Top 8 Objectives of Fiscal Policy

Fiscal policy must be designed to be performed in two ways-by expanding investment in public
and private enterprises and by diverting resources from socially less desirable to more desirable
investment channels.

The objective of fiscal policy is to maintain the condition of full employment, economic stability
and to stabilize the rate of growth.

For an under-developed economy, the main purpose of fiscal policy is to accelerate the rate of
capital formation and investment.

“Arthur Smithies, fiscal policy aims primarily at controlling aggregate demand and leaves private
enterprise its traditional field- the allocation of resources among alternative uses.”

Therefore, fiscal policy in under-developed countries has a different objective to that of

advanced countries.

Generally following are the objectives of a fiscal policy in a developing economy:

1. Full employment

2. Price stability

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3. Accelerating the rate of economic development

4. Optimum allocation of resources

5. Equitable distribution of income and wealth

6. Economic stability

7. Capital formation and growth

8. Encouraging investment

1. Full Employment:

The first and foremost objective of fiscal policy in a developing economy is to achieve and
maintain full employment in an economy. In such countries, even if full employment is not
achieved, the main motto is to avoid unemployment and to achieve a state of near full
employment. Therefore, to reduce unemployment and under-employment, the state should
spend sufficiently on social and economic overheads. These expenditures would help to create
more employment opportunities and increase the productive efficiency of the economy.

In this way, public expenditure and public sector investment have a special role to play in a
modern state. A properly planned investment will not only expand income, output and
employment but will also step up effective demand through multiplier process and the economy
will march automatically towards full employment. Besides public investment, private
investment can also be encouraged through tax holidays, concessions, cheap loans, subsidies
etc.

In the rural areas attempts can be made to encourage domestic industries by providing them
training, cheap finance, equipment and marketing facilities. Expenditure on all these measures
will help in eradicating unemployment and under-employment.

In this context, Prof. Keynes made the following recommendations to achieve full employment in
an economy:
(a) To capture the excessive purchasing power and to curb private spending:

(b) Compensate the deficiency in private investment through public investment;

(c) Cheap money policy or lower interest rates to attract more and more private entrepreneurs.

2. Price Stability:

There is a general agreement that economic growth and stability are joint objectives for
underdeveloped countries. In a developing country, economic instability is manifested in the
form of inflation. Prof. Nurkse believed that “inflationary pressures are inherent in the process of
investment but the way to stop them is not to stop investment. They can be controlled by
various other ways of which the chief is the powerful method of fiscal policy.”

Therefore, in developing economies, inflation is a permanent phenomena where there is a

tendency to the rise in prices due to expanding trend of public expenditure. As a result of rise in
income, aggregate demand exceeds aggregate supply. Capital goods and consumer goods fail to
keep pace with rising income.

Thus, these result in inflationary gap. The price rise generated by demand pull reinforced by cost
push inflation leads to further widening the gap. The rise in prices raises demand for more
wages. This further gives rise to repeated wage-price spirals. If this situation is not effectively
controlled, it may turn into hyper inflation.

In short, fiscal policy should try to remove the bottlenecks and structural rigidities which cause
imbalance in various sectors of the economy. Moreover, it should strengthen physical controls of
essential commodities, granting of concessions, subsidies and protection in the economy. In
short, fiscal measures as well as monetary measures go side by side to achieve the objectives of
economic growth and stability.
3. To Accelerate the Rate of Economic Growth:

Primarily, fiscal policy in a developing economy, should aim at achieving an accelerated rate of
economic growth. But a high rate of economic growth cannot be achieved and maintained
without stability in the economy. Therefore, fiscal measures such as taxation, public borrowing
and deficit financing etc. should be used properly so that production, consumption and
distribution may not adversely affect. It should promote the economy as a whole which in turn
helps to raise national income and per capita income.

In this connection it is significant to quote the views of Mrs. Hicks, who observed, “now that
fiscal policy has been developed as an established economic function of a government, every
country is anxious to gear its public finance in pursuit of the twin aims of stability and growth,
but their relative importance is very differently regarded from one country to another… A steady
rate of expansion will tend to reduce the violence of such fluctuations as may occur; a successful
full employment policy will provide an atmosphere which is congenial for growth.”

4. Optimum Allocation of Resources:

Fiscal measures like taxation and public expenditure programmes, can greatly affect the
allocation of resources in various occupations and sectors. As it is true, the national income and
per capita income of underdeveloped countries is very low. In order to gear the economy, the
government can push the growth of social infrastructure through fiscal measures. Public
expenditure, subsidies and incentives can favorably influence the allocation of resources in the
desired channels.

Tax exemptions and tax concessions may help a lot in attracting resources towards the favored
industries. On the contrary, high taxation may draw away resources in a specific sector. Above all,
direct curtailment of consumption and socially unproductive investment may be helpful in
mobilization of resources and the further check of the inflationary trends in the economy.
Sometimes, the policy of protection is a useful tool for the growth of some socially desired
industries in an under-developed country.

Prof. R.N. Tripathi suggests the following steps to raise the saving ratio which provides the
required finance for developmental schemes:
(i) Direct physical control.

(ii) Increasing the rate of existing taxes.

(iii) Introduction of new taxes,

(iv) Public borrowing of non-inflationary nature,

(v) Deficit financing.

5. Equitable Distribution of Income and Wealth:

It is needless to emphasize the significance of equitable distribution of income and wealth in a

growing economy. Generally, inequality in wealth persists in such countries as in the early stages
of growth, it concentrates in few hands. It is also because private ownership dominates the
entire structure of the economy. Besides, extreme inequalities create political and social
discontentment which further generate economic instability. For this, suitable fiscal policy of the
government can be devised to bridge the gap between the incomes of the different sections of
the society.

To reduce inequalities and to do distributive justice, the government should invest in those
productive channels which incur benefit to low income groups and are helpful in raising their
productivity and technology. Therefore, redistributive expenditure should help economic
development and economic development should help redistribution.

Thus, well-planned fiscal programme, public expenditure can help development of human
capital which in turn possesses positive effects on income distribution. Regional disparities can
also be removed by providing incentives to backward regions. A redistributive tax policy should
be highly progressive and aim at imposing heavy taxation on the richer and exempting poorer
sections of the community. Similarly, luxurious items, which are consumed by the higher section,
may be subject to heavy taxation.

6. Economic Stability:

Fiscal measures, to a larger extent, promote economic stability in the face of short-run
international cyclical fluctuations. These fluctuations cause variations in terms of trade, making
the most favourable to the developed and unfavorable to the developing economies. So, for the
purpose of bringing economic stability, fiscal methods should incorporate built-in-flexibility in
the budgetary system so that income and expenditure of the government may automatically
provide compensatory effect on the rise or fall of the nation’s income.

