ASSIGNMENT

Indian Economy 4

MONETARY V/S FISCAL POLICY:

EFFECTIVENESS IN INDIA
GROUP NO. 15

Submitted to faculty: Miss Vishakha Gandhi

Date of Submission: 29th December, 2019.

Students’ Details
Roll No. Name of the Student
17-EC-216 Abhishek Harwani
17-EC-244 Prem Chauhan
17-EC-248 Anshu Kumari
INTRODUCTION
Monetary and Fiscal policies are the most common and widely used tools to influence a
nation’s economic activities. Monetary policy addresses the interest rates and the supply of
money in circulation, and it is generally managed by a central bank. Fiscal policy addresses
taxation and government spending, and it is generally determined by legislation(Central
Government).

Monetary policy and fiscal policy together have a great influence over a nation’s economy,
its businesses and its consumers.

SIGNIFICANCE
(A) MONETRY POLICY

Monetary policy refers to the use of monetary instruments under the control of the Central
bank to govern magnitudes such as interest rates, money supply and availability of credit
with a view to achieve the ultimate objectives of economic policy.

PaulEizing defined monetary policy as “The attitude of the political authority towards the
monetary system of the community under its control”.

Monetary policies hold a significant place in developing countries, since these policies are
effective in diminishing the fluctuations in price levels and general economic activity thus,
maintaining a proper balance between the demand for and supply of money.

Some general objectives of a monetary policy of a country are: (a) Exchange stability (b)
Economic stability (c) Full employment (d) to maintain equilibrium in Balance of payment
(e) to stabilize price level (f) neutrality of money.

Economic development is usually followed by inflation. However, it is the task of the

monetary policy to ensure growth while keeping the prices under control.
In India, the RBI uses various monetary instruments like REPO rate, Reserve REPO rate,
SLR, CRR etc to achieve its purpose.

(B) FISCAL POLICY

Fiscal policy means the use of taxation and public expenditure by the government for
stabilization or growth of the economy.

According to Culbarston, “By fiscal policy we refer to government actions affecting its
receipts and expenditures which ordinarily as measured by the government’s receipts, its
surplus or deficit.”

As against the monetary policy, the fiscal policy is concerned with non-monetary
instruments. A fiscal policy helps in securing stabilization in developed economies and
accentuates economic growth in the developing countries through its tools that include: (i)
taxes (ii) Public Borrowing (iii) Public Expenditure.

By comparison, fiscal policy generally has a greater impact on consumers than

monetary policy, as it can directly influence employment and income.KK Kurihara
regards fiscal policy as an additional saver, an investor and an income redistributor.

The main aim of any government fiscal policy is to target the total level of spending, the total
composition of spending or both in an economy.When the business activities lose momentum
in an economy, a govt. may increase its spending as an alternative to accelerate production
and consumption. This is referred to as “Stimulate Spending”. Another alternative can be
relaxation in tax rates which have a direct impact on consumption expenditure incurred by the
public. On the other hand, if a govt. decides to slow down the economic activities, it may
resort to increased tax rates or reduction in total spending.

A Government must choose what to spend on and what to tax when it incurs expenditure or
changes the tax policy. By doing so, the govt. can target particular communities, industries,
investment or commodities to either favour or discourage production.
DATA/STATISTICS:

KEY RATES RALATING TO THE MONETARY POLICY:

Year Bank Rate(%) Repo Rate(%) Reverse Repo

Rate(%)
2014 9.00 8.00 7.00
2015 7.75 6.75 5.75
2016 6.75 6.25 5.75
2017 6.25 6.00 5.75
2018 6.75 6.50 6.25
2019 5.40 5.15 4.90
Table (i)

ANALYSIS AND DISCUSSION:

Table (i) shows the trends of key rates of the Indian Economy over the last five years as
determined by the Reserve Bank of India.

