Fiscal System/ Public Finance in India

1 Fiscal System/ Public Finance in India

2020-06-09 18:58: 14

• 1 Fiscal System/ Public Finance in India
  • 1.1 Fiscal Policy
  • 1.2 Receipts
    • 1.2.1 Revenue Receipts
      • 1.2.1.1 Tax Revenue
      • 1.2.1.2 Non Tax Revenue
    • 1.2.2 Capital Receipts
      • 1.2.2.1 Non Debt Creating Capital Receipts
      • 1.2.2.2 Debt Creating Capital Receipts
  • 1.3 Expenditure
    • 1.3.1.1 Revenue account Expenditure
    • 1.3.1.2 Capital Account Expenditure
    • 1.3.1.3 Plan and Non Plan Expenditure
  • 1.4 Deficit
    • 1.4.1 Fiscal Deficit
      • 1.4.1.1 Disadvantages of FD
    • 1.4.2 Primary Deficit
    • 1.4.3 Revenue Deficit
      • 1.4.3.1 Effective Revenue Deficit
    • 1.4.4 Budget Deficit
    • 1.4.5 Monetised Deficit
    • 1.4.6 Deficit Financing
  • 1.5 FRBM Act 2003
    • 1.5.1 NK Singh #Committee 2016 to Review FRBM
  • 1.6 Debt
    • 1.6.1 Public Debt/ Internal Debt
      • Public Debt of India
      • Public Debt Management
    • 1.6.2 External Debt
      • 1.6.2.1 External Debt Mgt
      • 1.6.2.2 Rupee Debt
      • 1.6.2.3 Masala Bonds
    • 1.6.3 Zero Base Budgeting
    • 1.6.4 Ways and Means Advance WMA
      • 1.6.4.1 Normal WMAs
      • 1.6.4.2 Special WMA
  • Direct Benefit Transfer
  • 1.7 Important Definitions

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Public Finance includes matters connected with public money ie what govt gets, spends, borrows, lends, raises or prints aka public economies.

Budget : annual financial statement of income and exependiture. Art 112 has provision for this.

• Union budget has 3 sets of data for every concerned sector. Actual data of preceding year, Provisional Estimates PE of current year, Budget Estimate BE of 1 year after the yr on which budget is presented.
• Revised Estimate shows contemporary situation of either BE or PE it is an interim data.
• Quick Estimate type of revised estimate shows most latest situation and is useful in determining future projections.

1.1 Fiscal Policy

• deals revenue and expenditure or budget, both quantity and quality of public financed
• Gov policy dealing with ==raising revenue through tax and deciding on the amount and purpose of gov spending==
• influences macroeconomic conditions, affect tax rates

1.2 Receipts

• Every receiving or accrual of money to a govt by revenue or non revenue sources is a receipt. Total receipts is its sum. It includes all income and non income accruals of govt. ![[Pasted image 20220228115222.png]]

1.2.1 Revenue Receipts

= taxes + non tax sources

• recurrent in nature
• it is of 2 types Tax Revenue and Non-tax revenue

1.2.1.1 Tax Revenue

• All revenue govt collects from all direct and indirect tax collections.
• Corporation tax : Collections, Surcharges, Education Cess/ Health cess, Penalties etc
• Taxes on Income ex Banking transaction tax, Security transaction tax, Hotel receipts etc
• Wealth Tax : ex Estate duty
• Customs : import duties, basic duties, additional customs, National calamity contingent duty NCCD, Education cess, export duty etc
• Union Excise Duties
• Service Tax
• GST
• Other Taxes and Duties on Commodities and Services
• Taxes of UTs

1.2.1.2 Non Tax Revenue

• Recurring income earned other than taxes
• Interest Receipts : from states, UTs, etc
• Dividends and Profits : from PSU, RBIs, PSBs etc
• Fiscal Services : currency, coinage and mint
• General Services : Administrative services, PSC, Police, Supplies and Disposals, Stationery and Printing etc
• Social Services : Education, Sports, Art and culture, medical and public health, family welfare, Housing etc
• Economic Services : Agriculture, Animal husbandry, dairy etc
• Railway Revenue
• Grants-in-aid and Contribution
• Non Tax Revenue of Union Territories

1.2.2 Capital Receipts

• are those ==that create liabilities or reduce financial asset of the Govt==, also refers to incoming cash flows. #important #concept
• All non-revenue receipts are called capital receipts. They are for investment purposes and supposed to be spent on plan development.