Therefore, fiscal policy plays a leading role in maintaining economic stability in the face of
internal and external forces. The instability caused by external forces is corrected by a policy,
popularly known as ‘tariff policy’ rather than aggregative fiscal policy. In the period of boom,
export and import duties should be imposed to minimize the impact of international cyclical
fluctuations.

To curb the use of additional purchasing power, heavy import duty on consumer goods and
luxury import restrictions are essential. During the period of recession, government should
undertake public works programmes through deficit financing. In nut shell, fiscal policy should
be viewed from a larger perspective keeping in view the balanced growth of various sectors of
the economy.

7. Capital Formation and Growth:

Capital assumes a central place in any development activity in a country and fiscal policy can be
adopted as a crucial tool for the promotion of the highest possible rate of capital formation. A
newly developing economy is encompassed by a ‘vicious circle of poverty’. Therefore, a balanced
growth is needed to breakdown the vicious circle which is only feasible with higher rate of
capital formation. Once a country comes out of the clutches of backwardness, it stimulates
investment and encourage capital formation.

Prof. Raja J. Chelliah recommends that fiscal policy must aim at the following for attaining rapid
economic growth:

(i) Raising the ratio of saving (s) to Income (y) by controlling consumption (c);

(ii) Raising the rate of investment:

(iii) Encouraging the flow of spending into productive way;

(iv) Reducing glaring inequalities of income and wealth.

Therefore, fiscal policy must be designed to be performed in two ways-by expanding investment
in public and private enterprises and by diverting resources from socially less desirable to more
desirable investment channels.

This Policy will help to raise the level of aggregate savings in the economy and create capital for
bringing about a qualitative improvement in it. Capital formation, however, can also be
facilitated by taxation, deficit spending and foreign borrowing. In fact, fiscal measures of the
government can induce the private entrepreneurs to take active participation for mobilizing
resources at least in the long run.

8. To Encourage Investment:

Fiscal policy aims at the acceleration of the rate of investment in the public as well as in private
sectors of the economy. Fiscal policy, in the first instance, should encourage investment in public
sector which in turn effect to increase the volume of investment in private sector. In other
words, fiscal policy should aim at rapid economic development and must encourage investment
in those channels which are considered most desirable from the point of view of society.

It should aim at curtailing conspicuous consumption and investment in unproductive channels.

In the early stages of economic development, the government must try to build up economic
and social overheads such like transport and communication, irrigation, flood control, power,
ports, technical training, education, hospital and school facilities, so that they may provide
external economies to induce investment in industrial and agricultural sectors of the economy.

These economies will be helpful for widening the size of the market, reducing the cost of
production and increasing the social marginal productivity of investment. Here it must be
remembered that projects of social marginal productivity should wisely be selected keeping in
view its practical implication.

What is Fiscal Policy?

One of the factors that helps determine the country's economic direction is fiscal policy. The
government uses fiscal policy to influence the economy by adjusting revenue and spending
levels. In the United States, both the executive and legislative branches of the government
determine fiscal policy.

Fiscal policy is based on the theories of British economist John Maynard Keynes, which state that
increasing or decreasing revenue (taxes) and expenditures (spending) levels influences inflation,
employment and the flow of money through the economic system. Fiscal policy is often used in
combination with monetary policy, which in the United States is set by the Federal Reserve, to
influence the direction of the economy and meet economic goals.

The two main tools of fiscal policy are taxes and spending. Taxes influence the economy by
determining how much money the government has to spend in certain areas and how much
money individuals have to spend. For example, if the government is trying to spur spending
among consumers, it can decrease taxes. A cut in taxes provides families with extra money,
which the government hopes they will turn around and spend on other goods and services, thus
spurring the economy as a whole.

Spending is used as a tool for fiscal policy to drive government money to certain sectors that
need an economic boost. Whoever receives those dollars will have extra money to spend – and,
as with taxes, the government hopes that money will be spent on other goods and services. The
key is finding the right balance and making sure the economy doesn't lean too far either way.
Prior to the Great Depression in the 1920s, the U.S. government took a very hands-off approach
when it came to setting economic policy. Afterward, the U.S. government decided it needed to
play a larger role in determining the direction of the economy.
Types of fiscal policy

There are two main types of fiscal policy: expansionary and contractionary. Expansionary fiscal
policy, designed to stimulate the economy, is most often used during a recession, times of high
unemployment or other low periods of the business cycle. It entails the government spending
more money, lowering taxes, or both. The goal is to put more money in the hands of consumers
so they spend more and stimulate the economy.

Contractionary fiscal policy is used to slow down economic growth, such as when inflation is
growing too rapidly. The opposite of expansionary fiscal policy, contractionary fiscal policy raises
taxes and cuts spending.

Setting fiscal policy

Today's U.S. fiscal policies are tied into each year's federal budget. The federal budget spells out
the government’s spending plans for the fiscal year and how it plans to pay for that spending,
such as through new or existing taxes. The budget is developed through a collaborative effort
between the president and Congress.

The president will first submit a budget to Congress that sets the tone for the coming year's fiscal
policy by outlining how much money the government should spend on public needs, such as
defense and health care; how much the government should take in in tax revenues; and how
much of a deficit, or surplus, is projected. Congress then reviews the president's budget request
and develops its own budget resolutions, which set broad levels for spending and taxation. Once
those are approved, legislators start the appropriations process, which spells out where each
dollar will be spent. The president must sign those appropriations bills before they can be
enacted.

Essay on Fiscal Policy of India

In this essay we will discuss about Fiscal Policy in India. After reading this essay you will learn
about: 1. Definition of Fiscal Policy 2. Objectives of Fiscal Policy 3. Role 4. Techniques 5. Merits 6.
Shortcomings 7. Suggestions 8. Measures.

Essay # 1. Definition of Fiscal Policy:

Fiscal policy is playing an important role on the economic and social front of a country.
Traditionally, fiscal policy in concerned with the determination of state income and expenditure
policy. But with the passage of time, the importance of fiscal policy has been increasing
continuously for attaining rapid economic growth.

Accordingly, it has included public borrowing’ and deficit financing as a part of fiscal policy of the
country. An effective fiscal policy is composed of policy decisions relating to entire financial
structure of the government including tax revenue, public expenditures, loans, transfers, debt
management, budgetary deficit, etc.

The policy also tries to attain proper balance between these aforesaid units so as to achieve the
best possible results in terms of economic goals. Harvey and Joanson, M., defined fiscal policy as
“changes in government expenditure and taxation designed to influence the pattern and level of
activity.”

According to G.K. Shaw, “We define fiscal policy to include any design to change the price level,
composition or timing of government expenditure or to vary the burden, structure or frequency
of the tax payment.” Otto Eckstein defined fiscal policy as “changes in taxes and expenditure
which aim at short run goals of full employment price level and stability.”

