BUDGET 2018

The Functioning of an Economy

Macro Variables To
look out for
•Output
•Employment
•Prices
 The Government Sector and the Economy
• Early economic thinkers propounded the philosophy of Laissez-Faire
• Governments were meant to play very little role in the economy
• However it was realised that ‘market failures’ led to insufficient
provision of certain goods and services
• Therefore the Government’s role was recognised
• Government sector thus became an integral part of the economy
• Private sector which is driven by market principle is complemented
by the Government sector
 The Government Sector and the Economy
• A Government performs the following functions in an economy
• Allocation of Resources
• Distribution of Income and Wealth
• Stabilisation of the Economy
 Stabilisation Function of the Goverment

• A market driven economy is prone to fluctuations in income,

employment and prices-Business Cycles
• Thus we need anti-cyclical measures by the Government to
stabilise the economy
• During recessions when demand is low the Government can
increase total spending through deficit financing
• During boom time when there is excess demand and inflationary
trends the Government should reduce total spending
 Stabilisation Function of the Government
• However the use of public expenditure as anti-cyclical measure
would be effective if there is a strong market mechanism so that
it spreads to the rest of the economy
• In developed economies Government expenditure can add to
effective demand
• Emerging economies suffer from rigidities in the market
• There are shortages of social overheads, skilled labour and capital
• Therefore in emerging economies Government expenditure are
primarily used to provide social overheads
• This eases out private investment and production
 Function of the Government
• Therefore in a country like India Allocation function,
Distribution Function and Stabilisation Function are entwined
• Allocation to Social overheads and upliftment of weaker
sections through distribution of income lead to
– Increase in demand
– Increase in production
 Types of Government Budget
Legislative and Executive Budget
• A legislative Budget is prepared by the various committees
appointed by the legislature from among its members
• An executive budget is the one which is prepared by the
executive branch of the government
– Such a budget is normally passed and adopted by the legislature but
the initiative is in the hand of government
 Types of Government Budget
Unified and Multiple Budget
• A unified budget is one in which all the financial flows are recorded in a systematic
manner as one piece and presented to the authority for its passage
• The financial flows are suitably classified under different heads
• A multiple budget is prepared and submitted for passage in parts without cross
reference
– Better evaluation of the functions of the government
• With multiple budget it is felt that true fiscal operations of the government gets
scattered and difficult to trace
• The best way is to present unified budget in which important sub-portions being
classified and presented separately
 Types of Government Budget
Cash-Flow based versus Accrual Based Budgeting
• Cash-flow based budget accounting records the transaction when cash
is exchanged
• Accrual based budget accounting record a financial flow at the time
when economic value is created, transformed, exchanged, transferred
or extinguished, whether or not cash is exchanged at the time
– E.g accruing superannuation liabilities and depreciation being incorporated in
the production of public budget
– A large no. of countries have shifted to this form
 Types of Government Budget
• Some advantages of Accrual Based Accounting
• Optimise the beneficial spill-over effect of the budget
• Evaluate accumulation of debt by indulging in huge fiscal deficit
• Some Disadvantages of Accrual Based Accounting
• Complex system
• Choice of assumptions subjective
 Types of Government Budget
Revenue and Capital Budget
• Distinguish between revenue and capital expenditure (receipts not
