Unit-1

 Main objectives of Fiscal Policy in India

 Economic growth: It helps to maintain the economy’s growth rate so

that

certain economic goals can be achieved.

 Price stability: It controls the price level in the country so that when the

inflation is too high, prices can be regulated.

 Full employment: It aims to achieve full employment, or near full

employment,

as a tool to recover from low economic activity.

Importance of Fiscal Policy in India

 In a country like India, fiscal policy plays a key role in elevating the rate
of

capital formation both in the public and private sectors.

 Through taxation, the fiscal policy helps to mobilise a considerable

amount of

resources for financing its numerous projects.

 Fiscal policy also helps in providing stimulus to elevate the savings rate.

 The fiscal policy gives adequate incentives to the private sector to

expand its

activities.

 Fiscal policy aims to minimise the imbalance in the dispersal of income

and

wealth.

FRBM Act

 The Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) is

an

Act of the Parliament of India to institutionalize financial discipline, reduce

India’s fiscal deficit, improve macroeconomic management and the overall

management of the public funds by moving towards a balanced budget.

Recent Trends in India’s Fiscal Policy (as of 2024-25):

 Post-COVID Recovery Measures: Fiscal stimulus packages like

Aatmanirbhar Bharat, increased capital expenditure.

 Focus on Infrastructure: Increased allocation to roads, railways,

and digital infrastructure.

 Fiscal Consolidation: Government aiming to reduce fiscal deficit

to below 4.5% of GDP by 2025-26.

 Targeted Welfare: Expansion of schemes like PM Awas Yojana, PM

Garib Kalyan Yojana.

 Disinvestment: Strategic sale of PSUs to mobilize non-tax revenue

(e.g., LIC IPO).

Challenges:

 Rising fiscal deficit and public debt.

 Limited tax base and tax evasion.

 Inefficiency in subsidy delivery.

 Pressure from populist measures during elections.

Objectives

 Reduction of fiscal deficit and revenue deficit;

 To achieve inter-generational equity in fiscal management by reducing

the debt

burden of the future generation;

 Achieving long-term macroeconomic stability;

 Better coordination between fiscal and monetary policy;

 Transparency in fiscal operations of the Government.

Major Provisions of the FRBM Act, 2003

 The FRBM rule set a target reduction of fiscal deficit to 3% of the GDP by

2008-09. This will be realized with an annual reduction target of 0.3% of

GDP

per year by the Central government.

 Revenue deficit has to be reduced by 0.5% of the GDP per year with
complete

elimination by 2008-09.
 Reduction of Public Debt

 The government has to take appropriate measures to reduce the fiscal

deficit and

revenue deficit so as to eliminate revenue deficit by 2008-09 and

thereafter,

sizable revenue surplus has to be created.

 It mandated setting annual targets for the reduction of fiscal deficit and
revenue

deficit, contingent liabilities and total liabilities.

 The government shall end its borrowing from the RBI except for
temporary

advances.

 The RBI was supposed to not subscribe to the primary issues of the
central

government securities after 2006.

 The revenue deficit and fiscal deficit may exceed the targets specified in
the

rules only on grounds of national security, calamity and other exceptional

grounds to be specified by the Central government.

 Amendments to FRBM Act: Fiscal Responsibility and Budget

Management

Act, 2003 was amended in 2012 that mandated the Central Government
to lay

before the Houses of Parliament, Macro-Economic Framework Statement,

Medium Term Fiscal Policy Statement and Fiscal Policy Strategy Statement

along with the Annual Financial Statement and Demands for Grants.

