INSTITUTE OF PROFESSIONAL EDUCATION AND RESEARCH

BHOPAL

(Approved by AICTE Govt. Of India, New Delhi)

For partial fulfillment of Post Graduate Diploma in Management

ASSIGNMENT ON:
FISCAL POLICY OF INDIA

SUBMITTED BY:
SUBMITTED TO:
SANA ISMAIL
Prof.(Dr.) A.K.SHARAN
ROLL NO.-42
Lecturer of Economics
TRIMESTER-II ,
IPER PGDM
 ABBREVIATION:
AD=Aggregate Demand
RBI=Reserve Bank Of India
CPI=consumer price index
WTO=world trade organisation
 CONTENTS

SERIAL PARTICULAR
NO.
1 IMPORTANCE OF FISCAL POLICY

2 BASIC FEATURES OF FISCAL POLICY

3 CONTEMPORARY ISSUES

4 BIBILIOGRAPHY

5 ANNEXURES
 PART-1

IMPORTANCE OF FISCAL POLICY:

As being a PGDM student my keen interest is in studying about macro

part,macro means talking about whole economy.So fiscal policy is one of the
important aspects in a economy like India and to became business manager
,study of fiscal policy is important because it is used for making various
strategic decisions..fiscal policy plays a very important role to affect aggregate
demand,price level.cost conditions,rate of interest,money supply,international
trade,financial markets and the overall growth of the economy through the
changes in expenditure,public debts and taxation.

Fiscal policy has been developed by J.M.Keynes. Fiscal policy is the means
by which a government adjusts its levels of spending in order to monitor and
influence a nation's economy. It is the sister strategy to monetary policy with
which a central bank influences a nation's money supply. These two policies
are used in various combinations in an effort to direct a country's economic
goals. Here we take a look at how fiscal policy works, how it must be
monitored and how its implementation may affect different people in an
economy.

Fiscal policy is the federal government’s policy regarding taxation and

spending, as set by Congress and the presidential administration and
conducted through the federal budget process. Fiscal policy is used to
influence the overall operation of the economy and maintain economic
stability. Methods of taxation are both deliberate and discretionary on the part
of the government; however, there are also some “automatic” stabilizers that
have been built into the economy to automatically reduce taxes and increase
government spending during periods of economic sluggishness. For example,
mandatory spending for social service programs such as unemployment
insurance, Medicaid, and food stamps increases because eligibility for benefits
increases in times of high unemployment. In addition, tax payments
automatically fall as personal income and corporate profits decline.
Fiscal policy is an additional method to determine public revenue and public
expenditure. In the recent years importance of fiscal policy has increased due
to economic fluctuations. Fiscal policy is an important instrument in the
modern time.
According to Arther Simithies 'fiscal policy is a policy under which
government uses its expenditure and revenue programme to produce desirable
effects and avoid undesirable effects on the national income, production and
employment.'
 PART-2
BASIC FEATURES OF FISCAL POLICY

MEANING OF FISCAL POLICY

Fiscal Policy is the main part of Economic Policy and Fiscal Policy's first
word Fiscal is taken from French word 'Fisc' it means treasure of Govt. So we
can define fiscal policy as the revenue and expenditure policy of Govt. of
India .It is prime duty of Government to make fiscal policy. By making this
policy, Govt. collects money from his different resources and utilize it in
different expenditure . Thus fiscal policy is related to development policy. All
welfare projects are completed under this policy.
Macro economics is divided under three major policies to stabilize whole
economy.they are as under:

MACRO
ECONOMIC
S

MONETORY
FISCAL COMMERCIAL
AND CREDIT
POLICY POLICY
POLICY

As it can be seen in the above chart that fiscal policy is also important as
monetory and credit policy as well as commercial policy.

Objectives of Fiscal Policy

There are following objectives of fiscal policy :-

1. Development of Country :-
For development of Country , every country has to make fiscal policy . With
this policy , all work work is done govt. planning and proper use of fund for
development functions . If govt. does not make fiscal policy , then it may
happen that revenue may be misused without targeted expenditure of govt.

2. Employment :-
Getting the full employment is also objective of fiscal policy . Govt. can take
many action for increase employment. Government can fix certain amount
which can be utilized for creation of new employment for unemployed people.

3. Inequality :-
In developing country like India , it can be seen the difference one basis of
earning . 10% of people are earning more than Rs. 100000 per day and other
are earning less than Rs . 100 per day . By making a good fiscal policy , govt.
can reduce this difference . If govt makes it as his target .

4. Fixation of Govt. Responsibility :-

It is the duty of Govt. to effective use of resources and by making of fiscal
policy different minister's accountability can be checked .

5. Degree of inflation:
In under-developed countries, a degree of inflation is required for economic
development. After a limit, inflationary be used to get rid of this situation.

6. Increase in capital formation:

In under-developed countries deficiency of capital is the main reason for
under-development. Large amounts are required for industry and economic
development. Fiscal policy can divert resources and increase capital.

7.To achieve desirable price level:

The stability of general prices is necessary for economic stability. The
maintenance of a desirable price level has good effects on production,
employment and national income. Fiscal policy should be used to remove;
fluctuations in price level so that ideal level is maintained.

