Be-Unit - Iii

BUSINESS ENVIRONMENT
UNIT -III
Fiscal Policy: nature and significance – public revenues – expenditure- debt, development
activities allocation of funds – critical analysis of the recent fiscal policy of Government of
India. Balance of Payments: Nature – structure – major components – causes for
disequilibrium in balance of payments – correction measures.
Fiscal policy
Introduction: One major function of the government is to stabilize the economy (prevent unemployment
or inflation). Stabilization can be achieved in part by manipulating the public budget-government spending
and tax collections-to increase output and employment or to reduce inflation.
Meaning:
Fisc : A French word means ‘Treasure of Government’.
Fiscal Policy = Revenue + Expenditure Policy by Government of India and related to ‘Development
Policy’ of the Nation.
Fiscal policy refers to the government policy regarding taxation, public expenditure, and public
debt, Tax receipts.
Definition:
“Fiscal policy deals with the taxation and expenditure decisions of the government. These include,
tax policy, expenditure policy, investment or disinvestment strategies and debt or surplus
management”.
- Kaushik Basu (Former Chief Economic Adviser)
“Fiscal policy means public expenditure and tax policy”.
- Paul Samuelson
“Government uses its expenditure and revenue program to produce desirable effects and avoid
undesirable effects on National Income, production and employment”.
- Arthur Smithies
Nature of Fiscal policy:
Common accounting year for income tax
Reliance on indirect taxes (exercise duty or custom duty)
Reduce the creation of black money
ANKIREDDY.YENIREDDY Page 1
A cure of inflation Economic

developm
ent
activities
Functions of Fiscal policy: Distribut Fiscal Policy Price

ion of stabilizat
 Allocation of funds income functions ion
 Distribution of income
 Price stabilization
 Economic development activities Allocatio
n of
funds
OBJECTIVES OF FISCAL POLICY
The objectives of fiscal policy differ from country to country according to the level of economic
growth and ideological milieu. The basic objective of fiscal policy in developed economies is to
maintain the conditions of full employment, economic stability and stabilize the rate of economic
growth. In case of underdeveloped economy the main purpose if fiscal policy is to accelerate the
rate of capital formation and investment.
Full employment
Price stability
Accelerate of the rate of economic

Growth
Fiscal Policy Objectives Optimum allocation of resources
Equitable distribution of income

and wealth
Economic stability
Capital formation and growth
Full employment: the first and foremost objective of fiscal policy in developing economy is to
achieve and maintain the full employment in the economy. Why because the economic gains from
full employment are enormous. Full employment yields individuals security. Security promotes
progress. Full employment contributes human dignity and weakens non functional discrimination,
is essential to protect democratic society.
Price stability: fiscal policy should be supplemented with monetary measures to make them more
effective. Moreover, efforts should be made to increase production especially essential
commodities. In short, fiscal policy should try to remove the bottlenecks and structural rigidities
which cause imbalance in various sectors of the economy. Thus, fiscal policy measures as well as
monetary measures go side by side to achieve the objectives of economic growth and stability.
Accelerate of the rate of economic growth: in developing economy, fiscal policy should aim at
achieving an accelerated rate of economic growth. But a high rate of economic growth cannot be
achieved and maintained without stability in the economy. Therefore, fiscal measures such as
taxation, public borrowings and deficit financing etc. should be used properly. Sothat, production,
consumption, and distribution may not be adversely affected. It should promote the economy and
help in raising national income and per capita income.
Optimum allocation of resources: fiscal measures, taxation and public expenditure programmes
which affects the allocation of resources in various occupations and sectors. National income and
per capita income is very low in under developed countries. It is true. Therefore, financing
development plans posses a severe threat to the government. In order to gear the economy, the
government pushes the growth of social infrastructure through fiscal measures. Public
expenditure, subsidies and incentives can favorably influence the allocation of resources in the
desired channels. Tax exemption and tax concession may help in attracting resources towards the
favored sectors.
Equitable distribution of income and wealth: generally, in underdeveloped countries income and
wealth are in few hands. That’s why private ownership dominates the entire structure of the
economy. Extreme inequalities create political and social discontentment generates economic
instability. Fiscal policy of the government can bridge the gap between the incomes of different
sections of the society. And reduce the inequalities through distributive justice.
Economic stability: fiscal policy plays a leading role in maintaining economic stability in the face of
external and internal forces. The instability is caused by external forces, is corrected by a separate
policy that is none other than “Tariff policy” rather than aggregative fiscal policy.
Capital formation and growth: capital occupies central place in any development activity in a
country. Fiscal policy can be adopted as a crucial tool for the promotion of the highest possible
rate of capital formation.
Importance of Fiscal Policy:
 Government activities are enlarged.
 Tax- Revenue and Expenditure accounts for large proportion of GNP.
 Government affects the Economic activities through gap between government

receipts and borrowings.
 It indicates the level of overall borrowings by the government.
It is the indicator of fiscal health of the economy.
Instruments of Fiscal policy:

Fiscal policy refers to the part of government policy which is concerned with raising revenues through
taxation, deciding on the level of public expenditure and public debt.
Fiscal policy also known as “budgetary policy" operates through budget

It occupies the central place for maintaining full employment without inflationary and deflationary forces
in the economy. It is an instrument to achieve goals The various instruments or measures which influence
the economic stability of an economy are as under :
Public revenue
Public expenditure
Public debt or public borrowings
Public revenue:
Introduction
Public revenue is exactly income generated from sources of government in order to meet
requirements of expenses of Public. Public revenue generally refers to government revenue. Some
important sources or concepts that are included in public revenue consist of taxes, fees, sale of
public goods and services, fines, donations, etc.
Classification of Public Revenues

Governments need to perform various functions in the field of political, social and economic
activities to maximize social and economic welfare. In order to perform these duties and functions
government require large amount of resources. These resources are called public revenues.
Public revenue consists of taxes and Non-tax revenues:
Sources of Public
Revenues
Tax Revenue Non-tax Revenue
Direct Tax Indirect Tax Fees

Fines and Penalties
Surplus form Public
Personal Tax Enterprises
Value Add Tax Special Assessment of
Net wealth Tax
Real Estate Tax Betterment Levy
Capital Tax
Stamp Duty Grants and Gifts
Customes Duty Deficit Financing
Tax Revenue:
Taxes are the first and foremost sources of public revenue. Taxes are compulsory payments to
government without expecting direct benefit or return by the tax payer. Taxes collected by government
are used to provide common benefits to all mostly in form of public welfare services. Taxes do not
guarantee any direct benefit for person who pays the tax. It is not based on direct quidpro quo
principle.0018
Characteristics of Tax:
The following are the characteristics of a tax:
I) A tax is a compulsory payment made to the government.

