UNIT 2nd

Economic Environment

Nature of the Economy Disparities in Income Distribution Low per CAPITA Income Dominance of Agriculture Over-Population: Unbalanced Economic Development Lack of Industrialisation Lack of Capital: Operation of Economic Vicious Circles Market Imperfections: Limited Availability of Transport and

Communication Facilities

Low per CAPITA Income Per capita income level is much low in India

as compared with other developed countries. At present a new modify system of comparing and calculating per capital income has been adopted at international level in which the per capita income of a country is calculated on the basis of purchasing power of currency of that particular country; while old traditional method was based on exchange rate of currencies.

Disparities in Income Distribution: High degree of disparity in income/wealth

distribution is found in India. Though the objective of establishing a socialistic society was adopted in Second Five Year Plan but ithas not been yet achieved. According to the data shown by National Sample Survey Office (NSSO), 39% of rural population possesses only 5% of all the rural assets while, on the other hand, 8% top households possess 46% of total rural assets.

Dominance of Agriculture:

Land-labor ratio is not favourable in India. Per capita land availability is very low and, on the contrary, labor use per hectare is very high in India. Agriculture sector today provides livelihood to about 65% to 70% of the total population, contributes nearly 17% of Gross Domestic Product (GDP).

Over-Population: India is over-populated. In every decade Indian

population gets increased by about 24%. During 2001-2011, population increased by 17.64%. The compound annual growth rate of population during 2001-2011 was 1.58% against the level of 1.95% during the preceding decade 1991-2001. With this high growth rate of population about 1.58 crores new persons are added to Indian population every year. According to 2011 census, the total Indian population stands at a high level of 121.02 crores which is 17.5% of the world's total population. To maintain this 17.5% of world population India holds only 2.42% of total land area of the world.

Unbalanced Economic Development:

India has not yet achieved the goal of balanced economic development. According to latest World Development Report 2007 about 64% of total labor-force is dependent on agriculture, 16% on industries and the rest about 20% on trade, transport, and other services.

Lack of Industrialisation India lacks in large industrialisation

based on modern and advanced technology, which fails to accelerate the pace of development in .the economy. Average annual growth rate of industrial sector (including mining, manufacturing, and power generation) was 8.5% against the target of 8.7% p.a.

Market Imperfections: Indian economy faces a number of

market imperfections like lack of mobility among production factors from one place to the other and lack of specialisations which hinder the optimum utilisation of available resources. All these market imperfections and their results are important reasons for undeveloped state of Indian economy.

Limited Availability of Transport and Communication

Facilities Transport and communications facilities do

play a vital role in economic development of a country like India, but these facilities are not yet extended to the required level. Transport facilities are not available in remote areas of the country due which industrial development is not equally distributed among various parts of the economy. It also hinders the process of exploiting available resources in the country.

Structure of the EconomyProportionate contribution of different sectors tends to change with the process of growth. Central Statistics Organisation has divided the economy into three basic sectors:1)Primary Sector: The primary sector of the economy is the change of natural resources into primary products. Most products from this sector provide raw materials for other industries. The share of primary sector has decreased from the past four decades.

Mining: Fishing: Agriculture:

Cont.. Agriculture: Agriculture in India is the major sector of its

economy. Almost two-thirds of the total workforce earns their livelihood through farming and other allied sectors like forestry, logging and fishing which account 18% of the GDP. These sectors provide employment to 60% of the country's total population, About 43% of the country's total geographical area is used for agricultural purposes. After independence additional areas were brought under cultivation and new methods, practices and techniques of irrigation and farming were introduced by the government.

Fishing: Fish breeding has increased almost five times since India got independence and is a prime industry in coastal regions.

Mining: It is the term used for the extraction of useful material from the treatment of ore, vein or coal seam. Materials obtained from extraction may be base metals, precious metals, iron, uranium, coal, diamonds, limestone, oil shale, rock salt, and potash. Any material obtained from agriculture or cultured in laboratory requires to be mined.

Cont..Secondary Sector: The secondary sector of the economy includes those economic sectors that create a finished usable product and hence depend on primary sector industries for the raw materials. The secondary sector contributes 24% of the share in Indian economy. This sector includes:i) Industry: India's industrial sector accounts for 27.6% of the GDP and gives employment to 17% of the total workforce. Though agriculture is the foremost occupation of the majority of the people, the government had always laid stress on the industrial development of the country. Thus policies and strategies were framed to give a boost to India's industry. The government aims at achieving self-sufficiency in production and protection from foreign competition. Since independence, India is marching ahead to become a diverse industrial base.ii)Construction: The process of building or assembling of infrastructure is known as a term commonly used in architecture and civil engineering - "construction". Construction job is all about multi-tasking and needs the services from project manager, construction manager, design engineer, construction engineer and project architect.

