BSC45 ECONOMICS ASSIGNMENT 2: INDIA ECONOMY

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http://www.bloomberg.com/news/2013-07-29/rbi-says-restoring-indian-rupee-stability-is-
priority-for-policy.html

ABSTRACT
The study uses data from 2011 to 2013 to analyse the increasing unemployment rate as well
as the chronic inflation problem that India has been persistently facing. The article
highlighted on the key policy objective of the new India Government and the behaviour of
monetary and fiscal policies interaction to put the economy on sustainable and balanced high
growth path.

1.0 INTRODUCTION
Interaction between fiscal and monetary policies to facilitate the attainment of
macroeconomic objectives has been a central practice across various countries.Monetary
policy is often pursued to achieve the objective of low inflation to stabilise the economy from
output and price shocks. On the other hand, fiscal policy is often biased towards high growth
and employment even at the cost of higher inflation (Alesina and Tabelini, 1990; Aurbach,
2004). For achieving an optimal mix of macroeconomic objectives of growth and price
stability, it is essential that the two policies complement each other. However,
complementary of policies will vary according to the stage of development of the countrys
financial markets and institutions.

The biggest challenge India is facing in 2014 will be to revive an economy that is caught in
the worst slowdown since the 1980s due to variable issues such as strained public finances,
persistently high inflation, high interest rates and rising bad loans at banks.
Public finances are in dire straits as government spending has outpaced revenues.
Hence, it is imperative for the new government administration to be directedtowards slashing
subsidies spending, which would threaten budget blow out and a credit rating downgrade.

2.0 UNEMPLOYMENT
Unemployment is defined as people able, available and willing to find work and actively
seeking work, however, not employed.
Employment has always been one of the major challenges of the India. Despite the economic

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reforms and the Information Technology (IT) & Business Process Outsourcing (BPO) boom
in 2003, the unemployment situation in India is still on the rise.
Unemployment rate in India is showing an increasing trend since 2011 when it was 3.5%.
The same rose to 3.6% in 2012 and climbed to 3.7% last year. (Times of India, 2014)

2.1 CAUSES OF UNEMPLOYMENT IN INDIA
1. Insufficient Opportunities
Although many employment opportunities were opened up,
The expansion of production in India has led to economic growth, and as a result,
employment opportunities were opened up. However, these opportunities were not sufficient
to solve the problem of unemployment. Moreover, economic growth in a developing country,
such as India, does not assure that unemployment issue will be naturally resolved.
2. Increase in Labour Force
Since independence, India faced a rapid population growth, particularly in the rural areas. As
a consequence, labour force has also increased at a rapid pace. Moreover, over the years,
education among women has also changed their attitude towards employment. A great
number of them have also entered the job market. The economy, however, has not been able
to meet the challenge adequately and the net result has been continuous increase in
unemployment backlog.
3. Emphasis on Capital Intensive Projects
An increasing importance has been given to capital intensive projects during the process of
planning. In a labour surplus economy, use of automatic machines and other sophisticated
equipment is not justified as it has resulted in large-scale unemployment in India.
4. Inappropriate Educational System
Indias education system does not develop human resources properly. It fails to train the
people for the jobs consistent with present economic environment. As a result, even the
highly educated people in India, fail to get appropriate jobs. There is no correlation between
education and employment as far as India planning is concerned.

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3.0 INDIA CONTRACTIONARY FISCAL POLICY
India has adopted a contractionary policyto restrain the economy during inflation-inducing
business-cycle expansion, which involves decreasing the government spending and/or an
increase in the taxes imposed.

This aims to decrease aggregate demand enough to return the economy to its potential output
thereby reducing unemployment and increasing Real Gross Domestic Product
(GDP).Contractionary fiscal policy leads to a smaller government budget deficit
(expenditures>tax revenues) or a smaller budget surplus (tax revenues>expenditures).

3.1 OBJECTIVES OF INDIA FISCAL POLICY
1. Development by effective Mobilisation of Resources
The central and the state governments in India have used fiscal policy to mobilise resources.
The financial resources can be mobilised by:
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.
Public Savings: The resources can be mobilised through public savings by reducing
government expenditure and increasing surpluses of public sector enterprises.
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, issue of government bonds, etc., loans
from domestic and foreign parties and by deficit financing.
2. Reduction in inequalities of Income and Wealth
It aims at achieving equity 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 luxury goods, 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.

