Role of Fiscal Policy in Economic Development

Fiscal policy refers to the guiding principles of the financial work which are constituted by the state based on political, economic and social development tasks under a certain period. Its purpose is to regulate aggregate demand through government’s spending and tax policies. On the one hand, an increase in government spending will stimulate aggregate demand and increase the national income. Correspondingly, a decrease will depress aggregate demand and reduce national income. On the other hand, a tax is a kind of contraction strength to national income. Therefore, the aggregate demand and the national income will be restrained though increasing government revenue. And they will be increased due to reducing in government revenue as well. The fiscal policy with a distinct class character is formulated by the state, represents the will and interests of the ruling class, and is subject to a certain level of development of social productive forces and economic relations. The state fiscal policy is an integral part of overall economic policy, and is closely linked with the other economic policies. In fact, the development and implementation of fiscal policy must be cooperated with the financial policy, industrial policy and income distribution policy and other economic policy.

The important role played by the fiscal policy in a developing economy can be explained through :

  1. Fiscal policy during inflation,
  2. Fiscal policy during depression,
  3. Fiscal policy and unemployment,
  4. Fiscal policy and income inequalities and
  5. Fiscal policy and economic growth.
Fiscal Policy during Inflation

Inflation is a period in which the purchasing power with, the people in the economy is high.… Read the rest

Deficit Financing

Deficit financing is understood in different ways in different countries. It is understood as the excess of current expenditure over current revenue which is financed either through public borrowing or the creation of new money by the government. So the deficit budget is also called deficit financing in USA. But in India deficit financing is understood in a different way from deficit budget. While the former refers to a situation where the current expenditure exceeds current revenue of the government, the latter is taken to mean the excess of aggregate expenditure (both on current and capital accounts) over aggregate revenue. The former is called deficit budgeting and the latter deficit financing in India.

Deficit financing in Indian context refers to the meeting of budgetary deficit through the creation of new money adding to the existing money supply in the economy. Deficit financing includes any or all of the following in India:

  1. The government withdrawing its cash balance with the Central bank,
  2. The government borrowing funds from the Central bank, and
  3. The government resorting to printing of new currency notes with a view to cover the budget deficit
Purpose of Deficit Financing

There are several purposes for resorting to deficit financing. The following are the major purposes:

  1. War Finance: A country in war experiences severe shortage of financial, resources, especially the cost of modem warfare is so prohibitive that the country resorts to deficit financing. During this period the country cannot resort to taxation or public borrowing because of the situation in the economy.
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Measures of Selective Credit Control for Banking

Qualitative or selective credit control policy refers to the set of policies implemented by the central bank in order to channelize the available credit in-the desired direction. For example, suppose in India the agricultural and small scale industry sectors are to be encouraged, then the RBI may direct the commercial banks to be more liberal in lending to these sectors and be strict while lending to other sectors. This will help the economy to provide ample opportunities for the priority sectors to grow. In other words, in every country the government determines in advance the priorities and to ensure that the banks conform to the priorities in their lending policies, the selective credit control policies are implemented. Hence, while the quantitative credit control policies aim at controlling the volume of credit created, and the money supply in the economy, the qualitative credit control policies help in using the available funds only for the important purposes and discourage unnecessary lending by commercial banks.

Objectives of Selective Credit Control

The objectives of the selective credit control policies are :

  1. To divert available funds only to the urgent and desirable purposes,
  2. To control and regulate a particular sector an economy without affecting the entire economy as a whole
  3. To discourage wasteful and uneconomical consumer expenditure on non-essential items.
  4. To correct the unfavorable balance of payments of a country and
  5. To control and regulate even the non-banking financial houses or intermediaries.
Methods of Selective Credit Control

The important methods of selective credit control policies are discussed in detail.… Read the rest

Lead Bank Scheme

A milestone in the history of banking in India is the nationalization of the 14 major commercial banks in 1969. This process was undertaken with the main objective of involving the banking sector in a big way in the nation building and economic development. To help to achieve this commendable objective, two committees were set up viz., National Credit Council Study Group with D.R. Gadgil as the Chairman and the Committee of Bankers under the chairmanship of Nariman. These   committees   independently   went into   their   terms   of reference  and recommended an ‘area approach’ for involving the banks in   economic development. This paved the way for giving a concrete shape to the Lead Bank Scheme. As nationalization of banks took place to extend and expand the banking services to all the non-banked areas especially the rural areas, the RBI decided to implement its Lead Bank Scheme through the nationalized banks. But this did not discourage the private sector banks from playing their role in economic development. Infact the Lead bank Scheme involved all the nationalized banks, State bank of India and its associates and three private sector banks. Hence, the era of bank-propelled economic development started.

Features of Lead Bank Scheme

The Lead bank scheme has the following features :

  1. All the districts in the country except the Metropolitan area were allotted among the banks selected for this purpose.
  2. Each bank was expected to take all the initiative to develop the district allotted to it. The initiative includes conducting a detailed survey to identify the resources and the potential of the district concerned and then to devise suitable schemes for utilizing these resources.
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National Income Accounting in India

According to the First report of the National Income Committee, “National income estimate measures the volume of commodities and services turned out during a given period, counted without duplication.” This means the total volume of goods and services produced in a year in a country is valued in monetary terms to obtain the National income of the country concerned.

Regarding the measurement of National income, it could be done in three different ways depending upon the interpretation of concept of national income. If National income is considered as a flow of goods and services, then the method used is called Product method. If National income is treated as a flow of income then the relevant method of measuring it is called Income method. Alternatively, if National income is treated as a flow of expenditure, the method used is called the Expenditure method. Apart from these traditional methods of measuring National income, one more method is evolved and it is called the Value added method. Let us now look into the contents of each of these methods.

  1. Product method: In this method, the value of goods and services produced in an economy during a year is found at the market prices, to obtain the GNP at market prices. By subtracting indirect taxes and adding subsidies, we obtain the Gross National Product (GNP) at factor cost. By deducting from GNP the depreciation, we obtain the Net National Product (NNP).
  2. Income method: When we aggregate the income received by various factor services, like rent, wages/salaries, interest and profit we obtain the National income at a factor cost.
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Correction of Balance of Payments (BoP) Deficit

Balance of Payments Adjustments

The short-term and small deficits in balance of payments are quite likely to emerge in wide range of international transactions. These deficits do not call for immediate corrective actions. More importantly, irregular short-term changes in the domestic economic policies with a view to remove the short-term deficits in balance of payments may do more harms than good to the economy. Since these changes cause dislocations in the process of reallocation of resources and short-term fluctuations in the economy. Therefore, short-term deficits of smaller magnitude are not a serious concern to the policy makers. A constant deficit indicates that the country’s imports dominates exports or depreciation of its foreign exchange and gold reserves. These countries lose their international liquidity and credibility. This situation often leads to compromise with economic and political independence of these countries.

India faced a similar situation in July 1990. Therefore, a country facing constant large deficits in balance of payments is forced to adopt corrective measures, such as changes in its internal economic policies for wiping out the deficits, or at least to bring it in a manageable size. It is a widely accepted view that the conditions for an automatic corrective mechanism visualized under gold standard, based on international price mechanism do not exist. Therefore, the government has no option but to intervene with the market conditions of demand and supply with the policy measures available to them. It should be borne in mind that policy-mix in this regard may vary from country to country and from time to time depending on the prevailing economic conditions.… Read the rest