BALIYANS.COM | AN INSIGHT INITIATIVE

BALIYANS.COM | AN INSIGHT INITIATIVE Telegram : https://t.me/baliyans | Youtube: https://bit.ly/2QdIs3n | Website: https://baliyans.com/

| Central Delhi: 73, Near Axis Bank, Old Rajinder Nagar |

| PH. No. - 011-47401259, 9811906458, 9818333201 |

1

INTRODUCTION

Fiscal Policy refers to the policy under which the government uses its expenditure and revenue programmes to produce desirable effects and avoid undesirable effects on the national income, production and employment. It is the means by which the government adjusts its spending levels and tax rates to monitor and influence a nation’s economy.

Fiscal policy is based on the theories of British economist John Maynard Keynes. Also known as Keynesian economics, this theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn, curbs inflation (generally considered to be healthy when between 2-3%), increases employment and maintains a healthy value of money. Fiscal policy is very important to the economy.

Objectives of Fiscal Policy

The following are the objectives of fiscal policy:

To maintain and achieve full employment.

To stabilise the price level.

To stabilise the growth rate of the economy.

To maintain equilibrium in the balance of payments.

To promote the economic development of underdeveloped countries.

Types of Fiscal Policy

There are two types of fiscal policy: Expansionary and Contractionary.

The objective of expansionary fiscal policy is to reduce unemployment. Thus, an increase in government spending and/or decrease in taxes are implemented that results in better GDP and reduced unemployment. However, it can also cause some inflation.

On the other hand, the objective of contractionary fiscal policy is to reduce inflation. Therefore, a decrease in government spending and/or an increase in taxes are implemented that leads to decreasing inflation. However, it can also trigger some unemployment.

In other words, fiscal policy that increases aggregate demand directly through an increase in government spending is typically called expansionary or loose. By contrast, fiscal policy is often considered contractionary or tight if it reduces demand via lower spending.

Tools of Fiscal Policy

The first tool is taxation, it includes income, capital gains from investments, property, sales etc. Taxes provide the major revenue source that funds the government. The downside of taxes is that whatever or whoever is taxed has less income to spend on themselves. That makes taxes unpopular.

The second tool is government spending. That includes subsidies, transfer payments including welfare programs, public works projects and government salaries. Whoever receives the funds has more money to spend. That increases demand and economic growth.

BUDGETING PROCESS IN INDIA

The budget process in India comprises four distinct phases:

Budget Formulation : Preparation of estimates of expenditure and receipts for the ensuing financial year;

Budget Enactment : Approval of the proposed Budget by the Legislature through the enactment of Finance Bill and Appropriation Bill;

ECONOMIC & SOCIAL DEVELOPMENT Fiscal Policy

BRITISH RULE

https://t.me/baliyans

https://bit.ly/2QdIs3n

https://baliyans.com/



| PH. No. - 011-47401259, 9811906458, 9818333201 |

2

Budget Execution : Enforcement of the provisions in the Finance Act and Appropriation Act by the government

-collection of receipts and making disbursements for various services as approved by the Legislature; and

Legislative review of budget implementation: Audits of government’s financial operations on behalf of the Legislature

The following discussion will be on the first two phases only:

Budget Formulation

In the Union Government, there is a budget division in the Department of Economic Affairs under the Ministry of Finance. This division starts the process of formulation of the next financial year’s Union budget in the months of August - September every year.

To start the process, the budget division issues an annual budget circular around the last week of August or the first fortnight of September every year. This annual budget circular contains detailed instructions for the Union government ministries/departments relating to the form and content of the statement of budget estimates to be prepared by them.

The ministries are required to provide three different kinds of figures relating to their expenditures and receipts during this process of budget preparation. These are: Budget Estimates, Revised Estimates and Actual Estimates.

Example : Suppose the Union government is preparing the budget for 2018-19 during the time period of September 2017 to February 2018. In this case, the approval of Parliament would be sought for the estimated receipts/expenditures for 2018-19, which would be called budget estimates.

At the same time, the Union government, in its budget for 2018-19, would also present revised estimates for the ongoing financial year 2017-18.

Finally, ministries would also be reporting their actual receipts and expenditures for the previous financial year 2016-17.

Next, the revenue-earning ministries of the Union government provide the estimates for their revenue receipts in the current fiscal year (revised estimates) and next fiscal year (budget estimates) to the finance ministry.

The finance minister examines the budget proposals prepared by the ministry and makes changes in them, if required. The finance minister consults the prime minister and also briefs the Union Cabinet, about the budget at this stage.

The budget division in the finance ministry consolidates all figures to be presented in the budget and prepares the final budget documents. The National Informatics Centre (NIC) helps the budget division in the process of consolidation of the budget data,

At the end of this process, the finance minister takes the permission of the President of India for presenting the Union budget to Parliament.

Budget Enactment

As per Rule 204(1) of the Rules of Procedure and Conduct of Business in the Lok Sabha, the Budget is presented to the Parliament on such date as fixed by the President.

The General Discussion on the Budget is held on a day appointed by the Speaker, subsequent to the day of presentation of the Budget and for such period of time as the Speaker may decide. During the general discussions, the House is at liberty to discuss the budget as a whole or any question of principle involved therein, but no motion can be moved nor can the budget be submitted to the vote of the House.

