Ideally, a country’s economy is controlled by two types of economic measures – fiscal and monetary.
While the fiscal policy is framed and implemented by the government with regulation of its spending and
collection of revenue, the monetary policy is controlled by the central bank of the country (in India,
it is Reserve Bank of India).
These policies may be designed and implemented for the expansion or contraction of the economy. Policy
measures aimed to increase the gross domestic product (GDP) and the economic growth are called
expansionary. The measures taken to check the inflationary trends in the economy are the contractionary
measures. Conceptually, when demand is low in the economy, the government can step in and increase its
spending to stimulate demand. It may also lower taxes to increase disposable income for people. It is,
therefore, the manipulation of the level of aggregate demand in the economy is to achieve economic
objectives of price stability, full employment, and economic growth.
Monetary policy, on the other hand, is the process by which the monetary authority of a country (RBI,
in case of India) controls the supply of money by adopting different quantitative or qualitative
measures. These steps include bringing changes in key policy rates often targeting correction in rate
of interest, cash reserve ratio (CRR) and statutory liquidity ratio (SLR) to leave more/less disposable
funds with financial institutions to influence outcomes like economic growth, inflation, exchange rates
with other currencies and unemployment.
Both the fiscal and monetary policies have to be framed and implemented coherently to attain a set of
objectives oriented towards the growth and stability of the economy. However, in India for the past two
decades, the mismatch between the fiscal and monetary policies has remained a major concern.
Unsustainable fiscal deficits and public debt levels created the spectre of fiscal dominance, leading
to high and volatile inflation and elevated risk on government debt. An unfavourable exchange rate
dynamic – linked to weak fiscal and monetary policy credibility – has been the key factor in the
destabilized capital outflows.
If the fiscal authority i.e. the government during the period of inflationary trends brings out more
budgetary deficits and resorts to subsidies, more public spending & more public debt, hefty deficit
financing, thereby increasing money supply in the economy, it will result in an increase in the rate of
inflation instead of checking it.
The Reserve Bank of India, in order to curtail money supply, resorts to quantitative control measures
like higher bank rate policy and higher CRR & SLR. This mismatch, in fact, nullifies the contractionary
effect of monetary policy with the implementation of expansionary fiscal policy. It is argued that the
Indian fiscal policy is more oriented towards achieving political gains rather than economic ones.
For 2012-13, though the fiscal deficit target has been pegged at 5.1 per cent of the GDP, the
government feels it may be difficult to stick to that target mainly because both the policies are not
supportive to each other.
The Indian economy requires monetary and fiscal policies following each other in right perspective. RBI
deputy governor H R Khan said, "As we have articulated time and again, it (monetary policy) has to be
in tandem with the fiscal policy. It has to be a joint venture. It is not a solo play."
It is important to focus on the primary deficit. The indicator of understanding where we stand is the
primary deficit, deficit net of interest payments. Under normal circumstances, a country should always
run primary surpluses. In 1999, India fought the war in Kargil, so one or two years of primary deficit
might be understood. In 2008-09, there was a global crisis; but one year of primary deficit would be
enough to recover.
But in every normal year, we should be running primary surpluses. The government has taken some bold
steps like reduction in subsidies, FDI in retail, etc. and it appears that the country is coming out of
current account deficit. The balance of payment is moving towards surplus territory, appreciation in
the rupee is expected, and money markets are expected to react positively to it with the greater
confidence of foreign investors. To support these growth prospects, a well designed monetary policy is
required.
Instead of blaming the fiscal policy, the monetary policy has to deliver lower and stable inflation
which may become a catalyst to the growth. Finance minister P Chidambaram said, “Rates must come down.
The fiscal policy steps that we are taking to encourage the Central Bank to take monetary policy action
which will result in lower interest rates, I think that will be good.”
Interest rates, reserve requirements, discount window, quantitative easing, and open market operations
should signal the path of reforms to boost the growth and stability. A nominal deficit financing in
such situation will function as a multiplier of growth in a vibrant economy.
In the global economic meltdown, the fiscal and monetary policies will play a key role in defining the
growth map. The Reserve Bank of India has so far been following the path of stringent monetary policy
as against the reform-oriented fiscal policy which has had a negative impact on the growth. This has to
be liberalized further. The Kelkar report that advocated reforms might prove to be a guiding path
towards better formation and implementation of these policies.
