MONETARY AND FISCAL POLICIES OF INDIA

Kritika Gupta (16102163)

Jaypee Institute of Information Technology, Noida

Abstract
Monetary and fiscal policies of a country are major determinants of its economic stability. As the
definition of economic development varies with the improved standards of living, so do the monetary and
fiscal policies to keep pace with the economic growth. Though the economic managers of both the
policies are different but fiscal policy directs the functioning of the monetary policy. Thus the government
should make effective use of the expenditure policy that comes under fiscal policy, to make this money
come in reach of the undeveloped sector of the economy thereby making the functioning of fiscal policy
more effective. The government should also make effective use of the taxation policies so that the tax gets
converted to investments.This paper reviews the historical and present trends of the policies in India,
changes made in the policies since 1991 economic reforms and suggestd policy measures for their
effective functioning. Since 1991, many changes have been made in these policies responding to the
needs of growing population, achieving fiscal deficits and GDP targets and controlling inflation. So, these
policies reflect the economic growth by stabilizing the supply of money in the economy. Thus, both the
policies should be formulated in order to maintain the money supply without increasing the prices and
hence maitaining price stability.

Introduction
Monetary policy mainly deals with the price stability, adequate flow of credit to the productive sectors of
the economy, interest rates and money supply in order to promote full economic growth, employment and
regulate inflation. Fiscal policy deals with the government revenue and expenditure to regulate inflation
and cure recession. If monetary policy is controlled by the Reserve Bank of India then Fiscal policy is
controlled by the Indian Government. The main instruments of monetary policy are Bank Rate of Interest,
Cash Reserve Ratio (CRR), Staututory Liquidity Ratio (SLR), Issuance of new currency, Repo rate,
Reverse Repo Rate, Margin requirements, Open Operations Market and credit Control. The main
instruments of fiscal policy are Government Revenue, Government Expenditure and Taxation policies.

To control inflation, RBI increases the CRR that is the portion of money, banks have to deposit with RBI.
This reduces the lending capacity of banks because of which the savings increase more than investments
and spending capacity of people decreases curtailing consumption and lowering prices, and the cycle goes
on. Whereas the government controls inflation by increasing the taxes, controlling the wages, increasing
the exports over imports, easing the trade restrictions and etc.

Whenever government revenue exceeds its expenditure, there is a surplus else there is a fiscal deficit. The
possible causes of fiscal deficit are interest payments on borrowings, subsidies, defence expenditure,
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pressure of population and high demand for gold etc. High fiscal deficit can heighten inflation, remove
effectiveness of monetary policy stimulants, increase the risk of external sector imbalances and can
dampen private investment. It can also leads to debt trap for the economies.

To meet the additional expenditures, it needs to borrow from domestic or foreign sources, draw upon its
foreign exchange reserves or increase the tax. If the government borrows too much from abroad, an
external shock (such as an exchange rate depreciation or inability to roll over the debt due to perceived
lack of ability to repay) may lead to a debt crisis. If it draws down on its foreign exchange reserves, a
balance of payments (BoPs) crisis may arise. And so, the impact of a large deficit on long-run growth and
economic well-being is negative.

The monetary policy is related to fiscal polcy in a way that RBI finances its deficits which is also called as
deficit financing. As the deficits are not fixed there arise variations in the monetary policy because of
which the CRR and SLR increase leading to a decrease in flow of credit to the productive sectors. Thus,
the fiscal policy should turn out to the needs of RBI and the taxation policies should be such that the tax
gets converted to investments and not get wasted under corruption

