Economics(Module-05)

Central Bank:
The Central Bank is the apex institute that aids in the optimum
management of currency and money flow within a market. However, it is
also the center for last resort which lends money to the banking sector
during a financial crisis. Most Central Banks have a critical and
mandatory responsibility of:

• Discouraging and having a low tolerance towards fraudulent

behaviors by other member banks.
• Ensuring that the other banks possess the aspect of solvency
• Preventing bank runs

The economy’s political and government system, usually, keeps a close

watch on the functioning of the Central Bank. However, the Central
Banks at many emerging and developed economies are free from political
intervention. In such a case, they are free to take decisions in an
autonomous manner without being accountable to a higher authority.

Functions of Central Bank:

1. An Issue Bank
The Central Bank is the sole authority that has been given the sole right to issue
money. Moreover, they are responsible for the rightful printing, minting and
circulation of money into the economy. However, with great powers, comes
great responsibility. Therefore, the Central Bank is responsible for controlling
elasticity, ensuring uniformity and providing supervision.

2. Holder of Cash Reserves

One of the most crucial functions of the Central Bank is that they are the
custodians of cash. Moreover, banks in every country reserve some percentage
of their deposits with the central bank. This makes the central bank, the legal
and the most safest holder of cash reserves.

3. Adviser to the Government

The central bank is said to be the most trustworthy bank to the government.
Also, the central bank is vested upon by the government to be their advisor in
terms of financial and monetary crisis. In addition, the central bank collects
deposits, makes payments and handles the financial matters of a country.
Therefore, the central bank is the government’s:
Advisor
Agent
Banker
 4. Last Resort Lender
When everything with a bank’s functioning, seems to be going down and under-
performing,the central bank is ready to rescue. In other words, when the
commercial banks are unable to lift themselves up from a crisis, they take to the
last resort. In this case, the last monetary resort is one of the most important
functions of Central Bank.

5. Holder of Foreign Currency Reserves

By now, it is a known fact that the central bank is a holder of cash reserves. It is
only fair, safe, legal and best suited for the central bank to be the house for
foreign currency reserves. Moreover, by making the central bank the official
foreign currency holder, the government can promise economic disciple.

6. Credit Controller
The commercial banks create a lot of credit during their course of operations.
However, this credit can be one of the most critical and leading reasons for the
emergence of inflation in an economy.

In such a case, a governing body is required to monitor the credit rates.

Therefore, the central bank works on the control and modification of credit rates
and the control of inflation.

7. Protector of Depositor’s Interests

The central bank has much variety of depositors. Some of the most important
depositors are the commercial banks and the government itself. One of the most
critical functions of a central bank is to protect its customer interest.

Credit Control by the Central Bank

Credit control is one of the most important functions of a
central bank. It refers to the regulation of the volume,
availability, and direction of credit in an economy, with the
objective of maintaining price stability, economic growth,
and financial discipline. By controlling credit, the central
bank influences inflation, investment, consumption, and
liquidity in the market.
Objectives of Credit Control
• To maintain monetary stability

• To control inflation or deflation

• To ensure adequate credit for productive sectors

• To prevent speculative lending

• To stabilize the currency and exchange rates

Types of Credit Control Measures

Credit control is exercised mainly through two types of
instruments:
1. Quantitative (General) Methods
These control the overall volume of credit in the economy.
• Bank Rate Policy: The central bank changes the bank rate

(the rate at which it lends to commercial banks). A higher

bank rate discourages borrowing, reducing credit
creation.
• Open Market Operations (OMO): Buying or selling

government securities in the open market. Selling

securities absorbs excess liquidity, while buying injects
funds into the banking system.
• Cash Reserve Ratio (CRR): The percentage of a bank’s

total deposits that must be maintained as reserves with

the central bank. An increase in CRR reduces the lending
capacity of banks.
• Statutory Liquidity Ratio (SLR): The percentage of net

demand and time liabilities (NDTL) that banks must

maintain in liquid assets. A higher SLR restricts credit
availability.

2. Qualitative (Selective) Methods

These target specific sectors or purposes of credit.
• Margin Requirements: Adjusting the margin between the

loan amount and the value of securities. Higher margins

reduce credit for speculative purposes.
• Credit Rationing: The central bank may set limits on the

amount of credit extended to particular sectors.

