FISCAL IMBALANCE

INDIAN ECONOMY: ASSIGNMENT

FAJRUL IHSAN P V
IMA ECONOMICS
THIRD YEAR
I170313
 OBJECTIVE
The major objective of the assignment is to
findout what is fiscal imbalance and its impacts on
different aspects of economy.Fiscal imbalance has
far reaching impact on various parts of the
economy. It arises due to the imbalace in the
revenue and expenditure of the governments. So
we are trying to analyse how the fiscal imbalace
arises and its consequences on various segments
in a detail way. And finally to findout how fiscal
imbalance could be solved
What is fiscal imbalance
Fiscal imbalance refers to a situation where all of
the future debt obligations of a government are
different from the future income streams. 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. Fiscal imbalances can occur for a
government at any given time. If there is a
sustained positive fiscal imbalance, then tax
revenues will likely increase in the future, causing
current and future household consumption to fall.

When do fiscal imbalance arises

tsThere are two main types of fiscal imbalance. 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. Horizontal fiscal imbalances
require equalization transfers, or payments to a
state or province from the federal government to
offset monetary imbalances between different
parts of the country. A vertical fiscal imbalance is a
structural issue and requires revenue and
expenditure responsibilities to be reassigned.
A horizontal fiscal imbalance occurs when sub-
national governments do not have the same
capabilities in terms of raising funds from their tax
bases and to provide certain services. This type of
fiscal imbalance creates differences in net fiscal
benefits, which are a combination of levels
of taxation and public services. These benefits are
also the root cause of horizontal fiscal differences
that eventually require equalization payment.

Fiscal imbalance in India

Fiscal transfers from the centre to states are
critical in India. Unlike in many developed
federations when the tax base differentials are not
very significant, India has large and growing
horizontal fiscal imbalances besides a high degree
of vertical imbalances arising from the assignment
of tax powers and expenditure responsibilities in
the Constitution, said a document submitted to the
Niti Aayog.

“Design and implementation of general and

specific purpose transfers is critical in Indian
federation from the viewpoint of not only ensuring
horizontal equity, balanced regional development
and overall stability and integrity of the federation.
This becomes even more important when the fact
that there are significant hindrances to mobility of
population and therefore, it is necessary to take
capital to the people and not wait for the people to
move towards capital,” said the document - Central
transfers to states in India rewarding performance
while ensuring equity.

The study was sponsored with financial support of

NITI Aayog and conducted by National Institute of
Public Finance and Policy, New Delhi.
Consequences of fiscal imbalance[an
example]
The Greek debt crisis had its origins in the fiscal
profligacy, or wasteful and excessive expenditure,
of previous governments. After Greece joined the
European Community in 1981, its economy and
finances were in good shape, but its financial
situation deteriorated dramatically over the next 30
years. The populist Panhellenic Socialist
Movement (PASOK) alternated in power with the
New Democracy Party. In a continuing bid to keep
their voters happy, both parties enacted liberal
welfare policies that created an inefficient
economy. As a result of low productivity, eroding
competitiveness and rampant tax evasion, the
government resorted to a massive debt binge to
keep the party going.
Greece's admission into the Eurozone in 2001 and
its adoption of the euro made it much more easier
for the government to borrow. Greek bond yields
and interest rates declined sharply as they
converged with those of strong European
Union members like Germany. As a result, the
Greek economy boomed, with real GDP growth
averaged 3.9 percent per year between 2001 and
2008.
However, the financial crisis of 2008-2009 caused
investors and creditors to focus on the
massive sovereign debt loads of the U.S. and
Europe. With default a real possibility investors
began demanding much higher yields for
sovereign debt issued by Greece as compensation
for this added risk. As Greece's economy
contracted in the aftermath of the crisis, its debt-to-
GDP ratio skyrocketed.

Measures to overcome fiscal

imbalance in india
A. Reduce government expenditure
1. Reduce interest burden
2. Reducing subsidies
3. Reduction in government overheads
4. Closure of sick units
B. Raise government funds
1. Collection of user charges
2. Improving perfomance of PSU s
3. Proper mobilisation of tax resourses
4. Market oriented development