National income:

National income means the value of goods and services produced by a country
during a financial year. Thus, it is the net result of all economic activities of any
country during a period of one year and is valued in terms of money. National
income is an uncertain term and is often used interchangeably with the national
dividend, national output, and national expenditure. The National Income is the
total amount of income accruing to a country from economic activities in a year’s
time. It includes payments made to all resources either in the form of wages,
interest, rent, and profits. The progress of a country can be determined by
the growth of the national income of the country

GDP and GNP:

GDP measures the aggregate money value of output produced by the economy
over a year. In other words, GDP is obtained by valuing all final goods and
services produced domestically in a year at market prices. GDP is also calculated
by adding all the incomes generated by the act of production.

Since only domestically produced goods and services is estimated, we use the
word ‘domestic’ to distinguish it from the gross national product. The
word ‘gross’ means that no deduction for depreciation is allowed.
GNP includes GDP plus net property income from abroad. Thus, GNP includes
income that nationals earn abroad, but it does not include the income earned by
foreign nationals. On the other hand, GDP is concerned with incomes generated
domestically even by the foreigners. GDP ignores incomes received from abroad.

It is a measure of the goods and services produced within the country, regardless
of who owns the assets. And, GNP is the total of incomes earned by the residents
of a country, regardless of where the assets are located. India’s GNP includes
profits from Indian- owned businesses located in other countries. In other words,

GNP = market value of domestically produced goods and services + incomes

earned by the nationals in foreign countries — incomes earned in the country by
the foreigners.

GDP = market value of goods and services produced in the country + incomes
earned in the country by the foreigners — incomes received by resident nationals
from abroad. Thus,

GNP = GDP + net property income from abroad

Thus GDP measures the aggregate money value of all goods and services
produced by factors of production located and paid for in the domestic economy,
even if these factors are owned abroad.

GDP at Market Price and GDP at Factor Cost:

When national product is measured, it is measured at current market prices.

Market prices always reflect taxes and subsidies on the commodities produced. If
indirect taxes are imposed on commodities, market prices of the commodities go
up. Tax is included in the price of a commodity and tax is not a production.
Similarly, subsidies are provided to some commodities, as a result of which prices
decline. If we do not make any adjustment for such taxes and subsidies, we obtain
GDP at market price.

GDP at market prices does not reflect true incomes of factors of production. It
includes taxes and subsidies but such are not production and, hence, they cannot
be treated as incomes of productive inputs. So, taxes and subsidies are to be
excluded and included to obtain the true figure of production. Value of output can
never be equal to the value of incomes paid to all productive inputs. By adjusting
taxes and subsidies, we obtain GDP at factor cost, i.e.

GDP at factor cost = GDP at market price – indirect taxes (T) + subsidies (SU)
NI = NNP – T + SU
Or, NI = (GNP – D) – T + SU
NNP:
If we deduct depreciation from gross product we obtain net product. GDP minus
depreciation is called NNP. NNP is sometimes called national income.

Anyway, to measure NNP, we must make a distinction between gross investment

(IG) and net investment (IN). Gross investment refers to total expenditure for new
plant, equipment, etc., plus the change in inventories. Net investment is equal to
gross investment less depreciation. That is,
IN = IG – depreciation
Since, GNP = C + IG + G + (X – M),
NNP = C + IN + G + (X – M)
Or, NNP = GNP – depreciation

Although NNP gives us the better measure of an economy’s performance, we pay

more attention to GNP. This is because estimation of NNP is difficult in practice,
as one has to measure depreciation to obtain the net investment figure. In practice,
GNP is the more commonly used indicator than NNP.

