Monetary and Fiscal Policy of India Presented by

Monica Vashisht Olga Tutt

Shrein Anthony Vidhya Jeyakodi

Agenda •Monetary Policy–Role & Objectives–Instruments–Inflation

•Fiscal Policy–Role & Objectives–Budget -> Revenue and Expenditure

–Taxation -> Structure–Fiscal Deficit

Objectives of Monetary policyReserve 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

Measures of Money StockReserve Bank of India employs FOUR measures of money stock, namely M1, M2, M3, M4

M1 : M1 is usually described as the money supply. The components of money supply are currency with the public(i.e., notes n circulation, circulation of rupee coins and circulation of small coins) and deposits(demand deposits with banks and other deposits with the RBI).

M2 : M2 is M1 + Post Office Savings Bank Deposits.

M3 : M3 is M1 + Time Deposits with the banks. In other words, M3 is money supply plus fixed deposits with the banks. M3 is usually referred to as aggregate monetary resources.

M4 : M4 is M3 plus the total Post Office Deposits.

Monetary policy

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 MethodsThe general methods affect the total quantity of credit and affect the economy generally.There are three general or quantitative instruments of credit control. 1. The Bank Rate 2. Open Market Operations3. Variable Reserve Requirements

The Bank rate, also known as the Discount Rate.The Bank Rate Policy seeks to affect both the cost and availability of credit.

General Quantitative methodsOpen Market OperationsOpen market operations indicate the buying/ selling of govt. securities in the open market to balance the money supply in the economy .Its refer broadly to the purchase and sale by the Central Bank of a variety of assets, such as foreign exchange, gold, government securities and even company shares. To increase the money supply, the central bank buys securities from commercial banks and public. Deployment of CreditThe RBI has taken various measures to deploy credit in different sector of the economy. The certain %age of the bank credit has been fixed for various sectors like agriculture, export etc.

Direct Instruments / Indirect instruments Direct InstrumentsCash 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 InstrumentsLiquidity 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.

Repo Rate: Repo rate is the rate at which the RBI lends shot-term money to the banks against securities. When the repo rate increases borrowing from RBI becomes more expensive. 

Reverse Repo Rate: The rate at which RBI borrows from commercial banks

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 CREDITMARGIN REQUIREMENTSDISCRIMINATORY RATES OF INTEREST

InflationInflation 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.

How does monetary policy affect inflation and other problems

Expansionary Monetary Policy•Problem: Recession and Unemployment Measures:Central Bank buys securities through open market operationsIt reduces CRRIt lowers bank rate

Money supply increases

Interest rate falls

Investment falls

Aggregate demand increase

Aggregate output increase

Contractionary Monetary Policy•Problem: Inflation Measure:Central bank sells securities through open market operationsIt raises CRR and SLRIt raises Bank RateIt raises maximum margin against holding of stocks of goods

Money supply deceases

Interest rate raises

Investment expenditure declines

Aggregate demand declines

Price level falls

Monetary policy 2013-14RBI's first-quarter monetary policy •Repo rate unchanged at 7.25%. •The Reverse Repo Rate stood at 6.25% •Marginal Standing Facility (MSF) and Bank Rate stood at 10.25%•Cash reserve ratio too unchanged at 4 percent•Cuts GDP forecast for FY'14 to 5.5 percent from 5.7 percent earlier•Next mid-quarter review of policy on September 18; second quarter policy review on October 29.•This is RBI Governor D Subbarao's last policy before expiry of his five year term.

Fiscal Policy 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:•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

- Kaushik Basu ( Former Chief Economic Adviser )

•Neutral position - This 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.•Expansionary position - This is when there is a higher budget deficit where the Govt. spending is higher than the revenue collected from the tax. •Contractionary position- This is when there is a lower budget deficit where the Govt. spending is lower than the revenue collected from the tax.

Fiscal Policy There are three possible positions.

Instruments of Fiscal policy

There are 2 main instruments of Fiscal policy.

• Revenue budget

• Expenditure budget

Revenue budget

Direct tax• Individual

Income Tax & Corporate Tax.

• Wealth Tax @ 1%• Tax deducted at

source

Indirect tax• Central excise (a

tax on manufactured goods)

• VAT @ 12.5%• Service tax @ 12%• Customs duty • Educational cess @

3%

Revenue

Budget

Direct

Taxes

Indirect Taxes

Non Tax revenue

The taxing powers of the central government encompass taxes on income, excise on goods produced (other than alcohol), customs duties, and inter-state sale of goods. The state governments are vested with the power to tax land and buildings, sale of goods (other than inter-state), and excise on alcohol.

Expenditure BudgetThe 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.

The Expenditure budget includes four main revenue expenditures

Total expenditure of 16.68 trillion INR

•Total Expenditure 16,65,297 •Revenue Expenditure 14,36,168 •Capital Expenditure 2,29,129 •Plan Expenditure at ` 5,55,322 crore. •Fiscal deficit for the current year contained at 5.2 per cent and for the year 2013-14 at 4.8 per cent.• Revenue deficit for the current year at 3.9 per cent and for the year 2013-14 at 3.3 per cent.• By 2016-17 fiscal deficit to be brought down to 3 per cent, revenue deficit to 1.5 per cent and effective revenue deficit to zero %•No change in the normal rates of 12 percent for excise duty and service tax.•No case to revise either the slabs or the rates of Personal Income Tax. Even a moderate increase in the threshold exemption will put hundreds of thousands of Tax Payers outside Tax Net

Fiscal Policy 2013-14

Any Question ?