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What is Fiscal Policy? What is its role in economic growth and stability

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For the Union Budget 2024, it is expected that Finance Minister Nirmala Sitharaman will choose the path of fiscal consolidation. This means the government may not increase its spending considerably. However, the government is likely to reduce the tax burden of the salaried class and announce some measures to provide relief for the rural economy.

Let us wait and watch to see what decisions the government will make.

Understanding Fiscal Policy

You would have often heard terms like fiscal policy and monetary policy being used by experts, economists, ministers, etc. They may sound a bit complex to understand, but in reality, they are pretty simple to grasp.

Besides, in times of budget, fiscal policy assumes greater significance. But don’t you worry because we’ll simplify how this budget can impact India’s fiscal situation. After all, at Bajaj Broking, we believe that #BudgetSimpleHai.

The upcoming Union Budget 2024 is likely to make several announcements related to fiscal policy.

Fiscal policy is about the spending and taxation of the government. When it comes to managing an economy, the government has two important functions. The first one is spending, which means spending money for the betterment of its people.

The second one is about taxation, which means levying taxes on individuals and businesses to earn money. At the end of the day, the government too has to manage its finances, just like any individual. Unless it earns through taxes, it won’t be able to spend on its people.

You may ask, how does the government use its fiscal policy? In times of an economic slowdown when people buy less because they earn less, the government can give a boost to the economy by either reducing taxes (thereby giving more money to people) or increasing its spending (through government projects, which provide income to people working on those projects).

In times of economic growth, if the government thinks that growth may result in escalating prices, it may reduce its spending or increase taxes on people (so that they have less money and they buy less).

Governments Utilise 2 Main Levers Within Fiscal Policy

#BudgetSimpleHai

According to reports, Finance Minister Nirmala Sitharaman will present the 2024 Union Budget on 23rd July. This Budget is expected to have announcements on policies, schemes, income tax rate slabs, and more that are likely to affect everything around us. To simplify this year’s Budget and to decode its impact on your life, your investment portfolio, and all that you do, we bring you #BudgetSimpleHai!

Join us on our website or head over to any of our social handles to get the latest updates on the Union Budget as it happens. Read in-depth reports, watch videos, and get a clear understanding of what’s in store. Kyunki Bajaj Broking ke saath, #BudgetSimpleHai

Within fiscal policy, the government has two main levers to impact an economy – taxes and spending. Let’s talk about taxes first. Consider the upcoming Union Budget 2024. Many salaried individuals are expecting the government to reduce their tax burden.

You may ask, why are individuals having such expectations? There could be many reasons. For example, inflation tends to be high in India, which reduces the value of money every year. Besides, the Indian economy is going through some sort of a slowdown, especially in rural areas.

If the government reduces taxes, it will provide more money to people, which they can either spend or save. This lever is called “taxation.” The other lever is “spending.” You may wonder what the government spends on.

The government spends on those things, which typically are not provided by the private sector. For example, hospitals, roads, and defence. At times, private players participate in these areas, but the government remains the dominant player.

Let’s say that the government decides to build a road. There are many ways an economy can benefit from it. The government may work on this project with a private company. In that case, that company, its shareholders, employees, etc. will gain.

That company may hire labour on a contract basis, which means people working on daily wage will gain. This shows the trickle-down impact of government spending. When the government wants to give a stimulus to an economy, it can increase its spending.

However, if it wants to check the growth, it can reduce its spending. Similarly, it can tweak the tax rates to either give a boost to an economy or check the rate of its growth.

The need for Fiscal Policy

From our discussion so far, you may be thinking whether the fiscal policy only involves changing government spending and taxation. The fact is the government tries to address several societal and developmental issues through these two levers. So, it’s extremely important for a country to have a prudent fiscal policy.

For example, in recent times, the Indian government has focused on improving the country’s infrastructure. As a result, successive budgets have increased allocations to sectors like transportation, urban development, energy, aviation, etc.

You might have read about the government planning to build bridges or improve power supply. All such expenditures come under infrastructure. This explains how fiscal policy is important for a country’s infrastructure.

Then, you must have read about the government introducing the goods-and-services-tax (GST) in 2017. The main purpose of GST implementation was to unify and simplify the country’s indirect tax system.

Also Read: GST Collection Recorded at ₹1.74 Lakh Crore in June 2024

Therefore, fiscal policy is not only about reducing or increasing taxes, but it is also about rationalising the tax structure of India for the benefit of its people and businesses.

The government also offers tax incentives to industries to promote industrialisation and generate employment for people. For example, over the years, the state government of Karnataka has offered tax rebates to IT companies, which is one of the major reasons it has become an IT hub.

That said, you should also keep in mind that fiscal policy does not work in isolation. In reality, fiscal policy and monetary policy work together to shape an economy.

Historical Significance

Fiscal policy has been used for centuries, with governments managing economies through taxes and spending. In medieval times, tariffs protected local industries.