II) There is no quidpro quo between a tax payer and public authorities. This means that the tax
payer cannot claim any specific benefit in return for the payment of a tax.
III) Every tax involves some sacrifice on part of the tax payer.
IV) A tax is not levied as a fine or penalty for breaking law.
V) The government collects tax revenue by way of direct and indirect taxes. Direct taxes
include corporate tax; personal income tax, capital gain tax and wealth tax. Indirect taxes
include custom duty, central excise duty, and VAT and service tax.
In 2006-07 (India related), the tax revenue contributed about 81% of the total revenue receipts of the
Central Government, whereas non-tax revenue receipts contributed the remaining 19%.
Classification of Tax
1) Direct Tax: Direct taxes are levied on wealth and income of individuals or organizations. These
taxes are personal income tax, corporate tax, and gift or wealth tax. The impact of direct taxes is on
the same person. Direct taxes are developing in nature and the tax rate increases along with the tax
base.
i) Personal Tax: Personal income tax is levied on only about 3.5% of India's more than one
billion citizens. The states levy profession tax on salaried employees and persons carrying on
profession or trade rates that vary by state. An individual's income is categorized into different
employment income, business or professional income, income from real estate, capital gains, and
other income. Ordinarily residents of India are taxed on worldwide income. Persons not
ordinarily resident generally do not pay tax on income earned outside India unless it is
derived from a business/profession controlled in India, or the income is accrued or first
received in India or is deemed to have accrued in India.
ii) Net Wealth Tax: All individuals and other specified persons must pay a 1 % wealth tax on
the aggregate value of net wealth exceeding INR 3 million of non-productive assets such as land;
buildings not used as factories; commercial property not used for business or profession;
residential accommodation for employees earning over INR 5,00,000 per annum; gold, silver, platinum
and other precious metals, gems and ornaments; and cars aircraft and yachts.
iii) Capital Tax: India does not levy capital duty, although a registration duty is levied.
2) Indirect Tax: Indirect taxes are imposed on goods & commodities. These taxes include sales tax,
excise duty, service tax, customs duty, VAT, etc. The impact of indirect taxes may be implied on
different people. Indirect taxes are not progressive but regressive in nature. Here, the burden to
pay duties is indirectly or directly bearded by the consumer irrespective of their income level.
Indirect taxes are of utmost importance for countries that are developing and face low income
levels.
i) Value Added Tax: All Indian states, including union territories, have moved to the VAT
regime a broad-based " consumption-type destination-based VAT" driven by the invoice tax credit
method that applies to almost all types of movable goods and specified intangible goods, barring
a few exempted goods that vary from state to state. The standard VAT rate is 12.5%, with reduced
rates of 5% and 1% in most states. The reduced rates apply to the sale of agricultural and
industrial inputs, capital goods and medicines, precious metals, etc. A refund of input tax is
available for exporters.
ii) Real Estate Tax: Owners of real estate are liable to various taxes imposed by the state and
municipal authorities. These taxes vary from state to state.
iii) Stamp Duty: This is levied on instruments recording certain transactions, at rates depending on
the nature of instrument and whether the instrument is to be stamped under the Indian Stamp Act, 1899
or under a State Stamp Law. Stamp duty rates for an instrument vary from state to state.
iv) Customs Duty: These are levied by the Central Government generally on the import of goods
into India, although certain exported goods also are liable to customs duties. The basis of
valuation in respect of imports and exports is the transaction value, except where the value is not
available or has to be established because of the relationship between the parties.
The rate of basic customs duty is l0%. However, the aggregate customs duty, including additional
duties and the education cess, is 26.85%. Several products attract the basic customs duty of 7.5%,
which works out to an effective duty of 23.89%. The rates vary depending on the classification of me
goods under me Customs Tariff Act, 1975. Safeguard and anti-dumping duties also are levied on
specified goods. The clearance of goods from customs is based on self-assessment of bills of entries for
imports.
Non-Tax Revenue
The revenue obtained by the government from sources over than tax is called non-tax revenue. The
sources of non-tax revenue are:
Fees: these are important source revenue for the government. A fee is charged by public
authorities for rendering a service to the citizens. Unlike tax, there is no compulsion involved in
case of fees. The government provides certain services and charges certain fees for them. For
example, fees are charged for issuing of passports, driving licenses, etc.
2) Fines or Penalties: These are imposed as a form of punishment for breach of law or non-
fulfillment or certain conditions or for failure to observe some regulations. Like taxes, fines are
compulsory payments without quidpro quo. But while taxes are generally imposed to collect
revenue. Fines are imposed as a form of punishment or to prevent people from breaking the law.
They are not expected to be a major source of revenue to the government.
3) Surplus from Public Enterprises: The government also gets revenue by way of surplus
from public enterprises. In India, the government has set-up several public sector enterprises to
provide public goods and services. Some of the public sector enterprises to make a good
amount of profits. The profits or dividends which the government gets can be utilized for public
expenditure There is some sort of quid pro quo in the case of surplus from public enterprises,
This is because, the public gets goods and services, and the government gets prices, and
consequently profits from selling such goods and services.
4) Special Assessment of Betterment Levy: It is a kind of special charge levied on certain

`
members of the community who are beneficiaries of certain government activities or public
projects. For example, due to a public park in a locality or due to the construction of a road,
people in that locality may experience an appreciation in the value of their property or land.
Thus, due to public expenditure, some people may experience unearned increments' in their
asset holding Betterment levy is like a tax because it is a compulsory payment, but unlike
tax, in case of betterment levy there is some element of quid proquo.
5) Grants and Gifts: Gifts are voluntary contributions by individuals or institutions to the
government. Gifts are significant source of revenue during war and emergency. A grant from one
government to another is an important source of ' revenue in the modern days. The government
at the centre provides grants to state governments and the state governments provide grants to the
local government to carry out their functions. Grants from foreign countries are known as foreign
aid. Developing countries receive military aid, food aid, technological aid, etc., from developed
countries.
6) Deficit Financing: Deficit means an excess of public expenditure over public revenue. This excess
may be met by borrowings from the market, borrowings from abroad, by the central bank creating
currency. In case of borrowing from abroad there cannot be compulsion for the lenders, but in
case of internal borrowings there may be compulsion. The government may force various
Types of Public Expenditure
Productive Expenditure
Unproductive Expenditure
Transfer Expenditure Non- transfer Expenditure
individuals, firms and institutions to lend to it at a much lower rate than the market would have
offered.
Public Expenditure:
Introduction:
Government expenditure refers to public expenditure, i.e., government spending It is incurred by
central, state and local governments of a country. Public expenditure can be defined as, “The
expenditure incurred by public authorities like central, state and local governments to satisfy the
collective social wants of the people is known as public expenditure”.
Throughout the 19th century, most governments followed laissez faire economic policies and their
functions were only restricted to defending aggression and maintaining law and order. The size of
public expenditure was very small. But now the expenditure of governments all over has
significantly increased In the early 20th century, John Maynard Keynes advocated the role of
public expenditure in determination of level of income and its distribution.
In developing countries, public expenditure policy not only accelerates economic growth and
promotes employment opportunities but also plays a useful role in reducing poverty and
inequalities in income distribution.
Types of Public Expenditure

Public expenditure is expenditure by public authorities. Public expenditure is expenditure by the
Central, State and local governments on various social, economic and political activities. The objective
of public expenditure is public welfare, i.e., it should be in such areas which help to achieve the
objectives of fiscal policy. Thus, public expenditure is the expense which the government incurs for
its own maintenance as also for the society and the economy as a whole.
The explanation of these four heads of public expenditure is as follows:
1) Productive Expenditure: They are defined as those expenditures which are incurred to create
and maintain social overheads. In other words, only those public expenditures are productive
which create tangible assets in an economy. Productive expenditure includes those items which
increase the productive efficiency of an economy. For example, expenditure on roads, canals,
research, and water works, parks, etc.

2) Unproductive Expenditure: They are defined as those expenditures which are wasteful
and avoidable expenditure. For example, time and again elections, maintenance of State, etc.
3) Transfer Expenditure: They are defined as those expenditures which are in the form of
payment to certain sections of the society. These sections of the society are free to decide
where to use the money. For example, pension, unemployment benefit, etc.
4) Non-Transfer Expenditure: They are defined as those expenditures in which the state
pays for the purchase or use of goods and services. For example, defense, education, etc.
Developmental Activities Financed by Public Expenditure

The developmental activities financed by public expenditure are given as follows:
1) Development of Infrastructure: Development of infrastructural facilities which
include development of power projects, railways, road, transportation system, bridges,
darns, irrigation projects, hospitals, educational institutions and so on involves huge
expenditure by the government because private investors are reluctant to invest in these
areas considering their low rate of profitability and high risk.
2) Development of Public Enterprises: The development of heavy and basic industries is very
important for the development of an underdeveloped country. But the establishment of these
industries involves huge investment and a considerable proportion of risk. Naturally, the private
sector cannot take the responsibility to develop these industries. The development of these
industries has become a responsibility of the Government of India particularly since the
introduction of the Industrial Policy of 1956. A significant portion of the public expenditure has
been utilized for the establishment and improvement of these public enterprises.
3) Support to Private Sector: Providing the necessary support to the private sector for the
establishment of industry and other projects is another important objective of the public expenditure
policy formulated by the Government of India.
4) Social Welfare and Employment Programs: Public expenditure policy pursued by the
Government of India is its growing involvement in attaining various social welfare programs and
stress on employment generation programs.
5) Increase Production: Public expenditure contributes to production through a large number of
public enterprises both in industries and agriculture, Government incurs a lot of expenditure in
the agricultural sector, e.g., on irrigation and power, seed forms, fertilizer factories, warehouses,
etc., and in the industrial sector by setting up public enterprises like the steel plants, heavy
electrical, heavy engineering, machine making factories, etc. All these enterprises are calculated
to promote production and thereby economic development.
6) Exploitation and Development of Mineral Resources: Minerals provide a base for further
economic development. The government has to undertake schemes of exploitation and
development of essential minerals, e.g., coal and oil. Public expenditure has to play its role here
too.
7) Promote Price Stability: Increase in public expenditure relieves the economy from the
dilemma of depression and conversely public expenditure can be scaled down when there is a fear
of inflationary rise in prices. Thus public expenditure helps in stabilizing price.
8) Promote Balanced Growth: There is a tendency to use economic resources for the further
development of already developed regions. But for overall growth, special attention needs to be paid
for the development of backward areas and underdeveloped regions. This requires huge amounts
for which reliance has to be placed on public expenditure.
9) Reduce Inequality of Income: Public expenditure is to reduce the inequality of income.
Expenditure on old age pensions, unemployment relief, free education, free mid-day meals, etc.,
benefits the poorer classes of die community at the expense of the rich.
Effects of Public Expenditure

