Public Finance in India: Components, Objectives and Fiscal Policies |
Public Finance: Components and Management Strategies
- Public finance is the management of a country’s revenue, expenditures, and debt through various Government, quasi-government institutions, policies, and tools.
- Components of public finance: public expenditure + public revenue + financial scrutiny + fiscal policy + financial administration + public borrowing.
Public Finance and Budgeting in India: India’s Annual Financial Statement ( Art 112)
- The term budget is nowhere used in the Constitution.
- Budget is referred to as the Annual Financial Statement in the constitution under 112.
- The Rail Budget was separated from the General Budget on the recommendations of the Acworth Committee in 1924.
- However, it was merged again in 2017.
- The Budget is a statement of the Government estimated receipts and expenditure in a financial year starting from APRIL 1 and ending on 31 MARCH.
- Those receipts and expenditure that relate to the current financial year only are included in the revenue account (also called revenue budget) and
- Those that concern the assets and liabilities of the government into the capital account (also called capital budget).
| Budget
Receipt
Non-Revenue Receipt Expenditure
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OBJECTIVES OF BUDGET
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| Receipts | Revenue Receipts: |
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| Non-Revenue Receipts |
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| Expenditure | Revenue Expenditure: Broadly, any expenditure which does not lead to any creation of assets or reduction in liability is treated as revenue expenditure. Examples of revenue expenditure are salaries of government employees, interest payment on loans taken by the government, pensions, subsidies, grants, rural development, education and health services, etc. The purpose of such expenditure is not to build up any capital asset, but to ensure normal functioning of government machinery. It is recurring in nature and incurred regularly. | |
| Capital Expenditure: An expenditure which either creates an asset (e.g., school building) or reduces liability (e.g., repayment of loan) is called capital expenditure. Repayment of loan is also capital expenditure because it reduces liability. It is non-recurring in nature. | ||
How is Fiscal Consolidation achieved in Public Finance Management?
Fiscal consolidation is a process where the government’s fiscal health is getting improved and is indicated by reduced fiscal deficit. Improved tax revenue realization and better aligned expenditure are the components of fiscal consolidation as the fiscal deficit reaches at a manageable level.
Types of Fiscal Deficits and Monetary Policies in Public Finance
| Revenue Deficit | RD = (2.7 % of GDP)=Revenue expenditure – Revenue receipts. |
| Effective Revenue Deficit | Effective Revenue Deficit signifies that amount of capital receipts that are being used for actual consumption expenditure of the Government.
ERD = (1.8% of GDP)=Revenue Deficit -Grants for creation of capital assets |
| Fiscal Deficit | Difference between total revenue and total expenditure of the government is termed as fiscal deficit. It is an indication of the total borrowings needed by the government. While calculating total revenue, borrowings are not included.
FD = (3.5% of GDP)=Budget deficit +Borrowings |
| Primary Deficit | Primary Deficit indicates the borrowing requirements of the government, excluding interest. It is the amount by which the total expenditure of a government exceeds the total income. Note that the primary deficit does not include the interest payments made.
Primary Deficit = Fiscal Deficit (Total expenditure – Total income of the government) – Interest payments (of previous borrowings) It is 0.4 % of GDP |
| Off Budget Financing | Expenditure that’s not funded through the budget. |
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Budget Deficit
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A budget deficit occurs when expenses exceed revenue and indicate the financial health of a country. The government generally uses the term budget deficit when referring to spending rather than businesses or individuals. Accrued deficits form national debt. |
| Zero Primary Deficit
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Hence, when the primary deficit is zero, the fiscal deficit becomes equal to the interest payment. This means that the government has resorted to borrowings just to pay off the interest payments. Further, nothing is added to the existing loan. |
| Fiscal Slippage’ | Fiscal slippage in simple terms is any deviation in expenditure from the expected. |
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Monetized deficit
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The Monetised Deficit is the extent to which the RBI helps the central government in its borrowing programme. In other words, a monetised deficit means the increase in the net RBI credit to the central government, such that the monetary needs of the government could be met easily. |
Golden Rule of Public Finance: Borrowing for Investment, Not Spending
The Golden Rule is a guideline for the operation of fiscal policy, especially in countries who use high borrowing to run the budget. It states that over the economic cycle, the Government should borrow only to invest and not to fund current spending (current expenditure means day to day running expenses). In layman’s terms, this means that the government should borrow to finance investment that benefits future generations.