 NK Singh committee, that was set up in 2016 to review the FRBM Act,

recommended that the government must target a fiscal deficit of 3% of

the GDP

in the years up to March 31, 2020, subsequently cut it to 2.8% in 2020-21

and to

2.5% by 2023.
  TRADE AND INVESTMENT POLICIES

India has a long history of being a highly developed economic system with
strong commercial ties to other regions of the globe. Many economists
hailed India’s 3.5 percent growth rate in 1950, claiming it had double the
pace of growth during the British Raj’s last 50 years. It was a success for
India’s economic policies, which were introverted and dominated by public
sector firms, according to socialists.India’s GDP growth rate was modest
before 1980, but it accelerated once economic reforms began in 1981.
After the reforms were fully implemented in 1991, it was strengthened. In
the three decades from 1950 to 1980, the growth rate of GNP was only
1.49 percent. During this time, government policies were based on
socialism. The income tax rate has risen to as high as 97.75 percent. A
large number of industries were nationalized. The government had
stepped up its efforts to gain complete control of the economy. Mild
economic liberalism in the 1980s boosted GNP per capita growth to 2.89
percent per year. Per capita, GNP increased to 4.19 percent after major
economic liberalization in the 1990s. The Indian government announced
important economic reforms in 1991, which were huge initiatives in terms
of foreign trade liberalization, financial liberalization, tax reforms, and
demands for foreign investment. These policies aid in revving up the
Indian economy. Since then, India’s economy has progressed significantly.
The average growth rate of Gross Domestic Product (at factor cost)
increased from 4.34 percent between 1951 and 1991 to 6.24 percent
between 1991 and 2011. In 2015, the Indian economy exceeded the $2
trillion mark.

Trade policy reforms since 1991

The Indian government implemented extensive economic reforms in 1991,

including foreign trade liberalization, banking liberalization, tax reforms,
and demands for foreign investment. These policies aided the Indian
economy in gaining traction. India’s economy has progressed significantly
since then.

The following are the key characteristics of the new trade policy:

Free imports and exports:

Before 1991, India’s imports were regulated by a positive list of items that
may be freely imported. Imports have been monitored by a limited
negative list since 1992. For example, the 1 April 1992 trade policy
liberalized imports of practically all intermediate and capital items. At that
time, only 71 goods were still prohibited. On March 31st, 1996, the tariff
line voice import policy was initially announced, and 6161 tariff lines were
rendered free at the time. Until March 2000, this amount had risen to
8066. From 2001 to 2002, the excise policy removed quantitative limits.
India’s obligation to the World Trade Organization has been fulfilled.
Quantitative limitations on all import products have been lifted by the
World Trade Organization, allowing India to import and export more freely.

Quantitative constraints and rationalization of tariff structure:

In its report, the Chelliah Committee suggested a large reduction in import

duties. It had predicted a 50 percent peak rate. As a first step toward a
gradual reduction in tariffs, the 1991-92 budgets reduced the top rate of
import tax from more than 300 percent to 150 percent. The strategy of
lowering customs rates was continued in the following budgets.

Houses of Commerce:

Under the 1991 policy, export houses and trading houses were allowed to
import a wide variety of goods. For the objective of encouraging exports,
the government also allowed the establishment of trading houses with 51
percent foreign equity. Export houses and trading houses, for example,
were given the benefit of self-certification under the advance licensing
system, which allows duty-free imports for exports, under the 1992-97
trade strategy.

Rupee Depreciation and Convertibility in Current Account:

On July 1 and 3, 1991, the government made a two-step downward

adjustment in the rupee’s exchange rate of 18-19%. The introduction of
Liberalized Exchange Rate Management System (LERMS), which included
partial rupee convertibility in 1992-93, full convertibility on the trading
account in 1993-94, and complete convertibility on the current account in
August 1994, was followed by the introduction of LERMS. The rupee’s
convertibility was another international trade protection mechanism in the
Indian economy. In the 1992-93 budgets, the Indian government made the
rupee partly convertible.

Investment Policy Reforms Since 1991

During the post-reform period, the government made several steps to

encourage foreign

investment in India. The following are some of the most crucial indicators:

 In 1991, the government established a list of high-tech and high-

investment priority

industries for which automatic authorization for foreign direct investment

(FDI) up to
51 percent foreign equity was granted. For several of these industries, the
cap was

lifted to 74 percent and then to 100 percent. Furthermore, over time,

several new

industries have been added to the list.

 The Foreign Investment Promotion Board (FIPB) was established to

engage with

international companies and approve direct foreign investment in certain

sectors.

 From time to time, steps were taken to encourage foreign institutional

investment (FII)

in India.

 Foreign investors that participate in Special Economic Zones benefit

from a variety of

tax breaks, including exemptions from taxes on export earnings, capital

gains, dividend

distribution, customs tariffs on imported goods, and local excise.

 The 1991 industrial policy justified foreign investor entry by noting FDI’s
inherent

benefits, such as advanced technology, established management

competence, and

current marketing strategies.

 Financial Policies and Their Implications

Introduction:

Financial policies refer to the strategies adopted by the government or

central authorities (like the Reserve Bank of India) to regulate and
manage the financial system, including monetary policies, banking
regulations, capital market rules, and financial inclusion efforts.
These policies aim to ensure economic stability, promote investment,
control inflation, and maintain financial discipline.

Key Components of Financial Policy:

 1. Monetary Policy:

o Managed by the RBI through instruments like repo rate,

reverse repo rate, CRR, SLR.

o Aims to control inflation and ensure liquidity.

