ECONOMY NOTES FOR UPSC

Economy holds a very important role in UPSC civil service examination be it in prelims or mains. Generally, it is seen that student from non economics background fear a lot with this subject so here we are with the solution i.e. a series of economy notes for upsc examination.

Economy question related to Indian economy are generally asked in prelims and mains but in mains certain occurrence of any event in global arena with light on Indian economy can be asked.

Notes presented here are in a series with a simpler and understandable language so follow regularly to get them.

Note- soon there will also notes for economy survey and budget too.

CHAPTER 3 :- ECONOMIC POLICIES

ECONOMIC POLICIES

 

Monetary policy                                         Fiscal policy

Monetary policy: – monetary policy is strategy to influence movements of money supply and interest rates to affect output and decreasing value of money (can also be said as inflation). Monetary policies are generally done by central bank of that country. Basically a macroeconomic policy tool is to manage the states’ money supply to influence interest rates, inflation and credit availability through changes in supply of money available in economy.

Fiscal policy:- segment of government policy which deals with raising revenues (through taxation and with deciding on the amounts and purpose of government spending) and spending in order to monitor  and influence a nation’s economy. Fiscal policy includes raising and spending money in quantitative and qualitative terms. Fiscal policy tries to achieve important public policy goals like growth, equity, promotion of small scale industries, export promotion etc.

Monetary policy the use by central bank of interest rate and other instruments to influence money supply to achieve certain macro economics goals is known as monetary policy. Credit policy is a part of monetary policy as it deals with how much and at what rate credit is advanced by banks.

Objectives  speeding growth of economy, price stability in economy, stabilization of exchange rate, balancing savings and investments and generating employment.

Monetary policy can be expansionary or contractionary according to increase and decreasing money supply.

Tools of monetary policy

Quantitative tools	Qualitative
Reserve ratio :- Cash reserve ratio(CRR), Statutory liquidity ratio(SLR)	Margin or loan to value
Open market operation(OMO)	Consumer credit control/down payments
Rates (repo rate, reverse repo rate, bank rate	Rationing
Marginal  standing facility (MSF)	Moral suasion
Liquidity adjustment facility (LAF)	Direct action

All the above stated tools are counted on NET DEMAND AND TIME LIBILITIES. Net demand for banks is the total amount of money they received in current account and saving account (remember it by memorizing CASA). Time liabilities are the amount of money banks is liable to pay on maturity which is kept with bank in form of recurring deposits and fixed deposits. NDTL is counted fortnightly. (Time liabilities are more than demand liabilities)

Reserve ratio:- 

Cash reserve ratio (CRR) is the amount of money fixed by RBI to be followed by all banks to keep with RBI in form of cash. Generally it is very less because the banks don’t get any profit now around 4%

Statutory liquidity ratio (SLR) is the amount of money decided by RBI for the all banks have to keep with themselves in form cash, gold, rbi approved securities.  Here bank earns some profit. Now around 21%.

Open market operation (OMO) of RBI can be described as purchase and sale of government securities in open market by RBI  in order to influence the volume of money and credit in economy .so purchase means injection of money and sell means absorbing money from market. (omo’s donot change the total stock of government securities)

Rates :-1) bank rate:- RBI give loan to banks on long term basis so interest paid by banks to rbi is bank rate.(nothing is collateral here)

2). Repo rate :-also known as  POLICY RATE,short term basis for lending of money .RBI will give money and purchase government securities. Generally, rate is 1%higher then reverse repo.

3). Reverse repo rate:-  it can be understand by as it is borrowing from market (absorbs excess liquidity)with the sale of securities and repurchase them the next day.

(here all the securities talk about are RBI approved securities)

4). Liquidity adjustment facility(LAF) ;- introduced by rbi in year 2000.here bank can borrow from RBI and lend to RBI. Minimum amount is 5 crore and banks and NBFC can use this facility.

5).marginal standing facility (MSF) :- By RBI in 2011. Here in this facility bank can borrow overnight upto 9% of net demand and time liabilities.

