Module 7

Economic Policies
Economic Policies: Fiscal Policy: Objectives, Instruments, Union Budget,
Monetary Policy: Measures of Money Supply, Monetary Policy in India objectives,
tools for Credit Control. Role and functions of Comptroller and Auditor General of India
(CAG)
--------------------------------------------------------------------------------------------------------------------FISCAL POLICY
Fiscal policy is the governments schedule for spending and tax implementation to influence the
economy for the year. Government introduces fiscal policy every year to cope with problem faced
by its economy and for the betterment of society. The fiscal policy is concerned with the raising of
government revenue and incurring of government expenditure. To generate revenue and to incur
expenditure, the government frames a policy called budgetary policy or fiscal policy.
Fiscal policy refers to the policy of the government as regards taxation, public borrowings and public
expenditure with specific objectives in view. These objectives are to produce desirable effect and avoid
undesirable effect on the national income, production, employment, and general price level.
OBJECTIVES OF FISCAL POLICY

Development by effective Mobilization of Resources

The principal objective of fiscal policy is to ensure rapid economic growth and development. This
objective of economic growth and development can be achieved by Mobilization of Financial Resources.
The central and the state governments in India have used fiscal policy to mobilize resources.
The financial resources can be mobilized by :1. 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.
2. Public Savings : The resources can be mobilised through public savings by reducing
government expenditure and increasing surpluses of public sector enterprises.
3. Private Savings : Through effective fiscal measures such as tax benefits, the government
can raise resources from private sector and households. Resources can be mobilized
through government borrowings by ways of treasury bills, issue of government bonds, etc.,
loans from domestic and foreign parties and by deficit financing.

Efficient allocation of Financial Resources

The central and state governments have tried to make efficient allocation of financial resources. These
resources are allocated for Development Activities which includes expenditure on railways,
infrastructure, etc. While Non-development Activities includes expenditure on defense, interest payments,
subsidies, etc.

Reduction in inequalities of Income and Wealth

Fiscal policy aims at achieving equity or social justice by reducing income inequalities among different
sections of the society. The direct taxes such as income tax are charged more on the rich people as
compared to lower income groups. Indirect taxes are also more in the case of semi- luxury and luxury
items, which are mostly consumed by the upper middle class and the upper class. The government invests
a significant proportion of its tax revenue in the implementation of Poverty Alleviation Programmes to
improve the conditions of poor people in society.
Price Stability and Control of Inflation
One of the main objective of fiscal policy is to control inflation and stabilize price. Therefore, the
government always aims to control the inflation by Reducing fiscal deficits, introducing tax savings
schemes, Productive use of financial resources, etc.
Employment Generation
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.

Control of business cycles

Balanced growth
Export development
INSTRUMENTS OF FISCAL POLICY
1. Taxation
Taxation is the most important source of public revenue of both development and developing countries.
On account of this reason, the governments of developing countries are trrying to increase the
proportions of national income collected in taxes from 10 to 15 percent to 30 to 40 percent levels
reached in developed countries like USA, UK, France, Germany etc.
Tax revenue is usually considered under two headings: direct taxes on individuals and firms, and
indirect (commodity) taxes on goods and services. Direct taxes includes taxes on personal
income, corporate income tax, taxes on property and wealth.
Indirect or commodity taxes include sales tax, excise duty and customs duties (import and
export). While developed countries depend on direct taxes more for their tax revenue, developing
countries depend more on the indirect taxes.
2. Public Borrowing
The second most important source of public revenue is public borrowing; it is different from taxation,
since all borrowing from public must be repaid.
Repayment will require the raising of resources in future when the time comes. On account of this
obligation of repayment it is customary to regard public borrowing as merely an exercise of

fund raising for government while taxation is income proper.

