A SEMINAR REPORT ON

FISCAL POLICY
SEMINAR ON CONTEMPORARY MANAGEMENT ISSUES (PAPER NO. 207) IN PARTIAL FULLFILLMENT FOR IN M.B.A. PROGRAMME OF RAJASTHAN TECHNICAL UNIVERSITY, KOTA

Submitted By: Submitted To:

Satish Kumar Vijay Dr. V.N. Pradhan

MBA II Sem.

2009-2011 DEEPSHIKHA INSTITUTE OF MANAGEMENT STUDIES

ISI-17, RIICO INSTITUTIONAL AREA, SITAPURA JAIPUR

DECLARATION

I, Satish Kumar Vijay S/o Shri Jagdish Prasad Vijay, declare that the Report titled ''FISCAL POLICY'' is based on my study. This Report is my original work and this has not been used for any purpose anywhere. Satish Kumar Vijay M.B.A. II Sem.

PREFACE
As we know that M.B.A Programme is more concern with the knowledge aspect of the business world. The M.B.A students need to gain more and more knowledge by different

methods. It is not possible for them to have this from classroom lectures only. They should undergo with various seminars. Financial Market plays an important role in the economy of every country. Without existence of Financial Market, we cant think about any countys growth. Financial Market can be dividing into two types, which are capital market & money market. Money market is useful for short term & Capital market is useful for Long term Financial Needs. Everyone should know the concept of financial market because its a tool which provides the safe place of the money with certain return.

ACKNOWLEDGEMENT

I express my sincere thanks to my seminar guide, Ms. Sonali Yadav for guiding me right from the inception till the successful Preparation of the seminar. I sincerely acknowledge her for extending their usable guidance, support for literature, critical reviews of seminar and above all the moral support she had provided to me with all stages of this seminar. I would also like to thank the supporting lecturers, for their help and cooperation throughout the seminar.

Satish Kumar Vijay MBA, II Sem.

EXECUTIVE SUMMARY

Decisions by government

the President and Congress, spending, with the

usually

relating

to

taxation

and

goals of full

employment, price

stability,

and economic growth. By changing tax laws, the government can effectively modify the amount of disposable income available to its taxpayers. For example, if taxes were and in to turn increase, would have consumers would have less disposable income less money to spend on goods

and services. This difference in disposable income would go to the government instead of going to consumers, who would pass the money onto companies. Or, the government could choose to increase government spending by directly purchasing goods and services from private companies. This would increase the flow of money through the economy and would eventually increase the disposable income available to consumers. Unfortunately, this process takes time, as the money needs to wind its way through the economy, creating a significant lag between the implementation of fiscal policy and its effect on the economy.

Table of Contents

S. No. PARTICULARS 1 2 3 4 5 6 7 8 9 10 Introduction Indias fiscal situation-A brief prelude Fiscal Policy- overview Objectives of fiscal Policy Role of RBI in fiscal reforms Role of fiscal Policy Economic effect of fiscal Policy Principles of fiscal Policy Long term fiscal Policy challenges Limitations of fiscal Policy

Pg.No. 1 2 5 10 12 15 16 18 22 24

BUDGET
1 2 3 4 5 6 Definition Purpose of business budget Control and Evaluation Planning Communication and Motivation Current news related to budget 25 25 26 26 27 28

FISCAL- POLICY
In economics, fiscal policy is the use of government expenditure and revenue collection to influence the economy.The word Fisc means state treasury and fiscal policy refers to policy concerning the use of state treasury or the govt. finance to achieve the macroeconomic goals Decisions by government the President and Congress, spending, with the usually relating to taxation and

goals of full

employment, price

stability,

and economic growth. By changing tax laws, the government can effectively modify the amount of disposable income available to its taxpayers. For example, if taxes were and in to turn increase, would have consumers would have less disposable income less money to spend on goods

and services. This difference in disposable income would go to the government instead of going to consumers, who would pass the money onto companies. Or, the government could choose to increase government spending by directly purchasing goods and services from private companies. This would increase the flow of money through the economy and would eventually increase the disposable income available to consumers. Unfortunately, this process takes time, as the money needs to wind its way through the economy, creating a significant lag between the implementation of fiscal policy and its effect on the economy. In economics, fiscal policy is the use of government expenditure and revenue collection to influence the economy. The word Fisc means state treasury and fiscal policy refers to policy concerning the use of state treasury or the govt. finance to achieve the macroeconomic goals According to G.K. Shah 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.

