Fiscal Responsibility and Budget Management

FISCAL RESPONSIBILITY AND
BUDGET MANAGEMENT
Certificate Course in Indirect Tax

Presented by
CA Paras Savla
On
19 August 2012

19/08/2012

BACKGROUND
Deficit Budgeting

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FISCAL RESPONSIBILITY & BUDGET MANAGEMENT

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KEYNESIAN ECONOMICS

The ideas of One of most influential British economist of the twentieth
century John Maynard Keynes (1883–1946).
The principal feature of Keynesian economics is its advocacy of government
deficit spending to stimulate economic growth.

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SOURCE CODE – DEFICIT
BUDGET

The General Theory of Employment, Interest and Money
published by Keynes in 1936.
It argued in the favour of budget deficits and increases
in the money supply to restore economic growth.
The prevailing view among both economists and
politicians of the time was that government budgets
should be balanced and that the money supply should
be tied to the gold standard.
Keynes believed that workers would never allow wage
rates to fall enough to eliminate unemployment. He
thus favored inflationary policies that would cause the
real level of wages to fall even though nominal rates
remained unchanged.

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SPREAD OF KEYNESIAN POLICIES

After the World War II Keynesian policies became the foundation of both
economic theory and economic policy in all Western nations.
The United States, for example, codified Keynesian economics in the
Employment Act of 1946, which obliged the government to utilize Keynesian
policies to sustain full employment.
By the 1960s, Keynesian economics dominated economic policymaking in the
U.S. The Kennedy tax cut of 1964 was explicitly based on Keynesian
economics and by 1971 even President Richard Nixon confessed to being a
Keynesian. However, the development of rapid inflation and slow growth in
the 1970s, combined with rising budget deficits, severely eroded the credibility
of Keynesian policies.

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CRITICS OF KEYNESIAN
ECONOMICS

Professor Milton Friedman of the University of Chicago, had
always viewed it as dangerously inflationary. The stagflation of
the 1970s appeared to confirm this view.
Professor Martin Feldstein of Harvard, expressed concerned
about the growth of budget deficits and began to view them as a
drag on the economy.
Austrian economist Friedrich Hayek criticized policies for what
he called their fundamentally "collectivist" approach, arguing
that such theories encourage centralized planning, which leads to
malinvestment of capital, which is the cause of business cycles
By the 1980s, most economists had already turned away from
Keynesian economics, although many of its doctrines continue
to be embedded in economics textbooks.
The advent of the global financial crisis in 2008 has caused a
resurgence in Keynesian thought.

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INTERNATIONAL SCENARIO
Post Keynesian

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GRAMM–RUDMAN–HOLLINGS
BALANCED BUDGET ACT

The Gramm-Rudman-Hollings Balanced Budget and
Emergency Deficit Control Act of 1985

The Acts were aimed at cutting the budget deficit, which
at the time was the largest in history. They provided for
automatic spending cuts (called "sequesters") if the deficit
exceeded a set of fixed deficit targets.
The process for determining the amount of the automatic
cuts was found unconstitutional in the case of Bowsher v.
Synar, 478 U.S. 714 (1986).

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SERIES OF LAWS TO CONTROL
DEFICIT

Budget and Emergency Deficit Control Reaffirmation Act of 1987; The
Budget Enforcement Act of 1990
The Act created two new budget control processes: a set of caps on annually-
appropriated spending, and a "pay-as-you-go" or "PAYGO" process for
entitlements and taxes. But the law departed from the fixed deficit targets of
Gramm-Rudman-Hollings.

Pay-As-You-Go Act of 2010
Like the BEA, new law brought back the requirement that the Administration
send up a Constitutionally valid sequester order to Congress if Congress
increases mandatory spending or decreases taxes in a way that, on net,
increases the deficit. However, this law was lacking in Gramm-Rudman's
discretionary spending caps, and so was considerably less powerful as a check
on appropriated discretionary spending.
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INCREASE SPENDING'S

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STABILITY AND GROWTH PACT

The Stability and Growth Pact (SGP) is an agreement, among the 27
Member states of the European Union, to facilitate and maintain the stability
of the Economic and Monetary Union.
The pact was adopted in 1997 so that fiscal discipline would be maintained
and enforced in the EMU. Member states adopting the euro have to meet the
Maastricht convergence criteria, and the SGP ensures that they continue to
observe them.

The actual criteria that member states must respect
are: an annual budget deficit no higher than 3% of
GDP (this includes the sum of all public budgets, including
municipalities, regions, etc.) and a national debt lower than
60% of GDP or approaching that value

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EU RECENT SCENARIO

The Pact has proved to be unenforceable against big countries
such as France and Germany, which were its strongest promoters
when it was created. These countries have run "excessive"
deficits under the Pact definition for some years. The reasons
that larger countries have not been punished include their
influence and large number of votes on the Council of Ministers.
In March 2005, the EU Council, under the pressure of France
and Germany, relaxed the rules.
In March 2011, following the 2010 European sovereign debt
crisis, the EU member states adopted a new reform under the
Open Method of Coordination, aiming at straightening the rules
e.g. by adopting an automatic procedure for imposing of
penalties in case of breaches of either the deficit or the debt
rules.

