In the meanwhile, the

dialogue with the State Governments for finalizing the structure, design and roadmap for

the implementation of GST would continue.

There are several specific proposals in the Budget 2012-13 to recalibrate the tax effort on

indirect taxes so that fiscal consolidation may be achieved in the short term. The important

and revenue significant proposals include:

Shift from a “positive” list approach to a “negative” list approach in the taxation of

services;

12

Fiscal Outlook for 2013-14 to 2015-16.

Government undertook p0ath of fiscal consolidation with mid-year course correction in

2012-13. Fiscal policy 2013-14 has been designed to meet the macro-economic challenges

faced by India in an uncertain international economic situation. By 7bringing back the focus

on fiscal consolidation process, government has undertaken measures to reduce the fiscal

deficit from 5.2 per cent of GDP in RE 2012-13 to 4.8 per cent of GDP in BE 2013-14. This

reduction in fiscal deficit by 0.4 percentage point is largely revenue driven. While

expenditure is retained at the same level of 14.6 per cent of GDP in BE 2013-14, increase

28

in tax revenue and non-tax revenue is of the order of 0.4 per cent and 0.2 per cent of GDP

respectively.

Revenue deficit has been estimated at 3.3 per cent of GDP in BE 2013-14. The revenue

deficit is marginally lower than BE 2012-13 level of 3.4 per cent. However, it is substantially

lower than the RE 2012-13 at 3.9 per cent. Slew of policy measures taken to tackle the

increasing subsidy bills, especially decision to progressively increase diesel prices to link it

to market prices will be yielding results progressively. It is expected that with better

expenditure management the revenue deficit will be reduced to 2.7 per cent and 2.0 per

cent in financial year 2014-15 and 2015-16 respectively.

As a significant proportion of revenue expenditure is being provided as grants for creation

of capital assets, it would be pertinent to look at the effective revenue deficit of the

government. The effective revenue deficit, after factoring in the above mentioned grant

component in the revenue account, is estimated at 1.8 per cent of GDP in BE 2013-14. It is

further projected to decline to 0.9 per cent in 2014-15 and 0.0 per cent in 2015-16

It is this component of imbalance in revenue account which needs to be addressed in right

earnest – through expenditure management and revenue augmentation.

Total liabilities of the government, as a percentage of GDP, will also see a decline

continuing with the trend in the recent past. At end of 2012-13, a total liability of the

Government is estimated at 45.9 per cent of GDP which will reduce to 45.7 per cent by the

end of 2013-14. Continuing the declining trend it is likely to reduce to 44.3 per cent in 2014-

15 and 42.3 per cent in 2015-16. A progressive reduction in debt-GDP ratio of the

Government will ease the interest burden and allow more space for the government to

spend particularly on infrastructure development without taking recourse to additional

borrowings

Gross tax revenue is estimated to increase from 10.4 per cent of GDP in RE 2012-13 to

10.9 per cent in BE 2013-14 (reflecting growth of 19.1 per cent over RE 2012-13), which is

however still lower than peak of 11.9 per cent of GDP achieved during 2007-08 With

economy reverting back to the path of trend growth rate, it would be possible to get back to

the achieved level of tax to GDP ratio. In the medium term targets, gross tax collection as

percentage of GDP is projected at 11.2 per cent in 2014-15 and 11.5 per cent in 2015-16.

29

The fiscal consolidation roadmap enumerated in this Statement, is designed with a

conscious effort to bring down total expenditure of the government as percentage of GDP to

the pre-crisis level i.e. of 2007-08. Including issuance of securities in lieu of subsidies and

securities issued to nationalized banks, total expenditure of the government during 2007-08

was 15.9 per cent of GDP. This went up to 17.3 per cent in 2008-09 (inclusive of securities

issued in lieu of subsidies) and has declined to 15.4 per cent in RE 2010-11. With re-

prioritization of expenditure towards developmental side and curtailing the growth in non-

developmental expenditure, the total expenditure is estimated to be brought down to 14.7

per cent of GDP in BE 2013-14. In the medium term projection, it is estimated to further

decline to 13.7 percent of GDP in 2014-15 and 13.1 per cent in 2015-16.

13

SWORT Analysis

Strengths

Huge pool of labour force

High percentage of cultivable land

Diversified nature of the economy

Huge English speaking population, availability of skilled manpower

30

Stable economy, does not get affected by external changes

Extensive higher education system, third largest reservoir of engineers

High growth rate of economy

Rapid growth of IT and BPO sector bringing valuable foreign exchange

Abundance of natural resources

Weakness

Very high percentage of workforce involved in agriculture which contributes only 23%

of GDP

Around a quarter of a population below the poverty line

High unemployment rate

Stark inequality in prevailing socio economic conditions

Poor infrastructural facilities

Low productivity

Huge population leading to scarcity of resources

Low level of mechanization

Red tapism, bureaucracy

Low literacy rates

Unequal distribution of wealth

Rural-urban divide, leading to inequality in living standards

Opportunities

Scope for entry of private firms in various sectors for business

Inflow of Foreign Direct Investment is likely to increase in many sectors

Huge foreign exchange earning prospect in IT and ITES sector

Investment in R&D, engineering design

Area of biotechnology

Huge population of Indian Diaspora in foreign countries (NRIs)

Area of Infrastructure 31

Huge domestic market: Opportunity for MNCs for sales

Huge matural gas deposits found in India, natural gas as a fuel has tremendous

opportunities

Vast forest area and diverse wildlife

Huge agricultural resources, fishing, plantation crops, livestock

Threats

Global economy recession/slowdown

High fiscal deficit

Threat of government intervention in some states

Volatility in crude oil prices across the world

Growing Import bill

Population explosion, rate of growth of pobulation still high

Agriculture excessively dependent on monsoons

Bibliography

Financial Management (Text, Problem and Cases)

Author : M Y Khan & P K Jain

Publication : Tata McGraw-Hill Publishing Company Limited

Understanding of Financial Market(e-book)

Author : Bram van den Berg

32

Website : www.eagletraders.com

Financial Institution and Market

Author : Meir Kohn

Publication : Oxford University Press

Webiliography

http://www.sebi.gov.in/sebiweb/home/list/1/3/0/0/Regulations

http://www.sebi.gov.in/sebiweb/home/list/1/2/0/0/Rules

http://en.wikipedia.org/wiki/Securities_and_Exchange_Board_of_India

www.sahara.in

http://www.bloomberg.com/news/2011-05-11/rajaratnam-is-found-guilty-of-all-

counts-in-galleon-insider-trading-trial.html

http://en.wikipedia.org/wiki/Raj_Rajaratnam

33