Fiscal Policy
KUSHAL JAIN
Fiscal policy
Fiscal policy is the means by which a government adjusts its spending levels and tax rates to
monitor and influence a nation’s economy.
It is a complimentary strategy to monetary policy (through which a central bank influences a
nation’s money supply).
These two policies are used in various combinations to direct a country’s economic goals.
Fiscal policy deals with the taxation borrowing and expenditure decisions of the government.
Fiscal policy is an important constituent of the overall economic framework of a country and
is therefore intimately linked with its general economic policy strategy.
Types of Fiscal Policy
Expansionary fiscal policy
Contractionary fiscal policy
Expansionary fiscal policy
It is defined as an increase in
government expenditures and/or a A government can adopt Expansionary
decrease in taxes that causes the fiscal policy on the following basis:
government’s budget deficit
• Government needs to borrow from
domestic or foreign sources.
• Print an equivalent amount of money.
• Draws upon its foreign exchange
reserves
Drawbacks of Expansionary fiscal policy
The flipside of printing is it leads to inflation.
If the government borrows too much from abroad it leads to a debt
crisis.
If it draws down on its foreign exchange reserves, a balance of
payments crisis may arise
Contractionary fiscal policy
It is defined as a
decrease in government
expenditures and/or an
increase in taxes that
causes the government’s
budget deficit to
decrease or its budget
surplus to increase.
BUDGET
Budget is an Annual Financial Budgeting is the process of
Statement of yearly estimated It acts as instruments of control and estimating the availability of
receipts and expenditures of the act as a benchmark to evaluate the resources and then allocating them
government in respect of every progress of various departments. to various activities according to a
financial year. pre-determined priority.
Constitutional requirement
The Constitution refers to the budget as the ‘annual financial
statement’.
In other words, the term ‘budget’ has nowhere been used in
the Constitution.
It is the popular name for the ‘annual financial statement’
that has been dealt with in Article 112 of the Constitution
The Annual Financial Statement
The documents consist of estimated receipts and expenditures of the
Government of India for the coming year in relation to revised
estimates for the previous year as also the actual amounts for the
year prior to it.
The Annual Financial Statement
3. Budget estimates of
current year which must
1. Budget estimate for have been presented in
the next financial year. the previous budget.
2. Revised estimates for 4. Actual estimates for
the current fiscal year previous financial year
Stages in Enactment
3. Scrutiny by 4. Voting on 5. Passing of
1. Presentation of 2. General 6. Passing of
departmental demands for appropriation
budget. discussion. finance bill.
committees. grants. bill.
Funds
Consolidated Fund of
India (Article 266)
Public Account of
India (Article 266)
Contingency Fund of
India (Article 267)
Consolidated Fund of India
It is a fund to which all receipts are credited and all payments are debited. In other
words,
• (a) all revenues received by the Government of India;
• (b) all loans raised by the Government by the issue of treasury bills, loans or ways and means of
advances; and
• (c) all money received by the government in repayment of loans forms the Consolidated Fund of India.
All the legally authorized payments on behalf of the Government of India are made
out of this fund. No money out of this fund can be appropriated (issued or drawn)
except in accordance with a parliamentary law
Public Account of India
All other public money (other than those which are credited to the Consolidated Fund of
India) received by or on behalf of the Government of India shall be credited to the Public
Account of India.
This includes provident fund deposits, judicial deposits, savings bank deposits, departmental
deposits, remittances and so on.
This account is operated by executive action, that is, the payments from this account can by
made without parliamentary appropriation. Such payments are mostly in the nature of
banking transactions
Contingency Fund of India
The Constitution authorised the Parliament to establish a ‘Contingency Fund of India’, into which
amounts determined by law are paid from time to time. Accordingly, the Parliament enacted the
contingency fund of India Act in 1950.
This fund is placed at the disposal of the president, and he can make advances out of it to meet
unforeseen expenditure pending its authorization by the Parliament.
The fund is held by the finance secretary on behalf of the president. Like the public account of
India, it is also operated by executive action
Components of budget
Budget
Receipts Expenditure
Revenue Revenue Capital
Capital receipts
Receipts Expenditure Expenditure
Charged Expenditure
The budget consists of two types of
expenditure–the expenditure
‘charged’ upon the Consolidated
Fund of India and the expenditure
‘made’ from the Consolidated Fund
of India.