Public expenditure affects various sections of the society. Effects of public expenditure are as follows:
i) Effect on Production: According to Professor Dalton, the effect of public expenditure

depends upon three factors:
a) Ability to work, save and invest,
b) Willingness of people to work, save and invest, and
c) Effects of division of economic resources as between different uses and areas.
According to Professor Dalton, public expenditure certainly increases production.

Expenditure on police and armed forces creates the condition under which alone organized
Production can take place.
ii) Effect on Distribution: ` Just like taxes, the public expenditure can be proportional,
progressive and regressive. According to Professor Dalton, that system of public expenditure is
the, best which reduces the income inequalities and maximizes social welfare.
iii) Effect on Economic Stability: Effect of public expenditure should be to bring about a
situation of full employment in the country since unemployment gives birth to moral
degradation. Also, public expenditure should curb inflationary tendencies prevailing in the
country. During depression, public expenditure can help to raise the decreased demand and
maintain stability in the country.
iv) Effect on Economic Growth: Public expenditure helps in stimulating saving and capital
accumulation. Public expenditure leads to economic growth by developing education and
training centers, creation of infrastructural facilities, etc.
Reasons for Growth of Public Expenditure
There has been phenomenal increase in the public expenditure during the planning period in India. It has
grown from 983/- crores (at current prices) in 1950-51 to 4 ,26,131 crores in 2003-04. At constant
prices, public expenditure has increased twenty times in the last five decades. Causes responsible for
the increase in public expenditure in India since 1950-51 are:
Increasing Public Sector Investment: Government has been undertaking huge amount of
investment for economic development in the country.
Increasing Defense Expenditure: Modern war has become very expensive with the use of atomic
weapons, surface to surface missiles, etc. A huge expenditure is incurred on maintaining army and
defense preparations.
Increasing Interest Expenditure: Interest payments on internal and external loans have
constituted around 25 per cent of the total public expenditure. There has been considerable rise
in the growth of interest payments over the years. The increase in the interest liability is the
outcome of rising fiscal deficits and recourse to market borrowings to meet the deficits.
Increasing Subsidy Expenditure: Government is spending huge amountf of money as subsidies on
various items like food, domestic LPG, kerosene supplied through public distribution system, fertilizers,
export promotion, etc.
Increasing Development and Social Expenditure: India has accepted the principle of welfare
state `and consequently, huge public expenditure on welfare activities is essential. The government
has to make large provisions for public health, education and hospitals. Their establishment,
maintenance and improvement require huge public expenditure.
Increasing Administration Expenditure: Large amount of public expenditure is incurred on

unnecessary setting-up of committees and sub-committees due to lack of coordination between
different departments.
Population Growth: Another factor responsible for increase in public expenditure is the growth of
population. Population has been increasing at an explosive rate. Growing population necessitates
adequate facilities of education, public health, roads, transport facilities and administrative services. All
these add to public expenditure.
Providing Employment and Undertaking Relief Works: The government has taken over
several sick units and incurred expenditure in order to ensure that workers are not rendered
unemployed. Also, it undertakes relief works when natural calamity occurs.
Price Increase: Due to price rise, the cost of plan and non-plan projects goes up. This has
necessitated increased expenditure by the government.
Public debt:
Meaning and Definition
Public debt is an instrument of resource mobilization by the modern government. The revenue raised
through taxation and other sources is not sufficient to meet the increased expenditure of the government
Revenue from taxation cannot be raised beyond, a certain limit while, the deficit financing becomes
inflationary when it crosses the safe limit. Hence the government has to resort to public debt to
accelerate the process of development.
Public debt denotes borrowing by the government from the people, banks, financial institution, and so
on. To sum-'up, public debt is the debt incurred by the government in mobilizing resources in the form
of loans, which are to be repaid at a future date with interest
According to J.K. Mehta, “Public debt carries with it the obligation on the part of the government
to pay money back to me individuals from whom it has been obtained" .
According to Philip E. Taylor, “The debt is in the form of promises by the treasury to pay to me
holders of these promises a principal sum and in most cases interest on that principal”.
According to R. Musgrave and P. Musgrave, “Public borrowing involves withdrawal made in return
for the government's promise to repay at a future date and to pay interest at the interim”.
Components of Public Debt

The various components of public are as follows:
1) Internal Debt: The internal debt is a major component of public debt of the Central Government of
India.
The following are the various components of internal debt:
i) Market Loan: These have a maturity period of 12 months or more at the time of issue and
is generally interest bearing. The government issues such loans almost every year. These
loans are raised in the ` open market by sale of securities or otherwise. Total market
loans as at the end of March 2005 are estimated at 7, 58,999 /- crores.
ii) Bonds: The Government borrows funds by way of issue of bonds. The government
obtains funds through the issue of bonds such as National Rum! Development Bonds,
Central Investment Bonds. The bonds are issued at different maturity periods, which may
range from 3 years to 10 years period. They provide medium-term to long-term funds to the
government.
iii) Treasury Bills: A major source of short-term funds for the government is obtained by issue
of treasury bills. At present, government issues 91 day and 364 day treasury bills. The
treasury bills are purchased by commercial banks and others. The amount of debt as a
result of treasury bills decreased from 64,760/- crore in 1997 to 7,184/- crores as at the
end of March 2006.
iv) Special Floating and Other Loans: These represent India's contribution towards share
capital of international financial institutions like lMF, World Bank, International
Development Agency and so on. These are non-negotiable and non-interest bearing
securities The Government of India is liable to pay the amount at the call of these institutions.
Accordingly, it is a short-term debt upon the Government of India.
v) Special Securities issued by RBI: The government obtains temporary loans for a period
of maximum 12 months from RBI and issues special securities, which are non-negotiable
and non-interest bearing. Such securities provide short-term funds to the Government.'
vi) Ways and Mean Advances: The Government of India obtains ways and means
advances from the Reserve Bank of India to meet its short period expenditure. These debts
are purely temporary in nature and are usually repaid within three months.
vii) Securities against Small Savings: Since 1999-2000, under the new accounting system,
national small savings have been converted into the Central Government securities. As a
result there has been a sharp increase in internal debt and corresponding decline in small
savings.
External Debt: This refers to the liabilities of me Indian Government, public sector, private
sector and financial institutions to overseas parties. The Government of India has raised foreign
loans from U.S.A., 'U.K., France, U.S.S.R, Japan, etc.
The external debt can be broadly divided into two
groups:
Long-Term Debt
i) Multilateral borrowings, and
ii) Bilateral borrowings.
For example, Loans from IMF, World Bank, etc.
Short-Term Debt: It is to be noted that the overall external debt of India comprises of
government debt and non-government debt. The government debt is owed by government authorities,
both Central and State Governments; whereas the non-government debt is owed by private parties in
India, In terms of composition, India's external debt has shifted in favour of private debt over the last
decade.
Other Internal Liabilities: The government does not include liabilities under public debt. However,
the government is liable to make repayment of these liabilities. There following liabilities that comes
under it:
Small Savings
a) In recent years small savings have increased due to rising money income in the economy.
b) Recently the Government of India launched a number of small savings instruments. These include
9% Relief Bonds 1987, Kisan Vikas Patras, Indira Vikas Patras, etc.
c) The outstanding amount of small savings increased from 2,209/- crores in 1971 to 4,18,110/- crores at
the end of March, 2006.
Provident Funds: These are divided into two categories:
a) Employee Provident Funds meant for employees.
b) Public Provident Funds meant for general public.
c ) O u t s t a n d i n g amount under provident fund stood 66,217 crores at the

