ESSENTIALS OF BUSINESS ESSENTIALS OF BUSINESS ENVIRONMENTENVIRONMENT

Chapter 26MONETARY AND FISCAL POLICIES

Himalaya Publishing HouseEssentials of Business Environment

K. Aswathappa

Chapter 26Monetary and Fiscal Policies

Learning Objectives

Define monetary policy, understand techniques to measure the extent of money, and evaluate RBI’s monetary policy

Understand the meaning and functions of money market, examine operations in money market and assess functioning of commercial banks

3Define fiscal policy, know how budget operates and make critical assessment of fiscal policy

Bring out the highlights of the Union Budget 2000-2001

Himalaya Publishing HouseEssentials of Business Environment

K. Aswathappa

Chapter 26Monetary and Fiscal Policies

M1 This represents money supply with the public. M1 has two components; (a) currency with the public and (b) deposits of the public with the banks.

Currency with the public is the sum total of notes in circulation and circulation of rupee coins and small coins minus the cash on hand with banks.Deposits of the public with banks is the sum total of demand deposits with banks and ‘other’ deposits of the public with the RBI.

M2 This represents the total of M1 plus post office savings and bank deposits.

M3 It is the sum total of M2 and the time deposits with banks.

M4 This represents M3 plus total post office deposits.

Extent of MoneyExtent of Money

Himalaya Publishing HouseEssentials of Business Environment

K. Aswathappa

Chapter 26Monetary and Fiscal Policies

Control MeasuresControl Measures

General Selective

Bank Rate

Open Market Operations

Special Facilities to some groupsLiberalisation of the BillMarket SchemeCash Reserve RequestStatutory Liquidity RatioRefinance Policy

(i) Insisting on minimum margins for lending against specific securities;(ii) Fixing a ceiling on the amounts of credit for certain purposes;(iii)Charging discriminatory rates of interest on certain types of advances;(iv) Moral suasion and(v) Direct action.

Himalaya Publishing HouseEssentials of Business Environment

K. Aswathappa

Chapter 26Monetary and Fiscal Policies

Balance Sheet of Monetary PolicyBalance Sheet of Monetary Policy Weaknesses Strengths

— Higher proportion of non-banking credit — Decision making and implementation is — No check on price rise faster than fiscal policy— High currency-deposit ratio rendering — More reliance on selective credit

control the RBI’s role less effective measures and less on quantitative controls

— Selective application of credit making RBI’s pressure on commercial constraints banks severe less

— Defective statistical and monitoring system.— Growing fiscal needs of the economy — Has been responsive to the needs of

the economy

Himalaya Publishing HouseEssentials of Business Environment

K. Aswathappa

Chapter 26Monetary and Fiscal Policies

Functions of Money MarketFunctions of Money Market1. By providing various kinds of credit instruments suitable and

attractive for different sections, a money market augments the supply of funds.

2. The efficient working of the money market helps minimise the gluts and stringencies in the money market due to the seasonal variations in the flow of and demand for funds.

3. A money market helps avoid seasonal fluctuations in interest rates.4. A money market, by augmenting the supply of funds and making

them readily available to the legitimate borrowers, helps in making funds available at cheaper rates.

5. A well-organised money market, through the quick transfer of funds from one place to another, helps avoid regional gluts and stringencies of funds.

6. It enhances the amount of liquidity available to the economy. 7. A money market, by providing profitable investment opportunities for

short-term funds, helps increase the profit of financial institutions and individuals.

Himalaya Publishing HouseEssentials of Business Environment

K. Aswathappa

Chapter 26Monetary and Fiscal Policies

Money Market OperationsMoney Market Operations

(i) Call (overnight) money(ii) Notice money(iii) Commercial Bills(iv) Treasury Bills(v) Certificates of Deposits

(vi) Commercial papers. (vii) Repos

Himalaya Publishing HouseEssentials of Business Environment

K. Aswathappa

Chapter 26Monetary and Fiscal Policies

Himalaya Publishing HouseEssentials of Business Environment

K. Aswathappa

Chapter 26Monetary and Fiscal Policies

Agenda in Fiscal Management

(i) Completion of the tax reform agenda (ii)Curb wasteful expenditure(iii) Minimise budgetary allocations to public

sector undertakings(iv) Adopt a new approach to administered

prices (v) Reduce and redirect subsidies

Himalaya Publishing HouseEssentials of Business Environment

K. Aswathappa

Chapter 26Monetary and Fiscal Policies

Features of the Outcome Budget

(i) A single document to offer details on the financial allocations for the next year, physical performance targets expected to be achieved as a result of the outlay and the actual outcome achieved in the first nine months of the current year.

(ii) The same document will list out what are called ‘tax expenditures.’ These are the revenues foregone while promoting the government’s policy objectives. The ideas would be to capture the real cost of certain measures that the government takes to implement its policies.

(iii) The financial allocation for programmes in the Outcome Budget will also include the resources being pooled in by states and other public sector as well as autonomous bodies.

(iv) The ministries will have the option to appoint independent evaluators to examine the effectiveness of programmes for which financial

allocations have been made.

Himalaya Publishing HouseEssentials of Business Environment

K. Aswathappa

Chapter 26Monetary and Fiscal Policies

Monetary PolicyMonetary Policy

Monetary policy refers to the policy of RBI regulate Monetary policy refers to the policy of RBI regulate supply of money and credit for achieving the objectives supply of money and credit for achieving the objectives of economic policy. The main objectives of monetary of economic policy. The main objectives of monetary policy are:policy are:

• expansion in the supply of moneyexpansion in the supply of money• control on the expansion of credit control on the expansion of credit • achieving price stabilityachieving price stability• maintain healthy balance of payment maintain healthy balance of payment

Himalaya Publishing HouseEssentials of Business Environment

K. Aswathappa

Chapter 26Monetary and Fiscal Policies

Fiscal PolicyFiscal Policy

Fiscal policy refers to the policy of government regarding Fiscal policy refers to the policy of government regarding taxation, public expenditure, and public debt. The taxation, public expenditure, and public debt. The objectives of fiscal policy are:objectives of fiscal policy are:

• accelerating the rate of investmentaccelerating the rate of investment• promoting socially desirable investmentpromoting socially desirable investment• achieving rapid economic developmentachieving rapid economic development• achieving full employmentachieving full employment• promoting foreign tradepromoting foreign trade• reducing inequalities of income reducing inequalities of income • establishing a welfare stateestablishing a welfare state

Himalaya Publishing HouseEssentials of Business Environment

K. Aswathappa

Chapter 26Monetary and Fiscal Policies