Policy objectives The goals and objectives set out for the nation by Pandit Nehru, Indias first

Prime Minister, on the eve of Independence. These were: rapid agricultural and industrial development of India; rapid expansion of opportunities for gainful employment;

Historical perspective Industrial licensing policy Foreign Investment Foreign Technology Agreements Public sector policy Monopolies and Restrictive Trade Practices Act Decisions of Government

progressive reduction of social and economic disparities; removal of poverty and attainment of self-reliance.

These remain as valid today as at the time Pandit Nehru first set them out before the nation. Any industrial policy must contribute to the realisation of these goals and objectives at an accelerated pace. The present statement of industrial policy is inspired by these very concerns, and represents a renewed initiative towards consolidating the gains of national reconstruction at this crucial stage. Historical perspective In 1948, immediately after Independence, Government introduced the Industrial Policy Resolution. This outlined the approach to industrial growth and development. It emphasised the importance to the economy of securing a continuous increase in production and ensuring its equitable distribution. After the adoption of the Constitution and the socio-economic goals, the Industrial Policy was comprehensively revised and adopted in 1956. To meet new challenges from time to time, it was modified through statements in 1973, 1977 and 1980. The Industrial Policy Resolution of 1948 was followed by the Industrial Policy Resolution of 1956, which had as its objective the acceleration of the rate of economic growth and the speeding up of industrialisation as a means of achieving a socialist pattern of society. In 1956, capital was scarce and the base of entrepreneurship not strong enough. Hence the 1956 Industrial Policy Resolution gave primacy to the role of the State to assume a predominant and direct responsibility for industrial development. The Industrial Policy Statement of 1973, inter alia, identified high priority industries where investment from large industrial houses and foreign companies would be permitted. The Industrial Policy Statement of 1977 laid emphasis on decentralisation and on the role of small-scale, tiny and cottage industries. The Industrial Policy Statement of 1980 focused attention on the need for promoting competition in the domestic market, technological upgradation and modernisation. The policy laid the foundation for an increasingly competitive export base and for encouraging foreign investment in high-technology areas. This found expression in the Sixth Five-Year Plan, which bore the distinct stamp of Mrs Indira Gandhi. It was Mrs Gandhi who emphasised the need for productivity to be the central concern in all economic and production activities. These policies created a climate for rapid industrial growth in the country. Thus, on the eve of the Seventh Five-Year Plan a broad-based infrastructure had been built up. Basic industries had been

established. A high degree of self-reliance in a large number of items--raw materials, intermediates, and finished goods had been achieved. New growth centres of industrial activity had emerged, as had a new generation of entrepreneurs. A large number of engineers, technicians and skilled workers had also been trained. The Seventh Plan recognised the need to consolidate on these strengths and to take initiatives to prepare Indian industry to respond effectively to the emerging challenges. A number of policy and procedural changes were introduced in 1985 and 1986 under the leadership of Mr Rajiv Gandhi aimed at increasing productivity, reducing costs and improving quality. The accent was on opening the domestic market to increased competition and readying our industry to stand on its own in the face of international competition. The public sector was freed from a number of constraints and given a larger measure of autonomy. The technological and managerial modernisation of industry was pursued as the key instrument for increasing productivity and improving our competitiveness in the world. The net result of all these changes was that Indian industry grew by an impressive average annual growth rate of 8.5 per cent in the Seventh Plan period. Government is pledged to launching reinvigorated struggle for social and economic justice, to end poverty and unemployment and to build a modem, democratic, socialist, prosperous and forward-looking India. Such a society can be built if India grows as part of the world economy and not in isolation. While Government will continue to follow the policy of self-reliance, there would be greater emphasis placed on building up our ability to pay for imports through our own foreign exchange earnings. Government is also committed to development and utilisation of indigenous capabilities in technology and manufacturing as well as its upgradation to world standards. Government will continue to pursue a sound policy framework encompassing encouragement of entrepreneurship, development of indigenous technology through investment in research and development, bringing in new technology, dismantling of the regulatory system, development of the capital markets and increasing competitiveness for the benefit of the common man. The spread of industrialisation to backward areas of the country will be actively promoted through appropriate incentives, institutions and infrastructure investments. Government will provide enhanced support to the small-scale sector so that it flourishes in an environment of economic efficiency and continuous technological upgradation. Foreign investment and technology collaboration will be welcome to obtain higher technology, to increase exports and to expand the production base. Government will endeavour to abolish the monopoly of any sector or any individual enterprise in any field of manufacture, except on strategic or military considerations and open all manufacturing activity to competition. Government will ensure that the public sector plays its rightful role in the evolving socio-economic scenario of the country. Government will ensure that the public sector is run on business lines as envisaged in the Industrial Policy Resolution of 1956 and would continue to innovate and lead in strategic areas of national importance. In the 1950s and 1960s, the principal instrument for controlling the commanding heights of the economy was investment in the capital of key industries. Today, the State has other instruments of intervention, particularly fiscal and monetary instruments. The State also commands the bulk of the nation's savings. Banks and financial institutions are under State control. Where State intervention is necessary; these instruments will prove more effective and decisive. Government will fully protect the interests of labour, enhance their welfare and equip them in all respects to deal with the inevitability of technological change. Government believes that no small section of society can corner the gains of growth, leaving workers to bear its pains. Labour will be made an equal partner in progress and prosperity. Workers' participation in management will be promoted. Workers co-operatives