end of March 2006.
Other Accounts: Other accounts include Postal Insurance and Life Annuity Fund, Borrowings against
compulsory Deposits, Income Tax Annuity Deposit, Special Deposit of Non-government Provident
Fund and Outstanding Amount.
Reserve Funds and Deposits: These are divided into two categories:
a) Interest bearings, and
b) Non-interest bearings.
They include depreciation and reserve funds of Railways, Department of Post
Telecommunication, Deposits of Local Funds, Departmental and Judicial Deposits, Civil Deposits, etc.
~ Classification of Public Debt

a) Internal and External: When the government borrows within the country, it is called internal
debt. When she government, on the other hand, borrows from outside the country, it is called
external debt. Internally, “the government borrows from individuals, business establishments,
financial institutions, commercial hanks, and central bank. Externally, it borrows from
foreigners, foreign banks, foreign governments, and informational institutions. Unlike internal
debt, external debt involves material loss to the debtor country.
b) Voluntary and Compulsory: When the government borrows by issuing sec unties to which
people are free to subscribe, it is called voluntary debt, when the government, on the other
hand, enforces borrowing through legal compulsion, it is called compulsory debt. Generally,
public debts are voluntary in nature. The government resorts to compulsory loan under
extraordinary circumstances like war, famine, or to curb inflation.
c) Productive and Unproductive: Productive debt is one which is incurred for those projects
which yield come to the government. For example, the debt incurred to meet
expenditure on power projects, irrigation projects, public enterprises, and railways. The
income derived from these assets is used to pay the -interest and the principal of the debt.
Unproductive debt, on the other hand, is one which neither yields any income to the government
nor creates any asset. For example, debt incurred to cover any budgetary deficit or to finance
war, earthquake, famine, and drought Hicks called these two types of debts as active debt and
dead weight debt respectively.
d) Funded and Unfunded: Funded debt is a long-term debt, payable after a year, while
unfunded debt is a short term debt, payable within a year. The former is incurred to create a
permanent asset, whereas the latter is incurred to meet temporary gap in budget. Unfunded
debt is also known as floating debt and includes treasury bills, ways and means advances from
central bank and so on.
e) Redeemable and Irredeemable: When the government borrows money with a promise to pay-
off in future at a specified date, it is known as redeemable debt. When the government, on
the other hand, borrows without any intention to repay the same in future, it is known
as irredeemable debt. However, the government continues to pay the interest on such loans.
The redeemable and irredeemable debts are also known as terminable and perpetual debts.
A situation in which borrowings have to be resorted to just keep-up with the servicing of debt is
known as debt trap'. Debt servicing denotes payment of interest on debts as well as re -payment of
installments of debts. The debt trap could be both internal and external.
MEASURES TO REDUCE
PUBLIC DEBT
Reduction in Growth of Current

Reduction in Primary Deficit Expenditure
Raising Efficency of Borrowing Reforms in Debt Management of

Program of Central Government States
Foreign Institutional Investors

Consolidation Sinking Fund
and Public Debt
Improving the State of Debt

Disinvestement Policy
Market
Proper monitoring of Expenditure
Measures to Reduce Public Debt

The increase in Public debt puts a burden on the citizens of the country. The burden of public debt
adversely affects the growth and development of the economy. Therefore there is a need to
effectively manage public debt. Management of public debt involves; repayment of public debt,
controlling the amount of borrowings and productive use of borrowed funds for development.
Following are the measures to be undertaken to reduce and repay public debt.
Reduction in Primary Deficit: Corrective action with respect to the growing internal debt must be
carried out in two stages. In the first stage, action must be directed toward slowing down the pace of
growth of the debt ratio or reducing it to a reasonable level. In the second stage, attempts must be
made to contain most revenue expenditures within the revenues raised by the Government so that
Government's net borrowing is used only for productive purposes.
a) Reduction in Growth of Current Expenditure: In order to reduce primary deficit,

emphasis has to be placed more on reducing the growth of current expenditure of -the
Government than on raising the rate of growth of revenues.
b) Raising efficiency of Borrowing Program of Central Government: The RBI has played a
major role in improving the efficiency of borrowing programmes of the Central Government.
Since 1992, the RBI has been raising Central Government debts at market related rates.
From 1997, a new system of ways and means advances to meet the temporary mismatches of
the central government finances replaced the earlier system of ad hoc treasury bills. While
deciding to issue a loan, RBI takes into account the cash needs of the government, the liquidity
conditions in the market and primary and secondary market yields. All this has helped in
making the borrowing programme more market oriented.
c) Reforms in Debt Management of States: While several reforms in debt management policy
have been introduced in the respect of sale of central government securities, sale of state
government loans continue to be on old pattern and procedures. Under the present system, there
is no scope for better managed states to access funds at competitive rates of interest. Hence, it
is necessary to bring flexibility in the borrowing programs of the state ‘governments with the
help of RBI initiatives.

d) Foreign Institu6onal Investors and Public Debt: Foreign Institutional Investors have been
permitted to invest in government debt. In respect of government debt, they are permitted
to invest only in dated government securities.
e) Consolidated Sinking Fund (CSF): It is argued that there is an urgent need to create a
Consolidated Sinking Fund. The CSF has the objective of breaking the vicious cycle of rise
in repayment, burden of public debt. Even the State Government should set upsuch a fund in
view of problem of repayment of loan.
f) Improving the State of Debt Market: Since 1997, the RBI has taken various measures to
widen and deepen the debt market in India These measures include uniform price auction of
91 days treasury bills, undertaking repos in non-government debt instruments, sale of capital
index bonds, etc.
g) Disinvestment Policy: The government should disinvest public sector units, especially, those
which are not strategic, especially the sick ones. Disinvestment will enable the government to
raise f unds, which can be utilized to repay a part of the public debt.
h) Proper Monitoring of Expenditure: The Government should make effort, to monitor the
use of funds. The wastage of funds should be monitored by Government Authorities.
Critical Analysis of Recent Fiscal Policy of Government of India
The critical evaluation for the current fiscal policy is as follows:
1) Tax Revenues: Government of India has forecast that its gross tax revenues will expand by
19% in 2013-14, primarily reflecting an increase in surcharges for direct taxes; and factoring
in COGS expectation that nominal economic growth would be 13.4%. ICRA expects real
economic growth of 5.8-6.0% in 2013-14. Corporation tax collections are estimated to expand
by 17% in 2013-14. Considerably higher than the 11% growth in 2012-13 RE, benefiting from
an expected recovery of corporate profitability.
2) Non-Tax Revenue and Disinvestment Proceeds: The Budget Estimate (BE) for 2013.14
forecast inflows from telecom to double to t400 billion from 200/- billion in FY13, the
achievement of which would depend on market conditions and the outcome of ongoing
legislation regarding one-time spectrum fee from private GSM players. GOI has assumed a
sharp up tick in dividends and profits to 740/- billion in FY14 from -?555 billion in FY13.
The target for disinvestment has been set at 558/- billion.
3) Revenue Expenditure: It is budgeted to increase by 14% in 2013-14 relative to 10% in 2012-
13 RE. Non.. plan revenue expenditure is expected to rise by a modest 8% in 2013-14 BE, lower
than the 13% growth in 2012-13 RE. However, plan revenue expenditure is expected to
expand by a healthy 29% in FY14, following the low 3% growth in 2012-13 RE. In
particular, grants for capital assets are estimated to grow by 41% in FY14 after contracting by
6% in FY13.
4) Capital Expenditure: Capital expenditure and gross lending is budgeted to rise by a sharp 37%
in 2013-14 relative to the modest 6% in 2012-13 RE. Capital expenditure on defense is
expected to rise by 25% in 2013-14 `BE, following the low 2% growth in 2012-13 RE. Non-
defense capital outlay and gross loans and advances are estimated to expand by a sharp 45% in
the corning fiscal (8% in 2012-13 RE). This includes an allocation of 155/- billion for
capitalization of public sector banks, regional rural banks, etc.
5) Fiscal Balances: The revenue deficit and effective revenue deficit are estimated to decline in
2013-14 as compared to 2012-13 RE even as the fiscal deficit is estimated to widen to 5.4/-
trillion from CS.2 trillion, respectively. In particular, the effective revenue deficit is estimated to
decline appreciably to 22.1 trillion in 2013-14 from 2.7/- trillion in the ongoing fiscal.
Moreover, the targeted fiscal deficit of 4.8% of GDP is in line with the target set in October
2012.
6) Borrowings: Government of India has indicated a net long-term borrowing programme of
4.84/- trillion in 2013"14, marginally higher than the borrowings of 4.67/- trillion in
2012-13. However, the gross borrowings to be undertaken by Government of India in 2013-
14 exceeded market expectations (5.8-6.0/- trillion), causing long-term bond yields to harden.
This was on account of the decision to introduce a buyback/swapping of government securities

