Unit - II

Fiscal policy

Fiscal policy means the use of taxation and public expenditure by the government for
stabilization or growth of the economy.

According to Culbarston, “By fiscal policy we refer to government actions affecting its receipts
and expenditures which ordinarily as measured by the government’s receipts, its surplus or
deficit.” The government may change undesirable variations in private consumption and
investment by compensatory variations of public expenditures and taxes.

Main Objectives of Fiscal Policy in India

Fiscal policy of India always has two objectives, namely improving the growth performance of
the economy and ensuring social justice to the people.

General objectives of Fiscal Policy are given below:

1. To maintain and achieve full employment.

2. To stabilize the price level.
3. To stabilize the growth rate of the economy.
4. To maintain equilibrium in the Balance of Payments.
5. To promote the economic development of underdeveloped countries.

The fiscal policy is designed to achieve certain objectives as follows:-

1. Development by effective Mobilisation of Resources: The principal objective of fiscal

policy is to ensure rapid economic growth and development. This objective of economic growth
and development can be achieved by Mobilisation of Financial Resources. The central and state
governments in India have used fiscal policy to mobilise resources.

The financial resources can be mobilised by:-

a. Taxation: Through effective fiscal policies, the government aims to mobilise resources by
way of direct taxes as well as indirect taxes because most important source of resource
mobilisation in India is taxation.

b. Public Savings: The resources can be mobilised through public savings by reducing
government expenditure and increasing surpluses of public sector enterprises.

c. Private Savings: Through effective fiscal measures such as tax benefits, the government can
raise resources from private sector and households. Resources can be mobilised through
government borrowings by ways of treasury bills, issuance of government bonds, etc., loans
from domestic and foreign parties and by deficit financing.

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2. Reduction in inequalities of Income and Wealth: Fiscal policy aims at achieving equity or
social justice by reducing income inequalities among different sections of the society. The direct
taxes such as income tax are charged more on the rich people as compared to lower income
groups. Indirect taxes are also more in the case of semi-luxury and luxury items which are
mostly consumed by the upper middle class and the upper class. The government invests a
significant proportion of its tax revenue in the implementation of Poverty Alleviation
Programmes to improve the conditions of poor people in society.

3. Price Stability and Control of Inflation: One of the main objectives of fiscal policy is to
control inflation and stabilize price. Therefore, the government always aims to control the
inflation by reducing fiscal deficits, introducing tax savings schemes, productive use of financial
resources, etc.

4. Employment Generation: The government is making every possible effort to increase

employment in the country through effective fiscal measures. Investment in infrastructure has
resulted in direct and indirect employment. Lower taxes and duties on small-scale industrial
(SSI) units encourage more investment and consequently generate more employment. Various
rural employment programmes have been undertaken by the Government of India to solve
problems in rural areas. Similarly, self employment scheme is taken to provide employment to
technically qualified persons in the urban areas.

5. Balanced Regional Development: there are various projects like building up dams on rivers,
electricity, schools, roads, industrial projects etc run by the government to mitigate the regional
imbalances in the country. This is done with the help of public expenditure.

6. Reducing the Deficit in the Balance of Payment: some time government gives export
incentives to the exporters to boost up the export from the country. In the same way import
curbing measures are also adopted to check import. Hence the combine impact of these measures
is improvement in the balance of payment of the country.

7. Increases National Income: it’s the strength of the fiscal policy that is brings out the desired
results in the economy. When the government want to increase the income of the country then it
increases the direct and indirect taxes rates in the country. There are some other measures like:
reduction in tax rate so that more peoples get motivated to deposit actual tax.

8. Development of Infrastructure: when the government of the concerned country spends

money on the projects like railways, schools, dams, electricity, roads etc to increase the welfare
of the citizens, it improves the infrastructure of the country. A improved infrastructure is the key
to further speed up the economic growth of the country.

9. Foreign Exchange Earnings: when the central government of the country gives incentives
like, exemption in custom duty, concession in excise duty while producing things in the domestic
markets, it motivates the foreign investors to increase the investment in the domestic country.

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Monetary policy

Monetary policy refers to the credit control measures adopted by the central bank of a country. In
case of Indian economy, RBI is the sole monetary authority which decides the supply of money
in the economy. The Chakravarty committee has emphasized that price stability, growth, equity,
social justice, promoting and nurturing the new monetary and financial institutions have been
important objectives of the monetary policy in India.