Essay # 2. Objectives of Fiscal Policy:

In India, the fiscal policy is gaining its importance in recent years with the growing involvement
of the government in developmental activities of the country.

Following are some of the important objectives of fiscal policy adopted by the Government of
India:

1. To mobilise adequate resources for financing various programmes and projects adopted for
economic development.
2. To raise the rate of savings and investment for increasing the rate of capital formation;

3. To promote necessary development in the private sector through fiscal incentive;

4. To arrange an optimum utilisation of resources;

5. To control the inflationary pressures in economy in order to attain economic stability;

6. To remove poverty and unemployment;

7. To attain the growth of public sector for attaining the objective of socialistic pattern of society;

8. To reduce regional disparities; and

9. To reduce the degree of inequality in the distribution of income and wealth.

In order to attain all these aforesaid objectives, the Government of India has been formulating
its fiscal policy incorporating the revenue, expenditure and public debt components in a
comprehensive manner.

Essay # 3. Role of Fiscal Policy in Economic Development:

One of the important goals of fiscal policy formulated by the Government of India is to attain
rapid economic development of the country.

To attain such economic development in the country, the fiscal policy of the country has adopted
following two objectives:
1. To raise the rate of productive investment of both public and private sector of the country.

2. To enhance the marginal and average rates of savings for mobilising adequate financial
resources for making .investment in public and private sectors of the economy.

The fiscal policy of the country is trying to attain both these two objectives during the plan
periods.

Essay # 4. Techniques of Fiscal Policy:

Following are the four important techniques of fiscal policy of India:

(i) Policy of Taxation of Government of India:

One of the important sources of revenue of the Government of India is the tax revenue. Both the
direct and indirect taxes are being levied by the Government of India. Direct taxes are
progressive by nature and most of indirect taxes are regressive in nature. Taxation plays an
important role in mobilising resources for plan.

During the First, Second and Third Plan, additional taxation alone contributed nearly 12.7 per
cent, 22.8 per cent and 34 per cent of public sector plan expenditure respectively. The shares
during the Fourth, Fifth, Sixth and Seventh Plan were 27 per cent, 37 per cent 22 per cent and 15
per cent respectively.

Total tax revenue collected by the Government of India stands at 72.13 per cent of the total
revenue of the Government. Mobilisation of taxes by the Government stands around 15 to 16
per cent of the national income of the country during recent years.

Main objectives of taxation policy in India includes:

(a) Mobilisation of resources for financing economic development;

(b) Formation of capital by promoting saving and investment through time deposits, investment
in government bonds, in units, insurance etc.;

(c) Attainment of equality in the distribution of income and wealth through the imposition of
progressive direct taxes; and

(d) Attainment of price stability by adopting anti-inflationary taxation policy.

(ii) Public Expenditure Policy of Government of India:

Public expenditure is playing an important role in the economic development of a country like
India. With increase in responsibilities of the government and with the increasing participation
of government in economic activities of the country, the volume of public expenditure in a highly
populated country like India is increasing at a galloping rate. In 1992-93, the public expenditure
as percentage of GDP was around 30 per cent.

Public expenditure is of two different types, i.e., developmental and non-developmental

expenditure. Developmental expenditure of the Government is mostly related to the
developmental activities viz., development of infrastructure, industry, health facilities,
educational institutions etc.

The non-developmental expenditure is mostly a maintenance type of expenditure and which is

related to maintenance of law and order, defence, administrative services etc. The public
expenditure incurred by the Government of India has been creating a serious impact on the
production and distribution pattern of the economy.

Following are some of the important features of the policy of public expenditure formulated by
the Government of India:

(a) Development of infrastructure:

Development of infrastructural facilities which include development of power projects, railways,
road, transportation system, bridges, dams, irrigation projects, hospitals, educational institutions
etc. involves huge expenditure by the Government as private investors are very much reluctant
to invest in these areas considering the low rate of profitability and high risk involved in it.

(b) Development of public enterprises:

Development of heavy and basic industries are very important for the development of
underdeveloped country. But the establishment of these industries involves huge investment
and a considerable proportion of risk. Naturally private sector cannot take the responsibility to
develop these industries.

Development of these industries has become a responsibility of the Government of India

particularly since the introduction of Industrial Policy, 1956. A significant portion of public
expenditure has been utilised for the establishment and improvement of these public
enterprises.

(c) Support to Private Sector:

Providing necessary support to the private sector for the establishment of industry and other
projects is another important objective of public expenditure policy formulated by the
Government of India.

(d) Social Welfare and Employment Programmes:

Another important feature of public expenditure policy pursued by the Government of India is
its growing involvement in attaining various social welfare programmes and also on employment
generation programmes.

(iii) Policy of Deficit Financing of Government of India:

Following the policy of deficit financing as introduced by J.M. Keynes, the Government of India
has been adopting the policy for financing its developmental plans since its inception. The deficit
financing in India indicates taking loan by the Government from the Reserve Bank of India in the
form of issuing fresh dose of currency.

Considering the low level of income, low rate of savings and capital formation, the Government
is taking recourse to deficit financing in increasing proportion. Deficit financing is a kind of forced
savings.

Accordingly, Dr. V.K.R.V. Rao observed, “Deficit financing is the name of volume of those forced
savings which are the result of increase in prices during the period of the government
investment. Thus deficit financing helps the country by providing necessary funds for meeting
the requirements of economic growth but at the same time it also create the problem of
inflationary rise in prices. Thus the deficit financing must be kept within the manageable limit.”

During the First, Second, Third and Fourth Plan deficit financing as percentage of total plan
resources was to the extent of 17 per cent, 20 per cent, 13 per cent and 13.5 per cent
respectively. But due to adverse consequence of deficit financing through inflationary rise in
price level, the extent of deficit financing was reduced to only 3 per cent during the Fifth Plan.

But due to resource constraint, the extent of deficit financing again rose to 14 per cent and 16
per cent of total plan resources respectively.

Thus knowing fully the evils of deficit financing, planners are still maintaining a high rate of
deficit financing in the absence of increased tax revenue due to large scale tax evasion and
negative contribution of public enterprises. But considering the present inflationary trend in
prices, the Government should give lesser stress on deficit financing.

(iv) Public Debt Policy of the Government of India:

As the taxation has got its limit in a poor country like India due to poor taxable capacity of the
people, thus the Government is taking recourse to public debt for financing its developmental
expenditure. In the post-independence period, the Central Government has been raising a good
amount of public debt regularly in order to mobilise a huge amount of resources for meeting its
developmental expenditure. Total public debt of the Central Government includes internal debt
and external debt.

Internal Debt:

Internal debt indicates the amount of loan raised, by the Government from within the country.
The Government raises internal public debt from the open market by issuing bonds and cash
certificates and 15 years annuity certificates. The Government also borrows for a temporary
period from RBI (treasury bills issued by RBI) and also from commercial banks.

