PUBLIC FINANCE

PUBLIC FINANCE

  • 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.]

 

 

Annual Financial Statement (Budget): Art 112

  • The term budget is nowhere used in the Constitution.
  • Budget is referred to as Annual Financial Statement in the constitution under 112.
  • Rail Budget was separated from the General Budget on the recommendations of the Acworth Committee in 1924.
  • However, 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

  • Revenue Receipt
  • Tax Revenue
  • Non-Tax Revenue

Non-Revenue Receipt

Expenditure

  • Capital Expenditure
  • Revenue Expenditure

 

OBJECTIVES OF BUDGET

  • RESOURCE ALLOCATION FOR PUBLIC GOODS
  • REDISTRIBUTION OF INCOME
  • STABILISATION IN THE ECONOMY

 

 

 

 

Receipts

 

 

 

Revenue Receipts:

 

  •         Tax Revenue: Tax collected by government in the form of direct and indirect tax.
  •         Non-Tax Revenue: Profits and dividends from PSU’s, grants received by government, fiscal and general services, interest on loan forwarded by government, fees, penalties, fines etc.
Non-Revenue Receipts
  •         They are loan taken by government which possesses financial liability on government.
 

 

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.

 

FISCAL CONSOLIDATION

Fiscal consolidation is a process where 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 Deficits

 

Revenue DeficitRD = (2.7 % of GDP)=Revenue expenditure – Revenue receipts.
Effective Revenue DeficitEffective 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 DeficitDifference 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 DeficitPrimary 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 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 FinancingExpenditure that’s not funded through the budget.
 

Budget  Deficit

 

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

 

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.
 

Monetized deficit

 

The Monetised Deficit is the extent to which the RBI helps the central government in its borrowing programme. In other words, 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 BUDGET

The Golden Rule is a guideline for the operation of fiscal policy, especially in countries who uses 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 BUDGET

 

Balanced BudgetThe 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 BudgetIf the estimated government expenditure exceeds the expected government revenue in a particular financial year.
Outcome BudgetIt is a budget that convert 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 BudgetingAll expenses are evaluated each time a budget is made and expenses must be justified for each new period
Sunset BudgetingScheme are announced with deadline, designed to self-destruct within a prescribed time.

 

FISCAL POLICY

 

FISCAL POLICYMONETARY 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 governmentSet by the RBI.
No specific targetsInflation targeting.

 

TYPES OF FISCAL POLICY:

 

Expansionary Fiscal PolicyContractionary Fiscal PolicyNeutral Fiscal Policy
It seeks to increase the economic activity by putting more money into the market.It seeks to decrease the 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.

 

 

Measures-Lowering of taxes and increased government spending are the components of expansionary fiscal policyMeasures- 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
  • Deficit financing means generating funds to finance the deficit which results from excess of expenditure over revenue.
  • Sources of Deficit financing are External Aids, External Grants, External and Internal Borrowings, Printing of currency.
  • Printing new currency notes increases the flow of money in the economy.
  • Leads to increase in inflationary pressures which leads to rise of prices of goods and
    services in the country.

 

MONETISATION OF THE DEFICIT
  • Monetisation of deficit happens when RBI buys government securities directly from the primary market to fund government’s expenses.
  • In Simple terms, monetisation of 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
  1. 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.
  2. Indirect Monetisation– RBI does when it conducts the Open Market Operations (OMOs) and/ or purchases bonds in the secondary market.
  • Issues with monetization the deficit
  • It triggers a spike in inflation rate
  • May increase the interest rates
  • Poses threat to the financial stability of the economy

 

WAYS AND MEANS ADVANCES
  • 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.

 

FISCAL CONSOLIDATION
  • 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

  • INTEREST RATE IS REPO RATE MINUS 1%

NORMAL WAYS AND MEANS ADVANCES

  • INTEREST RATE=REPO RATE

Expenditure Management Commission (EMC)

The constitution of 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, 2003
  • 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:
  1. Revenue deficit as a percentage of GDP
  2. Fiscal deficit as a percentage of GDP.
  3. Tax revenue as a percentage of GDP.
  4. 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.

 

DEBT / GOVERNMENT BORROWINGS
  • 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
  • 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 is phenomenon is called crowding out.

 

N K SINGH COMMITTEE/ FRBM REVIEW COMMITTEE
  • It proposed to replace the FRBM Act, 2003 with a Debt Management and Fiscal Responsibility Bill, 2017.
  • Escape Clause was introduced.

 

 

 

 

 

 

ESCAPE CLAUSE

 

  •          It refers to the situation under which the central government can deviate from the fiscal deficit target-for up to 0.5 % GDP, from the stipulated fiscal deficit target during special circumstances.
  •          GOI used escape clause this year as COVID 19 is a national calamity.
  •          Under Section 4(2) of the Act, the Centre can exceed the annual fiscal deficit target citing certain grounds:

Ø  National security, war

Ø  National Calamity

Ø  Collapse of Agriculture

Ø  Structural Reforms

Ø  Decline in real output growth of a quarter by at least three percentage points below the average of the previous four quarters.

 

TRENDS
  • 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.