FISCAL DEFICIT

PRESENTED BY:

Ankit Gupta(05-MBA-12)

Ankush Bagal (07-MBA-12)

Manish Mahajan (20-MBA-12)

Shivani Gupta (46-MBA-12)

Virender Singh (56-MBA-12)

Vishavdeep Sharma (58-MBA-12)

DEFINITION

When a government's total expenditures exceed the revenue that it

generates (excluding money from borrowings). Deficit differs from
debt, which is an accumulation of yearly deficits.

A fiscal deficit is regarded by some as a positive economic event.

For example, economist John Maynard Keynes believed that deficits
help countries climb out of economic recession.

On the other hand, fiscal conservatives feel that governments should

avoid deficits in favor of a balanced budget policy.

DEFICIT SPENDING

When a government's expenditures exceed its revenues, causing or

deepening a deficit.

This excess spending needs to be financed through borrowing,

likely from foreign governments.

The increased government spending can help stimulate the economy

as more money flows in, but the jump in borrowing can have an
adverse effect by raising interest rates.

John Maynard Keynes was an advocate of deficit spending as a fiscal

policy tool to help stimulate an economy in recession.

During a recession, increased government spending can stimulate

business activity, create jobs and spur consumer spending.

This creates a multiplier effect in which $1 of government spending

helps increase GDP by more than $1.

Some complain that the negative effect of deficit spending is that

interest rates will increase as the government borrows more.

The higher rates make borrowing money more expensive and can
stifle growth.

FISCAL POLICY

Government spending policies that influence macroeconomic

conditions. These policies affect tax rates, interest rates and
government spending, in an effort to control the economy.

Since the 1980s, most western countries have held a "tight" policy,
limiting public expenditure.

FISCAL EFFORT

The amount of revenue collected by a government, often shown as a

percent of the fiscal capacity.

This value creates an estimate of the total amount the government

could collect in revenue.

The amount that a government collects in revenue, mainly taxes, is

dependent on several factors.

This includes the tax rates for individuals and businesses, and the tax
breaks and exemptions offered to the population.

The fiscal effort is also determined by the government's ability to

enforce tax laws and collect the taxes.

FISCAL IMBALANCE

A situation where all of the future debt obligations of a government

are different from the future income streams.

Both of the obligations and the income streams are measured at their
respective present values, and will be discounted at the risk free rate
plus a certain spread.

A vertical fiscal imbalance describes a situation where revenues do

not match expenditures for different levels of government.

A horizontal imbalance describes a situation where revenues do not

match expenditures for different regions of the country.

To measure the fiscal imbalance, take the difference between the

present value of all future debt and the present value of all income
streams.

At any given time, there will be a fiscal imbalance for a particular

government; a sustained and positive balance will be detrimental to
society and the economy.

If there is a sustained positive fiscal imbalance, then tax revenues

will likely increase in the future, causing both current and future
household consumption to fall.

FISCAL DRAG

Fiscal drag is an economics term referring to a situation where a

government's net fiscal position (equal to its spending less any taxation)
does not meet the net savings goals of the private economy.

This can result in deflationary pressure attributed to either lack of state

spending or to excess taxation.

One cause of fiscal drag is the consequence of expanding economies with

progressive taxation.

In general, individuals are forced into higher tax brackets as their income
rises. The greater tax burden can lead to less consumer spending.

For the individuals pushed into a higher tax bracket, the proportion of
income as tax has increased, resulting in fiscal drag.

Fiscal drag is essential a drag or damper on the economy caused by

lack of spending or excessive taxation.

As increased taxation slows the demand for goods and services,

fiscal drag results.

Fiscal drag is a natural economic stabilizer, however, since it tends

to keep demand stable and the economy from overheating.

Because it is an economic stabilizer, fiscal drag can influence

economic equality among citizens of the same region.

FISCAL CAPACITY

In economics, the ability of groups, institutions, etc. to generate revenue. The

fiscal capacity of governments depends on a variety of factors including
industrial capacity, natural resource wealth and personal incomes.

When governments develop their fiscal policy, determining fiscal capacity is an

important step.

Identifying fiscal capacity gives governments a good idea of the different

programs and services that they will be able to provide to their citizens.

It also helps governments determine the tax rate necessary to provide a certain
level of programs.

The theory behind fiscal capacity can also be used by other groups, such as
school districts, who need to determine what they will be able to provide to
their students.