Types of Budgets in Public Finance
| Balanced Budget | The government may spend an amount equal to the revenue it collects. |
| Surplus Budget | If the expected government revenues exceed the estimated government expenditure in a particular financial year. |
| Deficit Budget | If the estimated government expenditure exceeds the expected government revenue in a particular financial year. |
| Outcome Budget | It is a budget that converts outlays into outcomes by planning the expenditure, fixing appropriate targets, quantifying deliverables in each scheme and bringing to the knowledge of all, the outcomes for each scheme/programme under various ministries. |
| Gender Budgeting | It is not an accounting exercise but an ongoing process of keeping a gender perspective in policy/ programme formulation, its implementation and review. |
| Zero Based Budgeting | All expenses are evaluated each time a budget is made and expenses must be justified for each new period |
| Sunset Budgeting | Schemes are announced with a deadline, designed to self-destruct within a prescribed time. |
Comparing Fiscal and Monetary Policies in Public Finance
| FISCAL POLICY | MONETARY POLICY |
| The use of Government Taxation and Expenditure policies like tax policy, expenditure policy, investment or disinvestment strategies and debt or surplus management to obtain the macro-economic goals. | Use of change in interest rate and money supply to obtain the macro-economic goals. |
| Set by the government | Set by the RBI. |
| No specific targets | Inflation targeting. |
What are the different types of Fiscal Policy in Public Finance and how do they impact Economic Activity?
| Expansionary Fiscal Policy | Contractionary Fiscal Policy | Neutral Fiscal Policy |
| It seeks to increase economic activity by putting more money into the market. | It seeks to decrease economic activity by taking out money from the market. | Govt. spending is equal to the Tax revenue |
| Adopted in response to contractions in the business cycle and prevent economic recessions. | It is designed to combat rising inflation. |
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| Measures-Lowering of taxes and increased government spending are the components of expansionary fiscal policy | Measures- reduction in government spending or a reduction in the rate of monetary expansion by a central bank or raising taxes by the government. | — |
Deficit Financing Sources in Public Finance: What Strategies are Utilized?
- Deficit financing means generating funds to finance the deficit which results from excess expenditure over revenue.
- Sources of Deficit financing are External Aids, External Grants, External and Internal Borrowings, Printing of currency.
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Monetization of Deficit in Public Finance: Implications and Mechanisms
- Monetisation of deficit happens when RBI buys government securities directly from the primary market to fund government’s expenses.
- In Simple terms, monetisation of the deficit means printing more money.
- This is resorted to only when the government cannot borrow from the market (Banks and other Financial Institutions like LIC).
- The money printed by the RBI is called high powered money or reserve money or monetary base.
- There are two types of monetisation: Direct and Indirect Monetisation
- Direct Monetisation– Reserve Bank of India directly funds the Central government’s deficit against government bonds or securities. Until 1997, the government used to sell securities directly to the RBI. This allowed the government to technically print equivalent amounts of currency to meet its budget deficit. However, this practice was stopped over its inflationary impact and in favour of fiscal prudence. State Bank of India (SBI) has recommended direct monetisation as a possible way of funding the Centre’s deficit at lower rates, without increasing inflation and affecting debt sustainability.
- Indirect Monetisation– RBI does when it conducts the Open Market Operations (OMOs) and/ or purchases bonds in the secondary market.
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Ways and Means Advances in Public Finance
- WMA are temporary loan facilities provided by RBI to the governments of both Centre and States to enable it to meet temporary mismatches between revenue and expenditure.
- The rate of interest is the same as the repo rate.
- The tenure is 3 months.
Strategies for Fiscal Consolidation in Public Finance
- It is the process for reducing the fiscal deficit of the country.
