BSC45 ECONOMICS ASSIGNMENT 2: INDIA ECONOMY

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http://www.bloomberg.com/news/2013-07-29/rbi-says-restoring-indian-rupee-stability-is-
priority-for-policy.html
ABSTRACT
The study uses data from 2011 to 2013 to analyse the increasing unemployment rate as well
as the chronic inflation problem that India has been persistently facing. The article
highlighted on the key policy objective of the new India Government and the behaviour of
monetary and fiscal policies interaction to put the economy on sustainable and balanced high
growth path.

1.0 INTRODUCTION
One of the major challenges for India in 2014 is to revive economic growth, as it is currently
caught up in worst economy downturn, a dip of Gross Domestic Product (GDP) to less than
5% in the past decade. Poverty has been a pestering issue, and there is a huge inequalities of
wealth among the citizens. Amidst the variable issues that India is facing, the main reasons
for the plunge in GDP are strained public finances, lack of economic reform and the
persistent high inflation. Hence, it is imperative for the new government to cut expenditures
plans so as to keep public finances in check and to counter price-rise in order to keep
inflation down.
The main focus that this essay will be touching is to address the unemployment and inflation
problems, and the fiscal and monetary policies that the government should be implementing
to resolve the issues.

Monetary policy involves the actions of a government done to change interest rates by
affecting the growth of aggregate demand (AD), inflation and source of funds. Government
introduce such policies to control inflation, maintaining economic growth and managing low
unemployment rate. On the other hand, fiscal policy involves a governments efforts to
oversee an economy by adjusting its tax rates and distribution of spending. It aims to deter a
boom and bust economic cycle, curb unemployment as well as encouraging economic growth
in a period of recession. It is paramount that countries use a balance of these two policies to
achieve macroeconomic objectives of growth and price stability. However, the use of these
policies will be in compliance to the stage of development of the countrys financial markets.

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2.0 UNEMPLOYMENT
In general, unemployment is a situation when people are constantly and actively seeking
employment opportunities however unsuccessful. (Ramandeep Kaur, 2013)
Despite the economic reforms and the Information Technology (IT) & Business Process
Outsourcing (BPO) boom in 2003, the unemployment situation in India has a constant
increase in recent financial years, between the ages of 15-29 years.
Unemployment rate in India is showing an increasing trend of 3.5% in 2011, and rose to
3.6% in 2012 and escalated to 3.7% last year. (Times of India, 2014)

2.1 CAUSES OF UNEMPLOYMENT IN INDIA
1. Insufficient Opportunities
Although the expansion of production has opened up plenty of employment opportunities,
they were not sufficient to solve the unemployment problem. Furthermore, economic growth
in a developing country, such as India, does not necessarily assure that unemployment issue
will be naturally resolved.
2. Increase in Labour Force
India faced an increasing growth in population, notably in undeveloped areas. This rapid
growth in population encouraged unemployment by expanding the labour force, as the rate of
job supply are not as high as population growth would have required. In addition, education
has changed the mentality of women towards employment, resulting in a large capacity of
them joining the job market.
3. Emphasis on Capital Intensive Projects
An increasing importance has been given to capital intensive projects during the process of
planning. In a labour surplus economy, use of automatic machines and other sophisticated
equipment is not justified as it has replaced human effort and resulted in large-scale
unemployment in India.
4. Defective system of education

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Indias education system does not develop human resources properly. It fails to train the
people for the jobs consistent with present economic environment. As a result, even the
highly educated people in India, fail to get appropriate jobs. There is no correlation between
education and employment as far as India planning is concerned.

3.0 INDIA CONTRACTIONARY FISCAL POLICY
India has adopted a contractionary policy to restrain the economy during inflation-inducing
business-cycle expansion, which involves slashing government expenditure and/or increase
of taxation imposed.

This aims to achieve economic equilibrium thus decreasing unemployment and improving
Real Gross Domestic Product (GDP). Contractionary fiscal policy leads to a smaller
government budget deficit (expenditures>tax revenues) or a smaller budget surplus (tax
revenues>expenditures).

3.1 OBJECTIVES OF INDIA FISCAL POLICY
1. Development by effective Mobilisation of Resources
Fiscal policy has been implemented by central bank of India to mobilise resources through
the different channels as stated below:

Taxation: Taxation is one of the most crucial source of resource in India, which help the
government to mobilise the resources more efficiently through fiscal policies.