Indias Fiscal Situation: A Brief Prelude

Broadly, during the first 30 years of independence, between 1950 and 1980, the fiscal deficits of both the central and the state governments were not excessive. This was a period of revenue surplus in general. However, automatic monetisation of government deficit by the RBI, which started as an exception during the mid 1950s, became a regular practice thereafter. Simultaneously, there was also a distinct shift in the management of the financial sector with the nationalization of major commercial banks in 1969 and 1980. These two developments had a significant bearing on the relationship between the monetary authority (RBI) and the fiscal authority (Government). There was a significant deterioration in the fiscal situation in the 1980s, accompanied by large and automatic monetisation of government deficits. The process involved issue of ad-hoc Treasury bills at rates initially on par with 91- day Treasury Bills. Since July 1974, the ad-hoc Treasury bills were offered at off-market discount rate of 4.6 percent which was less than half of the prevailing market rates. There were two immediate consequences. One, when large government deficits were monetised, there was excess liquidity in the system, which prompted the monetary authorities to increase the cash reserve ratio (CRR) for banks at regular intervals with a view to mop up the excess liquidity. Two, to facilitate the central government to borrow comfortably, the monetary authority, which is also the debt manager for the government, periodically increased the statutory liquidity ratio (SLR) to be maintained by banks. This process went on to an extent that CRR and SLR, together, pre-empted more than 50 percent of banking sector liabilities, for a period. In other words, more than 50 percent of the resources of the banking sector were preempted to primarily finance the budget deficits of the governments. Further, the deposit and lending rates of banks were, for most part, administered. This situation impacted the health of the banking system and the consequential adjustments during the banking sector reform process were, naturally, somewhat complex. The large fiscal deficit and its monetisation had some spill-over effect on the external sector, which reflected in the widening current account deficit in the late 1980s and early 1990s. Triggered by the balance of payments crisis in the early 1990s, when our foreign currency assets

depleted rapidly to the extent that it could barely finance just two weeks of imports, we started the reform process in 1991-92. A credible macroeconomic structural and stabilization programme encompassing trade, industry, foreign investment, exchange rate, public finance and financial sector was put in place, which created an environment that was conducive for the expansion of trade and investment. Simultaneously, several reform measures towards the marketisation of government borrowings were initiated. At the instance of Dr. Rangarajan, one of my illustrious predecessors as Governor, the RBI entered into the first agreement with the government in 1994 to place a limit on automatic monetization. The First Supplemental Agreement between the RBI and the Government of India was signed in 1994 setting out a system of limits for creation of ad hoc treasury bills during the three-year period ending 1996-97. Then in 1997, soon after I moved to the RBI, the second agreement with the government was signed, where Mr. Montek Singh Ahluwalia represented the government. In pursuance of this Second Supplemental Agreement between the RBI and the Government of India on March 6, 1997, the ad hoc Treasury Bills were completely phased out from April 1997, replaced by a scheme of Ways and Means Advances, subject to limits. In order to smoothen the transition, the Government of India was allowed to incur also an overdraft, but at an interest rate higher than the rate applicable for Ways and Means Advances (WMA). With effect from April 1, 1999 these overdrafts were allowed only for a maximum of ten working days. These features placed the Central Government on par with the State governments which were brought under an Overdraft Regulation Scheme since 1985. Furthermore, it was agreed that the RBI would trigger fresh floatation of Government securities whenever 75 percent of the WMA limit was reached. It was also agreed that the governments surplus cash balances with the RBI, beyond an agreed level, would be invested by it in government securities. While the transition to a full-fledged WMA and overdraft mechanism was gradual, non-disruptive and consensual, the successful implementation of this mechanism made it possible to incorporate some of these practices into a law the Fiscal Responsibility and Budget Management Act (FRBM Act). It is noteworthy that this law also practically prohibited RBI from participating in primary issues of all government securities.

FISCAL POLICY OVERVIEW

The growth trends for the last four years indicate a continuous upswing in the economy. Increasing productivity, growth of service sector and buoyancy in tax receipts associated with the growth and to some extent, improvement in tax compliance and enforcement as a result of a more rational, liberal and efficient tax system, have contributed toward achieving quantitative goals set under the FRBM Act. Reduction of fiscal deficit has been achieved from 4.5 per cent of GDP in 200304 to 3.1 per cent of GDP in RE 2007-08. During the same period, revenue deficit has declined from 3.6 per cent of GDP to 1.4 per cent. The advance estimate for growth of GDP at factor cost at constant (1999-2000) prices in 2007-08 is pegged at 8.7 per cent which is the average growth of the last four years, albeit lower by 0.9 percentage points as compared to 2006-07 (Quick Estimates 9.6 per cent ). The slowdown is triggered by lower than expected growth in manufacturing sector, although services sector continued to record double digit growth in first half of 200708. Improvement in deficit indicators has been achieved through growth in tax receipts, which exceeded growth of revenue expenditure, notwithstanding increase in non-plan revenue expenditure fuelled largely by a high subsidy bill and interest payments. The process of fiscal consolidation would continue to be sustained through improvement in tax-GDP ratio, moderate growth in non tax revenue, reprioritization and improving the quality of expenditure including promotion of capital expenditure to boost infrastructure development while ensuring adequate resources for social sectors like health and education.