The government can raise public debt either in the form of voluntary loan or in the form of compulsory
loan. Voluntary loan is secured by the government by issue of various types of bills and securities in the
money market. In compulsory loan, bonds are issued by government for periods ranging between five to
ten years having tax free interest payment.
3. Forced savings or Deficit Financing
Deficit financing has become an important tool of financing government expenditure. In simple terms it
means the way the gap between excess of government expenditure over its receipts is financed. However
the concept of deficit financing is interpreted in different ways in the western countries and in India.
In the western countries whenever the public expenditure is greater than its revenue receipts, it is
financed through public borrowing or creation of new money. Whenever there is deficit in the current
account, its financing becomes deficit financing. Even public borrowing is a way of deficit
financing.
In the modern sense public borrowings to finance excess of public expenditure over revenue is included
in the capital account of the budget. After including these borrowings in the capital account, there
may still be a deficit in the budget. The method adopted by the government to finance this overall
budget deficit in the current and capital account together is known as deficit financing. India adopts
deficit financing of this type.
The Planning Commission in India defines deficit financing as "the direct addition to gross national
expenditure through budget deficits whether the deficits are on revenue or capital accounts".
In Developing countries like India, deficit financing is identical to printing more currency and putting it
into circulation.
4. Public Expenditure
After the Second World War, many underdeveloped countries embarked upon ambitious programs of
economic development. As private sector does not have either the willingness or the resources to invest
in infrastructure such as the laying of railway tracks, power generation, development in communication
etc. Therefore, the responsibility of building up the infrastructure of the economy and large capital goods
industries has be borne by the government.
In the modern day world, the state has also to fulfill social obligation like provision of cheap or free
public health service, education, cheap housing facility etc. therefore additional expenditure have to be
incurred towards the provision of these facilities. Many developed countries provided monetary
assistance to unemployment persons. This is known as unemployment compensation. Pensions to senior
citizens are also provided.
UNION BUDGET
The policy of government to promote economic growth and avoid undesirable effects on
economy through taxation, government expenditure and debt management is called as fiscal policy. The
implementation of fiscal policy is through annual union budget exercise. The budget depicits a complete
picture of estimated receipts and expenditure of government for ensuing financial year

Union is an important event which has great significance for entire nation and is normally introduced
in the last week of February every year. The budget is prepared and presented by finance minister before
the parliament. The finance bill of budget has to be passed in the parliament to approve the tax proposal
and an appropriation bill has to be cleared to authorise expenditure
In the budget, a distinction is made between revenue account and capital account. Revenue account
may be classified into Revenue receipt and Revenue expenditure. Similarly, capital account can be
classified into capital receipts and capital expenditure
Receipts which involve no disposal of assets or incurring of liabilities are revenue receipts. The
revenue receipts include direct taxes like corporation tax, income tax, wealth tax, gift tax etc. Indirect
taxes include customs duty , excise duty, sales tax etc. The non tax incomes like net income by public
sector undertakings are also accounted under Revenue receipts. On the other hand the money raised
through borrowings by government or sale of government property etc, constitute capital receipts i.e.
capital receipts include governments market borrowings, provident fund, small savings etc. And
external assistance like loans grants, etc
Likewise revenue expenditure are those which neither add to governments assets nor reduce the
liabilities. Salaries of government employees, purchase of stationeries, maintainence of public utilities
etc are part of revenue expenditure. Capital expenditure refers to items that involves acquisition of
assets ex:-investment in railways, roads, bridges, power projects and irrigation works
When total expenditure exceeds total receipts, we call it as budget deficit. The excess of total
expenditure over revenue receipts are financed by borrowings from government which are
classified under Domestic capital receipts and external capital receipts.The market borrowings , small
savings, provident funds etc come under domestic capital receipts.The loans and other assistance
received from international agencies come under external capital receipts.
In other words , we can say that greater part of budgetary gap is restored through Deficit Financing.
The tools of Deficit Financing are (i)borrowings by central government against Treasury bills (ii)
Withdrawl of accumulated cash balances of government from RBI (iii)issuance of new currency by
government . The deficit financing should be within manageable limit as excess use of created money
may fuel inflationary tendencies. It is worth nothing that some amount of deficit financing is prevalent in
developing countries also
BUDGET AT A GLANCE AND FISCAL DEFICIT
Fiscal deficit as a term is used in the union budget exercise. Fiscal deficit is the sum of amount the
central government borrows and the overall budget deficit in order to meet the excess expenses
over receipts during a financial year. It can also be defined as budgetary deficit plus borrowings of
government. On the other hand revenue deficit measures the gap between governments tax and non tax
receipts and expenditure on revenue account . the following table would give you clear idea about how
these figures can be calculated
Classification
yearly estimate
(1) Revenue receipts of which
(a)Tax revenue

