Fiscal Policy Report_2

8/6/2019 Fiscal Policy Report_2

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A

SEMINAR REPORT

ON

FISCAL POLICY

SEMINAR ON CONTEMPORARY MANAGEMENT ISSUES

(PAPER NO. 207)

IN PARTIAL FULLFILLMENT FOR

IN

M.B.A. PROGRAMME

OF

RAJASTHAN TECHNICAL UNIVERSITY, KOTA

Submitted By:

Submitted To:

Satish Kumar Vijay Dr. V.N. Pradhan

MBA II Sem.

2009-2011

DEEPSHIKHA INSTITUTE OF MANAGEMENT STUDIES

ISI-17, RIICO INSTITUTIONAL AREA, SITAPURA

JAIPUR

DECLARATION


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I, Satish Kumar Vijay S/o Shri Jagdish Prasad Vijay, declare that the Report titled

''FISCAL POLICY''is based on my study.

This Report is my original work and this has not been used for any purpose anywhere.

Satish Kumar Vijay

M.B.A. II Sem.

PREFACE

As we know that M.B.A Programme is more concern with the knowledge aspect of thebusiness world. The M.B.A students need to gain more and more knowledge by different


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methods. It is not possible for them to have this from classroom lectures only. They should

undergo with various seminars.

Financial Market plays an important role in the economy of every country. Without existence

of Financial Market, we cant think about any countys growth. Financial Market can bedividing into two types, which are capital market & money market. Money market is useful for

short term & Capital market is useful for Long term Financial Needs. Everyone should know

the concept of financial market because its a tool which provides the safe place of the

money with certain return.


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ACKNOWLEDGEMENT

I express my sincere thanks to my seminar guide, Ms. Sonali Yadav for guiding me right

from the inception till the successful Preparation of the seminar. I sincerely acknowledge her

for extending their usable guidance, support for literature, critical reviews of seminar and

above all the moral support she had provided to me with all stages of this seminar.

I would also like to thank the supporting lecturers, for their help and cooperation throughout

the seminar.

Satish Kumar Vijay

MBA, II Sem.


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EXECUTIVE SUMMARY

Decisions by the President and Congress, usually relating to taxation and

government spending, with the goals of full employment, price stability,

and economic growth. By changing tax laws, the government can effectively modify

the amount of disposable income available to its taxpayers.

For example, if taxes were to increase, consumers would have less

disposable income and in turn would have less money to spend on goods

and services. This difference in disposable income would go to the government

instead of going to consumers, who would pass the money onto companies. Or, the

government could choose to increase government spending by

directly purchasing goods and services from private companies. This would increase

the flow of money through the economy and would eventually increase the

disposable income available to consumers. Unfortunately, this process takes time, as

the money needs to wind its way through the economy, creating a

significant lag between the implementation of fiscal policy and its effect on the

economy.


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Table of Contents

S. No.PARTICULARS

Pg.No.

1 Introduction 1

2 Indias fiscal situation-A brief prelude 2

3 Fiscal Policy- overview 5

4 Objectives of fiscal Policy 10

5 Role of RBI in fiscal reforms 12

6 Role of fiscal Policy 15

7 Economic effect of fiscal Policy 16

8 Principles of fiscal Policy 18

9 Long term fiscal Policy challenges 22

10 Limitations of fiscal Policy 24

BUDGET

1 Definition 25

2 Purpose of business budget 25

3 Control and Evaluation 26

4 Planning 26

5 Communication and Motivation 27

6 Current news related to budget 28


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FISCAL- POLICY

In economics, fiscal policy is the use of government expenditure and revenue

collection to influence the economy.The word Fisc means state treasury and fiscal

policy refers to policy concerning the use of state treasury or the govt. finance to

achieve the macroeconomic goals

Decisions by the President and Congress, usually relating to taxation and

government spending, with the goals of full employment, price stability,

and economic growth. By changing tax laws, the government can effectively modify

the amount of disposable income available to its taxpayers.

For example, if taxes were to increase, consumers would have less

disposable income and in turn would have less money to spend on goods

and services. This difference in disposable income would go to the government

instead of going to consumers, who would pass the money onto companies. Or, the

government could choose to increase government spending by

directly purchasing goods and services from private companies. This would increase

the flow of money through the economy and would eventually increase thedisposable income available to consumers. Unfortunately, this process takes time, as

the money needs to wind its way through the economy, creating a

significant lag between the implementation of fiscal policy and its effect on the

economy.

In economics, fiscal policy is the use of government expenditure and revenue

collection to influence the economy.

The word Fisc means state treasury and fiscal policy refers to policy concerning the

use of state treasury or the govt. finance to achieve the macroeconomic goals

According to G.K. Shah any decision to change the level composition Or timing of

govt. expenditure or to vary the burden the structure or frequency of the tax payment

is fiscal policy.


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Indias Fiscal Situation: A Brief Prelude

Broadly, during the first 30 years of independence, between 1950 and 1980, the

fiscal deficits of both the central and the state governments were not excessive. This

was a period of revenue surplus in general. However, automatic monetisation of

government deficit by the RBI, which started as an exception during the mid 1950s,

became a regular practice thereafter. Simultaneously, there was also a distinct shift

in the management of the financial sector with the nationalization of major

commercial banks in 1969 and 1980. These two developments had a significant

bearing on the relationship between the monetary authority (RBI) and the fiscal

authority (Government). There was a significant deterioration in the fiscal situation in

the 1980s,accompanied by large and automatic monetisation of government deficits. The

process involved issue of ad-hoc Treasury bills at rates initially on par with 91- day

Treasury Bills. Since July 1974, the ad-hoc Treasury bills were offered at off-market

discount rate of 4.6 percent which was less than half of the prevailing market rates.