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INDIAN SCENARIO

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FISCAL MANAGEMENT

Considering the deplorable financial condition of India, 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 (Rs 12,000 billion) and Rs 1,000 billion of
liabilities 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 2000 which
subsequently went on to become the Fiscal Responsibility and Budget Management
Act, 2003.

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FRBM ACT OBJECTIVE

An Act to provide for the responsibility of the Central Government to ensure
inter-generational equity in fiscal management and long-term macro-economic
stability by achieving sufficient revenue surplus and removing fiscal
impediments in the effective conduct of monetary policy and prudential debt
management consistent with fiscal sustainability through limits on the Central
Government borrowings, debt and deficits, greater transparency in fiscal
operations of the Central Government and conducting fiscal policy in a
medium-term framework and for matters connected therewith or incidental
thereto.

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FEW CONCEPTS

Fiscal deficit - the excess of total disbursements, from the Consolidated
Fund of India excluding repayment of debt, over total receipts into the Fund
(excluding the debt receipts), during a financial year.
Revenue deficit - the difference between revenue expenditure and revenue
receipts which indicates increase in liabilities of the Central Government
without corresponding increase in assets of Government.
Fiscal indicators - the measures such as numerical ceilings and proportions
to gross domestic product, as may be prescribed, for evaluation of the fiscal
position of the Central Government.

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POLICY STATEMENT TO BE LAID
BEFORE PARLIAMENT

The Central Government shall lay in each financial year before both Houses
of Parliament the following statements of fiscal policy along with the annual
financial statement and demands for grants
(a) Medium-term Fiscal Policy Statement
(h) Fiscal Policy Strategy Statement;
(c) Macro-economic Framework Statement
(d) Medium-term Expenditure Framework Statement

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MEDIUM-TERM FISCAL
STATEMENT

It shall set forth a three-year rolling target for prescribed fiscal indicators with
specification of underlying assumptions and shall include
• the assessment of sustainability relating to the balance between revenue
receipts and
• revenue expenditures and the use of capital receipts including market
borrowings for generating productive assets.

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FISCAL POLICY STRATEGY
STATEMENT

The policies of the Central Government for the ensuing financial year relating
to taxation, expenditure. market borrowings and other liabilities, lending and
investments, pricing of administered goods and services, securities and
description of other activities such as underwriting and guarantees which have
potential budgetary implications.
The strategic priorities of the Central Government for the ensuing financial
year in the fiscal area.
The key fiscal measures and rationale for any major deviation in fiscal
measures pertaining to taxation, subsidy, expenditure, administered pricing and
borrowings.
An evaluation as to how the current policies of the Central Government are in
conformity with the fiscal management principles and the objectives set out in
the Medium-term Fiscal Policy Statement

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MACRO-ECONOMIC FRAMEWORK
STATEMENT

It shall contain an-assessment of the growth prospects of the economy with
specification of underlying assumptions and shall contain
• the growth in the gross domestic product,
• the fiscal balance of the Union Government as reflected in the revenue
balance and gross fiscal balance and
• the external sector balance of the economy as reflected in the current
account balance of the balance of payments

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MEDIUM-TERM EXPENDITURE
FRAMEWORK STATEMENT

It set forth a three-year rolling target for prescribed expenditure indicators
with specification of underlying assumptions and risk involved, shall contain
• the expenditure commitment of major policy changes involving new
service, new instruments of service, new schemes and programmes
• the explicit contingent liabilities, which are in the form of stipulated
annuity payments over a multi-year time-frame
• the detailed breakup of grants for creation of capital assets.
This statement is newly added in the family post amendment by the Finance
Act 2012. Hence first such statement would be published along with Fiance
Bill 2013.

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FISCAL MANAGEMENT
PRINCIPLES

To reduce fiscal deficit and revenue deficit -
• so as to eliminate revenue deficit by 31st March 2008, with a minimum
annual reduction by 0.5% of GDP and
• to reduce the fiscal deficit by an amount by at least 0.3% of the GDP, so
that fiscal deficit is less than 3 per cent of GDP by the end of 2008-2009
To limit guarantees to at most 0.5 per cent of the GDP in any financial year
To limit additional liabilities (including external debt at current exchange rate)
to 9% of GDP in 2004-05, 8% of GDP in 2005-2006, 7% of GDP in 2006-
2007.

