Govt Role in Fiscal and Moteray Policy

8/3/2019 Govt Role in Fiscal and Moteray Policy

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P RE SE NT ED B Y :

MANSI ANAND 8106

DIVYA CHADHA 8108

MEGHA SISAUDIA 8109

AVINASH SARAF 8110

GOVERNMENTS ROLE:

FISCALAND MONETARY

POLICY


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THE INDIAN ECONOMY

Pre-liberalization period (1947-1991)- License Raj Mixed Economy system post liberalization (Post 1991) Progress towards free market economy by the turn of 20th century

GDP $1.53trillion(nominal: 10th;2010)

GDP Growth 8.5%(2010-11)

GDPper

capita

$1,265(nominal: 138th;2010)

GDPbysector Services(55.3%), Industry(28.6%),Agriculture(16.1%)(2010)

Inflation(CPI) 9.44%(June2011)

CURRENT STATISTICS


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WHY IS GOVERNMENT INTERVENTION NEEDED?

Regulationofoligopolies/cartelbehaviour

Directprovisionofpublicgoods(defence) Policiestointroducecompetitioninto

markets(de-regulation)

Tocorrectfor market failure

Progressivetaxes, Directtaxonwealth,etc.

Provisions(PDS) Benefits(Pensions)

Toachieveamore equitabledistributionof

incomeand wealth

Createequilibriumwhereprivatesectorfailstodoso

Maintainingtheappropriatelevelsofmoneysupplyintheeconomy

Toimprovethe performanceof

theeconomy


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MODES OF GOVERNMENT INTERVENTION

MONETARY

POLICYFISCALPOLICY

LAWS ANDPROVISIONS

MANAGINGCOMPETITION


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MONETARY POLICY

MeaningProcessbywhichthe monetaryauthority ofacountrycontrols: ThesupplyofmoneyAvailabilityofmoney

Costofmoneyorrateofinterest

PurposePromoting economic growthandstability

Impacts Inflation Exchangerateswithothercurrencies Unemployment


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Effectiveinfightinginflation

Helpstorespondquickly

Fine-tuningeasier

PoliticalImmunity

Cannotpushinmoneyeasily

Cannotactuallyrestrict

investment

Conflictinggoals

Cannotpreventfiscaldominance

ADVANTAGES DISADVANTAGES


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EXPANSIONARY MONETARYPOLICY

CONTRACTIONARY MONETARYPOLICY

TYPESO

F MO

NETARYPOLICY


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EXPANSIONARY MONETARY POLICY

Expansionary monetary policy expands (increases) the supply of money

and is followed during deflation.

y Expansionary monetary policy causes an increase in bond prices and

a reduction in interest rates.

y Lower interest rates lead to higher levels of capital investment.y The lower interest rates make domestic bonds less attractive, so the

demand for domestic bonds falls and the demand for foreign bonds

rises.

y The demand for domestic currency falls and the demand for foreign

currency rises, causing a decrease in the exchange rate. (The value of

the domestic currency is now lower relative to foreign currencies)

y A lower exchange rate causes exports to increase, imports to decrease

and the balance of trade to increase.


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CONTRACTIONARY MONETARY

POLICY

This policy decreases the money supply and is followed during inflation.

y Contractionary monetary policy causes a decrease in bond prices and

an increase in interest rates.

y Higher interest rates lead to lower levels of capital investment.

y The higher interest rates make domestic bonds more attractive, so the

demand for domestic bonds rises and the demand for foreign bonds

falls.

y The demand for domestic currency rises and the demand for foreign

currency falls, causing an increase in the exchange rate. (The value of

the domestic currency is now higher relative to foreign currencies)

y A higher exchange rate causes exports to decrease, imports to

increase and the balance of trade to decrease.


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QUANTITATIVE MEASURES

QUALITATIVE MEASURES

INSTRU

MENTSOF

MONETARY POLICY


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QUANTITATIVE MEASURES

CASH RESEVE RATIO

STATUTORYLIQUIDITY

REQUIREMENT

BANK RATE POLICY

OPEN MARKETOPERATIONS


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CASH RESERVE RATIO

TheThe cashcash reservereserve ratioratio isis thethe percentagepercentage ofof totaltotal depositsdepositswhichwhich commercialcommercial banksbanks areare requiredrequired toto maintainmaintain inin thetheformform ofof cashcash reservereserve withwith thethe centralcentral bankbank..

TheThe objectiveobjective ofof cashcash reservereserve isis toto preventprevent shortageshortage ofof cashcashforfor meetingmeeting thethe cashcash demanddemand byby thethe depositorsdepositors..

