Fiscal Policy

It is the means by which a government adjusts its spending levels

and tax rates to monitor and influence a nation's economy with an
objective to achieve the macro-economic goals(3 goals already
discussed in the class). Government uses its expenditure and
revenue program to produce desirable effects on National Income ,
production and employment.
More broadly:
Government's revenue (taxation) and spending policy designed to
(1) counter economic cycles in order to achieve lower 
Unemployment
(2) achieve low or no inflation, and (3) achieve sustained but
controllable economic growth. In a recession, governments
stimulate the economy with deficit spending (expenditure exceeds
revenue). During period of expansion, they restrain a fast growing
economy with higher taxes and aim for a surplus (revenue exceeds
expenditure).
 Objectives of Fiscal Policy

• To effectively mobilise resources for Economic Growth

• To redistribute financial resources in the favour of poor
• To make Balanced regional development
• To go for Equitable distribution of Income and wealth
• To Restrain inflationary forces in the Economy
• To encourage capital formation
• To aim at increasing national income
• To promote export & foreign exchange earnings
• To develop infrastructure
• To bring out overall development with equity & social justice.
 Tools of Fiscal Policy
Tools of
Fiscal
Policy

Public Public
Revenue Expenditure

Revenue Capital Revenue Capital

Receipt Receipt Expenditure Expenditure

Tax Non- Tax

Direct Tax Indirect Tax

 Public Expenditure (Payments)
• Revenue Expenditure
An expenditure which
neither creates assets nor
reduces liability is called
Revenue Expenditure, e.g.,
salaries of employees,
interest payment on past
debt, subsidies, pension,
grants, rural development,
education and health
services etc.
 Capital Expenditure
An expenditure which either
creates an asset or reduces
liability is called capital
expenditure. Expenditure on
purchase of land, buildings,
machinery, investment in
shares, loans by Central
government to state
government AND Repayment
of loan is capital expenditure
because it reduces liability
 Public Revenue (Receipts)
• Revenue Receipts
All Government receipts which
neither create liability nor reduce
assets of Government are called
revenue receipts.
– Tax (direct and indirect)
– Non- Tax Receipts
• Fines and Penalties
• Fees
• Profits of PSU
• Govt Interest
• Grants and Gifts
 Capital Receipts
All Government receipts which
either create liability or reduce
assets are treated as capital
receipts whereas receipts
Recovery of Govt loans
 Disinvestment of PSU
 Market Borrowings –
Internal and International
sources
 (` crore)
2009-10 2010-11 2011-12 2012-13 2013-14 2013-14 2013-14
(BE) (RE) (P)
Direct (a) 367648 438477 488113 553705 661389 630821 633473
Personal income tax 122475 139069 164485 196512 240919 236194 237789
Corporation tax 244725 298688 322816 356326 419520 393677 394677
Indirect(b) 244737 344530 391738 473792 564254 518770 496231
Customs 83324 135813 149328 165346 187308 175056 172132
Excise 102991 137701 144901 175845 196805 178787 169469
Service tax 58422 71016 97509 132601 180141 164927 154630
Gross tax revenue # 624528 793072 889177 1036235 1235870 1158905 1133832
Tax revenue as a percentage of gross tax revenue
Direct (a) 58.9 55.3 54.9 53.4 53.5 54.4 55.9
Peronal income tax 19.6 17.5 18.5 19.0 19.5 20.4 21.0
Corporation tax 39.2 37.7 36.3 34.4 33.9 34.0 34.8
Indirect(b) 39.2 43.4 44.1 45.7 45.7 44.8 43.8
Customs 13.3 17.1 16.8 16.0 15.2 15.1 15.2
Excise 16.5 17.4 16.3 17.0 15.9 15.4 14.9
Service tax 9.4 9.0 11.0 12.8 14.6 14.2 13.6
Tax revenue as a percentage of gross domestic product
Direct(a) 5.7 5.6 5.4 5.5 5.8 5.6 5.6
Personal income tax 1.9 1.8 1.8 1.9 2.1 2.1 2.1
Corporation tax 3.8 3.8 3.6 3.5 3.7 3 .5 3.5
Indirect(b) 3.8 4.4 4.3 4.7 5.0 4.6 4.4
Customs 1.3 1.7 1.7 1.6 1.6 1.5 1.5