Governments strategy to pursue fiscal consolidation Tax Policy:

In recent years, tax policy has been governed by the overarching objective of increasing the tax-GDP ratio for achieving fiscal consolidation. This is sought to be achieved both through appropriate policy interventions and a steadfast improvement in the quality and effectiveness of tax administration. On the policy side, a strategy of moderate and few rates, removal of exemptions and broadening of the tax base has yielded good results. As for tax administration, the extensive adoption of Information Technology solutions has enabled a less intrusive tax system that fosters voluntary compliance. In a broad sense, the relatively high buoyancy exhibited by direct taxes indicates that the tax system is maturing. On the indirect tax side, the objective is to integrate the taxes on goods (Central Excise) and services and finally move to a comprehensive Goods and Services Tax (GST). It is also the aim to improve the revenue yield from service tax in keeping with the contribution of the service sector to GDP.

Indirect Taxes
Customs duty : In the wake of the sharp appreciation of the rupee against the US dollar, the peak rate of customs duty on non-agricultural goods has been maintained at 10 percent Continuing the pace of reforms, the rate of customs duty on Project Imports has been reduced from 7.5 per cent to 5 per cent. This will serve as an incentive for setting up of large projects, and also encourage capacity expansion and modernization of existing industries. For promotion of exports, customs duty reduction has been effected on specified machinery and raw materials for producing sports goods, and also on cubic zirconia (rough and polished) and rough corals used in the gems and jewellery sector.

To improve the availability of base metals in the country, import duty on melting scrap of iron or steel and aluminium scrap raw materials for the ferrous and non-ferrous sector, has been exempted.

To help conserve the countrys natural resource of chromium ores, and increased domestic availability of this scarce raw material, export duty on chromium ores and concentrates has been increased.

For the Electronics and Information technology hardware sector, problem of inversion arising on account of various FTAs and PTAs has been sought to be addressed by providing customs duty exemptions on specified raw materials on end use basis.

As a part of continued review of existing exemptions, customs duty on naphtha imported for manufacture of specified polymers has been withdrawn.

Excise duty :
-The general Cenvat rate has been reduced from 16 per cent to 14 per cent i.e. a reduction of 12.5 per cent in Central excise duty. This is likely to boost growth of the domestic manufacturing sector, which has suffered a slowdown. - Several sector specific interventions have also been made to provide a fillip to growth through lower excise duties. The important sectors are: automobiles, paper, drugs and pharmaceuticals, and food processing. - To provide clean drinking water, excise duty on water filtering and purifying devices has been reduced. - For replenishment of the National Calamity Contingency Fund, one per cent National Calamity Contingent duty has been imposed on mobile phones. -Specific rates of duty on cement clinker and non-filter cigarettes have been rationalized.

Service Tax:
- Widening of service tax base, simplification of law and procedure, improved tax administration and increase in tax compliance continue to show higher buoyancy in service tax revenue collection during 2007- 08 also. Service tax revenue during the period April December 2007, has grown by about 37 per cent as compared to the corresponding period of the previous year. - In order to facilitate small service providers and to ensure optimum utilization of the administrative resources, threshold limit of annual turnover to small service providers for full service tax exemption has been increased from Rs. 8 lacs to Rs.10 lakh w.e.f. 1.4.2008. This exemption would benefit about 65,000 small service providers. -In line with the Governments declared policy of broadening the tax base, the scope and coverage of services livable to service tax is being further widened by adding more services and expanding the scope of some of the existing services.

Direct Taxes
Over the last four years, widespread reforms have been ushered into the direct tax arena. The touch stone of such reforms have been the following: -Distortions within the tax structure have been minimized by expanding the tax base an Maintaining moderate tax rates. -Tax administration has been geared up to provide taxpayer services and also enhance deterrence levels. Both these objectives reinforce each other and have promoted voluntary compliance. -Business Processes have been re-engineered in the Income-Tax Department through extensive use of information technology, viz., e-filing of returns; issue of

refunds through ECS and refund banks; selection of returns for scrutiny through computers; etc. These measures have modernized the Department and enhanced its functional efficiency. The Union Budgets of 2006-07 and 2007-08 managed to consolidate the landmark achievements of the 2005-06 Budget in the field of direct tax reforms. In the Union Budget of 2007-08, some major tax concessions provided in the Income-tax statute were either eliminated or curtailed to broaden the tax base. For example, the MAT base was expanded by bringing the profits of STPI units and Export Oriented Units within its ambit; the rate of Dividend Distribution Tax (DDT) for domestic companies on distribution of profits to share holders was increased; new rates of Dividend Distribution Tax were specified for Money Market Mutual Funds (MMMF) and Liquid Funds (LF) on distribution of income to unit holders; and the non-chargeability of capital gain tax on sale of a long-term capital asset, by investing the same in certain bonds, was restricted to a maximum amount of Rs. 50 lakhs in a year.