mentioned in constitution but still classified)
• Revenue expenditure does not add to or subtract from capital assets
• Any economic agent
– Classifies current expenditure and capital expenditure
– Current expenditure same as consumption
– Acquisition of capital asset not treated as current expenditure
– Only when they depreciate then considered under current expenditure
• It is argued that Government should also follow the same logic
 Types of Government Budget
Revenue and Capital Budget
• It is argued that as a working rule
– All current expenditure should be met through taxation
– All capital expenditure should be met through borrowing
• But that might make policy making too restrictive
Plan and Non Plan
Now replaced by Niti Ayog
 Public Budget
• Policy statement of the government with its financial implications
• Typically a government wants to take up economic and non-economic
activities
• Government pursues a set of policies
• These have financial counterparts in the form of receipts, borrowings and
expenditures
• Government describes its intentions and policies to be pursued and makes a
financial plan
• The financial plan contains details of estimated receipts and proposed
expenditure
• A budget is both a description of fiscal policies and the financial plan
 GOI Finances
• The receipts and disbursements are categorised into
– Consolidated Fund of India
• Tax and non tax receipts
• Recoveries of Loans and other receipts
• All loans raised on the security of Consolidated Fund
• Owned by the Government
• Disbursement from the fund can be made under authorisation from Parliament
– Contingency Fund of India
• Imprest amount placed at the disposal of the President to meet urgent unforeseen expenditure pending
authorisation by Parliament
– Public Accounts of India
• Transactions which enter the Government for which the Government acts as a banker
• PPF, Small Savings
• Both receipt and expenditure sides of GOI are split into
– Revenue Account
– Capital Account
 Capital Account
• Receipts and Disbursements
– Which add or subtract from Government’s financial claims and
liabilities to third parties (deposits, collections of small savings and
other forms of loans)
– Results in variation in physical assets of the government
– Results in variations in financial claims upon or liabilities to third
parties
• Borrowing, lending, recovery, repayment of loans
 Revenue Account
• Variation in financial balance created or owned by the Centre
– Tax collection, their spending, receipt and payment of interest,
dividends, profit, rent, fees and fines, grants
• Expenditure on maintenance of physical assets
• Cost of administration, police, judiciary
 Expenditure Policy
• Expenditure by GOI constitutes the following components
– Gross fixed capital formation
– Financial investments and loans to rest of the economy
– Consumption expenditure
– Transfer payments
• GOI budgets characterised by deficit financing
• Fiscal Deficit
– Total Expenditure less its Revenue Receipts=Total Borrowings
• Revenue Deficit
• Primary Deficit
– arrived at by deducting interest payment from fiscal deficit 
 Budget
• Budget of GOI is a statement of estimated
• Financial Receipt
• Financial Disbursement/Expenditure
• Financial Receipt
• Revenue Receipt-adds to government’s purchasing power but does not add to financial claims on
the government
• Examples -tax, interest receipt, grants profits, dividends
• Capital Receipt- add to financial claims on the government
• Examples-borrowings, deposits, grants, recovery of loans and advances
• Taxes which are a part of Revenue Receipt consist of
– Direct Taxes
– Indirect Taxes
 Budget
• Financial Expenditure
• Revenue Expenditure-expenditures by the government which does not result in creation of
physical assets or financial claims on others
• Capital Expenditure- expenditures by the government which leads to creation of physical assets
or financial claims on others
• Expenditure by GOI constitutes the following components
– Gross fixed capital formation
– Financial investments and loans to rest of the economy
– Consumption expenditure
– Transfer payments