There were two immediate consequences. One, when large government deficits

were monetised, there was excess liquidity in the system, which prompted the

monetary authorities to increase the cash reserve ratio (CRR) for banks at regular

intervals with a view to mop up the excess liquidity. Two, to facilitate the central

government to borrow comfortably, the monetary authority, which is also the debt

manager for the government, periodically increased the statutory liquidity ratio (SLR)

to be maintained by banks. This process went on to an extent that CRR and SLR,

together, pre-empted more than 50 percent of banking sector liabilities, for a period.

In other words, more than 50 percent of the resources of the banking sector were

preempted

to primarily finance the budget deficits of the governments. Further, the deposit and

lending rates of banks were, for most part, administered. This situation impacted the

health of the banking system and the consequential adjustments during the banking

sector

reform process were, naturally, somewhat complex. The large fiscal deficit and its

monetisation had some spill-over effect on the external sector, which reflected in the

widening current account deficit in the late 1980s and early 1990s. Triggered by the

balance of payments crisis in the early 1990s, when our foreign currency assets


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depleted rapidly to the extent that it could barely finance just two weeks of imports,

we started the reform process in 1991-92. A credible

macroeconomic structural and stabilization programme encompassing trade,

industry, foreign investment, exchange rate, public finance and financial sector was

put in place, which created an environment that was conducive for the expansion of

trade and investment. Simultaneously, several reform measures towards the

marketisation of government borrowings were initiated.

At the instance of Dr. Rangarajan, one of my illustrious predecessors as Governor,

the RBI entered into the first agreement with the government in 1994 to place a limit

on automatic monetization. The First Supplemental Agreement between the RBI and

the Government of India was signed in 1994 setting out a system of limits for

creation of ad hoc treasury bills during the three-year period ending 1996-97. Then in

1997, soon after I moved to the RBI, the second agreement with the government

was signed, where Mr. Montek Singh Ahluwalia represented the government. In

pursuance of this Second Supplemental Agreement between the RBI and

the Government of India on March 6, 1997, the ad hoc Treasury Bills were

completely phased out from April 1997, replaced by a scheme of Ways and Means

Advances, subject to limits.

In order to smoothen the transition, the Government of India was allowed to incur

also an overdraft, but at an interest rate higher than the rate applicable for Ways and

Means Advances (WMA). With effect from April 1, 1999 these overdrafts were

allowed only for a maximum of ten working days. These features placed the Central

Government on par with the State governments which were brought under an

Overdraft Regulation Scheme since 1985. Furthermore, it was agreed that the RBI

would trigger fresh floatation of Government securities whenever 75 percent of the

WMA limit was reached. It was also agreed that the governments surplus cash

balances with the RBI, beyond an agreed level, would be invested by it in

government securities. While the transition to a full-fledged WMA and overdraft

mechanism was gradual, non-disruptive and consensual, the successful

implementation of this mechanism made it possible to incorporate some of these

practices into a law the Fiscal Responsibility and Budget Management Act (FRBM

Act). It is noteworthy that this law also practically prohibited RBI from participating in

primary issues of all government securities.


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FISCAL POLICY OVERVIEW

The growth trends for the last four years indicate a continuous upswing in the

economy. Increasing productivity, growth of service sector and buoyancy in tax

receipts associated with the growth and to some extent, improvement in tax

compliance and enforcement as a result of a more rational, liberal and efficient tax

system, have contributed toward achieving quantitative goals set under the FRBM

Act. Reduction of fiscal deficit has been achieved from 4.5 per cent of GDP in 2003-

04 to 3.1 per cent of GDP in RE 2007-08. During the same period, revenue deficit

has declined from 3.6 per cent of GDP to 1.4 per cent. The advance estimate for

growth of GDP at factor cost at constant (1999-2000) prices in 2007-08 is pegged at

8.7 per cent which is the average growth of the last four years, albeit lower by 0.9percentage points as compared to 2006-07 (Quick Estimates 9.6 per cent ). The

slowdown is triggered by lower than expected growth in manufacturing sector,

although services sector continued to record double digit growth in first half of 2007-

08. Improvement in deficit indicators has been achieved through growth in tax

receipts, which exceeded growth of revenue expenditure, notwithstanding increase

in non-plan revenue expenditure fuelled largely by a high subsidy bill and interest

payments. The process of fiscal consolidation would continue to be sustained

through improvement in tax-GDP ratio, moderate growth in non tax revenue,

reprioritization and improving the quality of expenditure including promotion of capital

expenditure to boost infrastructure development while ensuring adequate resources

for social sectors like health and education.

Governments strategy to pursue fiscal consolidation Tax

Policy:


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In recent years, tax policy has been governed by the overarching objective of

increasing the tax-GDP ratio for achieving fiscal consolidation. This is sought to be

achieved both through appropriate policy interventions and a steadfast improvement

in the quality and effectiveness of tax administration. On the policy side, a strategy of

moderate and few rates, removal of exemptions and broadening of the tax base has

yielded good results. As for tax administration, the extensive adoption of Information

Technology solutions has enabled a less intrusive tax system that fosters voluntary

compliance. In a broad sense, the relatively high buoyancy exhibited by direct taxes

indicates that the tax system is maturing. On the indirect tax side, the

objective is to integrate the taxes on goods (Central Excise) and services and finally

move to a comprehensive Goods and Services Tax (GST). It is also the aim to

improve the revenue yield from service tax in keeping with the contribution of the

service sector to GDP.