The Finance Minister has a right to reply at the end of the discussions. The scope of discussions at this stage is confined to general examination of budget, policy of taxation as expressed in the Budget speech of the Finance Minister and general schemes and structures etc. Specific points or grievances can be discussed on the floor of the House when it takes up relevant Demands for Grants or the Finance Bill.






| PH. No. - 011-47401259, 9811906458, 9818333201 |

3

After the conclusion of the General Discussion, the Demands for Grants of individual Ministries/Departments are taken up in the Lok Sabha for discussion as per the time table decided by the Business Advisory Committee of the House and is subjected to vote. In order to facilitate proper examination of different Demands for Grants, different departmentally related Standing Committees of the Parliament are constituted every year to consider the concerned Demands for Grants and make a report on them to the House. However, these Committees are not empowered to suggest anything in the nature of ‘cut motions’ and they have only persuasive value.

When a Demand is taken up for discussion, any Member may seek reduction in the amount of the Demand by moving any of the following types of Cut Motions:

Policy Cut (by moving “that the amount of the Demand be reduced to Re. 1”, thereby representing a disapproval of the policy underlying the demand);

Economy Cut (by moving “that the amount of the demand be reduced by a specified amount”, thereby representing the economy that can be effected); and

Token Cut (by moving “that the amount of the demand be reduced by Rs. 100”, in order to ventilate a specific grievance).

At the end of the period allotted for discussion on the Demands for Grants, the Speaker puts all the outstanding Demands for Grants to the vote of the House. This process is known as ‘Guillotine’ which acts as a device for bringing the debate on financial proposals to an end within a specified time with the result that several Demands have to be voted by the House without discussions. At the same time, Cut Motions which have been moved are also put to vote and disposed of.

The Appropriation Bill for withdrawal from the Consolidated Fund of India is introduced in the Lok Sabha with the prior approval of the President. The Appropriation Bill becomes the Appropriation Act after it is given assent by the President. This act authorizes (or legalises) the payments from the Consolidated Fund of India.

The scope of debate on an Appropriation Bill relating to Demands for Grants for the financial year after the remaining demands have been guillotined is restricted to matters of public importance or administrative policy implied in the grants covered by the Bill which have not already been raised while relevant Demands for Grants were under consideration.

The Finance Bill is introduced to give effect to the financial proposals of the Government of India for the following year. It is subjected to all the conditions applicable to a Money Bill. The Finance Act legalises the income side of the budget and completes the process of the enactment of the budget.

COMPONENTS OF THE GOVERNMENT BUDGET

The budget comprises of the (a) Revenue Budget and the (b) Capital Budget:

REVENUE ACCOUNT

The Revenue Budget shows the current receipts of the government and the expenditure that can be met from these receipts.






| PH. No. - 011-47401259, 9811906458, 9818333201 |

4

Revenue Receipts

Revenue receipts are receipts of the government which are non-redeemable, that is, they cannot be reclaimed from the government. They are divided into tax and non-tax revenues.

Tax revenues consist of the proceeds of taxes and other duties levied by the central government. Tax revenues, an important component of revenue receipts, comprise of:

Direct taxes – which fall directly on individuals (personal income tax) and firms (corporation tax).

Indirect taxes like excise taxes (duties levied on goods produced within the country), customs duties (taxes imposed on goods imported into and exported out of India) and service tax.

Other direct taxes like wealth tax, gift tax and estate duty (now abolished) have never been of much significance in terms of revenue yield and have thus been referred to as ‘paper taxes’.

Direct taxes made up for 36.31 per cent of the total taxes in 2000 - 01. This ratio has risen to 51.05 per cent in 2015 - 16. The ratio of direct taxes to total taxes in 2015-16 is the lowest in past 9 years with a peak of 60.78 per cent being hit in 2009 - 10. The ratio was 52.97 per cent in 2007 - 08 and over 56 per cent in 2013 - 14 and 2014-15.

Non-tax revenue of the central government mainly consists of:

Interest receipts on account of loans by the central government;

Dividends and profits on investments made by the government,

Fees and other receipts for services rendered by the government.

Revenue from Spectrum Auctions has been one of the major sources of Non-Tax revenue for its government.

Cash, Grants-in-aid from foreign countries and international organizations are also included

Revenue Expenditure

Revenue Expenditure is expenditure incurred for purposes other than the creation of physical or financial assets of the central government. It relates to those expenses incurred for the normal functioning of the government departments and various services, interest payments on debt incurred by the government and grants given to state governments and other parties (even though some of the grants may be meant for creation of assets).

Budget document used to classify total expenditure into plan and non-plan expenditure. Since Budget 2017 – 18, the distinction between Plan and Non-Plan Expenditure has been done away.

Plan Revenue Expenditure was related to central Plans (the Five-Year Plans) and central assistance for State and Union Territory plans.

Non-plan expenditure, the more important component of revenue expenditure, covered a vast range of general, economic and social services of the government. The main items of non-plan expenditure were:

Interest Payments;

Defense services;

Subsidies;

Grants to State and UTs (Including the grants for the creation of capital assets)

Salaries; and

Pensions.