• GOI budgets characterised by deficit financing

• Fiscal Deficit
– Total Expenditure less its Revenue Receipts=Total Borrowings
 Budget at a Glance (Rs.Crore)
2016-2017 2017-2018 2017-2018 2018-2019
Actuals Budget Estimate Revised Estimate Budget Estimate

1 Revenue Receipts 1374203 1515771 1505428 1725738

2. Tax Revenue 1101372 1227014 1269454 1480649

3. Non-Tax Revenue 272831 288757 235974 245089

4 Capital Receipts1 600991 630964 712322 716475

5. Recovery of Loans 17630 11933 17473 12199

6. Other Receipts 47743 72500 100000 80000

7. Borrowings and Other Liabilitites2

535618 546531 594849 624276

8 Total Receipts (1+4) 1975194 2146735 2217750 2442213

9 Total Expenditure (10+13) 1975194 2146735 2217750 2442213

16 Fiscal Deficit [9-(1+5+6)] 535618 546531 594849 624276

17 Primary Deficit (16-11) 54904 23453 64006 48481

 Fiscal Deficit and its Impact on The Economy
According to John Maynard
Keynes, a deficit prevents an
economy from falling into
recession
Many economists think that if
the deficit is financed by
raising debt from the central
bank it may lead to an
inflationary scenario
• Higher Fiscal Deficit means Government has to borrow more
• This borrowing can be done from the financial market
• Cost of borrowing tends to go up
• Crowds out private investment
• Deficit can be met by monetisation by the Central Bank
• Leads to inflationary pressures
• Higher fiscal deficit is one of the reasons for the Indian economy to
have relatively higher inflation
• Therefore we talk about fiscal prudence and bringing down the
Fiscal Deficit to GDP ratio
• At the same time under expenditure and under collection of taxes
lead to under availability of essential goods and services leading to
a low equilibrium trap situation
Fiscal Deficit as Percentage of GDP
 Areas of Focus for Budget 2018
• Agriculture
• Healthcare
• Employment
• Infrastructure
• Direct Effect-Expenditures on these sectors add to the demand
for goods and services
• Indirect Effect-People save more, businesses invest more,
businesses expand their operations and increase the level of
output which leads to economic growth
 Economic Classification of the
Central Government Budget

• Ministry of Finance has been preparing an economic classification of the Central