Per Capita Income: The average income of the people of a country in a particular
year is called Per Capita Income for that year. Per Capita Income for 2011 =
National Income for 2011 divided by Population in 2011. This concept enables
us to know the average income and the standard of living of the people. But it is
not very reliable due to unequal distribution of national income exist in every
country
Fiscal policy:

Fiscal policy refers to the use of government spending and tax policies to
influence economic conditions, especially macroeconomic conditions, including
aggregate demand for goods and services, employment, inflation, and economic
growth. Fiscal policy is largely based on ideas from John Maynard Keynes, who
argued governments could stabilize the business cycle and regulate economic
output. During a recession, the government may employ expansionary fiscal
policy by lowering tax rates to increase aggregate demand and fuel economic
growth. In the face of mounting inflation and other expansionary symptoms, a
government may pursue a contractionary fiscal policy.

Objectives of fiscal policy:

The major objectives of fiscal policy are:

1. Attainment of full-employment
2. Attainment of economic stability
3. Attainment of price stability
4. Acceleration of growth and development
5. Equitable distribution of income and wealth
6. Optimum allocation of resources
7. Encouraging investments
8. Promotion of capital formation
9. Removal of regional imbalances
10. Elimination of cyclical fluctuations

Some of the major instruments of fiscal policy are as follows: A) Budget B)

Taxation C) Public Expenditure D) Deficit financing E) Public Debt.
A. Budget:

The budget of a nation is a useful instrument to assess the fluctuations in an

economy. Budget is an important instrument of financial administration. It is the
annual statement of income and expenditure of the government prepared by the
financial authority covering the current year, the preceding year and the following
year. It consists of proposals for the collection of revenue and allocation of the
revenue resources among various heads of expenditure. The government can
bring desired changes in the economic conditions of a country with the help of
the instrument of budget. All other fiscal instruments such as taxation, public
expenditure, public debt, deficit financing are regulated through the budgetary
operations.

B. Taxation:
Taxation is a powerful instrument of fiscal policy in the hands of public
authorities which greatly effect the changes in disposable income, consumption
and investment. An anti- depression tax policy increases disposable income of
the individual, promotes consumption and investment. Obviously, there will be
more funds with the people for consumption and investment purposes at the time
of tax reduction. This will ultimately result in the increase in spending activities
i.e. it will tend to increase effective demand and reduce the deflationary gap. An
anti-inflationary tax policy, on the contrary, must be directed to plug the
inflationary gap. During inflation, fiscal authorities should not only retain the
existing tax structure but also evolve such measures (new taxes) to wipe off the
excessive purchasing power and consumer demand. To this end, expenditure tax
and excise duty can be raised.

C. Public Expenditure:
The appropriate variation in public expenditure can have more direct effect upon
the level of economic activity than even taxes. The increased public spending will
have a multiple effect upon income, output and employment exactly in the same
way as increased investment has its effect on them. Similarly, a reduction in
public spending, can reduce the level of economic activity through the reverse
operation of the government expenditure multiplier. During the period of
inflation, the basic reason of inflationary pressures is the excessive aggregate
spending. Both private consumption and investment spending are abnormally
high. In these circumstances, public spending policy must aim at reducing the
government spending. In depression, public spending emerges with greater
significance. It is helpful to lift the economy out of the morass of stagnation. In
this period, deficiency of demand is the result of sluggish private consumption
and investment expenditure. Therefore, it can be met through the additional doses
of public expenditure equivalent to the deflationary gap. The multiplier and
acceleration effect of public spending will neutralize the depressing effect of
lower private spending’s and stimulate the path of recovery.

D. Deficit financing
Deficit financing is an important tool of financing government expenditure. It
refers to the process of financing the deficit or gap between expenditure and
revenue of the government. Whenever expenditure exceeds revenue, there arise
the deficit and the method to bridge this deficit is called deficit financing. The
important methods for deficit financing include borrowings, withdrawal of past
accumulated savings, and printing of new currency.

E. Public Debt:
Public debt is a sound fiscal weapon to fight against inflation and deflation. It
brings about economic stability and full employment in an economy. The
governments borrow when their expenditure tend to exceed their revenue. The
government borrowing may assume any of the following forms mentioned as
under:
(a) Borrowing from Non-Bank Public
(b) Borrowing from Banking System
(c) Drawing from Treasury
(d) Printing of Money

Monetary policy:

Monetary policy refers to the credit control measures adopted by the central bank
of a country. Monetary policy is an economic policy that manages the size and
growth rate of the money supply in an economy. It is a powerful tool to regulate
macroeconomic variables such as inflation and unemployment.