• Moral Suasion: The central bank uses persuasion,

meetings, and circulars to influence banks to act in the

national interest.
• Direct Action: The central bank may penalize non-

compliant banks through restrictions or withdrawing

privileges.

Conclusion
Credit control is a vital tool of monetary policy through
which the central bank ensures a stable and sustainable
financial system. In India, the Reserve Bank of India (RBI)
uses a combination of quantitative and qualitative tools to
balance the goals of economic growth, price stability, and
financial discipline.

Financing of Government Expenditure: Taxation

The government requires funds to perform various functions
such as administration, defense, infrastructure
development, welfare schemes, education, and health
services. One of the primary and most reliable sources of
financing this expenditure is taxation.

Meaning of Taxation
Taxation refers to the compulsory financial contribution
imposed by the government on individuals and businesses,
without any direct return of services. It is a non-debt source
of revenue and a key component of fiscal policy.

Role of Taxation in Government Finance

1. Revenue Generation:
Taxation is the main source of revenue for
governments. Both direct taxes (like income tax,
corporate tax) and indirect taxes (like GST, excise duty)
help mobilize funds.
2. Redistribution of Income:
Progressive taxation ensures that the wealthier sections
contribute more, promoting equity in income
distribution.
3. Regulation of Economy:
Taxes can be used to control inflation or deflation, by
reducing or increasing disposable income and demand.
4. Promoting Social Welfare:
Tax revenues are used to fund public goods and
services, subsidies, poverty alleviation programs, and
welfare schemes.
5. Encouraging or Discouraging Activities:
The government can impose higher taxes on harmful
goods (like tobacco or alcohol) and provide tax
 incentives for positive actions (like investment in green
energy or education).

Types of Taxes for Financing

• Direct Taxes: Paid directly by individuals or organizations
(e.g., income tax, wealth tax).
• Indirect Taxes: Collected through sale of goods and

services (e.g., GST, customs duties).

Conclusion
Taxation plays a central role in the financing of government
expenditure. A well-structured tax system not only helps raise
revenue but also supports economic growth, social justice,
and public welfare. Efficient tax administration and
widening the tax base are essential to ensure sustainable
development and responsible fiscal management.

Public Expenditure and Union Budget

(For 15 Marks)

1. Public Expenditure: Meaning and Objectives

Public expenditure refers to the spending incurred by the
government at all levels—Union, State, and Local—for
administrative functions, welfare programs, development
activities, defense, and public services.
Objectives of Public Expenditure:
• Provision of public goods and services (e.g., roads,

education, healthcare)
• Economic development and infrastructure creation

• Redistribution of income to reduce inequality

• Stabilization of the economy during inflation or recession

• Promotion of social justice through subsidies, welfare

schemes, etc.

2. Types of Public Expenditure

1. Revenue Expenditure:
Recurring expenses like salaries, pensions, subsidies,
 interest payments, etc.
2. Capital Expenditure:
Investment in long-term assets like roads, railways,
schools, and defense equipment. It creates future
economic value.
3. Planned vs Non-Planned Expenditure (relevant in past
budgets):
o Planned: Under the Five-Year Plans (now replaced

by NITI Aayog).
o Non-Planned: Routine administrative and

maintenance costs.

Union Budget:

Introduction
The Union Budget is the annual financial statement of the
Government of India, presented by the Finance Minister in
Parliament under Article 112 of the Indian Constitution. It
outlines the estimated receipts and expenditures of the
central government for a particular financial year (1st April to
31st March).
The Union Budget is a crucial tool for economic policy,
resource allocation, and national development planning. It
reflects the government’s fiscal vision and socio-economic
priorities.

Objectives of the Union Budget

1. Efficient Allocation of Resources
Funds are allocated based on priority sectors like
infrastructure, defense, health, education, etc.
2. Economic Stability
Helps in controlling inflation, unemployment, and
ensuring growth.
3. Income Redistribution
Progressive taxation and targeted subsidies help in
reducing income inequality.
4. Promoting Welfare and Development
Supports social welfare schemes and development
projects to improve citizens’ quality of life.
 5. Fiscal Discipline
Ensures responsible borrowing, deficit management, and
sustainable public finance.

Components of the Union Budget

The Union Budget is broadly divided into two parts:
1. Revenue Budget
• Revenue Receipts:

o Tax Revenue: Income tax, corporate tax, GST,

customs, excise, etc.

o Non-Tax Revenue: Dividends from PSUs, interest on

loans, license fees, etc.

