Fiscal Policy Notes for UPSC
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Fiscal Policy Notes for UPSC

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Economics

Fiscal Policy Notes for UPSC

The fiscal policy of a country determines various expenditures and tax structures of the country for the coming years. It thus acts as a backbone for the Economy of a country. If you are a Civil Services Aspirant then it is a must-read topic for you. You can view the Previous year's prelims papers for UPSC prelims and have an idea that every year a number of questions are asked by UPSC CSE on this topic. In the present article, you will find details of the Fiscal Policy of India.

Fiscal Policy Notes for UPSC

FISCAL POLICY

  • Fiscal policy deals with the taxation and expenditure decisions of the government. It is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation’s economy.
  • Fiscal policy is composed of:
    • tax policy,
    • expenditure policy,
    • investment or
    • disinvestment strategies and
    • debt or surplus management
  • Fiscal policy is carried out by the legislative and/or executive branches of government.

FUNCTIONS OF FISCAL POLICY

Allocative function:

Public goods (like national defense, roads) are distinct from private goods and must be provided by the government.

Distributive function:

The government affects the income of households by making transfer payments and collecting taxes, therefore, altering the income distribution.

Stabilization requirements:

The economy is subjected to fluctuations. Ex. During inflation restrictive conditions are needed to stabilize the requirements of the domestic economy. 

Read also: Inflation Notes for UPSC

TYPES OF FISCAL POLICY

Expansionary Fiscal Policy

  • It is defined as an increase in government expenditure and/ or decrease in taxes that causes the government’s budget deficit to increase or the budget surplus to decrease.
  • In this case, the government needs to borrow from domestic or foreign sources, draw upon its foreign exchange reserves or print an equivalent amount of money.

Impact of Expansionary Fiscal Policy

  • Excessive printing of money can lead to inflation.
  • If the government borrows a lot of money from abroad, it can lead to debt or financial crisis.
  • If it draws on its FOREX, a balance of payment crisis may arise.
  • Excessive borrowing from domestic sources can lead to an increase in interest rates.
  • A large fiscal deficit can lead to a negative growth of an economy.

Contractionary Fiscal Policy

  • It is defined as a decrease in government expenditure and/ or an increase in taxes, that causes the government’s budget deficit to decrease and the budget surplus to increase.
  • It is used by the government when an economy is in a boom.

 

BUDGET

  • It is an estimation of the revenue and expenses over a specified future period of time.
  • A surplus budget means profits are anticipated.
  • A balanced budget means revenues expected are equal to expenses.
  • A deficit budget means expenses will exceed revenues.

 

GOVERNMENT EXPENDITURE

Plan Expenditure

  • Plan Expenditure relates to items dealing with long-term socio-economic goals as determined by the planning process.
  • They relate to specific schemes and projects.
  • They are usually given through central ministries to state governments for achieving certain desired objectives.

Non-Plan Expenditure

It covers the general economic and social services of the government.

Non- Plan Revenue Expenditure:

It includes:

(a) Interest payments on the loans taken by the Government of India;

(b)Defence services (except defense equipment);

(c) Subsidies

(d) Grants to the states and UTs, including those from calamity fund

(e) Pensions, Social services such as healthcare, education, etc.

(f) Economic services such as agriculture

(g) Grants to foreign governments

Non- Plan Capital Expenditure:

It includes:

(a) Defence equipment and modernization of current ones;

(b) Loans to Public sector companies; and

(c) Loans to states and Union territories.

Deficit Financing

  • The process of financing a deficit budget by the government.
  • The government may utilize the amount of money created as the deficit to sustain its budget for developmental or political needs.
  • It is also known as Public expenditure.
  • It can be divided into revenue and capital expenditure.

Revenue Expenditure

  • It is the expenditure incurred for purposes other than the creation of physical or financial assets of the central government.
  • It includes:

(a)Expenses incurred for the normal functioning of the government

(b) Interest payments on debt incurred by the government, and 

(c) grants are given to state governments and other parties.