of t500 billion in 2013-14, to reduce redemption pressure between 2014 -15 to 2018-19.
The fiscal policy for 2013"14, as enunciated in the union budget, has been designed to meet the
macroeconomic challenges faced by India in an uncertain global environment:
1) Revival of Investment Patterns: The reduction in the GFD-GDP ratio in 2013-14 (BE) is based
on higher mobilization of disinvestment proceeds, tax revenues, telecommunication receipts and
reduction in expenditure on subsidies. As the budget relies largely on revenue-led fiscal consolidation,
its success would depend on the revival of investment climate and growth.
2) Reduction in Revenue Deficit: The reduction in revenue deficit by 0.6 per cent of GDP during
2013-14 critically hinges upon the success in meeting the projected tax and non-tax revenues.
The government would have to continue with its efforts towards rationalizing and reducing
subsidies in order to create space for meeting future commitments under the proposed Food
Security Act.
3) Prioritization of Capital Expenditure: The re-prioritization of expenditure in favour of
capital expenditure would increase capital outlay-Gm ratio from 28.1 per cent in 2012-13 to
38.5 per cent in 2013-14. It may be noted that during the fiscal consolidation phase the capital
outlay-GFD ratio, on an average, was as high as 51.4 per cent.
4) Fiscal Consolidation Measures: Overall, the fiscal consolidation measures announced in the
budget will lay the foundation for a sustainable re-balancing of government finances. Fiscal
prudence would impart confidence in the economy and support domestic and foreign investments.
5) Growth in Capital Formation: The envisaged elimination of effective revenue deficit by 2015-
16 would make available additional resources for financing investment and capital expenditure
(including grants for creation of capital assets), ensure the use of government borrowing primarily
for capital formation and aid the growth process. -
`
Suggestions for Reforms in the Fiscal Policy
There are some necessary reforms which should be followed under fiscal policy are as follows:
1) Government undertook path of fiscal consolidation with mid-year course correction in 2012-
13. Fiscal policy 2014-15 should be designed to meet the macroeconomic challenges faced by
India in an uncertain international economic situation.
2) Government should focus on fiscal consolidation process and take some measures to reduce
the fiscal deficit.
3) Government should focus on the creation of capital assets from revenue expenditure; it can be done
through expenditure management and revenue augmentation.
4) A progressive reduction in debt-GDP ratio of the Government will ease the interest burden and
allow more space for the government to spend particularly on infrastructure development without
taking recourse to additional borrowings.
5) With re-prioritization of expenditure towards developmental side and curtailing the growth
in non developmental expenditure, the total expenditure can be easily brought down.
6) The moderation in growth coupled with sticky inflation at much higher than the comfort level
necessitated a change of stance in fiscal policy of the government. The process of fiscal
consolidation which resumed had to be paused once again. For this, government has come up
with a revised fiscal roadmap with gradually reducing fiscal deficit in corning year.
7) Government is determined to bring the deficit down to a more sustainable level and at the same
time re- orient government expenditure towards priority sectors like health, education, irrigation
with added focus on infrastructure and investment related activities.
Development Activities and Allocation of Funds
Funds for carrying out various developmental activities in the District are allocated through the State
budget. In addition, funds are also released directly to the implementing agencies for various
socio-economic and developmental programmes sponsored by Government of India and State
Government,
Allocation of funds is the first major function of fiscal policy is to determine exactly how funds
will be allocated. This is closely related to the issues of taxation and spending, because the
allocation of funds depends upon the ,collection of taxes and the government using that revenue
for specific purposes. The national budget determines how funds are allocated This means that a
specific amount of f unds is set aside for purposes specifically laid out by the government.
This has a direct economic impact on the country.
Development activities seem to indicate economic growth and that is. in fact, its overall purpose.
However, fiscal policy is far more complicated than determining how much the government wdl tax
citizens one year and then determining how that money will be spent. True economic growth
occurs when various projects are financed and carried-out using borrowed funds, This sterns from the
belief that the private sector cannot grow the economy by itself. Instead, some government input and
influence are needed. Borrowing funds for this economic growth is one way in which the
government brings about development. Some of the development activities under fiscal policy 2013-
14 are as follows:
I) GDP Growth: Quarterly GDP at factor cost at constant {2004-2005) prices for Ql of 2013-14 is
estimated
at, 13.71 lac crane, as against ?13.14 lac crane in Ql of 2012-13, showing a growth rate of 4.4
per cent over the corresponding quarter of previous year.
2) Growth in Economic Ac6vities: The economic activities which registered significant growth
in Ql of 2013-14 over Ql of 2012-13 are financing, insurance, real estate and business
services' at 8.9% and community, social and personal services' at 9.4%.
The estimated growth rates in other economic activities are - 3.9% in trade, hotels,
transport and communication', 3.7 per cent in electricity, gas and water supply', 2.8 per cent in
construction, 2.7 per cent in agriculture, forestry and fishing', (-) 1.2 per cent in manufacturing
and(-) 2.8 per cent in mining and quarrying' during this period.
3) Growth in Agricultural Sector: According to the information furnished by the Department of
Agriculture and Cooperation (DAC), which has been used in compiling the estimate of GDP from
agriculture in Ql of 2013-14, the production of coarse cereals and pulses during the Rabi season
of agriculture year 2012-13 (which ended in June 2013) recorded growth rates of 9.8 per cent, 13,7
per cent respectively while rice and wheat declined by 7.0 per cent and 2.6 per cent over the
production in the corresponding season of previous agriculture year. Among the commercial crops,
the production of oilseeds increased by 11.4 per cent during the Rabi season of 2012-13.
4) Growth in Industrial Production: According. to the latest estimates available on the Index of
Industrial Production (IIP)the index of ruining, manufacturing and electricity, registered growth
rates of (-) 4.5%, (-) 1.2% and 3.5%, respectively during Ql of 2013-14, as compared to the growth
rates of (- ) 1.6 per cent, (-) 0.8 per cent and 6.4 per cent in these sectors during Ql of 2012-13.
5) Growth in Construc6on Sector: The key indicators of construction sector, namely, production of
cement and consumption of finished steel registered growth rate of 3.3 per cent and 0.2 per
cent, during Ql of 201314.
6) Growth in Services Sectors: Among the services sectors, the key indicators of railways, namely,
the net tone kilometers have shown growth rate of 1.8 per cent but passenger kilometers declined
by 3.4 per cent during Ql of 2013-14, In case of other transport sectors, passengers handled by the
civil aviation registered growth rates of 3.4 per cent, while the sales of commercial vehicles, cargo
handled at major ports, cargo handled by the civil aviation registered the decline of 8.1 per cent,
1.0 per cent and 2.1 per cent respectively during Ql of 2013-14 over Ql of 2012-13.
The other key indicators, namely, aggregate bank deposits, and bank credits have shown growth rates
of 13.8 per cent, and 13.7 per cent, respectively as on June 2013. It may be mentioned that the
growth of these two indicators - viz,. credits and deposits as on June 2012 were 16.5% and 13.5%
respectively.
Balance of payment
Balance of payments (BOP) meaning:
Nations continually carry out economic, commercial and financial transactions

between residents of one nation and rest of world in the form of:
-- Exchange of goods for goods
-- Goods for services
-- Services for services
-- Goods and services for money etc.
Summary of these transactions for a period carries great economic significance