Instruments of Monetary Policy

The instruments of monetary policy are of two types:

1. Quantitative, general or indirect (CRR, SLR, Open market operations, bank rate, repo rate,
reverse repo rate)

2. Qualitative, selective or direct (change in the margin money, direct action, moral suasion)

These both methods affect the level of aggregate demand through the supply of money, cost of
money and availability of credit. Of the two types of instruments, the first category includes bank
rate variations, open market operations and changing reserve requirements (cash reserve ratio,
statutory reserve ratio). They are meant to regulate the overall level of credit in the economy
through commercial banks. The selective credit controls aim at controlling specific types of
credit. They include changing margin requirements and regulation of consumer credit.

We discuss them as under:

a. Bank Rate Policy:

The bank rate is the minimum lending rate of the central bank at which it rediscounts first class
bills of exchange and government securities held by the commercial banks. When the central
bank finds that inflation has been increasing continuously, it raises the bank rate so borrowing
from the central bank becomes costly and commercial banks borrow less money from it (RBI).

The commercial banks, in reaction, raise their lending rates to the business community and
borrowers who further borrow less from the commercial banks. There is contraction of credit and
prices are checked from rising further. On the contrary, when prices are depressed, the central
bank lowers the bank rate.

It is cheap to borrow from the central bank on the part of commercial banks. The latter also
lower their lending rates. Businessmen are encouraged to borrow more. Investment is
encouraged and followed by rise in Output, employment, income and demand and the downward
movement of prices is checked.

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b. Open Market Operations:

Open market operations refer to sale and purchase of securities in the money market by the
central bank of the country. When prices start rising and there is need to control them, the central
bank sells securities. The reserves of commercial banks are reduced and they are not in a position
to lend more to the business community or general public.

Further investment is discouraged and the rise in prices is checked. Contrariwise, when
recessionary forces start in the economy, the central bank buys securities. The reserves of
commercial banks are raised so they lend more to business community and general public. It
further raises Investment, output, employment, income and demand in the economy hence the
fall in price is checked.

c. Changes in Reserve Ratios:

Under this method, CRR and SLR are two main deposit ratios, which reduce or increases the idle
cash balance of the commercial banks. Every bank is required by law to keep a certain
percentage of its total deposits in the form of a reserve fund in its vaults and also a certain
percentage with the central bank. Current 2018 CRR is 19.50and SLR is 4%

When prices are rising, the central bank raises the reserve ratio. Banks are required to keep more
with the central bank. Their reserves are reduced and they lend less. The volume of investment,
output and employment are adversely affected. In the opposite case, when the reserve ratio is
lowered, the reserves of commercial banks are raised. They lend more and the economic activity
is favourably affected.

d. Repo rate and Reverse Repo rate:

Repo rate also known as the benchmark interest rate is the rate at which the RBI lends money to
the banks for a short term. When the repo rate increases, borrowing from RBI becomes more
expensive. If RBI wants to make it more expensive for the banks to borrow money, it increases
the repo rate similarly, if it wants to make it cheaper for banks to borrow money it reduces the
repo rate. Current 2018 repo rate is 6.25%

Reverse Repo rate is the short term borrowing rate at which RBI borrows money from banks.
The Reserve bank uses this tool when it feels there is too much money floating in the banking
system. An increase in the reverse repo rate means that the banks will get a higher rate of interest
from RBI. As a result, banks prefer to lend their money to RBI which is always safe instead of
lending it others (people, companies etc) which is always risky. Current 2018reverse repo rate is
6%

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Repo Rate signifies the rate at which liquidity is injected in the banking system by RBI, whereas
Reverse Repo rate signifies the rate at which the central bank absorbs liquidity from the banks.

2. Selective Credit Controls:

Selective credit controls are used to influence specific types of credit for particular purposes.
They usually take the form of changing margin requirements to control speculative activities
within the economy. When there is brisk speculative activity in the economy or in particular
sectors in certain commodities and prices start rising, the central bank raises the margin
requirement on them.

Structure of Banking Sector in India

a. Change in Margin Money:

The result is that the borrowers are given less money in loans against specified securities. For
instance, raising the margin requirement to 70% means that the pledger of securities of the value
of Rs 10,000 will be given 30% of their value, i.e. Rs 3,000 as loan. In case of recession in a
particular sector, the central bank encourages borrowing by lowering margin requirements.

b. Moral Suasion: Under this method RBI urges to commercial banks to help in controlling the
supply of money in the economy.

