ECONOMICS : BUDGET AND BASIC CONCEPTS

Group Ten

15-Dec-14

OUR GROUP

1.Amal : Meaning of Budget-concepts-plan and non plan expenditure.

2.Navami:Fiscal Deficit- Revenue Deficit-Inflation and its types- Bank rates.

3.Arun : SLR,CRR,repo,reverse repo, quantitative credit control.

4.Mumtaz : Monetary and Fiscal Policies of India.

5.Midhu: Quantitative theory of money-Fisher;Keynes;Triedman;Tobin

BUDGET

MeaningIt is an estimation of the revenue and expenses

over a specified future period of time. A budget

can be made for a person, family, group of

people, business, government, country. A budget

is prepared to have effective utilization of funds.

Definition

According to Prof. Dimock “A budget is abalanced estimate of expenditures and receipts of agiven period of time. In the hands of administration, the budget is a record of past performance, amethod of current control, and a projection of futureplans”.

In the Indian Constitution ,a budget has beenreferred to as the annual financial statement of theestimated receipts and expenditure of theGovernment of India or of a State Government inthe respect of a financial year.

IMPORTANCE OF A BUDGET:

It sets a framework for policy formulation.

Budgeting is a means of policy

implementation.

The budget is a means of legal control.

Budget document may be a source of public

information on the past activities, current

decisions and future prospectus.

PLAN AND NON PLAN EXPENDITURE

(a) Plan Expenditure:

Any expenditure that is incurred on programs which are detailed under the current (Five Year) Plan of the centre. Provision of such expenditure in the budget is called Plan Expenditure.

(b) Non-Plan Expenditure:

Non-Plan expenditure covers all expenditure of Government not included in the Plan. It may either be revenue expenditure or capital expenditure.

CHARACTERISTICS OF A BUDGET

It is expressed in quantitative or monetary terms.

It is prepared for a fixed period of time.

It must be realistic and should be flexible.

On the basis of budget report performance of the organization is constantly monitored.

The anticipations of revenues and expenditure must make a positive contribution to the realization of economic goals.

Prepared on the basis of established standards of performance.

TYPES OF BUDGET

Sales budget – It is an estimate of future sales. It is used to create company sales goals.

Production budget- it is an estimate of the number of units that must be manufactured to meet the sales goals. The production budget also estimates the various costs involved with manufacturing those units, including labor and material. Created by product oriented companies.

Capital budget- it is used to determine whether an organization's long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects etc ..are worth pursuing.

Cash flow/cash budget – a prediction of future cash receipts and expenditures for a particular time period

Marketing budget – an estimate of the funds needed for promotion, advertising, and public relations in order to market the product or service.

Project budget – a prediction of the costs associated with a particular company project. These costs include labor, materials, and other related expenses.

Revenue budget -The revenue budget consists of revenue receipts of the government (revenues from tax and other sources), and its expenditure.

COMING UP NEXT:

Navami:

Fiscal Deficit-

Revenue Deficit-

Inflation and its types-

Bank rates.

FISCAL DEFICIT

Fiscal deficit is the difference between the government’s total

expenditure and its total receipts (excluding borrowing)

If the government spends more than it earns we have a situation

which is called a fiscal deficit

FISCAL DEFICIT = [ GOVERNMENT SPENDING - GOVERNMENT REVENUE]

REVENUE DEFICIT

The difference between the government’s current

(or revenue)expenditure and total current receipts

(that is, excluding borrowing)

REVENUE DEFICIT= [BUDGET REVENUE -ACTUAL NET REVENUE]

INFLATION TYPES

1. Creeping inflation

2. Walking inflation

3. Running inflation

4. Hyper inflation

CREEPING INFLATION

When the rise in prices is very low like that of a

snail or creeper is called a creeping inflation

WALKING INFLATION

When the price rise is moderate and the annual

inflation rate is of a single digit, it is called

walking inflation. It is a warning signal for the

government to control it before it turns into

running inflation.

RUNNING INFLATION

o Prices rise rapidly

o Also called runway or galloping inflation

o Immeasurable and uncontrollable

HYPER INFLATION

Prices rise very fast at double or triple digit

rate.

BANK RATE

The rate at which commercial banks give money to

public.

Whenever a bank has a shortage of funds, they

can typically borrow from the central bank based

on the monetary policy of the country.

CURRENT BANK RATE-9%

COMING UP NEXT :

Arun :

SLR

CRR

Repo

reverse repo

quantitative credit control.

SLR

Statutory liquidity ratio (SLR) is the Indian government term for reserve requirement that the commercial banks in India require to maintain in the form of gold or government approved securities before providing credit to the customers. Statutory Liquidity Ratio is determined and maintained by Reserve Bank of India in order to control the expansion of bank credit.

The SLR is determined as a percentage of total demand and time liabilities.