Excise 1.6 1.8 1.6 1.7 1.7 1.6 1.5
Service tax 0.9 0.9 1.1 1.3 1.6 1.5 1.4
Gross tax revenue # 9.6 10.2 9.9 10.2 10.9 10.2 10.0
 DEFICITS ( BE –Budget Estimate, RE-Revised Estimate,
P- Provisional)
Items 2009-10 2010-11 2011-12 2012-13 2013-14 2013-14 2013-14
(BE) (RE) (P)
1. Revenue receipts (a+b) 8.8 10.1 8.3 8.7 9.3 9.1 8.9
(a) Tax revenue (net of states’ share) 7.0 7.3 7.0 7.3 7.8 7.4 7.2
(b) Non-tax revenue 1.8 2.8 1.4 1.4 1.5 1.7 1.8
2. Revenue expenditure 14.1 13.4 12.7 12.3 12.6 12.4 12.1
of which:
(a) Interest payments 3.3 3.0 3.0 3.1 3.3 3.4 3.3
(b) Major subsidies 2.1 2.1 2.3 2.4 1.9 2.2 2.2
(c) Defence expenditure 1.4 1.2 1.1 1.1 1.0 1.1 1 .1
3. Revenue def icit (2-1) 5.2 3.2 4.4 3.6 3.3 3.3 3.2
4. Capital receipts 7.0 5.2 6.1 5.3 5.4 5.0 4.8
of which:
(a) Recovery of loans 0.1 0.2 0.2 0.2 0.1 0.1 0.1
(b) Other receipts (mainly CPSEs 0.4 0.3 0.2 0.3 0.5 0.2 0.2
disinvestment)
(c) Borrowings and other liabilities $ 6.5 4.8 5.7 4.9 4.8 4.6 4.5
5. Capital expenditure 1.7 2.0 1.8 1.6 2.0 1.7 1.7
6. Non-debt receipts 1+4(a)+4(b) 9.4 10.6 8.8 9.1 9.9 9.4 9.3
7. Total expenditure [2+5=7(a)+7(b)] 15.8 15.4 14.5 13.9 14.6 14.0 13.8
of which:
(a) Plan expenditure 4.7 4.9 4.6 4.1 4.9 4.2 4.0
(b) Non-plan expenditure 11.1 10.5 9.9 9.9 9.8 9.8 9.8
8. Fiscal def icit [7-6] 6.5 4.8 5.7 4.9 4.8 4.6 4.5
9. Primary def icit [8-2(a)] 3.2 1.8 2.7 1.8 1.5 1.3 1.2
 2013-14 2013-14 2013-14
Sl. Items 2012-13 2013-14 RE 2013-14 as per cent as per cent as per cent
No. Actuals BE RE P Absolute of RE of BE of GDP
1 2 3 4 5 6 7 8 8 10
1 Revenue receipts (2+3) 877613 1056330 1029251 1015279 -13972 98.6 96.1 8.9
Gross tax revenue 1036235 1235870 1158905 1138832 -20073 98.3 92.1 10
2 Tax (net to Centre) 740256 884078 836025 816046 -19979 97.6 92.3 7.2
3 Non-tax 137357 172252 193226 199233 6007 103.1 115.7 1.8
4 Non-Debt Capital 42158 66468 36644 40057 3413 109.3 60.3 0.4
Receipts(5+6)
5 Recovery of loans 16268 10654 10803 12502 1699 115.7 117.3 0.1
6 Disinvestment proceeds 25890 55814 25841 27555 1714 106.6 49.4 0.2
7 Total Non-debt receipt (1+4) 919771 1122798 1065895 1055336 -10559 99 94 9.3
Memo items
Corporation tax 356326 419520 393677 394677 1000 100.3 94.1 3.5
Income tax 196512 240919 236194 237789 1595 100.7 98.7 2.1
Union excise duty 175845 196805 178787 169469 -9318 94.8 86.1 1.5
Customs 165346 187308 175056 172132 -2924 98.3 91.9 1.5
Service tax 132601 180141 164927 154630 -10297 93.8 85.8 1.4
Total (Memo items) 1026630 1224693 1148641 1128697 -19944 98.3 92.2 9.9
Devolution to states 291547 346992 318230 318230 0 100 91.7 2.8
8 Non-Plan expenditure (a+b) 996742 1109975 1114902 1110400 -4502 99.6 100 9.8
( a ) On revenue account 914301 992908 1027688 1023047 -4641 99.5 103 9
of which:
( 1 ) Interest payments 313169 370684 380066 377502 -2564 99.3 101.8 3.3
(2) Major subsidies 247493 220972 245451 247596 2145 100.9 112 2.2
(3) Pensions 69478 70726 74076 74606 530 100.7 105.5 0.7
(b) On capital account 82441 117067 87214 87353 139 100.2 74.6 0.8
9 Plan expenditure (12+13) 413625 555322 475532 453085 -22447 95.3 81.6 4
(a) Revenue account 329208 443260 371851 352543 -19308 94.8 79.5 3.1
(b) Capital account 84417 112062 103681 100542 -3139 97 89.7 0.9
10 Total expenditure (8+9) 1410367 1665297 1590434 1563485 -26949 98.3 93.9 13.8
11 Revenue expenditure (8a+9a) 1243509 1436168 1399539 1375590 -23949 98.3 95.8 12.1
12 Grants for capital assets 115513 174656 121283 129839 8556 107.1 74.3 1.1
13 Capital expenditure (8b+9b) 166858 229129 190895 187895 -3000 98.4 82 1.7
14 Revenue Def icit (1-11) 365896 379838 370288 360311 -9977 97.3 94.9 3.2
15 Effective Revenue Def icit 250383 205182 249005 230472 -18533 92.6 112.3 2
(14-12)
16 Fiscal Def icit (7-10) 490596 542499 524539 508149 -16390 96.9 93.7 4.5
17 Primary Def icit (14-8(a)(1) 177427 171815 144473 130647 -13826 90.4 76 1.2
 Fiscal Policy
• Expansionary Policy • Contractionary Policy
P P
R R
I I
C C
E E