Techniques of Fiscal Policy

In the above graph,it can be seen that there is an equilibrium between
government income and government expenditure.Government should made
fiscal policy in an equilibrium manner.

Fiscal policy is that policy which is made by government for controlling the
government expenditure, supply of money and taxes. Fiscal policy is great
equipment in the hand of any country’s government to make better tax system
and to manage the public loan and expenditures. If government budget shows
that estimated expenditures are more than estimated incomes. At that time, it
is very necessary to make fiscal policy to bring this adverse situation to
balance level where will be total expenditure will equal to total income of
government. For this government can use following five techniques of fiscal
policy.

1. Taxation Policy
By amendment in Indian tax law 1961, government of India has power to
make new taxation policy according to the current Indian economic situation.
Either government can increase the tax rate or decrease exemption for
collecting more tax for previous year income. Taxation policy is relating to
new amendments in direct tax and indirect tax . Govt. of India passes finance
bill every year . In this policy govt. determines the rate of taxes . Govt. can
increase or decrease these tax rates and amend previous rules of taxation
.Govt.'s earning's main source is taxation . But more tax on public will adverse
effect on the development of economy.
→ If Govt. will increase taxes , more burden will be on the public and it will
reduce production and purchasing power of public .
→ If Govt. will decrease taxes , then public's purchasing power will increase
and it will increase the inflation.
Govt. analyzes both the situation and will make his taxation policy more
progressive .

2. Public expenditure policy

Public expenditure policy is very useful to reduce the government
expenditure. Government divides total expenditures into two major categories
one is development expenditure and other is non development expenditure.
With this policy, government encourages only development expenditure and
tries to reduce non development expenditure.
There are large number of public expenditure like opening of govt schools ,
colleges and universities , making of bridges , roads and new railway tracks .
In all above projects govt has paid large amount for purchasing and paying
wages and salaries all these expenditure are paid after making govt.
expenditure policy . Govt. can increase or decrease the amount of public
expenditure by changing govt. budget . So , govt. expenditure is technique of
fiscal policy by using this , govt. use his fund first on very necessary sector
and other will be done after this .

3. Deficit financing policy

If above two equipment does not work to create balance in government
budget, government can get loan from central bank to adjust deficiency or
deficit. For this RBI has to issue new currency notes. But this decision should
be taken very carefully because increasing trend of deficit financing will
decrease the value of currency in world market and it will increase the prices
of commodities in commodity market. If Govt.'s expenditures are more than
his revenue , then govt. should have to collect this amount . This amount is
deficit and it can be fulfilled by issuing new currency by central bank of
country . But , it will reduce the purchasing power of currency . More new
currency will increase inflation and after inflation value of currency will
decrease . So, deficit financing is very serious issue in the front of govt. Govt.
should use it , if there is no other source of govt. earning .

4. Seigniorage
Seigniorage is also technique to take benefits by issuing new notes and it is
important role to make fiscal policy.

5. Public Debt Policy

Public debt means, loan is taken by government to fulfill government
expenditures. Government should make this policy very seriously. If there any
other source, then government should use to pay government expenditure or
reducing expenditure is better than taking loan. Sometime, under the pressure
of foreign creditor, government of India has to take many decisions which are
against public interest. So, government of India’s minister should live in
simple life and think high. They should use internet for doing all work. With
this, India can save Rs. 500,000 per month/ per minister for travelling
expenditure.
If Govt. thinks that deficit financing is not sufficient for fulfilling the public
expenditure or if govt. does not use deficit financing , then govt. can take loan
from world bank , or take loan from public by issuing govt. securities and
bonds . But it will also increase the cost of debt in the form of interest which
govt. has to pay on the amount of loan . So, govt. has to make solid budget
for this and after this amount is fixed which is taken as debt. This policy can
also use as the technique of fiscal policy for increase the treasure of govt.

Limitation of Fiscal Policy

1. After issuing new notes for payment of govt. of expenses , inflation of India
is increasing rapidly and in this inflation , prices of necessary goods are
increasing very fastly. Living of poor person has become difficult . So , these
sign shows the failure of Indian fiscal policy.

2. Govt. fiscal policy has failed to reduce the black money . Even large
amount of past minister is in the form of black money which is deposited in
Swiss Bank.

3. After taking loan from world bank under the fiscal policy's debt technique ,
govt. has to obey the rules and regulations of world bank and IMF . These
rules are more harmful for developing small domestic business of India. These
organisation are inter related with WTO and they want to stop Indian domestic
Industry.

4. After expending large amount for generating new employment under fiscal
policy , rate of unemployment is increasing fastly and big lines on govt.
employment exchange can be seen generally in working days . Database of
employment exchanges are full from educated unemployed candidates .

Before the Great Depression in the United States, the government's approach
to the economy was laissez faire. But following the Second World War, it was
determined that the government had to take a proactive role in the economy to
regulate unemployment, business cycles, inflation and the cost of money. By
using a mixture of both monetary and fiscal policies (depending on the
political orientations and the philosophies of those in power at a particular
time, one policy may dominate over another), governments are able to control
economic phenomena.