TABLE TO REMEMBER:-

Monetary policy tools	TO COMBAT INFLATION	TO COMBAT DEFLATION
CRR and SLR	INCREASE	DECREASE
REPO RATE	DECREASE	INCREASE
REVERSE REPO RATE	INCREASE	DECREASE
MSF and LAF	INCREASE	DECREASE
OMO’S	SELLING	PURCHASE

Recent development in monetary policy–

1.Monetary policy framework between GOI and RBI.

:-Monetary policy will be made by governor of RBI.

:-monetary policy will be based on flexible inflation targeting.

:-policy rate=repo rate

:- monetary policy will be on theNEW CPI based

:- RBI  will  be considered failed when less then target for continuing upto 3 quarters.

:-monetary policy committee will bw made along with statutory status.

 6.Double financial repression on banks:-It means repression on the both sides of accounts

Assets side repression because	Liability side repression because
Higher NPA	Less deposits
Higher SLR(low return)	Less equity
Due to Priority sector lending norms poor performance mainly because of less agriculture return due to low monsson

 7.Newly made Bank Board of Bureau . chairman is elected for 2 years +3 members , +3 ex-officio member

Functions would be :- search and selection of heads of PSB’s Non –executive chairman, whole time directors

:-organisation reform by creating a holding company, and will help in bank consolidation.

:-financial reforms by raising capital and helping in recovering NPA.

:- accountability by improving governance at PSB’s.

FISCAL POLICY

Existence of state is for fulfillment of social and merit goods and services. These goods and services either can’t reach to market or in relation to them market will fail to deliver these. These goods are available by budget of state.

Supply cost of these goods is expenditure and to fulfill these expenditure state earn revenue from tax or non-tax sources. If not fulfilled then there is issuance of new notes.(deficit financing). All this is fiscal policy

Four sides of fiscal policy

1. Distribution of sources
2. Income distribution
3. Economic stabilization
4. Economic development

Tools of fiscal policy:-

Taxation

Expenditure

Borrowing

Fiscal policy is all about financial bill or budget under article 112 and article 265  and 266.

Funds :- consolidate fund and public accounts and contingency fund.

(study in polity classes)

Interim budget: – presented in election year or in extreme situation. It is not considered morally right to make big changes by outgoing government. It is valid as other budget for whole year but it can be changed by new government.

Vote on account: – budget presented in feb but passed in april so for working of government it is given. It is presented every year. It is valid till appropriation bill is passed.

Government budget

PART OF Government budget:-

CAPITAL BUDGET

CAPITAL RECEIPTS

CAPITAL EXPENDITURE

PLAN CAPITAL EXPENDITURE

NON-PLAN CAPITAL EXPENDITURE

REVENUE BUDGET

REVENUE RECEIPTS

REVENUE EXPENDITURE

PLAN REVENUE EXPENDITURE

NON –PLAN REVENUE EXPENDITURE

TAX REVENUE RECEIPTS

NON-TAX REVENUE

DIRECT AX

INDIRECT TAX

 

Plan and Non-plan expenditure

In 1987 changed from development and non-development. Plan and non plan was suggested by sukhomoy chakrvati committee, recently c. rangarajan panel suggested for redefining.

Plan expenditure are expenditure in names of plan. It means the expenditure according to five year plan. All assets creation and productive expenditure are plan expenditure.

Non- plan expenditure are all consumptive and non-productive expenditure.

Revenue:– every form of money generation in nature of income, earning which do not increase financial liability of government. i.e. tax income, on tax income along with foreign grants.

Non-revenue:- not income or earning if they increase financial liabilities (money raise via borrowings)

Revenue Receipts:-  tax revenue receipts =all money earned by government by different taxes either by direct or indirect sources.

Non-tax revenue receipts =all money earned by government other then taxes.Ex

Profits and dividend-from psu’s

Interest-loan forwarded by it inside or outside

Financial services-stamp printing,medals,printing currency

General services by government ,like power distribution,irrigation,banking, insurance

Fees and penalties received by government 

Grants received

Revenue expenditure  :- expenditure that is consumptive kind and do not involve creation of productive assets, either used in running of productive process or running a government.Ex-

-Interest paid by government on internal or external loan.