Capital Account : represents the BoP for a country. Keeps track of net change in a nations assets and liabilities during a year. Tells us wether country is net importer or exporter of capital. Capital Account of India has both equity and debt flows.

• Debt flows comprise of commercial borrowings, external assistance, short term trade credits, NRI deposits.
• Equity flows comprise of FDI, portfolio investment.

Capital budget : deals with receipts and expenditures of the capital by the govt.

1.2.2.1 Non Debt Creating Capital Receipts

• they create reduction in financial assets but do not create debt. Ex recovery of loans, disinvestment ^8ce0a9
• Recoveries of Loans & Advances (is not the same as interest receipts)
• Disinvestment, issue of Bonus shares, Writebacks of amt

1.2.2.2 Debt Creating Capital Receipts

• which the govt has to payback at some point of time
• Borrowings both external and Internal
• Securities against Small Savings
• Raising State Provident Funds
• Other Receipts (Internal Debts and Public Account)
• External Debt
• Market Stabilisation Scheme

1.3 Expenditure

• All expenditure by govt are either revenue kind or current kind or compuslive kind.
• Transfer payments are also a type of expenditure

1.3.1.1 Revenue account Expenditure

• ==Non plan exp that does not directly create assets==, incurred for normal functioning of govt
• ex interest payment on debt (both external and internal), Salaries, pensions and Provident fund paid by govt to its employees, grants given to state gov, defence expenditure, subsidies, public adm, Postal deficits of govt, Law and order expenditure.

1.3.1.2 Capital Account Expenditure

• ==loans made to states, UT, PSUs, expentiure for asset creation==,
• loans repayment by the govt might be internal or external. This includes only the capital/ principal of the loan since interest on them are part of revenue expenditure.
• plan expenditure of the govt
• capital expenditure on defence by the govt -> part of non plan expenditure.
• General services such as railways, postal, water supply, education, rural extension.
• other liabilities of the govt ex PF liabilities

1.3.1.3 Plan and Non Plan Expenditure

• Plan expenditure is done for productive purposes ex projects of ministries whereas Non-plan is done for non-productive ones ex salaries, subsidies, loans and interest payments.
• Plan expenditure means exp on annual projects contributing to 5 year plans
• Non-Plan expenditure may be revenue or capital.
• Sukhmoy Chakravarti #committee 1987-88 was set up on it.
• Rangarajan #committee panel was set up in 2011 to suggest redifining plan and non plan expenditure.

Plan Expenditure	Non-Plan Expenditure
All asset creating, productive expenditures	All consumptive, non-productive, non-asset building

1.4 Deficit

1.4.1 Fiscal Deficit

• balance of govts total receipts (revenue + capital receipts) and total expenditure (revenue and capital expenditure) is negative it is called FD.

= Total Revenue - Total Expenditure = Total [[#Expenditure]] - ([[#Revenue receipts|Revenue Receipts]] + [[#Non Debt Creating Capital Receipts]] )

• ==includes revenue deficit and expenditure but not non debt creating capital== #important

Gross Fiscal Deficit = Total Expenditure including loans

1.4.1.1 Disadvantages of FD

• may cause macroeconomic instability
• Corporate sector is crowded out
• monetising FD could lead to inflationary tendencies
• long term could mean future generation paying more taxes
• Interest payments inc, BoP pressure could mount
• downgrading by rating agencies

1.4.2 Primary Deficit

• to know amount of borrowing govt can utilise after interest payment

= [[#1 4 1 Fiscal Deficit |Fiscal Deficit]] - Net Interest liabilities (Interest payment - Interest receipts)

• brings transparency in govt expenditure pattern.
• Primary Surplus : is when tax receipts of govt are higher than its total expenditures excluding interest payments.

1.4.3 Revenue Deficit

• If balance of total revenue receipts and total revenue expenditures turns out to be negative.