- Vijay Kelkar Committee presented a roadmap for fiscal consolidation.
- Steps Taken For Fiscal Consolidation:
- Implementation of the FRBM ACT,2003, GST, Insolvency and Bankruptcy Bill.
- Better targeting of Government subsidies through Direct Benefit Transfer,
- Through Improving Tax Collections by better compliance mechanisms, increasing the tax base and Tax to GDP ratio of the country
- The government pegged disinvestment target for 2020-21 at Rs 1.20 lakh crore etc.
| WMA TYPES
SPECIAL DRAWING RIGHTS
NORMAL WAYS AND MEANS ADVANCES
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Role and Impact of the Expenditure Management Commission (EMC) on Public Finance Reform in India
The constitution of the Expenditure Management Commission (EMC) of India was announced in the Budget Speech by Finance Minister of India Arun Jaitley in the budget of 2014–15. The Commission will be a recommendation body with the primary responsibility of suggesting major expenditure reforms that will enable the government to reduce and manage its fiscal deficit at more sustainable levels.
FRBM Act of 2003 aims to enhance public finance management and fiscal discipline in India
- Aim– Transparency, equitable distribution of debt, fiscal stability.
- To reduce fiscal deficit, to eliminate revenue deficit and a major step towards Fiscal Consolidation.
- It limited the fiscal deficit to 3% of the GDP.
- The NK Singh committee (set up in 2016) recommended that the government should target a fiscal deficit of 3% of the GDP in years up to March 31, 2020 cut it to 2.8% in 2020-21 and to 2.5% by 2023.
- The Act made it mandatory for the government to place the following along with the Union Budget documents in Parliament annually: Medium Term Fiscal Policy Statement + Macroeconomic Framework Statement + Fiscal Policy Strategy Statement.
- The FRBM rules mandate four fiscal indicators to be projected in the medium-term fiscal policy statement. These are:
- Revenue deficit as a percentage of GDP
- Fiscal deficit as a percentage of GDP.
- Tax revenue as a percentage of GDP.
- Total outstanding liabilities as a percentage of GDP.
- The latest provisions of the FRBM act – to limit the fiscal deficit to 3% of the GDP by March 31, 2021, and the debt of the central government to 40% of the GDP by 2024-25.
Public Debt and Fiscal Sustainability in India: Debt-to-GDP Ratio
- Government liabilities against the Consolidated Fund of India are defined as Public Debt.
- Other Liabilities include liabilities on account of Provident Funds, Reserve Funds and Deposits, Other Accounts, etc.
- DEBT TO GDP RATIO: Debt-GDP ratio is an important indicator of medium and long-term sustainability of any country. It indicates how likely the country can pay off its debt.
- India’s public debt to gross domestic product (GDP) is likely to increase to a record high of 89.3 per cent in 2020, breaking the previous high of 84.2 per cent in 2003.
- The ratio was 72.3 per cent in 2019 and 68.8 per cent five years ago in 2015, according to the data from the International Monetary Fund’s World Economic Outlook (WEO).
Crowding Out Effect in Public Finance: Impact on Private Investment and Economic Growth
- When governments borrow, they compete with everybody else in the economy who wants to borrow the limited amount of savings available.
- It causes a decrease in the quantity of funds that is available to meet the investment needs of the private sector.
- As a result of this competition, the real interest rate increases and private investment decreases. This phenomenon is called crowding out.
N K Singh Committee’s Recommendations and the Escape Clause in Public Finance
- It proposed to replace the FRBM Act, 2003 with a Debt Management and Fiscal Responsibility Bill, 2017.
- Escape Clause was introduced.
| ESCAPE CLAUSE |
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Trends in Public Finance
- As per this trend- Gross Tax receipt, Direct Tax and Indirect Tax all are varying in the last decade.
- Overall Direct tax is more than the indirect tax.
- According to Budget 2020-2021:
- Non tax revenue- Dividend and profit >> interest receipts.
- Capital Receipt- Debt Receipt >> Market Loans >> Small Savings and state provident funds.
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