How Fiscal Policy Works ?

Fiscal policy is based on the theories of British economist John Maynard
Keynes. Also known as Keynesian economics, this theory basically states that
governments can influence macroeconomic productivity levels by increasing
or decreasing tax levels and public spending. This influence, in turn, curbs
inflation (generally considered to be healthy when at a level between 2-3%),
increases employment and maintains a healthy value of money.

Balancing Act
The idea, however, is to find a balance in exercising these influences. For
example, stimulating a stagnant economy runs the risk of rising inflation. This
is because an increase in the supply of money followed by an increase in
consumer demand can result in a decrease in the value of money - meaning
that it will take more money to buy something that has not changed in value.

Let's say that an economy has slowed down. Unemployment levels are up,
consumer spending is down and businesses are not making any money. A
government thus decides to fuel the economy's engine by decreasing taxation,
giving consumers more spending money while increasing government
spending in the form of buying services from the market (such as building
roads or schools). By paying for such services, the government creates jobs
and wages that are in turn pumped into the economy. Pumping money into the
economy is also known as "pump priming". In the meantime, overall
unemployment levels will fall.

With more money in the economy and less taxes to pay, consumer demand for
goods and services increases. This in turn rekindles businesses and turns the
cycle around from stagnant to active.

If, however, there are no reins on this process, the increase in economic
productivity can cross over a very fine line and lead to too much money in the
market. This excess in supply decreases the value of money, while pushing up
prices (because of the increase in demand for consumer products). Hence,
inflation occurs.

For this reason, fine tuning the economy through fiscal policy alone can be a
difficult, if not improbable, means to reach economic goals. If not closely
monitored, the line between an economy that is productive and one that is
infected by inflation can be easily blurred.

And When The Economy Needs To Be Curbed…

When inflation is too strong, the economy may need a slow down. In such a
situation, a government can use fiscal policy to increase taxes in order to suck
money out of the economy. Fiscal policy could also dictate a decrease in
government spending and thereby decrease the money in circulation. Of
course, the possible negative effects of such a policy in the long run could be a
sluggish economy and high unemployment levels. Nonetheless, the process
continues as the government uses its fiscal policy to fine tune spending and
taxation levels, with the goal of evening out the business cycles.

Who Does Fiscal Policy Affect?

Unfortunately, the effects of any fiscal policy are not the same on everyone.
Depending on the political orientations and goals of the policymakers, a tax
cut could affect only the middle class, which is typically the largest economic
group. In times of economic decline and rising taxation, it is this same group
that may have to pay more taxes than the wealthier upper class.

Similarly, when a government decides to adjust its spending, its policy may
affect only a specific group of people. A decision to build a new bridge, for
example, will give work and more income to hundreds of construction
workers. A decision to spend money on building a new space shuttle, on the
other hand, benefits only a small, specialized pool of experts, which would not
do much to increase aggregate employment levels
 PART-3
CONTEMPORARY ISSUES
One of the biggest obstacles facing policymakers is deciding how much
involvement the government should have in the economy. Indeed, there have
been various degrees of interference by the government over the years. But for
the most part, it is accepted that a degree of government involvement is
necessary to sustain a vibrant economy, on which the economic well being of
the population depends.

Evaluation / Criticism of Fiscal Policy

1. Disincentives of Tax Cuts. Increasing Taxes to reduce AD may cause
disincentives to work, if this occurs there will be a fall in productivity
and AS could fall. However higher taxes do not necessarily reduce
incentives to work if the income effect dominates.
2. Side Effects on Public Spending. Reduced govt spending to Increase
AD could adversely effect public services such as public transport and
education causing market failure and social inefficiency.
3. Poor Information Fiscal policy will suffer if the govt has poor
information. E.g. If the govt believes there is going to be a recession,
they will increase AD, however if this forecast was wrong and the
economy grew too fast, the govt action would cause inflation.
4. Time Lags. If the govt plans to increase spending this can take along
time to filter into the economy and it may be too late.Spending plans
are only set once a year. There is also a delay in implementing any
changes to spending patterns.
5. Budget Deficit Expansionary fiscal policy (cutting taxes and
increasing G) will cause an increase in the budget deficit which has
many adverse effects.Higher budget deficit will require higher taxes in
the future and may cause crowding out (see below
6. Other Componenets of AD. If the governmentt uses fiscal policy its
effectiveness will also depend upon the other components of AD, for
example if consumer confidence is very low, reducing taxes may not
lead to an increase in consumer spending.
7. Depends on Multiplier And change in injections may be increased by
the multiplier effect, therefore the size of the multiplier will be
significant.
8. Crowding Out Increased Govt spending (G) to increased AD may
cause “Crowding out” Crowding out occurs when increased
 government spending results in decreasing the size of the private
sector.
• For example if the govt increase spending it will have to increase taxes
or sell bonds and borrow money, both method reduce private
consumption or investment. If this occurs AD will not increase or
increase only very slowly.
• Also Classical economists argue that the govt is more inefficient in
spending money than the private sector therefore there will be a
decline in economic welfare
• Increased government borrowing can also put upward pressure on
interest rates. To borrow more money the interest rate on bonds may
have to rise, causing slower growth in the rest of the economy.
9. Monetarist Critique. Monetarists argue that in the LR AS is inelastic
therefore an increase in AD will only cause inflation to increase

One each for monetary and fiscal policy

It is a debate which is going for fiscal and monetory policy.This debate is
supported by Shubhada M Rao, Chief Economist, Yes Bank.It is as follows:

In recent months, inflation and inflation indices have received significant

attention from analysts and policymakers. The volatility and, in some cases,
structural rigidities have prompted a fresh review and an overhaul of the
country’s inflation indices.