ByBy changingchanging thethe CRR,CRR, thethe centralcentral bankbank cancan changechange thethemoneymoney supplysupply overnightovernight..

WhenWhen economiceconomic conditionsconditions demanddemand aa contractionarycontractionarymonetarymonetary policy,policy, thethe centralcentral bankbank raisesraises thethe CRRCRR.. AndAnd whenwheneconomiceconomic conditionsconditions demanddemand monetarymonetary expansionexpansion ,the,thecentralcentral bankbank cutscuts downdown thethe CRRCRR..


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STATUTORYLIQUIDITY REQUIREMENT

InIn IndiaIndia ,the,the RBIRBI hashas imposedimposed anotheranother reservereserve requirementrequirement ininadditionaddition toto CRRCRR.. ItIt isis calledcalled statutorystatutory liquidityliquidity requirementrequirement..

TheThe SLRSLR isis thethe proportionproportion ofof thethe totaltotal depositsdeposits whichwhich commercialcommercialbanksbanks areare statutorilystatutorily requiredrequired toto maintainmaintain inin thethe formform ofof liquidliquidassetsassets inin additionaddition toto cashcash reservereserve ratioratio..

TheThe SLRSLR isis raisedraised underunder contractionarycontractionary monetarymonetary policypolicy andand isis

decreaseddecreased underunder expansionaryexpansionary policypolicy..


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BANK RATE POLICY

y Bank rate is the official minimum rate of interest at which central

bank lends money to commercial banks. So bank rate is known as

the central banks lending rate.

y In order to correct excess demand or inflationary situations,

Central Bank increase bank rate. Consequent upon an increase in

bank rate, commercial banks raise their lending rate to the general

public. This makes the borrowing from commercial banks costlier.

y In case of deficient demand the bank rate is reduced which in turn

increases the borrowings and capital investment.


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OPEN MARKET OPERATIONS

TheThe openopen marketmarket operationsoperations isis salesale andand purchasepurchase ofofgovernmentgovernment securitiessecurities andand TreasuryTreasury BillsBills byby thethe centralcentral bankbankofof thethe countrycountry..

WhenWhen thethe centralcentral bankbank decidesdecides toto pumppump moneymoney intointocirculation,circulation, itit buysbuys backback thethe governmentgovernment securities,securities, billsbills andandbondsbonds..

WhenWhen itit decidesdecides toto reducereduce moneymoney inin circulationcirculation itit sellssells thethe

governmentgovernment bondsbonds andand securitiessecurities..

TheThe centralcentral bankbank carriescarries outout itsits openopen marketmarket operationsoperationsthroughthrough thethe commercialcommercial banksbanks..


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QUALITATIVE MEASURES

CONSUMER CREDITREGULATION

MORAL SUASION

CHANGE IN LENDINGMARGINS

DIRECT ACTION


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CONSUMER CREDIT REGULATION

y If there is excess demand for certain consumer durables

leading to their high prices, central bank can reduce

consumer credit by (a) increasing down payment, and (b)

reducing the number of installments of repayment of such

credit.

y On the other hand, if there is deficient demand for certain

specific commodities causing deflationary situation, central

bank can increase consumer credit by (a) reducing down

payment and (b) increasing the number of installments of

repayment of such credit.


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MORAL SUASION

y Moral suasion means persuasion and request. To arrest inflationary

situation central bank persuades and request the commercial

banks to refrain from giving loans for speculative and non-essential

purposes.

y On the other hand, to counteract deflation central bank persuades

the commercial banks to extend credit for different purposes.

y Central bank also appeals commercial banks to extend theirwholehearted co-operation to achieve the objectives of monetary

policy. Being the monetary authority directions of the central bank

are usually followed by commercial banks.


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CHANGE IN LENDING MARGINS

TheThe banksbanks provideprovide loansloans onlyonly upup toto aa certaincertain percentagepercentage ofof

thethe valuevalue ofof thethe mortgagedmortgaged propertyproperty..

TheThe gapgap betweenbetween thethe valuevalue ofof thethe mortgagedmortgaged propertyproperty andand

amountamount advancedadvanced isis calledcalled LendingLending MarginMargin..

TheThe centralcentral bankbank isis empoweredempowered toto increaseincrease thethe lendinglending

marginmargin withwith aa viewview toto decreasedecrease thethe bankbank creditcredit..


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DIRECT ACTIONDIRECT ACTION

This method is adopted when a commercial bank does not co-

operate the central bank in achieving its desirable objectives.

