Monetary & Fiscal Policies of INDIA

Somya Agrawal (09020541004)Amish Daniel (09020541008)Nikhil Girme (09020541022)Priyesh Agrawal (09020541042)Siddhartha Das (09020541047)Sneha Bhadoria (09020541054)

Fiscal Policy???

Fisc-> State Treasury

Fiscal Policy-> use of government finances

Objectives…………..

→ To achieve macroeconomic goals

→ Relating to any typical problem

Macroeconomic Goals!!!

Economic Growth

Employment

Stabilization

Economic stability

Price Stability

BUDGET

“A budget is a detailed plan of operations for some specific future period”

Components of budget Revenue receipts Capital receipts Revenue expenditure Capital expenditure

Revenue Receipts

1990-91 2000-01 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08a

2008-09 2008-090

100000

200000

300000

400000

500000

600000

700000

Revenue receipts

Revenue receipts

Capital Receipts

1990-91 2000-01 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08a

2008-09 2008-090

50000

100000

150000

200000

250000

300000

350000

400000

Capital Receipts

Capital Receipts

Revenue Expenditure

1990-91 2000-01 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08a

2008-09 2008-090

100000

200000

300000

400000

500000

600000

700000

800000

900000

Revenue Expenditure

Revenue Expenditure

Capital Expenditure

1990-91 2000-01 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08a

2008-09 2008-090

20000

40000

60000

80000

100000

120000

140000

Capital Expenditure

Capital Expenditure

Instruments of Fiscal Policies

Budgetary surplus and

deficit

Government expenditure

Taxation

Public Debt

Government Expenditure

Government spending on the purchase of goods & services.

Payment of wages and salaries of government servants

Public investment

Transfer payments

Government Expenditure

Government Expenditure

Taxation

Non quid pro quo transfer of private income to public coffers by means of taxes.

1. Direct taxes- Corporate tax, Div. Distribution Tax, Personal Income Tax, Fringe Benefit taxes, Banking Cash Transaction Tax

2. Indirect taxes- Central Sales Tax, Customs, Service Tax, Excise duty.

Direct Tax

1990-91 2000-01 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08a 2008-09 2008-090

50000

100000

150000

200000

250000

300000

350000

400000

Direct Tax

Direct Tax

Indirect Tax

1990-91 2000-01 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08a 2008-09 2008-090

50000

100000

150000

200000

250000

300000

350000

Indirect Tax

Indirect Tax

Tax Slabs(09-10)

Table : New Proposed Tax Slabs

Individuals Tax Rate

Existing Income Slab (Rs)

Proposed Income Slab (Rs)

Nil Up to Rs 1,60,000* Up to Rs 1,60,000*

10% 1,60,001 – 3,00,000 1,60,001-10,00,000

20% 3,00,001 – 5,00,000 10,00,001-25,00,000

30% Over 5,00,000 Over 25,00,000* Minimum slab changes to Rs 1.9 lakhs for women and Rs 2.4 lakhs for senior citizens

Taxation Contd…..

The Tax system has been modernized considerably.

Eliminating exemptions and loopholes for both direct and indirect taxes would level the playing field, reduce distortions and make the system simpler for both tax payers and the administration.

Public Debt

Internal borrowings 1. Borrowings from the public by means of

treasury bills and govt. bonds2. Borrowings from the central bank

(monetized deficit financing)

External borrowings 1. Foreign investments2. International organizations like

World Bank & IMF3. Market borrowings

Budgetary Surplus & Deficit

Early 1980s:net of depreciation consistently negative.

Late 1980s:large deficit averaging about 8% of GDP

Post liberalization: Fiscal deficit decreased.

LPG effect was till 1996-1997 2001:Fiscal deficit increased to 10%

of GDP.

Budgetary Surplus & Deficit

2003:FRBM was adopted. FRBM improved the transparency in

budgetary policy. As a result fiscal deficit decreased to

3.7% of GDP. In 2007-2008 fiscal deficit was 2.7 % Shot up to 6 % in 2008-2009.