A sound measurement of inflation is an imperative for policymakers as the

direction and magnitude of economic activity is determined by the policy
actions that are based on these highly-sensitive parameters.

India ‘suffers’ from a plethora of inflation indices with varied frequencies and
coverage that pose a significant challenge for the policymakers to make timely
policy interventions. With a divergent population base, it may be
inappropriate now to have a single measure of inflation, especially when
consumption pattern remains significantly diverse between a rural and an
urban household.

The latest NSS survey on household consumer expenditure (2007-08 ) reveals

that food accounts for 51.8% of total monthly per-capita consumption
expenditure in a rural household against 39.3% in an urban household.

It is an appropriate step to consolidate and regroup the CPIs into two broad
groups: CPI-Urban and CPI-Rural. Having just two CPIs would be useful
from both monetary and fiscal policy perspective. For the RBI, this would
give a better understanding of inflationary pressure at the retail level for two
distinct sets of consumers covering the entire consumer base. Juxtaposing this
information with the price level data from the wholesale side, the RBI can
conduct a superior analysis for its monetary policy .

For the government, the implications would be much more important as Plan
expenditure tends to be channelised for both rural and urban sectors. Since
wages paid by the government are generally indexed to some measure of
consumer price inflation, the process of indexation could be streamlined with
the adoption of CPI-Urban and CPI-Rural.

This would enhance the coverage of the target population and, as a result,
avoid wasteful leakages. The final objective should be to arrive at a
comprehensive and consolidated CPI for the country as a whole in sync with
international practices.

Economists debate the effectiveness of fiscal stimulus. The argument mostly

centers on crowding out, a phenomenon where government borrowing leads to
higher interest rates that offset the stimulative impact of spending. When the
government runs a budget deficit, funds will need to come from public
borrowing (the issue of government bonds), overseas borrowing, or
monetizing the debt. When governments fund a deficit with the issuing of
government bonds, interest rates can increase across the market, because
government borrowing creates higher demand for credit in the financial
markets. This causes a lower aggregate demand for goods and services,
contrary to the objective of a fiscal stimulus. Neoclassical economists
generally emphasize crowding out while Keynesians argue that fiscal policy
can still be effective especially in a liquidity trap where, they argue, crowding
out is minimal.

Some classical and neoclassical economists argue that crowding out

completely negates any fiscal stimulus; this is known as the Treasury View,
which Keynesian economics rejects. The Treasury View refers to the
theoretical positions of classical economists in the British Treasury, who
opposed Keynes' call in the 1930s for fiscal stimulus. The same general
argument has been repeated by some neoclassical economists up to the
present.

In the classical view, the expansionary fiscal policy also decreases net exports,
which has a mitigating effect on national output and income. When
government borrowing increases interest rates it attracts foreign capital from
foreign investors. This is because, all other things being equal, the bonds
issued from a country executing expansionary fiscal policy now offer a higher
rate of return. In other words, companies wanting to finance projects must
compete with their government for capital so they offer higher rates of return.
To purchase bonds originating from a certain country, foreign investors must
obtain that country's currency. Therefore, when foreign capital flows into the
country undergoing fiscal expansion, demand for that country's currency
increases. The increased demand causes that country's currency to appreciate.
Once the currency appreciates, goods originating from that country now cost
more to foreigners than they did before and foreign goods now cost less than
they did before. Consequently, exports decrease and imports increase.[2]

Other possible problems with fiscal stimulus include the time lag between the
implementation of the policy and detectable effects in the economy, and
inflationary effects driven by increased demand. In theory, fiscal stimulus
does not cause inflation when it uses resources that would have otherwise
been idle. For instance, if a fiscal stimulus employs a worker who otherwise
would have been unemployed, there is no inflationary effect; however, if the
stimulus employs a worker who otherwise would have had a job, the stimulus
is increasing labor demand while labor supply remains fixed, leading to wage
inflation and therefore price inflation.
 BIBILIOGRAPHY

BOOK:
Pal,Karam & Kumar,Surender.2008.Managerial Economics.Excel Books,New
Delhi.

WEB RESOURCES:
• http://www.investopedia.com/articles/04/051904.asp
• http://shiksha-mba.blogspot.com/2009/11/what-is-fiscal-policy-what-
are.html
• http://www.rediff.com/money/2009/feb/16bud-budget-the-fiscal-
policy-overview.htm
• http://economictimes.indiatimes.com/opinion/et-debate/One-each-for-
monetary-and-fiscal-policy/articleshow/6604423.cms
 ANNEXURES
Union Budget: The fiscal policy overview
External Affiars and Finance Minister Pranab Mukherjee said the government
cannot indulge in 'reckless borrowing' and did not have Parliamentary
mandate to tweak taxes.