The SLR is commonly used to

contain inflation and fuel growth, by

increasing or decreasing it respectively. This

counter acts by decreasing or increasing the

money supply in the system respectively.

The maximum limit of SLR is 40% and

minimum limit of SLR is 22% [its current

value is 22%]

OBJECTIVES

The main objectives for maintaining the SLR ratio are the following:

to control the expansion of bank credit. By changing the level of SLR, the Reserve Bank of India can increase or decrease bank credit expansion.

to ensure the solvency [The ability of a company to meet its long-

term financial obligations.]of commercial banks.

to compel the commercial banks to invest in government securities like government bonds.

SLR rate =

(liquid assets / (demand + time liabilities)) ×

100%

CRR

Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with the RBI. If the central bank decides to increase the CRR, the available amount with the banks comes down. The RBI uses the CRR to drain out excessive money from the system.

Increase in CRR means that banks have less funds available and money is sucked out of circulation. Thus we can say that this serves duel purposes

(a) ensures that a portion of bank deposits is kept with RBI and is totally risk-free,

(b) enables RBI to control liquidity in the system, and thereby, inflation by tying the hands of the banks in lending money.

WHAT IS A REPO RATE?

The rate at which the RBI lends money to

commercial banks is called repo rate. It is an

instrument of monetary policy. Whenever

banks have any shortage of funds they can

borrow from the RBI.

A reduction in the repo rate helps banks get

money at a cheaper rate and vice versa.

WHAT IS REVERSE REPO RATE?

Reverse Repo rate is the rate at which the RBI borrows money from commercial banks. Banks are always happy to lend money to the RBI since their money are in safe hands with a good interest.

An increase in reverse repo rate can prompt banks to park more funds with the RBI to earn higher returns on idle cash.It is also a tool which can be used by the RBI to

drain excess money out of the banking system.

LAF

Liquidity Adjustment Facility or [LAF]

Both Repo and Reverse repo are the LAF.

Repo rate 8%.

Reverse repo rate 7%

QUANTITATIVE CREDIT CONTROL

The objectives of quantitative methods of credit control are as follows:

(i) Controlling the volume of credit in the economy.

(ii) Maintaining equilibrium between saving and investment in the economy.

(iii) Maintaining the stability in exchange rates.

(iv) Correcting disequilibrium in the balance of payments of the country.

(v) Removing shortage of money in the money market.

FOUR QUANTITATIVE CREDIT CONTROL

METHODS

1. Bank rate policy

2. Open market operations

3. Variation of cash reserve ratio

4. 'Repo' or Repurchase Transactions

BANK RATE POLICY

It is also known as discount rate policy. Bank

rate is the rate at which the Central Bank is

prepared to rediscount the approved bills or

to lend on eligible paper.

The bank rate is raised in times of inflation

and is lowered in times of deflation.

OPEN MARKET OPERATIONS

Open market operation refers to buying and

selling of eligible securities by the Central

Bank in the money market and capital

market. The buying and selling of securities

by the Central Bank results in an increase or

decrease in the cash resources of the

commercial banks.

COMING UP NEXT

Mumtaz :

Monetary and Fiscal Policies of India.

MONETARY POLICY –MEANING….

Reserve Bank of India states that,

Monetary policy refers to the use of

instruments under the control of the central

bank to regulate the availability, cost and use

of money and credit.

OBJECTIVES

Maintaining price stability

Ensuring adequate flow of credit to the

productive Sectors of the economy to

support economic growth

Rapid economic growth

METHODS

The RBI aims to achieve its objectives of

economic growth and control of inflation

through various methods.

These methods can be grouped as:

General/ quantitative methods

Selective/ qualitative methods

GENERAL/ QUANTITATIVE METHODS

These methods maintain and control the total quantity or volume of credit or money supply in the economy.

Open Market OperationsOpen market operations indicate the buying/ selling of govt.

securities in the open market to balance the money supply in the economy

Deployment of Credit The RBI has taken various measures to deploy credit in

different sector of the economy. The certain percentage of the bank credit has been fixed for various sectors like agriculture, export etc.

SELECTIVE/ QUALITATIVE MEASURES

The RBI directs commercial banks to meet their social obligations through selective/ qualitative measures.

These measures control the distribution and direction of credit to various sectors of the economy.

CEILING ON CREDIT

DISCRIMINATORY RATES OF INTEREST

FACTORS AFFECTING MONETARY POLICY

Excess of non-banking financial

institutions (NBFI)

Money not appearing in an economy

Time lag affects success of monetary

policy

Monetary policy and fiscal policy lacks

coordination

FISCAL POLICY: MEANING

Fiscal policy deals with the taxation and

expenditure decisions of the government.

These include, tax policy, expenditure policy,

investment or disinvestment strategies and

debt or surplus management.- Kaushik Basu ( Former Chief Economic Adviser )

OBJECTIVES OF FISCAL POLICY

Increase in capital formation.