Cont.. tertiary sector of economy involves the provision of services to

business as well as final consumers. Services may involve the transport, distribution, and sale of goods from producer to consumers as happen in wholesaling and retailing, or may involve the provision of a service, such as in PEST control or entertainment. The tertiary sectors account for 51% of the GDP. The tertiary sectors includes:

i) Insurance, ii) Banking, and iii) Transport.

Cont…. The higher the productivity in primary and secondary

sector and lower the employment in these sectors, the better it is. People need more and more services for leading qualitatively better lifestyle. They need more means of transport, more communication and educational facilities, more training, more medical facilities, entertainment, technical facilities, banking facilities, etc.

Tertiary sector depends on scientific research and innovative developments to increases productivity and it provides engineering and construction consultancy support services for all projects in all sectors. Developed countries employ more than 80% the services sector.

Economic Policies There are several economic policies which can have a very

great impact on business, important economic policies are industrial policy, trade policy, foreign exchange policy, monetary policy , fiscal policy and foreign investment and technology policy.

Some types or categories of business are favourably affected by government policy, some adversely affected, while it is neutral in respect of others.

Similarly, an industry that falls within the priority sector in terms of the government policy get a number of incentives and other positive support from the government, whereas those industries which are regarded as inessential may have the odds against them.

Cont… Macroeconomic policy, as determined and changed

from time to time, impacts business conditions more directly. The policy design can be a response to actual economic conditions or problems or is developed to create favourable conditions in the near future. The basic objectives of macroeconomic policy is to stimulate or maintain growth, achieve economic stability, increase employment, stabilize balance of payments, correct regional imbalances and make the economy more competitive. Much depends on the wisdom and philosophy of the riding government and the quality of policy implementation and economic administration.

Cont.. In open or globalising economies, the policy is

significantly affected by world economic conditions. The countries which borrow heavily from multilateral institutions like IMF and World Bank often have to adjust their macroeconomic policy structure to the lending criteria and condition imposed by these institutions. Changes in the policy are also warranted by international treaties, laws, conventions and agreements. Quite often, political considerations have an overriding influence on the policy design and implementation. All these developments pose formidable challenges to the business manager.

The main components of the policy are the following:-

Monetary policy Fiscal policy Industrial policy Trade policy

Monetary policy of India

Meaning Monetary policy is the process by which

monetary authority of a country, generally a central bank controls the supply of money in the economy by exercising its control over interest rates in order to maintain price stability and achieve high economic growth. IN India, the central monetary authority is the Reserve Bank of India (RBI). is so designed as to maintain the price stability in the economy.

Objectives of the monetary policy of India, as stated by RBI, are:

Price Stability:- Price Stability implies promoting economic development with considerable emphasis on price stability. The centre of focus is to facilitate the environment which is favorable to the architecture that enables the developmental projects to run swiftly while also maintaining reasonable price stability.

Controlled Expansion Of Bank Credit:- One of the important functions of RBI is the controlled expansion of bank credit and money supply with special attention to seasonal requirement for credit without affecting the output.

Promotion of Fixed Investment:- The aim here is to increase the productivity of investment by restraining non essential fixed investment.

Cont…. Restriction of Inventories:- Overfilling of stocks and

products becoming outdated due to excess of stock often results is sickness of the unit. To avoid this problem the central monetary authority carries out this essential function of restricting the inventories. The main objective of this policy is to avoid over-stocking and idle money in the organization

Promotion of Exports and Food Procurement Operations :- Monetary policy pays special attention in order to boost exports and facilitate the trade. It is an independent objective of monetary policy.

Desired Distribution of Credit:- Monetary authority has control over the decisions regarding the allocation of credit to priority sector and small borrowers. This policy decides over the specified percentage of credit that is to be allocated to priority sector and small borrowers.

Cont… Equitable Distribution of Credit:- The policy of Reserve Bank

aims equitable distribution to all sectors of the economy and all social and economic class of people

To Promote Efficiency:- It is another essential aspect where the central banks pay a lot of attention. It tries to increase the efficiency in the financial system and tries to incorporate structural changes such as deregulating interest rates, ease operational constraints in the credit delivery system, to introduce new money market instruments etc.