Indirect Taxes

Customs duty :

In the wake of the sharp appreciation of the rupee against the US dollar, the

peak rate of customs duty on non-agricultural goods has been maintained at

10 percent

Continuing the pace of reforms, the rate of customs duty on Project Imports

has been reduced

from 7.5 per cent to 5 per cent. This will serve as an incentive for setting up of

large projects, and also encourage capacity expansion and modernization of

existing industries.

For promotion of exports, customs duty reduction has been effected on

specified machinery and raw materials for producing sports goods, and also

on cubic zirconia (rough and polished) and rough corals used in the gems and

jewellery sector.

To improve the availability of base metals in the country, import duty on

melting scrap of iron or steel and aluminium scrap raw materials for the

ferrous and non-ferrous sector, has been exempted.


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To help conserve the countrys natural resource of chromium ores, and

increased domestic availability of this scarce raw material, export duty on

chromium ores and concentrates has been increased.

For the Electronics and Information technology hardware sector, problem ofinversion arising on account of various FTAs and PTAs has been sought to be

addressed by providing customs duty exemptions on specified raw materials

on end use basis.

As a part of continued review of existing exemptions, customs duty on

naphtha imported for manufacture of specified polymers has been withdrawn.

Excise duty :

-The general Cenvat rate has been reduced from 16 per cent to 14 per cent i.e. a

reduction of 12.5 per cent in Central excise duty. This is likely to boost growth of the

domestic manufacturing sector, which has suffered a slowdown.

- Several sector specific interventions have also been made to provide a fillip to

growth through

lower excise duties. The important sectors are: automobiles, paper, drugs and

pharmaceuticals,

and food processing.

- To provide clean drinking water, excise duty on water filtering and purifying devices

has been

reduced.

- For replenishment of the National Calamity Contingency Fund, one per cent

National Calamity

Contingent duty has been imposed on mobile phones.

-Specific rates of duty on cement clinker and non-filter cigarettes have been

rationalized.


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Service Tax:

- Widening of service tax base, simplification of law and procedure, improved tax

administrationand increase in tax compliance continue to show higher buoyancy in service tax

revenue collection during 2007- 08 also. Service tax revenue during the period April

December 2007, has grown by about 37 per cent as compared to the

corresponding period of the previous year.

- In order to facilitate small service providers and to ensure optimum utilization of the

administrative resources, threshold limit of annual turnover to small service providers

for full service tax exemption has been increased from Rs. 8 lacs to Rs.10 lakh w.e.f.

1.4.2008. This exemption would benefit about 65,000 small service providers.

-In line with the Governments declared policy of broadening the tax base, the scope

and coverage of services livable to service tax is being further widened by adding

more services and expanding the scope of some of the existing services.

Direct Taxes

Over the last four years, widespread reforms have been ushered into the direct tax

arena. The touch stone of such reforms have been the following:

-Distortions within the tax structure have been minimized by expanding the tax base

an

Maintaining moderate tax rates.

-Tax administration has been geared up to provide taxpayer services and also

enhance

deterrence levels. Both these objectives reinforce each other and have promoted

voluntary

compliance.

-Business Processes have been re-engineered in the Income-Tax Department

through extensive use of information technology, viz., e-filing of returns; issue of


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refunds through ECS and refund banks; selection of returns for scrutiny through

computers; etc. These measures have modernized the Department and enhanced its

functional efficiency.

The Union Budgets of 2006-07 and 2007-08 managed to consolidate the landmark

achievements of the 2005-06 Budget in the field of direct tax reforms. In the Union

Budget of 2007-08, some major tax concessions provided in the Income-tax statute

were either eliminated or curtailed to broaden the tax base. For example,

the MAT base was expanded by bringing the profits of STPI units and Export

Oriented Units within its ambit; the rate of Dividend Distribution Tax (DDT) for

domestic companies on distribution of profits to share holders was increased; new

rates of Dividend Distribution Tax were specified for Money Market Mutual Funds

(MMMF) and Liquid Funds (LF) on distribution of income to unit holders; and the

non-chargeability of capital gain tax on sale of a long-term capital asset, by investing

the same in certain bonds, was restricted to a maximum amount of Rs. 50 lakhs in a

year.

Objectives of fiscal policy

The role of fiscal policy in developed economies is to maintain full employment and

stabilize growth. In contrast, in developing countries, fiscal policy is used to create an

environment for rapid economic growth. The various aspects of this are:

1. To achieve desirable price level:

The stability of general prices is necessary for economic stability. The maintenance

of a desirable price level has good effects on production, employment and national


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income. Fiscal policy should be used to remove; fluctuations in price level so that

ideal level is maintaine

2. To Achieve desirable consumption level:

A desirable consumption level is important for political, social and economic

consideration. Consumption can be affected by expenditure and tax policies of the

government. Fiscal policy should be used to increase welfare of the economy

through consumption level.

3. To Achieve desirable employment level:

The efficient employment level is most important in determining the living standard of

the people. It is necessary for political stability and for maximization of production.

Fiscal policy should achieve this level.

4. To achieve desirable income distribution:

The distribution of income determines the type of economic activities the amount of

savings. In this way, it is related to prices, consumption and employment. Income

distribution should be equal to the most possible degree. Fiscal policy can achieve

equality in distribution of income.

5. Increase in capital formation:

In under-developed countries deficiency of capital is the main reason for under-

development. Large amounts are required for industry and economic development.

Fiscal policy can divert resources and increase capital.