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3. Price Stability and Control of Inflation
By reducing fiscal deficits, introducing tax savings schemes, productive use of financial
resources, etc. helps to control inflation and stabilize price.
4. Employment Generation
The government is making every possible effort to increase employment in the country
through effective fiscal measure. 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 generates 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.

3.2 EFFECT OF FISCAL POLICY ON AGGREGATE DEMAND
Aggregate Demand is the sum of Consumption expenditures (C), Investment (I), Government
Expenditure (G) and net exports(X-M)).
That is
Y = C + I + G + (X-M)
Contractionary Policy aims to decrease the spending by the government (G), which will
directly decrease aggregate demand curve by reducing government demand for goods and
services. Increases in tax levels will also slow growth, as consumers will have less money to
consume (C) and invest, thereby indirectly reducing the aggregate demand curve, shifting the
AD Curve to the left.

The amount by which potential GDP exceeds real GDP is the inflationary gap, and
contractionary policy is designed to close the inflationary gap by changing aggregate
expenditures and shifting the aggregate demand curve. An inflationary gap is closed with a
leftward shift of the aggregate demand curve.


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4.0 INFLATION IN INDIA

Inflation rate in India is calculated as per Consumer Price Index (CPI). Recently, the inflation
rate touched 10.92% in 2013 (worldwide inflation data, 2013), one of the highest in the recent
years.The Reserve Bank of India (RBI)s current assessment shows that the threshold level of
inflation for India ranging from 4 6 %, maintaining inflation within the comfort zone is
crucial in facilitating sustainable growth.
The government has plans to take firm measures in controlling inflation, where it plans to ban
the export of steel and cement which relate to the rising prices. Another measure is to lower
the excise duty on steel from 14% to 18%.

Inflation has caused a significant resistance on Indian economy. Where prices are increasing
rapidly in other countries, exports to other countries became harder for Indian businesses.
Volatility has also seen to increase due to the fast-rising price, companies tend to be more
conservative in making investment in new projects. With a highly inflated economy, the poor
are affected at the worst by rapid increase in price as they tend to hold most of their savings
in cash.

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4.1 CAUSES OF INFLATION IN INDIA

The continuous inflation in India are caused by the lessen demand as well as the cost push
inflation factors. These include the overflowing supply of products and high dependant on
imported energy and lax fiscal policy. While a loose fiscal policy has aid collective demand,
especially across undeveloped areas, a permissive environment to amplify supply response is
lacking, resulting in an additional inflation pressures.
Demand Pull Factors include, but not limiting to,
a) High Monetary Expansion - the rate of supply of money is too fast each year imbalance
with the supply of goods and services as the rate does not match according with it.
b) Increase in PopulationThe rate of population growth in India is about 3%, hence due to
this, aggregate demand is increasing.
c) Black Money When income tax payers misrepresent their income statements to the tax
authorities, it lead to creation of black money, hence creating more demand.

Demand pull inflation is caused due to the changes in the determinants of AD. Whenever,
any of the components of AD (i.e. consumption, investment, and government spending and
net exports) will increase, this will result in an increase in aggregate demand.


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Cost Push Factors include, but not limiting to,
a) Increase in Indirect Taxation Leads to increase in prices, hence inflation.
b) Increase in Wages and Bonuses Leads to increase in cost of production, hence rise in
price, which causes inflation.

Increase in cost of production will result in cost push inflation. As the cost of production
increases, the firms will reduce supply. The aggregate supply will shift to the left, from
SRAS1 to SRAS2. This will result in an increase in the average price level in the economy.
Real output will fall.



4.2INDIA CONTRACTIONARY MONETARY POLICY

As stated by RBI, monetary policy refers to the adoption of different instrument managed by
the central bank to monitor the availability and the use of funds.
The aim is to anchor inflationary expectations, improve real interest rates, increase domestic
savings, thus providing a support for more sustainable growth.