will be encouraged to participate in packages designed to one word turn around sick companies. Intensive training, skill development and upgradation programmes will be launched. Government will continue to visualise new horizons. The Major objectives of the new industrial policy package will be to build on the gains already made, correct the distortions or weaknesses that may have crept in, maintain a sustained growth in productivity and gainful employment and attain international competitiveness. The pursuit of these objectives will be tempered by the need to preserve the environment and ensure the efficient use of available resources. All sectors of industry whether small, medium or large, belonging to the public, private or cooperative sector will be encouraged to grow and improve on their past performance. Government's policy will be continuity with change. In pursuit of the above objectives, the Government has decided to take a series of initiatives in respect of the policies relating to the following areas. Industrial Licensing Foreign Investment Foreign Technology Agreements Public Sector Policy MRTP Act.

A package for the small and tiny sectors of Industry is being announced separately Industrial licensing policy Industrial Licensing is governed by the Industries development & Regulation Act, 1951. The Industrial Policy Resolution of 1956 identified the following three categories of industries: those that would be reserved for development in the public sector; those that would be permitted for development through private enterprise with or without State participation; and those in which investment initiatives would ordinarily emanate from private entrepreneurs.

Over the years, keeping in view the changing industrial scene in the country, the policy has undergone modifications. Industrial Licensing policy and procedures have also been liberalised from time to time. A full realisation of the industrial potential of the country calls for a continuation of this process of change. In order to achieve the objectives of the strategy for the industrial sector for the 1990s and beyond, it is necessary to make a number of changes in the system of industrial approvals. Major policy initiatives and procedural reforms are called for in order to actively encourage and assist Indian entrepreneurs to exploit and meet the emerging domestic and global opportunities and challenges. The bedrock of any such package of measures must be to let the entrepreneurs make investment decisions on the basis of their own commercial judgment. The attainment of technological dynamism and international competitiveness requires that enterprises must be enabled to swiftly respond to fast changing external conditions that have become characteristic of today's industrial world. Government policy and procedures must be geared to assisting entrepreneurs in their efforts. This can be done only if the role played by the Government were to be changed from that of only exercising control to one of providing help and guidance by making essential procedures fully transparent and by eliminating delays. The winds of change have been with us for some time. The industrial licensing system has been gradually moving away from the concept of capacity licensing. The system of reservations for public sector undertakings has been evolving towards an ethos of greater flexibility and private sector enterprise