2. Banking Sector Regulation:

o Ensuring stability of banks via norms like Basel III, NPA

management, and bank recapitalization.

3. Capital Market Reforms:

o SEBI (Securities and Exchange Board of India) regulates

equity/debt markets.

o Promotes transparency, reduces fraud, and ensures investor

protection.

4. Financial Inclusion Policies:

o Policies like Jan Dhan Yojana, Digital India, and UPI to

increase access to financial services.

5. Foreign Investment Policies:

o Liberalization of FDI norms to attract foreign capital in sectors

like defense, telecom, and infrastructure.

Implications of Financial Policies:

Positive Implications:

1. Economic Stability:
Sound monetary policy helps control inflation and avoid boom-bust
cycles.

2. Increased Investment:
FDI liberalization and deep capital markets attract both domestic
and foreign investments.

3. Banking Sector Strengthening:

Regulation of NPAs and recapitalization improves credit flow and
stability.

4. Boost to Financial Inclusion:

Schemes like PMJDY have brought millions into the formal financial
system.
 5. Enhanced Digital Economy:
UPI and digital payment policies have increased financial
transparency and convenience.

Negative Implications / Challenges:

1. Policy Transmission Issues:

Changes in repo rates may not always impact lending rates due to
structural issues.

2. Banking Sector Vulnerability:

Rising NPAs and frauds (e.g., PMC Bank, YES Bank) expose systemic
risks.

3. Volatility Due to FII/FDI Flow:

Sudden capital outflows can destabilize markets and the rupee.

4. Over-dependence on RBI:
Excessive reliance on monetary policy may limit effectiveness in
addressing deep structural issues.

Recent Examples (2023–2025):

 RBI’s tightening of monetary policy to control inflation post-

COVID.

 Merger of public sector banks to improve efficiency and scale.

 Digital lending guidelines issued by RBI to curb fraudulent

practices.

 India’s rising stock market participation, driven by retail

investors and reforms in capital markets.

 Monetary policy
Monetary policy refers to the use of monetary instruments under the
control of the central bank to regulate magnitudes such as interest rates,
money supply and availability of credit with a view to achieving the
ultimate objective of economic policy. It is through the monetary policy,
RBI controls inflation in the country.

Monetary policy refers to the use of monetary instruments under the

control of the central bank to regulate magnitudes such as interest
rates, money supply and availability of credit with a view to achieving
the ultimate objective of economic policy.

An expansionary monetary policy is focused on expanding (increasing) the

money supply in an economy. An expansionary monetary policy is
implemented by lowering key interest rates thus increasing market
liquidity.

A contractionary monetary policy is focused on contracting (decreasing)

the money supply in an economy. A contractionary monetary policy is
implemented by increasing key interest rates thus reducing market
liquidity.

The primary objectives of monetary policies are the management of

inflation or unemployment, and maintenance of currency exchange rates.

1. Inflation

Monetary policies can target inflation levels. A low level of inflation is

considered to be healthy for the economy. If inflation is high, a
contractionary policy can address this issue.

2. Unemployment

Monetary policies can influence the level of unemployment in the

economy. For example, an expansionary monetary policy generally
decreases unemployment because the higher money supply stimulates
business activities that lead to the expansion of the job market.

3. Currency exchange rates

Using its fiscal authority, a central bank can regulate the exchange rates
between domestic and foreign currencies. For example, the central bank
may increase the money supply by issuing more currency. In such a case,
the domestic currency becomes cheaper relative to its foreign
counterparts.

Instruments

Quantitative measures

1.Bank Rate Policy

The bank rate at which central bank lend money to commercial bank(more
than 90 days).

2.Reserve Ratios

The commercial banks have to keep a certain amount of reserve assets in

the form of reserve cash. Some portion of these cash reserves is their
total assets in the form of cash.

To maintain liquidity and to control credit in the economy, the RBI also
keeps a certain amount of cash reserves. These reserve ratios are known
as SLR (Statutory Liquidity Ratio) and CRR (Cash Reserve Ratio).
a) CRR refers to a certain percentage of commercial bank's net demand
and time liability that commercial banks have to maintain with the RBI at
all times.

b) SLR refers to a certain percentage of reserves to be maintained in the

form of gold and foreign securities.

3. Open Market Operations (OMO)

The sale and purchase of security in the long run/short run by the RBI in
the money market is known as open market operations.