The following is the government's fiscal policy strategy statement that the
finance minister announced in Parliament.

A. Fiscal Policy Overview

1. The Union Budget 2008-09 was presented in the backdrop of impressive

growth in the Indian economy which clocked about 9 per cent of average
growth in the last four years.

This striking performance coupled with significant improvement in fiscal

indicators, during the Fiscal Responsibility and Budget Management (FRBM)
Act, 2003 regime definitely put the country on a higher growth trajectory
inspiring confidence in the medium to long term prospects of the economy.
The process of fiscal consolidation during these years has resulted in
improvement in fiscal deficit from 5.9 per cent of GDP in 2002-03 to 2.7 per
cent of GDP in 2007-08. During the same period, revenue deficit has declined
from 4.4 per cent to 1.1 per cent of GDP.

In tune with the philosophy of equitable growth, the process of fiscal

consolidation was taken forward without constricting the much-required social
sector and infrastructure related expenditure.

This improvement in the state of public finances was achieved through higher
revenue buoyancy, driven by efficient tax administration and improved
compliance which is evident from increase in the tax to GDP ratio from 8.8
per cent in 2002-03 to 12.5 per cent in 2007-08.

2. Riding on the path of fiscal consolidation, the Union Budget 2008-09 was
presented with fiscal deficit estimated at 2.5 per cent of GDP and revenue
deficit at 1 per cent of GDP.
However after the presentation of the Union Budget in February 2008, the
world economy was hit by three unprecedented crises -- first, the petroleum
price rise; second, rise in prices of other commodities; and third, the
breakdown of the financial system.

The combined effect of these crises of these orders are bound to affect
emerging market economies and India was no exception. The first two crises
resulted in serious inflationary pressure in the first half of 2008-09. The focus
of the monetary as well as fiscal policy shifted from fuelling growth to
containing inflation, which had reached 12.9 per cent in August, 2008.

Series of fiscal measures both on tax revenue and expenditure side were
undertaken with the objective of easing supply side constraints. These
measures were supplemented by monetary initiatives through policy rate
changes by the Reserve Bank of India [ Get Quote ], and contributed to the
softening of domestic prices.

Headline inflation fell to 4.39 per cent in January, 2009. However, the fiscal
measures undertaken through tax concessions and increased expenditure on
food, fertiliser and petroleum subsidies along with increased wage bill for
implementing the Sixth Central Pay Commission recommendations
significantly altered the deficit position of the Government.

3. The global financial crisis in the second half of the financial year which
heralded recessionary trends the world over, also impacted the Indian
economy causing the focus of fiscal policy to be shifted to providing growth
stimulus.

The moderation in growth of the economy and the impact of the fiscal
measures taken to stimulate growth can be seen reflected in the estimates for
gross tax revenue which stand reduced from Rs 6,87,715 crore in B.E.2008-09
to Rs 6,27,949 crore in R.E.2008-09.

Additional budgetary resources of Rs.1,50,320 crore provided as part of

stimulus package and various committed liabilities of Government including
rising subsidy requirement, provision under NREGS, implementation of
Central Sixth Pay Commission recommendations and Agriculture Debt
Waiver and Debt Relief Scheme for Farmers contributed to the higher fiscal
deficit of 6 per cent of GDP in RE 2008-09 as compared to 2.5 per cent of
GDP in B.E.2008-09.
4. The Country is facing difficult economic situation, the cause of which is not
emanating from within its boundaries. However, left unattended, the impact of
this crisis is going to affect us in medium to long term.

The Government had two policy options before it. In view of falling buoyancy
in tax receipts, the Government could have taken a decision to cut expenditure
and thereby live within the estimated deficit for the year.

The second option was to increase public expenditure, even with reduced
receipts, to stimulate economy by creating demand and maintain the growth
trajectory which the country was witnessing in the recent past.

The Government took the second option of adopting fiscal measures to

increase public expenditure to boost demand and increase investment in
infrastructure sector.

Ensuring revival of the higher growth of the economy will restore revenue
buoyancy in medium term and afford the required fiscal space to revert to the
path of fiscal consolidation.

B. Fiscal Policy for the ensuing financial year 5. The Interim Budget 2009-
2010 is being presented in the backdrop of uncertainties prevailing in the
world economy. The impact of this is seen in the moderation of the recent
trend in growth of the Indian economy in 2008-09 which at 7.1 per cent still
however makes India the second fastest growing economy in the World.

The measures taken by Government to counter the effects of the global

meltdown on the Indian economy, have resulted in a short fall in revenues and
substantial increases in government expenditures, leading to a temporary
deviation from the fiscal consolidation path mandated under the FRBM Act
during 2008-09 and 2009-2010.

The revenue deficit and fiscal deficit for R.E.2008-09 and B.E.2009-2010 are,
as a result, higher than the targets set under the FRBM Act and Rules.

The grounds due to which this temporary deviation has taken place, are
detailed in the Fiscal Policy Overview above and also in the Macro-economic
Framework Statement being presented in the Parliament. The fiscal policy for
the year 2009-2010 will continue to be guided by the objectives of keeping the
economy on the higher growth trajectory amidst global slowdown by creating
demand through increased public expenditure in identified sectors.