CAPITAL ACCOUNT

The Capital Budget is an account of the assets as well as liabilities of the central government, which takes into consideration the changes in capital. It consists of capital receipts and capital expenditure of the government. This shows the capital requirements of the government and the pattern of their financing.

Capital Receipts

All those receipts of the government which create liability or reduce financial assets are termed as capital receipts. The capital receipts in India include the following capital kind of accruals to the government:






| PH. No. - 011-47401259, 9811906458, 9818333201 |

5

Examples of Debt Creating Capital Receipts Examples of Non-Debt Creating Capital Receipts

Loans raised by the government from the public (Market Borrowings).

Borrowing from the RBI.

Borrowing from the commercial banks and other

financial institutions.

Loans received from foreign governments and

international organizations.

Other items include small savings instruments such

as Post-office Savings Accounts etc. and Provident

funds.

Recovery of Loans

Proceeds from the sale of shares of public

enterprises (Disinvestment)

Capital Expenditure

All the areas which get capital from the government are part of the capital expenditure. It includes so many heads in India:

Loan Disbursals by the Government: The loans forwarded by the government might be internal (i.e., to the states, UTs, PSUs, FIs, etc.) or external (i.e., to foreign countries, foreign banks, purchase of foreign Bonds, loans to IMF and WB, etc.).

Loan Repayments by the Government of the Borrowings Made in the Past: Again loan payments might be internal as well as external. This consists of only the capital part of the loan repayment as the element of interest on loans is shown as a part of the revenue expenditure.

Capital Expenditure on Defence by the Government: This consists of all kinds of capital expenses to maintain the defense forces, the equipment purchased for them as well as the modernisation expenditures.

General Services: These also need huge capital expenditure by the government - the railways, postal department, water supply, education, rural extension, etc.

Other Liabilities of the Government: Basically, this includes all the repayment liabilities of the government on the items of the Other Receipts.

With the merger of Plan and Non-Plan Expenditure, there have been changes in reported categories of expenditure. The Central Government expenditure is broadly classified into six broad categories of:

Establishment Expenditures of the Centre: This category includes salaries, medical expenses, wages, allowances, travel expenses, office expenses, training, professional services, rent paid, taxes, pensions, etc. This is expenditure that is incurred for maintaining the administrative entity, as opposed to expenditure incurred on programme and schemes.

Central Sector Schemes: These are schemes for which the central government provides the entire budgetary support and most of them are implemented by the central government.

Transfers under Centrally Sponsored Schemes: For these schemes, the central government shares the budgetary support with State or Union Territory government (based on a sharing pattern determined by the central government). These schemes are implemented by the State/UT governments.

Other Central Expenditure: This category includes expenditure on CPSEs and Autonomous Bodies.

Finance Commission Transfers: These are grants given under Article 275(1) of the Constitution to urban and rural






| PH. No. - 011-47401259, 9811906458, 9818333201 |

6

local bodies, grant-in-aid to State Disaster Response Funds (SDRF) and post-devolution revenue deficit grant.

The revenue deficit grant is meant to cover gap in revenue expenditure after taking into account all the sources of revenue for states. Based on 14th Finance Commission’s recommendations, 11 states receive these grants and about a third of the grant goes to Jammu and Kashmir.

Other Transfers (to States): This mainly includes additional central assistance for externally aided projects (given as grants or block loans) and special assistance to states.

DIFFERENT KINDS OF DEFICITS

A deficit is the amount by which a resource falls short of a mark, most often used to describe a difference between cash inflows and outflows. Deficit is the opposite of surplus and is synonymous with shortfall or loss.

Monetised Deficit

Monetized Deficit is broadly defined as the creation of money by the Central Bank to fund the fiscal deficit of the Government. The money so created is normally provided to the Government by the Central Bank against special securities created for this purpose.

With the issue of more money to the government, the money supply in the economy increases, as a result of which the inflationary pressure prevails. Hence, we can say that monetised deficits are the part of a fiscal deficit that leads to the inflation in the economy.

Until 1993, fiscal deficit in India was automatically monetized through the issue of special securities called Ad- Hoc Treasury Bills issued by the RBI on behalf of the Central Government to itself. After the crisis of 1991, this form of monetization came under severe criticism and following an understanding between the Central Government and the RBI, it was discontinued completely in 1997.

Budget Deficit

Budgetary deficit is the difference between all receipts and expenses in both revenue and capital account of the government. This difference is met by the net addition of the treasury bills issued by the RBI and drawing down of cash balances kept with the RBI.






| PH. No. - 011-47401259, 9811906458, 9818333201 |

7

The concept of budgetary deficit has lost its significance after the presentation of the 1997-98 Budget. In this budget, the practice of ad hoc treasury bills as source of finance for government was discontinued.

Budgetary deficit = Total Expenditure – Total Receipts (Excluding sale of Treasury Bills)

Revenue Deficit

Revenue deficit is the excess of total revenue expenditure of the government over its total revenue receipts. It is related to only revenue expenditure and revenue receipts of the government. Alternatively, the shortfall of total revenue receipts compared to total revenue expenditure is defined as revenue deficit.