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CURRENT SCENARIO

The targets were not achieved because the global credit crisis hit the markets
in 2008 and the government had to roll out a fiscal stimulus to revive the
economy and this increased the deficits.
In the 2011 budget, the finance minister said that the FRBM Act would be
modified and new targets would be fixed and flexibility will be built in to have
a cushion for unforeseen circumstances. According to the 13th Finance
Commission, fiscal deficit will be brought down to 3.5% in 2013-14. Likewise,
revenue deficit is expected to be cut to 2.1% in 2013-14.
In the 2012 Budget speech, the finance minister announced an amendment to
the FRBM Act. He also announced that instead of the FRBM targeting the
revenue deficit, the Government will now target the effective revenue deficit
by 31st March 2015 and reach revenue deficite of 2% of GDP by 31st March
2015.
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LIGHTER MOVEMENTS

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FISCAL INDICATORS – ROLLING
TARGETS AS PERCENTAGE OF GDP

S. Fiscal Indicators Revised Budgeted Target for
No. Estimates Estimated 2013-14 2014-15
2011-12 2012-13
Effective Revenue
1 Deficit 2.9 1.8 1 0
2 Revenue Deficit 4.4 3.4 2.8 2
3 Fiscal Deficit 5.9 5.1 4.5 3.9
4 Gross Tax Revenue 10.1 10.6 11.1 11.7
Total outstanding
liabilities at the end
5. of the year 45.7 45.5 44 41.9
6. Interest to Gross tax 42.9 41.5 39.0 35.9
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FISCAL ROAD MAP COMPARISON

2011-12 2012-13 2013-14 2014-15
Fiscal Deficit
MTFP 5.9 5.1 4.5 3.9
13th FC 4.8 4.2 3 3
Revenue Deficit
MTFP 4.4 3.4 2.8 2
13th FC 2.3 1.2 0 -0.5
Debt*
MTFP 45.7 45.5 44 41.9
13th FC 52.5 50.5 47.5 44.8
* Excluding NSSF Loans to States, Loans under MSS and accounting for external debt at current exchange rate.

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CRAFTY ACCOUNTING

Concept of “Effective Revenue Deficit” was introduced by amendment to
FRBM Act.
Effective Revenue Deficit is the difference between revenue deficit and
grants for creation of capital assets. This will help in reducing consumptive
component of revenue deficit and create space for increased capital spending.
In other words, capital expenditure will now be removed from the revenue
deficit and whatever remains (effective revenue deficit) will now be the new
goalpost of the fiscal consolidation eg non-plan expenditure to set up power
plant would not be called revenue deficit because it is towards maintaining a
capital asset.

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BORROWING FROM RBI

Prior to the FRBM Act, Central Government deficits were financed through
monetisation of deficits by the RBI (a process known as ‘Deficit Financing’).
The state governments have no such facility and their deficits had to be met
through borrowings from the central government.
The FRBM Act envisaged complete phase out of monetisation of deficits by
RBI from 2006. Central Government budgetary deficits were to be met
through market borrowings. State governments could borrow from market as
well. FRBM equivalents were proposed for state governments.
FRBM had imposed complete ban to borrow directly from the RBI. But
allowed temporary borrowing from RBI to meet excess of cash disbursement
over cash receipts during any financial year as per the agreed terms.

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BORROWING FROM RBI

RBI was allowed to subscribe to the primary issues of Central Government
Securities up to 31/3/2006. But RBI was allowed to buy and sell the Central
Government Securities in the secondary market.

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OBLIGATIONS

The Central Government shall take suitable measures to ensure greater
transparency in its fiscal operations in the public interest and minimise as far
as practicable, secrecy in the preparation of the annual financial statement and
demands for grants.
The Central Government shall, at the time of presentation of annual financial
statement and demands for grants, make prescribed disclosures and in
prescribed form

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REVIEW & CORRECTIVE
MEASURES

The Finance Minister shall review every quarter the trends in receipts and
expenditure in relation to the budget and place before both Houses of
Parliament the outcome of such reviews.
In case of shortfall in revenue or excess of expenditure over the pre-specified
levels mentioned in the Fiscal Policy Strategy Statement or the rules during
the financial year, the Central Government shall take appropriate measures for
increasing revenue or for reducing the expenditure including curtailing of the
sums authorised to be paid and applied from and out of the Consolidated
Fund of India under any Act so as to provide for the appropriation of such
sums.

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DEVIATION

No deviation in meeting the obligations cast on the Central Government under this
Act, is permissible without Parliament’s approval and in case of deviation due to
unforeseen circumstances Finance Minister shall explain in the Parliament
• deviation in meeting the obligations
• whether such deviation is substantial and relates to the actual or the potential
budgetary outcomes and
• the remedial measures proposed to be taken

Neither any penal provisions has been provided on occurrence of deviation nor any
review by independent authority has been provided. But FRBM Act as amended by
Finance Act 2012 provides that Central Government may entrust the Comptroller and
Auditor-General of India for periodically review and the compliance of the
provisions of the Act and such reviews shall be laid on the table of both Houses of
Parliament.
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MISCELLANEOUS PROVISIONS

Central Government is empower to make rules for carrying out provisions of
the Act
Rules so made shall be laid before each House of Parliament
No Civil court shall have jurisdiction to question the legality of any action
taken by, or any decision of. the Central Government, under this Act.
No suit, prosecution or other legal proceedings shall lie against the Central
Government or any officer of the Central Government for anything which is
in good faith done or intended to be done under the Act or the rules.

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LET’S DISCUSS

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19/08/2012

THANK YOU

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Fiscal Responsibility and Budget Management

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