However, the medium term objective will be to revert to the path of fiscal
consolidation at the earliest, with improvement in the economic situation.
Tax Policy

Indirect Taxes

6. During the first half of the fiscal year, the global spurt in commodity prices
(crude petroleum, food items and metals) led to increases in domestic prices
of essential items and industrial inputs, putting a severe inflationary pressure
on the economy.

Hence, the Government took several measures after the presentation of the
Union Budget 2008-09, particularly on the Customs side, to contain the rising
inflation, as detailed below:-

Customs

On 21.3.2008, to curb the inflationary trends in the economy arising out of a

rise in prices of food items, a sharp reduction was effected in the import duty
rates on various food items such as semi-milled or wholly milled rice (70% to
nil) and crude and refined edible oils (from 40%-75% to 20%-27.5%). On
01.04.2008, a further reduction was effected in the import duty rate- on all
crude edible oils duty was reduced to nil, and on refined edible oils duty was
reduced to 7.5%.
Export duty of Rs 8,000 PMT was imposed on exports of Basmati rice with
effect from 10.5.2008.
With effect from 10.5.2008, import duties on crude petroleum was reduced to
nil and on petrol and diesel to 2.5% (earlier 7.5%). Customs duty on other
petroleum products was reduced from 10% to 5% on 04.06.2008.
Import duties were reduced to nil on many iron and steel items as well as on
specified inputs for this sector (zinc, ferro-alloys, metcoke) on 29.4.2008.
Further, in order to increase the domestic availability and bring about
moderation in prices, export duties were imposed on many items in the iron
and steel sector @ 15% ad valorem on pig iron, sponge iron, iron and steel
scrap, iron or steel pencil ingots, semi finished products and HR coils/sheets,
etc.
On 08.07.2008, raw cotton was also fully exempted from customs duties so as
to contain the prices of raw cotton and augment the domestic supply.
Excise

With effect from 04.06.2008, excise duty on unbranded motor spirit (MS) was
reduced from Rs 6.35 per litre to Rs 5.35 per litre and on unbranded high
speed diesel (HSD), excise duty was reduced from Rs 2.6 per litre to Rs 1.6
per litre. In the post-October stage, while the inflationary pressures on the
economy were subdued, the global meltdown and resultant slowdown of the
Indian economy required review of the existing policy in favour of
maintaining the growth momentum and retaining export markets. As such, the
following policy changes were effected which would be reviewed in the
ensuing financial year in the light of the macroeconomic situation particularly
the growth of the manufacturing sector:
Excise

With effect from 07.12.2008, a fiscal stimulus package was implemented.

As part of this package, Government implemented an across-the board
reduction of 4 percentage points in the ad valorem rates of excise duty on non-
petroleum items, with a few exceptions. Thus the three major ad valorem rates
of Central Excise duty viz. 14%, 12% and 8% have been reduced to 10%, 8%
and 4%, respectively.
The specific rates of duty applicable to cement and cement clinker were also
reduced proportionately.
Customs

Export duties on iron and steel items were withdrawn w.e.f. 31.10.2008.
Aviation turbine fuel was fully exempted from basic customs duty for the
benefit of the aviation industry w.e.f. 31.10.2008.
In addition, to provide a level playing field to the domestic industry, some
customs duty exemptions provided earlier to combat inflation, on iron and
steel items, zinc and ferro-alloys, were withdrawn w.e.f. 18.11.2008.
As an incentive to the infrastructure sector, the CVD and Special CVD
exemption granted to imports of cement has been withdrawn w.e.f. 2nd
January, 2009 to provide a cushion to domestic cement industry and boost
demand.
In the power sector, customs duty on naphtha used for generation of electricity
by electrical generating stations has been fully exempted w.e.f. 2nd January,
2009 till the end of this financial year.
Service Tax

The refund of service tax paid by exporters on various taxable services

attributable to export of goods has been further extended to include clearing
and forwarding agents services.
The upper limit of refund of service tax paid by exporters on foreign
commission agent services has been enhanced from 2% of FOB value to 10%
of FOB value of export goods.
Drawback benefit can now be availed of simultaneously with refund of
service tax paid in respect of exports.
In order to mitigate the genuine hardships of goods transport agencies, eight
specified services which are provided to goods transport agency have also
been fully exempted from service tax.
Direct Taxes

7. Over the last five years, widespread reforms have been ushered in the area
of direct taxes. The reform strategy comprises the following elements: -

Minimizing distortions within the tax structure by expanding the tax base and
rationalizing the tax rates.
Enabling the tax administration to provide quality taxpayer services and also
enhance deterrence levels. Both these objectives reinforce each other and have
promoted voluntary compliance.
Re-engineering business processes in the Income-tax Department through
extensive use of information technology, viz., e-filing of returns; issue of
refunds through ECS and refund bankers; selection of returns for scrutiny
through computers; e-payment of taxes; establishing a Centralized Processing
Centre and an effective taxpayer information system. These measures have
substantially enhanced the direct tax revenue productivity from 3.81 per cent
of GDP in 2003-04 to an estimated 6.35 per cent of GDP in 2008-09. Further,
the share of direct taxes in the Central tax revenues is now significantly higher
than the share of indirect taxes resulting in a substantial improvement in the
equity of the tax system. Therefore, the reform strategy in the medium term is
to consolidate the achievements of the past.
8. Since there is no change in the tax base and rates, the prospects of growth in
direct tax collection in the ensuing financial year will remain unchanged vis-a-
vis the revised estimate for the financial year 2008-09.