Reducing the Rigidity:- RBI tries to bring about the flexibilities in the operations which provide a considerable autonomy. It encourages more competitive environment and diversification. It maintains its control over financial system whenever and wherever necessary to maintain the discipline and prudence in operations of the financial system.

monetary policy instrumentsQuantitative methods(based upon lending or credit creating capacity of comm. banks) Bank rate Open market operations(OMOs) Legal reserve requirement Statutory liquidity requirements

Monetary operations

Monetary operations involve monetary techniques which operate on monetary magnitudes such as money supply, interest rates and availability of credit aimed to maintain Price Stability, Stable exchange rate, Healthy Balance of Payment, Financial stability, Economic growth. RBI, the apex institute of India which monitors and regulates the monetary policy of the country stabilizes the price by controlling Inflation.RBI takes into account the following monetary policies:

Open Market Operations

An open market operation is an instrument of monetary policy which involves buying or selling of government securities from or to the public and banks. This mechanism influences the reserve position of the banks, yield on government securities and cost of bank credit. The RBI sells government securities to contract the flow of credit and buys government securities to increase credit flow. Open market operation makes bank rate policy effective and maintains stability in government securities market

Cash Reserve Ratio Cash Reserve Ratio is a certain percentage of 

bank deposits which banks are required to keep with RBI in the form of reserves or balances .Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa.RBI is empowered to vary CRR between 15 percent and 3 percent. But as per the suggestion by the Narshimam committee Report the CRR was reduced from 15% in the 1990 to 5 percent in 2002. As of October 2013, the CRR is 4.00 percent.

Statutory Liquidity Ratio

Every financial institution has to maintain a certain quantity of liquid assets with themselves at any point of time of their total time and demand liabilities. These assets can be cash, precious metals, approved securities like bonds etc. The ratio of the liquid assets to time and demand liabilities is termed as the Statutory liquidity ratio . There was a reduction of SLR from 38.5% to 25% because of the suggestion by Narshimam Committee. The current SLR is 23%

Bank Rate Policy The bank rate, also known as the discount rate, is

the rate of interest charged by the RBI for providing funds or loans to the banking system. This banking system involves commercial and co-operative banks, Industrial Development Bank of India, IFC, EXIM Bank, and other approved financial institutes. Funds are provided either through lending directly or rediscounting or buying money market instruments like commercial bills and treasury bills. Increase in Bank Rate increases the cost of borrowing by commercial banks which results into the reduction in credit volume to the banks and hence declines the supply of money. Increase in the bank rate is the symbol of tightening of RBI monetary policy. As of 1 January 2013, the bank rate was 8.75% and from August 2013 bank rate is 10.25%

Credit Ceiling In this operation RBI issues prior

information or direction that loans to the commercial banks will be given up to a certain limit. In this case commercial bank will be tight in advancing loans to the public. They will allocate loans to limited sectors. Few example of ceiling are agriculture sector advances, priority sector lending.

Credit Authorization Scheme Credit Authorization Scheme was

introduced in November, 1965 when P C Bhattacharya was the chairman of RBI. Under this instrument of credit regulation RBI as per the guideline authorizes the banks to advance loans to desired sectors

Repo Rate and Reverse Repo Rate

Repo rate is the rate at which RBI lends to commercial banks generally against government securities. Reduction in Repo rate helps the commercial banks to get money at a cheaper rate and increase in Repo rate discourages the commercial banks to get money as the rate increases and becomes expensive. Reverse Repo rate is the rate at which RBI borrows money from the commercial banks. The increase in the Repo rate will increase the cost of borrowing and lending of the banks which will discourage the public to borrow money and will encourage them to deposit. As the rates are high the availability of credit and demand decreases resulting to decrease in inflation. This increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the policy. As of October 2013, the repo rate is 7.75 % and reverse repo rate is 6.75%.

Current RatesIndicator Current rateInflation 6.46%Bank rate 8.75%CRR 4.00%SLR 23.00%Repo rate 7.75%Reverse repo rate 6.75%Marginal Standing facility rate 8.75%Base Rate                9.80% - 10.25% Savings Deposit Rate    4.00% * Term Deposit Rate        8.00% - 9.05%

QUALITATIVE INSTRUMENTSQualitative instruments of monetary policy seek to alter the terms or direction of credit in an economy. These measures are selectively rather than generally applied so that they impact the distribution rather than the quantum of credit. The central bank, with the help of these instruments, may increase die flow of credit to certain sectors which act as the growth drivers or leading sectors of the economy or which are socially important (like agriculture and small scale industry) and reduce the flow of credit to sectors which are not essential or are inefficient. Similarly, credit may be restricted in areas which are prone to inflation or speculation. There can even be political considerations behind allocation of credit under qualitative instruments.

Cont….Some of the common forms of qualitative instruments

are the following:Changes in Margin Requirements:- Margin requirements for lending may be varied according to the type of securities, assets or commodities to be financed. A higher margin requirement reduces the quantum of finance for a specific industry or purpose.Differential Interest Rates :- Central bank may prescribe different rates of interest for lending to different sectors or for different activities. For example, lower interest rate could be required for priority sectors such as small-scale industry, exports and agriculture and higher rates may be permitted for sectors to which the central bank intends to reduce credit.