Revenue Expenditure = Law & Order + subsidies + civil administration + defence + grants to states + interest payments

 

Capital Expenditure

  • These expenditures are used for the creation of physical or financial assets or reduction in financial liabilities.
  • These include expenditure on acquisition of land, building, machinery, equipment, investment in shares.
  • These also include loans and advances by the central government to state government and union territory governments.

Capital expenditure = Expenditure on infrastructure + repayment of past loans + loans given to state government

 

Revenue Receipts

  • The receipts of the government which are non-redeemable, i.e., they cannot be reclaimed from the government.

Revenue Receipts = Tax receipts + Non Tax Receipts

  • Tax receipts include receipts from both direct and indirect taxes.
  • Non-tax revenue consists of items such as:

(a)Government’s interest income from the loans made to States and Union Territories

(b)Departmental Undertakings such as railways, post, and telegraphs, etc.,

(c)Dividend income from its ownership of public enterprises

(d)Fees and user charges for public services.

(e)Fines, penalties, challans, and other minor items.

Capital Receipts

  • All those receipts of the government create liability or reduce financial assets.
  • It includes:

(a) Loans raised by the government from the public which are called market borrowings;

(b) Borrowing by the government from the Reserve Bank and Commercial banks and other financial institutions through the sale of treasury bills;

(c) Loans received from a foreign government and international organizations.

  • It also includes:

(a)Recoveries of past loans granted by the central government;

(b)Small savings (Post- Office Savings Accounts, National Savings Certificate);

(c) Provident funds; and

(d) Net receipts obtained from the sale of shares in Public Sector Undertakings.

Capital Receipts = Disinvestment + sale of assets (land, machinery, 2 G) + recoveries of past loans + market borrowings

Read also: Introduction to Economics- Basic Concepts

IMPORTANT TERMINOLOGIES

Public debt

  • Public debt receipts and public debt disbursals are borrowings and repayments during the year, respectively, by the government.
  • It can be divided into internal debt and external debt.

Internal debt

  • Internal debt is that part of the debt that is owed to lenders within the country.
  • It is the money that the government borrows from its citizens.
  • The government borrows by issuing Government bonds and Treasury bills. It also includes the market borrowings by the government.

External debt

  • It is owed to creditors outside the country.
  • The outside creditors can be foreign governments, International Financial Institutions such as World Bank, Asian Development Bank, etc., corporate and foreign private households.
  • External debt may be of several kinds such as multilateral, bilateral, IMF loans, Trade credits, External Commercial borrowings, etc.
  • When NRI parks their funds in India, it is also a type of external debt and is called NRI deposits
  • If the external debt is denominated in Indian Rupee, it is called Rupee Debt.

Revenue Deficit

  • If the balance of total revenue receipts and total revenue expenditure turns out to be negative, it is known as a revenue deficit.
  • It may be shown in quantitative form (as how much the gross deficit is in currency terms) or in percentage terms of the GDP for that particular year (shown as a percentage of GDP).
  • Usually, it is shown as a percentage of GDP for domestic as well as international analysis.

Revenue Deficit = Revenue Receipt - Revenue Expenditure

 

Effective Revenue Deficit

  • It is the Revenue Deficit excluding those revenue expenditures of the GoI which were done in the form of GoCA (grants for creation of capital assets).
  • The GoCA includes the GoI grants forwarded to the states and UTs for the implementation of the centrally sponsored programs.

Effective Revenue Deficit = Revenue Deficit - Grants given to States  for creation of capital assets

 

Fiscal Deficit

  • When the balance of the government’s total receipts (i.e., revenue + capital receipts) and total expenditures (i.e., revenue + capital expenditures) turns out to be negative, it is the situation of fiscal deficit.
  • It may be shown in the quantitative form or in the percentage form of the GDP for that particular year.