≤ [[#1 2 1 Revenue receipts |Revenue Receipts]] - [[#1 3 1 1 Revenue account expenditure |Revenue Expenditure]]

• does not create liability nor creates any reduction in asset of gov.
• ==synonymous w/ consumtion and non-dev==
• expenditure on social services like education, health, welfare are Revenue expenditure and creates RD.
• Revenue Budget : Part of budget that deals with income and expenditure of revenue by the govt.
  • If balance of revenue receipts and revenue expenditure is negative it is called revenue deficit budget if positive then it is called Rev surplus budget.

1.4.3.1 Effective Revenue Deficit

• ==intro by FRBM Act 2012==

= [[#Revenue Deficit]] - Grants for capital creation

• In the case of Revenue deficit even those expenditure that create productive capital assets are included. If we remove these grants we get Effective Revenue Deficit.
• Grants for Capital creation : grant in aids given by Centre to States, Constitutional bodies, Autonomous bodies etc for creation of capital assets

1.4.4 Budget Deficit

= total budgeted receipts - total expenditure

• not in use anymore

1.4.5 Monetised Deficit

• ==borrowing made from RBI through printing fresh currency==
• Earlier Govt used to issue short term (T-bills) and long term securities (G-Secs) that was to be purchased by RBI on compulsory basis to finance deficits.
• This was later removed. Now most govt expenditures are financed through market borrowings.

1.4.6 Deficit Financing

• Process of financing/supporting deficit by a govt.
• was mostly done in conjunction with Budget deficit most commonly through RBI printing money and providing it to the govt. This has been ==disallowed by FRBM==

Money Printed by RBI is called ==high powered money or reserve money or monetary base==

Means of Deficit Financing

• External Aid : are the best means to fulfil govts deficit requirement including external grants. External grants did not come to India till 1975 or we did not accept it.

• External Borrowings : next best way to manage FD if they have low interest rate and are long term.

  • External borrowing brings in foreign currency/ hard currency that gives more spending power to govt.
  • it does not cause crowding out that happens due to internal borrowings.

• Internal borrowings : are 3rd preferred route of fiscal deficit mgt but it caused crowding out for public and corporate sector.

• Printing Currency : last resort for the govt in managing its deficit. Biggest handicap with the govt is that they cannot go for expenditures are to be made in foreign currency.

  • it increases inflation proprotionally and brings regular pressure and obligation on the govt for upward revision in wages and salaries of govt employees.

• Fiscal consolidation is a reduction in the underlying fiscal deficit. Fiscal Consolidation refers to the policies undertaken by Governments (national and sub-national levels) to reduce their deficits and accumulation of debt stock. #important

What are the best case scenarios for deficit financing?

• FD with a surplus revenue budget or a zero revenue expenditure is the best composition of FD and most suitable for deficit financing.
• deficit requirements for lower revenue expenditure and higher capital expenditure are next best situtation for deficit financing.
• Last is when major part of deficit financing is to fulfil revenue expenditure and minor part goes for capital expenditure.

1.5 FRBM Act 2003

• Fiscal Responsibility and Budget Mgt
  • Aim
  • to bring fiscal discipline, mgt of expenditure, revenue and debt
  • macroeconomic stability, coordination b/w fiscal and monetary policy
  • transparency in fiscal operation of Gov, balance budget
• Dealt w/ 4 fiscal parameters [[#Revenue Deficit]], [[#Fiscal Deficit]], Tax revenue (% to GDP) and outstanding liabilities all represented as a % of GDP.
• Provided for certain documents to be tabled in the parliament
  • Medium-term Fiscal Policy Statement
  • Fiscal Policy Strategy Statement
  • Macro-economic Framework Statement
  • Medium term Expenditure Framework
• It set targets to beachieved by 2009 initially which the Gov was not able to meet
• FRBM targets revised by amendment in 2012
• FRBM amendment in 2015 set the target of FD to 3% by 2018, not met
• #important Escape Clause :
  • deviate from FD target in certain cases through an amendment in 2018 such as National security, act of war, National Calamity, Collapse of agriculture, Structural reforms in the economy, decline in real output growth of a quarter by 3% below its avg.
  • deviation of 0.5%
  • invoked after formal consultation of Fiscal Council

