Ramesh Singh Summary: Public Finance in India- 2 | Indian Economy for UPSC CSE PDF Download

Fiscal Policy

• Fiscal policy has been defined as 'the policy of the government with regard to the level of government purchases, the level of transfers, and the tax structure'— probably the best and the most acclaimed definition among experts. Later, the impact of fiscal policy on macro-economy was beautifully analysed.
• The policy has a deep impact on the overall performance of the economy, fiscal policy is also defined as the policy which handles public expenditure and tax to direct and stimulate the level of economic activity (numerically denoted by the Gross Domestic Product).
• It was J. M. Keynes, the first economist who developed a theory linking fiscal policy and economic performance. Fiscal policy is also defined as 'changes in government expenditures and taxes that are designed to achieve macroeconomic policy goals.

Deficit Financing in India
India was declared to be a planned economy right after Independence. As development responsibilities of the government were very high, there was a need of huge funds in rupee as well as in foreign currency forms. India faced continuous crises in managing the required fund to support its five Year Plans—neither foreign funds came nor internal resources could be mobilised in sufficient amount.

The First Phase (1947-1970)
This phase had no concept of deficit financing and the deficits were shown as Budgetary Deficits. Major aspects of this phase were—

• Trying to borrow from inside and outside the economy but unable to meet the target.
• In the 1950s, a serious attempt was made to increase tax collections and check revenue expenditures to be ultimately able to emerge as a surplus revenue budget economy. But huge cost was paid in the form of tax evasion, rise in corruption, stagnating standard of life and a neglected social sector.
• Taking recourse to heavy borrowings from the RBI and finally nationalisation of banks so that their money could be used by the government to support the plans.

The Second Phase (1970-1991)
This is considered the period of deficit financing, follow up of unsound fundamentals of economics and finally culminating in severe financial crisis by the year 1990-91. Major highlights of this phase may be summed up as follows—

• Upcoming PSUs increased the total expenditure of the government's revenue as well as capital.
• His phase saw the nationalisation policy and simultaneous revival of an increased emphasis on expansion of the PSU.
• Existing PSUs were taking their own due from the economy—the illogical
  employment creation excessively increased the burden of salaries, pensions and PF.

The Third Phase T1991 onwards : This started with the initiation of the economic reforms process under the conditionalities put forth by the IMF (controlling fiscal deficit was one amongst them). As the economy moved from government dominance to market dominance, things needed a restructuring and public finance also needed a touch of rationality.

Indian Fiscal Situation: A Summary

• In December 1985, the Government of India presented a discussion paper in the Parliament titled 'Long-Term Fiscal Policy'.
• It was for the first time in the fiscal history of India that we see a long-term perspective coming on the fiscal issue from the government.
• This also included the policy of government expenditure.
• The paper was bold enough to recognise the deterioration in India's fiscal position and accepted it among the most important challenges of the eighties—the paper set specific targets and policies to set the things right.
• This paper was followed by a country-wide debate on the issue and it was in 1987 that the government came ahead with two bold steps in the direction—
  (i) A virtual freeze was announced on government expenditure
  (ii) A ceiling on the budgetary deficit.
• As per the experts, the debt situation in the states would have been even worse, but for the fact that the states, unlike the Centre, did not have independent powers to borrow either from the RBI or the market because of the statutory overdraft regulatory scheme. Thus, their deficits have been self-limiting— whenever the states tried to cut down their deficits the care of the social sector and capital expenditure suffered and development prospects in the states also suffered.
  (i) Political factor : The political lobbies and sectional politics as well as the subsidies are supposed to be one big factor for rising government expenditure. We see this on a higher scale if there is a probable midterm election or closer to a general election.
  (ii) Institutional factor : The administrative size combined with the processes of reporting, accounting, supervising and monitoring getting greater importance than the production and delivery of goods and services.
  (iii) Ethical factor : This is a more powerful factor as it easily generates wide public support for the government expenditure. There are many heads of such expenditures such as subsidies (food, power, fertilizer, irrigation, etc.) poverty alleviation programmes, employment generation programmes, education, health and social services.

FRBM Act. 2003
(i) The fiscal policy of an economy has been considered as the building block for enabling macroenvironment by economists, policymakers and the IMF, alike.
(ii) It does not only provide stability and predictability to the policy regime, but also ensures that national resources are allocated in terms of their defined priorities through the tax transfer mechanism.
(iii) Unproductive government expenditures, tax distortions and high deficits are considered to have constrained the Indian economy from realising its full growth potential.
(iv) The fiscal consolidation which followed in 1991 failed to give the desired results as there was no defined mandate for it.
(v) Neither was there any statutory obligation to do so. This is why the Fiscal Reforms and Budget Management Act (FRBMA) was enacted on 26 August, 2003 to provide the support of a strong institutional/statutory mechanism. Designed for the purpose of medium-term management of the fiscal deficit, the FRBMA came into effect on 5 July, 2004.