84,209
62,739

(b)Non tax revenue

22,470

(2) capital receipts of which

42,800

(a)Recovery of loans

6,655

(b)other receipts

3,500

(c)Borrowings ,other liabilities

32,645

(3) Total receipts(1+2)

1,27,009

(4) Revenue expenditure

1,01,839

(5) Capital expenditure

29,484

(6 )Total expenditure(4+5)

1,31,323

(7) Budgetary deficit(6-3)

4,314

(8 )Revenue deficit(4-1)

17,630

(9) Fiscal deficit(7+2c)

36,959

THE INDIAN MONETARY POLICY/SYSTEM

The monetary policy of Indiaa developing economyhas focused on accelerating
economic development, while maintaining price and financial stability. RBI has been adopting a
monetary policy that aims at controlled monetary expansion whose twin objectives are (a)
To ensure that there is no paucity of funds for all legitimate economic activities and (b) The
availability of funds is not excessive to cause inflation. This implies that while there is expansion
in the supply of money, there is restraint on the secondary expansion of credit.
With regard to the expansion of money supply, it has to expand it to the extent that it more
than matches the growth in national income. This is because of two factors: (a) With the
growth in incomes, the demand for money to be set aside as savings tends to go up, and (b) with
the sizeable growth in the economy, there is a gradual reduction in non- monetized sector that
augments money supply.
BANK RATE
The bank rate is the rate at which bank borrow from RBI(reserve bank of india).it is also defined
as the rate of which reserve bank gives loans to banks by discounting bills.any revision in the
bank rate by the RBI is a signal to banks to banks to revise deposit rates as well as prime lending
rate.
.REPO RATE
The repo rate is the rate at which RBI borrows from the banks. This is also the floor rate at
which overnight deals are struck. Besides lowering the cost of funds ,a lower repo rate will see
the emergency of a short term yield curve.
CRR AND SLR

.CRR is the cash reserve ratio which is the percentage of net funds that commercial banks have to park
fortnightly with the RBI to do business. Lowering of CRR means means that more money comes
into circulation. In addition to the CRR requirement banks are supposed to maintain a certain
percent of net deposits in the government securities and similar instruments specified. This is known as
statutory liquidity ratio(SLR) which is 25% present.
MONETARY POLICY OPERATIONS
LIQUIDITY MANAGEMENT:
The reserve bank modulates market liquidity through a mix of repo operations.as a capital flows
persisted,the reserve bank portfolio necessited a switch from out right OMO TO REPO
operations.the monetary policy operations has emerged as a key instrument of liquidity
management.
INTEREST RATE POLICY
The reserve bank continued to take policy initiatives to impart a greater degree of
flexibility to the interest rate structure.it also follow credit policy.
MONETARY POLICY
Monetary policy refers to the policy adopted by the monetary authority of a country with respect to the
supply of money, the rate of interest and other matters. In other words, it is the process by which the
government, central bank or monetary authority of a country controls (i) the supply of money, (ii) the
availability of money, and (iii) the cost of money or the rate of interest in order to attain a set of
objectives oriented towards the growth and stability of the economy.
According to Torado and Smith, monetary policy refers to the activities of a central bank
designed to influence financial variables such as money supply and interest rates.
It can be explained as that component of economic policy that regulates the level of money supply
in the economy--with the view to achieving certain desired policy objective such as control of
inflation, an improvement in the export earnings, realization of a certain level of employment, or growth
in the countrys GDP. Monetary policy and fiscal policy are the two policy instruments with the help of
which the government can influence the functioning of the economy.
Monetary policy is based on the assumption that money in a modern complex economic system,
wherein savings and investments are carried out by different groups of people, performs a
dynamic function, apart from serving as a medium of exchange. In such a scheme of things, money
becomes capable of influencing the size of national income, the level of employment, the demand for
consumers and producers goods and, therefore, the volume of both savings and investment. Monetary
policy, hence, is used to vary the supply of money and also to effect changes in its liquidity. Monetary
policy is referred to as expansionary when it increases the total supply of money in the economy. It
is traditionally used to combat unemployment during recession by lowering interest rates.
Monetary policy deals with (i) the control of financial institutions, (ii) active purchase and sales of paper
assets by monetary authority as deliberate attempt to affect changes in monetary conditions, and (iii)
passive purchases and sales of paper assets resulting from the maintenance of a particular interest
structure, the stability of security prices or meeting other obligations and commitments.
OBJECTIVES

1.
2.
3.
4.
5.
6.
7.