1.5.1 NK Singh #Committee 2016 to Review FRBM

• Target FD to 3% by 2020, 2.8 in 2021, 2.5 by 2023
• suggested using ==debt as primary target for fiscal policy==
• Debt to GDP ratio of 60%; 40% limit for centre and 20% for states
• Rev deficit of 0.5% of GDP by 2023
• new Debt and Fiscal Responsibility Act after repealing FRBM

Fiscal Consolidation :

• ==strengthening gov finances through tax reforms, disinvestment, better targeting of subsidies==
• Reduction in plan expenditure is not a feasible way to cut FD

Kelkar #Committee 2012

• roadmap for fiscal consolidation
• reduction in deficit should be achieved through combination of share sale of PSEs, rationalising petro product subsidies and implementing GST
• also recom beefing IT infra

Bimal Jalan #Committee 2014 on Expenditure Mgt

• suggest ==ways to reduce food, fertiliser, oil subsidies to narrow FD==
• Recom were
  • ban on 5 star venue, foreign locations, executive class tickets for gov meetings.
  • keep size of delegation going abroad to minimal etc

Rangarajan #Committee

• 2012 ==efficient mgt of Public Expenditure==
• also to see if classification of Plan, Non Plan was prudent, recom removel of this distinction.

1.6 Debt

1.6.1 Public Debt/ Internal Debt

• ==borrowing inside the country ex from RBI, open market loans, bonds== like oil, fertilizer etc, money realised from MSS
• other debt is outstanding against small savings schemes, PF etc
• Objectives of public debt/ Borrowing
  • Cover the gap b/w proposed expenditure and expected revenue
  • During recession or depression when people do not want to spend
  • to curb inflation
  • to finance development plans ex poverty, expand education and health services.
• NK Singh Comm envisages Debt-to-GDP ratio of 40% for centre and 20% for States for a total of 60%
• Public debt is called as national debt and in the broader sense it also includes non govt debt.

Public Debt of India

• Liabilities of the centre have 3 segments in it namely - Internal Liabilities, External Liablities and Public Account Liabilities. In the case of India it has only Internal and External segment
• Internal segment : it includes a variety of instruments used by the centre to mobilise resources inside the economy.
  • Dated securities aka G-Secs which are primarily issued by the Centre as fixed coupon bonds of different maturities. Single most source of deficit financing.
  • [[006 Finanacial Market - Money and Capital Market#1 Treasury Bills Gov securities |Treasury Bills]]
  • Securities issued to international financial institutions by Centre ex WB, IMF, ADB.
  • Securities issued against ‘small savings’ scheme that are credited to the NSSF (National Small Savings Fund)
• External Segment : includes external liabilites created through external borrowings by the centre for its own uses. It constitutes multilateral and bilateral loans from IMF, EB, ADB, Sovereign Funds, Foreign govts.
• Adjusted Debt : #todo

Public Debt Management

• Has imp role in macro economic policy of a country.
• borrowing is done to raise the required amt of funds at low cost over the medium to long run considering a prudent amt of risk.
• maintain a stable and sustainable debt structure to ensure fin stability across time period.
• support a domestic bond market -> help govt in pricing the govt debts efficiently
• Indias public debt is more than 100% the reasons for this are
  • Bank recapitalisation that was done in 2017.
  • UDAY bonds
  • Taxes as proportion of population is low at around 10%.
  • Indian tax system has many loopholes
  • Misuse of Public Income
• Rising public debt -> higher risk premium in interest rates -> reduced private investment/ crowding out -> contraction of GDP.
• Need is to privatise loss making PSU, Follow FRBM and leverage PFMS; harmonise tax regime.

1.6.2 External Debt

• what gov owes to foreign lenders from ==Borrowings/loans abroad, NRI deposits, international FIs etc, trade credit.==
• #concept FDI, FPI and Depository receipts are non-debt creating but ==FII in Gsec is external debt.==
• IMF 2021 data projects debt to GDP of 90%

1.6.2.1 External Debt Mgt

• focus on ==monitoring long and short term debt, raising sovereign loans w/ longer maturities==
• regulating ECBs, encourage Rs denominated bonds viz Masala Bonds
• rationalising interest rates on NRI deposits

1.6.2.2 Rupee Debt

• #important ==currency risk is borne by the creditor not by borrower==; it is risk arising from appreciation depreciation of nominal exchange rate
• Comprises of :
  • Rupee debt mostly was extended by USSR to IN, repayment was through export of good to RUS #TIL
  • Rs denominated NRI deposit
  • FII in Gov treasury bill and dated security and in corporate debt security

1.6.2.3 Masala Bonds

• Indian entities can raise money in Rs.
• no currency risk, diversity funding sources, cost of borrowing lower than domestic market.
• stable exchange rate, constant inflation levels are required for better returns.
• step to internationalise Rs, facilitate full rupee convertibility.