External Debt:

As the internal debt is insufficient thus the Government is also collecting loan from external
sources, i.e., from abroad, in the form of foreign capital, technical knowhow and capital goods.
Accordingly, the Central Government is also borrowing from international financing agencies for
financing various developmental projects.

These agencies include World Bank, IMF, IDA, IFC etc. Moreover, the Government is also
collecting inter-governmental loans from various developed countries of the world for financing
its various infrastructural projects.

The volume of public debt in India increased at a considerable rate i.e. from Rs 204 crore during
the First Plan to Rs 2,135 crore during the Fourth Plan and then to Rs 1,03,226 crore during the
Seventh Plan. During the Eighth Plan, the volume of internal debt of the Central Government
was amounted to Rs 1,59,972 crore and that of external debt was to the extent of Rs 2,454
crore.

At the end of the second year of the Twelfth Plan, i.e., in 2013-14, total outstanding loan
(liabilities) of the Central Government stood at Rs 55,87,000 crore.

Essay # 5. Merits or Advantages of Fiscal Policy of India:

Following are some of the important merits or advantages of fiscal policy of Government of
India:

(i) Capital Formation:

Fiscal policy of the country has been playing an important role in raising the rate of capital
formation in the country both in its public and private sectors. The gross domestic capital
formation as per cent of GDP in India increased from 8.4 per cent in 1950-51 to 19.9 per cent in
1980-81 and then to 39.1 per cent in 2007-08. Therefore, it has created a favourable impact on
the public and private sector investment of the country.

(ii) Mobilisation of Resources:

Fiscal policy of the country has been helping to mobilise considerable amount of resources
through taxation, public debt etc. for financing its various developmental projects. The extent of
internal resource mobilisation for financing plan increased considerably from 70 per cent in
1965- 66 to around 90 per cent in 1997-98.

(iii) Incentives to Savings:

The fiscal policy of the country has been providing various incentives to raise the savings rate
both in household and corporate sector through various budgetary policy changes, viz., tax
exemption, tax concession etc. The saving rate increased from a mere 8.6 per cent in 1950-51 to
37.7 per cent in 2007-08.

(iv) Inducement to Private Sector:

Private sector of the country has been getting necessary inducement from the fiscal policy .of
the country to expand its activities. Tax concessions, tax exemptions, subsidies etc. incorporated
in the budgets have been providing adequate incentives to the private sector units engaged in
industry, infrastructure and export sector of the country.

(v) Reduction of Inequality:

Fiscal policy of the country has been making constant endeavour to reduce the inequality in the
distribution of income and wealth. Progressive taxes on income and wealth tax exemption,
subsidies, grant etc. are making a consolidated effort to reduce such inequality. Moreover, the
fiscal policy is also trying to reduce the regional disparities through its various budgetary policies.

(vi) Export Promotion:

The Fiscal policy of the Government has been making constant endeavour to promote export
through its various budgetary policy in the form of concessions, subsidies etc. As a result, the
growth rate of export has increased from a mere 4.6 per cent in 1960-61 to 10.4 per cent in
1996-97.

(vii) Alleviation of Poverty and Unemployment:

Another important merit of Indian fiscal policy is that it is making constant effort to alleviate
poverty and unemployment problem through its various poverty eradication and employment
generation programmes, like, IRDP, JRY, PMRY, SJSRY, EAS, NREGA etc.

Essay # 6. Shortcomings of Fiscal Policy in India:

Following are the major shortcomings of the fiscal policy of the country:

(i) Instability:

Fiscal policy of the country has failed to attain stability on various fronts. Growing volume of
deficit financing has created the problem of inflationary rise in price level. Disequilibrium in its
balance of payments has also affected the external stability of the country.

(ii) Defective Tax Structure:

Fiscal policy has also failed to provide a suitable tax structure for the country. Tax structure has
failed to raise the productivity of direct taxes and the country has been relying much on indirect
taxes. Therefore, the tax structure has become burdensome to the poor.

(iii) Inflation:

Fiscal policy of the country has failed to contain the inflationary rise in price level. Increasing
volume of public expenditure on non-developmental heads and deficit financing has resulted in
demand-pull inflation. Higher rate of indirect taxation has also resulted in cost-push inflation.
Moreover, the direct taxes has failed to check the growth of black money which is again
aggravating the inflationary spiral in the level of prices.

(iv) Negative Return of the Public Sector:

The negative return on capital invested in the public sector units has become a serious problem
for the Government of India. In-spite of having a huge total investment to the extent of Rs
4,21,089 crore in 2007 on PSUs the return on investment has remained mostly negative or lower.
In order to maintain those PSUs, the Government has to keep huge amount of budgetary
provisions, thereby creating a huge drainage of scarce resources of the country.

(v) Growing Inequality:

Fiscal policy of the country has failed to contain the growing inequality in the distribution of
income and wealth throughout the country. Growing trend of tax evasion has made the tax
machinery ineffective for the purpose. Growing reliance on indirect taxes has made the tax
structure regressive.

Essay # 7. Suggestions for Necessary Reforms in Fiscal Policy:

Following are some of the important measures suggested for necessary reforms of the fiscal
policy of the country:

(i) Progressive Taxes:

The tax structure of the country should try to infuse more progressive elements so that it can
put heavy burden on the rich and less burden on the poor. Necessary amendments should be
made in respect of irrigation tax, sales tax, excise duty, land revenue, property taxes etc.

(ii) Agricultural Taxation:

The tax net of the country should be extended to the agricultural sector for rapping a huge
amount of revenue from the rich agriculturists.
(iii) Broad-based Tax Net:

Tax net of the country should be broad-based so that it can cover increasing number of
population having the taxable capacity.

(iv) Checking Tax Evasion:

Adequate measures be taken to check the problem of tax evasion in the country. Tax laws should
be made stricter for prosecuting the tax evaders. Tax machinery should be made more efficient
and honest to gear up its operations. Tax rate should be reduced to encourage the growing trend
of tax compliance.

(v) Increasing Reliance on Direct Taxes:

Tax machinery of the country should attach much more reliance on direct taxes instead of
indirect taxes. Accordingly, the tax machinery should try to introduce wealth tax, estate duty, gift
tax, expenditure tax etc.

(vi) Simplified Tax Structure:

Tax structure and rules of the country should be simplified so that it can encourage tax
compliance among the people and it can remove the unnecessary harassment of the tax payers.

(vii) Reduction of Non-Development Expenditure:

The fiscal policy of the country should try to reduce the non-developmental expenditure of the
country. This would reduce the volume of unproductive expenditure and can reduce the
inflationary impact of such expenditure.