Government budgetary transactions
• Make the budget a more useful tool of economic analysis
Economic classification
• The Central Government's total expenditure
• The Central Government's final outlays
• Capital formation out of the budgetary resources of the Central Government
• Net capital formation and savings of the Central Government
• The various measures of deficit in the Central Government's budgetary transactions
• Income generation by the Central Government
 Economic Classification of the
Central Government Budget
1. Final outlays
– Government consumption expenditure
– Gross capital formation
2. Transfer payments to the rest of the economy
– Current transfers
– Capital transfers
3. Financial investments and loans to the rest of the economy
4. Total expenditure (1+2+3)
 Economic Classification
• Account 1:Transactions in commodities and services and transfers-Current
account of Government Administration
• Account 2:Transactions in commodities and services and transfers-Current
account of Department of Commercial undertaking
• Account 3:Transactions in commodities and services and transfers-
Combined
• Account 4:Changes in Financial Assets -Capital Account of Government
Administration and Department of Commercial undertaking
• Account 5:Changes in Financial Liabilities -Capital Account of Government
Administration and Department of Commercial undertaking
• Account 6: Cash and Capital Reconciliation Account of Government
Administration and Department of Commercial undertaking
 Economic Classification of the
Central Government Budget
Account 1
• Transactions in commodities and services and transfers : Current Account of
Government Administration
• On the expenditure side this account is concerned with the Government’s
– Consumption expenditure
– Current transfer payments
• On receipt side,
– Tax receipts
– Income from Government property and enterprises and fees and miscellaneous receipts
– The surplus arising out of the excess of current revenue over expenditure on
consumption and current transfer payment denotes the saving of the Central
Government administration and together with savings of the commercial undertakings
constitutes the saving of the Central Government available for capital formation
 Economic Classification of the
Central Government Budget
Item 1
Consumption Expenditure
• The Government’s consumption expenditure comprises wages
and salaries paid to employees and current expenditure
incurred on purchases of commodities and services
• This indicates the value of the available supplies of goods and
factors drawn into the Government’s current use, for
developmental as well as non-developmental purposes
 Economic Classification of the
Central Government Budget
• Item 1.1
• Wages and Salaries (including allowances)
• Item 1.2
• Commodities and Services
• Transfer Payments: These expenditures do not involve direct demand on goods and
services; they are of the nature of mere transfers intended to add to incomes of others. In
the present analysis, a distinction has been drawn between current transfers and capital
transfers on the hypothesis that while current transfers supplement the income accounts
of recipients, capital transfers are intended to assist capital expenditure. Current transfers
alone appear here; these comprise interest payments, current grants to States, Union
Territories, local authorities and non-profit making institutions, subsidies, pensions and
transfer payments to others.
 Economic Classification of the
Central Government Budget
• Item 2
• Transfer Payments
• These expenditures do not involve direct demand on goods and services
• Intended to add to incomes of others
• Only current transfers appear under this head not capital transfers
– Current transfers supplement the income accounts of recipients
– Capital transfers are intended to assist capital expenditure
– Current transfers alone appear here; these comprise interest payments, current
grants to States, Union Territories, local authorities and non-profit making
institutions, subsidies, pensions and transfer payments to others.
 Functional Classification
• A functional classification is designed to group the main items of Government
expenditures in terms of broad purposes to be served, defence, administration,
health, education, economic services
• Functional classification relates essentially to expenditures and does not apply
to receipts
• The expenditure of the Central Government has been grouped into four main
categories
– General Services
– Social Services
– Economic Services
– Unallocable
 Functional Classification
General Services
– Covers both civil and defence
– For the provision of the basic administrative structure of the nation
– E.g. expenses on general administration, tax collection, police, currency and the mint,
conduct of external relations, defence and the non-plan provision against natural
calamities are shown under this category
– The administrative expenditures concerned with the direction and superintendence of
the various social and economic activities appear under the relevant functional heads.
– Where more than one activity is involved (e.g. public works), an attempt is made to
apportion, to the extent possible, the administrative overheads to the various activities
 Functional Classification
Social Services
• Concerned with the provision of basic social amenities to the community
• Expenditures on education, medical and public health and other social services are included here
• Education covers both general and technical education (e.g. engineering and medical colleges) and
also basic research
• However, in-service training and applied research have been allocated to the activities concerned
• For instance, both atomic and industrial research appear under Industry
• The sub-group ‘medical and public health’ also covers family welfare programmes
• The sub-group ‘other social services, includes housing, labour welfare and other social welfare
schemes, museums, archaeology, public libraries and also expenditures connected with broadcasting
and other publicity media
• Expenditures provided in the budget for various programmes of employment are also included here
• This subgroup also covers such expenditures as the lump-sum provision made in the budget for
primary education, slum improvement, rural water supply and rural home sites
• The expenditure on nutrition programme for children is also shown here. The relief expenditure for
displaced persons are included here.
 Functional Classification
Economic Services
• includes all such expenditures made to promote, directly or indirectly, productive activity within the
economy
• Producer’s subsidies such as for fertilisers, coal and railways, as also the assistance for export promotion
and market development are, therefore, included here
• Further sub-division into agriculture, industry, transport and communications and ‘other economic
services’ is done according to the type of economic activity
– Agriculture includes irrigation, animal husbandry, fisheries, forestry, cooperation and community development.
Industry broadly covers both large, small scale and village industries, power development, exploitation of mineral
resources and trade and export promotion.
– Transport and communications include Railways, Posts, Tele-communications, ports, shipping, civil aviation, roads etc
– ‘Other economic services’ is a residual category which includes items like outlays on multipurpose projects, and States’
share in small savings
– The block grants and loans granted by the Centre to the States for plan assistance, although shown separately, also
belong to the same category.
– All these expenditures are concerned with more than one type of economic activity
 Functional Classification
Unallocable
• There are certain types of expenditure which cannot be related to specific purposes and
have been grouped under the category “unallocable”
• The main types of expenditures included here are interest payment, pensions, consumer
subsidies (such as on food, edible oils and controlled cloth) and such transfers to the State
Governments as statutory grants-in-aid, and special loans
• While consumption subsidies have been treated as unallocable, other subsidies such as
subsidies for fertilisers, and exports have been allocated to the relevant functional
categories
• The unallocable category also includes transfer to foreign countries e.g. grants to Nepal and
Bhutan, technical credits and other loans to foreign countries.
• Contributions to such organisations as World Health Organisation and Food and Agricultural
Organisation of the United Nations, appear under the respective functional heads (viz.
health and agriculture) contribution to the United Nations and also subscription to IMF, IBRD
etc. are shown under General Services
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