Objectives of fiscal policy

The role of fiscal policy in developed economies is to maintain full employment and stabilize growth. In contrast, in developing countries, fiscal policy is used to create an environment for rapid economic growth. The various aspects of this are: 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 maintaine 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: The efficient employment level is most important in determining the living standard of 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 underdevelopment. 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.

Role of RBI in Fiscal Reforms

As a central bank, we are generally sensitive to the fiscal situation. It is not true that the RBI was not aware of the implications of what was happening on the fiscal front during the first three decades (1950 to 1980). Given the institutional arrangement, the RBIs primary objective is to maintain monetary stability. It was clear that the fiscal situation was something that was decided and determined by the sovereign. Once the fiscal situation was decided and determined by the sovereign, it was the central banks responsibility to ensure that monetary stability was maintained and the governments borrowing programme was managed with minimum disruptions, in

terms of stability. Some argue that accommodating the fiscal pressure through monetary action is like, what some people call, a soft-budget constraint. Let me revert to the reform process and how we got rid of the remnants of automatic monetisation of the previous years. The stock of ad hoc Treasury bills, when we put an end to issue of such bills, was over Rs. 1,00,000 crore. This stock was in fact public debt in perpetuity, held by the RBI, bearing a discount rate of 4.6 percent though the market rates were far higher. In coordination with the government, it was agreed that these papers will be converted into dated marketable securities at market related rates, in phases, depending on the market conditions warranting open market operations by the RBI. Thus, the stock of the ad hoc treasury bills has been wiped-out. This is an evidence of the varieties of ways in which the RBI conceives and implements the process of reforms, in a non-disruptible fashion, in coordination with the government. Let me share a story related to the FRBM Act with you. One day, Governor Jalan said that the Finance Minister is making an announcement on introduction of Fiscal Responsibility Bill (which was the then proposed nomenclature). Governor Jalan said that he had discussed with the Minister and that they had decided that I will be named the Chairman of a Committee that would draft the Fiscal Responsibility Bill. I submitted that the government officials should be working on the legislation relating to fiscal issues and that the RBI should not be involved, as the ownership of the Fiscal Responsibility Bill should be with the government. Governor Jalan did not relent and said No, it has been decided that you do it. So finally, we arrived at a compromise. A main formal Committee was set up in 2000 with the then Secretary, Economic Affairs, Dr. E.A.S. Sarma as the Chairman and Dr. Ashok Lahiri as one of the members; and a working group comprising of RBI officials was set-up under my Chairmanship to provide technical assistance to the main Committee on several aspects for drafting the Fiscal Responsibility Bill. The RBI Working Group was actively involved in the Sarma Committee to draft the Fiscal Responsibility Bill. Mr. Prem Chand of the IMF, at our invitation, spent some time advising us on the international best practices in this regard. At this stage, we advised the Government that without incorporating transparent budget management rules and medium term fiscal framework, the objective of fiscal responsibility would not be achieved. Therefore, the name of the Bill was changed to Fiscal

Responsibility and Budget Management Bill incorporating additional features. In short, I am illustrating that the RBI has been actively collaborating with the government, whenever sought, but with appropriate propriety. Our experience shows that the FRBM Act has a positive effect of focusing attention on fiscal issues. At the same time, it may, sometimes, unintentionally lead to increased recourse to expanding off-budget fiscal liabilities. Such a practice is not entirely uncommon in many countries, but the magnitudes involved and the persistence in resorting to offbudget liabilities in India are noteworthy. The issue is not merely one of transparency in fiscal operations or a de facto larger borrowing programme of the Government than admitted, but one with significant implications for the Government debt market and monetary management. Past experience clearly suggests that recourse to such off-budget items is not ad hoc or one-time only. The repeated recourse to issue of Government bonds has been exercised not only for fuel, food and fertilizers for financing subsidies, but also for financing deferred liabilities in regard to bank loan waivers and contribution to the capital of public sector banks. Hence, unless there is a noticeable change in global prices or a change in policy towards recurrent subsidies and deferred liabilities, continuation of such special bonds may not be ruled out. The significant quasi-fiscal transactions to finance recurrent revenue expenditures through de facto borrowings pose challenges in managing the links between fiscal, external and monetary management. The RBI has rendered advice on FRBM to the state governments also. A forum has been provided by the RBI, which brings together the Finance Secretaries of state governments, for exchange of ideas and sorting out the issues. The bi-annual conference of State Finance Secretaries hosted by the RBI, initiated in 1996, is also attended by the Secretaries in the Ministry of Finance, Government of India, representatives from the Planning Commission, the Comptroller and Auditor General of Accounts (CAG) and the Controller General of Accounts (CGA). The deliberations in these bi-annual conferences have proved very useful in identifying the common issues and developing best practices in regard to state government finances. A number of important initiatives relating to ways and means advances, approach to market borrowing programme, investment of surpluses, ceilings on state government guarantees, model scheme for state level fiscal legislations, apart from changes in