L AD2 L
E E AD1
V AD1 V
AD2
E E
L L
REAL GDP REAL GDP
Canons / Principles of TAX by Adam-Smith

(1) Canon of Equity

(2) Canon of Certainty
(3) Canon of Convenience or Ease
(4) Canon of Economy

Other Canons

(5) Canon of Productivity

(6) Canon or Elasticity
(7) Canon of Simplicity
(8) Canon of Diversity
(9) Canon of Desirability or Expediency
Canons / Principles of Public Expenditure

The Principle of Maximum Social Advantage

The Principle of Economy
The Principle of Sanction
The Principle of balanced Budgets
The Principle of Elasticity
No unhealthy effect on Production and Distribution
 Monetary Policy In India
It is the process by which monetary authority of a country, generally a central
bank(RBI) controls the supply of money in the economy by its control over interest
rates in order to maintain price stability and achieve high economic growth.

The objectives are to bring about :

• Price Stability (stabilization) – Controlling inflation & deflation (inflation is unjust

while deflation is inexpedient)
• Promotion of investment or savings (depends on the economic condition)
• Promotion of activities that encourages growth prospects,
• Controlled & desired distribution of credit,
• promotion of financial sector reforms or modification for their most efficient use
etc.
• regulated credit provision at each & and every point of time after looking at the
availability of goods & services in the economy & the speed of transaction.
 Credit Control is an important tool used by RBI, a major weapon of the monetary
policy used to control the demand and supply of money (liquidity) in the economy. Its
done in the following ways

Quantitative credit control:

• Open Market Operations : involves buying or selling of government securities from
or to the public and banks . The RBI sells government securities to contract the
flow of credit and buys government securities to increase credit flow and thus
money supply
• Cash Reserve Ratio : certain percentage of bank deposits which banks are required
to keep with RBI in the form of reserves or balances .Higher the CRR with the RBI
lower will be the liquidity in the system & thus money supply can be controlled by
increasing CRR.
• Statutory Liquidity Ratio : Banks have to maintain certain quantity of liquid assets
with themselves at any point of time of their total time and demand liabilities.
These assets can be cash, precious metals, approved securities like bonds etc.
 Monetary Policy Cont.
• Bank Rate / discount rate: The bank rate is the Official interest rate at which RBI
lends money to commercial banks. For reducing the credit, inflation and money
supply, RBI will increase the Bank Rate and vice-versa.

• Repo Rate and Reverse Repo Rate: Repo rate is the rate at which RBI lends to
commercial banks generally against government securities. Reverse Repo rate is
the rate at which RBI borrows money from the commercial banks. Of course
borrowing rate would be less than lending rate.

• The increase in the Repo rate will increase the cost of borrowing and lending of the
banks which will discourage the public to borrow money and will encourage them
to deposit. As the rates are high the availability of credit and demand decreases
resulting to decrease in inflation.
• Reduction in Repo rate helps the commercial banks to get money for short term at
a cheaper rate and increase in Repo rate discourages the commercial banks to get
money as the rate increases and becomes expensive.
 Monetary Policy Cont.
Qualitative credit control:
Qualitative Method controls the manner of channelizing of cash and credit in the economy. It is a
‘selective / discretionary method’ of control specific sectors & thereby controlling inflation more
effectively.
• Credit Ceiling In this operation RBI issues prior information or direction that loans to the
commercial banks will be given up to a certain limit. This fixes down payments and maximum
maturities of installment credit for purchase of goods.
•
Publicity: RBI uses media for the publicity of its views on the current market condition and its
directions that will be required to be implemented by the commercial banks to control the
unrest.
• Moral Suasion: just as a request by the RBI to the commercial banks to take so and so action
and measures in so and so trend of the economy. RBI may request commercial banks not to
give loans for unproductive purpose which does not add to economic growth but increases
inflation.
• Direct Action RBI has the authority to take strict action against any of the commercial
banks that refuses to obey the directions given
TTD : FIND OUT THE CURRENT POLICY RATES…
 What RBI reports daily…
Policy Repo Rate : 6.25%
Reverse Repo Rate : 6.00%
Marginal Standing Facility Rate : 6.50%
Bank Rate : 6.50%