FISCAL AGENT

An organization, such as a bank or trust company, that takes

responsibility for the fiscal duties of an unrelated party.

These fiscal responsibilities generally include the disbursement of

interest and maturity payments on bonds, dividend payouts, and
certain tax issues related to corporate securities.

HOW IS FD BRIDGED ?

FD represent the extent to which the government needs fund, but

does not have them.

One simple way getting funds you dont have is to Borrow.

GoI is the largest borrower in India. Annual borrowings of Govt. are

probably larger then that of entire
Corporate Sector.

Besides, borrowing the govt. has another way of finding funds it

does not have.
Being the law maker of the land gives the govt. the power to
create money which is simply printing additional notes
.This is called monetization.

HOW TO MAKE SENSE OF FD

NUMBER ? IS IT GOOD OR BAD?

FD to some extent is fine. One typically looks at ratio of FD to

gross domestic product. This ratio should ideally remain around 4%
for a country like India. So says the IMF.A much higher number is
bad news.
Typically many nation and definitely developing nation, will run FD
as govt, has the government has large role to play in the economy in
areas like infrastructure, education, social support
( India does not have this), defense, Civil admn. and so on.
Government, Needs are likely to more then its income in a growing
economy.

WHY IS FD SO IMPORTANT?

FD has a lot of impact on govt. policy. For example, if it turns out to

be very high in a year the govt will have to either borrow a lot or
print a lot of money.

Borrowing a lot will push up interest rate their by making the

economy costlier and reducing

Competitiveness of goods produced Vis--vis those made by other

country.

Printing lots of money breeds inflation, which is also bad beyond a

point. Sustained high deficits can lead to very high accumulation of
debt by the govt. leading to what is called internal debt trap.

HOW TO KEEP FD IN CONTROL?

It is important keep FD within a limit for this there are obvious ways

Increase revenue or cut expenses or both. Revenue can be increased

in three fashion- increase tax rate or tax more things or reduce tax
evasion.

One example of tax more things is taxing agricultural income,

currently free from levy in India.

In cutting expenses GOI has traditionally taken easier route. Like

cutting infrastructure spending instead harder ones like cutting
subsidies or freezing recruitment.

FISCAL RESPONSIBILITY AND BUDGET

MANAGEMENT ACT, 2003

The Fiscal Responsibility and Budget Management Act, 2003

(FRBMA) was enacted by the Parliament of India 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.

The main purpose was to eliminate revenue deficit of the country

(building revenue surplus thereafter) and bring down the fiscal
deficit to a manageable 3% of the GDP by March 2008.

However, due to the 2007 international financial crisis, the

deadlines for the implementation of the targets in the act was
initially postponed and subsequently suspended in 2009.

In 2011, given the process of ongoing recovery, Economic Advisory

Council publicly advised the Government of India to reconsider
reinstating the provisions of the FRBMA.

BACKGROUND

The historical balance of payments crisis of India resulted in several

radical changes to the Indian economy, including the process of
economic liberalisation in India.

Given, the deplorable financial condition of India, subsequent

governments formed several commissions and laws to improve the
financial situation of the country.

By the year 2000, at the central government level, India was running
total liabilities equivalent to 6 times its annual revenue.12,000
billion rupees) Further 1,000 billion rupees of liabilities were being
added every year.

The interest payments alone were consuming one-thirds of the tax

revenue (or 50% of the government revenue) of India due to
increased Government borrowings to fund the persistently rising
revenue deficits of the country.

In the light of this need for change, the NDA government of India
introduced the Fiscal Responsibility and Budget Management Bill in
year 2000 which subsequently went on to become the Fiscal
Responsibility and Budget Management Act, 2003.

ENACTMENT

The FRBM Bill was introduced in India by the Finance Minister of

India, Mr.Yashwant Sinha in December, 2000.

Firstly, the bill highlighted the terrible state of government finances

in India both at the Union and the state levels under the statement of
objects and reasons.

Secondly, it sought to introduce the fundamentals of fiscal discipline

at the various levels of the government.

The FRBM bill was introduced with the broad objectives of

eliminating revenue deficit by 31 Mar 2006, prohibiting government
borrowings from the Reserve Bank of India three years after
enactment of the bill, and reducing the fiscal deficit to 2% of GDP
(also by 31st Mar 2006).

Further, the bill proposed for the government to reduce liabilities to

50% of the estimated GDP by year 2011.

There were mixed reviews among economists about the provisions

of the bill, with some criticizing it as too drastic.