Revenue deficit signifies that government’s own earning is insufficient to meet normal functioning of government departments and provision of services. Revenue deficit results in borrowing. Simply put, when government spends more than what it collects by way of revenue, it incurs revenue deficit.

Revenue Deficit = Revenue Expenditure – Revenue Receipts

A high revenue deficit warns the government either to curtail its expenditure or increase its tax and non-tax receipts.

Effective Revenue Deficit (ERD)

Effective Revenue deficit is a new term introduced in the Union Budget 2012-13. Effective Revenue Deficit is the difference between revenue deficit and grants for creation of capital assets. In other words, the Effective Revenue Deficit excludes those revenue expenditures which were done in the form of grants for creation of capital assets.

Grants for creation of capital assets are defined as “the grants-in-aid given by the Central Government to the State Governments, constitutional authorities or bodies, autonomous bodies and other scheme implementing agencies for creation of capital assets”.

Effective Revenue Deficit signifies that amount of capital receipts that are being used for actual consumption expenditure of the Government.

Effective Revenue Deficit = Revenue Deficit – Grants for Creation of Capital Assets

Fiscal Deficit

This is widely used as a summary indicator of the macroeconomic impact of the budget in several industrialized countries. This measure has been adopted by the IMF as the principal policy target in their programmes. In India, the government began to report the fiscal deficit only after 1991.

Fiscal deficit is defined as excess of total budget expenditure (revenue and capital) over total budget receipts (revenue and capital) excluding borrowings during a fiscal year. Fiscal deficit is a measure of how much the government needs to borrow from the market to meet its expenditure when its resources are inadequate.

Fiscal Deficit = Total Expenditure – Total Receipts Excluding the Borrowing of the Government

If we add borrowing in total receipts, fiscal deficit is zero. Clearly, fiscal deficit gives borrowing requirements of the government. A little reflection will show that fiscal deficit is, in fact, equal to borrowings. Thus, fiscal deficit gives the borrowing requirement of the government.

Fiscal Deficit = Total Expenditure – (Revenue Receipts + Capital Receipts Excluding Borrowing)

Fiscal Deficit = Total Expenditure – (Revenue Receipts + Non-Debt Creating Capital Receipts)

Fiscal Deficit = Total Expenditure – (Revenue Receipts + Recovery of Loans + Disinvestment)

Greater fiscal deficit implies greater borrowing by the government. The extent of fiscal deficit indicates the amount of expenditure for which the government has to borrow money.

How is Fiscal Deficit to be financed?

Since fiscal deficit is the excess of government’s total expenditure over its total receipts excluding borrowings, therefore borrowing is the only way to finance fiscal deficit.

Borrowing from Domestic Sources:

Fiscal deficit can be met by borrowing from domestic sources, e.g., public and commercial banks. It also includes tapping of money deposits in provident fund and small saving schemes.






| PH. No. - 011-47401259, 9811906458, 9818333201 |

8

Borrowing from public to deal with deficit is considered better than deficit financing because it does not increase the money supply which is regarded as the main cause of rising prices.

Borrowing from external sources:

It means borrowing from international institutions like World Bank, IMF and Foreign Banks.

Printing of new currency notes

Another measure to meet fiscal deficit is by borrowing from Reserve Bank of India. This method of financing fiscal deficit is called as Monetised Deficit. (Discussed above)

Measures to reduce Fiscal Deficit: Some of the measures highlighted to reduce fiscal deficit are:

By reducing public expenditure

A drastic reduction in expenditure on major subsidies.

Reduction in expenditure on bonus, LTC, leaves encashment, etc.

Austerity steps to curtail non-plan expenditure.

By increasing revenue

Tax base should be broadened and concessions and reduction in taxes should be curtailed.

Tax evasion should be effectively checked.

More emphasis on direct taxes to increase revenue.

Restructuring and sale of shares in public sector units.

Primary Deficit

Primary deficit is defined as fiscal deficit of current year minus interest payments on previous borrowings. In other words whereas fiscal deficit indicates borrowing requirement inclusive of interest payment, primary deficit indicates borrowing requirement exclusive of interest payment (i.e., amount of loan).

It shows how much government borrowing is going to meet expenses other than Interest payments. Thus, zero primary deficits means that government has to resort to borrowing only to make interest payments.

Primary Deficit = Fiscal Deficit – Net Interest Liabilities

FISCAL CONSOLIDATION

According to Financial time’s lexicon, “Fiscal consolidation is a reduction in the underlying fiscal deficit. It is not aimed at eliminating fiscal debt.”

Fiscal consolidation is a process where government’s fiscal health getting improved indicated by reduced fiscal deficit which is manageable and bearable for the economy. Improved tax revenue realization and better aligned expenditure are thus components of fiscal consolidation.

Fiscal Responsibility and Management (FRBM) Act, 2003

Reason for its Introduction

The FRBM Act was enacted in 2003 as rising government borrowing and the resultant government debts have seriously eroded the financial health of the government. High revenue deficit due to higher expenditure on subsidies, salaries, defence etc. compelled the government to make big borrowing from early 1990s onwards.