Cont….Some of the common forms of qualitative instruments are the following:Restrictions on Bill Discounting :- The Central bank may disallow restricted discounting of bills against price restive products.Restrictions on Clean Advances:- There could be restriction on clean advances in areas where speculation is rife or hoardings are common (like trading and warehousing segments).Central banks, particularly in developing countries, keep on fine-tuning selective credit controls to control speculation, inflation or undesirable changes in the distribution of scarce credit.

Measures of Money supply in IndiaM1: Money with the public (currency

notes and coins) + Demand Deposits of Banks (on current and saving account) + other deposits with RBI

M2: M1 + Saving bank deposits with post offices

M3: M1 + Time deposits with BanksM4: M3 + all deposits of post offices

Problems of monetary policies There exist a Non-Monetized Sector

In many developing countries, there is an existence of non-monetized economy in large extent. People live in rural areas where many of the transactions are of the barter type and not monetary type. Similarly, due to non-monetized sector the progress of commercial banks is not up to the mark. This creates a major bottleneck in the implementation of the monetary policy.

Problems of monetary policies 2. Excess Non-Banking Financial

Institutions (NBFI) As the economy launch itself into a higher

orbit of economic growth and development, the financial sector comes up with great speed. As a result many Non-Banking Financial Institutions (NBFIs) come up. These NBFIs also provide credit in the economy. However, the NBFIs do not come under the purview of a monetary policy and thus nullify the effect of a monetary policy.

Problems of monetary policies Existence of Unorganized Financial Markets The financial markets help in implementing the

monetary policy. In many developing countries the financial markets especially the money markets are of an unorganized nature and in backward conditions. In many places people like money lenders, traders, and businessman actively take part in money lending. But unfortunately they do not come under the purview of a monetary policy and creates hurdle in the success of a monetary policy.

Problems of monetary policies Higher Liquidity Hinders Monetary Policy In rapidly growing economy the deposit base

of many commercial banks is expanded. This creates excess liquidity in the system. Under this circumstances even if the monetary policy increases the CRR or SLR, it does not deter commercial banks from credit creation. So the existence of excess liquidity due to high deposit base is a hindrance in the why of successful monetary policy.

Problems of monetary policies 5. Money Not Appearing in Banking

System Large percentage of money never comes in the

mainstream banking economy. Rich people, traders, businessmen and other people prefer to spend rather than to deposit money in the bank. This shadow money is used for buying precious metals like gold, silver, ornaments and land; and in speculation. This type of lavish spending gives rise to inflationary trend in mainstream economy and the monetary policy fails to control it.

Problems of monetary policies 6. Time Lag Affects Success of

Monetary Policy The success of the monetary policy

depends on timely implementation of it. However, in many cases unnecessary delay is found in implementation of the monetary policy. Or many times timely directives are not issued by the central bank, then the impact of the monetary policy is wiped out.

Problems of monetary policies 7. Monetary & Fiscal Policy Lacks Coordination In order to attain a maximum of the above objectives it is

necessary that both the fiscal and monetary policies should. go hand in hand. As both these policies are prepared and implemented by two different authorities, there is a possibility of non-coordination between these two policies. This can harm the interest of the overall economic policy.

These are major obstacles in implementation of monetary policy. If these factors are controlled or kept within limit, then the monetary policy can give expected results. Thus though the monetary policy suffers from these limitations, still it has an immense significance in influencing the process of economic growth and development.

ConclusionIt refers all the actions of the government or the central bank of a country which affect, directly or indirectly, supply of money, credit, rate of interest and the banking system. Basically, it affects the cost and availability of credit in the economy. For individual firms, the policy changes affect their liquidity, cost of capital and tend to induce them to adjust their debt-equity ratios. A restrictive monetary policy seeks to raise the rate of interest, reduce money supply growth rate and restrict the flow of credit and is generally aimed to fight inflation. A liberal or accommodating monetary policy is generally meant to fight recession and stimulate demand through credit liberalization, monetary expansion and fall in the rate of interest. In an open economy, monetary also seeks to regulate the foreign exchange market and exchange rates.

FISCAL POLICY OF INDIA

Meaning Fiscal Policy is that part of government

economic policy which deals with taxation, expenditure, borrowing and the management of public debt in the economy.

Arthur Smithies, "A policy under which the government uses its expenditure and revenue programmes to produce desirable effects and to avoid undesirable effects on national income, production and employment."

Meaning Professor G: K. Shaw, "We define fiscal

policy to encompass any decision to change the level of composition or timing of government expenditure or to vary the burden, structure or frequency of tax payment."