Monetary Policy in India

Monetary policy was established by RBI on 1 April, 1935 but became active after 1991 economic
reforms. During the 1991 economic reforms, the main focus of monetary policy was on deficit financing
because of which there was an ever high compensatory increase in CRR of upto 15% and that of in SLR
upto 38.5%. This led to a decrease in the flow of credit to the private sectors as the lending capacity of
banks decreased inspite of the fact that the money supply was growing at a rapid rate. During the global
financial crisis in October 2008, The RBI regulated decreasing inflation rates with the help of monetary
policy by decreasing the CRR to 6.5% and SLR to 25% as can be observed from the SLR and CRR chart
given below. The RBI made Open Market Operations more active during this period which led to an
increase in the investments thus controlling the situation positively. In the later half of 2009-2010, when
inflation rates begin to soar, the RBI again started tightening monetary policy and increased the CRR
from 5.75% to 6% in order to fight inflation. From 2010 to 2014 the CRR decreased to 4%.
From 2014 to 2018, the CRR has been constant that is 4% as observed from the SLR and CRR chart given
below.At present the inflation rates are in control with CRR upto 4% and SLR upto 19.5%.
Demonetization took place on 8 November, 2016 which is not a tool of monetary policy as it was
announced by the government but it followed the instrument of monetary policy of issuing new currency.
Though demonetization took place to curb corruption but it affected the functioning of monetary policy as
there was less cash in the market leading to a reduction in the demand of commodities and hence prices.
Now to restore the money supply, RBI decreased the bank rate of interest so that more people are able to
borrow and thus demonetization leads to lowering of interest rates without affecting inflation.
Many formulations have been made in monetary policy such as, in the Union Budget 2016-2017, upon the
agreement of government and RBI, the Reserve Bank of India (RBI) Act, 1934 was amended to form
Monetary Policy Committee (MPC). Its task is to fix the benchmark policy rate (repo rate) required to
contain inflation within the specified target level in order to order to maintain the price stability, inflation
targeting while keeping in mind the growth objective. It came into force on June 27, 2016 and it is
mentioned under the amended Act that government of India after consulting the central bank (RBI) would
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decide the inflation target once in every five years and the amended Act further provides for a statutory
basis for the constitution of an empowered Monetary Policy Committee (MPC).
RBI in its fourth bi-monthly monetary policy statement published in October 4, 2016 the MPC has
reduced the policy repo rate from 6.5 % to 6.25 %. Bank rate stood at 6.75 %. Due to demonetization, the
repo rate got reduced from 6.25% to 6% in December 2016. In RBI’s Fourth Bi-monthly Monetary Policy
Conference conducted on 9 October, 2018, MPC decided to keep the repo rate unchanged that is 6.25%.

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Fiscal Policy in India
The fiscal policy is controlled by the Government of India and its main focus has always been on
increasing the revenue in order to reduce fiscal deficits and making the efficient use of tax system so that
the money from private sector gets transferred to the public sector to boost the industrialzation process.
Post independence, the main focus of the government was to reduce the fiscal deficit but due to some
inefficiency it couldn’t control fiscal deficits in 1980s which led to liberalization in 1991.

Since then many reforms have taken place in the fiscal policy such as during the global financial crisis in
2008, government became more dependent on RBI to finance its deficits which affected the liquid cash
with banks. Various committed liabilities of Government including rising subsidy requirement, provision
under NREGS, implementation of Central Sixth Pay Commission recommendations and Agriculture Debt
Waiver and Debt Relief Scheme for Farmers contributed to the higher fiscal deficit of 6 per cent of GDP
in RE 2008-09 as compared to 2.5 per cent of GDP in B.E.2008-09.
In order to counter the effects of global meltdown, the government revenue decreased to an extent that
fiscal deficit became equal to 11% of GDP. In the year 2012-2013 the government expenditure reduced in
order to control the deficits. The fiscal deficit of 2017-2018 is 3.5% of GDP to which government wants
to trim to 3.3%.

The taxation policies include direct and indirect taxes. A direct tax is a tax which a person or organization
pays directly to the government, for example income tax. The more the direct taxes reduce the more the
investments increase. The income tax was 40% during the 1992-1993budget and since then many reforms
have been made in order to maintain the government revenue with the tax compliance and achieve
stability. The tax-GDP ratio which rose to 11.9 per cent in 2007-08 declined to 10.8% and 9.6 per of GDP
in 2008-09 and 2009-10 respectively due to lowering of indirect taxes in 2008-09 and 2009-10 to prevent
large economic slowdown. The share of direct tax as percentage of GDP which was 3% of GDP rose to
5.6 per cent of GDP in 2012-13. This increase in share of direct taxes and fall in indirect tax in total tax
revenue of Central Government has made the Indian tax system more equitable. An indirect tax is a tax on
goods and services which is added to their price. Earlier, the excise duties and sales tax were levied on
inputs which had a cascading effect on raising prices of final products. So VAT came into effect from 1
April, 2005 in order to replace it. The biggest reform in the indirect tax system is GST.