1.6.3 Zero Base Budgeting

• method of budgeting ==where all expenses must be justified==
• close and critical examination of existing gov programmes etc to ensure funds are made available to high priority items
• eliminates outdated programs, reduce funding to low priority ones.
• objective to inc productivity.
• limited use in HDI and poverty alleviation programs.
• Economy in public expenditure is the reason for its existence
• Prioritisation is another special feature order of priority is prepared and funds allocated accordingly.
• Limitations :
  • Govt has certain limitations on certain expenditures ex charged expenditures.
  • certain public services deny cost benefit analysis ex defence, law and order, foreign relations etc.
  • Mo Finance could be all powerful institution
• There are no commited pre expenses and balances are not carried forward.

1.6.4 Ways and Means Advance WMA

• Temporary loan for gov ==to meet mismatches b/w revenue and expenditure==.
• Mutually decided by RBI and GOI.
• interest rate is same as repo, tenure is 3 months.
• After it Overdraft of 10 days, interest on it is 2% more than repo

1.6.4.1 Normal WMAs

• are ==unsecured extended at Bank Rate==
• limits based on 3 yr avg of State’s actual rev and capital expenditure
• withdrawal beyond limit is considered as overdraft
• interest are payed by State on it

1.6.4.2 Special WMA

• extended ==against gov securities this is given first==
• interest is 1% point less that Repo

Direct Benefit Transfer

• JAM or (Jan Dhan-Aadhaar-Mobile) trinity was brought in to enable DBT.
• It can effectively target public resources to those who need them most.
• Advantages :
  • removal of fake and duplicate entities from beneficiary list
  • prevention of leakage and wastage
  • saves time, effort and cost
  • ensures full traceability of flow of funds
  • transparency checks corruption
  • accountability of flow of funds
  • expenditure rationalisation

1.7 Important Definitions

Fiscal Drag : ==high inflation pushes income to higher tax brackets== -> inc tax for gov but dec consumption and there is no inc in real purchasing power. Automatic in nature.

• Govts net fiscal position (spending - taxation) fails to cover net savings desires of private economy ie private economy’s spending gap (earnings - spending + private investment)
• The lack of aggregate demand lead to deflationary pressures, or drag on the economy which is due to lack of state spending or to excess taxation.

Fiscal Neutrality : net ==effect of taxation and public spending is neutral== neither stimulating nor dampening deman

Crowding Out : ==Excess gov borrowing dec liquidity in market==, interest rate inc and private investment in crowded out (forced out of a place/situation) #important

Pump Priming ==deficit financing on public works to revive economy during recession==

• can raise purchasing power

Public Goods #important : ==consumption by some does not diminish them for others== or are non rivalrous

• Merit Goods : have positive externalities ex health, education etc
• Demerit G : consumption for them should be discouraged

Giffen Goods : whoese demand goes up when price inc, status markers and exclusive #important

Twin Deficits : ==Budget and Curret Account Deficit together== where former fuels the latter

Fiscal Cliff : ==sudden condition of high taxes and reduced public expenditure== after long period of tax cuts and liberal public expenditure

• these or other set of factors cause or threaten sudden and severe economic decline

Output-Outcome framework : OOF is an important reform towards outcome based monitoring of developmental actions of the ministries and departments. Development Monitoring and Evaluation Office of the NITI Aayog works on this.

• Certain measurable indicators have been put in place monitoring objectives of Central Sector CS and Centrally Sponsored Schemes CSS

Golden Rule : proposition that govt should borrow only to invest and not to finance current spending is known as golden rule of finance.

Balanced Budget : when revenue deficit is zero when total public sector spending equals total govt income from taxes and charges for public services.

Gender Budgeting : allocates funds and responsibility on basis of gender done in economies where socio economic disparities are chronic and clearly visible.