Direct action may take any of the following forms:

y Central banks may charge a penal rate of interest over and above

the bank rate upon the defaulting banks;

y Central bank may refuse to rediscount the bills of those banks

which are not following its directives;

y Central bank may refuse to grant further accommodation to

those banks whose borrowings are in excess of their capital and

reserves.


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MONETARY POLICYSTATEMENT OF RBI

2011-2012

KEY HIGHLIGHTS


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y Short term lending rate (repo) hiked by 50 bps from 6.75 to 7.25

pc.

y Repo rate to be only effective policy rate to better signal monetary

policy stance from now on.

y Reverse repo to be fixed 100 bps lower than the repo rate.

y Short-term borrowing rate (reverse repo) up by 50 bps to 6.25

pc.

y Cash reserve ratio (CRR) and bank rate left unchanged at 6 pc

each.y Interest rates on savings bank deposits hiked to 4 pc from 3.5 pc.

y Economic growth projected lower at 8 pc for FY12.


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y WPI inflation projection lowered to 6 pc.

y Objective is to contain inflation by curbing demand-side

pressures.

y Favours aligning of fuel prices with international crude prices to

avert widening of fiscal deficit.

y Banks to get a new overnight borrowing window under Marginal

Standing Facility at 8.25 pc.

y Likelihood of oil prices moderating significantly is low.

y Malegam Committee recommendations on MFI sector broadlyaccepted.

y Bank loan to MFIs on or after April 1, 2011, will be treated as

priority sector loans.


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HOW

MO

NETARY POL

ICYCONTROLS INFLATION?


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CENTRAL BANK

SECURITIES AND

TRESURY BILLSBANK RATE

COMMERCIAL BANKS

CORPORATES INDIVIDUALS

CASH

CASH RESERVE

RATIO

REDUCED BORROWING OF

LOANS REDUCE LIQUIDITYIN MARKET

STATUTORY

LIQUID RATIO


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FISCAL POLICY

Fiscalpolicyreferstothepolicyofthegovernmentasregardstaxation,publicborrowingandpublicexpenditure

withtheobjectivetoprovidedesirableeffectsonthenationalincome,production,employmentandgeneralpricelevel.

Thewordfiscalisderivedfromtheword

fiscwhichmeanstreasury.


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KEYNISIAN ECONOMICS

The Great Depression1930wasthebeginningoffiscalpolicyand Govt.involvementintheeconomy.

Keynesarguedthatsincein

depressionprivateinvestorswerereluctanttoundertakeinvestment

becauseofunexpectedreturn,Governmentshouldundertake

investment. Thisinvestmentwillhavemultifold

impactonincomebecauseoftheworkingofmultiplier.


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OBJECTIVES

Development by effective Mobilisation ofResources.

Efficient allocation ofFinancial Resources

Reduction in inequalities ofIncome and Wealth

Price Stability and Control ofInflation.

Employment Generation

Balanced Regional Development

Development ofInfrastructure


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STANCES OF FISCAL POLICY

y Neutral Fiscal Policy: Government runs with a balanced budgetwhere government spending is equal to tax revenues.

G = T

y Reflationary (Expansionary) Fiscal Policy : happens when

the government is running a large deficit budget. Here, thegovernment borrows money to inject funds into the economy so asto increase the level of aggregate demand and economic activity.

G > T

y Deflationary (Contractionary) Fiscal Policy : happens whenthe government runs a budget surplus. The government is injectingfewer funds into the economy than it is withdrawing through taxes.The level of aggregate demand and economic activity falls.

G < T


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ECONOMIC STABILIZATION

Automatic Stabilizers

An automatic stabilizer isan expenditure programmeor tax law thatautomatically increasesexpenditure (or decreasestaxes) when an economyenters a recession andautomatically decreasesexpenditure (or increasestaxes) when an economyenters a period of inflation.

DiscretionaryFiscalPolicy

Discretionary Fiscal Policyimplies deliberate changesundertaken by thegovernment of the countryin the tax rates and plannedoutlays in an effort tostabilise the economy.


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AUTOMATIC STABILIZERS

y Tax revenues: When the economy is expanding rapidlythe amount of tax revenue increases which takes moneyout of the circular flow of income and spending.

y Welfare spending:Agrowing economy means that the

government does not have to spend as much on means-tested welfare benefits such as income support andunemployment benefits.

y Budget balance and the circular flow: A fast-growing economy tends to lead to a net outflow of moneyfrom the circular flow. Conversely during a slowdown ora recession, the government normally ends up running alarger budget deficit.