Public Savings: Resources can be gathered through public savings by decreasing
government spending and allow government sectors to raise their surpluses.

Private Savings: Implementation of tax benefits can introduce more resources from
corporate firms and households. Fiscal policy effectiveness can be promoted through
government borrowings by ways of treasury bills, government bonds, loans from local and
overseas parties and by debt financing.
2. Reduction in inequalities of Income and Wealth
By charging more income taxes on higher income group, it reduces income inequalities
among the different society groups, gearing towards equity in income and wealth. Indirect
taxes on high expenses goods, whereby typically can be purchased by the rich. Such

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implementations allow the improvements of poverty ratio in the society in which,
government have focus large investment through Poverty Alleviation Programmes.
3. Price Stability and Control of Inflation
Introduction of tax savings schemes, easing the fiscal deficits and effective use of funds,
benefit inflation control and price stabilization.
4. Employment Generation
Lower taxes on small-scale industries has encourage
Investing in infrastructure has affect employment directly and indirectly. In placement of low
duty taxes allows small-scale industrial to invest more and provide more employment.
Movements such as under developed areas employment programmes has been embarked to
work out employment issues in under-developed regions. Correspondingly, self employment
scheme has been initiated to create job opportunities to qualified persons in the developed
areas.

3.2 EFFECT OF FISCAL POLICY ON AGGREGATE DEMAND
Aggregate Demand is the combination of Consumption expenditures (C), Investment (I),
Government Expenditure (G) and net exports(X-M)).
That is
Y = C + I + G + (X-M)
Contractionary Policy aims to decrease government expenditure (G), which lower the
aggregate demand curve by downsizing the goods and services required by the government.
The rise in tax levels will result in sluggish growth, as consumers will have less spending
power (C), thereby decreasing the demand curve, shifting the AD Curve to the left.

Amount of potential GDP outstands the real GDP is classified as inflationary gap, and
contractionary policy is devised to narrow the inflationary gap by altering aggregate
expenditures and moving the aggregate demand curve. Inflationary gap is narrowed with a
leftward adjustment of the aggregate demand curve.


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4.0 INFLATION IN INDIA

Inflation rate in India is calculated as per Consumer Price Index (CPI). Recently, the inflation
rate touched 10.92% in 2013, one of the highest in the recent years. The Reserve Bank of
India (RBI)s current assessment shows that the threshold level of inflation for India ranging
from 4 6 %, maintaining inflation within the comfort zone is crucial in facilitating
sustainable growth.
The government has plans to take firm measures in controlling inflation, where it plans to ban
the export of steel and cement which relate to the rising prices. Another measure is to lower
the excise duty on steel from 14% to 18%.
Inflation has caused a significant resistance on Indian economy. Where prices are increasing
rapidly in other countries, exports to other countries became harder for Indian businesses.
Volatility has also seen to increase due to the fast-rising price, companies tend to be more
conservative in making investment in new projects. With a highly inflated economy, the poor
are affected at the worst by rapid increase in price as they tend to hold most of their savings
in cash.


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4.1 CAUSES OF INFLATION IN INDIA

The continuous inflation in India are caused by the lessen demand as well as the cost push
inflation factors. These include the overflowing supply of products and high dependant on
foreign resources such as energy and lax fiscal policy. While a flexible fiscal policy has aid
collective demand, especially under developed areas, it lacks permissive background to
amplify supply, resulting in an additional inflation pressures.

Demand Pull Factors include, but not limiting to,
a) High Monetary Expansion Sources of funds are expanding rapidly annually but the
inventory of goods and services is not improving accordance to the rate causing the rise in
prices.
b) Population Growth Aggregate demand is on the rise due to the increase in population,
which is about 3% in India currently.
c) Black Money When income tax payers misrepresent their income statements to the tax
authorities, it lead to creation of black money, hence creating more demand.

Demand pull inflation is a result from the changes in the factors of AD. When one of the
factors of AD (consumption, investment, and government expenditure and net exports) goes

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up, aggregate demand goes up as well.

Cost Push Factors include, but not limiting to,
a) Increase in Indirect Taxation Leads to increase in prices, hence inflation.
b) Increase in Wages and Bonuses Leads to increase in cost of production, hence rise in
price, which causes inflation.

When the cost of production rises, it results in cost push inflation, as such, supply by firms
decreases. There will be a left shift of the aggregate supply from SRAS1 to SRAS2, affecting
an increase in the average price level in the market and real output will plunge.