Objectives or Goals of Monetary Policy:

The following are the principal objectives of monetary policy:

1. Full Employment:

Full employment has been ranked among the foremost objectives of monetary
policy. It is an important goal not only because unemployment leads to wastage
of potential output, but also because of the loss of social standing and self-respect.

2. Price Stability:

One of the policy objectives of monetary policy is to stabilise the price level. Both
economists and laymen favour this policy because fluctuations in prices bring
uncertainty and instability to the economy.

3. Economic Growth:

One of the most important objectives of monetary policy in recent years has been
the rapid economic growth of an economy. Economic growth is defined as “the
process whereby the real per capita income of a country increases over a long
period of time.”

4. Balance of Payments:

Another objective of monetary policy since the 1950s has been to maintain
equilibrium in the balance of payments.

Instruments of Monetary Policy:

The instruments of monetary policy are of two types: first, quantitative, general
or indirect; and second, qualitative, selective or direct. They affect the level of
aggregate demand through the supply of money, cost of money and availability
of credit. Of the two types of instruments, the first category i.e. quantitative
measures includes bank rate variations, open market operations and changing
reserve requirements. They are meant to regulate the overall level of credit in the
economy through commercial banks. The selective credit controls or qualitative
measures aim at controlling specific types of credit. They include changing
margin requirements and regulation of consumer credit. We discuss them as
under:

Bank Rate Policy:

The bank rate is the minimum lending rate of the central bank at which it
rediscounts first class bills of exchange and government securities held by the
commercial banks. Bank rate is used to control inflation and deflation. Inflation
is corrected by increasing the bank rate and deflation is corrected by decreasing
the bank rate.

Open Market Operations:

Open market operations refer to sale and purchase of securities in the money
market by the central bank. When prices are rising and there is need to control
them, the central bank sells securities. The reserves of commercial banks are
reduced and they are not in a position to lend more to the business community.
Further investment is discouraged and the rise in prices is checked. Contrariwise,
when recessionary forces start in the economy, the central bank buys securities.
The reserves of commercial banks are raised. They lend more. Investment, output,
employment, income and demand rise and fall in price is checked.

Changes in Reserve Ratios:

Every bank is required by law to keep a certain percentage of its total deposits in
the form of a reserve fund in its vaults and also a certain percentage with the
central bank. When prices are rising, the central bank raises the reserve ratio.
Banks are required to keep more with the central bank. Their reserves are reduced
and they lend less. The volume of investment, output and employment are
adversely affected. In the opposite case, when the reserve ratio is lowered, the
reserves of commercial banks are raised. They lend more and the economic
activity is favourably affected.

Statutory Liquidity ratio:

SLR implies the percentage of total deposits which the commercial banks are
statutorily required to maintain themselves in the form of liquid assets as cash
reserves, gold and government securities in addition to CRR. This measure was
undertaken to prevent the commercial banks from liquidating their liquid assets
when CRR is raised.

Repo rate:

Repo is the rate at which the commercial banks avail short term loans from the
RBI. It is one of the most powerful instruments for attaining stability by short
term interest rate adjustments.
Reverse repo rate:

Reverse repo is the rate at which banks park their short term surplus funds with
the RBI. It is also one of the most powerful instruments for attaining stability by
short term interest rate adjustments.

Selective Credit Controls:

Selective credit controls are used to influence specific types of credit for
particular purposes. The major measures under this category include:

Margin requirements:

Margin requirements are the percentage that the commercial banks are not
permitted to lend. It is the difference between the value of the mortgaged property
and the maximum amount of loan against that security. The banks are generally
providing loans and advances after maintaining this lending margin.

Consumer credit regulation:

Here, credit is regulated directly to control the use of the credit for purchasing
durable consumer goods. Under this, a certain percentage of the price of the
consumer goods is paid by the consumer in cash and only the balance amount is
financed by the commercial banks through credit.