the content and format for reporting budget related documents to ensure transparency etc. have emanated and taken shape as a result of interactions in these meetings. The RBI has, through this forum, also helped the state governments prepare the state level FRBM legislations. Incidentally, the first research and policy paper on pension funds in India was prepared by Dr. Urjit Patel, who used to work with us. In those days, it was so hard to get any data that we had to tap our informal links in the various offices in Delhi, including some of my old colleagues, to give him some access to relevant information. Dr. Urjit Patel did a very good job and then he published an article in the Economic & Political Weekly. Thus, the public policy on pensions was, in a sense, triggered by the work done by a consultant in RBI, at our request. RBI also worked on a Report on Pensions for state government employees. This is another evidence of the collaboration between the RBI and the governments and often our views are accepted. Now, let me come to the fiscal and monetary management issues.

ROLE OF FISCAL POLICY- ITS SIGNIFICANCE TO BUSINESS ECONOMY IN DEVELOPING COUNTRIES The main goal of the fiscal policy in developing countries is the promotion of the highest possible rate of capital formation. Underdeveloped economies are in the constant deficit of the capital in the economy and thus, in order to have balanced growth accelerated rate of capital formation is required. For this purpose the fiscal policy has to be designed in a way to raise the level of aggregate savings and to reduce the actual and potential consumption of people. To divert existing resources from unproductive to productive and socially more desirable uses. Hence, fiscal policy must be blended with planning for development. To create an equitable distribution of income and wealth in the society.

 To protect the economy from the ills of inflation and unhealthy competition from foreign countries. To maintain relative price stability through fiscal measures. The approach to fiscal policy must be aggregate as well as segmental. the sectoral imbalances can be curbed by appropriate segmental fiscal measures. The government expenditure on developmental planning projects must be increased. For this deficit financing can be used. It refers to creation of additional money supply either by creation of new money by printing by government or by borrowing from the central bank. Public borrowing, loans from foreign nations etc can be used in the development of the resources for public sector. Fiscal policy in the developing economy has to operate within the framework of social, cultural and political conditions which inhibit formation and implementation of good economic policies. In order to reduce inequalities of wealth and distribution, taxation must be progressive and government spending must be welfare-oriented. The hindrances in the effective implementation of fiscal policy in the developing countries are loopholes in taxation laws, corrupt tax administration, a high population growth, extravagant governmental spending on non-developmental items, an orthodox society etc.

ECONOMIC EFFECT 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 towards 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. 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 in the form of hot money. 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 foreign goods now cost less than they did before. Consequently, exports decrease and imports increase. Other possible problems with fiscal stimulus include the time lag between the implementation of the policy and detectable effects in the economy, and inflationary effects driven by increased demand. In theory, fiscal stimulus does not cause inflation when it uses resources that would have otherwise been idle. For instance, if a fiscal stimulus employs a worker who otherwise would have been unemployed, there is no inflationary effect; however, if the stimulus employs a worker who otherwise would have had a job, the stimulus is increasing demand while labor supply remains fixed, leading to inflation.

Principles of Fiscal PolicyFiscal Policy concerns the use of changes in the amount of government spending G and taxation T to influence the national economy. This policy can affect both Aggregate Demand (AD) and Aggregate Supply (AS), though it is worth noting that the affect on AD is much more direct and immediate, whereas AS is affected through indirect means over a greater period of time. Contents1 -Aggregate Demand 2 -Aggregate Supply 2.1 Capital Spending 2.2 Workforce Incentives 2.3 R&D and Innovation 3- Fiscal Policy Terms

Aggregate Demand G stands for government spending. Taxation is accounted for in the affect it has on the other components of aggregate demand (higher taxes reduce consumption).Increases in government spending will increase aggregate demand, which will have affects on the economy overall. It leads to an increase in output and average prices, other things being equal. However, the degree to which output/prices rise depends on the elasticity of Aggregate Supply (AS). This can be easily shown on an AD-AS model. If Aggregate Supply is elastic, an large increase in output may result with little risk of inflationary pressures. However, if AS is inelastic increased government spending may not be the best way of boosting the economy, as it is at risk of 'overheating' - that is, at risk of causing inflation rather than growth in output. Similarly, a fall in government spending will 'cool' the economy, and cause a contraction in Aggregate Demand (AD).

Aggregate Supply
aggregate supply is the total supply of goods and services that firms in a national economy plan on selling during a specific time period. It is the total amount of goods and services that firms are willing to sell at a given price level in an economy.

The price P of a product is determined by a balance between production at each price (supply S) and the desires of those with purchasing power at each price

(demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in an increase in price (P) and quantity sold (Q) of the product.