6. Degree of inflation:

In under-developed countries, a degree of inflation is required for economic

development. After a limit, inflationary be used to get rid of this situation.

Role of RBI in Fiscal Reforms

As a central bank, we are generally sensitive to the fiscal situation. It is not true that

the RBI was not aware of the implications of what was happening on the fiscal front

during the first three decades (1950 to 1980). Given the institutional arrangement,

the RBIs primary objective is to maintain monetary stability. It was clear that the

fiscal situation was something that was decided and determined by the sovereign.

Once the fiscal situation was decided and determined by the sovereign, it was the

central banks responsibility to ensure that monetary stability was maintained and the

governments borrowing programme was managed with minimum disruptions, in


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terms of stability. Some argue that accommodating the fiscal pressure through

monetary action is like, what some people call, a soft-budget constraint.

Let me revert to the reform process and how we got rid of the remnants of automatic

monetisation of the previous years. The stock of ad hoc Treasury bills, when we put

an end to issue of such bills, was over Rs. 1,00,000 crore. This stock was in fact

public debt in perpetuity, held by the RBI, bearing a discount rate of 4.6 percent

though the market rates were far higher. In coordination with the government, it was

agreed that these papers will be converted into dated marketable securities at

market related rates, in phases, depending on the market conditions warranting open

market operations by the RBI.

Thus, the stock of the ad hoc treasury bills has been wiped-out. This is an evidence

of the varieties of ways in which the RBI conceives and implements the process of

reforms, in a non-disruptible fashion, in coordination with the government.

Let me share a story related to the FRBM Act with you. One day, Governor Jalan

said that the Finance Minister is making an announcement on introduction of Fiscal

Responsibility Bill (which was the then proposed nomenclature). Governor Jalan said

that he had discussed with the Minister and that they had decided that I will be

named the Chairman of a Committee that would draft the Fiscal Responsibility Bill. I

submitted that the government officials should be working on the legislation relating

to fiscal issues and that the RBI should not be involved, as the ownership of the

Fiscal Responsibility Bill should be with the government. Governor Jalan did not

relent and said No, it has been decided that you do it. So finally, we arrived at a

compromise. A main formal Committee was set up in 2000 with the then Secretary,

Economic Affairs, Dr. E.A.S. Sarma as the Chairman and Dr. Ashok Lahiri as one of

the members;

and a working group comprising of RBI officials was set-up under my Chairmanship

to provide technical assistance to the main Committee on several aspects for

drafting the Fiscal Responsibility Bill.

The RBI Working Group was actively involved in the Sarma Committee to draft the

Fiscal Responsibility Bill. Mr. Prem Chand of the IMF, at our invitation, spent some

time advising us on the international best practices in this regard. At this stage, we

advised the Government that without incorporating transparent budget management

rules and medium term fiscal framework, the objective of fiscal responsibility would

not be achieved. Therefore, the name of the Bill was changed to Fiscal


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Responsibility and Budget Management Bill incorporating additional features. In

short, I am illustrating that the RBI has been actively collaborating with the

government, whenever sought, but with appropriate propriety. Our experience shows

that the FRBM Act has a positive effect of focusing attention on fiscal issues.

At the same time, it may, sometimes, unintentionally lead to increased recourse to

expanding off-budget fiscal liabilities. Such a practice is not entirely uncommon in

many countries, but the magnitudes involved and the persistence in resorting to off-

budget liabilities in India are noteworthy. The issue is not merely one of transparency

in fiscal operations or a de facto larger borrowing programme of the Government

than admitted, but one with significant implications for the Government debt market

and monetary management. Past experience clearly suggests that recourse to such

off-budget items is not ad hocor one-time only. The repeated recourse to issue of

Government bonds has been exercised not only for fuel, food and fertilizers for

financing subsidies, but also for financing deferred liabilities in regard to bank loan

waivers and contribution to the capital of public sector banks. Hence, unless there is

a noticeable change in global prices or a change in policy towards recurrent

subsidies and deferred liabilities, continuation of such special bonds may not be

ruled out. The significant quasi-fiscal transactions to finance recurrent revenue

expenditures through de facto borrowings pose challenges in managing the links

between fiscal, external and monetary management.

The RBI has rendered advice on FRBM to the state governments also. A forum has

been provided by the RBI, which brings together the Finance Secretaries of state

governments, for exchange of ideas and sorting out the issues.

The bi-annual conference of State Finance Secretaries hosted by the RBI, initiated in

1996, is also attended by the Secretaries in the Ministry of Finance, Government of

India, representatives from the Planning Commission, the Comptroller and Auditor

General of Accounts (CAG) and the Controller General of Accounts (CGA). The

deliberations in these bi-annual conferences have proved very useful in identifying

the common issues and developing best practices in regard to state government

finances. A

number of important initiatives relating to ways and means advances, approach to

market borrowing programme, investment of surpluses, ceilings on state government

guarantees, model scheme for state level fiscal legislations, apart from changes in


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the content and format for reporting budget related documents to ensure

transparency etc. have emanated and taken shape as a result of interactions in

these meetings. The RBI has, through this forum, also helped the state governments

prepare the state level FRBM legislations. Incidentally, the first research and policy

paper on pension funds in India was prepared by Dr. Urjit Patel, who used to work

with us. In those days, it was so hard to get any data that we had to tap our informal

links in the various offices in Delhi, including some of my old colleagues, to give him

some access to relevant information.