Credit rationing:

Credit rationing implies a process of fixing priorities or diverting the financial

resources into productive channels fixed by the planning authority. Rationing
may be of two types. A) Limiting the maximum loans and advances to the
commercial banks and B) fixing a ceiling for specific categories of loans and
advances.
Moral suasion:

Moral suasion means requesting, advising and persuading the commercial banks
to co-operate with the central bank in its policies. It is a process of convincing the
commercial banks to advance credit in accordance with the directives of the
central bank in the overall economic interest of the country.

Direct action:

Directive action implies coercive measures against the commercial banks when
all other methods prove ineffective. The central bank resort to direct control
measures with clear directive to carry out the lending activity in a specified and
desirable manner.

Publicity:

Through publicity, the central bank seeks to influence the credit policies of
commercial banks, to provide the general public information regarding the
economic and monetary conditions of the economy and to seek the public opinion
in favour of its monetary policy.

Conclusion:

For an effective anti-cyclical monetary policy, bank rate, open market operations,
reserve ratio and selective control measures are required to be adopted
simultaneously. But it has been accepted by all monetary theorists that (i) the
success of monetary policy is nil in a depression when business confidence is at
its lowest ebb; and (ii) it is successful against inflation. The monetarists contend
that as against fiscal policy, monetary policy possesses greater flexibility and it
can be implemented rapidly.
 Inflation- meaning, types and effects:

Inflation is an economic indicator that indicates the rate of rising prices of goods
and services in the economy. Ultimately it shows the decrease in the buying
power of the rupee. It is measured as a percentage. This percentage indicates the
increase or decrease from the previous period. Inflation can be a cause of concern
as the value of money keeps decreasing as inflation rises.
Inflation is a quantitative economic measure of a rate of change in prices of
selected goods and services over a period of time. Inflation indicates how much
the average price has changed for the selected basket of goods and services. It is
expressed as a percentage. Increase in inflation indicates a decrease in the
purchasing price of the economy.
Types of Inflation:
The three types of Inflation are Demand-Pull, Cost-Push and Built-in inflation.
Demand-pull Inflation: It occurs when the demand for goods or services is
higher when compared to the production capacity. The difference between
demand and supply (shortage) result in price appreciation.
Cost-push Inflation: It occurs when the cost of production increases. Increase in
prices of the inputs (labour, raw materials, etc.) increases the price of the product.
Built-in Inflation: Expectation of future inflations results in Built-in Inflation. A
rise in prices results in higher wages to afford the increased cost of living.
Therefore, high wages result in increased cost of production, which in turn has an
impact on product pricing. The circle hence continues.
Effects of a rise in the inflation rate:
A rise in an inflation rate can cause more than a fall in purchase power.

• Inflation could lead to economic growth as it can be a sign of rising demand.

• Inflation could further lead to an increase in costs due to workers demand to
increase wages to meet inflation. This might increase unemployment as
companies will have to lay off workers to keep up with the costs.
• Domestic products might become less competitive if inflation within the country
is higher. It can weaken the currency of the country.

India’s Inflation rate in 2022 is around 7.10%. The inflation rate of an economy
is determined by the increase in the price of the product basket. The product
basket consists of the services and goods on which an average consumer spends
through the year. For example, rent, power, clothing, groceries,
telecommunication, domestic needs (oil, gas), recreational activities, and taxes,
etc. In 2020, India’s inflation was around 3.34%.

Budget:

A budget is a calculation plan, usually but not always financial, for a

defined period, often one year. A budget may include anticipated sales volumes
and revenues, resource quantities including time, costs and expenses,
environmental impacts such as greenhouse gas emissions, other
impacts, assets, liabilities and cash flows. Companies, governments, families,
and other organizations use budgets to express strategic plans of activities in
measurable terms.

A budget expresses intended expenditures along with proposals for how to meet
them with resources. A budget may express a surplus, providing resources for use
at a future time, or a deficit in which expenditures exceed income or other
resources.

