INDIAN MONETARY & FISCAL POLICY

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• MEANING -

• Monetary policy refers to the use of instruments within the control of

Reserve bank to influence the level of demand for the supply of goods
& services or to influence the trends in certain sectors of the economy.

• At times of recession monetary policy involves the adoption of some

monetary tools which tends to increase the money supply and lower
interest rate so as to stimulate aggregate demand in the economy.

• At the time of inflation monetary policy seeks to contract aggregate

spending by tightening the money supply or raising the rate of return.

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MEASURES OF MONEY STOCK

• The RBI employs four measures of money stock, namely M1, M2, M3,
M4.

• M1: M1 is usually described as money supply. The components of

money supply are currency with public i.e. (Notes & Coins in
circulation). Currency with public forms less than the total of money
supply as the demand deposits .

• ** A demand deposit or bank money refers to the funds held in

demand deposit accounts in commercial banks. A transactional
/current account is a deposit account held at a bank or other financial
institution, for the purpose of securely and quickly providing frequent
access to funds on demand.

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• Transactional accounts are meant neither for the purpose of earning
interest nor for the purpose of savings, but for convenience of the
business or personal client; hence they tend not to bear interest.
Instead, a customer can deposit or withdraw any amount of money any
number of times, subject to availability of funds.

• In advanced countries, demand deposits form a major part of of the

money supply.

• M2: It is M1 + Post office saving bank deposits.

• M3 : M1 + time deposits with the banking system (i.e. money supply +

fixed deposits in banks)

• M4 = M1 +Total Post office deposits.

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• THREE IMPORTANT OBJECTIVES

• To ensure the economic stability at full employment or potential level of

output.

• To achieve price stability by controlling inflation and deflation.

• To promote and encourage economic growth in the economy.

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• INSTRUMENTS OF MONETARY POLICY –

• The instruments of monetary policy can be broadly divided in to two

parts :

• 1. General (Quantitative) methods.

• 2. Selective (Qualitative) methods.

• 1. General (Quantitative) methods –

• These methods are closely inter-related & have to be operated in
coordination. All these instruments affect the level of Bank reserves.

• The 3 general methods are :

• 1.Bank Rate Policy 2. Open Market Operations
• 3. Variable Reserve Ratios.
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• BANK RATE POLICY –

• Bank rate is the minimum rate at which the central bank of a country
provides loan to the commercial bank of the country.

• Bank rate is also called discount rate because bank provide finance to the
commercial bank by rediscounting the bills of exchange.

• **A bill of exchange or "draft" is a written order by the drawer to the

drawee to pay money to the payee. A common type of bill of exchange is
the cheque defined as a bill of exchange drawn on a banker and payable
on demand

• When general bank raises the bank rate, the commercial bank raises their
lending rates, it results in less borrowings and reduces money supply in
the economy & vice-versa.
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• OPEN MARKET OPERATIONS

• It means the purchase and sale of various type of assets (such as Foreign
exchange, Gold, Securities & Company shares ) by central bank of the
country.

• For e.g. If RBI buys Gold of 100 crores it will pay the Rs 100 crores to
Commercial banks thus currency with the public increase to 100 crores
and there is a increase in money supply in the market.

• When government wants to increase the money supply in the market it

buys the assets & vice – versa.

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• VARIABLE RESERVE RATIOS : -

• In every country commercial banks have to maintain certain % of

deposit with the central bank in the form of balances with central bank
(Reserve Bank in case of India).The central bank have the power to vary
these reserve requirements which affect the credit creating capacity of
the banks.

• These are of 2 types :-

• CRR - CRR means Cash Reserve Ratio.  Banks in India are required to
hold a certain proportion of their deposits in the form of  cash.  This
minimum ratio (that is the part of the total deposits  to be held as cash)
is stipulated by the RBI and is known as the CRR or Cash Reserve Ratio
• 6.00% (w.e.f. 24/04/2010)

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• SLR – SLR stands for Statutory Liquidity Ratio. This term is used by
bankers and indicates  the minimum percentage of deposits that the
bank has to maintain in form of gold, cash or other approved securities.
• 25%(w.e.f. 07/11/2009)

•  2. Selective (Qualitative) methods.

• Selective credit controls refers to regulation of credit for specific
purposes or branches of economic activity. While general credit
controls operates on the cost & total volume credit, selective controls
relate to the distribution or direction of available credit supplies.

• Some major selective techniques are: -

• A. Minimum margins for lending against specific securities.
• B. Ceilings on the amounts of credit for certain purposes.
• C. Discriminatory rates of interest charged on certain types of advances.

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• CRR SLR

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• FISCAL POLICY – It is that part of government policy which is concerned with
raising revenue through taxation and other means and deciding on the level
& pattern of expenditure.

• The fiscal policy operates through budget. The budget is an estimate of

government expenditure & revenue for the ensuring financial year .

• Techniques of Fiscal Policy

1. Taxation Policy

By amendment in Indian tax law 1961, government of India has power to

make new taxation policy according to the current Indian economic situation.
Either government can increase the tax rate or decrease exemption for
collecting more tax for previous year income. Tax are of 2 types as follows : -

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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.

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• 2. Public expenditure policy

Public expenditure policy is very useful to reduce the government

expenditure. Government divides total expenditures into two major
categories one is development expenditure and other is non development
expenditure. With this policy, government encourages only development
expenditure and tries to reduce non development expenditure.