4. Repo Rate

A Repo rate is a rate at which commercial banks borrow money by selling

their securities to the RBI to maintain liquidity. Commercial banks sell their
securities in case of a shortage of funds. It is one of the main instruments
of the RBI to keep inflation under control.

5. Reverse Repo Rate

Sometimes, the RBI borrows money from commercial banks when there is
excess liquidity in the market. In that case, commercial banks get benefits
by receiving the interest on their holdings with the RBI.

At the time of higher inflation in the country, RBI increases the reverse
repo rate that encourages banks to park more funds with the RBI, which
will help it earn higher returns on excess funds.

Qualitative measures

1. Rationing of Credit

RBI fixes a credit amount to be granted for commercial banks. Credit is

given by limiting the amount available for each commercial bank. For
certain purposes, the upper credit limit can be fixed, and banks have to
stick to that limit. This helps in lowering the bank's credit exposure to
unwanted sectors.

2. Change in Marginal Requirement

Margin is referred to the certain proportion of the loan amount that is not
offered or financed by the bank. Change in marginal can lead to change in
the loan size. This instrument is used to encourage the credit supply for
the necessary sectors and avoid it for the unnecessary sectors. That can
be done by increasing the marginal of unnecessary sectors and reducing
the marginal of other needy sectors.

3. Moral Suasion
Moral suasion refers to the suggestions to commercial banks from the RBI
that helps in restraining credits in the inflationary period. Through
monetary policy, commercial banks get informed of the expectations of
RBI. The RBI can issue directives, guidelines, suggestions for commercial
banks regarding reducing credit supply for speculative purposes under the
moral suasion.

Evolution of monetary policies:

1. Initial Phase (1935-1949):

Monetary policy was largely influenced by the Reserve Bank of India Act,
1934, focusing on currency stability and controlling inflation during WWII.
The RBI acted mainly as a currency issuer and government’s banker.

2. Developmental Years (1949-1969):

Monetary policy supported India’s planned economic development with

emphasis on credit control to priority sectors. It aimed to facilitate
industrialization and agricultural growth under the First and Second Five-
Year Plans.

3. Credit Planning (1969-1985):

Introduction of quantitative credit control techniques and emphasis on

directed credit policies to support socio-economic goals. Priority sector
lending became institutionalized to ensure equitable resource distribution.

4. Monetary Targeting (1985-1998):

RBI adopted monetary targeting by controlling money supply (M3) to

regulate inflation and growth. It marked a shift towards more market-
oriented policy while keeping an eye on monetary aggregates.

5. Multiple Indicators Approach (1998-2015):

Monetary policy decisions were based on a wide range of indicators

including inflation, growth, exchange rates, and fiscal conditions. This
approach allowed more flexibility amid liberalization and globalization.

6. Flexible Inflation Targeting (2015 Onwards):

RBI formally adopted inflation targeting with a specific target band (4% ±
2%) to anchor expectations. Monetary policy became more transparent
and forward-looking, balancing growth and price stability.

 Labour Policies and Suggestions Prior to 2020-2021

Introduction:
Labour policies in India are designed to regulate working conditions,
protect workers’ rights, and promote fair employment practices. Before
2020, India had a complex and fragmented labour law system with over
40 central laws and many state laws addressing different aspects of
labour welfare, safety, wages, social security, and industrial relations.

Key Labour Policies Prior to 2020:

1. The Factories Act (1948):

Regulated working hours, health, safety, and welfare of factory
workers.

2. The Industrial Disputes Act (1947):

Provided mechanisms to resolve disputes between employers and
employees to maintain industrial peace.

3. The Minimum Wages Act (1948):

Ensured payment of minimum wages to workers in various sectors
to prevent exploitation.

4. The Employees’ Provident Fund and Miscellaneous

Provisions Act (1952):
Social security for workers through pension and provident fund
schemes.

5. The Trade Unions Act (1926):

Legal recognition and protection for trade unions to represent
workers.

6. The Contract Labour (Regulation & Abolition) Act (1970):

Regulated employment of contract labour to improve working
conditions.

Challenges in Pre-2020 Labour Policies:

 Fragmentation and complexity leading to difficulties in compliance.

 Inflexibility restricting labour market dynamism.

 Poor enforcement and outdated provisions.

 Limited social security coverage, especially for informal sector

workers.

 Rigid industrial dispute resolution processes affecting ease of doing

business.

Suggestions Prior to 2020:

1. Labour Law Consolidation:

Simplify and merge numerous labour laws into fewer,
 comprehensive codes (a recommendation later realized in 2020 with
Labour Code reforms).