(viii) Checking Black Money:

The fiscal policy of the country should try to check the problem of black money. In this direction
schemes like VDIS should be repeated. Tax rates should be reduced. Corruption and political
interference should be abolished. Smuggling and other nefarious activities should be checked.

(ix) Raising the Profitability of PSUs:

The Government should try to restructure its policy on public sector enterprises so that its
efficiency and rate of return on capital invested can be raised effectively. PSUs should be
managed in rational manner with least government interference and on commercial lines.
Accordingly, the policy of budgetary provisions for maintaining the PSUs should gradually be
eliminated.

Essay # 8. Measures of Fiscal Policy Reforms:

The Government of India has introduced several fiscal policy reforms which constitute the main
basis of the stabilisation policy of the country.

Following are some of the important measures of fiscal policy reforms adopted by the
Government of India in recent years:

(i) Reduction of Rates of Direct Taxes:

The peak rate of income tax was reduced to 30 per cent in 1997-98 budget. This has resulted in
an increase in the share of direct taxes in total revenue of the country from 19 per cent in 1990-
91 to around 61 per cent in 2008-09.

(ii) Simplification of Tax Procedure:

In recent years as per the recommendation of Raja Chelliah or Taxation Reform Committee,
several steps have been taken to simplify the tax procedure in the successive budgets. The 1998-
99 budget has introduced a series of tax simplification measures, viz., “Saral”, “Samadhan” and
“Samman”, which is considered as an important step in right direction.

(iii) Reforms in Indirect Taxes:

These reforms include introduction of advalorem rates, MODVAT scheme etc.

(iv) Fall in the volume of Government Expenditure:

Several measures were undertaken recently by the government. Accordingly, total expenditure
of the Government under various heads has been reduced. As a result, total public expenditure
as per cent of GDP has declined from 19.7 per cent of GDP in 1990-91 to 16.9 per cent in 2008-
09.

(v) Reduction in the Volume of Subsidies:

Central Government has been making huge payments in the form of subsidies, i.e., food
subsidies, fertiliser subsidies, export subsidies etc. Steps have been taken to reduce these
subsidies in a phased manner.

(vi) Reduction in Fiscal Deficit:

The Central Government has been trying seriously to contain the fiscal deficit in its annual
budget. Accordingly, it has reduced the extent of fiscal deficit from 7.7 per cent of GDP in 1990-
91 to 6.1 per cent in 2008-09. But fiscal stabilisation necessitates containing the fiscal deficit at
least to 3 per cent of GDP.

(vii) Reduction in Public Debt:

Recently, the Central Government has been trying to reduce the burden of public debt.
Accordingly, the external debt as per cent of GDP which was 5.4 per cent in 1990-91 gradually
declined to 4.9 per cent in 2008-09. The internal debt as per cent of GDP has declined from 48.6
per cent in 1990-91 to 37.9 per cent in 2008-09.

Similarly, the total outstanding loan or liabilities as per cent of GDP also declined from 63.0 per
cent in 2003-04 to 58.9 per cent in 2008-09.

(viii) Disinvestment in Public Sector:

Another important fiscal policy reforms introduced by the Government of India is to disinvest
the shares of the public sector enterprises. The government has disinvested as part of its stake in
39 selected PSUs since the disinvestment process began in 1992. Till 2006-07, it has raised
around Rs 51,608 crore through disinvestment of share of PSUs.

In the mean time, the Government has constituted a Disinvestment Commission to advise it on
how to go about disinvesting the shares of PSUs. The Commission, in its first three reports has
given its recommendations on 15 PSUs out of 50 referred to it.

The Commission submitted at least eight reports covering 43 PSUs and also undertook diagnostic
studies in 1998-99 in respect of these undertakings for giving recommendations.

Fiscal Policy of India: Definition, Objectives and

Evaluation

Let us make in-depth study of the definition, objectives and evaluation of fiscal policy of India.

Definition:

Fiscal policy is playing an important role on the economic and social front of a country.
Traditionally, fiscal policy in concerned with the determination of state income and expenditure
policy. But with the passage of time, the importance of fiscal policy has been increasing
continuously for attaining rapid economic growth.

Accordingly, it has included public borrowing and deficit financing as a part of fiscal policy of the
country. An effective fiscal policy is composed of policy decisions relating to entire financial
structure of the government including tax revenue, public expenditures, loans, transfers, debt
management, budgetary deficit, etc.

The policy also tries to attain proper balance between these aforesaid units so as to achieve the
best possible results in terms of economic goals. Harvey and Joanson, M., defined fiscal policy as
“changes in government expenditure and taxation designed to influence the pattern and level of
activity.”

According to G.K. Shaw, “We define fiscal policy to include any design to change the price level,
composition or timing of government expenditure or to vary the burden, structure of frequency
of the tax payment.” Otto Eckstein defined fiscal policy as “changes in taxes and expenditure
which aim at short run goals of full employment price level and stability.”
Objectives of Fiscal Policy:
In India, the fiscal policy is gaining its importance in recent years with the growing involvement
of the government in developmental activities of the country.

The following are some of the important objectives of fiscal policy adopted by the Government
of India:

1. To mobilise adequate resources for financing various programmes and projects adopted for
economic development.

2. To raise the rate of savings and investment for increasing the rate of capital formation;

3. To promote necessary development in the private sector through fiscal incentive;

4. To arrange an optimum utilisation of resources;

5. To control the inflationary pressures in economy in order to attain economic stability;

6. To remove poverty and unemployment;

7. To attain the growth of public sector for attaining the objective of socialistic pattern of society;

8. To reduce regional disparities; and

9. To reduce the degree of inequality in the distribution of income and wealth.

In order to attain all these aforesaid objectives, the Government of India has been formulating
its fiscal policy incorporating the revenue, expenditure and public debt components in a
comprehensive manner.

Fiscal Policy and Economic Development:

One of the important goals of fiscal policy formulated by the Government of India is to attain
rapid economic development of the country.

To attain such economic development in the country, the fiscal policy of the country has adopted
the following two objectives:

1. To raise the rate of productive investment of both public and private sector of the country.

2. To enhance the marginal and average rates of savings for mobilizing adequate financial
resources for making investment in public and private sectors of the economy.

The fiscal policy of the country is trying to attain both these two objectives during the plan
periods.

Evaluation of Fiscal Policy:

Fiscal policy formulated by the Government of India has been creating considerable impact on
the economy of the country. Taxation, public expenditure and public debt have been increasing
at a considerable proportion. Public sector of the country has also been expanded considerably.

The country has been able to attain significant development of its industrial and infrastructural
sector. But the burden of taxation in our country is comparatively heavy and thereby it has been
affecting the saving capacity of the people.