CRR : 4%
SLR : 19.25%

Base Rate : 8.95% - 9.45%

MCLR (Overnight) : 8.15% - 8.55%
Savings Deposit Rate : 3.50% - 4.00%
Term Deposit Rate > 1 Year : 6.25% - 7.50%
Is DEVALUATION always a better solution to
raise trade balance?

Elasticity of Demand <1 Elasticity of Demand >1

EXPORT Total expenditure by Total expenditure by

foreigners would go foreigners would go up.

down

IMPORT Total expenditure by YOU Total expenditure by YOU

would go up. would go down.

 Exchange rate determination
• Theoretically it can be done in many ways [like ppp – purchasing
power parity(law of one price), (Absolute and Realative PPP)]
but in practice it depends on forex demand and suuply.

• REER- Real Effective Exchange Rate

• NEER- Nominal Effective Exchange Rate
• https://rbidocs.rbi.org.in/rdocs/PressRelease/Pdfs/PR244092CF
7ADD0B2649ED9662D80316FA7134.PDF
• https://www.rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=16707
 BoP
The Balance of Payments (BoP) of a country is the
record of all economic transactions between the
residents of the country and the rest of the world
in a particular financial period. These transactions
are made by individuals, firms and government
bodies from both side.

Thus the balance of payments includes all external

visible and non-visible transactions of a country
with others.
 Components of BOP
• Current account: It records the trade of goods and
services of an economy with other countries of the world.
The three components are - net exchange i.e. exports
minus imports of goods, net exchange of services and net
transfers to and from the country.
• Capital Account: It gives a summary of the capital
expenditure and income for a country. The capital
expenditure and income is tracked by way of funds in the
form of investments and loans flowing in and out of an
economy. It gives a summary of the net flow of both
private and public investment into an economy.
 Indian Balance Payments Summary(US$ billion)
  2011-12 2012-13 2013-14 2014-15
I Current Account
i Exports BOP  
309.8
 
306.6
 
318.6
 
316.5
ii Imports 499.5 502.2 466.2 461.5
iii Trade Balance -189.8 -195.7 -147.6 -144.9
iv Invisibles (net) 111.6 107.5 115.2 118.1
A. Services 64.1 64.9 73 76.6
B. Transfers (remittances, donations, gifts etc.) 63.5 64 65.3 65.7
C. Income (profit, interest, dividend etc.) -16 -21.5 -23 -24.1
Current Account Balance -78.2 -88.2 -32.4 -26.8
II Capital Account        
i External Assistance 2.3 1 1 1.7
ii ECBs 10.3 8.5 11.8 1.6
iii Short-term Debt 6.7 21.7 -5 -0.1
iv Banking Capital        
of which:        
Non-Resident Deposits 11.9 14.8 38.9 14.1
v. Foreign Investment 39.2 46.7 26.4 73.5
A. FDI 22.1 19.8 21.6 31.3
B. Portfolio Investment 17.2 26.9 4.8 42.2
vi. Other Flows -7 -5.1 -10.8 1
Capital Account Balance 67.8 89.3 48.8 89.3
III Errors and Omissions -2.4 2.7 -0.9 -1.1
Capital Account Balance 65.3 92 47.9 88.2
(including errors & omissions)        
IV Overall Balance -12.8 3.8 15.5 61.4
V Reserves Change 12.8 -3.8 -15.5 -61.4
(-) indicates increase,        
(+) indicates decrease        
Source: RBI        
 Twin Deficit
C + I + G + (X - M) = C + S + T
(G – T) = (S - I) + (M - X)
Fiscal deficit = (S - I) + Trade deficit

Given S-I, any increase in fiscal deficit has to be financed by

Trade deficit.
EXAMPLE:
If govt wants to give water pumps in every village without
taxing people and S-I also does not change, then it will import
water pumps from rest of the world, so trade deficit rises.

• An economy is deemed to have a double deficit if it has a

current account deficit and a fiscal deficit. This persistent
double deficits will lead to currency devaluation/depreciation.