2. Flexible Labour Markets:

Introduce flexibility in hiring and layoffs while balancing worker
protection to boost employment generation.

3. Expand Social Security:

Broaden coverage to informal and gig workers for health, pension,
and insurance benefits.

4. Skill Development:
Promote vocational training and skill upgradation aligned with
industry needs.

5. Strengthen Enforcement:
Improve monitoring and grievance redressal mechanisms using
technology.

6. Promote Industrial Harmony:

Encourage dialogue and cooperation between employers,
employees, and trade unions.

 LABOUR LAW REFORMS

● How does development take place?

1. Movement of workers out of agriculture into industry and services

(around 50% are

employed in agriculture)

2. Progressive shift of workers from informal to formal sector (90%

informal)

3. Rapid urbanization (66% in rural)

India’s progress on all 3 fronts has been very slow. According to the
authors the main reason for this is the stringent labor laws. Let’s
understand the main reasons for the slow progress

1. Slow growth of manufacturing – A common feature of fast-growing low-

income

countries is the rapid expansion of manufacturing (China, Vietnam, East-

Asian

economies) pulling unskilled workers from agriculture into industry. India

has failed
to do this. There has been a direct jump from agriculture to services
sector. The share

of manufacturing industry in GDP actually fell from 16.8% in 1981 to

15.8% in 2009.

2. Poor performance of labor-intensive manufacturing – In a recent study,

31 out of

96 manufacturing were identified as labor-intensive industries. They

accounted for

only around 13% of GVA in manufacturing. The fastest growing industries

have been

automobiles, telecommunications, pharmaceuticals, finance and software.

All of these

industries are capital-intensive. Capital intensive industries accounted for

40% of

commodity exports in 1991. The share of these products rose to 65% by

2008. For

readymade garments (which are the most labor-intensive goods) the share
declined

from 12% to 6% during the same period.

3. Capital deepening – Labour-capital ratios in the vast majority of

manufacturing

industries in India are lower than in other countries with similar

development levels.

India’s productivity growth is driven by capital deepening. Capital

deepening =

Increase in capital-labor ratio.

Understanding the labor laws

1. Labor is on the concurrent list on the constitution. That means that both
the state and

the center can make laws on this subject. There are 52 central labor laws
and 150 state

level laws. This brings the total to around 200 labor laws.
2. Some labor laws are in contradiction with each other. You can’t
implement Indian

labor laws 100% without violating 20% of them.

3. Trade unions act 1926 – The act requires that firms with seven or more
workers

should allow them to form a trade union. This gives firms with 6 or lesser
workers the

most labor market labor flexibility. This incentivizes firms to stay small.

4. Factories act 1948 – This act applies to manufacturing units with 10

workers using

power and with 20 workers even if not using power. This limits the
maximum hours

of work per week to 48, requires a paid holiday for each 20 days of work,
limits work

without a day of rest to 10 days.

5. Other legislation – Minimum wages act 1948, Payment of bonus act

1965, payment of

gratuity act 1972 etc.

6. Industrial dispute acts 1947 – This covers all industrial disputes

regardless of firm

size. It states conditions under which employers can alter the tasks
assigned to

workers, conditions under which they can be laid off, and the rules
regulating strikes.

It stacks the deck against the employers. The legislation defines an

industrial dispute

as any dismissal, discharge, or retrenchment of a worker in a firm of any

size.

7. Contract labor act 1970 – Contract workers are hired indirectly and paid
by a

contractor who has in turn contracted with the establishment. The

establishment has

no direct direct responsibility to contract workers. Factories and

establishments prefer
contract workers to avoid the burden imposed on them by the onerous
labor laws.

Adverse Impact of Labor Laws

While labor laws in India are designed to protect workers, they have also
led to some unintended negative consequences, especially due to their
rigidity and complexity:

1. Reduced Flexibility for Employers:

 Strict rules on hiring, layoffs, and retrenchment make it difficult for

companies to adjust workforce size according to market conditions.

 This discourages firms from expanding or hiring permanent

employees.

2. Encouragement of Informal Employment:

 Complex compliance and costly formalities push many employers to

hire workers informally, depriving workers of legal protections and
social security.

3. Lower Job Creation:

 Fear of litigation and high costs associated with compliance reduce

incentives to create new jobs, especially in the organized sector.

4. Inefficient Dispute Resolution:

 Lengthy and complex industrial dispute procedures lead to delays,

increasing costs and tensions between employers and employees.