• The Government has accepted (in Union Budget 2018-19) some key recommendations of the Review Committee—
  (i) Debt Rule which suggested the Government to bring down Central Government's Debt to GDP ratio to 40 per cent. The Committee has suggested this ratio to be 20 per cent in case of the States.
  (ii) Fiscal Glide Path as the key operational parameter of fiscal management. This provides the Government a flexibility of 0.5 per cent in targeting the fiscal deficit.

LIMITING GOVERNMENT EXPENDITURE

• Elected governments are composed of different interest groups and lobbies. At times, such governments might intend to use its economic policies in a highly populist way for greater political mileage without caring for the national exchequer.
• Such acts might force the governments to go in for excessive internal and external borrowing and printing of currency. Governments generally avoid to increase tax or impose new taxes for their revenue increase as such acts are politically unpopular.
• On the other hand, borrowings and printing of currency impose no immediate economic or political costs.
• A government in the election year usually spends money frugally by borrowings (from the RBI in India) because it is the coming government after the elections who is supposed to repay them.
• Government expenditures remain higher and expanding due to some economic reasons also—by doing so extra employment is generated and the output (GDP) of the economy is also boosted.
• If governments go for anti expansionary fiscal and monetary policies with the objective of reducing its expenditures the employment as well as the GDP both will be hampered. This is considered a bias in the economic policies of the elected governments.
• But there has always been a consensus among the experts and policymakers that an external (i.e., outside the government) and some form of a statutory check must be over the government on its powers of money creation (i.e., by borrowings or printing).
• With the objective of removing the bias—to make fiscal policy less sensitive to electoral considerations, several countries had introduced some legal provisions on their governments before India enacted its FRBMA.

Fiscal consolidation in India

• The average combined fiscal deficits, of the Centre and states after 1975, had been above 10 per cent of the GDP till 2000-01. More than half of it had been due to huge revenue deficits.
• The governments were cautioned by the RBI, the planning Commission as well as by the IMF and the WB about the unsustainability of the fiscal deficits.
• It was at the behest of the IMF that India started the politically and socially painful process of fiscal reforms, a step towards fiscal consolidation.
• A number of steps were taken by the government at the Centre in this direction and there had been incessant attempts to do the same in the states' public finances too.
• Government's follow-up to the FRBM Act has shown mixed results. Introspecting the situation, the Government did set up a review committee on the Act in 2016-17 with a wish to have 'range' as the target of fiscal deficit in place of 'number'.

Zero-Based Budgeting

• The idea of zero-base budgeting (ZBB) first came to the privately owned organisation of the USA by the 1960s. This basically belonged to a long list of guidelines for managerial excellence and success, others being Management by Objectives (MBO), Matrix Management, Portfolio Management, etc to name a few.
• It was the US financial expert Peter Phyrr who first proposed this idea for
  government budgeting and Jimmy Carter, Governor of Georgia, USA was the first elected executive to introduce ZBB to the public sector.
• When he presented the US Budget in 1979 as the US President it was the first use of the ZBB for any nation state. Since then many governments of the world have gone for such budgeting.
• Zero-base budgeting is the allocation of resources to agencies based on periodic re-evaluation by those agencies of the need for all the programmes for which they are responsible, justifying the continuance or termination of each programme in the agency budget proposal—in other words, an agency reassesses what it is doing from top to bottom from a hypothetical zero base.

Output-Outcome Framework

• By 2019-20, the Government of India developed the idea of the Output-Outcome Framework (OOF). The OOF is an important reform towards outcome-based monitoring of developmental actions of the ministries and departments.
• This is a creative modification of a similar effort of past (i.e. the ‘Outcome & Performance Budgeting' initiated in 2005-06). The DMEO (Development Monitoring and Evaluation Office) at Niti Aayog has been working on it since 2017, which actively supports the Government agencies in the process.
• Under it, a framework of 'measurable indicators' have been put in place monitoring the objectives (i.e. 'Outcomes') of the Central Sector (CS) and Centrally Sponsored Schemes (CSSs) which account for around 40 per cent of the Government's budget expenditures.
• This is a paradigm shift from measuring simply 'physical and financial' progress, to a 'governance model based' on outcomes.
• Actively tracking progress against defined targets, the framework provides two key benefits to improve governance—
  (i) Enhancing the development impact
  (ii) Improving accountability and trans-parency.
• The Output-Outcome Framework 2019-20 lays the foundation of the journey towards a stronger portfolio of Government's development programmes.