Direct taxes have been projected to increase to Rs.1150000 crore in BE 2018-19. This implies a growth of
14.4 per cent in 2018-19 compared to RE (Revenue Expenditure) 2017-18. The increase in direct taxes is
expected to be from both the arms of direct tax, namely Corporate Income Tax and Personal Income Tax.
These have been budgeted to increase to Rs. 621000 crore and Rs. 529000 crore respectively. 18. Indirect
taxes in BE 2018-19 are expected to be Rs.1116000 crore. It is anticipated that the GST revenues will be
Rs. 743900 crore in BE 2018-19 compared to Rs. 444631 crore in RE 2017-18. The fact that GST was
imposed only after the completion of the first quarter. The non-GST component of the indirect taxes

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would be Rs. 372100 crore in BE 2018- 19. This is compared to Rs. 491744 crore in RE 2017- 18. It is
expected that Indirect taxes will grow by 17.3 per cent in 2018-19 over RE 2017-18.

The government expenditure consists of interest payments for servicing past public debt, expenditure on
defence, pensions and wages and salaries of government employees .The annual rate of growth in
percentage terms was 29.73% during the period from 2000-01 to 2015-16. The RE 2017-18 for the total
Expenditure has been pegged at Rs. 2217750 crore compared to the BE 2017-18 of Rs. 2146735 crore.
This implies an increase of Rs.71015 crore or 3.3 per cent over the Budget estimates.

According to the Union Budget of 2018-2019, interest payments have been budgeted to show an increase
of Rs. 44952 crore (8.5 per cent increases) from RE 2017-18. These increased to Rs. 575795 crore in BE
2018-19 from Rs. 530843 crore in RE 2017-18. Pension payments have increased by Rs. 21079 crore
(14.3 per cent) from an RE of Rs.147387 crore to an amount of Rs.168466 crore in BE 2018-19. The
expenditure on major subsidies have increased by 15.1 per cent from an RE of Rs.229716 crore to a BE
2018-19 of Rs.264336 crore. The increase in major subsidies of the government has been evidenced in all
the subsidy heads namely food, fertiliser and fuel. However, as a per cent of GDP the Major Subsidies are
expected to remain stagnant at 1.4 per cent of GDP. Expenditure on Defence Services has also seen an
increase in allocation from Rs.267107 crore in RE 2017-18 to Rs.282734 crore in BE 2017-18. The
increase in defence service allocation is to the tune of Rs. 15627 crore in absolute terms or an increase of
5.9 per cent compared to RE 2017-18. The Capital Expenditure in BE 2018-19 has been budgeted to
increase to Rs.300441 crore from the RE 2017-18 figure of Rs.273445 crore. This shows that the
government spending is increasing which can lead to an increase in the fiscal deficit thereby increasing
the deficit financing and taxes. So, the government should focus more on generating revenues cutting
down unnecessary expenditures.
Some of the important initiatives for improvising expenditure management are Public Financial
Management System (PFMS), Direct benefit Transfer (DBT), Rationalization of major subsidies and
FRBM.

Fiscal Responsibility and Budget Management (FRBM) Act, 2003 improved the fiscal deficit from 5.9
per cent of GDP in 2002-03 to 2.7 per cent of GDP in 2007-08. During the same period, revenue deficit
has declined from 4.4 per cent to 1.1 per cent of GDP.And so without constricting the government
expenditure there was an equitable growth. This improvement in the state of public finances was achieved
through higher revenue buoyancy, driven by efficient tax administration and improved compliance which
is evident from increase in the tax to GDP ratio from 8.8 per cent in 2002-03 to 12.5 per cent in 2007-08.
Its target is to achieve fiscal deficit target of 3% of GDP.

Rollout of GST
One of the significant measures taken under the indirect tax system of fiscal policy is Goods and Services
Tax which came into existence on 1st July, 2017. It brought a new era of indirect taxation with the motto
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of “One Tax, One Market, and One Nation”. It subsumed almost all major indirect taxes like Central
Excise Duty, Service Tax, VAT, CST, Entertainment tax, Octroi, Luxury tax, a large number of
cesses/surcharges and various other state and central levies on goods and services.

It leads to uniform taxation of goods and services across all states as the state and central taxes gate
subsumed to a common tax. All business processes have been made common, including the IT processes
relating to registration, return, payment and refund of taxes. This has paved the way for making the whole
nation a common market. GST removes the cascading effect of paying states taxes and VAT. It will help
government revenue find buoancy by expanding the tax base whilst enhancing the taxpayer
compliance.Under the GST, there will be seamless flow and availability of a common set of data to both
the Centre and states, making direct tax collections more effective. With the introduction of GST, the
check posts in the states have been removed as the whole nation has same tax and compliance structure. If
this trend continues, the reduction in transport costs, fuel use, and corruption could be significant.