Dr. Urjit Patel did a very good job and then he published an article in the Economic &

Political Weekly. Thus, the public policy on pensions was, in a sense, triggered by

the work done by a consultant in RBI, at our request. RBI also worked on a Report

on Pensions for state government employees. This is another evidence of the

collaboration between the RBI and the governments and often our views are

accepted. Now, let me come to the fiscal and monetary management issues.

ROLE OF FISCAL POLICY- ITS SIGNIFICANCE TO BUSINESS ECONOMY IN

DEVELOPING COUNTRIES

The main goal of the fiscal policy in developing countries is the promotion of the

highest possible rate of capital formation. Underdeveloped economies are in the

constant deficit of the capital in the economy and thus, in order to have balanced

growth accelerated rate of capital formation is required. For this purpose the fiscal

policy has to be designed in a way to raise the level of aggregate savings and to

reduce the actual and potential consumption of people.

To divert existing resources from unproductive to productive and socially more

desirable uses. Hence, fiscal policy must be blended with planning for development.

To create an equitable distribution of income and wealth in the society.


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To protect the economy from the ills of inflation and unhealthy competition from

foreign countries.

To maintain relative price stability through fiscal measures.

The approach to fiscal policy must be aggregate as well as segmental. the sectoral

imbalances can be curbed by appropriate segmental fiscal measures.

The government expenditure on developmental planning projects must be

increased. For this deficit financing can be used. It refers to creation of additional

money supply either by creation of new money by printing by government or by

borrowing from the central bank.

Public borrowing, loans from foreign nations etc can be used in the development of

the resources for public sector.

Fiscal policy in the developing economy has to operate within the framework of

social, cultural and political conditions which inhibit formation and implementation of

good economic policies.

In order to reduce inequalities of wealth and distribution, taxation must be

progressive and government spending must be welfare-oriented.

The hindrances in the effective implementation of fiscal policy in the developing

countries are loopholes in taxation laws, corrupt tax administration, a high population

growth, extravagant governmental spending on non-developmental items, an

orthodox society etc.

ECONOMIC EFFECT OF FISCAL POLICY

Governments use fiscal policy to influence the level of aggregate demand in the

economy, in an effort to achieve economic objectives of price stability, full

employment, and economic growth. Keynesian economics suggests that adjusting

government spending and tax rates are the best ways to stimulate aggregate

demand. This can be used in times of recession or low economic activity as an

essential tool for building the framework for strong economic growth and working

towards full employment. The government can implement these deficit-spending

policies to stimulate trade due to its size and prestige. In theory, these deficits would


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be paid for by an expanded economy during the boom that would follow; this was the

reasoning behind the New Deal.

Governments can use budget surplus to do two things: to slow the pace of strong

economic growth, and to stabilize prices when inflation is too high. Keynesian theory

posits that removing funds from the economy will reduce levels of aggregate demand

and contract the economy, thus stabilizing prices.

Some classical and neoclassical economists argue that fiscal policy can have no

stimulus effect; this is known as the Treasury View, which Keynesian economics

rejects. The Treasury View refers to the theoretical positions of classical economists

in the British Treasury, who opposed Keynes' call in the 1930s for fiscal stimulus.

The same general argument has been repeated by neoclassical economists up to

the present. From their point of view, when government runs a budget deficit, funds

will need to come from public borrowing (the issue of government bonds), overseas

borrowing, or the printing of new money. When governments fund a deficit with the

release of government bonds, interest rates can increase across the market.

This is because government borrowing creates higher demand for credit in the

financial markets, causing a lower aggregate demand (AD), contrary to the objective

of a budget deficit. This concept is called crowding out; it is a "sister" of monetary

policy.

In the classical view, fiscal policy also decreases net exports, which has a mitigating

effect on national output and income. When government borrowing increases

interest rates it attracts foreign capital from foreign investors in the form of hot

money. This is because, all other things being equal, the bonds issued from a

country executing expansionary fiscal policy now offer a higher rate of return. In

other words, companies wanting to finance projects must compete with their

government for capital so they offer higher rates of return.

To purchase bonds originating from a certain country, foreign investors must obtain

that country's currency. Therefore, when foreign capital flows into the country

undergoing fiscal expansion, demand for that country's currency increases. The

increased demand causes that country's currency to appreciate. Once the currency

appreciates, goods originating from that country now cost more to foreigners than


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they did before and foreign goods now cost less than they did before. Consequently,

exports decrease and imports increase.

Other possible problems with fiscal stimulus include the time lag between the

implementation of the policy and detectable effects in the economy, and inflationary

effects driven by increased demand. In theory, fiscal stimulus does not cause

inflation when it uses resources that would have otherwise been idle. For instance, if

a fiscal stimulus employs a worker who otherwise would have been unemployed,

there is no inflationary effect; however, if the stimulus employs a worker who

otherwise would have had a job, the stimulus is increasing demand while labor

supply remains fixed, leading to inflation.

Principles of Fiscal Policy-

Fiscal Policy concerns the use of changes in the amount of government spending

G and taxation T to influence the national economy. This policy can affect both

Aggregate Demand (AD) and Aggregate Supply (AS), though it is worth noting that

the affect on AD is much more direct and immediate, whereas AS is affected through

indirect means over a greater period of time.

Contents-

1 -Aggregate Demand

2 -Aggregate Supply

2.1 Capital Spending

2.2 Workforce Incentives

2.3 R&D and Innovation

3- Fiscal Policy Terms


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Aggregate Demand

G stands for government spending. Taxation is accounted for in the affect it has on

the other components of aggregate demand (higher taxes reduce

consumption).Increases in government spending will increase aggregate demand,

which will have affects on the economy overall. It leads to an increase in output and

average prices, other things being equal.