Safeguarding the countrys gold and forex reserves.

Price stability.
Foreign exchange stability.
Managing cyclical fluctuations and adopting suitable stabilization measures.
Ensuring full employment
Ensuring balance of payments equilibrium (to the maximum possible extent).
Accelerating economic growth (primarily in developing economies).

FUNCTIONS
1. A most suitable interest structure.
2. A correct balance between the demand and supply of money.
3. The provision of adequate credit facilities for a growing economy, while preventing undue
expansion that may cause inflation, and overseeing the channeling of credit to user as per perplanned investment decisions.
4. The establishment, functioning and growth of financial institutions of the economy.
5. Proper management of public debts.
TOOLS FOR CREDIT CONTROL
The monetary authority uses various tools to control the supply of money, these are known as
instruments or tools of credit control. These tools can be divided into two categories quantitative and
qualitative credit control. There are three main methods of quantitative credit controlbank rate policy,
open market operation and changes in statutory reserve requirements. The qualitative methods of credit
control are also known as selective credit control method. These include rationing, direct action,
changes in margin requirements, moral suasion, etc. the quantitative control measures are also known as
traditional credit control measures.
Traditional credit control measures:The following are the traditional or quantitative control measures that have been used by central banks
all over the world to control the supply of both money and credit.
1. Bank rate policy: It is the oldest and subtle method of credit control that operates
through changes in bank rate made by the central bank. Bank rate is defined as the official
minimum rate at which the central bank rediscounts approved bills of exchange. It is the rate at
which the central bank is ready to buy or rediscount eligible bills of exchange and other
commercial papers. The RBI gives large proportion of its advances to commercial banks against
government securities and as refinance. When the central bank raises the bank rate, the
obtaining fund from the central bank becomes costlier for commercial banks. The reverse
happens when the bank rate is lowered during the period of depression.
2. Open-market operation: It is a primary tool of monetary policy which calls for
managing the quantity of money in circulation through the buying and selling of various credit
instruments, foreign currencies or commodities. All of these purchases or sales result in more or
less base currency entering or leaving market circulation. The open- market operations refer to
the purchase and sale of government securities and other approved securities by the central bank.
An open-market sale decreases the money supply and a purchase increases the money supply.
The RBI, which is our central bank, transacts both with the public and other banks. During the
boom, the RBI sells the government and other approved securities from its portfolio in the open

market in order to reduce the aggregate supply of money in the economy. The reverse happens
when there is a slump.
3. Cash reverse requirements: It refers to that portion of banks total cash reserve which they
are statutory required to hold with the RBI. The remaining portion of the total cash reserves of
the banks refers to excess reserves which banks keep them-selves to facilitate their normal
functioning. An increase in the legal cash reserves ratio decreases the banks and their optimum
credit creating capacity. The reserve is true when the RBI increases the statutory cash reserve
ratio.
4. Statutory liquidity ratio: Commercial banks in India are required to maintain a
particular level of liquidity. The main role of the statutory liquidity ratio is to allocate bank
credit between government and commercial sectors. This instrument is also used to control the
supply of money. Commercial banks are statutorily required to hold a proportion of their total
demand and time liabilities in the form of excess reserves, investments in unencumbered
government and other approved securities and current account balances with other banks.
Selective credit control measures:
Selective credit control can be easily distinguished from the traditional methods of monetary
management in as much as they are directed towards particular uses of credit and not merely to total
volume outstanding. The selective credit control measures are very popular in developing countries like
India. These controls are exercised through official regulations. Section 21 of Banking Regulation Act
1949 empowers the RBI to issue directives to banks with regard to advances. These directives may be
with regard to,
(a) The purpose for which banks may or may not give advances.
(b) The margins to be maintained with regard to secured advances.
(c) The maximum amount of advance to any particular borrower.
(d) The rate of interest and the other terms and conditions for granting advances.
(e) The maximum amount up to which guarantee may be given by the bank.
They aim at curtailing the flow of credit into unproductive channels and diverting them into productive
channels. They operate by means of official regulations issued and enforced by Central Bank. Some of
the important methods of Selective Credit control tools are:
Rationing of credit:
Central Bank may issue direction to commercial banks to restrict (ration) credit to certain sectors or
sections of the population. This method is useful in controlling inflationary pressures. Variable Margin
Requirements: This measure to thwart speculation and hoarding activities by traders. Instance if
traders hoard necessary commodities like food grains in an attempt to create artificial scarcity and
thereby push up prices, then the Central Bank can raise marginal requirements with respect to such
goods.If the margin requirement is 50% , than the trader can get a loan of only Rs. 10 lakh against A
security of Rs. 20 lakhs. If the margin requirements raised to Rs. 75% , he can get a loan of only Rs. 5
lakhs against the same security.
Moral suasion:
Measure used by the Central Bank to put pressure upon the lending activities of commercial banks by
urging them to voluntarily adopt certain restrictive practices.

