Role of Finance Ministry in Monetary and Fiscal Policy

Role of Finance Ministry in Monetary and Fiscal Policy

Fiscal role of ministry of finance

The Ministry of Finance plays a very crucial role in development planning in India. It supervise the financial institution and is responsible for the overall financial management of the country.

The Ministry of Finance is responsible for the fiscal administration of the country. It has three departments, Department of Economic Affairs, Department of Expenditure and Department of Revenue. The Department of Economic Affairs has a Budget Division and it prepares the budget of the Government. The role of the Ministry of Finance is based on ‘Financial Control’ by the Finance Ministry particularly by its Department of Expenditure. It has three main parts, control exercised during the preparation of the budget, control exercised during the execution of the budget and control on miscellaneous matters.

It scrutinises all proposals emanating from the spending department in so far as they have financial implications. This enables the Ministry to have a free hand in the formulation of policies of other departments. Generally, the scrutiny exercised by the Ministry of Finance in very broad and is more concerned with the over-all financial implications of the proposals and its impact on the expenditure”.

The Cabinet attaches considerable weight to the opinion of the Ministry. After all the proposals have been received from the spending ministries, it proceeds to determine the priorities in the larger interests of the nation. It’s main concern is to obtain “Proper balance of expenditure between services, so that greater value could not be obtained for the total expenditure by reducing the money spent on one service and increasing expenditure on another”3 and to secure a uniform standard in the measurement of the financial sacrifice involved in the activities of all departments”.

The Ministry of Finance, thus, plays an important role in development planning in India. It monitors the financial institution, which is responsible for the entire fiscal administration of the country. The focus purpose of these financial institution is on the socio-economic development of the country. The role of Ministry of Finance extents to every department, directly or indirectly and its impact is writ large on the entire administration. It maintains financial discipline in the country. As the economic development of India is linked with the successful implementation of the five year plans, the Ministry of Finance cannot remain aloof from it. It plays a vital role in the formulation of plans. In a word, the Ministry constitutes the backbone of development, financial stability and good governance.

Role of ministry of finance in monetary policy

Monetary Policy is the process by which monetary authority(an authority that controls all matters relating to money) of a country, generally a central bank controls the supply of money in the economy by exercising its control over interest rates in order to maintain price stability,reduce inflation and achieve high economic growth. A sound monetary policy ensures that various sectors of the economy have sufficient tokens/authority to carry out their transactions. It provides the basis to the fiscal policy and the fiscal policy influences the monetary policy and gives it a direction to proceed in. Monetary policy helps in keeping the money supply and economy of a nation stable whereas the fiscal policy is more involved in development and infrastructural work and policy making and enactment of budget. A monetary policy is changed from time to time to combat inflation,deflation,price rise,imbalance in demand and supply,etc by mopping up excess money or infusing money in the market as the requirement may be. A sound monetary policy helps the government determine its fiscal policy and how much it will collect as revenue and spend as expenditure. The fiscal policy helps bring money into the market whereas the monetary policy helps in managing that money supply and keeping it stable. In India the monetary policy is managed by the RBI which is the central bank as well as monetary authority of the country.

It was an open secret that the Union finance ministry did not see eye to eye with the Reserve Bank of India (RBI) on monetary policy. The rift is now out in the open.

The sequence of recent events is as follows. The finance ministry had summoned the members of the monetary policy committee (MPC) to New Delhi to discuss interest rate policy. The MPC members formally refused to attend the meeting. RBI governor Urjit Patel made this public in an interaction with journalists. The MPC also decided—rightly in our opinion—to not cut interest rates in their policy meeting on . Chief economic adviser Arvind Subramanian put out a statement on why he disagreed with the decision.

Such conflicts between finance ministries and central banks are not uncommon across the world. The question is how well the creative tension is managed. India itself provides starkly different examples.

There was excellent coordination between New Delhi and Mumbai when Manmohan Singh was finance minister and C. Rangarajan was RBI governor, even when the central bank went in for a brutal tightening of policy in response to double-digit inflation. We saw a similar smooth working relationship between Yashwant Sinha and Bimal Jalan.

Matters have been more tense since then. The episodes of friction between the two masters of our financial universe are well known. Some of them were highlighted in the book written by former RBI governor D. Subbarao, Who Moved My Interest Rate?. These years of conflict also saw a concerted campaign from New Delhi to cut the RBI down to size, as when the financial stability and development council was set up in 2010 with the central bank as just one of several regulatory institutions who are its members. The rupee crisis of 2013 did act as a glue, but even here most of the coordination was done by officials rather than the finance minister and the governor.

Institutional coordination is as much an art as a science. The art comes from the ability of people to work together despite conflicting views. The science comes from the institutional rules that set out the specific areas of responsibility. Both need to be nurtured.

The MPC members did well to not attend the meeting in the finance ministry. We had argued in these columns earlier that such a meeting was in conflict with the clear provisions of the RBI Act. However, the finance ministry is also empowered under the revised Act to offer its views on interest policy in writing to the MPC. Subramanian has done precisely that, though in the public sphere.

Disagreement is not in itself a bad thing, as long as the legal provision that the MPC gets freedom to pursue the inflation target formally given to it by the government is respected. What matters more right now is the threat of a breakdown in communication. It is not just about interest rate policy. The biggest risks to economic stability right now come from the banking sector. Several policies have been tried out. Several ideas have been floated. The mountain of bad loans has kept getting bigger.


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