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TOOLS AND TECHNIQUES

Following are the Tools and Techniques of FiscalPolicy in India.

A. Taxation Policy

B. Government Expenditure Policy

C. Deficit Financing Policy

D. Public Debt Policy


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TAXATION POLICY

Taxationpolicyisrelatingtonewamendmentsindirecttaxandindirecttaxasperfinance

bill Govt.ofIndiapasseseveryyear.

Taxesarethemainsourceofearningforthe Govt.

Ataxisacompulsorypayment,leviedonapersonorassociation,tomeettheexpenditureincurredonconferringcommonbenefitsuponthepeopleofacountry.

Moretaxes,moreburdenonpeople,decreaseproductionandpurchasingpower.

Lesstaxes,

increase

govt.

dependenceonPublic Debtand Deficitfinancingwhichincreaseinflation.


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CLASSIFICATION OF TAXES

Direct taxes

Direct taxes are the taxes which are not shifted i.e. the incidence of which falls on persons that pay them to the government. For

example, income tax and wealth tax.

Equity

Certainty Relative Elastic Economical Anti-inflationary

Tax Evasion

ArbitraryRates Inconvenient NarrowCoverage Sectoral

Imbalance


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Indirect Taxes

Indirect taxes are the taxes in which the burden of paying tax ispassed on the third party. For example service tax, VAT, exciseduty, custom duty

Convenient Difficulttoevade Wide Coverage

Elastic Influenceon

patternofProduction

SocialWelfare

Highcostofcollection

Increaseincome

inequalities Affectconsumption Uncertainty Inflationary Possibilityoftax

evasion


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INCOME TAX

The provisions of Indian Income-Tax are governed by IndianIncome-Tax Act, 1961 which extends to the whole of India and

became effective from 1stApril 1962.

y Personal Tax- Tax on the personal income of assessee fromsalary, house property, business/profession, capital gains andincome from other sources.

y Corporate

Ta

x- Atax levied on corporations' profits, becausecorporations are legal entities separate from their owners, they

may be taxed as if they were persons.Acorporate tax, then, is theequivalent of the income tax for natural persons.


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INCOME TAX SLAB (PY 2011-12, AY 2012-13)

INCOME TAX RATE

Upto 1,80,000 NIL

Next 3,20,000 10%

Next 3,00,000 20%A bove 8,00,000 30%

Resident IndividualINCOME TAX RATE

Upto 1,90,000 NIL

Next 3,10,000 10%

Next 3,00,000 20%A bove 8,00,000 30%

ResidentWoman

INCOME TAX RATE

Upto 2,50,000 NIL

Next 2,50,000 10%

Next 3,00,000 20%

A bove 8,00,000 30%

Senior Citizen60yrsandabove VerySenior Citizen80yrsandabove

INCOME TAX RATE

Upto 5,00,000

NIL

Next 3,00,000 20%

A bove 8,00,000 30%

Everyassessee hastopayprimaryeducationalcess @2%andsecondary

andhighereducationalcess @1%onsuchtax


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WEALTH TAX

Wealth tax came into existence on 1stApril 1957 under wealthtax act 1957.

W

ealth tax is derived from the property owned by theproprietor.

Wealth tax will be charged in respect of the net wealth on thecorresponding valuation date@1% of the amount by whichthe net wealth exceeds Rs. 15 lakhs.


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SALES TAX

y Sales tax is levied on the sale of a commodity which is produced or

imported and sold for the first time.

y The sales tax is an indirect form of tax, it is the responsibility of

seller of the commodity to collect or recover the tax from thepurchaser

y Each state has its own sales tax act and levies the tax at various

rates on within the state sales.

y The Central Sales Tax (CST) Act 1956 that comes under the

direction of Central Government takes into consideration all the

interstate sales of commodities.


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Rates underVAT(sales tax) system within state:y 0% for the essential commodities

y 1% on gold bullions as well as expensive stones

y 4% on capital merchandise, industrial inputs, and commodities of mass

consumption

y 12.5% on all other items

y Variable rates (depending on state) are applicable for tobacco, liquor,petroleum products, etc.

Central sales tax shall equal to the rate of local salestax but max. 2%


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EXCISE AND CUSTOM DUTY

EXCISE DUTY

y Excise Duty is an indirect tax levied and collected on the goodsmanufactured in India.

y Administered through The Central ExciseAct, 1944

y The rates at which the excise duty is to be collected are stipulated in theCentral Excise TariffAct, 1985.

