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UNIT 1UNIT 1 Economic EnvironmentEconomic Environment

Concepts & Significance of economic environment at

national & international level

Economic System: Lassiez faire, capitalism, socialism &

mixed economy

National Income

Monetary & Fiscal Policy

Finance commission

Industrial Policy

Latest five year plan

State Industrial Policy

Union Budget

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Important factors of economic environmentImportant factors of economic environment

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Economic Systems

Market economy or capitalism

Planned economy or command economy

Mixed economy

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National IncomeNational Income

Income of a country in a given year.

Measures the economic growth of a country.

Components of National Income GDP

GNP

NDP

NNP

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Monetary PolicyMonetary Policy

Monetary Policy refers to the use of

instruments within the control of the Central

Bank to influence the level of aggregate

demand for goods and services or to

influence the trends in certain sectors of the

economy.

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Measures ofMoney Stock

A knowledge of the measures of money stock in an

economy would help us to understand monetary

policy better. The Reserve Bank of India employs four measures

of money stock, namely, M1, M2, M3 and M4.

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M1: The measure of money stock designated by M1 is

usually described as the money supply.

M2: M2 is M1 + Post Office Savings Bank Deposits.

M3: M3 is M1 + Time Deposits with the banks. In otherwords, M3 is money supply plus fixed deposits with the

banks. M3 is usually referred to as aggregate monetary

resources.

M4: M4 is M3 plus the total Post Office Deposits.

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Instruments ofMonetary Policy

The instruments of monetary policy (methods of credit

control) may be broadly divided into:

General (Quantitative) methods; and Selective (Qualitative) methods.

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Credit Control

Bank Rate

Open Market Operations (OMO)

Cash Reserve Ratio (CRR)

Selective Credit Control (SCC)

Contd

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General Credit Controls

There are three general or quantitative instruments

of credit control, namely, the Bank Rate, Open

Market Operations and Variable ReserveRequirements.

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Bank Rate Policy

The term Bank Rate refers to the minimum rate at

which the central bank provides financialaccommodation to commercial banks in the

discharge of its function as the lender of the last

resort.

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Variable Reserve Ratios

The central bank has the power to vary this reserve

requirement; and the variation in the reserverequirements affect the credit creating capacity of

commercial banks.

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Selective Credit Regulation

Selective and qualitative credit control refers to

regulation of credit for specific purposes or branchesof economic activity.

The aim of selective controls is to discourage such

forms of activity as are considered to be relatively

inessential or less desirable.

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Fiscal Policy

Fiscal Policy is that part of Government policy whichis concerned with raising revenue through taxationand other means and deciding on the level andpattern of expenditure.

The fiscal policy operates through the budget.

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The Union Budget The Constitution of India provides that

1. No tax can be levied or collected except by authority

of law.2. No expenditure can be incurred for public funds

except in the manner provided in the Constitution.

3. The executive authorities must spend public money

only in the manner sanctioned by Parliament in thecase of the Union and by the State legislature in thecase of a State.

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State Budgets Like the Union Government, State Governments,

too, have their own budgets. Estimates of receipts

and expenditure are presented by the StateGovernments to their legislatures before the

beginning of the financial year and legislative

sanction of expenditure is secured through similar

procedure.

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Importance of The Budget

There is no other Government measure that affectsthe whole economy as the Budget.

No wonder all sections of the people await the

annual Budget with mixed feelings-anxiety, fear andhope.

The endeavour of the Finance Minister is to presenta Budget which gives maximum support to forces

that can move the country forward on the path ofgrowth with stability and social justice.

The Budget should set the stage for theachievement of economic and social goals.

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MONETARY POLICYOF INDIA

Monetary policy is primarily concerned with themanagement of supply of money in a growing economyand managing the rate of growth of money supply perperiod.

Historically, the monetary policy was announced twice ayeara slack-season policy (AprilSeptember) and abusy-season policy (OctoberMarch) in accordance withagricultural cycles. These cycles also coincide with thehalves of the financial year.

Initially, the RBI used to announce all its monetarymeasures twice a year in the monetary and credit policy.The monetary policy has now become dynamic in natureas RBI reserves its right to alter it from time to time,depending on the state of the economy.

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OBJECTIVES OF THE MONETARY

POLICY

There are four main channels which the RBI looks at.

They are

1. Quantum channel: money supply and credit (affects

real output and price level throughchanges in reserves money, money supply, and credit

aggregates).

2. Interest-rate channel.

3. Exchange-rate channel (linked to the currency).4. Asset price.

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RBIS MONETARY POLICYMEASURES

In recent years, the monetary policy of the country

has been following two sets of objectives.

Firstly, the policy is trying to enhance the flow of

bank credit in adequate quantity to industry,agriculture and trade to meet the requirement, and

also to provide special assistance for neglected

sectors and weaker sections of the community.

Secondly, monetary policy of the RBI is also tryingto maintain internal price stability by controlling the

flow of credit to the optimum level.