TYPES OF BUDGETS

• Golden Rule : The proposition that a government should borrow only to invest (i.e., capital expenditure in India) and not to finance current spending (i.e., revenue expenditure in India) is known as the golden rule of public finance. This rule is undoubtedly prudent but provided spending is honestly described as investment, investments are efficient and does not crowd out the important private sector investments.
• Balanced Budget : A budget is said to be a balanced budget when total public-sector spending equals total government income (revenue receipts) during the same period from taxes and charges for public services. In other terms, a budget with zero revenue deficit is balanced budget. Such budget making is popularly known as balanced budgeting.
• Gender Budgeting : A general budget by the government which allocates funds and responsibilities on the basis of gender is gender budgeting. It is done in an economy where socio-economic disparities are chronic and clearly visible on a sex basis.

Cut Motion

• In democratic political systems, there is a provision of Cut Motion in the House/Parliament.
• There are different constitutional provisions by which the Parliament starts discussion to reduce the demands, grants, etc. proposed by the government in the Budget —
  (i) Token Cut : This motion intends to 'reduce the demand by ₹100'. Such a motion is moved in order to express a specific grievance which is within the sphere of the responsibility of the Government of India—the discussion remains confined to the particular grievance specified in the motion.
  (ii) Economy Cut : This motion intends to 'reduce the demand by a specified amount' representing the economy (in expenditure) that can be affected.
  (iii) Disapproval of Policy Cut : This motion intends to 'reduce the demand to Re. 1'. This represents disapproval of the policy underlying the demand—the discussion remains confined to the particular policy and is open to members to advocate an alternate policy.
  (iv) Guillotine is the process in which the Speaker puts all the outstanding demands made by the Budget directly to vote in the House—ending further discussions (intended to cut short the discussion on the Budget).

Trilemmas

• Putting the right kind of fiscal policy has always been the most challenging policy decision to be taken by the democratic governments around the world, there are some famous 'trilemmas' related to this aspect.
• Dani Rodrik argued that if a country wants more of globalisation, it must either give up some democracy or some national sovereignty.
• Niall Ferguson highlighted the trilemma of a choice between commitment to globalisation, to social order and to a small state.

Direct Benefit Transfer

• In 2015, the new government in Centre introduced the game-changing potential of technologyenabled Direct Benefits Transfers (DBT), namely the JAM (Jan Dhan-Aadhaar-Mobile) Number Trinity solution.
• It offers possibilities for effectively targeting public resources to those who need them most, and including all those who have been deprived in multiple ways.
• Under it, the beneficiaries will get the money 'directly' into their bank or post-office accounts linked to their 12-digit biometric identity number (Aadhar) provided by the Unique Identification Authority of India (UIDAI).
• To ensure targeted disbursement of government subsidies and financial assistance to the actual beneficiaries, is a critical component of 'minimum government and maximum governance' of the Government of India. After the successful introduction of DBT in LPG, the government in 2016-17 introduced it on pilot basis for fertilizer in few districts.
• The Economic Survey 2015-16 suggested the DBT solution for farm loans and interest subvention schemes availed by the farmers. It further advised for replacing the existing system of MSP/procurement based PDS with DBT which will free the market of all controls on domestic movement and import.

Change in Fiscal Year

• To examine the 'desirability and feasibility' of having a new financial year, the Government did set up a high-level committee headed by the former Chief Economic Adviser Shankar Acharya in July 2016 with the following term of reference :
  (i) To examine the genesis of the current financial year and the studies made in the past on the desirability of a new financial year.
  (ii) To examine the suitability of the existing financial year from the point of view of— estimation of receipts and expenditure of the governments; impact on agricultural crops, businesses, taxation, statistics and data, budgetary process; and other relevant matters
  (iii) Recommend a suitable financial year together with the changes needed in tax laws during transitional period, changes in the coverage of the recommendations of the Finance Commission and the appropriate timing of change.
• The Committee submitted its report (still not available in the public domain) by end December 2016 is under the consideration of the Government. For shifting to a new financial year there needs to be a consensus among the governments—the reason this proposal was floated by the PM in one of the meetings of the Governing Council of the NITI Aayog.