Business Environment-3 Macro Stability and Business 1

Macro stability and Business 1,Macro stability aims at stable and satisfactory growth. Growth stimulates aggregate demand 2. Macro stability is at a high and stable level of employment and a consistently low level of unemployment. Higher employment creates higher purchasing power and stimulates demand, 2

Macro stability and Business 3. Macrostability aims at reducing inflation. Inflation creates uncertainty. Lenders lose. Borrowers gain. The nominal interest goes up or real interest falls. The demand declines 3

Macro stability and business 4. Macro stability aims at ensuring stabiity of exchange rate. The overvaluing of currency discourages exports. The devaluation increases price of imports and lowers price of export. Exchange rate is important for exporters and domestic producers who use imported raw materials. 4

Main instruments of macro policy 1. Fiscal policy 2. Monetary policy 3. Exchange rate policy 5

Tools of Fiscal Policy !. Taxation 2. Public Expenditure including subsidies 3. Deficit Financing and Public debt. 6

Taxation : Income tax and business 1. Direct taxes. Business dislikes direct taxes like income tax because it reduces their real income. However, the prices of goods remain unchanged. It is also flexible. In times of recession income tax falls. In times of boom, income tax revenue increases. Thus income tax operates as a built in stabilizer. It also promotes better distribution of income 7

Taxation : Income tax and business 2. Business prefer tax holidays. This is a considered as a major incentive. 3. Corporate tax is higher than individual income tax. This discourages formation of companies. 8

Taxation. Custom Duty and Business Domestic business likes it as it protects their products against foreign competition. It also easy to collect. It is regressive. It adds to cost of living and erodes incomes of consumers. It makes the protected industry less competitive. Sometimes it may reduce employment 9

Custom Duty and Business Tariff Anomaly may arise when raw materials and intermediate products are taxed at a higher rate than final inputs. Custom duty may stand in the way of trade facilitation. This also creates the problem of rent seeking. 10

Indirect taxes Sales Tax, Excise Duty, VAT. The main justification for VAT is to eliminate tax on taxes. Two essential condition for VAT - documentation for exemption at every stage -seller of goods and services collect the tax on behalf of the government. The seller is the collector of taxes. 11

Indirect taxes Broad based tax- collects lot of revenue Regressive. Two sets of exemptions – (1) for essential goods such as food items (2) exemptions for small producers Distortions. Exemptions create distortions. Example: Soap, shoe industry –turnover tax for small and cottage industries 12

Indirect tax Supplementary Duty. Usually levied on luxuries. Reduces demand for such products. Supplementary duty is not a protective tariff – should be equally applicable to domestic products. 13

Government Expenditure and Subsidies 1. Producer Subsidies help business directly. Subsidies for consumers help business indirectly. Subsidies helpful in the short run but harmful in the long run. They undermine competitiveness and makes business dependent on government. 14

2. The expenditure issues which concern business are: (a) Size. The bigger the size of government, lower the role of private sector. (b) Implementation. How much is implemented by private sector? The private sector may be crowded out. (c) composition: Higher investment on infrastructure the better. Higher welfare expenditure decreases supply of labor and exerts upward pressure on wage rate. 15

Deficit 1. How much 2. Sources of Deficit 3. Effects of Deficit. 16

How much deficit? There are deficits at three levels: national, state and local. Usually, national deficit is discussed. In European Monetary Union, the ceiling for national deficit is three per cent. In India, the combined deficit of Federal and state government is usually between 6 to 10%. There is controversy on the definition of deficit. Is foreign aid deficit or investment? Usually, IMF and World Bank consider it as deficit. 17

Sources of deficit 1. Borrowing from Public. Bond, National Saving Certificates. Difference between bond and NSC: Bond is limited, the sale of NSC is open. 2. Borrowing from commercial banks 3. Borrowing from Central Bank. 4. Foreign Aid 5. Sovereign debt from outside. 18

Effects of deficit 1. Deficit stimulates inflation. It depends on where the deficit is spent. Investment in infrastructure may raise productivity and dampen inflationary pressure. 2. Deficit financing reduces private sector investment. 3. Deficit financing for consumption needs may create debt trap for future generation. 19

Budget Announcement Budget announcements provide signals for economic agents. Together they create expectations. 20

Monetary Policy Monetary policies serve two- fold roles: 1. affect the supply of money and credit 2. affect the term on which credit is available to borrowers. 21

Instruments of Monetary Policy 1. Open market operations refer to the buying and selling of Government securities by a Central Bank. Open market operations have not as yet developed in countries like Bangladesh. Through open market operation, the central Bank may increase or decrease money supply. 22

Instruments of Monetary Policy 2. Reserve requirements. Two types of reserves are maintained by banks: Cash reserve ratio (CRR) and Statutory liquidity ratio (SLR) maintained in securities. These ratios may be varied by the Central Bank thereby affecting money supply. CRR in Bangladesh – 6% (Jan 2011) and SLR- 19% (Jan 2011). 23

Instruments of Monetary Policy 3. Bank rate. This is the rate at which central banks lend to commercial banks. Lowering of bank rate encourages credit expansion and vice versa. Bank rate of BB is 5 percent (July 2011) 24

Instruments of monetary policy Repo rates. Repo short for repurchase agreements are contracts for the sale and future repurchase of a financial asset, most often treasury securities. The interest which is paid for such transactions are known as repo rate. 25

Business and Monetary Policy 1. Higher interest rate increases cost of production. 2. Higher interest rate discourages investment. 3. Contractionary money supply poses problems for firms which are run with borrowed money. 26

Exchange rate Policy Two main issues: Currency convertibility Rate of Exchange 27

Currency Convertibility Current account convertibility: no restriction on trade related payments Capital account convertibility- no restriction on transfer of money. It turned out to be disastrous to South East Asian Countries. 28

Exchange rate Exchange rate is the rate at which one currency (such as dollar) can be exchanged for another (such as Taka). In the past it used to be fixed. Now it is market driven which may change continuously. 29

Exchange rate and business 1. Exchange rate instability increases the cost of business. The input and output prices need to be continuously changed for the survival of business. 2. Appreciation of currency increases the real price of exportables and reduces the price of imports. This is likely to lead to balance payment crisis. 30

Exchange rate and Business Devaluation lowers the cost of exports in international markets and raises the cost of imports in the country. It may improve balance of payment. However, it may accelerate inflation. 31

Issues for discussion 1. Explain how macro stability affects business. 2. Explain the major issues of direct and indirect taxes from the point of view of business. 3. Discuss the major issues of public expenditure from the point of view of business. 4. Explain what are the implications of deficit financing for business. 5. Discuss the main tools of monetary policy. How is business affected by monetary policy. 6. Explain the main issues of exchange rate policies from the point of view of business. 32