Degree of Growth.

To achieve desirable price level.

To achieve desirable consumption level.

To achieve desirable employment level.

To achieve desirable income distribution.

FISCAL POLICY THERE ARE THREE POSSIBLE

POSITIONS

A Neutral position applies when the budget outcome has neutral effect on the level of economic activity where the govt. spending is fully funded by the revenue collected from the tax.

An Expansionary position is when there is a higher budget deficit where the govt. spending is higher than the revenue collected from the tax.

An Contractionary position is when there is a lower budget deficit where the govt. spending is lower than the revenue collected from the tax.

THE TWO MAIN INSTRUMENTS OF FISCAL

POLICY

Revenue Budget

Expenditure Budget

Direct Tax

Individual Income Tax

& Corporate Tax.

Wealth Tax @ 1%

Indirect Tax

central excise (a

tax on

manufactured

goods)

VAT @ 12.5%

service tax

customs duty

Educational cess

THE EXPENDITURE BUDGET INCLUDES FOUR

MAIN REVENUE EXPENDITURES

EXPENDITURE BUDGET

The central government is responsible for issues that usually concern the country as a whole like national defence, foreign policy, railways, national highways, shipping, airways, post and telegraphs, foreign trade and banking.

The state governments are responsible for other items including, law and order, agriculture, fisheries, water supply and irrigation, and public health.

Some items for which responsibility vests in both the Centre and the states include forests, economic and social planning, education, price control and electricity.

COMING UP NEXT:

Midhu:

Quantitative theory of money-

Fisher;

Keynes;

Triedman;

Tobin

QUANTITY THEORY OF MONEY

The quantity theory of money states that there is a

direct relationship between the quantity of money

in an economy and the level of prices of goods

and services.

The main theories are:-

1. The Fisher’s Quantity Theory of Money

2.Keynes reformulated Quantity theory of

money 3.Friedman’s restatement of QTM

4.Tobin’s Portfolio-QTM

1. FISHER’S QUANTITY THEORY OF MONEY-THE CASH

TRANSACTION APPROACH

According to Fisher when “Other things remaining

unchanged, as the quantity of money in circulation

increases, the price level also increases in direct proportion

and the value of money decreases and vice-versa”

It means the value of money in a given period of time depends

upon the quantity of money in the circulation of the economy.

EQUATION OF EXCHANGE:

The Cash transaction version of the quantity theory of money was presented by Irving fisher in the form of an equation:

P = MV + M1 V1 or PT= MV+ M1V1T

Here,P is the price LevelM is the quantity of moneyV is the velocity of circulation of MM1 is the volume of credit moneyV1 is the velocity of circulation of M1T is the total volume of goods and Trade

Fisher’s quantity theory of money is explained

with the help of following figure

2.KEYNES REFORMULATED QUANTITY THEORY

OF MONEY

According to Keynes

“when the economy reaches the full

employment level of output, any further

increase in aggregate money demand brings

about a proportionate increase in the price

level but output remains unchanged at that

level”

According to him, the effect of a change in the

quantity of money on prices is indirect and non-

proportional.

3.FRIEDMAN’S RESTATEMENT OF QTM

According to Friedman, the quantity theory is fundamentally a theory of the

demand for money and not a theory of output, or of money income, or of

the price level and includes

total wealth from all sources of income or consumable services which is

capitalized income.

Wealth can be held in 5 different forms-

Money, Bonds, Equities, Physical goods, Human capital

The present discounted value of expected income flows is expressed as

Friedman expands the detail of wealth and returns to identify the variety of assets and returns in the potential port folio:

M=f(P,rb,re,ra,w,gp;u)

P-----price level

rb----- returns on bonds

re------ returns on equities

ra------ returns on real assets

w------- ratio of human to non human wealth

gp------- total wealth

u------portfolio variable

4.TOBIN’S PORTFOLIO-QTM

According to Tobin, an investor is faced with a

problem of what proportion of his portfolio of

financial assets he should keep in the form of

money (which earns no interest) and interest-

bearing bonds. The portfolio of individuals

may also consist of more risky assets such as

shares .

Tobin‘s Liquidity Preference Function:

Tobin derives the aggregate liquidity preference

curve by determining the effects of changes in

interest rate on the asset demand for money in the

portfolio of individual.

The liquidity preference curve is negatively

sloped which incurs that at a higher rate of

interest, the demand for holding money (i.e.,

liquidity) will be less and therefore they will hold

more bonds in their portfolio. On the other hand,

at a lower rate of interest they will hold more

money and less bonds in their portfolio.

REFERENCES

http://www.yourarticlelibrary.com/economics/money

en.wikipedia.org/Books:

Budgeting Profit planning and Control; Glenn A.Welsh,Ronald W,Hilton,Paul N.Gordon.

Public Economics ;Om Prakash

Indian Economic Policy; Bimal Jalan

Inflation