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FISCAL POLICYOF INDIA

An effective fiscal policy is composed of

policy decisions relating to entire financial

structure of the government, including tax

revenue, public expenditures, loans,

transfers, debt management, budgetary

deficit, and so on.

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OBJECTIVES OF THE FISCAL

POLICY To mobilise adequate resources for financing various programmes and

projects adopted for economic development

To raise the rate of savings and investment for increasing the rate ofcapital formation;

To promote necessary development in the private sector through fiscal

incentive; To arrange an optimum utilisation of resources;

To control the inflationary pressures in economy in order to attaineconomic stability;

To remove poverty and unemployment;

To attain the growth of public sector for attaining the objective of

socialistic pattern of society; To reduce regional disparities; and

To reduce the degree of inequality in the distribution of income andwealth.

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Fiscal Policy & Economic DevelopmentFiscal Policy & Economic Development

Raise the productive investment of both

public & private sector

Enhance the marginal & average rates of

savings for mobilising adequate financial

resources for making investment in public &

private sectors of the economy.

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Aspects of fiscal policy

Taxation policy

Public expenditure policy

Public debt policy Deficit financing policy

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Shortcomings

of fiscal policy of India Instability

Defective tax structure

Inflation Negative return of the public sector

Growing instability

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Suggestions for necessary reforms in Fiscal

Policy Progressive taxes

Agricultural taxation

Broad based tax net

Checking tax evasion

Increasing reliance on direct taxes

Simplified tax structure

Reduction of non development expenditure Checking black money

Raising the profitability of PSUs

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Recent fiscal policy reforms

Reduction of rates of direct taxes

Simplification of tax procedure

Reform in indirect taxes Fall in the volume of government expenditure

Reduction in volume of subsidies

Reduction in fiscal deficits Reduction of public debt

Disinvestments in public sector

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Finance CommissionFinance Commission

The Constitution of India provides for the establishment

of a Finance Commission for the purpose of allocation

of certain resources of revenue between the Union and

the State Governments. The Finance Commission is

established underArticle 280 of the Constitution of India

by the President.

The qualifications, powers and procedures of the

Commission itself are regulated by the Finance

Commission (Miscellaneous Provisions) Act 1951. SuchCommissions are deemed to be civil courts for the

purposes of the Code of Criminal Procedure 1898.

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The Finance Commission is constituted to define

financial relations between the Center and the States.

Under the provision ofArticle 280 of the constitution, the

President appoints a Finance Commission for the

specific purpose of devolution of non-plan revenue

resources.

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Functions ofFinance Commission

UnderArticle 280 of the Constitution the Finance Commissionis required to make recommendations to President inrespect of:

The distribution of net proceeds of taxes to be shared

between the Centre and the States, and the allocationbetween the States, the respective share of such proceeds.

The principles which should govern the grants-in-aid by theCentre to States out of the Consolidated Fund of India.

The measures needed to augment the Consolidated fund ofa State to supplement the resources of the Panchayats andthe Municipalities in the state on the basis of therecommendations made by the State Finance Commission.

Any other matter referred to it by the President in the

interests of sound finance.

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INDUSTRIAL POLICY

Meaning -

Industrial policy means rules, regulations, principles,

policies, and procedures laid down by government

for regulating, developing, and controlling industrial

undertakings in the country.

The pattern and pace of development of the

economy are significantly influenced by industrial

policy.

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Industrial Policy Up To 1991

The industrial policy of India prior to the liberalisation

ushered in 1991 was characterised by the following

features. Reservation of Industries

Dominance of Public Sector

Entry and Growth Restrictions

Restrictions on Foreign Capital and Technology

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Objectives - The New Industrial Policy

1. To build on the gains already made.2. To correct the distortions or weakness that may have

crept in.

3. To maintain a sustained growth in productivity andgainfull employment.

4. To attain international competitiveness.5. Reducing or minimising the bureaucratic control of the

industrial economy of India

6. Liberalisation of industrial and economic activities for

integrating the Indian economy with the world economy7. Removing restrictions on foreign direct investment

8. Freeing the domestic entrepreneur from excessiveMRTP restrictions

9. Streamlining the role of public sector enterprises.

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Among the areas covered, the most important

ones

are:

1. Industrial licensing,

2. Foreign investment,3.Technology transfer and import of foreign

technology,

4. Public sector policy,5. Policy relating to MRTP Act, and

6. An exclusive small-sector policy.

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An Evaluation of The New Policy

The industrial policy announced in July 1991 alongwith other economic policy changes and measuresushered in a process of economic reforms in India.

Now there are no entry and growth restrictions onthe private sector, except in a very small number ofindustries. The policy towards foreign capital andtechnology has been substantially liberalised.Imports have been very significantly liberalized;quantitative restrictions on imports, by and large,have been removed.

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Latest five year plan

Eleventh five year plan