A. G. Buchlar, "By fiscal policy is meant the use of public finance or expenditure, taxes, borrowing and financial administration to further our national income objective."

Objectives of Fiscal Policy of India Main objectives of the fiscal policy adopted by

the government of India are as under : Mobilisation of real and financial resources for

the public sector without hampering the expansion of resources for the private sector.

Promotion and acceleration of capital formation in the public private sectors.

Removal of unemployment. Promotion and maintenance of price stability. Reduction of economic inequality. Reduction of regional disparities. To achieve favourable balance; of payment.

COMPONENTS OR INSTRUMENTS of Fiscal Policy of India The following are the important components of the Budget. With the help of them the objective of fiscal policy are achieved Taxation Policy Public Expenditure Policy, Public Debt Policy, Deficit Financing Policy.

Taxation Taxes are imposed in many ways. We can

distinguish taxes as direct tax and indirect tax.

Direct taxes are those the burden of which is borne by those on whom it is imposed. Income tax is an example of direct tax. Indirect taxes are those which are imposed on an entity at some point in the system, but whose burden can be shifted to some other entiry of entities, excise duty, custom duty, etc. are examples of indirect tax.

cont….. Taxation Direct taxes are increased during inflation

which leads to a fall in disposable income in the economy. This reduces the purchasing power of the people and hence aggregate demand. Lower demand results in fall in the general price level curbing inflation.

During recession taxes are reduced so as to increase disposable income in the economy. This leaves people with more purchasing power and leads to a rise in aggregate demand. Increasing demand induces more investment to come in and finally results in rise in income and output taking the economy towards recovery.

Public Expenditure PolicyAll public expenditure is classified into : Non Plan Expenditure : Non Plan expenditure of the

central govt. is divided into revenue expenditure and capital expenditure

Revenue expenditure includes : interest payment, defence revenue expenditure, major subsidies (export, food and fertilizer), interest and other subsidies, debt relief to farmers, postal deficit, police, pension and other general services, social service, economic service (agriculture, industry, power, transport, communications, science and technology, etc.) and grants to states and union territories, and to foreign governments.

Capital non-plan expenditure includes such items such as defence capital expenditure, loans to public enterprise, loans to states and territories and loans to foreign governments.

Plan Expenditure : Plan expenditure is meant to finance central pin ns drawn up for agriculture, rural development, irrigation and flood control, and industries like energy, minerals, transport, communication, science and technology, environment, social services and other. Plan expenditure also includes central assistance for plans of states union territories.

Cont…..Public Expenditure Policy

Public expenditure is decreased or at least not increased in time of inflation. This is done so that additional income does not go into the economy. This puts a check on demand in the economy and has an anti inflationary impact as lower demand leads to reduction in prices.

During recession public expenditure is increased and it is believed to be necessary to bring out the economy from recession. Increase in public expenditure, whether revenue or capital results in higher income and investment in the economy. This creates more demand and private investment is also encouraged.

PUBLIC DEBT Policy Public debt refers to the borrowings of the Central

and State governments. Gross public debt is the gross financial liability of the government. Net public debt is the gross debt minus the value of capital assets of the government and loans and advances given by the government to other sectors.

Debt obligation of the central Govt. are broadly divided into two categories:

(1) Internal debt: (2) External Debt :

PUBLIC DEBT Policy (1) Internal debt: This includes loans raised within the

country, likeOthers, comprising balance of expired loans, compensation and

other bonds such as National Rural Development Bonds and Capital Investment Bonds

Current market loans, Special Bearer Bonds Treasury Bills Special floating and other loan Special securities issued to the RBI Small savings Provident funds Other accounts Reserve funds and deposits. (2) External Debt : External debt is raised in foreign

currency and a substantial part of it is also repayable in foreign currency. External debt represents loans raised by a country from outside sources and includes debt raised by the government and by non-government sources such as NRI deposits, commercial borrowings from abroad, suppliers credit and short-term borrowings, etc.

DEFICIT FINANCING Deficit Financing can be defined as "the financing of

deliberately created gap between public revenue and public expenditure or a budgetary deficit, the method of financing resorted to being borrowing of a type that results in a net addition to national outlay or aggregate expenditure." Therefore, we can say it is deliberate unbalancing of the budget in such a way that government expenditure exceeds government revenue. In India, great reliance has been placed on deficit financing for mobilizing resources for the plans. Deficit financing has been explained in different ways :

DEFICIT FINANCING Revenue Deficit = Revenue expenditure -

Revenue Receipts Budget Deficit = Total expenditure - Total Receipts Fiscal Deficit = Revenue Receipts (Net tax revenue

+ non tax revenue) + Capital Receipts (only recoveries of loans and other receipts) - Total expenditure (plan and non-Plan)