Objectives of the Monetary Policy of India

1. Price Stability: Price Stability implies promoting economic development with considerable
emphasis on price stability. The centre of focus is to facilitate the environment which is
favourable to the architecture that enables the developmental projects to run swiftly while also
maintaining reasonable price stability.

2. Controlled Expansion Of Bank Credit: One of the important functions of RBI is the
controlled expansion of bank credit and money supply with special attention to seasonal
requirement for credit without affecting the output.

3. Promotion of Fixed Investment: The aim here is to increase the productivity of investment
by restraining non essential fixed investment.

4. Restriction of Inventories: Overfilling of stocks and products becoming outdated due to

excess of stock often results is sickness of the unit. To avoid this problem the central monetary
authority carries out this essential function of restricting the inventories. The main objective of
this policy is to avoid over-stocking and idle money in the organization

5. Promotion of Exports and Food Procurement Operations: Monetary policy pays special
attention in order to boost exports and facilitate the trade. It is an independent objective of
monetary policy.

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6. Desired Distribution of Credit: Monetary authority has control over the decisions regarding
the allocation of credit to priority sector and small borrowers. This policy decides over the
specified percentage of credit that is to be allocated to priority sector and small borrowers.

7. Equitable Distribution of Credit: The policy of Reserve Bank aims equitable distribution to
all sectors of the economy and all social and economic class of people

8. To Promote Efficiency: It is another essential aspect where the central banks pay a lot of
attention. It tries to increase the efficiency in the financial system and tries to incorporate
structural changes such as deregulating interest rates, ease operational constraints in the credit
delivery system, to introduce new money market instruments etc.

9. Reducing the Rigidity: RBI tries to bring about the flexibilities in the operations which
provide a considerable autonomy. It encourages more competitive environment and
diversification. It maintains its control over financial system whenever and wherever necessary
to maintain the discipline and prudence in operations of the financial system.

Differences between Fiscal Policy and Monetary Policy

The following are the major differences between fiscal policy and monetary policy.

1. The policy of the government in which it utilises its tax revenue and expenditure policy to
influence the aggregate demand and supply for products and services the economy is known
as Fiscal Policy. The policy through which the central bank controls and regulates the
supply of money in the economy is known as Monetary Policy.

2. Fiscal Policy is carried out by the Ministry of Finance whereas the Monetary Policy is
administered by the Central Bank of the country.

3. Fiscal Policy is made for a short duration, normally one year, while the Monetary Policy
lasts longer.

4. Fiscal Policy gives direction to the economy. On the other hand, Monetary Policy brings
price stability.

5. Fiscal Policy is concerned with government revenue and expenditure, but Monetary Policy
is concerned with borrowing and financial arrangement.

6. The major instrument of fiscal policy is tax rates and government spending. Conversely,
interest rates and credit ratios are the tools of Monetary Policy.

7. Political influence is there in fiscal policy. However, this is not in the case of monetary
policy.

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EXIM Policy

The Export-Import Policy (EXIM Policy), announced under the Foreign Trade (Development
and Regulation Act), 1992, would reflect the extent of regulations or liberalization of foreign
trade and indicate the measures for export promotion. Although the EXIM Policy is announced
for a five- year period, announcing a Policy on March 31st of every year, within the broad frame
of the Five Year Policy, for the ensuring year.

A very important feature of the EXIM policy since 1992 is freedom. Licensing, quantitative
restrictions and other regulatory and discretionary controls have been substantially eliminated.

The Union Commerce Ministry, Government of India announces the integrated Foreign Trade
Policy FTP in every five year. This is also called EXIM policy. This policy is updated every year
with some modifications and new schemes. New schemes come into effect on the first day of
financial year, i.e., April 1, every year. The Foreign Trade Policy which was announced on
August 28, 2009 is an integrated policy for the period 2009-14.

Export-Import (EXIM) Policy frames rules and regulations for exports and imports of a country.
This policy is also known as Foreign Trade Policy. It provides policy and strategy of the
government to be followed for promoting exports and regulating imports. This policy is
periodically reviewed to incorporate necessary changes as per changing domestic and
international environment. In this policy, approach of government towards various types of
exports and imports is conveyed to different exporters and importers.

