Ramesh Singh Summary: Public Finance in India- 2

Table of Contents
1. Fiscal Policy
2. Deficit Financing in India
3. Indian Fiscal Situation: A Summary
4. Fiscal Responsibility and Budget Management Act (FRBMA), 2003
5. Limiting Government Expenditure
6. Fiscal Consolidation in India
7. Zero-Base Budgeting
8. Output-Outcome Framework
9. Types of Budgets
10. Cut Motion
11. Trilemmas
12. Direct Benefit Transfer (DBT)
13. Change in Financial Year
14. Concluding Notes
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Fiscal Policy

Fiscal policy refers to the government's decisions about the level and composition of government purchases, taxes and transfers to influence macroeconomic outcomes. In practice it covers the management of public expenditure and taxation to direct aggregate demand, output (measured by Gross Domestic Product), employment and inflation. The most widely cited concise definition describes fiscal policy as the policy of the government with regard to the level of government purchases, the level of transfers, and the tax structure.

The link between fiscal policy and overall economic performance was developed systematically by J. M. Keynes. Keynesian analysis emphasises that changes in government expenditures and taxes can be used to stabilise short-run fluctuations in aggregate demand and thus achieve macroeconomic policy goals such as full employment and price stability.

Deficit Financing in India

After Independence India adopted a planned economy model. The government assumed large development responsibilities through the Five Year Plans, creating an urgent need for funds-both domestic and foreign. Internal resources and foreign assistance often proved insufficient, and the government resorted to various forms of deficit financing to meet plan expenditure.

The First Phase (1947-1970)

• In the early decades after 1947 there was little concept of planned deficit financing as an instrument; budgetary imbalances were presented simply as budgetary deficits.
• Efforts were made to increase tax collection and restrict revenue expenditure, aiming for a surplus revenue budget. These attempts had mixed results and at times produced undesirable outcomes such as tax evasion, administrative strain and stagnation in living standards.
• The government borrowed from domestic and external sources; heavy borrowings from the Reserve Bank of India (RBI) and subsequent policy actions (including bank nationalisation) were used to support plan financing.

The Second Phase (1970-1991)

• This period is widely regarded as the era when deficit financing became extensive, accompanied by weakening macro fundamentals and, ultimately, the balance-of-payments crisis of 1990-91.
• Expansion of public sector undertakings (PSUs) and public employment increased both revenue and capital expenditures. Nationalisation and expansion of PSUs led to fiscal commitments that strained public finances.
• PSUs often became a drain on public resources through operating losses, rising salary, pension and provident fund obligations, and at times inefficient employment creation.

The Third Phase (1991 onwards)

The 1991 crisis ushered in economic reforms, including fiscal correction measures. Structural reforms moved the economy from government dominance towards market orientation. As part of stabilisation conditionalities and domestic policy choices, controlling the fiscal deficit became an explicit objective and public finance required restructuring and greater fiscal discipline.

Indian Fiscal Situation: A Summary

• In December 1985 the Government of India presented a discussion paper to Parliament titled "Long-Term Fiscal Policy", the first explicit long-term fiscal perspective from the Centre. The paper acknowledged deterioration in fiscal position and proposed targets and policies to improve the situation.
• Following discussion and debate, the government in 1987 announced two important measures: a virtual freeze on some government expenditure and the imposition of a ceiling on the budgetary deficit.
• State finances were partly constrained by statutory arrangements (such as overdraft regulations) that limited their independent borrowing, which often meant that deficits in states were self-limiting but at the cost of underinvestment in social and capital sectors.

Factors that contributed to rising government expenditure include:

• Political factor: Short-term political incentives, electoral cycles and powerful interest groups can push governments to increase spending or retain popular subsidies around elections.
• Institutional factor: Large administrative size and procedural emphasis on reporting, accounting and supervision can prioritise process over efficient delivery of goods and services.
• Ethical/social factor: Wide public support for social spending-such as subsidies (food, power, fertiliser, irrigation), poverty alleviation programmes, employment generation, education and health-drives persistent revenue commitments.

Fiscal Responsibility and Budget Management Act (FRBMA), 2003

The fiscal consolidation efforts of the 1990s did not have a statutory backing or a legally enforceable mechanism. To provide a stronger institutional framework the Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) was enacted on 26 August 2003 and came into effect on 5 July 2004. The Act aimed at medium-term management of fiscal deficits, greater transparency in fiscal operations and discipline in fiscal management.

• The FRBMA sought to set targets for revenue deficit and fiscal deficit, improve fiscal discipline and compel the government to move towards prudent debt levels and predictable fiscal policy.
• Over time the Government established review arrangements and committees to examine the appropriateness of targets and rules under the FRBMA.

• A significant review occurred when a high-level committee suggested adopting a debt rule (reducing the Central Government's debt-to-GDP ratio) and a fiscal glide path as operational parameters of fiscal management. The Union Budget accepted key recommendations, including a target to bring down Central Government debt to around 40 per cent of GDP and to provide a flexibility margin (around 0.5 percentage point) in the glide path for targeting fiscal deficit; however, actual debt levels remain above this target in recent years.

Limiting Government Expenditure

• Elected governments often face pressure from various interest groups to adopt populist measures. Rather than raising taxes, which are politically unpopular, governments may prefer borrowing or monetisation (printing money) to finance higher expenditure because these impose no immediate political cost.
• Borrowing from the central bank (as overdrafts) or market borrowings can shift the repayment burden to future governments. This creates an electoral bias in fiscal policy where short-term expansion is favoured over long-term fiscal prudence.
• Excessive public expenditure can be expansionary-boosting employment and GDP in the short run-but may be unsustainable if financed by persistent deficits that raise debt and crowd out private investment.
• To remove the electoral bias and limit unproductive money creation, many countries have adopted legal and institutional checks. India's FRBMA is an example of a statutory measure intended to make fiscal policy less sensitive to electoral considerations.