has been gradually allowed to enter into many of these areas on a case by case basis. Further inputs must be provided to these changes which alone can push this country towards the attainment of its entrepreneurial and industrial potential. This calls for bold and imaginative decisions designed to remove restraints on capacity creation, while, at the same time ensuring that overriding national interests are not jeoparadised. In the above context, industrial licensing will henceforth be abolished for all industries, except those specified, irrespective of levels of investment. These specified industrieswill continue to be subject to compulsory licensing for reasons related to security and strategic concerning social reasons, problems related to safety and overriding environmental issues, manufacture of products of hazardous nature and articles of elitist consumption. The exemption from licensing will be particularly helpful to the many dynamic small and medium entrepreneurs who have been unnecessarily hampered by the licensing system. As a whole the Indian economy will benefit by becoming more competitive, more efficient and modem and will take its rightful place in the world of industrial progress. Foreign Investment While freeing Indian industry from official controls, opportunities for promoting foreign investments in India should also be fully exploited. In view of the significant development of India's industrial economy in the last 40 years, the general resilience, size and level of sophistication achieved, and the significant changes that have also taken place in the world industrial economy, the relationship between domestic and foreign industry needs to be much more dynamic than it has been in the past in terms of both technology and investment. Foreign investment would bring attendant advantages of technology transfer, marketing expertise, introduction of modern managerial techniques and new possibilities for promotion of exports. This is particularly necessary in the changing global scenario of industrial and economic cooperation marked by mobility of capital. The Government will therefore, welcome foreign investment, which is in the interest of the country's industrial development. In order to invite foreign investment in high priority industries, requiring large investments and advanced technology, it has been decided to provide approval for direct foreign investment upto 51 per cent foreign equity in such industries. There shall be no bottlenecks of any kind in this process. This group of industries has generally been known as the "Appendix I industries" and are areas in which FERA companies have already been allowed to invest on a discretionary basis. This change will go a long way in making Indian policy on foreign investment transparent. Such a framework will make it attractive for companies abroad to invest in India. Promotion of exports of Indian products calls for a systematic exploration of world markets possible only through intensive and highly professional marketing activities. To the extent that expertise of this nature is not well developed in India, Government will encourage foreign trading companies to assist us in our export activities. Attraction of substantial investment and access to high technology, often closely held, and to world markets, involves interaction with some of the world's largest international manufacturing and marketing firms. The Government will appoint a special board to negotiate with such a firm so that we can engage in purposive negotiation with such large firms, and provide the avenues for large investments in the development of industries and technology in the national interest. Foreign Technology Agreements There is a great need for promoting an industrial environment where the acquisition of technological capability receives priority. In the fast changing world of technology the relationship between the suppliers and users of technology must be a continuous one. Such a relationship becomes difficult to achieve when the approval process includes unnecessary governmental interference on a case to case basis involving endemic delays and fostering uncertainty. The Indian entrepreneur has now come of age so that he no longer needs such bureaucratic clearances of his commercial technology relationships with foreign

technology suppliers. Indian industry can scarcely be competitive with the rest of the world if it is to operate within such a regularity environment. With a view to injecting the desired level of technological dynamism in Indian industry, Government will provide automatic approval for technology agreements related to high priority industries within specified parameters. Similar facilities will be available for other industries as well if such agreements do not require the expenditure of free foreign exchange. Indian companies will be free to negotiate the terms of technology transfer with their foreign counterparts according to their own commercial judgement. The predictability and independence of action that this measure is providing to Indian industry will induce them to develop indigenous competence for the efficient absorption of foreign technology. Greater competitive pressure will also induce our industry to invest much more in research and development than they have been doing in the past. In order to help this process, the hiring of foreign technicians, and foreign testing of indigenously developed technologies, will also not require prior clearance as prescribed so far, individually or as a part of industrial or investment approvals. Public sector policy The public sector has been central to our philosophy of development. In the pursuit of our development objectives, public ownership and control in critical sector of the economy have played an important role in preventing the concentration of economic power, reducing regional disparities and ensuring that planned development serves the common good. The Industrial Policy Resolution of 1956 gave the public sector a strategic role in the economy. Massive investments have been made over the past four decades to build a public sector, which has a commanding role in the economy. Today key selectors of the economy are dominated by the mature public enterprises that have successfully expanded production, opened up new areas of technology and built up a reserve of technical competence in a number of areas. After the initial exuberance of the public sector entering new areas of industrial and technical competence, a number of problems have begun to manifest themselves in many of the public enterprises. Serious problems are observed in the insufficient growth in productivity, poor project management, overmanning, lack of continuous technological upgradation and inadequate attention to R&D and human resources development. In addition, public enterprises have shown a very Low rate of return on the capital invested. This has inhibited their ability to regenerate themselves in terms of new investments as well as in technology development. The result is that many of the public enterprises have become a burden rather than being an asset to the Government. The original concept of the public sector has also undergone considerable dilution. The most striking example is the takeover of sick units from the private sector. This category of public sector units accounts for almost one third of the total losses of central public enterprises. Another category of public enterprises, which does not fit into the original idea of the public sector being at the commanding heights of the economy, is the plethora of public enterprises which are in the consumer goods and services sectors. It is time, therefore, that the Government adopt a new approach to public enterprises. There must be a greater commitment to the support of public enterprises, which are essential for the operation of the industrial economy. Measures must be taken to make these enterprises more growth oriented and technically dynamic. Units, which may be faltering at present but are potentially viable must be restructured and given a new lease of Life. The priority areas for growth of public enterprises in the future will be the following: Essential infrastructure goods and services Exploration and exploitation of oil and mineral resources Technology development and building of manufacturing capabilities in areas which are crucial in the long term development of the economy and where private sector investment is inadequate Manufacture of products where strategic considerations predominate such as defence equipment.