The budget of a government is a summary or plan of the anticipated resources

(often but not always from taxes) and expenditures of that government. There are
three types of government budget: the operating or current budget, the capital or
investment budget, and the cash or cash flow budget.

The budget is prepared by the Budget Division Department of Economic Affairs

of the Ministry of Finance annually. The Finance Minister is the head of the
budget making committee. The present Indian Finance minister is Nirmala
Sitharaman. The Budget includes supplementary excess grants and when a
proclamation by the President as to failure of Constitutional machinery is in
operation in relation to a State or a Union Territory, preparation of the Budget of
such State.

The first budget of India was submitted on 18 February 1860 by James Wilson.
P C Mahalanobis is known as the father of Indian budget.

Revenue Expenditure and Capital Expenditure:

An expenditure that neither creates assets nor reduces a liability is categorised as

revenue expenditure. If it creates an asset or reduces a liability, it is categorised
as capital expenditure.

This is the basis of classification between revenue expenditure and capital

expenditure.

(a) Revenue Expenditure:

Simply put, an expenditure which neither creates assets nor reduces liability is
called Revenue Expenditure, e.g., salaries of employees, interest payment on past
debt, subsidies, pension, etc. These are financed out of revenue receipts. Broadly,
any expenditure which does not lead to any creation of assets or reduction in
liability is treated as revenue expenditure.

Generally, expenditure incurred on normal running of the government

departments and maintenance of services is treated as revenue expenditure.
Examples of revenue expenditure are salaries of government employees, interest
payment on loans taken by the government, pensions, subsidies, grants, rural
development, education and health services, etc.
It is a short period expenditure and recurring in nature which is incurred every
year (as against capital expenditure which is long period expenditure and non-
recurring in nature). The purpose of such expenditure is not to build up any capital
asset, but to ensure normal functioning of government machinery. Traditionally,
all grants given to state governments are treated as revenue expenditure even
though some of the grants may before creation of assets.

(b) Capital Expenditure:

An expenditure which either creates an asset (e.g., school building) or reduces

liability (e.g., repayment of loan) is called capital expenditure.

(A) Capital expenditure which leads to creation of assets are (a) expenditure on
purchase of land, buildings, machinery, (b) investment in shares, loans by Central
government to state government, foreign governments and government
companies, cash in hand and (c) acquisition of valuables. Such expenditures are
incurred on long period development programmes, real capital assets and
financial assets. This type of expenditure adds to the capital stock of the economy
and raises its capacity to produce more in future.

(B) Repayment of loan is also capital expenditure because it reduces liability.

These expenditures are met out of capital receipts of the government including
capital transfers from rest of the world.

Comparison between Revenue Expenditure and Capital Expenditure

Revenue Expenditure Capital Expenditure
1. It is incurred for normal running 1. It is incurred for acquisition of capital
of government departments and assets.
maintenance.
2. It does not result in creation of 2. It results in creation of assets.
assets.
 3. It is recurring in nature and 2. It is non-recurring in nature.
incurred regularly.
4. It is short period expenditure. 4. It is generally a long period expenditure.
5. For example, expenditure on 5. For example, construction of a hospital
medicines and salaries of doctors building is capital expenditure.
for rendering services is

Deficit: revenue deficit and fiscal deficit:

Revenue Deficit: It refers to the excess of total revenue expenditure of the

government over its total revenue receipts. Revenue deficit = Total Revenue
expenditure – Total Revenue receipts. OR Revenue deficit = Total Revenue
expenditure – (Tax Revenue + Non-Tax Revenue)

Fiscal Deficit: Fiscal deficit is defined as excess of total expenditure over

total receipts excluding borrowings during a fiscal year.

Fiscal deficit = Total budget expenditure – Total budget receipts excluding

borrowings

OR

Fiscal Deficit = (Revenue expenditure + Capital expenditure) – (Revenue

Receipts + Capital receipts excluding borrowings)

Fiscal deficit shows the borrowing requirements of the govt. during the
budget year for financing the expenditure including interest payments.
Fiscal deficit indicates the additional number of financial resources needed
to meet government expenditure.