This bill was approved by the Cabinet of Ministers of the Union

Government of India in February, 2003 and following the due
enactment process of Parliament, it received the assent of the
President of India on 26 August 2003.

Subsequently, it became effective on 5 July 2004.This would serve

as the day of commencement of this Act.

OBJECTIVES

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 fiscal stability for India in the long run

Additionally, the act was expected to give necessary flexibility to

Reserve Bank of India(RBI) for managing inflation in India.

CONTENT OF THE ACT

Since the act was primarily for the management of the governments'
behavior, it provided for certain documents to be tabled in the
Parliament annually with regards to the country's fiscal policy.

This included the following along with the Annual Financial

Statement and demands for grants:

a document titled Medium-term Fiscal Policy Statement This

report was to present a three-year rolling target for the fiscal
indicators with any assumptions, if applicable.

This statement was to further include an assessment of sustainability

with regards to revenue deficit and the use of capital receipts of the
Government (including market borrowings) for generating
productive assets.

A document titled Fiscal Policy Strategy Statement This was a tactical

report enumerating strategies and policies for the upcoming Financial
Year including strategic fiscal priorities, taxation policies, key fiscal
measures and an evaluation of how the proposed policies of the Central
Government conform to the 'Fiscal Management Principles' of this act.

A document titled Macro-economic Framework Statement This report

was to contain forecasts enumerating the growth prospects of the
country. GDP growth, revenue balance, gross fiscal balance and
external account balance of the balance of payments were some of the
key indicators to be included in this report.

The Act further required the government to develop measures to

promote fiscal transparency and reduce secrecy in the preparation of the
Government financial documents including the Union Budget.

FISCAL MANAGEMENT PRINCIPLES

The Central Government, by rules made by it, was to specify the

following:

a plan to eliminate revenue deficit by 31 Mar 2008 by setting annual

targets for reduction starting from day of commencement of the act.

reduction of annual fiscal deficit of the country

annual targets for assuming contingent liabilities in the form of

guarantees and the total liabilities as a percentage of the GDP

BORROWINGS FROM RBI

The Act provided that the Central Government shall not borrow
from the Reserve Bank of India(RBI) except under exceptional
circumstances where there is temporary shortage of cash in
particular financial year.

It also laid down rules to prevent RBI from trading in the primary
market for Government securities.

It restricted them to the trading of Government securities in the

secondary market after a April, 2005, barring situations highlighted
in exceptions paragraph.

CRITICISM

Some quarters, including the subsequent Finance Minister Mr. P.

Chidambaram, criticized the act and its rules as adverse since it
might require the government to cut back on social expenditure
necessary to create productive assets and general upliftment of rural
poor of India.

The vagaries of monsoon in India, the social dependence on

agriculture and over-optimistic projections of the task force incharge of developing the targets were highlighted as some of the
potential failure points of the Act.

However, other viewpoints insisted that the act would benefit the
country by maintaining stable inflation rates which in turn would
promote social progress.

Some others have drawn parallel to this act's international

counterparts like the Gramm-Rudman-Hollings Act (US) and the
Growth and Stability Pact (EU) to point out the futility of enacting
laws whose relevance and implementation over time is bound to
decrease.

They described the law as wishful thinking and a triumph of hope

over experience. Parallels were drawn to the US experience of
enacting debt-ceilings and how lawmakers have traditionally been
able to amend such laws to their own political advantage.

Similar fate was predicted for the Indian version which indeed was
suspended in 2009 when the economy hit rough patches.

BUDGET 2012: TO MAKE SOME AMENDMENTS

TO FRBM ACT

Finance Minister in his Budget speech stated that FRBM implementation

is back on track and there will be some amendments to FRBM act.

This is what Pranab Mukherji had said in his Budget speech in February
2011.

"The Thirteenth Finance Commission has worked out a fiscal

consolidation road map for States requiring them to eliminate revenue
deficit and achieve a fiscal deficit of 3 per cent of their respective Gross
State Domestic Product latest by 2014-15.

It has also recommended a combined States' debt target of 24.3 per cent of
GDP to be reached during this period. The States are required to amend or
enact their FRBM Acts to conform to these recommendations."

FISCAL DEFICIT 2015

Fiscal deficit seen at 3.9 percent of GDP in
2015/16
Focus on meeting the challenging fiscal target of
4.1 percent of GDP
Remain committed to meeting medium term
fiscal deficit target of 3 percent of GDP

THANK YOU