At the same time the public sector will not be barred from entering areas not specifically reserved for it.

In view of these considerations, Government will review the existing portfolio of public investments with greater realism. This review will be in respect of industries based on low technology, small scale and nonstrategic areas, inefficient and unproductive areas, areas with low or nil social considerations or public purpose, and areas where the private sector has developed sufficient expertise and resources. Government will strengthen those public enterprises, which fall in the reserved areas of operation or are in high priority areas or are generating good or reasonable profits. Such enterprises will be provided a much greater degree of management autonomy through the system of memoranda of understanding. Competition will also be induced in these areas. Government holdings in the equity share capital of these enterprises will be disinvested in order to provide further market discipline to the performance of public enterprises. There are a large number of chronically sick public enterprises incurring heavy losses, operating in a competitive market and serve little or no public purpose. These need to be attended to. The country must be proud of the public sector that it owns and it must operate in the public interest. Monopolies and Restrictive Trade Practices Act (MRTP Act) The principal objectives sought to be achieved through the MRTP Act are as follows:

i. ii.

Prevention of concentration of economic power to the common detriment, control of monopolies, and Prohibition of monopolistic and restrictive and unfair trade practices.

The MRTP Act became effective in June 1970. With the emphasis placed on productivity in the Sixth Plan, major amendments to the MRTP Act were carried out in 1982 and 1984 in order to remove impediments to industrial growth and expansion. This process of change was given a new momentum in 1985 by an increase of threshold limit of assets. With the growing complexity of industrial structure and the need for achieving economies of scale for ensuring higher productivity and competitive advantage in the international market, the interference of the Government through the MRTP Act in investment decisions of large companies has become deleterious in its effects on Indian industrial growth. The pre-entry scrutiny of investment decisions by so-called MRTF companies will no longer be required. Instead, emphasis will be on controlling and regulating monopolistic, restrictive and unfair trade practices rather than making it necessary for the monopoly houses to obtain prior approval of Central Government for expansion, establishment of new undertakings, merger, amalgamation and takeover and appointment of certain directors. The thrust of policy will be more on controlling unfair or restrictive business practices. The MRTP Act will be restructured by eliminating the legal requirements for prior governmental approval for expansion of present undertakings and establishment of new undertakings. The provisions relating to merger, amalgamation, and takeover will also be repealed. Similarly, the provisions regarding restrictions on acquisition of and transfer of shares will be appropriately incorporated in the Companies Act. Simultaneously, provisions of the MRTP Act will be strengthened in order to enable the MRTP Commission to take appropriate action in respect of the monopolistic, restrictive and unfair trade practices. The newly empowered MRTP Commission will be encouraged to require investigation suo mote or on complaints received from individual consumers or classes of consumers. Decisions of Government In view of the considerations outlined above, the Government has decided to take a series of measures to unshackle the Indian industrial economy from the cobwebs of unnecessary bureaucratic control. These

measures complement the other series of measures being taken by the Government in the areas of trade policy, exchange rate management, fiscal policy, financial sector reform and overall macro economic management. A. Industrial licensing policy

i.

ii. iii.

Industrial Licensing will be abolished for all projects except for a short list of industries related to security and strategic concerns, social reasons, hazardous chemicals and overriding environmental reasons, and items of elitist consumption list attached as Annex II). Industries reserved for the small scales sector will continue to be so reserved. Areas where security and strategic concerns predominate will continue to be reserved for the public sector (list attached as Annex 1) In projects where imported capital goods are required, automatic clearance will be given -

a. b.

in cases where foreign exchange availability is ensured through foreign equity, - or if the c.i.f. value of imported capital goods required is less than 25 per cent of total value (net of taxes) of plant and - equipment, upto a maximum value of Rs 2 crore.

In view of the current difficult foreign exchange situation, this scheme [i.e., (iii)(b) will come into force from April 1992. In other cases, imports of capital goods will require clearance from the Secretariat of Industrial Assistance (SIA) in the Department of Industrial Development according to availability of foreign exchange resources.

i.

ii. iii. iv. v.