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4.2 INDIA CONTRACTIONARY MONETARY POLICY

As stated by RBI, monetary policy refers to the adoption of different instrument managed by
the central bank to monitor the availability and the use of funds.
The aim is to anchor inflationary expectations, improve real interest rates, increase domestic
savings, thus providing a support for more sustainable growth.

The RBI implements the monetary policy through:
a) Maintaining the Required Reserve Ratio (RRR) Keeping it unchanged at 4.0 %(
Raghuram G. Rajan, 2013)
b) Open market operations The RBI sells government securities to contract the flow of
credit
c) Increasing Discount Rate Hiked to 7.75%

These acts lead to the decrease of excess reserve of commercial banks for loans.
4.3 OBJECTIVES OF INDIA MONETARY POLICY


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1. Growth with Stability
Conventionally, India was focusing on controlling inflation by decreasing funds, which
contributed to poor economy. Thus, RBI recently implemented the Growth with Stability
policy. This means that sufficient source of funds are available for expansion of different
industries in the economy, concurrently, inflation will be sustained within expected range.
2. Encouraging Savings and Investments
By offering better interest rates to encourage savings, increases the availability of funds and
promotes investment. Promoting of subjective monetary direction by implementing attractive
interest rates can affect the saving patterns in the country.
3. Redistribution Of Income And Wealth
Controlling fluctuations of inflation and redeployment credits to under developed sectors,
especially poverty areas, by initiating monetary policy to promote better balance of
inequalities.
4. Generation of Employment
The increase in the rate of investment and allocation of investment due to the influence of
monetary policy, help with generating more employment.
5. Promoting Priority Sector
This sector emphasizes on agriculture, export, and small businesses. Assisted by the central
bank, RBI caters prompt and sufficient funds at desired cost of which benefit those weaker
sector and low earners.

4.3 EFFECT OF MONETARY POLICY TO REDUCE INFLATION


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When money supply shrinks, interest rates increases, investment declines, consumption and
net exports will decrease.


Such changes will cause a leftward shift of the AD and Q1 will rebound back to Qp but
without an incline in price.

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5.0 CONCLUSION

In conclusion, the economic challenges confronting India are immense, it would require
much precision and tenacity on the policies and economic reforms along with swift decision
making to boost the economy.

Successful fiscal and monetary policies relies on taking well-timed measures and the
governments effective administration during implementation. Despite gaps in Indias fiscal
policy to achieve economic equilibrium, and the contradictory objectives in monetary
policies, the government has been striving towards achieving their economic objectives and
GDP growth.











REFERENCES
India Objective in 2014
http://www.dnaindia.com/india/report-budget2014-india-s-economic-policies-will-be-growth-
oriented-arvind-mayaram-1997191

Unemployment

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http://www.azadindia.org/social-issues/Unemployment-in-India.html
http://timesofindia.indiatimes.com/business/india-business/Unemployment-levels-rising-in-
India-experts-say/articleshow/29403619.cms
http://business.mapsofindia.com/bpo-services-india/growth.html
http://www.tradingeconomics.com/india/unemployment-rate
http://data.worldbank.org/indicator/SL.EMP.TOTL.SP.ZS
http://www.tradingeconomics.com/india/labor-participation-rate-total-percent-of-total-
population-ages-15-plus--wb-data.html

Causes of Unemployment
http://satendrasaini.hubpages.com/hub/unemployment-causes
http://www.preservearticles.com/201105096376/what-are-the-causes-of-unemployment-in-
india.html

India Inflation
http://www.bbc.com/news/world-asia-india-24753675
http://www.inflation.eu/inflation-rates/india/historic-inflation/cpi-inflation-india-2013.aspx
http://www.ft.com/cms/s/0/f0256d5c-8506-11e3-a793-00144feab7de.html#axzz35UT5XcOs


India Monetary Policy
http://www.livemint.com/Opinion/rQCCxiHvRCuAupD2w6naGP/5-questions-on-
overhauling-Indias-monetary-policy-framewor.html
http://www.rbi.org.in/home.aspx
http://business.nab.com.au/wp-content/uploads/2013/11/india-monetary-policy-10-2013.pdf
http://articles.economictimes.indiatimes.com/2014-06-17/news/50651109_1_term-repo-
excess-rupee-liquidity-the-reserve-bank
http://in.reuters.com/article/2013/10/29/highlights-rbi-repo-rate-msf-cuts-
idINDEE99S03U20131029