Contingent and other Liabilities 9. The FRBM Act mandates the Central
Government to specify the annual target for assuming contingent liabilities in
the form of guarantees. Accordingly the FRBM Rules prescribe a cap of 0.5
per cent of GDP in any financial year on the quantum of guarantees that the
Central Government can assume in the particular financial year.

The Central Government extends guarantees primarily on loans from

multilateral/bilateral agencies, bond issues and other loans raised by various
Public Sector Undertakings/Public Sector Financial Institutions.

The stock of contingent liabilities in the form of guarantees given by the

government has reduced from Rs 1,07,957 crore at the beginning of the
FRBM Act regime i.e. 2004-05 to Rs 1,04,872 crore at the end of 2007-08. As
a percentage of GDP, it has reduced from 3.4 per cent in 2004-05 to 2.3 per
cent in year 2006-07 and further to 2.2 per cent for the year 2007-08.
The disclosure statement on outstanding Guarantees as prescribed in the
FRBM Rules, 2004 is appended in the Receipts Budget as Annex 3 (iii).

10. Assumption of contingent liability in the form of guarantee by the

sovereign helps to leverage private sector participation in areas of national
priorities. In the current situation, wherein a large number of infrastructure
projects are being cleared for implementation under the Public Private
Partnership (PPP) mode, difficulties are being faced in reaching financial
closure due to the current uncertainties in the global financial market.

Within the given fiscal constraints and with a view to supporting financing of
above mentioned PPP projects, the India Infrastructure Financing Company
Limited (IIFCL) has been authorized to raise Rs 10,000 crore through
Government guaranteed tax free bonds, by the end of 2008-09 and additional
Rs 30,000 crore on the same basis as per requirement in the next financial
year.

The capital so raised will be used by IIFCL to refinance bank lending of

longer maturity to eligible infrastructure projects. This initiative of the
government is expected to result in leveraging of bank financing to PPP
programmes of about Rs one lakh crore.

The likely assumption of contingent liability in the form of guarantee for

2008-09, including the above mentioned Rs 10,000 crore for IIFCL, will
amount to Rs 36,606 crore which will be 0.67 percentage of GDP during
2008-09, higher than the target of 0.5 per cent of GDP set under the FRBM
Rules.

This deviation has been necessiated in the larger interest of re-invigorating the
economy in the background of the current economic scenario, to stimulate
demand and increase investment in infrastructure sector projects. In the
medium term while this may not have a potential budgetary impact, the
additional demand thus created will help restore the economy to its higher
growth path and contribute to higher revenue buoyancy which has shown a
slump in the current financial year due to moderation in the growth in
economy.

Government Borrowings, Lending and Investments

11. The Government policy towards borrowings to finance its deficit

continues to remain anchored on the following principles namely (i) greater
reliance on domestic borrowings over external debt, (ii) preference for market
borrowings over instruments carrying administered interest rates, (iii)
elongation of the maturity profile and consolidation of the debt portfolio and
(iv) development of a deep and wide market for Government securities to
improve liquidity in secondary market.

12. In the first half of the current financial year, the government borrowing
was in line with the indicated auction calendar decided upon in consultation
with the Reserve Bank of India.

However, due to the need to provide the fiscal stimulus to counter the
situation created by the effects of the global financial crisis, the borrowing
calendar of the government had to be revised in the second half of the current
financial year.

The gross and net market borrowings (dated securities and 364- day Treasury
Bills) of the Central Government during 2008-09 (up to February 9, 2009)
amounted to Rs 2,40,167 crore and Rs 1,68,710 crore, respectively. As part of
policy to elongate maturity profile, Central Government has been issuing
securities with maximum 30--year maturity.

The weighted average maturity of dated securities issued during 2008-09 (up
to February 9, 2009) was 14.45 years which was marginally lower than 14.90
years during the corresponding period of the previous year. The weighted
average yield of dated securities issued during 2008-09 (up to February 9,
2009) was 7.91 per cent and was lower than 8.12 per cent during the
corresponding period of last year.

13. Consequent to the transition to the FRBM Act mandated environment,

recourse to borrowing from RBI under normal circumstances is prohibited.
During the year 2008-09 (up to February 7, 2009) the Central Government
resorted to ways and means advance to meet the temporary mismatch in
receipts and expenditure for 77 days as compared with 91 days a year ago.

The daily average utilization of ways and means advance by the Central
Government was Rs 7,383 crore as compared with Rs 14,498 crore a year ago.
The Central Government also availed of Overdraft (OD) for 24 days up to
February 7, 2009. The daily average of OD was Rs.11,233 crore as compared
with Rs 6,381 crore a year ago.