Primary Deficit: Primary deficit is defined as fiscal deficit minus interest

payments on previous borrowings. Primary deficit shows the borrowing
requirements of the govt. for meeting expenditure excluding interest
payment. Gross Primary deficit = Fiscal deficit – Interest payments

Net Primary deficit = Fiscal deficit + Interest received – Interest payments It

shows the total amount that the central government needs to borrow.

Balance of payments:

The balance of payments accounts of a country record the payments and receipts
of the residents of the country in their transactions with residents of other
countries. If all transactions are included, the payments and receipts of each
country are, and must be, equal. Although the totals of payments and receipts are
necessarily equal, there will be inequalities—excesses of payments or receipts,
called deficits or surpluses—in particular kinds of transactions. Thus, there can
be a deficit or surplus in any of the following: merchandise trade (goods),

• services trade,
• foreign investment income,
• unilateral transfers (foreign aid),
• private investment,
• the flow of gold and money between central banks and treasuries, or
• Any combination of these or other international transactions.

Balance of trade:

The difference in value over a period of time between a country’s imports and
exports of goods and services, usually expressed in the unit of currency of a
particular country or economic union (e.g., dollars for the United States, pounds
sterling for the United Kingdom, or euros for the European Union). If the exports
of a country exceed its imports, the country is said to have a favourable balance
of trade, or a trade surplus. Conversely, if the imports exceed exports, an
unfavourable balance of trade, or a trade deficit, exists.
The current account and capital account:

The current account and capital account comprise the two elements of the
balance of payments in international trade. Whenever an economic actor
(individual, business or government) in one country trades with an economic
actor in a different country, the transaction is recorded in the balance of
payments. The current account tracks actual transactions, such as import and
export goods. The capital account tracks the net balance of international
investments – in other words, it keeps track of the flow of money between a
nation and its foreign partners. The balance of payments always has the same
value of debits and credits. A country that has a current accounts deficit
necessarily has a capital accounts surplus and vice versa.

Current Account:

There are three broad components of the current account: balance of trade, net
factor income, and net transfer payments. Most traditional forms of international
trade are covered in the current account. These transactions tend to be more
immediate and more visible than the transactions recorded in the capital account.

Capital Account

Flows in and out of the capital account represent changes in asset value through
investments, loans, banking balances, and real property value. The capital
account is less immediate and more invisible than the current account. Many
common misunderstandings about international trade stem from a lack of
understanding of the capital account. Common forms of capital account
transactions include foreign direct investment or loans from foreign
governments. The vast majority of global capital account transfers take place
between the world's wealthiest businesses, banks, and governments.
Foreign Direct Investment and Foreign Portfolio Investment

Foreign direct investment (FDI) and foreign portfolio investment (FPI) are two
of the most common routes for investors to invest in an overseas economy. FDI
implies investment by foreign investors directly in the productive assets of
another nation. FPI means investing in financial assets, such as stocks and bonds
of entities located in another country. FDI and FPI are similar in some respects
but very different in others.

Differences Between FDI and FPI

Although FDI and FPI are similar in that they both involve foreign investment,
there are some very fundamental differences between the two.

The first difference arises in the degree of control exercised by the foreign
investor. FDI investors typically take controlling positions in domestic firms or
joint ventures and are actively involved in their management. FPI investors, on
the other hand, are generally passive investors who are not actively involved in
the day-to-day operations and strategic plans of domestic companies, even if they
have a controlling interest in them.

The second difference is that FDI investors perforce have to take a long-term
approach to their investments since it can take years from the planning stage to
project implementation. On the other hand, FPI investors may profess to be in
for the long haul but often have a much shorter investment horizon, especially
when the local economy encounters some turbulence.

This brings us to the final point. FDI investors cannot easily liquidate their assets
and depart from a nation, since such assets may be very large and quite illiquid.
FPI investors can exit a nation literally with a few mouse clicks, as financial
assets are highly liquid and widely traded.