With inadequate revenues, government resorted to high level of borrowing. The borrowing again produced high interest payments. In this way, interest payments became the largest expenditure item of the government.






| PH. No. - 011-47401259, 9811906458, 9818333201 |

9

To arrest this financial weakness in its budget, the government has taken some serious deficit cut targets by introducing a law in the form of the FRBM.

Objectives of FRBM Act

The major objectives of the Act are:

Institutionalizing Fiscal Discipline;

Reduction of Fiscal Deficit;

Creating transparent Fiscal management system;

Achieve Inter-generational equity in fiscal management;

Long-Run macroeconomic stability; and

Better co-ordination between fiscal and monetary policy

Important Provisions of the Act

The FRBM rule set a target reduction of fiscal deficit to 3% of the GDP by 2008-09. This will be realized with an annual reduction target of 0.3% of GDP per year by the Central government.

Revenue deficit has to be reduced by 0.5% of the GDP per year with complete elimination by 2008-09.

The central government shall not borrow from the Reserve Bank of India except by Ways and Means Advances (WMAs) to meet temporary excess of cash disbursements over cash receipts.

The revenue deficit and fiscal deficit may exceed the targets specified in the rules only on grounds of national security, calamity etc.

The central government to lay before both Houses of Parliament three statements:

Medium-term Fiscal Policy Statement,

The Fiscal Policy Strategy Statement, and

The Macroeconomic Framework Statement along with the Annual Financial Statement.

However, due to the 2007 international financial crisis, the deadlines were not met.

FRBM 2.0 – Amendments in FRBM Act, 2003

Union Budget 2012-13 saw introduction of amendments to the FRBM Act as part of Finance Bill, 2012. Concept of “Effective Revenue Deficit” and “Medium Term Expenditure Framework” statement are two important features of amendment to FRBM Act in the direction of expenditure reforms.

Effective Revenue Deficit (ERD) and not Revenue Deficit should be reduced to 0% by 31st March, 2015.

Fiscal Deficit should achieve the target of 3% by 31st March 2017.

“Medium Term Expenditure Statement be placed before Parliament along with this budget”.

N K Singh Committee

As per the Union Budget 2016-17, the government constituted a Committee to review the implementation of the FRBM Act. The committee was headed by Former Revenue Secretary and Rajya Sabha MP, NK Singh. Its members were former Finance and Revenue Secretary Sumit Bose, Chief Economic Adviser (CEC) Dr. Arvind Subramanian, Deputy Governor of RBI Urijit Patel and Director of National Institute Public Finance and Policy (NIPFP) Rathin Roy. The panel was also stated to consider the possibility of replacing absolute fiscal deficit targets with a target range.

Recommendations:

It has recommended Debt (Combined Debt of the Centre and States) as the new anchor and not the Fiscal Deficit.

The panel has recommended enacting a new Debt and Fiscal Responsibility Act after repealing the existing Fiscal Responsibility and Budget Management (FRBM) Act.

It has recommended a debt-to-GDP ratio of 38.7% for the central government, 20% for the state governments together and a fiscal deficit of 2.5% of GDP (gross domestic product), both by financial year 2022-23.

At present, the ratio of India’s debt to gross domestic product (GDP) is estimated at a staggering 70%—among the worst among other comparable economies. The plan is to bring this down to 60%.






| PH. No. - 011-47401259, 9811906458, 9818333201 |

10

Revenue deficit-to-GDP ratio has been envisaged to decline steadily by 0.25 percentage points each year from 2.3% in 2016-17 to 0.8% in 2022-23.

The panel has recommended the administration of the new fiscal rules be vested with a new body manned by experts: Fiscal Council under the Finance Ministry.

The proposed three-member fiscal council will prepare multi-year fiscal forecasts for the central and state governments

They will also provide an independent assessment of the central government’s fiscal performance and compliance with targets set under the new law.

The panel has dispensed with the idea of a band for the new metric. Instead, the panel has proposed specific escape clauses to deal with unforeseen circumstances.

The committee has specified deviation in fiscal deficit target of not more than 0.5 percentage points in any circumstance.

A similar buoyancy clause has also been proposed so that fiscal deficit must fall atleast 0.5% below the target if the real output grows 3% faster than that of the average.

Implications of the New Fiscal Rules

India’s sovereign credit rating is likely to improve by shifting the anchor to Debt from Fiscal Deficit. This improved credit rating will help in cheap borrowing from abroad.

The creation of fiscal council would have several advantages:

A Fiscal Council, with technical expertise, would help generate better understanding of the consistency of fiscal stance of each budget with the longer-term fiscal trajectory envisaged under the FRBM Act.

Improving the quality of Parliamentary oversight.

Contributing to a more informed public debate.

Having institutions like Monetary Policy Committee and Fiscal Council, there could be perhaps greater congruence between monetary and fiscal policy.

The new fiscal rules have also considered the need for flexibility in fiscal targets. This is important because a fixed deficit target can pose problems if there is a cyclical downturn in GDP.

TYPES OF GOVERNMENT BUDGETING

Budgeting is the process of estimating the availability of resources and then allocating them to various activities of an organization according to a pre-determined priority. In most cases, approval of a budget also means the approval to various spending units to utilize the allocated resources.