Fiscal Deficit(as % of GDP)

Fiscal Deficit (in crores of Rs.)

1990-91 2000-01 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08a 2008-09 2008-090

50000

100000

150000

200000

250000

300000

350000

Fiscal Deficit

Fiscal Deficit

Fiscal Policy Overview (2009-10) Budget 2008-09 presented in the

backdrop of impressive growth. Fiscal deficit 2009-10 estimated at 2.5

per cent of GDP After presentation of budget Indian

economy was hit by global crisis. Fiscal policy shifted from fuelling growth

to containing inflation, which had reached 12.9 per cent in August, 2008.

Stimulus package of Rs .1,50,320 crore was provided

Tax Policy

Customs:1. Sharp reduction was effected in the import duty

rates of various food items.2. Import duties on crude petroleum was reduced to

nil and on petrol and diesel to 2.5% (earlier 7.5%).

Excise:Reduction of 4 %points in the ad valorem rates of excise duty on non-petroleum items.

Service tax:1. Service Tax continued at 10%.2. Tax base widened.

Government Borrowings, Lending and Investments

The gross borrowings: Rs 2,40,167 crore

The net borrowings : Rs 1,68,710

An Overdraft (OD) for 24 days daily average of OD was Rs.11,233 crore.

Government has set up National Investment fund

Policy Evaluation

Fiscal consolidation during the FRBM act.

2007-08:fiscal deficit was 2.7%.

Increase in fiscal deficit due to global meltdown (10.3% of GDP).

Government steps helped reduce inflation(7.8%).

India still growing at the rate of 6.7%(08-09)

Monetary Policy??

The part of the economic policy which regulates the level of money in the economy in order to achieve certain objectives.

In INDIA,RBI controls the monetary policy. It is announced twice a year, through which RBI,regulate the price stability for the economy.

1.Slack season policy

April-September

2.Busy season policy

October-March

Central Banks

India Reserve Bank of India.

U.S.A. Federal Reserve bank.

U.K. Bank of England.

Pakistan Bank of Pakistan.

Establishment of RBI

Established in April 1935 with a share capital of Rs. 5 crores.

Nationalized in the year 1949. Initially established in Calcutta but

permanently moved to Mumbai in 1937.

Governor of RBI : D. Subbarao

Objectives of monetary policy

Maximum feasible output. High rate of growth. Growth in employment & income Price stability. Stability of Forex & national currency Inflation Control Greater equality in the distribution of income

and wealth. Healthy balance in balance of payments(BOP).

Types of control

MONETARYPOLICY

QUALITATIVECONTROL

QUANTITATIVE

CONTROL

Quantitative control Tools

Open market operations: The open market operations is sale and purchase of

government securities and Treasury Bills by the central bank of the country.

When the central bank decides to pump money into circulation, it buys back the government securities, bills and bonds.

When it decides to reduce money in circulation it sells the government bonds and securities.

The central bank carries out its open market operations through the commercial banks.

2000

2002

2004

2006

2008

0

2

4

6

8

10

12

OMO’s Tools

Repo rate: A repurchase agreement or ready forward deal

is a secured short-term (usually 15 days) loan by one bank to another against government securities.

Legally, the borrower sells the securities to the lending bank for cash, with the stipulation that at the end of the borrowing term, it will buy back the securities at a slightly higher price, the difference in price representing the interest.

Reverse repo rate is the rate that RBI offers the banks for parking their funds with it. Reverse repo operations suck out liquidity from the system.

Bank Rate Policy

Bank rate is the minimum rate at which the central bank provides loans to the commercial banks. It is also called the discount rate.

Dear money policy: Bank rate inc interest rate inc borrowing will

be less profitable results contraction of credit.

Near money policy: Bank rate dec interest rate low borrowing will

be more profitable results expansion of credit.

