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Monetary and Fiscal Policy of India

S.Bharathi B.S ABM


Monetary Policy
Role & Objectives Instruments Inflation

Fiscal Policy
Role & Objectives Budget -> Revenue and Expenditure Taxation -> Structure Fiscal Deficit

Reviews Conclusion


Monetary Policy

Monetary Policy Meaning.

Reserve 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.

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

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 methods

These methods maintain and control the total quantity or volume of credit or money supply in the economy.
Open Market Operations
Open market operations indicate the buying/ selling of govt. securities in the open market to balance the money supply in the economy

Deployment of Credit
The 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
Cash reserve ratio (CRR)
The money supply in the economy is influenced by CRR. It is the ratio of a banks 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 Instruments
Liquidity 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.
i. 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.

ii. Reverse Repo Rate:

The rate at which RBI borrows from commercial banks.

Marginal Standing Facility (MSF):

Market Stabilization Scheme (MSS):

Liquidity of a more enduring nature arising from large capital flows is absorbed through sale of short-dated government securities and treasury bills.

Instituted under which scheduled commercial banks can borrow over night at their discretion up to one per cent of their respective NDTL at 100 basis points above the repo rate to provide a safety valve against unanticipated liquidity shocks

Bank rate:
Bank Rate is the rate at which central bank of the country (in India it is RBI) allows finance to commercial banks.

The mobilized cash is held in a separate government account with the Reserve Bank.

Bank Rate is a tool, which central bank uses for short-term purposes.
Any upward revision in Bank Rate by central bank is an indication that banks should also increase deposit rates as well as Base Rate / Benchmark Prime Lending Rate.


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.



There exist a non-monetized sector

Excess of non-banking financial institutions (NBFI)

Existence of unorganized financial market Money not appearing in an economy Time lag affects success of monetary policy Monetary policy and fiscal policy lacks coordination

Inflation 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. The Reserve Banks current assessment suggests that the threshold level of inflation for India is in the range of 46 per cent.

How does monetary policy affect inflation and other problems?

decreases raises


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.
- Kaushik Basu ( Former Chief Economic Adviser )


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.

Fiscal Policy there are three possible positions

A Neutral position 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. An Expansionary position is when there is a higher budget deficit where the govt. spending is higher than the revenue collected from the tax. An Contractionary position is when there is a lower budget deficit where the govt. spending is lower than the revenue collected from the tax.

The Two Main instruments of fiscal policy

Revenue Budget

Expenditure Budget

Revenue Budget
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.

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%

Expenditure Budget
The central government is responsible for issues that usually concern the country as a whole like national defence, 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 is Rs.16,65,297 crores (11.5% increase)

Fiscal Deficit
Fiscal Deficit = Total Expenditure (that is Revenue Expenditure + Capital Expenditure) (Revenue Receipts + Recoveries of Loans + Other Capital Receipts) Currently the deficit is 5.3 % of GDP

Major Changes in Budget(2013-14) to curb Deficit

One year surcharge of 10 % on the Superrich.

Increased Duties on Imported or domestic luxury vehicles such as SUVs, Mobiles (>Rs.2000), set top boxes, A/c restaurants and Cigarettes.( bring in Rs.18,000 crores)
Disinvestment Proceedings to be around Rs.55,000 Crore for this fiscal. No additional subsidy for fuel, food and fertilizer prices. Buyers of immovable property other than agriculture land will have to pay a tax of 1% of the sale where the value exceeds Rs.50 lakh.

Fiscal deficit

Current account deficit

Currency depreciation Lower growth Supply side gap in Food (inflation) ????? Only 42800 earn more than 1 crore and 1.9 lakh people earn more than 10 lakhs!!!!!!

Subbarao, RBI Governor (2012) explained that, India is unique in the sense that we are one of the economies in the world that is supply constrained. There is shortage of infrastructure both in quantum and quality. We need to improve that so that corporates become more competitive, so that economic production becomes more competitive. First on infrastructure, second, we need to improve supply of food, especially of protein foods. Third, is skilled labour. It is one thing to have a huge labour force but another to have a labour force that is not adequately skilled. The skill shortage is going to be a big threat.

Bhatt (2012) suggested that the need of today is not just the pumping of liquidity in to the Indian economy but also in addition the injection of demand. This can occur only through direct fiscal action by government. In India, larger government expenditure has to be oriented towards agriculture, rural development, health, human resources and infrastructure to make inclusive and balanced growth.

REFERENCES: [1] Dr. Rajiv Kumar Bhatt: Associate Professor of Economics at Banaras Hindu University Recent Global Recession and Indian Economy: An Analysis International Journal of Trade, Economics and Finance, Vol. 2, No. 3, June 2011 [2] Dr. Kausik Basu: Former Chief Economic Advisor Fiscal Policy in India: Trends and Trajectory Supriyo De January, 2012 [3] Dr. Sunita Mishra Has our monetary policy been successful in checking inflation? International Journal of Research in Finance & Marketing, May 2012 [4] Reserve Bank of India [5] Project on Monetary Policy of Reserve Bank of India [6] Shweta Punj Who will blink first? Chidambaram-Subbarao differences erupt into the open after monetary policy review November, 2012 [7] Sharanarthy Jaswanth Inflation Vs Growth, Business line, 2011 [8] Jagdish Bhagwati RBI overplaying inflation; must focus on growth now, PTI Nov 21, 2012 [9] Venky Vembu Inflation vs growth: Stiglitz is wandering in the wrong continent, Oct 18, 2012 [10] Indias Reserve Bank and Government Lock Horns in Growth vs. Inflation Debate, November 1, 2012 [11] D H Pai Panandiker The growth versus inflation dilemma, July 19, 2012 [12] Should policy focus on growth or inflation? DEBATE Business Standard / May 16, 2012 [13] RBI Governor Duvvuri Subbarao People are making too much of the finance minister's response

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