3. Deficit financing policy

If above two equipment does not work to create balance in government

budget, government can get loan from central bank to adjust deficiency or
deficit. For this RBI has to issue new currency notes. But this decision
should be taken very carefully because increasing trend of deficit financing
will decrease the value of currency in world market and it will increase the
prices of commodities in commodity market.

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• 4. Seigniorage

Seigniorage is also technique to take benefits by issuing new notes and it

is important role to make fiscal policy.

• ** Seigniorage is part of public finance and government's

meager earning source like income tax and VAT. If we have to define
seigniorage, we can say, "Seigniorage is earning of government for
issuing new notes."

5. Public Debt Policy

Public debt means, loan is taken by government to fulfill government

expenditures. Government should make this policy very seriously. If there
is any other source, then government should use to pay government
expenditure or reducing expenditure is better than taking loan.

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• Public Debt

• Internal borrowings
1. Borrowings from the public by means of treasury bills and govt. bonds
2. Borrowings from the central bank (monetized deficit financing)

• External borrowings
1. Foreign investments
2. International organizations like World Bank & IMF
3. Market borrowings

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• Government Expenditure

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• Government Expenditure

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• Indian Financial Sector
• Indian Financial Sector reveals that it is at present going through a phase
of stable growth rate which is experiencing a upward swing. The rise can
be maintained over a long period by keeping the inflation down. The
financial sector in India has experienced a growth rate of 8.5% per
annum.

• The analysis of Indian financial sector

• Analysis of the Indian Capital market
• The introduction of infotech systems in the National Stock Exchange
(NSE) in order to cater to the various investors in different locations
• Privatization of stock exchanges .

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• Analysis of the Indian Venture Capital market

• The venture capital sector in India is one of the most active in the
financial sector in spite of the hindrances by the external set up
• Presently in India there are around 34 national and 2 international SEBI
registered venture capital funds

• Analysis of the Indian Banking sector

• The banking system in India is the most extensive. The total asset value
of the entire banking sector in India is nearly US$ 270 billion. The total
deposits is nearly US$ 220 billion. Banking sector in India has been
transformed completely. Presently the latest inclusions such as Internet
banking and Core banking have made banking operations more user
friendly and easy.

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• Analysis of the Indian Insurance sector

• With the opening of the market, foreign and private Indian players are
keen to convert untapped market potential into opportunities by
providing tailor-made products:
• The insurance market is filled up with new players which has led to the
introduction of several innovative insurance based products, value add-
ons, and services. Many foreign companies have also entered the arena
such as Tokio Marine, Aviva, Allianz, Lombard General, AMP, New York
Life, Standard Life, AIG, and Sun Life
• The competition among the companies has led to aggressive marketing,
and distribution techniques
• The active part of the Insurance Regulatory and Development Authority
(IRDA) as a regulatory body has provided to the development of the
sector

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• CAPITAL MARKET –

• A capital market is a market for securities where business enterprises

(companies) and governments can raise long-term funds. It is defined as
a market in which money is provided for periods longer than a year.

• Capital markets may be classified as primary markets and secondary

markets.

• 1. PRIMARY MARKET –

• The primary market is that part of the capital markets that deals with the
issue of new securities.
• Companies, governments or public sector institutions can obtain funding
through the sale of a new stock or bond issue. In the case of a new stock
issue, this sale is an initial public offering (IPO).

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• Features of primary markets are:

• This is the market for new long term equity capital. The primary market is
the market where the securities are sold for the first time. Therefore it is
also called the new issue market (NIM).
• In a primary issue, the securities are issued by the company directly to
investors. The company receives the money and issues new security
certificates to the investors.
• Primary issues are used by companies for the purpose of setting up new
business or for expanding or modernizing the existing business.
• The primary market performs the crucial function of facilitating capital
formation in the economy.
• The new issue market does not include certain other sources of new long
term external finance, such as loans from financial institutions.
• The financial assets sold can only be redeemed by the original holder.

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• SECONDARY MARKET
• The secondary market, also known as the aftermarket, is the financial
market where previously issued securities and financial instruments such
as stock, bonds, options, and futures are bought and sold.

• The capital market is composed of following shown in the figure: -

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• PROCESS OF ECONOMIC REFORM –

• The Indian financial system of the pre-reform period, before 1991,

essentially catered to the needs of planned development in a mixed-
economy framework, where the Government sector had a predominant
role in economic activity.

• The need for financial reforms had arisen because the financial
institution and markets were in a bad shape.  The banking sector suffered
from lack of competition, low capital base, low productivity, and high
intermediation costs. 

• The role of technology was minimal, and the quality of service did not
receive adequate attention.  Proper risk management system was not
followed, and prudential norms were weak.  All these resulted in poor
assets quality. These leads to the process of reform
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• Main and sub-objectives of financial reforms introduced in 1991:

• To develop a market-oriented, competitive, world-integrated,

diversified, autonomous, transparent financial system.

• To increase the allocative efficiency of available savings and to promote

accelerated growth of the real sector.

• To increase or bring about the effectiveness, accountability, profitability,

viability, vibrancy, balanced growth, operational economy and flexibility,
professionalism in the financial sector.

• To increase the rate of return on real investment.

• To promote free entry and exit for institutions and market players.

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