Moreover, the fiscal policy of the country has also failed to check the extent of inequality in the
distribution of income and wealth and has also failed to solve the problem of unemployment
and poverty even after 50 years of planning. The fiscal policy has also failed to maintain stability
in price level of the country. It would now be better to study the advantages and shortcomings of
the fiscal policy of the country in a brief manner.

I. Merits or Advantages of Fiscal Policy of India:

The following are some of the important merits or advantages of fiscal policy of Government of
India:

1. Capital Formation:

Fiscal policy of the country has been playing an important role in raising the rate of capital
formation in the country both in its public and private sectors. The gross domestic capital
formation as per cent of GDP in India has increased from 10.2 per cent in 1950-51 to 22.9 per
cent in 1980-81 and then to 24.8 per cent in 1997-98. Therefore, it has created a favourable
impact on the public and private sector investment of the country.

2. Mobilisation of Resources:

Fiscal policy of the country has been helping to mobilize considerable amount of resources
through taxation, public debt etc. for financing its various developmental projects. The extent of
internal resources mobilisation for financing plan has increased considerably from 70 per cent in
1965-66 to around 90 per cent in 1997-98.

3. Incentives to Savings:

The fiscal policy of the country has been providing various incentives to raise the savings rate
both in household and corporate sector through various budgetary policy changes, viz., tax
exemption, tax concession etc. Accordingly, the saving rate has increased from a mere 10.4 per
cent in 1950-51 to 23.1 per cent in 1997-98.

4. Inducement to Private Sector:

Private sector of the country has been getting necessary inducement from the fiscal policy of the
country to expand its activities. Tax concessions, tax exemptions, subsidies etc. incorporated in
the budgets have been providing adequate incentives to the private sector units engaged in
industry, infrastructure and export sector of the country.

5. Reduction of Inequality:

Fiscal policy of the country has been making constant endeavor to reduce the inequality in the
distribution of income and wealth. Progressive taxes on income and wealth tax exemption,
subsidies, grant etc. are making a consolidated effort to reduce such inequality. Moreover, the
fiscal policy is also trying to reduce the regional disparities through its various budgetary policies.

6. Export Promotion:

The Fiscal policy of the government has been making constant endeavor to promote export
through its various budgetary policy in the form of concessions, subsidies etc. As a result, the
growth rate of export has increased from a mere 4.6 per cent in 1960-61 to 10.4 per cent in
1996-97.

7. Alleviation of Poverty and Unemployment:

Another important merit of Indian fiscal policy is that it is making constant effort to alleviate
poverty and unemployment problem through its various poverty eradication and employment
generation programmes, like, IRDP, JRY, PMRY, SJSRY, EAS etc.
II. Shortcomings of Fiscal Policy of India:
The following are the main shortcomings of the fiscal policy of the country:

1. Instability:

Fiscal policy of the country has failed to attain stability on various fronts. Growing volume of
deficit financing has created the problem of inflationary rise in price level. Disequilibrium in its
balance of payments has also affected the external stability of the country.

2. Defective Tax Structure:

Fiscal policy has also failed to provide a suitable tax structure for the country. Tax structure has
failed to raise the productivity of direct taxes and the country has been relying much on indirect
taxes. Therefore, the tax structure has become burdensome to the poor.

3. Inflation:

Fiscal policy of the country has failed to contain the inflationary rise in price level. Increasing
volume of public expenditure on non-developmental heads and deficit financing has resulted in
demand-pull inflation. Higher rate of indirect taxation has also resulted in cost-push inflation.
Moreover, the direct taxes has failed to check the growth of black money which is again
aggravating the inflationary spiral in the level of prices.

4. Negative Return of the Public Sector:

The negative return on capital invested in the public sector units has become a serious problem
for the Government of India. In-spite of having a huge total investment to the extent of Rs.
2,04,054 crore in 1998 on PSUs the return on investment has remained mostly negative. In order
to maintain those PSUs, the Government has to keep huge amount of budgetary provisions,
thereby creating a huge drainage of scarce resources of the country.
5. Growing Inequality:

Fiscal policy of the country has failed to contain the growing inequality in the distribution of
income and wealth throughout the country. Growing trend of tax evasion has made the tax
machinery ineffective for the purpose. Growing reliance on indirect taxes has made the tax
structure regressive.

III. Suggestions for Necessary Reforms in Fiscal Policy:

The following are some of the important measures suggested for necessary reforms of the fiscal
policy of the country:

1. Progressive Taxes:

The tax structure of the country should try to infuse more progressive elements so that it can
put heavy burden on the rich and less burden on the poor. Necessary amendments be made in
respect of irrigation tax, sales tax, excise duty, land revenue, property taxes etc.

2. Agricultural Taxation:

The tax net of the country should be extended to the agricultural sector for tapping a huge
amount of revenue from the rich agriculturists.

3. Broad-based Tax net:

Tax net of the country should be broad-based so that it can cover increasing number of
population having the taxable capacity.
4. Checking Tax Evasion:

Adequate measures be taken to check the problem of lax evasion in the country. Tax laws should
be made stricter for prosecuting the tax evaders. Tax machinery should be made more efficient
and honest to gear up its operations. Tax rate should be reduced to encourage the growing trend
of tax compliance.

5. Increasing Reliance on Direct Taxes:

Tax machinery of the country should attach much more reliance on direct taxes instead of
indirect taxes. Accordingly, the tax machinery should try to introduce wealth tax, estate duty, gift
tax, expenditure tax etc.

6. Simplified Tax Structure:

Tax structure and rules of the country should be simplified so that it can encourage tax
compliance among the people and it can remove the unnecessary harassment of the tax payers.

7. Reduction of Non-development Expenditure:

The fiscal policy of the country should try to reduce the non-developmental expenditure of the
country. This would reduce the volume of unproductive expenditure and can reduce the
inflationary impact of such expenditure.

8. Checking Black Money:

The fiscal policy of the country should try to check the problem of black money. In this direction
schemes like VDIS should be repeated. Tax rates should be reduced. Corruption and political
interference should be abolished. Smuggling and other nefarious activities should be checked.
9. Raising the Profitability of PSUs:

The government should try to restructure its policy on public sector enterprises so that its
efficiency and rate of return on capital invested can be raised effectively. PSUs should be
managed in rational manner with least government interference and on commercial lines.
Accordingly, the policy of budgetary provisions for maintaining the PSUs should gradually be
eliminated.

IV. Recent Fiscal Policy Reforms:

In the mean time, the Government of India has introduced various fiscal policy reforms which
constitute the main basis of the stabilization policy of the country.

The following are some of the important measures of fiscal policy reforms adopted by the
Government of India in recent years:

1. Reduction of Rates of Direct Taxes:

The peak rate of income tax was reduced to 30 per cent in 1997-98 budget. This has resulted an
increase in the share of direct taxes in total revenue of the country from 19 per cent in 1990-91
to around 30 per cent in 1996-97.

