Unit 3

Monetary and Fiscal System of India

Monetary policy
• 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.
• 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.
Objectives of the monetary policy
• Price stability
• Price Stability implies promoting economic development with considerable emphasis
on price stability.
• The center of focus is to facilitate the environment which is favorable 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 investments
• The aim here is to increase the productivity of investment by restraining non
essential fixed investment.
• Restriction of inventories and stock
• Overfilling of stocks and products becoming outdated due to excess of stock often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 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.
Fiscal policy
• It means use of public taxation and public expenditure by the
government for stabilization or growth.
• 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.
Objectives of Fiscal policy
1. To mobilize adequate resources for financing various programs and
projects adopted for economic development.
• Mobilized through taxation, public savings and private savings
2. Reduction in inequalities of income.
3. Price stability and control of inflation.
4. Employment generation
5. Balanced Regional development.
6. Reducing deficit in BOP.
7. Increasing National Income
8. Development of Infrastructure.
9. Foreign Exchange earnings.
The Banking sector in India
 BASIS FOR COMPARISON SCHEDULED BANKS
Meaning Scheduled banks is a
banking corporation whose
minimum paid up capital is
Rs. 25 lakhs and does not
harm the interest of the
depositors.
Second Schedule Listed in the second
schedule.
Cash Reserve Ratio Maintained with RBI.
Borrowing Scheduled banks are
allowed to borrow money
from RBI for regular banking
purposes.
Returns To be submitted
periodically.
Members of clearing house It can become a member of It cannot become member
clearing house. of clearing house.
NON-SCHEDULED BANKS
Non-scheduled banks are
the banks which do not
comply with the rules
specified by the Reserve
Bank of India, or say the
banks which do not come
under the category of
scheduled banks.
Not-listed in the second
schedule.
Maintained with
themselves.
Non-Scheduled banks are
not allowed to borrow
money from RBI for regular
banking purposes.
No such provision of
submitting periodic returns.
To qualify as a scheduled bank, the bank should conform to the
following conditions:
• The total minimum value of paid up capital and reserve must be of Rs.
25 lacs.
• The bank requires to satisfy the central bank that its affairs are not
carried out in a way that causes harm to the interest of the
depositors.
• The bank needs to be a corporation rather than a sole-proprietorship
or partnership firm.
Indian Financial System
Financial Institutions
A financial institution is an establishment that conducts financial
transactions such as investments, loans and deposits. Here is an
overview of some of the major categories of financial institutions and
their roles in the financial system.
• Commercial Banks
• Investment Banks
• Insurance Companies
• Brokerages
• Investment Companies
Non Financial Institutions
• A credit union is a financial institution that is owned and controlled by its
members rather than shareholders. The members of the credit union pool
their deposits and provide loans and other financial services to each other.
• A savings and loan association (S&L) is a financial institution that
specializes in savings deposits and mortgage loans, and has become one of
the primary sources of mortgage loans for homebuyers today.
It offers mortgage services to people from
the savings and deposits received from private investors. Depositors and
borrowers are members with voting rights and have the ability to direct
the financial and managerial goals of the organization.
• Shadow Banks: This is a collection of investment banks, hedge funds,
insurers and other non-bank financial institutions that replicate some of
the activities of regulated banks, but do not operate in the same regulatory
environment
Financial Market
Financial Market is a mechanism that allows people to indulge themselves in the
buying and selling i.e. trade of financial securities (for example stocks and bonds),
commodities (for example precious metals) at prices that reflect the market’s
effectiveness.
1. Capital Market – Market where business enterprises or government entities
raise fund for long term using the weapon of securities or debts. It includes the
Stock market (equities) and Bond Market (debt) for fund raising.
2. Commodity Market – Commodity is a good for which there is a demand by the
people thus commodity market is the market where such goods are traded.

3. Money Market – Deals with the assets involved in short-term borrowing and
lending with original maturities ranging from a period of one year or even
lesser time frames.
4) Derivative Market – The derivative market is the financial market
meant for derivatives. The financial instruments like the futures contracts or
options, which are derived from other forms of assets, are traded in these
markets.

5) Insurance Market – Deals with the trading of insurance policies.

6) Futures Market – A vertical in financial market where people can trade

standardized futures contracts which is a contract to buy specific number of
quantities of a commodity or financial instrument at a specified price
with the delivery of the commodity or financial instrument set at a specified
time in the future.

7) Foreign Exchange Market – Also known as Forex is a global, worldwide

decentralized financial market meant only for the trading of currencies.
Financial Services
• As the name suggests financial services are the services provided by the Financial
Institutions. These services generally include the banking services, Foreign exchange
services, investment services, insurance services and few others. Following is a very brief
description of the services
• Banking Services – Includes all the operations provided by the banks including to the
simple deposit and withdrawal of money to the issue of loans, credit cards etc.
• Foreign Exchange services – this includes the currency exchange, foreign exchange
banking or the wire transfer
• Investment Services – It generally includes the asset management, hedge fund
management and the custody services
• Insurance Services – It deals with the selling of insurance policies, brokerages, insurance
underwriting or the reinsurance
• Some of the other services include the advisory services, venture capital, angel
investment etc.