However, the degree to which output/prices rise depends on the elasticity of

Aggregate Supply (AS). This can be easily shown on an AD-AS model. If Aggregate

Supply is elastic, an large increase in output may result with little risk of inflationary

pressures. However, if AS is inelastic increased government spending may not be

the best way of boosting the economy, as it is at risk of 'overheating' - that is, at risk

of causing inflation rather than growth in output.

Similarly, a fall in government spending will 'cool' the economy, and cause a

contraction in Aggregate Demand (AD).

Aggregate Supply

aggregate supply is the total supply of goods and services that firms in a national

economy plan on selling during a specific time period. It is the total amount of goodsand services that firms are willing to sell at a given price level in an economy.

The price P of a product is determined by a balance between production at each

price (supply S) and the desires of those with purchasing power at each price


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(demand D). The diagram shows a positive shift in demand from D1 to D2, resulting in

an increase in price (P) and quantity sold (Q) of the product.

Capital Spending

Gagong spending on infrastructure, such as new transport networks, increases the

potential output of an economy. Also, lower corporation taxes mean that businesses

can invest greater sums at the same time, contributing both to AD and AS.

Capital spending could also include investment in human capital, such as retraining,

higher education and vocational training as ways to increase the supply of labour,

reduce unemployment and provide a more productive workforce.

Human capital is becoming ever more important as many developed countries now

aim for a knowledge-based economy, in which labour is more productive.

Workforce Incentives

Changes in the benefits system, such as a reduction in income tax, could create

greater incentive for individuals to return to work. This increases labor supply, and

hence overall supply as labour is a factor of production. It could be argued

that welfare and benefit reform is more important ie. fewer benefits for the

unemployed to incentivize them to work.

R&D and Innovation

Increased G could encourage developments in technology, which also increase the

potential output of an economy, though without an accompanying increase in

demand, this will only increase 'slack' in the economy, reducing inflationary pressure,

rather than an actual increase in total output.

These AS effects are dependent upon carefully targeted government spending, and

it is important to note that government spending alone will not necessarily affect AS.

Fiscal Policy Terms

Expansionary Fiscal Policy = G > T. That means that government spending is

greater than the rate of taxation, so it is a boost to the economy. The disadvantage to

this is that a budget deficit will ultimately build up
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Contractionary Fiscal Policy = G < T. This has a contractionary, deflationary effect on

the economy, but it will improve the government finances over time.

Long-Term Fiscal Policy Challenges

Indias loose fiscal policy has reduced growth below potential without showing any

discernible signs of an imminent crisis. However, if the fiscal imbalances are not

addressed and growth continues to fall short of potential, the risks of a conventional

crisis fiscal, monetary or external will increase. According to some scenarios, in

which real interest rates stay relatively high and greater efficiencies in investment are

only partially realized, even fiscal reform that cuts the primary deficit substantially

over the next three years will just succeed in maintaining something like the current

deficit-GDP ratio of about 10%, and debt will continue to accumulate, though less

rapidly than in the last few years. This is a minimal objective to aim for over the next

few years. Critical elements of any scenario that does not lead to almost certain

crisis down the road are an increase in the tax-GDP ratio, and a reorientation of

public expenditure toward efficient investment in physical infrastructure and human

development, and away from distortionary and inefficient subsidies.

The most serious medium and long-term issue that must be anticipated is the futurecost of the pension system. Many of the conference papers emphasize this relatively

recent addition to the causes for concern with respect to Indias fiscal future. While

some demographic trends will help, by increasing the proportion of the population

that is of working age, the increase in life expectancy will increase the number of

years for which pensions are paid, relative to the number of working years.

Managing this problem by increasing the retirement age can be politically difficult if it

reduces the employment chances of young entrants. However, with sufficiently rapid

growth of GDP and employment, this difficulty will ease. Be that as it may, Hellers


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paper quotes World Bank estimates that the cash-flow deficit of the Employees

Pension Scheme (EPS), which is a defined benefit scheme, will grow to almost 1%

of GDP over the next few decades, even without increases in coverage. If more

employees are covered by the EPS as growth increases the relative size of the

formal sector, then the potential problem will grow accordingly.

Recently, various income transfer and social insurance schemes that reach into rural

areas and the informal sector of the economy have been announced. While the

objectives of such policies are laudable, they introduce yet additional demands on

the budget, which will be difficult to reverse, as they become viewed as entitlements.

Srinivasan (2002) and Rajaraman (2004) emphasize that the Pay Commission

award was not an exogenous shock, but one that was predictable in the context of

institutional and political economy considerations. Thus, one can argue that pay,

pensions and social insurance are all areas in which there is virtually no uncertainty

about their future costs so that the government will have to do long term planning.

While we have suggested that the broad outlines of technical solutions to Indias

short run fiscal problems are well understood, leaving only the political difficulties of

implementation, in the case of long-term budgetary commitments, there seems to be

a need for an integrated analysis of the

various possibilities. For example, the last Pay Commission award was followed by

increases in the pensions of those who had already retired while such ex post

adjustments may again have laudable motives, they represent a contingency that

must be allowed for in projecting the future liabilities of the government. The

announcement in the interim budget for 2004-05 of the merger of 50% of dearness

allowance of civil servants into their basic salary is not a good signal.

The overall picture of the future of government pay and pensions, and social

insurance schemes is gloomy. However, attention to these factors not only allows the

government to plan, but can also increase the awareness of the need for immediate

fiscal adjustment on other fronts, if not this one. One hopeful area, again, is tax

reform. Heller (2004) points out that the tax treatment of pension contributions is

unduly generous, and also creates some perverse incentives. This is one area where

short-term remedies, such as phased reductions of tax preferences, ought to be


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politically feasible and relatively easy to implement, once they are on the policy

agenda.