The charged expenditure is non-
votable by the Parliament, that is, it
can only be discussed by the
Parliament, while the other type
has to be voted by the Parliament.
charged expenditure
1. Emoluments and allowances of the President and other expenditure relating to his office.
2. Salaries and allowances of the Chairman and the Deputy Chairman of the Rajya Sabha and the Speaker
and the Deputy Speaker of the Lok Sabha.
3. Salaries, allowances and pensions of the judges of the Supreme Court.
4. Pensions of the judges of high courts.
5. S a l a r y, a l l o w a n c e s a n d p e n s i o n o f t h e C o m p t r o l l e r a n d A u d i t o r G e n e r a l o f I n d i a .
6. Salaries, allowances and pension of the chairman and members of the Union Public Service Commission.
7. Administrative expenses of the Supreme Court, the office of the Comptroller and Auditor General of
India and the Union Public Service Commission including the salaries, allowances and pensions of the
persons serving in these offices.
8. The debt charges for which the Government of India is liable, including interest, sinking fund charges
and redemption charges and other expenditure relating to the raising of loans and the service and
redemption of debt.
Various Accounts
Revenue account: Current accounts (Income and outgoing of current year)
Capital account: Long term accounts (Income and outgoing beyond one year)
Revenue Income: includes tax and non-tax receipts which do not add up to liabilities
Tax receipts: Include Direct and Indirect tax
Non-Tax receipts: PSU profits/Interest or loans received/Fees, fines and penalty/User charges
Revenue expenditure: subsidy/defence/salaries and pensions/law and order/interest payments
Capital receipts: Market borrowing/Proceeds from disinvestment/Recoveries of past loans/Proceeds from asset sale
Capital Expenditure: Expenditure on infrastructure/loans to state/repayment of past loans
Various Deficits
Effective
Revenue Deficit Fiscal Deficit Primary Deficit
Revenue Deficit
Fiscal Deficit
Fiscal deficit is the difference between the government’s total expenditure and its total receipts
excluding borrowing.
The fiscal deficit will have to be financed through borrowing. Thus, it indicates the total borrowing
requirements of the government from all sources.
Gross fiscal deficit = Total expenditure - (Revenue receipts + Non-debt creating capital receipts)
From the financing side: Gross fiscal deficit = Net borrowing at home + Borrowing from RBI +
Borrowing from abroad
Revenue Deficit
Revenue deficit refers to the excess of government’s revenue expenditure
over revenue receipts
Revenue deficit = Revenue expenditure - Revenue receipts.
The revenue deficit includes only such transactions that affect the current
income and expenditure of the government.
Revenue Deficit
This situation means that the Since a major part of revenue
When the government incurs a
government will have to borrow not expenditure is committed
revenue deficit, it implies that the
only to finance its investment but expenditure, it cannot be reduced.
government is dissaving and is
also its consumption requirements. Often the government reduces
using up the savings of the other
This will lead to a build-up of stock productive capital expenditure or
sectors of the economy to finance a
of debt and interest liabilities and welfare expenditure. This would
part of its consumption
force the government, eventually, mean lower growth and adverse
expenditure.
to cut expenditure. welfare implications.
Effective revenue deficit
Effective revenue deficit: Revenue deficit - those grants
given to states which are used for creation of capital assets
Primary Deficit
Borrowing requirements of the government includes interest obligations on accumulated debt.
The goal of measuring primary deficit is to focus on present fiscal imbalances.
Primary deficit is used to obtain an estimate of borrowing on account of current expenditures exceeding
revenues. It is simply the fiscal deficit minus the interest payments.
Gross primary deficit = Gross fiscal deficit - Net interest liabilities
Net interest liabilities consist of interest payments minus interest receipts by the government on net domestic
lending
Fiscal Responsibility and Budget Management (FRBM) Act
Enacted in 2003, the FRBM Act requires the elimination of revenue deficit by 2008-09. This means that
from 2008-09, the government will have to meet all its revenue expenditure from its revenue receipts.
Any borrowing would then only be to meet capital expenditure - repayment of loans, lending and fresh
investment.
The Act also mandates a 3% limit on the fiscal deficit after 2008-09. This is a reasonable limit that
allows significant-cant leverage to the government to build capacities in the economy without
compromising fiscal stability
FRBM ACt
The Act requires that on a quarterly basis, the Government would have to place before both the Houses of Parliament an
assessment of trends of receipts and expenditure. The Government also has to annually present the macro-economic
framework statement, medium term fiscal policy statement and fiscal policy strategy statement. The three statements would
provide the macroeconomic background and assessment relating to the achievement of FRBM goals.
The medium term fiscal policy statement will contain a three-year rolling target for key fiscal parameters that underpin the
Government’s fiscal correction trajectory. !