OR = Budget Deficit + Government's market borrowing

and liabilities. Primary Deficit : Primary deficit is obtained by

subtracting interest payment (a component of non Plan expenditure) from fiscal deficit. Therefore, the primary deficit is the deficit of the current year and it is accordingly triggered by an expansionary fiscal policy during the year

LIMITATIONS OF FISCAL POLICYIn theory inflation or recession can easily be overcome

by the fine-tuning of fiscal policy. However, in reality the situation is complex and many economists argue for ignoring fiscal policy as a tool for managing aggregate demand focusing instead on the role that monetary policy can play in stabilising demand and output. They give the following limitations of fiscal policy:

1. Recognition Lags and Policy Time Lags It takes time for government policy-makers to

recognise that aggregate demand is growing either too quickly or too slowly and a need for some active changes in spending or taxation exists.

LIMITATIONS OF FISCAL POLICY 2. Fiscal Crowding-OutThe "crowding-out hypothesis" became popular in the 1970s and 1980s when free market economists argued against the rising share of national income being takenby the public sector. The essence of the crowding out view is that a rapid growth of government spending leads to a transfer of scarce productive resources from the private sector to the public sector. For example, if the government seeks to increase aggregate demand by reducing taxation, or by increasing government spending, then this may lead to a budget deficit. To finance the deficit the government willhave to resort to public borrowing. Attracting individuals and institutions to provide funds to government through debt instruments may require higher interest rates.

LIMITATIONS OF FISCAL POLICY 3. Reaction to Tax Cuts - Rational

Expectations According to a school of economic thought that

believes in 'rational expectations', when the government sells government securities to fund a tax cut or an increase in expenditure, then a rational individual will realise that at some future date he will face higher tax liabilities to pay for the interest repayments. Thus, he should increase his savings as there has been no increase in his permanent income. The implications are clear. Any change in fiscal policy will have no impact on the economy if all individuals are rational. Fiscal policy in these circumstances may become ineffective.

Union BudgetThe Constitution of India provides that - No tax can be levied or collected except by

authority of law. No expenditure can be incurred for public

funds except in the manner provided in Constitution.

The executive authorities must spend public money only in the manner sanctioned by Parliament in the case of the Union and by the State legislature in the case of a State.

Union Budget Union Budget, which is a yearly affair, is a comprehensive display of the

Government’s finances. It is the most significant economic and financial event in India. The Finance Minister puts down a report that contains Government of India’s revenue and expenditure for one fiscal year. The fiscal year runs from April 01 to March 31. 

The Union budget is preceded by an Economic Survey which outlines the broad direction of the budget and the economic performance of the country. 

The Budget is the most extensive account of the Government`s finances, in which revenues from all sources and expenses of all activities undertaken are aggregated. It comprises the revenue budget and the capital budget. It also contains estimates for the next fiscal year called budgeted estimates.

Barring a few exceptions -- like elections – Finance Minister presents the annual Union Budget in the Parliament on the last working day of February. The budget has to be passed by the Lok Sabha before it can come into effect on April 01.

Union Budget The Union Budget of India, referred to as

the Annual Financial Statement[1] in Article 112 of the Constitution of India, is the annual budget of the Republic of India, presented each year on the last working day of February by the Finance Minister of India in Parliament. The budget, which is presented by means of the Financial Bill and the Appropriation bill has to be passed by the House before it can come into effect on April 1, the start of India's financial year.

STATE BUDGETS Like the Union Government, State Governments,

too, have their own budgets. Estimates of receipts and expenditure are presented by the State Governments to their legislatures before the beginning of the financial year and legislative sanction of expenditure is secured through similar procedure.

As in the case of the Union Government, the Constitution has provided for the establishment of a Consolidated Fund, a Public Account and a Contingency Fund for each State.

FINANCES OF THE UNION AND STATES

The Constitution of India has earmarked separate sources of revenue for the Union and the States.

Sources of Revenue for the UnionThe Union List in the Constitution includes the following revenue subjects:

1.Taxes on income other than agricultural income;2.Duties and customs, including export duties;3.Duties of excise on tobacco and other goods manufactured or produced in India, except alcoholic liquors for human consumption and opium, Indian hemp and other narcotic" drugs and narcotics;

4.Corporation tax;5.Taxes on the capital value of assets, exclusive of agricultural land, of individual companies taxes on the capital of companies;

6.Estate duty in respect of property other than agricultural land;

Cont..7. Duties in respect of succession to property other

than agricultural land;8. Terminal taxes on goods of passengers carried by

the railways, by sea, or air; taxes on railway fares and freight;

9. Taxes other than stamp duties on transactions on stock exchanges;

10. Rate of stamp duty on bills of exchange;11. Taxes on sale or purchase of newspapers and on

advertisements published therein;12. Fees in respect of any of the matters in the Union

List, but not including fees taken in any court;13. Any tax not mentioned in the State List or

Concurrent List.