Fiscal Deficit = Revenue Receipts + non-financial liability or non-debt imposing capital receipts - Total Expenditure 

 

Primary Deficit

  • The primary deficit shows what the government’s fiscal deficit would have been if there was no burden of interest payments on past loans.
  • If this deficit is negative, it means that the entire fiscal deficit is on account of interest payments on past loans.

Primary Deficit = Fiscal Deficit - Interest Payments

 

Monetised Deficit

  • It implies that the deficit may be plugged by borrowing from the RBI and not from banks.
  • In this case, RBI prints fresh currency to finance borrowings of the government.

Monetised Deficit = Net increase in the RBI credit to the government

 

Budgetary Deficit

    • It is defined as the sum of the net increase in the floating debt of the government and the new withdrawal of their cash balances.
  • Floating debt comprises treasury bills of the Central Government and the RBI, Ways and Means advance, and overdrafts to State Governments.
  • The budget deficit was a misleading concept as showed a deficit after taking into account the government’s borrowings. This meant that government would plug the deficit by borrowing from the RBI at a very low rate of interest by pledging its securities and ask the RBI to print currency to bridge this deficit.

Budgetary Deficit = Total Receipts - Total Expenditure

 

Ways & Means advances

  • Under this, by way of a mutual agreement with the RBI, the government resorts to borrowing from RBI only to meet its temporary mismatch between revenue and expenditure.
  • This borrowing has to be on a quarterly basis so that unless at least 75% of borrowing has been repaid, the RBI may not lend to the government for the next quarter.
  • This borrowing is at a mutually agreed rate of interest, which may be close to the Bank rate/ market rate.

Fiscal Consolidation

  • Fiscal consolidation is a process where the government’s fiscal health is getting improved and is indicated by a reduced fiscal deficit. 
  • Improved tax revenue realization and better-aligned expenditure are the components of fiscal consolidation as the fiscal deficit reaches a manageable level.

Fiscal Sustainability

It calls for reforming the tax system to augment revenue mobilization and containing expenditure by downsizing the government and reducing a large number of useless expenditures.

Zero-Based Budget

  • It implies preparing a budget of a department or ministry on the assumption that there was no budget in the past to refer to.
  • The objective is to rationalize the expenditure.

Performance Budget

  • A budget that reflects the input of resources and the output of services for each unit of an organization.
  • Decisions made on these types of budgets are more focused on outputs or outcomes of services.

Outcome Budget

  • It measures the intermediate physical ‘outputs’ and the ‘outcomes’ which are the ultimate objectives of state intervention.
    • Outlays are financial resources deployed for achieving certain outcomes.
  • Inputs are physical resources subsumed under outlays.
  • Outputs are a measure of the physical quantity of goods and services produced through a government scheme. They are usually an intermediate stage between ‘outlays’ and ‘outcomes’.
  • Outcomes are the end results of various Government initiatives. Ex. ‘Construction of school’ is an ‘output’ and ‘increase in the literacy rate is the ‘final outcome’.

 

Gender Budgeting

  • It was firstly introduced in Australia in 1984.
  • It was introduced in India in 2005-2006.
  • The main objective is to the mainstream gender perspective in all sectoral policies and to work towards the ultimate goal of gender discrimination and creating the enabling environment for gender justice and women empowerment.

Read also: Most relevant MCQ for Economics asked in UPSC, HCS exam

15th FINANCE COMMISSION

The 15th Finance Commission has been constituted to make recommendations for the five years commencing 1 April 2020 till 31 March 2025.

Composition of Commission

    • NK Singh, former bureaucrat, and ex-Member Parliament is its Chairman.
  • Arvind Mehta is Secretary to the Commission.
  • Its other members are Shaktikanta Das, Dr Anoop Singh. 
  • Dr. Ashok Lahiri and Dr. Ramesh Chand will be the Part-time members.