There is ample evidence to suggest that logistics costs within India are high. GSTC Council has taken all
possible measures to address the concerns of stake holders. The concerns raised by the stakeholders were
related to business processes (relating to migration, registration, return filing and refunds on the portal),
GST rates, difficulties faced by MSME sector in compliance, cash flow issues of exporter on account of
delay in getting refunds on exports. The GST Council had several meetings in quick succession post GST
implementation and it took specific measures to address all the concerns in a short span of time. To
address the IT issues, a GOM (Group of Ministers) has been constituted which since then has taken a
number of measures. It is expected that it will be helpful in increasing production and the purchasing
power of the buyer which may increase the GDP by 1% to 3%.

Comparison
Monetary policy differs from fiscal policy in many ways such as it is regulated by the RBI whereas fiscal
policy is regulated by the government. Monetary policy is governed by the factors such as CRR, SLR,
LAF, Repo Rate, Reverse Repo Rate, Open Operations Market, Margin Requirements and Bank Rate of
Interest whreas fiscal policy is governed by the factors such as Government Expenditure, Government
Revenue, Taxation policies and Deficit financing. But the primary concern of central banks has always
been price stability as it prevents long term inflation. And so even though inflation is reduced, but
economic growth also gets reduced. And thus, the short term price stability is preferred more over long
term developments. Whereas the main focus of government has always been on reducing the fiscal
deficits, by either cutting down the expenditure or borrowing through other means such as RBI or foreign
exchange reserves thereby regulating the inflation. It can also control its deficits by increasing taxes. And
thus, the way of controlling inflation is different for both the policies.

Policy Suggestions
Both the policies play a major role in determining economic stability and hence there needs to
coordination and cooperation between both the policies to promote economic development and growth.
Thus, without compressing upon the government expenditure the fiscal deficits should be controlled by
the government revenue and taxation policies in order to achieve equitable growth with economic
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stability. The taxation system should be such that the tax gets converted to investments without getting
wasted in corruption. Hence the efforts should be made to substantially raise the tax GDP ratio. The share
of direct taxes should also be increased by enforcing an equitable tax system such that all the tax payers
are covered in the taxation system maitaining economic growth by reducing fiscal deficits. Larger
revenues should be extracted from the indirect tax system generated from higher industrial production.
The problems of people regarding GST should be addressed making it more effective. The government
expenditure consists of interest payments for servicing past public debt, expenditure on defence, pensions
and wages and salaries of government employees and so expenditure can’t be compressed in short run.
Thus, the growth in the non-plan and non-developmental spending should be reduced in order to control
the deficits and divert the spending more towards anti poverty programmes and welfare schemes. And so
the monetary policy and fiscal policy should work in cooperation and coordination in order to curb the
problems which are hampering the economic growth and development.

Conclusion
The paper deals with the historical and present trends of monetary and fiscal policies of India. It also
covered the changes that have been made in both the policies since the economic reforms of 1991, how
the government and RBI controlled the global financial crisis of 2008 and also suggested policy measures
for their effective functioning.The statistical data of the instruments of both the policies helped in
comparing the changes that have been made in these policies till now and their effect on the ecoomic
growth. The variations in CRR and SLR ratios helped in understanding monetary policy and how the
MPC formulated the changes in monetary policy. The effective functioning of fiscal policy mainly
depends upon the fact that how the fiscal deficits are being controlled without compromising on the
expenditures. There were many amendments made in fiscal policy such as GST and FRBM Act, 2003.
From the policy measures we mainly concluded that the government should properly plan its expenditure
so that unnecessary spending is controlled and it gets diverted to funding of social welfare schemes and
antipoverty programmes. Though both the policies function differently but as fiscal policy directs the
functioning of monetary policy so both the policies should work in coordination in order to maintain price
stability, money supply, economic growth and development.

References
 https://www.ijeronline.com/documents/volumes/2015/Vol%206%20Iss%2001%20JF%202015/ije
r%20vol6i1%20JF%202015(6).pdf
 https://www.indiabudget.gov.in/ub2018-19/frbm/frbm3.pdf
 http://www.ijtef.org/papers/431-A10006.pdf
 http://www.economicsdiscussion.net/fiscal-policy/reforms/reforms-in-indias-fiscal-policy-and-its-
performance/10975
 https://craytheon.com/charts/rbi_base_rate_repo_reverse_rate_crr_slr.php