Two other aspects of demographic trends and predictable future demands on the fisc

are in the areas of primary education and urban infrastructure. Based on projected

fertility rates, one can predict the number of school children that will need basic

education, and plan for this.48 To some extent, the problems of Indias education

system lie more in inefficient rather than insufficient public expenditure, but as the

demands of being part of a modern workforce increase, the need to fund education

more effectively will also rise. Much of this burden will fall on the State governments,

and given the fiscal adjustment that is going to be required of them, tax reform that

gives State (and local) governments more scope to tax will be imperative.

In general, therefore, looking at the longer term and at broader public welfare

concerns can have three benefits. First, it allows for better intertemporal planning of

public expenditures within and across categories. Second, it improves the pattern of

near-term public expenditures toward spending that reduces the chances of larger

expenditures in the future. Third, it emphasizes the need for a fiscal cushion or self-

insurance to meet unavoidable expenditures should they occur in the future. Finally,

considering the long run necessitates modeling the dynamics of the economy more

explicitly as we have stressed in Section 5 in addition to analyzing debt dynamics

and intertemporal insurance against exogenous shocks. Growth is critical in the long

run, and working out steady state implications of current policy adjustments (as well

as adjustment paths) also requires explicit modeling.

Evaluation / Criticisms / limitation of Fiscal Policy

Fiscal Policy is the use of Government spending and taxation to influence the level of

economic activity. In theory, fiscal policy can be used to prevent inflation and avoid

recession. But, in practice there are many limitations of using fiscal policy.

1. Disincentives of Tax Cuts. Increasing Taxes to reduce AD may cause

disincentives to work, if this occurs there will be a fall in productivity and AS could

fall. However higher taxes do not necessarily reduce incentives to work if the

income effect dominates.


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2. Side Effects on Public Spending. Reduced govt. spending to Increase AD

could adversely effect public services such as public transport and education

causing market failure and social inefficiency.

3. Poor Information Fiscal policy will suffer if the govt. has poor information.

E.g. If the govt. believes there is going to be a recession, they will increase AD,

however if this forecast was wrong and the economy grew too fast, the govt.

action would cause inflation.

4. Time Lags. If the govt. plans to increase spending this can take along time to

filter into the economy and it may be too late. Spending plans are only set once a

year. There is also a delay in implementing any changes to spending patterns.

5. Budget Deficit Expansionary fiscal policy (cutting taxes and increasing G) will

cause an increase in the budget deficit which has many adverse effects. Higher

budget deficit will require higher taxes in the future and may cause crowding out

(see below

6. Other Components of AD. If the government uses fiscal policy its

effectiveness will also depend upon the other components of AD, for example if

consumer confidence is very low, reducing taxes may not lead to an increase inconsumer spending.

7. Depends on MultiplierAnd change in injections may be increased by the

multiplier effect, therefore the size of the multiplier will be significant.


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Budget

Definition:

A Budget is a plan that outlines an organization's financial and operational goals. So

a budget may be thought of as an action plan; planning a budget helps a business

allocate resources, evaluate performance, and formulate plans.

While planning a budget can occur at any time, for many businesses, planning a

budget is an annual task, where the past year's budget is reviewed and budget

projections are made for the next three or even five years.

The basic process of planning a budget involves listing the business's fixed and

variable costs on a monthly basis and then deciding on an allocation of funds to

reflect the business's goals.

Businesses often use special types of budgets to assess specific areas of operation.

A cash flow budget, for instance, projects your business's cash inflows and

outflows over a certain period of time. It's main use is to predict our business's ability

to take in more cash than it pays out.

The Purpose of a Business Budget

Business budgeting is a basic and essential process that allows businesses to attain

many goals in one course of action. There are several goals that many businesses

seek to achieve (or should be trying to work toward) when they create and

implement a budget. These goals include control and evaluation, planning,

communication, and motivation.

Control and Evaluation

Perhaps the most obvious of budgeting goals is that of control and evaluation.

Budgeting allows a company to have a certain degree of control over costs, such as

not allowing many types of expenses to take place if they were not budgeted for, or


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assigning responsibility for these expenses. A budget also gives a company a

benchmark by which to evaluate business units, departments, and even individual

managers.

Unfortunately this purpose of budgeting can cause employees to have negative

feelings about the budgeting process because their compensation and, in certain

cases, their jobs, may be dependent on meeting certain budgeting goals. This is

especially true in companies that focus on the evaluation purpose of budgeting and

when the budgeting is a top-down process, rather than a participative one.

Planning

Planning is another purpose of budgeting, and is arguably its primary purpose.

Budgeting allows a business to take stock of revenue and expenses from the

previous period, and judge where the business will be in future periods. It also allows

the organization to add and remove products and services from its plan for the future

period. In larger organizations, the budgeting process may be completed by

individual business units and compiled to form a master budget for the organization.

This allows top management to get a picture of the entire business so they are able

to better plan accordingly.

Communication and Motivation

Other goals that an organization may use its budget to achieve that are less obvious

include communication and motivation. Budgets allow management to communicate

goals and to promote goal congruence so resources can be coordinated and focused

in key areas. Budgets also allow a company to motivate its employees by involving

them in the budget. While top-down budgeting does not accomplish this goal very

effectively, participative budgeting can be motivating. When an employee is involvedin creating his or her departments budget, that person will be more likely to strive to

achieve that budget.