2. Simplification of Tax Procedure:

In recent years as per the recommendation of Raja Chelliah or Taxation Reform Committee,
several steps have been taken to simplify the tax procedure in the successive budgets. The 1998-
99 budget has introduced a series of tax simplification measures, viz., “Saral”, “Samadhan” and
“Samman”, which is considered as an important step in right direction. The 2003-04 budget
introduced filing of return through e-mail.
3. Reforms in Indirect Taxes:

These include introduction of ad-velorem rates, MODVAT scheme etc.

4. Fall in the Volume of Government Expenditure:

Several measures were undertaken recently by the government. Accordingly, total expenditure
of the government under various heads has been reduced. As a result, total public expenditure
as per cent of GDP has declined from 19.7 per cent of GDP in 1990-91 to 16.4 per cent in 1996-
97.

5. Reduction in the Volume of Subsidies:

Central Government has been making huge payments in the form of subsidies, i.e., food
subsidies, fertilizer subsidies, export subsidies etc. Steps have been taken to reduce these
subsidies phase-wise.

6. Reduction in Fiscal Deficit:

The Central Government has been trying seriously to contain the fiscal deficit in its annual
budget. Accordingly, it has reduced the extent of fiscal deficit from 7.7 per cent of GDP in 1990-
91 to 5.1 per cent in 1998-99. But fiscal stabilisation necessitates containing the fiscal deficit at
least to 3 per cent of GDP.

7. Reduction in Public Debt:

Recently, the Central Government has been trying to reduce the burden of public debt.
Accordingly, the external debt as per cent of GDP which was 5.4 per cent in 1990-91 gradually
declined to 3.2 per cent in 1998-99 (BE). The internal debt as per cent of GDP has declined from
48.6 per cent in 1990-91 to 49.8 per cent in 1998-99. Similarly, the total outstanding loan or
liabilities as per cent of GDP has also declined from 54.0 per cent to 49.1 per cent during the
same period.

8. Disinvestment in Public Sector:

Another important fiscal policy reforms introduced by the Government of India is to disinvest
the shares of the public sector enterprises. The government has disinvested as part of its stake in
39 selected PSUs since the disinvestment process began in 1992. Till 2002-03, it has raised
around Rs. 29,440 crore through disinvestment of share of PSUs. In the mean time, the
government has constituted a Disinvestment Commission to advise it on how to go about
disinvesting the shares of PSUs. A separate Ministry of Disinvestment has also been formed.

Definition of 'Monetary Policy'

Definition: Monetary policy is the macroeconomic policy laid down by the central bank. It
involves management of money supply and interest rate and is the demand side economic policy
used by the government of a country to achieve macroeconomic objectives like inflation,
consumption, growth and liquidity.

Description: In India, monetary policy of the Reserve Bank of India is aimed at managing the
quantity of money in order to meet the requirements of different sectors of the economy and to
increase the pace of economic growth.

The RBI implements the monetary policy through open market operations, bank rate policy,
reserve system, credit control policy, moral persuasion and through many other instruments.
Using any of these instruments will lead to changes in the interest rate, or the money supply in
the economy. Monetary policy can be expansionary and contractionary in nature. Increasing
money supply and reducing interest rates indicate an expansionary policy. The reverse of this is a
contractionary monetary policy.
For instance, liquidity is important for an economy to spur growth. To maintain liquidity, the RBI
is dependent on the monetary policy. By purchasing bonds through open market operations, the
RBI introduces money in the system and reduces the interest rate.

Monetary Policy of India: Main Elements and

Objectives

Monetary Policy of India: Main Elements and Objectives!

Monetary Policy of India is formulated and executed by Reserve Bank of India to achieve specific
objectives. It refers to that policy by which central bank of the country controls(i) the supply of
money, and (ii) cost of money or the rate of interest, with a view to achieve particular objectives.

In the words of D.C. Rowan, “The monetary policy is defined as discretionary act undertaken by
the authorities designed to influence (a) the supply of money, (b) cost of money or rate of
interest, and (c) the availability of money for achieving specific objective.”

Thus, monetary policy of India refers to that policy which is concerned with the measures taken
to regulate the volume of credit created by the banks. The main objectives of monetary policy
are to achieve price stability, financial stability and adequate availability of credit for growth.

Following are the main elements of the monetary policy of India:

i. It regulates the stocks and the growth rate of money supply.

ii. It regulates the entire banking system of the economy.

iii. It determines the allocation of loans among different sectors.

iv. It provides incentives to promote savings and to raise the savings-income ratio.

v. It ensures adequate availability of credit for growth and tries to achieve price stability.

Objectives of Monetary Policy:

According to RBI Governor Dr. D. Subba Rao, “The objectives of monetary policy in India are
price stability and growth. These are pursued through ensuring credit availability with stability in
the external value of rupee and overall financial stability.”

Following are the main objectives of monetary policy:

i. To Regulate Money Supply in the Economy:

Money supply includes both money in circulation and credit creation by banks. Monetary policy
is farmed to regulate the money supply in the economy by credit expansion or credit
contraction. By credit expansion (giving more loans), the money supply can be expanded. By
credit contraction (giving less loans) money supply can be decreased.

The main aim of the monetary policy of the Reserve Bank was to control the money supply in
such a manner as to expand it to meet the needs of economic growth and at the same time
contract it to curb inflation. In other words monetary policy aimed at expanding and contracting
money supply according to the needs of the economy.

ii. To Attain Price Stability:

Another major objective of monetary policy in India is to maintain price stability in the country. It
implies Control over inflation. Price level, is affected by money supply. Monetary policy regulates
money supply to maintain price stability.

iii. To promote Economic Growth:

An important objective of monetary policy is to make available necessary supply of money and
credit for the economic growth of the country. Those sectors which are quite significant for the
economic growth are provided with adequate availability of credit.

iv. To Promote saving and Investment:

By regulating the rate of interest and checking inflation, monetary policy promotes saving and
investment. Higher rates of interest promote saving and investment.

v. To Control Business Cycles:

Boom and depression are the main phases of business cycle. Monetary policy puts a check on
boom and depression. In period of boom, credit is contracted, so as to reduce money supply and
thus check inflation. In period of depression, credit is expanded, so as to increase money supply
and thus promote aggregate demand in the economy.

vi. To Promote Exports and Substitute Imports:

By providing concessional loans to export oriented and import substitution units, monetary
policy encourages such industries and thus help to improve the position of balance of payments.

vii. To Manage Aggregate Demand:

Monetary authority tries to keep the aggregate demand in balance with aggregate supply of
goods and services. If aggregate demand is to be increased than credit is expanded and the
interest rate is lowered down. Because of low interest rate, more people take loan to buy goods
and services and hence aggregate demand increases and vice-verse.