Capital Spending
Gagong spending on infrastructure, such as new transport networks, increases the potential output of an economy. Also, lower corporation taxes mean that businesses can invest greater sums at the same time, contributing both to AD and AS. Capital spending could also include investment in human capital, such as retraining, higher education and vocational training as ways to increase the supply of labour, reduce unemployment and provide a more productive workforce. Human capital is becoming ever more important as many developed countries now aim for a knowledge-based economy, in which labour is more productive.

Workforce Incentives
Changes in the benefits system, such as a reduction in income tax, could create greater incentive for individuals to return to work. This increases labor supply, and hence overall supply as labour is a factor of production. It could be argued that welfare and benefit reform is more important ie. fewer benefits for the unemployed to incentivize them to work. R&D and Innovation Increased G could encourage developments in technology, which also increase the potential output of an economy, though without an accompanying increase in demand, this will only increase 'slack' in the economy, reducing inflationary pressure, rather than an actual increase in total output. These AS effects are dependent upon carefully targeted government spending, and it is important to note that government spending alone will not necessarily affect AS. Fiscal Policy Terms Expansionary Fiscal Policy = G > T. That means that government spending is greater than the rate of taxation, so it is a boost to the economy. The disadvantage to this is that a budget deficit will ultimately build up

Contractionary Fiscal Policy = G < T. This has a contractionary, deflationary effect on the economy, but it will improve the government finances over time.

Long-Term Fiscal Policy Challenges

Indias loose fiscal policy has reduced growth below potential without showing any discernible signs of an imminent crisis. However, if the fiscal imbalances are not addressed and growth continues to fall short of potential, the risks of a conventional crisis fiscal, monetary or external will increase. According to some scenarios, in which real interest rates stay relatively high and greater efficiencies in investment are only partially realized, even fiscal reform that cuts the primary deficit substantially over the next three years will just succeed in maintaining something like the current deficit-GDP ratio of about 10%, and debt will continue to accumulate, though less rapidly than in the last few years. This is a minimal objective to aim for over the next few years. Critical elements of any scenario that does not lead to almost certain crisis down the road are an increase in the tax-GDP ratio, and a reorientation of public expenditure toward efficient investment in physical infrastructure and human development, and away from distortionary and inefficient subsidies. The most serious medium and long-term issue that must be anticipated is the future cost of the pension system. Many of the conference papers emphasize this relatively recent addition to the causes for concern with respect to Indias fiscal future. While some demographic trends will help, by increasing the proportion of the population that is of working age, the increase in life expectancy will increase the number of years for which pensions are paid, relative to the number of working years. Managing this problem by increasing the retirement age can be politically difficult if it reduces the employment chances of young entrants. However, with sufficiently rapid growth of GDP and employment, this difficulty will ease. Be that as it may, Hellers

paper quotes World Bank estimates that the cash-flow deficit of the Employees Pension Scheme (EPS), which is a defined benefit scheme, will grow to almost 1% of GDP over the next few decades, even without increases in coverage. If more employees are covered by the EPS as growth increases the relative size of the formal sector, then the potential problem will grow accordingly. Recently, various income transfer and social insurance schemes that reach into rural areas and the informal sector of the economy have been announced. While the objectives of such policies are laudable, they introduce yet additional demands on the budget, which will be difficult to reverse, as they become viewed as entitlements. Srinivasan (2002) and Rajaraman (2004) emphasize that the Pay Commission award was not an exogenous shock, but one that was predictable in the context of institutional and political economy considerations. Thus, one can argue that pay, pensions and social insurance are all areas in which there is virtually no uncertainty about their future costs so that the government will have to do long term planning. While we have suggested that the broad outlines of technical solutions to Indias short run fiscal problems are well understood, leaving only the political difficulties of implementation, in the case of long-term budgetary commitments, there seems to be a need for an integrated analysis of the various possibilities. For example, the last Pay Commission award was followed by increases in the pensions of those who had already retired while such ex post adjustments may again have laudable motives, they represent a contingency that must be allowed for in projecting the future liabilities of the government. The announcement in the interim budget for 2004-05 of the merger of 50% of dearness allowance of civil servants into their basic salary is not a good signal. The overall picture of the future of government pay and pensions, and social insurance schemes is gloomy. However, attention to these factors not only allows the government to plan, but can also increase the awareness of the need for immediate fiscal adjustment on other fronts, if not this one. One hopeful area, again, is tax reform. Heller (2004) points out that the tax treatment of pension contributions is unduly generous, and also creates some perverse incentives. This is one area where short-term remedies, such as phased reductions of tax preferences, ought to be