Cont.. Sources of Revenue for the StateThe State List in the Constitution includes the

following revenue subjects:1.Land revenue, including the assessment and collection of revenue, the maintenance of land records, survey for revenue purposes and records of rights and alienation of revenue.2.Taxes on agricultural income.3.Duties in respect of succession to agricultural lands.4.Estate duty in respect of agricultural land.5.Taxes on lands and buildings.6.Taxes on mineral rights, subject to any limitations imposed by Parliament by law relating to mineral development.

Cont..7.Duties of excise on the following goods manufactured or produced elsewhere in India: (a) alcoholic liquors for human consumption; (b) opium, Indian hemp and other narcotic drugs and narcotics.8.Taxes on the entry of goods into a local area for consumption, use or sale therein.9.Taxes on the consumption or sale of electricity.10.Taxes on the sale or purchase of goods (other than news papers). Taxes on advertisements (other than those on newspapers).11.Taxes on goods and passengers carried by road or inland water ways.12.Taxes on vehicles, whether mechanically propelled or not, used on roads.

Cont..14.Taxes on animals and boats.15.Tolls. 16.Taxes on profession, trades, callings and employment.17.Capitation taxes.18.Taxes on luxuries, including taxes on entertainment, amusements, betting and gambling.19.Rates of stamp duty in respect of documents other than those specified.20.Fees in respect of any of the matters in this list but not including fees taken in any court.21.Fisheries.22.Forests.23.Irrigation, water storage and water power.

Cont..Concurrent ListThe main revenue items in the Concurrent List under

the Constitution are:

Stamp duties other than duties or fees collected by means of judicial stamps but including rates of stamp duty.

Fees in respect of any of the matters in this list but no including fees taken in any court.

The Finance Commission Under the Constitution of India, a Finance Commission is to

be constituted every fifth year or at such earlier time as the President considers necessary to make recommendations to the President as to:

The distribution between the Union and States of the net proceeds of taxes which are to be or may be divided between the States of the respective shares of such proceeds;

The principles which should govern the grants-in-aid of the revenues of the State in need of such assistance out of the Consolidated Fund of India; and Any other matters referred to the Commission by the President in the interest of sound finance.

The recommendation of the Commission, together with an explanatory memorandum as to the action taken thereon, are laid before each House of Parliament.

The Finance CommissionThe Finance Commission is constituted by the President under article 280 of the Constitution, mainly to give its recommendations on distribution of tax revenues between the Union and the States and amongst the States themselves. Two distinctive features of the Commission’s work involve redressing the vertical imbalances between the taxation powers and expenditure responsibilities of the centre and the States respectively and equalization of all public services across the States.

 What are the functions of the Finance Commission?  It is the duty of the Commission to make

recommendations to the President as to—   the distribution between the Union and the

States of the net proceeds of taxes which are to be, or may be, divided between them and the allocation between the States of the respective shares of such proceeds; 

the principles which should govern the grants-in-aid of the revenues of the States out of the Consolidated Fund of India;

 What are the functions of the Finance Commission? the measures needed to augment the Consolidated Fund

of a State to supplement the resources of the Panchayats in the State on the basis of the recommendations made by the Finance Commission of the State;

the measures needed to augment the Consolidated Fund of a State to supplement the resources of the Municipalities in the State on the basis of the recommendations made by the Finance Commission of the State;

any other matter referred to the Commission by the President in the interests of sound finance.

The Commission determines its procedure and have such powers in the performance of their functions as Parliament may by law confer on them.

Who appoints the Finance Commission and what are the qualifications for Members?  The Finance Commission is appointed by the President under

Article 280 of the Constitution.   As per the provisions contained in the Finance Commission [Miscellaneous Provisions] Act, 1951 and The Finance Commission (Salaries & Allowances) Rules, 1951, the Chairman of the Commission is selected from among persons who have had experience in public affairs, and the four other members are selected from among persons who—

(a) are, or have been, or are qualified to be appointed as Judges of a High Court; or(b) have special knowledge of the finances and accounts of Government; or(c) have had wide experience in financial matters and in administration; or(d) have special knowledge of economics

How are the recommendations of Finance Commission implemented?    The recommendations of the Finance Commission

are implemented  as under:- Those to be implemented by an order of the

President: The recommendations relating to distribution of Union Taxes and Duties and Grants-in-aid fall in this category.Those to be implemented by executive orders:  The recommendations in respect of sharing of Profit Petroleum, Debt Relief, Mode of Central Assistance, etc. are implemented by executive orders.