In locations other than cities of more than 1 million population, there will be no requirement of obtaining industrial approvals from the Central Government except for industries subject to compulsory licensing. In respect of cities with population greater than 1 million, industries other than those of a non-polluting nature such as electronics, computer software and printing will be located outside 25 km. of the periphery, except in prior designated industrial areas. A flexible location policy would be adopted in respect of such cities (with population greater than 1 million) which require industrial regeneration. Zoning the land use regulation and environmental legislation will continue to regulate industrial locations. Appropriate incentives and the design of investments in infrastructure development will be used to promote the dispersal of industry particularly to rural and backward areas and to reduce congestion in cities. The system of phased manufacturing programmes run on an administrative case by case basis will not be applicable to new projects. Existing projects with such programmes will continue to be governed by them. Existing units will be provided a new broad banding facility to enable them to produce any article without additional investment The exemption from licensing will apply to all substantial expansions of existing units. The mandatory convertibility clause will no longer be applicable for term loans from the financial institutions for new projects. Procedural consequences

vi. vii.

All existing registration schemes (delicenced registration, exempted industries registration DGTD registration) will be abolished Entrepreneurs will henceforth only be required to file an information memorandum on new projects and substantial expansions.

viii.

The lists at Annex n and Annex m will be notified in the India Trade Classification (Harmonized System).

B. Foreign Investment

i.

ii.

iii. iv.

v.

Approvals will be given for direct foreign investment upto 51 per cent foreign equity in high priority industries (Annex III). There shall be no bottlenecks of any kind in this process. Such clearance will be available if foreign equity covers the foreign exchange requirement for imported capital goods. Consequential amendments to the Foreign Exchange Regulation Act, 1973 shall be carried out. While the import of components, raw materials and intermediate goods, and payment of knowhow fees and royalties will be governed by the general policy applicable to other domestic units, the payment of dividends would be monitored through the Reserve Bank of India so as to ensure that outflows on account of dividend payments are balanced by export earnings over a period of time. Other foreign equity proposal including proposals involving 51 per cent foreign equity which do not meet the criteria under (i) above, will continue to need-prior clearance. Foreign equity proposals need not necessarily be accompanied by foreign technology agreements. To provide access to international markets, majority foreign equity holding upto 51 per cent equity will be allowed for trading companies primarily engaged in export activities. While the thrust would be on export activities, such trading houses shall be at par with domestic trading and export houses in accordance with the Export-Import Policy. A special empowered Board would be constituted to negotiate with a number of large international firms and approve direct foreign investment in select areas. This would be a special programme to attract substantial investment that would provide access to high technology and world markets. The investment programmes of such firms would be consideration totality, free from pre-determined parameters or procedures

C. Foreign technology agreements

i.

ii. iii. iv.

Authentic permission will be given or foreign technology agreements in high priority industries (Annex III) upto a lumpsum payment of Rs 1 crore, 5 per cent loyalty for domestic sales and 8 per cent for export, subject to total payments of 8 per cent of sales over a 10 year period from date of agreement or 7 years from commencement of production. The prescribed royalty rates are net of taxes and will be calculated according to standard procedures. In respect of industries other than those in Annex III, automatic permission will be given subject to the same guidelines as above if no free foreign exchange is required for any payments. All other proposals will need special approval under the general procedures in force. No permission will be necessary for hiring of foreign technicians and foreign testing of indigenously developed technologies. Payment may be made from blanket permits or free foreign exchange according to RBI guidelines.

D. Public sector

i.

Portfolio of public sector investments will be reviewed with a view to focus the public sector on strategic, high-tech and essential infrastructure. Where as some reservations for the public sector is being retained, there would be no bar for areas of exclusivity to be opened up to the private sector selectively. Similarly, the public sector will also be allowed entry in areas not reserved for it.

ii.

iii. iv. v.

vi.

Public enterprises which are chronically sick and which are unlikely to be turned around will, for the formulation of revival/rehabilitation schemes, be referred to the Board for Industrial and financial Reconstruction (BIFR) or other similar high level institutions created for the purpose. A social security mechanism will be created to protect the interests of workers likely to be affected by such rehabilitation packages. In order to raise resources and encourage wider public participation, a part of the Government's share holding in the public sector would be offered to mutual funds, financial institutions, general public and workers. Boards of public sector companies would be made more professional and given great powers. There will be a greater thrust on performance improvement through the memorandum of understanding (MOU) system through which management would be granted greater autonomy and will be held accountable. Technical expertise on the part of the Government would be upgraded to make the MOU negotiations and implementation more effective. To facilitate a fuller discussion on performance, the MOU signed between Government and the public enterprise would be placed in Parliament. While focusing on major management issues, this would also place matters on day to day operations of public enterprises in their correct perspective.