CUSTOM DUTY

y Custom duty is an indirect tax levied and collected on the goodsimported in India

y Administered through Indian CustomAct 1962

y The rates at which taxes under custom duty is charged are given underCustom tariff act, 1975


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SERVICE TAX

y First introduced in India in 1994, by then financeminister Dr. Manmohan Singh.

y Provision of service tax are in FinanceAct 1994

y At beginning Service tax was imposed on only 3

services but at present service tax is payable on more

than 100 services

y Service Tax shall be collected by service provider @10% + education cess 3% of such tax


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PUBLIC BORROWING

Ifrevenuecollectedthroughtaxes & othersourcesisnotadequatetocovergovernmentexpendituregovernmentmayresorttoborrowing.

Varioussourcesofpublicborrowingare:y Internal

y External

y Borrowingfrom RBI


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DEFICIT FINANCING

y Deficit financing refers to means of financing the

deliberate excess of expenditure over income

through printing of currency notes or through

borrowings.y Deficit financing is primarily to cover the fiscal

deficit of the government.

y Borrowing from the central bank of the country

(RBI), withdrawal of accumulated cash balances andissue of new currency are included within itspurview.


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BUDGET DEFICIT

y Budgetary Deficit is the difference between allreceipts and expenditure of the government, bothrevenue and capital.

y The concept of budgetary deficit has lost its

significance after the presentation of the 1997-98Budget.

BUDGET DEFICIT= TOTAL EXPENDITURE TOTAL RECEIPTS


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FISCAL DEFICIT

y Fiscal Deficit is a difference between total expenditure(both revenue and capital) and revenue receipts pluscertain non-debt capital receipts like recovery of loans,proceeds from disinvestment.

y

This concept fully reflects the indebtedness of thegovernment and throws light on the extent to which thegovernment has gone beyond its means and the ways in

which it has done so.

FISCAL DEFICIT = TOTAL EXP. (REV. RECIEPTS+ NON- DEBTCAPITAL RECEIPTS)


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TABLE 236 : COMBINED DEFICITSOF THE CENTRAL AND STATE

GOVERNMENTS (AspercentagetoGDP)

YEAR GROSS FISCALDEFICIT

GROSS PRIMARYDEFICIT

REVENUEDEFICIT

1 2 3 4

2000-01 9.43 3.53 6.69

2001-02 9.86 3.65 7.052002-03 9.48 3.04 6.72

2003-04 8.42 2.03 5.87

2004-05 7.20 1.31 3.63

2005-06 6.46 0.96 2.68

2006-07 5.38 -0.01 1.29

2007-08 4.12 -1.13 0.19

2008-09 8.50 3.35 4.14

2009-10 9.59 4.29 5.06


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TABLE 105 : CENTRES GROSS FISCALDEFICIT

YEAR GFD RECEIPTS GFD

EXPENDITURE

GROSS

FISCAL

DEFICIT

GROSS FISCAL

DEFICIT

( AS PERCENTAGEOF GDP)

2000-01 194730 313546 118816 5.65

2001-02 204952 345907 140955 6.19

2002-03 233985 379057 145072 5.912003-04 280765 404038 123273 4.48

2004-05 310415 436209 125794 3.88

2005-06 348658 495093 146435 3.95

2006-07 434921 577494 142573 3.33

2007-08 580659 707571 126912 2.56

2008-09 540825 877817 336992 6.05

2009-10 603252 1017293 414041 6.64

2010-11 722212 1103620 381408 5.50


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IMPACT OF DEFICIT FINANCING

Govt.borrowfrom RBI

MoneySupplyincrease

Rateofinterest

decrease

Investment

Increase,increasingaggregatedemand

Ifnotbacked

bySupply,inflation


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Deficit financing: anecessaryevilin developingeconomy


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GOVERNMENT EXPENDITURE

The expenditure incurred by public authorities like central,state and local governments to satisfy the collective social

wants of the people is known as public or governmentexpenditure.

Itacceleratesthegrowthrateoftheeconomy,

providesmoreemploymentopportunities, raisesincome,standardofliving,

reduces povertyandinequalitiesinincome

distribution, encouragesprivatesectorinvestment, bringsregionalbalanceintheeconomy.

Duringtimesofinflation,governmentcontrolsinflationbyreducingitsexpenditure.


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TYPESOF GOVERNMENT EXPENDITURE

Functional Classification

Revenueand Capital Expenditure

Transferand Non-Transfer Expenditure

Developmentand Non-Development Expenditure


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LIMITATIONS

y Recognition lags and policy time lags

y The importance of the national income multiplier imperfect information

y Fiscal Crowding-Out


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Govt Role in Fiscal and Moteray Policy

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