• Revenue Expenditure:

o Salaries, subsidies (like food and fertilizer),

pensions, interest payments, defense revenue

expenditure, etc.
o It does not lead to asset creation.

2. Capital Budget
• Capital Receipts:

o Borrowings, disinvestment proceeds, recovery of

loans, etc.
• Capital Expenditure:

o Investments in infrastructure, acquisition of assets,

loans to state governments or PSUs.

o It creates future economic value.

Types of Budget Based on Deficit

1. Balanced Budget: Revenue = Expenditure
2. Surplus Budget: Revenue > Expenditure
3. Deficit Budget: Revenue < Expenditure (India generally
follows this)

Budget Presentation and Approval Process

1. Preparation: Led by Ministry of Finance with inputs
from all ministries.
2. Presentation: Finance Minister presents it in the Lok
Sabha (typically on 1st February).
 3. Budget Speech: Divided into two parts – economic
review and proposals.
4. Parliamentary Approval: Includes discussion, demands
for grants, and passage of Appropriation and Finance
Bills.

Types of Budget Documents

• Annual Financial Statement
• Demand for Grants

• Finance Bill

• Appropriation Bill

• Economic Survey (presented a day before the Budget)

Recent Trends in Union Budgets (Optional Enrichment)

• Focus on infrastructure: PM Gati Shakti, Vande Bharat
trains, highways
• Digital push: Digital India, FinTech support, digital

universities
• Green economy: Solar mission, green hydrogen policy

• Welfare schemes: PM Awas Yojana, Jal Jeevan Mission,

Ayushman Bharat
• Disinvestment and asset monetization

Significance of the Union Budget

• It acts as a policy instrument to guide the nation’s
economy.
• Ensures accountability and transparency in government

spending.
• Enables citizen empowerment by addressing their

economic and social needs.

• Helps India stay resilient during global financial

challenges.

Conclusion
The Union Budget is more than just an income-expenditure
statement—it is the government’s vision document for
national growth, equity, and stability. A well-crafted budget
boosts investor confidence, supports welfare, and paves the
way for Viksit Bharat (Developed India).

ROLE OF UNION BUDGET: DEFICIT FINANCE AND

GROWTH:
Introduction
The Union Budget is the Government of India’s annual
financial statement that outlines its projected expenditure
and revenue for the financial year. One of its vital roles is to
balance economic growth with fiscal discipline, especially
through the mechanism of deficit financing—a tool used
when expenditures exceed revenues.

What is Deficit Financing?

Deficit financing refers to the financing of the budget
deficit through borrowing from internal or external sources,
or by monetization (printing new money). In India, this is
typically done through:
• Borrowing from the RBI and financial markets

• Issuing government securities and bonds

Role of Deficit Financing in the Union Budget

1. Promoting Economic Growth
• Funds are used for infrastructure development,

industrial growth, and capital formation.

• Increases employment opportunities, aggregate demand,

and GDP.
2. Counter-Cyclical Fiscal Policy
• During economic slowdowns, deficit financing stimulates

demand and boosts private sector activity.

• Helps counter recessions and revive the economy

(Keynesian economics).
3. Supporting Welfare and Developmental Schemes
• Enables financing of social sector programs (health,

education, housing).
• Assists in achieving inclusive growth and poverty

reduction.
4. Financing Large-Scale Public Investment
• Long-term investments in transport, energy, and digital

infrastructure need large capital outlays, which are met

through deficit finance.

Challenges of Deficit Financing

• Inflationary pressures due to excessive money supply.
• Crowding out of private investment if borrowing from

markets increases interest rates.

• Debt burden increases, leading to higher interest

payments.
• Reduced credit ratings and investor confidence if fiscal

deficit remains unchecked.

Growth-Oriented Budgeting
In recent years, Union Budgets have focused on growth-led
fiscal policies, balancing deficit targets with capital
investments:
• Introduction of Fiscal Responsibility and Budget

Management (FRBM) Act to maintain fiscal prudence.

• Investment in PM Gati Shakti, Make in India, and

National Infrastructure Pipeline.

• Strategic deficit financing to boost productivity without

overheating the economy.

Conclusion
The Union Budget plays a pivotal role in stimulating
economic growth through prudent deficit financing.
However, striking a balance between fiscal expansion and
sustainability is crucial. When managed wisely, deficit
financing can serve as a powerful tool to transform India into
a resilient and developed economy.