Terms of Reference of Commission

  • The Commission will make recommendations on the distribution of net proceeds of taxes between Centre and States, the principles which should govern grants-in-aid of revenues of States out of Consolidated Fund of India.
  • It will suggest measures needed to augment the Consolidated Fund of State to supplement resources of Panchayats and Municipalities in State on basis of recommendations made by the Finance Commission of State.
  • It will review the current status of finance, debt levels, cash balances, deficit, and fiscal discipline efforts of Centre and States and recommend fiscal consolidation roadmap for better fiscal management.
  • While making recommendations, it will look at resources of Central Government and State Governments for 5 years commencing on 1st April 2020 on basis of levels of tax and non-tax revenues likely to be reached by 2024-25.
  • The Commission will examine the implications of GST on the finance of the Centre and states. It will look at the impact of GST, including payment of compensation for possible loss of revenues for 5 years. 
  • It may consider proposing measurable performance-based incentives for States, at the appropriate level of government.

 

FISCAL RESPONSIBILITY AND BUDGETARY MANAGEMENT ACT

  • Fiscal Responsibility and Budgetary Management Act, 2003 was passed by the government to institutionalize financial discipline, reduce India's fiscal deficit, improve macroeconomic management and the overall management of the public funds by moving towards a balanced budget and strengthen fiscal prudence.
  • Its objective was to eliminate revenue deficit (building revenue surplus thereafter) and bring down the fiscal deficit to a manageable 3% of the GDP by March 2008.
  • The main objectives of the act were:
    • to introduce transparent fiscal management systems in the country.
    • to introduce a more equitable and manageable distribution of the country's debts over the years.
    • to aim for financial stability for India in the long run.

FRBM Review Committee

  • A Committee was set up under N.K. Singh to review India’s fiscal rules. It submitted its report in January 2017.

Fiscal Policy Notes for UPSC

Recommendations of the Panel

  • This and other recommendations form part of the draft debt management and fiscal responsibility Bill, which, if accepted by the present government, will replace the existing FRBM Act.
  • In the four-volume report, it was in favor of reducing revenue deficit to GDP ratio steadily by 0.25% points each year.
  • With an aim to provide flexibility to policymakers within the fiscal framework, the panel has suggested a steady target of 3% from FY18 to FY20.
  • Certain strict 'escape clauses' will allow the govt deviate from the fiscal road map by 0.5% for any given year.
  • Setting up a ‘fiscal council’, an independent body that will monitor the government’s fiscal announcements for any given year.
  • It will provide its own forecasts and analysis for the same as well as advise the finance ministry on triggering the escape clauses.
  • To ensure these escape clauses are not misused by the government, the panel said they have been defined very narrowly and specifically.
  • The escape clauses are proposed for overriding consideration of national security like acts of war, calamities of national proportion and collapse of agriculture, etc.,
  • They can be invoked by the Centre after formal consultations and advice of the fiscal council.
  • It also provided that it should be accompanied by a clear commitment to return to the original fiscal target in the ensuing fiscal year.
  • The panel’s report also says that the focus of policymakers should be on reducing the primary deficit rather than the fiscal deficit.

Read also: 100 Most Important Multiple choice questions on Economics asked in various Competitive exams

FINANCIAL STABILITY

  • Financial stability means financial institutions individually and collectively are being able to deliver their functions properly, withstanding external shocks and avoiding internal weaknesses.
  • Financial stability could be defined as a situation in which the financial sector provides critical services to the real economy without any discontinuity.”

Important Financial Regulators

  • SEBI
  • IRDA
  • PFRDA

 

SECURITIES AND EXCHANGE BOARD OF INDIA

  • SEBI is the regulatory body for dealing with all matters related to the development and regulation of the securities market in India.
  • It was established on 12th April 1988.