viii. To Ensure more Credit for Priority Sector:

Monetary policy aims at providing more funds to priority sector by lowering interest rates for
these sectors. Priority sector includes agriculture, small- scale industry, weaker sections of
society, etc.

ix. To Promote Employment:

By providing concessional loans to productive sectors, small and medium entrepreneurs, special
loan schemes for unemployed youth, monetary policy promotes employment.

x. To Develop Infrastructure:

Monetary policy aims at developing infrastructure. It provides concessional funds for developing
infrastructure.

xi. To Regulate and Expand Banking:

RBI regulates the banking system of the economy. RBI has expanded banking to all parts of the
country. Through monetary policy, RBI issues directives to different banks for setting up rural
branches for promoting agricultural credit. Besides it, government has also set up cooperative
banks and regional rural banks. All this has expanded banking in all parts of the country.
Monetary policy of India
From Wikipedia, the free encyclopedia

Monetary policy is the process by which monetary authority of a country , generally central bank
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.[1] In India, the central monetary
authority is the Reserve Bank of India (RBI). It is so designed as to maintain the price stability in
the economy. Other objectives of the monetary policy of India, as stated by RBI, are:-

Price Stability

Price Stability implies promoting economic development with considerable emphasis on price
stability. The centre of focus is to facilitate the environment which is favourable to the
architecture that enables the developmental projects to run swiftly while also maintaining
reasonable price stability.

Controlled Expansion Of Bank Credit

One of the important functions of RBI is the controlled expansion of bank credit and money
supply with special attention to seasonal requirement for credit without affecting the output.

Promotion of Fixed Investment

The aim here is to increase the productivity of investment by restraining non essential fixed
investment.

Restriction of Inventories and stocks

Overfilling of stocks and products becoming outdated due to excess of stock often results in
sickness of the unit. To avoid this problem the central monetary authority carries out this
essential function of restricting the inventories. The main objective of this policy is to avoid over-
stocking and idle money in the organization.

To Promote Efficiency

It is another essential aspect where the central banks pay a lot of attention. It tries to increase
the efficiency in the financial system and tries to incorporate structural changes such as
deregulating interest rates, ease operational constraints in the credit delivery system, to
introduce new money market instruments etc.

Reducing the Rigidity

RBI tries to bring about the flexibilities in the operations which provide a considerable
autonomy. It encourages more competitive environment and diversification. It maintains its
control over financial system whenever and wherever necessary to maintain the discipline and
prudence in operations of the financial system.

Contents

1 Monetary Policy Committee

2 Monetary operations

3 Instruments of Monetary policy

4 Key Indicators

5 References

6 Further reading

Monetary Policy Committee

The Reserve Bank of India Act, 1934 (RBI Act) was amended by the Finance Act, 2016, to provide
for a statutory and institutionalised framework for a Monetary Policy Committee, for maintaining
price stability, while keeping in mind the objective of growth. The Monetary Policy Committee is
entrusted with the task of fixing the benchmark policy rate (repo rate) required to contain
inflation within the specified target level. As per the provisions of the RBI Act, out of the six
Members of Monetary Policy Committee, three Members will be from the RBI and the other
three Members of MPC will be appointed by the Central Government.

The Government of India, in consultation with RBI, notified the 'Inflation Target' in the Gazette of
India Extraordinary dated 5th August 2016 for the period beginning from the date of publication
of this notification and ending on the March 31, 2021 as 4%. At the same time lower and upper
tolerance levels were notified to be 2% and 6% respectively.[2]

Monetary operations

Monetary operations involve monetary techniques which operate on monetary magnitudes such
as money supply, interest rates and availability of credit aimed to maintain Price Stability, Stable
exchange rate, Healthy Balance of Payment, Financial stability, Economic growth. RBI, the apex
institute of India which monitors and regulates the monetary policy of the country stabilizes the
price by controlling Inflation. RBI takes into account the following monetary policies:
Instruments of Monetary policy

These instruments are used to control the money flow in the economy,

Open Market Operations

An open market operation is an instrument of monetary policy which involves buying or selling
of government securities from or to the public and banks. This mechanism influences the
reserve position of the banks, yield on government securities and cost of bank credit. The RBI
sells government securities to control the flow of credit and buys government securities to
increase credit flow. Open market operation makes bank rate policy effective and maintains
stability in government securities market.

CRR Graph from 1992 to 2011[3]

Cash Reserve Ratio

Cash Reserve Ratio is a 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 and vice versa. RBI is empowered to vary CRR between 15 percent and 3
percent. But as per the suggestion by the Narsimham committee Report the CRR was reduced
from 15% in the 1990 to 5 percent in 2002. As of 4 October 2016, the CRR is 4.00 percent.[4]

SLR Graph from 1991 to 2011[5]

Statutory Liquidity Ratio

Every financial institution has to maintain a certain quantity of liquid assets with themselves at
any point of time of their total time and demand liabilities. These assets have to be kept in non
cash form such as G-secs precious metals, approved securities like bonds etc. The ratio of the
liquid assets to time and demand liabilities is termed as the Statutory liquidity ratio.There was a
reduction of SLR from 38.5% to 25% because of the suggestion by Narsimham Committee. The
current SLR is 19.50%.[6]

Bank Rate Graph from 1991 to 2011

Bank Rate Policy[7]

The bank rate, also known as the discount rate, is the rate of interest charged by the RBI for
providing funds or loans to the banking system. This banking system involves commercial and co-
operative banks, Industrial Development Bank of India, IFC, EXIM Bank, and other approved
financial institutes. Funds are provided either through lending directly or discounting or buying
money market instruments like commercial bills and treasury bills. Increase in Bank Rate
increases the cost of borrowing by commercial banks which results in the reduction in credit
volume to the banks and hence declines the supply of money. Increase in the bank rate is the
symbol of tightening of RBI monetary policy. As on 2nd August 2017, bank rate is 6.25 percent.
[8]

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. In this case commercial bank will be tight in advancing loans to the
public. They will allocate loans to limited sectors. Few examples of ceiling are agriculture sector
advances, priority sector lending.

Credit Authorization Scheme

Credit Authorization Scheme was introduced in November, 1965 when P C Bhattacharya was the
chairman of RBI. Under this instrument of credit regulation RBI as per the guideline authorizes
the banks to advance loans to desired sectors.[9]

Moral Suasion

Moral Suasion is 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.

Repo Rate and Reverse Repo Rate

Repo rate is the rate at which RBI lends to its clients generally against government securities.
Reduction in Repo rate helps the commercial banks to get money at a cheaper rate and increase
in Repo rate discourages the commercial banks to get money as the rate increases and becomes
expensive. Reverse Repo rate is the rate at which RBI borrows money from the commercial
banks. 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.
This increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the policy.