politically feasible and relatively easy to implement, once they are on the policy agenda. Two other aspects of demographic trends and predictable future demands on the fisc are in the areas of primary education and urban infrastructure. Based on projected fertility rates, one can predict the number of school children that will need basic education, and plan for this.48 To some extent, the problems of Indias education system lie more in inefficient rather than insufficient public expenditure, but as the demands of being part of a modern workforce increase, the need to fund education more effectively will also rise. Much of this burden will fall on the State governments, and given the fiscal adjustment that is going to be required of them, tax reform that gives State (and local) governments more scope to tax will be imperative. In general, therefore, looking at the longer term and at broader public welfare concerns can have three benefits. First, it allows for better intertemporal planning of public expenditures within and across categories. Second, it improves the pattern of near-term public expenditures toward spending that reduces the chances of larger expenditures in the future. Third, it emphasizes the need for a fiscal cushion or selfinsurance to meet unavoidable expenditures should they occur in the future. Finally, considering the long run necessitates modeling the dynamics of the economy more explicitly as we have stressed in Section 5 in addition to analyzing debt dynamics and intertemporal insurance against exogenous shocks. Growth is critical in the long run, and working out steady state implications of current policy adjustments (as well as adjustment paths) also requires explicit modeling.

Evaluation / Criticisms / limitation of Fiscal Policy

Fiscal Policy is the use of Government spending and taxation to influence the level of economic activity. In theory, fiscal policy can be used to prevent inflation and avoid recession. But, in practice there are many limitations of using fiscal policy.
1.

Disincentives of Tax Cuts. Increasing Taxes to reduce AD may cause disincentives to work, if this occurs there will be a fall in productivity and AS could fall. However higher taxes do not necessarily reduce incentives to work if the income effect dominates.

2.

Side Effects on Public Spending. Reduced govt. spending to Increase AD could adversely effect public services such as public transport and education causing market failure and social inefficiency.

3.

Poor Information Fiscal policy will suffer if the govt. has poor information. E.g. If the govt. believes there is going to be a recession, they will increase AD, however if this forecast was wrong and the economy grew too fast, the govt. action would cause inflation.

4.

Time Lags. If the govt. plans to increase spending this can take along time to filter into the economy and it may be too late. Spending plans are only set once a year. There is also a delay in implementing any changes to spending patterns.

5.

Budget Deficit Expansionary fiscal policy (cutting taxes and increasing G) will cause an increase in the budget deficit which has many adverse effects. Higher budget deficit will require higher taxes in the future and may cause crowding out (see below

6.

Other Components of AD. If the government uses fiscal policy its effectiveness will also depend upon the other components of AD, for example if consumer confidence is very low, reducing taxes may not lead to an increase in consumer spending.

7. Depends on Multiplier And change in injections may be increased by the multiplier effect, therefore the size of the multiplier will be significant.

Budget
Definition:
A Budget is a plan that outlines an organization's financial and operational goals. So a budget may be thought of as an action plan; planning a budget helps a business allocate resources, evaluate performance, and formulate plans. While planning a budget can occur at any time, for many businesses, planning a budget is an annual task, where the past year's budget is reviewed and budget projections are made for the next three or even five years. The basic process of planning a budget involves listing the business's fixed and variable costs on a monthly basis and then deciding on an allocation of funds to reflect the business's goals. Businesses often use special types of budgets to assess specific areas of operation. A cash flow budget, for instance, projects your business's cash inflows and outflows over a certain period of time. It's main use is to predict our business's ability to take in more cash than it pays out.

The Purpose of a Business Budget

Business budgeting is a basic and essential process that allows businesses to attain many goals in one course of action. There are several goals that many businesses seek to achieve (or should be trying to work toward) when they create and implement a budget. These goals include control and evaluation, planning, communication, and motivation.

Control and Evaluation

Perhaps the most obvious of budgeting goals is that of control and evaluation. Budgeting allows a company to have a certain degree of control over costs, such as not allowing many types of expenses to take place if they were not budgeted for, or

assigning responsibility for these expenses. A budget also gives a company a benchmark by which to evaluate business units, departments, and even individual managers. Unfortunately this purpose of budgeting can cause employees to have negative feelings about the budgeting process because their compensation and, in certain cases, their jobs, may be dependent on meeting certain budgeting goals. This is especially true in companies that focus on the evaluation purpose of budgeting and when the budgeting is a top-down process, rather than a participative one.

Planning
Planning is another purpose of budgeting, and is arguably its primary purpose. Budgeting allows a business to take stock of revenue and expenses from the previous period, and judge where the business will be in future periods. It also allows the organization to add and remove products and services from its plan for the future period. In larger organizations, the budgeting process may be completed by individual business units and compiled to form a master budget for the organization. This allows top management to get a picture of the entire business so they are able to better plan accordingly.

Communication and Motivation

Other goals that an organization may use its budget to achieve that are less obvious include communication and motivation. Budgets allow management to communicate goals and to promote goal congruence so resources can be coordinated and focused in key areas. Budgets also allow a company to motivate its employees by involving them in the budget. While top-down budgeting does not accomplish this goal very effectively, participative budgeting can be motivating. When an employee is involved in creating his or her departments budget, that person will be more likely to strive to achieve that budget.