1940

1952

1953

1981

1990

1991

1997

2001

2007

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00 Chart Title

Years

in %

Trends of Bank Rate

In 1940’s BR was at low 3% and remained unchanged till 1953.In 1953 RBI adopted policy controlled expansion BR raised to 3.5%.It reached at max. level in 1991 to 12%. Presently it is 6 %

Reserve Requirements Changes:

The central bank of a country is empowered to determine within statutory limits, the cash reserve requirements of the commercial banks.

Statutory liquid ratio: Bank has to keep portion of

total deposits with itself in liquid assets. Cash reserve ratio: The percentage of bank’s

deposits which they must keep as cash with RBI.

SLR Trend

It was 25% in 1949 after that it increased continuously 32%(1972)--- 35% (1981)---36%(1984)--- 38%(1988). From 1997 it is

constant at 25%

CRR Trend

• In beginning it was 5% of demand deposit & 2% of time deposits.

•Reached max. in 1991,92 after 1993 it followed Narsimham report & decreased.

• But from dec.06 it raised 7 times, 250bp to cool credit growth & supply.

•Currently, it is 5 %

Qualitative Control Tools:

o Selective credit control

o They are distinguishable from quantitative tools by the fact that they are directed towards particular uses of credit and merely to total volume outstanding.

Important selective control measures are:• Rationing of credit.• Changes in margin requirements.• Moral suasion.

When there is a shortage of institutional credit available for the business sector, the large and financially strong sectors or industries tend to capture the lion’s share in the total institutional credit.

As a result the priority sectors and essential industries are of necessary funds.

Below two measures are generally adopted: Imposition of upper limits on the credit available to

large industries and firms Charging a higher or progressive interest rate on

the bank loans beyond a certain limit.

Credit Rationing

The banks provide loans only up to a certain percentage of the value of the mortgaged property.

The gap between the value of the mortgaged property and amount advanced is called Lending Margin.

The central bank is empowered to increase the lending margin with a view to decrease the bank credit.

Change in Lending Margins

The moral suasion is a method of persuading and convincing the commercial banks to advance credit in accordance with the directives of the central bank in overall economic interest of the country.

Under this method the central bank writes letter to hold meetings with the banks on money and

credit matters.

Moral Suasion

EXPANSIONARY MONETARY POLICY

Problem: Recession and unemployment Measures: (1) Central bank buys securities through open market operation (2) It reduces cash reserves ratio (3) It lowers the bank rate  Money supply increases   Investment increases 

Aggregate demand increases  Aggregate output increases by a multiple of the increase in investment

CONTRACTIONARY MONETARY POLICY

Problem: Inflation Measures: (1) Central bank sells securities through open market operation (2) It raises cash reserve ratio and statutory liquidity (3) It raises bank rate (4) It raises maximum margin against holding of stocks of goods Money supply decreases

Interest rate raises  Investment expenditure declines  Aggregate demand declines   Price level falls 

Recommendation of Narshimham Committee Nov.1991

• SLR should not be used for directed investment in PSUs. It should be lower down to minimum limit of 25%

• CRR should be lower than the present rate. As an instrument it should be used less & Govt. should depend upon OMOs.

• Selective credit control should be slowly phased out

Prime lending rate of commercial bank should be independent of RBI control

How Monetary Policy Controls Inflation?

CENTRAL BANK

SECURITIES AND TRESURY BILLS

BANK RATE

COMMERCIAL BANKS

CORPORATES INDIVIDUALS

SOLDC

ASH

INCREA

SE

LEND

ING

RATE

CASH RESERVE RATIO

REDUCED BORROWING OF LOANS

INC

REA

SE IN

C

RR

%

REDUCE LIQUIDITY IN MARKET

STATUTORY LIQUID RATIO

The Monetary Policy aims to maintain price stability, full employment and economic growth.

Emphasis on these objectives have been changing time to time depending on prevailing circumstances.

For explanation of monetary policy, the whole period has been divided into 4 sub periods:

a) Monetary policy of controlled expansion (1951 to 1972)

b) Monetary Policy during Pre Reform period (1972 to 1991)

c) Monetary Policy in the Post-Reforms (1991 to 1996)

d) Easing of Monetary policy since Nov 1996

Monetary Policy of India - Overview

To regulate the expansion of money supply and bank credit to promote growth.To restrict the excessive supply of credit to the private sector so as to control inflationary pressures.