 In 2014, during the Q2 ending in September 2014, India’s GVA (at base prices)
increased at a rate of 8.4% at basic prices with the Final Consumption Expenditure
rising at 7.4%. However, the Index of Industrial Production (IIP) registered a negative
growth of 2.7%. Services sector contributed majorly by showing an increase of 10.2%
in its growth rate. The Scheduled banks saw a surge in their lending activities with a
10.7% increase in bank credits. The major concern here was the inflation which was
5.5% during that time period. In order to curb the inflation, the RBI adopted a slightly
contractionary policy and set the bank rate, repo rate and the reverse repo rate at
9.00%, 8.00% and 7.00% respectively.
 RBI successfully implemented its contractionary policy and brought down the
inflation by 50 basis points to 5%. The GVA (at base prices) of India, during the Q2
 ending in September 2015, grew by 7.3% which was quite good. One of the major
positive outcomes was the increase in IIP growth rate, a whopping 9.9%. This led to
an increase in the economy’s GDP while maintaining a price level. Bank credits
increased by 8.8% as compared to the previous year’s 10.7%. With a view to further
accelerate the growth process in India; the RBI started easing off the rates. Towards
the end of the FY15, bank rate reduced to 7.75%, Repo Rate reduced to 6.75% and the
Reverse Repo Rate reduced to 5.75%.
 RBI’s expansionary policy did not achieve the success that it had expected. During
Q2 ending in September 2016, the GVA(at base prices) grew at a rate of 6.8% as
compared to last year’s 7.3%. The major factor involved was the decline in the IIP
growth rate, which declined drastically to 4.2% as compared to the previous year’s
9.9% due to weakened demand conditions in the domestic market. Even with lowered
bank rate and repo rate, the scheduled bank credits saw an increase of only 9.2% as
compared to the previous year’s 10.5%. The inflation rate reduced drastically to 4.2%.
Thus, the RBI further eased the monetary policy by reducing the Bank rate to 6.75%,
the Repo rate to 6.25% and the Reverse Repo rate to 5.75% at the end of the FY16.
 The growth rate of GVA (at base prices) further declined to 6.1% during Q2 ending in
September 2017 despite the RBI’s efforts to accelerate the process of economic
growth. The IIP hit very low with a growth rate of only 1.8% during the Q2. The
economy was still recovering from the impact of demonetisation which had occurred
in November, 2016 leaving the middle class and poor household in a state of
confusion and chaos. The Final Consumption Expenditure, which is an indicator of
aggregate demand, grew at 6.0% as compared to the previous year’s 7.4%. The
implementation of GST, in July 2017, received a mixed review. As against the RBI’s
expectations, the rate of lending of the scheduled banks grew at a mere 6.8% as
compared to the previous year’s 8.7%. This declining trend is indicative of the fact
that the investment activity was gradually slowing down and the consumer demand
was also slow. However, the RBI was successful in cutting down the rate of inflation
to 3.6%. In hopes of gaining momentum in terms of investment and aggregate
demand, the RBI further reduced the key rates as follows: Bank rate – 6.25%; Repo
Rate – 6.00%; Reverse Repo Rate – 5.75%.
 During the Q2 ending in September 2018, the economy managed to pick up some
momentum with GVA (at base prices) increasing at a rate of 6.9%. This was the result
 of a very high growth rate in IIP and Final Consumption Expenditure both of which
increased at rates of 8.4% and 10% respectively. On the basis of year-on-year
comparison, the growth rate had increased drastically. The ‘Eight Core Industries’
showed quite a positive growth. A reduction in bank and other rates led to a growth of
lending activities by 14.6% as compared to the previous year’s 6.8%. Again, the
inflation rate reduced to 3.4%. Overall, FY18 was a very positive and encouraging
year for the Indian Economy. However, with a view to curb inflation in the light of
increased crude oil prices, the RBI increased the Bank rate to 6.75%; the Repo rate to
6.50% and the Reverse Repo rate to 6.50%.
 In 2019, the Indian economy was at its lowest in a very long time. Not only did the
inflation increase to 4.6%, the growth rate of GVA (at base prices), during the Q2
ending in September 2019, reduced to 4.3% as compared to 6.9% (year-on year
basis). A lot of factors were responsible for this drastic decline in the economy’s
health. The IIP registered a negative growth of 3.3% due to a major decline in the
output of the ‘eight core industries’. The Final Consumption Expenditure grew only at
6.9%. The services sector also witnessed a decline. The bank credit reduced to 8.9%.
In order to lift the economy from this recession, the RBI used the expansionary
approach and reduced the key rates drastically towards the end of FY19: Bank Rate –
5.40%; Repo rate – 5.15; Reverse Repo Rate – 4.90.

FISCAL POLICY:

 The crisis unfolded, the government activated a series of stimulus package on

7th December, 2009. The central excise duty cut off by 4%. The additional
plan expenditure increase the level of about 200 billion, further state
government borrowing for planned expenditure amounting around 300 billion,
a further reduction of central excise duty and service tax for export industries
by 2%(that is central excise duty was reduce by 6%). By 2008-2009, the GDP
was estimated to be around 1.8% and the GDP was amounted to be about 3%,,
if the public expenditure increased across the budget of 2007-2008 and 2008-
09 is take together.
 The GDP growth declined by 5% in the second half of 208-09 as compared to
7.8% in the first half. By 2009-10 the GDP was grown by 8% (quick estimate
 and this increased further by 8.5% in 2010-11 RE). Now, it is important to
restore the process of fiscal consolidation. This was very fragile process,
where fiscal tightening had to be achieved without making the growth process
more different or impossible.
 . The 2010-11 budgets adopted a mark targeting a fiscal deficit of 5.5% of
GDP in 2010-11. But it was declined by 5.1% of GDP in 2010-11. This was
also an important over the 13th FC roadmap target of 5.7%. The fiscal policy
was target by 4.6% of the GDP in 2011-12 as against the target of 4.8% of the
13th FC.
 By 2009-10 the indirect tax was shared about 32% whereas, direct tax
contributing around 48% of revenue. And, in the budget 2011-12, the direct
tax contributes around 47% and in indirect tax shared about 31% (Ministry of
finance, 2011).
 Recent development points to the fact that policymakers have agreed upon
strict budgetary constraints, with a view to maximise resources for
developmental activities. The approach paper to the plan while projecting the
centre’s fiscal resources diligently predicts an average fiscal deficit of 3.25%
of GDP for the entire plan period with the fiscal deficit projected to come
down from 4.1% in 2012-13 to 3.5% in 2013-14. It is then expected to remain
at 3% of GDP for the next three financial years. It is projected to increase
from 4.92% of GDP IN 2011-12 TO 5.75% by the end of the 12th plan.
 By the 12th plan the defence expenditure was projected to fall down by 1.85%
of the GDP in the base year (2011-12) to 1.56% of the GDP in the final year
(2016-17). It was forecasted that subsidies got declined by 1.6% of GDP in
2011-12 to 1.24% of GDP in 2016-17. But still non plan expenditure account
was expected to be projected for 18.8% during the 12th plan.