Functions of SEBI as per the SEBI Act, 1992

  • Registering the stock exchanges, merchant banks, mutual funds, underwriters, registrars to the issues, brokers, sub-brokers, transfer agents, and others.
  • Levying various fees and other charges.
  • Promoting investor education.
  • Inspection and audit of stock exchanges and various intermediaries.

 

INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY

  • Insurance Regulatory Development and Authority is the statutory, independent, and apex body that governs and supervises the Insurance Industry in India.

Functions and duties of IRDA

  • It issues the registration certificates to insurance companies and regulates them.
  • It protects the interest of policyholders.
  • It provides licenses to insurance intermediaries such as agents and brokers after specifying the required qualifications and set norms/code of conduct for them.
  • It promotes and regulates the professional organizations related to the insurance business to promote efficiency in the insurance sector.
  • It regulates and supervises the premium rates and terms of insurance covers.
  • It specifies the conditions and manners, according to which the insurance companies and other intermediaries have to make their financial reports.
  • It regulates the investment of policyholder's funds by insurance companies.
  • It also ensures the maintenance of solvency margin (company's ability to pay out claims) by insurance companies.

 

PENSION FUND REGULATORY AND DEVELOPMENT AUTHORITY

  • PFRDA was instated in the year 2003.
  • The body was set up with an aim to promote, regulate and develop the pension sector in the country. 

Functions of PFRDA

  • Promote pension schemes in the country for fostering mandatory as well as voluntary pension schemes in order to serve the old age income needs of retired personnel.
  • National Pension system, both tier 1 and tier 2 are under the purview of PFRDA and are dictated by the same.
  • It appoints various intermediate agencies like Pension Fund Managers, Central Recordkeeping Agency, etc.
  • Educating the general public and stakeholders about the importance of pensions.
  • Training of intermediaries that perform the task of popularizing and educating people about the importance of pension.
  • Addressing grievances related to various pension schemes.
  • Addressing and resolving disputes between various intermediaries like banks and between customers and intermediaries.

 

Pension Sector Reforms

  • The New Pension System (NPS) was introduced on January 1, 2004, for new entrants to the Central Government Service, except to the Armed forces, was to be extended to the remaining workforce on a voluntary basis. 
  • NPS design is self-sustainable and scalable.
  • NPS could provide various investment options and choices to individuals to switch from one investment option to another subject to some regulatory restrictions.
  • PFRDA was responsible for the implementation of full NPS architecture. It consisted of Central Recordkeeping Agency (CRA), Pension Fund Managers, and Trustee Bank.
  • The National Securities Depository Limited was selected as the CRA by PFRDA.
  • SBI, UTI Asset Management Company, and LIC were appointed as Pension Fund Sponsors under the NPS.
  • The NPS has been extended to autonomous bodies, State Governments, and Unorganized sector and micro-pension initiatives have been introduced.
  • Tier-I of the NPS constitutes the non-withdrawable pension account and Tier- II constitutes withdrawable accounts.
  • Pension Fund Managers manage three separate schemes. The asset classes specified for the purpose consist of:
    • Equity
    • Government securities
    • Credit risk-bearing fixed income instruments
  • The investment by an NPS participant inequity would be subjected to a cap of 50%. The Fund Managers will invest only in index funds that replicate either BSE sensitive Index or NSE Nifty 50 Index.
  • The PFRDA is also seeking tax relief for NPS like Employees’ Provident Fund Organisation products.

 

FINANCIAL STABILITY AND DEVELOPMENT COUNCIL

  • The government set up an apex-level Financial Stability and Development Council (FSDC) in December 2010.
  • The Council is chaired by the Finance Minister and has heads of financial-sector regulatory authorities, the Finance Secretary and/ or Secretary, Department of Economic Affairs; Secretary, Department of Financial Services, and the Chief Economic Advisor as members.
  • The Council monitors macro-prudential supervision of the economy, including the functioning of large financial conglomerates, and addresses inter- regulatory coordination and financial-sector development issues.
  • It also focuses on financial inclusion and financial literacy.

 

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