Fiscal Consolidation in India

• The combined average fiscal deficit (Centre and states) after 1975 remained high and exceeded 10 per cent of GDP up to 2000-01; much of it was driven by large revenue deficits.
• The Reserve Bank of India, the Planning Commission (now NITI Aayog) and international institutions such as the IMF and the World Bank repeatedly warned about the unsustainability of fiscal deficits.
• India's fiscal reforms from the 1990s sought consolidation, and successive governments implemented a range of measures at the Centre and in the states to restore fiscal health. Results have been mixed and the FRBMA itself was reviewed to introduce greater flexibility-moving from a single numeric target to a 'range' for fiscal variables and linking targets to debt rather than only to deficit.

Zero-Base Budgeting

• Zero-base budgeting (ZBB) is an approach to budget formulation in which every programme and expenditure line is re-justified from a hypothetical zero base for each budget cycle rather than carrying forward past allocations.
• The idea originates in managerial practice in the United States in the 1960s-1970s. The financial expert Peter Pyhrr is widely credited with developing and promoting ZBB within private organisations.
• The concept was introduced into public sector budgeting in the US when Jimmy Carter, as Governor of Georgia, used ZBB in state administration and later incorporated elements of it in the federal budgetary discourse when he became President. Since then various governments around the world have experimented with ZBB to improve allocative efficiency.
• Under ZBB, an agency must periodically reassess the need for all its programmes; each programme is justified in detail, and continuance or termination is decided on the basis of present priorities and evidence.

Output-Outcome Framework

• The Government of India has institutionalised an Output-Outcome Framework (OOF) to shift monitoring of government schemes from inputs and physical outputs to measurable outcomes.

• The Development Monitoring and Evaluation Office (DMEO) at NITI Aayog has been supporting the design and implementation of this framework since 2017.
• OOF introduces measurable indicators to monitor the objectives (outcomes) of Central Sector (CS) schemes and Centrally Sponsored Schemes (CSS), which together account for a large share (around 40 per cent) of central budget expenditure.
• Benefits of the framework include enhanced development impact and improved accountability and transparency by actively tracking progress against defined targets.

Types of Budgets

• Golden Rule: This rule states that government borrowing should be limited to financing investment (capital expenditure) and not for current/revenue expenditure. The rule is prudent provided spending classified as investment is genuinely productive and does not crowd out private investment.
• Balanced Budget: A budget is balanced when total public spending equals government revenue receipts (taxes and charges) in the same period-equivalently, a budget with zero revenue deficit.
• Gender Budgeting: Gender budgeting allocates funds and responsibilities in the budget with explicit attention to gender impacts, aiming to reduce socio-economic disparities between men and women through targeted expenditures and policy design.

Cut Motion

• In parliamentary democracies members have the facility of moving a Cut Motion to express dissent on budgetary demands. Different forms include:
• Token Cut: A motion to reduce a demand by a token amount (typically ₹100) to draw attention to a specific grievance confined to the responsibility of the government.
• Economy Cut: A motion to reduce a demand by a specified amount that represents potential economy in expenditure.
• Disapproval of Policy Cut: A motion to reduce a demand to Re. 1, signalling disapproval of the policy underlying the demand and allowing debate on alternatives.
• Guillotine: A procedure whereby the Speaker may put all outstanding demands to vote at once, thereby cutting short further discussion on the Budget.

Trilemmas

• Fiscal policy choice in democracies involves difficult trade-offs-often expressed as trilemmas linking policy, politics and economics.
• Dani Rodrik's political-economy trilemma argues that a country cannot simultaneously have full democracy, national sovereignty and deep global economic integration; choosing two constrains the third.
• Niall Ferguson highlighted a different trilemma involving commitment to globalisation, maintenance of social order and a small state-again suggesting that not all three can be achieved fully at once.

Direct Benefit Transfer (DBT)

• Since 2015 the Government of India has expanded technology-enabled Direct Benefit Transfer (DBT) using the JAM trinity-Jan Dhan (bank accounts), Aadhaar (biometric identity) and Mobile (phone connectivity). DBT aims to transfer subsidies and benefits directly into beneficiaries' bank or post-office accounts, reducing leakages and improving targeting.
• DBT requires accounts to be linked to the 12-digit Aadhaar identity issued by the Unique Identification Authority of India (UIDAI).
• DBT was piloted in the LPG subsidy reform and later in fertiliser distribution in selected districts. The Economic Survey recommended extending DBT to areas such as farm loan subsidies and interest subvention schemes and suggested replacing procurement-based public distribution mechanisms in some cases with DBT to free market movements and reduce distortions.

Change in Financial Year

• The Government constituted a high-level committee under former Chief Economic Adviser Shankar Acharya to examine the desirability and feasibility of changing India's financial year.
• The committee's terms included examining the origin of the current financial year, suitability for revenue and expenditure estimation, impacts on agriculture, business, taxation, statistics, budget processes and other relevant matters; and recommending a suitable financial year and transitional changes in law and practice.
• The committee submitted its report, and the recommendations have been considered; however, no change has been implemented. A change of financial year requires broad consensus across the Centre and states because of the multiple legal, administrative and fiscal implications.

Concluding Notes

The evolution of India's public finance reflects a sustained tension between development spending needs and fiscal discipline. Institutional reforms-such as the FRBMA, outcome-oriented monitoring (OOF), experimentations with ZBB and technological innovations like DBT-have aimed to improve the quality, targeting and sustainability of public expenditure. Continued fiscal consolidation requires transparent fiscal rules, prudent debt management, improved tax effort and expenditure reforms that promote efficient and equitable delivery of public services.