E. MRTP Act

i.

ii.

iii.

The MRTP Act will be amended to remove the threshold limits of assets in respect of MRTP companies and dominant undertakings. This eliminates the requirement of prior approval of Central Government for establishment of new undertakings, expansion of undertakings, merger, amalgamation and takeover and appointment of Directors under certain circumstances. Emphasis will be placed on controlling and regulating monopolistic, restrictive and unfair trade practices. Simultaneously, the newly empowered MRTP Commission will be authorised to initiate investigations suo mote or on complaints received from individual consumers or classes of consumers in regard to monopolistic, restrictive and unfair trade-practices. Necessary comprehensive amendments will be made in the MRTP Act in this regard and for enabling the MRTP Commission to exercise punitive and compensatory powers.

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. (For background on fiscal policies, see Formulating Monetary Policy.), 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. (To read more on this subject, see Can Keynesian Economics Reduce BoomBust Cycles? and How Influential Economists Changed Our History.) 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. (To learn more about inflation and employement, see Surveying The Employment Report and The Importance Of Inflation And GDP.) 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. (For more on economic cycles, see Understanding Cycles - The Key To Market Timing and How Much Influence Does The Fed Have?) 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. Conclusion 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. Read more: http://www.investopedia.com/articles/04/051904.asp#ixzz1YqjHhxWX

In economics, fiscal policy is the use of government expenditure and revenue collection (taxation) to influence the economy.[1] Fiscal policy can be contrasted with the other main type of macroeconomic policy, monetary policy, which attempts to stabilize the economy by controlling interest rates and the money supply. The two main instruments of fiscal policy are government expenditure and taxation. Changes in the level and composition of taxation and government spending can impact on the following variables in the economy:

Aggregate demand and the level of economic activity; The pattern of resource allocation; The distribution of income.

Fiscal policy refers to the use of the government budget to influence the first of these: economic activity.
Contents
[hide]

1 Stances of fiscal policy

o o o

1.1 Methods of funding 1.2 Borrowing 1.3 Consuming prior surpluses

2 Economic effects of fiscal policy 3 Fiscal Straitjacket 4 See also 5 References 6 Bibliography 7 External links

[edit]Stances

of fiscal policy

The three possible stances of fiscal policy are neutral, expansionary and contractionary. The simplest definitions of these stances are as follows:

A neutral stance of fiscal policy implies a balanced economy. This results in a large tax revenue. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity.

An expansionary stance of fiscal policy involves government spending exceeding tax revenue.

A contractionary fiscal policy occurs when government spending is lower than tax revenue.

However, these definitions can be misleading because, even with no changes in spending or tax laws at all, cyclical fluctuations of the economy cause cyclical fluctuations of tax revenues and of some types of government spending, altering the deficit situation; these are not considered to be policy changes. Therefore, for purposes of the above definitions, "government spending" and "tax revenue" are normally replaced by "cyclically adjusted government spending" and "cyclically adjusted tax revenue". Thus, for example, a government budget that is balanced over the course of the business cycle is considered to represent a neutral fiscal policy stance. [edit]Methods

of funding

Governments spend money on a wide variety of things, from the military and police to services like education and healthcare, as well as transfer payments such as welfare benefits. This expenditure can be funded in a number of different ways:

Taxation Seigniorage, the benefit from printing money Borrowing money from the population or from abroad Consumption of fiscal reserves. Sale of fixed assets (e.g., land).