14. The outstanding balance under Market Stabilization Scheme (MSS) on 1st
April, 2008 was Rs 1,70,554 crore. Notwithstanding fresh issuance of Rs
43,500 crore during 2008-09, the outstanding balance under the MSS declined
to Rs 1,05,773 crore mainly reflecting the change in policy and unwinding
MSS through buyback of Rs 47,544 crores. This was done in order to ease
liquidity in the system in the backgrounds of the additional borrowing plan
during the second half of 2008-09 to finance the increased deficit.
15. In order to have prudent management of debt and greater focus on
carrying cost as well as meeting secondary market liquidity, the government
has set up a Middle Office which in due course will merge with the proposed
Debt Management Office.

16. Central Government has stopped playing the role of financial intermediary
for State Government for domestic market borrowings and the trends in the
current year shows that this transition has been very smooth resulting in
reduction in cost for the State Governments while at the same time bringing in
a sense of market discipline.

17. Government has set up National Investment Fund (NIF) to which the
disinvestment proceeds from Central PSUs are being transferred. This fund is
being managed by professional fund managers. The receipts in the Fund are
not reckoned as resources for the purpose of financing the fiscal deficit. The
income from investments under NIF is used to finance social infrastructure
and provide capital to viable public sector enterprises without depleting the
corpus of NIF.

Initiatives in Public Expenditure Management

18. The focus has shifted from financial outlays to outcomes for ensuring that
the budgetary provisions are not merely spent within the financial year but
have resulted in intended outcomes. Initiatives have been taken to evenly pace
plan expenditure during the year and also to avoid rush of expenditure at the
year end which results in poor quality of expenditure. The practice of
restricting the expenditure in the month of March to 15 per cent of budget
allocation within the fourth quarter ceiling of 33 per cent is being enforced
religiously.

The quarterly exchequer control based cash and expenditure management

system which inter alia involves preparing a Monthly Expenditure Plan (MEP)
continues to be followed in select Demands for Grants. The emphasis is on
right pacing plan expenditure by ensuring adequate resources for execution of
budgeted schemes. At the same time, steps have also been taken in the form of
austerity instructions to reduce expenditure in non-priority areas without
compromising on operational efficiency. This has resulted in availability of
adequate resources from realised receipts for priority schemes.

19. Delays in receipts of utilization certificate are broadly indicative of poor

implementation strategy, diversion of funds or delay in utilization of funds for
intended purposes. Monitoring of utilization certificates and unspent balances
with the implementing authorities is reviewed at the highest level in the
Ministry of Finance. Necessary control mechanisms have been put in place
with the help of the office of the Controller General of Accounts (CGA) to
avoid parking of funds and to track expenditure.

20. A central monitoring, evaluation and accounting system for the 1258
centrally sponsored schemes and central sector schemes of the Government
has been instituted under the Central Plan Schemes Monitoring System. All
sanctions issued by the Central Ministries under these schemes are now
identified with a unique sanction ID that enables the tracking of release as per
their accounting and budget heads across the different implementing agencies.
This central system is hosted on the e-lekha portal of the CGA.

21. In addition pilots are currently underway in the States of Punjab

[ Images ], Karnataka [ Images ] and Uttarakhand [ Images ] for testing a
system for expenditure filing and direct payment to beneficiaries under the
schemes. The results of the pilot would form the basis of designing
comprehensive IT based Decision Support System and Management

Information System for all the centrally sponsored schemes and central sector
schemes. This initiative assumes special significance in the light of the
significant increase in the social sector spending by the Government.

22. The application software COMPACT has been extended to all civil
ministries of the Government and expenditure data is being uploaded on a
daily basis by the Pay and Accounts Offices on e-lekha. This is a significant
step towards faster and accurate compilation of the accounts for the
Government of India and will lead to the development of a core accounting
solution. The monthly and annual Finance and Appropriation Accounts are
regularly updated on the CGA website: www.cgaindia.gov.in.

C. Policy evaluation

23. The process of fiscal consolidation during the FRBM Act regime has
created necessary fiscal space to undertake much needed social sector
expenditure and provide for higher infrastructure outlays.

The performance up to 2007-08 was heartening. Fiscal deficit was brought

down from 4.5 per cent of GDP in 2003-04 to 2.7 per cent in 2007-08.
Similarly, revenue deficit was reduced from 3.6 per cent of GDP in 2003-04
to 1.1 per cent in 2007-08. The government was steadfast in following the
fiscal consolidation path which is reflected in the deficit estimates of
B.E.2008-09.
However, subsequent to the global meltdown, there was a compelling need to
adjust the fiscal policy to take care of exceptional circumstances through
which the economy has been passing. The result of the fiscal measures taken
by the Government for containing inflation has been positive as is evident
from headline inflation dropping from high of 12.9 per cent in August 2008 to
4.39 per cent in January 2009.

Similarly the intervention of the Government has ensured that the economy
grows at a healthy rate of 7.1 per cent in a difficult year when most of the
developed economies are facing recession. The fiscal consolidation process
has to be put on hold temporarily.

The process of fiscal consolidation will be back on track once there is an

improvement in economic conditions.