Line – Item Budgeting

In the late nineteenth century, line-item budgeting was introduced in some countries. The line item budget is defined as “the budget in which the individual financial statement items are grouped by cost centers or departments. It shows the comparison between the financial data for the past accounting or budgeting periods and estimated figures for the current or a future period”.






| PH. No. - 011-47401259, 9811906458, 9818333201 |

11

In a line-item system, expenditures for the budgeted period are listed according to objects of expenditure, or “line-items.” These line items include detailed ceilings on the amount a unit would spend on salaries, travelling allowances, office expenses, etc.

The line item budget approach is easy to understand and implement. It also facilitates centralized control and fixing of authority and responsibility of the spending units. Its major disadvantage is that it does not provide enough information to the top levels about the activities and achievements of individual units.

Performance Budgeting

The concept of Performance Budgeting is essentially ‘a technique of presenting Government operations in terms of functions, programmes, activities and projects’. Thus, governmental activities were sought to be identified in the budget in financial and physical terms so that a proper nexus between inputs and outputs could be established and performance assessed in relation to costs.

Under performance budgeting, the emphasis would get shifted from the means of accomplishment to the accomplishments themselves. The important thing under this technique was the precise definition of the work to be done or services to be rendered and a correct estimate of what that work or service would cost.

A performance budget is prepared in terms of functional categories and their sub-division into programmes, activities and projects and not merely in terms of organizational units and the objects of expenditure. A performance budget thus developed in terms of costs and results facilitates management control by bringing out the programmes and accomplishments in financial and physical terms closely interwoven into one comprehensive document.

Zero – Based Budgeting (ZBB)

A system of Zero-Base Budgeting (ZBB) was first introduced in the United States Department of Agriculture in its 1964 fiscal year budget. It was based on the concept that all programmes of the Department were to be reviewed afresh from the base zero and not merely in terms of incremental changes proposed for the budget year.

The Ministry of Finance formally introduced Zero-Base Budgeting in 1986 asking all the Ministries and Departments of the Government to adopt Zero-Base Budgeting approach with effect from the budget for 1987-88. The basic tenet of zero-based budgeting (ZBB) is that program activities and services must be justified annually during the budget development process.

Benefits of ZBB

The benefits of ZBB are substantial. These benefits are set out below:

Since ZBB does not assume that last year’s allocation of resources is necessarily appropriate for the current year, all of the activities of the organisation are re-evaluated annually from a zero base. Most importantly therefore, inefficient and obsolete activities are removed and wasteful spending is curbed. This has got to be the biggest benefit of zero-based budgeting compared to incremental budgeting and was the main reason why it was developed in the first place.

By its nature, it encourages a bottom-up approach to budgeting in order for ZBB to be used in practice. This should encourage motivation of employees.

It challenges the status quo and encourages a questioning attitude among managers.

It responds to changes in the business environment from one year to the next.

Overall, it should result in a more efficient allocation of resources.

The concept didn’t prove to be in India for the following reasons:

Due to lack of capability building.

Distinction being followed in India between Plan and Non-Plan expenditure. Ideally, prioritisation should be done among all items of expenditure whether on-going or new. Non-Plan or Plan. But the system in which Plan and Non-Plan expenditure are treated differently and assigned varying priorities, ZBB would have to be applied separately to Plan and Non-Plan expenditures.

Outcome Budgeting

Due to the realisation that ‘certain weaknesses have crept in the performance budget documents such as lack of clear one to-one relationship between the Financial Budget and the Performance Budget and inadequate target-






| PH. No. - 011-47401259, 9811906458, 9818333201 |

12

setting in physical terms for ensuing years’ it was felt that there was need for tracking ‘outcomes’ and not the readily measurable ‘outputs’.

The first outcome budget was passed in the Parliament on August 25, 2005. The guidelines for the 2006-07 outcome budget provided that each Ministry/Department will separately prepare the outcome budget documents in respect of ‘all Demands/ Appropriations controlled by them’. These contained:

Details about the mandate, goals and objectives as well as the policy framework and vision statement of the Ministry/Department

Details in indicated tabular format comprising financial outlays, projected physical outputs and projected/ budgeted outcomes.

The key words used here are ‘Outlays’, ‘Outputs’ and ‘Outcomes’.

Outlays imply total financial resources deployed for achieving certain outcomes.

Outputs have been defined as the ‘measure of the physical quantity of the goods or services produced through an activity under a scheme or programme’. They are identified as an intermediate stage between ‘outlays’ and ‘outcomes’.

Outcomes are the end product/results of various Government initiatives and interventions, including those involving partnership with the State Governments, Public Sector Undertakings, Autonomous Bodies, private sector and the community.

Budget 2017-18 for the first time laid down a consolidated Outcome budget covering all Ministries and Department along with the other Budget documents.

Gender Budgeting

The Budget year 2005-06 was very significant for women in the country, as for the first time the ‘Gender Responsive Budgeting’ (GRB) was adopted. The GRB is a method of planning, programming and budgeting that helps advance gender equality and women’s rights. It serves as an indicator of the government’s commitment towards the above mentioned objectives. So far, 57 government Ministries/departments in India have set up Gender Budgeting Cells, which is a positive step and will bring improvement in the lives of the women in society.