All of these except taxation are forms of deficit financing [edit]Borrowing A fiscal deficit is often funded by issuing bonds, like treasury bills or consols and gilt-edged securities. These pay interest, either for a fixed period or indefinitely. If the interest and capital repayments are too large, a nation may default on its debts, usually to foreign creditors. [edit]Consuming

prior surpluses

A fiscal surplus is often saved for future use, and may be invested in local (same currency) financial instruments, until needed. When income from taxation or other sources falls, as during an economic slump, reserves allow spending to continue at the same rate, without incurring additional debt. [edit]Economic

effects of fiscal policy

Governments use fiscal policy to influence the level of aggregate demand in the economy, in an effort to achieve economic objectives of price stability, full employment, and economic growth. Keynesian economics suggests that increasing government spending and decreasing tax rates are the best ways to stimulate aggregate demand. This can be used in times of recession or low economic activity as an essential tool for building the framework for strong economic growth and working towards full employment. In theory, the resulting deficits would be paid for by an expanded economy during the boom that would follow; this was the reasoning behind the New Deal. Governments can use a budget surplus to do two things: to slow the pace of strong economic growth, and to stabilize prices when inflation is too high. Keynesian theory posits that removing spending from the economy will reduce levels of aggregate demand and contract the economy, thus stabilizing prices. 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[citation needed], 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. [edit]Fiscal

Straitjacket

The concept of a fiscal straitjacket is a general economic principle that suggests strict constraints on government spending and public sector borrowing, to limit or regulate the budget deficit over a time period. The term probably originated from the definition of straitjacket: anything that severely confines, constricts, or hinders. [3] Various states in the United States have various forms of self-imposed fiscal straitjackets. [edit]See

also

his paper examines varies areas of Indias fiscal policy, in particular fiscal discipline, the structure of government spending, the tax system and fiscal federalism. It describes reforms over the past decades which, as part of the overall economic reform agenda, helped lifting the Indian economy to a higher growth path. It also discusses where further reforms are desirable to further reduce economic distortions and improve the provision of public services. It finds that after high fiscal deficits have often been recorded during the past two decades, after the adoption of the Fiscal Responsibility and Budget Management Act in 2003, fiscal discipline has significantly improved. As to government spending, it argues that, given the large share which is used to subsidise commercial undertakings, agriculture and food distribution, there is much room to improve the quality of spending and to target it better to improving infrastructure and reducing poverty. It describes the tax system which has undergone major reforms since the early 1990s. Nonetheless, there are still many exemptions and loopholes which suggest that a broadening of the tax bases would allow further reductions in tax rates and make the system simpler, fairer and more efficient. The paper also suggests that reforms of indirect taxes should focus on creating a common market within

India so that goods can move between states without border controls. Finally, on fiscal federalism it finds that India's federal structure has led to a well-developed system of tax-sharing and transfers, both through constitutionally empowered bodies and delivered through the annual budget. While overall, Indias fiscal federalism has worked well moving resources towards the poorest states, it has become very complex and there are still some features which weaken fiscal discipline of the states. Furthermore, a major drawback is the lack of an effective local government system, most notably in rural areas and strengthening the local level would be important for improving accountability and responsiveness to citizens needs as threequarters of the population live in states with over 50 million inhabitants. This Working Paper relates to the 2007 OECD Economic Survey of India

Fiscal Policy is the main part ofEconomic Policy and Fiscal Policy's first word Fiscal is taken from French word Fisc it meanstreasure 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 .

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 peoples .

3. Inequality :-

In developing country like India , we can see 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 . I was seeing the Episode of Chanakya on YouTube in which I found that in old time fiscal policy was made and treasury officer and even prime minister are also responsible for any shortage of govt .fund .

See the video

Techniques of Fiscal Policy

1. Taxation Policy

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. Govt. Expenditure Policy 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 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. Public Debt Policy 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 he fiscal policy is concerned with the raising of government revenue and incurring of government expenditure. To generate revenue and to incur expenditure, the government frames a policy called budgetary policy or fiscal policy. So, the fiscal policy is concerned with government expenditure and government revenue.

Image Credits Center for American Progress. Fiscal policy has to decide on the size and pattern of flow of expenditure from the government to the economy and from the economy back to the government. So, in broad term fiscal policy refers to "that segment of national economic policy which is primarily concerned with the receipts and expenditure of central government." In other words, fiscal policy refers to the policy of the government with regard to taxation, public expenditure and public borrowings. The importance of fiscal policy is high in underdeveloped countries. The state has to play active and important role. In a democratic society direct methods are not approved. So, the government has to depend on indirect methods of regulations. In this way, fiscal policy is a powerful weapon in the hands of government by means of which it can achieve the objectives of development.

