We often see a country going through a tough time, with rising inflation and unemployment negatively affecting its GDP. This scenario usually occurs when the country’s economy is not financially sustainable and suffers in the long term, even when some policies positively affect it in the short term. For example, a country may lower the tax rates by a hefty margin without increasing other revenues. Although this may benefit the citizens for some time, the increased money in hand may result in inflation and negatively impact the economy’s financial stability in the long term.
Hence, various government policies directly or indirectly affect financial sustainability by dictating how long a newly introduced policy will benefit an economy’s stability. Understanding how policies impact an economy’s financial sustainability is essential for a better understanding of policy making and financial stability.
What is financial sustainability
Financial sustainability refers to the ability of a government, organisation or the overall economy to maintain its positive financial health over the long term. Financial sustainability is a term used by economies to define their financial stability, which is more long-term than short-term and comes without any excessive risk or heavy financial dependency on external agencies or institutions. Financial sustainability also means that a government organisation of an economy can easily cover its debt obligations without hurting its financial situation.
Key aspects of financial sustainability
Here are some key aspects of financial sustainability:
- Revenue stability: Financial sustainability includes a regular income stream and lower dependency on a single income channel.
- Efficient resource allocation: This is a key aspect of financial sustainability, as it ensures the optimum use of all available resources for long-term financial stability.
- Debt management: Effective debt management is one major aspect of financial sustainability. Borrowing should be balanced with repayment capability for long-term financial stability.
- Financial planning: Effective financial sustainability includes long-term financial planning with clear income and expense channels. This helps tackle financial challenges easily.
How do policies impact financial sustainability
Every policy developed and implemented by a government at the country level, or an organisation at the company level affects financial sustainability. This is because a policy directly affects economic stability, risk management, resource allocation, revenue, and the resulting financial performance. A well-designed policy can help an economy or organisation achieve long-term financial growth, while a poorly developed or implemented policy can lead to long-term financial stability.
For a better understanding, here is how policies impact financial sustainability in detail:
Macroeconomic policies and financial sustainability
Macroeconomic policies govern the economy as a whole and include fiscal and monetary policies. Since they shape the financial environment of the overall economy, they directly affect financial sustainability. Fiscal policies govern taxation laws, government borrowings, and spending and directly impact public debt and economic growth. If a government has a continuous budget deficit (spending more and earning less) and does not develop a policy for correction, it may lead to financial instability in the long term. On the other hand, if the fiscal policies are effective, budget deficits can be resolved, leading to long-term financial sustainability.
Monetary policies are controlled by the apex banks (RBI in India), which regulate interest rates and the money supply. Financial sustainability is possible through monetary policies that maintain moderate inflation. Conversely, if a monetary policy does not maintain inflation, it can weaken financial sustainability. Similarly, excessively high interest rates can discourage investments and borrowings, slowing economic progress. Hence, fiscal and monetary policies heavily influence financial sustainability at the macroeconomic level.
Regulatory and compliance policies
Regulatory and compliance policies are made to ensure financial transactions and processes are transparent, stable and accountable so that citizens or customers do not suffer financially. Policies such as the statutory liquidity ratio, which dictates the minimum percentage of deposits a bank must hold as liquid assets, ensure that banks can cater to the deposit demands of customers without default. These policies allow the RBI to limit systemic risks and maintain customer confidence in the banking system.
On the other hand, a corporation may implement governance policies to maintain financial transparency, conduct audits, and disclose financial statements. Policies that ensure financial transparency and ethical business practices are more likely to maintain long-term financial sustainability.
Environmental, social, and governance (ESG) Policies
ESG policies are linked to governments and organisations that carry out their economic and business activities in a way that limits any negative effects on the environment and society. It is believed that policies that enforce environmental protection, carbon taxation, and sustainable business practices contribute to long-term financial resilience. Businesses that adopt eco-friendly policies benefit from cost savings, improved reputation, and regulatory compliance, strengthening their financial sustainability.
Furthermore, social policies that encourage fair wages, ethical business practices, labour and human rights are more likely to benefit the economy or the organisation by increasing productivity, loyalty and motivation. Policies that encourage such measures are likely to contribute more to financial sustainability in the long term. For example, an NBFC with an ethical business standard may create an employee-centric policy for its sales department to lower the workload.
Conclusion
Policies significantly impact financial sustainability by shaping economic stability, risk management, resource allocation, and long-term financial planning. Since governments and businesses have switched to digital and online marketplaces, policies are also affecting financial sustainability digitally. Well-implemented macroeconomic, regulatory, taxation, trade, ESG, and risk management policies support financial resilience, while poor policy choices can lead to financial instability and economic crises. Effective policymaking ensures that businesses, governments, and economies remain financially sustainable, promoting long-term growth and stability.