Gender Budgeting is a powerful tool for achieving gender mainstreaming so as to ensure that benefits of development reach women as much as men. It is not an accounting exercise but an ongoing process of keeping a gender perspective in policy/ programme formulation, its implementation and review. GB entails dissection of the Government budgets to establish its gender differential impacts and to ensure that gender commitments are translated in to budgetary commitments.

The rationale for gender budgeting arises from recognition of the fact that national budgets impact men and women differently through the pattern of resource allocation. Women, constitute 48% of India’s population, but they lag behind men on many social indicators like health, education, economic opportunities, etc. Hence, they warrant special attention due to their vulnerability and lack of access to resources. The way Government budgets allocate resources, has the potential to transform these gender inequalities. In view of this, Gender Budgeting, as a tool for achieving gender mainstreaming, has been propagated.

India has adopted gender budgeting and institutionalized the process (at the union level) since 2005-06. Though, gender budgeting calls for looking both at qualitative and quantitative aspect but India has categorically focused on the quantitative aspect. The trends of some of the major schemes under Ministry of Women and Child Development are analysed which reveals that the share of allocation has increased if see them in vacuum but if we see in comparison to the overall budgetary allocations and ministries total allocation, their share has decreased.

In the last 10 years (2005-2015), if we see the gender budget percentage to the total Budget of the Central Government, it started with the lowest (2.79 per cent) in the year 2005 and increased to the highest level with (6.22 per cent) in the year 2011. But from the year 2012, the percentage of the gender budget saw reduction in the total Budget of the Central Government and in the present Budget (2015-16) it is estimated at 4.46 per cent, one percentage reduction compared to last year (5.46 per cent) in 2014-15.






| PH. No. - 011-47401259, 9811906458, 9818333201 |

13

Percentage of Gender Budget to total Budget of the Central Government

Year Percentage (%) Year Percentage (%)

ADDITIONAL CONCEPTS

Different Types of Debts

In India, total Central Government Liabilities constitutes the following categories;

Internal Debt

External Debt

Public Debt in India includes Internal and External Debt incurred by the Central Government.

Internal Debt includes liabilities incurred by resident units in the Indian economy to other resident units, while External Debt includes liabilities incurred by residents to non-residents.

Internal Debt

The major instruments covered under Internal Debt are as follows:

Dated Securities:

These securities are primarily fixed coupon securities of short, medium and long-term maturity which have a specified redemption date. These are the single-most important component of financing the fiscal deficit of the Central Government average maturity of around 10 years.

Treasury Bills:

Zero coupon securities that are issued at a discount and redeemed in face value at maturity. These are issued to address short term receipt-expenditure mismatches under the auction program of the Government. These are primarily issued in three tenors; 91, 182 and 364 days.

Securities issued against ‘Small Savings’:

All deposits under small savings schemes are credited to the National Small Savings Fund (NSSF). The balance in the NSSF (net of withdrawals) is invested in special Government securities.

Market Stabilization Scheme (MSS) Bonds:

These are governed by a Memorandum of Understanding between the Government of India and the Reserve Bank of India. MSS was created to assist the RBI in managing its sterilization operations. Government of India borrows under this scheme from the RBI, while proceeds from such borrowings are maintained in a separate cash account with the latter and is used only for redemption of T-bills /dated securities raised under this scheme. (For more information about the MSS Bonds, refer the chapter on “Monetary Policy”)

External Debt

External Debt is the portion of a country’s debt that was borrowed from foreign lenders including commercial banks, governments or international financial institutions.

When a country (that includes government, firms and individual) borrows money from other countries that is from non-residents, then an external debt is created. A debt crisis can occur if a country with a weak economy is not able to repay external debt due to the inability to produce and sell goods and make a profitable return. The International Monetary Fund (IMF) is one of the agencies that keep track of the country’s external debt.






| PH. No. - 011-47401259, 9811906458, 9818333201 |

14

Ways and Means Advances (WMA)

The method of deficit financing or monetisation of the government deficits as practiced was discontinued with effect from April 1, 1997. It was replaced by Ways and Means Advances scheme. This step was taken following the agreement reached between Central Government and the Reserve Bank of India (RBI) on March 26. 1997.

In subsequent years, the entire requirement is being met through the ‘Ways and Means’ Advance (WMA) system and market borrowing. The WMA is an overdraft facility from the RBI. The facility is available for 10 days. The interest rate on WMA and overdraft are linked to the repo rate.

Under the new scheme of WMA:

RBI provides facilities for temporary accommodation of the financial needs of the government up to a ceiling (or limited amount) fixed in advance. The government’s receipts (through taxes, etc.) fall short of government expenditure. To meet this gap the RBI allows from time to time the government to draw upon the credit extended by it.

The credit/loan thus drawn has to be repaid or in technical language the government vacates WMA from time to time. As a result, the WMA will be reduced to zero at the end of the financial year. Thus, the WMA is purely a mechanism to bridge the temporary mismatch between the government’s receipts and expenditure.

While it is a gap-tilling device, it cannot be drawn upon to any amount as limits have been fixed on the maximum amount that can be availed of by the government.

Another feature of the scheme is the interest charged on WMA and overdraft facility. Loans under WMA will be charged interest that is related to the repo. The interest on the overdraft will be higher by two percent points above that charged for WMA.