Through the FRBM discipline, the Government is also committed to undertake an intra-year assessment of the achievement of
its budgetary targets. During the Economy Crisis of 2008, the FBRM guidelines were not followed rigorously but now
government is committed for reducing the deficits
Guillotine
Parliament, unfortunately, has very limited time for scrutinising the expenditure
demands of all the Ministries.
So, once the prescribed period for the discussion on Demands for Grants is over, the
Speaker of Lok Sabha puts all the outstanding Demands for Grants, Whether discussed
or not, to the vote of the House.
This process is popularly known as ‘Guillotine’.
Vote on Account
The government cannot withdraw money from the Consolidated Fund of India till the enactment of the appropriation bill.
This takes time and usually goes on till the end of April. But the government needs money to carry on its normal activities after 31
March (the end of the financial year).
To overcome this functional difficulty, the Constitution has authorised the Lok Sabha to make any grant in advance in respect to the
estimated expenditure for a part of the financial year, pending the completion of the voting of the demands for grants and the
enactment of the appropriation bill.
This provision is known as the ‘vote on account’. It is passed (or granted) after the general discussion on budget is over. It
is generally granted for two months for an amount equivalent to onesixth of the total estimation.
Interim Budget
An Interim Budget is presented during the transition period when a
new government is due to take over but the ruling government
needs Parliament's go-ahead to take out money from the
Consolidated Fund of India.
The Interim Budget documents every detail of the government’s
expenses and earning during that period. The Interim Budget
contains all the relevant estimates of the government’s expenditure
and revenue, and also some policy measures if necessary.
How is Vote on Account different from Interim Budget?
In the Budgetary context, ‘Vote on Account’ and ‘Interim Budget’ are two different terms.
The ‘Vote on Account’ is just the estimate of expenses the outgoing government requires before the
General Election’s period.
The ‘Vote on Account’ only deals with the government’s expenditures. On the contrary, an Interim
Budget gives full details of the government’s accounts, including both receipts and expenditures.
Deficit Financing
Deficit Financing is a practice in which a government spends more money than it receives as revenue,
the difference being made up by borrowing or minting new funds.
Excessive domestic borrowing by the government may lead to higher real interest rates and the
domestic private sector being unable to access funds resulting in the crowding out of private
investment. Sometimes a combination of these can occur.
In any case, the impact of a large deficit on long run growth and economic well-being is negative.
Therefore, it is not prudent for a government to run an unduly large deficit
Deficit Financing
The challenge then for most developing country governments is to meet
infrastructure and social needs while managing the government’s finances
in a way that the deficit or the accumulating debt burden is not too great.
Although budget deficits may occur for numerous reasons, the term usually
refers to a conscious attempt to stimulate the economy by lowering tax
rates or increasing government expenditures.
Fiscal Stimulus
Example: Governments can adopt
practices such as lowering interest
Fiscal or Economic Stimulus are rates, increasing government
attempts by government to spending and quantitative easing,
financially stimulate an economy. to name a few, to accomplish this.
An economic stimulus is the use of
monetary or fiscal policy changes
to kick start a lagging or struggling
economy.
Public Debt
B u d g e t a r y d e f i c i t s m u s t b e f i n a n c e d b y e i t h e r t a x a t i o n o r b o r r o w i n g o r p r i n t i n g m o n e y.
G o v e r n m e n t s h av e m o s t l y r e l i e d o n b o r r o w i n g , g i v i n g r i s e t o w h a t i s c a l l e d g o v e r n m e n t d e b t . T h e
concepts of deficits and debt are closely related.
Deficits can be thought of as a flow which adds to the stock of debt. If the government continues to
b o r r o w y e a r a f t e r y e a r, i t l e a d s t o t h e a c c u m u l a t i o n o f d e b t a n d t h e g o v e r n m e n t h a s t o p a y m o r e
a n d m o r e b y w ay o f i n t e r e s t . T h e s e i n t e r e s t p ay m e n t s t h e m s e l v e s c o n t r i b u t e t o t h e d e b t .
B y b o r r o w i n g , t h e g ov e r n m e n t t ra n s fe r s t h e b u r d e n o f r e d u c e d c o n s u m p t i o n o n f u t u r e g e n e ra t i o n s .