In the global crisis the Indian economy fall down by 5.8% in the second half of 2008-
09 and then it bounced by 8.5% in 2009-10. In the view of the recovery the fiscal
stimulus was adopted in a slow exit whereby fiscal consolidation was achieved
without choking off the recovery process. In the recent policy document like 12th plan
approach it was indicated that fiscal policy was fairly well institutionalised in the
country’s policy establishment. In the future government would focus on tax reform
 and targeting social expenditure to maintain the process of inclusive growth and to
achieve fiscal consolidation.

LIMITATIONS:

MONETARY POLICY:

1) Huge budgetary deficits by the Union Govt. act as a hurdle in achieving the objectives
of the monetary policy of the RBI. The federal bank, through its instruments such as
CRR, SLR, Bank Rate, etc. makes every possible attempt to check inflation in the
economy and balance money supply in the market. However, excessive spending by the
Govt. leads to a surplus in the supply of money.

2) RBI’s tools can reach only as far as the organised money market which comprises of
the banking institutions. Therefore, fluctuations in the general price level caused by these
institutions can be controlled by the apex bank. But, inflation also occurs due to heavy
Govt. spending, scarcity of goods/services, etc. over which the RBI may not have
desirable control.

3) One of the major obstacles that a monetary policy faces in the Indian economy is the
presence of the Unorganised Money Market. Various indigenous money lenders, bankers
and NBFCs do not fall under the direct regulation of the Reserve Bank, which makes the
monetary policy less effective.

4) Indian economy also faces the problem of ‘Monetary Policy Transmission’. With a
view to curb inflation, the Reserve Bank increases the rates but this change is not
observed/passed through to the banking institutions effectively. Example: When RBI
reduced the Repo Rate by 75 bps during Feb-Jun 2019, there was a pass through of only
29 bps over a period of about two months.

5) Parallel Economy or black money becomes yet another issue. The RBI has no control
whatsoever over the creation/use of black money in the market which means that a large
proportion of money supply remains unaffected by the monetary instruments.
In the above analyses also, we observe that the monetary instruments affected only those
sectors and institutions which are directly under the purview of the Federal Bank. Even then,
the presence of a parallel economy and unorganised money market coupled with the
integration of domestic & foreign exchange markets and lack of transparency in policy
formulation heavily influence the efficacy of the monetary policy.

FISCAL POLICY:

1) In recent times, the major concern surrounding the fiscal policy is its timing. A fiscal
policy would not make much difference unless the variations in tax rates and the
public expenditure are appropriately times. In India, we observe three kinds of policy
lags: (a) Recognition Lag; (b) Administrative Lag; (c) Operational Lag.
2) A fiscal policy has a selective impact on the economy. The area and extent of public
expenditure may directly influence certain areas in a positive manner while other
areas in a negative manner, depending upon the value judgements.
3) Another major limitation of the Fiscal Policy is the “Crowding Out” of private sector.
Crowding out takes place when the increased public expenditure causes the private
sector to shrink, since there’ll be a competition for various resources in the economy.
Moreover, when there is an increased public expenditure in the economy during the
onset of recession, the private sector starts becoming pessimistic about market
conditions and reduces its spending.

CONCLUSION

Both the monetary and the fiscal policy play a significant and a fundamental role in the
proper and smooth functioning of the economy. Each policy employs its own methods and
each one is equipped with its own advantages and limitations. In this sense, the Govt. of India
in co-operation with the Reserve Bank of India, make use of the advantages of the both these
policies and tries to achieve economic stabilization.
BIBLIOGRAPHY/REFERENCES

Economics Discussion Website (2015): Top 13 Limitations Of Fiscal Policy.

Jagranjosh website (2018): Fiscal Policy of India: Meaning, Objectives and Impacts on the
Economy.

Kumar, A. - IAS Maker Website (2019): Limitations of the Monetary Policy of RBI.

Planning Commission (2011): “Approach to the Twelfth Five-Year Plan”

RBI Website (2011): Database on the Indian Economy.

RBI Website (2019): RBI Bulletins of years 2014 through 2019.

Sribd Website (2019): Role of Monetary and Fiscal Policy in Economic Development.

Segal, T - Investopedia Website (2019): Monetary Policy vs. Fiscal Policy: What's the
Difference?

Supriyo De (2012): Fiscal Policy in India: Trends and Trajectory.