Following steps were taken:1. Changes in Bank Rate from 3% in 1951 to 6% in 1965

and it remained the same till 1971.

2. Changes in SLR from 20% in 1956 to 28% in 1971.

3. Select Credit Control: In order to reduce the credit or bank loans against essential commodities, margin was increased.

Monetary policy of controlled expansion (1951 to 1972)

Monetary Policy during Pre Reform period (1972 to 1991)

Also known as the Tight Monetary policy: Price situation worsened during 1972 to 1974.

Following Monetary Policy was adopted in 70’s and 80’s which were mainly concerned with the task neutralizing the impact of fiscal deficit and inflationary pressure.

1) Changes in CRR to the maximum limit of 25%2) Changes in SLR also to the maximum limit of 38.5%

Monetary Policy in the Post-Reforms – 1991 to 1996

The year 1991-1992 saw a fundamental change in the institutional framework It had twin objectives which were Price stability and economic growth. 1) Continuing the same maximum CRR and SLR of 25%

and 38.5%, mopped up bank deposits to the extent of 63.5%

2) In order to ensure profitability of banks, Monetary Reforms Committee headed by late Prof. S Chakravarty, recommended raising of interest rate on Government Securities which activated Open Market Operations (OMO).

3) Bank rate was raised from 10% in Apr 1991 to 12% in Oct 1991 to control the inflationary pressures.

Easing of Monetary policy since Nov 1996:

In 1996-97, the rate of inflation sharply declined. In the later half 1996-97, industrial recession gripped the Indian economy. To encourage the economic growth and to tackle the recessionary trend, the RBI eased its monetary policy.

1. Introduction of Repo rate. Repo rate increased from 3% in 1998 to 6.5% in 2005. This instrument was consistently used in the monitory policy as a result of rapid industrial growth during 2005-06.

2. Reverse Repo rate –Through RRR, the RBI mops up liquidity from the banking system. The Repo rate was cut from 3.50% to 3.25%.

Easing of Monetary policy since Nov 1996: (Contd)

3. Flow of credit to Agriculture – The flow of credit to agriculture has increased from 34,013 (9.2% of overall credit) in 2008 to 52,742 (13% in overall credit) in 2009 – (Rs. in crore).

4. Reduction in Cash Reserve Ratio – The CRR which was at 15% until 1995 gradually reduced to 5% in 2005. The CRR remained unchanged in the current monetary policy.

5. Lowering Bank rate – The Bank rate was gradually reduced from 12% in 1997 to 6% in 2003.

RBI In Recession

CRR cut to 5% Repo rate cut to 5.5% Reverse Repo rate cut to 4% Short-term lending and borrowing rates

cut Slashed tax rates Injection of Money Opening up new borrowing channels for

banks Government hikes its spending

Review of 2009/10 Monetary Policy GDP growth at 7.9% for Q2 2009 which was predicted

to be 6.3

WPI-currently at 4.78%. Food Inflation touched 19% because of easy monetary policies & decreasing agricultural production

Bank Rate has been retained unchanged at 6.0 per cent

Repo Rate has been retained unchanged at 4.75 per cent

Reverse Repo Rate has been retained unchanged at 3.25 per cent

CRR- 5 per cent & SLR to 25 per cent of their NDTL Planning to tighten liquidity scenario from January

IS CURVE

LM CURVE

IS/LM CURVE

Expansionary Fiscal Policy - shifts IS right: will tend to increase Y and also increase the interest rate (r)

Contractionary Fiscal Policy - shifts IS left: will tend to reduce both Y and r

Expansionary Monetary Policy - shifts LM right - reduces r and increases Y Contractionary Monetary Policy - shifts LM left increases r and reduces Y

Shifts in Curve

Shifts in Curve

Thank You…….