Main Objectives of Fiscal Policy In India

The fiscal policy is designed to achive certain objectives as follows :-

1. Development by effective Mobilisation of Resources

The principal objective of fiscal policy is to ensure rapid economic growth and development. This objective of economic growth and development can be achieved by Mobilisation of Financial Resources. The central and the state governments in India have used fiscal policy to mobilise resources. The financial resources can be mobilised by :1. 2. 3. Taxation : Through effective fiscal policies, the government aims to mobilise resources by way of direct taxes as well as indirect taxes because most important source of resource mobilisation in India is taxation. Public Savings : The resources can be mobilised through public savings by reducing government expenditure and increasing surpluses of public sector enterprises. Private Savings : Through effective fiscal measures such as tax benefits, the government can raise resources from private sector and households. Resources can be mobilised through government borrowings by ways of treasury bills, issue of government bonds, etc., loans from domestic and foreign parties and by deficit financing.

2. Efficient allocation of Financial Resources

The central and state governments have tried to make efficient allocation of financial resources. These resources are allocated for Development Activities which includes expenditure on railways, infrastructure, etc. While Non-development Activities includes expenditure on defence, interest payments, subsidies, etc. But generally the fiscal policy should ensure that the resources are allocated for generation of goods and services which are socially desirable. Therefore, India's fiscal policy is designed in such a manner so as to encourage production of desirable goods and discourage those goods which are socially undesirable.

3. Reduction in inequalities of Income and Wealth

Fiscal policy aims at achieving equity or social justice by reducing income inequalities among different sections of the society. The direct taxes such as income tax are charged more on the rich people as compared to lower income groups. Indirect taxes are also more in the case of semi-luxury and luxury items, which are mostly consumed by the upper middle class and the upper class. The government invests a significant proportion of its tax revenue in the implementation of Poverty Alleviation Programmes to improve the conditions of poor people in society.

4. Price Stability and Control of Inflation

One of the main objective of fiscal policy is to control inflation and stabilize price. Therefore, the government always aims to control the inflation by Reducing fiscal deficits, introducing tax savings schemes, Productive use of financial resources, etc.

5. Employment Generation

The government is making every possible effort to increase employment in the country through effective fiscal measure. Investment in infrastructure has resulted in direct and indirect employment. Lower taxes and duties on small-scale industrial (SSI) units encourage more investment and consequently generates more employment. Various rural employment programmes have been undertaken by the Government of India to solve problems in rural areas. Similarly, self employment scheme is taken to provide employment to technically qualified persons in the urban areas.

6. Balanced Regional Development

Another main objective of the fiscal policy is to bring about a balanced regional development. There are various incentives from the government for setting up projects in backward areas such as Cash subsidy, Concession in taxes and duties in the form of tax holidays, Finance at concessional interest rates, etc.

7. Reducing the Deficit in the Balance of Payment

Fiscal policy attempts to encourage more exports by way of fiscal measures like Exemption of income tax on export earnings, Exemption of central excise duties and customs, Exemption of sales tax and octroi, etc. The foreign exchange is also conserved by Providing fiscal benefits to import substitute industries, Imposing customs duties on imports, etc. The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve balance of payments problem. In this way adverse balance of payment can be corrected either by imposing duties on imports or by giving subsidies to export.

8. Capital Formation

The objective of fiscal policy in India is also to increase the rate of capital formation so as to accelerate the rate of economic growth. An underdeveloped country is trapped in vicious (danger) circle of poverty mainly on account of capital deficiency. In order to increase the rate of capital formation, the fiscal policy must be efficiently designed to encourage savings and discourage and reduce spending.

9. Increasing National Income

The fiscal policy aims to increase the national income of a country. This is because fiscal policy facilitates the capital formation. This results in economic growth, which in turn increases the GDP, per capita income and national income of the country.

10. Development of Infrastructure

Government has placed emphasis on the infrastructure development for the purpose of achieving economic growth. The fiscal policy measure such as taxation generates revenue to the government. A part of the government's revenue is invested in the infrastructure development. Due to this, all sectors of the economy get a boost.

11. Foreign Exchange Earnings

Fiscal policy attempts to encourage more exports by way of Fiscal Measures like, exemption of income tax on export earnings, exemption of sales tax and octroi, etc. Foreign exchange provides fiscal benefits to import substitute industries. The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve balance of payments problem.

Conclusion On Fiscal Policy

The objectives of fiscal policy such as economic development, price stability, social justice, etc. can be achieved only if the tools of policy like Public Expenditure, Taxation, Borrowing and deficit financing are effectively used. Though there are gaps in India's fiscal policy, there is also an urgent need for making India's fiscal policy a rationalised and growth oriented one. The success of fiscal policy depends upon taking timely measures and their effective administration during implementation.