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http://www.bloomberg.com/news/2013-07-29/rbi-says-restoring-indian-rupee-stability-is-

priority-for-policy.html

ABSTRACTThe 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 INTRODUCTIONOne 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 to

influence the growth of aggregate demand (AD), the money supply, output, jobs and

inflation. Countries often introduce monetary policies in an attempt to maintain a low and

state rate of inflation and promoting sustainable economic growth and low unemployment.

On the other hand, fiscal policy involves a government’s efforts to monitor and influence a

nation’s 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

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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 country’s financial markets.

2.0 UNEMPLOYMENTIn general, unemployment is a situation when people are able, available and willing to find

work and actively seeking work, however, not employed. (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 increased

marginally between 2009-10 and 2011-12 financial years, especially for youngsters of 15-29

years of age.(National Sample Survey Office, 2014)

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 INDIA1. 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 making large addition to the labour

force, as the rate of job expansion is 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.

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4. Defective system of education

India’s 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 decrease aggregate demand enough to return the economy to its potential output

thereby reducing unemployment and increasing 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 POLICY1. Development by effective Mobilisation of Resources

Fiscal policy has been implemented by the central and state governments in India to mobilise resources through the different channels as stated below:

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

Taxation: Taxation is one of the most crucial source of resource in India, effective fiscal

policies help the government to mobilise the resources more efficiently through fiscal

policies.

Public Savings: Resources can be mobilised through public savings by decreasing

government spending and allow public sector firms to raise their surpluses.

Private Savings: Implementation of tax benefits can introduce more resources from private

sectors and households. Fiscal policy effectiveness can be promoted through government

borrowings by ways of treasury bills, issue of government bonds, etc., loans from domestic

and foreign parties and by deficit financing.

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2. Reduction in inequalities of Income and Wealth

By charging more direct taxes such as income tax on the higher income group, it reduces

income inequalities among the different society groups, gearing towards equity in income and

wealth. Indirect taxes are also charged more in terms of luxury goods, which are typically

consumed by the upper society class. Such 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 productive use of financial

resources, etc. benefit inflation control and price stabilization.

4. Employment Generation

Investment in infrastructure has resulted in direct and indirect employment. Lower taxes and

duties on small-scale industrial encourage more investment and consequently generates more

employment. Movements such as rural employment programmes have been embarked by the

government to solve employment issues in under-developed regions. Correspondingly, self

employment scheme has been initiated to provide employment to technically qualified

persons in the urban areas.

3.2 EFFECT OF FISCAL POLICY ON AGGREGATE DEMANDAggregate Demand is the sum 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 the spending by the government (G), which will

directly decrease aggregate demand curve by reducing government demand for goods and

services. Increases in tax levels will also slow growth, as consumers will have less money to

consume (C) and invest, thereby indirectly reducing the aggregate demand curve, shifting the

AD Curve to the left.

The amount by which potential GDP exceeds real GDP is the inflationary gap, and

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contractionary policy is designed to close the inflationary gap by changing aggregate

expenditures and shifting the aggregate demand curve. An inflationary gap is closed with a

leftward shift of the aggregate demand curve.

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 (worldwide inflation data, 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.

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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.

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

imported energy and lax fiscal policy. While a loose fiscal policy has aid collective demand,

especially across undeveloped areas, a permissive environment to amplify supply response is

lacking, resulting in an additional inflation pressures.

Demand – Pull Factors include, but not limiting to,

a) High Monetary Expansion - The supply of money expanding quickly every year but the

supply of goods and services is not increasing according to that rate. Due to this prices are

rising.

b) Increase in Population – The rate of population growth in India is about 3%, hence due to

this, aggregate demand is increasing.

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 caused due to the changes in the determinants of AD. Whenever,

any of the components of AD (i.e. consumption, investment, and government spending and

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net exports) will increase, this will result in an increase in aggregate demand.

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.

Increase in cost of production will result in cost push inflation. As the cost of production

increases, the firms will reduce supply. The aggregate supply will shift to the left, from

SRAS1 to SRAS2. This will result in an increase in the average price level in the economy.

Real output will fall.

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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

Traditionally, monetary policy of India focused on sustaining inflation through the reduction

of money supply and credit, which causes poor growth performance. Thus, RBI recently

adopted the policy of ‘Growth with Stability’. This means that sufficient source of funds are

available for expansion of different industries in the economy at the same time, inflation will

be controlled within a certain 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

Priority sector includes agriculture, export and small scale enterprises and weaker portion of

population. With the assistance of the central bank, RBI provides timely and sufficient credit

at affordable cost of which benefit the those weaker sector and low income groups.

4.3 EFFECT OF MONETARY POLICY TO REDUCE INFLATION

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As the money supply is contracted, interest rates rise, investment will fall, consumption will

fall and net exports will fall.

All of these changes will shift the AD to the left and return output to Qp but without a price

increase.

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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.

The success of fiscal and monetary policy is built upon taking timely measures and the

government’s effective administration during implementation. Despite gaps in India’s 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

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Unemployment

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

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