for the nation.
The systematic record of all economic transactions between residents of a country

and rest of world in a given period is called the Balance of Payment.
BOP statistics are published monthly by RBI in India. These are analyzed by
bankers, businessmen, and economists’ foreign exchange traders etc. to know
international economic performance of the country.
BOP is a double entry system statement of followings:
-- all receipts for goods exported
-- all services rendered
-- capital received by residents* of the nation
-- and payments made by residents* for goods imported and services received in
addition to capital transferred to non-residents and foreigners.
Residents mean
-- Individuals, businesses and govt. agencies.
-- Military personnel, diplomats, tourists and workers who emigrate

temporarily are considered residents of the country of their citizenship.
Definition:
“The Balance of Payments of a country is a systematic record of all economic

transactions between the residents of a country and the rest of the world.”
“A record of international transactions between residents of one country and the

rest of the world”
“A record of all transactions made between one particular country and all other
countries during a specified period of time.”
“The balance of payments of a country is a systematic record of all economic

transactions between the residents of a country and the rest of the world. It
presents a classified record of all receipts on account of goods exported, services
rendered and capital received by residents and payments made by them on
account of goods imported and services received and capital transferred to non-
residents or foreigners.”
-- Reserve Bank of
India
Balance of Payment is a systematic record of all its monetary transactions with

other countries in the world in a given period of time. i.e. one year. When we say a
country’s balance of payments, we are referring to the transactions of citizens and
government.
Objective:
Its main objective is to represent the economic position of a country, whether its
currency is rising or falling in its external value.
Characteristics of Balance of Payments:
• It is statement having two sides.
• It is a record of economic transactions.
• It shows a relation between receipts & payments.
• Visible & Invisible items both are included in this statement.
• It is prepared for a certain period of time.
IMPORTANCE OF B.O.P
 Records all the transactions that create demand for and supply of a
currency.
 Indicates demand-supply equation of the currency.
 Confirm trend in economy’s international trade and exchange rate of the

currency.
 Indicate change or reversal in the trend.
 Indicate policy shift of the monetary authority (RBI) of the country.
Structure of balance of payments accounts
The balance of payments account of a country is based on the principle of

double-entry book-keeping.
Each transaction is entered on the credit and debit side of statement. But
balance of payments accounting differs from business accounting in one
respect. In business accounting, debit (-) are shown on the left side
BALANCE OF PAYMENTS ACCOUNT
STRUCTURE OF BALANCE OF PAYMENT

Credits (+) Receipts Debits (-) Payments
Current account
1. Merchandise Export of goods. (sale 1. Merchandise Import of goods.
of goods) (Purchase of goods)
2. Invisible Exports (sale of services) 2. Invisible Imports (Purchase of services)

a. Transport services(sold) a. Transport services(Purchase)
b. Insurance (sold abroad) b. Insurance (Purchase abroad)
c. Foreign tourist (expenditure in c. Foreign tourist (expenditure in foreign)

country)
d. Other services (sold to abroad) d. Other services (Purchase from abroad)
e. Income received on loans and e. Income paid on loans and investments
investments abroad in home country.
Capital account
Foreign long-term investment long term investment abroad
a. Direct investments in home a. Direct investments in home
b. Foreign investments securities in b. investments in Foreign securities
domestic
c. Other investment c. Other investment
Unilateral transfer account
Private remittance received from Private remittance abroad
abroad
Pension payments received from Pension payments abroad
abroad
Government grants received from Government grants abroad
abroad
Official statement account
Official sale of foreign currency or Official purchase of foreign currency or
other reserve assets abroad other reserve assets abroad
Total credit Total debit
Components of Balance of Payment
1) B.O.P. on Current account

2) B.O.P. on Capital account
3) Unilateral Payment accounts
4) Official Settlement accounts
* Balance Of Payment on Current Account
The current account of the balance of payments records India’s total

transactions, both visible and invisible.
Merchandise exports and imports: merchandise exports include the sale of

goods to foreign countries. Most of these transactions are on credit basis. All
these transactions give rise to monetary claims on foreign importing
companies. These claims are credits. Contrary to these transactions,
merchandise imports include purchase of goods from foreign countries. Debit
entries are made for these transactions as they rise to foreign exchange claims
on the home country. These claims are debits.
Invisible exports and imports: All current transactions include both visible
and invisible items. The export and import of goods are known as visible items.
Whereas invisible items include 121 items these are classified into 8 heads.
Such as travel, transportation, insurance, investment income, government not
included elsewhere, miscellaneous (receipts/ payments for patents and

royalties), shipping, and banking etc.
Invisible exports include the sale of services to the foreigners like insurance,
tourism, transportation, banking, financial services, etc. similarly, invisible
exports also include interest and dividends received from the foreign countries.
These are debit side.
Invisible imports include the purchase of services from the foreigners like
insurance, tourism, transportation, banking, financial services, payment of
interest and dividend to the foreigners. These items are placed on credit side.
Credits (+) Receipts Debits (-) Payments

Current account
1. Merchandise Export of goods. 1. Merchandise Import of goods.
(sale of goods) (Purchase of goods)
2. Invisible Exports (sale of services) 2. Invisible Imports (Purchase of

services)
e. Transport services(sold) f. Transport services (Purchase)
f. Insurance (sold abroad) g. Insurance (Purchase abroad)
g. Foreign tourist (expenditure in h. Foreign tourist (expenditure in
country) foreign)
h. Other services (sold to abroad) i. Other services (Purchase from
abroad)
j. Income received on loans and f. Income paid on loans and
investments abroad investments in home country.
Balance of Payment on Capital Account
-- It comprises of
i) Private capital (both long and short-term) : Long- term with maturity
period of more than one year and short-term with maturity of one year or less.
-- Long-term private capital includes Foreign Investments (both Direct

and Portfolio), long term loans, foreign currency deposits and unclassified
capital account receipts of foreign currency, SDRs etc.
ii) Banking capital covers the external financial assets and liabilities of
commercial and co-operative banks who deal in foreign exchange.
iii) Official capital is RBI’s holding of foreign currency, SDRs etc. on behalf of
Govt. of India in the form of loan miscellaneous receipts, payments etc.
-- Capital outflow from home country to foreign countries is treated as debit

and inflow of capital from foreign countries to home country is treated as credit.
* Unilateral Transfers Account
It comprises of uni-directional transactions like ‘giving of gifts. Disaster relief,

foreign aids, govt. grants, pension paid to and received by Indian citizens for
services rendered abroad.
* Official Settlements Account
It represents official sales of foreign currencies and other reserves to foreign

countries or official purchase of foreign currencies or other reserves from foreign
countries.
-- Credits here are money received from official sale of foreign currencies and
reserves. Similarly, debits comprise of official purchases of foreign currencies and
other assets.
Factors affecting BOP:
Cost of production: the cost of production (land, labour, capital, taxes,

incentives etc.) in the exporting economy vis-à-vis those in the importing
economy.
Demand and supply: the demand and supply trend define the cost of domestic
products to be sold in the
international market.
FACTORS AFFECTING BOP
Cost and availability: the cost
and availability of raw materials,
COST OF PRODUCTION
intermediate goods, and other DEMAND AND SUPPLY
inputs.
EXCHANGE RATE
COST AND AVAILABILITY
Exchange rate movements: for MOVEMENTS
nations with low exchange rate
values, balance of trade tends to DOMESTIC BUSINESS TRADE AGREEMENTS
remain unfavourable.
EXTERNAL PRESURES PRICE
Domestic business: sound and
domestic policies are required to
boost production and international trade. Some countries like the US provide
subsidies to local manufacturers for exported goods and services.
Trade agreements: bilateral agreements govern international trade3 and define

the products and their prices in the global context.
External pressures: many countries export items that face heavy competition in
international market. This results in market segmentation and low pricing.
Price: prices of goods manufactured at home. these are influence by

responsiveness of supply.
EQUILIBRIUM AND DISEQUILIBRIUM IN BOP:

Balance of payments is the difference between the receipts from and
payments to foreigners by residents of a country. In accounting sense balance of
payments, must always balance. Debits must be equal to credits. So, there will be
equilibrium in balance of payments.
Symbolically, B = R - P
Where: - B = Balance of Payments
R = Receipts from Foreigners
P = Payments made to Foreigners
When B = Zero, there is said to be equilibrium in balance of payments.
When B is positive there is favourable balance of payments; When &. B is

negative there is unfavourable or adverse balance of payments.' When there is a
surplus or a deficit in balance of payments there is said: to be disequilibrium in
balance of payments. Thus, disequilibrium refers to imbalance in balance of
payments.
Types of Disequilibrium in Balance of Payments:

Balance of payments is the difference between the receipts from and
payments to foreigners by residents of a country. In accounting sense balance of
payments, must always balance. Debits must be equal to credits. So, there will be
equilibrium in balance of payments.
Symbolically, B = R - P
Where: - B = Balance of Payments
R = Receipts from Foreigners
P = Payments made to Foreigners
When B = Zero, there is said to be equilibrium in balance of payments.
When B is positive there is favorable balance of payments; When &. B is

negative there is unfavorable or adverse balance of payments.' When there is a
surplus or a deficit in balance of payments there is said: to be disequilibrium in
balance of payments. Thus, disequilibrium refers to imbalance in balance of
payments.
TYPES OF DISEQUILIBRIUM IN BOP:

The following are the main types of disequilibrium in the balance of
payments: -
1. Structural Disequilibrium: -
Structural disequilibrium is caused by structural changes in the economy
affecting demand and supply relations in commodity and factor markets. Some of
the structural disequilibria are as follows: -
a. A shift in demand due to changes in tastes, fashions, income etc. would
decrease or increase the demand for imported goods thereby causing
disequilibrium in BOP.
b. If foreign demand for a country's products declines due to new and cheaper
substitutes abroad, then the country's exports will decline causing a deficit.
c. Changes in the rate of international capital movements may also cause
structural Disequilibrium.
d. If supply is affected due to crop failure, shortage of raw-materials, strikes,
political instability etc., then there would be deficit in BOP.
e. A war or natural calamities also result in structural changes which may
affect not only goods
but also factors of production causing disequilibrium in BOP.
f. Institutional changes that take place within and outside the country may
result in BOP
disequilibrium. For Eg. if a trading block imposes additional import duties on
products imported in member countries of the block, then the exports of
exporting country would be restricted or reduced. This may worsen the BOP
position of exporting country.
2. Cyclical Disequilibrium: -
Economic activities are subject to business cycles, which normally have
four phases Boom or Prosperity, Recession, Depression and Recovery. During
boom period, imports may increase considerably due to increase in demand for
imported goods. During recession and depression, imports may be reduced due to
fall in demand on account of
reduced income. During
recession exports may increase
due to fall in prices. During boom TYPES OF DISEQULIBRIUM
period, a country may face deficit
in BOP on account of increased Structural disequilibrium Cyclical disequilibrium
imports.
short - run long - term
Cyclical disequilibrium in
disequilibrium disequilibrium
BOP may occur because
a. Trade cycles follow different Monetary disequilibrium Technological
paths and patterns in different disequilibrium
countries.
b. Income elasticities of demand
for imports in different countries are not identical.
c. Price elasticities of demand for imports differ in different countries.
3. Short - Run Disequilibrium: -
This disequilibrium occurs for a short period of one or two years. Such
BOP disequilibrium is temporary in nature. Short - run disequilibrium arises due
to unexpected contingencies like failure of rains or favourable monsoons, strikes,
industrial peace or unrest etc. Imports may increase exports or exports may
increase imports in a year due to these reasons and causes a temporary
disequilibrium exists.
International borrowing or lending for a short - period would cause short -
run disequilibrium in balance of payments of a country.
Short term disequilibrium can be corrected through short - term borrowings.
If short - run disequilibrium occurs repeatedly it may pave way for long - run
disequilibrium.
4. Long - Run I Secular Disequilibrium: -
Long run or fundamental disequilibrium refers to a persistent deficit or a
surplus in the balance of payments of a country. It is also known as secular
disequilibrium. The causes of long - term disequilibrium are
a. Continuous increase in demand for imports due to increasing population.
b. Constant price changes - mostly inflation which affects exports on continuous
basis.
c. Decline in demand for exports due to technological improvements in importing
countries, and as
such the importing countries depend less on imports.
The long run disequilibrium can be corrected by making constant efforts to
increase exports and to reduce imports.
5. Monetary Disequilibrium
Monetary disequilibrium takes place on account of inflation or deflation.
Due to inflation, prices of products in domestic market rises, which makes
exports expensive. Such a situation may affect BOP equilibrium. Inflation also
results in increase in money income with people, which in turn may
increase demand for imported goods. As a result, imports may turn BOP position
in disequilibrium.
6. Exchange Rate Fluctuations: -
A high degree of fluctuation in exchange rate may affect the BOP position.
For Eg. if Indian Rupee gets appreciated against dollar, then Indian exporters will
receive lower amounts of foreign exchange, whereas, there will be more outflow of
foreign exchange on account of higher imports. Such a situation will adversely
affect BOP position. But, if domestic currency depreciates against foreign
currency, then the BOP position may have positive impact.
Causes of BOP Disequilibrium
Any disequilibrium in the balance of payment is the result of imbalance between
receipts and payments for imports and exports. Normally, the term disequilibrium
is interpreted from a negative angle and therefore, it implies deficit in BOP.
The disequilibrium in BOP is caused due to various factors. Some of them are
I. Import - Related Causes
The rise in imports has been the most important factor responsible for
large BOP deficits. The causes of rapid expansion of imports are :-
1. Population Growth
Population Growth may increase the demand for imported goods such as
food items and non-food items, to meet their growing needs. Thus, increase in
imports may lead to BOP disequilibrium.
2. Development Programme
Increase in development programmes by developing countries may
require import of capital goods, raw materials and technology. As development is
a continuous process, imports of these items continue for a long time landing the
developing countries in BOP deficit.
3. Imports of Essential Items
Countries which do not have enough supply of essential items like Crude
oil or Capital equipments are required to import them. Again, due to natural
calamities government may resort to heavy imports, which adversely affect the
BOP position.
4. Reduction of Import Duties
When import duties are reduced, imports become cheaper as such
imports increases. This increases the deficit in BOP position.
5. Inflation
Inflation in domestic markets may increase the demand for imported
goods, provided the imported goods are available at lower prices than in domestic
markets.
6. Demonstration Effect
An increase in income coupled with awareness of higher living standard
of foreigners, induce people at home to imitate the foreigners. Thus, when people
become victims of demonstration effect, their propensity to import increases.
II. Export Related Causes: -
Even though export earnings have increased but they have not been
sufficient enough to meet the rising imports. Exports may reduce without a
corresponding decline in imports. Following are the causes for decrease in exports
1. Increase In Population: -
Goods which were earlier exported may be consumed by rising
population. This reduces the export earnings of the country leading to BOP
disequilibrium.
2. Inflation: -
When there is inflation in domestic market, prices of export goods
increases. This reduces the demand of export goods which in turn results in trade
deficit.
3. Appreciation of Currency: -
Appreciation of domestic currency against foreign currencies results in
lower foreign exchange to exporters. This demotivates the exporters.
4. Discovery Of Substitutes: -
With technological development new substitutes have come up. Like plastic
for rubber, synthetic fiber for cotton etc. This may reduce the demand for raw
material requirement.
5. Technological Development: -
Technological Development in importing countries may reduce their
imports. This can be possible when they start manufacturing goods which they
were exporting earlier. This will have an adverse effect on exporting countries.
6. Protectionist Trade Policy: -
Protectionist trade policy of importing country would encourage domestic
producers by giving them incentives, whereas, the imports would be discouraged
by imposing high duties. This will affect exports.
III. Other Causes: -
1. Flight of Capital
Due to speculative reasons, countries may lose foreign exchange or gold
stocks. Investors may also withdraw their investments, which in turn puts
pressure on foreign exchange reserves.
2. Globalization
Globalization and the rules of WTO have brought a liberal and open
environment in global trade. It has positive as well as negative effects on imports,
exports and investments. Poor countries are unable to cope up with this new
environment. Ultimately, they become loser and their BOP is adversely affected.
3. Cyclical Transmission
International trade is also affected by Business cycles. Recession or
depression in one or more developed countries may affect the rest of the world.
The negative effects of trade cycle (low income, low demand, etc.) are transmitted
from one country to another. For eg. The current financial crisis in U.S.A. is
affecting the rest of the world.
4. Structural Adjustments
Many countries in recent years are undergoing structural changes. Their
economies are being liberalized. As a result, investment, income and other
variables are changing resulting in changes in exports and imports.
5. Political factors
The existence of political instability may result in disrupting the productive
apparatus of the country causing a decline in exports and increase in imports.
Likewise, payment of war expenses may also seriously affect disequilibrium in the
country’s BOP. Thus, political factors may also produce serious disequilibrium in
the country’s BOPs.
Different measures to correct disequilibrium in BOP:

