Economic Environment of Business

Session 11 B: Managing Public

Finances and Business
Government Deficit and
Administrative Reforms

Veena Keshav Pailwar

Professor
IMT Nagpur
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Government must focus on how it funds the fiscal
deficit
• Key Concepts

• Key Deficit Indicators: Revenue Deficit, Fiscal Deficit,

Primary Deficit, Monetized Deficit

• Why Are So Many Deficit Indicators Estimated and

Published?

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 Revenue and Capital Receipts of the Government
Receipts Notation Disbursement Notation
A. Revenue Receipts RR Revenue Expenditure RE
1. Tax Receipts R1 1. Interest Expenditure E1
2. Non Tax Receipts (2a + R2 (R21+R22) 2. Other Expenditure E2
2b)
2a. Interest Receipts R21
2b. Non Interest Earning R22
B. Capital Receipts CR Capital Expenditure CE
1. Grants R3 Domestic Lending E3
2. Recovery of Loans R4 Other Expenses E4
3. Disinvestment Receipts R5
4. Borrowing (4a + 4b) R6 (R61+R62)
4a. Domestic R61
4b. Foreign R62
Aggregate Receipts RR + CR Aggregate RE + CE
Expenditure
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 Balance Sheet of the Government

Aggregate Receipts
RR+CR = (R1+R2) +(R3+R4+R5+R6)

Aggregate Expenditure
RE+CE = (E1+E2) + (E3+E4)

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 Deficit

Total Expenditure – Total Own Account

Receipts
= Borrowing

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 Revenue Deficit
RE- RR
=
Revenue Expenditure
= E1+E2

-
Revenue Receipts
= R1+R2
• Reflects the government ’s inability to meet its day to day
expenditure requirements out of its current income
• Indicates the dependence on borrowing or disinvestment for
meeting consumption requirement
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 Capital Account Deficit

=
Capital Account Expenditure
= E3+E4

-
Own Capital Receipts
= R3+R4+R5
• Reflects that earnings on capital account are not sufficient to meet the
investment requirements
• Indicates the dependence on borrowing for meeting capital
requirement
•Not of a great worry - adds to the productive capacity & self sustaining
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 Fiscal Deficit
Broader Concept of Deficit
Revenue Expenditure + Capital Expenditure
= (E1+E2) +(E3+E4)

-
Revenue Receipts + Own Capital Receipts
= R1+R2+R3+R4+R5
=
R6 = Revenue deficit + Capital account deficit = Borrowings

Captures the entire shortfall in the resource gap that is

expected to be financed by undertaking borrowing operations

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 Gross Primary Deficit
R6 – E1
=
Gross Fiscal Deficit

-
Interest Payments

Indicates the extent to which current fiscal

operations affect the indebtedness of the government
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 Deficit Indicators: A Summary

• Different indicators reflect different dimensions

of government financing pattern and its impact
on the economy
• Revenue deficit: How far capital receipts
utilized for current consumption
• Fiscal deficit: total burden on the economy
• Primary deficit: Reflects current fiscal stance
• Monetized deficit: Reflects impact of govt.
deficit on money supply & inflation
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Financing of Fiscal Deficit

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 Sources of Financing Deficit: Pros & Cons

Borrowing from • Known as monetized deficit

the Central Bank • Generates additional resources
• Boosts up economic growth
• In the presence of capacity constraint - Inflationary

Borrowing from • Helps in mobilizing idle resources

Domestic Markets • In the presence of resource constraints:
- Increases interest rate
- Drives out more efficient private investment
- Growth retarding

Borrowing from • Provides additional resources for a country

• Increased inflow of foreign currency appreciate Rs,
External Sources –Makes imports cheaper and increases trade deficit
• In the long run – may drain out the resources
-In the form of debt servicing
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Source: Budget 2021-22
 Trends in Fiscal and Revenue Deficits
• India has not only substantial fiscal deficit but also
revenue deficit

• Persistent revenue deficit reflects deteriorating quality

of government expenditure. It adversely affects the
productive capacity of the economy

• FRBM makes it mandatory for the government to

bring down the fiscal deficit to below 3% of the GDP
and revenue deficit to zero in the long run

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Trends in Deficit of the Central Government in the Pre-
FRBM Period (pre 2002 period)

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What is Needed to Improve Fiscal Strength?
• Persistence fiscal deficit above the laid out norm
of 3 % of GDP implies that the fiscal deficit is not
only an outcome of cyclical fluctuations but also
large part of it is structural in nature. Thus, to
obtain satisfactory level of deficit, structural
reforms are needed.
• The large deviation between FD and PD indicates
large portion of deficit is on account of interest
payment. Contraction in FD thus is possible only
by bringing in reduction in other items of
expenditure.
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What is Needed to Improve Fiscal Strength?
• Revenue deficit is persistently greater than the
zero or surplus value.

• As revenue expenditure is unproductive in nature,

i.e., it does not result in build up of additional
production capacity, the revenue deficit should be
reduced. The reduction in the fiscal deficit should
be brought about by reducing revenue account
deficit.

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 Major Administrative Reforms Carried
Out in India
Administrative Reforms
Fiscal Responsibility Budget Management Act,
2003: makes the government to

•Bring down the fiscal deficit to below 3 % of

GDP over the long run

•Eliminate revenue deficit

•Achieve surplus on primary balance 18

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 Institutional Reforms for Fiscal Consolidation

Requirements of the FRBM Act 2003 and FRBM Rules

2004 (as amended through the Finance Act 2004)
Requirement Enactment date
Revenue deficit
Date for elimination 31/3/2009
Minimum annual gain (reduction) 0.5 % of GDP
Fiscal deficit to GDP
Ceiling 3% by 31/3/2009
Minimum annual gain (reduction) 0.3 % of GDP
Contingent liabilities (maximum annual 0.5% of GDP in any financial
issuance) year
Total additional liabilities (including 9% of GDP in 2004-05, In each
external debt at current exchange rate)
Annual reduction 1% of GDP
RBI primary market purchases of GOI Cease on 1/4/2006
bonds
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 Institutional Reforms for Fiscal Consolidation

Fiscal Responsibility and Budget Management

• Introduced to place institutional mechanism to strengthen fiscal discipline
• Stresses on inter-generational equity in fiscal management and long term
macroeconomic stability
• Aims to shift in the composition of total expenditure in favour of capital
expenditure
• Enhances transparency in the fiscal operations

• Several amendments were made to the Bill.

• The latest amendment was in 2015

• FRBM ACT Amendments, 2015

– The govt. should prepare Medium Term Expenditure Framework: Set three
year rolling target for fiscal deficit, revenue deficit, and effective revenue
deficit.
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 Institutional Reforms for Fiscal Consolidation

Trends in Deficit of the Central Government in the Post-

FRBM Period

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Medium Term Fiscal Policy Statements: Rolling
Targets as a Per cent of GDP

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Central Govt’s Fiscal Performance

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Gross Fiscal Deficit of Central Government (% of GDP)

Source: Economic Survey, 2017-18

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Trend in Government Deficit as a Percent of GDP

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Source: Budget Documents, 2021-22