The RBI implements the monetary policy through:
a) Maintaining the Required Reserve Ratio (RRR) Keeping it unchanged at 4.0

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%(Raghuram G. Rajan, 2013)
b) Open market operations The RBI sells government securities to contract the flow of
credit
c) Increasing Discount Rate Hiked to 7.75%

These acts lead to the decrease of excess reserve of commercial banks for loans.
4.3 OBJECTIVES OF INDIA MONETARY POLICY

1. Growth with Stability
Traditionally, monetary policy of India focused on sustaining inflation through the reduction
of money supply and credit, which causes poor growth performance. Thus, RBI recently
adopted the policy of Growth with Stability. This means that sufficient source of funds are
available for expansion of different industries in the economy at the same time, inflation will
be controlled within a certain range.
2. Encouraging Savings and Investments
By offering better interest rates to encourage savings, increases the availability of funds and
promotes investment. Promoting of subjective monetary direction by implementing attractive
interest rates can affect the saving patterns in the country.
3. Redistribution Of Income And Wealth
By control of inflation and deployment of credit to weaker sectors of society the monetary
policy may redistribute income and wealth favouring to weaker sections.
4. Generation of Employment
Monetary policy helps in employment generation by influencing the rate of investment and
allocation of investment among various economic activities of different labour Intensities.
5. Promoting Priority Sector
Priority sector includes agriculture, export and small scale enterprises and weaker section of
population. RBI with the help of bank provides timely and adequately credit at affordable
cost of weaker sections and low income groups.

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4.4 EFFECT OF MONETARY POLICY TO REDUCE INFLATION


As the money supply is contracted, interest rates rise, investment will fall, consumption will
fall and net exports will fall.



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All of these changes will shift the AD to the left and return output to Qp but without a price
increase.
5.0 CONCLUSION
Fiscal Policy
The objectives of fiscal policy such as economic development, price stability, social justice,
etc. can be achieved only if the tools of policy like Public Expenditure, Taxation, Borrowing
and deficit financing are effectively used.Though there are gaps in India's fiscal policy, there
is also an urgent need for making India's fiscal policy a rationalised and growth oriented
one.The success of fiscal policy depends upon taking timely measures and their effective
administration during implementation.

Monetary Policy
The RBI aims at one time was controlled expansion. On one hand it was taking steps to
expand bank credit. On other hand RBI uses quantitative and qualitative methods to control
credit. These two contradictory objectives limited the success of monetary policy.Despite
several problems RBI has made a good effort for effective implementation of the monetary
policy in India.












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REFERENCES

India Objective in 2014
http://www.dnaindia.com/india/report-budget2014-india-s-economic-policies-will-be-growth-
oriented-arvind-mayaram-1997191

Unemployment
http://www.azadindia.org/social-issues/Unemployment-in-India.html
http://timesofindia.indiatimes.com/business/india-business/Unemployment-levels-rising-in-
India-experts-say/articleshow/29403619.cms
http://business.mapsofindia.com/bpo-services-india/growth.html
http://www.tradingeconomics.com/india/unemployment-rate
http://data.worldbank.org/indicator/SL.EMP.TOTL.SP.ZS
http://www.tradingeconomics.com/india/labor-participation-rate-total-percent-of-total-
population-ages-15-plus--wb-data.html

Causes of Unemployment
http://satendrasaini.hubpages.com/hub/unemployment-causes
http://www.preservearticles.com/201105096376/what-are-the-causes-of-unemployment-in-
india.html

India Inflation
http://www.bbc.com/news/world-asia-india-24753675
http://www.inflation.eu/inflation-rates/india/historic-inflation/cpi-inflation-india-2013.aspx
http://www.ft.com/cms/s/0/f0256d5c-8506-11e3-a793-00144feab7de.html#axzz35UT5XcOs


India Monetary Policy
http://www.livemint.com/Opinion/rQCCxiHvRCuAupD2w6naGP/5-questions-on-
overhauling-Indias-monetary-policy-framewor.html
http://www.rbi.org.in/home.aspx
http://business.nab.com.au/wp-content/uploads/2013/11/india-monetary-policy-10-2013.pdf

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http://articles.economictimes.indiatimes.com/2014-06-17/news/50651109_1_term-repo-
excess-rupee-liquidity-the-reserve-bank
http://in.reuters.com/article/2013/10/29/highlights-rbi-repo-rate-msf-cuts-
idINDEE99S03U20131029