John Maynard Keynes significantly influenced modern fiscal policy during the 1930s Great Depression, advocating for increased government spending to boost demand and reduce unemployment. Post-World War II, countries increased spending to rebuild their economies.

In India, post-independence, a conservative fiscal policy aimed to keep the fiscal deficit low and funded public sector-led industrialization through taxes, but growth remained slow. Reforms in the 1980s led to a higher fiscal deficit and public debt, resulting in the 1991 balance of payments crisis and subsequent economic liberalisation. Since then, India has aligned its policies with global realities.

Successive Indian governments have used fiscal and monetary policies to drive economic growth and meet public expectations.

Contemporary Challenges and Considerations

The Indian government faces many challenges when it comes to its fiscal policy. Most developing countries, including India, have to spend a lot on improving their infrastructure and social welfare.

If the government increases its spending on these things, it can increase its deficit and public debt. However, there’s a way to deal with it. If the government increases its tax revenue, it can increase its spending without increasing fiscal deficit and public debt.

That said, increasing tax revenue for any government is easier said than done. If the government increases taxes, it may discourage people and businesses from spending more. So, ideally, the government should increase tax compliance, which means that it should ensure that more people pay taxes.

In India, currently, a tiny minority pays their income tax. The government should find ways to plug such loopholes to increase its tax revenue. With more revenue, the government will be able to spend on infrastructure and social welfare.

Some experts have opined that India’s public debt is already high, which limits the government’s ability to spend on social welfare. They even expect the government to go for fiscal consolidation, which means the government is unlikely to increase fiscal deficit. Therefore, it may be difficult for the government to increase spending on social welfare.

In Conclusion

If you are an investor with a demat account, you should track the announcements related to fiscal policy on the budget day. In fact, you should track all the developments related to fiscal policy and monetary policy. The government’s focus is likely to be infrastructure in this budget. If you have investments in equities, you should watch out for how infrastructure stocks react to announcements.

In case the finance minister announces tax-relief measures, consumption-led sectors like FMCG may see a surge in their stock prices.

Keep an eye on Bajaj Broking’s website on the budget day because we’ll provide you with a lot of insights that will help you understand in simple terms how the budget will impact your investments. After all, Bajaj Broking ke saath #BudgetSimpleHai.

Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing. This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.

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Frequently Asked Questions

What are the governments plans to manage the fiscal deficit in Union Budget 2024?

Answer Field

The government had indicated in the interim budget that it plans to maintain the fiscal deficit at 5.1% of the GDP. It is expected that the government will stick to this target in the upcoming budget, which may result in fiscal consolidation.

Will there be changes in the allocation of funds for key sectors like healthcare, education, and infrastructure?

Answer Field

Recently, the government has received a significant dividend of Rs. 2.11 lakh crores from the Reserve Bank of India (RBI). As the government has money, it seems that it will spend more on infrastructure, like roads, bridges, etc. However, when it comes to education and healthcare, we need to wait and watch for what the budget planners announce.

How will the budget address inflation and its impact on the economy?

Answer Field

Food inflation has been a matter of concern. Therefore, it is expected that the government may lower tax rates for certain categories of taxpayers. However, it’s tough to say what those announcements will be as of now. So, we should wait and watch.

Will there be any proposed measures to boost economic growth and employment?

Answer Field

The rural economy has faced distress. Therefore, it is likely that the budget planners may take some steps to improve the skill levels of rural youth so that they can find better jobs. This will also boost economic growth in rural areas.

What steps will be taken to attract foreign investments and improve investor confidence?

Answer Field

Certain sections of investors have said that the angel tax results in needless scrutiny of the managers of the venture capital funds, which affects funding for early-stage startups. Therefore, the government may address this issue in the budget.

Will there be revisions to tax policies affecting businesses and individuals?

Answer Field

A lot of salaried individuals are expecting that the budget planners will announce some sort of tax relief for them by introducing deductions and exemptions under the new tax regime. Meanwhile, telecom players have requested the government to allow them to carry forward their losses for up to 16 assessment years as opposed to 8 years they are allowed currently. It is not clear currently what the government will announce.

How will the budget impact subsidies and welfare schemes?

Answer Field

Union Budget 2024 is expected to increase spending on rural welfare schemes, particularly because the rural economy is facing distress. Therefore, more subsidies are expected for the rural economy.

Will there be new initiatives to promote sustainable development and environmental conservation?

Answer Field

As of now, the central government provides support to only new investments in the electric vehicles (EVs) space. But the upcoming budget may announce support for even those manufacturers that have already invested in the EV space.

What measures are likely to be announced to address income inequality and social welfare?

Answer Field

It is expected that the government may announce measures to deal with income inequality and social welfare, but it is not clear as of now what those measures will be. So, we should wait and watch for July 23.

How will the budget support sectors affected by the COVID-19 pandemic and subsequent economic challenges?

Answer Field

While there are sectors that are affected by COVID-19 and subsequent economic slowdown, it is not clear how the budget will address them. Therefore, it is best to wait and watch out for the budget.

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