What is the composition of the Fourteenth Finance Commission? The Fourteenth Finance Commission has been set up

under the Chairmanship of Dr. Y.V.Reddy [Former Governor Reserve Bank of India].  Other Members of the Commission are Ms. Sushma Nath [ Former Union Finance Secretary ], Dr. M.Govinda Rao [ Director, National Institute for Public Finance and Policy, New Delhi ), Dr. Sudipto Mundle, Former Acting Chairman, National Statistical Commission. Prof Abhijit Sen (Member, Planning Commission) is the part-time Member of the Fourteenth Finance Commission.  Shri Shri Ajay Narayan Jha is the Secretary, Fourteenth Finance Commission.

What is the tenure of the Fourteenth Finance Commission?  The Finance Commission is required to give its

report by 31st October, 2014. Its recommendations will cover the five year period commencing from 1st April, 2015.

IMPORTANCE OF THE BUDGET There is no other Government measure that affects

the whole economy as the Budget. No wonder all sections of the people await the annual Budget with mixed feelings-anxiety, fear and hope. The Endeavour of the Finance Minister is to present a Budget which gives maximum support to forces that can move the country forward on the path of growth with stability and social justice. The Budget should set the stage for the achievement of economic and social goals.

The importance of functional finance and pump priming are recognised all over the world.

IMPORTANCE OF THE BUDGET In India, today, about a half of the GDP is channeled

into the Government sector by the Union, State and UT Budgets and disbursed by the Union, State and UT Governments under various development and non-development heads. These indicate the development and distributive importance and implications of the Budgetary operations.

There has been a steep increase in the Government expenditures, both in absolute and relative terms. The total budgetary expenditures (of the Centre, States and Union Territories) are about 50 per cent of the GDP today. The Central Government expenditures alone account for over one-fourth of the GDP today.

Economic StabilizationThere are two forms of fiscal policy

responses to instability in an economy:-

Automatic stabilizers Discretionary fiscal policy

Automatic StabilizersAn automatic stabilizer is an expenditure programme or tax law that automatically increases expenditures (or decreases taxes) when an economy enters a recession and automatically decreases expenditures (or increases taxes) when an economy enters a period of inflation.As is clear from this definition, automatic stabilizers refer to the built-in responses that are generated in the system without any deliberate action on the part of the government, to correct instability and thus restore economic stability in the economy. Such stabilizers are also known as built-in stabilizers. The two main automatic stabilizers that are generally discussed in economic literature are1. changes in tax revenues, and 2. unemployment compensation and welfare

payments.

1. Changes in Tax Revenues.

As the Gross National Product (GNP) of a country rises, some people who did not have taxable income before become taxable while many tax payers are shifted into higher tax brackets. Thus tax revenues increase with an increases in GNP. This is of course the direction in which tax should move as the national income increase. Conversely, when the GNP falls, some tax payers find their incomes dropping below the taxable level on the one hand, while many tax payers fall into lower tax brackets. Thus tax revenues are reduced as GNP falls. Hence, the tax revenues again move in the direction required for stabilization.

2. Unemployment Compensation and Welfare Payments

In many developed countries of the West unemployment compensation is paid to workers who are laid off. During recession, as more people become unemployed, unemployment compensation paid by the government to the unemployed automatically increases. This means that consumption expenditures, an important component of aggregate demand, will not fall as far as they otherwise would. During period of boom as business activity expands the number of unemployed people falls and, correspondingly, the unemployment compensation falls. Thus increase in spending is curbed and this is just what we want to see happen. This shows that unemployment compensation has an automatic stabilizing effect on the economy. Various welfare programmes also have the same effect and tend to vary counter cyclically government outlays rising when GNP falls and falling when GNP rises.

Discretionary Fiscal PolicyDiscretionary fiscal policy implies deliberate changes undertaken by the government of a country in the tax rates and planned outlays in an effort to stabilize the economy. As is clear from this definition, it is the discretionary fiscal policy that is the fiscal policy 'proper' as it entails definite and conscious actions initiated by the government of a country to alter tax rates and its own expenditures. However, two comments are in order on this conventional definition of discretionary fiscal policy :

Cont…First, on the revenue side, tax rates (or taxation) is not the sole tool in the hands of the government authorities. Two other important tools that have assumed considerable importance over time are (i) public borrowing, and (ii) forced saving (also known as deficit financing). Second, the definition given above is from the point of view of the developed countries where the prime issue is economic stabilization. However, in the case of the developing countries, the main issue is economic development. Therefore, viewed from the perspective of the developing countries, discretionary fiscal policy would imply deliberate policy actions undertaken by the government on public revenue -and public expenditure front to promote the economic development of the country.