Budget Graph 2009-10

Estimates and Expenditure

80 70 60 50 BE (Rs. in Crores) 40 RE Actual 30 20 10 0 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Year s

(Rs. In crore) 200405 200506 200607 200708 2008-09 200910

BE RE Actual

7 10 6

35 19 17.4

38 26 22

50 40 35.4

65 45 45 (provisional)

80

Administrative Expenditure* vis--vis Scheme Expenditure in the year (2009-10 Estimate)

8 0 75 70 65 60 55 50 (Rs. in 40 Crores) 35 45

30 25 20 15 10 5 0 2007-08 2008-09 20092004-05 2005-06 2006-07 10

Administrative Cost include salary, allowances, medical expenses, professional charges & offices expenses Scheme Expenditure includes Expenditure on Schemes, Capital Exp., PBD, Advertising & publicity, Publications. Seminars and Studies and International Conferences

Govt. budget

= G - (tax transfers) =GT

WhereG= govt. purchases T= net taxes

Budget deficit

Budget surplus

If G T > 0 ; a budget deficit in the year, If G T < 0 ; a budget surplus in the year, and If G T = 0 ; a balanced budget in the year.

Delhi Govt. announces increase VAT on CNG, diesel budget 2010

2010-03-22 22:10:00 The Government of National Capital Territory of Delhi on Monday announced increase in the value added tax (VAT) on natural gas (CNG), diesel, dry fruits, Desi ghee, glucose and tea while withdrawing the Rs. 40 subsidy on LPG (cooking gas) in the Budget 2010 and cited Commonwealth Games as the reason. Addressing media, after presenting the Budget, Delhi's Finance Minister A K Walia said the enhancement in VAT rates and withdrawal of subsidy on LPG were necessitated by the increased expenditure on infrastructural projects related to Commonwealth Games 2010. Walia said that in view of increased expenditure due to the Commonwealth Games related projects and schemes and inadequate collection of taxes due to down turn in economy, additional sources of revenue are required. Walia, however, assured that there would be no extra burden on the "common man" as the prices of essential commodities would not be increased. "In any case with the implementation of GST next year, the subsidy on most items will have to be withdrawn," Walia said. The Budget removes the current subsidy of Rs 40 on the LPG which will lead to increase in prices to Rs 322.80 per gas cylinder. The withdrawal of subsidy will relieve the State Government of a burden of Rs 160 to Rs 170 crore per annum. The VAT on CNG for use in transport sector has been hiked to five per cent which will translate into a hike of Rs 1.09 per litre while the VAT on diesel have been increased from 12.5 per cent to 20 per cent which amounts to a hike of Rs 2.37 per litre.

Moreover, the VAT on writing instruments, watches above Rs 5,000, mobile phones and accessories above Rs 10,000 and readymade garments has also been enhanced.(ANI)

Pranab Mukherjee Confident About Budget 2010 Achieving Its Goals

Friday, April 2nd, 2010 Finance Minister Pranab Mukherjee reiterated his belief in the Union Budget presented by him February last by announcing that it would help in reviving private investment and set the economy on a higher growth rate. Mr. Mukherjee was speaking at the foundation day function of Small Industries Development Bank of India (SIDBI). He said, I am optimistic that the measures I have outlined in this years Budget will revive private investment and put the economy back on the growth path of 9 per cent. He added that the growth rate for the last financial year would be around 7.2% and the economy would post a growth in the range of 8.25% to 8.75% in the current fiscal. He called this growth impressive by global standards. Mr. Mukherjee named micro, small and medium enterprise (MSME) sector as the pillar of the Indian economy and said that government is taking various measures to promote the sector. The enhancement in the limit for presumptive taxation, extension of interest subvention for exports in certain sectors, increasing the threshold for compulsory auditing of accounts of small businesses and exemption from capital gains tax are some of the notable steps. Finance Minister observed that finance is one of the most effective tools in the fight against poverty and for aiding inclusive growth. He added, Timely availability of credit to MSMEs is extremely important to meet their growing needs and to help them keep their business lifeline vibrant and progressive. MSME sectors contribution to GDP growth is 8%. It also chips in with 45% in manufactured output, 40% in exports and provides employment to almost 60mn. Mr. Mukherjee assured that government would act on the recommendations of the PMs task force on MSMEs in a time-bound manner.

Bibliography
Books :
1. Parmeswaran sunil. K. Futures markets, mc tata pub, 2009

2. Bhagwati J (1993). India in Transition: Freeing the Economy. Oxford

University
3. Bhardwaj G, Dave S (2006). Towards estimating Indias implicit pension

debt.

Magazine Times of India Economics Times

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