Any disequilibrium (deficit or surplus) in balance of payments is bad for
normal internal economic operations and international economic relations. A
deficit is more harmful for a country’s economic growth; thus, it must be
corrected sooner than later. The measures to correct disequilibrium can be
broadly divided into four groups
I. Monetary Measures: -
1) Monetary Policy: -
The monetary policy is concerned with money supply and credit in the
economy. The Central Bank may expand or contract the money supply in the
economy through appropriate measures which will affect the prices.
A. Inflation: -
If in the country there is inflation, the Central Bank through its monetary
policy will make an attempt to reduce inflation. The Central Bank will adopt tight
monetary policy. Money supply will be controlled by increase in Bank Rate, Cash
Reserve Ratio, Statutory Ratio etc.
The monetary policy measures may reduce money supply, and encourage
people to save more, which would reduce inflation. If inflation is reduced, the
prices of domestic market will decrease and also that of export goods. In foreign
markets there will be more demand for export goods, which would correct BOP
disequilibrium.
B. Deflation :-
During deflation the
Central Bank of the country
may adopt easy monetary
policy. It will try to increase
money supply and credit in the EXCHANGE
economy, which would RATE POLICY POLICY
increase investment. More FISCAL MONETARY
investment leads to more POLICY NON-
production. Surplus can be

MOETARY
exported, which in turn may POLICY
improve BOP position.
2) Fiscal Policy
Fiscal policy is government's policy on income and expenditure.
Government incurs development and non - development expenditure, it gets
income through taxation and non - tax sources. Depending upon the situation
governments expenditure may be increased or decreased.
a) Inflation
During inflation the government may adopt easy fiscal policy. The tax
rates for corporate sector may be reduced, which would encourage more
production and distribution including exports. Increased exports will bring more
foreign exchange there by making the BOP position favorable.
b) Deflation
During deflation the government would adopt restrictive fiscal policy. It
may impose additional taxes on consumers or may introduce tax saving schemes.
This may reduce the consumption of citizens, which in turn may enable more
export surplus.
To restrict imports the government may also impose additional tariffs or
customs duties which may improve the BOP position.
3) Exchange Rate Policy
Foreign exchange rate in the market may directly or indirectly be

influenced by the Government.
a) Devaluation
When foreign exchange problem is faced by the country, the government
tries to reduce imports and .increase exports. This is done through devaluation of
domestic currency. Under devaluation, the- government makes a deliberate effort
to reduce the value of home country. If devaluation is carried out, then the
exports will become cheaper and imports costlier. This is turn will help to reduce
imports and increase exports.
b) Depreciation
Depreciation like devaluation lowers the value of domestic currency or
increases the value of foreign currency. Depreciation of a country's currency
takes place in free or competitive foreign exchange market due to market forces.
Depreciation and devaluation have the same effect on exchange rate. If there is
high demand for foreign currency than its supply, it will appreciate and vice
versa. However, in several countries the system of managed flexibility is followed.
If there is more demand for foreign exchange, the central bank will release the
foreign currency in the market from its reserves so as to reduce the appreciation
of foreign currency. If there is less demand for foreign exchange, it will purchase
the foreign currency from market so as to reduce the depreciation of foreign
country and appreciation of domestic currency.
Due to devaluation and depreciation of domestic currency, the exports
become cheaper and imports become expensive. This helps to increase exports.
I) Non-Monetary / General Measures:
A deficit country along with monetary measures may adopt the following
non-monetary measures too, which will either restrict imports or promote
exports.
1) Tariffs: -
Tariffs refer to duties on imports to restrict imports. Tariff is a fiscal device
which may be used to correct an adverse balance of payments. The imposition of
import duties will raise the prices of imports. This will lead to a reduction in
demand for imports thereby improving the balance of payments position.
2) Quotas: -
Under Quota System, the government may fix and permit the maximum
quantity or value of a commodity to be imported during a given period. By
restricting imports through quota system, the deficit is reduced and the balance
of payments position is improved.
3) Export Promotion: -
The government may introduce a number of export promotion measures to
encourage exporters to export more so as to earn valuable foreign exchange,
which in turn would improve BOP Situation. Some of the incentives are
Subsidies, Tax Concessions, Grants, Octroi refund, Excise exemption, Duty
Drawback, Marketing facilities etc.
4) Import Substitution
Governments, especially, that of the developing countries may encourage
import substitution so as to restrict imports and save valuable foreign exchange.
The government may encourage domestic producers to produce goods which were
earlier imported. The domestic producers may be given several incentives such as
Tax holiday, Cash Subsidy, Assistance in Research & Development, Providing
technical assistance, Providing Scarce inputs etc.
CONCLUSION: -
From the above measures it is clear that more exports with import
substitution based on economic strength of the country are the real effective
solutions to correct the disequilibrium in the balance of payments.

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Be-Unit - Iii

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BUSINESS ENVIRONMENT

Fisc : A French word means ‘Treasure of Government’.

- Kaushik Basu (Former Chief Economic Adviser)

“Fiscal policy means public expenditure and tax policy”.

Nature of Fiscal policy:

Common accounting year for income tax

Reliance on indirect taxes (exercise duty or custom duty)

Reduce the creation of black money

A cure of inflation Economic

Functions of Fiscal policy: Distribut Fiscal Policy Price

Accelerate of the rate of economic

Fiscal Policy Objectives Optimum allocation of resources

Equitable distribution of income

Capital formation and growth

Importance of Fiscal Policy:

 Government activities are enlarged.

 Tax- Revenue and Expenditure accounts for large proportion of GNP.

 Government affects the Economic activities through gap between government

 It indicates the level of overall borrowings by the government.

It is the indicator of fiscal health of the economy.

Instruments of Fiscal policy:

Fiscal policy also known as “budgetary policy" operates through budget

Classification of Public Revenues

Public revenue consists of taxes and Non-tax revenues:

Tax Revenue Non-tax Revenue

Direct Tax Indirect Tax Fees

The following are the characteristics of a tax:

I) A tax is a compulsory payment made to the government.

4) Special Assessment of Betterment Levy: It is a kind of special charge levied on certain

Types of Public Expenditure

Transfer Expenditure Non- transfer Expenditure

Types of Public Expenditure

research, and water works, parks, etc.

Developmental Activities Financed by Public Expenditure

Effects of Public Expenditure

i) Effect on Production: According to Professor Dalton, the effect of public expenditure

According to Professor Dalton, public expenditure certainly increases production.

Increasing Administration Expenditure: Large amount of public expenditure is incurred on

Components of Public Debt

Provident Funds: These are divided into two categories:

a) Employee Provident Funds meant for employees.

b) Public Provident Funds meant for general public.

c ) O u t s t a n d i n g amount under provident fund stood 66,217 crores at the

~ Classification of Public Debt

Reduction in Growth of Current

Raising Efficency of Borrowing Reforms in Debt Management of

Foreign Institutional Investors

Improving the State of Debt

Proper monitoring of Expenditure

Measures to Reduce Public Debt

a) Reduction in Growth of Current Expenditure: In order to reduce primary deficit,

help of RBI initiatives.

This was on account of the decision to introduce a buyback/swapping of government securities

Suggestions for Reforms in the Fiscal Policy

Nations continually carry out economic, commercial and financial transactions

-- Exchange of goods for goods

-- Goods for services

-- Services for services

-- Goods and services for money etc.

Summary of these transactions for a period carries great economic significance

The systematic record of all economic transactions between residents of a country

BOP is a double entry system statement of followings:

-- all receipts for goods exported