Export refers to selling goods and services to other countries, while import means buying goods
and services from other countries. Now in the era of globalization, no economy in the world can
remain cut-off from rest of the world. Export and import play a significant role in the economic
development of all the developed and developing economies. With the growth of international
organisations like WTO, UNCTAD, ASEAN, etc., world trade is growing at a very fast rate.

Objectives of EXIM Policy:

The principal objectives of this Policy are:

1) To facilitate sustained growth in exports to attain a share of atleast 1 % of global merchandise

trade.

2) To stimulate sustained economic growth by providing access to essential raw materials,

intermediates, components, consumables and capital goods required for augmenting production
and providing services.

3) To enhance the technological strength and efficiency of Indian agriculture, industry and
services, thereby improving their competitive strength while generating new employment
opportunities, and to encourage the attainment of internationally accepted standards of quality.

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4) To provide consumers with good quality goods and services at internationally competitive
prices while at the same time creating a level playing field for the domestic produce.

Role of EXIM Bank

The Export-Import Bank of India, commonly known as the EXIM bank, was set up on January 1,
1982 to take over the operations of the international finance wing of the IDBI and to provide
financial assistance to exporters and importers to promote India’s foreign trade. It also provides
refinance facilities to the commercial banks and financial institutions against their export-import
financing activities.

The important functions of the EXIM Bank are as follows:

 Financing of export and import of goods and services both of India and of outside India.
 Providing finance for joint ventures in foreign countries.
 Undertaking merchant banking functions of companies engaged in foreign trade.
 Providing technical and administrative assistance to the parties engaged in export and
import business.
 Offering buyers’ credit and lines of credit to the foreign governments and banks.
 Providing advance information and business advisory services to Indian exports in
respect of multilaterally funded projects overseas.
 During the year 1994-95, the EXIM Bank introduced the ‘Clusters of Excellence’
programme for up-gradation of quality standards and obtaining ISO 9000 certification in
various parts of the country.
 The Bank also entered into framework cooperation agreement with European Bank for
Reconstruction and Development (EBRD) for acquiring advance information on EBRD
funded projects in order to enter into co-financing proposals with EBRD in Eastern
Europe and CIS.

With a view to promote exports, EXIM Bank has introduced the following three schemes:

 Production Equipment Finance Programme

 Export Marketing Finance
 Export Vendor Development Finance

Over the period, expansion /diversification programme has claimed the maximum share (54.3%)
of EXIM Bank’s sanctions, followed by new projects, (33.2%) and modernisation /acquisition of
equipment (12.5%).

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Forms of Financial Assistance Provided by EXIM Bank to Indian Companies-

 Delayed Payment Exports- Term loans are provided to those exporters who deal with
exporting of goods and services and this enables them to offer delayed credit to the
foreign buyers. This system of deferred credit covers Indian consultancies, technology,
and other services. Commercial banks take part in this program either directly or under
risk syndication arrangements.

 Pre-shipment credit-Indian companies which are highly involved in the execution of

export activities beyond the cycle time of six months are funded by EXIM Bank. The
construction or turnkey project exporters enjoy the provision of rupee mobilization.

 Term loans for export production- EXIM Bank offers term loans to the 100 percent
export oriented units, units involved in free trade zones, and exporters of various
softwares in India. EXIM bank also works in association with International Finance
Corporation, Washington, to provide financial assistance to the small scale and medium
industrial units in terms of ameliorating the export production capacity of these units in
India. EXIM Bank also provides funded and non- funded facilities to deemed exports
from India.

 Foreign Investment Finance- EXIM bank provides financial assistance for equity
contribution to the Indian companies who form Joint Venture with the foreign companies.

 Financing export marketing-It helps the exporters carry out their export market
development plan in Indian market.

Financial Assistance Provided by EXIM Bank to Overseas Companies-

 Foreign Buyer's Credit- the foreign players are entitled to a sum of financial assistance
in order to import goods and services on deferred payments.

 Lines of Credit- EXIM bank also offers financial assistance to the overseas financial
institutions and various government agencies for import of goods and services from
India.

 Reloaning Options to Foreign Banks- The foreign banks are entrusted with funding
from EXIM bank in order to provide the same to the their clients across the globe for
importing of goods from India.