-salaries, pensions and provident fund.

-subsidies, defence expenditure, law and order expenses, expenditure on social services and general services.

-government grants to Indian states and foreign countries.

REVENUE DEFICIT    This terminology is in use since(1997-98).it occurs when total revenue receipts are less then total revenue expenditure. These are of immediate nature. Since these are non productive these are considered bad in fiscal policy. in 2 plans surplus but not appreciated because  bad impact of imports on economy.

EFFECTIVE REVENUE DEFICIT New term introduced in budget 2011-12. Revenue deficit include some assets creation to states not centre since these revenue expenses are adding to productivity or growth of economy. Assets creation like government of India grants to states for schemes like Pardhanmantri gram sadak yozna etc.

CAPITAL BUDGET

Deals with receipts and expenditure of capital by government that means by which capital is managed and areas where capital is spent.

Capital receipts  all non revenue receipts of government for investment purpose and suppose to spent on plan- development by government.

-loan recovery :-the money spent in and abroad(but interest on these loans comes under revenue reciepts)

-borrowing by government :- all long tern loans inside or outside

-long term accrual through provident fund ,postal deposits, various small saving schemes.(these are kind of loan on which government needs to pay interest)

Capital expenditure  Plan and non-plan capital expenditure. Plan expenditure to central schemes and states and union territories grants.

Non plan expenditure on general services, social sector services capital expenditure on economic services and advance loans.

If revenue deficit and capital expenditure don’t fulfill revenue surplus and capital receipt, the remaining will be considered as budgetary deficit. Abolished in 1997.

INTERNAL LOAN LIABILITY

+Market loan

+non-market loan

+RBI support to public borrowings.

+ foreign loan liability

+RBI loan by ad-hoc treasury bill.

Fiscal deficit

When balance of government’s total receipts and total expenditure is negative. Concept is in use since 1997-98 in India by Manmohan singh .

Fiscal deficit =government expenditure  – total receipts

Primary deficit

When interest liabilities are deducted from fiscal deficit it is called as primary deficit. By this we can  know in which year government depended more on loan and the reason behind higher or lower fiscal deficit.

Primary deficit=fiscal deficit – interest liabilities

Operational deficit

The increase in deficit due to the effect of inflation is deducted from fiscal deficit.

Operational deficit=fiscal deficit – inflation

Surplus budget :- if expenditure is less then revenue earned by government it is called as surplus budget.

ZERO BASED BUDGETING

ZBB is allocation of resources to agencies based on peroiodic evaluation(programme for which they are responsible, justifying the continuance or termination of each programme in agency budget.)

In India practiced since 1997-98.

ZBB will be followed for rationalization of expenditure. Many sates follow this methodology like Rajasthan, Maharashtra

Fiscal drag

When inflation push income in higher brackets but no increase in real purchasing power. It is mainly during periods of high inflation, government gain but economy suffers, growth is dragged down due to less demand.

In economy overheat fiscal drag work as automatic stabilizing agents.

Fiscal neutrality

When net effect of taxation and public spending is neutral. Neither increase nor decrease in demand.

Pump priming

Deficit financing and spending by government on public works for boosting economy during recession.

Twin deficits

When there is high level of fiscal deficit with high current account deficit

Traditionally macroeconomics predicts that persistant double effect will lead to currency devaluation that can be severe and sudden.

 

 

 

Fiscal cliff

 A situation in which particular set of financial factors causes or threaten sudden and severe economic decline.

Like massive spending programme threatens to send our nation over fiscal cliff leading to even higher taxes and fewer jobs. In USA in jan 2013.

Stimulus these measures are taken to make economy healthy, done by spending more(wisely and creating jobs) and cutting tax rate(this will leads to more spending). Here interest rate are around zero. Three times in india this package is used in oct2008 and jan2009 and feb 2009.

Austerity these measures are done by increasing tax rate resulting deficit redeuction. Imposed on GRECCE and spain .

Gender budgeting

A general budget by government which allocates funds and responsibilities on the basis of gender. Done in economies where socio-economic disparities are chronic and clearly visible on sex basis.

Introduced in india in 2006-07.