Role and functions of CAG

The Comptroller and Auditor General (CAG) of India is an authority, established by the Constitution
of India.
Under Chapter V of the Indian Constitution, CAG audits all receipts and expenditure of the Government
of India and the state governments, including those of bodies and authorities substantially financed by the
government. The CAG is also the external auditor of government-owned companies. The reports of the
CAG are taken into consideration by the Public Accounts Committees, which are special committees in
the Parliament of India and the state legislatures.
The CAG of India is also the head of the Indian Audit and Accounts Department, which has more than
55,000 employees across the country.
The current CAG of India is Shashi Kant Sharma, who was appointed on 23 May 2013. He is the 12th
CAG of India.
Audit Jurisdiction
The organisations subject to the audit of the Comptroller and Auditor General of India are:All the Union and State Government departments and offices including the Indian Railways and Posts
and Telecommunications. About 1500 public commercial enterprises controlled by the Union and State
governments, i.e. government companies and corporations. Around 400 non-commercial autonomous
bodies and authorities owned or controlled by the Union or the States. Over 4,400 authorities and bodies
substantially financed from Union or State revenues
Audit of Government Companies (Commercial Audit)
There is a special arrangement for the audit of companies where the equity participation by government
is 51 percent or more. The primary auditors of these companies are Chartered Accountants, appointed by
the Comptroller and Auditor General of India, who gives the directions to the auditors on the manner in
which the audit should be conducted by them. The Comptroller and Auditor General of India is also
empowered to comment upon the audit reports of the primary auditors.
Audit Board Setup in Commercial Audit
A unique feature of the audit conducted by the Indian Audit and Accounts Department is the constitution
of Audit Boards for conducting comprehensive audit appraisals of the working of Public Sector
Enterprises engaged in diverse sectors of the economy.
These Audit Boards associate with them experts in disciplines relevant to the appraisals. They discuss
their findings and conclusions with the managements of the enterprises and their controlling ministries
and departments of government to ascertain their view points before finalization. The results of such
comprehensive appraisals are incorporated by the Comptroller and Auditor General in his reports
Nature of Audit
While fulfilling his Constitutional obligations, the Comptroller & Auditor General examines various
aspects of Government expenditure. The audit done by C&A G is broadly classified into Regularity Audit
and Performance Audit.
What is Regularity Audit? It is an audit against provision of funds to ascertain whether the moneys

shown as expenditure in the Accounts were authorised for the purpose for which they were spent; against
rules and regulation to see that the expenditure incurred was in conformity with the laws, rules and
regulations framed to regulate the procedure for expending public money and whether expenditure on
every item was done with the approval of the competent authority in the Government for expending the
public money.
What is Propriety Audit? This extends beyond scrutinising the mere formality of expenditure to it
wisdom and economy and to bring to light cases of improper expenditure or waste of public money.
While conducting the audit of receipts of the Central and State Governments, the Comptroller & Auditor
General satisfies himself that the rules and procedures ensure that assessment, collection and allocation of
revenue are done in accordance with the law and there is no leakage of revenue which legally should
come to Government.
What is Performance Audit? It focuses on whether Government programmes have achieved the desired
objectives at lowest cost and given the intended benefits.
In conclusion the CAG is an official mandated by the Constitution to act as a watchdog on government
finances and its functioning. By auditing the accounts of bodies at various levels of government he plays
an essential role in making the government more transparent and accountable to the legislature as well as
civil society.