Budget Graph 2009-10


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Estimates and Expenditure

80

70

60

50

(Rs. in Crores)

40

BE

RE

30

Actual

s

20

10

02004-05 2005-06 2006-07 2007-08 2008-09

2009-10

Year

(Rs. In crore)

2004- 2005- 2006- 2007- 2008-09 2009-

05 06 07 08 10


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BE 7 35 38 50 65 80

RE 10 19 26 40 45

Actual 6 17.4 22 35.4 45

(provisional)

Administrative Expenditure* vis--vis Scheme Expenditure in the year (2009-10

Estimate)

8

0

75

7065

60

55

50

(Rs. 45

in

40

Crores) 35


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30

25

20

15

10

5

0

2004-05 2005-06 2006-07

2007-08 2008-09 2009-

10

Administrative Cost include salary, allowances, medical expenses,

professional

charges & offices expenses

Scheme Expenditure includes Expenditure on Schemes, Capital Exp., PBD,

Advertising & publicity, Publications. Seminars and Studies and

International

Conferences

Govt. budget = G - (tax transfers)

= G T

Where-

G= govt. purchases

T= net taxes

Budget deficit Budget surplus


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If G T > 0 ; a budget deficit in the year,

If G T < 0 ; a budget surplus in the year, and

If G T = 0 ; a balanced budget in the year.

Delhi Govt. announces increase VAT on CNG,

diesel budget 2010

2010-03-22 22:10:00

The Government of National Capital Territory of Delhi on Monday announced

increase in the value added tax (VAT) on natural gas (CNG), diesel, dry fruits, Desi

ghee, glucose and tea while withdrawing the Rs. 40 subsidy on LPG (cooking gas) in

the Budget 2010 and cited Commonwealth Games as the reason.

Addressing media, after presenting the Budget, Delhi's Finance Minister A K Walia

said the enhancement in VAT rates and withdrawal of subsidy on LPG were

necessitated by the increased expenditure on infrastructural projects related to

Commonwealth Games 2010.

Walia said that in view of increased expenditure due to the Commonwealth Games

related projects and schemes and inadequate collection of taxes due to down turn

in economy, additional sources of revenue are required.

Walia, however, assured that there would be no extra burden on the "common man"

as the prices of essential commodities would not be increased.

"In any case with the implementation of GST next year, the subsidy on most items

will have to be withdrawn," Walia said.

The Budget removes the current subsidy of Rs 40 on the LPG which will lead to

increase in prices to Rs 322.80 per gas cylinder.

The withdrawal of subsidy will relieve the State Government of a burden of Rs 160 to

Rs 170 crore per annum.

The VAT on CNG for use in transport sector has been hiked to five per cent which

will translate into a hike of Rs 1.09 per litre while the VAT on diesel have been

increased from 12.5 per cent to 20 per cent which amounts to a hike of Rs 2.37 per

litre.


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Moreover, the VAT on writing instruments, watches above Rs 5,000, mobile phones

and accessories above Rs 10,000 and readymade garments has also been

enhanced.(ANI)

Pranab Mukherjee Confident About Budget 2010 Achieving Its Goals

Friday, April 2nd, 2010

Finance Minister Pranab Mukherjee reiterated his belief in the Union Budget

presented by him February last by announcing that it would help in reviving private

investment and set the economy on a higher growth rate. Mr. Mukherjee was

speaking at the foundation day function of Small Industries Development Bank ofIndia (SIDBI).

He said, I am optimistic that the measures I have outlined in this years Budget will

revive private investment and put the economy back on the growth path of 9 per

cent. He added that the growth rate for the last financial year would be around 7.2%

and the economy would post a growth in the range of 8.25% to 8.75% in the

current fiscal. He called this growth impressive by global standards.

Mr. Mukherjee named micro, small and medium enterprise (MSME) sector as the

pillar of the Indian economy and said that government is taking various measures to

promote the sector. The enhancement in the limit for presumptive taxation, extension

of interest subvention for exports in certain sectors, increasing the threshold for

compulsory auditing of accounts of small businesses and exemption from capital

gains tax are some of the notable steps.

Finance Minister observed that finance is one of the most effective tools in the fight

against poverty and for aiding inclusive growth. He added, Timely availability of

credit to MSMEs is extremely important to meet their growing needs and to help

them keep their business lifeline vibrant and progressive.

MSME sectors contribution to GDP growth is 8%. It also chips in with 45% in

manufactured output, 40% in exports and provides employment to almost 60mn. Mr.

Mukherjee assured that government would act on the recommendations of the PMs

task force on MSMEs in a time-bound manner.


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Bibliography

Books :

1. Parmeswaran sunil. K. Futures markets, mc tata pub, 2009


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2. Bhagwati J (1993). India in Transition: Freeing the Economy. OxfordUniversity

3. Bhardwaj G, Dave S (2006). Towards estimating Indias implicit pensiondebt.

Magazine

Times of India

Economics Times

WEBSITES :-

www.google.com

www.yahoofinance.com www.indiabudget.nic.in

www.blogofindia.in

www.invesopedia.com
http://www.google.com/http://www.google.com/http://www.yahoofinance.com/http://www.indiabudget.nic.in/http://www.indiabudget.nic.in/http://www.indiabudget.nic.in/http://www.blogofindia.in/http://www.invesopedia.com/http://www.google.com/http://www.yahoofinance.com/http://www.indiabudget.nic.in/http://www.blogofindia.in/http://www.invesopedia.com/

Fiscal Policy Report_2

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