The economic environment of business is composed of various set of economic policies, economic system, strategy of economic growth and development, resource endowment, size of market and status of infrastructural facilities in a country. All these economic policies affecting business environment one way or the other.
Economic policies include fiscal policy, monetary policy, foreign trade policy, price policy, etc. These policies lay the framework within which every organization has to function. To understand the impact of these policies on business environment, let us discuss each one of these components in detail.
1. Fiscal Policy
By fiscal policy we mean, the government’s tax efforts, public expenditure and public borrowing. Through these the government can effectively encourage consumption, investment and savings habits and also restrict them. For example, suppose there is inflation in a country. Inflation implies that the people have high purchasing power and so they demand goods. To curb this, the government may raise the personal tax and also the corporate tax. Consequently, individuals will be left with lesser disposable income and to minimize tax, they may start saving through various tax-saving schemes. As far as the corporate are concerned, they have to part with more by way of tax to the government and this would bring down the rate of profit and dividend declared. As a result the corporate would resort to upward price revision, which might lead to further fall in demand for their products and services. During deflationary period, the government would reduce the tax so as to encourage more spending and investment. Even in tax policy, the government can be selective in taxing more of rich and exempting the poor completely. This would facilitate income re-distribution and improve the conditions of poor.
Similarly, by altering its expenditure on various public projects, the government would be able to influence the prevailing economic condition. Government expenditures are incurred on infrastructural development, public utility services like hospitals, new industrial units of very huge size, etc. For instance, suppose there is inflation in a country. The government would reduce its level of expenditure, thereby reducing the income of the people. With lesser income, the demand would, go down and so the price. At the time of deflation, the government would expand its public expenditure by investing in a number of public projects, so that there will be income generation find demand generation which will revive the economy.
Public borrowing is one more instrument in the hands of the government to influence the economic condition in a country. This involves government issuing bonds and encouraging common public and other institutions to buy them. By this, the government would be able to bring down the level of purchasing power in the economy and control the inflation. During deflation, the government would redeem the bonds and so with more purchasing power, the economy would be able to revive.
2. Monetary Policy
Monetary policy refers to the set of policies determined and implemented by the central bank of a country to control the economic condition. The central bank of a country has the basic responsibility to maintain the price level and money supply in a country. This is possible only when the central bank has certain instruments. These instruments available with the central bank to control the money supply and price level are called monetary policy instruments. They are called Credit control policy. Credit controls can be of two types, Quantitative credit controls and Qualitative credit controls. The former aims at limiting the money supply, while the latter is used to channelize the available credit in the country.
Quantitative credit control policy includes three tools: bank rate, open market operations and variable reserve ratio. Bank rate refers to the rate at which the central bank would re-discount the eligible bills already discounted by the commercial banks. By revising the bank rate upwards, the central bank would be able to make the discounting by business organizations with commercial banks costly. This would discourage discounting and thereby money supply in the economy, would come down. Alternatively, by lowering the bank rate, the central bank makes credit available at a cheaper rate, and so the business organizations would go for a larger discounting of eligible bills with commercial banks. This liberal credit policy would have expansionary effects on the economy. Similarly, using open market operations, the central bank would buy or sell the securities in the open market and through that increase or contract money supply in the economy. For example, suppose there is inflation in an economy. To bring down the money supply, the central bank would sell the securities it has which will be bought by the commercial banks and other institutions. In this process the excess money with these institutions would be siphoned off, there by they have to restrict credit. Alternatively when there is deflation, the central bank would buy the securities and the money equivalent transferred to the banking system would facilitate adoption of liberal credit. Variable reserve ratio refers to the increase or decrease in the quantum of Statutory liquidity ratio and the Cash reserve ratio which the commercial banks have to maintain as a proportion of their total deposits. By increasing the ratios, the commercial banks would be left with lesser volume of funds and so they can lend less. By reducing the ratio, the commercial banks would be left with more funds with which they can make lending liberal. All these monetary policies would have a direct impact on the business organizations and their operations.
Through qualitative credit controls, the central bank can regulate consumer credit, alter the margin requirements, resort to persuasive efforts, take direct action on erring commercial banks, etc. Through these policies, the central bank would be able to regulate and direct the available credit to the priority sector and discourage credit for less priority or no priority sector. Hence, business organizations, which fall under priority sector, would be able to expand their business with cheap funds and assistance
3. Foreign Trade Policy
The foreign trade policy determines the scope for trade between countries. It would directly affect the business prospects of the business organizations. A liberal policy would extend the scope for exports and imports, while a restrictive policy would narrow the scope. Similarly, if protectionism is favored, then the business organizations will have lesser market threats from multinational corporations. Alternatively if liberalization is the policy, then every domestic business organization has to tune itself to every type of challenge posed by the business giants from abroad. Foreign trade policy also includes the exchange rate policy and exchange controls and customs duties. All these are fundamental to the growth of a business organization. For example, suppose there is full convertibility, then the business organizations would be able to export and import and make payments with lesser restrictions. On the other hand, if there is only partial convertibility, the scope for trade is correspondingly less and the business organizations have to go through a sickening process of getting licenses for export or import and route all their payments through proper channel. Customs duties also play a vital role in determining the volume of external trade. A rise in customs duties would discourage domestic demand because the price of imported goods and services would go up find remain at a high level compared to the domestically produced goods and services. A reduction in customs duties would encourage imports and be favorable to the domestic manufacturers.
Government frequently changes the foreign trade policy, keeping in view the requirements of the country and the economic condition. To tide over the glance of payments difficulties, government may resort to various policy measures like currency devaluation, exchange clearing agreements, tariffs and duties, exchange control regulations, etc. These tools would be suitably modified to achieve the desired goals. For example, to encourage exports and discourage imports, the government may devalue the currency, by which the imports of Indian goods abroad become cheaper and the imports of foreign goods in India become costlier. Hence the business organizations have to continuously monitor the changes in the trade policies so as to position themselves accordingly.
4. Price Policy
Price policy refers to the controls that government has on the price in a country. This is necessary, because, unless price is controlled, there is bound to be inflation and then economic instability. Further in Indian context, nearly 35% of the population is living below the poverty line. They do not have any permanent employment. Especially the rural poverty is very serious. To overcome this situation, the government resorts to price control policy. All the essential and basic necessary goods are subjected to price control. While the poor and downtrodden are provided the essential goods at a controlled and subsidized rate through public distribution, the others are expected to meet their requirements through open market. Through demand and supply management, the government makes all the efforts to keep the prices under control. For instance, by building up buffer stocks, the government overcomes the shortage of food commodities during adverse period. Similarly, specific concessions are given to industrial units located in backward regions and rural areas. This helps them to run on sound basis. As regards the manufactured products, the government adopts the administered price mechanism to control the prices. For example, the cooking gas is supplied to the public at one price, to the commercial establishments at a different price. This helps to minimize the strain of the population using LPG as cooking media. Sugar, cement, etc., are also subjected to administered price. Hence, through price policy the government protects the interests of the people and this policy has a direct impact on the functioning of the business organization in our country.