This is because it borrows by issuing bonds to the people living at present but may decide to pay off
t h e b o n d s s o m e t w e n t y y e a r s l a t e r b y ra i s i n g t a xe s . T h e s e m a y b e l e v i e d o n t h e y o u n g p o p u l a t i o n s
t h a t h a v e j u s t e n t e r e d t h e w o r k fo r c e , w h o s e d i s p o s a b l e i n c o m e w i l l g o d o w n a n d h e n c e
c o n s u m p t i o n . T h u s , n a t i o n a l s av i n g s , i t w a s a r g u e d , w o u l d f a l l . A l s o , g o v e r n m e n t b o r r o w i n g f r o m
t h e p e o p l e r e d u c e s t h e s av i n g s ava i l a b l e t o t h e p r i va t e s e c t o r. To t h e e x t e n t t h a t t h i s r e d u c e s
c a p i t a l fo r m a t i o n a n d g r o w t h , d e b t a c t s a s a ‘ b u r d e n’ o n f u t u r e g e n e ra t i o n s .
Public Debt
If the
Budgetary government
Accumulation
continues to
of debt
deficits borrow year
after year
Pay more
Government and more
Borrowing
debt
by way of
interest
Burden on future generations
Because it borrows by issuing These may be levied on the young
By Borrowing, the government
bonds to the people living at populations that have just entered
transfers the burden of reduced
present but may decide to pay off the work force, whose disposable
consumption on future
the bonds some twenty years later income will go down and hence
generations
by raising taxes. consumption.
.To the extent that this reduces
Also, government borrowing from
capital formation and growth, debt
the people reduces the savings Thus, national savings would fall.
acts as a ‘burden’ on future
available to the private sector.
generations.
Debt sustainability
A c o u n try' s p u b l i c de bt i s c o n s ide red s us t a ina ble i f t h e g o ve r n m ent i s a b l e t o m e e t a l l i t s c u r r ent a n d
f u t ure p a ym e n t o b l i g a tion s wi t h o u t e xc e p t io nal f i n a nci al a s s i sta nce o r g o i n g i n t o d e f a ult.
Counter cyclical fiscal policy
C o u n t e r -cycl i ca l f i s ca l p o l i cy r e fers t o t h e s t e p s t a ke n b y t h e g ove r n men t t h a t g o a g a i n s t
t h e d i r e ct i o n o f t h e e co n o m i c o r b u s i n e s s cycl e .
T h u s , i n a r e ce ssi o n o r s l o w d o wn , t h e g ove r nm en t i n cr e a ses e x p e n di t u re a n d r e d u ces
t a xe s t o cr e a te a d e m a n d t h a t ca n d r i ve a n e co n o m i c b o o m . T h e s u r vey g i ve s a co l o r f u l
e x a m p l e o f a n ci e n t In d i a n k i n g s b u i l d i n g p a l a ce s d u r i n g d r o u g h t s t o d r i ve h o m e t h i s
po i n t. O n th e o th e r h a n d , d u r i n g a b o o m i n t h e e co n o my, co u n te r -c yc l i c a l f i s c a l p o l i c y
a i m s a t ra i s i n g t a xe s a n d cu t t i n g p u b l i c e x p e nd i t u re t o co n t r o l i n f l a t i o n a n d d e b t .
Debt Sustainabili ty throug h higher growth followi ng the Asian Financial Crisis
A c r o s s e c o n o m i c c r i s e s o v e r t h e l a s t c e n t u r y, f i s c a l p o l i c y h a s b e e n a p r o m i n e n t s a v i o r t o b r i n g b a c k
economic growth. For the past three decades, the Indian economic story has been characterized by long
spells of high GDP growth. Fiscal policy has been a key determinant of growth acceleration af ter an
exogenous global shock led to a decline in growth.
Consider the shock due to the Asian Financial Crisis (1997 -98). During the period 1997-98 to 2002-03,
growth slowed down to an average of 5.3 per cent in real terms. Despite a fall in growth levels, an
expansionary fiscal policy that focused on infrastructure spending was adopted by the Government.
Government expenditure increased consistently during these years, which led to general government debt
reaching record levels. This fiscal push imparted the necessary impetus required for the growth to take off
and average 8 per cent in real terms over the next six years from 2003 - 04 to 2008-09. High growth in this
period brought debt down from the record high levels of 83 per cent of GDP attained in 2003 -04 to around
70 per cent of GDP in 2009 -10
Practice Question
" I s I n d i a's c u r re nt l eve l o f d e bt s u stai nabl e i n t h e l o n g te r m , co n s i de ri ng fa c tors s u c h a s e co n o mi c g ro wth ,
f i s ca l p o l i c i e s, a n d ex te r n a l i nf l u e n c e s? "
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