The minimum balance required to be maintained by the Government of India with RBI will not be less than Rs. 100 crores on Friday, on the date of closure of the Government of India’s financial year and on June 30, and not less than Rs. 10 crore on other days.

Fiscal Drag

Fiscal drag is a concept where inflation and earnings growth may push more tax payers into higher tax brackets. Therefore, fiscal drag has the effect of raising government tax revenue without explicitly raising tax rates.

This fiscal drag has the effect of reducing Aggregate Demand and becomes an example of deflationary fiscal policy. It could also be viewed as an automatic fiscal stabiliser because higher earnings growth will lead to higher tax and therefore moderate inflationary pressure in the economy.

One cause of fiscal drag is the consequence of expanding economies with progressive taxation. In general, individuals are forced into higher tax brackets as their income rises. The greater tax burden can lead to less consumer spending. For the individuals pushed into a higher tax bracket, the proportion of income as tax has increased, resulting in fiscal drag.






| PH. No. - 011-47401259, 9811906458, 9818333201 |

15

Fiscal Neutrality

Fiscal neutrality occurs when taxes and government spending are neutral, with neither having an effect on demand. Fiscal neutrality creates a condition where demand is neither stimulated nor diminished by taxation and government spending.

A balanced budget is an example of fiscal neutrality, where government spending is covered almost exactly by tax revenue – in other words, where tax revenue is equal to government spending.

A situation where spending exceeds the revenue generated from taxes is called a fiscal deficit and requires the government to borrow money to cover the shortfall. When tax revenues exceed spending, a fiscal surplus results, and the excess money can be invested for future use.

Crowding Out Effect

The crowding out effect is an economic theory stipulating that rises in public sector spending drive down or even eliminate private sector spending. Though the “crowding out effect” is a general term, it is often used in reference to the stifling of private spending in areas where government purchasing is high.

A situation when increased interest rates lead to a reduction in private investment spending such that it dampens the initial increase of total investment spending is called crowding out effect.

Sometimes, government adopts an expansionary fiscal policy stance and increases its spending to boost the economic activity. This leads to an increase in interest rates. Increased interest rates affect private investment decisions. A high magnitude of the crowding out effect may even lead to lesser income in the economy.

With higher interest rates, the cost for funds to be invested increases and affects their accessibility to debt financing mechanisms. This leads to lesser investment ultimately and crowds out the impact of the initial rise in the total investment spending. Usually the initial increase in government spending is funded using higher taxes or borrowing on part of the government.

Pump Priming

Pump priming is the action taken to stimulate an economy usually during a recessionary period, through government spending, and interest rate and tax reductions.

Pump priming assumes that the economy must be primed to function properly once again. In this regard, government spending is assumed to stimulate private spending, which in turn should lead to economic expansion.

Pump priming involves introducing relatively small amounts of government funds into a depressed economy in order to spur growth. This is accomplished through the increase in purchasing power experienced by those affected by the injection of funds, with the goal of prompting higher demand for goods and services. The increase in demand experienced through pump priming can lead to increased profitability within the private sector, which assists with overall economic recovery.

Pump priming relates to the Keynesian economic theory, named after noted economist John Maynard Keynes, which states that government intervention within the economy, aimed at increasing aggregate demand, can result in a positive shift within the economy. This is based on the cyclic nature of money within an economy, in which one person’s spending directly relates to another person’s earnings, and that increase in earnings leads to a subsequent increase in spending.

Economic Stimulus

Economic stimulus consists of attempts by governments or government agencies to financially stimulate an economy. An economic stimulus is the use of monetary or fiscal policy changes to kick start growth during a recession. Governments can accomplish this by using tactics such as lowering interest rates, increasing government spending and quantitative easing, to name a few.

Over the course of a normal business cycle, governments may try to influence the pace and composition of economic growth using various tools at their disposal. Central governments, including the U.S. federal government, may utilize fiscal and monetary policy tools to stimulate growth. Similarly, state and local governments can also engage in stimulus spending by initiating projects or enacting policies that encourage private sector investment.






| PH. No. - 011-47401259, 9811906458, 9818333201 |

16

Tax Expenditure

Tax Expenditures, as the word might indicate, does not relate to the expenditures incurred by the Government in the collection of taxes. Rather it refers to the opportunity cost of taxing at concessional rates, or the opportunity cost of giving exemptions, deductions, rebates, deferrals credits etc. to the tax payers. Tax expenditures indicate how much more revenue could have been collected by the Government if not for such measures. In other words, it shows the extent of indirect subsidy enjoyed by the tax payers in the country.

Tax expenditures or the revenue forgone are sanctioned in the tax laws. A statement of the same, (as far as Federal / Union / Central Government is concerned) is presented to the Parliament at the time of Union Budget by way of a separate budget document titled “Statement of Revenue Foregone”. It lists the revenue impact of tax incentives or tax subsidies that are part of the tax system of the Central Government. This document also estimates the revenue to be foregone during the proposed financial year on the basis of the revenue foregone figures of the previous financial year.

***********************




Documents

BALIYANS.COM | AN INSIGHT INITIATIVE